Financial Analysis

Tamil Nadu Urban Flagship Investment Program (RRP IND 49107-003)

FINANCIAL ANALYSIS

I. INTRODUCTION AND METHODOLOGY

A. Introduction

1. A financial analysis was conducted for the proposed Tranche 1 of the Tamil Nadu Urban Flagship Investment Program (program) in accordance with Asian Development Bank (ADB) guidelines.1

2. The proposed investment program uses a multitranche financing facility (MFF) financing modality. The MFF will focus on the improvement of water supply and sewerage sectors in project cities in Tamil Nadu, with the following outputs: (i) climate-resilient sewage collection and treatment, and drainage systems developed in at least eight cities; (ii) water supply systems in at least five cities improved with smart features; and (iii) institutional capacity, public awareness, and urban governance strengthened. Tranche 1 is planned to be implemented in six cities of Tamil Nadu, including: (i) Chennai (water supply and sewerage); (ii) Coimbatore (sewerage), (iii) Rajapalayam (sewerage), (iv) Tiruchirapalli (sewerage), (v) Tirunelveli (sewerage), and (vi) Vellore (sewerage).

B. Methodology

3. A financial analysis generally assesses the ability of a project to meet its costs, including capital and operation and maintenance (O&M) expenditures, out of its revenue streams. However, the approach taken by the Government of Tamil Nadu (GOTN) to water supply and sewerage tariffs is not premised on full cost recovery. Once Tranche 1 is completed, the five project urban local bodies (ULBs) and Chennai Metro Water Supply and Sewerage Board (CMWSSB) will operate and maintain the developed assets. 2 The financial analysis focused on the cash flow of the subprojects to assess whether O&M costs could be covered by tariff revenues. This analysis also: (i) reviewed the historical financial performance of the operating agencies and (ii) prepared a financial forecast to determine whether the operating agencies could operate and maintain the assets following completion of Tranche 1.

II. FINANCIAL ANALYSIS OF TRANCHE 1

A. Proposed User Charges and Affordability Analysis

4. Water and sewerage charges in Chennai are specified in the CMWSSB tariff notification. Tariffs were last revised in 1998. The current flat tariff for domestic consumers for combined water and sewerage is ₹50 per month per connection in Chennai. Water and sewerage taxes are 7% of the assessed annual rental value.

5. In the project ULBs (with the exception of Rajapalayam Municipality) sewerage tariffs are in place and notified in sewerage-available areas.3 Rajapalayam Municipality is finalizing its

1 ADB. 2005. Guidelines for the Financial Management and Analysis of Projects. Manila. 2 The ULBs are Coimbatore Municipal Corporation (CMC), Tirunelveli Municipal Corporation (TNMC), Vellore Municipal Corporation (VMC), Tiruchirapalli Municipal Corporation (TMC), and Rajapalayam Municipality. CMWSSB is responsible for the operation and maintenance of water supply and sewerage systems in Chennai. 3 CMC notified sewerage tariffs in June 2017. In TNMC, TMC, and VMC, sewerage tariffs are also in place in areas already having sewerage system. These tariffs are based on the property tax paid by the property owners.

2 proposed sewerage tariffs,4 which will be implemented once the proposed sewerage scheme is completed. In addition, a water supply and drainage tax is collected as part of the property tax.

B. Affordability Analysis

8. The average monthly household water tariff is ₹30 in Chennai; in 2017 the willingness to pay (WTP) for improved water supply was ₹73 for slum and ₹88 for non-slum households.5 Following implementation of an improved water supply through Tranche 1, CMWSSB plans to introduce a volumetric tariff in Chennai. Other project cities currently have flat rates for water supply of ₹125–₹200 per month. Sewerage components will be implemented in areas that presently lack sewerage systems. The sewerage tariff WTP is ₹74–₹100. Sewerage tariffs implemented in other parts of the project cities will be introduced in the project areas.6

9. Slum households currently pay about 0.3%–1.7% of their income for water supply and sewerage, and this is forecasted to increase to 1.3%–3.3% in 2023 when operations start; costs for non-slum households of 0.5%–1.6% of monthly income are projected (Table 1). The proposed water supply and sewerage tariffs are affordable for all income categories, using a generally accepted benchmark for India of 5% of monthly household income.7

