With the exception of Turkey, the performance of the water supply and sanitation sector in the Europe and Central Asia (ECA) Region has been significantly influenced by the recent transition events. Depending on a host of factors-such as the state of the sector prior to the transition, the evolution of macro economic performance and household income, the extent of reforms undertaken so far, availability of external assistance-outcomes have been strikingly different among the countries in the region. Some countries have made great progress in improving the level and quality of services and institutional and financial performance. In others, the sector is still in the midst of a severe crisis and deep reforms needed to improve sector performance and service to the people have not yet been initiated. Great differences in service provision, and institutional and financial capacity also continue to exist within countries. Large cities have been able to deal much better with the transition than smaller ones. Rural communities are still suffering most from the transition and the failure of governments to initiate and sustain reform.

In terms of sector performance and prospects, the ECA region may be divided into four broad groups of countries. Group I includes the first tier European Union (EU) accession countries. In these countries, the transition is well under way and has largely succeeded in improving the level and quality of services and the capacity and financial viability of sector institutions. The main challenge for the future is to continue enhancing the efficiency of sector institutions and mobilize the enormous resources needed to meet standards for wastewater treatment demanded by the EU. Group II includes the second tier EU accession countries. These countries have also made important strides, but have a much longer way to go than countries in Group I. Group III comprises the post conflict countries of the Balkans. There, war related damage and ethnic divisions exacerbate the magnitude and difficulty of sector reform. Group IV includes the countries of Commonwealth of Independent States (CIS), excluding the Baltic states. These countries have a far less developed infrastructure and institutional capacity and suffer from much more severe fiscal constraints, reductions in household income, and a much slower reform process than the other countries in the region. This has led to an alarming deterioration of services and weakening of sector institutions. Of the CIS, countries in Central Asia and the Caucasus are facing a particularly challenging uphill battle in preventing the collapse of present infrastructure and urgently need to reform sector policies and rebuild and strengthen sector institutions.

Region-wide Issues and Constraints

The poor state of the water supply and wastewater industry in ECA is largely due to the policies and practices of sector management in the past. The following sector development issues and constraints are common to all countries in the region, although their severity and relative importance vary widely.

Institutional/Regulatory Weakness. Compared to international standards, water and wastewater enterprises are over staffed, poorly managed, and inefficient. Lack of modern management and control systems makes informed decision-making difficult. Sector enterprises have limited autonomy and control over crucial aspects of their business (e.g., tariff setting).

Poor State of Repair of Facilities. Lack of appropriate maintenance, poor planning, use of low- quality materials and equipment, and substandard construction quality, combined with the recent shortages of resources, are responsible for the poor state of repair and continued deterioration of assets. Large investments are needed to rehabilitate existing systems.

Inefficient Operation. Plants are often inappropriately designed and poorly maintained. Water networks suffer from excessive leakage (loss rates of 50 percent and more are not uncommon), hydraulically improper design, and excessive infiltration in sewer pipes. Consumers, unaccustomed to water conservation, tend to use more water than counterparts in Western Europe. These inefficiencies unnecessarily drive up operating costs, particularly for energy.

Lack of Financial viability. While some water utilities in Group I countries have attained financial viability, the loss of past subsidies, low tariffs, and poor collections have placed most, if not all, water and wastewater enterprises in the region in a financially untenable situation. Particularly in Group IV countries, enterprises no longer have the resources needed for maintenance or addressing even the most urgent rehabilitation needs. Many have stopped paying their suppliers, most notably electricity providers. Due to increases in energy costs, electricity has become the highest cost item for most utilities. A solid financial footing for enterprises is essential for the revival and development of the sector. The financial crisis is particularly acute in smaller cities and rural areas. Throughout the Central Asia and Caucasus countries, many rural communities have lost their water supply systems

Restricted Willingness to Pay and Affordability. The transition has led to significant erosion of personal income and dramatically increased the number of the poor. Safety nets adopted by most countries to assist the most vulnerable are not operational. In this situation, many people are reluctant or unable to pay the increased rates that enterprises need desperately to survive and provide services. In the absence of subsidies from government, consumers will have to pay more and/or service provision will need to be aligned to consumer's ability to pay.

