Economics of Water Supply

TRIBHUVAN UNIVERSITY
INSTITUTE OF ENGINEERING
DEPARTMENT OF ARCHITECTURE AND URBAN PLANNING
PULCHOWK CAMPUS

A SEMINAR ON
ECONOMICS OF

WATER ALLOCATION

MODULE: ECONOMICS

SUBMITTED TO:
DR. JIBGAR JOSHI

SUBMITTED BY:
KIRAN MAN JOSHI| 066‐MUP‐205
MONICA MANANDHAR| 066‐MUP‐207
SACHEEN MAHARJAN | 066‐MUP‐214
SAMIR BYANJANKAR | 066‐MUP‐215
SUCHITA BAJRACHARYA | 066‐MUP‐218
Economics of Water Allocation

CHAPTER 1| INTRODUCTION
1.1 Background
Water is rapidly becoming scarce in almost all countries and cities of the world with growing population on
one hand and fast growing economics, commercial, industrial and developmental activities on the other. This
scarcity makes water both social & economic commodity. Being an essential component of life, the use of
water is independent of economic condition or occupation of the people although it may affect its demand.
Tremendous socio‐economic, political, commercial, educational and other activities are going on every
moment. For all such activities, water is essential. But the rate of increase of supply of water is very low as
compared to the rate of population growth and urban expansion coupled with hectic social, industrial,
commercial and other activities. More than that, it is heart breaking to know that the total amount of water
that can be harnessed inside the Kathmandu Valley in no way will be able to meet the future demand of
Kathmandu. Insufficiency in water supply meant further deterioration of the problem of wastewater. So, any
delay in finding a solution for the water supply and waste water treatment could lead to a serious
environmental disaster in Kathmandu.
1.2 Introduction Water as economic commodity
In addition to being a basic need and a non‐homogeneous good, water could be excludable, non‐excludable,
rival or non‐rival, depending on the way in which it is packaged. For example, rainwater is a non‐
rival and non‐excludable good; a private metered connection is rival and excludable. A non‐rival good is
one whose consumption by one person does not reduce the consumption by others. A good is non‐excludable
if it is prohibitively costly to exclude someone from receiving the benefits of the good after it has become
available. A public good is characterized by no rivalry in consumption.
There are both excludable and non excludable public goods. A non excludable public good is a good that is
non rival in consumption and that cannot be denied to a person who does not pay for it. Therefore, the
benefit derived from improved water supply is a non excludable. Water has public good characteristics
because improved water services to households translates to better health of the community,
improvement in the workforce, and reduction in the demand for health care. Using water that is
below standard can lead to water‐based, water‐borne, or other water‐related diseases such as diarrhea,
ring worm. In many developing countries, millions of dollars are spent every year to treat outbreaks of
disease most of which are water‐related. Such expenditures are usually part of the budget of the
ministry of health which most times cannot afford these costs. To satisfy minimum health and safety
requirements, a sufficient quantity of water for consumption purposes must be at or above a certain quality
level, to prevent water‐based illnesses. Water for bathing must be of a certain quality to prevent skin‐related
water‐borne diseases. Other households in the community must satisfy these constraints as well to prevent
negative externalities resulting from water borne disease spread within the neighborhood.
Health benefits clearly are a public good aspect of improved water quality. Reducing the time women
and children spend fetching water allows them to engage in other economic activities that contribute to
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improved family well being and the economy at large. Provision of adequate water supply will also reduce
the time girls spend in fetching water allowing them more time for schoolwork. Girls’ education yields a
higher rate of return than any other investment in developing countries. Educating girls has large social
benefits in terms of savings from improved hygiene and birth control, as educated women choose to have
fewer children. Bringing water closer to home and reducing the time girls have to spend fetching water
therefore has a positive externality or benefit that accrues to society as a whole. Arguments of whether these
benefits are public or private are issues of concern in the literature. But the fact that improved water
supply and sanitation provide health benefits to society as a whole is apparent and undisputable.
1.3 Objectives
• To know about economics factor involved in water Supply and its proper disposal
• To understand the cost factor, economic and financial benefits involved in a water supply projects
1.4 Scope and limitation
• The study is an attempt to understand the economic principles behind public water supply system
taking the reference of Melamchi Water Supply Project
• The study is conducted within a very short period of time depending upon readymade data.
• The study of MWSP project has been done taking the reference of financial and economic analysis
carried out at time of ADB’s funding of the project. The project has gone through several changes in
policies, budget and strategy within that period.
1.5 Methodologies
The adopted methodologies are as follows:
A. Selection of the Topic:
Through the rigorous group discussion, the topic “Economics of water supply projects” for the seminar was
selected.
B. Literature Review:
Reference books and related papers were studied and planning was done for the interpretation of the raw
data.
C. Data collection:
The Secondary data was collected from the internet sources.
D. Analysis:
Analysis of data in terms of economics aspects
E. Data Presentation:
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The raw data was analyzed and developed in a form of graphical representation. Conclusion and
recommendation are extracted from case study.
CHAPTER 2 | WATER AND WATER SUPPLY
2.1 Water sources
2.1.1 Surface water
These are open sources of water which includes river, ponds, streams etc. They are usually the main sources
of water for water supply system. Since they are exposed to air, they are generally polluted and should be
firstly purified, collected before distributing. The main sources of water in Nepal’s Context are rivers. The
presence of Himalayas makes Nepal rich in water resources. The rivers are fed through melting of snow in the
Himalayas. Rivers are renewable source of water. Water is available from these rivers all the year round but
during rainy seasons water level is higher. This makes the surface water most feasible for use in water supply
water system.
2.1.2 Ground Water
Ground water can be a cheap and reliable source of water where it is available. Ground water can be obtained
though well or deep boring (by hand pumps). Ground water is usually clean from impurities but it may contain
dissolved salts, minerals and sometimes harmful metals like arsenic. In general, ground water is safer from
pollution when the aquifer is deep and confined; even then it is advisable to use ground water for general
purpose other than drinking .i.e. non potable use. One drawback of ground water is that it is not renewable
naturally in a short period and extreme reliance and use of ground water can cause geological disorder. One
way to tackle this problem is by recharging ground water during rainy seasons by rain water.
2.1.3 Rain Water
Rain water is the ultimate source of water which feeds the entire secondary source including Surface water
and Ground water. Even though it is primary source of water, practical implementation of rain water
harvesting was not seen until recently. Direct collection and use of rainwater is however, widely practiced at
an informal level by householders. Although it cannot be considered as reliable source of water, the fact that
it is renewable and free source of water makes it important source of water.
2.2 Water supply system
2.2.1 State owned system
Since water supply system is extremely capital intensive, and the financial benefits achieved are also low but
the economical benefits that the water supply projects provide are of major importance. It is the main reason
why most water supply projects are mainly carried out by the government.
The main goal of the state owned system is to provide service to general public. It is however usually
inefficient, non‐flexible and non‐responsive.
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2.2.2 Private system
Being a profit based system, it is efficient, responsive and feasible. However private system may not look after
environmental and sustainability factor because the main aim is profit.
Example of Private system is Ground water supply in apartments through deep boring and other means. Since
profit is main factor, environmental issues such as making retention pond , ground water recharging are
usually not covered
2.2.3 Public Private Partnership system
PPP is the new model for implementing public projects. The main idea of PPP model is that the private sector,
community organizations and non government and government organizations should be partners in
development. The Millennium Development Goal (MDG) Assessment Study for Nepal estimated that 33 per
cent of the expenditure necessary to achieve the MDGs will have to come from non‐government sources.
Public‐private partnerships are one of the means of achieving this.
A. Definition of Public Private Partnerships
There is no clear agreement on what does and what does not constitute a public‐private partnership (PPP).

