To promote the provision of public utility services that contribute to the long-term economic development of the region and to the well-being of its people by adopting a sector structure and regulatory policy seeking to:

To Ensure Long-term Sustainability of the Services. Ensuring long-term sustainability of the services is contingent on the availability of resources to fund the operation, maintenance and investments that are required to improve and expand the services to existing and future consumers. Therefore, service suppliers must be assured a stream of financial flows that covers the operating, maintenance and capital expenditures associated with the services; macroeconomic and sector conditions must foster a favorable investment environment in the industry, facilitate access to financial resources and reduce the cost of capital; and consumers must be satisfied or the political sustainability of the services may be in jeopardy.

To Achieve Economic Efficiency. When economic efficiency is achieved, prices can be kept at the minimum level compatible with the long-term sustainability of the service, and at the same time, they can provide consumers with incentives resulting in an optimal use of the services. If circumstances permit, competition will be the most effective means of promoting economic efficiency. However, when circumstances do not permit, efficiency incentives can still be enhanced through a variety of institutional and regulatory mechanisms.

To Safeguard Quality. The adequacy of any public service will be contingent on safeguarding the quality provided to the consumer. It is therefore important to ensure that cost changes are properly balanced with any change in the quality of service. This balance can be obtained only with the development of a sound framework for quality of service regulation. This framework will encompass a set of procedures whereby feasible quality standards are clearly defined with reference to the balance of costs and benefits, and subsequently monitored and enforced via a system of penalties and incentives.

To Promote Accessibility. Promoting the accessibility of the service to all citizens occupies an important position in the political philosophy of public service provision, particularly for the water supply and waste water disposal sectors. However, there is evidence to suggest that social policies have not always been effective in reaching the most disadvantaged. There has been a traditional emphasis on improving the affordability of the service to existing users, while often overlooking the fact that those in greatest need lack any kind of access to the service at all. Consequently, social policies should reflect the importance of promoting access to all users.

To Meet Wider National Objectives. The operation of public services may sometimes be in conflict with wider national objectives such as the protection of the environment. Sectors such as power, water supply, waste water disposal and waste disposal clearly have a substantial impact on environmental quality and/or other uses of water. As a consequence these sectors must be integrated within a framework of environmental regulation which is compatible with the economic circumstances of the country.

A number of important trade-offs exist among the objectives mentioned before. For example, long-term sustainability may come into direct conflict with promoting accessibility and attaining efficiency. Where such situations arise, difficult judgments will need to be made. While the appropriate balance will be highly context-dependent, the resolution of such trade-offs should be guided by the long-run achievement of the objectives; should be based on a thorough analysis of the problem; and should be resolved via the use of transparent policy mechanisms that minimize any economic distortion. Project documents should clearly state the extent to which the objectives are attained. However, there is one area in which no compromise should be made and that is, in meeting the objective of long-term service sustainability by ensuring that financial flows rise to a level compatible with full cost recovery, while guaranteeing economic efficiency as a general goal of service provision.

Basic Conditions

Basic conditions that must be met to assure the accomplishment of the objectives are:

Separation of Roles. The single most important contribution to the joint achievement of the objectives is to separate the roles of policy formulator, regulator and entrepreneur. Under the traditional model, the State combined a variety of roles when providing public utility services. This combination of roles compromised the achievement of the policy's objectives, by creating an operating environment characterized by insufficient tariffs, soft budget constraints, weak efficiency incentives, and low accountability. This situation must be remedied by clearly defining each role and allocating it to a distinct and appropriate institution. Thus the authorities will retain responsibility for policy formulation, while a separate public sector body will implement the regulatory regime, leaving the service provider with a purely entrepreneurial role for either public or privately owned utilities.

Sector Structure. The possibilities of achieving efficiency in a given sector and country are highly dependent on the existence of a sector structure that fosters economic efficiency and maximizes the scope for completion. Therefore, the adequacy of every sector structure should be judged by its overall impact on the efficiency of the sector, and in particular by the extent to which this structure can facilitate the development of competition. Facilitating the development of competition may be achieved by the separation of natural monopoly activities from potentially competitive activities via vertical separation and horizontal break-up of the sector. The extent to which these separations are feasible and desirable will depend both on the nature of the sector and on the size of the market. The nature of the sector determines the activities functioning as natural monopolies; the size of the market determines the feasibility of the creation of an adequate number of competitors operating at an efficient scale. In general, the creation of international networks enhances the prospects for competition in certain sectors. This will be particularly true in the case of small countries. In addition, improving efficiency may be achieved by the horizontal break-up of naturally monopolistic activities with a view to facilitating yardstick competition. For example, in the water supply sector, the creation of a number of distinct local service providers introduces the possibility of making efficiency comparisons among them and thereby inducing competitive behavior. Under somewhat different circumstances, an overly fragmented sector may benefit from the horizontal integration of a number of existing business units in order to reach a minimum efficient scale.

