Managing political risk through increased local participation : innovations in water sector PSP from Tirupur, India

Using primary data from an innovative water project in Tirupur, India with findings from two well-documented water projects in Latin America, this thesis asks: How might greater equity participation and decision-making authority among a broad base of users insulate against key political risks that have beset water sector private sector participation (PSP) in the past? I utilize concepts from the political risk literature, which have mainly been applied to the extractive and manufacturing industries, and extend this consideration to the water sector. I present preliminary findings, based on field research in India, that suggest increased local participation in water sector PSPs can mitigate against key political risks that have created problems elsewhere. These early findings challenge the conventional wisdom about water privatization and suggest a means to improve the design of future PSPs to reduce some of the risks and controversy that have characterized the sector. Thesis Supervisor: Lawrence Susskind Title: Ford Professor of Urban and Environmental Planning Thesis Reader: Balakrishnan Rajagopal Title: Ford International Assistant Professor of Law and Development ACKNOWLEDGEMENTS I wish to thank my thesis advisor Professor Lawrence Susskind for his critical feedback and help developing a framework for this paper. Thank you also to my thesis reader Professor Balakrishnan Rajagopal. I would also like to thank Professor Jennifer Davis for exposing me to the wonderful world of water and for her encouragement, even before I was a student at DUSP; Professor Karen Polenske, a great teacher and constant support; and Professor Alice Amsden and the Rodwin Fellowship which enabled me to pursue my research interests in India. I am indebted to many people in India that graciously made time to be interviewed and in other ways facilitated this thesis. I wish to thank Dr. Jha of Sulbh International for hosting me in New Delhi and Sameer Vyas and Sujatha of the NTADCL offices in Tamil Nadu. Most critically, the numerous and invaluable conversations with Hari Sankaran of IL&FS made this study possible; I am grateful for his assistance and support. I want to thank my two great roommates, Ella and Alex, always quick to laugh-even when I wasn't joking. My academic partners in crime: Carli, Evan, and Jill, thank you. And thanks also to Ariel and the thesis Wednesday crew. Thanks to my parents, Susan and Richard, and the rest of my family for their support, especially getting through the shock and awe of the first semester. And, of course, Kelsey, your advice and support at every step made all the differenceespecially towards the end when things got a little Conradian. Thanks for waiting. Chapter I: Introduction . 9 Chapter 11: Literature Review and Research Methodology . 13 Privatization . 13 Political Risk . 19 Research Methodology . 29 Case Summaries . 30 . Chapter 111: Case Analysis 37 Case Analyses and Political Risks in Context A: Cochabamba. Bolivia and Buenos Aires. Argentina . 37 . Public Opposition 37 Limited Regulatory Capacity . 41 Unstable Deal Structures . 46 Summary . 51 Case Analysis and Political Risks in Context B: Tirupur . India . 53 . Tirupur Project Background 53 . Tirupur Exporters' Association (TEA) 55 . Infrastructure Leasing and Financial Services (IL&FS) 57 Public Opposition . 59 Limited Regulatory Capacity . 64 Unstable Deal Structures . 65 Summary . 73 . Chapter IV: Conclusions and Recommendations 77 . Key Findings 79 Recommendations . 81 References . 91 Chapter I: Introduction The Problem The need for water and sanitation infrastructure in the developing world is staggering; an estimated one billion people lack access to adequate drinking water and two billion lack access to adequate sanitation (World Bank 2004; Izaguirre, Hahn et al. 2005; United Nations 2005). Annual infrastructure investment shortfalls are predicted to be in the hundreds of billions of US dollars and cash-strapped developing countries are simply unable to pay for these projects (World Bank 1997; Uitto and Biswas 2000; Kessides 2004). Compounding the problem are decades of poor maintenance (TWUWS 1996; World Bank 1997), low collection rates (World Bank 1997; Komives 1999; Yepes 1999), and competing budgetary priorities (Huber, Ruitenbeek et al. 1998; World Bank 2004), which have left many existing utilities in a downward service spiral and increasingly unable to meet the needs of growing populations (Uitto and Biswas 2000; Kessides 2004). In response to these continuing problems, development banks began to tap multinational corporations in the 1980s; they aimed to fill these infrastructure gaps across a variety of sectors in developing countries (World Bank 1997). Between 1990 and 2003, there were over 260 projects with some degree of private sector participation (PSP) in the water sector in 53 lowand middle-income countries, with total investments approaching $40 billion (World Bank 2005). Through government contracts, typically in the form of 20or 30-year leases or concession agreements, corporations contributed capital to build new facilities and/or maintain existing systems as well as take over fee collection and operations and maintenance (O&M). In exchange, private firms gained access to user fees and possibly additional government subsidies; most firms earn profit margins approaching 20% in order to make the investment worthwhile (World Bank 1997; Guasch 2004). Privatization of this type-generally with foreign capital and characterized by limited local ownership and decision-making authority-has been the dominant model for water privatization in the developing world for more than two decades (Pfefferman and Madanassy 1989; World Bank 1997; Guasch 2004; Kessides 2004; World Bank 2004) . ' Unfortunately, the conventional privatization model described above-in which local decision-making authorities cede control to foreign investors-does not appear to be working. Indeed, the same companies that were strongly in support of privatization are now backing out of some of the deals they made and are looking outside of the developing world for new business (RWE 2005; Suez 2005; Veolia 2005; Wells and Royere 2005; World Bank 2005). The primary explanation for this seems to be that political risks associated with these projects have not been dealt with effectively. By political risks I mean 1) Public opposition to the loss of local control and to the intrusion of outside corporate interests (Moran 1998; Komives 1999). 2) Inability to use the regulatory powers of government to ensure fair, efficient and well operating systems (Gomez-Ibafiez 2003; Kessides 2004; Newcornbe 2005), and, 3) Unstable deal structures where revenue projections were not realized and losses not anticipated (Kessides 2004; Wells and Royere 2005). Literature in the field of business and political risk management have described local ownership of infrastructure projects to be a critical key to project success (Wells Water privatization or water sector includes water and sanitation unless otherwise noted.