Under a typical PPP scheme, the government specifies the services it wants the private sector to deliver, and
then the private partner designs and builds an asset for that purpose, finances its construction, and
subsequently operates the asset and provides the services deriving from it. This contrasts with traditional
public investment where the government designs and finances an asset and then contracts with the private
sector to build it.
In most cases, the government then operates the asset once it is built. The difference between these two
approaches reflects a belief that giving the private sector combined responsibility for designing, building,
financing, and operating an asset is a source of the increased efficiency in service delivery that justifies PPPs.
B. Stakeholders of Public Private Partnership
The Partnership generics evolve from the possible linkages among the stakeholders involved in the UWM
System. In general, there are three major groups of stakeholders and three categories of partnerships
linkages. The PPP is particularly known as partnership between the Government and the Private Sector. This
category of partnership is the part of concern and will be discussed more in depth.
The other two forms of partnership between the Government and the Communities, and partnership between
the Private Sector and the communities or Civil Society are not discussed. The partnership between the
Government and the Civil Societies is based on the policy of the Government on particular sector to include
and empower the Civil Societies when required.
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The partnership between Business and Civil Societies is based on the Social and Corporate Responsibility
policy adopted by the Business houses and becomes their internal matter. However, the latest two forms of
partnership are more conveniently understood based on the modalities discussed for Public Private
Partnership.
C. Public Private Partnership Structure
The stakeholder under the Government category included the Central and Local Government Bodies as
Ministries, Departments, Municipalities, DDC and VDC. The Donor Agencies and other Government Owned
Agencies also fall under this category. The second category of stakeholder is the Formal and Informal Private
Sector comprising of profit making and nonprofit making organizations as business houses, industries,
companies, enterprises, service providers, NGO, CBO, and individuals. The third category of stakeholders is the
consumers comprising of service users from Government to citizens who are responsible for generation of
waste.
D. Partnership Development Approach
The approaches of Partnership Development are‐
Top Down Approach – where the Government takes initiatives and call for Partnership.
Such initiatives are almost rare unless it is mediated and pressurized by the Civil Societies.
Bottom Up Approach – This requires influence on Policy, Plans and Programs of the Government and very
difficult to achieve.
Lateral Approach – This approach is not dependent on Government Policy. Mostly it is carried out by the
Communities and Private Sector at grass root level following their Corporate and Idealistic Responsibility. The
Lateral Partnership has very strong effect on Government Policy depending upon the strength and extends of
spatial coverage of membership of the partnership. The recent political changes in Nepal could attribute to
this form of partnership where the communities and individual informal partners united for achieving a
particular goal of political change.
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CHAPTER 3.0 | ECONOMY BEHIND WATER SUPPLY
3.1 Factors involved in water Supply
Following factors are to be analyzed before making economical analysis of water supply system
A. Water supply and Sanitary are inter‐connected with each other. Once water is delivered to house
hold, it is bound to generate waste water. The water supply cost should include the provision and cost
of removal and treatment of waste water generated.
B. Water supply and sanitation services are broadly conceived as huge societal enterprise. Its day to day
need and its requirement for lots of day to day activities for all sectors of society makes it a important
part of urban ecology. Reliable and efficient water supply is good measure of a developed and healthy
society.
For an example if we compare the water supply and sanitation system of European cities and cities of
developing nations like Kathmandu we can see huge difference in quality of service which reflects the
development condition of society.
C. The provision of water and sanitation services is very capital intensive. Moreover, in many cases there
are significant economies of scale, and the physical capital tends to be long‐lived. This has several
important implications. It is critical to get the investment planning decisions right because one can
make big mistakes by overbuilding, by building too far in advance of demand, by building facilities that
no one wants, or by failing to maintain and operate such capital‐intensive facilities efficiently.
For an example, in Kathmandu Valley, where water supply is intermittent, major cause for inefficient
distribution of water is lack of effective valve system. Due to these households near the reservoir are
always getting excess water while those away from it are getting none at all. Although initial
investment may be on higher end, using valve and two pipe systems may be a better choice here.
D. Household demand for very small quantities of drinking water is extremely price inelastic because
people must have water to live. If there are no other sources of water, the amount of money
someone will pay for 3‐4 liters of water per day is limited only by his/her income. This extremely
inelastic demand for small quantities coupled with shortages of water supply can combine to create
situations in the developing world that are beyond the experience of people in richer countries.
For example, in some places in rural Tanzania a 20‐liter bucket of water can cost a day’s wages of an
unskilled laborer. You can take your choice: walk all day for water, or work all day in the fields and
buy a bucket of water.
E. The fact that the price inelasticity for small quantities of water is so low, and the provision of services
is very capital intensive, the water supply system provides large opportunities for bribery and
kickbacks on construction contracts and equipment purchases. These problems greatly increase the
transaction costs of doing business, and thus the total cost of providing improved water and sanitation
services in many developing countries.
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For Example, one of the causes for cost increase and subsequent delay in construction of Melamchi
Water Supply Project is due to corruption during various phases of construction.
F. Water is very different than electric power when it comes to storage and transport. The storage of
water is relatively easy, while transporting water long distances to urban centers is expensive because
water is so voluminous. With electricity, by contrast, storage is expensive and transportation is easy.
Because water is typically expensive to transport long distances, it can be prohibitively expensive to
provide customers with very high levels of service reliability.
3.2 Financial and Economic Analysis
3.2.1 With and Without‐Project Cases
After choosing the best among alternatives, the next step is to test the financial and economic viability of
the project, which is the chosen, least‐cost alternative. The initial step in testing the financial and
economic viability of a project is to identify and quantify the costs and benefits.
