The level is rising

There surely is demand for timely and quality delivery of water and there is no lack of funds to support the projects. What is missing is the framework that can ensure that interest of all the stakeholders are taken care of, writes Sushi Shyamal.
 
India is witnessing a sharp change in its demographic composition. Factors including rapid economic growth and migration of the rural population to urban areas is leading to a never before seen growth in urbanisation levels. Both government and independent analyses project colossal figures for the next decade. The level of urbanisation has been currently pegged at 28 per cent and it's predicted to rise to 41 per cent by 2021.
 
Water is a key pillar for any city's infrastructure and the rapid urbanisation has put tremendous pressure on it. Our cities are facing acute water shortage which is highlighted in a recent Asian Development Bank report. Spend on water related infrastructure is estimated to be Rs 7.5 lakh crore over the next 20 years and a major part of this would only go in quenching the pent up demand.
 
Cities running short of water
The water situation has gone from bad to worse over the last few decades. Unlike the other infrastructure sectors like roads, ports, power, aviation etc, water as a sector faces some unique challenges. The biggest of the challenge is the general belief of water being a free good and this coupled with the fact that it's a state subject makes it difficult to implement sweeping changes in the way water is being supplied to the end users. Over the last few years, municipalities have been trying to improve the water supply scenario by increasingly implementing Public Private Partnerships (PPP) models of various types.  However, it has not been a great performance till date. Most of the older concession agreements were lacking the structures to adequately ring fence the risks that a private concessioners would ideally like to avoid.  These are risks like assured intake water supply, collection of tariffs, etc. At the same time, financial health of the municipalities to honour the 20-25 year long concession agreement is questionable and it does not give a lot of comfort to the financing institutions.   
 
PPP models being tried out
Water PPP models are being tried out at both industrial and municipal levels. Industrial water treatment and supply projects are only possible at large industrial clusters or SEZs.  And these need to be backed by adequately secured take or pay contracts. Demand estimation is a major challenge in the case of bulk water supply projects and some projects have been facing trouble because of overestimated demand projections which turn out to be far from on ground reality. This problem can be addressed by having a take or pay contract and the same can be guaranteed by a government/quasi government agency.  Tirupur water treatment and supply project is an example where the estimated demand didn't fructify due to various macro and industry related issues and ultimately the financial viability of the project suffered. In another recent case, Hitachi and Hyflux have formed a joint venture (JV) to jointly develop a desalination plant and supply raw water to Dahej SEZ over a 30 year period. Industrial water PPP initiatives are far and few and will take some time to develop as we don't have a many large enough industrial clusters.  

However, what can be implemented now are municipal water PPP projects. The segments of water where various municipal PPP models have been tried are desalination, city water supply & distribution projects and sewage & waste treatment. In the case of city water supply projects, the problems stem from the fact that there is no on-ground infrastructure to ensure an efficient distribution system. And if the basic systems exist then the volume of water used by consumers is not being measured which leads to the problem of Non Revenue Water (NRW). Taking the example of metro cities in India, the NRW is at a high of 50-60 per cent. Because of the high NRWs even the operating cost of the city water supply is not being met. And when the entire city water supply requires an up gradation at a huge capital cost, the question arises as to who is going to bear the cost.  The PPP models proposed for city water supply includes capital contribution by both the private sector, government and also has a grant component. But, for the model to succeed, there has to be some cost recovery element build into concession agreement which can be gradually implemented by increasing the tariffs. The model will become self-sufficient in a few years time as there would be an annual increase in the water tariff and this will be coupled with the gradual reduction in NRW.  
 
