central and eastern europe local government and housing
TRANSCRIPT
Central and Eastern Europe Local Government and Housing Privatization
Prepared for the Office of Housing and Urban Programs Agency for International Development
International Municipal
Programs
ICMA Consortium Report
Consortium Members
International CityCounty Management Association Urban Institute
Urban Land Institute National League of Cities
MUNICIPAL STRATEGIES FOR INFRASTRUCTURE INANCE PLANNED SEWAGE PROJECTS IN
Two BUDAPEST DISTRICTS
JUNE 1994
Prepared for the Office of Housing and Urban Programs US AGENCY FOR INTERNATIONAL DEVELOPMENT
Prepared by
Philip Rosenberg Katherine Mark
Juliana Pigey
The Urban Institute
and
The Metropolitan Research Institute
INTERNATIONAL CITYCOUNTY MANAGEMENT ASSOCIATION USAID Project No 180-0034
USAID Contract No EUR-0034-C-00-2034-00 Local Government and Housing Privatization
Request for Services 69
ABSTRACT
Two proposed sewerage investment projects in Budapest outer districts are analyzedin this -report with the aim of assessing present financing practices and possiblealternatives The principal conclusions are that there are more options available than are currently considered and that assistance in developing certain skills could be useful to local governments facing these new responsibilities
This review finds that existing capital improvements practices are woefullyinsufficient to meet current and future sewerage capital needs In addition to limited financial capacity inadequate intergovernmental coordination in a context of greatdiffusion of control among a range of government entities inhibits comprehensive capitalplanning programming and budgeting and there is no vehicle to resolve these differences Other problems arise in connection with project financing and once projectfunding is in place project management often appears to be inadequate
Areas proposed for USAID technical assistance to districts and the capitalgovernment include the assessment of current and alternative financial sources help in the development of a capital plan and budget costing and pricing enterprise management contract management and collaboration between the city and the districts
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EXECUTIVE SUMMARY
Two proposed municipal infrastructure projects are analyzed in this reportinvestments in the sewer systems for the R area of Budapest District XVII and for the Pestszentimre area of Budapest District XVIII The aim was to assess both presentpractices and possible alternatives for financing these two projects within the context of current local responsibilities and capabilities The principal conclusions are that there are more options available than are currently considered and that assistance indeveloping certain skills could be useful to local governments facing these new responsibilities
In Budapest which consists of a capital city government and 22 district governments responsibility for construction ownership and maintenance of publicinfrastructure has been splintered among several entities competingand local governments Due in part to the large responsibilities placed on the capital governmentand the insufficiency of funds to respond in the short and medium term to the mostpressing needs some districts have sought to mitigate the lack of action by initiating and financing projects which would normally be in the domain of the capital
Sewage pipes connect 87-88 percent of households in Budapest although this isheavily concentrated in the center Districts XVII and XVIll have among the lowest levels of sewerage coverage in Budapest Sewage treatment is below the adequate level with less than 20 percent biologically treated
This review finds that existing capital improvements practices are woefullyinsufficient to meet current and future sewerage capital needs There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including targeted subsidies provided by the central government contributions from the Capital and own source revenues (including allocations made through the annual local budget process sale or lease of district owned land and mid-term borrowing(defined as 2-3 years) from OTP) citizens contribute through the creation of construction communities or neighborhood associations and connection fees
In addition to limited financial capacity inadequate intergovernmental coordination in a context of great diffusion of control among a range of government entities inhibits comprehensive capital planning programming and budgeting and there is no vehicle toresolve these differences Two other problems arise in connection with project financing(1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actuallyneeded Once project funding is in place project management often appears to beinadequate It does not seem that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users The current delinquency rate of 8 is generally not acceptable
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and the
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livabihty of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is the provision of technical assistance that will help local officials make smarter sewer and general capital investment and management decisions Areas proposed for assistance include the assessment of current financial sources such as connection fees long term debt taxation including property tax) and user fees along with alternative financing methods such as the creation of tax increment or betterment districts
General capital financing technical assistance to both districts and Capital City should include assistance in the development of a capital plan and budget costing and pricing enterprise management contract management and collaboration between the city and the districts At the central government level assistance should be provided to revise the current system of targeted grants and to consider more effective means to assist in local infrastructure investment
MUNICIPAL STRATEGIES FOR INFRASTRUCTURE FINANCE PLANNED SEWAGE PROJECTS IN TWO BUDAPEST DISTRICTS
INTRODUCTION
The responsibility for construction and maintenance of municipal infrastructureincluding water management drainage of rainwater and sewage transferred towas Hungarian local governments in 1990 by the Act on Local Self-Government In orderfor these tasks to be effectively undertaken the assets of state economic organizationsproviding these public utilities were likewise transferred to local governments2 These are new and demanding responsibilities for local governments In the past decades there has been considerable neglect of infrastructure investment in Hungary moreover localfinancial resources are already severely strained Since 1993 USAID has begun toprovide assistance to Hungarian local governments i meeting the need to finance infrastructure development
Two proposed municipal infrastructure projects are analyzed in this report the sewer system for the Rdkosliget area of Budapest District XVII and the sewer system forthe Pestszentimre area of Budapest District XVIII The aim is to assess present practicesand possible alternatives for financing these two investments within the context of current local responsibilities and capabilities The principal conclusions are that there are more options available than are currently considered and that assistance in developing certain skills could be useful to local governments facing these newresponsibilities We start by examining the specific responsibilities of Budapest districtsthe municipality the public works and the central government Then we describe the two proposed sewage projects and current financing practices Finally we propose areas for assistance
Act No LXV of 1990 Article 8(1)
2 Ibid Article 107(l)(b)
For a description of the broad scope of USAID assistance in this sector see Dowall HegedosMark and Tosics Establishing a Franwworkfor MunicipalTechnicalAssstanceinInfrastructure 1993
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ENFRASTRUCTURE INVESTMENT RESPONSIBILITIES IN BUDAPEST
The city of Budapest comprises 23 local self-governments including the Capital Citygovernment (F6vdros) and the twenty-two districts According to Article 63 of the Act on local self-government the district governments of Budapest are mainly responsible for the provision of primary public services while the Capital government is responsible for tasks which affect the whole or a large part of the city
A separate law further defines the respective responsibilities of the Capital and of the districts4 Article 10 of this Act lists specific rights and duties of the capital citygovernment which includes provision of water gas and steam water regulation storm sewerage and channeling and the provision of potable water to the entire capital or its major portions Some of these duties may be transferred by the capital city to the district governments on two conditions that sufficient funds are provided for carrying out these services and that the district accepts this transfer5
In practice responsibility for construction ownership and maintenance of publicinfrastructure has been splintered among several entities and competing local governments This situation is further complicated by the ambiguity of legislative textsand by the transformation of the Budapest Sewerage Works (or FCSMI) which became a joint-stock company on 1 December 1993
As a res-it due in part to the large responsibilities placed on the capital government and the insufficiency of funds to respond in the short and medium term to the most pressing needs some districts have sought to mitigate the lack of action on the part of the capital by initiating and financing projects which would normally be in the domain of the capital
The fragmentation of responsibility for preparation of urban development and master plans between the capital and the districts may lead to conflicts in the realization of certain infrastructure projects The general assembly of the Capital formulates the urban development program and the general master plan for the capital city howeverthe views of the Government and of the districts must be solicited The basic plan for each district is determined by the district assembly in conformity with the generalmaster plan of the capital However the new Capital general master plan has not yetbeen finalized this fact has not deterred the districts from developing their own local development plans which may sometimes be in conflict with the general master plan8
4 Law XXIV of 1991 on the self-government of the capital city and of the capital city districts
5 Ibid Article 12
6 F6vdrosi Csatornmmzsi Mvek
7 Ibid Articles 8(4) and 11
8 According to the Budapest Department of Public Utility Works
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It is therefore difficult for the city to combat a possible Not in my backyard (NIMBY) mentality on the part of the districts as in the case of construction of a new sewerage treatment plant
In the case of the specific projects for Districts XVII and XVIII several actors are responsible for different phases of project planning financing construction and management These include the capital city the FCSM the districts neighborhood associations and construction communities and the Ministry of Transportation Communication and Water Management (MTCWM) The role of each of these actors is described below
THE BUDAPEST MUNICIPAL GOVERNMENT (FOVAROS)
The Capital City is responsible for formuiating development plans for the city For sewerage development a long-term plan through the year 2015 has been established However consultations were engaged with the Government the districts and the FCSM during the preparation of the plan For actual implementation an annual or a two-year development plan is prepared based on the stated objectives of the capital assembly Three current main priorities in the area of sewage are (1) increase in collection and carrying capacity of the sewerage main in North Pest (2) increase in capacity of the treatment plant in North Buda and (3) construction of a treatment plant in South Pest The investment projects of the districts in sewer networks generally have to be in conformity with the general development plan of the Capital City
District XVIIs sewage project is dependent on the achievement of priority 1 as the main collecting pipe from the district leads into the sewage main of North Pest District XVIIIs project is linked to construction of the South Pest treatment plant (priority 3) once the district networks have been built they may not be put into operation until completion of the treatment plant
The capital finances the construction of main sewerage lines treatment plants collection and pumping stations these projects involve new facilities and mains or the increase in capacity of existing plants The actual technical plans are prepared by the FCSM reviewed by the public utility works department of the Capital City and prescnted to the genera assembly
Project preparation in the capital follows the prescription of a decree passed in 19929 Requirements include the submission of a detailed plan the Assemblyto including cost estimates but no financing plan The General Assembly must vote approval on all projects over a cost of HUF 50 million The financial plans for the realization of the capital city projects may include the following resources targeted subsidies funds from the general capital city budget contributions from the districts
9 Decree No 121992
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loans participation by the FCSM and contributions from the beneficiaries (businesseshouseholds) In only one case has the city taken out a specific project-related loan-from EBRD for a sewage treatment center
For 1993 the sewer fee included a portion dedicated specifically to the financingof new investments (HUF 470m 3 ) This was the first time that a part of the fee has been specifically assigned to the financing of new investment This development portion of the fee was only in place for 1993 and was not renewed for 1994 The proposals for the use of the development portion of the fee were made by the public utility works department
Until 1 January 1994 the sewer fee was set by the MTCWM based on a proposalof the city the technical aspects of the proposal are prepared by the FCSM and approvedby the general assembly of the capital The Capital City was authorized to determine the sewer fee for the first time this January although guidelines have been set by theMTCWM The initial technical proposal is prepared by the Finance Department of the FCSM Nevertheless the final say on the actual price rests with the general assembly of the Capital For the new fee options under consideration were to multiply the current fee by a price index for the sector (which would lead to an estimated 20 percent increase but would exclude any specific investment portion) or to include different developmentcosts in the fee The new fee (HUF 20 plus 10 percent value-added tax) was introduced in April 1994 although FCSM had recommended a tee of HUF 215 No part of the sewer fee is allocated to investments in the network undertaken by the districts The FCSM also plans to introduce a flat sewage fee of HUF 200-500 in areas not serviced at present to cover the cleaning of septic tanks
Actual construction of the projects is managed by the FCSM as the principal contractor Nevertheless the public utility works department of the Capital monitors the ongoing works approves bills submitted by the contractor and sub-contractors and authorizes payment to the FCSM (who pays the sub-contractors) Every six months a project report on use of funds and the advance of work is presented to the generalassembly If there are Impor ant cost overruns or construction delays then a change of scope of the project must be approved by the general assembly Once the project has been completed the equipment is turned over to the FCSM which is responsible for maintenance repairs rehabilitation and replacement
THE FCSM
The FCSM was previously a state-owned enterprise and was transferred to the ownership of the capital city according to the provisions of the Local Self-Government Act From 1 January 1992 the ownership rights of the sewerage network were transferred to the capital city The assets were managed by FCSM but it appears that no fee for lease of these assets was paid to the Capital City
From 1 December 1993 the FCSM was transformed into a joint-stock companywholly-owned by the capital city Before the transformation of the company the budget
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of the sewer works company was approved by the general assembly of the Capital In addition the Supervisory Board of 13 members was appointed by the general assemblyOn 1 December 1993 the FCSM was transformed into a joint-stock company wholly owned by the Capital city Under this structure the Supervisory Board of nine members-three from FCSM staff and six from the Assembly-will be responsible for approving the companys budget and al strategically important decisions
The assets relating to sewerage were the property of the Capital City but were transferred to the FCSM as of 1 December 1993 as part of the companys transformation First the assets were reassessed and their replacement value was determined to be HUF 70 billion a considerable increase from the HUF 20 billion previously estimated10 With the transformation these assets were transferred to the ownership of the joint-stock company
Any additional networks and additions to the system will also be transferred to the FCSM However according to provisions of the 1991 Accounting Act any network built privately is transferred at zero value thus preventing the company from taking any depreciation on the value of the stock
As a means of circumventing this problem the FCSM arranged to be assigned as both investor and builder However when targeted subsidies are used to finance part of the network such an arrangement becomes more difficult because the local government must be the investor
For sewer projects initiated by the districts the FCSM is responsible for reviewing the technical plans and giving an expert opinion before construction begins Upon completion of the equipment the FCSM will inspect the equipment for adherence to technical norms (such as pressure tests or camera inspections within the pipes) and will authorize operation of the network This authorization will depend on capacity of eidsting mains and treatment plants to handle a larger flow of effluent in the system Thus due to the saturation of the main pipes in North Pest new business and industrial connections will not be authorized until the capacity of this part of the network has been increased
The principal activity of the FCSM is the operation and maintenance of the sewerage system within the city of Budapest In addition reconstruction and rehabilitation of all existing pipes pumping stations and treatment plants are the responsibility of the company These activities (operation maintenance reconstruction) are financed through the sewage fee
o It is believed that the primary purpose of this revaluation was to Increase depreciation funds However the higher valuation may have an adverse effect on the prospects for privatization
I Based on a conversation with the Technical Department of the FCSM
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The fee is collected in part by the FCSM however a collecting company12 collectsft sfrom private homes and the Water Works Company collects fees from industrial users and rental housing Thus the FCSM only seems to directly collect the fees from individuals with water wells but who are connected to the sewer system This systemof collection often leads to delays of at least two months in receipt of fees the amount ofunpaid fees were estimated at HUF 500-600 million in June 1993 and in May 1994 at HUF 338 million of which HUF 240 million Is from residences Total receipts in 1993 were HUF 4-5 billion putting delinquencits at about 8 percent
THE DISTRICTS
De facto due to lack of funds in the face of so many pressing needs the districtshave been made responsible for the construction of the secondary sewerage network(pipes leading from homes and businesses to the main collecting pipes and the collection system) The connections leading from homes and businesses to the secondary network are financed by the beneficiaries but constructed by the districts
Once a district decides to undertake the construction of part of the sewer system a water authorization permit is required from the MTCWM An expert opinion on thetechnical plans must be solicited from the FCSM The district is responsible for raisingfunds for construction Sources of financing may include district own fundscontributions from the Capital City targeted grants grants from the national Water Development Fund contributions from the population and loans
The means of financing used for these projects often leads to inefficient use of resources as matching funds and grants must remain in the accounts until construction has actually commenced This is the case for both the districts and the Capital CityTargeted grants require matching funds from the district which must be kept in the local government account as proof that this requirement has been met If there are delays in the start of the project these funds are left unused instead of being appropriated for more immediate needs
In the same way contributions from the Capital City must be negotiated on a caseby case basis and success in obtaining them may depend on the extent to which theparticular project corresponds to the capital citys own priorities However if the districts do not commence work on the project in a timely manner the Capital City funds are alsolying unused in an account For this reason the Capital has placed conditions on projectconstruction start-up dates if these requirements are not respected the districts may
This company was recently privatized through an employee share purchasing program It collects all utilities and municipal housing rents In Budapest for a fee of 3 to 4 percent of collections Recentlythe electricity company ended the contract and makes Its own collections while th gas company hascontracted out to other private companies in certain districts although their collections fees are muchhigher The Collection Company is currently in the process of revising its contractual relationshipswith its clients
12
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lose the grant For example District XVII received a promise of a HUF 14 million grant for the Rkosliget sewer project on condition that construction commenced by 1 December 1993
Appropriate financial products are currently not available to local governments for financing long-term investments such as sewer networks 3 For the moment the districts do not have access to the sewer fee which would enable them to appropriate part of this user fee for the reimbursement of debt Thus districts have placed heavyreliance on up-front population contributions through neighborhood associations and construction communities to finance part of secondary networks (and sometimef- the main networks) in addition to direct household connections to the network ----se connection fees are the only user charge to which districts have access As there o legal restriction on the level of the connection fee the only consideration in settin e fee is affordability
The construction of the project is monitored by the district Once completed technical certification of the equipment is required by the FCSM (pumping test and verification of pipes with a camera) If the results of these verifications are unsatisfactory then the operation of the pipes will not be authorized by the FCSM 4 If the FCSM grants approval the entire network is transferred to the Sewer Works Company which is responsible for operation maintenance rehabilitation and replacement of the equipment
NEIGHBORHOOD ASSOCIATIONS AND CONSTRUCTION COMMUNITIES
Under the previous system in order fc - neighbor-ods and towns to obtain quicker connections to public utilities organizea forms G population participation were developed these methods of financing infrastructure have continued and may take the form of a neighborhood association or a construction community
Neighborhood associations (ktzmitdrsulds) for the financing of infrastructure network- are formed when at least 66 percent of the residents of a neighborhood agree to their creation membership is open to all residents and contributions to the cost of infrastructure investment is compulsory Membership entitles residents to receive five-to seven year loans from OTP with 70 percent of the interest subsidized by the central
13 See Hegedes Mark Pigey Municipal Lending in Hungary March 1993
This has posed a problem for District XVII in 1993 30 kilometers of pipes of 40 constructed failed the camera verification test however the contractors had already been paid before this verification The District is unable to pave the roads or put system into operation until the pipes are repaired to satisfactory condition
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government 5 Through these loans investment funds are available up front to the district and it is the OTP which takes the credit risk
The members of the association appoint a steering committee (or an executiveboard) which works with the district issues tenders and selects the contractor The amount of contributions by members is assessed by the committee and any remainingfunds available after construction may be redistributed to the residents The committee also defines the contributions of new members
Construction communities (6pit6kbzOss~g) are a more flexible form of populationparticipation as they are not legal entities and have no right to sign contracts in their own name The community elects an executive board this board will work with the local government during construction in terms of choosing a constructor monitoringrealization countersigning contracts and bills However the legal investor is the local government This form of construction is used in District XVII
A separate account is established for the investment and members of theconstruction community pay their contributions into the account as the work proceedsIndividuals may contract loans to finance their contribution but these are at market rates and not the subsidized loans available to members of neighborhood associations Thus the district takes a credit risk and there are cases where members have not been able to pay the full amount of their assessed participation
In interviews with Districts XVII and XVIII it has often been stated that households have reached the limits of their capacity to contribute to financing the sewage network This system of financing is not limited to capital investments in sewer networks but has also been used to finance other public utilities such as potable water gas connections and telephone lines
Although districts do receive a portion of the personal income tax (for which there is a specific distribution formula between the capital city and the districts and among the districts) the actual incomes of the district populations are not known with precisionIn order for the district governments to better Judge the capacity of their population tocontribute both now and in the future small surveys of the population of selected areas in the district may be useful Such surveys may help to establish the level of incomesand expenditures as well as assess a realistic burden for construction and developmentlees or local taxes
15 In January 1994 subsidies for direct household loans for utility connections were terminated making the neighborhood association loans the only remaining subsidy for utility connections
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MINISTRY OF TRANSPORTATION COMMUNICATION AND WATER MANAGEMENT (MTCWM)
The Ministry of Transportation Communication and Water Management must approve all projects in Hungary relating to water no sewerage project may go forward without first obtaining the water authorization permit from this Ministry
Until 1 January 1994 the Miniszry also played a role in setting the water and sewer tariffs According to the 1990 Act on Prices the fee must include the expenses of efficient operation and the profit required for efficient operation although no definition of efficiency or provisions for monitoring are included in the Act
The final allowed price was set by the Ministry based on tariffs proposed by the sewer company and the Capital City From the beginning of 1994 the pricing of sewer services has been completely devolved to the city of Budapest although the Ministry has set non-binding guidelines for fees
PROPOSED SEWAGE INVESTMENTS
SEWAGE DEVELOPMENT NEEDS IN DISTRICTS XVII AND XVIII
Citywide there are 4000 km of sewage pipes connecting approximately 88 percentof households in Budapest although this is heavily concentrated in the center so that
8outer districts have only about 50 to 60 percent coverage 1 Sewage treatment is below the adequate level FCSM estimates that 80 percent of sewage receives mechanical treatment but less than 20 percent is biologically treated
Districts XVII and XVIII have among the lowest levels of sewerage coverage in Budapest but according to the FCSM Investment Department District XVII is worse off because in District XVIII only one area (Pestszentimre) is badly underserviced Both district governments list sewerage as their most pressing infrastructure developmentneed and both have projects planned which they hope to address in the near future
District XVII
District XVII has a split sewage system-ie two separate subsystems for sewageand storm water collection-and has a big deficit in both systems The district has
1039a comprehensive sewage construction plan with an estimated total cost of HUF billion which has already been begun A first task to lay a network in Rakosliget and Rakoscsaba uJtelep has already been partially completed although some difficulties with the contractor left the laid pipes not ready for use The result was that the municipal sewer company (FCSM) refused to accept the pipes and the district has had to ask the city for a special grant of HUF 80 million 8 to complete the work and repave the roads under a new contract
The plan calls for three additional phases of construction the first part will be to construct sewerage in the most urgent areas (the district center and RAkoscsaba) the second is to complete a parallel principal main which is a precondition for expanding the network and the third is to connect some other areas to the system Phase I to construct about 30 kilometers in Rakoscsaba was begun in early 1994
Targeted subsidies have already been granted for the sewage projectHUF 285 million for 1993 and HUF 21 million for 1994 In both cases despite approvalthe district will receive funds one year later because of central budget limitations The local assembly also has approved the local portion of funding (30 percent of the originalcost estimate) which comes from the social normative grant but the schedule has to be
16 For the outer districts the 1992 flgures are 76-78 percent coverage (districts XV and l) 50-60 percent (XVIII MX and XXI) and 41-43 percent (XVII and XVI)
17 As is the case for most outer areas in Budapest
1s This grant was obtained in return for permission for the Capital City to use the districts landfill
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rethought One difficulty is that because they could not start construction before 1 December 1993 they forfeited the promised HUF 14 million from the City
In some ways storm water collection is a more urgent problem in the district and financially more problematic because no targeted subsidies are available and because it is impossible to charge the public directly for any portion of the development costs The district plans to build a series of ditches for storm water collecting water in one location but because these are open the Sewage Company will not operate them
The district assembly has approved sewerage construction plans but has not actually appropriated the money 9 so that the district has not been able to apply for some other available subsidies One such potential subsidy comes from the Water Management Fund which requires a permit from the water authority As the permit expires in two years the district will probably have to reapply because they may not be able to begin construction of the next phase within two years
One portion of the district contribution is paying the value-added tax portion of the connections (Until January 1993 this amount at 25 percent of cost would have been refunded by the central government) There is a preliminary agreement between the FCSM and the districts that starting 1 January 1994 the FCSM will pay the VAT and be reimbursed by the central government
Citizens contributions will have to make up a larger proportion than foreseen (probably 60 percent instead of 40 percent) A neighborhood association has already been formed in RiLkosllget two construction communities (one of over 700 households) have been formed for the Rakoscsaba work Conditions for households have changed considerably as of January 1994 because the 50 percent subsidies on utility connection loans are no longer available The district is therefore allowing those households unable to pay up front to pay in installments with no interest
Enterprises of course can be - arged higher connection fees and the district wants to use those to cross-subsidize household connections The district Public Utilities Division believes enterprises could be charged up to HUF 1 billion for the sewage development contribution plus HUF 80 million for the actual connection
District XVII has no outstanding loans nor do they levy any local taxes at present They do not have committees or a project preparation unit set up to work on cost of projects instead the technical department alone has put this project together There will be some political difficulties in getting this project approved because those in housing estates which are already connected to the sewage system and who represent the bulk
Not all assembly representatives heartily endorse the plan moreover the assembly did not think the central government would grant the targeted subsidy
20 This may be a problem at some point as when capacity problems exist the FCSM has indicated that it may grant permits for connection only to households and not to enterprises
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of the voting power will be opposed to the expenditure This same argument was used to explain why the council would be opposed to incurring debt although it is possiblethat debt could be structured to be repaid by the benefiting area only
The district does not have solid data on incomes but there is a general sense that probably only 20 percent of households can afford the sewage connection at HUF 30000shy40000 those who cannot would have to be subsidized by the local government byreceiving interest-free loans
DistrictXV37
District XVIII has almost the lowest per capita income in Budapest (it ranks 18th among the 22 districts) it is fourth in area seventh in population and only district XVII has less sewerage coverage according to the Deputy Mayor
Pestszentimre a neighborhood of mostly single-family houses containing about one quarter of district households (a population of 25000 in a district of 98000) is the area most urgently needing sewerage development The cost for this development is estimated at between HUF 12 and 16 billion Four storage tanks that pump sewage into the main system will have to be built The current plan is to begin construction in 1996 the schedule has been pushed back mostly because of financial considerations Sewage is still very much a priority investment for the district
The district hopes to have 30 percent of the cost covered by district resources 30 percent by the Capital City and 40 percent by a targeted subsidy (because Budapestapplied for the subsidy with the district the subsidy is worth an extra 10 percent of estimated cost) A cooperation agreement was required but because Budapest did not sign it the district has not yet applied for the subsidy
The Southern Pest Treatment Center is at capacity now and the new sewerage will not be able to be connected until the Center is expanded District XVIII feels confident that the expansion will be undertaken next year so the technical problem will be solved Budapest would take a loan for this project apparently the City Council is in favor of the project Even though the Treatment Center has not yet been expanded the FCSM has given the district their permit to begin construction
The gas network was recently completed in the same area funded throughneighborhood associations work was completed in 1993 The connection fee of HUF 46000 per household will take three years to pay off so that payments will stop in 1995 Even so the connection fee alone did not cover the total cost which came to about HUF 150000-200000 per property
If a connection fee for sewerage is set too high district officials are afraid somehouseholds may elect not to connect at all If more than 60 percent of households want to connect the district will begin construction but they risk having some households subsequently decide not to connect and withdraw their contributions District officials
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expect the connection fee to be HUF 60000-65000 the District will pay an additional HUF 15000 fee per household to cover the cost of preparing the technical construction plans
The Deputy Mayor assumes the district will have to take on debt and he believes the district would definitely approach various banks as OTP does not offer attractive terms A technical implementation report on the project has been prepared but it includes no work on financial returns
CURRENT SEWER INFRASTRUCTURE FINANCING PRACTICES
As described in the first section districts are responsible for the construction of sewer collection systems that once built are turned over to the Capital City Sewer Company for operation and maintenance The Capital City is responsible for construction of interceptor sewers and sewage treatment plants Once the infrastruc-ture is in place system stewardship is the responsibility of the Budapest Municipal Sewage Company (FCSM)
There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including
Central Government Targeted subsidies provided by the central government are used to finance construction of sewer collection systems Targeted subsides are matching grants given to districts on a competitive basis The level of funding provided by targeted subsides is 30 percent for sewer collection projects (40 percentif the application is made jointly by both the district and the Capital City) However the reliability of this revenue source to finance future sewer projects is subject to the priorities and conditions set by the Parliament as recommended by the Ministry of the Interior Therefore there is no assurance that targetedsubsidies can be used to finance sewer collection systems in the future2
1 It is noted that the central government provides addressed subsidies however sewer collection system financing is not an eligible use of such subsidies
Capital City The Capital City can contribute to the cost of district sewer construction projects However district projects mus conform to Capital City priorities to be considered for funding
21 For example in 1993 the amounts needed to fund all eligible projects exceed the grant monies budgeted by the central government so those projects are approved but local governments will receive funds two or three years from now
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District Own source revenues for sewer collection system construction and connections to properties in public ownership are derived from (1) allocations made through the annual local budget process derived from local taxes miscellaneous fees and intergovernmental transfers (eg normative subsidies) (2) sale or lease of district owned land and (3)mid-term borrowing (defined as 2-3 years) from OTP Loans are repaid from own source revenue in the form of proceeds from the sale or lease of district-owned land
Citizens Citizens contribute to the construction of sewer systems in two ways (1)through the creation of construction communities or neighborhood associations citizens pay a portion of the collection system construction cost and (2)connection fees
FINANCING OPTIONS
This is a period of intensive change in the ways in which the central governmentdistricts the Capital City and the recently privatized Budapest Municipal SewageCompany finance and maintain the municipal sewer system Existing capitalimprovements practices are woefully insufficient to meet current and future seweragecapital needs Reasons for this state of affairs include
Limited Financial Capacity
The lack of adequate own source revenue has a profound impact on limitingavailable funds necessary to finance sewage system expansion There is a great disparitybetween capital needs and the anticipated revenue available to meet these needs Sewer construction projects are very expensive Existing financing mechanisms are inadequate
Debt Financing Districts make limited use of debt financing When debt is issuedIt is for a 2 or 3 year period This short term debt financing places an undue burden on the districts limited financial resources and the present populationsability to amortize the debt The high cost of borrowing (27 percent interest) further exacerbates this problem as well as increasing the cost of capital development
Capital financing typically requires the issuance of long term debt (20 to 30 years)that roughly correlates to the useful life of the facility This method of financingalso is considered to be equitable to those who benefit from the system (egcitizens commerce industry) since each generation pays its fair share of the cost of the facility A long-life asset such as a sewer system should be paid for by its users throughout its normal life rather than all at once by those who may not have the use of it full term Even with higher cost due to interest if spread over a largenumber of userspayers the cost to all is lowered Given Hungarys high rate of inflation and thus ever increasing construction costs it may be cheaper to borrow and pay todays prices rather than wait and pay tomorrows prices Furthermorethe use of long term debt puts less financial pressure on the operating budget
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OperatingBudget (ie pay-as-you-go)There is some attempt to finance a portion of the cost of sewer improvements through the operating budget The operatingbudget is reliant on revenues derived from intergovernmental transfers and therefore provides very little fiscal flexibility to support capital development Furthermore there are no reserve accounts that may be used to set aside funds for future capital development or meet emergencies (It will be noted of course that with Hungarys high rate of inflation the reserve accounts will be rapidly eroded so it may be decided to keep them at a mintimum)
Typically the operating budget is not used to finance large scale capital projects such as sewer collection systems Annual appropriations tend to be used to pay for municipal operations and service Small scale projects equipment purchases and the repair of existing facilities may be funded through the operating budgetHowever the use of the operating budget to finance large capital projects should be frowned upon for the following reasons
It forces local officials to make extremely difficult choices between service
delivery government operations and capital expansion
It places a heavy burden on the budget for the project year
It creates awkward fluctuating expenditure cycles that do not occur with extended financing
Since funding is based on yearly increments the use of the operating budget helps foster an environment wherein projects often go uncompleted
Sale of Land Districts rely on the sale of land to raise revenue for infrastructure financing This raises several concerns First land is not liquid and its value is subject to market forces In a sagging market such as currently exists land priceshave eroded to the point where districts are unable to raise adequate capital through the sale of land to finance sewer construction Furthermore there are few entrepreneurs with adequate resources to buy land
A related issue is that the land being sold is not serviced by sewer and other infrastructure components The offering price most likely reflects the absence of infrastructure If the infrastructure were in place prior to the sale or lease of district-owned land the district would realize a greater return than it currently receives
Finally land is finite Districts should think carefully about diminishing this resource to finance capital investment particularly before the capital is in placeLater in this paper we describe financing mechanisms that should be considered as feasible alternatives Particular attention should be paid to the use of tax increment financing or other forms of betterment financing
Municipal Strategiesfor InfrastructureFinance The Urban InstmtePlanned Sewage Projectsin Two Budapest Districts Page 17
Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
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Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
MunicipalStrategiesfor InfrastructureFinance 7he UrbanInstitute PlannedSewage Projectsin Two BudapestDistlcts Page 20
ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
MunicipalStrategiesfor Infrastlcire Finance The Urban InstiutePlanned Sewage Projectsin Two BudapestDistrLts Page 21
projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
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Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
MunicipalStrategiesfor InfrastructureFinance The UrbanInstitutePlannedSewage Projectsin Tio BudapestDistricts Page23
plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
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FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
MunicipalStrategiesfor Infrastuctu-e Finance The UrbanInsttute PlannedSewage Projects in Two BudapestDistricts Page 26
ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
MUNICIPAL STRATEGIES FOR INFRASTRUCTURE INANCE PLANNED SEWAGE PROJECTS IN
Two BUDAPEST DISTRICTS
JUNE 1994
Prepared for the Office of Housing and Urban Programs US AGENCY FOR INTERNATIONAL DEVELOPMENT
Prepared by
Philip Rosenberg Katherine Mark
Juliana Pigey
The Urban Institute
and
The Metropolitan Research Institute
INTERNATIONAL CITYCOUNTY MANAGEMENT ASSOCIATION USAID Project No 180-0034
USAID Contract No EUR-0034-C-00-2034-00 Local Government and Housing Privatization
Request for Services 69
ABSTRACT
Two proposed sewerage investment projects in Budapest outer districts are analyzedin this -report with the aim of assessing present financing practices and possiblealternatives The principal conclusions are that there are more options available than are currently considered and that assistance in developing certain skills could be useful to local governments facing these new responsibilities
This review finds that existing capital improvements practices are woefullyinsufficient to meet current and future sewerage capital needs In addition to limited financial capacity inadequate intergovernmental coordination in a context of greatdiffusion of control among a range of government entities inhibits comprehensive capitalplanning programming and budgeting and there is no vehicle to resolve these differences Other problems arise in connection with project financing and once projectfunding is in place project management often appears to be inadequate
Areas proposed for USAID technical assistance to districts and the capitalgovernment include the assessment of current and alternative financial sources help in the development of a capital plan and budget costing and pricing enterprise management contract management and collaboration between the city and the districts
3
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EXECUTIVE SUMMARY
Two proposed municipal infrastructure projects are analyzed in this reportinvestments in the sewer systems for the R area of Budapest District XVII and for the Pestszentimre area of Budapest District XVIII The aim was to assess both presentpractices and possible alternatives for financing these two projects within the context of current local responsibilities and capabilities The principal conclusions are that there are more options available than are currently considered and that assistance indeveloping certain skills could be useful to local governments facing these new responsibilities
In Budapest which consists of a capital city government and 22 district governments responsibility for construction ownership and maintenance of publicinfrastructure has been splintered among several entities competingand local governments Due in part to the large responsibilities placed on the capital governmentand the insufficiency of funds to respond in the short and medium term to the mostpressing needs some districts have sought to mitigate the lack of action by initiating and financing projects which would normally be in the domain of the capital
Sewage pipes connect 87-88 percent of households in Budapest although this isheavily concentrated in the center Districts XVII and XVIll have among the lowest levels of sewerage coverage in Budapest Sewage treatment is below the adequate level with less than 20 percent biologically treated
This review finds that existing capital improvements practices are woefullyinsufficient to meet current and future sewerage capital needs There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including targeted subsidies provided by the central government contributions from the Capital and own source revenues (including allocations made through the annual local budget process sale or lease of district owned land and mid-term borrowing(defined as 2-3 years) from OTP) citizens contribute through the creation of construction communities or neighborhood associations and connection fees
In addition to limited financial capacity inadequate intergovernmental coordination in a context of great diffusion of control among a range of government entities inhibits comprehensive capital planning programming and budgeting and there is no vehicle toresolve these differences Two other problems arise in connection with project financing(1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actuallyneeded Once project funding is in place project management often appears to beinadequate It does not seem that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users The current delinquency rate of 8 is generally not acceptable
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and the
Munidpal Strategies for InfrastnuctureFinance- The UrbanInstitute PannedSewage Projectsin Two BudapestDtstrcts Pageft
livabihty of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is the provision of technical assistance that will help local officials make smarter sewer and general capital investment and management decisions Areas proposed for assistance include the assessment of current financial sources such as connection fees long term debt taxation including property tax) and user fees along with alternative financing methods such as the creation of tax increment or betterment districts
General capital financing technical assistance to both districts and Capital City should include assistance in the development of a capital plan and budget costing and pricing enterprise management contract management and collaboration between the city and the districts At the central government level assistance should be provided to revise the current system of targeted grants and to consider more effective means to assist in local infrastructure investment
MUNICIPAL STRATEGIES FOR INFRASTRUCTURE FINANCE PLANNED SEWAGE PROJECTS IN TWO BUDAPEST DISTRICTS
INTRODUCTION
The responsibility for construction and maintenance of municipal infrastructureincluding water management drainage of rainwater and sewage transferred towas Hungarian local governments in 1990 by the Act on Local Self-Government In orderfor these tasks to be effectively undertaken the assets of state economic organizationsproviding these public utilities were likewise transferred to local governments2 These are new and demanding responsibilities for local governments In the past decades there has been considerable neglect of infrastructure investment in Hungary moreover localfinancial resources are already severely strained Since 1993 USAID has begun toprovide assistance to Hungarian local governments i meeting the need to finance infrastructure development
Two proposed municipal infrastructure projects are analyzed in this report the sewer system for the Rdkosliget area of Budapest District XVII and the sewer system forthe Pestszentimre area of Budapest District XVIII The aim is to assess present practicesand possible alternatives for financing these two investments within the context of current local responsibilities and capabilities The principal conclusions are that there are more options available than are currently considered and that assistance in developing certain skills could be useful to local governments facing these newresponsibilities We start by examining the specific responsibilities of Budapest districtsthe municipality the public works and the central government Then we describe the two proposed sewage projects and current financing practices Finally we propose areas for assistance
Act No LXV of 1990 Article 8(1)
2 Ibid Article 107(l)(b)
For a description of the broad scope of USAID assistance in this sector see Dowall HegedosMark and Tosics Establishing a Franwworkfor MunicipalTechnicalAssstanceinInfrastructure 1993
-7
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ENFRASTRUCTURE INVESTMENT RESPONSIBILITIES IN BUDAPEST
The city of Budapest comprises 23 local self-governments including the Capital Citygovernment (F6vdros) and the twenty-two districts According to Article 63 of the Act on local self-government the district governments of Budapest are mainly responsible for the provision of primary public services while the Capital government is responsible for tasks which affect the whole or a large part of the city
A separate law further defines the respective responsibilities of the Capital and of the districts4 Article 10 of this Act lists specific rights and duties of the capital citygovernment which includes provision of water gas and steam water regulation storm sewerage and channeling and the provision of potable water to the entire capital or its major portions Some of these duties may be transferred by the capital city to the district governments on two conditions that sufficient funds are provided for carrying out these services and that the district accepts this transfer5
In practice responsibility for construction ownership and maintenance of publicinfrastructure has been splintered among several entities and competing local governments This situation is further complicated by the ambiguity of legislative textsand by the transformation of the Budapest Sewerage Works (or FCSMI) which became a joint-stock company on 1 December 1993
As a res-it due in part to the large responsibilities placed on the capital government and the insufficiency of funds to respond in the short and medium term to the most pressing needs some districts have sought to mitigate the lack of action on the part of the capital by initiating and financing projects which would normally be in the domain of the capital
The fragmentation of responsibility for preparation of urban development and master plans between the capital and the districts may lead to conflicts in the realization of certain infrastructure projects The general assembly of the Capital formulates the urban development program and the general master plan for the capital city howeverthe views of the Government and of the districts must be solicited The basic plan for each district is determined by the district assembly in conformity with the generalmaster plan of the capital However the new Capital general master plan has not yetbeen finalized this fact has not deterred the districts from developing their own local development plans which may sometimes be in conflict with the general master plan8
4 Law XXIV of 1991 on the self-government of the capital city and of the capital city districts
5 Ibid Article 12
6 F6vdrosi Csatornmmzsi Mvek
7 Ibid Articles 8(4) and 11
8 According to the Budapest Department of Public Utility Works
Cl
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It is therefore difficult for the city to combat a possible Not in my backyard (NIMBY) mentality on the part of the districts as in the case of construction of a new sewerage treatment plant
In the case of the specific projects for Districts XVII and XVIII several actors are responsible for different phases of project planning financing construction and management These include the capital city the FCSM the districts neighborhood associations and construction communities and the Ministry of Transportation Communication and Water Management (MTCWM) The role of each of these actors is described below
THE BUDAPEST MUNICIPAL GOVERNMENT (FOVAROS)
The Capital City is responsible for formuiating development plans for the city For sewerage development a long-term plan through the year 2015 has been established However consultations were engaged with the Government the districts and the FCSM during the preparation of the plan For actual implementation an annual or a two-year development plan is prepared based on the stated objectives of the capital assembly Three current main priorities in the area of sewage are (1) increase in collection and carrying capacity of the sewerage main in North Pest (2) increase in capacity of the treatment plant in North Buda and (3) construction of a treatment plant in South Pest The investment projects of the districts in sewer networks generally have to be in conformity with the general development plan of the Capital City
District XVIIs sewage project is dependent on the achievement of priority 1 as the main collecting pipe from the district leads into the sewage main of North Pest District XVIIIs project is linked to construction of the South Pest treatment plant (priority 3) once the district networks have been built they may not be put into operation until completion of the treatment plant
The capital finances the construction of main sewerage lines treatment plants collection and pumping stations these projects involve new facilities and mains or the increase in capacity of existing plants The actual technical plans are prepared by the FCSM reviewed by the public utility works department of the Capital City and prescnted to the genera assembly
Project preparation in the capital follows the prescription of a decree passed in 19929 Requirements include the submission of a detailed plan the Assemblyto including cost estimates but no financing plan The General Assembly must vote approval on all projects over a cost of HUF 50 million The financial plans for the realization of the capital city projects may include the following resources targeted subsidies funds from the general capital city budget contributions from the districts
9 Decree No 121992
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loans participation by the FCSM and contributions from the beneficiaries (businesseshouseholds) In only one case has the city taken out a specific project-related loan-from EBRD for a sewage treatment center
For 1993 the sewer fee included a portion dedicated specifically to the financingof new investments (HUF 470m 3 ) This was the first time that a part of the fee has been specifically assigned to the financing of new investment This development portion of the fee was only in place for 1993 and was not renewed for 1994 The proposals for the use of the development portion of the fee were made by the public utility works department
Until 1 January 1994 the sewer fee was set by the MTCWM based on a proposalof the city the technical aspects of the proposal are prepared by the FCSM and approvedby the general assembly of the capital The Capital City was authorized to determine the sewer fee for the first time this January although guidelines have been set by theMTCWM The initial technical proposal is prepared by the Finance Department of the FCSM Nevertheless the final say on the actual price rests with the general assembly of the Capital For the new fee options under consideration were to multiply the current fee by a price index for the sector (which would lead to an estimated 20 percent increase but would exclude any specific investment portion) or to include different developmentcosts in the fee The new fee (HUF 20 plus 10 percent value-added tax) was introduced in April 1994 although FCSM had recommended a tee of HUF 215 No part of the sewer fee is allocated to investments in the network undertaken by the districts The FCSM also plans to introduce a flat sewage fee of HUF 200-500 in areas not serviced at present to cover the cleaning of septic tanks
Actual construction of the projects is managed by the FCSM as the principal contractor Nevertheless the public utility works department of the Capital monitors the ongoing works approves bills submitted by the contractor and sub-contractors and authorizes payment to the FCSM (who pays the sub-contractors) Every six months a project report on use of funds and the advance of work is presented to the generalassembly If there are Impor ant cost overruns or construction delays then a change of scope of the project must be approved by the general assembly Once the project has been completed the equipment is turned over to the FCSM which is responsible for maintenance repairs rehabilitation and replacement
THE FCSM
The FCSM was previously a state-owned enterprise and was transferred to the ownership of the capital city according to the provisions of the Local Self-Government Act From 1 January 1992 the ownership rights of the sewerage network were transferred to the capital city The assets were managed by FCSM but it appears that no fee for lease of these assets was paid to the Capital City
From 1 December 1993 the FCSM was transformed into a joint-stock companywholly-owned by the capital city Before the transformation of the company the budget
ii
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of the sewer works company was approved by the general assembly of the Capital In addition the Supervisory Board of 13 members was appointed by the general assemblyOn 1 December 1993 the FCSM was transformed into a joint-stock company wholly owned by the Capital city Under this structure the Supervisory Board of nine members-three from FCSM staff and six from the Assembly-will be responsible for approving the companys budget and al strategically important decisions
The assets relating to sewerage were the property of the Capital City but were transferred to the FCSM as of 1 December 1993 as part of the companys transformation First the assets were reassessed and their replacement value was determined to be HUF 70 billion a considerable increase from the HUF 20 billion previously estimated10 With the transformation these assets were transferred to the ownership of the joint-stock company
Any additional networks and additions to the system will also be transferred to the FCSM However according to provisions of the 1991 Accounting Act any network built privately is transferred at zero value thus preventing the company from taking any depreciation on the value of the stock
As a means of circumventing this problem the FCSM arranged to be assigned as both investor and builder However when targeted subsidies are used to finance part of the network such an arrangement becomes more difficult because the local government must be the investor
For sewer projects initiated by the districts the FCSM is responsible for reviewing the technical plans and giving an expert opinion before construction begins Upon completion of the equipment the FCSM will inspect the equipment for adherence to technical norms (such as pressure tests or camera inspections within the pipes) and will authorize operation of the network This authorization will depend on capacity of eidsting mains and treatment plants to handle a larger flow of effluent in the system Thus due to the saturation of the main pipes in North Pest new business and industrial connections will not be authorized until the capacity of this part of the network has been increased
The principal activity of the FCSM is the operation and maintenance of the sewerage system within the city of Budapest In addition reconstruction and rehabilitation of all existing pipes pumping stations and treatment plants are the responsibility of the company These activities (operation maintenance reconstruction) are financed through the sewage fee
o It is believed that the primary purpose of this revaluation was to Increase depreciation funds However the higher valuation may have an adverse effect on the prospects for privatization
I Based on a conversation with the Technical Department of the FCSM
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The fee is collected in part by the FCSM however a collecting company12 collectsft sfrom private homes and the Water Works Company collects fees from industrial users and rental housing Thus the FCSM only seems to directly collect the fees from individuals with water wells but who are connected to the sewer system This systemof collection often leads to delays of at least two months in receipt of fees the amount ofunpaid fees were estimated at HUF 500-600 million in June 1993 and in May 1994 at HUF 338 million of which HUF 240 million Is from residences Total receipts in 1993 were HUF 4-5 billion putting delinquencits at about 8 percent
THE DISTRICTS
De facto due to lack of funds in the face of so many pressing needs the districtshave been made responsible for the construction of the secondary sewerage network(pipes leading from homes and businesses to the main collecting pipes and the collection system) The connections leading from homes and businesses to the secondary network are financed by the beneficiaries but constructed by the districts
Once a district decides to undertake the construction of part of the sewer system a water authorization permit is required from the MTCWM An expert opinion on thetechnical plans must be solicited from the FCSM The district is responsible for raisingfunds for construction Sources of financing may include district own fundscontributions from the Capital City targeted grants grants from the national Water Development Fund contributions from the population and loans
The means of financing used for these projects often leads to inefficient use of resources as matching funds and grants must remain in the accounts until construction has actually commenced This is the case for both the districts and the Capital CityTargeted grants require matching funds from the district which must be kept in the local government account as proof that this requirement has been met If there are delays in the start of the project these funds are left unused instead of being appropriated for more immediate needs
In the same way contributions from the Capital City must be negotiated on a caseby case basis and success in obtaining them may depend on the extent to which theparticular project corresponds to the capital citys own priorities However if the districts do not commence work on the project in a timely manner the Capital City funds are alsolying unused in an account For this reason the Capital has placed conditions on projectconstruction start-up dates if these requirements are not respected the districts may
This company was recently privatized through an employee share purchasing program It collects all utilities and municipal housing rents In Budapest for a fee of 3 to 4 percent of collections Recentlythe electricity company ended the contract and makes Its own collections while th gas company hascontracted out to other private companies in certain districts although their collections fees are muchhigher The Collection Company is currently in the process of revising its contractual relationshipswith its clients
12
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lose the grant For example District XVII received a promise of a HUF 14 million grant for the Rkosliget sewer project on condition that construction commenced by 1 December 1993
Appropriate financial products are currently not available to local governments for financing long-term investments such as sewer networks 3 For the moment the districts do not have access to the sewer fee which would enable them to appropriate part of this user fee for the reimbursement of debt Thus districts have placed heavyreliance on up-front population contributions through neighborhood associations and construction communities to finance part of secondary networks (and sometimef- the main networks) in addition to direct household connections to the network ----se connection fees are the only user charge to which districts have access As there o legal restriction on the level of the connection fee the only consideration in settin e fee is affordability
The construction of the project is monitored by the district Once completed technical certification of the equipment is required by the FCSM (pumping test and verification of pipes with a camera) If the results of these verifications are unsatisfactory then the operation of the pipes will not be authorized by the FCSM 4 If the FCSM grants approval the entire network is transferred to the Sewer Works Company which is responsible for operation maintenance rehabilitation and replacement of the equipment
NEIGHBORHOOD ASSOCIATIONS AND CONSTRUCTION COMMUNITIES
Under the previous system in order fc - neighbor-ods and towns to obtain quicker connections to public utilities organizea forms G population participation were developed these methods of financing infrastructure have continued and may take the form of a neighborhood association or a construction community
Neighborhood associations (ktzmitdrsulds) for the financing of infrastructure network- are formed when at least 66 percent of the residents of a neighborhood agree to their creation membership is open to all residents and contributions to the cost of infrastructure investment is compulsory Membership entitles residents to receive five-to seven year loans from OTP with 70 percent of the interest subsidized by the central
13 See Hegedes Mark Pigey Municipal Lending in Hungary March 1993
This has posed a problem for District XVII in 1993 30 kilometers of pipes of 40 constructed failed the camera verification test however the contractors had already been paid before this verification The District is unable to pave the roads or put system into operation until the pipes are repaired to satisfactory condition
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government 5 Through these loans investment funds are available up front to the district and it is the OTP which takes the credit risk
The members of the association appoint a steering committee (or an executiveboard) which works with the district issues tenders and selects the contractor The amount of contributions by members is assessed by the committee and any remainingfunds available after construction may be redistributed to the residents The committee also defines the contributions of new members
Construction communities (6pit6kbzOss~g) are a more flexible form of populationparticipation as they are not legal entities and have no right to sign contracts in their own name The community elects an executive board this board will work with the local government during construction in terms of choosing a constructor monitoringrealization countersigning contracts and bills However the legal investor is the local government This form of construction is used in District XVII
A separate account is established for the investment and members of theconstruction community pay their contributions into the account as the work proceedsIndividuals may contract loans to finance their contribution but these are at market rates and not the subsidized loans available to members of neighborhood associations Thus the district takes a credit risk and there are cases where members have not been able to pay the full amount of their assessed participation
In interviews with Districts XVII and XVIII it has often been stated that households have reached the limits of their capacity to contribute to financing the sewage network This system of financing is not limited to capital investments in sewer networks but has also been used to finance other public utilities such as potable water gas connections and telephone lines
Although districts do receive a portion of the personal income tax (for which there is a specific distribution formula between the capital city and the districts and among the districts) the actual incomes of the district populations are not known with precisionIn order for the district governments to better Judge the capacity of their population tocontribute both now and in the future small surveys of the population of selected areas in the district may be useful Such surveys may help to establish the level of incomesand expenditures as well as assess a realistic burden for construction and developmentlees or local taxes
15 In January 1994 subsidies for direct household loans for utility connections were terminated making the neighborhood association loans the only remaining subsidy for utility connections
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MINISTRY OF TRANSPORTATION COMMUNICATION AND WATER MANAGEMENT (MTCWM)
The Ministry of Transportation Communication and Water Management must approve all projects in Hungary relating to water no sewerage project may go forward without first obtaining the water authorization permit from this Ministry
Until 1 January 1994 the Miniszry also played a role in setting the water and sewer tariffs According to the 1990 Act on Prices the fee must include the expenses of efficient operation and the profit required for efficient operation although no definition of efficiency or provisions for monitoring are included in the Act
The final allowed price was set by the Ministry based on tariffs proposed by the sewer company and the Capital City From the beginning of 1994 the pricing of sewer services has been completely devolved to the city of Budapest although the Ministry has set non-binding guidelines for fees
PROPOSED SEWAGE INVESTMENTS
SEWAGE DEVELOPMENT NEEDS IN DISTRICTS XVII AND XVIII
Citywide there are 4000 km of sewage pipes connecting approximately 88 percentof households in Budapest although this is heavily concentrated in the center so that
8outer districts have only about 50 to 60 percent coverage 1 Sewage treatment is below the adequate level FCSM estimates that 80 percent of sewage receives mechanical treatment but less than 20 percent is biologically treated
Districts XVII and XVIII have among the lowest levels of sewerage coverage in Budapest but according to the FCSM Investment Department District XVII is worse off because in District XVIII only one area (Pestszentimre) is badly underserviced Both district governments list sewerage as their most pressing infrastructure developmentneed and both have projects planned which they hope to address in the near future
District XVII
District XVII has a split sewage system-ie two separate subsystems for sewageand storm water collection-and has a big deficit in both systems The district has
1039a comprehensive sewage construction plan with an estimated total cost of HUF billion which has already been begun A first task to lay a network in Rakosliget and Rakoscsaba uJtelep has already been partially completed although some difficulties with the contractor left the laid pipes not ready for use The result was that the municipal sewer company (FCSM) refused to accept the pipes and the district has had to ask the city for a special grant of HUF 80 million 8 to complete the work and repave the roads under a new contract
The plan calls for three additional phases of construction the first part will be to construct sewerage in the most urgent areas (the district center and RAkoscsaba) the second is to complete a parallel principal main which is a precondition for expanding the network and the third is to connect some other areas to the system Phase I to construct about 30 kilometers in Rakoscsaba was begun in early 1994
Targeted subsidies have already been granted for the sewage projectHUF 285 million for 1993 and HUF 21 million for 1994 In both cases despite approvalthe district will receive funds one year later because of central budget limitations The local assembly also has approved the local portion of funding (30 percent of the originalcost estimate) which comes from the social normative grant but the schedule has to be
16 For the outer districts the 1992 flgures are 76-78 percent coverage (districts XV and l) 50-60 percent (XVIII MX and XXI) and 41-43 percent (XVII and XVI)
17 As is the case for most outer areas in Budapest
1s This grant was obtained in return for permission for the Capital City to use the districts landfill
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rethought One difficulty is that because they could not start construction before 1 December 1993 they forfeited the promised HUF 14 million from the City
In some ways storm water collection is a more urgent problem in the district and financially more problematic because no targeted subsidies are available and because it is impossible to charge the public directly for any portion of the development costs The district plans to build a series of ditches for storm water collecting water in one location but because these are open the Sewage Company will not operate them
The district assembly has approved sewerage construction plans but has not actually appropriated the money 9 so that the district has not been able to apply for some other available subsidies One such potential subsidy comes from the Water Management Fund which requires a permit from the water authority As the permit expires in two years the district will probably have to reapply because they may not be able to begin construction of the next phase within two years
One portion of the district contribution is paying the value-added tax portion of the connections (Until January 1993 this amount at 25 percent of cost would have been refunded by the central government) There is a preliminary agreement between the FCSM and the districts that starting 1 January 1994 the FCSM will pay the VAT and be reimbursed by the central government
Citizens contributions will have to make up a larger proportion than foreseen (probably 60 percent instead of 40 percent) A neighborhood association has already been formed in RiLkosllget two construction communities (one of over 700 households) have been formed for the Rakoscsaba work Conditions for households have changed considerably as of January 1994 because the 50 percent subsidies on utility connection loans are no longer available The district is therefore allowing those households unable to pay up front to pay in installments with no interest
Enterprises of course can be - arged higher connection fees and the district wants to use those to cross-subsidize household connections The district Public Utilities Division believes enterprises could be charged up to HUF 1 billion for the sewage development contribution plus HUF 80 million for the actual connection
District XVII has no outstanding loans nor do they levy any local taxes at present They do not have committees or a project preparation unit set up to work on cost of projects instead the technical department alone has put this project together There will be some political difficulties in getting this project approved because those in housing estates which are already connected to the sewage system and who represent the bulk
Not all assembly representatives heartily endorse the plan moreover the assembly did not think the central government would grant the targeted subsidy
20 This may be a problem at some point as when capacity problems exist the FCSM has indicated that it may grant permits for connection only to households and not to enterprises
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of the voting power will be opposed to the expenditure This same argument was used to explain why the council would be opposed to incurring debt although it is possiblethat debt could be structured to be repaid by the benefiting area only
The district does not have solid data on incomes but there is a general sense that probably only 20 percent of households can afford the sewage connection at HUF 30000shy40000 those who cannot would have to be subsidized by the local government byreceiving interest-free loans
DistrictXV37
District XVIII has almost the lowest per capita income in Budapest (it ranks 18th among the 22 districts) it is fourth in area seventh in population and only district XVII has less sewerage coverage according to the Deputy Mayor
Pestszentimre a neighborhood of mostly single-family houses containing about one quarter of district households (a population of 25000 in a district of 98000) is the area most urgently needing sewerage development The cost for this development is estimated at between HUF 12 and 16 billion Four storage tanks that pump sewage into the main system will have to be built The current plan is to begin construction in 1996 the schedule has been pushed back mostly because of financial considerations Sewage is still very much a priority investment for the district
The district hopes to have 30 percent of the cost covered by district resources 30 percent by the Capital City and 40 percent by a targeted subsidy (because Budapestapplied for the subsidy with the district the subsidy is worth an extra 10 percent of estimated cost) A cooperation agreement was required but because Budapest did not sign it the district has not yet applied for the subsidy
The Southern Pest Treatment Center is at capacity now and the new sewerage will not be able to be connected until the Center is expanded District XVIII feels confident that the expansion will be undertaken next year so the technical problem will be solved Budapest would take a loan for this project apparently the City Council is in favor of the project Even though the Treatment Center has not yet been expanded the FCSM has given the district their permit to begin construction