To identify project costs and benefits and to compare the net benefit flows, the without‐project
situation should be compared with the with‐project situation. The without‐project situation is different from
the before‐project situation. The without‐project situation is that one which would prevail without the
project vis‐à‐vis factors like population increase. As water is getting scarcer, the water use pattern and the
cost are also likely to change.
3.2.2 Financial Vs Economic Analysis
Financial and economic analyses have similar features. Both estimate the net benefits of an investment
project based on the difference between the with‐project and the without‐project situations.
However, the concept of financial net benefit is not the same as economic net benefit. While financial
net benefit provides a measure of the commercial (financial) viability of the project on the project‐operating
entity, economic net benefit indicates the real worth of a project to the country.
Financial and economic analyses are also complementary. For a project to be economically viable, it must be
financially sustainable. If a project is not financially sustainable, there will be no adequate funds to
properly operate, maintain and replace assets; thus the quality of the water service will deteriorate,
eventually affecting demand and the realization of financial revenues and economic benefits.
It has sometimes been suggested that financial viability not be made a concern because as long as a
project is economically sound, it can be supported through government subsidies. However, in most cases,
governments face severe budgetary constraints and consequently, the affected project entity may run
into severe liquidity problems, thereby jeopardizing even its economic viability.
The basic difference between the financial and economic benefit‐cost analyses of the project is that the
former compares benefits and costs to the enterprise in constant financial prices, while the latter
compares the benefits and costs to the whole economy measured in constant economic prices.
Financial prices are market prices of goods and services that include the effects of government
intervention and distortions in the market structure. Economic prices reflect the true cost and value to the
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economy of goods and services after adjustment for the effects of government intervention and
distortions in the market structure through shadow pricing of the financial prices. In such analyses,
depreciation charges, sunk costs and expected changes in the general price should not be included.
In financial analysis, the taxes and subsidies included in the price of goods and services are integral parts
of financial prices, but they are treated differently in economic analysis. Financial and economic analyses
also differ in their treatment of external effects (benefits and costs), favorable effects on health and the UFW
of a WSP.
Economic analysis attempts to value such externalities, health effects and nontechnical losses.
3.2.3 Financial vs. Economic Viability
The steps in determining the financial viability of the proposed project include:
(i) Identifying and quantifying the costs and revenues;
(ii) Calculating the project net benefits;
(iii) Estimating the average incremental financial cost, financial net present value and financial internal rate
of return (FIRR).
The FIRR is the rate of return at which the present value of the stream of incremental net flows in financial
prices is zero. If the FIRR is equal to or greater than the financial opportunity cost of capital, the project is
considered financially viable. Thus, financial benefit‐cost analysis covers the profitability aspect of the project.
The steps in determining the economic viability of a project include the following:
(i) Identifying and quantifying (in physical terms) the costs and benefits;
(ii) Valuing the costs and benefits, to the extent feasible, in monetary terms; and
(iii) Estimating the EIRR or economic net present value (NPV) discounted at EOCC = 12% by comparing
benefits with the costs.
The EIRR is the rate of return for which the present value of the net benefit stream becomes zero, or
at which the present value of the benefit stream is equal to the present value of the cost stream. For
a project to be acceptable, the EIRR should be greater than the economic opportunity cost of capital. The Bank
uses 12% as the minimum rate of return for projects; but for projects with considerable no
quantifiable benefits, 10% may be acceptable.
3.2.4 Procedures for Economic Analysis
The economic analysis of a Water Supply Projects (urban or rural) has to follow a sequence of
interrelated steps:
A. Defining the project objectives and economic rationale
Under this will be defining the main goal of the project, why it is needed and how it will be achieved.
To acquire the knowledge about the physical features, present situation regarding existing facilities
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and their use constraints (if any) against their optimal use, the communities and their socio economic
conditions, surveys and field visits need to be done.
For an example if the area is rural or based on economic condition of the household in the area, a
community taps serving few household may be more beneficial socio‐economically than providing
individual taps
B. Demand analysis and forecasting effective demand for project outputs.
This is to be based on either secondary information sources or socio‐economic and other
surveys in the project area. Demand of water is depended on the tariff rate of water. The demand of
water also fluctuates with season and on the time of a day. The project needs to access the peak
demand.
C. Establishing the gap between future demand and supply from existing facilities after ensuring their
optimum use.
For example if the future demand of water of an area (as calculated from the survey) is expected to be
16mlpd and existing facilities provides around 5mlpd with their optimum use then water supply
system which can provide additional 11mlpd will be required.
The optimal use of facilities (if applicable) here need to be achieved through physical and policy
related measures. The physical measures are like leakage control, replacing faulty valves and
adequate maintenance and operation, (unless new network systems are proposed for water supply)
etc; policy measures can be charging an economically efficient tariff and implementing institutional
reforms.
D. Identifying project alternatives to meet the above gap in terms of technology, process, scale and
location through a least‐cost and/or cost‐Effectiveness analysis using economic prices for all inputs.
This includes short listing and identifying the least‐cost alternative of achieving the required output.
All the life‐cycle costs (market and non‐market) associated with each alternative are to be taken into
account.
The alternatives are not to be confined to technical or physical elements only, e.g., ground water or
surface water, gravity or pumping, large or small scale, etc. They can also include activities due to
policy measures, e.g. leakage detection and control, institutional reforms and managerial
reorganization.
For an example, we assume that cities near the seas can easily address it’s water need. But most of
the time it is actually cheaper to use other sources of water than to purify and remove salt from the
sea water (the process known as desalination) and distribute the desalinated water to higher level
(since sea level lie below normal land level). The least‐cost analysis of different projects will reveal if
the water supply project is feasible enough to implement or not.
E. Identifying benefits, both quantifiable and non‐quantifiable, and determining whether

