borrowing/debt rather than by private equity.<sup>34</sup> The main difference is that the chances of consumers rather than taxpayers reimbursing the debt are higher and hence demand management easier to implement since the tariff will eventually reflect, at least some of, the cost of private debt. This trend has been encouraged by very low interest rates for some time now and has accelerated since the mid2000s, but makes the tariff quite sensitive to fluctuations in interest rates and inflation.

The third observation is that underpricing in a commercial sense is the main driver of the increasing debt stock needed to finance subsidies in the short run. Even if excess costs revealed by the efficiency studies mentioned earlier are also inflating the financing requirements of the sector, pricing continues to be an issue as it reduces the ability of the sector to finance its investment and operational needs. Underpricing of water by utilities when matched against their excess costs implies high quasi-fiscal deficits or QFD (i.e. the comparison of observed excess costs and revenue gaps with the costs and revenue that would be prevailing if the utilities were performing well). The African Infrastructure Country Diagnostic estimated in 2008 that QFD reached 0.6% on average in the region, based on a large sample of countries. This represents close to 50% of the financing needs of the region and underpricing accounted for almost 55 percent of this QFD.

The fourth observation is that the fiscal pressure in the sector may be an unexpected side-effect of the packaging of investment projects made to attract private operators. This packaging may indeed lead operators to “cream skim” the best investment opportunities, leaving the ones with low or negative returns to the public sector. This is because the packaging is usually done to minimize the dependence on public subsidies and, to do so, it needs to focus on regions or customers capable of ensuring the financial autonomy of the investors. This generally means that the high cost, low revenue activities are left with the public sector, which adds to the fiscal constraint since it lowers the margin to rely on cross-subsidies. This has the perverse effect of reducing the financial sustainability of the sector by contributing to a higher public debt financing requirement.

This is one of the underestimated consequences of project finance techniques focused on the deal, rather than on the sector in risky environments. It is also one of the main sources of difference in assessments of the sector-wide outcomes and of the project-specific transaction designs. More private financing may thus mean a higher fiscal cost for a given service coverage target. And this is in addition to the many instances in which project finance results in a renegotiation resulting in explicit or implicit subsidies. In sum, scarce public resources end up captured rather than allocated efficiently or fairly to address the needs of the poor or less attractive service areas.

> 34 Equity has in general been doing quite well in the sector. By mid-2014, the S&P Global Water index of 50 global companies involved in water related businesses had delivered a 10.4% annualized performance over 10 years. This includes regulated and unregulated water businesses.

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