Water privatization in Metro Manila

Water privatization in Metro Manila began in 1997 with the high-profile award of two concession contracts for the Eastern and Western halves of Metro Manila, Philippines. These concessions represent the largest population served by private operators in the developing world.^[1] Both companies, Maynilad in West Manila and especially Manila Water in East Manila, submitted bids with very low tariffs. These tariffs proved to be too low to finance the investments needed to expand water and sewer service, to improve service quality and to reduce water losses, especially after the East Asian financial crisis and the devaluation of the Filipino Peso made international debt financing much more difficult. The concession in West Manila failed when Maynilad went bankrupt in 2003. It was sold to new investors in 2007 and performance has improved since then. The share of the population with access to piped water in West Manila increased from 67 percent in 1997 to 86 percent in 2006^[2] and the share of customers that enjoys 24-hour water supply increased from 32 percent in 2007 to 71 percent in early 2011.^[3] Manila Water also struggled initially, but was able to increase its contractual rate of return against the willo of the government through the decision of an arbitration panel. While neither of the two companies was able to achieve its contractual targets in terms of access, as of 2010 Manila Water had achieved significant improvements in access, service quality and efficiency: the population served more than doubled from 3 million in 1997 to 6.1 million in 2009, the share of customers with continuous water supply increased from 26 percent to more than 98 percent, and non-revenue water declined from 63 percent to 16 percent.^[4] However, tariffs in both halves of the metropolitan area increased substantially. Compared to the pre-privatization level and measured in current Pesos, they were three times higher in East Manila and four times higher in West Manila in 2009.^[5]

Under a concession agreement, private companies collect and own revenues from water tariffs. In return they have to pay for operating costs and investments. In addition, in the case of Manila they have to pay a concession fee to MWSS in order to pay for the legacy debt and the relatively modest cost of running a regulatory office.

The investments under the Manila concessions are financed through debt in the form of loans, equity - direct participations or the sale of stocks - and retained earnings. During the first years of the concessions the companies faced difficulties in obtaining loans due to the East Asian financial crisis. However, in 2003 Manila Water obtained a USD 30 million loan from the International Finance Corporation (IFC) followed by two more loans of the same amount. In addition, IFC took an equity participation of USD 15 million in Manila Water in preparation of the Initial Public Offering (IPO) of Manila Water shares in the Manila stock exchange.^{[6] [7]}

The private companies are allowed to earn a rate of return on total capital that was stated in their respective financial bids. In the contract, the rate of return was called weighted average cost of capital or market-based appropriate discount rate. Manila Water's rate of return in its bid was only 5.2 percent. On that basis it submitted a very low tariff that allowed it to win the concession. After international arbitration Manila Water succeeded in having its rate of return increased to 9.3 percent in 2001. Maynilad's rate of return in its bid had been a more realistic 10.4 percent from the beginning.^[8] If the rate of return on total capital is higher than the cost of debt, the rate of return on equity is higher than the rate of return on total capital invested. However, in the opposite case losses on equity can also be multiplied if the total return is lower than the cost of debt.

Water tariffs in Manila are adjusted on the basis of four mechanisms:

• First, tariffs are adjusted automatically on the basis of exchange rate fluctuations applied to the company's debt. This mechanism is revenue-neutral. Initially this mechanism was applied with a lag, but after a contract amendment it is now applied every three months.
• Second, tariffs are adjusted annually on the basis of inflation (indexing to the consumer price index).
• Third, tariffs are adjusted every five years to guarantee a certain rate of return to the private concession holder (rate rebasing). The company's performance vis a vis regulatory targets is also considered in determining the tariff.
• Fourth, extraordinary price adjustments can also be granted, but only in spefific circumstances such as a change in law or force majeure. Tariffs are set by the Board of MWSS upon recommendation of its regulatory office.^[9]

Both private companies initially had to post a performance bond that could be called by MWSS if the companies failed to fulfill their obligations. Maynilad had posted USD 120 million because of its larger share both of the concession area and MWSS' old debts and Manila Water posted USD 80 million.^[10]