economic benefits exceed economic costs.
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For an example, when the dam was proposed for construction in the Narayani River in Chitwan, the
financial study revealed that the project would really take a long time to attain the financial breakeven
state. But the project was considered economically feasible due to following reason‐
• With the new irrigation network, the farmers will be able to produce more crops, which will result in
increase in economic activity and farmers end up paying more taxes. Also as a social benefit nation
will get more food yield. These non market, economic and social benefits cannot be easily quantified
but these factors are considered for analyzing of economic benefits of the projects.
• Generally, if the average income of the farmers in the area before the project is 5000 per month and if
due to the project they could increase their crop yield and earn income of around 15000 per month
then 10000 is considered as economic benefit of the project. In the above case if the farmer earns
10000 more it is assumed that certain% (say 10‐20% i.e. 1000 to 2000) of the earned income will
return to government in the form of tax paid which is considered as financial gain in the case of state
projects
F. Assessing whether the project’s net benefits will be sustainable throughout the life of the
project through cost‐recovery, tariff and subsidy (if any) based on financial (liquidity) analysis
and financial benefit‐cost analysis.
The benefits of the water supply projects are more economical and social than financial but given that
it is the state which generally invests in water supply projects which low priority of financial return.
But for water supply projects to be sustainable, the operation and maintenance cost and future
upgrading cost has to be provided by the end users. Failing to achieve this will make the project
unfeasible even at cost of its social benefits.
In case of above example of water supply for irrigation in Chitwan thorough Narayani river, the
farmers has to pay the charges for using water for irrigation. Prices are charged as per unit of land
irrigated. This cost collected should cover the O & M cost of the project so the project is financially
sustainable throughout the life of project.
G. Testing for risks associated with the project through sensitivity and risk analyses.
In calculating the EIRR or ENPV for WSPs, the most likely values of the variables are incorporated in
the cost and benefit streams. Future values are difficult to predict and there will always be some
uncertainty about the project results. Sensitivity analysis is therefore undertaken to identify those
benefit and cost parameters that are both uncertain and to which EIRR and FIRR are sensitive.
A sensitivity indicator shows the percentage change in NPV (or EIRR) to the percentage change in a
selected variable. A high value for the indicator indicates project sensitivity to the variable. Measures
minimizing against major sources of uncertainty are incorporated into the project design, thus
improving it.
For an example some of the variable that may affect the water supply projects includes long term
reliability of water source, WTP (Willingness to pay) factors of the consumer, the government policies
and economic ability of the government, political stability of the country which should be taken into
account.
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3.3 Cost involved in Water Supply System
As said earlier, development of water supply system is extremely capital intensive. The treatment and delivery
of water to the households and removal and treatment of the waste water generated cost serious money. The
financial benefits achieved are also low but the economical benefits that the water supply projects provide are
of major importance. It is the main reason why water supply projects are mainly carried out by the
government. The private sectors (whose main goal is profit) hence generally refrain for water supply projects
unless low interest donations and grants are involved in the project.
3.3.1 Market Costs
The economic costs of providing a household with modern water and sanitation services are the sum of seven
principal components:
A. Opportunity costs of diverting raw water from alternative uses to the household (or resource rents)
If, for example, a drinking water project uses raw water diverted from agriculture, the use of this
water for drinking will result in a loss for farmers. These costs are measured as the opportunity cost
of water which, in this example, equals the “benefits foregone” of the use of that water in
agriculture.
B. Storage and transmission of untreated water to the urban area
This includes cost in construction and operation of infrastructure used for trapping and storing
(pumps, dams) the water source and transmission of the water to the area of distribution.
C. Treatment of raw water to drinking water standards
The most commonly adopted and cheap method here is sand filtration and chlorination.
D. Distribution of treated water within the urban area to the household
Making Supply Network and providing household connections of the treated water comprise a major
cost component.
E. Collection of wastewater from the household (sewerage collection)
F. Treatment of wastewater (sewage treatment)
G. Any remaining costs or damages imposed on others by the discharge of treated wastewater (negative
externalities).
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Table 1. Cost estimates: improved water and sanitation services
No. Cost component US$ per m3 % of total
1 Opportunity cost of raw water supply 0.05 2%
2 Storage and transmission to treatment plant 0.15 6%
3 Treatment to drinking water standards 0.15 6%
4 Distribution of water to households (including 0.75 30%