The gas network was recently completed in the same area funded throughneighborhood associations work was completed in 1993 The connection fee of HUF 46000 per household will take three years to pay off so that payments will stop in 1995 Even so the connection fee alone did not cover the total cost which came to about HUF 150000-200000 per property
If a connection fee for sewerage is set too high district officials are afraid somehouseholds may elect not to connect at all If more than 60 percent of households want to connect the district will begin construction but they risk having some households subsequently decide not to connect and withdraw their contributions District officials
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expect the connection fee to be HUF 60000-65000 the District will pay an additional HUF 15000 fee per household to cover the cost of preparing the technical construction plans
The Deputy Mayor assumes the district will have to take on debt and he believes the district would definitely approach various banks as OTP does not offer attractive terms A technical implementation report on the project has been prepared but it includes no work on financial returns
CURRENT SEWER INFRASTRUCTURE FINANCING PRACTICES
As described in the first section districts are responsible for the construction of sewer collection systems that once built are turned over to the Capital City Sewer Company for operation and maintenance The Capital City is responsible for construction of interceptor sewers and sewage treatment plants Once the infrastruc-ture is in place system stewardship is the responsibility of the Budapest Municipal Sewage Company (FCSM)
There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including
Central Government Targeted subsidies provided by the central government are used to finance construction of sewer collection systems Targeted subsides are matching grants given to districts on a competitive basis The level of funding provided by targeted subsides is 30 percent for sewer collection projects (40 percentif the application is made jointly by both the district and the Capital City) However the reliability of this revenue source to finance future sewer projects is subject to the priorities and conditions set by the Parliament as recommended by the Ministry of the Interior Therefore there is no assurance that targetedsubsidies can be used to finance sewer collection systems in the future2
1 It is noted that the central government provides addressed subsidies however sewer collection system financing is not an eligible use of such subsidies
Capital City The Capital City can contribute to the cost of district sewer construction projects However district projects mus conform to Capital City priorities to be considered for funding
21 For example in 1993 the amounts needed to fund all eligible projects exceed the grant monies budgeted by the central government so those projects are approved but local governments will receive funds two or three years from now
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District Own source revenues for sewer collection system construction and connections to properties in public ownership are derived from (1) allocations made through the annual local budget process derived from local taxes miscellaneous fees and intergovernmental transfers (eg normative subsidies) (2) sale or lease of district owned land and (3)mid-term borrowing (defined as 2-3 years) from OTP Loans are repaid from own source revenue in the form of proceeds from the sale or lease of district-owned land
Citizens Citizens contribute to the construction of sewer systems in two ways (1)through the creation of construction communities or neighborhood associations citizens pay a portion of the collection system construction cost and (2)connection fees
FINANCING OPTIONS
This is a period of intensive change in the ways in which the central governmentdistricts the Capital City and the recently privatized Budapest Municipal SewageCompany finance and maintain the municipal sewer system Existing capitalimprovements practices are woefully insufficient to meet current and future seweragecapital needs Reasons for this state of affairs include
Limited Financial Capacity
The lack of adequate own source revenue has a profound impact on limitingavailable funds necessary to finance sewage system expansion There is a great disparitybetween capital needs and the anticipated revenue available to meet these needs Sewer construction projects are very expensive Existing financing mechanisms are inadequate
Debt Financing Districts make limited use of debt financing When debt is issuedIt is for a 2 or 3 year period This short term debt financing places an undue burden on the districts limited financial resources and the present populationsability to amortize the debt The high cost of borrowing (27 percent interest) further exacerbates this problem as well as increasing the cost of capital development
Capital financing typically requires the issuance of long term debt (20 to 30 years)that roughly correlates to the useful life of the facility This method of financingalso is considered to be equitable to those who benefit from the system (egcitizens commerce industry) since each generation pays its fair share of the cost of the facility A long-life asset such as a sewer system should be paid for by its users throughout its normal life rather than all at once by those who may not have the use of it full term Even with higher cost due to interest if spread over a largenumber of userspayers the cost to all is lowered Given Hungarys high rate of inflation and thus ever increasing construction costs it may be cheaper to borrow and pay todays prices rather than wait and pay tomorrows prices Furthermorethe use of long term debt puts less financial pressure on the operating budget
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OperatingBudget (ie pay-as-you-go)There is some attempt to finance a portion of the cost of sewer improvements through the operating budget The operatingbudget is reliant on revenues derived from intergovernmental transfers and therefore provides very little fiscal flexibility to support capital development Furthermore there are no reserve accounts that may be used to set aside funds for future capital development or meet emergencies (It will be noted of course that with Hungarys high rate of inflation the reserve accounts will be rapidly eroded so it may be decided to keep them at a mintimum)
Typically the operating budget is not used to finance large scale capital projects such as sewer collection systems Annual appropriations tend to be used to pay for municipal operations and service Small scale projects equipment purchases and the repair of existing facilities may be funded through the operating budgetHowever the use of the operating budget to finance large capital projects should be frowned upon for the following reasons
It forces local officials to make extremely difficult choices between service
delivery government operations and capital expansion
It places a heavy burden on the budget for the project year
It creates awkward fluctuating expenditure cycles that do not occur with extended financing
Since funding is based on yearly increments the use of the operating budget helps foster an environment wherein projects often go uncompleted
Sale of Land Districts rely on the sale of land to raise revenue for infrastructure financing This raises several concerns First land is not liquid and its value is subject to market forces In a sagging market such as currently exists land priceshave eroded to the point where districts are unable to raise adequate capital through the sale of land to finance sewer construction Furthermore there are few entrepreneurs with adequate resources to buy land
A related issue is that the land being sold is not serviced by sewer and other infrastructure components The offering price most likely reflects the absence of infrastructure If the infrastructure were in place prior to the sale or lease of district-owned land the district would realize a greater return than it currently receives
Finally land is finite Districts should think carefully about diminishing this resource to finance capital investment particularly before the capital is in placeLater in this paper we describe financing mechanisms that should be considered as feasible alternatives Particular attention should be paid to the use of tax increment financing or other forms of betterment financing
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Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
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Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
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ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
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projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
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Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
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plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
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FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
MunicipalStrategiesfor Infrastuctu-e Finance The UrbanInsttute PlannedSewage Projects in Two BudapestDistricts Page 26
ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
ABSTRACT
Two proposed sewerage investment projects in Budapest outer districts are analyzedin this -report with the aim of assessing present financing practices and possiblealternatives The principal conclusions are that there are more options available than are currently considered and that assistance in developing certain skills could be useful to local governments facing these new responsibilities
This review finds that existing capital improvements practices are woefullyinsufficient to meet current and future sewerage capital needs In addition to limited financial capacity inadequate intergovernmental coordination in a context of greatdiffusion of control among a range of government entities inhibits comprehensive capitalplanning programming and budgeting and there is no vehicle to resolve these differences Other problems arise in connection with project financing and once projectfunding is in place project management often appears to be inadequate
Areas proposed for USAID technical assistance to districts and the capitalgovernment include the assessment of current and alternative financial sources help in the development of a capital plan and budget costing and pricing enterprise management contract management and collaboration between the city and the districts
3
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EXECUTIVE SUMMARY
Two proposed municipal infrastructure projects are analyzed in this reportinvestments in the sewer systems for the R area of Budapest District XVII and for the Pestszentimre area of Budapest District XVIII The aim was to assess both presentpractices and possible alternatives for financing these two projects within the context of current local responsibilities and capabilities The principal conclusions are that there are more options available than are currently considered and that assistance indeveloping certain skills could be useful to local governments facing these new responsibilities
In Budapest which consists of a capital city government and 22 district governments responsibility for construction ownership and maintenance of publicinfrastructure has been splintered among several entities competingand local governments Due in part to the large responsibilities placed on the capital governmentand the insufficiency of funds to respond in the short and medium term to the mostpressing needs some districts have sought to mitigate the lack of action by initiating and financing projects which would normally be in the domain of the capital
Sewage pipes connect 87-88 percent of households in Budapest although this isheavily concentrated in the center Districts XVII and XVIll have among the lowest levels of sewerage coverage in Budapest Sewage treatment is below the adequate level with less than 20 percent biologically treated
This review finds that existing capital improvements practices are woefullyinsufficient to meet current and future sewerage capital needs There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including targeted subsidies provided by the central government contributions from the Capital and own source revenues (including allocations made through the annual local budget process sale or lease of district owned land and mid-term borrowing(defined as 2-3 years) from OTP) citizens contribute through the creation of construction communities or neighborhood associations and connection fees
In addition to limited financial capacity inadequate intergovernmental coordination in a context of great diffusion of control among a range of government entities inhibits comprehensive capital planning programming and budgeting and there is no vehicle toresolve these differences Two other problems arise in connection with project financing(1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actuallyneeded Once project funding is in place project management often appears to beinadequate It does not seem that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users The current delinquency rate of 8 is generally not acceptable
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and the
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livabihty of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is the provision of technical assistance that will help local officials make smarter sewer and general capital investment and management decisions Areas proposed for assistance include the assessment of current financial sources such as connection fees long term debt taxation including property tax) and user fees along with alternative financing methods such as the creation of tax increment or betterment districts
General capital financing technical assistance to both districts and Capital City should include assistance in the development of a capital plan and budget costing and pricing enterprise management contract management and collaboration between the city and the districts At the central government level assistance should be provided to revise the current system of targeted grants and to consider more effective means to assist in local infrastructure investment
MUNICIPAL STRATEGIES FOR INFRASTRUCTURE FINANCE PLANNED SEWAGE PROJECTS IN TWO BUDAPEST DISTRICTS
INTRODUCTION
The responsibility for construction and maintenance of municipal infrastructureincluding water management drainage of rainwater and sewage transferred towas Hungarian local governments in 1990 by the Act on Local Self-Government In orderfor these tasks to be effectively undertaken the assets of state economic organizationsproviding these public utilities were likewise transferred to local governments2 These are new and demanding responsibilities for local governments In the past decades there has been considerable neglect of infrastructure investment in Hungary moreover localfinancial resources are already severely strained Since 1993 USAID has begun toprovide assistance to Hungarian local governments i meeting the need to finance infrastructure development
Two proposed municipal infrastructure projects are analyzed in this report the sewer system for the Rdkosliget area of Budapest District XVII and the sewer system forthe Pestszentimre area of Budapest District XVIII The aim is to assess present practicesand possible alternatives for financing these two investments within the context of current local responsibilities and capabilities The principal conclusions are that there are more options available than are currently considered and that assistance in developing certain skills could be useful to local governments facing these newresponsibilities We start by examining the specific responsibilities of Budapest districtsthe municipality the public works and the central government Then we describe the two proposed sewage projects and current financing practices Finally we propose areas for assistance
Act No LXV of 1990 Article 8(1)
2 Ibid Article 107(l)(b)
For a description of the broad scope of USAID assistance in this sector see Dowall HegedosMark and Tosics Establishing a Franwworkfor MunicipalTechnicalAssstanceinInfrastructure 1993
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ENFRASTRUCTURE INVESTMENT RESPONSIBILITIES IN BUDAPEST
The city of Budapest comprises 23 local self-governments including the Capital Citygovernment (F6vdros) and the twenty-two districts According to Article 63 of the Act on local self-government the district governments of Budapest are mainly responsible for the provision of primary public services while the Capital government is responsible for tasks which affect the whole or a large part of the city
A separate law further defines the respective responsibilities of the Capital and of the districts4 Article 10 of this Act lists specific rights and duties of the capital citygovernment which includes provision of water gas and steam water regulation storm sewerage and channeling and the provision of potable water to the entire capital or its major portions Some of these duties may be transferred by the capital city to the district governments on two conditions that sufficient funds are provided for carrying out these services and that the district accepts this transfer5
In practice responsibility for construction ownership and maintenance of publicinfrastructure has been splintered among several entities and competing local governments This situation is further complicated by the ambiguity of legislative textsand by the transformation of the Budapest Sewerage Works (or FCSMI) which became a joint-stock company on 1 December 1993
As a res-it due in part to the large responsibilities placed on the capital government and the insufficiency of funds to respond in the short and medium term to the most pressing needs some districts have sought to mitigate the lack of action on the part of the capital by initiating and financing projects which would normally be in the domain of the capital
The fragmentation of responsibility for preparation of urban development and master plans between the capital and the districts may lead to conflicts in the realization of certain infrastructure projects The general assembly of the Capital formulates the urban development program and the general master plan for the capital city howeverthe views of the Government and of the districts must be solicited The basic plan for each district is determined by the district assembly in conformity with the generalmaster plan of the capital However the new Capital general master plan has not yetbeen finalized this fact has not deterred the districts from developing their own local development plans which may sometimes be in conflict with the general master plan8
4 Law XXIV of 1991 on the self-government of the capital city and of the capital city districts
5 Ibid Article 12
6 F6vdrosi Csatornmmzsi Mvek
7 Ibid Articles 8(4) and 11
8 According to the Budapest Department of Public Utility Works
Cl
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It is therefore difficult for the city to combat a possible Not in my backyard (NIMBY) mentality on the part of the districts as in the case of construction of a new sewerage treatment plant
In the case of the specific projects for Districts XVII and XVIII several actors are responsible for different phases of project planning financing construction and management These include the capital city the FCSM the districts neighborhood associations and construction communities and the Ministry of Transportation Communication and Water Management (MTCWM) The role of each of these actors is described below
THE BUDAPEST MUNICIPAL GOVERNMENT (FOVAROS)
The Capital City is responsible for formuiating development plans for the city For sewerage development a long-term plan through the year 2015 has been established However consultations were engaged with the Government the districts and the FCSM during the preparation of the plan For actual implementation an annual or a two-year development plan is prepared based on the stated objectives of the capital assembly Three current main priorities in the area of sewage are (1) increase in collection and carrying capacity of the sewerage main in North Pest (2) increase in capacity of the treatment plant in North Buda and (3) construction of a treatment plant in South Pest The investment projects of the districts in sewer networks generally have to be in conformity with the general development plan of the Capital City
District XVIIs sewage project is dependent on the achievement of priority 1 as the main collecting pipe from the district leads into the sewage main of North Pest District XVIIIs project is linked to construction of the South Pest treatment plant (priority 3) once the district networks have been built they may not be put into operation until completion of the treatment plant
The capital finances the construction of main sewerage lines treatment plants collection and pumping stations these projects involve new facilities and mains or the increase in capacity of existing plants The actual technical plans are prepared by the FCSM reviewed by the public utility works department of the Capital City and prescnted to the genera assembly
Project preparation in the capital follows the prescription of a decree passed in 19929 Requirements include the submission of a detailed plan the Assemblyto including cost estimates but no financing plan The General Assembly must vote approval on all projects over a cost of HUF 50 million The financial plans for the realization of the capital city projects may include the following resources targeted subsidies funds from the general capital city budget contributions from the districts
9 Decree No 121992
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loans participation by the FCSM and contributions from the beneficiaries (businesseshouseholds) In only one case has the city taken out a specific project-related loan-from EBRD for a sewage treatment center
For 1993 the sewer fee included a portion dedicated specifically to the financingof new investments (HUF 470m 3 ) This was the first time that a part of the fee has been specifically assigned to the financing of new investment This development portion of the fee was only in place for 1993 and was not renewed for 1994 The proposals for the use of the development portion of the fee were made by the public utility works department
Until 1 January 1994 the sewer fee was set by the MTCWM based on a proposalof the city the technical aspects of the proposal are prepared by the FCSM and approvedby the general assembly of the capital The Capital City was authorized to determine the sewer fee for the first time this January although guidelines have been set by theMTCWM The initial technical proposal is prepared by the Finance Department of the FCSM Nevertheless the final say on the actual price rests with the general assembly of the Capital For the new fee options under consideration were to multiply the current fee by a price index for the sector (which would lead to an estimated 20 percent increase but would exclude any specific investment portion) or to include different developmentcosts in the fee The new fee (HUF 20 plus 10 percent value-added tax) was introduced in April 1994 although FCSM had recommended a tee of HUF 215 No part of the sewer fee is allocated to investments in the network undertaken by the districts The FCSM also plans to introduce a flat sewage fee of HUF 200-500 in areas not serviced at present to cover the cleaning of septic tanks
Actual construction of the projects is managed by the FCSM as the principal contractor Nevertheless the public utility works department of the Capital monitors the ongoing works approves bills submitted by the contractor and sub-contractors and authorizes payment to the FCSM (who pays the sub-contractors) Every six months a project report on use of funds and the advance of work is presented to the generalassembly If there are Impor ant cost overruns or construction delays then a change of scope of the project must be approved by the general assembly Once the project has been completed the equipment is turned over to the FCSM which is responsible for maintenance repairs rehabilitation and replacement
THE FCSM
The FCSM was previously a state-owned enterprise and was transferred to the ownership of the capital city according to the provisions of the Local Self-Government Act From 1 January 1992 the ownership rights of the sewerage network were transferred to the capital city The assets were managed by FCSM but it appears that no fee for lease of these assets was paid to the Capital City
From 1 December 1993 the FCSM was transformed into a joint-stock companywholly-owned by the capital city Before the transformation of the company the budget
ii
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of the sewer works company was approved by the general assembly of the Capital In addition the Supervisory Board of 13 members was appointed by the general assemblyOn 1 December 1993 the FCSM was transformed into a joint-stock company wholly owned by the Capital city Under this structure the Supervisory Board of nine members-three from FCSM staff and six from the Assembly-will be responsible for approving the companys budget and al strategically important decisions
The assets relating to sewerage were the property of the Capital City but were transferred to the FCSM as of 1 December 1993 as part of the companys transformation First the assets were reassessed and their replacement value was determined to be HUF 70 billion a considerable increase from the HUF 20 billion previously estimated10 With the transformation these assets were transferred to the ownership of the joint-stock company
Any additional networks and additions to the system will also be transferred to the FCSM However according to provisions of the 1991 Accounting Act any network built privately is transferred at zero value thus preventing the company from taking any depreciation on the value of the stock
As a means of circumventing this problem the FCSM arranged to be assigned as both investor and builder However when targeted subsidies are used to finance part of the network such an arrangement becomes more difficult because the local government must be the investor
For sewer projects initiated by the districts the FCSM is responsible for reviewing the technical plans and giving an expert opinion before construction begins Upon completion of the equipment the FCSM will inspect the equipment for adherence to technical norms (such as pressure tests or camera inspections within the pipes) and will authorize operation of the network This authorization will depend on capacity of eidsting mains and treatment plants to handle a larger flow of effluent in the system Thus due to the saturation of the main pipes in North Pest new business and industrial connections will not be authorized until the capacity of this part of the network has been increased
The principal activity of the FCSM is the operation and maintenance of the sewerage system within the city of Budapest In addition reconstruction and rehabilitation of all existing pipes pumping stations and treatment plants are the responsibility of the company These activities (operation maintenance reconstruction) are financed through the sewage fee
o It is believed that the primary purpose of this revaluation was to Increase depreciation funds However the higher valuation may have an adverse effect on the prospects for privatization
I Based on a conversation with the Technical Department of the FCSM
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The fee is collected in part by the FCSM however a collecting company12 collectsft sfrom private homes and the Water Works Company collects fees from industrial users and rental housing Thus the FCSM only seems to directly collect the fees from individuals with water wells but who are connected to the sewer system This systemof collection often leads to delays of at least two months in receipt of fees the amount ofunpaid fees were estimated at HUF 500-600 million in June 1993 and in May 1994 at HUF 338 million of which HUF 240 million Is from residences Total receipts in 1993 were HUF 4-5 billion putting delinquencits at about 8 percent
THE DISTRICTS
De facto due to lack of funds in the face of so many pressing needs the districtshave been made responsible for the construction of the secondary sewerage network(pipes leading from homes and businesses to the main collecting pipes and the collection system) The connections leading from homes and businesses to the secondary network are financed by the beneficiaries but constructed by the districts
Once a district decides to undertake the construction of part of the sewer system a water authorization permit is required from the MTCWM An expert opinion on thetechnical plans must be solicited from the FCSM The district is responsible for raisingfunds for construction Sources of financing may include district own fundscontributions from the Capital City targeted grants grants from the national Water Development Fund contributions from the population and loans
The means of financing used for these projects often leads to inefficient use of resources as matching funds and grants must remain in the accounts until construction has actually commenced This is the case for both the districts and the Capital CityTargeted grants require matching funds from the district which must be kept in the local government account as proof that this requirement has been met If there are delays in the start of the project these funds are left unused instead of being appropriated for more immediate needs
In the same way contributions from the Capital City must be negotiated on a caseby case basis and success in obtaining them may depend on the extent to which theparticular project corresponds to the capital citys own priorities However if the districts do not commence work on the project in a timely manner the Capital City funds are alsolying unused in an account For this reason the Capital has placed conditions on projectconstruction start-up dates if these requirements are not respected the districts may
This company was recently privatized through an employee share purchasing program It collects all utilities and municipal housing rents In Budapest for a fee of 3 to 4 percent of collections Recentlythe electricity company ended the contract and makes Its own collections while th gas company hascontracted out to other private companies in certain districts although their collections fees are muchhigher The Collection Company is currently in the process of revising its contractual relationshipswith its clients
12
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lose the grant For example District XVII received a promise of a HUF 14 million grant for the Rkosliget sewer project on condition that construction commenced by 1 December 1993
Appropriate financial products are currently not available to local governments for financing long-term investments such as sewer networks 3 For the moment the districts do not have access to the sewer fee which would enable them to appropriate part of this user fee for the reimbursement of debt Thus districts have placed heavyreliance on up-front population contributions through neighborhood associations and construction communities to finance part of secondary networks (and sometimef- the main networks) in addition to direct household connections to the network ----se connection fees are the only user charge to which districts have access As there o legal restriction on the level of the connection fee the only consideration in settin e fee is affordability
The construction of the project is monitored by the district Once completed technical certification of the equipment is required by the FCSM (pumping test and verification of pipes with a camera) If the results of these verifications are unsatisfactory then the operation of the pipes will not be authorized by the FCSM 4 If the FCSM grants approval the entire network is transferred to the Sewer Works Company which is responsible for operation maintenance rehabilitation and replacement of the equipment
NEIGHBORHOOD ASSOCIATIONS AND CONSTRUCTION COMMUNITIES
Under the previous system in order fc - neighbor-ods and towns to obtain quicker connections to public utilities organizea forms G population participation were developed these methods of financing infrastructure have continued and may take the form of a neighborhood association or a construction community
Neighborhood associations (ktzmitdrsulds) for the financing of infrastructure network- are formed when at least 66 percent of the residents of a neighborhood agree to their creation membership is open to all residents and contributions to the cost of infrastructure investment is compulsory Membership entitles residents to receive five-to seven year loans from OTP with 70 percent of the interest subsidized by the central
13 See Hegedes Mark Pigey Municipal Lending in Hungary March 1993
This has posed a problem for District XVII in 1993 30 kilometers of pipes of 40 constructed failed the camera verification test however the contractors had already been paid before this verification The District is unable to pave the roads or put system into operation until the pipes are repaired to satisfactory condition
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government 5 Through these loans investment funds are available up front to the district and it is the OTP which takes the credit risk
The members of the association appoint a steering committee (or an executiveboard) which works with the district issues tenders and selects the contractor The amount of contributions by members is assessed by the committee and any remainingfunds available after construction may be redistributed to the residents The committee also defines the contributions of new members
Construction communities (6pit6kbzOss~g) are a more flexible form of populationparticipation as they are not legal entities and have no right to sign contracts in their own name The community elects an executive board this board will work with the local government during construction in terms of choosing a constructor monitoringrealization countersigning contracts and bills However the legal investor is the local government This form of construction is used in District XVII
A separate account is established for the investment and members of theconstruction community pay their contributions into the account as the work proceedsIndividuals may contract loans to finance their contribution but these are at market rates and not the subsidized loans available to members of neighborhood associations Thus the district takes a credit risk and there are cases where members have not been able to pay the full amount of their assessed participation
In interviews with Districts XVII and XVIII it has often been stated that households have reached the limits of their capacity to contribute to financing the sewage network This system of financing is not limited to capital investments in sewer networks but has also been used to finance other public utilities such as potable water gas connections and telephone lines
Although districts do receive a portion of the personal income tax (for which there is a specific distribution formula between the capital city and the districts and among the districts) the actual incomes of the district populations are not known with precisionIn order for the district governments to better Judge the capacity of their population tocontribute both now and in the future small surveys of the population of selected areas in the district may be useful Such surveys may help to establish the level of incomesand expenditures as well as assess a realistic burden for construction and developmentlees or local taxes
15 In January 1994 subsidies for direct household loans for utility connections were terminated making the neighborhood association loans the only remaining subsidy for utility connections
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MINISTRY OF TRANSPORTATION COMMUNICATION AND WATER MANAGEMENT (MTCWM)
The Ministry of Transportation Communication and Water Management must approve all projects in Hungary relating to water no sewerage project may go forward without first obtaining the water authorization permit from this Ministry
Until 1 January 1994 the Miniszry also played a role in setting the water and sewer tariffs According to the 1990 Act on Prices the fee must include the expenses of efficient operation and the profit required for efficient operation although no definition of efficiency or provisions for monitoring are included in the Act
The final allowed price was set by the Ministry based on tariffs proposed by the sewer company and the Capital City From the beginning of 1994 the pricing of sewer services has been completely devolved to the city of Budapest although the Ministry has set non-binding guidelines for fees
PROPOSED SEWAGE INVESTMENTS
SEWAGE DEVELOPMENT NEEDS IN DISTRICTS XVII AND XVIII
Citywide there are 4000 km of sewage pipes connecting approximately 88 percentof households in Budapest although this is heavily concentrated in the center so that
8outer districts have only about 50 to 60 percent coverage 1 Sewage treatment is below the adequate level FCSM estimates that 80 percent of sewage receives mechanical treatment but less than 20 percent is biologically treated
Districts XVII and XVIII have among the lowest levels of sewerage coverage in Budapest but according to the FCSM Investment Department District XVII is worse off because in District XVIII only one area (Pestszentimre) is badly underserviced Both district governments list sewerage as their most pressing infrastructure developmentneed and both have projects planned which they hope to address in the near future
District XVII
District XVII has a split sewage system-ie two separate subsystems for sewageand storm water collection-and has a big deficit in both systems The district has
1039a comprehensive sewage construction plan with an estimated total cost of HUF billion which has already been begun A first task to lay a network in Rakosliget and Rakoscsaba uJtelep has already been partially completed although some difficulties with the contractor left the laid pipes not ready for use The result was that the municipal sewer company (FCSM) refused to accept the pipes and the district has had to ask the city for a special grant of HUF 80 million 8 to complete the work and repave the roads under a new contract
The plan calls for three additional phases of construction the first part will be to construct sewerage in the most urgent areas (the district center and RAkoscsaba) the second is to complete a parallel principal main which is a precondition for expanding the network and the third is to connect some other areas to the system Phase I to construct about 30 kilometers in Rakoscsaba was begun in early 1994
Targeted subsidies have already been granted for the sewage projectHUF 285 million for 1993 and HUF 21 million for 1994 In both cases despite approvalthe district will receive funds one year later because of central budget limitations The local assembly also has approved the local portion of funding (30 percent of the originalcost estimate) which comes from the social normative grant but the schedule has to be
16 For the outer districts the 1992 flgures are 76-78 percent coverage (districts XV and l) 50-60 percent (XVIII MX and XXI) and 41-43 percent (XVII and XVI)
17 As is the case for most outer areas in Budapest
1s This grant was obtained in return for permission for the Capital City to use the districts landfill
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rethought One difficulty is that because they could not start construction before 1 December 1993 they forfeited the promised HUF 14 million from the City
In some ways storm water collection is a more urgent problem in the district and financially more problematic because no targeted subsidies are available and because it is impossible to charge the public directly for any portion of the development costs The district plans to build a series of ditches for storm water collecting water in one location but because these are open the Sewage Company will not operate them
The district assembly has approved sewerage construction plans but has not actually appropriated the money 9 so that the district has not been able to apply for some other available subsidies One such potential subsidy comes from the Water Management Fund which requires a permit from the water authority As the permit expires in two years the district will probably have to reapply because they may not be able to begin construction of the next phase within two years
One portion of the district contribution is paying the value-added tax portion of the connections (Until January 1993 this amount at 25 percent of cost would have been refunded by the central government) There is a preliminary agreement between the FCSM and the districts that starting 1 January 1994 the FCSM will pay the VAT and be reimbursed by the central government
Citizens contributions will have to make up a larger proportion than foreseen (probably 60 percent instead of 40 percent) A neighborhood association has already been formed in RiLkosllget two construction communities (one of over 700 households) have been formed for the Rakoscsaba work Conditions for households have changed considerably as of January 1994 because the 50 percent subsidies on utility connection loans are no longer available The district is therefore allowing those households unable to pay up front to pay in installments with no interest
Enterprises of course can be - arged higher connection fees and the district wants to use those to cross-subsidize household connections The district Public Utilities Division believes enterprises could be charged up to HUF 1 billion for the sewage development contribution plus HUF 80 million for the actual connection
District XVII has no outstanding loans nor do they levy any local taxes at present They do not have committees or a project preparation unit set up to work on cost of projects instead the technical department alone has put this project together There will be some political difficulties in getting this project approved because those in housing estates which are already connected to the sewage system and who represent the bulk
Not all assembly representatives heartily endorse the plan moreover the assembly did not think the central government would grant the targeted subsidy
20 This may be a problem at some point as when capacity problems exist the FCSM has indicated that it may grant permits for connection only to households and not to enterprises
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of the voting power will be opposed to the expenditure This same argument was used to explain why the council would be opposed to incurring debt although it is possiblethat debt could be structured to be repaid by the benefiting area only
The district does not have solid data on incomes but there is a general sense that probably only 20 percent of households can afford the sewage connection at HUF 30000shy40000 those who cannot would have to be subsidized by the local government byreceiving interest-free loans
DistrictXV37
District XVIII has almost the lowest per capita income in Budapest (it ranks 18th among the 22 districts) it is fourth in area seventh in population and only district XVII has less sewerage coverage according to the Deputy Mayor
Pestszentimre a neighborhood of mostly single-family houses containing about one quarter of district households (a population of 25000 in a district of 98000) is the area most urgently needing sewerage development The cost for this development is estimated at between HUF 12 and 16 billion Four storage tanks that pump sewage into the main system will have to be built The current plan is to begin construction in 1996 the schedule has been pushed back mostly because of financial considerations Sewage is still very much a priority investment for the district
The district hopes to have 30 percent of the cost covered by district resources 30 percent by the Capital City and 40 percent by a targeted subsidy (because Budapestapplied for the subsidy with the district the subsidy is worth an extra 10 percent of estimated cost) A cooperation agreement was required but because Budapest did not sign it the district has not yet applied for the subsidy
The Southern Pest Treatment Center is at capacity now and the new sewerage will not be able to be connected until the Center is expanded District XVIII feels confident that the expansion will be undertaken next year so the technical problem will be solved Budapest would take a loan for this project apparently the City Council is in favor of the project Even though the Treatment Center has not yet been expanded the FCSM has given the district their permit to begin construction
The gas network was recently completed in the same area funded throughneighborhood associations work was completed in 1993 The connection fee of HUF 46000 per household will take three years to pay off so that payments will stop in 1995 Even so the connection fee alone did not cover the total cost which came to about HUF 150000-200000 per property
If a connection fee for sewerage is set too high district officials are afraid somehouseholds may elect not to connect at all If more than 60 percent of households want to connect the district will begin construction but they risk having some households subsequently decide not to connect and withdraw their contributions District officials
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expect the connection fee to be HUF 60000-65000 the District will pay an additional HUF 15000 fee per household to cover the cost of preparing the technical construction plans
The Deputy Mayor assumes the district will have to take on debt and he believes the district would definitely approach various banks as OTP does not offer attractive terms A technical implementation report on the project has been prepared but it includes no work on financial returns
CURRENT SEWER INFRASTRUCTURE FINANCING PRACTICES
As described in the first section districts are responsible for the construction of sewer collection systems that once built are turned over to the Capital City Sewer Company for operation and maintenance The Capital City is responsible for construction of interceptor sewers and sewage treatment plants Once the infrastruc-ture is in place system stewardship is the responsibility of the Budapest Municipal Sewage Company (FCSM)
There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including
Central Government Targeted subsidies provided by the central government are used to finance construction of sewer collection systems Targeted subsides are matching grants given to districts on a competitive basis The level of funding provided by targeted subsides is 30 percent for sewer collection projects (40 percentif the application is made jointly by both the district and the Capital City) However the reliability of this revenue source to finance future sewer projects is subject to the priorities and conditions set by the Parliament as recommended by the Ministry of the Interior Therefore there is no assurance that targetedsubsidies can be used to finance sewer collection systems in the future2
1 It is noted that the central government provides addressed subsidies however sewer collection system financing is not an eligible use of such subsidies
Capital City The Capital City can contribute to the cost of district sewer construction projects However district projects mus conform to Capital City priorities to be considered for funding
21 For example in 1993 the amounts needed to fund all eligible projects exceed the grant monies budgeted by the central government so those projects are approved but local governments will receive funds two or three years from now
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District Own source revenues for sewer collection system construction and connections to properties in public ownership are derived from (1) allocations made through the annual local budget process derived from local taxes miscellaneous fees and intergovernmental transfers (eg normative subsidies) (2) sale or lease of district owned land and (3)mid-term borrowing (defined as 2-3 years) from OTP Loans are repaid from own source revenue in the form of proceeds from the sale or lease of district-owned land
Citizens Citizens contribute to the construction of sewer systems in two ways (1)through the creation of construction communities or neighborhood associations citizens pay a portion of the collection system construction cost and (2)connection fees
FINANCING OPTIONS
This is a period of intensive change in the ways in which the central governmentdistricts the Capital City and the recently privatized Budapest Municipal SewageCompany finance and maintain the municipal sewer system Existing capitalimprovements practices are woefully insufficient to meet current and future seweragecapital needs Reasons for this state of affairs include
Limited Financial Capacity
The lack of adequate own source revenue has a profound impact on limitingavailable funds necessary to finance sewage system expansion There is a great disparitybetween capital needs and the anticipated revenue available to meet these needs Sewer construction projects are very expensive Existing financing mechanisms are inadequate
Debt Financing Districts make limited use of debt financing When debt is issuedIt is for a 2 or 3 year period This short term debt financing places an undue burden on the districts limited financial resources and the present populationsability to amortize the debt The high cost of borrowing (27 percent interest) further exacerbates this problem as well as increasing the cost of capital development
Capital financing typically requires the issuance of long term debt (20 to 30 years)that roughly correlates to the useful life of the facility This method of financingalso is considered to be equitable to those who benefit from the system (egcitizens commerce industry) since each generation pays its fair share of the cost of the facility A long-life asset such as a sewer system should be paid for by its users throughout its normal life rather than all at once by those who may not have the use of it full term Even with higher cost due to interest if spread over a largenumber of userspayers the cost to all is lowered Given Hungarys high rate of inflation and thus ever increasing construction costs it may be cheaper to borrow and pay todays prices rather than wait and pay tomorrows prices Furthermorethe use of long term debt puts less financial pressure on the operating budget
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OperatingBudget (ie pay-as-you-go)There is some attempt to finance a portion of the cost of sewer improvements through the operating budget The operatingbudget is reliant on revenues derived from intergovernmental transfers and therefore provides very little fiscal flexibility to support capital development Furthermore there are no reserve accounts that may be used to set aside funds for future capital development or meet emergencies (It will be noted of course that with Hungarys high rate of inflation the reserve accounts will be rapidly eroded so it may be decided to keep them at a mintimum)
Typically the operating budget is not used to finance large scale capital projects such as sewer collection systems Annual appropriations tend to be used to pay for municipal operations and service Small scale projects equipment purchases and the repair of existing facilities may be funded through the operating budgetHowever the use of the operating budget to finance large capital projects should be frowned upon for the following reasons
It forces local officials to make extremely difficult choices between service
delivery government operations and capital expansion
It places a heavy burden on the budget for the project year
It creates awkward fluctuating expenditure cycles that do not occur with extended financing
Since funding is based on yearly increments the use of the operating budget helps foster an environment wherein projects often go uncompleted
Sale of Land Districts rely on the sale of land to raise revenue for infrastructure financing This raises several concerns First land is not liquid and its value is subject to market forces In a sagging market such as currently exists land priceshave eroded to the point where districts are unable to raise adequate capital through the sale of land to finance sewer construction Furthermore there are few entrepreneurs with adequate resources to buy land
A related issue is that the land being sold is not serviced by sewer and other infrastructure components The offering price most likely reflects the absence of infrastructure If the infrastructure were in place prior to the sale or lease of district-owned land the district would realize a greater return than it currently receives
Finally land is finite Districts should think carefully about diminishing this resource to finance capital investment particularly before the capital is in placeLater in this paper we describe financing mechanisms that should be considered as feasible alternatives Particular attention should be paid to the use of tax increment financing or other forms of betterment financing
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Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
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Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
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ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
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projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
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Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
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plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
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FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
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ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
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EXECUTIVE SUMMARY
Two proposed municipal infrastructure projects are analyzed in this reportinvestments in the sewer systems for the R area of Budapest District XVII and for the Pestszentimre area of Budapest District XVIII The aim was to assess both presentpractices and possible alternatives for financing these two projects within the context of current local responsibilities and capabilities The principal conclusions are that there are more options available than are currently considered and that assistance indeveloping certain skills could be useful to local governments facing these new responsibilities
In Budapest which consists of a capital city government and 22 district governments responsibility for construction ownership and maintenance of publicinfrastructure has been splintered among several entities competingand local governments Due in part to the large responsibilities placed on the capital governmentand the insufficiency of funds to respond in the short and medium term to the mostpressing needs some districts have sought to mitigate the lack of action by initiating and financing projects which would normally be in the domain of the capital
Sewage pipes connect 87-88 percent of households in Budapest although this isheavily concentrated in the center Districts XVII and XVIll have among the lowest levels of sewerage coverage in Budapest Sewage treatment is below the adequate level with less than 20 percent biologically treated
This review finds that existing capital improvements practices are woefullyinsufficient to meet current and future sewerage capital needs There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including targeted subsidies provided by the central government contributions from the Capital and own source revenues (including allocations made through the annual local budget process sale or lease of district owned land and mid-term borrowing(defined as 2-3 years) from OTP) citizens contribute through the creation of construction communities or neighborhood associations and connection fees
In addition to limited financial capacity inadequate intergovernmental coordination in a context of great diffusion of control among a range of government entities inhibits comprehensive capital planning programming and budgeting and there is no vehicle toresolve these differences Two other problems arise in connection with project financing(1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actuallyneeded Once project funding is in place project management often appears to beinadequate It does not seem that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users The current delinquency rate of 8 is generally not acceptable
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and the
Munidpal Strategies for InfrastnuctureFinance- The UrbanInstitute PannedSewage Projectsin Two BudapestDtstrcts Pageft
livabihty of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is the provision of technical assistance that will help local officials make smarter sewer and general capital investment and management decisions Areas proposed for assistance include the assessment of current financial sources such as connection fees long term debt taxation including property tax) and user fees along with alternative financing methods such as the creation of tax increment or betterment districts
General capital financing technical assistance to both districts and Capital City should include assistance in the development of a capital plan and budget costing and pricing enterprise management contract management and collaboration between the city and the districts At the central government level assistance should be provided to revise the current system of targeted grants and to consider more effective means to assist in local infrastructure investment
MUNICIPAL STRATEGIES FOR INFRASTRUCTURE FINANCE PLANNED SEWAGE PROJECTS IN TWO BUDAPEST DISTRICTS
INTRODUCTION
The responsibility for construction and maintenance of municipal infrastructureincluding water management drainage of rainwater and sewage transferred towas Hungarian local governments in 1990 by the Act on Local Self-Government In orderfor these tasks to be effectively undertaken the assets of state economic organizationsproviding these public utilities were likewise transferred to local governments2 These are new and demanding responsibilities for local governments In the past decades there has been considerable neglect of infrastructure investment in Hungary moreover localfinancial resources are already severely strained Since 1993 USAID has begun toprovide assistance to Hungarian local governments i meeting the need to finance infrastructure development
Two proposed municipal infrastructure projects are analyzed in this report the sewer system for the Rdkosliget area of Budapest District XVII and the sewer system forthe Pestszentimre area of Budapest District XVIII The aim is to assess present practicesand possible alternatives for financing these two investments within the context of current local responsibilities and capabilities The principal conclusions are that there are more options available than are currently considered and that assistance in developing certain skills could be useful to local governments facing these newresponsibilities We start by examining the specific responsibilities of Budapest districtsthe municipality the public works and the central government Then we describe the two proposed sewage projects and current financing practices Finally we propose areas for assistance
Act No LXV of 1990 Article 8(1)
2 Ibid Article 107(l)(b)
For a description of the broad scope of USAID assistance in this sector see Dowall HegedosMark and Tosics Establishing a Franwworkfor MunicipalTechnicalAssstanceinInfrastructure 1993
-7
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ENFRASTRUCTURE INVESTMENT RESPONSIBILITIES IN BUDAPEST
The city of Budapest comprises 23 local self-governments including the Capital Citygovernment (F6vdros) and the twenty-two districts According to Article 63 of the Act on local self-government the district governments of Budapest are mainly responsible for the provision of primary public services while the Capital government is responsible for tasks which affect the whole or a large part of the city
A separate law further defines the respective responsibilities of the Capital and of the districts4 Article 10 of this Act lists specific rights and duties of the capital citygovernment which includes provision of water gas and steam water regulation storm sewerage and channeling and the provision of potable water to the entire capital or its major portions Some of these duties may be transferred by the capital city to the district governments on two conditions that sufficient funds are provided for carrying out these services and that the district accepts this transfer5
In practice responsibility for construction ownership and maintenance of publicinfrastructure has been splintered among several entities and competing local governments This situation is further complicated by the ambiguity of legislative textsand by the transformation of the Budapest Sewerage Works (or FCSMI) which became a joint-stock company on 1 December 1993
As a res-it due in part to the large responsibilities placed on the capital government and the insufficiency of funds to respond in the short and medium term to the most pressing needs some districts have sought to mitigate the lack of action on the part of the capital by initiating and financing projects which would normally be in the domain of the capital
The fragmentation of responsibility for preparation of urban development and master plans between the capital and the districts may lead to conflicts in the realization of certain infrastructure projects The general assembly of the Capital formulates the urban development program and the general master plan for the capital city howeverthe views of the Government and of the districts must be solicited The basic plan for each district is determined by the district assembly in conformity with the generalmaster plan of the capital However the new Capital general master plan has not yetbeen finalized this fact has not deterred the districts from developing their own local development plans which may sometimes be in conflict with the general master plan8
4 Law XXIV of 1991 on the self-government of the capital city and of the capital city districts
5 Ibid Article 12
6 F6vdrosi Csatornmmzsi Mvek
7 Ibid Articles 8(4) and 11
8 According to the Budapest Department of Public Utility Works
Cl
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It is therefore difficult for the city to combat a possible Not in my backyard (NIMBY) mentality on the part of the districts as in the case of construction of a new sewerage treatment plant
In the case of the specific projects for Districts XVII and XVIII several actors are responsible for different phases of project planning financing construction and management These include the capital city the FCSM the districts neighborhood associations and construction communities and the Ministry of Transportation Communication and Water Management (MTCWM) The role of each of these actors is described below
THE BUDAPEST MUNICIPAL GOVERNMENT (FOVAROS)
The Capital City is responsible for formuiating development plans for the city For sewerage development a long-term plan through the year 2015 has been established However consultations were engaged with the Government the districts and the FCSM during the preparation of the plan For actual implementation an annual or a two-year development plan is prepared based on the stated objectives of the capital assembly Three current main priorities in the area of sewage are (1) increase in collection and carrying capacity of the sewerage main in North Pest (2) increase in capacity of the treatment plant in North Buda and (3) construction of a treatment plant in South Pest The investment projects of the districts in sewer networks generally have to be in conformity with the general development plan of the Capital City
District XVIIs sewage project is dependent on the achievement of priority 1 as the main collecting pipe from the district leads into the sewage main of North Pest District XVIIIs project is linked to construction of the South Pest treatment plant (priority 3) once the district networks have been built they may not be put into operation until completion of the treatment plant
The capital finances the construction of main sewerage lines treatment plants collection and pumping stations these projects involve new facilities and mains or the increase in capacity of existing plants The actual technical plans are prepared by the FCSM reviewed by the public utility works department of the Capital City and prescnted to the genera assembly
Project preparation in the capital follows the prescription of a decree passed in 19929 Requirements include the submission of a detailed plan the Assemblyto including cost estimates but no financing plan The General Assembly must vote approval on all projects over a cost of HUF 50 million The financial plans for the realization of the capital city projects may include the following resources targeted subsidies funds from the general capital city budget contributions from the districts
9 Decree No 121992
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loans participation by the FCSM and contributions from the beneficiaries (businesseshouseholds) In only one case has the city taken out a specific project-related loan-from EBRD for a sewage treatment center
For 1993 the sewer fee included a portion dedicated specifically to the financingof new investments (HUF 470m 3 ) This was the first time that a part of the fee has been specifically assigned to the financing of new investment This development portion of the fee was only in place for 1993 and was not renewed for 1994 The proposals for the use of the development portion of the fee were made by the public utility works department
Until 1 January 1994 the sewer fee was set by the MTCWM based on a proposalof the city the technical aspects of the proposal are prepared by the FCSM and approvedby the general assembly of the capital The Capital City was authorized to determine the sewer fee for the first time this January although guidelines have been set by theMTCWM The initial technical proposal is prepared by the Finance Department of the FCSM Nevertheless the final say on the actual price rests with the general assembly of the Capital For the new fee options under consideration were to multiply the current fee by a price index for the sector (which would lead to an estimated 20 percent increase but would exclude any specific investment portion) or to include different developmentcosts in the fee The new fee (HUF 20 plus 10 percent value-added tax) was introduced in April 1994 although FCSM had recommended a tee of HUF 215 No part of the sewer fee is allocated to investments in the network undertaken by the districts The FCSM also plans to introduce a flat sewage fee of HUF 200-500 in areas not serviced at present to cover the cleaning of septic tanks
Actual construction of the projects is managed by the FCSM as the principal contractor Nevertheless the public utility works department of the Capital monitors the ongoing works approves bills submitted by the contractor and sub-contractors and authorizes payment to the FCSM (who pays the sub-contractors) Every six months a project report on use of funds and the advance of work is presented to the generalassembly If there are Impor ant cost overruns or construction delays then a change of scope of the project must be approved by the general assembly Once the project has been completed the equipment is turned over to the FCSM which is responsible for maintenance repairs rehabilitation and replacement
THE FCSM
The FCSM was previously a state-owned enterprise and was transferred to the ownership of the capital city according to the provisions of the Local Self-Government Act From 1 January 1992 the ownership rights of the sewerage network were transferred to the capital city The assets were managed by FCSM but it appears that no fee for lease of these assets was paid to the Capital City
From 1 December 1993 the FCSM was transformed into a joint-stock companywholly-owned by the capital city Before the transformation of the company the budget
ii
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of the sewer works company was approved by the general assembly of the Capital In addition the Supervisory Board of 13 members was appointed by the general assemblyOn 1 December 1993 the FCSM was transformed into a joint-stock company wholly owned by the Capital city Under this structure the Supervisory Board of nine members-three from FCSM staff and six from the Assembly-will be responsible for approving the companys budget and al strategically important decisions
The assets relating to sewerage were the property of the Capital City but were transferred to the FCSM as of 1 December 1993 as part of the companys transformation First the assets were reassessed and their replacement value was determined to be HUF 70 billion a considerable increase from the HUF 20 billion previously estimated10 With the transformation these assets were transferred to the ownership of the joint-stock company
Any additional networks and additions to the system will also be transferred to the FCSM However according to provisions of the 1991 Accounting Act any network built privately is transferred at zero value thus preventing the company from taking any depreciation on the value of the stock
As a means of circumventing this problem the FCSM arranged to be assigned as both investor and builder However when targeted subsidies are used to finance part of the network such an arrangement becomes more difficult because the local government must be the investor
For sewer projects initiated by the districts the FCSM is responsible for reviewing the technical plans and giving an expert opinion before construction begins Upon completion of the equipment the FCSM will inspect the equipment for adherence to technical norms (such as pressure tests or camera inspections within the pipes) and will authorize operation of the network This authorization will depend on capacity of eidsting mains and treatment plants to handle a larger flow of effluent in the system Thus due to the saturation of the main pipes in North Pest new business and industrial connections will not be authorized until the capacity of this part of the network has been increased
The principal activity of the FCSM is the operation and maintenance of the sewerage system within the city of Budapest In addition reconstruction and rehabilitation of all existing pipes pumping stations and treatment plants are the responsibility of the company These activities (operation maintenance reconstruction) are financed through the sewage fee
o It is believed that the primary purpose of this revaluation was to Increase depreciation funds However the higher valuation may have an adverse effect on the prospects for privatization
I Based on a conversation with the Technical Department of the FCSM
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The fee is collected in part by the FCSM however a collecting company12 collectsft sfrom private homes and the Water Works Company collects fees from industrial users and rental housing Thus the FCSM only seems to directly collect the fees from individuals with water wells but who are connected to the sewer system This systemof collection often leads to delays of at least two months in receipt of fees the amount ofunpaid fees were estimated at HUF 500-600 million in June 1993 and in May 1994 at HUF 338 million of which HUF 240 million Is from residences Total receipts in 1993 were HUF 4-5 billion putting delinquencits at about 8 percent
THE DISTRICTS
De facto due to lack of funds in the face of so many pressing needs the districtshave been made responsible for the construction of the secondary sewerage network(pipes leading from homes and businesses to the main collecting pipes and the collection system) The connections leading from homes and businesses to the secondary network are financed by the beneficiaries but constructed by the districts
Once a district decides to undertake the construction of part of the sewer system a water authorization permit is required from the MTCWM An expert opinion on thetechnical plans must be solicited from the FCSM The district is responsible for raisingfunds for construction Sources of financing may include district own fundscontributions from the Capital City targeted grants grants from the national Water Development Fund contributions from the population and loans
The means of financing used for these projects often leads to inefficient use of resources as matching funds and grants must remain in the accounts until construction has actually commenced This is the case for both the districts and the Capital CityTargeted grants require matching funds from the district which must be kept in the local government account as proof that this requirement has been met If there are delays in the start of the project these funds are left unused instead of being appropriated for more immediate needs
In the same way contributions from the Capital City must be negotiated on a caseby case basis and success in obtaining them may depend on the extent to which theparticular project corresponds to the capital citys own priorities However if the districts do not commence work on the project in a timely manner the Capital City funds are alsolying unused in an account For this reason the Capital has placed conditions on projectconstruction start-up dates if these requirements are not respected the districts may
This company was recently privatized through an employee share purchasing program It collects all utilities and municipal housing rents In Budapest for a fee of 3 to 4 percent of collections Recentlythe electricity company ended the contract and makes Its own collections while th gas company hascontracted out to other private companies in certain districts although their collections fees are muchhigher The Collection Company is currently in the process of revising its contractual relationshipswith its clients
12
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lose the grant For example District XVII received a promise of a HUF 14 million grant for the Rkosliget sewer project on condition that construction commenced by 1 December 1993
Appropriate financial products are currently not available to local governments for financing long-term investments such as sewer networks 3 For the moment the districts do not have access to the sewer fee which would enable them to appropriate part of this user fee for the reimbursement of debt Thus districts have placed heavyreliance on up-front population contributions through neighborhood associations and construction communities to finance part of secondary networks (and sometimef- the main networks) in addition to direct household connections to the network ----se connection fees are the only user charge to which districts have access As there o legal restriction on the level of the connection fee the only consideration in settin e fee is affordability
The construction of the project is monitored by the district Once completed technical certification of the equipment is required by the FCSM (pumping test and verification of pipes with a camera) If the results of these verifications are unsatisfactory then the operation of the pipes will not be authorized by the FCSM 4 If the FCSM grants approval the entire network is transferred to the Sewer Works Company which is responsible for operation maintenance rehabilitation and replacement of the equipment
NEIGHBORHOOD ASSOCIATIONS AND CONSTRUCTION COMMUNITIES
Under the previous system in order fc - neighbor-ods and towns to obtain quicker connections to public utilities organizea forms G population participation were developed these methods of financing infrastructure have continued and may take the form of a neighborhood association or a construction community
Neighborhood associations (ktzmitdrsulds) for the financing of infrastructure network- are formed when at least 66 percent of the residents of a neighborhood agree to their creation membership is open to all residents and contributions to the cost of infrastructure investment is compulsory Membership entitles residents to receive five-to seven year loans from OTP with 70 percent of the interest subsidized by the central
13 See Hegedes Mark Pigey Municipal Lending in Hungary March 1993
This has posed a problem for District XVII in 1993 30 kilometers of pipes of 40 constructed failed the camera verification test however the contractors had already been paid before this verification The District is unable to pave the roads or put system into operation until the pipes are repaired to satisfactory condition
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government 5 Through these loans investment funds are available up front to the district and it is the OTP which takes the credit risk
The members of the association appoint a steering committee (or an executiveboard) which works with the district issues tenders and selects the contractor The amount of contributions by members is assessed by the committee and any remainingfunds available after construction may be redistributed to the residents The committee also defines the contributions of new members
Construction communities (6pit6kbzOss~g) are a more flexible form of populationparticipation as they are not legal entities and have no right to sign contracts in their own name The community elects an executive board this board will work with the local government during construction in terms of choosing a constructor monitoringrealization countersigning contracts and bills However the legal investor is the local government This form of construction is used in District XVII
A separate account is established for the investment and members of theconstruction community pay their contributions into the account as the work proceedsIndividuals may contract loans to finance their contribution but these are at market rates and not the subsidized loans available to members of neighborhood associations Thus the district takes a credit risk and there are cases where members have not been able to pay the full amount of their assessed participation
In interviews with Districts XVII and XVIII it has often been stated that households have reached the limits of their capacity to contribute to financing the sewage network This system of financing is not limited to capital investments in sewer networks but has also been used to finance other public utilities such as potable water gas connections and telephone lines
Although districts do receive a portion of the personal income tax (for which there is a specific distribution formula between the capital city and the districts and among the districts) the actual incomes of the district populations are not known with precisionIn order for the district governments to better Judge the capacity of their population tocontribute both now and in the future small surveys of the population of selected areas in the district may be useful Such surveys may help to establish the level of incomesand expenditures as well as assess a realistic burden for construction and developmentlees or local taxes
15 In January 1994 subsidies for direct household loans for utility connections were terminated making the neighborhood association loans the only remaining subsidy for utility connections
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MINISTRY OF TRANSPORTATION COMMUNICATION AND WATER MANAGEMENT (MTCWM)
The Ministry of Transportation Communication and Water Management must approve all projects in Hungary relating to water no sewerage project may go forward without first obtaining the water authorization permit from this Ministry
Until 1 January 1994 the Miniszry also played a role in setting the water and sewer tariffs According to the 1990 Act on Prices the fee must include the expenses of efficient operation and the profit required for efficient operation although no definition of efficiency or provisions for monitoring are included in the Act
The final allowed price was set by the Ministry based on tariffs proposed by the sewer company and the Capital City From the beginning of 1994 the pricing of sewer services has been completely devolved to the city of Budapest although the Ministry has set non-binding guidelines for fees
PROPOSED SEWAGE INVESTMENTS
SEWAGE DEVELOPMENT NEEDS IN DISTRICTS XVII AND XVIII
Citywide there are 4000 km of sewage pipes connecting approximately 88 percentof households in Budapest although this is heavily concentrated in the center so that
8outer districts have only about 50 to 60 percent coverage 1 Sewage treatment is below the adequate level FCSM estimates that 80 percent of sewage receives mechanical treatment but less than 20 percent is biologically treated
Districts XVII and XVIII have among the lowest levels of sewerage coverage in Budapest but according to the FCSM Investment Department District XVII is worse off because in District XVIII only one area (Pestszentimre) is badly underserviced Both district governments list sewerage as their most pressing infrastructure developmentneed and both have projects planned which they hope to address in the near future
District XVII
District XVII has a split sewage system-ie two separate subsystems for sewageand storm water collection-and has a big deficit in both systems The district has
1039a comprehensive sewage construction plan with an estimated total cost of HUF billion which has already been begun A first task to lay a network in Rakosliget and Rakoscsaba uJtelep has already been partially completed although some difficulties with the contractor left the laid pipes not ready for use The result was that the municipal sewer company (FCSM) refused to accept the pipes and the district has had to ask the city for a special grant of HUF 80 million 8 to complete the work and repave the roads under a new contract
