When privatization goes wrong

Privatization of government enterprises is premised on the logic that government bureaucrats are bad business managers, and ergo, should leave the business of doing business to the experts, i.e., the entrepreneur.

This was the thinking behind the move to privatize the Metropolitan Water and Sewerage System (MWSS). The simplified approach, engineered by the International Finance Corp. (IFC) with help from the World Bank and the International Monetary Fund, was to bid out the entire distribution system.

The bidding process was quite simple. Two envelopes were required: the first contained the business master plan complete with financial spreadsheets and simulations; and the second had the rate bid.

The first envelope was used to screen the bidders and identify those who seem to be competent. It was, however, the contents of the second envelope that was used as the basis for awarding the bid. It is not folly to base decisions on a "lowest bid" principle; but – as my business friends will agree with me – it should not be the only basis.

But that was exactly what was done for the MWSS privatization. Now, barely five years after the concession contracts were signed, we have a looming problem that may end up with government terminating or re-bidding at least one of the contracts.

As we mentioned in the last Biz Links column, Manila Water Co. and Maynilad Water Services, Inc. won the bids. In their hands hung the fate of the MWSS privatization.

It was actually Manila Water that bid lowest for both the east and west divides. But because rules explicitly disallowed one company from operating both, Maynilad got the west zone. Manila Water’s bid was at P2.32 per cubic meter; Maynilad’s was at P4.97 per cubic meter.

Since the average MWSS rate pre-privatization was at P8.78 per cubic meter, an immediate reduction in water rates was imminent especially for those in the east zone. But the Asian currency flu, when it broke out in 1997, prevented the promised low water cost from becoming a reality.

Comparing both companies, it is Maynilad that seems to have been burdened by more problems. They began to gripe on just about everything: the Asian contagion, the El Nino, the inefficiency of the currency adjustment mechanism and just about all other mechanisms contained in their contract with the MWSS.

Their biggest complaint however was in the assignment of 90 percent of MWSS’s loans amounting to $800 million.

When Maynilad submitted its bid, the MWSS, as advised by the IFC, reasoned that the private utility firm should service 90 percent of the MWSS foreign loans since it was charging twice more than Manila Water for every cubic meter of water sold.

This seemed logical at first. Until the peso currency went on a downward depreciation spiral because of the 1997 regional financial crisis. Overnight, Maynilad needed to pay MWSS an additional P2.67 billion just to service the dollar-denominated debts.

Manila Water, on the other hand, because of its lower exposure to dollar-denominated loans, was not as severely affected. In fact, in 2000, Manila Water had already started showing some profits.

Maynilad’s dilemma was further aggravated by its limited ability to raise rates to reflect the higher debt servicing cost resulting from the peso currency depreciation. Already, Maynilad customers’ end billing including all adjustments (currency exchange rate, extraordinary price and foreign currency differential) have resulted to an almost four-fold change from the original bid rate.

Maynilad no doubt is in stress. It stopped payment of concession fees last year. It negotiated to suspend part of the debt servicing costs. Talk is rich that one of the partners is selling out. Worse, no one seems to be interested in buying.

The MWSS privatization is being paraded as a brilliant example of a developing government’s success in divesting itself of a multi-billion peso state enterprise. But with the seemingly irresolvable problems of the east zone concessionaire, it seems that the IFC may have to come up with a new scheme to save the day.

One of the objectives of the privatization effort was the transfer of financial responsibility in the provision of water and sewerage services to the private sector while allowing them a fair rate of return.

But you may ask: Is privatization working for Manila Water, for Maynilad, and for the consuming public?

Call in the bonds for non-performance

As of now, the MWSS privatization roadmap seems not to bear good fruits. Both Manila Water and Maynilad have not kept their covenants in terms of plugging leaks and water theft. Manila Water has been gaining some ground, but Maynilad’s pilferage rate has reportedly even worsened.

Both also are lagging in the provision of 24-hour water supplies. Water quality leaves a lot to be desired. The number of new connections does not look comforting for both companies to meet the total water service target by 2007.

There are other promises that risk being broken. Already, discussions are brewing for a re-base of water tariffs before the prescribed 10-year moratorium period. The 1997 contract stipulated no real increases in basic rate water tariffs until 2007.

Sewer service connection, now at about 10 percent only, should reach 83 percent at the end of the 25-year contract period. Government subsidies, on the other hand, should be totally eliminated. But just last year, Maynilad has already asked MWSS to service once again part of its assigned debt payments.

There is also a brewing rift between MWSS and the concessionaires due to the inability of MWSS to deliver new water sources, and this is one reason being cited by concessionaires for the need to increase water rates.

Caught in the middle of this sticky web of financial and legal posturings are, of course, the 11 million Metro Manilans who are still looking forward to seeing better water distribution service. No amount of blaming can help solve the problem.

There is a combined bond amounting to $200 million that Manila Water and Maynilad posted in case they failed to deliver on their commitment. Shouldn’t we draw on this?

Definitely, the consumers will praise government for getting tough, calling in the performance bonds, and using proceeds to somewhat reduce prevailing water rates.

Should you wish to share any insights, write me at Link Edge, 4th Floor, 156 Valero Street, Salcedo Village, 1227 Makati City. Or e-mail me at [email protected]. If you wish to view the previous columns, you may also visit my website at http://bizlinks.linkedge.biz.