Adoption of a Sound and Adequate Regulatory Regime. Adopting a sound regulatory regime appropriate to the particular conditions of each sector in each country is a key factor in the attainment of the objectives. This will imply that a model of regulation based on incentives will be most suitable to the attainment of efficiency as a general goal. A regulatory regime should therefore contribute to create a favorable climate for investments and to a lowering of the cost of capital; promote and oversee competition; regulate prices for natural monopolies assuring economic efficiency while keeping financial sustainability; assure an efficient fulfillment of social or national objectives, including a judicious use of subsidies when necessary; and maintain consumer satisfaction by being responsive to their interests. The following considerations are relevant:

a) A Favorable Investment and Credit Climate contributes to the long-term sustainability of the services. This climate is obtained by adopting transparent procedures and appealing mechanisms, making clear decisions, and other elements that minimize the risk to investors and lenders without compromising the prospects for competition or the consumer interest.

b) Competition Is Promoted because, when feasible and desirable, it is the best tool to achieve efficiency. Direct competition in the market reduces the prices ultimately paid by the consumer and maximizes their satisfaction while keeping the regulatory burden at a minimum. When this is not possible or desirable because of sector or country conditions, competition for the market may be an alternative. Because the transition from an integrated monopoly to a competitive market cannot be expected to take place in a smooth and instantaneous manner, a considerable degree of regulatory oversight will be required. This will ensure that competition is preserved and developed, that markets function efficiently, economic efficiency is achieved and that equitable terms of access are provided to all competitors. When the market becomes competitive, it would be the role of the regulator to foster the conditions that lead to achieving the objectives of the policy, to supervise compliance and promote enforcement.

c) Prices for Natural Monopolies are regulated to assure long-term financial sustainability and to attain economic efficiency when competition is not possible. Long-term sustainability is achieved by adopting incentive regulation mechanisms to create a stream of cash flows that cover all costs, including a remuneration to capital commensurate with the risks and other local conditions. Where natural monopoly conditions prevail, adequate incentives for achieving economic efficiency in service provision may be provided through a variety of regulatory instruments while avoiding the temptation to intervene in the day to day affairs of the utilities. Success in the application of these instruments will inevitably depend on the flow of accurate and consistent information between the service provider and the regulator. Cost comparisons among utilities enhance the capacity of the regulator to regulate tariffs. Regulators should also work towards the creation of the conditions that lead to the adoption of tariffs that signal the marginal cost of the service to the end user. In the case of State Owned Enterprises (SOEs), adoption of tariffs signaling marginal costs while maintaining the long run financial viability of the utility with an adequate return must be a goal to be achieved. Nonetheless, the most elegant tariff structure will prove ineffectual in this regard unless it is underpinned by a well-functioning system for measuring and billing consumption whenever the benefits from measurement outweigh the costs.

d) Subsidies And/or Other Forms of Intervention as a mechanism to achieve wider national objectives relating to social equity and environmental preservation may be considered in some cases. However, such a broadening of the regulatory agenda carries certain pitfalls and requires careful thought. In situations where it is deemed desirable, it must always be accompanied by an adequate degree of coordination with other government entities, and must always be undertaken through the vehicle of transparent policy mechanisms. Well-designed social policies should be comprised of the following elements: (1) an explicit statement and clear justification of the chosen social objective; (2) a procedure ensuring a mechanism for collecting the necessary funds, whether from general taxation or tariff revenues; and (3) a transparent mechanism for allocating funds to the target group. This implies avoiding the use of cross-subsidies, unless it can be clearly demonstrated that they are the best available alternative to meet the objectives. A common and effective way to avoid efficiency distortions is to concentrate the use of subsidies in facilitating access to services, and/or in reducing fixed charges to the poor, rather than modifying the variable part of the tariff.

e) Promoting Consumers Interests and ensuring that they reap the full benefits of efficiency gains in the sector is a necessary condition for the sustainability of the regulatory regime. This is achieved by avoiding potential abuses of market power on the part of the service provider, establishing and enforcing quality and customer service standards.