The plan calls for three additional phases of construction the first part will be to construct sewerage in the most urgent areas (the district center and RAkoscsaba) the second is to complete a parallel principal main which is a precondition for expanding the network and the third is to connect some other areas to the system Phase I to construct about 30 kilometers in Rakoscsaba was begun in early 1994
Targeted subsidies have already been granted for the sewage projectHUF 285 million for 1993 and HUF 21 million for 1994 In both cases despite approvalthe district will receive funds one year later because of central budget limitations The local assembly also has approved the local portion of funding (30 percent of the originalcost estimate) which comes from the social normative grant but the schedule has to be
16 For the outer districts the 1992 flgures are 76-78 percent coverage (districts XV and l) 50-60 percent (XVIII MX and XXI) and 41-43 percent (XVII and XVI)
17 As is the case for most outer areas in Budapest
1s This grant was obtained in return for permission for the Capital City to use the districts landfill
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rethought One difficulty is that because they could not start construction before 1 December 1993 they forfeited the promised HUF 14 million from the City
In some ways storm water collection is a more urgent problem in the district and financially more problematic because no targeted subsidies are available and because it is impossible to charge the public directly for any portion of the development costs The district plans to build a series of ditches for storm water collecting water in one location but because these are open the Sewage Company will not operate them
The district assembly has approved sewerage construction plans but has not actually appropriated the money 9 so that the district has not been able to apply for some other available subsidies One such potential subsidy comes from the Water Management Fund which requires a permit from the water authority As the permit expires in two years the district will probably have to reapply because they may not be able to begin construction of the next phase within two years
One portion of the district contribution is paying the value-added tax portion of the connections (Until January 1993 this amount at 25 percent of cost would have been refunded by the central government) There is a preliminary agreement between the FCSM and the districts that starting 1 January 1994 the FCSM will pay the VAT and be reimbursed by the central government
Citizens contributions will have to make up a larger proportion than foreseen (probably 60 percent instead of 40 percent) A neighborhood association has already been formed in RiLkosllget two construction communities (one of over 700 households) have been formed for the Rakoscsaba work Conditions for households have changed considerably as of January 1994 because the 50 percent subsidies on utility connection loans are no longer available The district is therefore allowing those households unable to pay up front to pay in installments with no interest
Enterprises of course can be - arged higher connection fees and the district wants to use those to cross-subsidize household connections The district Public Utilities Division believes enterprises could be charged up to HUF 1 billion for the sewage development contribution plus HUF 80 million for the actual connection
District XVII has no outstanding loans nor do they levy any local taxes at present They do not have committees or a project preparation unit set up to work on cost of projects instead the technical department alone has put this project together There will be some political difficulties in getting this project approved because those in housing estates which are already connected to the sewage system and who represent the bulk
Not all assembly representatives heartily endorse the plan moreover the assembly did not think the central government would grant the targeted subsidy
20 This may be a problem at some point as when capacity problems exist the FCSM has indicated that it may grant permits for connection only to households and not to enterprises
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of the voting power will be opposed to the expenditure This same argument was used to explain why the council would be opposed to incurring debt although it is possiblethat debt could be structured to be repaid by the benefiting area only
The district does not have solid data on incomes but there is a general sense that probably only 20 percent of households can afford the sewage connection at HUF 30000shy40000 those who cannot would have to be subsidized by the local government byreceiving interest-free loans
DistrictXV37
District XVIII has almost the lowest per capita income in Budapest (it ranks 18th among the 22 districts) it is fourth in area seventh in population and only district XVII has less sewerage coverage according to the Deputy Mayor
Pestszentimre a neighborhood of mostly single-family houses containing about one quarter of district households (a population of 25000 in a district of 98000) is the area most urgently needing sewerage development The cost for this development is estimated at between HUF 12 and 16 billion Four storage tanks that pump sewage into the main system will have to be built The current plan is to begin construction in 1996 the schedule has been pushed back mostly because of financial considerations Sewage is still very much a priority investment for the district
The district hopes to have 30 percent of the cost covered by district resources 30 percent by the Capital City and 40 percent by a targeted subsidy (because Budapestapplied for the subsidy with the district the subsidy is worth an extra 10 percent of estimated cost) A cooperation agreement was required but because Budapest did not sign it the district has not yet applied for the subsidy
The Southern Pest Treatment Center is at capacity now and the new sewerage will not be able to be connected until the Center is expanded District XVIII feels confident that the expansion will be undertaken next year so the technical problem will be solved Budapest would take a loan for this project apparently the City Council is in favor of the project Even though the Treatment Center has not yet been expanded the FCSM has given the district their permit to begin construction
The gas network was recently completed in the same area funded throughneighborhood associations work was completed in 1993 The connection fee of HUF 46000 per household will take three years to pay off so that payments will stop in 1995 Even so the connection fee alone did not cover the total cost which came to about HUF 150000-200000 per property
If a connection fee for sewerage is set too high district officials are afraid somehouseholds may elect not to connect at all If more than 60 percent of households want to connect the district will begin construction but they risk having some households subsequently decide not to connect and withdraw their contributions District officials
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expect the connection fee to be HUF 60000-65000 the District will pay an additional HUF 15000 fee per household to cover the cost of preparing the technical construction plans
The Deputy Mayor assumes the district will have to take on debt and he believes the district would definitely approach various banks as OTP does not offer attractive terms A technical implementation report on the project has been prepared but it includes no work on financial returns
CURRENT SEWER INFRASTRUCTURE FINANCING PRACTICES
As described in the first section districts are responsible for the construction of sewer collection systems that once built are turned over to the Capital City Sewer Company for operation and maintenance The Capital City is responsible for construction of interceptor sewers and sewage treatment plants Once the infrastruc-ture is in place system stewardship is the responsibility of the Budapest Municipal Sewage Company (FCSM)
There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including
Central Government Targeted subsidies provided by the central government are used to finance construction of sewer collection systems Targeted subsides are matching grants given to districts on a competitive basis The level of funding provided by targeted subsides is 30 percent for sewer collection projects (40 percentif the application is made jointly by both the district and the Capital City) However the reliability of this revenue source to finance future sewer projects is subject to the priorities and conditions set by the Parliament as recommended by the Ministry of the Interior Therefore there is no assurance that targetedsubsidies can be used to finance sewer collection systems in the future2
1 It is noted that the central government provides addressed subsidies however sewer collection system financing is not an eligible use of such subsidies
Capital City The Capital City can contribute to the cost of district sewer construction projects However district projects mus conform to Capital City priorities to be considered for funding
21 For example in 1993 the amounts needed to fund all eligible projects exceed the grant monies budgeted by the central government so those projects are approved but local governments will receive funds two or three years from now
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District Own source revenues for sewer collection system construction and connections to properties in public ownership are derived from (1) allocations made through the annual local budget process derived from local taxes miscellaneous fees and intergovernmental transfers (eg normative subsidies) (2) sale or lease of district owned land and (3)mid-term borrowing (defined as 2-3 years) from OTP Loans are repaid from own source revenue in the form of proceeds from the sale or lease of district-owned land
Citizens Citizens contribute to the construction of sewer systems in two ways (1)through the creation of construction communities or neighborhood associations citizens pay a portion of the collection system construction cost and (2)connection fees
FINANCING OPTIONS
This is a period of intensive change in the ways in which the central governmentdistricts the Capital City and the recently privatized Budapest Municipal SewageCompany finance and maintain the municipal sewer system Existing capitalimprovements practices are woefully insufficient to meet current and future seweragecapital needs Reasons for this state of affairs include
Limited Financial Capacity
The lack of adequate own source revenue has a profound impact on limitingavailable funds necessary to finance sewage system expansion There is a great disparitybetween capital needs and the anticipated revenue available to meet these needs Sewer construction projects are very expensive Existing financing mechanisms are inadequate
Debt Financing Districts make limited use of debt financing When debt is issuedIt is for a 2 or 3 year period This short term debt financing places an undue burden on the districts limited financial resources and the present populationsability to amortize the debt The high cost of borrowing (27 percent interest) further exacerbates this problem as well as increasing the cost of capital development
Capital financing typically requires the issuance of long term debt (20 to 30 years)that roughly correlates to the useful life of the facility This method of financingalso is considered to be equitable to those who benefit from the system (egcitizens commerce industry) since each generation pays its fair share of the cost of the facility A long-life asset such as a sewer system should be paid for by its users throughout its normal life rather than all at once by those who may not have the use of it full term Even with higher cost due to interest if spread over a largenumber of userspayers the cost to all is lowered Given Hungarys high rate of inflation and thus ever increasing construction costs it may be cheaper to borrow and pay todays prices rather than wait and pay tomorrows prices Furthermorethe use of long term debt puts less financial pressure on the operating budget
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OperatingBudget (ie pay-as-you-go)There is some attempt to finance a portion of the cost of sewer improvements through the operating budget The operatingbudget is reliant on revenues derived from intergovernmental transfers and therefore provides very little fiscal flexibility to support capital development Furthermore there are no reserve accounts that may be used to set aside funds for future capital development or meet emergencies (It will be noted of course that with Hungarys high rate of inflation the reserve accounts will be rapidly eroded so it may be decided to keep them at a mintimum)
Typically the operating budget is not used to finance large scale capital projects such as sewer collection systems Annual appropriations tend to be used to pay for municipal operations and service Small scale projects equipment purchases and the repair of existing facilities may be funded through the operating budgetHowever the use of the operating budget to finance large capital projects should be frowned upon for the following reasons
It forces local officials to make extremely difficult choices between service
delivery government operations and capital expansion
It places a heavy burden on the budget for the project year
It creates awkward fluctuating expenditure cycles that do not occur with extended financing
Since funding is based on yearly increments the use of the operating budget helps foster an environment wherein projects often go uncompleted
Sale of Land Districts rely on the sale of land to raise revenue for infrastructure financing This raises several concerns First land is not liquid and its value is subject to market forces In a sagging market such as currently exists land priceshave eroded to the point where districts are unable to raise adequate capital through the sale of land to finance sewer construction Furthermore there are few entrepreneurs with adequate resources to buy land
A related issue is that the land being sold is not serviced by sewer and other infrastructure components The offering price most likely reflects the absence of infrastructure If the infrastructure were in place prior to the sale or lease of district-owned land the district would realize a greater return than it currently receives
Finally land is finite Districts should think carefully about diminishing this resource to finance capital investment particularly before the capital is in placeLater in this paper we describe financing mechanisms that should be considered as feasible alternatives Particular attention should be paid to the use of tax increment financing or other forms of betterment financing
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Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
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Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
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ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
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projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
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Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
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plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
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FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
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ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
EXECUTIVE SUMMARY
Two proposed municipal infrastructure projects are analyzed in this reportinvestments in the sewer systems for the R area of Budapest District XVII and for the Pestszentimre area of Budapest District XVIII The aim was to assess both presentpractices and possible alternatives for financing these two projects within the context of current local responsibilities and capabilities The principal conclusions are that there are more options available than are currently considered and that assistance indeveloping certain skills could be useful to local governments facing these new responsibilities
In Budapest which consists of a capital city government and 22 district governments responsibility for construction ownership and maintenance of publicinfrastructure has been splintered among several entities competingand local governments Due in part to the large responsibilities placed on the capital governmentand the insufficiency of funds to respond in the short and medium term to the mostpressing needs some districts have sought to mitigate the lack of action by initiating and financing projects which would normally be in the domain of the capital
Sewage pipes connect 87-88 percent of households in Budapest although this isheavily concentrated in the center Districts XVII and XVIll have among the lowest levels of sewerage coverage in Budapest Sewage treatment is below the adequate level with less than 20 percent biologically treated
This review finds that existing capital improvements practices are woefullyinsufficient to meet current and future sewerage capital needs There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including targeted subsidies provided by the central government contributions from the Capital and own source revenues (including allocations made through the annual local budget process sale or lease of district owned land and mid-term borrowing(defined as 2-3 years) from OTP) citizens contribute through the creation of construction communities or neighborhood associations and connection fees
In addition to limited financial capacity inadequate intergovernmental coordination in a context of great diffusion of control among a range of government entities inhibits comprehensive capital planning programming and budgeting and there is no vehicle toresolve these differences Two other problems arise in connection with project financing(1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actuallyneeded Once project funding is in place project management often appears to beinadequate It does not seem that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users The current delinquency rate of 8 is generally not acceptable
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and the
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livabihty of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is the provision of technical assistance that will help local officials make smarter sewer and general capital investment and management decisions Areas proposed for assistance include the assessment of current financial sources such as connection fees long term debt taxation including property tax) and user fees along with alternative financing methods such as the creation of tax increment or betterment districts
General capital financing technical assistance to both districts and Capital City should include assistance in the development of a capital plan and budget costing and pricing enterprise management contract management and collaboration between the city and the districts At the central government level assistance should be provided to revise the current system of targeted grants and to consider more effective means to assist in local infrastructure investment
MUNICIPAL STRATEGIES FOR INFRASTRUCTURE FINANCE PLANNED SEWAGE PROJECTS IN TWO BUDAPEST DISTRICTS
INTRODUCTION
The responsibility for construction and maintenance of municipal infrastructureincluding water management drainage of rainwater and sewage transferred towas Hungarian local governments in 1990 by the Act on Local Self-Government In orderfor these tasks to be effectively undertaken the assets of state economic organizationsproviding these public utilities were likewise transferred to local governments2 These are new and demanding responsibilities for local governments In the past decades there has been considerable neglect of infrastructure investment in Hungary moreover localfinancial resources are already severely strained Since 1993 USAID has begun toprovide assistance to Hungarian local governments i meeting the need to finance infrastructure development
Two proposed municipal infrastructure projects are analyzed in this report the sewer system for the Rdkosliget area of Budapest District XVII and the sewer system forthe Pestszentimre area of Budapest District XVIII The aim is to assess present practicesand possible alternatives for financing these two investments within the context of current local responsibilities and capabilities The principal conclusions are that there are more options available than are currently considered and that assistance in developing certain skills could be useful to local governments facing these newresponsibilities We start by examining the specific responsibilities of Budapest districtsthe municipality the public works and the central government Then we describe the two proposed sewage projects and current financing practices Finally we propose areas for assistance
Act No LXV of 1990 Article 8(1)
2 Ibid Article 107(l)(b)
For a description of the broad scope of USAID assistance in this sector see Dowall HegedosMark and Tosics Establishing a Franwworkfor MunicipalTechnicalAssstanceinInfrastructure 1993
-7
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ENFRASTRUCTURE INVESTMENT RESPONSIBILITIES IN BUDAPEST
The city of Budapest comprises 23 local self-governments including the Capital Citygovernment (F6vdros) and the twenty-two districts According to Article 63 of the Act on local self-government the district governments of Budapest are mainly responsible for the provision of primary public services while the Capital government is responsible for tasks which affect the whole or a large part of the city
A separate law further defines the respective responsibilities of the Capital and of the districts4 Article 10 of this Act lists specific rights and duties of the capital citygovernment which includes provision of water gas and steam water regulation storm sewerage and channeling and the provision of potable water to the entire capital or its major portions Some of these duties may be transferred by the capital city to the district governments on two conditions that sufficient funds are provided for carrying out these services and that the district accepts this transfer5
In practice responsibility for construction ownership and maintenance of publicinfrastructure has been splintered among several entities and competing local governments This situation is further complicated by the ambiguity of legislative textsand by the transformation of the Budapest Sewerage Works (or FCSMI) which became a joint-stock company on 1 December 1993
As a res-it due in part to the large responsibilities placed on the capital government and the insufficiency of funds to respond in the short and medium term to the most pressing needs some districts have sought to mitigate the lack of action on the part of the capital by initiating and financing projects which would normally be in the domain of the capital
The fragmentation of responsibility for preparation of urban development and master plans between the capital and the districts may lead to conflicts in the realization of certain infrastructure projects The general assembly of the Capital formulates the urban development program and the general master plan for the capital city howeverthe views of the Government and of the districts must be solicited The basic plan for each district is determined by the district assembly in conformity with the generalmaster plan of the capital However the new Capital general master plan has not yetbeen finalized this fact has not deterred the districts from developing their own local development plans which may sometimes be in conflict with the general master plan8
4 Law XXIV of 1991 on the self-government of the capital city and of the capital city districts
5 Ibid Article 12
6 F6vdrosi Csatornmmzsi Mvek
7 Ibid Articles 8(4) and 11
8 According to the Budapest Department of Public Utility Works
Cl
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It is therefore difficult for the city to combat a possible Not in my backyard (NIMBY) mentality on the part of the districts as in the case of construction of a new sewerage treatment plant
In the case of the specific projects for Districts XVII and XVIII several actors are responsible for different phases of project planning financing construction and management These include the capital city the FCSM the districts neighborhood associations and construction communities and the Ministry of Transportation Communication and Water Management (MTCWM) The role of each of these actors is described below
THE BUDAPEST MUNICIPAL GOVERNMENT (FOVAROS)
The Capital City is responsible for formuiating development plans for the city For sewerage development a long-term plan through the year 2015 has been established However consultations were engaged with the Government the districts and the FCSM during the preparation of the plan For actual implementation an annual or a two-year development plan is prepared based on the stated objectives of the capital assembly Three current main priorities in the area of sewage are (1) increase in collection and carrying capacity of the sewerage main in North Pest (2) increase in capacity of the treatment plant in North Buda and (3) construction of a treatment plant in South Pest The investment projects of the districts in sewer networks generally have to be in conformity with the general development plan of the Capital City
District XVIIs sewage project is dependent on the achievement of priority 1 as the main collecting pipe from the district leads into the sewage main of North Pest District XVIIIs project is linked to construction of the South Pest treatment plant (priority 3) once the district networks have been built they may not be put into operation until completion of the treatment plant
The capital finances the construction of main sewerage lines treatment plants collection and pumping stations these projects involve new facilities and mains or the increase in capacity of existing plants The actual technical plans are prepared by the FCSM reviewed by the public utility works department of the Capital City and prescnted to the genera assembly
Project preparation in the capital follows the prescription of a decree passed in 19929 Requirements include the submission of a detailed plan the Assemblyto including cost estimates but no financing plan The General Assembly must vote approval on all projects over a cost of HUF 50 million The financial plans for the realization of the capital city projects may include the following resources targeted subsidies funds from the general capital city budget contributions from the districts
9 Decree No 121992
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loans participation by the FCSM and contributions from the beneficiaries (businesseshouseholds) In only one case has the city taken out a specific project-related loan-from EBRD for a sewage treatment center
For 1993 the sewer fee included a portion dedicated specifically to the financingof new investments (HUF 470m 3 ) This was the first time that a part of the fee has been specifically assigned to the financing of new investment This development portion of the fee was only in place for 1993 and was not renewed for 1994 The proposals for the use of the development portion of the fee were made by the public utility works department
Until 1 January 1994 the sewer fee was set by the MTCWM based on a proposalof the city the technical aspects of the proposal are prepared by the FCSM and approvedby the general assembly of the capital The Capital City was authorized to determine the sewer fee for the first time this January although guidelines have been set by theMTCWM The initial technical proposal is prepared by the Finance Department of the FCSM Nevertheless the final say on the actual price rests with the general assembly of the Capital For the new fee options under consideration were to multiply the current fee by a price index for the sector (which would lead to an estimated 20 percent increase but would exclude any specific investment portion) or to include different developmentcosts in the fee The new fee (HUF 20 plus 10 percent value-added tax) was introduced in April 1994 although FCSM had recommended a tee of HUF 215 No part of the sewer fee is allocated to investments in the network undertaken by the districts The FCSM also plans to introduce a flat sewage fee of HUF 200-500 in areas not serviced at present to cover the cleaning of septic tanks
Actual construction of the projects is managed by the FCSM as the principal contractor Nevertheless the public utility works department of the Capital monitors the ongoing works approves bills submitted by the contractor and sub-contractors and authorizes payment to the FCSM (who pays the sub-contractors) Every six months a project report on use of funds and the advance of work is presented to the generalassembly If there are Impor ant cost overruns or construction delays then a change of scope of the project must be approved by the general assembly Once the project has been completed the equipment is turned over to the FCSM which is responsible for maintenance repairs rehabilitation and replacement
THE FCSM
The FCSM was previously a state-owned enterprise and was transferred to the ownership of the capital city according to the provisions of the Local Self-Government Act From 1 January 1992 the ownership rights of the sewerage network were transferred to the capital city The assets were managed by FCSM but it appears that no fee for lease of these assets was paid to the Capital City
From 1 December 1993 the FCSM was transformed into a joint-stock companywholly-owned by the capital city Before the transformation of the company the budget
ii
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of the sewer works company was approved by the general assembly of the Capital In addition the Supervisory Board of 13 members was appointed by the general assemblyOn 1 December 1993 the FCSM was transformed into a joint-stock company wholly owned by the Capital city Under this structure the Supervisory Board of nine members-three from FCSM staff and six from the Assembly-will be responsible for approving the companys budget and al strategically important decisions
The assets relating to sewerage were the property of the Capital City but were transferred to the FCSM as of 1 December 1993 as part of the companys transformation First the assets were reassessed and their replacement value was determined to be HUF 70 billion a considerable increase from the HUF 20 billion previously estimated10 With the transformation these assets were transferred to the ownership of the joint-stock company
Any additional networks and additions to the system will also be transferred to the FCSM However according to provisions of the 1991 Accounting Act any network built privately is transferred at zero value thus preventing the company from taking any depreciation on the value of the stock
As a means of circumventing this problem the FCSM arranged to be assigned as both investor and builder However when targeted subsidies are used to finance part of the network such an arrangement becomes more difficult because the local government must be the investor
For sewer projects initiated by the districts the FCSM is responsible for reviewing the technical plans and giving an expert opinion before construction begins Upon completion of the equipment the FCSM will inspect the equipment for adherence to technical norms (such as pressure tests or camera inspections within the pipes) and will authorize operation of the network This authorization will depend on capacity of eidsting mains and treatment plants to handle a larger flow of effluent in the system Thus due to the saturation of the main pipes in North Pest new business and industrial connections will not be authorized until the capacity of this part of the network has been increased
The principal activity of the FCSM is the operation and maintenance of the sewerage system within the city of Budapest In addition reconstruction and rehabilitation of all existing pipes pumping stations and treatment plants are the responsibility of the company These activities (operation maintenance reconstruction) are financed through the sewage fee
o It is believed that the primary purpose of this revaluation was to Increase depreciation funds However the higher valuation may have an adverse effect on the prospects for privatization
I Based on a conversation with the Technical Department of the FCSM
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The fee is collected in part by the FCSM however a collecting company12 collectsft sfrom private homes and the Water Works Company collects fees from industrial users and rental housing Thus the FCSM only seems to directly collect the fees from individuals with water wells but who are connected to the sewer system This systemof collection often leads to delays of at least two months in receipt of fees the amount ofunpaid fees were estimated at HUF 500-600 million in June 1993 and in May 1994 at HUF 338 million of which HUF 240 million Is from residences Total receipts in 1993 were HUF 4-5 billion putting delinquencits at about 8 percent
THE DISTRICTS
De facto due to lack of funds in the face of so many pressing needs the districtshave been made responsible for the construction of the secondary sewerage network(pipes leading from homes and businesses to the main collecting pipes and the collection system) The connections leading from homes and businesses to the secondary network are financed by the beneficiaries but constructed by the districts
Once a district decides to undertake the construction of part of the sewer system a water authorization permit is required from the MTCWM An expert opinion on thetechnical plans must be solicited from the FCSM The district is responsible for raisingfunds for construction Sources of financing may include district own fundscontributions from the Capital City targeted grants grants from the national Water Development Fund contributions from the population and loans
The means of financing used for these projects often leads to inefficient use of resources as matching funds and grants must remain in the accounts until construction has actually commenced This is the case for both the districts and the Capital CityTargeted grants require matching funds from the district which must be kept in the local government account as proof that this requirement has been met If there are delays in the start of the project these funds are left unused instead of being appropriated for more immediate needs
In the same way contributions from the Capital City must be negotiated on a caseby case basis and success in obtaining them may depend on the extent to which theparticular project corresponds to the capital citys own priorities However if the districts do not commence work on the project in a timely manner the Capital City funds are alsolying unused in an account For this reason the Capital has placed conditions on projectconstruction start-up dates if these requirements are not respected the districts may
This company was recently privatized through an employee share purchasing program It collects all utilities and municipal housing rents In Budapest for a fee of 3 to 4 percent of collections Recentlythe electricity company ended the contract and makes Its own collections while th gas company hascontracted out to other private companies in certain districts although their collections fees are muchhigher The Collection Company is currently in the process of revising its contractual relationshipswith its clients
12
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lose the grant For example District XVII received a promise of a HUF 14 million grant for the Rkosliget sewer project on condition that construction commenced by 1 December 1993
Appropriate financial products are currently not available to local governments for financing long-term investments such as sewer networks 3 For the moment the districts do not have access to the sewer fee which would enable them to appropriate part of this user fee for the reimbursement of debt Thus districts have placed heavyreliance on up-front population contributions through neighborhood associations and construction communities to finance part of secondary networks (and sometimef- the main networks) in addition to direct household connections to the network ----se connection fees are the only user charge to which districts have access As there o legal restriction on the level of the connection fee the only consideration in settin e fee is affordability
The construction of the project is monitored by the district Once completed technical certification of the equipment is required by the FCSM (pumping test and verification of pipes with a camera) If the results of these verifications are unsatisfactory then the operation of the pipes will not be authorized by the FCSM 4 If the FCSM grants approval the entire network is transferred to the Sewer Works Company which is responsible for operation maintenance rehabilitation and replacement of the equipment
NEIGHBORHOOD ASSOCIATIONS AND CONSTRUCTION COMMUNITIES
Under the previous system in order fc - neighbor-ods and towns to obtain quicker connections to public utilities organizea forms G population participation were developed these methods of financing infrastructure have continued and may take the form of a neighborhood association or a construction community
Neighborhood associations (ktzmitdrsulds) for the financing of infrastructure network- are formed when at least 66 percent of the residents of a neighborhood agree to their creation membership is open to all residents and contributions to the cost of infrastructure investment is compulsory Membership entitles residents to receive five-to seven year loans from OTP with 70 percent of the interest subsidized by the central
13 See Hegedes Mark Pigey Municipal Lending in Hungary March 1993
This has posed a problem for District XVII in 1993 30 kilometers of pipes of 40 constructed failed the camera verification test however the contractors had already been paid before this verification The District is unable to pave the roads or put system into operation until the pipes are repaired to satisfactory condition
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government 5 Through these loans investment funds are available up front to the district and it is the OTP which takes the credit risk
The members of the association appoint a steering committee (or an executiveboard) which works with the district issues tenders and selects the contractor The amount of contributions by members is assessed by the committee and any remainingfunds available after construction may be redistributed to the residents The committee also defines the contributions of new members
Construction communities (6pit6kbzOss~g) are a more flexible form of populationparticipation as they are not legal entities and have no right to sign contracts in their own name The community elects an executive board this board will work with the local government during construction in terms of choosing a constructor monitoringrealization countersigning contracts and bills However the legal investor is the local government This form of construction is used in District XVII
A separate account is established for the investment and members of theconstruction community pay their contributions into the account as the work proceedsIndividuals may contract loans to finance their contribution but these are at market rates and not the subsidized loans available to members of neighborhood associations Thus the district takes a credit risk and there are cases where members have not been able to pay the full amount of their assessed participation
In interviews with Districts XVII and XVIII it has often been stated that households have reached the limits of their capacity to contribute to financing the sewage network This system of financing is not limited to capital investments in sewer networks but has also been used to finance other public utilities such as potable water gas connections and telephone lines
Although districts do receive a portion of the personal income tax (for which there is a specific distribution formula between the capital city and the districts and among the districts) the actual incomes of the district populations are not known with precisionIn order for the district governments to better Judge the capacity of their population tocontribute both now and in the future small surveys of the population of selected areas in the district may be useful Such surveys may help to establish the level of incomesand expenditures as well as assess a realistic burden for construction and developmentlees or local taxes
15 In January 1994 subsidies for direct household loans for utility connections were terminated making the neighborhood association loans the only remaining subsidy for utility connections
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MINISTRY OF TRANSPORTATION COMMUNICATION AND WATER MANAGEMENT (MTCWM)
The Ministry of Transportation Communication and Water Management must approve all projects in Hungary relating to water no sewerage project may go forward without first obtaining the water authorization permit from this Ministry
Until 1 January 1994 the Miniszry also played a role in setting the water and sewer tariffs According to the 1990 Act on Prices the fee must include the expenses of efficient operation and the profit required for efficient operation although no definition of efficiency or provisions for monitoring are included in the Act
The final allowed price was set by the Ministry based on tariffs proposed by the sewer company and the Capital City From the beginning of 1994 the pricing of sewer services has been completely devolved to the city of Budapest although the Ministry has set non-binding guidelines for fees
PROPOSED SEWAGE INVESTMENTS
SEWAGE DEVELOPMENT NEEDS IN DISTRICTS XVII AND XVIII
Citywide there are 4000 km of sewage pipes connecting approximately 88 percentof households in Budapest although this is heavily concentrated in the center so that
8outer districts have only about 50 to 60 percent coverage 1 Sewage treatment is below the adequate level FCSM estimates that 80 percent of sewage receives mechanical treatment but less than 20 percent is biologically treated
Districts XVII and XVIII have among the lowest levels of sewerage coverage in Budapest but according to the FCSM Investment Department District XVII is worse off because in District XVIII only one area (Pestszentimre) is badly underserviced Both district governments list sewerage as their most pressing infrastructure developmentneed and both have projects planned which they hope to address in the near future
District XVII
District XVII has a split sewage system-ie two separate subsystems for sewageand storm water collection-and has a big deficit in both systems The district has
1039a comprehensive sewage construction plan with an estimated total cost of HUF billion which has already been begun A first task to lay a network in Rakosliget and Rakoscsaba uJtelep has already been partially completed although some difficulties with the contractor left the laid pipes not ready for use The result was that the municipal sewer company (FCSM) refused to accept the pipes and the district has had to ask the city for a special grant of HUF 80 million 8 to complete the work and repave the roads under a new contract
The plan calls for three additional phases of construction the first part will be to construct sewerage in the most urgent areas (the district center and RAkoscsaba) the second is to complete a parallel principal main which is a precondition for expanding the network and the third is to connect some other areas to the system Phase I to construct about 30 kilometers in Rakoscsaba was begun in early 1994
Targeted subsidies have already been granted for the sewage projectHUF 285 million for 1993 and HUF 21 million for 1994 In both cases despite approvalthe district will receive funds one year later because of central budget limitations The local assembly also has approved the local portion of funding (30 percent of the originalcost estimate) which comes from the social normative grant but the schedule has to be
16 For the outer districts the 1992 flgures are 76-78 percent coverage (districts XV and l) 50-60 percent (XVIII MX and XXI) and 41-43 percent (XVII and XVI)
17 As is the case for most outer areas in Budapest
1s This grant was obtained in return for permission for the Capital City to use the districts landfill
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rethought One difficulty is that because they could not start construction before 1 December 1993 they forfeited the promised HUF 14 million from the City
In some ways storm water collection is a more urgent problem in the district and financially more problematic because no targeted subsidies are available and because it is impossible to charge the public directly for any portion of the development costs The district plans to build a series of ditches for storm water collecting water in one location but because these are open the Sewage Company will not operate them
The district assembly has approved sewerage construction plans but has not actually appropriated the money 9 so that the district has not been able to apply for some other available subsidies One such potential subsidy comes from the Water Management Fund which requires a permit from the water authority As the permit expires in two years the district will probably have to reapply because they may not be able to begin construction of the next phase within two years
One portion of the district contribution is paying the value-added tax portion of the connections (Until January 1993 this amount at 25 percent of cost would have been refunded by the central government) There is a preliminary agreement between the FCSM and the districts that starting 1 January 1994 the FCSM will pay the VAT and be reimbursed by the central government
Citizens contributions will have to make up a larger proportion than foreseen (probably 60 percent instead of 40 percent) A neighborhood association has already been formed in RiLkosllget two construction communities (one of over 700 households) have been formed for the Rakoscsaba work Conditions for households have changed considerably as of January 1994 because the 50 percent subsidies on utility connection loans are no longer available The district is therefore allowing those households unable to pay up front to pay in installments with no interest
Enterprises of course can be - arged higher connection fees and the district wants to use those to cross-subsidize household connections The district Public Utilities Division believes enterprises could be charged up to HUF 1 billion for the sewage development contribution plus HUF 80 million for the actual connection
District XVII has no outstanding loans nor do they levy any local taxes at present They do not have committees or a project preparation unit set up to work on cost of projects instead the technical department alone has put this project together There will be some political difficulties in getting this project approved because those in housing estates which are already connected to the sewage system and who represent the bulk
Not all assembly representatives heartily endorse the plan moreover the assembly did not think the central government would grant the targeted subsidy
20 This may be a problem at some point as when capacity problems exist the FCSM has indicated that it may grant permits for connection only to households and not to enterprises
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of the voting power will be opposed to the expenditure This same argument was used to explain why the council would be opposed to incurring debt although it is possiblethat debt could be structured to be repaid by the benefiting area only
The district does not have solid data on incomes but there is a general sense that probably only 20 percent of households can afford the sewage connection at HUF 30000shy40000 those who cannot would have to be subsidized by the local government byreceiving interest-free loans
DistrictXV37
District XVIII has almost the lowest per capita income in Budapest (it ranks 18th among the 22 districts) it is fourth in area seventh in population and only district XVII has less sewerage coverage according to the Deputy Mayor
Pestszentimre a neighborhood of mostly single-family houses containing about one quarter of district households (a population of 25000 in a district of 98000) is the area most urgently needing sewerage development The cost for this development is estimated at between HUF 12 and 16 billion Four storage tanks that pump sewage into the main system will have to be built The current plan is to begin construction in 1996 the schedule has been pushed back mostly because of financial considerations Sewage is still very much a priority investment for the district
The district hopes to have 30 percent of the cost covered by district resources 30 percent by the Capital City and 40 percent by a targeted subsidy (because Budapestapplied for the subsidy with the district the subsidy is worth an extra 10 percent of estimated cost) A cooperation agreement was required but because Budapest did not sign it the district has not yet applied for the subsidy
The Southern Pest Treatment Center is at capacity now and the new sewerage will not be able to be connected until the Center is expanded District XVIII feels confident that the expansion will be undertaken next year so the technical problem will be solved Budapest would take a loan for this project apparently the City Council is in favor of the project Even though the Treatment Center has not yet been expanded the FCSM has given the district their permit to begin construction
The gas network was recently completed in the same area funded throughneighborhood associations work was completed in 1993 The connection fee of HUF 46000 per household will take three years to pay off so that payments will stop in 1995 Even so the connection fee alone did not cover the total cost which came to about HUF 150000-200000 per property
If a connection fee for sewerage is set too high district officials are afraid somehouseholds may elect not to connect at all If more than 60 percent of households want to connect the district will begin construction but they risk having some households subsequently decide not to connect and withdraw their contributions District officials
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expect the connection fee to be HUF 60000-65000 the District will pay an additional HUF 15000 fee per household to cover the cost of preparing the technical construction plans
The Deputy Mayor assumes the district will have to take on debt and he believes the district would definitely approach various banks as OTP does not offer attractive terms A technical implementation report on the project has been prepared but it includes no work on financial returns
CURRENT SEWER INFRASTRUCTURE FINANCING PRACTICES
As described in the first section districts are responsible for the construction of sewer collection systems that once built are turned over to the Capital City Sewer Company for operation and maintenance The Capital City is responsible for construction of interceptor sewers and sewage treatment plants Once the infrastruc-ture is in place system stewardship is the responsibility of the Budapest Municipal Sewage Company (FCSM)
There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including
Central Government Targeted subsidies provided by the central government are used to finance construction of sewer collection systems Targeted subsides are matching grants given to districts on a competitive basis The level of funding provided by targeted subsides is 30 percent for sewer collection projects (40 percentif the application is made jointly by both the district and the Capital City) However the reliability of this revenue source to finance future sewer projects is subject to the priorities and conditions set by the Parliament as recommended by the Ministry of the Interior Therefore there is no assurance that targetedsubsidies can be used to finance sewer collection systems in the future2
1 It is noted that the central government provides addressed subsidies however sewer collection system financing is not an eligible use of such subsidies
Capital City The Capital City can contribute to the cost of district sewer construction projects However district projects mus conform to Capital City priorities to be considered for funding
21 For example in 1993 the amounts needed to fund all eligible projects exceed the grant monies budgeted by the central government so those projects are approved but local governments will receive funds two or three years from now
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District Own source revenues for sewer collection system construction and connections to properties in public ownership are derived from (1) allocations made through the annual local budget process derived from local taxes miscellaneous fees and intergovernmental transfers (eg normative subsidies) (2) sale or lease of district owned land and (3)mid-term borrowing (defined as 2-3 years) from OTP Loans are repaid from own source revenue in the form of proceeds from the sale or lease of district-owned land
Citizens Citizens contribute to the construction of sewer systems in two ways (1)through the creation of construction communities or neighborhood associations citizens pay a portion of the collection system construction cost and (2)connection fees
FINANCING OPTIONS
This is a period of intensive change in the ways in which the central governmentdistricts the Capital City and the recently privatized Budapest Municipal SewageCompany finance and maintain the municipal sewer system Existing capitalimprovements practices are woefully insufficient to meet current and future seweragecapital needs Reasons for this state of affairs include
Limited Financial Capacity
The lack of adequate own source revenue has a profound impact on limitingavailable funds necessary to finance sewage system expansion There is a great disparitybetween capital needs and the anticipated revenue available to meet these needs Sewer construction projects are very expensive Existing financing mechanisms are inadequate
Debt Financing Districts make limited use of debt financing When debt is issuedIt is for a 2 or 3 year period This short term debt financing places an undue burden on the districts limited financial resources and the present populationsability to amortize the debt The high cost of borrowing (27 percent interest) further exacerbates this problem as well as increasing the cost of capital development
Capital financing typically requires the issuance of long term debt (20 to 30 years)that roughly correlates to the useful life of the facility This method of financingalso is considered to be equitable to those who benefit from the system (egcitizens commerce industry) since each generation pays its fair share of the cost of the facility A long-life asset such as a sewer system should be paid for by its users throughout its normal life rather than all at once by those who may not have the use of it full term Even with higher cost due to interest if spread over a largenumber of userspayers the cost to all is lowered Given Hungarys high rate of inflation and thus ever increasing construction costs it may be cheaper to borrow and pay todays prices rather than wait and pay tomorrows prices Furthermorethe use of long term debt puts less financial pressure on the operating budget
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OperatingBudget (ie pay-as-you-go)There is some attempt to finance a portion of the cost of sewer improvements through the operating budget The operatingbudget is reliant on revenues derived from intergovernmental transfers and therefore provides very little fiscal flexibility to support capital development Furthermore there are no reserve accounts that may be used to set aside funds for future capital development or meet emergencies (It will be noted of course that with Hungarys high rate of inflation the reserve accounts will be rapidly eroded so it may be decided to keep them at a mintimum)
Typically the operating budget is not used to finance large scale capital projects such as sewer collection systems Annual appropriations tend to be used to pay for municipal operations and service Small scale projects equipment purchases and the repair of existing facilities may be funded through the operating budgetHowever the use of the operating budget to finance large capital projects should be frowned upon for the following reasons
It forces local officials to make extremely difficult choices between service
delivery government operations and capital expansion
It places a heavy burden on the budget for the project year
It creates awkward fluctuating expenditure cycles that do not occur with extended financing
Since funding is based on yearly increments the use of the operating budget helps foster an environment wherein projects often go uncompleted
Sale of Land Districts rely on the sale of land to raise revenue for infrastructure financing This raises several concerns First land is not liquid and its value is subject to market forces In a sagging market such as currently exists land priceshave eroded to the point where districts are unable to raise adequate capital through the sale of land to finance sewer construction Furthermore there are few entrepreneurs with adequate resources to buy land
A related issue is that the land being sold is not serviced by sewer and other infrastructure components The offering price most likely reflects the absence of infrastructure If the infrastructure were in place prior to the sale or lease of district-owned land the district would realize a greater return than it currently receives
Finally land is finite Districts should think carefully about diminishing this resource to finance capital investment particularly before the capital is in placeLater in this paper we describe financing mechanisms that should be considered as feasible alternatives Particular attention should be paid to the use of tax increment financing or other forms of betterment financing
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Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
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Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
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ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
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projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
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Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
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plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
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FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
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ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
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livabihty of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is the provision of technical assistance that will help local officials make smarter sewer and general capital investment and management decisions Areas proposed for assistance include the assessment of current financial sources such as connection fees long term debt taxation including property tax) and user fees along with alternative financing methods such as the creation of tax increment or betterment districts
General capital financing technical assistance to both districts and Capital City should include assistance in the development of a capital plan and budget costing and pricing enterprise management contract management and collaboration between the city and the districts At the central government level assistance should be provided to revise the current system of targeted grants and to consider more effective means to assist in local infrastructure investment
MUNICIPAL STRATEGIES FOR INFRASTRUCTURE FINANCE PLANNED SEWAGE PROJECTS IN TWO BUDAPEST DISTRICTS
INTRODUCTION
The responsibility for construction and maintenance of municipal infrastructureincluding water management drainage of rainwater and sewage transferred towas Hungarian local governments in 1990 by the Act on Local Self-Government In orderfor these tasks to be effectively undertaken the assets of state economic organizationsproviding these public utilities were likewise transferred to local governments2 These are new and demanding responsibilities for local governments In the past decades there has been considerable neglect of infrastructure investment in Hungary moreover localfinancial resources are already severely strained Since 1993 USAID has begun toprovide assistance to Hungarian local governments i meeting the need to finance infrastructure development
Two proposed municipal infrastructure projects are analyzed in this report the sewer system for the Rdkosliget area of Budapest District XVII and the sewer system forthe Pestszentimre area of Budapest District XVIII The aim is to assess present practicesand possible alternatives for financing these two investments within the context of current local responsibilities and capabilities The principal conclusions are that there are more options available than are currently considered and that assistance in developing certain skills could be useful to local governments facing these newresponsibilities We start by examining the specific responsibilities of Budapest districtsthe municipality the public works and the central government Then we describe the two proposed sewage projects and current financing practices Finally we propose areas for assistance
Act No LXV of 1990 Article 8(1)
2 Ibid Article 107(l)(b)
For a description of the broad scope of USAID assistance in this sector see Dowall HegedosMark and Tosics Establishing a Franwworkfor MunicipalTechnicalAssstanceinInfrastructure 1993
-7
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ENFRASTRUCTURE INVESTMENT RESPONSIBILITIES IN BUDAPEST
The city of Budapest comprises 23 local self-governments including the Capital Citygovernment (F6vdros) and the twenty-two districts According to Article 63 of the Act on local self-government the district governments of Budapest are mainly responsible for the provision of primary public services while the Capital government is responsible for tasks which affect the whole or a large part of the city
A separate law further defines the respective responsibilities of the Capital and of the districts4 Article 10 of this Act lists specific rights and duties of the capital citygovernment which includes provision of water gas and steam water regulation storm sewerage and channeling and the provision of potable water to the entire capital or its major portions Some of these duties may be transferred by the capital city to the district governments on two conditions that sufficient funds are provided for carrying out these services and that the district accepts this transfer5
In practice responsibility for construction ownership and maintenance of publicinfrastructure has been splintered among several entities and competing local governments This situation is further complicated by the ambiguity of legislative textsand by the transformation of the Budapest Sewerage Works (or FCSMI) which became a joint-stock company on 1 December 1993
As a res-it due in part to the large responsibilities placed on the capital government and the insufficiency of funds to respond in the short and medium term to the most pressing needs some districts have sought to mitigate the lack of action on the part of the capital by initiating and financing projects which would normally be in the domain of the capital
The fragmentation of responsibility for preparation of urban development and master plans between the capital and the districts may lead to conflicts in the realization of certain infrastructure projects The general assembly of the Capital formulates the urban development program and the general master plan for the capital city howeverthe views of the Government and of the districts must be solicited The basic plan for each district is determined by the district assembly in conformity with the generalmaster plan of the capital However the new Capital general master plan has not yetbeen finalized this fact has not deterred the districts from developing their own local development plans which may sometimes be in conflict with the general master plan8
4 Law XXIV of 1991 on the self-government of the capital city and of the capital city districts
5 Ibid Article 12
6 F6vdrosi Csatornmmzsi Mvek
7 Ibid Articles 8(4) and 11
8 According to the Budapest Department of Public Utility Works
Cl
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It is therefore difficult for the city to combat a possible Not in my backyard (NIMBY) mentality on the part of the districts as in the case of construction of a new sewerage treatment plant
In the case of the specific projects for Districts XVII and XVIII several actors are responsible for different phases of project planning financing construction and management These include the capital city the FCSM the districts neighborhood associations and construction communities and the Ministry of Transportation Communication and Water Management (MTCWM) The role of each of these actors is described below
THE BUDAPEST MUNICIPAL GOVERNMENT (FOVAROS)
The Capital City is responsible for formuiating development plans for the city For sewerage development a long-term plan through the year 2015 has been established However consultations were engaged with the Government the districts and the FCSM during the preparation of the plan For actual implementation an annual or a two-year development plan is prepared based on the stated objectives of the capital assembly Three current main priorities in the area of sewage are (1) increase in collection and carrying capacity of the sewerage main in North Pest (2) increase in capacity of the treatment plant in North Buda and (3) construction of a treatment plant in South Pest The investment projects of the districts in sewer networks generally have to be in conformity with the general development plan of the Capital City
District XVIIs sewage project is dependent on the achievement of priority 1 as the main collecting pipe from the district leads into the sewage main of North Pest District XVIIIs project is linked to construction of the South Pest treatment plant (priority 3) once the district networks have been built they may not be put into operation until completion of the treatment plant
The capital finances the construction of main sewerage lines treatment plants collection and pumping stations these projects involve new facilities and mains or the increase in capacity of existing plants The actual technical plans are prepared by the FCSM reviewed by the public utility works department of the Capital City and prescnted to the genera assembly
Project preparation in the capital follows the prescription of a decree passed in 19929 Requirements include the submission of a detailed plan the Assemblyto including cost estimates but no financing plan The General Assembly must vote approval on all projects over a cost of HUF 50 million The financial plans for the realization of the capital city projects may include the following resources targeted subsidies funds from the general capital city budget contributions from the districts
9 Decree No 121992
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loans participation by the FCSM and contributions from the beneficiaries (businesseshouseholds) In only one case has the city taken out a specific project-related loan-from EBRD for a sewage treatment center
For 1993 the sewer fee included a portion dedicated specifically to the financingof new investments (HUF 470m 3 ) This was the first time that a part of the fee has been specifically assigned to the financing of new investment This development portion of the fee was only in place for 1993 and was not renewed for 1994 The proposals for the use of the development portion of the fee were made by the public utility works department
Until 1 January 1994 the sewer fee was set by the MTCWM based on a proposalof the city the technical aspects of the proposal are prepared by the FCSM and approvedby the general assembly of the capital The Capital City was authorized to determine the sewer fee for the first time this January although guidelines have been set by theMTCWM The initial technical proposal is prepared by the Finance Department of the FCSM Nevertheless the final say on the actual price rests with the general assembly of the Capital For the new fee options under consideration were to multiply the current fee by a price index for the sector (which would lead to an estimated 20 percent increase but would exclude any specific investment portion) or to include different developmentcosts in the fee The new fee (HUF 20 plus 10 percent value-added tax) was introduced in April 1994 although FCSM had recommended a tee of HUF 215 No part of the sewer fee is allocated to investments in the network undertaken by the districts The FCSM also plans to introduce a flat sewage fee of HUF 200-500 in areas not serviced at present to cover the cleaning of septic tanks
Actual construction of the projects is managed by the FCSM as the principal contractor Nevertheless the public utility works department of the Capital monitors the ongoing works approves bills submitted by the contractor and sub-contractors and authorizes payment to the FCSM (who pays the sub-contractors) Every six months a project report on use of funds and the advance of work is presented to the generalassembly If there are Impor ant cost overruns or construction delays then a change of scope of the project must be approved by the general assembly Once the project has been completed the equipment is turned over to the FCSM which is responsible for maintenance repairs rehabilitation and replacement
THE FCSM
The FCSM was previously a state-owned enterprise and was transferred to the ownership of the capital city according to the provisions of the Local Self-Government Act From 1 January 1992 the ownership rights of the sewerage network were transferred to the capital city The assets were managed by FCSM but it appears that no fee for lease of these assets was paid to the Capital City
From 1 December 1993 the FCSM was transformed into a joint-stock companywholly-owned by the capital city Before the transformation of the company the budget
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of the sewer works company was approved by the general assembly of the Capital In addition the Supervisory Board of 13 members was appointed by the general assemblyOn 1 December 1993 the FCSM was transformed into a joint-stock company wholly owned by the Capital city Under this structure the Supervisory Board of nine members-three from FCSM staff and six from the Assembly-will be responsible for approving the companys budget and al strategically important decisions
The assets relating to sewerage were the property of the Capital City but were transferred to the FCSM as of 1 December 1993 as part of the companys transformation First the assets were reassessed and their replacement value was determined to be HUF 70 billion a considerable increase from the HUF 20 billion previously estimated10 With the transformation these assets were transferred to the ownership of the joint-stock company
Any additional networks and additions to the system will also be transferred to the FCSM However according to provisions of the 1991 Accounting Act any network built privately is transferred at zero value thus preventing the company from taking any depreciation on the value of the stock
As a means of circumventing this problem the FCSM arranged to be assigned as both investor and builder However when targeted subsidies are used to finance part of the network such an arrangement becomes more difficult because the local government must be the investor
For sewer projects initiated by the districts the FCSM is responsible for reviewing the technical plans and giving an expert opinion before construction begins Upon completion of the equipment the FCSM will inspect the equipment for adherence to technical norms (such as pressure tests or camera inspections within the pipes) and will authorize operation of the network This authorization will depend on capacity of eidsting mains and treatment plants to handle a larger flow of effluent in the system Thus due to the saturation of the main pipes in North Pest new business and industrial connections will not be authorized until the capacity of this part of the network has been increased
The principal activity of the FCSM is the operation and maintenance of the sewerage system within the city of Budapest In addition reconstruction and rehabilitation of all existing pipes pumping stations and treatment plants are the responsibility of the company These activities (operation maintenance reconstruction) are financed through the sewage fee
o It is believed that the primary purpose of this revaluation was to Increase depreciation funds However the higher valuation may have an adverse effect on the prospects for privatization
I Based on a conversation with the Technical Department of the FCSM
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The fee is collected in part by the FCSM however a collecting company12 collectsft sfrom private homes and the Water Works Company collects fees from industrial users and rental housing Thus the FCSM only seems to directly collect the fees from individuals with water wells but who are connected to the sewer system This systemof collection often leads to delays of at least two months in receipt of fees the amount ofunpaid fees were estimated at HUF 500-600 million in June 1993 and in May 1994 at HUF 338 million of which HUF 240 million Is from residences Total receipts in 1993 were HUF 4-5 billion putting delinquencits at about 8 percent
THE DISTRICTS
De facto due to lack of funds in the face of so many pressing needs the districtshave been made responsible for the construction of the secondary sewerage network(pipes leading from homes and businesses to the main collecting pipes and the collection system) The connections leading from homes and businesses to the secondary network are financed by the beneficiaries but constructed by the districts
Once a district decides to undertake the construction of part of the sewer system a water authorization permit is required from the MTCWM An expert opinion on thetechnical plans must be solicited from the FCSM The district is responsible for raisingfunds for construction Sources of financing may include district own fundscontributions from the Capital City targeted grants grants from the national Water Development Fund contributions from the population and loans
The means of financing used for these projects often leads to inefficient use of resources as matching funds and grants must remain in the accounts until construction has actually commenced This is the case for both the districts and the Capital CityTargeted grants require matching funds from the district which must be kept in the local government account as proof that this requirement has been met If there are delays in the start of the project these funds are left unused instead of being appropriated for more immediate needs
In the same way contributions from the Capital City must be negotiated on a caseby case basis and success in obtaining them may depend on the extent to which theparticular project corresponds to the capital citys own priorities However if the districts do not commence work on the project in a timely manner the Capital City funds are alsolying unused in an account For this reason the Capital has placed conditions on projectconstruction start-up dates if these requirements are not respected the districts may
This company was recently privatized through an employee share purchasing program It collects all utilities and municipal housing rents In Budapest for a fee of 3 to 4 percent of collections Recentlythe electricity company ended the contract and makes Its own collections while th gas company hascontracted out to other private companies in certain districts although their collections fees are muchhigher The Collection Company is currently in the process of revising its contractual relationshipswith its clients
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lose the grant For example District XVII received a promise of a HUF 14 million grant for the Rkosliget sewer project on condition that construction commenced by 1 December 1993
Appropriate financial products are currently not available to local governments for financing long-term investments such as sewer networks 3 For the moment the districts do not have access to the sewer fee which would enable them to appropriate part of this user fee for the reimbursement of debt Thus districts have placed heavyreliance on up-front population contributions through neighborhood associations and construction communities to finance part of secondary networks (and sometimef- the main networks) in addition to direct household connections to the network ----se connection fees are the only user charge to which districts have access As there o legal restriction on the level of the connection fee the only consideration in settin e fee is affordability
The construction of the project is monitored by the district Once completed technical certification of the equipment is required by the FCSM (pumping test and verification of pipes with a camera) If the results of these verifications are unsatisfactory then the operation of the pipes will not be authorized by the FCSM 4 If the FCSM grants approval the entire network is transferred to the Sewer Works Company which is responsible for operation maintenance rehabilitation and replacement of the equipment
NEIGHBORHOOD ASSOCIATIONS AND CONSTRUCTION COMMUNITIES
Under the previous system in order fc - neighbor-ods and towns to obtain quicker connections to public utilities organizea forms G population participation were developed these methods of financing infrastructure have continued and may take the form of a neighborhood association or a construction community
Neighborhood associations (ktzmitdrsulds) for the financing of infrastructure network- are formed when at least 66 percent of the residents of a neighborhood agree to their creation membership is open to all residents and contributions to the cost of infrastructure investment is compulsory Membership entitles residents to receive five-to seven year loans from OTP with 70 percent of the interest subsidized by the central
13 See Hegedes Mark Pigey Municipal Lending in Hungary March 1993
This has posed a problem for District XVII in 1993 30 kilometers of pipes of 40 constructed failed the camera verification test however the contractors had already been paid before this verification The District is unable to pave the roads or put system into operation until the pipes are repaired to satisfactory condition
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government 5 Through these loans investment funds are available up front to the district and it is the OTP which takes the credit risk
The members of the association appoint a steering committee (or an executiveboard) which works with the district issues tenders and selects the contractor The amount of contributions by members is assessed by the committee and any remainingfunds available after construction may be redistributed to the residents The committee also defines the contributions of new members
Construction communities (6pit6kbzOss~g) are a more flexible form of populationparticipation as they are not legal entities and have no right to sign contracts in their own name The community elects an executive board this board will work with the local government during construction in terms of choosing a constructor monitoringrealization countersigning contracts and bills However the legal investor is the local government This form of construction is used in District XVII
A separate account is established for the investment and members of theconstruction community pay their contributions into the account as the work proceedsIndividuals may contract loans to finance their contribution but these are at market rates and not the subsidized loans available to members of neighborhood associations Thus the district takes a credit risk and there are cases where members have not been able to pay the full amount of their assessed participation
In interviews with Districts XVII and XVIII it has often been stated that households have reached the limits of their capacity to contribute to financing the sewage network This system of financing is not limited to capital investments in sewer networks but has also been used to finance other public utilities such as potable water gas connections and telephone lines
Although districts do receive a portion of the personal income tax (for which there is a specific distribution formula between the capital city and the districts and among the districts) the actual incomes of the district populations are not known with precisionIn order for the district governments to better Judge the capacity of their population tocontribute both now and in the future small surveys of the population of selected areas in the district may be useful Such surveys may help to establish the level of incomesand expenditures as well as assess a realistic burden for construction and developmentlees or local taxes
15 In January 1994 subsidies for direct household loans for utility connections were terminated making the neighborhood association loans the only remaining subsidy for utility connections