Water Resources Scarcity and Pollution. Many water supply enterprises in the region suffer from water shortages and poor water quality. At the same time, they are major polluters, along with agriculture and industry. Present institutions, legislation, and policies dealing with water resources are not equipped to introduce modern [water resources management] principles that would ensure a cost

The Challenge Ahead

The resources needed to rehabilitate existing systems and provide a safe level of water supply, sanitation services, and adequate waste water treatment exceeds the present financial capacity in all countries in the region. The financial shortfalls are most acute in Group IV countries, where the need for investment is the greatest. The recovery and future development of the sector will have to proceed in phases. In each country, the pace of recovery will be determined by the level of resource mobilization from all sources and the cost-effective utilization of these resources. To achieve these goals, the root causes of poor performance will have to be addressed. Particularly, Group IV countries will have no choice but to undertake aggressive sector reform programs if they are to stem the current trend of continued service deterioration and put the water supply and water sector on a sustainable footing. These reforms must address the sector issues and constraints identified earlier.

Strengthening Sector Institutions and Governance Relationships. For large cities, the development of an autonomous, corporate, commercially-oriented, and self-reliant utility operating under the regulatory oversight of municipal government is essential. For smaller cities, economies of scale suggest the creation of autonomous regional utilities. Extensive institutional strengthening and intensive capacity building are essential. Working with autonomy and insulated from undue political interference, utilities must be held accountable for improving service and productivity by their regulators.

Putting the Sector on a Viable Financial Footing. Recognizing their inability to fund the sector from already over stretched budgets, governments have no choice but to strive for full recovery of operation, maintenance, and capital costs from the consumer. Tariff increases and rigorous collection are the basis for the financial viability of utilities. Reliance on full cost recovery as the sole source of financing the sector is clearly not possible, however, particularly in the poor and disadvantaged areas of Group IV countries, some subsidies will be unavoidable.

Improving the Cost-Effective Utilization of Scarce Resources. The more effectively

resources are used, the faster services will improve. Programs of demand management, plant and network efficiency improvements, energy conservation, leakage reduction, and careful priority setting will bring the highest return in reducing operating costs and improving service.

Making Consumers Key Participants in Future Sector Development. Consumers need to understand that the level and quality of services they receive will depend largely on the level of tariffs they are willing and able to pay. Sector institutions must strive to provide the service that people want at the least possible cost. Consumers should not be asked to pay higher tariffs only to have them squandered by wasteful management and inefficient operations. In rural areas, community driven and supported development needs to be introduced.

Promoting Private Sector Participation. A private support industry providing quality equipment and services at competitive prices has already emerged in country Groups I, II and III, but is still missing in Group IV countries. Given the severe limits on public financial resources and the dearth of management and operations capacity, entry of private utility operators and investors in the form of management contracts, leases or concessions will be a key element of future sector development. The flow of private sector expertise and money has already begun in Group I and II countries. Although conditions in Group IV are not yet conducive for private investment, the provision of private sector know-how in utility management and operations through service or management contracts is crucial for addressing the severe capacity shortages in these countries.

Within its overall mission to reduce poverty and improve living standards through sustainable growth and investment in people, the Bank's objective for the sector is to help people obtain adequate and safe water supply and waste water services at an affordable price. The Bank offers assistance to governments and the sector communities in the ECA region to improve water and wastewater services in accordance with their needs and capacities. The Bank's support for a country and a specific project depends on a number of considerations. While need is an important criterion, the Bank is selective in deploying its limited capacity to assist in preparing and implementing projects. The Bank gives preference to those governments and borrowing agencies which demonstrate commitment to a mutually agreed reform agenda that ensures sustainable results. In its policy and project advice the Bank brings to bear international best practices adopted for local conditions.