Appropriateness of Institutional Vehicles for Regulation. The selection of an institutional vehicle appropriate to the specific conditions of the country and sector is of major importance to the effectiveness and sustainability of the regulatory process. This vehicle may take a variety of forms, ranging from regulation by contract to more sophisticated approaches requiring the creation of an explicit regulatory body; in the case of the public services covered by this policy, the presumption is that some form of regulation will generally be needed. The appropriateness of any specific vehicle should be determined by comparing the benefits of regulation with its cost, keeping in mind that the costs of regulation comprise the potential for regulatory failure and the financial expenditures associated with the regulatory process. The regulatory body should be autonomous in character, entailing an effective insulation from political interference on the one hand and regulatory capture on the other. In promoting autonomy measures, such as the financial self-sufficiency of the body, the existence of prespecified conditions of appointment will be helpful, although they cannot of themselves guarantee it. Furthermore, the creation of a regulatory body raises a number of other more detailed design issues which will inevitably entail trade-offs, and which thus may only be resolved with reference to the particular political and economic context of any specific sector. The largest issue facing the regulatory body is its ability to make a credible commitment to the objectives of the policy. This is enhanced by assuring the transparency of the regulatory process and its ability to produce predictable and clear results. Other issues include: the appropriate degree of regulatory decentralization, a single national regulatory body or delegation of some functions to regional bodies; the desirability of multi-sectoral, including two or more utility sectors, and/or multi-functional, comprising regulation and its supervision, type of regulatory body; and leadership of the entity, a single regulator or a commission.

Adequacy of the Legal Framework. The legal framework of the country must be adequate with respect to the chosen sector structure and regulatory framework. Because many regulatory options, the existence of competition in the market, and some kinds of private sector participation can only function effectively within a specific legal context, countries should carefully study the adequacy and compatibility of the proposed options with their legal systems. If necessary, the country should consider the viability for wider changes in the system encompassing, among others, the areas of public sector procurement procedures and contract law, in order to facilitate various modes of private sector participation; competition and anti-trust legislation, in order to provide the basis for developing a competitive market; and appealing bodies and/or arbitration procedures, in order to support the resolution of disputes between the regulator and the service provider. The ability to undertake these changes, which is closely related to the size and level of development of the country, human resource endowments and the particular political environment, may severely limit the range of options and the timing of private sector participation available to the country.

Adoption of Governance Modes. The modes of governance adopted will determine to a significant degree the efficiency incentives faced by the management of the service provider. Efficiency at the enterprise level is enhanced when corporate decisions are taken on a purely commercial basis within the limits of an adequate regulatory framework. Generally speaking, the most effective means of achieving this goal is through private sector participation. Such participation need not entail outright asset sales, but may take a variety of lesser forms including, among others: lease contracts and concessions; and Built Operate and Own (BOO) or Built Operate and Transfer (BOT) type contracts. If private sector participation is not a viable option at the time, there are a number of modes of governance within the public sector which may be used to place the management of the enterprise within a more commercial operating environment such us corporatization and service and management contracts. Just as the regulatory entity must be insulated from direct political interference, a similar degree of autonomy should be introduced for the enterprise. An additional mode of governance which is worthy of consideration, particularly in rural settings, is that of the cooperative. Where different modes of ownership coexist within the same service sector, they all must be placed on an equal footing vis a vis the implementation of the regulatory regime.

The Existence of Firm Government Commitment With the Objectives of This Policy. The ultimate success of the whole process hinges on a sustained government commitment to enforce and develop the regulatory regime. In order to be successful a regulatory regime must not only be carefully designed but competently implemented. Even a minimum compliance with the basic conditions may require a number of radical and substantive measures, which can only be brought about and sustained in the presence of a profound long-term commitment on the part of their governments. In the absence of such a commitment, unilateral and/or piecemeal interventions on the part of the Bank are likely to prove ineffectual.

Compliance with the Basic Conditions and Bank Involvement in the Sector

The Bank must take both a long-term and a comprehensive view of its involvement in a particular public utility sector because of the depth and time-length of the reforms that many countries will require to comply with the basic conditions, the important interactions among these conditions, the variety and complementarity of the instruments available to the Bank to support the countries, and the continuous innovation in the field of regulation. The basic conditions help to define a core program of actions required for a self-sustaining sector reform process, in circumstances where such reforms are clearly required, and provide criteria on which to judge the adequacy of a given regulatory framework. Well-designed sector reforms are complex tasks that ordinarily take a long time to complete. Furthermore, the success of a reform process is not assured once all the constituent elements of the framework have been put in place. Success depends not only on an adequate design of a regulatory framework and regime, but also on the supervision, enforcement and on the continuous implementation and adaptations to changing circumstances. In particular, the process of regulation requires a sustained effort to ensure that the fruits of the reform are ultimately forthcoming. This will involve not only continued training and support, but also the strengthening of the institution as a whole by helping to create the appropriate "culture of regulation" in the countries concerned.