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MINISTRY OF TRANSPORTATION COMMUNICATION AND WATER MANAGEMENT (MTCWM)
The Ministry of Transportation Communication and Water Management must approve all projects in Hungary relating to water no sewerage project may go forward without first obtaining the water authorization permit from this Ministry
Until 1 January 1994 the Miniszry also played a role in setting the water and sewer tariffs According to the 1990 Act on Prices the fee must include the expenses of efficient operation and the profit required for efficient operation although no definition of efficiency or provisions for monitoring are included in the Act
The final allowed price was set by the Ministry based on tariffs proposed by the sewer company and the Capital City From the beginning of 1994 the pricing of sewer services has been completely devolved to the city of Budapest although the Ministry has set non-binding guidelines for fees
PROPOSED SEWAGE INVESTMENTS
SEWAGE DEVELOPMENT NEEDS IN DISTRICTS XVII AND XVIII
Citywide there are 4000 km of sewage pipes connecting approximately 88 percentof households in Budapest although this is heavily concentrated in the center so that
8outer districts have only about 50 to 60 percent coverage 1 Sewage treatment is below the adequate level FCSM estimates that 80 percent of sewage receives mechanical treatment but less than 20 percent is biologically treated
Districts XVII and XVIII have among the lowest levels of sewerage coverage in Budapest but according to the FCSM Investment Department District XVII is worse off because in District XVIII only one area (Pestszentimre) is badly underserviced Both district governments list sewerage as their most pressing infrastructure developmentneed and both have projects planned which they hope to address in the near future
District XVII
District XVII has a split sewage system-ie two separate subsystems for sewageand storm water collection-and has a big deficit in both systems The district has
1039a comprehensive sewage construction plan with an estimated total cost of HUF billion which has already been begun A first task to lay a network in Rakosliget and Rakoscsaba uJtelep has already been partially completed although some difficulties with the contractor left the laid pipes not ready for use The result was that the municipal sewer company (FCSM) refused to accept the pipes and the district has had to ask the city for a special grant of HUF 80 million 8 to complete the work and repave the roads under a new contract
The plan calls for three additional phases of construction the first part will be to construct sewerage in the most urgent areas (the district center and RAkoscsaba) the second is to complete a parallel principal main which is a precondition for expanding the network and the third is to connect some other areas to the system Phase I to construct about 30 kilometers in Rakoscsaba was begun in early 1994
Targeted subsidies have already been granted for the sewage projectHUF 285 million for 1993 and HUF 21 million for 1994 In both cases despite approvalthe district will receive funds one year later because of central budget limitations The local assembly also has approved the local portion of funding (30 percent of the originalcost estimate) which comes from the social normative grant but the schedule has to be
16 For the outer districts the 1992 flgures are 76-78 percent coverage (districts XV and l) 50-60 percent (XVIII MX and XXI) and 41-43 percent (XVII and XVI)
17 As is the case for most outer areas in Budapest
1s This grant was obtained in return for permission for the Capital City to use the districts landfill
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rethought One difficulty is that because they could not start construction before 1 December 1993 they forfeited the promised HUF 14 million from the City
In some ways storm water collection is a more urgent problem in the district and financially more problematic because no targeted subsidies are available and because it is impossible to charge the public directly for any portion of the development costs The district plans to build a series of ditches for storm water collecting water in one location but because these are open the Sewage Company will not operate them
The district assembly has approved sewerage construction plans but has not actually appropriated the money 9 so that the district has not been able to apply for some other available subsidies One such potential subsidy comes from the Water Management Fund which requires a permit from the water authority As the permit expires in two years the district will probably have to reapply because they may not be able to begin construction of the next phase within two years
One portion of the district contribution is paying the value-added tax portion of the connections (Until January 1993 this amount at 25 percent of cost would have been refunded by the central government) There is a preliminary agreement between the FCSM and the districts that starting 1 January 1994 the FCSM will pay the VAT and be reimbursed by the central government
Citizens contributions will have to make up a larger proportion than foreseen (probably 60 percent instead of 40 percent) A neighborhood association has already been formed in RiLkosllget two construction communities (one of over 700 households) have been formed for the Rakoscsaba work Conditions for households have changed considerably as of January 1994 because the 50 percent subsidies on utility connection loans are no longer available The district is therefore allowing those households unable to pay up front to pay in installments with no interest
Enterprises of course can be - arged higher connection fees and the district wants to use those to cross-subsidize household connections The district Public Utilities Division believes enterprises could be charged up to HUF 1 billion for the sewage development contribution plus HUF 80 million for the actual connection
District XVII has no outstanding loans nor do they levy any local taxes at present They do not have committees or a project preparation unit set up to work on cost of projects instead the technical department alone has put this project together There will be some political difficulties in getting this project approved because those in housing estates which are already connected to the sewage system and who represent the bulk
Not all assembly representatives heartily endorse the plan moreover the assembly did not think the central government would grant the targeted subsidy
20 This may be a problem at some point as when capacity problems exist the FCSM has indicated that it may grant permits for connection only to households and not to enterprises
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of the voting power will be opposed to the expenditure This same argument was used to explain why the council would be opposed to incurring debt although it is possiblethat debt could be structured to be repaid by the benefiting area only
The district does not have solid data on incomes but there is a general sense that probably only 20 percent of households can afford the sewage connection at HUF 30000shy40000 those who cannot would have to be subsidized by the local government byreceiving interest-free loans
DistrictXV37
District XVIII has almost the lowest per capita income in Budapest (it ranks 18th among the 22 districts) it is fourth in area seventh in population and only district XVII has less sewerage coverage according to the Deputy Mayor
Pestszentimre a neighborhood of mostly single-family houses containing about one quarter of district households (a population of 25000 in a district of 98000) is the area most urgently needing sewerage development The cost for this development is estimated at between HUF 12 and 16 billion Four storage tanks that pump sewage into the main system will have to be built The current plan is to begin construction in 1996 the schedule has been pushed back mostly because of financial considerations Sewage is still very much a priority investment for the district
The district hopes to have 30 percent of the cost covered by district resources 30 percent by the Capital City and 40 percent by a targeted subsidy (because Budapestapplied for the subsidy with the district the subsidy is worth an extra 10 percent of estimated cost) A cooperation agreement was required but because Budapest did not sign it the district has not yet applied for the subsidy
The Southern Pest Treatment Center is at capacity now and the new sewerage will not be able to be connected until the Center is expanded District XVIII feels confident that the expansion will be undertaken next year so the technical problem will be solved Budapest would take a loan for this project apparently the City Council is in favor of the project Even though the Treatment Center has not yet been expanded the FCSM has given the district their permit to begin construction
The gas network was recently completed in the same area funded throughneighborhood associations work was completed in 1993 The connection fee of HUF 46000 per household will take three years to pay off so that payments will stop in 1995 Even so the connection fee alone did not cover the total cost which came to about HUF 150000-200000 per property
If a connection fee for sewerage is set too high district officials are afraid somehouseholds may elect not to connect at all If more than 60 percent of households want to connect the district will begin construction but they risk having some households subsequently decide not to connect and withdraw their contributions District officials
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expect the connection fee to be HUF 60000-65000 the District will pay an additional HUF 15000 fee per household to cover the cost of preparing the technical construction plans
The Deputy Mayor assumes the district will have to take on debt and he believes the district would definitely approach various banks as OTP does not offer attractive terms A technical implementation report on the project has been prepared but it includes no work on financial returns
CURRENT SEWER INFRASTRUCTURE FINANCING PRACTICES
As described in the first section districts are responsible for the construction of sewer collection systems that once built are turned over to the Capital City Sewer Company for operation and maintenance The Capital City is responsible for construction of interceptor sewers and sewage treatment plants Once the infrastruc-ture is in place system stewardship is the responsibility of the Budapest Municipal Sewage Company (FCSM)
There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including
Central Government Targeted subsidies provided by the central government are used to finance construction of sewer collection systems Targeted subsides are matching grants given to districts on a competitive basis The level of funding provided by targeted subsides is 30 percent for sewer collection projects (40 percentif the application is made jointly by both the district and the Capital City) However the reliability of this revenue source to finance future sewer projects is subject to the priorities and conditions set by the Parliament as recommended by the Ministry of the Interior Therefore there is no assurance that targetedsubsidies can be used to finance sewer collection systems in the future2
1 It is noted that the central government provides addressed subsidies however sewer collection system financing is not an eligible use of such subsidies
Capital City The Capital City can contribute to the cost of district sewer construction projects However district projects mus conform to Capital City priorities to be considered for funding
21 For example in 1993 the amounts needed to fund all eligible projects exceed the grant monies budgeted by the central government so those projects are approved but local governments will receive funds two or three years from now
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District Own source revenues for sewer collection system construction and connections to properties in public ownership are derived from (1) allocations made through the annual local budget process derived from local taxes miscellaneous fees and intergovernmental transfers (eg normative subsidies) (2) sale or lease of district owned land and (3)mid-term borrowing (defined as 2-3 years) from OTP Loans are repaid from own source revenue in the form of proceeds from the sale or lease of district-owned land
Citizens Citizens contribute to the construction of sewer systems in two ways (1)through the creation of construction communities or neighborhood associations citizens pay a portion of the collection system construction cost and (2)connection fees
FINANCING OPTIONS
This is a period of intensive change in the ways in which the central governmentdistricts the Capital City and the recently privatized Budapest Municipal SewageCompany finance and maintain the municipal sewer system Existing capitalimprovements practices are woefully insufficient to meet current and future seweragecapital needs Reasons for this state of affairs include
Limited Financial Capacity
The lack of adequate own source revenue has a profound impact on limitingavailable funds necessary to finance sewage system expansion There is a great disparitybetween capital needs and the anticipated revenue available to meet these needs Sewer construction projects are very expensive Existing financing mechanisms are inadequate
Debt Financing Districts make limited use of debt financing When debt is issuedIt is for a 2 or 3 year period This short term debt financing places an undue burden on the districts limited financial resources and the present populationsability to amortize the debt The high cost of borrowing (27 percent interest) further exacerbates this problem as well as increasing the cost of capital development
Capital financing typically requires the issuance of long term debt (20 to 30 years)that roughly correlates to the useful life of the facility This method of financingalso is considered to be equitable to those who benefit from the system (egcitizens commerce industry) since each generation pays its fair share of the cost of the facility A long-life asset such as a sewer system should be paid for by its users throughout its normal life rather than all at once by those who may not have the use of it full term Even with higher cost due to interest if spread over a largenumber of userspayers the cost to all is lowered Given Hungarys high rate of inflation and thus ever increasing construction costs it may be cheaper to borrow and pay todays prices rather than wait and pay tomorrows prices Furthermorethe use of long term debt puts less financial pressure on the operating budget
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OperatingBudget (ie pay-as-you-go)There is some attempt to finance a portion of the cost of sewer improvements through the operating budget The operatingbudget is reliant on revenues derived from intergovernmental transfers and therefore provides very little fiscal flexibility to support capital development Furthermore there are no reserve accounts that may be used to set aside funds for future capital development or meet emergencies (It will be noted of course that with Hungarys high rate of inflation the reserve accounts will be rapidly eroded so it may be decided to keep them at a mintimum)
Typically the operating budget is not used to finance large scale capital projects such as sewer collection systems Annual appropriations tend to be used to pay for municipal operations and service Small scale projects equipment purchases and the repair of existing facilities may be funded through the operating budgetHowever the use of the operating budget to finance large capital projects should be frowned upon for the following reasons
It forces local officials to make extremely difficult choices between service
delivery government operations and capital expansion
It places a heavy burden on the budget for the project year
It creates awkward fluctuating expenditure cycles that do not occur with extended financing
Since funding is based on yearly increments the use of the operating budget helps foster an environment wherein projects often go uncompleted
Sale of Land Districts rely on the sale of land to raise revenue for infrastructure financing This raises several concerns First land is not liquid and its value is subject to market forces In a sagging market such as currently exists land priceshave eroded to the point where districts are unable to raise adequate capital through the sale of land to finance sewer construction Furthermore there are few entrepreneurs with adequate resources to buy land
A related issue is that the land being sold is not serviced by sewer and other infrastructure components The offering price most likely reflects the absence of infrastructure If the infrastructure were in place prior to the sale or lease of district-owned land the district would realize a greater return than it currently receives
Finally land is finite Districts should think carefully about diminishing this resource to finance capital investment particularly before the capital is in placeLater in this paper we describe financing mechanisms that should be considered as feasible alternatives Particular attention should be paid to the use of tax increment financing or other forms of betterment financing
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Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
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Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
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ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
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projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
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Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
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plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
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FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
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ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
MUNICIPAL STRATEGIES FOR INFRASTRUCTURE FINANCE PLANNED SEWAGE PROJECTS IN TWO BUDAPEST DISTRICTS
INTRODUCTION
The responsibility for construction and maintenance of municipal infrastructureincluding water management drainage of rainwater and sewage transferred towas Hungarian local governments in 1990 by the Act on Local Self-Government In orderfor these tasks to be effectively undertaken the assets of state economic organizationsproviding these public utilities were likewise transferred to local governments2 These are new and demanding responsibilities for local governments In the past decades there has been considerable neglect of infrastructure investment in Hungary moreover localfinancial resources are already severely strained Since 1993 USAID has begun toprovide assistance to Hungarian local governments i meeting the need to finance infrastructure development
Two proposed municipal infrastructure projects are analyzed in this report the sewer system for the Rdkosliget area of Budapest District XVII and the sewer system forthe Pestszentimre area of Budapest District XVIII The aim is to assess present practicesand possible alternatives for financing these two investments within the context of current local responsibilities and capabilities The principal conclusions are that there are more options available than are currently considered and that assistance in developing certain skills could be useful to local governments facing these newresponsibilities We start by examining the specific responsibilities of Budapest districtsthe municipality the public works and the central government Then we describe the two proposed sewage projects and current financing practices Finally we propose areas for assistance
Act No LXV of 1990 Article 8(1)
2 Ibid Article 107(l)(b)
For a description of the broad scope of USAID assistance in this sector see Dowall HegedosMark and Tosics Establishing a Franwworkfor MunicipalTechnicalAssstanceinInfrastructure 1993
-7
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ENFRASTRUCTURE INVESTMENT RESPONSIBILITIES IN BUDAPEST
The city of Budapest comprises 23 local self-governments including the Capital Citygovernment (F6vdros) and the twenty-two districts According to Article 63 of the Act on local self-government the district governments of Budapest are mainly responsible for the provision of primary public services while the Capital government is responsible for tasks which affect the whole or a large part of the city
A separate law further defines the respective responsibilities of the Capital and of the districts4 Article 10 of this Act lists specific rights and duties of the capital citygovernment which includes provision of water gas and steam water regulation storm sewerage and channeling and the provision of potable water to the entire capital or its major portions Some of these duties may be transferred by the capital city to the district governments on two conditions that sufficient funds are provided for carrying out these services and that the district accepts this transfer5
In practice responsibility for construction ownership and maintenance of publicinfrastructure has been splintered among several entities and competing local governments This situation is further complicated by the ambiguity of legislative textsand by the transformation of the Budapest Sewerage Works (or FCSMI) which became a joint-stock company on 1 December 1993
As a res-it due in part to the large responsibilities placed on the capital government and the insufficiency of funds to respond in the short and medium term to the most pressing needs some districts have sought to mitigate the lack of action on the part of the capital by initiating and financing projects which would normally be in the domain of the capital
The fragmentation of responsibility for preparation of urban development and master plans between the capital and the districts may lead to conflicts in the realization of certain infrastructure projects The general assembly of the Capital formulates the urban development program and the general master plan for the capital city howeverthe views of the Government and of the districts must be solicited The basic plan for each district is determined by the district assembly in conformity with the generalmaster plan of the capital However the new Capital general master plan has not yetbeen finalized this fact has not deterred the districts from developing their own local development plans which may sometimes be in conflict with the general master plan8
4 Law XXIV of 1991 on the self-government of the capital city and of the capital city districts
5 Ibid Article 12
6 F6vdrosi Csatornmmzsi Mvek
7 Ibid Articles 8(4) and 11
8 According to the Budapest Department of Public Utility Works
Cl
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It is therefore difficult for the city to combat a possible Not in my backyard (NIMBY) mentality on the part of the districts as in the case of construction of a new sewerage treatment plant
In the case of the specific projects for Districts XVII and XVIII several actors are responsible for different phases of project planning financing construction and management These include the capital city the FCSM the districts neighborhood associations and construction communities and the Ministry of Transportation Communication and Water Management (MTCWM) The role of each of these actors is described below
THE BUDAPEST MUNICIPAL GOVERNMENT (FOVAROS)
The Capital City is responsible for formuiating development plans for the city For sewerage development a long-term plan through the year 2015 has been established However consultations were engaged with the Government the districts and the FCSM during the preparation of the plan For actual implementation an annual or a two-year development plan is prepared based on the stated objectives of the capital assembly Three current main priorities in the area of sewage are (1) increase in collection and carrying capacity of the sewerage main in North Pest (2) increase in capacity of the treatment plant in North Buda and (3) construction of a treatment plant in South Pest The investment projects of the districts in sewer networks generally have to be in conformity with the general development plan of the Capital City
District XVIIs sewage project is dependent on the achievement of priority 1 as the main collecting pipe from the district leads into the sewage main of North Pest District XVIIIs project is linked to construction of the South Pest treatment plant (priority 3) once the district networks have been built they may not be put into operation until completion of the treatment plant
The capital finances the construction of main sewerage lines treatment plants collection and pumping stations these projects involve new facilities and mains or the increase in capacity of existing plants The actual technical plans are prepared by the FCSM reviewed by the public utility works department of the Capital City and prescnted to the genera assembly
Project preparation in the capital follows the prescription of a decree passed in 19929 Requirements include the submission of a detailed plan the Assemblyto including cost estimates but no financing plan The General Assembly must vote approval on all projects over a cost of HUF 50 million The financial plans for the realization of the capital city projects may include the following resources targeted subsidies funds from the general capital city budget contributions from the districts
9 Decree No 121992
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loans participation by the FCSM and contributions from the beneficiaries (businesseshouseholds) In only one case has the city taken out a specific project-related loan-from EBRD for a sewage treatment center
For 1993 the sewer fee included a portion dedicated specifically to the financingof new investments (HUF 470m 3 ) This was the first time that a part of the fee has been specifically assigned to the financing of new investment This development portion of the fee was only in place for 1993 and was not renewed for 1994 The proposals for the use of the development portion of the fee were made by the public utility works department
Until 1 January 1994 the sewer fee was set by the MTCWM based on a proposalof the city the technical aspects of the proposal are prepared by the FCSM and approvedby the general assembly of the capital The Capital City was authorized to determine the sewer fee for the first time this January although guidelines have been set by theMTCWM The initial technical proposal is prepared by the Finance Department of the FCSM Nevertheless the final say on the actual price rests with the general assembly of the Capital For the new fee options under consideration were to multiply the current fee by a price index for the sector (which would lead to an estimated 20 percent increase but would exclude any specific investment portion) or to include different developmentcosts in the fee The new fee (HUF 20 plus 10 percent value-added tax) was introduced in April 1994 although FCSM had recommended a tee of HUF 215 No part of the sewer fee is allocated to investments in the network undertaken by the districts The FCSM also plans to introduce a flat sewage fee of HUF 200-500 in areas not serviced at present to cover the cleaning of septic tanks
Actual construction of the projects is managed by the FCSM as the principal contractor Nevertheless the public utility works department of the Capital monitors the ongoing works approves bills submitted by the contractor and sub-contractors and authorizes payment to the FCSM (who pays the sub-contractors) Every six months a project report on use of funds and the advance of work is presented to the generalassembly If there are Impor ant cost overruns or construction delays then a change of scope of the project must be approved by the general assembly Once the project has been completed the equipment is turned over to the FCSM which is responsible for maintenance repairs rehabilitation and replacement
THE FCSM
The FCSM was previously a state-owned enterprise and was transferred to the ownership of the capital city according to the provisions of the Local Self-Government Act From 1 January 1992 the ownership rights of the sewerage network were transferred to the capital city The assets were managed by FCSM but it appears that no fee for lease of these assets was paid to the Capital City
From 1 December 1993 the FCSM was transformed into a joint-stock companywholly-owned by the capital city Before the transformation of the company the budget
ii
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of the sewer works company was approved by the general assembly of the Capital In addition the Supervisory Board of 13 members was appointed by the general assemblyOn 1 December 1993 the FCSM was transformed into a joint-stock company wholly owned by the Capital city Under this structure the Supervisory Board of nine members-three from FCSM staff and six from the Assembly-will be responsible for approving the companys budget and al strategically important decisions
The assets relating to sewerage were the property of the Capital City but were transferred to the FCSM as of 1 December 1993 as part of the companys transformation First the assets were reassessed and their replacement value was determined to be HUF 70 billion a considerable increase from the HUF 20 billion previously estimated10 With the transformation these assets were transferred to the ownership of the joint-stock company
Any additional networks and additions to the system will also be transferred to the FCSM However according to provisions of the 1991 Accounting Act any network built privately is transferred at zero value thus preventing the company from taking any depreciation on the value of the stock
As a means of circumventing this problem the FCSM arranged to be assigned as both investor and builder However when targeted subsidies are used to finance part of the network such an arrangement becomes more difficult because the local government must be the investor
For sewer projects initiated by the districts the FCSM is responsible for reviewing the technical plans and giving an expert opinion before construction begins Upon completion of the equipment the FCSM will inspect the equipment for adherence to technical norms (such as pressure tests or camera inspections within the pipes) and will authorize operation of the network This authorization will depend on capacity of eidsting mains and treatment plants to handle a larger flow of effluent in the system Thus due to the saturation of the main pipes in North Pest new business and industrial connections will not be authorized until the capacity of this part of the network has been increased
The principal activity of the FCSM is the operation and maintenance of the sewerage system within the city of Budapest In addition reconstruction and rehabilitation of all existing pipes pumping stations and treatment plants are the responsibility of the company These activities (operation maintenance reconstruction) are financed through the sewage fee
o It is believed that the primary purpose of this revaluation was to Increase depreciation funds However the higher valuation may have an adverse effect on the prospects for privatization
I Based on a conversation with the Technical Department of the FCSM
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The fee is collected in part by the FCSM however a collecting company12 collectsft sfrom private homes and the Water Works Company collects fees from industrial users and rental housing Thus the FCSM only seems to directly collect the fees from individuals with water wells but who are connected to the sewer system This systemof collection often leads to delays of at least two months in receipt of fees the amount ofunpaid fees were estimated at HUF 500-600 million in June 1993 and in May 1994 at HUF 338 million of which HUF 240 million Is from residences Total receipts in 1993 were HUF 4-5 billion putting delinquencits at about 8 percent
THE DISTRICTS
De facto due to lack of funds in the face of so many pressing needs the districtshave been made responsible for the construction of the secondary sewerage network(pipes leading from homes and businesses to the main collecting pipes and the collection system) The connections leading from homes and businesses to the secondary network are financed by the beneficiaries but constructed by the districts
Once a district decides to undertake the construction of part of the sewer system a water authorization permit is required from the MTCWM An expert opinion on thetechnical plans must be solicited from the FCSM The district is responsible for raisingfunds for construction Sources of financing may include district own fundscontributions from the Capital City targeted grants grants from the national Water Development Fund contributions from the population and loans
The means of financing used for these projects often leads to inefficient use of resources as matching funds and grants must remain in the accounts until construction has actually commenced This is the case for both the districts and the Capital CityTargeted grants require matching funds from the district which must be kept in the local government account as proof that this requirement has been met If there are delays in the start of the project these funds are left unused instead of being appropriated for more immediate needs
In the same way contributions from the Capital City must be negotiated on a caseby case basis and success in obtaining them may depend on the extent to which theparticular project corresponds to the capital citys own priorities However if the districts do not commence work on the project in a timely manner the Capital City funds are alsolying unused in an account For this reason the Capital has placed conditions on projectconstruction start-up dates if these requirements are not respected the districts may
This company was recently privatized through an employee share purchasing program It collects all utilities and municipal housing rents In Budapest for a fee of 3 to 4 percent of collections Recentlythe electricity company ended the contract and makes Its own collections while th gas company hascontracted out to other private companies in certain districts although their collections fees are muchhigher The Collection Company is currently in the process of revising its contractual relationshipswith its clients
12
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lose the grant For example District XVII received a promise of a HUF 14 million grant for the Rkosliget sewer project on condition that construction commenced by 1 December 1993
Appropriate financial products are currently not available to local governments for financing long-term investments such as sewer networks 3 For the moment the districts do not have access to the sewer fee which would enable them to appropriate part of this user fee for the reimbursement of debt Thus districts have placed heavyreliance on up-front population contributions through neighborhood associations and construction communities to finance part of secondary networks (and sometimef- the main networks) in addition to direct household connections to the network ----se connection fees are the only user charge to which districts have access As there o legal restriction on the level of the connection fee the only consideration in settin e fee is affordability
The construction of the project is monitored by the district Once completed technical certification of the equipment is required by the FCSM (pumping test and verification of pipes with a camera) If the results of these verifications are unsatisfactory then the operation of the pipes will not be authorized by the FCSM 4 If the FCSM grants approval the entire network is transferred to the Sewer Works Company which is responsible for operation maintenance rehabilitation and replacement of the equipment
NEIGHBORHOOD ASSOCIATIONS AND CONSTRUCTION COMMUNITIES
Under the previous system in order fc - neighbor-ods and towns to obtain quicker connections to public utilities organizea forms G population participation were developed these methods of financing infrastructure have continued and may take the form of a neighborhood association or a construction community
Neighborhood associations (ktzmitdrsulds) for the financing of infrastructure network- are formed when at least 66 percent of the residents of a neighborhood agree to their creation membership is open to all residents and contributions to the cost of infrastructure investment is compulsory Membership entitles residents to receive five-to seven year loans from OTP with 70 percent of the interest subsidized by the central
13 See Hegedes Mark Pigey Municipal Lending in Hungary March 1993
This has posed a problem for District XVII in 1993 30 kilometers of pipes of 40 constructed failed the camera verification test however the contractors had already been paid before this verification The District is unable to pave the roads or put system into operation until the pipes are repaired to satisfactory condition
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government 5 Through these loans investment funds are available up front to the district and it is the OTP which takes the credit risk
The members of the association appoint a steering committee (or an executiveboard) which works with the district issues tenders and selects the contractor The amount of contributions by members is assessed by the committee and any remainingfunds available after construction may be redistributed to the residents The committee also defines the contributions of new members
Construction communities (6pit6kbzOss~g) are a more flexible form of populationparticipation as they are not legal entities and have no right to sign contracts in their own name The community elects an executive board this board will work with the local government during construction in terms of choosing a constructor monitoringrealization countersigning contracts and bills However the legal investor is the local government This form of construction is used in District XVII
A separate account is established for the investment and members of theconstruction community pay their contributions into the account as the work proceedsIndividuals may contract loans to finance their contribution but these are at market rates and not the subsidized loans available to members of neighborhood associations Thus the district takes a credit risk and there are cases where members have not been able to pay the full amount of their assessed participation
In interviews with Districts XVII and XVIII it has often been stated that households have reached the limits of their capacity to contribute to financing the sewage network This system of financing is not limited to capital investments in sewer networks but has also been used to finance other public utilities such as potable water gas connections and telephone lines
Although districts do receive a portion of the personal income tax (for which there is a specific distribution formula between the capital city and the districts and among the districts) the actual incomes of the district populations are not known with precisionIn order for the district governments to better Judge the capacity of their population tocontribute both now and in the future small surveys of the population of selected areas in the district may be useful Such surveys may help to establish the level of incomesand expenditures as well as assess a realistic burden for construction and developmentlees or local taxes
15 In January 1994 subsidies for direct household loans for utility connections were terminated making the neighborhood association loans the only remaining subsidy for utility connections
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MINISTRY OF TRANSPORTATION COMMUNICATION AND WATER MANAGEMENT (MTCWM)
The Ministry of Transportation Communication and Water Management must approve all projects in Hungary relating to water no sewerage project may go forward without first obtaining the water authorization permit from this Ministry
Until 1 January 1994 the Miniszry also played a role in setting the water and sewer tariffs According to the 1990 Act on Prices the fee must include the expenses of efficient operation and the profit required for efficient operation although no definition of efficiency or provisions for monitoring are included in the Act
The final allowed price was set by the Ministry based on tariffs proposed by the sewer company and the Capital City From the beginning of 1994 the pricing of sewer services has been completely devolved to the city of Budapest although the Ministry has set non-binding guidelines for fees
PROPOSED SEWAGE INVESTMENTS
SEWAGE DEVELOPMENT NEEDS IN DISTRICTS XVII AND XVIII
Citywide there are 4000 km of sewage pipes connecting approximately 88 percentof households in Budapest although this is heavily concentrated in the center so that
8outer districts have only about 50 to 60 percent coverage 1 Sewage treatment is below the adequate level FCSM estimates that 80 percent of sewage receives mechanical treatment but less than 20 percent is biologically treated
Districts XVII and XVIII have among the lowest levels of sewerage coverage in Budapest but according to the FCSM Investment Department District XVII is worse off because in District XVIII only one area (Pestszentimre) is badly underserviced Both district governments list sewerage as their most pressing infrastructure developmentneed and both have projects planned which they hope to address in the near future
District XVII
District XVII has a split sewage system-ie two separate subsystems for sewageand storm water collection-and has a big deficit in both systems The district has
1039a comprehensive sewage construction plan with an estimated total cost of HUF billion which has already been begun A first task to lay a network in Rakosliget and Rakoscsaba uJtelep has already been partially completed although some difficulties with the contractor left the laid pipes not ready for use The result was that the municipal sewer company (FCSM) refused to accept the pipes and the district has had to ask the city for a special grant of HUF 80 million 8 to complete the work and repave the roads under a new contract
The plan calls for three additional phases of construction the first part will be to construct sewerage in the most urgent areas (the district center and RAkoscsaba) the second is to complete a parallel principal main which is a precondition for expanding the network and the third is to connect some other areas to the system Phase I to construct about 30 kilometers in Rakoscsaba was begun in early 1994
Targeted subsidies have already been granted for the sewage projectHUF 285 million for 1993 and HUF 21 million for 1994 In both cases despite approvalthe district will receive funds one year later because of central budget limitations The local assembly also has approved the local portion of funding (30 percent of the originalcost estimate) which comes from the social normative grant but the schedule has to be
16 For the outer districts the 1992 flgures are 76-78 percent coverage (districts XV and l) 50-60 percent (XVIII MX and XXI) and 41-43 percent (XVII and XVI)
17 As is the case for most outer areas in Budapest
1s This grant was obtained in return for permission for the Capital City to use the districts landfill
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rethought One difficulty is that because they could not start construction before 1 December 1993 they forfeited the promised HUF 14 million from the City
In some ways storm water collection is a more urgent problem in the district and financially more problematic because no targeted subsidies are available and because it is impossible to charge the public directly for any portion of the development costs The district plans to build a series of ditches for storm water collecting water in one location but because these are open the Sewage Company will not operate them
The district assembly has approved sewerage construction plans but has not actually appropriated the money 9 so that the district has not been able to apply for some other available subsidies One such potential subsidy comes from the Water Management Fund which requires a permit from the water authority As the permit expires in two years the district will probably have to reapply because they may not be able to begin construction of the next phase within two years
One portion of the district contribution is paying the value-added tax portion of the connections (Until January 1993 this amount at 25 percent of cost would have been refunded by the central government) There is a preliminary agreement between the FCSM and the districts that starting 1 January 1994 the FCSM will pay the VAT and be reimbursed by the central government
Citizens contributions will have to make up a larger proportion than foreseen (probably 60 percent instead of 40 percent) A neighborhood association has already been formed in RiLkosllget two construction communities (one of over 700 households) have been formed for the Rakoscsaba work Conditions for households have changed considerably as of January 1994 because the 50 percent subsidies on utility connection loans are no longer available The district is therefore allowing those households unable to pay up front to pay in installments with no interest
Enterprises of course can be - arged higher connection fees and the district wants to use those to cross-subsidize household connections The district Public Utilities Division believes enterprises could be charged up to HUF 1 billion for the sewage development contribution plus HUF 80 million for the actual connection
District XVII has no outstanding loans nor do they levy any local taxes at present They do not have committees or a project preparation unit set up to work on cost of projects instead the technical department alone has put this project together There will be some political difficulties in getting this project approved because those in housing estates which are already connected to the sewage system and who represent the bulk
Not all assembly representatives heartily endorse the plan moreover the assembly did not think the central government would grant the targeted subsidy
20 This may be a problem at some point as when capacity problems exist the FCSM has indicated that it may grant permits for connection only to households and not to enterprises
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of the voting power will be opposed to the expenditure This same argument was used to explain why the council would be opposed to incurring debt although it is possiblethat debt could be structured to be repaid by the benefiting area only
The district does not have solid data on incomes but there is a general sense that probably only 20 percent of households can afford the sewage connection at HUF 30000shy40000 those who cannot would have to be subsidized by the local government byreceiving interest-free loans
DistrictXV37
District XVIII has almost the lowest per capita income in Budapest (it ranks 18th among the 22 districts) it is fourth in area seventh in population and only district XVII has less sewerage coverage according to the Deputy Mayor
Pestszentimre a neighborhood of mostly single-family houses containing about one quarter of district households (a population of 25000 in a district of 98000) is the area most urgently needing sewerage development The cost for this development is estimated at between HUF 12 and 16 billion Four storage tanks that pump sewage into the main system will have to be built The current plan is to begin construction in 1996 the schedule has been pushed back mostly because of financial considerations Sewage is still very much a priority investment for the district
The district hopes to have 30 percent of the cost covered by district resources 30 percent by the Capital City and 40 percent by a targeted subsidy (because Budapestapplied for the subsidy with the district the subsidy is worth an extra 10 percent of estimated cost) A cooperation agreement was required but because Budapest did not sign it the district has not yet applied for the subsidy
The Southern Pest Treatment Center is at capacity now and the new sewerage will not be able to be connected until the Center is expanded District XVIII feels confident that the expansion will be undertaken next year so the technical problem will be solved Budapest would take a loan for this project apparently the City Council is in favor of the project Even though the Treatment Center has not yet been expanded the FCSM has given the district their permit to begin construction
The gas network was recently completed in the same area funded throughneighborhood associations work was completed in 1993 The connection fee of HUF 46000 per household will take three years to pay off so that payments will stop in 1995 Even so the connection fee alone did not cover the total cost which came to about HUF 150000-200000 per property
If a connection fee for sewerage is set too high district officials are afraid somehouseholds may elect not to connect at all If more than 60 percent of households want to connect the district will begin construction but they risk having some households subsequently decide not to connect and withdraw their contributions District officials
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expect the connection fee to be HUF 60000-65000 the District will pay an additional HUF 15000 fee per household to cover the cost of preparing the technical construction plans
The Deputy Mayor assumes the district will have to take on debt and he believes the district would definitely approach various banks as OTP does not offer attractive terms A technical implementation report on the project has been prepared but it includes no work on financial returns
CURRENT SEWER INFRASTRUCTURE FINANCING PRACTICES
As described in the first section districts are responsible for the construction of sewer collection systems that once built are turned over to the Capital City Sewer Company for operation and maintenance The Capital City is responsible for construction of interceptor sewers and sewage treatment plants Once the infrastruc-ture is in place system stewardship is the responsibility of the Budapest Municipal Sewage Company (FCSM)
There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including
Central Government Targeted subsidies provided by the central government are used to finance construction of sewer collection systems Targeted subsides are matching grants given to districts on a competitive basis The level of funding provided by targeted subsides is 30 percent for sewer collection projects (40 percentif the application is made jointly by both the district and the Capital City) However the reliability of this revenue source to finance future sewer projects is subject to the priorities and conditions set by the Parliament as recommended by the Ministry of the Interior Therefore there is no assurance that targetedsubsidies can be used to finance sewer collection systems in the future2
1 It is noted that the central government provides addressed subsidies however sewer collection system financing is not an eligible use of such subsidies
Capital City The Capital City can contribute to the cost of district sewer construction projects However district projects mus conform to Capital City priorities to be considered for funding
21 For example in 1993 the amounts needed to fund all eligible projects exceed the grant monies budgeted by the central government so those projects are approved but local governments will receive funds two or three years from now
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District Own source revenues for sewer collection system construction and connections to properties in public ownership are derived from (1) allocations made through the annual local budget process derived from local taxes miscellaneous fees and intergovernmental transfers (eg normative subsidies) (2) sale or lease of district owned land and (3)mid-term borrowing (defined as 2-3 years) from OTP Loans are repaid from own source revenue in the form of proceeds from the sale or lease of district-owned land
Citizens Citizens contribute to the construction of sewer systems in two ways (1)through the creation of construction communities or neighborhood associations citizens pay a portion of the collection system construction cost and (2)connection fees
FINANCING OPTIONS
This is a period of intensive change in the ways in which the central governmentdistricts the Capital City and the recently privatized Budapest Municipal SewageCompany finance and maintain the municipal sewer system Existing capitalimprovements practices are woefully insufficient to meet current and future seweragecapital needs Reasons for this state of affairs include
Limited Financial Capacity
The lack of adequate own source revenue has a profound impact on limitingavailable funds necessary to finance sewage system expansion There is a great disparitybetween capital needs and the anticipated revenue available to meet these needs Sewer construction projects are very expensive Existing financing mechanisms are inadequate
Debt Financing Districts make limited use of debt financing When debt is issuedIt is for a 2 or 3 year period This short term debt financing places an undue burden on the districts limited financial resources and the present populationsability to amortize the debt The high cost of borrowing (27 percent interest) further exacerbates this problem as well as increasing the cost of capital development
Capital financing typically requires the issuance of long term debt (20 to 30 years)that roughly correlates to the useful life of the facility This method of financingalso is considered to be equitable to those who benefit from the system (egcitizens commerce industry) since each generation pays its fair share of the cost of the facility A long-life asset such as a sewer system should be paid for by its users throughout its normal life rather than all at once by those who may not have the use of it full term Even with higher cost due to interest if spread over a largenumber of userspayers the cost to all is lowered Given Hungarys high rate of inflation and thus ever increasing construction costs it may be cheaper to borrow and pay todays prices rather than wait and pay tomorrows prices Furthermorethe use of long term debt puts less financial pressure on the operating budget
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OperatingBudget (ie pay-as-you-go)There is some attempt to finance a portion of the cost of sewer improvements through the operating budget The operatingbudget is reliant on revenues derived from intergovernmental transfers and therefore provides very little fiscal flexibility to support capital development Furthermore there are no reserve accounts that may be used to set aside funds for future capital development or meet emergencies (It will be noted of course that with Hungarys high rate of inflation the reserve accounts will be rapidly eroded so it may be decided to keep them at a mintimum)
Typically the operating budget is not used to finance large scale capital projects such as sewer collection systems Annual appropriations tend to be used to pay for municipal operations and service Small scale projects equipment purchases and the repair of existing facilities may be funded through the operating budgetHowever the use of the operating budget to finance large capital projects should be frowned upon for the following reasons
It forces local officials to make extremely difficult choices between service
delivery government operations and capital expansion
It places a heavy burden on the budget for the project year
It creates awkward fluctuating expenditure cycles that do not occur with extended financing
Since funding is based on yearly increments the use of the operating budget helps foster an environment wherein projects often go uncompleted
Sale of Land Districts rely on the sale of land to raise revenue for infrastructure financing This raises several concerns First land is not liquid and its value is subject to market forces In a sagging market such as currently exists land priceshave eroded to the point where districts are unable to raise adequate capital through the sale of land to finance sewer construction Furthermore there are few entrepreneurs with adequate resources to buy land
A related issue is that the land being sold is not serviced by sewer and other infrastructure components The offering price most likely reflects the absence of infrastructure If the infrastructure were in place prior to the sale or lease of district-owned land the district would realize a greater return than it currently receives
Finally land is finite Districts should think carefully about diminishing this resource to finance capital investment particularly before the capital is in placeLater in this paper we describe financing mechanisms that should be considered as feasible alternatives Particular attention should be paid to the use of tax increment financing or other forms of betterment financing
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Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
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Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
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ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
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projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
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Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
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plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
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FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
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ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
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ENFRASTRUCTURE INVESTMENT RESPONSIBILITIES IN BUDAPEST
The city of Budapest comprises 23 local self-governments including the Capital Citygovernment (F6vdros) and the twenty-two districts According to Article 63 of the Act on local self-government the district governments of Budapest are mainly responsible for the provision of primary public services while the Capital government is responsible for tasks which affect the whole or a large part of the city
A separate law further defines the respective responsibilities of the Capital and of the districts4 Article 10 of this Act lists specific rights and duties of the capital citygovernment which includes provision of water gas and steam water regulation storm sewerage and channeling and the provision of potable water to the entire capital or its major portions Some of these duties may be transferred by the capital city to the district governments on two conditions that sufficient funds are provided for carrying out these services and that the district accepts this transfer5
In practice responsibility for construction ownership and maintenance of publicinfrastructure has been splintered among several entities and competing local governments This situation is further complicated by the ambiguity of legislative textsand by the transformation of the Budapest Sewerage Works (or FCSMI) which became a joint-stock company on 1 December 1993
As a res-it due in part to the large responsibilities placed on the capital government and the insufficiency of funds to respond in the short and medium term to the most pressing needs some districts have sought to mitigate the lack of action on the part of the capital by initiating and financing projects which would normally be in the domain of the capital
The fragmentation of responsibility for preparation of urban development and master plans between the capital and the districts may lead to conflicts in the realization of certain infrastructure projects The general assembly of the Capital formulates the urban development program and the general master plan for the capital city howeverthe views of the Government and of the districts must be solicited The basic plan for each district is determined by the district assembly in conformity with the generalmaster plan of the capital However the new Capital general master plan has not yetbeen finalized this fact has not deterred the districts from developing their own local development plans which may sometimes be in conflict with the general master plan8
4 Law XXIV of 1991 on the self-government of the capital city and of the capital city districts
5 Ibid Article 12
6 F6vdrosi Csatornmmzsi Mvek
7 Ibid Articles 8(4) and 11
8 According to the Budapest Department of Public Utility Works
Cl
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It is therefore difficult for the city to combat a possible Not in my backyard (NIMBY) mentality on the part of the districts as in the case of construction of a new sewerage treatment plant
In the case of the specific projects for Districts XVII and XVIII several actors are responsible for different phases of project planning financing construction and management These include the capital city the FCSM the districts neighborhood associations and construction communities and the Ministry of Transportation Communication and Water Management (MTCWM) The role of each of these actors is described below
THE BUDAPEST MUNICIPAL GOVERNMENT (FOVAROS)
The Capital City is responsible for formuiating development plans for the city For sewerage development a long-term plan through the year 2015 has been established However consultations were engaged with the Government the districts and the FCSM during the preparation of the plan For actual implementation an annual or a two-year development plan is prepared based on the stated objectives of the capital assembly Three current main priorities in the area of sewage are (1) increase in collection and carrying capacity of the sewerage main in North Pest (2) increase in capacity of the treatment plant in North Buda and (3) construction of a treatment plant in South Pest The investment projects of the districts in sewer networks generally have to be in conformity with the general development plan of the Capital City
District XVIIs sewage project is dependent on the achievement of priority 1 as the main collecting pipe from the district leads into the sewage main of North Pest District XVIIIs project is linked to construction of the South Pest treatment plant (priority 3) once the district networks have been built they may not be put into operation until completion of the treatment plant
The capital finances the construction of main sewerage lines treatment plants collection and pumping stations these projects involve new facilities and mains or the increase in capacity of existing plants The actual technical plans are prepared by the FCSM reviewed by the public utility works department of the Capital City and prescnted to the genera assembly
Project preparation in the capital follows the prescription of a decree passed in 19929 Requirements include the submission of a detailed plan the Assemblyto including cost estimates but no financing plan The General Assembly must vote approval on all projects over a cost of HUF 50 million The financial plans for the realization of the capital city projects may include the following resources targeted subsidies funds from the general capital city budget contributions from the districts
9 Decree No 121992
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loans participation by the FCSM and contributions from the beneficiaries (businesseshouseholds) In only one case has the city taken out a specific project-related loan-from EBRD for a sewage treatment center
For 1993 the sewer fee included a portion dedicated specifically to the financingof new investments (HUF 470m 3 ) This was the first time that a part of the fee has been specifically assigned to the financing of new investment This development portion of the fee was only in place for 1993 and was not renewed for 1994 The proposals for the use of the development portion of the fee were made by the public utility works department
Until 1 January 1994 the sewer fee was set by the MTCWM based on a proposalof the city the technical aspects of the proposal are prepared by the FCSM and approvedby the general assembly of the capital The Capital City was authorized to determine the sewer fee for the first time this January although guidelines have been set by theMTCWM The initial technical proposal is prepared by the Finance Department of the FCSM Nevertheless the final say on the actual price rests with the general assembly of the Capital For the new fee options under consideration were to multiply the current fee by a price index for the sector (which would lead to an estimated 20 percent increase but would exclude any specific investment portion) or to include different developmentcosts in the fee The new fee (HUF 20 plus 10 percent value-added tax) was introduced in April 1994 although FCSM had recommended a tee of HUF 215 No part of the sewer fee is allocated to investments in the network undertaken by the districts The FCSM also plans to introduce a flat sewage fee of HUF 200-500 in areas not serviced at present to cover the cleaning of septic tanks
Actual construction of the projects is managed by the FCSM as the principal contractor Nevertheless the public utility works department of the Capital monitors the ongoing works approves bills submitted by the contractor and sub-contractors and authorizes payment to the FCSM (who pays the sub-contractors) Every six months a project report on use of funds and the advance of work is presented to the generalassembly If there are Impor ant cost overruns or construction delays then a change of scope of the project must be approved by the general assembly Once the project has been completed the equipment is turned over to the FCSM which is responsible for maintenance repairs rehabilitation and replacement
THE FCSM
The FCSM was previously a state-owned enterprise and was transferred to the ownership of the capital city according to the provisions of the Local Self-Government Act From 1 January 1992 the ownership rights of the sewerage network were transferred to the capital city The assets were managed by FCSM but it appears that no fee for lease of these assets was paid to the Capital City
From 1 December 1993 the FCSM was transformed into a joint-stock companywholly-owned by the capital city Before the transformation of the company the budget
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of the sewer works company was approved by the general assembly of the Capital In addition the Supervisory Board of 13 members was appointed by the general assemblyOn 1 December 1993 the FCSM was transformed into a joint-stock company wholly owned by the Capital city Under this structure the Supervisory Board of nine members-three from FCSM staff and six from the Assembly-will be responsible for approving the companys budget and al strategically important decisions
The assets relating to sewerage were the property of the Capital City but were transferred to the FCSM as of 1 December 1993 as part of the companys transformation First the assets were reassessed and their replacement value was determined to be HUF 70 billion a considerable increase from the HUF 20 billion previously estimated10 With the transformation these assets were transferred to the ownership of the joint-stock company
Any additional networks and additions to the system will also be transferred to the FCSM However according to provisions of the 1991 Accounting Act any network built privately is transferred at zero value thus preventing the company from taking any depreciation on the value of the stock
As a means of circumventing this problem the FCSM arranged to be assigned as both investor and builder However when targeted subsidies are used to finance part of the network such an arrangement becomes more difficult because the local government must be the investor
For sewer projects initiated by the districts the FCSM is responsible for reviewing the technical plans and giving an expert opinion before construction begins Upon completion of the equipment the FCSM will inspect the equipment for adherence to technical norms (such as pressure tests or camera inspections within the pipes) and will authorize operation of the network This authorization will depend on capacity of eidsting mains and treatment plants to handle a larger flow of effluent in the system Thus due to the saturation of the main pipes in North Pest new business and industrial connections will not be authorized until the capacity of this part of the network has been increased
The principal activity of the FCSM is the operation and maintenance of the sewerage system within the city of Budapest In addition reconstruction and rehabilitation of all existing pipes pumping stations and treatment plants are the responsibility of the company These activities (operation maintenance reconstruction) are financed through the sewage fee
o It is believed that the primary purpose of this revaluation was to Increase depreciation funds However the higher valuation may have an adverse effect on the prospects for privatization
I Based on a conversation with the Technical Department of the FCSM
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The fee is collected in part by the FCSM however a collecting company12 collectsft sfrom private homes and the Water Works Company collects fees from industrial users and rental housing Thus the FCSM only seems to directly collect the fees from individuals with water wells but who are connected to the sewer system This systemof collection often leads to delays of at least two months in receipt of fees the amount ofunpaid fees were estimated at HUF 500-600 million in June 1993 and in May 1994 at HUF 338 million of which HUF 240 million Is from residences Total receipts in 1993 were HUF 4-5 billion putting delinquencits at about 8 percent
THE DISTRICTS
De facto due to lack of funds in the face of so many pressing needs the districtshave been made responsible for the construction of the secondary sewerage network(pipes leading from homes and businesses to the main collecting pipes and the collection system) The connections leading from homes and businesses to the secondary network are financed by the beneficiaries but constructed by the districts
Once a district decides to undertake the construction of part of the sewer system a water authorization permit is required from the MTCWM An expert opinion on thetechnical plans must be solicited from the FCSM The district is responsible for raisingfunds for construction Sources of financing may include district own fundscontributions from the Capital City targeted grants grants from the national Water Development Fund contributions from the population and loans
The means of financing used for these projects often leads to inefficient use of resources as matching funds and grants must remain in the accounts until construction has actually commenced This is the case for both the districts and the Capital CityTargeted grants require matching funds from the district which must be kept in the local government account as proof that this requirement has been met If there are delays in the start of the project these funds are left unused instead of being appropriated for more immediate needs
In the same way contributions from the Capital City must be negotiated on a caseby case basis and success in obtaining them may depend on the extent to which theparticular project corresponds to the capital citys own priorities However if the districts do not commence work on the project in a timely manner the Capital City funds are alsolying unused in an account For this reason the Capital has placed conditions on projectconstruction start-up dates if these requirements are not respected the districts may
This company was recently privatized through an employee share purchasing program It collects all utilities and municipal housing rents In Budapest for a fee of 3 to 4 percent of collections Recentlythe electricity company ended the contract and makes Its own collections while th gas company hascontracted out to other private companies in certain districts although their collections fees are muchhigher The Collection Company is currently in the process of revising its contractual relationshipswith its clients
12
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lose the grant For example District XVII received a promise of a HUF 14 million grant for the Rkosliget sewer project on condition that construction commenced by 1 December 1993
Appropriate financial products are currently not available to local governments for financing long-term investments such as sewer networks 3 For the moment the districts do not have access to the sewer fee which would enable them to appropriate part of this user fee for the reimbursement of debt Thus districts have placed heavyreliance on up-front population contributions through neighborhood associations and construction communities to finance part of secondary networks (and sometimef- the main networks) in addition to direct household connections to the network ----se connection fees are the only user charge to which districts have access As there o legal restriction on the level of the connection fee the only consideration in settin e fee is affordability
The construction of the project is monitored by the district Once completed technical certification of the equipment is required by the FCSM (pumping test and verification of pipes with a camera) If the results of these verifications are unsatisfactory then the operation of the pipes will not be authorized by the FCSM 4 If the FCSM grants approval the entire network is transferred to the Sewer Works Company which is responsible for operation maintenance rehabilitation and replacement of the equipment
NEIGHBORHOOD ASSOCIATIONS AND CONSTRUCTION COMMUNITIES
Under the previous system in order fc - neighbor-ods and towns to obtain quicker connections to public utilities organizea forms G population participation were developed these methods of financing infrastructure have continued and may take the form of a neighborhood association or a construction community
Neighborhood associations (ktzmitdrsulds) for the financing of infrastructure network- are formed when at least 66 percent of the residents of a neighborhood agree to their creation membership is open to all residents and contributions to the cost of infrastructure investment is compulsory Membership entitles residents to receive five-to seven year loans from OTP with 70 percent of the interest subsidized by the central
13 See Hegedes Mark Pigey Municipal Lending in Hungary March 1993
This has posed a problem for District XVII in 1993 30 kilometers of pipes of 40 constructed failed the camera verification test however the contractors had already been paid before this verification The District is unable to pave the roads or put system into operation until the pipes are repaired to satisfactory condition
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government 5 Through these loans investment funds are available up front to the district and it is the OTP which takes the credit risk
The members of the association appoint a steering committee (or an executiveboard) which works with the district issues tenders and selects the contractor The amount of contributions by members is assessed by the committee and any remainingfunds available after construction may be redistributed to the residents The committee also defines the contributions of new members
Construction communities (6pit6kbzOss~g) are a more flexible form of populationparticipation as they are not legal entities and have no right to sign contracts in their own name The community elects an executive board this board will work with the local government during construction in terms of choosing a constructor monitoringrealization countersigning contracts and bills However the legal investor is the local government This form of construction is used in District XVII
A separate account is established for the investment and members of theconstruction community pay their contributions into the account as the work proceedsIndividuals may contract loans to finance their contribution but these are at market rates and not the subsidized loans available to members of neighborhood associations Thus the district takes a credit risk and there are cases where members have not been able to pay the full amount of their assessed participation
In interviews with Districts XVII and XVIII it has often been stated that households have reached the limits of their capacity to contribute to financing the sewage network This system of financing is not limited to capital investments in sewer networks but has also been used to finance other public utilities such as potable water gas connections and telephone lines
Although districts do receive a portion of the personal income tax (for which there is a specific distribution formula between the capital city and the districts and among the districts) the actual incomes of the district populations are not known with precisionIn order for the district governments to better Judge the capacity of their population tocontribute both now and in the future small surveys of the population of selected areas in the district may be useful Such surveys may help to establish the level of incomesand expenditures as well as assess a realistic burden for construction and developmentlees or local taxes
15 In January 1994 subsidies for direct household loans for utility connections were terminated making the neighborhood association loans the only remaining subsidy for utility connections
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MINISTRY OF TRANSPORTATION COMMUNICATION AND WATER MANAGEMENT (MTCWM)
The Ministry of Transportation Communication and Water Management must approve all projects in Hungary relating to water no sewerage project may go forward without first obtaining the water authorization permit from this Ministry
Until 1 January 1994 the Miniszry also played a role in setting the water and sewer tariffs According to the 1990 Act on Prices the fee must include the expenses of efficient operation and the profit required for efficient operation although no definition of efficiency or provisions for monitoring are included in the Act
The final allowed price was set by the Ministry based on tariffs proposed by the sewer company and the Capital City From the beginning of 1994 the pricing of sewer services has been completely devolved to the city of Budapest although the Ministry has set non-binding guidelines for fees
PROPOSED SEWAGE INVESTMENTS
SEWAGE DEVELOPMENT NEEDS IN DISTRICTS XVII AND XVIII
Citywide there are 4000 km of sewage pipes connecting approximately 88 percentof households in Budapest although this is heavily concentrated in the center so that
8outer districts have only about 50 to 60 percent coverage 1 Sewage treatment is below the adequate level FCSM estimates that 80 percent of sewage receives mechanical treatment but less than 20 percent is biologically treated
Districts XVII and XVIII have among the lowest levels of sewerage coverage in Budapest but according to the FCSM Investment Department District XVII is worse off because in District XVIII only one area (Pestszentimre) is badly underserviced Both district governments list sewerage as their most pressing infrastructure developmentneed and both have projects planned which they hope to address in the near future
District XVII
District XVII has a split sewage system-ie two separate subsystems for sewageand storm water collection-and has a big deficit in both systems The district has
1039a comprehensive sewage construction plan with an estimated total cost of HUF billion which has already been begun A first task to lay a network in Rakosliget and Rakoscsaba uJtelep has already been partially completed although some difficulties with the contractor left the laid pipes not ready for use The result was that the municipal sewer company (FCSM) refused to accept the pipes and the district has had to ask the city for a special grant of HUF 80 million 8 to complete the work and repave the roads under a new contract
The plan calls for three additional phases of construction the first part will be to construct sewerage in the most urgent areas (the district center and RAkoscsaba) the second is to complete a parallel principal main which is a precondition for expanding the network and the third is to connect some other areas to the system Phase I to construct about 30 kilometers in Rakoscsaba was begun in early 1994
Targeted subsidies have already been granted for the sewage projectHUF 285 million for 1993 and HUF 21 million for 1994 In both cases despite approvalthe district will receive funds one year later because of central budget limitations The local assembly also has approved the local portion of funding (30 percent of the originalcost estimate) which comes from the social normative grant but the schedule has to be
16 For the outer districts the 1992 flgures are 76-78 percent coverage (districts XV and l) 50-60 percent (XVIII MX and XXI) and 41-43 percent (XVII and XVI)
17 As is the case for most outer areas in Budapest
1s This grant was obtained in return for permission for the Capital City to use the districts landfill
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rethought One difficulty is that because they could not start construction before 1 December 1993 they forfeited the promised HUF 14 million from the City
In some ways storm water collection is a more urgent problem in the district and financially more problematic because no targeted subsidies are available and because it is impossible to charge the public directly for any portion of the development costs The district plans to build a series of ditches for storm water collecting water in one location but because these are open the Sewage Company will not operate them
