Secure investment strategies (1)

Modern infrastructure is urgently needed to combat China’s water crisis. New regulations will help, but incentivising private spending is also crucial, argues Hu Yusha.

Strategic water management is crucial to China’s social stability, economic prosperity, food security and long-term environmental sustainability. Northern China, home to 538 million of the country’s people, a quarter of its grain production and half of its produce, is in an especially poor position. It sits in the bottom tenth of global rankings in terms of water resources, with use further limited by heavy pollution of both surface and ground water. Southern China has a greater and cleaner supply of water per capita, but the situation remains dire throughout the country.

Water scarcity threatens the ability of China’s farmers to irrigate their crops, impacting food security as well as social stability, especially in the north. Water shortages cost the country an estimated 40 to 60 billion yuan (US$5.8 billion to US$8.8 billion) in lost economic output per year. Continued scarcity and uncertainty will affect the willingness of foreign and domestic companies to invest in China. And low water quality and pervasive pollution constitute an urgent public health hazard. In 2004, it was estimated that 300 million people lacked access to safe drinking water in China. The loss in biodiversity and the ecological damage already caused by water pollution and poor water management make the current situation even more grievous.

A comprehensive and strategic plan to combat China’s growing water-scarcity and water-quality problems must tackle the challenges facing all water users – municipal, industrial and agricultural. In the agricultural sector, more sustainable use of fertilisers, pesticides and herbicides is needed to reduce non-point source pollution that leaches into the watershed. Inefficient irrigation techniques applied by a fragmented sector largely made up of small-scale farmers also exacerbate water scarcity issues.

In the municipal and industrial sectors, improvement must include commitment to a sustained surge in water-infrastructure development, where significant technological and operational advances are required in water treatment, distribution and collection. To date, China’s efforts in pollution mitigation have focused on improvements in the municipal and industrial water sectors. As a result of the money and political will that China’s government has spent on this effort, the sector is beginning to see significant changes, which is resulting in opportunities for new approaches to be effective.

New paths forward for the development of municipal and industrial water infrastructure can increase the effectiveness of further government investment, both accelerating growth in the sector and providing a necessary opportunity for the government to expand its focus into other arenas, such as agriculture. Ultimately, the acceleration of water infrastructure development is important not only for the effective management of water resources but also for providing a buttress for China’s social and economic security.

China has not ignored its growing water crisis. In 1988, it created the first version of its National Water Law and, in 2000, set ambitious targets for the reduction of Chemical Oxygen Demand (COD) – the most prevalent measure of water pollution in China – as part of the 10th Five-Year Plan. COD is an indirect measure of the amount of suspended organic matter in a water sample; high organic content can lead to algal blooms and often indicates the presence of water-borne pathogens. China aimed to achieve a 10% reduction in the COD level of municipal and industrial wastewater discharge by 2005. This goal has carried over into the 11th Five-Year Plan, which promises an additional 10% reduction by the end of 2010.

China has also greatly expanded the number of regulations that govern water quality and management, making standards more stringent for wastewater discharge. It aims to decrease the percentage that is released without being treated at all, raising the rate of municipal wastewater treatment to 70% by the end of 2010. To address scarcity, it has set goals of reducing water consumption by 60% per unit of GDP by 2020 and achieving 20% water reuse in water-scarce northern cities.

All of these numbers and reduction targets point toward a tremendous build-up of political momentum. Meeting these goals will require new infrastructure, better technology in existing assets – so that more stringent levels of treatment can be reached – plus new management techniques and equipment to reach greater efficiency in conveyance.

However, the 10th Five-Year Plan saw extremely limited progress in all of these areas. This can be seen in the introduction of the 11th Five-Year, which plainly states that “The environmental protection targets of the ‘10th Five-Year Plan’ period had not been met.” Between 2000 and 2005, China claimed to achieve a 2.3% reduction in municipal and industrial COD, when it was aiming for a 10% cut. Similarly, more than a quarter of monitored surface water in China was graded unfit for human contact or use, and 62% failed to meet minimum standards for grade three quality, a level that is recommended for use only as a “second class” drinking-water source.

