But the director-general of Ofwat also said that the rise in share prices of many companies in the sector supported his belief that the industry could live with the proposed one-off 15 to 20 per cent cut in bills.
Initially, share prices fell sharply on news of the regulator's planned pounds 40 to pounds 50 cut in bills from April 2000. But they later staged a partial recovery. "The City does not appear to believe that these proposals are unfinanceable," Mr Byatt said.
He added that the rate of increase in dividend payments by the companies had been unsustainable in the past, but declined to say how they should adjust their dividend policies.
The regulator plans to allow the companies a lower rate of return than they now enjoy and to increase the proportion of their investment funded by debt rather than equity.
Mr Byatt proposes a rate of return for the period from 2000 to 2005 of between 4 and 5.5 per cent compared with a current range of 5 to 6 per cent. His new price formula assumes that water companies can save 2 to 4 per cent a year in operating costs, and make efficiency gains in capital expenditure of 10 to 15 per cent in the five-year period.
The price cuts drew a hostile response from water companies. Severn Trent, which is facing a pounds 150m to pounds 200m cut in income, said it was "very disappointed" and that it would challenge key assumptions behind Mr Byatt's calculations.
Mr Byatt said he believed that the water companies could afford to cut prices at the same time as funding a total investment programme of pounds 16bn, of which pounds 8.5bn relates to improvements in quality.
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