Table 1: Water Charges, Usage and Average Household Income Existing (2017) Proposed (2024)a Item Chennai Coimba Thirune-Vellore Trichi- Rajapa- Chen- Coim- Thiru- Vellore Trichi- Rajapa tore lveli rapalli layam nai batore nelveli rapalli -layam Water Bill 30.0 125.0 125.0 125.0 200.0 62.5 149.5 137.5 137.5 137.5 220.0 150.0 (₹/HH/month) Sewerage Bill 49.5 456.0 137.5 276.4 155.5 119.1 (₹/HH/month) Total 30.0 125.0 125.0 125.0 200.0 62.5 199.0 593.5 275.0 413.9 375.5 269.1 HHI: Slum 11,394 13,372 11,227 12,000 12,000 12,000 15,269 17,920 15,045 16,081 16,081 16,081 (₹/month) WSB % 0.3% 0.9% 1.1% 1.0% 1.7% 0.5% 1.3% 3.3% 1.8% 2.6% 2.3% 1.7% HHI: Non-Slum 27,044 28,438 24,118 26,660 26,660 26,660 36,242 38,110 32,320 35,727 35,727 35,727 (₹/month) WSB % 0.1% 0.4% 0.5% 0.5% 0.8% 0.2% 0.5% 1.6% 0.9% 1.2% 1.1% 0.8% HH = household, HHI = household income, WSB = water and sewerage bill. a 2024 is the operation start year for the project. Source: Chennai Metro Water Supply and Sewerage Board; project urban local bodies; ADB. 2017. Baseline Socio- Economic Survey Report for Chennai City. Consultant’s report. Manila (TA 9022-IND); and Asian Development Bank estimates.

III. OPERATION AND MAINTENANCE COST RECOVERY ANALYSIS

10. Water supply and sewerage subproject cash flows are projected for a 20-year operating period, using estimated tariff revenue and O&M expenditures, and the following assumptions: (i) all costs are based on nominal prices and converted at $1 = ₹64.3; (ii) for the water supply component, the implementation of a volumetric tariff was considered from 2024 in line with CMWSSB’s plan;

4 Rajapalayam Municipality has prepared the tariff proposal and this is expected to be approved in 2018. 5 ADB. 2017. India: State-Level Support for National Flagship Urban Programs. Baseline Socio-Economic Survey Report. Manila. (TA 9022-IND). 6 All project ULBs except CMWSSB periodically revise the water and sewer tariff (once every 5 years on average) and agreed to implement the revised tariff in the project areas. 7 The World Health Organization uses an expenditure benchmark of 5% of monthly household income. Water and Sanitation Program. 2011. Cost Recovery in Urban Water Services: Select Experiences in Indian Cities. Delhi.

(iii) existing water and sewerage tariffs were assumed to increase at 10% every 5 years;8 (iv) O&M costs included personnel, maintenance, administrative, chemicals, power, and establishment costs; and (v) based on existing performance, collection efficiency for water supply and sewerage are assumed at 80% for project ULBs and 90% for CMWSSB.

11. The cash flow projection shows that water supply and sewerage subprojects in the project ULBs will recover full O&M costs from the operation start year of 2024. This underlines the sustainability of all assets established under Tranche 1 (Table 2).

