Capital Subsidies Implicit in Concessional Finance : How to Make Them More Transparent and Better Targeted

Abstract

Multilateral Development Banks (MDBs)
 finance a significant share of developing country water
 sector investments in Vietnam. Much of this financing is
 concessional and often on-lent by national governments, at
 similar concessional terms, to water utilities. This
 concessionality carries an implicit subsidy, i.e., the
 difference between MDB financing terms and commercial
 financing terms priced more in line with the underlying
 credit risks. As such concessional financing is most often
 used for capital investment projects, the implicit subsidy
 can be considered a capital subsidy. This working paper asks
 whether there is an opportunity to increase the value of
 concessional financing for water sector investments by
 making implicit capital subsidies more explicit and
 targeting them to a clearly defined public policy objective.
 Specifically, the paper (i) considers the extent to which
 implicit subsidies exist in MDB lending for the water
 sector; (ii) identifies a possible approach to quantify the
 amount of subsidies involved; (iii) outlines an emerging
 framework to make subsidies more explicit as a basis for
 improved targeting; and (iv) discusses operational
 implications. By investigating these issues, the paper
 intends to be a first step for governments and donors to
 evaluate how best to use the implicit capital subsidies
 provided by concessional financing in the water sector. The
 paper also suggests areas of future research.