Theme 6: Financing Irrigation

Launching date: 8 October 2001

Theme Coordinator: Mark Svendsen, Water Resources Consultant and IWMI Fellow.

Financing is both a key motive for governments to undertake IMT programs and a key determinant of the success and sustainability of the new management structures. Pressure on government budgets caused by insufficient revenue generation and bloated public irrigation bureaucracies often drives reforms aimed at transferring control to local organizations. At the same time, the ability of the new managers to generate revenue from the sale of their services will determine whether or not the new set-up can sustain itself. Listed below are four central questions relating to the financing of irrigation services which can serve as a basis for discussion in the forum. Following that are some thoughts on issues underlying the questions.

1. Should direct beneficiaries of irrigation investments (farmers, landowners) pay the full cost of providing irrigation service?
2. How can irrigation charging systems create positive incentives for:
1. effective service provision by the provider?
2. efficient use of water by irrigators?
3. sound investment decisions in constructing new irrigation systems and rehabilitating old ones?
3. How can fees be appropriately assessed and successfully collected from farmers receiving water from an irrigation service provider?
4. What realistic and workable mechanisms are available to insure competent and honest handling of WUA finances?

The topic of financing transferred irrigation schemes can be broken down into three components. These are (1) who should pay for irrigation, (2) what are charging systems for, and (3) how can financing systems be made fair, honest, and effective.

The first issue is broader than IMT per se and asks how much of the cost of irrigation system construction, operation, maintenance, and rehabilitation primary beneficiaries should be expected to pay. Primary beneficiaries here are taken to be the owners of land receiving water from an irrigation system and the farmers who work that land (Primary beneficiaries would also include those who use water from the irrigation system for purposes other than farming, such as local domestic use and stock watering).

The question reaches beyond IMT because it applies to any type of irrigation system and not just those that are locally-controlled. IMT simplifies the issue, however. The point is often made that farmers should not be asked to pay the excess costs generated by an inefficient government bureaucracy in managing irrigation systems. Where water users themselves are in charge of the system and control its costs, however, this caveat does not apply. Issues can be simplified further if we ignore the original capital investment and restrict our thinking and discussion to annual recurrent (O&M) and replacement costs. Important questions remain, however.

First, are farmers the only beneficiaries of an irrigation system? Sometimes the answer is given that irrigation also benefits agricultural processors by supplying them with raw materials and sellers of inputs, such as fertilizer and implements, by expanding their markets. These effects are real, but to make this argument effectively, one must explain how the purchase of irrigation service from a provider differs from the purchase of these other inputs – fertilizer, implements, seeds, threshing services, and so on. Most would agree that these other goods and services should be paid for at market prices. If there is no difference, shouldn’t farmers pay market (full) prices for irrigation services also?

Although the issue of secondary benefits related to forward and backward linkages with private sector firms seems fairly clear, issues related to secondary public goods remain. Such benefits as low (below market) urban food prices, the recreation benefits of irrigation reservoirs, and the "amenity value" of attractive green swaths of irrigated land may be legitimate candidates for public payments to irrigation service providers.

Second, are beneficiaries already paying something for irrigation service through existing taxes? An example is a land tax that places irrigated land in a higher rate category than un-irrigated land. A more important kind of taxation takes place when domestic prices for farmers’ production are held below world market prices by government trade, procurement, or exchange rate policies. This, in effect, taxes all farmers, with irrigating farmers paying more than others because their yields are typically higher. This has been the case in India, for example, throughout much of the post-independence period.

Third, can farmers afford to pay the full cost of irrigation? Where irrigated farm incomes are below a poverty line, it can be argued that farmers should not be asked to pay the full cost of the irrigation input. However, this raises distinct equity questions relating to farmers with different size holdings (should some pay and others not?) and with respect to rainfed farmers (who would not be in a position to receive any of this subsidy even though probably poorer than their irrigating neighbors). Other ways to provide poverty relief exist, such as targeted food subsidies. This, coupled with full cost charging for irrigation, would generally seem to be a more equitable alternative than basing water charges on politically-determined social criteria.

The issue of broader public subsidies to agriculture, through output price supports for example, is a complicating factor. Such subsidies may be the only thing keeping irrigated cereals production profitable for farmers (allowing them to pay irrigation fees) as is argued for the case of Mexico. When such broader subsidies are transparent and made for accepted public policy purposes, they become part of the environment in which irrigation systems operate and do not need special consideration. In the context of global market economics, one would expect national governments, over time, to implement policies that encouraged irrigators to shift production to higher value crops not requiring public subsidies.