Furthermore, recent statistics have emerged to challenge even the lukewarm progress that was previously recorded. A nationwide pollution survey released in February of this year, which greatly increased the scale and scope of previous government studies, found that 2007 levels of industrial and municipal COD were 5.3% higher than previously reported, making it highly unlikely that there was actually a 2.3% reduction in COD between 2000 and 2005.

Clearly, improving water quality may not be as straightforward as simply building more infrastructure, upgrading equipment and increasing efficiency. The 10th Five-Year Plan’s failure to meet policy goals points to the existence of overwhelming challenges that have stood in the way of rapid progress. However, there have also been positive trends emerging during the present five-year plan period. When measuring COD with methodologies similar to those used for the 10th Five-Year Plan, China found that the level in 2007 was 6.6% down on 2005 figures, compared with the 2.3% reduction reported in the 10th Five-Year period. This significant decrease suggests that differences in policy between the 10th and 11th Five-Year Plans are beginning to have an effect on the pollution discharged from municipal and industrial sources. Examining differences in policy between the two planning periods can shed light on how to accelerate this trend and increase the development of infrastructure for the 12th Five-Year Plan.

One of the central problems facing the construction and operation of water infrastructure is the price of water that is paid by the end user. In order to make water a universally accessible good, the National Development and Reform Commission (NDRC) has traditionally heavily subsidised and regulated its price for all users, be they residential, industrial or agricultural.

However, low water tariffs often make it impossible for utilities and water companies to recover their capital expenditure through the collection of drinking and wastewater fees. In 2004, it was estimated that only 40% of municipal water utilities achieved a positive net income. These economics predictably discourage private-sector involvement, placing the investment burden more heavily on the public sector and, ultimately, taxpayers. In order to improve this situation and, in the long-term, create incentives for water-infrastructure development that are not dependent on political will, the government has recently made efforts to increase water prices and improve the ability of utilities to achieve cost recovery.

Water tariffs differ based on use, with industrial users typically subject to higher water prices than municipal or residential users, who pay still more than agricultural users. The reasoning for these differences is two-fold. The first consideration is economic: industrial wastewater can be more expensive to treat than municipal wastewater, while water used for irrigation is neither treated before being added back to the environment nor requires as much treatment prior to use. The second, and more significant, reason is socioeconomic: access to water is a basic right. Therefore, controlling affordability remains central to residential prices. The problem of affordability is even more acute in the agricultural sector, where small-scale subsistence farmers require large volumes of water for irrigation. Water price reform can then have a direct and dramatic impact on livelihood and, in turn, on levels of social unrest.

Within these limits, water tariffs have still seen dramatic changes in the past decade. In Tianjin, industrial tariffs almost tripled between 2000 and 2004, rising from 2 yuan (US$0.29) per cubic metre to 5.6 yuan (US$0.82) per cubic metre. Beijing, which currently has the highest municipal water tariffs in China, has been steadily increasing its rate from 0.30 yuan (US$0.04) per cubic metre in 1998 to the current 4 yuan (US$0.59) per cubic metre, initiating steep increases in the last year due to water shortages. Smaller cities have been following suit; Harbin, in north-east China, has recently moved forward with price increases that will raise residential user fees to 3.2 yuan (US$0.47) per cubic metre, though it has had to grapple with popular opposition to the scheme.

Tiered price changes, in which the price the customer pays is dependent on how much water they use, help to lessen the blow for the poor. The private sector has responded to these policy initiatives enthusiastically, with concrete moves to capture the market in anticipation of tariffs that will allow not only cost recovery but also reasonable profit margins. In 2007, Veolia Water offered 1.7 billion yuan (US$249 million) for a joint venture with the Lanzhou Water Supply Group, which represented a 1.4 billion yuan (US$205 million) premium over the asset price. High premiums that have recently been paid by Veolia and other firms provide evidence of optimism and interest from the private sector that are a direct result of price reform.

Hu Yusha recently completed a Fulbright fellowship at the Division of Environmental Policy & Management of Tsinghua University in Beijing.

An earlier version of this article was published in China Security as “Foreign Investment in China’s Water Infrastructure: A New Strategy for National Security”. It is used here with permission.

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Homepage image from Yellow River shows premier Wen Jiabao spraying wheatland in Henan province.