The district assembly has approved sewerage construction plans but has not actually appropriated the money 9 so that the district has not been able to apply for some other available subsidies One such potential subsidy comes from the Water Management Fund which requires a permit from the water authority As the permit expires in two years the district will probably have to reapply because they may not be able to begin construction of the next phase within two years
One portion of the district contribution is paying the value-added tax portion of the connections (Until January 1993 this amount at 25 percent of cost would have been refunded by the central government) There is a preliminary agreement between the FCSM and the districts that starting 1 January 1994 the FCSM will pay the VAT and be reimbursed by the central government
Citizens contributions will have to make up a larger proportion than foreseen (probably 60 percent instead of 40 percent) A neighborhood association has already been formed in RiLkosllget two construction communities (one of over 700 households) have been formed for the Rakoscsaba work Conditions for households have changed considerably as of January 1994 because the 50 percent subsidies on utility connection loans are no longer available The district is therefore allowing those households unable to pay up front to pay in installments with no interest
Enterprises of course can be - arged higher connection fees and the district wants to use those to cross-subsidize household connections The district Public Utilities Division believes enterprises could be charged up to HUF 1 billion for the sewage development contribution plus HUF 80 million for the actual connection
District XVII has no outstanding loans nor do they levy any local taxes at present They do not have committees or a project preparation unit set up to work on cost of projects instead the technical department alone has put this project together There will be some political difficulties in getting this project approved because those in housing estates which are already connected to the sewage system and who represent the bulk
Not all assembly representatives heartily endorse the plan moreover the assembly did not think the central government would grant the targeted subsidy
20 This may be a problem at some point as when capacity problems exist the FCSM has indicated that it may grant permits for connection only to households and not to enterprises
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of the voting power will be opposed to the expenditure This same argument was used to explain why the council would be opposed to incurring debt although it is possiblethat debt could be structured to be repaid by the benefiting area only
The district does not have solid data on incomes but there is a general sense that probably only 20 percent of households can afford the sewage connection at HUF 30000shy40000 those who cannot would have to be subsidized by the local government byreceiving interest-free loans
DistrictXV37
District XVIII has almost the lowest per capita income in Budapest (it ranks 18th among the 22 districts) it is fourth in area seventh in population and only district XVII has less sewerage coverage according to the Deputy Mayor
Pestszentimre a neighborhood of mostly single-family houses containing about one quarter of district households (a population of 25000 in a district of 98000) is the area most urgently needing sewerage development The cost for this development is estimated at between HUF 12 and 16 billion Four storage tanks that pump sewage into the main system will have to be built The current plan is to begin construction in 1996 the schedule has been pushed back mostly because of financial considerations Sewage is still very much a priority investment for the district
The district hopes to have 30 percent of the cost covered by district resources 30 percent by the Capital City and 40 percent by a targeted subsidy (because Budapestapplied for the subsidy with the district the subsidy is worth an extra 10 percent of estimated cost) A cooperation agreement was required but because Budapest did not sign it the district has not yet applied for the subsidy
The Southern Pest Treatment Center is at capacity now and the new sewerage will not be able to be connected until the Center is expanded District XVIII feels confident that the expansion will be undertaken next year so the technical problem will be solved Budapest would take a loan for this project apparently the City Council is in favor of the project Even though the Treatment Center has not yet been expanded the FCSM has given the district their permit to begin construction
The gas network was recently completed in the same area funded throughneighborhood associations work was completed in 1993 The connection fee of HUF 46000 per household will take three years to pay off so that payments will stop in 1995 Even so the connection fee alone did not cover the total cost which came to about HUF 150000-200000 per property
If a connection fee for sewerage is set too high district officials are afraid somehouseholds may elect not to connect at all If more than 60 percent of households want to connect the district will begin construction but they risk having some households subsequently decide not to connect and withdraw their contributions District officials
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expect the connection fee to be HUF 60000-65000 the District will pay an additional HUF 15000 fee per household to cover the cost of preparing the technical construction plans
The Deputy Mayor assumes the district will have to take on debt and he believes the district would definitely approach various banks as OTP does not offer attractive terms A technical implementation report on the project has been prepared but it includes no work on financial returns
CURRENT SEWER INFRASTRUCTURE FINANCING PRACTICES
As described in the first section districts are responsible for the construction of sewer collection systems that once built are turned over to the Capital City Sewer Company for operation and maintenance The Capital City is responsible for construction of interceptor sewers and sewage treatment plants Once the infrastruc-ture is in place system stewardship is the responsibility of the Budapest Municipal Sewage Company (FCSM)
There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including
Central Government Targeted subsidies provided by the central government are used to finance construction of sewer collection systems Targeted subsides are matching grants given to districts on a competitive basis The level of funding provided by targeted subsides is 30 percent for sewer collection projects (40 percentif the application is made jointly by both the district and the Capital City) However the reliability of this revenue source to finance future sewer projects is subject to the priorities and conditions set by the Parliament as recommended by the Ministry of the Interior Therefore there is no assurance that targetedsubsidies can be used to finance sewer collection systems in the future2
1 It is noted that the central government provides addressed subsidies however sewer collection system financing is not an eligible use of such subsidies
Capital City The Capital City can contribute to the cost of district sewer construction projects However district projects mus conform to Capital City priorities to be considered for funding
21 For example in 1993 the amounts needed to fund all eligible projects exceed the grant monies budgeted by the central government so those projects are approved but local governments will receive funds two or three years from now
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District Own source revenues for sewer collection system construction and connections to properties in public ownership are derived from (1) allocations made through the annual local budget process derived from local taxes miscellaneous fees and intergovernmental transfers (eg normative subsidies) (2) sale or lease of district owned land and (3)mid-term borrowing (defined as 2-3 years) from OTP Loans are repaid from own source revenue in the form of proceeds from the sale or lease of district-owned land
Citizens Citizens contribute to the construction of sewer systems in two ways (1)through the creation of construction communities or neighborhood associations citizens pay a portion of the collection system construction cost and (2)connection fees
FINANCING OPTIONS
This is a period of intensive change in the ways in which the central governmentdistricts the Capital City and the recently privatized Budapest Municipal SewageCompany finance and maintain the municipal sewer system Existing capitalimprovements practices are woefully insufficient to meet current and future seweragecapital needs Reasons for this state of affairs include
Limited Financial Capacity
The lack of adequate own source revenue has a profound impact on limitingavailable funds necessary to finance sewage system expansion There is a great disparitybetween capital needs and the anticipated revenue available to meet these needs Sewer construction projects are very expensive Existing financing mechanisms are inadequate
Debt Financing Districts make limited use of debt financing When debt is issuedIt is for a 2 or 3 year period This short term debt financing places an undue burden on the districts limited financial resources and the present populationsability to amortize the debt The high cost of borrowing (27 percent interest) further exacerbates this problem as well as increasing the cost of capital development
Capital financing typically requires the issuance of long term debt (20 to 30 years)that roughly correlates to the useful life of the facility This method of financingalso is considered to be equitable to those who benefit from the system (egcitizens commerce industry) since each generation pays its fair share of the cost of the facility A long-life asset such as a sewer system should be paid for by its users throughout its normal life rather than all at once by those who may not have the use of it full term Even with higher cost due to interest if spread over a largenumber of userspayers the cost to all is lowered Given Hungarys high rate of inflation and thus ever increasing construction costs it may be cheaper to borrow and pay todays prices rather than wait and pay tomorrows prices Furthermorethe use of long term debt puts less financial pressure on the operating budget
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OperatingBudget (ie pay-as-you-go)There is some attempt to finance a portion of the cost of sewer improvements through the operating budget The operatingbudget is reliant on revenues derived from intergovernmental transfers and therefore provides very little fiscal flexibility to support capital development Furthermore there are no reserve accounts that may be used to set aside funds for future capital development or meet emergencies (It will be noted of course that with Hungarys high rate of inflation the reserve accounts will be rapidly eroded so it may be decided to keep them at a mintimum)
Typically the operating budget is not used to finance large scale capital projects such as sewer collection systems Annual appropriations tend to be used to pay for municipal operations and service Small scale projects equipment purchases and the repair of existing facilities may be funded through the operating budgetHowever the use of the operating budget to finance large capital projects should be frowned upon for the following reasons
It forces local officials to make extremely difficult choices between service
delivery government operations and capital expansion
It places a heavy burden on the budget for the project year
It creates awkward fluctuating expenditure cycles that do not occur with extended financing
Since funding is based on yearly increments the use of the operating budget helps foster an environment wherein projects often go uncompleted
Sale of Land Districts rely on the sale of land to raise revenue for infrastructure financing This raises several concerns First land is not liquid and its value is subject to market forces In a sagging market such as currently exists land priceshave eroded to the point where districts are unable to raise adequate capital through the sale of land to finance sewer construction Furthermore there are few entrepreneurs with adequate resources to buy land
A related issue is that the land being sold is not serviced by sewer and other infrastructure components The offering price most likely reflects the absence of infrastructure If the infrastructure were in place prior to the sale or lease of district-owned land the district would realize a greater return than it currently receives
Finally land is finite Districts should think carefully about diminishing this resource to finance capital investment particularly before the capital is in placeLater in this paper we describe financing mechanisms that should be considered as feasible alternatives Particular attention should be paid to the use of tax increment financing or other forms of betterment financing
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Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
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Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
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ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
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projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
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Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
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plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
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FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
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ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
ENFRASTRUCTURE INVESTMENT RESPONSIBILITIES IN BUDAPEST
The city of Budapest comprises 23 local self-governments including the Capital Citygovernment (F6vdros) and the twenty-two districts According to Article 63 of the Act on local self-government the district governments of Budapest are mainly responsible for the provision of primary public services while the Capital government is responsible for tasks which affect the whole or a large part of the city
A separate law further defines the respective responsibilities of the Capital and of the districts4 Article 10 of this Act lists specific rights and duties of the capital citygovernment which includes provision of water gas and steam water regulation storm sewerage and channeling and the provision of potable water to the entire capital or its major portions Some of these duties may be transferred by the capital city to the district governments on two conditions that sufficient funds are provided for carrying out these services and that the district accepts this transfer5
In practice responsibility for construction ownership and maintenance of publicinfrastructure has been splintered among several entities and competing local governments This situation is further complicated by the ambiguity of legislative textsand by the transformation of the Budapest Sewerage Works (or FCSMI) which became a joint-stock company on 1 December 1993
As a res-it due in part to the large responsibilities placed on the capital government and the insufficiency of funds to respond in the short and medium term to the most pressing needs some districts have sought to mitigate the lack of action on the part of the capital by initiating and financing projects which would normally be in the domain of the capital
The fragmentation of responsibility for preparation of urban development and master plans between the capital and the districts may lead to conflicts in the realization of certain infrastructure projects The general assembly of the Capital formulates the urban development program and the general master plan for the capital city howeverthe views of the Government and of the districts must be solicited The basic plan for each district is determined by the district assembly in conformity with the generalmaster plan of the capital However the new Capital general master plan has not yetbeen finalized this fact has not deterred the districts from developing their own local development plans which may sometimes be in conflict with the general master plan8
4 Law XXIV of 1991 on the self-government of the capital city and of the capital city districts
5 Ibid Article 12
6 F6vdrosi Csatornmmzsi Mvek
7 Ibid Articles 8(4) and 11
8 According to the Budapest Department of Public Utility Works
Cl
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It is therefore difficult for the city to combat a possible Not in my backyard (NIMBY) mentality on the part of the districts as in the case of construction of a new sewerage treatment plant
In the case of the specific projects for Districts XVII and XVIII several actors are responsible for different phases of project planning financing construction and management These include the capital city the FCSM the districts neighborhood associations and construction communities and the Ministry of Transportation Communication and Water Management (MTCWM) The role of each of these actors is described below
THE BUDAPEST MUNICIPAL GOVERNMENT (FOVAROS)
The Capital City is responsible for formuiating development plans for the city For sewerage development a long-term plan through the year 2015 has been established However consultations were engaged with the Government the districts and the FCSM during the preparation of the plan For actual implementation an annual or a two-year development plan is prepared based on the stated objectives of the capital assembly Three current main priorities in the area of sewage are (1) increase in collection and carrying capacity of the sewerage main in North Pest (2) increase in capacity of the treatment plant in North Buda and (3) construction of a treatment plant in South Pest The investment projects of the districts in sewer networks generally have to be in conformity with the general development plan of the Capital City
District XVIIs sewage project is dependent on the achievement of priority 1 as the main collecting pipe from the district leads into the sewage main of North Pest District XVIIIs project is linked to construction of the South Pest treatment plant (priority 3) once the district networks have been built they may not be put into operation until completion of the treatment plant
The capital finances the construction of main sewerage lines treatment plants collection and pumping stations these projects involve new facilities and mains or the increase in capacity of existing plants The actual technical plans are prepared by the FCSM reviewed by the public utility works department of the Capital City and prescnted to the genera assembly
Project preparation in the capital follows the prescription of a decree passed in 19929 Requirements include the submission of a detailed plan the Assemblyto including cost estimates but no financing plan The General Assembly must vote approval on all projects over a cost of HUF 50 million The financial plans for the realization of the capital city projects may include the following resources targeted subsidies funds from the general capital city budget contributions from the districts
9 Decree No 121992
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loans participation by the FCSM and contributions from the beneficiaries (businesseshouseholds) In only one case has the city taken out a specific project-related loan-from EBRD for a sewage treatment center
For 1993 the sewer fee included a portion dedicated specifically to the financingof new investments (HUF 470m 3 ) This was the first time that a part of the fee has been specifically assigned to the financing of new investment This development portion of the fee was only in place for 1993 and was not renewed for 1994 The proposals for the use of the development portion of the fee were made by the public utility works department
Until 1 January 1994 the sewer fee was set by the MTCWM based on a proposalof the city the technical aspects of the proposal are prepared by the FCSM and approvedby the general assembly of the capital The Capital City was authorized to determine the sewer fee for the first time this January although guidelines have been set by theMTCWM The initial technical proposal is prepared by the Finance Department of the FCSM Nevertheless the final say on the actual price rests with the general assembly of the Capital For the new fee options under consideration were to multiply the current fee by a price index for the sector (which would lead to an estimated 20 percent increase but would exclude any specific investment portion) or to include different developmentcosts in the fee The new fee (HUF 20 plus 10 percent value-added tax) was introduced in April 1994 although FCSM had recommended a tee of HUF 215 No part of the sewer fee is allocated to investments in the network undertaken by the districts The FCSM also plans to introduce a flat sewage fee of HUF 200-500 in areas not serviced at present to cover the cleaning of septic tanks
Actual construction of the projects is managed by the FCSM as the principal contractor Nevertheless the public utility works department of the Capital monitors the ongoing works approves bills submitted by the contractor and sub-contractors and authorizes payment to the FCSM (who pays the sub-contractors) Every six months a project report on use of funds and the advance of work is presented to the generalassembly If there are Impor ant cost overruns or construction delays then a change of scope of the project must be approved by the general assembly Once the project has been completed the equipment is turned over to the FCSM which is responsible for maintenance repairs rehabilitation and replacement
THE FCSM
The FCSM was previously a state-owned enterprise and was transferred to the ownership of the capital city according to the provisions of the Local Self-Government Act From 1 January 1992 the ownership rights of the sewerage network were transferred to the capital city The assets were managed by FCSM but it appears that no fee for lease of these assets was paid to the Capital City
From 1 December 1993 the FCSM was transformed into a joint-stock companywholly-owned by the capital city Before the transformation of the company the budget
ii
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of the sewer works company was approved by the general assembly of the Capital In addition the Supervisory Board of 13 members was appointed by the general assemblyOn 1 December 1993 the FCSM was transformed into a joint-stock company wholly owned by the Capital city Under this structure the Supervisory Board of nine members-three from FCSM staff and six from the Assembly-will be responsible for approving the companys budget and al strategically important decisions
The assets relating to sewerage were the property of the Capital City but were transferred to the FCSM as of 1 December 1993 as part of the companys transformation First the assets were reassessed and their replacement value was determined to be HUF 70 billion a considerable increase from the HUF 20 billion previously estimated10 With the transformation these assets were transferred to the ownership of the joint-stock company
Any additional networks and additions to the system will also be transferred to the FCSM However according to provisions of the 1991 Accounting Act any network built privately is transferred at zero value thus preventing the company from taking any depreciation on the value of the stock
As a means of circumventing this problem the FCSM arranged to be assigned as both investor and builder However when targeted subsidies are used to finance part of the network such an arrangement becomes more difficult because the local government must be the investor
For sewer projects initiated by the districts the FCSM is responsible for reviewing the technical plans and giving an expert opinion before construction begins Upon completion of the equipment the FCSM will inspect the equipment for adherence to technical norms (such as pressure tests or camera inspections within the pipes) and will authorize operation of the network This authorization will depend on capacity of eidsting mains and treatment plants to handle a larger flow of effluent in the system Thus due to the saturation of the main pipes in North Pest new business and industrial connections will not be authorized until the capacity of this part of the network has been increased
The principal activity of the FCSM is the operation and maintenance of the sewerage system within the city of Budapest In addition reconstruction and rehabilitation of all existing pipes pumping stations and treatment plants are the responsibility of the company These activities (operation maintenance reconstruction) are financed through the sewage fee
o It is believed that the primary purpose of this revaluation was to Increase depreciation funds However the higher valuation may have an adverse effect on the prospects for privatization
I Based on a conversation with the Technical Department of the FCSM
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The fee is collected in part by the FCSM however a collecting company12 collectsft sfrom private homes and the Water Works Company collects fees from industrial users and rental housing Thus the FCSM only seems to directly collect the fees from individuals with water wells but who are connected to the sewer system This systemof collection often leads to delays of at least two months in receipt of fees the amount ofunpaid fees were estimated at HUF 500-600 million in June 1993 and in May 1994 at HUF 338 million of which HUF 240 million Is from residences Total receipts in 1993 were HUF 4-5 billion putting delinquencits at about 8 percent
THE DISTRICTS
De facto due to lack of funds in the face of so many pressing needs the districtshave been made responsible for the construction of the secondary sewerage network(pipes leading from homes and businesses to the main collecting pipes and the collection system) The connections leading from homes and businesses to the secondary network are financed by the beneficiaries but constructed by the districts
Once a district decides to undertake the construction of part of the sewer system a water authorization permit is required from the MTCWM An expert opinion on thetechnical plans must be solicited from the FCSM The district is responsible for raisingfunds for construction Sources of financing may include district own fundscontributions from the Capital City targeted grants grants from the national Water Development Fund contributions from the population and loans
The means of financing used for these projects often leads to inefficient use of resources as matching funds and grants must remain in the accounts until construction has actually commenced This is the case for both the districts and the Capital CityTargeted grants require matching funds from the district which must be kept in the local government account as proof that this requirement has been met If there are delays in the start of the project these funds are left unused instead of being appropriated for more immediate needs
In the same way contributions from the Capital City must be negotiated on a caseby case basis and success in obtaining them may depend on the extent to which theparticular project corresponds to the capital citys own priorities However if the districts do not commence work on the project in a timely manner the Capital City funds are alsolying unused in an account For this reason the Capital has placed conditions on projectconstruction start-up dates if these requirements are not respected the districts may
This company was recently privatized through an employee share purchasing program It collects all utilities and municipal housing rents In Budapest for a fee of 3 to 4 percent of collections Recentlythe electricity company ended the contract and makes Its own collections while th gas company hascontracted out to other private companies in certain districts although their collections fees are muchhigher The Collection Company is currently in the process of revising its contractual relationshipswith its clients
12
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lose the grant For example District XVII received a promise of a HUF 14 million grant for the Rkosliget sewer project on condition that construction commenced by 1 December 1993
Appropriate financial products are currently not available to local governments for financing long-term investments such as sewer networks 3 For the moment the districts do not have access to the sewer fee which would enable them to appropriate part of this user fee for the reimbursement of debt Thus districts have placed heavyreliance on up-front population contributions through neighborhood associations and construction communities to finance part of secondary networks (and sometimef- the main networks) in addition to direct household connections to the network ----se connection fees are the only user charge to which districts have access As there o legal restriction on the level of the connection fee the only consideration in settin e fee is affordability
The construction of the project is monitored by the district Once completed technical certification of the equipment is required by the FCSM (pumping test and verification of pipes with a camera) If the results of these verifications are unsatisfactory then the operation of the pipes will not be authorized by the FCSM 4 If the FCSM grants approval the entire network is transferred to the Sewer Works Company which is responsible for operation maintenance rehabilitation and replacement of the equipment
NEIGHBORHOOD ASSOCIATIONS AND CONSTRUCTION COMMUNITIES
Under the previous system in order fc - neighbor-ods and towns to obtain quicker connections to public utilities organizea forms G population participation were developed these methods of financing infrastructure have continued and may take the form of a neighborhood association or a construction community
Neighborhood associations (ktzmitdrsulds) for the financing of infrastructure network- are formed when at least 66 percent of the residents of a neighborhood agree to their creation membership is open to all residents and contributions to the cost of infrastructure investment is compulsory Membership entitles residents to receive five-to seven year loans from OTP with 70 percent of the interest subsidized by the central
13 See Hegedes Mark Pigey Municipal Lending in Hungary March 1993
This has posed a problem for District XVII in 1993 30 kilometers of pipes of 40 constructed failed the camera verification test however the contractors had already been paid before this verification The District is unable to pave the roads or put system into operation until the pipes are repaired to satisfactory condition
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government 5 Through these loans investment funds are available up front to the district and it is the OTP which takes the credit risk
The members of the association appoint a steering committee (or an executiveboard) which works with the district issues tenders and selects the contractor The amount of contributions by members is assessed by the committee and any remainingfunds available after construction may be redistributed to the residents The committee also defines the contributions of new members
Construction communities (6pit6kbzOss~g) are a more flexible form of populationparticipation as they are not legal entities and have no right to sign contracts in their own name The community elects an executive board this board will work with the local government during construction in terms of choosing a constructor monitoringrealization countersigning contracts and bills However the legal investor is the local government This form of construction is used in District XVII
A separate account is established for the investment and members of theconstruction community pay their contributions into the account as the work proceedsIndividuals may contract loans to finance their contribution but these are at market rates and not the subsidized loans available to members of neighborhood associations Thus the district takes a credit risk and there are cases where members have not been able to pay the full amount of their assessed participation
In interviews with Districts XVII and XVIII it has often been stated that households have reached the limits of their capacity to contribute to financing the sewage network This system of financing is not limited to capital investments in sewer networks but has also been used to finance other public utilities such as potable water gas connections and telephone lines
Although districts do receive a portion of the personal income tax (for which there is a specific distribution formula between the capital city and the districts and among the districts) the actual incomes of the district populations are not known with precisionIn order for the district governments to better Judge the capacity of their population tocontribute both now and in the future small surveys of the population of selected areas in the district may be useful Such surveys may help to establish the level of incomesand expenditures as well as assess a realistic burden for construction and developmentlees or local taxes
15 In January 1994 subsidies for direct household loans for utility connections were terminated making the neighborhood association loans the only remaining subsidy for utility connections
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MINISTRY OF TRANSPORTATION COMMUNICATION AND WATER MANAGEMENT (MTCWM)
The Ministry of Transportation Communication and Water Management must approve all projects in Hungary relating to water no sewerage project may go forward without first obtaining the water authorization permit from this Ministry
Until 1 January 1994 the Miniszry also played a role in setting the water and sewer tariffs According to the 1990 Act on Prices the fee must include the expenses of efficient operation and the profit required for efficient operation although no definition of efficiency or provisions for monitoring are included in the Act
The final allowed price was set by the Ministry based on tariffs proposed by the sewer company and the Capital City From the beginning of 1994 the pricing of sewer services has been completely devolved to the city of Budapest although the Ministry has set non-binding guidelines for fees
PROPOSED SEWAGE INVESTMENTS
SEWAGE DEVELOPMENT NEEDS IN DISTRICTS XVII AND XVIII
Citywide there are 4000 km of sewage pipes connecting approximately 88 percentof households in Budapest although this is heavily concentrated in the center so that
8outer districts have only about 50 to 60 percent coverage 1 Sewage treatment is below the adequate level FCSM estimates that 80 percent of sewage receives mechanical treatment but less than 20 percent is biologically treated
Districts XVII and XVIII have among the lowest levels of sewerage coverage in Budapest but according to the FCSM Investment Department District XVII is worse off because in District XVIII only one area (Pestszentimre) is badly underserviced Both district governments list sewerage as their most pressing infrastructure developmentneed and both have projects planned which they hope to address in the near future
District XVII
District XVII has a split sewage system-ie two separate subsystems for sewageand storm water collection-and has a big deficit in both systems The district has
1039a comprehensive sewage construction plan with an estimated total cost of HUF billion which has already been begun A first task to lay a network in Rakosliget and Rakoscsaba uJtelep has already been partially completed although some difficulties with the contractor left the laid pipes not ready for use The result was that the municipal sewer company (FCSM) refused to accept the pipes and the district has had to ask the city for a special grant of HUF 80 million 8 to complete the work and repave the roads under a new contract
The plan calls for three additional phases of construction the first part will be to construct sewerage in the most urgent areas (the district center and RAkoscsaba) the second is to complete a parallel principal main which is a precondition for expanding the network and the third is to connect some other areas to the system Phase I to construct about 30 kilometers in Rakoscsaba was begun in early 1994
Targeted subsidies have already been granted for the sewage projectHUF 285 million for 1993 and HUF 21 million for 1994 In both cases despite approvalthe district will receive funds one year later because of central budget limitations The local assembly also has approved the local portion of funding (30 percent of the originalcost estimate) which comes from the social normative grant but the schedule has to be
16 For the outer districts the 1992 flgures are 76-78 percent coverage (districts XV and l) 50-60 percent (XVIII MX and XXI) and 41-43 percent (XVII and XVI)
17 As is the case for most outer areas in Budapest
1s This grant was obtained in return for permission for the Capital City to use the districts landfill
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rethought One difficulty is that because they could not start construction before 1 December 1993 they forfeited the promised HUF 14 million from the City
In some ways storm water collection is a more urgent problem in the district and financially more problematic because no targeted subsidies are available and because it is impossible to charge the public directly for any portion of the development costs The district plans to build a series of ditches for storm water collecting water in one location but because these are open the Sewage Company will not operate them
The district assembly has approved sewerage construction plans but has not actually appropriated the money 9 so that the district has not been able to apply for some other available subsidies One such potential subsidy comes from the Water Management Fund which requires a permit from the water authority As the permit expires in two years the district will probably have to reapply because they may not be able to begin construction of the next phase within two years
One portion of the district contribution is paying the value-added tax portion of the connections (Until January 1993 this amount at 25 percent of cost would have been refunded by the central government) There is a preliminary agreement between the FCSM and the districts that starting 1 January 1994 the FCSM will pay the VAT and be reimbursed by the central government
Citizens contributions will have to make up a larger proportion than foreseen (probably 60 percent instead of 40 percent) A neighborhood association has already been formed in RiLkosllget two construction communities (one of over 700 households) have been formed for the Rakoscsaba work Conditions for households have changed considerably as of January 1994 because the 50 percent subsidies on utility connection loans are no longer available The district is therefore allowing those households unable to pay up front to pay in installments with no interest
Enterprises of course can be - arged higher connection fees and the district wants to use those to cross-subsidize household connections The district Public Utilities Division believes enterprises could be charged up to HUF 1 billion for the sewage development contribution plus HUF 80 million for the actual connection
District XVII has no outstanding loans nor do they levy any local taxes at present They do not have committees or a project preparation unit set up to work on cost of projects instead the technical department alone has put this project together There will be some political difficulties in getting this project approved because those in housing estates which are already connected to the sewage system and who represent the bulk
Not all assembly representatives heartily endorse the plan moreover the assembly did not think the central government would grant the targeted subsidy
20 This may be a problem at some point as when capacity problems exist the FCSM has indicated that it may grant permits for connection only to households and not to enterprises
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of the voting power will be opposed to the expenditure This same argument was used to explain why the council would be opposed to incurring debt although it is possiblethat debt could be structured to be repaid by the benefiting area only
The district does not have solid data on incomes but there is a general sense that probably only 20 percent of households can afford the sewage connection at HUF 30000shy40000 those who cannot would have to be subsidized by the local government byreceiving interest-free loans
DistrictXV37
District XVIII has almost the lowest per capita income in Budapest (it ranks 18th among the 22 districts) it is fourth in area seventh in population and only district XVII has less sewerage coverage according to the Deputy Mayor
Pestszentimre a neighborhood of mostly single-family houses containing about one quarter of district households (a population of 25000 in a district of 98000) is the area most urgently needing sewerage development The cost for this development is estimated at between HUF 12 and 16 billion Four storage tanks that pump sewage into the main system will have to be built The current plan is to begin construction in 1996 the schedule has been pushed back mostly because of financial considerations Sewage is still very much a priority investment for the district
The district hopes to have 30 percent of the cost covered by district resources 30 percent by the Capital City and 40 percent by a targeted subsidy (because Budapestapplied for the subsidy with the district the subsidy is worth an extra 10 percent of estimated cost) A cooperation agreement was required but because Budapest did not sign it the district has not yet applied for the subsidy
The Southern Pest Treatment Center is at capacity now and the new sewerage will not be able to be connected until the Center is expanded District XVIII feels confident that the expansion will be undertaken next year so the technical problem will be solved Budapest would take a loan for this project apparently the City Council is in favor of the project Even though the Treatment Center has not yet been expanded the FCSM has given the district their permit to begin construction
The gas network was recently completed in the same area funded throughneighborhood associations work was completed in 1993 The connection fee of HUF 46000 per household will take three years to pay off so that payments will stop in 1995 Even so the connection fee alone did not cover the total cost which came to about HUF 150000-200000 per property
If a connection fee for sewerage is set too high district officials are afraid somehouseholds may elect not to connect at all If more than 60 percent of households want to connect the district will begin construction but they risk having some households subsequently decide not to connect and withdraw their contributions District officials
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expect the connection fee to be HUF 60000-65000 the District will pay an additional HUF 15000 fee per household to cover the cost of preparing the technical construction plans
The Deputy Mayor assumes the district will have to take on debt and he believes the district would definitely approach various banks as OTP does not offer attractive terms A technical implementation report on the project has been prepared but it includes no work on financial returns
CURRENT SEWER INFRASTRUCTURE FINANCING PRACTICES
As described in the first section districts are responsible for the construction of sewer collection systems that once built are turned over to the Capital City Sewer Company for operation and maintenance The Capital City is responsible for construction of interceptor sewers and sewage treatment plants Once the infrastruc-ture is in place system stewardship is the responsibility of the Budapest Municipal Sewage Company (FCSM)
There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including
Central Government Targeted subsidies provided by the central government are used to finance construction of sewer collection systems Targeted subsides are matching grants given to districts on a competitive basis The level of funding provided by targeted subsides is 30 percent for sewer collection projects (40 percentif the application is made jointly by both the district and the Capital City) However the reliability of this revenue source to finance future sewer projects is subject to the priorities and conditions set by the Parliament as recommended by the Ministry of the Interior Therefore there is no assurance that targetedsubsidies can be used to finance sewer collection systems in the future2
1 It is noted that the central government provides addressed subsidies however sewer collection system financing is not an eligible use of such subsidies
Capital City The Capital City can contribute to the cost of district sewer construction projects However district projects mus conform to Capital City priorities to be considered for funding
21 For example in 1993 the amounts needed to fund all eligible projects exceed the grant monies budgeted by the central government so those projects are approved but local governments will receive funds two or three years from now
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District Own source revenues for sewer collection system construction and connections to properties in public ownership are derived from (1) allocations made through the annual local budget process derived from local taxes miscellaneous fees and intergovernmental transfers (eg normative subsidies) (2) sale or lease of district owned land and (3)mid-term borrowing (defined as 2-3 years) from OTP Loans are repaid from own source revenue in the form of proceeds from the sale or lease of district-owned land
Citizens Citizens contribute to the construction of sewer systems in two ways (1)through the creation of construction communities or neighborhood associations citizens pay a portion of the collection system construction cost and (2)connection fees
FINANCING OPTIONS
This is a period of intensive change in the ways in which the central governmentdistricts the Capital City and the recently privatized Budapest Municipal SewageCompany finance and maintain the municipal sewer system Existing capitalimprovements practices are woefully insufficient to meet current and future seweragecapital needs Reasons for this state of affairs include
Limited Financial Capacity
The lack of adequate own source revenue has a profound impact on limitingavailable funds necessary to finance sewage system expansion There is a great disparitybetween capital needs and the anticipated revenue available to meet these needs Sewer construction projects are very expensive Existing financing mechanisms are inadequate
Debt Financing Districts make limited use of debt financing When debt is issuedIt is for a 2 or 3 year period This short term debt financing places an undue burden on the districts limited financial resources and the present populationsability to amortize the debt The high cost of borrowing (27 percent interest) further exacerbates this problem as well as increasing the cost of capital development
Capital financing typically requires the issuance of long term debt (20 to 30 years)that roughly correlates to the useful life of the facility This method of financingalso is considered to be equitable to those who benefit from the system (egcitizens commerce industry) since each generation pays its fair share of the cost of the facility A long-life asset such as a sewer system should be paid for by its users throughout its normal life rather than all at once by those who may not have the use of it full term Even with higher cost due to interest if spread over a largenumber of userspayers the cost to all is lowered Given Hungarys high rate of inflation and thus ever increasing construction costs it may be cheaper to borrow and pay todays prices rather than wait and pay tomorrows prices Furthermorethe use of long term debt puts less financial pressure on the operating budget
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OperatingBudget (ie pay-as-you-go)There is some attempt to finance a portion of the cost of sewer improvements through the operating budget The operatingbudget is reliant on revenues derived from intergovernmental transfers and therefore provides very little fiscal flexibility to support capital development Furthermore there are no reserve accounts that may be used to set aside funds for future capital development or meet emergencies (It will be noted of course that with Hungarys high rate of inflation the reserve accounts will be rapidly eroded so it may be decided to keep them at a mintimum)
Typically the operating budget is not used to finance large scale capital projects such as sewer collection systems Annual appropriations tend to be used to pay for municipal operations and service Small scale projects equipment purchases and the repair of existing facilities may be funded through the operating budgetHowever the use of the operating budget to finance large capital projects should be frowned upon for the following reasons
It forces local officials to make extremely difficult choices between service
delivery government operations and capital expansion
It places a heavy burden on the budget for the project year
It creates awkward fluctuating expenditure cycles that do not occur with extended financing
Since funding is based on yearly increments the use of the operating budget helps foster an environment wherein projects often go uncompleted
Sale of Land Districts rely on the sale of land to raise revenue for infrastructure financing This raises several concerns First land is not liquid and its value is subject to market forces In a sagging market such as currently exists land priceshave eroded to the point where districts are unable to raise adequate capital through the sale of land to finance sewer construction Furthermore there are few entrepreneurs with adequate resources to buy land
A related issue is that the land being sold is not serviced by sewer and other infrastructure components The offering price most likely reflects the absence of infrastructure If the infrastructure were in place prior to the sale or lease of district-owned land the district would realize a greater return than it currently receives
Finally land is finite Districts should think carefully about diminishing this resource to finance capital investment particularly before the capital is in placeLater in this paper we describe financing mechanisms that should be considered as feasible alternatives Particular attention should be paid to the use of tax increment financing or other forms of betterment financing
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Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
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Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
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ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
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projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
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Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
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plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
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FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
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ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
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It is therefore difficult for the city to combat a possible Not in my backyard (NIMBY) mentality on the part of the districts as in the case of construction of a new sewerage treatment plant
In the case of the specific projects for Districts XVII and XVIII several actors are responsible for different phases of project planning financing construction and management These include the capital city the FCSM the districts neighborhood associations and construction communities and the Ministry of Transportation Communication and Water Management (MTCWM) The role of each of these actors is described below
THE BUDAPEST MUNICIPAL GOVERNMENT (FOVAROS)
The Capital City is responsible for formuiating development plans for the city For sewerage development a long-term plan through the year 2015 has been established However consultations were engaged with the Government the districts and the FCSM during the preparation of the plan For actual implementation an annual or a two-year development plan is prepared based on the stated objectives of the capital assembly Three current main priorities in the area of sewage are (1) increase in collection and carrying capacity of the sewerage main in North Pest (2) increase in capacity of the treatment plant in North Buda and (3) construction of a treatment plant in South Pest The investment projects of the districts in sewer networks generally have to be in conformity with the general development plan of the Capital City
District XVIIs sewage project is dependent on the achievement of priority 1 as the main collecting pipe from the district leads into the sewage main of North Pest District XVIIIs project is linked to construction of the South Pest treatment plant (priority 3) once the district networks have been built they may not be put into operation until completion of the treatment plant
The capital finances the construction of main sewerage lines treatment plants collection and pumping stations these projects involve new facilities and mains or the increase in capacity of existing plants The actual technical plans are prepared by the FCSM reviewed by the public utility works department of the Capital City and prescnted to the genera assembly
Project preparation in the capital follows the prescription of a decree passed in 19929 Requirements include the submission of a detailed plan the Assemblyto including cost estimates but no financing plan The General Assembly must vote approval on all projects over a cost of HUF 50 million The financial plans for the realization of the capital city projects may include the following resources targeted subsidies funds from the general capital city budget contributions from the districts
9 Decree No 121992
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loans participation by the FCSM and contributions from the beneficiaries (businesseshouseholds) In only one case has the city taken out a specific project-related loan-from EBRD for a sewage treatment center
For 1993 the sewer fee included a portion dedicated specifically to the financingof new investments (HUF 470m 3 ) This was the first time that a part of the fee has been specifically assigned to the financing of new investment This development portion of the fee was only in place for 1993 and was not renewed for 1994 The proposals for the use of the development portion of the fee were made by the public utility works department
Until 1 January 1994 the sewer fee was set by the MTCWM based on a proposalof the city the technical aspects of the proposal are prepared by the FCSM and approvedby the general assembly of the capital The Capital City was authorized to determine the sewer fee for the first time this January although guidelines have been set by theMTCWM The initial technical proposal is prepared by the Finance Department of the FCSM Nevertheless the final say on the actual price rests with the general assembly of the Capital For the new fee options under consideration were to multiply the current fee by a price index for the sector (which would lead to an estimated 20 percent increase but would exclude any specific investment portion) or to include different developmentcosts in the fee The new fee (HUF 20 plus 10 percent value-added tax) was introduced in April 1994 although FCSM had recommended a tee of HUF 215 No part of the sewer fee is allocated to investments in the network undertaken by the districts The FCSM also plans to introduce a flat sewage fee of HUF 200-500 in areas not serviced at present to cover the cleaning of septic tanks
Actual construction of the projects is managed by the FCSM as the principal contractor Nevertheless the public utility works department of the Capital monitors the ongoing works approves bills submitted by the contractor and sub-contractors and authorizes payment to the FCSM (who pays the sub-contractors) Every six months a project report on use of funds and the advance of work is presented to the generalassembly If there are Impor ant cost overruns or construction delays then a change of scope of the project must be approved by the general assembly Once the project has been completed the equipment is turned over to the FCSM which is responsible for maintenance repairs rehabilitation and replacement
THE FCSM
The FCSM was previously a state-owned enterprise and was transferred to the ownership of the capital city according to the provisions of the Local Self-Government Act From 1 January 1992 the ownership rights of the sewerage network were transferred to the capital city The assets were managed by FCSM but it appears that no fee for lease of these assets was paid to the Capital City
From 1 December 1993 the FCSM was transformed into a joint-stock companywholly-owned by the capital city Before the transformation of the company the budget
ii
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of the sewer works company was approved by the general assembly of the Capital In addition the Supervisory Board of 13 members was appointed by the general assemblyOn 1 December 1993 the FCSM was transformed into a joint-stock company wholly owned by the Capital city Under this structure the Supervisory Board of nine members-three from FCSM staff and six from the Assembly-will be responsible for approving the companys budget and al strategically important decisions
The assets relating to sewerage were the property of the Capital City but were transferred to the FCSM as of 1 December 1993 as part of the companys transformation First the assets were reassessed and their replacement value was determined to be HUF 70 billion a considerable increase from the HUF 20 billion previously estimated10 With the transformation these assets were transferred to the ownership of the joint-stock company
Any additional networks and additions to the system will also be transferred to the FCSM However according to provisions of the 1991 Accounting Act any network built privately is transferred at zero value thus preventing the company from taking any depreciation on the value of the stock
As a means of circumventing this problem the FCSM arranged to be assigned as both investor and builder However when targeted subsidies are used to finance part of the network such an arrangement becomes more difficult because the local government must be the investor
For sewer projects initiated by the districts the FCSM is responsible for reviewing the technical plans and giving an expert opinion before construction begins Upon completion of the equipment the FCSM will inspect the equipment for adherence to technical norms (such as pressure tests or camera inspections within the pipes) and will authorize operation of the network This authorization will depend on capacity of eidsting mains and treatment plants to handle a larger flow of effluent in the system Thus due to the saturation of the main pipes in North Pest new business and industrial connections will not be authorized until the capacity of this part of the network has been increased
The principal activity of the FCSM is the operation and maintenance of the sewerage system within the city of Budapest In addition reconstruction and rehabilitation of all existing pipes pumping stations and treatment plants are the responsibility of the company These activities (operation maintenance reconstruction) are financed through the sewage fee
o It is believed that the primary purpose of this revaluation was to Increase depreciation funds However the higher valuation may have an adverse effect on the prospects for privatization
I Based on a conversation with the Technical Department of the FCSM
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The fee is collected in part by the FCSM however a collecting company12 collectsft sfrom private homes and the Water Works Company collects fees from industrial users and rental housing Thus the FCSM only seems to directly collect the fees from individuals with water wells but who are connected to the sewer system This systemof collection often leads to delays of at least two months in receipt of fees the amount ofunpaid fees were estimated at HUF 500-600 million in June 1993 and in May 1994 at HUF 338 million of which HUF 240 million Is from residences Total receipts in 1993 were HUF 4-5 billion putting delinquencits at about 8 percent
THE DISTRICTS
De facto due to lack of funds in the face of so many pressing needs the districtshave been made responsible for the construction of the secondary sewerage network(pipes leading from homes and businesses to the main collecting pipes and the collection system) The connections leading from homes and businesses to the secondary network are financed by the beneficiaries but constructed by the districts
Once a district decides to undertake the construction of part of the sewer system a water authorization permit is required from the MTCWM An expert opinion on thetechnical plans must be solicited from the FCSM The district is responsible for raisingfunds for construction Sources of financing may include district own fundscontributions from the Capital City targeted grants grants from the national Water Development Fund contributions from the population and loans
The means of financing used for these projects often leads to inefficient use of resources as matching funds and grants must remain in the accounts until construction has actually commenced This is the case for both the districts and the Capital CityTargeted grants require matching funds from the district which must be kept in the local government account as proof that this requirement has been met If there are delays in the start of the project these funds are left unused instead of being appropriated for more immediate needs
In the same way contributions from the Capital City must be negotiated on a caseby case basis and success in obtaining them may depend on the extent to which theparticular project corresponds to the capital citys own priorities However if the districts do not commence work on the project in a timely manner the Capital City funds are alsolying unused in an account For this reason the Capital has placed conditions on projectconstruction start-up dates if these requirements are not respected the districts may
This company was recently privatized through an employee share purchasing program It collects all utilities and municipal housing rents In Budapest for a fee of 3 to 4 percent of collections Recentlythe electricity company ended the contract and makes Its own collections while th gas company hascontracted out to other private companies in certain districts although their collections fees are muchhigher The Collection Company is currently in the process of revising its contractual relationshipswith its clients
12
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lose the grant For example District XVII received a promise of a HUF 14 million grant for the Rkosliget sewer project on condition that construction commenced by 1 December 1993
Appropriate financial products are currently not available to local governments for financing long-term investments such as sewer networks 3 For the moment the districts do not have access to the sewer fee which would enable them to appropriate part of this user fee for the reimbursement of debt Thus districts have placed heavyreliance on up-front population contributions through neighborhood associations and construction communities to finance part of secondary networks (and sometimef- the main networks) in addition to direct household connections to the network ----se connection fees are the only user charge to which districts have access As there o legal restriction on the level of the connection fee the only consideration in settin e fee is affordability
The construction of the project is monitored by the district Once completed technical certification of the equipment is required by the FCSM (pumping test and verification of pipes with a camera) If the results of these verifications are unsatisfactory then the operation of the pipes will not be authorized by the FCSM 4 If the FCSM grants approval the entire network is transferred to the Sewer Works Company which is responsible for operation maintenance rehabilitation and replacement of the equipment
NEIGHBORHOOD ASSOCIATIONS AND CONSTRUCTION COMMUNITIES
Under the previous system in order fc - neighbor-ods and towns to obtain quicker connections to public utilities organizea forms G population participation were developed these methods of financing infrastructure have continued and may take the form of a neighborhood association or a construction community
Neighborhood associations (ktzmitdrsulds) for the financing of infrastructure network- are formed when at least 66 percent of the residents of a neighborhood agree to their creation membership is open to all residents and contributions to the cost of infrastructure investment is compulsory Membership entitles residents to receive five-to seven year loans from OTP with 70 percent of the interest subsidized by the central
13 See Hegedes Mark Pigey Municipal Lending in Hungary March 1993
This has posed a problem for District XVII in 1993 30 kilometers of pipes of 40 constructed failed the camera verification test however the contractors had already been paid before this verification The District is unable to pave the roads or put system into operation until the pipes are repaired to satisfactory condition
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government 5 Through these loans investment funds are available up front to the district and it is the OTP which takes the credit risk
The members of the association appoint a steering committee (or an executiveboard) which works with the district issues tenders and selects the contractor The amount of contributions by members is assessed by the committee and any remainingfunds available after construction may be redistributed to the residents The committee also defines the contributions of new members
Construction communities (6pit6kbzOss~g) are a more flexible form of populationparticipation as they are not legal entities and have no right to sign contracts in their own name The community elects an executive board this board will work with the local government during construction in terms of choosing a constructor monitoringrealization countersigning contracts and bills However the legal investor is the local government This form of construction is used in District XVII
A separate account is established for the investment and members of theconstruction community pay their contributions into the account as the work proceedsIndividuals may contract loans to finance their contribution but these are at market rates and not the subsidized loans available to members of neighborhood associations Thus the district takes a credit risk and there are cases where members have not been able to pay the full amount of their assessed participation
In interviews with Districts XVII and XVIII it has often been stated that households have reached the limits of their capacity to contribute to financing the sewage network This system of financing is not limited to capital investments in sewer networks but has also been used to finance other public utilities such as potable water gas connections and telephone lines
Although districts do receive a portion of the personal income tax (for which there is a specific distribution formula between the capital city and the districts and among the districts) the actual incomes of the district populations are not known with precisionIn order for the district governments to better Judge the capacity of their population tocontribute both now and in the future small surveys of the population of selected areas in the district may be useful Such surveys may help to establish the level of incomesand expenditures as well as assess a realistic burden for construction and developmentlees or local taxes
15 In January 1994 subsidies for direct household loans for utility connections were terminated making the neighborhood association loans the only remaining subsidy for utility connections
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MINISTRY OF TRANSPORTATION COMMUNICATION AND WATER MANAGEMENT (MTCWM)
The Ministry of Transportation Communication and Water Management must approve all projects in Hungary relating to water no sewerage project may go forward without first obtaining the water authorization permit from this Ministry
Until 1 January 1994 the Miniszry also played a role in setting the water and sewer tariffs According to the 1990 Act on Prices the fee must include the expenses of efficient operation and the profit required for efficient operation although no definition of efficiency or provisions for monitoring are included in the Act
The final allowed price was set by the Ministry based on tariffs proposed by the sewer company and the Capital City From the beginning of 1994 the pricing of sewer services has been completely devolved to the city of Budapest although the Ministry has set non-binding guidelines for fees
PROPOSED SEWAGE INVESTMENTS
SEWAGE DEVELOPMENT NEEDS IN DISTRICTS XVII AND XVIII
Citywide there are 4000 km of sewage pipes connecting approximately 88 percentof households in Budapest although this is heavily concentrated in the center so that
8outer districts have only about 50 to 60 percent coverage 1 Sewage treatment is below the adequate level FCSM estimates that 80 percent of sewage receives mechanical treatment but less than 20 percent is biologically treated
Districts XVII and XVIII have among the lowest levels of sewerage coverage in Budapest but according to the FCSM Investment Department District XVII is worse off because in District XVIII only one area (Pestszentimre) is badly underserviced Both district governments list sewerage as their most pressing infrastructure developmentneed and both have projects planned which they hope to address in the near future
District XVII
District XVII has a split sewage system-ie two separate subsystems for sewageand storm water collection-and has a big deficit in both systems The district has
1039a comprehensive sewage construction plan with an estimated total cost of HUF billion which has already been begun A first task to lay a network in Rakosliget and Rakoscsaba uJtelep has already been partially completed although some difficulties with the contractor left the laid pipes not ready for use The result was that the municipal sewer company (FCSM) refused to accept the pipes and the district has had to ask the city for a special grant of HUF 80 million 8 to complete the work and repave the roads under a new contract
The plan calls for three additional phases of construction the first part will be to construct sewerage in the most urgent areas (the district center and RAkoscsaba) the second is to complete a parallel principal main which is a precondition for expanding the network and the third is to connect some other areas to the system Phase I to construct about 30 kilometers in Rakoscsaba was begun in early 1994
Targeted subsidies have already been granted for the sewage projectHUF 285 million for 1993 and HUF 21 million for 1994 In both cases despite approvalthe district will receive funds one year later because of central budget limitations The local assembly also has approved the local portion of funding (30 percent of the originalcost estimate) which comes from the social normative grant but the schedule has to be
16 For the outer districts the 1992 flgures are 76-78 percent coverage (districts XV and l) 50-60 percent (XVIII MX and XXI) and 41-43 percent (XVII and XVI)
17 As is the case for most outer areas in Budapest
1s This grant was obtained in return for permission for the Capital City to use the districts landfill
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rethought One difficulty is that because they could not start construction before 1 December 1993 they forfeited the promised HUF 14 million from the City
In some ways storm water collection is a more urgent problem in the district and financially more problematic because no targeted subsidies are available and because it is impossible to charge the public directly for any portion of the development costs The district plans to build a series of ditches for storm water collecting water in one location but because these are open the Sewage Company will not operate them
The district assembly has approved sewerage construction plans but has not actually appropriated the money 9 so that the district has not been able to apply for some other available subsidies One such potential subsidy comes from the Water Management Fund which requires a permit from the water authority As the permit expires in two years the district will probably have to reapply because they may not be able to begin construction of the next phase within two years
One portion of the district contribution is paying the value-added tax portion of the connections (Until January 1993 this amount at 25 percent of cost would have been refunded by the central government) There is a preliminary agreement between the FCSM and the districts that starting 1 January 1994 the FCSM will pay the VAT and be reimbursed by the central government
Citizens contributions will have to make up a larger proportion than foreseen (probably 60 percent instead of 40 percent) A neighborhood association has already been formed in RiLkosllget two construction communities (one of over 700 households) have been formed for the Rakoscsaba work Conditions for households have changed considerably as of January 1994 because the 50 percent subsidies on utility connection loans are no longer available The district is therefore allowing those households unable to pay up front to pay in installments with no interest
Enterprises of course can be - arged higher connection fees and the district wants to use those to cross-subsidize household connections The district Public Utilities Division believes enterprises could be charged up to HUF 1 billion for the sewage development contribution plus HUF 80 million for the actual connection
District XVII has no outstanding loans nor do they levy any local taxes at present They do not have committees or a project preparation unit set up to work on cost of projects instead the technical department alone has put this project together There will be some political difficulties in getting this project approved because those in housing estates which are already connected to the sewage system and who represent the bulk
Not all assembly representatives heartily endorse the plan moreover the assembly did not think the central government would grant the targeted subsidy
20 This may be a problem at some point as when capacity problems exist the FCSM has indicated that it may grant permits for connection only to households and not to enterprises
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of the voting power will be opposed to the expenditure This same argument was used to explain why the council would be opposed to incurring debt although it is possiblethat debt could be structured to be repaid by the benefiting area only
The district does not have solid data on incomes but there is a general sense that probably only 20 percent of households can afford the sewage connection at HUF 30000shy40000 those who cannot would have to be subsidized by the local government byreceiving interest-free loans
DistrictXV37
District XVIII has almost the lowest per capita income in Budapest (it ranks 18th among the 22 districts) it is fourth in area seventh in population and only district XVII has less sewerage coverage according to the Deputy Mayor
Pestszentimre a neighborhood of mostly single-family houses containing about one quarter of district households (a population of 25000 in a district of 98000) is the area most urgently needing sewerage development The cost for this development is estimated at between HUF 12 and 16 billion Four storage tanks that pump sewage into the main system will have to be built The current plan is to begin construction in 1996 the schedule has been pushed back mostly because of financial considerations Sewage is still very much a priority investment for the district
The district hopes to have 30 percent of the cost covered by district resources 30 percent by the Capital City and 40 percent by a targeted subsidy (because Budapestapplied for the subsidy with the district the subsidy is worth an extra 10 percent of estimated cost) A cooperation agreement was required but because Budapest did not sign it the district has not yet applied for the subsidy
The Southern Pest Treatment Center is at capacity now and the new sewerage will not be able to be connected until the Center is expanded District XVIII feels confident that the expansion will be undertaken next year so the technical problem will be solved Budapest would take a loan for this project apparently the City Council is in favor of the project Even though the Treatment Center has not yet been expanded the FCSM has given the district their permit to begin construction
The gas network was recently completed in the same area funded throughneighborhood associations work was completed in 1993 The connection fee of HUF 46000 per household will take three years to pay off so that payments will stop in 1995 Even so the connection fee alone did not cover the total cost which came to about HUF 150000-200000 per property
If a connection fee for sewerage is set too high district officials are afraid somehouseholds may elect not to connect at all If more than 60 percent of households want to connect the district will begin construction but they risk having some households subsequently decide not to connect and withdraw their contributions District officials
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expect the connection fee to be HUF 60000-65000 the District will pay an additional HUF 15000 fee per household to cover the cost of preparing the technical construction plans
The Deputy Mayor assumes the district will have to take on debt and he believes the district would definitely approach various banks as OTP does not offer attractive terms A technical implementation report on the project has been prepared but it includes no work on financial returns
CURRENT SEWER INFRASTRUCTURE FINANCING PRACTICES
As described in the first section districts are responsible for the construction of sewer collection systems that once built are turned over to the Capital City Sewer Company for operation and maintenance The Capital City is responsible for construction of interceptor sewers and sewage treatment plants Once the infrastruc-ture is in place system stewardship is the responsibility of the Budapest Municipal Sewage Company (FCSM)
There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including
Central Government Targeted subsidies provided by the central government are used to finance construction of sewer collection systems Targeted subsides are matching grants given to districts on a competitive basis The level of funding provided by targeted subsides is 30 percent for sewer collection projects (40 percentif the application is made jointly by both the district and the Capital City) However the reliability of this revenue source to finance future sewer projects is subject to the priorities and conditions set by the Parliament as recommended by the Ministry of the Interior Therefore there is no assurance that targetedsubsidies can be used to finance sewer collection systems in the future2
1 It is noted that the central government provides addressed subsidies however sewer collection system financing is not an eligible use of such subsidies
Capital City The Capital City can contribute to the cost of district sewer construction projects However district projects mus conform to Capital City priorities to be considered for funding
21 For example in 1993 the amounts needed to fund all eligible projects exceed the grant monies budgeted by the central government so those projects are approved but local governments will receive funds two or three years from now
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District Own source revenues for sewer collection system construction and connections to properties in public ownership are derived from (1) allocations made through the annual local budget process derived from local taxes miscellaneous fees and intergovernmental transfers (eg normative subsidies) (2) sale or lease of district owned land and (3)mid-term borrowing (defined as 2-3 years) from OTP Loans are repaid from own source revenue in the form of proceeds from the sale or lease of district-owned land
Citizens Citizens contribute to the construction of sewer systems in two ways (1)through the creation of construction communities or neighborhood associations citizens pay a portion of the collection system construction cost and (2)connection fees
FINANCING OPTIONS
This is a period of intensive change in the ways in which the central governmentdistricts the Capital City and the recently privatized Budapest Municipal SewageCompany finance and maintain the municipal sewer system Existing capitalimprovements practices are woefully insufficient to meet current and future seweragecapital needs Reasons for this state of affairs include
Limited Financial Capacity
The lack of adequate own source revenue has a profound impact on limitingavailable funds necessary to finance sewage system expansion There is a great disparitybetween capital needs and the anticipated revenue available to meet these needs Sewer construction projects are very expensive Existing financing mechanisms are inadequate