There are four basic purposes for a charging systems for irrigation service: (1) to cover the costs of providing the service, (2) to provide incentives for careful water use and good service provision, (3) to allocate water to the highest priority uses, and (4) to encourage wise investment decisions. For pricing tools to be effective in each case, there has to exist a causal pathway that connects the welfare of individual decision-makers with the consequences of their decisions. For example, raising fees for irrigation service to full cost recovery levels will have no impact on individual decisions regarding water applications if the charging system is based on area irrigated. Likewise, setting the cost of water to cover service provision costs is pointless if the collection system is ineffective.

With respect to the first type of impact, cost recovery to pay for the service is generally a reasonable objective if costs are reasonable. Thus, as pointed out earlier, inflated costs due to bureaucratic inefficiency and corruption must be removed if full costs are to be passed to service clients. This suggests that cost recovery policies with this objective must be accompanied by steps to move irrigation agencies out of the public sector and to build into their structures incentives for efficient performance.

With respect to the second impact, to provide incentives for careful water use, it is necessary to establish a charging system that causes a water user to think carefully about the decision to apply water to her crops and to weigh marginal water use against its marginal cost. This implies some system of volumetric pricing, probably arranged in tiers. It is not necessary to assess the "full" cost of providing irrigation service to achieve this end. It is only necessary that the charge be related to the amount of water used and that the cost to the irrigator be "appreciable." This may actually lead to charges that are considerably higher than the cost of service provision. Chris Perry has shown this for the case of Egypt. On the other hand, where small-scale farmers operate very close to the margin, much lower fees may achieve the desired economies.

Where achieving an economically rational allocation of water across sectors is the aim, full cost pricing may be an appropriate tool, particularly in a developed economy with substantial factor mobility. However this is not a decision that most governments are willing to leave entirely to the market, especially where labor mobility is limited and where there are few or no other livelihood options available to the farmers so displaced. Here the social character of water asserts itself, and the risk to livelihoods of vulnerable groups must be included in the decision calculus over reallocation of existing water resources away from irrigation to uses promising a larger impact on the GDP.

The fourth aim, that of achieving a rational allocation of investment capital, would seem to call for passing full costs on to the beneficiaries of the investment. However, this too is a little more complicated than it may at first seem. Although water resource investments are occasionally made by private investors or direct beneficiaries, most often they are made by public agencies. Cost recovery policy may come into decision-makers’ thinking in this regard, but often it does not, since the investment decision is commonly related to a pressing political need or another public policy purposes, such as encouraging settlement or promoting regional economic growth. Investment decisions may also result from vested interests of bureaucracies seeking more projects and budgets. Where political pressure from potential beneficiaries is an important determinant of the investment decision, a stated and credible policy of investment cost recovery may be an effective incentive for rational public decision-making. Where beneficiary pressure and voice are not significant factors, it probably is not.

A clear public policy on responsibility for rehabilitation is an important component of a rational allocation of capital. Because of the potential trade-offs between deferred maintenance and rehabilitation, the absence of an expectation of cost sharing for rehabilitation will encourage irrigation associations to defer maintenance and shorten the return period for rehabilitation. A clear policy on this point is needed from the outset of an IMT program, a need often ignored. Also, because of this interaction, assessing the "financial sustainability" of a transferred irrigation system requires considering both the amount of funds flowing to O&M annually before and after transfer and also the condition of the system physical assets before and after transfer.

A related issue is that of property rights to irrigation infrastructure. Many governments are unable, for legal reasons, or reluctant, for other reasons, to transfer actual title to physical facilities to irrigation associations. "Ownership" is a bundle of property rights, including the right to use the asset and the right to sell or give it away. The most important element in this bundle is probably the use right. This right can be made secure either by transferring full "ownership", including the right to alienate (sell or give) the asset, or through a reliable agreement with the asset owner (the Government) for long term use. The latter probably provides sufficient assurance of long-term access, in most cases, assuming that the contract or concession is reliable and enforceable in the context of the national legal environment. Irrigation districts in the western United States have routinely operated on this basis for many years, maintaining and upgrading assets as required. Still, the relative merits of various mechanisms for providing secure access to physical irrigation assets needs further evidence.