Important objectives for every project are to improve management and operations, ensure the cost-effective use of scarce financial resources, and to address the root causes of poor service. Financial sustainability and cost recovery from tariffs, while providing inclusion and appropriate protection for the poor, is a key development objective for every project. Whenever appropriate, the Bank insists on a community-based approach, particularly in rural water supply and sanitation projects. The Bank will promote, whenever feasible and appropriate, the services of the private sector as a provider of management and operational know-how and capital for investments. Finally, the Bank is committed to work together with other financial and aid institutions and recognizes its role of "lender of last resort" and areas of comparative advantage.

Based on these principles, the Bank's sector assistance strategy varies significantly among the different groups of countries in the region. In Group I and II countries, where reforms have already taken hold and extensive assistance is available from other financing institutions and the private sector, the Bank will provide assistance only for activities and investments that are not available from other sources. The Bank is prepared to join a coordinated effort by the EU and other financing agencies to provide funding to assist utilities to meet EU water and wastewater standards. In Group III countries-the post conflict countries in the Balkans-the Bank is ready to use its international prestige and experience to help address political issues and obstacles created by ethnic tensions. The Bank's most needy clients are the countries of Group IV. Here the Bank is ready to help countries in defining and implementing the reforms that are necessary to create the conditions for sustained improvement and growth. Within this strategy, the Bank offers policy advice to interested countries through sector studies, dialogue, and financial support for specific investment projects. In Group IV countries-particularly in Central Asia and the Caucasus-the Bank aims at increasing its support for small towns and rural areas where poverty and deterioration of services are most pronounced.

As of June 2000, Bank investments in the ECA region water and wastewater sector totaled approximately US$800 million. Of this amount, US$50 million was for new investments approved for three projects in fiscal¹ 1999. To date, Bank-supported water and wastewater projects have assisted in policy reform, institution building, environmental improvements, and efforts to improve financial viability.

In Albania, the International Development Association (IDA) approved a US$11.6 million credit for the Durres Water Supply Project in 1994. The project is helping to improve the quality and safety of water supply in Durres, the second largest city in Albania, by rehabilitating existing facilities and strengthening the institutional capacity and financial viability of the Durres Water Company. The project was instrumental in initiating a dialogue with the government in support of reforms in the sector. To help respond to the damage caused to the sector during the Kosovo crisis, the Bank approved in 1999 a US$10 million Water Supply Urgent Rehabilitation Project, which provides funding for rehabilitating water supply assets in four Albanian cities: Durres, Fier, Lehze and Saranda. A follow-up project that will fund the continuation of rehabilitation and efficiency- improvement work with the assistance of a management contract with an international private utility operator is being prepared.

In Armenia, a US$30 million IDA credit was approved for a Municipal Development Project in 1998. The project was designed to fund the emergency short-term improvements in the water supply system required to restore the safety and reliability of the water availability in Yerevan. It includes support for turning over the management and operation of the Yerevan water supply and wastewater systems to a private foreign utility operator. It also assists the government in formulating a sector development strategy for the rest of the country. A follow-up project to assist with improving water services in the rest of the country is being prepared.

In Azerbaijan, a US$61 million IDA credit for the Greater Baku Water Supply Rehabilitation Project was approved in 1995. The primary objective is to rehabilitate water supply facilities throughout the city and improve the quality and quantity of water available to more than 500,000 people living in the metropolitan area of Baku. The project includes an important technical assistance program to help in the creation of the Baku water and wastewater utility and the definition of a water law for reforming water policies in the country. In 1999, the Bank completed a sector study that provides specific recommendations for reforming and strengthening the water supply and sanitation sector in Azerbaijan

In Bosnia and Herzegovina, a US$20 million loan was approved for a Water, Sanitation, and Solid Waste Urgent Works Project in 1996, to help repair and rehabilitate war-damage water supply, sanitation, and solid waste services in municipalities throughout the country. In 1999, the Bank approved a US$12 million IDA credit for a Mostar Water Supply and Sanitation Project. The objective of the project is to reestablish a united water supply and waste water utility, and provide funding for institutional strengthening and urgent investments for the rehabilitation of the city's water supply system.