Table 2: Operation and Maintenance Recovery Analysis for Water Supply and Sewerage Subprojects ($ million) CMWSSB-Water Supply CMWSSB-Sewerage CMC-Sewerage Details 2024 2026 2028 2030 2024 2026 2028 2030 2024 2026 2028 2030 Water Tariff Income 0.96 1.01 1.07 1.12 0.21 0.23 0.26 0.28 3.19 3.87 5.05 5.23 O&M Expenses 0.67 0.73 0.79 0.86 0.16 0.17 0.19 0.20 2.56 2.79 3.04 3.32 Surplus/(deficit) 0.29 0.29 0.28 0.26 0.05 0.06 0.08 0.08 0.64 1.08 2.01 1.92 Operating Ratio 69.3% 71.6% 74.1% 76.9% 74.3% 74.3% 70.8% 73.1% 80.0% 72.0% 60.2% 63.4% TNMC-Sewerage TMC-Sewerage VMC-Sewerage RM-Sewerage Details 2024 2026 2028 2024 2026 2028 2024 2026 2028 2024 2026 2028 Water Tariff Income 1.54 1.84 2.36 0.71 0.88 1.16 1.48 1.81 2.35 0.65 0.78 1.01 O&M Expenses 1.00 1.21 1.32 0.49 0.54 0.59 1.06 1.15 1.26 0.44 0.48 0.52 Surplus/(deficit) 0.55 0.63 1.04 0.22 0.34 0.57 0.42 0.66 1.10 0.22 0.31 0.49 Operating Ratio 64.7% 65.7% 55.9% 69.0% 61.2% 50.6% 71.5% 63.6% 53.4% 67.0% 61.0% 51.5% CMC = Coimbatore Municipal Corporation, CMWSSB = Chennai Metro Water Supply and Sewerage Board, O&M = operation and maintenance, TMC = Tiruchirapalli Municipal Corporation, TNMC = Tirunelveli Municipal Corporation, VMC = Vellore Municipal Corporation, RM = Rajapalayam Municipality Sources: Asian Development Bank estimates; and ADB. 2017. Baseline Socio-Economic Survey Report for Chennai City. Consultant’s report. Manila (TA 9022-IND).

IV. FINANCIAL PERFORMANCE AND PROJECTION OF CHENNAI METROPOLITAN WATER SUPPLY AND SEWERAGE BOARD AND PROJECT URBAN LOCAL BODIES

A. Chennai Metro Water Supply and Sewerage Board

13. The financial analysis assessed the impact of Tranche 1 subprojects on the overall financial capacity of CMWSSB. A financial performance analysis of CMWSSB operations for 2012-2016 (Table 3) indicates; (i) CMWSSB had an operational surplus only when grants were provided from GOTN; (ii) CMWSSB repaid the principal and interest for all non-GOTN loans, but no repayment of principal or interest on GOTN loans has been made; and (iii) water and sewerage revenues grew at a compound annual growth rate of 4.6% for 2012-2016. Water and sewerage tax revenues (levied at 7% on property tax) grew at a compound annual growth rate of 10.0%.

14. The analysis also developed financial projections for CMWSSB operations for a 20-year period beginning upon Tranche 1 completion, assuming regular tariff revisions of 10% every 5 years (Table 3). The financial projections show that CMWSSB would need continued GOTN support to cover operational expenditures. In addition, CMWSSB needs to prepare systematic

8 Tariff revisions are the responsibility of CMWSSB in Chennai and of ULB councils in other cities, subject to GOTN approval. In Chennai, CMWSSB has tried to revise tariffs periodically, but changes have not been approved by GOTN. In other cities, tariffs are revised every 5 or more years (in 2005 and 2010 in Tirunelveli, 2007 and 2013 in Coimbatore, and 2008 and 2014 in Tiruchirapalli).

4 plans to enhance revenues and reduce costs, including by implementing volumetric water tariffs (with periodic revisions), and by improving collection efficiency.9

Table 3: Financial Performance and Projections of Chennai Metropolitan Water Supply and Sewerage Board ($ million) Existing Projected Particulars 2012 2014 2016 2024 2027 2032 2037 2043 I. Revenue - Water & Sewerage Fee 37.0 40.6 44.3 64.9 74.3 93.1 116.8 153.2 - Water & Sewerage Tax 16.1 17.3 25.4 54.6 72.6 116.9 188.3 333.6 - Others Income 10.9 13.2 10.9 10.9 10.9 10.9 10.9 10.9 - Grants and Subsidies 18.3 40.0 53.4 114.5 152.4 245.5 395.4 703.4 Total 82.3 111.2 134.1 244.8 310.2 466.4 711.4 1,1201.1 II. Expenditure - Salaries & wages 24.7 24.5 30.7 47.3 55.7 73.0 95.8 132.6 - Power 9.9 12.1 28.0 60.0 79.9 128.6 207.1 366.9 - Purchase of Desalinated 19.6 26.8 28.9 62.0 82.5 132.9 214.0 379.1 Water 20.6 39.4 33.2 55.7 73.3 115.9 183.7 319.9 - O&M & Others Total 74.7 102.9 120.8 225.0 291.3 450.4 700.6 1,198.5 Surplus/Deficit 7.5 8.4 13.3 19.8 18.9 16.0 10.8 2.5 III. Debt Service 14.6 14.1 13.9 28.1 21.7 0.4 0.1 Surplus/Deficit (7.1) (5.7) (0.6) (8.3) (2.9) 15.6 10.7 2.5 Operating ratioa 90.9% 92.5% 90.1% 91.9% 93.9% 96.6% 98.5% 99.8% ( ) = negative, O&M = operation and maintenance a Calculated by dividing operating expenditure by revenues. Source: Asian Development Bank estimates based on Chennai Metropolitan Water Supply and Sewerage Board’s audited financial statements for 2012–2015 and provisional financial statements for 2016.