Debt Financing Districts make limited use of debt financing When debt is issuedIt is for a 2 or 3 year period This short term debt financing places an undue burden on the districts limited financial resources and the present populationsability to amortize the debt The high cost of borrowing (27 percent interest) further exacerbates this problem as well as increasing the cost of capital development
Capital financing typically requires the issuance of long term debt (20 to 30 years)that roughly correlates to the useful life of the facility This method of financingalso is considered to be equitable to those who benefit from the system (egcitizens commerce industry) since each generation pays its fair share of the cost of the facility A long-life asset such as a sewer system should be paid for by its users throughout its normal life rather than all at once by those who may not have the use of it full term Even with higher cost due to interest if spread over a largenumber of userspayers the cost to all is lowered Given Hungarys high rate of inflation and thus ever increasing construction costs it may be cheaper to borrow and pay todays prices rather than wait and pay tomorrows prices Furthermorethe use of long term debt puts less financial pressure on the operating budget
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OperatingBudget (ie pay-as-you-go)There is some attempt to finance a portion of the cost of sewer improvements through the operating budget The operatingbudget is reliant on revenues derived from intergovernmental transfers and therefore provides very little fiscal flexibility to support capital development Furthermore there are no reserve accounts that may be used to set aside funds for future capital development or meet emergencies (It will be noted of course that with Hungarys high rate of inflation the reserve accounts will be rapidly eroded so it may be decided to keep them at a mintimum)
Typically the operating budget is not used to finance large scale capital projects such as sewer collection systems Annual appropriations tend to be used to pay for municipal operations and service Small scale projects equipment purchases and the repair of existing facilities may be funded through the operating budgetHowever the use of the operating budget to finance large capital projects should be frowned upon for the following reasons
It forces local officials to make extremely difficult choices between service
delivery government operations and capital expansion
It places a heavy burden on the budget for the project year
It creates awkward fluctuating expenditure cycles that do not occur with extended financing
Since funding is based on yearly increments the use of the operating budget helps foster an environment wherein projects often go uncompleted
Sale of Land Districts rely on the sale of land to raise revenue for infrastructure financing This raises several concerns First land is not liquid and its value is subject to market forces In a sagging market such as currently exists land priceshave eroded to the point where districts are unable to raise adequate capital through the sale of land to finance sewer construction Furthermore there are few entrepreneurs with adequate resources to buy land
A related issue is that the land being sold is not serviced by sewer and other infrastructure components The offering price most likely reflects the absence of infrastructure If the infrastructure were in place prior to the sale or lease of district-owned land the district would realize a greater return than it currently receives
Finally land is finite Districts should think carefully about diminishing this resource to finance capital investment particularly before the capital is in placeLater in this paper we describe financing mechanisms that should be considered as feasible alternatives Particular attention should be paid to the use of tax increment financing or other forms of betterment financing
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Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
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Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
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ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
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projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
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Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
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plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
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FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
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ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
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loans participation by the FCSM and contributions from the beneficiaries (businesseshouseholds) In only one case has the city taken out a specific project-related loan-from EBRD for a sewage treatment center
For 1993 the sewer fee included a portion dedicated specifically to the financingof new investments (HUF 470m 3 ) This was the first time that a part of the fee has been specifically assigned to the financing of new investment This development portion of the fee was only in place for 1993 and was not renewed for 1994 The proposals for the use of the development portion of the fee were made by the public utility works department
Until 1 January 1994 the sewer fee was set by the MTCWM based on a proposalof the city the technical aspects of the proposal are prepared by the FCSM and approvedby the general assembly of the capital The Capital City was authorized to determine the sewer fee for the first time this January although guidelines have been set by theMTCWM The initial technical proposal is prepared by the Finance Department of the FCSM Nevertheless the final say on the actual price rests with the general assembly of the Capital For the new fee options under consideration were to multiply the current fee by a price index for the sector (which would lead to an estimated 20 percent increase but would exclude any specific investment portion) or to include different developmentcosts in the fee The new fee (HUF 20 plus 10 percent value-added tax) was introduced in April 1994 although FCSM had recommended a tee of HUF 215 No part of the sewer fee is allocated to investments in the network undertaken by the districts The FCSM also plans to introduce a flat sewage fee of HUF 200-500 in areas not serviced at present to cover the cleaning of septic tanks
Actual construction of the projects is managed by the FCSM as the principal contractor Nevertheless the public utility works department of the Capital monitors the ongoing works approves bills submitted by the contractor and sub-contractors and authorizes payment to the FCSM (who pays the sub-contractors) Every six months a project report on use of funds and the advance of work is presented to the generalassembly If there are Impor ant cost overruns or construction delays then a change of scope of the project must be approved by the general assembly Once the project has been completed the equipment is turned over to the FCSM which is responsible for maintenance repairs rehabilitation and replacement
THE FCSM
The FCSM was previously a state-owned enterprise and was transferred to the ownership of the capital city according to the provisions of the Local Self-Government Act From 1 January 1992 the ownership rights of the sewerage network were transferred to the capital city The assets were managed by FCSM but it appears that no fee for lease of these assets was paid to the Capital City
From 1 December 1993 the FCSM was transformed into a joint-stock companywholly-owned by the capital city Before the transformation of the company the budget
ii
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of the sewer works company was approved by the general assembly of the Capital In addition the Supervisory Board of 13 members was appointed by the general assemblyOn 1 December 1993 the FCSM was transformed into a joint-stock company wholly owned by the Capital city Under this structure the Supervisory Board of nine members-three from FCSM staff and six from the Assembly-will be responsible for approving the companys budget and al strategically important decisions
The assets relating to sewerage were the property of the Capital City but were transferred to the FCSM as of 1 December 1993 as part of the companys transformation First the assets were reassessed and their replacement value was determined to be HUF 70 billion a considerable increase from the HUF 20 billion previously estimated10 With the transformation these assets were transferred to the ownership of the joint-stock company
Any additional networks and additions to the system will also be transferred to the FCSM However according to provisions of the 1991 Accounting Act any network built privately is transferred at zero value thus preventing the company from taking any depreciation on the value of the stock
As a means of circumventing this problem the FCSM arranged to be assigned as both investor and builder However when targeted subsidies are used to finance part of the network such an arrangement becomes more difficult because the local government must be the investor
For sewer projects initiated by the districts the FCSM is responsible for reviewing the technical plans and giving an expert opinion before construction begins Upon completion of the equipment the FCSM will inspect the equipment for adherence to technical norms (such as pressure tests or camera inspections within the pipes) and will authorize operation of the network This authorization will depend on capacity of eidsting mains and treatment plants to handle a larger flow of effluent in the system Thus due to the saturation of the main pipes in North Pest new business and industrial connections will not be authorized until the capacity of this part of the network has been increased
The principal activity of the FCSM is the operation and maintenance of the sewerage system within the city of Budapest In addition reconstruction and rehabilitation of all existing pipes pumping stations and treatment plants are the responsibility of the company These activities (operation maintenance reconstruction) are financed through the sewage fee
o It is believed that the primary purpose of this revaluation was to Increase depreciation funds However the higher valuation may have an adverse effect on the prospects for privatization
I Based on a conversation with the Technical Department of the FCSM
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The fee is collected in part by the FCSM however a collecting company12 collectsft sfrom private homes and the Water Works Company collects fees from industrial users and rental housing Thus the FCSM only seems to directly collect the fees from individuals with water wells but who are connected to the sewer system This systemof collection often leads to delays of at least two months in receipt of fees the amount ofunpaid fees were estimated at HUF 500-600 million in June 1993 and in May 1994 at HUF 338 million of which HUF 240 million Is from residences Total receipts in 1993 were HUF 4-5 billion putting delinquencits at about 8 percent
THE DISTRICTS
De facto due to lack of funds in the face of so many pressing needs the districtshave been made responsible for the construction of the secondary sewerage network(pipes leading from homes and businesses to the main collecting pipes and the collection system) The connections leading from homes and businesses to the secondary network are financed by the beneficiaries but constructed by the districts
Once a district decides to undertake the construction of part of the sewer system a water authorization permit is required from the MTCWM An expert opinion on thetechnical plans must be solicited from the FCSM The district is responsible for raisingfunds for construction Sources of financing may include district own fundscontributions from the Capital City targeted grants grants from the national Water Development Fund contributions from the population and loans
The means of financing used for these projects often leads to inefficient use of resources as matching funds and grants must remain in the accounts until construction has actually commenced This is the case for both the districts and the Capital CityTargeted grants require matching funds from the district which must be kept in the local government account as proof that this requirement has been met If there are delays in the start of the project these funds are left unused instead of being appropriated for more immediate needs
In the same way contributions from the Capital City must be negotiated on a caseby case basis and success in obtaining them may depend on the extent to which theparticular project corresponds to the capital citys own priorities However if the districts do not commence work on the project in a timely manner the Capital City funds are alsolying unused in an account For this reason the Capital has placed conditions on projectconstruction start-up dates if these requirements are not respected the districts may
This company was recently privatized through an employee share purchasing program It collects all utilities and municipal housing rents In Budapest for a fee of 3 to 4 percent of collections Recentlythe electricity company ended the contract and makes Its own collections while th gas company hascontracted out to other private companies in certain districts although their collections fees are muchhigher The Collection Company is currently in the process of revising its contractual relationshipswith its clients
12
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lose the grant For example District XVII received a promise of a HUF 14 million grant for the Rkosliget sewer project on condition that construction commenced by 1 December 1993
Appropriate financial products are currently not available to local governments for financing long-term investments such as sewer networks 3 For the moment the districts do not have access to the sewer fee which would enable them to appropriate part of this user fee for the reimbursement of debt Thus districts have placed heavyreliance on up-front population contributions through neighborhood associations and construction communities to finance part of secondary networks (and sometimef- the main networks) in addition to direct household connections to the network ----se connection fees are the only user charge to which districts have access As there o legal restriction on the level of the connection fee the only consideration in settin e fee is affordability
The construction of the project is monitored by the district Once completed technical certification of the equipment is required by the FCSM (pumping test and verification of pipes with a camera) If the results of these verifications are unsatisfactory then the operation of the pipes will not be authorized by the FCSM 4 If the FCSM grants approval the entire network is transferred to the Sewer Works Company which is responsible for operation maintenance rehabilitation and replacement of the equipment
NEIGHBORHOOD ASSOCIATIONS AND CONSTRUCTION COMMUNITIES
Under the previous system in order fc - neighbor-ods and towns to obtain quicker connections to public utilities organizea forms G population participation were developed these methods of financing infrastructure have continued and may take the form of a neighborhood association or a construction community
Neighborhood associations (ktzmitdrsulds) for the financing of infrastructure network- are formed when at least 66 percent of the residents of a neighborhood agree to their creation membership is open to all residents and contributions to the cost of infrastructure investment is compulsory Membership entitles residents to receive five-to seven year loans from OTP with 70 percent of the interest subsidized by the central
13 See Hegedes Mark Pigey Municipal Lending in Hungary March 1993
This has posed a problem for District XVII in 1993 30 kilometers of pipes of 40 constructed failed the camera verification test however the contractors had already been paid before this verification The District is unable to pave the roads or put system into operation until the pipes are repaired to satisfactory condition
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government 5 Through these loans investment funds are available up front to the district and it is the OTP which takes the credit risk
The members of the association appoint a steering committee (or an executiveboard) which works with the district issues tenders and selects the contractor The amount of contributions by members is assessed by the committee and any remainingfunds available after construction may be redistributed to the residents The committee also defines the contributions of new members
Construction communities (6pit6kbzOss~g) are a more flexible form of populationparticipation as they are not legal entities and have no right to sign contracts in their own name The community elects an executive board this board will work with the local government during construction in terms of choosing a constructor monitoringrealization countersigning contracts and bills However the legal investor is the local government This form of construction is used in District XVII
A separate account is established for the investment and members of theconstruction community pay their contributions into the account as the work proceedsIndividuals may contract loans to finance their contribution but these are at market rates and not the subsidized loans available to members of neighborhood associations Thus the district takes a credit risk and there are cases where members have not been able to pay the full amount of their assessed participation
In interviews with Districts XVII and XVIII it has often been stated that households have reached the limits of their capacity to contribute to financing the sewage network This system of financing is not limited to capital investments in sewer networks but has also been used to finance other public utilities such as potable water gas connections and telephone lines
Although districts do receive a portion of the personal income tax (for which there is a specific distribution formula between the capital city and the districts and among the districts) the actual incomes of the district populations are not known with precisionIn order for the district governments to better Judge the capacity of their population tocontribute both now and in the future small surveys of the population of selected areas in the district may be useful Such surveys may help to establish the level of incomesand expenditures as well as assess a realistic burden for construction and developmentlees or local taxes
15 In January 1994 subsidies for direct household loans for utility connections were terminated making the neighborhood association loans the only remaining subsidy for utility connections
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MINISTRY OF TRANSPORTATION COMMUNICATION AND WATER MANAGEMENT (MTCWM)
The Ministry of Transportation Communication and Water Management must approve all projects in Hungary relating to water no sewerage project may go forward without first obtaining the water authorization permit from this Ministry
Until 1 January 1994 the Miniszry also played a role in setting the water and sewer tariffs According to the 1990 Act on Prices the fee must include the expenses of efficient operation and the profit required for efficient operation although no definition of efficiency or provisions for monitoring are included in the Act
The final allowed price was set by the Ministry based on tariffs proposed by the sewer company and the Capital City From the beginning of 1994 the pricing of sewer services has been completely devolved to the city of Budapest although the Ministry has set non-binding guidelines for fees
PROPOSED SEWAGE INVESTMENTS
SEWAGE DEVELOPMENT NEEDS IN DISTRICTS XVII AND XVIII
Citywide there are 4000 km of sewage pipes connecting approximately 88 percentof households in Budapest although this is heavily concentrated in the center so that
8outer districts have only about 50 to 60 percent coverage 1 Sewage treatment is below the adequate level FCSM estimates that 80 percent of sewage receives mechanical treatment but less than 20 percent is biologically treated
Districts XVII and XVIII have among the lowest levels of sewerage coverage in Budapest but according to the FCSM Investment Department District XVII is worse off because in District XVIII only one area (Pestszentimre) is badly underserviced Both district governments list sewerage as their most pressing infrastructure developmentneed and both have projects planned which they hope to address in the near future
District XVII
District XVII has a split sewage system-ie two separate subsystems for sewageand storm water collection-and has a big deficit in both systems The district has
1039a comprehensive sewage construction plan with an estimated total cost of HUF billion which has already been begun A first task to lay a network in Rakosliget and Rakoscsaba uJtelep has already been partially completed although some difficulties with the contractor left the laid pipes not ready for use The result was that the municipal sewer company (FCSM) refused to accept the pipes and the district has had to ask the city for a special grant of HUF 80 million 8 to complete the work and repave the roads under a new contract
The plan calls for three additional phases of construction the first part will be to construct sewerage in the most urgent areas (the district center and RAkoscsaba) the second is to complete a parallel principal main which is a precondition for expanding the network and the third is to connect some other areas to the system Phase I to construct about 30 kilometers in Rakoscsaba was begun in early 1994
Targeted subsidies have already been granted for the sewage projectHUF 285 million for 1993 and HUF 21 million for 1994 In both cases despite approvalthe district will receive funds one year later because of central budget limitations The local assembly also has approved the local portion of funding (30 percent of the originalcost estimate) which comes from the social normative grant but the schedule has to be
16 For the outer districts the 1992 flgures are 76-78 percent coverage (districts XV and l) 50-60 percent (XVIII MX and XXI) and 41-43 percent (XVII and XVI)
17 As is the case for most outer areas in Budapest
1s This grant was obtained in return for permission for the Capital City to use the districts landfill
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rethought One difficulty is that because they could not start construction before 1 December 1993 they forfeited the promised HUF 14 million from the City
In some ways storm water collection is a more urgent problem in the district and financially more problematic because no targeted subsidies are available and because it is impossible to charge the public directly for any portion of the development costs The district plans to build a series of ditches for storm water collecting water in one location but because these are open the Sewage Company will not operate them
The district assembly has approved sewerage construction plans but has not actually appropriated the money 9 so that the district has not been able to apply for some other available subsidies One such potential subsidy comes from the Water Management Fund which requires a permit from the water authority As the permit expires in two years the district will probably have to reapply because they may not be able to begin construction of the next phase within two years
One portion of the district contribution is paying the value-added tax portion of the connections (Until January 1993 this amount at 25 percent of cost would have been refunded by the central government) There is a preliminary agreement between the FCSM and the districts that starting 1 January 1994 the FCSM will pay the VAT and be reimbursed by the central government
Citizens contributions will have to make up a larger proportion than foreseen (probably 60 percent instead of 40 percent) A neighborhood association has already been formed in RiLkosllget two construction communities (one of over 700 households) have been formed for the Rakoscsaba work Conditions for households have changed considerably as of January 1994 because the 50 percent subsidies on utility connection loans are no longer available The district is therefore allowing those households unable to pay up front to pay in installments with no interest
Enterprises of course can be - arged higher connection fees and the district wants to use those to cross-subsidize household connections The district Public Utilities Division believes enterprises could be charged up to HUF 1 billion for the sewage development contribution plus HUF 80 million for the actual connection
District XVII has no outstanding loans nor do they levy any local taxes at present They do not have committees or a project preparation unit set up to work on cost of projects instead the technical department alone has put this project together There will be some political difficulties in getting this project approved because those in housing estates which are already connected to the sewage system and who represent the bulk
Not all assembly representatives heartily endorse the plan moreover the assembly did not think the central government would grant the targeted subsidy
20 This may be a problem at some point as when capacity problems exist the FCSM has indicated that it may grant permits for connection only to households and not to enterprises
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of the voting power will be opposed to the expenditure This same argument was used to explain why the council would be opposed to incurring debt although it is possiblethat debt could be structured to be repaid by the benefiting area only
The district does not have solid data on incomes but there is a general sense that probably only 20 percent of households can afford the sewage connection at HUF 30000shy40000 those who cannot would have to be subsidized by the local government byreceiving interest-free loans
DistrictXV37
District XVIII has almost the lowest per capita income in Budapest (it ranks 18th among the 22 districts) it is fourth in area seventh in population and only district XVII has less sewerage coverage according to the Deputy Mayor
Pestszentimre a neighborhood of mostly single-family houses containing about one quarter of district households (a population of 25000 in a district of 98000) is the area most urgently needing sewerage development The cost for this development is estimated at between HUF 12 and 16 billion Four storage tanks that pump sewage into the main system will have to be built The current plan is to begin construction in 1996 the schedule has been pushed back mostly because of financial considerations Sewage is still very much a priority investment for the district
The district hopes to have 30 percent of the cost covered by district resources 30 percent by the Capital City and 40 percent by a targeted subsidy (because Budapestapplied for the subsidy with the district the subsidy is worth an extra 10 percent of estimated cost) A cooperation agreement was required but because Budapest did not sign it the district has not yet applied for the subsidy
The Southern Pest Treatment Center is at capacity now and the new sewerage will not be able to be connected until the Center is expanded District XVIII feels confident that the expansion will be undertaken next year so the technical problem will be solved Budapest would take a loan for this project apparently the City Council is in favor of the project Even though the Treatment Center has not yet been expanded the FCSM has given the district their permit to begin construction
The gas network was recently completed in the same area funded throughneighborhood associations work was completed in 1993 The connection fee of HUF 46000 per household will take three years to pay off so that payments will stop in 1995 Even so the connection fee alone did not cover the total cost which came to about HUF 150000-200000 per property
If a connection fee for sewerage is set too high district officials are afraid somehouseholds may elect not to connect at all If more than 60 percent of households want to connect the district will begin construction but they risk having some households subsequently decide not to connect and withdraw their contributions District officials
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expect the connection fee to be HUF 60000-65000 the District will pay an additional HUF 15000 fee per household to cover the cost of preparing the technical construction plans
The Deputy Mayor assumes the district will have to take on debt and he believes the district would definitely approach various banks as OTP does not offer attractive terms A technical implementation report on the project has been prepared but it includes no work on financial returns
CURRENT SEWER INFRASTRUCTURE FINANCING PRACTICES
As described in the first section districts are responsible for the construction of sewer collection systems that once built are turned over to the Capital City Sewer Company for operation and maintenance The Capital City is responsible for construction of interceptor sewers and sewage treatment plants Once the infrastruc-ture is in place system stewardship is the responsibility of the Budapest Municipal Sewage Company (FCSM)
There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including
Central Government Targeted subsidies provided by the central government are used to finance construction of sewer collection systems Targeted subsides are matching grants given to districts on a competitive basis The level of funding provided by targeted subsides is 30 percent for sewer collection projects (40 percentif the application is made jointly by both the district and the Capital City) However the reliability of this revenue source to finance future sewer projects is subject to the priorities and conditions set by the Parliament as recommended by the Ministry of the Interior Therefore there is no assurance that targetedsubsidies can be used to finance sewer collection systems in the future2
1 It is noted that the central government provides addressed subsidies however sewer collection system financing is not an eligible use of such subsidies
Capital City The Capital City can contribute to the cost of district sewer construction projects However district projects mus conform to Capital City priorities to be considered for funding
21 For example in 1993 the amounts needed to fund all eligible projects exceed the grant monies budgeted by the central government so those projects are approved but local governments will receive funds two or three years from now
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District Own source revenues for sewer collection system construction and connections to properties in public ownership are derived from (1) allocations made through the annual local budget process derived from local taxes miscellaneous fees and intergovernmental transfers (eg normative subsidies) (2) sale or lease of district owned land and (3)mid-term borrowing (defined as 2-3 years) from OTP Loans are repaid from own source revenue in the form of proceeds from the sale or lease of district-owned land
Citizens Citizens contribute to the construction of sewer systems in two ways (1)through the creation of construction communities or neighborhood associations citizens pay a portion of the collection system construction cost and (2)connection fees
FINANCING OPTIONS
This is a period of intensive change in the ways in which the central governmentdistricts the Capital City and the recently privatized Budapest Municipal SewageCompany finance and maintain the municipal sewer system Existing capitalimprovements practices are woefully insufficient to meet current and future seweragecapital needs Reasons for this state of affairs include
Limited Financial Capacity
The lack of adequate own source revenue has a profound impact on limitingavailable funds necessary to finance sewage system expansion There is a great disparitybetween capital needs and the anticipated revenue available to meet these needs Sewer construction projects are very expensive Existing financing mechanisms are inadequate
Debt Financing Districts make limited use of debt financing When debt is issuedIt is for a 2 or 3 year period This short term debt financing places an undue burden on the districts limited financial resources and the present populationsability to amortize the debt The high cost of borrowing (27 percent interest) further exacerbates this problem as well as increasing the cost of capital development
Capital financing typically requires the issuance of long term debt (20 to 30 years)that roughly correlates to the useful life of the facility This method of financingalso is considered to be equitable to those who benefit from the system (egcitizens commerce industry) since each generation pays its fair share of the cost of the facility A long-life asset such as a sewer system should be paid for by its users throughout its normal life rather than all at once by those who may not have the use of it full term Even with higher cost due to interest if spread over a largenumber of userspayers the cost to all is lowered Given Hungarys high rate of inflation and thus ever increasing construction costs it may be cheaper to borrow and pay todays prices rather than wait and pay tomorrows prices Furthermorethe use of long term debt puts less financial pressure on the operating budget
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OperatingBudget (ie pay-as-you-go)There is some attempt to finance a portion of the cost of sewer improvements through the operating budget The operatingbudget is reliant on revenues derived from intergovernmental transfers and therefore provides very little fiscal flexibility to support capital development Furthermore there are no reserve accounts that may be used to set aside funds for future capital development or meet emergencies (It will be noted of course that with Hungarys high rate of inflation the reserve accounts will be rapidly eroded so it may be decided to keep them at a mintimum)
Typically the operating budget is not used to finance large scale capital projects such as sewer collection systems Annual appropriations tend to be used to pay for municipal operations and service Small scale projects equipment purchases and the repair of existing facilities may be funded through the operating budgetHowever the use of the operating budget to finance large capital projects should be frowned upon for the following reasons
It forces local officials to make extremely difficult choices between service
delivery government operations and capital expansion
It places a heavy burden on the budget for the project year
It creates awkward fluctuating expenditure cycles that do not occur with extended financing
Since funding is based on yearly increments the use of the operating budget helps foster an environment wherein projects often go uncompleted
Sale of Land Districts rely on the sale of land to raise revenue for infrastructure financing This raises several concerns First land is not liquid and its value is subject to market forces In a sagging market such as currently exists land priceshave eroded to the point where districts are unable to raise adequate capital through the sale of land to finance sewer construction Furthermore there are few entrepreneurs with adequate resources to buy land
A related issue is that the land being sold is not serviced by sewer and other infrastructure components The offering price most likely reflects the absence of infrastructure If the infrastructure were in place prior to the sale or lease of district-owned land the district would realize a greater return than it currently receives
Finally land is finite Districts should think carefully about diminishing this resource to finance capital investment particularly before the capital is in placeLater in this paper we describe financing mechanisms that should be considered as feasible alternatives Particular attention should be paid to the use of tax increment financing or other forms of betterment financing
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Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
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Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
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ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
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projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
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Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
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plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
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FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
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ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
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of the sewer works company was approved by the general assembly of the Capital In addition the Supervisory Board of 13 members was appointed by the general assemblyOn 1 December 1993 the FCSM was transformed into a joint-stock company wholly owned by the Capital city Under this structure the Supervisory Board of nine members-three from FCSM staff and six from the Assembly-will be responsible for approving the companys budget and al strategically important decisions
The assets relating to sewerage were the property of the Capital City but were transferred to the FCSM as of 1 December 1993 as part of the companys transformation First the assets were reassessed and their replacement value was determined to be HUF 70 billion a considerable increase from the HUF 20 billion previously estimated10 With the transformation these assets were transferred to the ownership of the joint-stock company
Any additional networks and additions to the system will also be transferred to the FCSM However according to provisions of the 1991 Accounting Act any network built privately is transferred at zero value thus preventing the company from taking any depreciation on the value of the stock
As a means of circumventing this problem the FCSM arranged to be assigned as both investor and builder However when targeted subsidies are used to finance part of the network such an arrangement becomes more difficult because the local government must be the investor
For sewer projects initiated by the districts the FCSM is responsible for reviewing the technical plans and giving an expert opinion before construction begins Upon completion of the equipment the FCSM will inspect the equipment for adherence to technical norms (such as pressure tests or camera inspections within the pipes) and will authorize operation of the network This authorization will depend on capacity of eidsting mains and treatment plants to handle a larger flow of effluent in the system Thus due to the saturation of the main pipes in North Pest new business and industrial connections will not be authorized until the capacity of this part of the network has been increased
The principal activity of the FCSM is the operation and maintenance of the sewerage system within the city of Budapest In addition reconstruction and rehabilitation of all existing pipes pumping stations and treatment plants are the responsibility of the company These activities (operation maintenance reconstruction) are financed through the sewage fee
o It is believed that the primary purpose of this revaluation was to Increase depreciation funds However the higher valuation may have an adverse effect on the prospects for privatization
I Based on a conversation with the Technical Department of the FCSM
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The fee is collected in part by the FCSM however a collecting company12 collectsft sfrom private homes and the Water Works Company collects fees from industrial users and rental housing Thus the FCSM only seems to directly collect the fees from individuals with water wells but who are connected to the sewer system This systemof collection often leads to delays of at least two months in receipt of fees the amount ofunpaid fees were estimated at HUF 500-600 million in June 1993 and in May 1994 at HUF 338 million of which HUF 240 million Is from residences Total receipts in 1993 were HUF 4-5 billion putting delinquencits at about 8 percent
THE DISTRICTS
De facto due to lack of funds in the face of so many pressing needs the districtshave been made responsible for the construction of the secondary sewerage network(pipes leading from homes and businesses to the main collecting pipes and the collection system) The connections leading from homes and businesses to the secondary network are financed by the beneficiaries but constructed by the districts
Once a district decides to undertake the construction of part of the sewer system a water authorization permit is required from the MTCWM An expert opinion on thetechnical plans must be solicited from the FCSM The district is responsible for raisingfunds for construction Sources of financing may include district own fundscontributions from the Capital City targeted grants grants from the national Water Development Fund contributions from the population and loans
The means of financing used for these projects often leads to inefficient use of resources as matching funds and grants must remain in the accounts until construction has actually commenced This is the case for both the districts and the Capital CityTargeted grants require matching funds from the district which must be kept in the local government account as proof that this requirement has been met If there are delays in the start of the project these funds are left unused instead of being appropriated for more immediate needs
In the same way contributions from the Capital City must be negotiated on a caseby case basis and success in obtaining them may depend on the extent to which theparticular project corresponds to the capital citys own priorities However if the districts do not commence work on the project in a timely manner the Capital City funds are alsolying unused in an account For this reason the Capital has placed conditions on projectconstruction start-up dates if these requirements are not respected the districts may
This company was recently privatized through an employee share purchasing program It collects all utilities and municipal housing rents In Budapest for a fee of 3 to 4 percent of collections Recentlythe electricity company ended the contract and makes Its own collections while th gas company hascontracted out to other private companies in certain districts although their collections fees are muchhigher The Collection Company is currently in the process of revising its contractual relationshipswith its clients
12
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lose the grant For example District XVII received a promise of a HUF 14 million grant for the Rkosliget sewer project on condition that construction commenced by 1 December 1993
Appropriate financial products are currently not available to local governments for financing long-term investments such as sewer networks 3 For the moment the districts do not have access to the sewer fee which would enable them to appropriate part of this user fee for the reimbursement of debt Thus districts have placed heavyreliance on up-front population contributions through neighborhood associations and construction communities to finance part of secondary networks (and sometimef- the main networks) in addition to direct household connections to the network ----se connection fees are the only user charge to which districts have access As there o legal restriction on the level of the connection fee the only consideration in settin e fee is affordability
The construction of the project is monitored by the district Once completed technical certification of the equipment is required by the FCSM (pumping test and verification of pipes with a camera) If the results of these verifications are unsatisfactory then the operation of the pipes will not be authorized by the FCSM 4 If the FCSM grants approval the entire network is transferred to the Sewer Works Company which is responsible for operation maintenance rehabilitation and replacement of the equipment
NEIGHBORHOOD ASSOCIATIONS AND CONSTRUCTION COMMUNITIES
Under the previous system in order fc - neighbor-ods and towns to obtain quicker connections to public utilities organizea forms G population participation were developed these methods of financing infrastructure have continued and may take the form of a neighborhood association or a construction community
Neighborhood associations (ktzmitdrsulds) for the financing of infrastructure network- are formed when at least 66 percent of the residents of a neighborhood agree to their creation membership is open to all residents and contributions to the cost of infrastructure investment is compulsory Membership entitles residents to receive five-to seven year loans from OTP with 70 percent of the interest subsidized by the central
13 See Hegedes Mark Pigey Municipal Lending in Hungary March 1993
This has posed a problem for District XVII in 1993 30 kilometers of pipes of 40 constructed failed the camera verification test however the contractors had already been paid before this verification The District is unable to pave the roads or put system into operation until the pipes are repaired to satisfactory condition
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government 5 Through these loans investment funds are available up front to the district and it is the OTP which takes the credit risk
The members of the association appoint a steering committee (or an executiveboard) which works with the district issues tenders and selects the contractor The amount of contributions by members is assessed by the committee and any remainingfunds available after construction may be redistributed to the residents The committee also defines the contributions of new members
Construction communities (6pit6kbzOss~g) are a more flexible form of populationparticipation as they are not legal entities and have no right to sign contracts in their own name The community elects an executive board this board will work with the local government during construction in terms of choosing a constructor monitoringrealization countersigning contracts and bills However the legal investor is the local government This form of construction is used in District XVII
A separate account is established for the investment and members of theconstruction community pay their contributions into the account as the work proceedsIndividuals may contract loans to finance their contribution but these are at market rates and not the subsidized loans available to members of neighborhood associations Thus the district takes a credit risk and there are cases where members have not been able to pay the full amount of their assessed participation
In interviews with Districts XVII and XVIII it has often been stated that households have reached the limits of their capacity to contribute to financing the sewage network This system of financing is not limited to capital investments in sewer networks but has also been used to finance other public utilities such as potable water gas connections and telephone lines
Although districts do receive a portion of the personal income tax (for which there is a specific distribution formula between the capital city and the districts and among the districts) the actual incomes of the district populations are not known with precisionIn order for the district governments to better Judge the capacity of their population tocontribute both now and in the future small surveys of the population of selected areas in the district may be useful Such surveys may help to establish the level of incomesand expenditures as well as assess a realistic burden for construction and developmentlees or local taxes
15 In January 1994 subsidies for direct household loans for utility connections were terminated making the neighborhood association loans the only remaining subsidy for utility connections
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MINISTRY OF TRANSPORTATION COMMUNICATION AND WATER MANAGEMENT (MTCWM)
The Ministry of Transportation Communication and Water Management must approve all projects in Hungary relating to water no sewerage project may go forward without first obtaining the water authorization permit from this Ministry
Until 1 January 1994 the Miniszry also played a role in setting the water and sewer tariffs According to the 1990 Act on Prices the fee must include the expenses of efficient operation and the profit required for efficient operation although no definition of efficiency or provisions for monitoring are included in the Act
The final allowed price was set by the Ministry based on tariffs proposed by the sewer company and the Capital City From the beginning of 1994 the pricing of sewer services has been completely devolved to the city of Budapest although the Ministry has set non-binding guidelines for fees
PROPOSED SEWAGE INVESTMENTS
SEWAGE DEVELOPMENT NEEDS IN DISTRICTS XVII AND XVIII
Citywide there are 4000 km of sewage pipes connecting approximately 88 percentof households in Budapest although this is heavily concentrated in the center so that
8outer districts have only about 50 to 60 percent coverage 1 Sewage treatment is below the adequate level FCSM estimates that 80 percent of sewage receives mechanical treatment but less than 20 percent is biologically treated
Districts XVII and XVIII have among the lowest levels of sewerage coverage in Budapest but according to the FCSM Investment Department District XVII is worse off because in District XVIII only one area (Pestszentimre) is badly underserviced Both district governments list sewerage as their most pressing infrastructure developmentneed and both have projects planned which they hope to address in the near future
District XVII
District XVII has a split sewage system-ie two separate subsystems for sewageand storm water collection-and has a big deficit in both systems The district has
1039a comprehensive sewage construction plan with an estimated total cost of HUF billion which has already been begun A first task to lay a network in Rakosliget and Rakoscsaba uJtelep has already been partially completed although some difficulties with the contractor left the laid pipes not ready for use The result was that the municipal sewer company (FCSM) refused to accept the pipes and the district has had to ask the city for a special grant of HUF 80 million 8 to complete the work and repave the roads under a new contract
The plan calls for three additional phases of construction the first part will be to construct sewerage in the most urgent areas (the district center and RAkoscsaba) the second is to complete a parallel principal main which is a precondition for expanding the network and the third is to connect some other areas to the system Phase I to construct about 30 kilometers in Rakoscsaba was begun in early 1994
Targeted subsidies have already been granted for the sewage projectHUF 285 million for 1993 and HUF 21 million for 1994 In both cases despite approvalthe district will receive funds one year later because of central budget limitations The local assembly also has approved the local portion of funding (30 percent of the originalcost estimate) which comes from the social normative grant but the schedule has to be
16 For the outer districts the 1992 flgures are 76-78 percent coverage (districts XV and l) 50-60 percent (XVIII MX and XXI) and 41-43 percent (XVII and XVI)
17 As is the case for most outer areas in Budapest
1s This grant was obtained in return for permission for the Capital City to use the districts landfill
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rethought One difficulty is that because they could not start construction before 1 December 1993 they forfeited the promised HUF 14 million from the City
In some ways storm water collection is a more urgent problem in the district and financially more problematic because no targeted subsidies are available and because it is impossible to charge the public directly for any portion of the development costs The district plans to build a series of ditches for storm water collecting water in one location but because these are open the Sewage Company will not operate them
The district assembly has approved sewerage construction plans but has not actually appropriated the money 9 so that the district has not been able to apply for some other available subsidies One such potential subsidy comes from the Water Management Fund which requires a permit from the water authority As the permit expires in two years the district will probably have to reapply because they may not be able to begin construction of the next phase within two years
One portion of the district contribution is paying the value-added tax portion of the connections (Until January 1993 this amount at 25 percent of cost would have been refunded by the central government) There is a preliminary agreement between the FCSM and the districts that starting 1 January 1994 the FCSM will pay the VAT and be reimbursed by the central government
Citizens contributions will have to make up a larger proportion than foreseen (probably 60 percent instead of 40 percent) A neighborhood association has already been formed in RiLkosllget two construction communities (one of over 700 households) have been formed for the Rakoscsaba work Conditions for households have changed considerably as of January 1994 because the 50 percent subsidies on utility connection loans are no longer available The district is therefore allowing those households unable to pay up front to pay in installments with no interest
Enterprises of course can be - arged higher connection fees and the district wants to use those to cross-subsidize household connections The district Public Utilities Division believes enterprises could be charged up to HUF 1 billion for the sewage development contribution plus HUF 80 million for the actual connection
District XVII has no outstanding loans nor do they levy any local taxes at present They do not have committees or a project preparation unit set up to work on cost of projects instead the technical department alone has put this project together There will be some political difficulties in getting this project approved because those in housing estates which are already connected to the sewage system and who represent the bulk
Not all assembly representatives heartily endorse the plan moreover the assembly did not think the central government would grant the targeted subsidy
20 This may be a problem at some point as when capacity problems exist the FCSM has indicated that it may grant permits for connection only to households and not to enterprises
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of the voting power will be opposed to the expenditure This same argument was used to explain why the council would be opposed to incurring debt although it is possiblethat debt could be structured to be repaid by the benefiting area only
The district does not have solid data on incomes but there is a general sense that probably only 20 percent of households can afford the sewage connection at HUF 30000shy40000 those who cannot would have to be subsidized by the local government byreceiving interest-free loans
DistrictXV37
District XVIII has almost the lowest per capita income in Budapest (it ranks 18th among the 22 districts) it is fourth in area seventh in population and only district XVII has less sewerage coverage according to the Deputy Mayor
Pestszentimre a neighborhood of mostly single-family houses containing about one quarter of district households (a population of 25000 in a district of 98000) is the area most urgently needing sewerage development The cost for this development is estimated at between HUF 12 and 16 billion Four storage tanks that pump sewage into the main system will have to be built The current plan is to begin construction in 1996 the schedule has been pushed back mostly because of financial considerations Sewage is still very much a priority investment for the district
The district hopes to have 30 percent of the cost covered by district resources 30 percent by the Capital City and 40 percent by a targeted subsidy (because Budapestapplied for the subsidy with the district the subsidy is worth an extra 10 percent of estimated cost) A cooperation agreement was required but because Budapest did not sign it the district has not yet applied for the subsidy
The Southern Pest Treatment Center is at capacity now and the new sewerage will not be able to be connected until the Center is expanded District XVIII feels confident that the expansion will be undertaken next year so the technical problem will be solved Budapest would take a loan for this project apparently the City Council is in favor of the project Even though the Treatment Center has not yet been expanded the FCSM has given the district their permit to begin construction
The gas network was recently completed in the same area funded throughneighborhood associations work was completed in 1993 The connection fee of HUF 46000 per household will take three years to pay off so that payments will stop in 1995 Even so the connection fee alone did not cover the total cost which came to about HUF 150000-200000 per property
If a connection fee for sewerage is set too high district officials are afraid somehouseholds may elect not to connect at all If more than 60 percent of households want to connect the district will begin construction but they risk having some households subsequently decide not to connect and withdraw their contributions District officials
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expect the connection fee to be HUF 60000-65000 the District will pay an additional HUF 15000 fee per household to cover the cost of preparing the technical construction plans
The Deputy Mayor assumes the district will have to take on debt and he believes the district would definitely approach various banks as OTP does not offer attractive terms A technical implementation report on the project has been prepared but it includes no work on financial returns
CURRENT SEWER INFRASTRUCTURE FINANCING PRACTICES
As described in the first section districts are responsible for the construction of sewer collection systems that once built are turned over to the Capital City Sewer Company for operation and maintenance The Capital City is responsible for construction of interceptor sewers and sewage treatment plants Once the infrastruc-ture is in place system stewardship is the responsibility of the Budapest Municipal Sewage Company (FCSM)
There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including
Central Government Targeted subsidies provided by the central government are used to finance construction of sewer collection systems Targeted subsides are matching grants given to districts on a competitive basis The level of funding provided by targeted subsides is 30 percent for sewer collection projects (40 percentif the application is made jointly by both the district and the Capital City) However the reliability of this revenue source to finance future sewer projects is subject to the priorities and conditions set by the Parliament as recommended by the Ministry of the Interior Therefore there is no assurance that targetedsubsidies can be used to finance sewer collection systems in the future2
1 It is noted that the central government provides addressed subsidies however sewer collection system financing is not an eligible use of such subsidies
Capital City The Capital City can contribute to the cost of district sewer construction projects However district projects mus conform to Capital City priorities to be considered for funding
21 For example in 1993 the amounts needed to fund all eligible projects exceed the grant monies budgeted by the central government so those projects are approved but local governments will receive funds two or three years from now
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District Own source revenues for sewer collection system construction and connections to properties in public ownership are derived from (1) allocations made through the annual local budget process derived from local taxes miscellaneous fees and intergovernmental transfers (eg normative subsidies) (2) sale or lease of district owned land and (3)mid-term borrowing (defined as 2-3 years) from OTP Loans are repaid from own source revenue in the form of proceeds from the sale or lease of district-owned land
Citizens Citizens contribute to the construction of sewer systems in two ways (1)through the creation of construction communities or neighborhood associations citizens pay a portion of the collection system construction cost and (2)connection fees
FINANCING OPTIONS
This is a period of intensive change in the ways in which the central governmentdistricts the Capital City and the recently privatized Budapest Municipal SewageCompany finance and maintain the municipal sewer system Existing capitalimprovements practices are woefully insufficient to meet current and future seweragecapital needs Reasons for this state of affairs include
Limited Financial Capacity
The lack of adequate own source revenue has a profound impact on limitingavailable funds necessary to finance sewage system expansion There is a great disparitybetween capital needs and the anticipated revenue available to meet these needs Sewer construction projects are very expensive Existing financing mechanisms are inadequate
Debt Financing Districts make limited use of debt financing When debt is issuedIt is for a 2 or 3 year period This short term debt financing places an undue burden on the districts limited financial resources and the present populationsability to amortize the debt The high cost of borrowing (27 percent interest) further exacerbates this problem as well as increasing the cost of capital development
Capital financing typically requires the issuance of long term debt (20 to 30 years)that roughly correlates to the useful life of the facility This method of financingalso is considered to be equitable to those who benefit from the system (egcitizens commerce industry) since each generation pays its fair share of the cost of the facility A long-life asset such as a sewer system should be paid for by its users throughout its normal life rather than all at once by those who may not have the use of it full term Even with higher cost due to interest if spread over a largenumber of userspayers the cost to all is lowered Given Hungarys high rate of inflation and thus ever increasing construction costs it may be cheaper to borrow and pay todays prices rather than wait and pay tomorrows prices Furthermorethe use of long term debt puts less financial pressure on the operating budget
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OperatingBudget (ie pay-as-you-go)There is some attempt to finance a portion of the cost of sewer improvements through the operating budget The operatingbudget is reliant on revenues derived from intergovernmental transfers and therefore provides very little fiscal flexibility to support capital development Furthermore there are no reserve accounts that may be used to set aside funds for future capital development or meet emergencies (It will be noted of course that with Hungarys high rate of inflation the reserve accounts will be rapidly eroded so it may be decided to keep them at a mintimum)
Typically the operating budget is not used to finance large scale capital projects such as sewer collection systems Annual appropriations tend to be used to pay for municipal operations and service Small scale projects equipment purchases and the repair of existing facilities may be funded through the operating budgetHowever the use of the operating budget to finance large capital projects should be frowned upon for the following reasons
It forces local officials to make extremely difficult choices between service
delivery government operations and capital expansion
It places a heavy burden on the budget for the project year
It creates awkward fluctuating expenditure cycles that do not occur with extended financing
Since funding is based on yearly increments the use of the operating budget helps foster an environment wherein projects often go uncompleted
Sale of Land Districts rely on the sale of land to raise revenue for infrastructure financing This raises several concerns First land is not liquid and its value is subject to market forces In a sagging market such as currently exists land priceshave eroded to the point where districts are unable to raise adequate capital through the sale of land to finance sewer construction Furthermore there are few entrepreneurs with adequate resources to buy land
A related issue is that the land being sold is not serviced by sewer and other infrastructure components The offering price most likely reflects the absence of infrastructure If the infrastructure were in place prior to the sale or lease of district-owned land the district would realize a greater return than it currently receives
Finally land is finite Districts should think carefully about diminishing this resource to finance capital investment particularly before the capital is in placeLater in this paper we describe financing mechanisms that should be considered as feasible alternatives Particular attention should be paid to the use of tax increment financing or other forms of betterment financing
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Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
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Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
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ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
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projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
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Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
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plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
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FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
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ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
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The fee is collected in part by the FCSM however a collecting company12 collectsft sfrom private homes and the Water Works Company collects fees from industrial users and rental housing Thus the FCSM only seems to directly collect the fees from individuals with water wells but who are connected to the sewer system This systemof collection often leads to delays of at least two months in receipt of fees the amount ofunpaid fees were estimated at HUF 500-600 million in June 1993 and in May 1994 at HUF 338 million of which HUF 240 million Is from residences Total receipts in 1993 were HUF 4-5 billion putting delinquencits at about 8 percent
THE DISTRICTS
De facto due to lack of funds in the face of so many pressing needs the districtshave been made responsible for the construction of the secondary sewerage network(pipes leading from homes and businesses to the main collecting pipes and the collection system) The connections leading from homes and businesses to the secondary network are financed by the beneficiaries but constructed by the districts
Once a district decides to undertake the construction of part of the sewer system a water authorization permit is required from the MTCWM An expert opinion on thetechnical plans must be solicited from the FCSM The district is responsible for raisingfunds for construction Sources of financing may include district own fundscontributions from the Capital City targeted grants grants from the national Water Development Fund contributions from the population and loans
The means of financing used for these projects often leads to inefficient use of resources as matching funds and grants must remain in the accounts until construction has actually commenced This is the case for both the districts and the Capital CityTargeted grants require matching funds from the district which must be kept in the local government account as proof that this requirement has been met If there are delays in the start of the project these funds are left unused instead of being appropriated for more immediate needs
In the same way contributions from the Capital City must be negotiated on a caseby case basis and success in obtaining them may depend on the extent to which theparticular project corresponds to the capital citys own priorities However if the districts do not commence work on the project in a timely manner the Capital City funds are alsolying unused in an account For this reason the Capital has placed conditions on projectconstruction start-up dates if these requirements are not respected the districts may
This company was recently privatized through an employee share purchasing program It collects all utilities and municipal housing rents In Budapest for a fee of 3 to 4 percent of collections Recentlythe electricity company ended the contract and makes Its own collections while th gas company hascontracted out to other private companies in certain districts although their collections fees are muchhigher The Collection Company is currently in the process of revising its contractual relationshipswith its clients
12
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lose the grant For example District XVII received a promise of a HUF 14 million grant for the Rkosliget sewer project on condition that construction commenced by 1 December 1993
Appropriate financial products are currently not available to local governments for financing long-term investments such as sewer networks 3 For the moment the districts do not have access to the sewer fee which would enable them to appropriate part of this user fee for the reimbursement of debt Thus districts have placed heavyreliance on up-front population contributions through neighborhood associations and construction communities to finance part of secondary networks (and sometimef- the main networks) in addition to direct household connections to the network ----se connection fees are the only user charge to which districts have access As there o legal restriction on the level of the connection fee the only consideration in settin e fee is affordability
The construction of the project is monitored by the district Once completed technical certification of the equipment is required by the FCSM (pumping test and verification of pipes with a camera) If the results of these verifications are unsatisfactory then the operation of the pipes will not be authorized by the FCSM 4 If the FCSM grants approval the entire network is transferred to the Sewer Works Company which is responsible for operation maintenance rehabilitation and replacement of the equipment
NEIGHBORHOOD ASSOCIATIONS AND CONSTRUCTION COMMUNITIES
Under the previous system in order fc - neighbor-ods and towns to obtain quicker connections to public utilities organizea forms G population participation were developed these methods of financing infrastructure have continued and may take the form of a neighborhood association or a construction community
Neighborhood associations (ktzmitdrsulds) for the financing of infrastructure network- are formed when at least 66 percent of the residents of a neighborhood agree to their creation membership is open to all residents and contributions to the cost of infrastructure investment is compulsory Membership entitles residents to receive five-to seven year loans from OTP with 70 percent of the interest subsidized by the central
13 See Hegedes Mark Pigey Municipal Lending in Hungary March 1993
This has posed a problem for District XVII in 1993 30 kilometers of pipes of 40 constructed failed the camera verification test however the contractors had already been paid before this verification The District is unable to pave the roads or put system into operation until the pipes are repaired to satisfactory condition
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government 5 Through these loans investment funds are available up front to the district and it is the OTP which takes the credit risk
The members of the association appoint a steering committee (or an executiveboard) which works with the district issues tenders and selects the contractor The amount of contributions by members is assessed by the committee and any remainingfunds available after construction may be redistributed to the residents The committee also defines the contributions of new members
Construction communities (6pit6kbzOss~g) are a more flexible form of populationparticipation as they are not legal entities and have no right to sign contracts in their own name The community elects an executive board this board will work with the local government during construction in terms of choosing a constructor monitoringrealization countersigning contracts and bills However the legal investor is the local government This form of construction is used in District XVII
A separate account is established for the investment and members of theconstruction community pay their contributions into the account as the work proceedsIndividuals may contract loans to finance their contribution but these are at market rates and not the subsidized loans available to members of neighborhood associations Thus the district takes a credit risk and there are cases where members have not been able to pay the full amount of their assessed participation
In interviews with Districts XVII and XVIII it has often been stated that households have reached the limits of their capacity to contribute to financing the sewage network This system of financing is not limited to capital investments in sewer networks but has also been used to finance other public utilities such as potable water gas connections and telephone lines
Although districts do receive a portion of the personal income tax (for which there is a specific distribution formula between the capital city and the districts and among the districts) the actual incomes of the district populations are not known with precisionIn order for the district governments to better Judge the capacity of their population tocontribute both now and in the future small surveys of the population of selected areas in the district may be useful Such surveys may help to establish the level of incomesand expenditures as well as assess a realistic burden for construction and developmentlees or local taxes
15 In January 1994 subsidies for direct household loans for utility connections were terminated making the neighborhood association loans the only remaining subsidy for utility connections
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MINISTRY OF TRANSPORTATION COMMUNICATION AND WATER MANAGEMENT (MTCWM)
The Ministry of Transportation Communication and Water Management must approve all projects in Hungary relating to water no sewerage project may go forward without first obtaining the water authorization permit from this Ministry
Until 1 January 1994 the Miniszry also played a role in setting the water and sewer tariffs According to the 1990 Act on Prices the fee must include the expenses of efficient operation and the profit required for efficient operation although no definition of efficiency or provisions for monitoring are included in the Act
The final allowed price was set by the Ministry based on tariffs proposed by the sewer company and the Capital City From the beginning of 1994 the pricing of sewer services has been completely devolved to the city of Budapest although the Ministry has set non-binding guidelines for fees
PROPOSED SEWAGE INVESTMENTS
SEWAGE DEVELOPMENT NEEDS IN DISTRICTS XVII AND XVIII
Citywide there are 4000 km of sewage pipes connecting approximately 88 percentof households in Budapest although this is heavily concentrated in the center so that
8outer districts have only about 50 to 60 percent coverage 1 Sewage treatment is below the adequate level FCSM estimates that 80 percent of sewage receives mechanical treatment but less than 20 percent is biologically treated
Districts XVII and XVIII have among the lowest levels of sewerage coverage in Budapest but according to the FCSM Investment Department District XVII is worse off because in District XVIII only one area (Pestszentimre) is badly underserviced Both district governments list sewerage as their most pressing infrastructure developmentneed and both have projects planned which they hope to address in the near future
District XVII
District XVII has a split sewage system-ie two separate subsystems for sewageand storm water collection-and has a big deficit in both systems The district has
1039a comprehensive sewage construction plan with an estimated total cost of HUF billion which has already been begun A first task to lay a network in Rakosliget and Rakoscsaba uJtelep has already been partially completed although some difficulties with the contractor left the laid pipes not ready for use The result was that the municipal sewer company (FCSM) refused to accept the pipes and the district has had to ask the city for a special grant of HUF 80 million 8 to complete the work and repave the roads under a new contract
The plan calls for three additional phases of construction the first part will be to construct sewerage in the most urgent areas (the district center and RAkoscsaba) the second is to complete a parallel principal main which is a precondition for expanding the network and the third is to connect some other areas to the system Phase I to construct about 30 kilometers in Rakoscsaba was begun in early 1994
Targeted subsidies have already been granted for the sewage projectHUF 285 million for 1993 and HUF 21 million for 1994 In both cases despite approvalthe district will receive funds one year later because of central budget limitations The local assembly also has approved the local portion of funding (30 percent of the originalcost estimate) which comes from the social normative grant but the schedule has to be
16 For the outer districts the 1992 flgures are 76-78 percent coverage (districts XV and l) 50-60 percent (XVIII MX and XXI) and 41-43 percent (XVII and XVI)
17 As is the case for most outer areas in Budapest
1s This grant was obtained in return for permission for the Capital City to use the districts landfill
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rethought One difficulty is that because they could not start construction before 1 December 1993 they forfeited the promised HUF 14 million from the City
In some ways storm water collection is a more urgent problem in the district and financially more problematic because no targeted subsidies are available and because it is impossible to charge the public directly for any portion of the development costs The district plans to build a series of ditches for storm water collecting water in one location but because these are open the Sewage Company will not operate them
The district assembly has approved sewerage construction plans but has not actually appropriated the money 9 so that the district has not been able to apply for some other available subsidies One such potential subsidy comes from the Water Management Fund which requires a permit from the water authority As the permit expires in two years the district will probably have to reapply because they may not be able to begin construction of the next phase within two years
One portion of the district contribution is paying the value-added tax portion of the connections (Until January 1993 this amount at 25 percent of cost would have been refunded by the central government) There is a preliminary agreement between the FCSM and the districts that starting 1 January 1994 the FCSM will pay the VAT and be reimbursed by the central government
Citizens contributions will have to make up a larger proportion than foreseen (probably 60 percent instead of 40 percent) A neighborhood association has already been formed in RiLkosllget two construction communities (one of over 700 households) have been formed for the Rakoscsaba work Conditions for households have changed considerably as of January 1994 because the 50 percent subsidies on utility connection loans are no longer available The district is therefore allowing those households unable to pay up front to pay in installments with no interest
Enterprises of course can be - arged higher connection fees and the district wants to use those to cross-subsidize household connections The district Public Utilities Division believes enterprises could be charged up to HUF 1 billion for the sewage development contribution plus HUF 80 million for the actual connection
District XVII has no outstanding loans nor do they levy any local taxes at present They do not have committees or a project preparation unit set up to work on cost of projects instead the technical department alone has put this project together There will be some political difficulties in getting this project approved because those in housing estates which are already connected to the sewage system and who represent the bulk
Not all assembly representatives heartily endorse the plan moreover the assembly did not think the central government would grant the targeted subsidy
20 This may be a problem at some point as when capacity problems exist the FCSM has indicated that it may grant permits for connection only to households and not to enterprises
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of the voting power will be opposed to the expenditure This same argument was used to explain why the council would be opposed to incurring debt although it is possiblethat debt could be structured to be repaid by the benefiting area only
The district does not have solid data on incomes but there is a general sense that probably only 20 percent of households can afford the sewage connection at HUF 30000shy40000 those who cannot would have to be subsidized by the local government byreceiving interest-free loans
DistrictXV37
