As water supply and sanitation (WSS) services are natural monopolies and have significant externalities, some form of regulation is needed regardless of the institutional structure of provision. Economic regulation refers to the organizations and rules that determine allowed tariffs and required service standards. Regulation and monitoring of performance can increase transparency and pressure for improved performance. Government ownership is another way of doing the same thing. Regulation can only complement ownership, not replace it.

Key Challenges
Effective regulation requires the ability to reward good performance and punish poor performance. Private utilities are regulated to control their monopoly power. If a regulator refuses to grant a tariff increase to a private utility that it finds inefficient, the utility’s owners may be moved to increase efficiency because the refusal threatens their profits.

Government ownership is another way of doing the same thing. For public utilities, regulation can only complement ownership, not replace it. Independent regulation of public utilities has often failed to deliver expected outcomes because regulators cannot sanction these utilities effectively. If a publicly owned utility is refused a tariff increase, the government-owner will likely cover the deficit through taxes or a cut back on expenditure – neither of which would serve the public interest.

A government that wants to separate ownership from policymaking and regulatory functions has a range of options – from having no regulatory oversight to having a full-fledged “independent regulator.” In-between options include having a unit in a government ministry that develops a competence in water utility monitoring, or an independent body that reports publicly on the utility’s efficiency and performance but does not set tariffs and service standards. Whichever option is chosen should build on existing competencies and incorporate ways to encourage good performance.

Developing robust regulatory frameworks and strong regulatory institutions is complex and time-consuming. Governments are often reluctant to transfer real independence in decision making to regulatory authorities, given the political dimension of water supply services. In many countries it will therefore be necessary to accept that regulators have limited capacity and independence, and pursue complementary approaches to provide stability and predictability in the regulatory regime – limiting the amount of discretion that regulatory bodies have in setting prices and key parameters.

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World Bank Response
The World Bank supports the definition and implementation of reform strategies that encompass many elements, including regulation. The strengthening of local governments and development of regulatory capacity is a central feature of most World Bank WSS projects.