The usual case in transferred irrigation systems is that fees covering at least operation and maintenance expenses must be collected from system users. There are variations. In Andhra Pradesh, for example, although fees are assessed by irrigator associations, an annual block grant for maintenance is provided to each IA by the State. Nevertheless, an important function of virtually every locally-managed system is the establishment of fee levels and the assessment and collection of fees.

The fairness of fee establishment and assessment depends on a number of things, including the competence of the system managers and, especially, the oversight and guidance provided by the governing body. The adequacy of the fees established depends on the time horizon of the governing body and the incentives they face. Their time horizon, in turn, depends on such things as the perceived security of land tenure, the perceived security of access to water, the profitability of agriculture, government policies and practices allocating financial responsibility for future rehabilitations, and whether they expect their children to follow them into farming. Together these factors can determine whether fees are assessed with an eye to next year’s irrigation only, or to the sustained operation of the system over the coming 5, 10 or 20 years.

Income received by the system depends, of course, not only on fee levels, but on the basis for the fees, i.e. water deliveries or area served, and actually making the collections. Collection efficiencies range from near 100% in many US irrigation districts, to 80 to 90% in Turkish irrigator associations, to much lower percentages in some other countries. Where collection rates are low, the solution clearly is not to raise the fee levels (penalizing those who do pay), but to increase collection efficiencies by collecting more from those who are not paying. To do this, both carrots and sticks are available ("incentives and "penalties").

The most basic requirement for effective fee collection is a sound administrative and record-keeping system. Land holding size and water use figures must be accurate and comprehensive. Bills must also be accurate and must be prepared and distributed in a timely way. Missed payment deadlines must be followed up quickly with additional requests for payment. Often the failure of government irrigation agencies to generate fee-based income results from their failure to collect competently rather than from a refusal of farmers to pay. Among the carrots available to system managers are discounts for prompt payment and praise and recognition for prompt payers (and for good collectors among the system staff).

"Sticks" should be a last resort. But the effectiveness of the carrots is to some extent dependent on the credible threat of a stick of some sort. In other words, irrigators will be much more likely to respond to incentives to pay if they believe that an unpleasant penalty will ultimately be imposed if they fail to pay. This has the effect of reducing the need to actually apply the penalties.

Penalties available to service providers vary. Most can impose financial penalties by increasing by some percentage the amount owed for service if payment is not received on time. All can expose late-payers or non-payers to social shame by publicizing names and arrears. Service pProviders, such as irrigation associations, can also cut off water to non-payers. However because of the severity of this measure and its impact on the farmers’ livelihoods, there is often considerable reluctance to apply it. Depending on their legal status and the measures available under the law, some service providers can may also apply sanctions through the court system, through such measures as seizing land (as has been is done in some places in the USA and Australia).

For irrigator groups inexperienced in managing finances and perhaps awed by the amounts of money being handled, financial management can be a major challenge. This challenge can take several forms. One is simply that of keeping up-to-date and accurate records of income and expenditures. Another is keeping physical track of cash generated from fee payments in small amounts at various locations by numerous irrigators and collected by different people. Yet another is the failure to reserve money for expenses expected to arise later in the financial year.

Training is one very important measure available for dealing with these challenges. Training in budgeting, financial management, and bookkeeping are all important. Training should be provided not only to the staff who perform these functions, but also to members of the management committee and to members of the governing body charged with oversight. Use of computer-based accounting programs can improve quality of recordkeeping.

Financial management also holds opportunities for theft and diversion of funds, as do processes of contracting and procurement. Neutralizing these opportunities depends on careful selection of staff, dedicated oversight, reducing temptation, and, above all, transparency. Having fees paid at a single location, or deposited directly into the association bank account has been used by some irrigator associations. Requiring the use of standardized accounting systems and formats and mandatory annual audits of account books by certified auditors are other basic steps. Finances should be monitored by an oversight committee of the governing body of the Association, the members of which have received training in financial management. Utilizing respected community members such as retired teachers or judges in this oversight role is another useful technique. All financial records should be open to examination by all members of the association as well. Ultimately, financial probity (honesty) depends on measures that make all financial transactions, internal or external, as transparent and open as possible.

Contact: imt-moderator@fao.org