house connections)
5 Collection of waste water from home and 1.00 40%
conveyance to wastewater treatment plant
6 Wastewater treatment 0.35 14%
7 Damages associated with discharge of treated 0.05 2%

wastewater
Total 2.50 100%
Table 1 presents some illustrative average unit costs for each of these seven cost components, expressed in
U.S. dollars per cubic meter. The cost estimates in Table 1 include both capital expenses and operation and
maintenance expenses. The calculation of annual capital costs uses a capital recovery factor of 0.12, assuming
a discount rate of 10% and an average life of capital equipment and facilities of 20 years.
The unit costs of these different cost components could vary widely in different locations. For example, in a
location with abundant fresh water supplies, item 1 (the opportunity cost of diverting water from existing or
future users to the potential target group) and item 7 (the damages imposed by the discharge of treated
wastewater) may, in fact, be very low or even zero. However, in more and more places these opportunity
costs associated with water diversion and the externalities from wastewater discharge are beginning to loom
large.
Some cost components are subject to significant economies of scale, particularly storage and transmission
(item 2), the treatment of raw water to drinking water standards (item 3), and the treatment of sewage (item
6). This means that the larger the quantity of water or wastewater treated, the lower the per‐unit cost. On the
other hand, some cost components are experiencing diseconomies of scale. As large cities go farther and
farther away in search of additional fresh water supplies, and good reservoir sites become harder to find, the
unit cost of storing and transporting raw water to a community increases. There are also tradeoffs between
different cost components: one can be reduced, but only at the expense of another. For example, wastewater
can receive only primary treatment, which is much cheaper than secondary treatment; but then the negative
externalities associated with wastewater discharge will increase.
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The opportunity costs of raw water supplies (item 1) are still quite low in most places, on the order of a few
cents per cubic meter. Even in places where urban water supplies are diverted from irrigated agriculture or
valuable environmental assets, the unit costs will rarely be above US$ 0.25 per cubic meter.
Raw water storage and transmission and subsequent treatment (items 2 and 3) will typically cost US$0.30 per
cubic meter. Within a city, the water distribution, collection and conveyance of sewage to a wastewater
treatment plant (item 5) is even more expensive than the water distribution; this will cost about US$1.00 per
cubic meter, 40% of the total cost. Secondary wastewater treatment (item 6) will cost about US$ 0.35 per
cubic meter. Damages resulting from the discharge of treated wastewater are very site‐specific, but
environmentalists correctly remind us that that they can be significant.
As shown, total economic costs comes to about US$2.50 per cubic meter in most location. However this value
is bound to change depending on various factors. For example, in small communities in the mountainous areas
of Upper Nepal, cost of Water and Sanitary services can easily be double or triple these amounts per cubic
meter. (Source: Designing Optimal Water Supply System for Developing countries)
Other factors which affect the economic cost of water includes the following:
3.3.2 Non Market Costs
Subsidies
Generally in Developing Countries, the subsidies provided to consumers of water and sanitation services are
not only huge, but also regressive. It is often not politically “desirable” for the majority of people to
understand that middle‐ and upper‐income households, who generally use more water, are thus actually
receiving the most benefit from subsidies. Most fundamentally, poor households are often not connected to
the W&S network at all and hence cannot receive the subsidized services. Even if they do have connections,
the poor use less water than richer households, thus receiving lower absolute amounts of subsidy.
For an example, the tariff rate of water for Nepal is among lowest in Asia due to subsidy provided by
Government which stand as Rs 80 for unmetered taps and maximum of 250 (Rs 50 for sewerage) for metered
taps. The people of Kathmandu are unwilling to pay more tariffs for water supply due to unreliability of the
service. This coupled with high ratio of loss due to existing use of old pipe is leading to failure of existing water
supply system in its social goal and financially.
Sustainability Cost
It can be referred cost added to ensure the future availability of resource and ensure its sustainability. This
specially applies to ground water whose excessive use can decrease the ground water table, making the
ground water difficult to obtain or not available at all in the future. Hence, to cope with such situation, special
cost called ‘Scarcity Premium’ is added to the resources.
Environmental Cost
This includes the cost to compensate for the environmental impact (if any) resulting due to use of water from
the source and due to wastewater discharge.
For an example, using water from the wetland for irrigation may disturb the ecosystem of the wetlands. The
environmental cost helps to compensate for such impacts
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3.4 Cost Recovery
In general, the cost of the water supply project is expected to be recovered by increasing the tariff rate.
Whereas there is cost recovery in most of the countries (Capital, O & M, Debt services etc), in developing
countries it is not always so. The greater gap between cost and prices leads to lower service reliability and
sustainability.
Most of the time, in developing countries, the cost of the project is not expected ot be recovered. The
government invests its own capital for the project, and the cost collected is used to cover the present and
future operation and maintenance goals only. The goal here is to achieve economic feasibility rather than
financial.
CHAPTER 4 | WATER SUPPLY SYSTEM IN KATHMANDU
4.1 Water Supply
In KMC, water is supplied by Nepal Water and Sewerage Corporation (NWSC) and private tanker services.
Besides these there are few community based supply system for specific towns and villages. For example
Siddhipur Water Supply project carried out by combined effort of NGOs, Community and Local level
Governemnt. In addition to that, many industries, hotels, hospitals and a large number of households use a
huge amount of ground water extracted by pumping.
The existing water pricing policy in the Kathmandu is partly based on block rate tariff(BRT) mechanism,
although the users’s charge fails to cover the cost of services or to generate revenue for evvective treatment
of available water supply and augment new water sources. In KMC, the tariff rate charged by NWSC is as
follows
4.2 Current drinking water tariffs
Pipe Minimum Minimum tariff in NRs Effective from 17th September 2004 as per volume
size consumption of water (price per 1000 Liters)
(in (ltr)
inch)
Household Government, Commercial Household Government, Commercial
Institutional & & institutional & &
public industrial public industrial
½” 10,000 50 50 50 15 15 15
¾” 27,000 810 810 810 30 30 30
1” 56,000 1,680 1,680 1,680 30 30 30
1.5” 155,000 4,650 4,650 4,650 30 30 30
2” 320,000 9,600 9,600 9,600 30 30 30
3” 881,000 26,430 26,430 26,430 30 30 30
4” 1,810,000 54,300 54,300 54,300 30 30 30
For those household who doesn’t owe meter have to pay minimum Rs 552.00 /month.
15 | P a g e

Water supplied by NSWC or private tankers or extracted and used by various institutions or households are
neither controlled by a uniform law nor well managed by the existing institutions. It was nationally and
internationally accepted that the problem of water supply both in quantity and quality are basically due to the
organizational and functional weakness of the major supplier of water, namely, Nepal Water Supply and
Sewerage Board which was reorganized as Nepal Water Supply Corporation in 1989 (NWSC). In order to
improve the situation, donors expressed the opinion that HMG/Nepal should bring in a private operator (PO)
to manage the water system assets and made this a condition for loans and grants. Taking this fact into
consideration, His Majesty of Government of Nepal (HMG/N) then proposed three major reforms and decided
• To bring in private company to manage the water supply staff and equipment
• To repair, upgrade and expand the present water supply network; and
• To construct a tunnel from the Melamchi valley to bring in more water.
All these reforms required a huge amount of money. The total cost of the reform was estimated to be around
US$ 468 million and is expected to be financed by loans (59%), grants (11%) and HMG/N (30%) to be spent
between 2002 and 2007. This appears to be a very expensive project (US$ 300 per person in the valley). The
roles of public and private sectors in the above reform process can be understood clearly from the following
allocations of funds:
• For private company US$ 4 million to be spent under certain condition
• For system upgrading US$ 136 million
• For Melamchi tunnel US$ 328million
CHAPTER 5.0 | MELAMCHI WATER SUPPLY PROJECT
5.1 Background
In 1988, the Government of Nepal decided that a tunnel should be built from the Melamchi Valley to the
Kathmandu Valley to improve the water supply in Kathmandu, Nepal’s capital city. The Melamchi Water
Supply Project (MWSP) was initially funded by a $71 million loan from the World Bank. However, seven years
later the project stalled when it was revealed that a fraction of this amount had actually been spent.
The World Bank demanded that an operator from the private sector be brought in before further funding was
offered. This condition remained when the World Bank withdrew and the Asian Development Bank (ADB)
became the main donor. By 2006, Severn Trent Water International was the only company to have made a
valid bid for the project.
The MWSP was an expensive project funded by an extensive foreign loan, which the government would have
to repay. The tunnel was taking years to happen and there was concern that the ordinary people of
Kathmandu, especially the 40,000 poor citizens living without a water connection, would have no say in the
design and planning of the project and no share in its potential benefits.
16 | P a g e

