Water woes

Second of two parts

This continues the discussion started on Dec. 16 on aspects of the Concession Agreements (CA), which have been tagged as “onerous” and “grossly disadvantageous” by the administration.

2. On the supposed illegal extension of the contract to 2037

The extension of the original contract is allowed under the CA and by law. This had been the subject of analysis and review in government for over a year in 2008/09: at the Metropolitan Waterworks and Sewerage System (MWSS) all the way to the Board; by the Department of Finance under Secretary Gary Teves, assisted by Undersecretary Jeremiah Paul and Director Soledad Cruz; by the Department of Justice under Secretary Raul Gonzales and Government Corporate Counsel Al Agra. It was also presented to the full cabinet and went through public consultations before final approval by President Gloria Macapagal-Arroyo.

The rationale for the extension is compelling:

a.) New waste water requirements set by the Clean Water Act and later by Supreme Court mandamus requiring 100% or full sewerage coverage for the concessions, and thus more investments for these;

b.) Tariff rate impacts had to be mitigated. By extending the contract through 2037, there is a longer period of recovery of these long life investments, and thus lower annual tariff adjustments.

3. On the recoverability of the corporate income taxes from tariffs:

Much ink and paper have been spent on this subject in the course of the arbitrations.

Let me strip it down to the basics.

a.) All firms in any business, be it burgers or water service, look at after-tax returns when they decide to invest.

b.) Considering this, the framers of the Concession Agreement allowed the investors to explicitly recover business taxes, as well as capital maintenance and investment expenditures efficiently and prudently incurred, and payments corresponding to debt service on the MWSS loans and concessionaire loans as part of its expenditures.

And for these to earn a rate of return after tax that is comparable to those of operators of long-term infrastructure concession arrangements in other countries having a credit standing similar to that of the Philippines. This rate of return, called “Appropriate Discount Rate” or ADR under the concession agreement, is a weighted average of the cost of borrowing and the return to equity, is REVIEWED AND RESET EVERY FIVE YEARS (emphasis mine) and arrived at using internationally accepted methodologies.

c.) If now the MWSS/ government changes its mind, as it did after 16 years of the concession agreement, or as a result of actions of courts past or prospective, and would not allow for corporate income taxes to be recovered via tariffs, then government is obligated to restore it in some other way to be faithful to (b). This was the verdict of the last arbitration panel that heard the Manila Water case.

Item (b) was how it was presented to the bidders in 1996, how it was implemented over the years until 2013, and how it was represented to the bidders again in 2007 when the west zone concession was rebid.

This was thus the basis upon which they gave their low water tariff bids. As the CEO of MWSS during the Ramos administration explained recently in his testimony at a hearing chaired by Senator Grace Poe: “income tax as part of the expenditures that the Concessionaires may recover from MWSS led to bids at lower water rates.” In the case of Manila Water, the bid in 1996 was around P2.32 per cubic meter vs the then prevailing MWSS rate of P8.78 per cubic meter.

Indeed, until the last administration (Aquino 2) came in, it was very clear to those appointed to the MWSS and the Regulatory Office that the ADR was an after-tax rate of return. It was also very clear to regulators and government authorities before the Aquino 2 administration that during the rate-rebasing process, there are only two ways to give the concessionaires an agreed upon after-tax rate of return. One is to use what is stipulated in the concession agreement, i.e., an after-tax rate of return and include the corporate income tax in recoverable expenditures. The other is to use a before-tax (and therefore higher) rate of return and exclude corporate income taxes from the set of recoverable expenditures.

The second methodology was not given as an option in the concession agreement but is equivalent to the first, i.e., it can be shown numerically that the two methodologies will result in the same tariff. Hence, if government now wants to remove corporate income taxes from allowable recoverable expenditures, the simple solution is to adopt the second methodology from hereon. This is similar to how other regulatory regimes do it.

4. On termination

This leads me to a final point, the consequences of a unilateral termination of the contract. Not being a lawyer, and based only on my recall of PPP (Public-Private Partnership) contracts in general, MAGA, or material adverse government action, obliges government to indemnify the private parties for actions it takes that harm, prejudice, or impair the rights and reduce the benefits of investors, i.e. shareholders and creditors. In this respect, the Performance Undertaking of the Republic is key — it guarantees performance of MWSS in accordance with the CA. The CA is truly the only real asset of the two concessionaires and upon which creditors rely; their loans do not enjoy concessionaires’ parent company guarantees.

Thus, if Government disregards its obligations under the CA, banks need to protect deposits by suspending disbursements of loans to the concessionaires. This will inevitably disrupt construction of projects meant to address looming water shortages.

Down the road, it will compound the burden on the tax paying public of future snowballing arbitration awards. And much worse, it will devalue the worth of government’s contractual commitments.

This cannot but prejudice government’s Build, Build, Build program at a time when it has been gaining momentum. Besides infrastructure PPP, all other local and foreign investments that depend on the stability of government’s commitments will be hurt. Already we have seen values of shares drop sharply in the stock market, not just of concessionaires, but all firms that are highly exposed to political and regulatory risks, thus dampening investment appetite.

This is most ill timed. Now that opportunities are being opened up by the regional dispersion of foreign direct investments (FDI) due to the US-China trade wars, and in light of notable achievements of the Duterte administration in nurturing a more investment-friendly environment to create more jobs and improve our people’s lives. These wins include the robust macroeconomic conditions, 30 places rank improvement in the IFC World Bank ease of doing business index, wide ranging reforms in the tax system, the passage of the Bangsa Moro Act, the Rice Tariffication Act, the Ease of Doing Business Act, and many more. We might as well also say goodbye to the aspired for A credit rating by 2022 of Finance Secretary Carlos Dominguez III and Central Bank Governor Benjamin Diokno.

Beyond these, I shudder to think about the future of the water system in Manila should the government continue on this termination course. Heaven deliver us from a repeat of the pre-1997 water service quality courtesy of MWSS. Their continuing decades-long failure to develop any new raw water source, even to start on a new one, hardly inspires renewed confidence. (Those of us old enough can already hear echoes of the plaintive cries of the ’90s — “Tubig!”)

Let me conclude with a quote from a letter of President Fidel Ramos to President Rodrigo Duterte counselling prudence, as reported in the newspapers:

“To achieve all this, the private sector mobilized funding from both foreign and local sources depending on the word of the Philippine government that the essential conditions of adherence to the sanctity of contracts and rule of law must be observed, These are the pillars that hold together any agreement, be it between governments and/or the government and the private sector. Our word must be our bond.”

 

Romeo L. Bernardo was finance undersecretary during the Cory Aquino and Fidel Ramos administrations. He serves as a director in several listed company boards, including BPI and Globe Telecom, sister companies of Manila Water.

romeo.lopez.bernardo@gmail.com