District XVIII has almost the lowest per capita income in Budapest (it ranks 18th among the 22 districts) it is fourth in area seventh in population and only district XVII has less sewerage coverage according to the Deputy Mayor
Pestszentimre a neighborhood of mostly single-family houses containing about one quarter of district households (a population of 25000 in a district of 98000) is the area most urgently needing sewerage development The cost for this development is estimated at between HUF 12 and 16 billion Four storage tanks that pump sewage into the main system will have to be built The current plan is to begin construction in 1996 the schedule has been pushed back mostly because of financial considerations Sewage is still very much a priority investment for the district
The district hopes to have 30 percent of the cost covered by district resources 30 percent by the Capital City and 40 percent by a targeted subsidy (because Budapestapplied for the subsidy with the district the subsidy is worth an extra 10 percent of estimated cost) A cooperation agreement was required but because Budapest did not sign it the district has not yet applied for the subsidy
The Southern Pest Treatment Center is at capacity now and the new sewerage will not be able to be connected until the Center is expanded District XVIII feels confident that the expansion will be undertaken next year so the technical problem will be solved Budapest would take a loan for this project apparently the City Council is in favor of the project Even though the Treatment Center has not yet been expanded the FCSM has given the district their permit to begin construction
The gas network was recently completed in the same area funded throughneighborhood associations work was completed in 1993 The connection fee of HUF 46000 per household will take three years to pay off so that payments will stop in 1995 Even so the connection fee alone did not cover the total cost which came to about HUF 150000-200000 per property
If a connection fee for sewerage is set too high district officials are afraid somehouseholds may elect not to connect at all If more than 60 percent of households want to connect the district will begin construction but they risk having some households subsequently decide not to connect and withdraw their contributions District officials
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expect the connection fee to be HUF 60000-65000 the District will pay an additional HUF 15000 fee per household to cover the cost of preparing the technical construction plans
The Deputy Mayor assumes the district will have to take on debt and he believes the district would definitely approach various banks as OTP does not offer attractive terms A technical implementation report on the project has been prepared but it includes no work on financial returns
CURRENT SEWER INFRASTRUCTURE FINANCING PRACTICES
As described in the first section districts are responsible for the construction of sewer collection systems that once built are turned over to the Capital City Sewer Company for operation and maintenance The Capital City is responsible for construction of interceptor sewers and sewage treatment plants Once the infrastruc-ture is in place system stewardship is the responsibility of the Budapest Municipal Sewage Company (FCSM)
There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including
Central Government Targeted subsidies provided by the central government are used to finance construction of sewer collection systems Targeted subsides are matching grants given to districts on a competitive basis The level of funding provided by targeted subsides is 30 percent for sewer collection projects (40 percentif the application is made jointly by both the district and the Capital City) However the reliability of this revenue source to finance future sewer projects is subject to the priorities and conditions set by the Parliament as recommended by the Ministry of the Interior Therefore there is no assurance that targetedsubsidies can be used to finance sewer collection systems in the future2
1 It is noted that the central government provides addressed subsidies however sewer collection system financing is not an eligible use of such subsidies
Capital City The Capital City can contribute to the cost of district sewer construction projects However district projects mus conform to Capital City priorities to be considered for funding
21 For example in 1993 the amounts needed to fund all eligible projects exceed the grant monies budgeted by the central government so those projects are approved but local governments will receive funds two or three years from now
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District Own source revenues for sewer collection system construction and connections to properties in public ownership are derived from (1) allocations made through the annual local budget process derived from local taxes miscellaneous fees and intergovernmental transfers (eg normative subsidies) (2) sale or lease of district owned land and (3)mid-term borrowing (defined as 2-3 years) from OTP Loans are repaid from own source revenue in the form of proceeds from the sale or lease of district-owned land
Citizens Citizens contribute to the construction of sewer systems in two ways (1)through the creation of construction communities or neighborhood associations citizens pay a portion of the collection system construction cost and (2)connection fees
FINANCING OPTIONS
This is a period of intensive change in the ways in which the central governmentdistricts the Capital City and the recently privatized Budapest Municipal SewageCompany finance and maintain the municipal sewer system Existing capitalimprovements practices are woefully insufficient to meet current and future seweragecapital needs Reasons for this state of affairs include
Limited Financial Capacity
The lack of adequate own source revenue has a profound impact on limitingavailable funds necessary to finance sewage system expansion There is a great disparitybetween capital needs and the anticipated revenue available to meet these needs Sewer construction projects are very expensive Existing financing mechanisms are inadequate
Debt Financing Districts make limited use of debt financing When debt is issuedIt is for a 2 or 3 year period This short term debt financing places an undue burden on the districts limited financial resources and the present populationsability to amortize the debt The high cost of borrowing (27 percent interest) further exacerbates this problem as well as increasing the cost of capital development
Capital financing typically requires the issuance of long term debt (20 to 30 years)that roughly correlates to the useful life of the facility This method of financingalso is considered to be equitable to those who benefit from the system (egcitizens commerce industry) since each generation pays its fair share of the cost of the facility A long-life asset such as a sewer system should be paid for by its users throughout its normal life rather than all at once by those who may not have the use of it full term Even with higher cost due to interest if spread over a largenumber of userspayers the cost to all is lowered Given Hungarys high rate of inflation and thus ever increasing construction costs it may be cheaper to borrow and pay todays prices rather than wait and pay tomorrows prices Furthermorethe use of long term debt puts less financial pressure on the operating budget
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OperatingBudget (ie pay-as-you-go)There is some attempt to finance a portion of the cost of sewer improvements through the operating budget The operatingbudget is reliant on revenues derived from intergovernmental transfers and therefore provides very little fiscal flexibility to support capital development Furthermore there are no reserve accounts that may be used to set aside funds for future capital development or meet emergencies (It will be noted of course that with Hungarys high rate of inflation the reserve accounts will be rapidly eroded so it may be decided to keep them at a mintimum)
Typically the operating budget is not used to finance large scale capital projects such as sewer collection systems Annual appropriations tend to be used to pay for municipal operations and service Small scale projects equipment purchases and the repair of existing facilities may be funded through the operating budgetHowever the use of the operating budget to finance large capital projects should be frowned upon for the following reasons
It forces local officials to make extremely difficult choices between service
delivery government operations and capital expansion
It places a heavy burden on the budget for the project year
It creates awkward fluctuating expenditure cycles that do not occur with extended financing
Since funding is based on yearly increments the use of the operating budget helps foster an environment wherein projects often go uncompleted
Sale of Land Districts rely on the sale of land to raise revenue for infrastructure financing This raises several concerns First land is not liquid and its value is subject to market forces In a sagging market such as currently exists land priceshave eroded to the point where districts are unable to raise adequate capital through the sale of land to finance sewer construction Furthermore there are few entrepreneurs with adequate resources to buy land
A related issue is that the land being sold is not serviced by sewer and other infrastructure components The offering price most likely reflects the absence of infrastructure If the infrastructure were in place prior to the sale or lease of district-owned land the district would realize a greater return than it currently receives
Finally land is finite Districts should think carefully about diminishing this resource to finance capital investment particularly before the capital is in placeLater in this paper we describe financing mechanisms that should be considered as feasible alternatives Particular attention should be paid to the use of tax increment financing or other forms of betterment financing
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Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
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Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
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ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
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projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
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Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
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plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
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FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
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ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
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lose the grant For example District XVII received a promise of a HUF 14 million grant for the Rkosliget sewer project on condition that construction commenced by 1 December 1993
Appropriate financial products are currently not available to local governments for financing long-term investments such as sewer networks 3 For the moment the districts do not have access to the sewer fee which would enable them to appropriate part of this user fee for the reimbursement of debt Thus districts have placed heavyreliance on up-front population contributions through neighborhood associations and construction communities to finance part of secondary networks (and sometimef- the main networks) in addition to direct household connections to the network ----se connection fees are the only user charge to which districts have access As there o legal restriction on the level of the connection fee the only consideration in settin e fee is affordability
The construction of the project is monitored by the district Once completed technical certification of the equipment is required by the FCSM (pumping test and verification of pipes with a camera) If the results of these verifications are unsatisfactory then the operation of the pipes will not be authorized by the FCSM 4 If the FCSM grants approval the entire network is transferred to the Sewer Works Company which is responsible for operation maintenance rehabilitation and replacement of the equipment
NEIGHBORHOOD ASSOCIATIONS AND CONSTRUCTION COMMUNITIES
Under the previous system in order fc - neighbor-ods and towns to obtain quicker connections to public utilities organizea forms G population participation were developed these methods of financing infrastructure have continued and may take the form of a neighborhood association or a construction community
Neighborhood associations (ktzmitdrsulds) for the financing of infrastructure network- are formed when at least 66 percent of the residents of a neighborhood agree to their creation membership is open to all residents and contributions to the cost of infrastructure investment is compulsory Membership entitles residents to receive five-to seven year loans from OTP with 70 percent of the interest subsidized by the central
13 See Hegedes Mark Pigey Municipal Lending in Hungary March 1993
This has posed a problem for District XVII in 1993 30 kilometers of pipes of 40 constructed failed the camera verification test however the contractors had already been paid before this verification The District is unable to pave the roads or put system into operation until the pipes are repaired to satisfactory condition
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government 5 Through these loans investment funds are available up front to the district and it is the OTP which takes the credit risk
The members of the association appoint a steering committee (or an executiveboard) which works with the district issues tenders and selects the contractor The amount of contributions by members is assessed by the committee and any remainingfunds available after construction may be redistributed to the residents The committee also defines the contributions of new members
Construction communities (6pit6kbzOss~g) are a more flexible form of populationparticipation as they are not legal entities and have no right to sign contracts in their own name The community elects an executive board this board will work with the local government during construction in terms of choosing a constructor monitoringrealization countersigning contracts and bills However the legal investor is the local government This form of construction is used in District XVII
A separate account is established for the investment and members of theconstruction community pay their contributions into the account as the work proceedsIndividuals may contract loans to finance their contribution but these are at market rates and not the subsidized loans available to members of neighborhood associations Thus the district takes a credit risk and there are cases where members have not been able to pay the full amount of their assessed participation
In interviews with Districts XVII and XVIII it has often been stated that households have reached the limits of their capacity to contribute to financing the sewage network This system of financing is not limited to capital investments in sewer networks but has also been used to finance other public utilities such as potable water gas connections and telephone lines
Although districts do receive a portion of the personal income tax (for which there is a specific distribution formula between the capital city and the districts and among the districts) the actual incomes of the district populations are not known with precisionIn order for the district governments to better Judge the capacity of their population tocontribute both now and in the future small surveys of the population of selected areas in the district may be useful Such surveys may help to establish the level of incomesand expenditures as well as assess a realistic burden for construction and developmentlees or local taxes
15 In January 1994 subsidies for direct household loans for utility connections were terminated making the neighborhood association loans the only remaining subsidy for utility connections
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MINISTRY OF TRANSPORTATION COMMUNICATION AND WATER MANAGEMENT (MTCWM)
The Ministry of Transportation Communication and Water Management must approve all projects in Hungary relating to water no sewerage project may go forward without first obtaining the water authorization permit from this Ministry
Until 1 January 1994 the Miniszry also played a role in setting the water and sewer tariffs According to the 1990 Act on Prices the fee must include the expenses of efficient operation and the profit required for efficient operation although no definition of efficiency or provisions for monitoring are included in the Act
The final allowed price was set by the Ministry based on tariffs proposed by the sewer company and the Capital City From the beginning of 1994 the pricing of sewer services has been completely devolved to the city of Budapest although the Ministry has set non-binding guidelines for fees
PROPOSED SEWAGE INVESTMENTS
SEWAGE DEVELOPMENT NEEDS IN DISTRICTS XVII AND XVIII
Citywide there are 4000 km of sewage pipes connecting approximately 88 percentof households in Budapest although this is heavily concentrated in the center so that
8outer districts have only about 50 to 60 percent coverage 1 Sewage treatment is below the adequate level FCSM estimates that 80 percent of sewage receives mechanical treatment but less than 20 percent is biologically treated
Districts XVII and XVIII have among the lowest levels of sewerage coverage in Budapest but according to the FCSM Investment Department District XVII is worse off because in District XVIII only one area (Pestszentimre) is badly underserviced Both district governments list sewerage as their most pressing infrastructure developmentneed and both have projects planned which they hope to address in the near future
District XVII
District XVII has a split sewage system-ie two separate subsystems for sewageand storm water collection-and has a big deficit in both systems The district has
1039a comprehensive sewage construction plan with an estimated total cost of HUF billion which has already been begun A first task to lay a network in Rakosliget and Rakoscsaba uJtelep has already been partially completed although some difficulties with the contractor left the laid pipes not ready for use The result was that the municipal sewer company (FCSM) refused to accept the pipes and the district has had to ask the city for a special grant of HUF 80 million 8 to complete the work and repave the roads under a new contract
The plan calls for three additional phases of construction the first part will be to construct sewerage in the most urgent areas (the district center and RAkoscsaba) the second is to complete a parallel principal main which is a precondition for expanding the network and the third is to connect some other areas to the system Phase I to construct about 30 kilometers in Rakoscsaba was begun in early 1994
Targeted subsidies have already been granted for the sewage projectHUF 285 million for 1993 and HUF 21 million for 1994 In both cases despite approvalthe district will receive funds one year later because of central budget limitations The local assembly also has approved the local portion of funding (30 percent of the originalcost estimate) which comes from the social normative grant but the schedule has to be
16 For the outer districts the 1992 flgures are 76-78 percent coverage (districts XV and l) 50-60 percent (XVIII MX and XXI) and 41-43 percent (XVII and XVI)
17 As is the case for most outer areas in Budapest
1s This grant was obtained in return for permission for the Capital City to use the districts landfill
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rethought One difficulty is that because they could not start construction before 1 December 1993 they forfeited the promised HUF 14 million from the City
In some ways storm water collection is a more urgent problem in the district and financially more problematic because no targeted subsidies are available and because it is impossible to charge the public directly for any portion of the development costs The district plans to build a series of ditches for storm water collecting water in one location but because these are open the Sewage Company will not operate them
The district assembly has approved sewerage construction plans but has not actually appropriated the money 9 so that the district has not been able to apply for some other available subsidies One such potential subsidy comes from the Water Management Fund which requires a permit from the water authority As the permit expires in two years the district will probably have to reapply because they may not be able to begin construction of the next phase within two years
One portion of the district contribution is paying the value-added tax portion of the connections (Until January 1993 this amount at 25 percent of cost would have been refunded by the central government) There is a preliminary agreement between the FCSM and the districts that starting 1 January 1994 the FCSM will pay the VAT and be reimbursed by the central government
Citizens contributions will have to make up a larger proportion than foreseen (probably 60 percent instead of 40 percent) A neighborhood association has already been formed in RiLkosllget two construction communities (one of over 700 households) have been formed for the Rakoscsaba work Conditions for households have changed considerably as of January 1994 because the 50 percent subsidies on utility connection loans are no longer available The district is therefore allowing those households unable to pay up front to pay in installments with no interest
Enterprises of course can be - arged higher connection fees and the district wants to use those to cross-subsidize household connections The district Public Utilities Division believes enterprises could be charged up to HUF 1 billion for the sewage development contribution plus HUF 80 million for the actual connection
District XVII has no outstanding loans nor do they levy any local taxes at present They do not have committees or a project preparation unit set up to work on cost of projects instead the technical department alone has put this project together There will be some political difficulties in getting this project approved because those in housing estates which are already connected to the sewage system and who represent the bulk
Not all assembly representatives heartily endorse the plan moreover the assembly did not think the central government would grant the targeted subsidy
20 This may be a problem at some point as when capacity problems exist the FCSM has indicated that it may grant permits for connection only to households and not to enterprises
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of the voting power will be opposed to the expenditure This same argument was used to explain why the council would be opposed to incurring debt although it is possiblethat debt could be structured to be repaid by the benefiting area only
The district does not have solid data on incomes but there is a general sense that probably only 20 percent of households can afford the sewage connection at HUF 30000shy40000 those who cannot would have to be subsidized by the local government byreceiving interest-free loans
DistrictXV37
District XVIII has almost the lowest per capita income in Budapest (it ranks 18th among the 22 districts) it is fourth in area seventh in population and only district XVII has less sewerage coverage according to the Deputy Mayor
Pestszentimre a neighborhood of mostly single-family houses containing about one quarter of district households (a population of 25000 in a district of 98000) is the area most urgently needing sewerage development The cost for this development is estimated at between HUF 12 and 16 billion Four storage tanks that pump sewage into the main system will have to be built The current plan is to begin construction in 1996 the schedule has been pushed back mostly because of financial considerations Sewage is still very much a priority investment for the district
The district hopes to have 30 percent of the cost covered by district resources 30 percent by the Capital City and 40 percent by a targeted subsidy (because Budapestapplied for the subsidy with the district the subsidy is worth an extra 10 percent of estimated cost) A cooperation agreement was required but because Budapest did not sign it the district has not yet applied for the subsidy
The Southern Pest Treatment Center is at capacity now and the new sewerage will not be able to be connected until the Center is expanded District XVIII feels confident that the expansion will be undertaken next year so the technical problem will be solved Budapest would take a loan for this project apparently the City Council is in favor of the project Even though the Treatment Center has not yet been expanded the FCSM has given the district their permit to begin construction
The gas network was recently completed in the same area funded throughneighborhood associations work was completed in 1993 The connection fee of HUF 46000 per household will take three years to pay off so that payments will stop in 1995 Even so the connection fee alone did not cover the total cost which came to about HUF 150000-200000 per property
If a connection fee for sewerage is set too high district officials are afraid somehouseholds may elect not to connect at all If more than 60 percent of households want to connect the district will begin construction but they risk having some households subsequently decide not to connect and withdraw their contributions District officials
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expect the connection fee to be HUF 60000-65000 the District will pay an additional HUF 15000 fee per household to cover the cost of preparing the technical construction plans
The Deputy Mayor assumes the district will have to take on debt and he believes the district would definitely approach various banks as OTP does not offer attractive terms A technical implementation report on the project has been prepared but it includes no work on financial returns
CURRENT SEWER INFRASTRUCTURE FINANCING PRACTICES
As described in the first section districts are responsible for the construction of sewer collection systems that once built are turned over to the Capital City Sewer Company for operation and maintenance The Capital City is responsible for construction of interceptor sewers and sewage treatment plants Once the infrastruc-ture is in place system stewardship is the responsibility of the Budapest Municipal Sewage Company (FCSM)
There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including
Central Government Targeted subsidies provided by the central government are used to finance construction of sewer collection systems Targeted subsides are matching grants given to districts on a competitive basis The level of funding provided by targeted subsides is 30 percent for sewer collection projects (40 percentif the application is made jointly by both the district and the Capital City) However the reliability of this revenue source to finance future sewer projects is subject to the priorities and conditions set by the Parliament as recommended by the Ministry of the Interior Therefore there is no assurance that targetedsubsidies can be used to finance sewer collection systems in the future2
1 It is noted that the central government provides addressed subsidies however sewer collection system financing is not an eligible use of such subsidies
Capital City The Capital City can contribute to the cost of district sewer construction projects However district projects mus conform to Capital City priorities to be considered for funding
21 For example in 1993 the amounts needed to fund all eligible projects exceed the grant monies budgeted by the central government so those projects are approved but local governments will receive funds two or three years from now
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District Own source revenues for sewer collection system construction and connections to properties in public ownership are derived from (1) allocations made through the annual local budget process derived from local taxes miscellaneous fees and intergovernmental transfers (eg normative subsidies) (2) sale or lease of district owned land and (3)mid-term borrowing (defined as 2-3 years) from OTP Loans are repaid from own source revenue in the form of proceeds from the sale or lease of district-owned land
Citizens Citizens contribute to the construction of sewer systems in two ways (1)through the creation of construction communities or neighborhood associations citizens pay a portion of the collection system construction cost and (2)connection fees
FINANCING OPTIONS
This is a period of intensive change in the ways in which the central governmentdistricts the Capital City and the recently privatized Budapest Municipal SewageCompany finance and maintain the municipal sewer system Existing capitalimprovements practices are woefully insufficient to meet current and future seweragecapital needs Reasons for this state of affairs include
Limited Financial Capacity
The lack of adequate own source revenue has a profound impact on limitingavailable funds necessary to finance sewage system expansion There is a great disparitybetween capital needs and the anticipated revenue available to meet these needs Sewer construction projects are very expensive Existing financing mechanisms are inadequate
Debt Financing Districts make limited use of debt financing When debt is issuedIt is for a 2 or 3 year period This short term debt financing places an undue burden on the districts limited financial resources and the present populationsability to amortize the debt The high cost of borrowing (27 percent interest) further exacerbates this problem as well as increasing the cost of capital development
Capital financing typically requires the issuance of long term debt (20 to 30 years)that roughly correlates to the useful life of the facility This method of financingalso is considered to be equitable to those who benefit from the system (egcitizens commerce industry) since each generation pays its fair share of the cost of the facility A long-life asset such as a sewer system should be paid for by its users throughout its normal life rather than all at once by those who may not have the use of it full term Even with higher cost due to interest if spread over a largenumber of userspayers the cost to all is lowered Given Hungarys high rate of inflation and thus ever increasing construction costs it may be cheaper to borrow and pay todays prices rather than wait and pay tomorrows prices Furthermorethe use of long term debt puts less financial pressure on the operating budget
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OperatingBudget (ie pay-as-you-go)There is some attempt to finance a portion of the cost of sewer improvements through the operating budget The operatingbudget is reliant on revenues derived from intergovernmental transfers and therefore provides very little fiscal flexibility to support capital development Furthermore there are no reserve accounts that may be used to set aside funds for future capital development or meet emergencies (It will be noted of course that with Hungarys high rate of inflation the reserve accounts will be rapidly eroded so it may be decided to keep them at a mintimum)
Typically the operating budget is not used to finance large scale capital projects such as sewer collection systems Annual appropriations tend to be used to pay for municipal operations and service Small scale projects equipment purchases and the repair of existing facilities may be funded through the operating budgetHowever the use of the operating budget to finance large capital projects should be frowned upon for the following reasons
It forces local officials to make extremely difficult choices between service
delivery government operations and capital expansion
It places a heavy burden on the budget for the project year
It creates awkward fluctuating expenditure cycles that do not occur with extended financing
Since funding is based on yearly increments the use of the operating budget helps foster an environment wherein projects often go uncompleted
Sale of Land Districts rely on the sale of land to raise revenue for infrastructure financing This raises several concerns First land is not liquid and its value is subject to market forces In a sagging market such as currently exists land priceshave eroded to the point where districts are unable to raise adequate capital through the sale of land to finance sewer construction Furthermore there are few entrepreneurs with adequate resources to buy land
A related issue is that the land being sold is not serviced by sewer and other infrastructure components The offering price most likely reflects the absence of infrastructure If the infrastructure were in place prior to the sale or lease of district-owned land the district would realize a greater return than it currently receives
Finally land is finite Districts should think carefully about diminishing this resource to finance capital investment particularly before the capital is in placeLater in this paper we describe financing mechanisms that should be considered as feasible alternatives Particular attention should be paid to the use of tax increment financing or other forms of betterment financing
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Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
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Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
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ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
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projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
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Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
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plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
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FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
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ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
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government 5 Through these loans investment funds are available up front to the district and it is the OTP which takes the credit risk
The members of the association appoint a steering committee (or an executiveboard) which works with the district issues tenders and selects the contractor The amount of contributions by members is assessed by the committee and any remainingfunds available after construction may be redistributed to the residents The committee also defines the contributions of new members
Construction communities (6pit6kbzOss~g) are a more flexible form of populationparticipation as they are not legal entities and have no right to sign contracts in their own name The community elects an executive board this board will work with the local government during construction in terms of choosing a constructor monitoringrealization countersigning contracts and bills However the legal investor is the local government This form of construction is used in District XVII
A separate account is established for the investment and members of theconstruction community pay their contributions into the account as the work proceedsIndividuals may contract loans to finance their contribution but these are at market rates and not the subsidized loans available to members of neighborhood associations Thus the district takes a credit risk and there are cases where members have not been able to pay the full amount of their assessed participation
In interviews with Districts XVII and XVIII it has often been stated that households have reached the limits of their capacity to contribute to financing the sewage network This system of financing is not limited to capital investments in sewer networks but has also been used to finance other public utilities such as potable water gas connections and telephone lines
Although districts do receive a portion of the personal income tax (for which there is a specific distribution formula between the capital city and the districts and among the districts) the actual incomes of the district populations are not known with precisionIn order for the district governments to better Judge the capacity of their population tocontribute both now and in the future small surveys of the population of selected areas in the district may be useful Such surveys may help to establish the level of incomesand expenditures as well as assess a realistic burden for construction and developmentlees or local taxes
15 In January 1994 subsidies for direct household loans for utility connections were terminated making the neighborhood association loans the only remaining subsidy for utility connections
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MINISTRY OF TRANSPORTATION COMMUNICATION AND WATER MANAGEMENT (MTCWM)
The Ministry of Transportation Communication and Water Management must approve all projects in Hungary relating to water no sewerage project may go forward without first obtaining the water authorization permit from this Ministry
Until 1 January 1994 the Miniszry also played a role in setting the water and sewer tariffs According to the 1990 Act on Prices the fee must include the expenses of efficient operation and the profit required for efficient operation although no definition of efficiency or provisions for monitoring are included in the Act
The final allowed price was set by the Ministry based on tariffs proposed by the sewer company and the Capital City From the beginning of 1994 the pricing of sewer services has been completely devolved to the city of Budapest although the Ministry has set non-binding guidelines for fees
PROPOSED SEWAGE INVESTMENTS
SEWAGE DEVELOPMENT NEEDS IN DISTRICTS XVII AND XVIII
Citywide there are 4000 km of sewage pipes connecting approximately 88 percentof households in Budapest although this is heavily concentrated in the center so that
8outer districts have only about 50 to 60 percent coverage 1 Sewage treatment is below the adequate level FCSM estimates that 80 percent of sewage receives mechanical treatment but less than 20 percent is biologically treated
Districts XVII and XVIII have among the lowest levels of sewerage coverage in Budapest but according to the FCSM Investment Department District XVII is worse off because in District XVIII only one area (Pestszentimre) is badly underserviced Both district governments list sewerage as their most pressing infrastructure developmentneed and both have projects planned which they hope to address in the near future
District XVII
District XVII has a split sewage system-ie two separate subsystems for sewageand storm water collection-and has a big deficit in both systems The district has
1039a comprehensive sewage construction plan with an estimated total cost of HUF billion which has already been begun A first task to lay a network in Rakosliget and Rakoscsaba uJtelep has already been partially completed although some difficulties with the contractor left the laid pipes not ready for use The result was that the municipal sewer company (FCSM) refused to accept the pipes and the district has had to ask the city for a special grant of HUF 80 million 8 to complete the work and repave the roads under a new contract
The plan calls for three additional phases of construction the first part will be to construct sewerage in the most urgent areas (the district center and RAkoscsaba) the second is to complete a parallel principal main which is a precondition for expanding the network and the third is to connect some other areas to the system Phase I to construct about 30 kilometers in Rakoscsaba was begun in early 1994
Targeted subsidies have already been granted for the sewage projectHUF 285 million for 1993 and HUF 21 million for 1994 In both cases despite approvalthe district will receive funds one year later because of central budget limitations The local assembly also has approved the local portion of funding (30 percent of the originalcost estimate) which comes from the social normative grant but the schedule has to be
16 For the outer districts the 1992 flgures are 76-78 percent coverage (districts XV and l) 50-60 percent (XVIII MX and XXI) and 41-43 percent (XVII and XVI)
17 As is the case for most outer areas in Budapest
1s This grant was obtained in return for permission for the Capital City to use the districts landfill
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rethought One difficulty is that because they could not start construction before 1 December 1993 they forfeited the promised HUF 14 million from the City
In some ways storm water collection is a more urgent problem in the district and financially more problematic because no targeted subsidies are available and because it is impossible to charge the public directly for any portion of the development costs The district plans to build a series of ditches for storm water collecting water in one location but because these are open the Sewage Company will not operate them
The district assembly has approved sewerage construction plans but has not actually appropriated the money 9 so that the district has not been able to apply for some other available subsidies One such potential subsidy comes from the Water Management Fund which requires a permit from the water authority As the permit expires in two years the district will probably have to reapply because they may not be able to begin construction of the next phase within two years
One portion of the district contribution is paying the value-added tax portion of the connections (Until January 1993 this amount at 25 percent of cost would have been refunded by the central government) There is a preliminary agreement between the FCSM and the districts that starting 1 January 1994 the FCSM will pay the VAT and be reimbursed by the central government
Citizens contributions will have to make up a larger proportion than foreseen (probably 60 percent instead of 40 percent) A neighborhood association has already been formed in RiLkosllget two construction communities (one of over 700 households) have been formed for the Rakoscsaba work Conditions for households have changed considerably as of January 1994 because the 50 percent subsidies on utility connection loans are no longer available The district is therefore allowing those households unable to pay up front to pay in installments with no interest
Enterprises of course can be - arged higher connection fees and the district wants to use those to cross-subsidize household connections The district Public Utilities Division believes enterprises could be charged up to HUF 1 billion for the sewage development contribution plus HUF 80 million for the actual connection
District XVII has no outstanding loans nor do they levy any local taxes at present They do not have committees or a project preparation unit set up to work on cost of projects instead the technical department alone has put this project together There will be some political difficulties in getting this project approved because those in housing estates which are already connected to the sewage system and who represent the bulk
Not all assembly representatives heartily endorse the plan moreover the assembly did not think the central government would grant the targeted subsidy
20 This may be a problem at some point as when capacity problems exist the FCSM has indicated that it may grant permits for connection only to households and not to enterprises
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of the voting power will be opposed to the expenditure This same argument was used to explain why the council would be opposed to incurring debt although it is possiblethat debt could be structured to be repaid by the benefiting area only
The district does not have solid data on incomes but there is a general sense that probably only 20 percent of households can afford the sewage connection at HUF 30000shy40000 those who cannot would have to be subsidized by the local government byreceiving interest-free loans
DistrictXV37
District XVIII has almost the lowest per capita income in Budapest (it ranks 18th among the 22 districts) it is fourth in area seventh in population and only district XVII has less sewerage coverage according to the Deputy Mayor
Pestszentimre a neighborhood of mostly single-family houses containing about one quarter of district households (a population of 25000 in a district of 98000) is the area most urgently needing sewerage development The cost for this development is estimated at between HUF 12 and 16 billion Four storage tanks that pump sewage into the main system will have to be built The current plan is to begin construction in 1996 the schedule has been pushed back mostly because of financial considerations Sewage is still very much a priority investment for the district
The district hopes to have 30 percent of the cost covered by district resources 30 percent by the Capital City and 40 percent by a targeted subsidy (because Budapestapplied for the subsidy with the district the subsidy is worth an extra 10 percent of estimated cost) A cooperation agreement was required but because Budapest did not sign it the district has not yet applied for the subsidy
The Southern Pest Treatment Center is at capacity now and the new sewerage will not be able to be connected until the Center is expanded District XVIII feels confident that the expansion will be undertaken next year so the technical problem will be solved Budapest would take a loan for this project apparently the City Council is in favor of the project Even though the Treatment Center has not yet been expanded the FCSM has given the district their permit to begin construction
The gas network was recently completed in the same area funded throughneighborhood associations work was completed in 1993 The connection fee of HUF 46000 per household will take three years to pay off so that payments will stop in 1995 Even so the connection fee alone did not cover the total cost which came to about HUF 150000-200000 per property
If a connection fee for sewerage is set too high district officials are afraid somehouseholds may elect not to connect at all If more than 60 percent of households want to connect the district will begin construction but they risk having some households subsequently decide not to connect and withdraw their contributions District officials
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expect the connection fee to be HUF 60000-65000 the District will pay an additional HUF 15000 fee per household to cover the cost of preparing the technical construction plans
The Deputy Mayor assumes the district will have to take on debt and he believes the district would definitely approach various banks as OTP does not offer attractive terms A technical implementation report on the project has been prepared but it includes no work on financial returns
CURRENT SEWER INFRASTRUCTURE FINANCING PRACTICES
As described in the first section districts are responsible for the construction of sewer collection systems that once built are turned over to the Capital City Sewer Company for operation and maintenance The Capital City is responsible for construction of interceptor sewers and sewage treatment plants Once the infrastruc-ture is in place system stewardship is the responsibility of the Budapest Municipal Sewage Company (FCSM)
There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including
Central Government Targeted subsidies provided by the central government are used to finance construction of sewer collection systems Targeted subsides are matching grants given to districts on a competitive basis The level of funding provided by targeted subsides is 30 percent for sewer collection projects (40 percentif the application is made jointly by both the district and the Capital City) However the reliability of this revenue source to finance future sewer projects is subject to the priorities and conditions set by the Parliament as recommended by the Ministry of the Interior Therefore there is no assurance that targetedsubsidies can be used to finance sewer collection systems in the future2
1 It is noted that the central government provides addressed subsidies however sewer collection system financing is not an eligible use of such subsidies
Capital City The Capital City can contribute to the cost of district sewer construction projects However district projects mus conform to Capital City priorities to be considered for funding
21 For example in 1993 the amounts needed to fund all eligible projects exceed the grant monies budgeted by the central government so those projects are approved but local governments will receive funds two or three years from now
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District Own source revenues for sewer collection system construction and connections to properties in public ownership are derived from (1) allocations made through the annual local budget process derived from local taxes miscellaneous fees and intergovernmental transfers (eg normative subsidies) (2) sale or lease of district owned land and (3)mid-term borrowing (defined as 2-3 years) from OTP Loans are repaid from own source revenue in the form of proceeds from the sale or lease of district-owned land
Citizens Citizens contribute to the construction of sewer systems in two ways (1)through the creation of construction communities or neighborhood associations citizens pay a portion of the collection system construction cost and (2)connection fees
FINANCING OPTIONS
This is a period of intensive change in the ways in which the central governmentdistricts the Capital City and the recently privatized Budapest Municipal SewageCompany finance and maintain the municipal sewer system Existing capitalimprovements practices are woefully insufficient to meet current and future seweragecapital needs Reasons for this state of affairs include
Limited Financial Capacity
The lack of adequate own source revenue has a profound impact on limitingavailable funds necessary to finance sewage system expansion There is a great disparitybetween capital needs and the anticipated revenue available to meet these needs Sewer construction projects are very expensive Existing financing mechanisms are inadequate
Debt Financing Districts make limited use of debt financing When debt is issuedIt is for a 2 or 3 year period This short term debt financing places an undue burden on the districts limited financial resources and the present populationsability to amortize the debt The high cost of borrowing (27 percent interest) further exacerbates this problem as well as increasing the cost of capital development
Capital financing typically requires the issuance of long term debt (20 to 30 years)that roughly correlates to the useful life of the facility This method of financingalso is considered to be equitable to those who benefit from the system (egcitizens commerce industry) since each generation pays its fair share of the cost of the facility A long-life asset such as a sewer system should be paid for by its users throughout its normal life rather than all at once by those who may not have the use of it full term Even with higher cost due to interest if spread over a largenumber of userspayers the cost to all is lowered Given Hungarys high rate of inflation and thus ever increasing construction costs it may be cheaper to borrow and pay todays prices rather than wait and pay tomorrows prices Furthermorethe use of long term debt puts less financial pressure on the operating budget
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OperatingBudget (ie pay-as-you-go)There is some attempt to finance a portion of the cost of sewer improvements through the operating budget The operatingbudget is reliant on revenues derived from intergovernmental transfers and therefore provides very little fiscal flexibility to support capital development Furthermore there are no reserve accounts that may be used to set aside funds for future capital development or meet emergencies (It will be noted of course that with Hungarys high rate of inflation the reserve accounts will be rapidly eroded so it may be decided to keep them at a mintimum)
Typically the operating budget is not used to finance large scale capital projects such as sewer collection systems Annual appropriations tend to be used to pay for municipal operations and service Small scale projects equipment purchases and the repair of existing facilities may be funded through the operating budgetHowever the use of the operating budget to finance large capital projects should be frowned upon for the following reasons
It forces local officials to make extremely difficult choices between service
delivery government operations and capital expansion
It places a heavy burden on the budget for the project year
It creates awkward fluctuating expenditure cycles that do not occur with extended financing
Since funding is based on yearly increments the use of the operating budget helps foster an environment wherein projects often go uncompleted
Sale of Land Districts rely on the sale of land to raise revenue for infrastructure financing This raises several concerns First land is not liquid and its value is subject to market forces In a sagging market such as currently exists land priceshave eroded to the point where districts are unable to raise adequate capital through the sale of land to finance sewer construction Furthermore there are few entrepreneurs with adequate resources to buy land
A related issue is that the land being sold is not serviced by sewer and other infrastructure components The offering price most likely reflects the absence of infrastructure If the infrastructure were in place prior to the sale or lease of district-owned land the district would realize a greater return than it currently receives
Finally land is finite Districts should think carefully about diminishing this resource to finance capital investment particularly before the capital is in placeLater in this paper we describe financing mechanisms that should be considered as feasible alternatives Particular attention should be paid to the use of tax increment financing or other forms of betterment financing
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Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
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Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
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ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
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projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
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Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
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plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
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FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
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ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
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MINISTRY OF TRANSPORTATION COMMUNICATION AND WATER MANAGEMENT (MTCWM)
The Ministry of Transportation Communication and Water Management must approve all projects in Hungary relating to water no sewerage project may go forward without first obtaining the water authorization permit from this Ministry
Until 1 January 1994 the Miniszry also played a role in setting the water and sewer tariffs According to the 1990 Act on Prices the fee must include the expenses of efficient operation and the profit required for efficient operation although no definition of efficiency or provisions for monitoring are included in the Act
The final allowed price was set by the Ministry based on tariffs proposed by the sewer company and the Capital City From the beginning of 1994 the pricing of sewer services has been completely devolved to the city of Budapest although the Ministry has set non-binding guidelines for fees
PROPOSED SEWAGE INVESTMENTS
SEWAGE DEVELOPMENT NEEDS IN DISTRICTS XVII AND XVIII
Citywide there are 4000 km of sewage pipes connecting approximately 88 percentof households in Budapest although this is heavily concentrated in the center so that
8outer districts have only about 50 to 60 percent coverage 1 Sewage treatment is below the adequate level FCSM estimates that 80 percent of sewage receives mechanical treatment but less than 20 percent is biologically treated
Districts XVII and XVIII have among the lowest levels of sewerage coverage in Budapest but according to the FCSM Investment Department District XVII is worse off because in District XVIII only one area (Pestszentimre) is badly underserviced Both district governments list sewerage as their most pressing infrastructure developmentneed and both have projects planned which they hope to address in the near future
District XVII
District XVII has a split sewage system-ie two separate subsystems for sewageand storm water collection-and has a big deficit in both systems The district has
1039a comprehensive sewage construction plan with an estimated total cost of HUF billion which has already been begun A first task to lay a network in Rakosliget and Rakoscsaba uJtelep has already been partially completed although some difficulties with the contractor left the laid pipes not ready for use The result was that the municipal sewer company (FCSM) refused to accept the pipes and the district has had to ask the city for a special grant of HUF 80 million 8 to complete the work and repave the roads under a new contract
The plan calls for three additional phases of construction the first part will be to construct sewerage in the most urgent areas (the district center and RAkoscsaba) the second is to complete a parallel principal main which is a precondition for expanding the network and the third is to connect some other areas to the system Phase I to construct about 30 kilometers in Rakoscsaba was begun in early 1994
Targeted subsidies have already been granted for the sewage projectHUF 285 million for 1993 and HUF 21 million for 1994 In both cases despite approvalthe district will receive funds one year later because of central budget limitations The local assembly also has approved the local portion of funding (30 percent of the originalcost estimate) which comes from the social normative grant but the schedule has to be
16 For the outer districts the 1992 flgures are 76-78 percent coverage (districts XV and l) 50-60 percent (XVIII MX and XXI) and 41-43 percent (XVII and XVI)
17 As is the case for most outer areas in Budapest
1s This grant was obtained in return for permission for the Capital City to use the districts landfill
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rethought One difficulty is that because they could not start construction before 1 December 1993 they forfeited the promised HUF 14 million from the City
In some ways storm water collection is a more urgent problem in the district and financially more problematic because no targeted subsidies are available and because it is impossible to charge the public directly for any portion of the development costs The district plans to build a series of ditches for storm water collecting water in one location but because these are open the Sewage Company will not operate them
The district assembly has approved sewerage construction plans but has not actually appropriated the money 9 so that the district has not been able to apply for some other available subsidies One such potential subsidy comes from the Water Management Fund which requires a permit from the water authority As the permit expires in two years the district will probably have to reapply because they may not be able to begin construction of the next phase within two years
One portion of the district contribution is paying the value-added tax portion of the connections (Until January 1993 this amount at 25 percent of cost would have been refunded by the central government) There is a preliminary agreement between the FCSM and the districts that starting 1 January 1994 the FCSM will pay the VAT and be reimbursed by the central government
Citizens contributions will have to make up a larger proportion than foreseen (probably 60 percent instead of 40 percent) A neighborhood association has already been formed in RiLkosllget two construction communities (one of over 700 households) have been formed for the Rakoscsaba work Conditions for households have changed considerably as of January 1994 because the 50 percent subsidies on utility connection loans are no longer available The district is therefore allowing those households unable to pay up front to pay in installments with no interest
Enterprises of course can be - arged higher connection fees and the district wants to use those to cross-subsidize household connections The district Public Utilities Division believes enterprises could be charged up to HUF 1 billion for the sewage development contribution plus HUF 80 million for the actual connection
District XVII has no outstanding loans nor do they levy any local taxes at present They do not have committees or a project preparation unit set up to work on cost of projects instead the technical department alone has put this project together There will be some political difficulties in getting this project approved because those in housing estates which are already connected to the sewage system and who represent the bulk
Not all assembly representatives heartily endorse the plan moreover the assembly did not think the central government would grant the targeted subsidy
20 This may be a problem at some point as when capacity problems exist the FCSM has indicated that it may grant permits for connection only to households and not to enterprises
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of the voting power will be opposed to the expenditure This same argument was used to explain why the council would be opposed to incurring debt although it is possiblethat debt could be structured to be repaid by the benefiting area only
The district does not have solid data on incomes but there is a general sense that probably only 20 percent of households can afford the sewage connection at HUF 30000shy40000 those who cannot would have to be subsidized by the local government byreceiving interest-free loans
DistrictXV37
District XVIII has almost the lowest per capita income in Budapest (it ranks 18th among the 22 districts) it is fourth in area seventh in population and only district XVII has less sewerage coverage according to the Deputy Mayor
Pestszentimre a neighborhood of mostly single-family houses containing about one quarter of district households (a population of 25000 in a district of 98000) is the area most urgently needing sewerage development The cost for this development is estimated at between HUF 12 and 16 billion Four storage tanks that pump sewage into the main system will have to be built The current plan is to begin construction in 1996 the schedule has been pushed back mostly because of financial considerations Sewage is still very much a priority investment for the district
The district hopes to have 30 percent of the cost covered by district resources 30 percent by the Capital City and 40 percent by a targeted subsidy (because Budapestapplied for the subsidy with the district the subsidy is worth an extra 10 percent of estimated cost) A cooperation agreement was required but because Budapest did not sign it the district has not yet applied for the subsidy
The Southern Pest Treatment Center is at capacity now and the new sewerage will not be able to be connected until the Center is expanded District XVIII feels confident that the expansion will be undertaken next year so the technical problem will be solved Budapest would take a loan for this project apparently the City Council is in favor of the project Even though the Treatment Center has not yet been expanded the FCSM has given the district their permit to begin construction
The gas network was recently completed in the same area funded throughneighborhood associations work was completed in 1993 The connection fee of HUF 46000 per household will take three years to pay off so that payments will stop in 1995 Even so the connection fee alone did not cover the total cost which came to about HUF 150000-200000 per property
If a connection fee for sewerage is set too high district officials are afraid somehouseholds may elect not to connect at all If more than 60 percent of households want to connect the district will begin construction but they risk having some households subsequently decide not to connect and withdraw their contributions District officials
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expect the connection fee to be HUF 60000-65000 the District will pay an additional HUF 15000 fee per household to cover the cost of preparing the technical construction plans
The Deputy Mayor assumes the district will have to take on debt and he believes the district would definitely approach various banks as OTP does not offer attractive terms A technical implementation report on the project has been prepared but it includes no work on financial returns
CURRENT SEWER INFRASTRUCTURE FINANCING PRACTICES
As described in the first section districts are responsible for the construction of sewer collection systems that once built are turned over to the Capital City Sewer Company for operation and maintenance The Capital City is responsible for construction of interceptor sewers and sewage treatment plants Once the infrastruc-ture is in place system stewardship is the responsibility of the Budapest Municipal Sewage Company (FCSM)
There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including
Central Government Targeted subsidies provided by the central government are used to finance construction of sewer collection systems Targeted subsides are matching grants given to districts on a competitive basis The level of funding provided by targeted subsides is 30 percent for sewer collection projects (40 percentif the application is made jointly by both the district and the Capital City) However the reliability of this revenue source to finance future sewer projects is subject to the priorities and conditions set by the Parliament as recommended by the Ministry of the Interior Therefore there is no assurance that targetedsubsidies can be used to finance sewer collection systems in the future2
1 It is noted that the central government provides addressed subsidies however sewer collection system financing is not an eligible use of such subsidies
Capital City The Capital City can contribute to the cost of district sewer construction projects However district projects mus conform to Capital City priorities to be considered for funding
21 For example in 1993 the amounts needed to fund all eligible projects exceed the grant monies budgeted by the central government so those projects are approved but local governments will receive funds two or three years from now
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District Own source revenues for sewer collection system construction and connections to properties in public ownership are derived from (1) allocations made through the annual local budget process derived from local taxes miscellaneous fees and intergovernmental transfers (eg normative subsidies) (2) sale or lease of district owned land and (3)mid-term borrowing (defined as 2-3 years) from OTP Loans are repaid from own source revenue in the form of proceeds from the sale or lease of district-owned land
Citizens Citizens contribute to the construction of sewer systems in two ways (1)through the creation of construction communities or neighborhood associations citizens pay a portion of the collection system construction cost and (2)connection fees
FINANCING OPTIONS
This is a period of intensive change in the ways in which the central governmentdistricts the Capital City and the recently privatized Budapest Municipal SewageCompany finance and maintain the municipal sewer system Existing capitalimprovements practices are woefully insufficient to meet current and future seweragecapital needs Reasons for this state of affairs include
Limited Financial Capacity
The lack of adequate own source revenue has a profound impact on limitingavailable funds necessary to finance sewage system expansion There is a great disparitybetween capital needs and the anticipated revenue available to meet these needs Sewer construction projects are very expensive Existing financing mechanisms are inadequate
Debt Financing Districts make limited use of debt financing When debt is issuedIt is for a 2 or 3 year period This short term debt financing places an undue burden on the districts limited financial resources and the present populationsability to amortize the debt The high cost of borrowing (27 percent interest) further exacerbates this problem as well as increasing the cost of capital development
Capital financing typically requires the issuance of long term debt (20 to 30 years)that roughly correlates to the useful life of the facility This method of financingalso is considered to be equitable to those who benefit from the system (egcitizens commerce industry) since each generation pays its fair share of the cost of the facility A long-life asset such as a sewer system should be paid for by its users throughout its normal life rather than all at once by those who may not have the use of it full term Even with higher cost due to interest if spread over a largenumber of userspayers the cost to all is lowered Given Hungarys high rate of inflation and thus ever increasing construction costs it may be cheaper to borrow and pay todays prices rather than wait and pay tomorrows prices Furthermorethe use of long term debt puts less financial pressure on the operating budget
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OperatingBudget (ie pay-as-you-go)There is some attempt to finance a portion of the cost of sewer improvements through the operating budget The operatingbudget is reliant on revenues derived from intergovernmental transfers and therefore provides very little fiscal flexibility to support capital development Furthermore there are no reserve accounts that may be used to set aside funds for future capital development or meet emergencies (It will be noted of course that with Hungarys high rate of inflation the reserve accounts will be rapidly eroded so it may be decided to keep them at a mintimum)
Typically the operating budget is not used to finance large scale capital projects such as sewer collection systems Annual appropriations tend to be used to pay for municipal operations and service Small scale projects equipment purchases and the repair of existing facilities may be funded through the operating budgetHowever the use of the operating budget to finance large capital projects should be frowned upon for the following reasons
It forces local officials to make extremely difficult choices between service
delivery government operations and capital expansion
It places a heavy burden on the budget for the project year
It creates awkward fluctuating expenditure cycles that do not occur with extended financing
Since funding is based on yearly increments the use of the operating budget helps foster an environment wherein projects often go uncompleted
Sale of Land Districts rely on the sale of land to raise revenue for infrastructure financing This raises several concerns First land is not liquid and its value is subject to market forces In a sagging market such as currently exists land priceshave eroded to the point where districts are unable to raise adequate capital through the sale of land to finance sewer construction Furthermore there are few entrepreneurs with adequate resources to buy land
A related issue is that the land being sold is not serviced by sewer and other infrastructure components The offering price most likely reflects the absence of infrastructure If the infrastructure were in place prior to the sale or lease of district-owned land the district would realize a greater return than it currently receives
Finally land is finite Districts should think carefully about diminishing this resource to finance capital investment particularly before the capital is in placeLater in this paper we describe financing mechanisms that should be considered as feasible alternatives Particular attention should be paid to the use of tax increment financing or other forms of betterment financing
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Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
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Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
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ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
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projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
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Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
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plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
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FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
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ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
PROPOSED SEWAGE INVESTMENTS
SEWAGE DEVELOPMENT NEEDS IN DISTRICTS XVII AND XVIII
Citywide there are 4000 km of sewage pipes connecting approximately 88 percentof households in Budapest although this is heavily concentrated in the center so that
8outer districts have only about 50 to 60 percent coverage 1 Sewage treatment is below the adequate level FCSM estimates that 80 percent of sewage receives mechanical treatment but less than 20 percent is biologically treated
Districts XVII and XVIII have among the lowest levels of sewerage coverage in Budapest but according to the FCSM Investment Department District XVII is worse off because in District XVIII only one area (Pestszentimre) is badly underserviced Both district governments list sewerage as their most pressing infrastructure developmentneed and both have projects planned which they hope to address in the near future
District XVII
District XVII has a split sewage system-ie two separate subsystems for sewageand storm water collection-and has a big deficit in both systems The district has
1039a comprehensive sewage construction plan with an estimated total cost of HUF billion which has already been begun A first task to lay a network in Rakosliget and Rakoscsaba uJtelep has already been partially completed although some difficulties with the contractor left the laid pipes not ready for use The result was that the municipal sewer company (FCSM) refused to accept the pipes and the district has had to ask the city for a special grant of HUF 80 million 8 to complete the work and repave the roads under a new contract
The plan calls for three additional phases of construction the first part will be to construct sewerage in the most urgent areas (the district center and RAkoscsaba) the second is to complete a parallel principal main which is a precondition for expanding the network and the third is to connect some other areas to the system Phase I to construct about 30 kilometers in Rakoscsaba was begun in early 1994
Targeted subsidies have already been granted for the sewage projectHUF 285 million for 1993 and HUF 21 million for 1994 In both cases despite approvalthe district will receive funds one year later because of central budget limitations The local assembly also has approved the local portion of funding (30 percent of the originalcost estimate) which comes from the social normative grant but the schedule has to be
16 For the outer districts the 1992 flgures are 76-78 percent coverage (districts XV and l) 50-60 percent (XVIII MX and XXI) and 41-43 percent (XVII and XVI)
17 As is the case for most outer areas in Budapest
1s This grant was obtained in return for permission for the Capital City to use the districts landfill
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rethought One difficulty is that because they could not start construction before 1 December 1993 they forfeited the promised HUF 14 million from the City
In some ways storm water collection is a more urgent problem in the district and financially more problematic because no targeted subsidies are available and because it is impossible to charge the public directly for any portion of the development costs The district plans to build a series of ditches for storm water collecting water in one location but because these are open the Sewage Company will not operate them
The district assembly has approved sewerage construction plans but has not actually appropriated the money 9 so that the district has not been able to apply for some other available subsidies One such potential subsidy comes from the Water Management Fund which requires a permit from the water authority As the permit expires in two years the district will probably have to reapply because they may not be able to begin construction of the next phase within two years
One portion of the district contribution is paying the value-added tax portion of the connections (Until January 1993 this amount at 25 percent of cost would have been refunded by the central government) There is a preliminary agreement between the FCSM and the districts that starting 1 January 1994 the FCSM will pay the VAT and be reimbursed by the central government
Citizens contributions will have to make up a larger proportion than foreseen (probably 60 percent instead of 40 percent) A neighborhood association has already been formed in RiLkosllget two construction communities (one of over 700 households) have been formed for the Rakoscsaba work Conditions for households have changed considerably as of January 1994 because the 50 percent subsidies on utility connection loans are no longer available The district is therefore allowing those households unable to pay up front to pay in installments with no interest
Enterprises of course can be - arged higher connection fees and the district wants to use those to cross-subsidize household connections The district Public Utilities Division believes enterprises could be charged up to HUF 1 billion for the sewage development contribution plus HUF 80 million for the actual connection
District XVII has no outstanding loans nor do they levy any local taxes at present They do not have committees or a project preparation unit set up to work on cost of projects instead the technical department alone has put this project together There will be some political difficulties in getting this project approved because those in housing estates which are already connected to the sewage system and who represent the bulk
Not all assembly representatives heartily endorse the plan moreover the assembly did not think the central government would grant the targeted subsidy
20 This may be a problem at some point as when capacity problems exist the FCSM has indicated that it may grant permits for connection only to households and not to enterprises
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of the voting power will be opposed to the expenditure This same argument was used to explain why the council would be opposed to incurring debt although it is possiblethat debt could be structured to be repaid by the benefiting area only
The district does not have solid data on incomes but there is a general sense that probably only 20 percent of households can afford the sewage connection at HUF 30000shy40000 those who cannot would have to be subsidized by the local government byreceiving interest-free loans
DistrictXV37
District XVIII has almost the lowest per capita income in Budapest (it ranks 18th among the 22 districts) it is fourth in area seventh in population and only district XVII has less sewerage coverage according to the Deputy Mayor
Pestszentimre a neighborhood of mostly single-family houses containing about one quarter of district households (a population of 25000 in a district of 98000) is the area most urgently needing sewerage development The cost for this development is estimated at between HUF 12 and 16 billion Four storage tanks that pump sewage into the main system will have to be built The current plan is to begin construction in 1996 the schedule has been pushed back mostly because of financial considerations Sewage is still very much a priority investment for the district
The district hopes to have 30 percent of the cost covered by district resources 30 percent by the Capital City and 40 percent by a targeted subsidy (because Budapestapplied for the subsidy with the district the subsidy is worth an extra 10 percent of estimated cost) A cooperation agreement was required but because Budapest did not sign it the district has not yet applied for the subsidy
The Southern Pest Treatment Center is at capacity now and the new sewerage will not be able to be connected until the Center is expanded District XVIII feels confident that the expansion will be undertaken next year so the technical problem will be solved Budapest would take a loan for this project apparently the City Council is in favor of the project Even though the Treatment Center has not yet been expanded the FCSM has given the district their permit to begin construction
The gas network was recently completed in the same area funded throughneighborhood associations work was completed in 1993 The connection fee of HUF 46000 per household will take three years to pay off so that payments will stop in 1995 Even so the connection fee alone did not cover the total cost which came to about HUF 150000-200000 per property
If a connection fee for sewerage is set too high district officials are afraid somehouseholds may elect not to connect at all If more than 60 percent of households want to connect the district will begin construction but they risk having some households subsequently decide not to connect and withdraw their contributions District officials