In Croatia, a US$38.4 million loan was approved for the Eastern Slavonia Reconstruction Project in 1998. The project aims to repair and rebuild the war-damaged water sector infrastructure while mitigating the negative environmental impacts on the adjacent nature reserve that are likely to occur when local agricultural activities resume. Repair of the water sector infrastructure, especially for local agriculture, is critical to restarting the country's economy. A US$36.3 million loan was approved in 1998 for a Municipal Environmental Infrastructure Project, which is designed to improve water and wastewater facilities in the cities of Split, Solin, Kastela, and Trogir; to help protect the coastal environment; and improve the safety, reliability, and delivery of drinking water in the area.

In 1999, a US$31.6 million equivalent loan was approved for a Municipal Waste Water Project in Hungary. The project supports investments for expanding municipal wastewater treatment capacity in the cities of Budapest and Dunaujvaros.

Also in 1999, a US$16.5 million loan was approved for a pilot Water Supply and Sanitation Project for the city of Atyrau in Kazakhstan. The project aims to strengthen the capacity of the city's water and wastewater enterprise to provide reliable and safe drinking water and disposal of sewage in an environmentally responsible manner. It entails physical investments in two of the most heavily populated areas of the city and changes in institutional and management structures to improve the financial and operational management of the city's water and wastewater enterprise. The project also finances the preparation of a full-scale project to improve the infrastructure in the remaining parts of the city.

In Poland, a US$21.5 million loan was approved for the Bielsko-Biala Water and Wastewater Management Project in 1996. The project supports the water and wastewater enterprise in Bielsko-Biala, a city with an estimated population of 190,000, located in the southern region of the country. Its aim is to improve the efficiency of water operations and expand wastewater treatment, thereby making a significant contribution to lowering the pollution load on the Vistula River. With the Bank's assistance, the Bielsko-Biala water and wastewater enterprise has developed into a well-managed, efficiently operated and financially healthy utility that can attract private investors for future ventures.

Turkey accounts for the highest proportion of Bank water loans in the ECA region. A US$173 million loan for the Ankara Sewerage Project was approved in 1989, a US$129.5 million loan for the Bursa Water and Sanitation Project was approved in 1993, and a US$13.1 million loan for Cesme Water Supply and Sewerage was approved in 1998. These projects help to improve and expand water and wastewater services and strengthen project executing institutions. Recently the Bank has concentrated its efforts on bringing in private sector know-how and capital to assist smaller cities. The Antalya Water Supply Project, a US$100 million loan approved in 1995, will rehabilitate and expand water supply and wastewater infrastructure under a concession contract with a foreign operator. The Cesme Water Supply Project supports improvements in the city's water and wastewater infrastructure through a management contract with a private foreign operator. The Bank responded very quickly to the earthquake in Turkey on August 17, 1999. Reconstruction of housing, water, and sewerage systems are high priorities in order to provide permanent housing, safe drinking water, and sanitation to the hundreds of thousands of people given temporary shelter and services. A large-scale project is being prepared to support this reconstruction as well as other potential needs in infrastructure and restoration of services in Turkmenistan, a US$30.3 million loan was approved for a Water Supply and Sanitation Project in 1997. It was designed to improve water supply and sanitation, and to assist with institutional changes in the water and sanitation sector.

In Uzbekistan, a US$75 million IDA credit was approved for a Water Supply, Sanitation, and Health Project in 1997. The project aims to provide safe drinking water along with improved hygiene education and sanitation facilities for the Republic of Karakalpakstan and Khorezm Oblast. Decreasing waterborne diseases among the population, particularly diarrhea among children, is a key objective. Another objective is to strengthen the institutional capacity of the involved utilities and regional health centers. Several studies are being supported to define a new sector development strategy for the country. Also, a follow-up project is planned for Samarkand and Bukhara.