Regulators in emerging markets sometimes struggle with how to let utilities handle concessionary financing (e.g., grants and low-interest loans). Regulators allow utilities to place their capital investment amounts in what is called the “rate base” or “regulatory asset base (RAB).” Utilities are then allowed to earn an appropriate return on these investments. Customers pay for that return on capital through the tariff. The investment principal is also returned to the utilities through repaid depreciation, which also comes from customers through the tariff (called the return of capital).
But, when a utility receives a grant or low interest loan, should ratepayers be forced to pay the utilities a return on money the utilities did not invest? Further, should the utilities receive that money back through a depreciation allowance when it was not their investment in the first place? After all, the grant or low-cost loan is usually being offered specifically to keep the tariff as low as possible.
It might not seem fair for customers to pay so the utility can earn a return on donated money, nor for them to return that money to the utility when the utility did not provide it. However, this “disallowance” may not serve the customer well in the long run, as it increases the cost of capital for the utility and may lead to declines in service quality.
If utilities cannot earn a return on concessional finance, they lack an incentive to pursue it. This keeps the utility’s cost of capital high and limits its sources of funding. Furthermore, if utilities cannot receive a portion of donated capital back, they may not be able to replace the equipment that was purchased with donated money, at the end of its useful life.
To incentivize utilities to pursue concessional financing, and leverage it toward capital improvements, the National Association of Regulated Utility Commissioners (NARUC) suggests the following as three strategies for the regulator :
 NARUC. 2021. Primer on the Impact and Treatment of Grants, Donor Assistance, and Concessional Financing.
Richard Swanson, Ph.D.
Asset valuation and project finance expert, specializing in financial and economic analysis of civil infrastructure assets.