Concept Note on Cost Recovery in Indian Water Sector

Concept Note on Cost Recovery in Indian Water Sector

The concept note is developed under the "Blueprint for Water Accounting in India" initiative of India-EU Water Partnership programme. 

It is available online for your comments/ suggestions. 

Introduction to pricing instruments for water management

Economic theory claims that putting a price on water can signal where water is scarce, or abundant; urge water users to avoid wastage; allocate water where it creates most value; stimulate (private) investment when and where appropriate.

Water prices play two roles:

  1. signal scarcity; this is predominately the role of abstraction charges; and
  2. generate revenues to cover the costs associated with water management and the provision of water services; this is predominately the role of tariffs for water-related services such as water supply, irrigation, or sanitation. In practice, pricing becomes a contentious issue when property rights are not well-defined.

In the case of water, the issue is not so much about who owns the water – few countries would agree that water can be appropriated by private hands - but who has a right to use it and when. Unlike natural resources like minerals and fossil fuels, rights to use water vary across sources (surface and ground water) and spaces (riparian rights).

The public good nature of several services associated with water leads to market failure. In the absence of a market for rights to use water, it is difficult to set prices that reflect the value of water for users. Therefore, underpricing and improper pricing of water lead to inefficiencies both in production, conservation and allocation of water across sectors. 

There are several components of costing water – resource cost (costs of water development/ collection, treatment and supply/ distribution), environmental cost (costs associated with depletion and degradation of water), opportunity cost (costs associated with not allocating water for best alternative uses and across generations) and cost of resource recovery (cost of pollution abatement, water reclamation).

Similarly, several pricing instruments can be combined to cover these costs: tariffs for water supply and sanitation services are meant to recover resource cost; they apply to bulk water production as well; abstraction charges are designed to signal the opportunity cost of using water (they are higher when water is scarce or competition to access it is fierce); pollution charges make pollution costly and recover the cost for downstream or future users.

The relative dimensions of costs are inter-dependent and vary across space and time. For example, depletion or degradation of local sources of water (i.e. environmental costs) results in sourcing water from distant sources at higher cost of transportation and distribution (i.e. resource costs). Similarly, avoiding costs of pollution abatement may result in higher costs for water treatment. In addition, human right aspects associated with access to safe sources of drinking water often make it politically difficult to recover full cost of water services from all beneficiaries or for all services.

Moreover, uncertainties associated with projecting prospective revenue stream of investment in water services infrastructure often discourage private investors to make investment in these services. International experience shows that some countries charge for only resource cost while others charge for resource and recovery costs.

Even under resource cost pricing, not all costs are passed on to users or beneficiaries. There are instances when water is priced based on only operation and maintenance (O&M) costs whereas capital costs are borne by the government. Not charging for capital costs (or costs associated with interest payment on outstanding loan) erodes the fiscal space of the government and leads to lower allocation of resources for other public goods and services (e.g., education and health).

Underpricing or not charging full cost pricing of water leads to inefficiency in production and distribution, which in turn reduces productivity of water in terms of gross value addition. India’s total water productivity (as measured in terms of constant 2005 USD GDP per cubic meter of total freshwater withdrawal) is very low and it is even lower than in developing countries in SubSaharan Africa (Figure 1). It follows that pricing for water essentially is a development issue.

Where and when water is a limiting factor to growth, water pricing is essentially an economic issue: underpricing leads to lost opportunities for economic and social development, through wasting water that could have been available for valuable uses; misallocation of water to low value uses while more valuable uses are deprived of access; additional cost to treat polluted water before it can be used again, thus affecting productivity of agriculture or industries; etc. 

Read the full blog here.