The high costs of inaction and delay

One of the glaring weaknesses of governance in our country is the bureaucratic tendency to strictness in dealing with little matters, and to laxity and obliviousness to rules when tackling larger issues. Our bureaucrats exhaust themselves debating the price of paper clips, and then get blindsided on the costs of high-ticket projects like roads, airports and communication networks.

Examples of this proclivity to penny-wise, pound-foolish governance are legion. One of the most distressing, because the case is glaring at us now, is the case of the MRT3 system and our government’s efforts to improve its financing arrangement.

The MRT3 system on EDSA is, by all measures, one of the country’s most successful private infrastructure projects. The system was financed, designed, built, equipped, tested and commissioned by the Metro Rail Transit Corp. (MRTC), and it was delivered to the Republic on time and on budget in 2000 pursuant to the terms of a Build-Lease-Transfer (BLT) Agreement. Since then, MRT3 has become an integral part of Metro Manila’s public transport system, reducing traffic along EDSA and operating at beyond capacity with a ridership in excess of 450,000 people on weekdays.

One problem that has dogged the project, however, was its financing arrangement.  MRT3 was contracted and built during a time of financial weakness for the Philippine economy, when everything was very expensive and credit was hard to come by. MRT3 financing is costly in comparison to the government’s many options today.

To illustrate, the long-bond annual yield in 2000 hit a high of 15-percent yield to maturity; a number similar to the full, long-term net economic return committed to MRTC
equity investors. A 15-percent equity return seems expensive today, but at the onset of the new century that was reasonable and fair considering that long bonds then traded at similar yield, and that equity in the MRTC was funded and expended before debt financial closing, with investors thus assuming great risk.  

MRTC and the Philippine Government are in broad agreement that the obligations under the BLT Agreement are full faith and credit sovereign obligations of the Republic. Our government’s direct, sovereign obligation to MRTC is a defined stream of equity rentals (Equity Rental Payments or ERP) defined in Annex Table 2 Annex A-1 of the BLT Agreement which total $2.40 billion from Aug. 14, 2000 to Jan. 14, 2025.

The remaining ERP schedule from Dec. 15, 2007 to Jan. 12, 2025 totals $2.21billion.

The value of the remaining ERP liability today is $1.30 billion which the present value of the remaining ERP obligation at the Republic’s cost of funds, which is 6.14 percent annually.  

With all the fiscal improvements of the Philippines today, however, this is certainly a very expensive financial obligation for the nation. This is why serious effort has been made to try to improve upon the financial arrangement for the MRT3.

As things stand, the government has three alternatives before it: (1) To properly service its obligations despite its inconvenient costliness; (2) To  willfully breach its direct sovereign obligation; or (3) To negotiate a refinancing and settlement with MRTC.

Option 1 — the silent and proper servicing of its direct, sovereign obligation — may be an acceptable way forward. The ERP obligation represents about one percent of the Republics debt obligation, and the government clearly has the
financial capability to service this. However, this option is
unconscionable if an option for refinancing is available whereby the government can achieve significant savings.

Option 2 — discontinuing service — is inappropriate and unwise for the government to adopt toward one percent of its direct, sovereign obligations, when it can clearly service 99 percent of its other debt obligations in a proper and timely manner. Poor service or breach of a direct, sovereign obligation due to inconvenient high cost is unbecoming of a country in good standing like the Philippines, and it threatens the rule of law, the validity of legal agreements, and the social contract of fulfilling clear obligations.

Option 3 — negotiating a refinancing — is by far the wisest course for the government to adopt. It has been clear for several years now to many government officials, including the technocrats at the Department of Finance, that
if an opportunity arises to refinance the ERP obligation at a level that  yields significant savings to the Republic, it would be the ideal resolution to the ERP obligations. Fortunately, this opportunity has now arisen with the improving finances and economic outlook of the economy. Early this year, a formal effort was launched to arrive at mutually acceptable terms for refinancing the ERP obligations.

A negotiated settlement was arrived at in principle between the DOF and MRTC last Aug. 27, 2007. But then came a crushing obstacle. The understanding in principle has not been finalized because of the non-acceptance of economic issues by the Department of Transportation and Communications (DOTC). The DOTC has been exhibiting undue concern over the size of the refinancing and misplaced fear of scrutiny over economics. As a consequence, it has frozen the agreement in mid-transaction.

While hopes are still high that a solution will be reached eventually, the DOTC’s freezing of the ball has costs. The freeze has caused a 107-day delay  since Aug. 27. The Republic has been paying excess interest, which is interest cost beyond refinancing costs of $120,000 per day. Furthermore, the 107-day delay has caused the MRTC and the government to miss  the capital markets financing window before mid-December, when the capital markets are practically closed to transactions. This has caused an additional structural delay of at least 40 more days. The total of 147 days delay to date has already cost the government $17.64 million.

More important, the freeze threatens the availability of the refinancing option itself. I understand that the refinancing discussions were at levels that provided the government with present value savings of $450 million in  comparison to present value of specific performance.  If the MRTC has no
avenue to negotiate a refinancing transaction with the Philippines, its only recourse is to resolve disputes that may arise out of the ERP  obligation through arbitration in Singapore as provided for in the BLT Agreement. It should be clear that the only foreseeable outcome in arbitration is enforced specific performance of a valid contract by the government.  Enforced specific performance would ensure that the government cure its arrears and settle related costs, and observe in full the payments schedule of the remaining ERP obligation. Even if no other damages are  awarded to the MRTC group, this will leave the government with a liability value today amounting to at least $1.35 billion, including arrears and interest thereon. This is $450 million more than what a proper refinancing may  cost today. That is the economic cost of indecision, lack of understanding and fear:  $17.64 million to date and maybe an eventual $450million if the DOTC continues to fail in understanding the repercussions of inaction.

I respectfully suggest that the top guys at DOTC carefully review this matter. There is too much at stake here for us to allow bureaucratic rigidity or timidity to carry the day on this one. Precious taxpayers’ money well into the future is on the line. Sound governance may fall victim in the process. While we understand that the DOTC was burned some in the much-publicized controversy over the ZTE broadband project, inaction on the MRT3 refinancing agreement is not the proper course to adopt. The department must act in the interests of the nation and our people, including those yet to be born.