Since 1973, the government of Nepal has done several studies and implemented the schemes to find out the
best solution to meet the water supply demand for the rapid growth of population in the Katmandu valley. In
1988, more specific pre‐ feasibility studies were carried out for the water supply sources for the valley. Based
on these studies, the Melamchi scheme was identified as the best long‐term solution to solve the constant
water shortage in the valley. Subsequently, in 1997, the government established the Melamchi water Limited
to seek funding for and implement the Melamchi Water Supply Project. In 1998, it was replaced by the
Melamchi Water Supply Development Board (MWSDB) while some key donors, such as Asian Development
Bank, Governments of Japan and Norway took interest in funding the project. Currently the government,
through MWSDB is implementing the project.
5.2 Introduction
Melamchi Water Supply Project is much‐debated
mega project. The project was visualized in 1973.
It is an alternative to address acute water
problems of Capital Kathmandu. The Project is
located in Sindhupalchok District, but covers
Kavrepalanchok, Kathmandu, Lalitpur and
Bhaktapur. 5100 Million Litters water per day will
be diverted from snow fed Melamchi, Larke and
Yangri rivers to KTM. In Kathmandu, per day 180
Million Liters water is necessary.
The Melamchi Water Supply Project and

institutional reforms were carried forward in the period in accordance with the government’s two pronged
strategy to achieve sustainable and consumer oriented water supply and sanitation services in the Kathmandu
Valley.
The Melamchi Water Supply Project will be implemented with high priority to provide a long‐term sustainable
bulk water supply in the Kathmandu Valley. The tunnel excavation works will be carried forward and
remaining road works are also being completed. Preparatory works will also be undertaken towards the
construction of a 170MLD Water Treatment Plant in Kathmandu Valley. The operations of the water supply
and sanitation services will be handed over to the Kathmandu Upatyaka Khanepani Limited (KUKL). A major
program for repair, replacement, rehabilitation and expansion of the age‐old distribution system is planned
and being worked out to control leaks. Institutional efficiency will also be increased.
5.3 Project Aims and Objectives
With the starting of the project, it had following objectives:
Solve the chronic water supply shortage and improve the water‐supply in Kathmandu (KTM) Valley
Rehabilitate and/or replace existing water supply network and associated equipment
17 | P a g e

Provide access to clean and safe water supply ensuring good health sanitation
Establish efficient water supply networking system on a sustainable basis
Reduce water pollution through establishment of sewer and waste water treatment plants
To improve river ecology, religious sites, and cultural Ghats located at river banks by augmenting water
flow at Bagmati and its tributaries
To expand the depleting ground water sources of KTM
5.4 MWSP: Cost Estimation
The total project cost was originally estimated at US$ 464 million; JBIC, Norway and Sweden agreed to co‐
finance the project. Tunnel construction would cover 32% of the total cost, rehabilitation of the network, 46%,
and the management contract plus institutional reforms, 4%. The World Bank earlier agreed to provide
financial support to the PSP process but pulled out in mid‐2002; ADB then came in to help prepare a 5‐year
management contract.
The main cost items (base costs) are the MDS ($74.29 million), WTP ($39.33 million), BDS ($48.47 million), and
the distribution network improvements ($65.95 million). The following table gives a summary of the estimated
costs:
Foreign Local
Item Total cost
Exchange Currency
A. Base
1. Infrastructure Improvements 193.03 83.36 276.39
2. Social and Environmental Support 2.10 10.34 12.44
3. Institutional reforms 1.80 0.76 2.56
4. Project Implementation Support 24.89 7.74 32.63
Subtotal (A) 221.82 102.2 324.02
B. Contingencies
1. Physical 22.20 10.20 32.40
2. Price 21.40 9.40 30.80
Subtotal (B) 43.6 19.6 63.2
C. Interest during Construction and Fees 7.60 33.20 40.80
D. Taxes and duties 0.00 36.00 36.00
Total 273.00 191.00 464.00
Percent 58.80 41.20 100

Full cost recovery for urban water supplies is among the reforms instituted through the Melamchi project. In
2004, the government decided to increase prices annually by 15%. For the past two years the tariff has
remained the same, which means the next increase would be a whopping 30%. Consumers paying Rs 50 for
10,000 liters, for instance, would have to pay Rs 66.
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Available Budget Budget Required as Resource Gap

Sector per Three Year
FY 000 Interim Plan
2007/08 2316231 4270234 1954003
Water and 2008/09 2547854 6618883 4071029
Sanitation
Sector 2009/10 2802640 6618883 3816243
Total 7666725 17508000 9841275

The estimated project cost is US$ 465 million. The Donors for the project are ADB, JBIC (Japanese Bank of
International Cooperation), NORAD (Norwegian Agency for International Cooperation), SIDA (Swedish
International Development Cooperation Agency. Asian Development Bank (ADB) is key donor and funding on
following components:
A. Construction
B. Social and Environment
C. Consultant
The main loan for the project will be provided by Asian Development Bank. The loan of Special Drawing Right
(SDR) 93,253,000.00 ($120.0 million equivalent) will be provided with a term of 30 years including a grace
period of 8 years, and an interest charge of 1% per annum during the grace period and 1.5% per annum
thereafter. The ADB funds for the Project as well as all other funds will be provided to the utility in an equal
mix of loan and grant. Interest for the loan will be at 8% per annum repayable over 20 years including 7 years
of grace.
5.5 Financial Analysis
5.5.1 Cost Recovery Policy and Assumptions
19 | P a g e

