Water woes — just the facts

First of two parts

The President unleashed a torrent of expletives on the two Metro Manila water concessionaires for supposedly “onerous” contracts. I tried to understand why. After all, this major privatization, undertaken in 1997 during the Ramos administration to respond to a water crisis, was a celebrated case of a working public private partnership and was awarded multiple times for the transparency and design of the bid process and for its success in addressing the core problem of poor water services provision, especially its inclusive business model of connecting millions of poor communities. The concession agreements were subsequently extended during the Arroyo term in recognition of this success and in order to enable more investments in water and sewerage services to be done, pursuant to the Clean Water Act.

So indeed, why? The best I can come up with is this: the President felt he was dealt a bad hand through no fault of his and has not been properly briefed on the background and history of this water PPP.

More specifically, the missteps and inactions of the last administration that have led to:

a) non-investment in raw water that resulted in the water shortage last summer and;

b) non-adjustment in tariff rates in accordance with the contract based on a flawed re-interpretation of the treatment of corporate income taxes (which deviated from the practice over the past 17 years) that has resulted in government losing in international arbitration, which now this administration has to pay.

(See my column: Never waste a good crisis, April 2019, BusinessWorld. https://www.bworldonline.com/never-waste-a-good-crisis-2/).

On top of this frustration for being in the hot seat, the President’s anger may have been driven by certain mis-appreciation of the facts about the water service business.

1) Is water free?

Yes, in its natural state. But to deliver safe drinking water to the taps in our homes require investments in storage and treatment facilities and underground distribution networks. These investments that yield high economic and social returns are not free.

Ask the 3.7 million mostly poor informal settlers who were unconnected to the pre-privatization water distribution system. They had to either take a whole morning going to a natural water source or buy their water by the pail at 10 times the cost of what they are now paying under the multi-awarded “Tubig Para sa Barangay” in the east zone where they were organized by Manila Water Co., Inc. into communities and connected to its network. Add to this, the medicine bills and lost hours of work and missed classes when they’s get sick from dysentery due to poor water quality pre-1997.

The reality is that it takes billions of pesos of investments to bring clean potable water to our homes. And, unlike businesses that have declining costs with volume, water is the opposite. As the concessionaires try to connect farther communities in hilly areas with sparser populations, unit costs go up, especially with increased demand for sewerage service which, incidentally, costs three times that of fresh water to put in place.

What is the score card of the two concessionaires in connecting people and in reducing the wastage from leakages and theft (non-revenue water or NRW)?

Here it is. (See the Table. — Ed.)

To achieve all these, the Manila Water and Maynilad have had to invest P166 billion and P208 billion respectively. Critics like giving out profit numbers of these companies without reference to the huge amounts of their investments. When that is done, the average Return on Invested Capital (ROIC) is around eight to 10 percent annually during the past five years, which is comparable to water concessions in other emerging market countries.

And by reducing the NRW through these massive investments and more efficient management, they have prevented a water shortage despite the failure of past administrations to put up a single new water source. Indeed, not a single stone was turned or shovel lifted, after tying the hands of the concessionaires from making such investments.

The amount of incremental water provided by the two concessionaires by reducing NRW is equivalent to the water output of three Kaliwa dams. The one Kaliwa dam that the last administration has talked about for six years and this one for three, but which has yet to be started, will cost P 12.2 billion using Chinese ODA.

2) Contracts were “onerous”?

The facts are that these contracts were diligently prepared and carefully reviewed by various agencies and professionals in government and expert consultants.

Preparing, reviewing, approving, and signing authorities for the original contract included: then MWSS (Metropolitan Waterworks and Sewerage System) management led by Dr. Angel Lazaro III, the entire MWSS Board led by Department of Public Works and Highways (DPWH) Secretary Gregorio Vigilar and his Chief of Staff Mark Dumol, Dept of Finance Secretary Roberto de Ocampo and undersecretaries, the Cabinet Level Privatization Committee, the National Economic and Development Authority (NEDA) Board whose secretariat was headed by Planning Secretary Cielito Habito, Justice Secretary Teofisto Guingona and his Usec Presbyterio Velasco, Chief Presidential Legal Counsel Rene Cayetano, Corporate Legal Counsel Oscar Garcia, Executive Secretary Ruben Torres, and, finally President Ramos himself (who is known for demanding CSW — complete staff work). A similar though less lengthy process was followed on the contract extension which was signed by President Gloria Arroyo and Finance Secretary Gary Teves. Additionally, consultants were engaged — the key ones were International Finance Corporation/World Bank (as the principal adviser for privatization), which in turn engaged NERA from the UK (as economic advisers), Sogreah, a French engineering firm (as process consultants), audit firm Punongbayan and Araullo, and lawyers ACCRALAW (led by attorney Eusebio Tan) and Cleary Gottlieb (led by Lee Buccheit) over a period of a year.