B. Project Urban Local Bodies

15. Analysis of the financial performance of the project ULBs for fiscal year (FY) 2012–FY2016 shows that all ULBs have depended on GOTN grants to meet their operational expenses (Table 4).

Table 4: Financial Performance of Urban Local Bodies ($ million) CMC TNMC TMC VMC RM Particulars 2012 2016 2012 2016 2012 2016 2012 2016 2012 2016 I. Revenue - Tax and non-tax 22.5 42.0 5.8 8.9 10.2 17.5 2.5 4.3 1.4 2.1 - Water & sewerage fees 5.7 8.5 2.0 2.2 2.7 4.5 0.3 0.6 0.3 0.5 - Assigned revenue 2.7 6.1 0.6 1.2 1.5 2.1 0.2 0.6 0.0 0.1 - Devolutions and grants 15.0 21.4 5.8 7.6 10.1 16.9 3.8 7.5 1.8 2.8 Total 46.0 78.1 14.2 19.8 24.5 41.0 6.8 12.9 3.4 5.4 II. Expenditure - Salaries & wages 16.2 22.9 5.6 10.9 11.0 15.9 3.3 3.1 1.3 2.4 - O&M & others 10.3 31.4 2.8 7.5 3.1 8.0 1.6 7.6 0.5 0.9 - Water & sewerage O&M 4.6 10.9 0.8 1.6 1.6 3.9 0.5 1.3 0.1 0.2 Total 31.2 65.2 9.2 20.0 15.7 27.9 5.4 12.0 1.9 3.5 Surplus/Deficit 14.8 12.9 5.0 (0.2) 8.8 13.1 1.3 0.9 1.5 1.8 III. Debt Service 0.8 3.6 0.7 0.9 2.1 1.7 0.2 0.8 0.5 0.5 Surplus/Deficit 14.0 9.3 4.3 (1.0) 6.6 11.4 1.1 0.2 0.9 1.4 Operating ratioa 67.8% 83.4% 65.0% 100.9% 64.2% 68.0% 80.3% 92.8% 56.8% 65.6% ( ) = negative, CMC = Coimbatore Municipal Corporation, O&M = operation and maintenance, RM = Rajapalayam Municipality, TMC = Tiruchirapalli Municipal Corporation, TNMC = Tirunelveli Municipal Corporation, VMC = Vellore Municipal Corporation. a Calculated by dividing operating expenditure by revenues. Source: CMC, TNMC, and VMC figures based on audited financial statements for FY2012–FY2015, and provisional accounts for FY2016. TMC and RM figures based on audited financial statements for FY2012–FY2016.

9 Although the tariff has not been revised since 1998, CMWSSB has prepared a plan to revise the tariff for O&M cost recovery; the proposal is pending approval of GOTN.

16. The analysis also developed financial projections for the five project ULBs for a 20-year operational period beginning upon Tranche 1 completion. All ULBs would be dependent on continued GOTN grants to sustain their operations (Table 5).