During the preproject period, average tariffs are expected to rise from NRs6.9/m3 in 2000 to NRs12.8/m3 in
2006 (in 2000 prices) to meet cash O&M costs as well as
WTP and Cost recovery
private operator and regulatory costs. The financial
projections assume: In 1989, The town in Indonesia was facing with
same problem as currently faced in Kathmandu.
Improved collection efficiency;
The water supply system was unreliable,
Metered standpipes charged at the lifeline rate; inefficient and owning to these facts people
Users meeting payment obligations; were unwilling to pay more tariff for water
supply. Although water use was 38 m3 per
Groundwater charges for nondomestic
household, there was large no of household not
consumers;
getting water at all and those getting it ware
Wastewater charged as a 50% surcharge on the misusing it owning to low tariff
water tariff. Post‐project, average tariffs will be
The old water supply system was becoming a
nrs23.0/m3 by 2008, adequate to cover O &M,
failure in its social goal and financial part too.
debt servicing, regulatory, and private operator
costs. All nondomestic use of groundwater is To improve this situation, the government after
assumed to cease by 2008. heavy investment, introduced a newer, efficient
and reliable water supply system to the city. The

tariff was increased by 115% for domestic use
and 170% for non domestic use. Given the
reliability and effectiveness of new services the
5.5.2 Financial Internal Rate of Return
people were willing to pay for it.
The overall financial internal rate of return for the
Project is 4.7%. This may be compared with a weighted The increase in tariff rate made the consumption
average cost of capital for the Project of 0%, where the of water per household to drop form 38m3 per
onlending rate is 8% and domestic inflation is 8% month to 27 m3 per month. The water loss in
resulting in a real interest rate of 0%. Similar to other new system was significantly lesser and project
urban water supply projects, the financial internal rate of was successful both economically and
return showed sensitivity to increases in capital costs financially.
and revenues. Hence Willingness to Pay (WTP) factor plays a

major role in cost recovery of project and price
5.5.3 Financial Sustainability
increase with proper and reliable service
There are mainly three aspects of financial sustainability increases the people’s WTP factor
in connection with MWSP:
(Developing optimized water supply system for
(i) Project funding and fiscal impact on government developing countries by Grace Ukoli‐Onodipe)
budget. WSPs are frequently funded by the government
and full cost recovery especially from poor water users may not be possible even for their basic minimum
needs.
(ii) Full or partial cost recovery of project costs from project beneficiaries. WSPs, like projects in other sectors,
can hardly be sustained on government subsidy alone, without the revenue generation from the sector itself.
Cost recovery and proper design of water tariff based on the costs of supply are required.
20 | P a g e

(iii) Financial incentives are necessary to ensure participation in the project of all stakeholders. In the context
of a WSP, the participants include:
lenders who lend money for capital investment
guarantors who guarantee the loan (In public projects like WSPs, the government is often the
guarantor)
suppliers of inputs to the project
users of project output (households/industries); and the organization which sponsors and runs the
project (water enterprise)

5.6 Economic Analysis
5.6.1 with and Without the Project
The without‐project option offers a very miserable scenario for Kathmandu Valley. Since NWSC would be
unable to meet demand, piped water delivery would continue to be limited to less than 2 hours every two
days, pressures and water quality would be poor, and inequality would persist for water distribution.
Therefore, the economic price of water would rise from NRs 40/m3 currently to NRs 110/m3 in 2012.
A number of alternative options, including in‐valley storages were considered, but were found to be
impractical because of various shortcomings, such as high financial and social costs, low yield, and other
problems associated with population density and land use. The proposed design involves a low‐level tunnel,
no impoundment storage, and no hydropower, and was considered a least‐cost and least environmentally
disruptive option. Furthermore, it retains the option for low‐cost gravity expansion of supply from the Yangri
and Larke rivers and in valley storage in the future.
5.6.2 Economic Internal Rate of Return
The economic evaluation assumes base economic costs of $322 million and incremental O&M costs at 1% of
total costs plus $0.04/m3 of water production. A standard conversion factor of 0.9 is assumed. Total costs are
high because of the need to provide a sound basis for future expansion. Benefits are estimated at NRs1,500
million/year initially and increase to about NRs6,000 million/year in subsequent years.
The economic internal rate of return (EIRR) for the Project (with 170 MLD capacity) is 13.5%, while the EIRR for
the full development is 15.3%. The EIRR was tested for sensitivity to tariff levels, water losses, income growth,
nondomestic tariffs, and capital costs. The EIRR is estimated to be 10.1% at the current water loss figure of
40%, 11.9% with real income growth reduced to 1% per year, 12.9% with a 50% decrease in the nondomestic
tariffs, and 12.6% with a 10% increase in capital costs.
21 | P a g e

5.7 Project Benefit
The Project’s primary target population is the 1.5 million people (180,000 households) living in the Kathmandu
Valley. The urban inhabitants will benefit from improved water supply services with better water quality,
increased quantity, improved supply, extended service areas, more equitable water distribution, and better
customer services. These benefits will go hand in hand with raised public health, hygiene, and environmental
awareness, and improved sanitation facilities and maintenance. The Project will also accumulate positive
socioeconomic and poverty reduction benefits to the Melamchi Valley population (40,000). These will include
increased incomes from the expanded market and upgraded skills, reduced workload for women, better
education for children, and reduced incidence of trafficking of girls.
• Benefit to those people residing in the area by getting adequate supply of water
• Water supply within the context of comprehensive water resource management, institutional and
sector administration responsibilities,
• Levels of service including those to the urban poor
• Capital investment mechanisms and development plans
• Private sector participation
• Subsidies and cost recovery objectives
• Human resources development
• Public awareness and hygiene education
• Promotes the efficient use of potable water, with less ground water extraction, resulting in
environmental benefits
• With the introduction of the project and the system upgrade, people would be willing to pay more for
the facility, helping in economic feasibility.
5.8 Other factors
5.8.1 Issues in Melamchi Implementation
• Breakeven point – will take many years to achieve
• Expensive – consume 80% of total investment on water
• Diversion of Melamchi river effects the livelihood of people and ecology of the area
5.8.2 Impact on poverty
Socioeconomic surveys conducted during project preparation suggest that about 20% of households in
Kathmandu Valley live in poverty, with incomes less than NRs 6,000 per month. The major project benefits are
savings and incremental benefits accumulating to water users and to the economy, from the improved water
supply and management. An examination of the demand curves indicates that the net benefit accruing to a
poor household (benefit less tariff paid) is about the same as that accruing to a not‐so‐poor household, but
the composition of the benefits is different. The poor household has a small absolute savings benefit and a
large absolute incremental benefit. Assuming a single rate tariff, the distribution of the net benefits to
consumers is about equal to the distribution of the population. However, the relative impact on the poor is
better, with impact ratios of net benefit over income estimated at 1.6 for the poor and 0.4 for the not‐so‐
poor. Assuming a stepped tariff structure, the impact ratio for the poor increases to 1.8, while that for the not‐
so‐poor decreases to 0.3.
22 | P a g e