The concessionaires were asked to bid on this contract competitively in both 1996 (there were four highly qualified consortia involving the best names locally, and the leading global water companies which bid) and then again in 2007 when the original west zone concessionaire, the Benpres-Lyonnaise des Eaux consortium, went bankrupt and the contract for Maynilad had to be re-bid. The fact that 50% of the original proponents failed is the best demonstration that there was absolutely no guarantee of returns, no sweetheart deal as contended.

Moreover, government tends to review Public-Private Partnership (PPP) contracts with today’s lenses without reference to the context at the time the contracts were entered into. This was done, I suspect by the Department of Justice in the review reported in the news without consulting the many people then who were involved in drafting, reviewing, and approving the contract.

Had they reached out, they would have appreciated the dramatically different situation then versus now in the conditions of the country and the MWSS. Contract terms offered needed to be appropriate to these conditions and global standards and requirements to attract the best qualified bidders.

Let me just cite a few facts:

1.) PPP then was very new. There were only a handful of contracts to serve as precedents in water or even other sectors, and thus the structure was perceived to be high risk considering especially regulatory uncertainty. The Philippines did not have a clear regulatory regime on water and thus had to develop an innovative “regulation by contract” scheme. A big part of the risk mitigation aspects of this depended on a performance undertaking by the Republic as represented by the Finance Secretary, and the provision of international arbitration for dispute resolution.

2.) The Philippines’ credit rating was below investment grade, interest rates on treasury bills were at double digits, our government debt to GDP and budget deficits to GDP were much higher, as was the external debt to GDP, the current account in deficit, while foreign reserve coverage was only two months’ worth of goods and services versus eight today.

3.) The MWSS then was a mess, very inefficient, there was intermittent water supply, very high water leakage and theft (NRW over 60%). It was over-staffed but had low productivity, was highly indebted, and with high technical risks — nobody knew the condition of the pipes, so this added to the risk premium.

Insofar as “onerous” provisions, let me try to respond to some of the points reported in the newspapers.

1.) The contention that “government interference” was not allowed under the contracts. This is completely false. The facts are that at every step, government is involved in rate setting in what is, after all, a public private partnership.

These steps include: a.) in setting the parameters in the concession agreements, b.) setting the service levels for both piped water and sewerage, c.) determining and auditing which expenditures are prudent and efficient, d.) determining the cost of capital that the concessionaires will receive, adjusted to market every five years, and, finally, e.) approval of the tariffs schedules after proper public hearings that derive from steps a.) through d.). The Republic simply undertook in the Performance Undertaking to respect this procedure.

This is Part One of this column. The second and concluding part will cover other supposed “onerous conditions” relating to recoverability of the corporate income taxes from tariffs, the extension of the contract, and the possible consequences of government terminating the contract unilaterally.

For those who wish to understand the subject more fully, I would refer you to:

1. “The Manila water concession: a key government official’s diary of the world’s largest privatization,” by Mark Dumol

http://documents.worldbank.org/curated/en/118971468776361965/The-Manila-water-concession-a-key-government-officials-diary-of-the-worlds-largest-water-privatization

2. Built on Dreams, Grounded in Reality: Economic Policy Reform in the Philippines by National Scientist and Prof. Emeritus Raul Fabella, https://asiafoundation.org/resources/pdfs/BuiltonDreamsGroundedinReality.pdf

3. Tap Secrets: The Manila Water Story by Virgilio C. Rivera, Jr.,

https://www.gwp.org/globalassets/global/toolbox/case-studies/asia-and-caucasus/cs_450_tap_-manila.pdf

4. The video tape of the Senate Hearings of Dec. 11, Chaired by Senator Grace Poe. In this link: https://www.facebook.com/sengracepoe/videos/845201489268434/

 

Romeo L. Bernardo is Vice-Chairman of the Foundation for Economic Freedom and GlobalSource Partners Philippine Advisor. He was Finance Undersecretary during the Corazon Aquino and Fidel Ramos administrations and was a Trustee of the MWSS from 1995 to June 1996, six months before award of the concessions.

romeo.lopez.bernardo@gmail.com