‘Tis the season of giving, and it seems appropriate to discuss how regulatory frameworks treat one particular type of giving: grant funding for utility infrastructure. This topic sits at the intersection of regulatory economics, development finance, and public policy, making it relevant to DHInfrastructure’s work in developed economies and emerging markets.
When international development partners—the World Bank, Asian Development Bank, USAID, the European Union, and others—provide grant funding for utility infrastructure in developing countries, a common question arises: How should these “gifted” assets be treated when setting utility tariffs? The answer seems straightforward from a regulatory economics perspective, but the reality is more nuanced than it first appears.
The regulatory economics are clear…
The principle guiding the treatment of grant-funded assets draws from well-established regulatory practice regarding Contributions in Aid of Construction (CIAC) in the United States. The rule is simple: assets funded through grants should earn neither a return ON the investment nor a return OF the investment through depreciation charges.
The logic is compelling. Why should a utility earn a return on capital it never invested? And why should customers pay depreciation charges to return capital the utility never spent? This treatment is thoroughly documented in regulatory precedent across U.S. jurisdictions.
… but the development context is complex
When we apply these principles in emerging markets, we often encounter resistance. Utility managers and development partners sometimes argue that depreciation charges should be allowed on grant-funded assets to build up funds for eventual replacement. Some even contend that including these assets in the rate base to earn a return is appropriate.
For years, I dismissed these arguments as simple misunderstandings of regulatory principles. Depreciation, after all, is meant to return invested capital, not create a slush fund for future investments. If a utility needs funding for future investments, it should either generate sufficient revenue through tariffs or be creditworthy enough to borrow against a healthy balance sheet.
But recently, I’ve realized that what appears to be a misunderstanding of regulatory principles might simply reflect different views about the purpose of infrastructure grants themselves.
Understanding Grant Intent
Some development partners view their grants as bootstrap funding—a one-time assist to help utilities achieve commercial viability. In these cases, strict application of CIAC principles makes perfect sense. The grant is a steppingstone toward self-sufficiency, not an ongoing subsidy.
Other grants, however, effectively function as humanitarian aid for utilities that are decades away from full cost recovery. In these cases, the inclination to allow some recovery on grant-funded assets becomes more understandable, if not technically correct.
Aligning intent with treatment
The solution is not to distort regulatory accounting principles but rather to align grant conditions with intended outcomes. Development partners should explicitly consider and specify how they want their grant-funded assets treated in the regulatory framework.
For utilities on the path to commercial viability, strict CIAC treatment is appropriate. For utilities requiring longer-term support, the better approach is to establish dedicated reserve funds for future capital investments. This provides greater transparency and accountability than the indirect approach of recovering depreciation on grant-funded assets. Such transparency might also help development partners better distinguish between their market-enabling investments and what is, effectively, humanitarian assistance for essential infrastructure services.
Reserve funds allow utilities and their development partners to: Plan explicitly for future investment needs, track progress toward financial sustainability, maintain clear separation between regulatory treatment and development support, and provide transparency in the use of funds.
Looking ahead
We recognize that implementing reserve funds presents its own challenges, particularly in jurisdictions where government ownership of utilities can lead to intervention in financial management. Even well-structured reserve funds can be vulnerable to “raids” during difficult times. These implementation challenges deserve their own discussion, which we’ll address in a future blog post about best practices in establishing and managing utility reserve funds.
So, in this season of giving, perhaps development partners should consider wrapping their infrastructure grants with something extra: clear intentions about how these gifts should keep on giving—or not—through the regulatory framework.