5.11 Cost estimates
The project is estimated to cost $464 million including contingencies, interest during construction, and taxes
and duties. Foreign exchange costs are estimated at 59% of total costs, local currency costs at 41%.
CHAPTER 6 | CONCLUSION
The benefits achieved from water supply projects should be measured more in terms of social and
economical factors rather than financial
Subsidies may be required for equity in water distribution, but not to the extent that this promotes
misuse and increases burden on the system
Participation of local communities during both design and implementation is crucial for project
efficiency, sustainability and success.
Project design should institute appropriate O & M mechanisms and properly delineate responsibilities.
Good governance and anticorruption measures contribute to a more favorable project
implementation environment.
Private sector participation should be encouraged, especially in the marketing, distribution, and
maintenance of project outputs.
23 | P a g e

REFERENCES:
1. Planning approaches in Nepal ‐ Dr. Jibgar Joshi
2. Handbook for the Economic Analysis of Water Supply Projects ‐ Asian Development Bank
3. Report and recommendation of the president to the board of directors on a proposed loan to the
kingdom of Nepal for the Melamchi water supply project ‐ Asian Development Bank
4. Designing optimal water supply systems for developing countries ‐ Grace Ukoli Onodipe, B.Sc., M.S.
5. The Economic Costs and Benefits of Investments in Municipal Water and Sanitation Infrastructure: A
Global Perspective ‐ Dale Whittington and W. M. Hanemann
6. Lecture notes ‐ Provided by Dr. Jibgar Joshi

ACKNOWLEDGEMENT
Our sincere appreciation goes to Mr. Jibgar Joshi, course coordinator of Economics, for his
encouragement in preparing this seminar report. His valuable guidance, suggestions and
wholehearted support is highly appreciable.
We highly appreciate timely assistance provided by guest lecturer, Mr. Tope Bahadur Basnet for
his valuable guidance and suggestions.
We would also like to thank program coordinator Mr. Ajaya Chandra Lal, Mr. Sudarshan
Raghubanshi , Mr. Suresh G.C and Mrs. Leela Pandey for their valuable supports and
cooperation.
Last but not the least we would like to express our sincere gratitude to all our friends who
helped us to prepare this report.

LIST OF ACRONYMS
ADB Asian Development Bank
EIA Environmental Impact Assessment
NWSC Nepal Water and Sewerage Corporation
NWSC Nepal Water Supply Corporation
KMC Kathmandu Metropolitan City
HMG His Majesty of Government
WSP Water Supply Project
IRR Internal Rate of Return
FIRR Financial Internal Rate of Return
EIRR Environmental Internal Rate of Return
NPV Net Present Value
WTP Willingness To Play
MWSP Melamchi Water Supply Project
MWSDB Melamchi Water Supply Development Project
KUKL Kathmandu Upatyaka Khanepani Limited
JBIC Japanese Bank of International Cooperation
NORAD Norwegian Agency for International Cooperation
SIDA Swedish International Development Cooperation Agency
O & M Operation and Maintenance
PPP Public Private Partnership
BDS Bulk Distribution System
MLPD Million Liters Per Day
VDC Village Development Committee
PO Private Operator

Table Of Contents
Chapter 1| INTRODUCTION ................................................................................................................................... 2
1.1 Background .................................................................................................................................................. 2
1.2 Introduction ‐ Water as economic commodity ............................................................................................ 2
1.3 Objectives ..................................................................................................................................................... 3
1.4 Scope and limitation..................................................................................................................................... 3
1.5 Methodologies ............................................................................................................................................. 3
Chapter 2 | WATER AND WATER SUPPLY .............................................................................................................. 4
2.1 Water sources .............................................................................................................................................. 4
2.2 Water supply system .................................................................................................................................... 4
Chapter 3.0 | ECONOMY BEHIND WATER SUPPLY ................................................................................................ 7
3.1 Factors involved in water Supply ................................................................................................................. 7
3.2 Financial and Economic Analysis .................................................................................................................. 8
3.3 Cost involved in Water Supply System ....................................................................................................... 12
3.4 Cost Recovery ............................................................................................................................................. 15
Chapter 4 | WATER SUPPLY SYSTEM IN KATHMANDU ........................................................................................ 15
4.1 Water Supply .............................................................................................................................................. 15
4.2 Current drinking water tariffs .................................................................................................................... 15
Chapter 5.0 | MELAMCHI WATER SUPPLY PROJECT ............................................................................................ 16
5.1 Background ................................................................................................................................................ 16
5.2 Introduction ............................................................................................................................................... 17
5.3 Project Aims and Objectives....................................................................................................................... 17
5.4 MWSP: Cost Estimation .............................................................................................................................. 18
5.5 Financial Analysis ....................................................................................................................................... 19
5.6 Economic Analysis ...................................................................................................................................... 21
5.7 Project Benefit ............................................................................................................................................ 22
5.8 Other factors .............................................................................................................................................. 22
5.11 Cost estimates .......................................................................................................................................... 23
Chapter 6 | CONCLUSION .................................................................................................................................... 23
References: ........................................................................................................................................................... 24

Economics of Water Supply

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There is no clear agreement on what does and what does not constitute a public‐private partnership (PPP).

E. Identifying benefits, both quantifiable and non‐quantifiable, and determining whether

1 Opportunity cost of raw water supply 0.05 2%

2 Storage and transmission to treatment plant 0.15 6%

3 Treatment to drinking water standards 0.15 6%

4 Distribution of water to households (including 0.75 30%

6 Wastewater treatment 0.35 14%

7 Damages associated with discharge of treated 0.05 2%

Total 2.50 100%

The Melamchi Water Supply Project and

Available Budget Budget Required as Resource Gap

urban water supply projects, the financial internal rate of was successful both economically and

return showed sensitivity to increases in capital costs financially.

and revenues. Hence Willingness to Pay (WTP) factor plays a

2. Handbook for the Economic Analysis of Water Supply Projects ‐ Asian Development Bank

4. Designing optimal water supply systems for developing countries ‐ Grace Ukoli Onodipe, B.Sc., M.S.

6. Lecture notes ‐ Provided by Dr. Jibgar Joshi

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