Will privatisation of city water lead to increased cost to users?
There is a general consensus that with private players entering the city water supply and distribution business, the tariffs will increase manifold. But what has been observed is starkly different from the perception. The general population is not averse to pay slightly higher tariff for their water use. If the city water supply operator can assure quality and on-time delivery of water, then the population would be more than willing to accept this change. In most cities, a large population is getting water by way of tankers and the cost of receiving water supply through water tankers is at least Rs 1,500 per tanker. In Mumbai, residents are required to pay anywhere between Rs 2,000-5,000 for a water tanker carrying 10,000 litre of water. And the same 10 kilolitre water is provided by the Brihanmumbai Municipal Corporation (BMC) for around Rs 150. So, even if the rates go up, the population will still be able to get quality and assured supply at a cost which is less than the current landed cost for them. A look at the current residential water tariffs across some major cities reveals that the municipal water tariffs are at least 80-90 per cent less than the tanker rates. Hence, where is the question of rising water rates going to impact the population?   
 
Large concessions being awarded: Foreign players queuing up
Some of the recent concessions awarded have witnessed foreign utility players like Veolia and Suez tying up with regional players. This could be a good strategy for foreign players as water is a very local subject and there has to be a strong local player who can execute the project on time.  

Apart from these, other players like Ranhill, Manila Water, Biwater, Sembcorp, Hyflux etc, have been eyeing Indian water projects. Typically, the size of water projects in developed markets is very large, but the existing projects which are coming up in India are much smaller than that. Still, foreign players realise the long term potential of the Indian water market and are willing to deploy their technology and knowhow by partnering local companies who have good execution capabilities.
 
Water as an investment opportunity
Water as a utility offers large investment opportunities. Typical water projects are of large size and have a long gestation period. This is where long term patient investors like pension funds and insurance companies need to deploy their capital to have a diversified basket of safe and almost assured returns. Even for banks in India, it is a new sector and it could take them some time before they start understanding this sector and its associated risks. Under the current system, banks face problems in lending to these ultra long term projects as banks raise short term capital and hence cannot fund long term projects, which if they do would lead to serious asset liability mismatch. Hence, government should try to create an environment which facilitates the growth of infrastructure bond market. Globally, bond markets are 10-15 times bigger than the equities market, but in India for some reasons it is just not picking up. An ecosystem where all these multiple financing streams and instruments thrive is the need of the hour. The concessions awarded are becoming bigger in size and it's only a matter of time when SPV and platform level investments will start in this sector.   
Going forward, we will witness water platforms and holding companies emerge which will own stakes in multiple water PPP projects. The momentum that the water sector has gained is encouraging and hopefully we are witnessing the emergence of a new large asset class. Considering the size and scale of Indian economy, this sector has the potential to achieve colossal scale.   
 
Performance of Indian water players
The Indian water market is highly scattered and fragmented. Apart from a handful of players like VA Tech Wabag, Doshion, Ion Exchange, Thermax, etc most players have been struggling to scale up. Most of the Indian players lack the experience of developing long gestation water BOT projects. The Indian players grow by scaling up their EPC or component manufacturing business. But the risks that come with a large-scale PPP project is something very new to them. Hence, they are open to partner strategic foreign players to jointly bid for projects. It helps them to assess the projects better and also reduces the capital contribution for the project. Synergistically it makes great sense for a foreign player to partner Indian water EPC company. Herein, the Indian company gets access to capital, technology, and risk assessment skill sets and the foreign partner get local execution support.
 
A lot of private equity investment has already gone into the Indian water EPC/components segment and these are now ripe for exits which in most cases would be by way of secondary sale to large foreign companies. Hence, we could potentially be witnessing the next wave of inbound M&A in the Indian water space.
 
Globally a mixed performance
Globally, water has been a very difficult sector and the performance of different countries in the water sector has been a mixed bag. India appears to be on the right path as far as its water development programme is concerned. But it will require a cohesive and collaborative approach to ensure that the current euphoria that surrounds the sector does not fizzles out. Like other infrastructure sectors, in water sector too, a model concession agreement has to evolve. There surely is demand for timely and quality delivery of water and there is no lack of funds to support the projects. What is missing is the framework that can ensure that interest of all the stakeholders are taken care of.  The change has begun and hopefully water will reach its deserved level in India too.