Regulating Water PPPs in the People's Republic of China

Until the end of the 1970s, water and sanitation in the People's Republic of China was one of the county's most centrally planned sectors. But market reforms challenged this system's institutional and economic foundations, which held that water was a basic public need that should be provided for free. The reforms compromised the financing and provisioning mechanisms for free water. The country's water infrastructure came under further pressure from a rising urban population and rapid industrialization, leading to a growing inability to supply enough water and wastewater treatment during the 1980s and 1990s.

To tackle the rising demand for water services and to help finance new projects, the government opened the sector to private participation, introducing national schemes to attract foreign investment in the 1990s. One notable policy was the 21st Century Urban Water Management Pilot Scheme in 1997, which liberalized water tariffs for projects that attracted foreign capital and allowed foreign investors to receive attractive rates of return from water projects. The promulgation of the Urban Water Price Regulation in 1998 allowed local governments to set water tariffs to guarantee foreign investors a net return of 8%-10%. These measures were well received by investors and brought the first wave of water PPPs to the country (Table 10.2). Foreign water companies, including France's Suez SA and Germany's RWE AG, participated in 17 out of 42 PPP water and sanitation projects during 1994-2001.

Table 10.2: Water and Sanitation PPPs in the People's Republic of China, 1994-2017

PPP = public-private partnership.

Source: Author's calculation based on the World Bank's Private Participation in Infrastructure Database (accessed 25 March 2018).

These early PPPs were hit by controversies and growing pains. One problem was the guaranteed rates of return to foreign investors. Opponents claimed that offering preferential terms to foreigners was unfair to local companies. There were also complaints that government officials were overeager to secure PPP projects because career advancement was closely linked with the amount of foreign direct investment they attracted. Many water and sanitation PPP contracts at the time were seen as too generous to foreign partners. In 2002, the General Office of the State Council stepped in, issuing a circular scrapping guaranteed fixed returns to foreign investors and extending this provision to existing PPP contracts.

The sudden change of policy was a major setback for foreign investors in the sector, and 12 out of 32 projects that had reached financial closure during 1994-2000 were canceled. The government, however, remained committed to PPPs, and showed this by launching a campaign to promote these partnerships by removing several other constraints to foreign investment in water. The 2002 Foreign Investment Industrial Guidance Catalogue allowed foreign investors to build and operate water supply and drainage networks in medium- and large-sized municipalities. The 2004 Measures on Public Utilities Concession Management allowed foreign investors to bid for any urban water services contracts. As part of efforts to promote PPPs in the sector, Chinese banks could finance investments in water PPPs instead of relying on international financing, thereby allowing local companies to participate in the sector's PPPs.

Arguably, the most important policy initiative was the "rationalization" of water tariffs from 2002. The 2004 Circular on Accelerating the Reform of Water Prices, Promoting Water Savings, and Protecting Water Resources tackled the need to raise water tariffs to more realistic levels (Zhong, Mol, and Fu 2008). With strong support from the central government, authorities in many cities substantially raised their water tariffs, which increased from 75% to 100% from 2004 to 2006 in some large cities (Owen 2006). However, tariffs, were still not high enough to reach full cost recovery. Even so, the government, by steadily increasing tariffs across the country, clearly showed its commitment to making the sector commercially viable. And this unleashed a second wave of water PPP projects at a time when interest in this modality was declining elsewhere in the world. From 2001 to 2017, 467 PPP projects were undertaken in water and sanitation in the People's Republic of China, accounting for more than 50% of the total number of these projects globally.

This impressive growth, however, is being overshadowed by the long-term prospects for water and sanitation PPPs in the country because of institutional weaknesses. Credible regulatory mechanisms for these partnerships are still lacking. Different ministries and agencies are involved in regulation, including the Ministry of Housing and Urban-Rural Development, the Ministry of Water Resources, and the Ministry of Environmental Protection. All of them have overlapping roles and responsibilities. Despite having numerous regulatory agencies, there is a policy vacuum and technical capacity is weak in regulation, including in the critical areas of economic regulation and tariff setting. Local governments have complete discretion in setting water tariffs, but they are not well suited for the task. Because local governments essentially own local water companies, rejecting a tariff increase will directly affect their budgets, which must cover tariff losses. Municipalities also do not usually have the technical capacity to regulate their water companies or reconcile the many national regulations applying to water companies.

Public accountability has not been a notable feature of PPPs in water and sanitation in the People's Republic of China. The public hearing process, as the primary regulatory mechanism for tariff reviews, has not been effective in compensating for the regulatory gap. Several scandals have exposed water utilities for manipulating agendas and proceedings in public hearings to avoid confrontations with the public. Transparency in production costs is lacking, and the absence of proper benchmarking prevents users from participating in informed discussions on rate setting. Only very rarely have proposals for rate adjustments been rejected or revised because of opposition in a public hearing. Yet, the public is becoming increasingly wary of water tariff increases, and protests against rate hikes may become a major obstacle to tariff reform in the future.

The strong bias favoring projects that involve large private investments is another concern. As noted earlier, the performance of local government officials is often evaluated on their success in attracting investments. This risks overinvestment in greenfield projects, while arrangements that may be more appropriate for increasing network efficiency, such as improved management contracts or leases, can get neglected. This may be an important reason why nonrevenue water that has been produced but does not reach users remains high in many cities, despite massive investments into the sector.