Table 5: Financial Projections of Urban Local Bodies CMC TNMC TMC VMC RM Particulars 2024 2034 2024 2034 2024 2034 2024 2034 2024 2034 I. Revenue - Tax & non-tax 87.3 217.6 19.1 49.6 29.4 57.9 9.2 23.8 4.5 11.7 - Water & sewerage fees 20.2 46.4 6.2 14.8 7.3 12.2 2.7 6.0 1.6 3.7 - Assigned revenue 13.1 33.9 2.6 6.7 4.1 9.8 1.4 3.5 0.2 0.4 - Devolutions and grants 41.1 93.0 16.2 42.0 36.2 93.8 16.0 41.5 4.7 9.3 Total 161.6 390.8 44.1 113.0 77.0 173.7 29.2 74.7 11.0 25.1 II. Expenditure - Salaries & wages 49.0 127.2 23.4 60.7 34.1 88.3 6.7 17.3 5.1 13.3 - O&M & others 67.3 174.7 14.9 35.2 17.2 44.7 16.3 42.3 2.0 5.1 - Water & sewerage O&M 25.9 64.4 4.2 9.4 8.9 22.6 3.8 8.7 0.9 1.9 Total 142.2 366.3 42.5 105.3 60.2 155.7 26.8 68.3 8.0 20.3 Surplus/Deficit 19.4 24.6 1.5 7.7 16.8 18.1 2.4 6.4 3.0 4.8 III. Debt Service 7.6 3.0 4.0 2.5 4.3 2.6 2.1 1.2 1.2 0.8 Surplus/Deficit 11.7 21.6 (2.5) 5.2 12.5 15.4 0.3 5.2 1.8 4.0 Operating ratio (%)a 88.0% 93.7% 96.5% 93.2% 78.2% 89.6% 91.7% 91.4% 72.7% 80.9% ( ) = negative, CMC = Coimbatore Municipal Corporation, O&M = operation and maintenance, RM = Rajapalayam Municipality, TMC = Tiruchirapalli Municipal Corporation, TNMC = Tirunelveli Municipal Corporation, VMC = Vellore Municipal Corporation. a Calculated by dividing operating expenditure by revenues. Source: Estimates based on financial statements of CMC, TNMC and TMC.

V. FINANCIAL CAPACITY OF THE GOVERNMENT OF TAMIL NADU

17. The GOTN experienced a revenue deficit during 2014–2016, but is projected to eliminate the deficit by 2020 through increased tax and non-tax revenue mobilization, and its share of central taxes and grants.10 The GOTN projects a revenue surplus from 2021 onwards (Table 6). GOTN’s budget allocation for water supply and sanitation has increased from $81 million in 2015 to $151 million in 2017,11 underling its commitment to basic urban infrastructure, including under Tranche 1.

Table 6: Financial Performance and Projections of Government of Tamil Nadu ($ million) Existing Projections Particulars 2012 2014 2016 2021 2023 2025 I. Revenue Receipts - Tax and non-tax revenues 10,144.9 12,923.7 13,909.1 24,858.1 31,372.2 34,723.2 - Transfer of central taxes 1,978.4 2,466.6 3,167.0 7,880.4 11,347.8 16,340.8 - Grants from Government of 1,133.7 1,419.3 2,996.7 7,772.8 11,380.1 16,661.6 India Total 13,256.9 16,809.7 20,072.8 40,511.3 54,100.0 72,607.0 II. Revenue Expenditure - Salary 4,023.0 4,753.2 5,659.9 9,115.3 11,029.5 13,345.7 - Pension 1,827.8 2,167.0 2,681.7 4,318.8 5,225.8 6,323.2 - Interest Payment 1,380.3 1,930.1 2,705.9 3,136.9 3,328.0 3,530.6 - Others 5,813.6 8,237.9 10,890.2 23,876.1 32,684.0 44,741.1 Total 13,044.7 17,088.2 21,937.6 40,447.1 52,267.2 67,940.6 Surplus/(deficit) 212.2 (278.5) (1,864.8) 64.2 1,832.8 4,666.3 Source: Government of Tamil Nadu. 2016. Report of the Comptroller and Auditor General of India on State Finances for the year ended March 2016.

10 Amended Fiscal Responsibility and Budgetary Management Act (2016). 11 Estimated from Reserve Bank of India. 2017. State Finances: A Study of Budgets 2016-17.