The order in which the various measures are carried out is also important because there are important interactions among the basic conditions. Although there is a considerable degree of simultaneity involved , there are at least some measures which should definitely precede others. For example, the form of the sector restructuring will affect the scope for competition and thus the design of the regulatory regime; therefore, restructuring of the sector and the creation of regulatory institutions and regimes should generally precede any major moves towards private sector participation, although it must be recognized that in some cases, where the legal framework is suitable, the public-private contract may cover the necessary regulation. Also, in most cases, it is desirable that such measures be implemented at a national level, thereby facilitating an integrated and cohesive treatment of the issues. With piecemeal eforms, there is always the danger of taking a narrow view of the problem resulting in the adoption of solutions which lack overall coherence, compromise the long term political viability of the effort, and which may constrain the options available elsewhere.

The Bank must consider how different policy, technical cooperation and lending instruments are likely to come into play at different stages in the process. Bank instruments are likely to be of greatest impact when employed in a coordinated fashion both within and across sectors. Therefore, any financial operation, public or private sector window of the Bank in the sector should be treated as part of a comprehensive and continuous process of support for the achievement of the objectives of the policy. When lending through the private sector window, the viability of the resulting private investments, present and future, will be highly dependent on the achievement of the basic conditions mentioned before. Thus, when considering private sector involvement in a specific sector, a determination should be made as to the adequacy of the existing sector structure and regulatory framework, including its supervision and enforcement, in achieving the objectives of the policy and its overall sustainability. Where deficiencies exist, these should be remedied by making use of the instruments available to the Bank. The Bank should take measures to promote the synergies which exist among its policy instruments, or at the very least, to avoid any inconsistencies in their application.

To assure a coherent and effective support to the countries, the nature of the Bank s involvement must reflect the degree of government commitment to the mutually agreed upon requirements in the country strategy; the pace of Bank's involvement should be set to accompany the progress obtained in the implementation of the agreed upon reform program; and significant action can only be taken when the government has already made credible and irreversible public commitment to the mutually agreed upon process, signaled by the adoption of some of the basic conditions, or at least by making satisfactory progress towards their implementation. Where this is not the case, Bank actions should be relatively modest in scope and should focus on the goal of strengthening government commitment up to a point where there is an adequate basis for further financial support. Once the major elements of the process have been completed, the Bank should continue its financial support to the sector as requested using the instruments that best suit the particular conditions. However, even in the absence of lending operations, and with the purpose of assisting the country in the necessary oversight and adjustments to the process, the Bank should maintain its involvement in the sector by means of the country dialogue and the judicious use of technical cooperation.

It is acknowledged that the present policy will be applied in a very wide range of circumstances, both as regards the conditions of the sector and the wider situation of the country. The policy cannot encompass all of these circumstances, and consequently, it is conceivable that a departure from one or more of the basic conditions could be countenanced in some cases. In such circumstances, those advocating any such departure must show compliance of the proposal with the objectives of this policy. Also, given the comparative newness of the field, it is likely that there are other possible methods for supporting the creation of a sound regulatory framework beyond those that are explicitly listed here. There is clearly much scope for innovation on the part of Bank personnel engaged in assisting governments in this area, and such innovation is to be encouraged. However, Management must perform periodic assessments of the adequacy of the policy. In particular, it will report to the Board of Executive Directors on the effectiveness of policy instruments in bringing about the desired changes, and on the contribution of the basic conditions themselves to the attainment of the overall objective of the policy.

Fields of Activity

This policy applies to all Bank operations, both public and private window, and is cross-sector in its scope. The policy is primarily targeted towards electricity, natural gas, water supply, waste water disposal, telecommunications and refuse collection, which jointly share many important economic characteristics.

The present policy is complemented by a other current policies:

a) Sectoral: Telecommunications (OP-732); Energy (OP-733); Electric Power ( OP-733-1); Sanitation ( OP-745); Public Health (OP-742), and

b) Multisectoral: Environment ( OP-703); Urban and Housing Development (OP-751); Rural Development (OP-752).

In recognition of the diversity of technological conditions facing the constituent sectors, Bank management will periodically issue sector-specific operational guidelines to facilitate the application of the policy in particular cases.

Prevailing Reference Documents:
GN-1869-3, August 1996.

* The operational policies of the Inter-American Development Bank are intended to provide operational guidance to staff in assisting the Bank's borrowing member countries. Over the course of the Bank's more than 40 years of operations, the approach to developing operational policies has taken various forms, ranging from the preparation of detailed guidelines to broad statements of principle and intent. Many policies have not been updated since they were originally issued, and a few reflect emphases and approaches of earlier years which have been superseded by specific mandates of the Bank's Governors, the most recent being the Eighth Replenishment mandates of 1994.

In accordance with the Bank's information disclosure policy, the Bank is making all of its operational policies available to the public through the Public Information Center. Users please note that the Bank's operational policies are under a process of continuous review. This review process includes preparation of best practice papers summarizing experience at the Bank and other similar institutions, and sector strategy papers.

Hello, Welcome to the IDB!

Please join our mailing list by simply entering your email below.