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expect the connection fee to be HUF 60000-65000 the District will pay an additional HUF 15000 fee per household to cover the cost of preparing the technical construction plans
The Deputy Mayor assumes the district will have to take on debt and he believes the district would definitely approach various banks as OTP does not offer attractive terms A technical implementation report on the project has been prepared but it includes no work on financial returns
CURRENT SEWER INFRASTRUCTURE FINANCING PRACTICES
As described in the first section districts are responsible for the construction of sewer collection systems that once built are turned over to the Capital City Sewer Company for operation and maintenance The Capital City is responsible for construction of interceptor sewers and sewage treatment plants Once the infrastruc-ture is in place system stewardship is the responsibility of the Budapest Municipal Sewage Company (FCSM)
There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including
Central Government Targeted subsidies provided by the central government are used to finance construction of sewer collection systems Targeted subsides are matching grants given to districts on a competitive basis The level of funding provided by targeted subsides is 30 percent for sewer collection projects (40 percentif the application is made jointly by both the district and the Capital City) However the reliability of this revenue source to finance future sewer projects is subject to the priorities and conditions set by the Parliament as recommended by the Ministry of the Interior Therefore there is no assurance that targetedsubsidies can be used to finance sewer collection systems in the future2
1 It is noted that the central government provides addressed subsidies however sewer collection system financing is not an eligible use of such subsidies
Capital City The Capital City can contribute to the cost of district sewer construction projects However district projects mus conform to Capital City priorities to be considered for funding
21 For example in 1993 the amounts needed to fund all eligible projects exceed the grant monies budgeted by the central government so those projects are approved but local governments will receive funds two or three years from now
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District Own source revenues for sewer collection system construction and connections to properties in public ownership are derived from (1) allocations made through the annual local budget process derived from local taxes miscellaneous fees and intergovernmental transfers (eg normative subsidies) (2) sale or lease of district owned land and (3)mid-term borrowing (defined as 2-3 years) from OTP Loans are repaid from own source revenue in the form of proceeds from the sale or lease of district-owned land
Citizens Citizens contribute to the construction of sewer systems in two ways (1)through the creation of construction communities or neighborhood associations citizens pay a portion of the collection system construction cost and (2)connection fees
FINANCING OPTIONS
This is a period of intensive change in the ways in which the central governmentdistricts the Capital City and the recently privatized Budapest Municipal SewageCompany finance and maintain the municipal sewer system Existing capitalimprovements practices are woefully insufficient to meet current and future seweragecapital needs Reasons for this state of affairs include
Limited Financial Capacity
The lack of adequate own source revenue has a profound impact on limitingavailable funds necessary to finance sewage system expansion There is a great disparitybetween capital needs and the anticipated revenue available to meet these needs Sewer construction projects are very expensive Existing financing mechanisms are inadequate
Debt Financing Districts make limited use of debt financing When debt is issuedIt is for a 2 or 3 year period This short term debt financing places an undue burden on the districts limited financial resources and the present populationsability to amortize the debt The high cost of borrowing (27 percent interest) further exacerbates this problem as well as increasing the cost of capital development
Capital financing typically requires the issuance of long term debt (20 to 30 years)that roughly correlates to the useful life of the facility This method of financingalso is considered to be equitable to those who benefit from the system (egcitizens commerce industry) since each generation pays its fair share of the cost of the facility A long-life asset such as a sewer system should be paid for by its users throughout its normal life rather than all at once by those who may not have the use of it full term Even with higher cost due to interest if spread over a largenumber of userspayers the cost to all is lowered Given Hungarys high rate of inflation and thus ever increasing construction costs it may be cheaper to borrow and pay todays prices rather than wait and pay tomorrows prices Furthermorethe use of long term debt puts less financial pressure on the operating budget
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OperatingBudget (ie pay-as-you-go)There is some attempt to finance a portion of the cost of sewer improvements through the operating budget The operatingbudget is reliant on revenues derived from intergovernmental transfers and therefore provides very little fiscal flexibility to support capital development Furthermore there are no reserve accounts that may be used to set aside funds for future capital development or meet emergencies (It will be noted of course that with Hungarys high rate of inflation the reserve accounts will be rapidly eroded so it may be decided to keep them at a mintimum)
Typically the operating budget is not used to finance large scale capital projects such as sewer collection systems Annual appropriations tend to be used to pay for municipal operations and service Small scale projects equipment purchases and the repair of existing facilities may be funded through the operating budgetHowever the use of the operating budget to finance large capital projects should be frowned upon for the following reasons
It forces local officials to make extremely difficult choices between service
delivery government operations and capital expansion
It places a heavy burden on the budget for the project year
It creates awkward fluctuating expenditure cycles that do not occur with extended financing
Since funding is based on yearly increments the use of the operating budget helps foster an environment wherein projects often go uncompleted
Sale of Land Districts rely on the sale of land to raise revenue for infrastructure financing This raises several concerns First land is not liquid and its value is subject to market forces In a sagging market such as currently exists land priceshave eroded to the point where districts are unable to raise adequate capital through the sale of land to finance sewer construction Furthermore there are few entrepreneurs with adequate resources to buy land
A related issue is that the land being sold is not serviced by sewer and other infrastructure components The offering price most likely reflects the absence of infrastructure If the infrastructure were in place prior to the sale or lease of district-owned land the district would realize a greater return than it currently receives
Finally land is finite Districts should think carefully about diminishing this resource to finance capital investment particularly before the capital is in placeLater in this paper we describe financing mechanisms that should be considered as feasible alternatives Particular attention should be paid to the use of tax increment financing or other forms of betterment financing
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Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
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Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
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ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
MunicipalStrategiesfor Infrastlcire Finance The Urban InstiutePlanned Sewage Projectsin Two BudapestDistrLts Page 21
projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
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Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
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plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
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FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
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ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
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rethought One difficulty is that because they could not start construction before 1 December 1993 they forfeited the promised HUF 14 million from the City
In some ways storm water collection is a more urgent problem in the district and financially more problematic because no targeted subsidies are available and because it is impossible to charge the public directly for any portion of the development costs The district plans to build a series of ditches for storm water collecting water in one location but because these are open the Sewage Company will not operate them
The district assembly has approved sewerage construction plans but has not actually appropriated the money 9 so that the district has not been able to apply for some other available subsidies One such potential subsidy comes from the Water Management Fund which requires a permit from the water authority As the permit expires in two years the district will probably have to reapply because they may not be able to begin construction of the next phase within two years
One portion of the district contribution is paying the value-added tax portion of the connections (Until January 1993 this amount at 25 percent of cost would have been refunded by the central government) There is a preliminary agreement between the FCSM and the districts that starting 1 January 1994 the FCSM will pay the VAT and be reimbursed by the central government
Citizens contributions will have to make up a larger proportion than foreseen (probably 60 percent instead of 40 percent) A neighborhood association has already been formed in RiLkosllget two construction communities (one of over 700 households) have been formed for the Rakoscsaba work Conditions for households have changed considerably as of January 1994 because the 50 percent subsidies on utility connection loans are no longer available The district is therefore allowing those households unable to pay up front to pay in installments with no interest
Enterprises of course can be - arged higher connection fees and the district wants to use those to cross-subsidize household connections The district Public Utilities Division believes enterprises could be charged up to HUF 1 billion for the sewage development contribution plus HUF 80 million for the actual connection
District XVII has no outstanding loans nor do they levy any local taxes at present They do not have committees or a project preparation unit set up to work on cost of projects instead the technical department alone has put this project together There will be some political difficulties in getting this project approved because those in housing estates which are already connected to the sewage system and who represent the bulk
Not all assembly representatives heartily endorse the plan moreover the assembly did not think the central government would grant the targeted subsidy
20 This may be a problem at some point as when capacity problems exist the FCSM has indicated that it may grant permits for connection only to households and not to enterprises
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of the voting power will be opposed to the expenditure This same argument was used to explain why the council would be opposed to incurring debt although it is possiblethat debt could be structured to be repaid by the benefiting area only
The district does not have solid data on incomes but there is a general sense that probably only 20 percent of households can afford the sewage connection at HUF 30000shy40000 those who cannot would have to be subsidized by the local government byreceiving interest-free loans
DistrictXV37
District XVIII has almost the lowest per capita income in Budapest (it ranks 18th among the 22 districts) it is fourth in area seventh in population and only district XVII has less sewerage coverage according to the Deputy Mayor
Pestszentimre a neighborhood of mostly single-family houses containing about one quarter of district households (a population of 25000 in a district of 98000) is the area most urgently needing sewerage development The cost for this development is estimated at between HUF 12 and 16 billion Four storage tanks that pump sewage into the main system will have to be built The current plan is to begin construction in 1996 the schedule has been pushed back mostly because of financial considerations Sewage is still very much a priority investment for the district
The district hopes to have 30 percent of the cost covered by district resources 30 percent by the Capital City and 40 percent by a targeted subsidy (because Budapestapplied for the subsidy with the district the subsidy is worth an extra 10 percent of estimated cost) A cooperation agreement was required but because Budapest did not sign it the district has not yet applied for the subsidy
The Southern Pest Treatment Center is at capacity now and the new sewerage will not be able to be connected until the Center is expanded District XVIII feels confident that the expansion will be undertaken next year so the technical problem will be solved Budapest would take a loan for this project apparently the City Council is in favor of the project Even though the Treatment Center has not yet been expanded the FCSM has given the district their permit to begin construction
The gas network was recently completed in the same area funded throughneighborhood associations work was completed in 1993 The connection fee of HUF 46000 per household will take three years to pay off so that payments will stop in 1995 Even so the connection fee alone did not cover the total cost which came to about HUF 150000-200000 per property
If a connection fee for sewerage is set too high district officials are afraid somehouseholds may elect not to connect at all If more than 60 percent of households want to connect the district will begin construction but they risk having some households subsequently decide not to connect and withdraw their contributions District officials
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expect the connection fee to be HUF 60000-65000 the District will pay an additional HUF 15000 fee per household to cover the cost of preparing the technical construction plans
The Deputy Mayor assumes the district will have to take on debt and he believes the district would definitely approach various banks as OTP does not offer attractive terms A technical implementation report on the project has been prepared but it includes no work on financial returns
CURRENT SEWER INFRASTRUCTURE FINANCING PRACTICES
As described in the first section districts are responsible for the construction of sewer collection systems that once built are turned over to the Capital City Sewer Company for operation and maintenance The Capital City is responsible for construction of interceptor sewers and sewage treatment plants Once the infrastruc-ture is in place system stewardship is the responsibility of the Budapest Municipal Sewage Company (FCSM)
There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including
Central Government Targeted subsidies provided by the central government are used to finance construction of sewer collection systems Targeted subsides are matching grants given to districts on a competitive basis The level of funding provided by targeted subsides is 30 percent for sewer collection projects (40 percentif the application is made jointly by both the district and the Capital City) However the reliability of this revenue source to finance future sewer projects is subject to the priorities and conditions set by the Parliament as recommended by the Ministry of the Interior Therefore there is no assurance that targetedsubsidies can be used to finance sewer collection systems in the future2
1 It is noted that the central government provides addressed subsidies however sewer collection system financing is not an eligible use of such subsidies
Capital City The Capital City can contribute to the cost of district sewer construction projects However district projects mus conform to Capital City priorities to be considered for funding
21 For example in 1993 the amounts needed to fund all eligible projects exceed the grant monies budgeted by the central government so those projects are approved but local governments will receive funds two or three years from now
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District Own source revenues for sewer collection system construction and connections to properties in public ownership are derived from (1) allocations made through the annual local budget process derived from local taxes miscellaneous fees and intergovernmental transfers (eg normative subsidies) (2) sale or lease of district owned land and (3)mid-term borrowing (defined as 2-3 years) from OTP Loans are repaid from own source revenue in the form of proceeds from the sale or lease of district-owned land
Citizens Citizens contribute to the construction of sewer systems in two ways (1)through the creation of construction communities or neighborhood associations citizens pay a portion of the collection system construction cost and (2)connection fees
FINANCING OPTIONS
This is a period of intensive change in the ways in which the central governmentdistricts the Capital City and the recently privatized Budapest Municipal SewageCompany finance and maintain the municipal sewer system Existing capitalimprovements practices are woefully insufficient to meet current and future seweragecapital needs Reasons for this state of affairs include
Limited Financial Capacity
The lack of adequate own source revenue has a profound impact on limitingavailable funds necessary to finance sewage system expansion There is a great disparitybetween capital needs and the anticipated revenue available to meet these needs Sewer construction projects are very expensive Existing financing mechanisms are inadequate
Debt Financing Districts make limited use of debt financing When debt is issuedIt is for a 2 or 3 year period This short term debt financing places an undue burden on the districts limited financial resources and the present populationsability to amortize the debt The high cost of borrowing (27 percent interest) further exacerbates this problem as well as increasing the cost of capital development
Capital financing typically requires the issuance of long term debt (20 to 30 years)that roughly correlates to the useful life of the facility This method of financingalso is considered to be equitable to those who benefit from the system (egcitizens commerce industry) since each generation pays its fair share of the cost of the facility A long-life asset such as a sewer system should be paid for by its users throughout its normal life rather than all at once by those who may not have the use of it full term Even with higher cost due to interest if spread over a largenumber of userspayers the cost to all is lowered Given Hungarys high rate of inflation and thus ever increasing construction costs it may be cheaper to borrow and pay todays prices rather than wait and pay tomorrows prices Furthermorethe use of long term debt puts less financial pressure on the operating budget
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OperatingBudget (ie pay-as-you-go)There is some attempt to finance a portion of the cost of sewer improvements through the operating budget The operatingbudget is reliant on revenues derived from intergovernmental transfers and therefore provides very little fiscal flexibility to support capital development Furthermore there are no reserve accounts that may be used to set aside funds for future capital development or meet emergencies (It will be noted of course that with Hungarys high rate of inflation the reserve accounts will be rapidly eroded so it may be decided to keep them at a mintimum)
Typically the operating budget is not used to finance large scale capital projects such as sewer collection systems Annual appropriations tend to be used to pay for municipal operations and service Small scale projects equipment purchases and the repair of existing facilities may be funded through the operating budgetHowever the use of the operating budget to finance large capital projects should be frowned upon for the following reasons
It forces local officials to make extremely difficult choices between service
delivery government operations and capital expansion
It places a heavy burden on the budget for the project year
It creates awkward fluctuating expenditure cycles that do not occur with extended financing
Since funding is based on yearly increments the use of the operating budget helps foster an environment wherein projects often go uncompleted
Sale of Land Districts rely on the sale of land to raise revenue for infrastructure financing This raises several concerns First land is not liquid and its value is subject to market forces In a sagging market such as currently exists land priceshave eroded to the point where districts are unable to raise adequate capital through the sale of land to finance sewer construction Furthermore there are few entrepreneurs with adequate resources to buy land
A related issue is that the land being sold is not serviced by sewer and other infrastructure components The offering price most likely reflects the absence of infrastructure If the infrastructure were in place prior to the sale or lease of district-owned land the district would realize a greater return than it currently receives
Finally land is finite Districts should think carefully about diminishing this resource to finance capital investment particularly before the capital is in placeLater in this paper we describe financing mechanisms that should be considered as feasible alternatives Particular attention should be paid to the use of tax increment financing or other forms of betterment financing
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Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
Municlpai Strategles for InfrastnrwAre Finance The Urban Instute Planned Sewage Projects in Two Budapest Districts Page 18
Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
MunicipalStrategiesfor InfrastructureFinance 7he UrbanInstitute PlannedSewage Projectsin Two BudapestDistlcts Page 20
ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
MunicipalStrategiesfor Infrastlcire Finance The Urban InstiutePlanned Sewage Projectsin Two BudapestDistrLts Page 21
projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
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Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
MunicipalStrategiesfor InfrastructureFinance The UrbanInstitutePlannedSewage Projectsin Tio BudapestDistricts Page23
plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
MunicipalStrategiesfor InfrasrucbtreFinance The UrbanInstLmte PlannedSewage Projectsin Two Budapest Districts Page24
FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
MunicipalStrategiesfor Infrastuctu-e Finance The UrbanInsttute PlannedSewage Projects in Two BudapestDistricts Page 26
ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
Munkdpal Strategiesfor InfrastrucureFinance The UrbanInstitutePlannedSewage Projects in Tw BudapestDistricts Page 13
of the voting power will be opposed to the expenditure This same argument was used to explain why the council would be opposed to incurring debt although it is possiblethat debt could be structured to be repaid by the benefiting area only
The district does not have solid data on incomes but there is a general sense that probably only 20 percent of households can afford the sewage connection at HUF 30000shy40000 those who cannot would have to be subsidized by the local government byreceiving interest-free loans
DistrictXV37
District XVIII has almost the lowest per capita income in Budapest (it ranks 18th among the 22 districts) it is fourth in area seventh in population and only district XVII has less sewerage coverage according to the Deputy Mayor
Pestszentimre a neighborhood of mostly single-family houses containing about one quarter of district households (a population of 25000 in a district of 98000) is the area most urgently needing sewerage development The cost for this development is estimated at between HUF 12 and 16 billion Four storage tanks that pump sewage into the main system will have to be built The current plan is to begin construction in 1996 the schedule has been pushed back mostly because of financial considerations Sewage is still very much a priority investment for the district
The district hopes to have 30 percent of the cost covered by district resources 30 percent by the Capital City and 40 percent by a targeted subsidy (because Budapestapplied for the subsidy with the district the subsidy is worth an extra 10 percent of estimated cost) A cooperation agreement was required but because Budapest did not sign it the district has not yet applied for the subsidy
The Southern Pest Treatment Center is at capacity now and the new sewerage will not be able to be connected until the Center is expanded District XVIII feels confident that the expansion will be undertaken next year so the technical problem will be solved Budapest would take a loan for this project apparently the City Council is in favor of the project Even though the Treatment Center has not yet been expanded the FCSM has given the district their permit to begin construction
The gas network was recently completed in the same area funded throughneighborhood associations work was completed in 1993 The connection fee of HUF 46000 per household will take three years to pay off so that payments will stop in 1995 Even so the connection fee alone did not cover the total cost which came to about HUF 150000-200000 per property
If a connection fee for sewerage is set too high district officials are afraid somehouseholds may elect not to connect at all If more than 60 percent of households want to connect the district will begin construction but they risk having some households subsequently decide not to connect and withdraw their contributions District officials
Municipal Strategies for Infrastructure Finance The Urban Institute Planned Sewage Projects in Two Budapest Districts Page 14
expect the connection fee to be HUF 60000-65000 the District will pay an additional HUF 15000 fee per household to cover the cost of preparing the technical construction plans
The Deputy Mayor assumes the district will have to take on debt and he believes the district would definitely approach various banks as OTP does not offer attractive terms A technical implementation report on the project has been prepared but it includes no work on financial returns
CURRENT SEWER INFRASTRUCTURE FINANCING PRACTICES
As described in the first section districts are responsible for the construction of sewer collection systems that once built are turned over to the Capital City Sewer Company for operation and maintenance The Capital City is responsible for construction of interceptor sewers and sewage treatment plants Once the infrastruc-ture is in place system stewardship is the responsibility of the Budapest Municipal Sewage Company (FCSM)
There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including
Central Government Targeted subsidies provided by the central government are used to finance construction of sewer collection systems Targeted subsides are matching grants given to districts on a competitive basis The level of funding provided by targeted subsides is 30 percent for sewer collection projects (40 percentif the application is made jointly by both the district and the Capital City) However the reliability of this revenue source to finance future sewer projects is subject to the priorities and conditions set by the Parliament as recommended by the Ministry of the Interior Therefore there is no assurance that targetedsubsidies can be used to finance sewer collection systems in the future2
1 It is noted that the central government provides addressed subsidies however sewer collection system financing is not an eligible use of such subsidies
Capital City The Capital City can contribute to the cost of district sewer construction projects However district projects mus conform to Capital City priorities to be considered for funding
21 For example in 1993 the amounts needed to fund all eligible projects exceed the grant monies budgeted by the central government so those projects are approved but local governments will receive funds two or three years from now
Municil4W Strategiesfor InfrastrucbireFinance The Urban InsttiaePlannedSewage PkoJcts in Two Budapest Districts Page 15
District Own source revenues for sewer collection system construction and connections to properties in public ownership are derived from (1) allocations made through the annual local budget process derived from local taxes miscellaneous fees and intergovernmental transfers (eg normative subsidies) (2) sale or lease of district owned land and (3)mid-term borrowing (defined as 2-3 years) from OTP Loans are repaid from own source revenue in the form of proceeds from the sale or lease of district-owned land
Citizens Citizens contribute to the construction of sewer systems in two ways (1)through the creation of construction communities or neighborhood associations citizens pay a portion of the collection system construction cost and (2)connection fees
FINANCING OPTIONS
This is a period of intensive change in the ways in which the central governmentdistricts the Capital City and the recently privatized Budapest Municipal SewageCompany finance and maintain the municipal sewer system Existing capitalimprovements practices are woefully insufficient to meet current and future seweragecapital needs Reasons for this state of affairs include
Limited Financial Capacity
The lack of adequate own source revenue has a profound impact on limitingavailable funds necessary to finance sewage system expansion There is a great disparitybetween capital needs and the anticipated revenue available to meet these needs Sewer construction projects are very expensive Existing financing mechanisms are inadequate
Debt Financing Districts make limited use of debt financing When debt is issuedIt is for a 2 or 3 year period This short term debt financing places an undue burden on the districts limited financial resources and the present populationsability to amortize the debt The high cost of borrowing (27 percent interest) further exacerbates this problem as well as increasing the cost of capital development
Capital financing typically requires the issuance of long term debt (20 to 30 years)that roughly correlates to the useful life of the facility This method of financingalso is considered to be equitable to those who benefit from the system (egcitizens commerce industry) since each generation pays its fair share of the cost of the facility A long-life asset such as a sewer system should be paid for by its users throughout its normal life rather than all at once by those who may not have the use of it full term Even with higher cost due to interest if spread over a largenumber of userspayers the cost to all is lowered Given Hungarys high rate of inflation and thus ever increasing construction costs it may be cheaper to borrow and pay todays prices rather than wait and pay tomorrows prices Furthermorethe use of long term debt puts less financial pressure on the operating budget
MunicipalStrategiesfor InfrastuctureFinance The UrbanInstute PlannedSewage Projects in Two BudapestDistricts Page 16
OperatingBudget (ie pay-as-you-go)There is some attempt to finance a portion of the cost of sewer improvements through the operating budget The operatingbudget is reliant on revenues derived from intergovernmental transfers and therefore provides very little fiscal flexibility to support capital development Furthermore there are no reserve accounts that may be used to set aside funds for future capital development or meet emergencies (It will be noted of course that with Hungarys high rate of inflation the reserve accounts will be rapidly eroded so it may be decided to keep them at a mintimum)
Typically the operating budget is not used to finance large scale capital projects such as sewer collection systems Annual appropriations tend to be used to pay for municipal operations and service Small scale projects equipment purchases and the repair of existing facilities may be funded through the operating budgetHowever the use of the operating budget to finance large capital projects should be frowned upon for the following reasons
It forces local officials to make extremely difficult choices between service
delivery government operations and capital expansion
It places a heavy burden on the budget for the project year
It creates awkward fluctuating expenditure cycles that do not occur with extended financing
Since funding is based on yearly increments the use of the operating budget helps foster an environment wherein projects often go uncompleted
Sale of Land Districts rely on the sale of land to raise revenue for infrastructure financing This raises several concerns First land is not liquid and its value is subject to market forces In a sagging market such as currently exists land priceshave eroded to the point where districts are unable to raise adequate capital through the sale of land to finance sewer construction Furthermore there are few entrepreneurs with adequate resources to buy land
A related issue is that the land being sold is not serviced by sewer and other infrastructure components The offering price most likely reflects the absence of infrastructure If the infrastructure were in place prior to the sale or lease of district-owned land the district would realize a greater return than it currently receives
Finally land is finite Districts should think carefully about diminishing this resource to finance capital investment particularly before the capital is in placeLater in this paper we describe financing mechanisms that should be considered as feasible alternatives Particular attention should be paid to the use of tax increment financing or other forms of betterment financing
Municipal Strategiesfor InfrastructureFinance The Urban InstmtePlanned Sewage Projectsin Two Budapest Districts Page 17
Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
Municlpai Strategles for InfrastnrwAre Finance The Urban Instute Planned Sewage Projects in Two Budapest Districts Page 18
Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
MunicipalStrategiesfor InfrastructureFinance 7he UrbanInstitute PlannedSewage Projectsin Two BudapestDistlcts Page 20
ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
MunicipalStrategiesfor Infrastlcire Finance The Urban InstiutePlanned Sewage Projectsin Two BudapestDistrLts Page 21
projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
MunicipalStrategies for InfrastructureFinance The Urban Insl ePlannedSewage Projects In Two Budapest Distrlcts Page 22
Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
MunicipalStrategiesfor InfrastructureFinance The UrbanInstitutePlannedSewage Projectsin Tio BudapestDistricts Page23
plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
MunicipalStrategiesfor InfrasrucbtreFinance The UrbanInstLmte PlannedSewage Projectsin Two Budapest Districts Page24
FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
MunicipalStrategiesfor Infrastuctu-e Finance The UrbanInsttute PlannedSewage Projects in Two BudapestDistricts Page 26
ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
Municipal Strategies for Infrastructure Finance The Urban Institute Planned Sewage Projects in Two Budapest Districts Page 14
expect the connection fee to be HUF 60000-65000 the District will pay an additional HUF 15000 fee per household to cover the cost of preparing the technical construction plans
The Deputy Mayor assumes the district will have to take on debt and he believes the district would definitely approach various banks as OTP does not offer attractive terms A technical implementation report on the project has been prepared but it includes no work on financial returns
CURRENT SEWER INFRASTRUCTURE FINANCING PRACTICES
As described in the first section districts are responsible for the construction of sewer collection systems that once built are turned over to the Capital City Sewer Company for operation and maintenance The Capital City is responsible for construction of interceptor sewers and sewage treatment plants Once the infrastruc-ture is in place system stewardship is the responsibility of the Budapest Municipal Sewage Company (FCSM)
There is no single revenue source upon which a district can rely to finance sewer projects Current infrastructure financing practices employed by Districts XVII and XVIII require a mix of revenues including
Central Government Targeted subsidies provided by the central government are used to finance construction of sewer collection systems Targeted subsides are matching grants given to districts on a competitive basis The level of funding provided by targeted subsides is 30 percent for sewer collection projects (40 percentif the application is made jointly by both the district and the Capital City) However the reliability of this revenue source to finance future sewer projects is subject to the priorities and conditions set by the Parliament as recommended by the Ministry of the Interior Therefore there is no assurance that targetedsubsidies can be used to finance sewer collection systems in the future2
1 It is noted that the central government provides addressed subsidies however sewer collection system financing is not an eligible use of such subsidies
Capital City The Capital City can contribute to the cost of district sewer construction projects However district projects mus conform to Capital City priorities to be considered for funding
21 For example in 1993 the amounts needed to fund all eligible projects exceed the grant monies budgeted by the central government so those projects are approved but local governments will receive funds two or three years from now
Municil4W Strategiesfor InfrastrucbireFinance The Urban InsttiaePlannedSewage PkoJcts in Two Budapest Districts Page 15
District Own source revenues for sewer collection system construction and connections to properties in public ownership are derived from (1) allocations made through the annual local budget process derived from local taxes miscellaneous fees and intergovernmental transfers (eg normative subsidies) (2) sale or lease of district owned land and (3)mid-term borrowing (defined as 2-3 years) from OTP Loans are repaid from own source revenue in the form of proceeds from the sale or lease of district-owned land
Citizens Citizens contribute to the construction of sewer systems in two ways (1)through the creation of construction communities or neighborhood associations citizens pay a portion of the collection system construction cost and (2)connection fees
FINANCING OPTIONS
This is a period of intensive change in the ways in which the central governmentdistricts the Capital City and the recently privatized Budapest Municipal SewageCompany finance and maintain the municipal sewer system Existing capitalimprovements practices are woefully insufficient to meet current and future seweragecapital needs Reasons for this state of affairs include
Limited Financial Capacity
The lack of adequate own source revenue has a profound impact on limitingavailable funds necessary to finance sewage system expansion There is a great disparitybetween capital needs and the anticipated revenue available to meet these needs Sewer construction projects are very expensive Existing financing mechanisms are inadequate
Debt Financing Districts make limited use of debt financing When debt is issuedIt is for a 2 or 3 year period This short term debt financing places an undue burden on the districts limited financial resources and the present populationsability to amortize the debt The high cost of borrowing (27 percent interest) further exacerbates this problem as well as increasing the cost of capital development
Capital financing typically requires the issuance of long term debt (20 to 30 years)that roughly correlates to the useful life of the facility This method of financingalso is considered to be equitable to those who benefit from the system (egcitizens commerce industry) since each generation pays its fair share of the cost of the facility A long-life asset such as a sewer system should be paid for by its users throughout its normal life rather than all at once by those who may not have the use of it full term Even with higher cost due to interest if spread over a largenumber of userspayers the cost to all is lowered Given Hungarys high rate of inflation and thus ever increasing construction costs it may be cheaper to borrow and pay todays prices rather than wait and pay tomorrows prices Furthermorethe use of long term debt puts less financial pressure on the operating budget
MunicipalStrategiesfor InfrastuctureFinance The UrbanInstute PlannedSewage Projects in Two BudapestDistricts Page 16
OperatingBudget (ie pay-as-you-go)There is some attempt to finance a portion of the cost of sewer improvements through the operating budget The operatingbudget is reliant on revenues derived from intergovernmental transfers and therefore provides very little fiscal flexibility to support capital development Furthermore there are no reserve accounts that may be used to set aside funds for future capital development or meet emergencies (It will be noted of course that with Hungarys high rate of inflation the reserve accounts will be rapidly eroded so it may be decided to keep them at a mintimum)
Typically the operating budget is not used to finance large scale capital projects such as sewer collection systems Annual appropriations tend to be used to pay for municipal operations and service Small scale projects equipment purchases and the repair of existing facilities may be funded through the operating budgetHowever the use of the operating budget to finance large capital projects should be frowned upon for the following reasons
It forces local officials to make extremely difficult choices between service
delivery government operations and capital expansion
It places a heavy burden on the budget for the project year
It creates awkward fluctuating expenditure cycles that do not occur with extended financing
Since funding is based on yearly increments the use of the operating budget helps foster an environment wherein projects often go uncompleted
Sale of Land Districts rely on the sale of land to raise revenue for infrastructure financing This raises several concerns First land is not liquid and its value is subject to market forces In a sagging market such as currently exists land priceshave eroded to the point where districts are unable to raise adequate capital through the sale of land to finance sewer construction Furthermore there are few entrepreneurs with adequate resources to buy land
A related issue is that the land being sold is not serviced by sewer and other infrastructure components The offering price most likely reflects the absence of infrastructure If the infrastructure were in place prior to the sale or lease of district-owned land the district would realize a greater return than it currently receives
Finally land is finite Districts should think carefully about diminishing this resource to finance capital investment particularly before the capital is in placeLater in this paper we describe financing mechanisms that should be considered as feasible alternatives Particular attention should be paid to the use of tax increment financing or other forms of betterment financing
Municipal Strategiesfor InfrastructureFinance The Urban InstmtePlanned Sewage Projectsin Two Budapest Districts Page 17
Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
Municlpai Strategles for InfrastnrwAre Finance The Urban Instute Planned Sewage Projects in Two Budapest Districts Page 18
Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
MunicipalStrategiesfor InfrastructureFinance 7he UrbanInstitute PlannedSewage Projectsin Two BudapestDistlcts Page 20
ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
MunicipalStrategiesfor Infrastlcire Finance The Urban InstiutePlanned Sewage Projectsin Two BudapestDistrLts Page 21
projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
MunicipalStrategies for InfrastructureFinance The Urban Insl ePlannedSewage Projects In Two Budapest Distrlcts Page 22
Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
MunicipalStrategiesfor InfrastructureFinance The UrbanInstitutePlannedSewage Projectsin Tio BudapestDistricts Page23
plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
MunicipalStrategiesfor InfrasrucbtreFinance The UrbanInstLmte PlannedSewage Projectsin Two Budapest Districts Page24
FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
MunicipalStrategiesfor Infrastuctu-e Finance The UrbanInsttute PlannedSewage Projects in Two BudapestDistricts Page 26
ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
Municil4W Strategiesfor InfrastrucbireFinance The Urban InsttiaePlannedSewage PkoJcts in Two Budapest Districts Page 15
District Own source revenues for sewer collection system construction and connections to properties in public ownership are derived from (1) allocations made through the annual local budget process derived from local taxes miscellaneous fees and intergovernmental transfers (eg normative subsidies) (2) sale or lease of district owned land and (3)mid-term borrowing (defined as 2-3 years) from OTP Loans are repaid from own source revenue in the form of proceeds from the sale or lease of district-owned land
Citizens Citizens contribute to the construction of sewer systems in two ways (1)through the creation of construction communities or neighborhood associations citizens pay a portion of the collection system construction cost and (2)connection fees
FINANCING OPTIONS
This is a period of intensive change in the ways in which the central governmentdistricts the Capital City and the recently privatized Budapest Municipal SewageCompany finance and maintain the municipal sewer system Existing capitalimprovements practices are woefully insufficient to meet current and future seweragecapital needs Reasons for this state of affairs include
Limited Financial Capacity
The lack of adequate own source revenue has a profound impact on limitingavailable funds necessary to finance sewage system expansion There is a great disparitybetween capital needs and the anticipated revenue available to meet these needs Sewer construction projects are very expensive Existing financing mechanisms are inadequate
Debt Financing Districts make limited use of debt financing When debt is issuedIt is for a 2 or 3 year period This short term debt financing places an undue burden on the districts limited financial resources and the present populationsability to amortize the debt The high cost of borrowing (27 percent interest) further exacerbates this problem as well as increasing the cost of capital development
Capital financing typically requires the issuance of long term debt (20 to 30 years)that roughly correlates to the useful life of the facility This method of financingalso is considered to be equitable to those who benefit from the system (egcitizens commerce industry) since each generation pays its fair share of the cost of the facility A long-life asset such as a sewer system should be paid for by its users throughout its normal life rather than all at once by those who may not have the use of it full term Even with higher cost due to interest if spread over a largenumber of userspayers the cost to all is lowered Given Hungarys high rate of inflation and thus ever increasing construction costs it may be cheaper to borrow and pay todays prices rather than wait and pay tomorrows prices Furthermorethe use of long term debt puts less financial pressure on the operating budget
MunicipalStrategiesfor InfrastuctureFinance The UrbanInstute PlannedSewage Projects in Two BudapestDistricts Page 16
OperatingBudget (ie pay-as-you-go)There is some attempt to finance a portion of the cost of sewer improvements through the operating budget The operatingbudget is reliant on revenues derived from intergovernmental transfers and therefore provides very little fiscal flexibility to support capital development Furthermore there are no reserve accounts that may be used to set aside funds for future capital development or meet emergencies (It will be noted of course that with Hungarys high rate of inflation the reserve accounts will be rapidly eroded so it may be decided to keep them at a mintimum)
Typically the operating budget is not used to finance large scale capital projects such as sewer collection systems Annual appropriations tend to be used to pay for municipal operations and service Small scale projects equipment purchases and the repair of existing facilities may be funded through the operating budgetHowever the use of the operating budget to finance large capital projects should be frowned upon for the following reasons
It forces local officials to make extremely difficult choices between service
delivery government operations and capital expansion
It places a heavy burden on the budget for the project year
It creates awkward fluctuating expenditure cycles that do not occur with extended financing
Since funding is based on yearly increments the use of the operating budget helps foster an environment wherein projects often go uncompleted
Sale of Land Districts rely on the sale of land to raise revenue for infrastructure financing This raises several concerns First land is not liquid and its value is subject to market forces In a sagging market such as currently exists land priceshave eroded to the point where districts are unable to raise adequate capital through the sale of land to finance sewer construction Furthermore there are few entrepreneurs with adequate resources to buy land
A related issue is that the land being sold is not serviced by sewer and other infrastructure components The offering price most likely reflects the absence of infrastructure If the infrastructure were in place prior to the sale or lease of district-owned land the district would realize a greater return than it currently receives
Finally land is finite Districts should think carefully about diminishing this resource to finance capital investment particularly before the capital is in placeLater in this paper we describe financing mechanisms that should be considered as feasible alternatives Particular attention should be paid to the use of tax increment financing or other forms of betterment financing
Municipal Strategiesfor InfrastructureFinance The Urban InstmtePlanned Sewage Projectsin Two Budapest Districts Page 17
Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
Municlpai Strategles for InfrastnrwAre Finance The Urban Instute Planned Sewage Projects in Two Budapest Districts Page 18
Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
MunicipalStrategiesfor InfrastructureFinance 7he UrbanInstitute PlannedSewage Projectsin Two BudapestDistlcts Page 20
ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
MunicipalStrategiesfor Infrastlcire Finance The Urban InstiutePlanned Sewage Projectsin Two BudapestDistrLts Page 21
projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
MunicipalStrategies for InfrastructureFinance The Urban Insl ePlannedSewage Projects In Two Budapest Distrlcts Page 22
Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
MunicipalStrategiesfor InfrastructureFinance The UrbanInstitutePlannedSewage Projectsin Tio BudapestDistricts Page23
plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
MunicipalStrategiesfor InfrasrucbtreFinance The UrbanInstLmte PlannedSewage Projectsin Two Budapest Districts Page24
FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
MunicipalStrategiesfor Infrastuctu-e Finance The UrbanInsttute PlannedSewage Projects in Two BudapestDistricts Page 26
ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
MunicipalStrategiesfor InfrastuctureFinance The UrbanInstute PlannedSewage Projects in Two BudapestDistricts Page 16
OperatingBudget (ie pay-as-you-go)There is some attempt to finance a portion of the cost of sewer improvements through the operating budget The operatingbudget is reliant on revenues derived from intergovernmental transfers and therefore provides very little fiscal flexibility to support capital development Furthermore there are no reserve accounts that may be used to set aside funds for future capital development or meet emergencies (It will be noted of course that with Hungarys high rate of inflation the reserve accounts will be rapidly eroded so it may be decided to keep them at a mintimum)
Typically the operating budget is not used to finance large scale capital projects such as sewer collection systems Annual appropriations tend to be used to pay for municipal operations and service Small scale projects equipment purchases and the repair of existing facilities may be funded through the operating budgetHowever the use of the operating budget to finance large capital projects should be frowned upon for the following reasons
It forces local officials to make extremely difficult choices between service
delivery government operations and capital expansion
It places a heavy burden on the budget for the project year
It creates awkward fluctuating expenditure cycles that do not occur with extended financing
Since funding is based on yearly increments the use of the operating budget helps foster an environment wherein projects often go uncompleted
Sale of Land Districts rely on the sale of land to raise revenue for infrastructure financing This raises several concerns First land is not liquid and its value is subject to market forces In a sagging market such as currently exists land priceshave eroded to the point where districts are unable to raise adequate capital through the sale of land to finance sewer construction Furthermore there are few entrepreneurs with adequate resources to buy land
A related issue is that the land being sold is not serviced by sewer and other infrastructure components The offering price most likely reflects the absence of infrastructure If the infrastructure were in place prior to the sale or lease of district-owned land the district would realize a greater return than it currently receives
Finally land is finite Districts should think carefully about diminishing this resource to finance capital investment particularly before the capital is in placeLater in this paper we describe financing mechanisms that should be considered as feasible alternatives Particular attention should be paid to the use of tax increment financing or other forms of betterment financing
Municipal Strategiesfor InfrastructureFinance The Urban InstmtePlanned Sewage Projectsin Two Budapest Districts Page 17
Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
Municlpai Strategles for InfrastnrwAre Finance The Urban Instute Planned Sewage Projects in Two Budapest Districts Page 18
Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
MunicipalStrategiesfor InfrastructureFinance 7he UrbanInstitute PlannedSewage Projectsin Two BudapestDistlcts Page 20
ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
MunicipalStrategiesfor Infrastlcire Finance The Urban InstiutePlanned Sewage Projectsin Two BudapestDistrLts Page 21
projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
MunicipalStrategies for InfrastructureFinance The Urban Insl ePlannedSewage Projects In Two Budapest Distrlcts Page 22
Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
MunicipalStrategiesfor InfrastructureFinance The UrbanInstitutePlannedSewage Projectsin Tio BudapestDistricts Page23
plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
MunicipalStrategiesfor InfrasrucbtreFinance The UrbanInstLmte PlannedSewage Projectsin Two Budapest Districts Page24
FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
MunicipalStrategiesfor Infrastuctu-e Finance The UrbanInsttute PlannedSewage Projects in Two BudapestDistricts Page 26
ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
Municipal Strategiesfor InfrastructureFinance The Urban InstmtePlanned Sewage Projectsin Two Budapest Districts Page 17
Subsidies Targeted subsidies are an important ingredient to financing sewer projects For example District XVII has applied and been approved for a targetedsubsidy to finance new sewer lines and District XVIII plans to apply for a targetedsubsidy However intense competition among local governments for these subsidies makes this source highly unpredictable It does not appear that the levelof funding 30 to 40 percent of project cost is sufficient to assure adequate projectfinancing
Since the time span between the allocation of the subsidy and receipt of the subsidyis significant district construction projects are often delayed During this hiatusthe value of the subsidy is eroded due to high inflation placing an even greaterburden on the district to come up with an adequate financing plan
An additional complication is that according to the 1990 legislation an entity thathas received a targeted subsidy cannot be privatized for the next ten years
Connection FeesUser Fees Districts rely upon connection fees to pay forhousehold connections and to some extentpart of the collection system Because districts have no ownership of the sewer system once it is built the use of user fees to retire debt issued to finance sewer construction or finance system operating andmaintenance costs is not feasible within current organizational arrangements
The City of Budapest effective 1 January 1994 received the authority to set userfees for the operation and maintenance of the Budapest Municipal SewageCompany The fee is a user charge for customer use of the sewage system It is notclear how the City of Budapest will establish sewer fees in the future and what thefee is intended to cover Depreciation should be included in the cost of operationsbut the depreciation rate appears to have been changed artificially There is no apparent benefit in terms of the fee structure that has resulted from the new depreciation schedule
Intergovernmental Coordination
Municipal entities within the City of Budapest have limited control over theirinfrastructure Districts are responsible for constructing collection systems that servicetheir respective jurisdictions The Capital City is responsible for constructing theinterceptor sewers and sewage treatment facilities Once constructed system ownershipis turned over to the Budapest Municipal Sewage Company This diffusion among a range of government entities inhibits comprehensive capital planning programming andbudgeting District plans may be at odds with Capital City or Sewage Company plansand funding priorities There is no vehicle to resolve these differences For example theCapital City is perceived as non-responsive to district needs and priorities Since thecollection interceptor and treatment facilities as well as overall financing are mutuallydependent coherent development policies must be formulated
Municlpai Strategles for InfrastnrwAre Finance The Urban Instute Planned Sewage Projects in Two Budapest Districts Page 18
Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
MunicipalStrategiesfor InfrastructureFinance 7he UrbanInstitute PlannedSewage Projectsin Two BudapestDistlcts Page 20
ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
MunicipalStrategiesfor Infrastlcire Finance The Urban InstiutePlanned Sewage Projectsin Two BudapestDistrLts Page 21
projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
MunicipalStrategies for InfrastructureFinance The Urban Insl ePlannedSewage Projects In Two Budapest Distrlcts Page 22
Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
MunicipalStrategiesfor InfrastructureFinance The UrbanInstitutePlannedSewage Projectsin Tio BudapestDistricts Page23
plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
MunicipalStrategiesfor InfrasrucbtreFinance The UrbanInstLmte PlannedSewage Projectsin Two Budapest Districts Page24
FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
MunicipalStrategiesfor Infrastuctu-e Finance The UrbanInsttute PlannedSewage Projects in Two BudapestDistricts Page 26
ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
Municlpai Strategles for InfrastnrwAre Finance The Urban Instute Planned Sewage Projects in Two Budapest Districts Page 18
Lack of Capital Improvements Planning and Budgeting
Districts lack a formal capital planning and budgeting (CIPB) processFurthermore historic records on what exists and its condition are lacking Planning for necessary and expensive public works takes place in a vacuum There is no prioritysetting Furthermore since there Is no CIPB process there is no forum within which financing options can be considered
Project Financing
There are two issues associated with project financing (1) construction often commences prior to having all funds necessary to complete the project available and (2) funds are set aside too far in advance of when they are actually needed With regard to the former construction may cease due to a lack of funds a shortfall in the proceedsrealized from the sale of land the withdrawal of a funding commitment or changingpolitical priorities Nothing is guaranteed and as a result there is a patchwork of uncompleted projects On the second point the Ministry of the Interior and the CapitalCity allocate funds for projects up to two years in advance of actual construction Given Hungarys high rate of inflation the value of the subsidy erodes greatly over time to the extent that subsidy financing may be equal to only 10 percent of project cost adjusting for inflation
Project Management
Once project funding is in place Districts appear to provide inadequate project management Cost overruns and poor construction quality have characterized sewer construction activities in District XVII such as the contractor difficulties on the Rakosliget project described above
Billing and Collection
It does not appear that the Budapest Municipal Sewage Company service area is metered adequately to fully capture the cost of providing sewer service to users There are some i400 meters missing particularly in the outlying districts A delinquency rate of 8 percent is generally not acceptable Accrued receivables are estimated at HUF 338 million in May 1994
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
MunicipalStrategiesfor InfrastructureFinance 7he UrbanInstitute PlannedSewage Projectsin Two BudapestDistlcts Page 20
ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
MunicipalStrategiesfor Infrastlcire Finance The Urban InstiutePlanned Sewage Projectsin Two BudapestDistrLts Page 21
projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
MunicipalStrategies for InfrastructureFinance The Urban Insl ePlannedSewage Projects In Two Budapest Distrlcts Page 22
Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
MunicipalStrategiesfor InfrastructureFinance The UrbanInstitutePlannedSewage Projectsin Tio BudapestDistricts Page23
plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
MunicipalStrategiesfor InfrasrucbtreFinance The UrbanInstLmte PlannedSewage Projectsin Two Budapest Districts Page24
FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
MunicipalStrategiesfor Infrastuctu-e Finance The UrbanInsttute PlannedSewage Projects in Two BudapestDistricts Page 26
ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
TECHNICAL ASSISTANCE RECOMMENDATIONS
Maintaining improving and expanding the sewer system as well as the generalinfrastructure is essential to the long term vibrancy of the district economies and thelivability of communities for their citizens Better methods of planning financing and managing infrastructure must be developed
Essential to the understanding acceptance and use of improved techniques is theprovision of technical assistance that will help local officials make smarter sewer andgeneral capital investment and management decisions In certain localities technicalassistance providers will work with local officials to ensure initiatives come to fruitionThese support mechanisms should enhance district Capital City and Sewage Companycapacity to evaluate infrastructure needs develop appropriate capital investment and management strategies and implement programs and projects Training how tomanuals policy papers illustrations of successful approaches that local governmentshave actually undertaken must be documented and disseminated
TECHNICAL ASSISTANCE FOR DISTRICT FINANCING OF SEWER PROJECTS
Consider Alternative FinancingMethods
Existing methods used by districts to finance their share of sewer construction projects are inadequate It is proposed that a technical assistance team work with district officials to explore feasible sewer financing alternatives = Alternatives that merit consideration include
ConnectionFees The use of connection fees is quite flexible and thought should be given to using them most effectively
Long Term Debt Consider extending the term of debt issuances (loans and bonds) to lower the impact debt has on district operating budgets
Tourism Communal Business Taxes and Other Taxes Explore the potential to use these and other miscellaneous taxes to finance sewer improvements
PropertyTax Assess the revenue raising capacity of the property tax
UserFees Generally user fees have limited applicability since districts do not own the system once it is constructed However the use of fees will be considered
The sewer revenue raising potential of each revenue source should be evaluatedagainst a standard set of criteria Criteria applied to each revenue option may include
As part of this analysis existing sewer financing methods (eg targeted subsidies sale of land and creation of construction communities) will be likewise evaluated in terms of their revenue raising potential
22
MunicipalStrategiesfor InfrastructureFinance 7he UrbanInstitute PlannedSewage Projectsin Two BudapestDistlcts Page 20
ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
MunicipalStrategiesfor Infrastlcire Finance The Urban InstiutePlanned Sewage Projectsin Two BudapestDistrLts Page 21
projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
MunicipalStrategies for InfrastructureFinance The Urban Insl ePlannedSewage Projects In Two Budapest Distrlcts Page 22
Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
MunicipalStrategiesfor InfrastructureFinance The UrbanInstitutePlannedSewage Projectsin Tio BudapestDistricts Page23
plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
MunicipalStrategiesfor InfrasrucbtreFinance The UrbanInstLmte PlannedSewage Projectsin Two Budapest Districts Page24
FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
MunicipalStrategiesfor Infrastuctu-e Finance The UrbanInsttute PlannedSewage Projects in Two BudapestDistricts Page 26
ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
MunicipalStrategiesfor InfrastructureFinance 7he UrbanInstitute PlannedSewage Projectsin Two BudapestDistlcts Page 20
ability to generate revenue dependability ability to respond to economic growth and inflation equity and administrative simplicity among others (At a brief seminar in District XVII a discussion was held to develop a preliminary taxonomy of revenue sources evaluated according to these criteria Annex B is the chart used in this effort)With respect to household contributions surveys will help assess the ability and willingness to pay
Once feasible revenue options are identified the technical assistance team will
work with districts to bring the project to fruition
Consider New Sewer FinancingMethods
Beyond existing methods of financing the districts share of a sewer construction project financing alternatives that are new to Hungary must be considered One option to be considered is the creation of tax increment or betterment districts In these cases a special district is created wherein various infrastructure improvements will take placeThe cost of these improvements is paid through the issuance of debt The additional taxes generated through increased property values attributed to the capitalimprovement is used to recover the projects cost An original assessment base for properties within the district is established and capital improvements are then financed by a special tax on the incremental increase in the assessed value of the benefitingproperties This approach can prove particularly effective in furthering each districts economic development objectives Obviously one important component will be to investigate the current feasibility and legality of such taxes
GENERAL CAPITAL FINANCING TECHNICAL ASSISTANCE TO DISTRICTS AND CAPITAL CITY
Assist in the Development of a Capital Plan and Budget
To provide a structure within which the districts and the Capital City can plan for their short and long term capital needs as well as explore financing options USAID will provide technical assistance to the Capital City and Districts XVII and XVIII in developing a simple capital improvements planning and budgeting (CIPB) process The CIPB will create a forum within which district officials can (1) identify existing capital stock and evaluate its condition (2) identify current and future needs (3) consider and comparealternative financing mechanisms and (4) make capital allocation decisions This process should link land use planning growth management and economic development to capital expenditures
There is a clear need for districts (as well as other local governments in Hungary) to develop capital plans and budgets The team proposes development of resource manuals and training programs on all aspects of CIPB based on work in Budapest The range of this effort will include establishing the administrative and policy framework capital inventory performing financial analysis and programming evaluating competing
MunicipalStrategiesfor Infrastlcire Finance The Urban InstiutePlanned Sewage Projectsin Two BudapestDistrLts Page 21
projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
MunicipalStrategies for InfrastructureFinance The Urban Insl ePlannedSewage Projects In Two Budapest Distrlcts Page 22
Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
MunicipalStrategiesfor InfrastructureFinance The UrbanInstitutePlannedSewage Projectsin Tio BudapestDistricts Page23
plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
MunicipalStrategiesfor InfrasrucbtreFinance The UrbanInstLmte PlannedSewage Projectsin Two Budapest Districts Page24
FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
MunicipalStrategiesfor Infrastuctu-e Finance The UrbanInsttute PlannedSewage Projects in Two BudapestDistricts Page 26
ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
MunicipalStrategiesfor Infrastlcire Finance The Urban InstiutePlanned Sewage Projectsin Two BudapestDistrLts Page 21
projects relation of CIPB to urban planning engineering and economic development concerns and monitoring the CIP3
To foster the local government development of CIPBs the central government maywish to require local governments to use a simple form of the CIPB process as a condition for obtaining funding assistance
Costing andPricing
Governments allocate their precious financial resources without a sense of whatit truly costs to deliver public goods and services Where fees are charged either for theprovision of capital or services there appears to be little attention paid to the relation of the fee to the cost of service Assistance in these areas will be provided directly to theCapital City and the districts lessons learned will be incorporated into workbooks andseminars on costing and pricing municipal services to be applicable to a largercommunity Concepts that merit inclusion include defining cost concepts such asdepreciation expenditure vs expense indirect cost fixed and variable costs job costspricing mechanisms such as full cost recovery average cost pricing profit pricingmarginal cost pricing peak load pricing economic and social equity issues and the use of subsidies
Cost Analysis The team proposes that district and City of Budapest officials set in motion procedures to accurately determine the cost of sewer services and tapsand establish fair pricing policies that reflect these costs This is particularlyimportant now that the Capital City is responsible for the first time for settingfees Costs and subsequent rate analysis can be determined either through cost accounting systems or less rigorous cost finding techniques Both methodologiesprovide a framework within which to collect cost data and set rates
UserFee Structure Typically sewer utility systems rely upon the imposition of user fees not only to meet the day-to-day cost of operation and maintenance but also to pay off over time the costs of the original capital outlays that are secured on the pledge of the enterprise projects revenue This self-supporting financingprinciple is essential to the successful operation of public utilities The team proposes that assistance be provided to the Capital City in establishing a fee structure that encompasses the cost of capital and reflects the cost of servicingvarious types of users (eg residential industrial commercial)
To the extent that the fee does or should reflect capital costs consideration should be given to allocating a portion of the fee for sewer capital expansionprojects initiated by districts Presently the Sewer Company can only invest in reconstruction not new construction This gives a bias towards users who already receive sewer service
MunicipalStrategies for InfrastructureFinance The Urban Insl ePlannedSewage Projects In Two Budapest Distrlcts Page 22
Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
MunicipalStrategiesfor InfrastructureFinance The UrbanInstitutePlannedSewage Projectsin Tio BudapestDistricts Page23
plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
MunicipalStrategiesfor InfrasrucbtreFinance The UrbanInstLmte PlannedSewage Projectsin Two Budapest Districts Page24
FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
MunicipalStrategiesfor Infrastuctu-e Finance The UrbanInsttute PlannedSewage Projects in Two BudapestDistricts Page 26
ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
MunicipalStrategies for InfrastructureFinance The Urban Insl ePlannedSewage Projects In Two Budapest Distrlcts Page 22
Enterprise Management
The transformation of the Sewage Company and the shift of responsibility for setting sewer fees from the Central Government to the City of Budapest offers an opportunity for the Capital City to finance the expansion rehabilitation and maintenance of the sewer system through the use of fees and charges However as a publicenterprise the Company must pay attention to the bottom line This includes applyingenterprise accounting and pricing principles to Company operations as well as enhancingoverall management capacity The team proposes that technical assistance be provided in the following areas
Establishing an enterprise accounting system (eg budgeting capital budgeting appropriation control restricted accounts fixed assets financial statements)
Determining the cost centers of the Companys operations
Establishing a cost accounting and cost allocation system
Assisting in the development of pricing policies (eg determining how demand determines the user charge pricing alternatives) and
Providing guidance on administrative considerations (eg charging billing and collection internal control purchasing project management)
Contract Management
This is a fertile area for technical assistance wherein benefits can be realized immediately The team proposes that training and guidelines on the construction management process from bidding contractor selection and bonding throughconstruction monitoring and interim contractor payment to final inspection payout and project acceptance be provided
Collaboration between the City and the Districts
It would be enormously advantageous to all parties to encourage flow of information and exchange of experiences among the districts and between the districts and the Capital City For example a committee of technical department heads of the different districts to encourage conception of model forms of bidstenders model forms of contracts to protect the districts or exchange of information on unreliable and reliable contractors
One example of this sort of cooperation is found in a recent proposal for the outer districts to band together in forming a public utility association to undertake missinginvestments an idea that is apparently also supported by the Capital City There are
MunicipalStrategiesfor InfrastructureFinance The UrbanInstitutePlannedSewage Projectsin Tio BudapestDistricts Page23
plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
MunicipalStrategiesfor InfrasrucbtreFinance The UrbanInstLmte PlannedSewage Projectsin Two Budapest Districts Page24
FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
MunicipalStrategiesfor Infrastuctu-e Finance The UrbanInsttute PlannedSewage Projects in Two BudapestDistricts Page 26
ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
MunicipalStrategiesfor InfrastructureFinance The UrbanInstitutePlannedSewage Projectsin Tio BudapestDistricts Page23
plans underway for an assembly comnittee consisting of experts and representafivesfrom each party to be established and for the elaboration of the association con-ract
TECHNICAL ASSISTANCE TO THE CENTRAL GOVERNMENT
Revise Current Subsidy System
The current system of targeted grants does not provide sufficient revenue or incentive for districts to construct new sewer collection systems Long term debt financing is a reasonable and preferable alternative to the current methods used bydistricts to raise their share of project cost
It is recommended that the central government consider establishing mechanisms to enhance opportunities for districts to use long term debt to finance infrastructure development Options to be considered include
Because local governments cite the unavailability ofaffordable long term loans as a major obstacle to sewer financing establish a revolving loan fund to finance sewer projects The fund can provide financing for a multitude of projects as local government uitll be required to repay their obligation These funds in turn can be used to finance new projects Consider providingmarket rate loans with a long term repayment period (tento twenty years) than present debt financing mechanisms permit or linking loans to smaller grants
Infrastructure Bond Bank - Use the financial resources of the central government to finance a number of individual projects under a single debt issuance
Guarantee debt issued by districts
Foster the development of alternative debt financing arrangements with the private sector such as deferred payment loans or balloon payments
Close the Gap Between Financing and Construction Start
To improve the real purchasing power of subsidies project financing should be made at such time as districts have a reasonable financing plan in place preliminaryplans and specifications are complete and there is significant progress towards acquiring necessary land and rights-of-way Priorities in allocating subsidies should include criteria such as districts readiness to proceed
MunicipalStrategiesfor InfrasrucbtreFinance The UrbanInstLmte PlannedSewage Projectsin Two Budapest Districts Page24
FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
MunicipalStrategiesfor Infrastuctu-e Finance The UrbanInsttute PlannedSewage Projects in Two BudapestDistricts Page 26
ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
MunicipalStrategiesfor InfrasrucbtreFinance The UrbanInstLmte PlannedSewage Projectsin Two Budapest Districts Page24
FinancingAlternatives
A technical assistance team should work with the central government to review alternatives to the existing subsidy mechanisms and with districts to explore options such as tax increment financing revolving loan funds enhanced target subsidy delivery mechanisms and fee sharing as viable alternatives to existing practices
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
MunicipalStrategiesfor Infrastuctu-e Finance The UrbanInsttute PlannedSewage Projects in Two BudapestDistricts Page 26
ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
Budapest XVII Keriilet
Jbzsef D6czi Peter Ktai tva Zsichla Boz6 IAszlo Tarlin Ldszlo Perlaki Gybrgy Fazekls
Budapest XVIII Keriiiet
Gdbor Vada Ern Zurdnyi J6zsef Veszteg Geza Dudds
Budapest Capital City
Agoston P~terffy Dr Kdroly Oszk6 Mrs Pd Kocsis Zoltan Kiss
ANNEX A
PERSONS INTERVIEWED
Mayor Deputy Mayor Department Head Economic Department Department Head City Development and Environment Division Head Public Utility and Transport Public Utility and Transport Division
Deputy Mayor for Finance Deputy Mayor for Economic Development Department Head City and Economic Development Office Department Head Finance and Tax Office
Chairman Commission of Public Works Department Head Public Utility Works Department Budget Section Public Utility Works Department Senior Advisor Public Utility Works Department
F6vrosi Csatornhizi MfzvekBudapest Sewerage Works
Veronika G6lya Department Head Economic Department J6zsef Kovacsv~lgyi Departmeri Head Investments Department Zsuzsanna Kolompar Division Head Investments
31
MunicipalStrategiesfor Infrastuctu-e Finance The UrbanInsttute PlannedSewage Projects in Two BudapestDistricts Page 26
ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
MunicipalStrategiesfor Infrastuctu-e Finance The UrbanInsttute PlannedSewage Projects in Two BudapestDistricts Page 26
ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb
ANNEX B
Evaluating Revenue Sources for IfFriuctu Finance
To be marked
Positve (+A N Uve(-High Hiamph Medium Medium Aw
Low LOw
EVALUATION CRITERION 4
I Predlctab a)wouue i level t h xkng
2 Abili toincase withlocal eoomic rowth
3 Ablity to respon to tnflsUon a) current hi future
4 Fairness amng urms
5 Promots vertical equity
6 Pronmoes use equity
7 Promots polUve bustnesseconomic climate
8 Magnitude of revenue rasing capacity
9 Controled by a) central governmnt bi city govemment c) dibct governmenk
10 Pmmotes adzlnlstmrtve impdty
Ii Pmmote pulic policy
12 POcalykeaubb
13 Other criterb