98 percent of the water used in Metro Manila comes from the Angat Dam about 40 km to the Northeast of Manila, a multi-purpose dam that also serves for irrigation and hydropower generation. During the drought of 1998 water supply to Metro Manila had to be reduced by 30 percent and water supply for irrigation was completely cut.^[11] Under normal hydrological conditions, Angat Dam supplies 4.1 million cubic meters per day of water for Metro Manila. Per capita water consumption in Metro Manila is about 100 liter per day.^[12] Even if one assumes 50 percent water distribution losses, Angat Dam can supply more than 20 million inhabitants with water under normal hydrological conditions, compared to a current population of 12 million. Nevertheless since the 1990s MWSS has pursued the construction of a new dam, the Laiban Dam, to supply Manila with water. This is being justified with projected increased domestic per capita demand and projected increased commercial and industrial water demand. Civil society groups oppose the dam, saying that it is not needed, it would cause social and environmental damage and that MWSS is "obsessed" with the dam. The construction of the dam has been repeatedly delayed for lack of funding.^[12]

The plan to privatize the government-owned and controlled water utility supplying Metro Manila emerged from the inability of the Metropolitan Waterworks and Sewerage System (MWSS) to expand coverage for a growing population or to improve service quality and efficiency. By 1996, MWSS only provided water for on average 16 hours every day to two thirds of Metro Manila.^[13] According to the Asian Development Bank, the amount of non-revenue water (NRW) (water supplied but not billable e.g. due to leakage and illegal connections) was more than 60 percent; this is similar to Jakarta, but very high compared to Seoul (35 percent), Kuala Lumpur (36 percent) and Bangkok (38 percent).^[14] Tariffs were low and as a result of poor cost recovery, MWSS was dependent on additional government subsidies. Furthermore, it was saddled with debts of USD 800 million owed to the Asian Development Bank, the World Bank and the Japan Bank for International Cooperation.^[15]

The government of Corazon Aquino had initiated a wide-ranging privatization programme resulting in the sale of 122 companies for USD 2 billion in 1986-1992. When her successor Fidel Ramos became President he broadened the privatization program to infrastructure, resolving an electric power crisis through rapid private investments in power plants in 1992-94. Based on this perceived success, the Ramos asked his Secretary of Public Works and Transport Gregorio Vigilar to apply the same approach to resolve the water problems of Manila.^[16] At that time many Filipinos had become accustomed to poor water service in Manila and did not feel a strong urge to change the situation. However, President Ramos himself insisted that there was a water crisis in Manila and began to convince others. The growing awareness of a water crisis increased political support for privatization.^[17]

In June 1994 the British company Biwater and a Malaysian firm approached Fidel Ramos with an unsolicited proposal to buy MWSS. The government refused this and other unsolicited proposals for two reasons: First, by law MWSS could not be sold. Second, if a public-private partnership such as a concession was to be pursued as an alternative to outright sale, the government wanted to award it on a competitive basis.^[17] The French embassy and the French water company Lyonnaise des Eaux told the government about what they presented as the success of the water privatization in Buenos Aires, where competitive bidding had initially reduced water tariffs below their level under government management. They also brought government officials to Macao where Lyonnaise des Eaux had successfully reduced water losses, as well as to France and England.^[18]

In 1995, the Water Crisis Act was passed, providing the legal framework for the privatization of MWSS. Privatization was in the form of concession contracts.^[19] In order to facilitate performance comparisons ("benchmarking"), the service area in Manila was divided in two zones, based on the model of Paris which at that time was served by two private water companies each serving one half of the city. There was some debate about this decision - the earlier water privatization in Buenos Aires was done without splitting the service area, while the parallel water privatization in Jakarta also involved a split of the service area. The split was complicated, since personnel, assets and the customer database had to be split in two, which brought benefits but also caused "huge complications" according to Mark Dumol who was a leading figure on the government team during the privatization.^[20]

The two concession contracts were for 25 years and included targets concerning coverage, service quality and economic efficiency. An objective was to increase water coverage in Metro Manila to 96 percent by 2006. The concessionaires were expected to be regulated by the newly created MWSS Regulatory Office, but the role of the Regulatory Office remained ambiguous. While some members of the office expected it to actively monitor and control the private companies, its first chief, Rex Tantiongco, insisted that it was part of the utility and that its role was to implement decisions agreed to between the MWSS Board of Trustees and the concessionaires.^[21] The Regulatory Office was staffed to a large extent with employees of the former government owned and controlled utility.

The two concession holders also were to inherit the debt of MWSS, but the debt was not shared equally between the two concessions in the metropolis. Because the area of the Western concession was considered more dense and more prosperous, 90 percent of the legacy debt was assigned to improvements in the Western zone. The concessions were awarded through international competitive bidding, with the International Finance Corporation (IFC) of the World Bank Group advising the government on the design and bidding of the two concession contracts.^[22]

In August 1996 tariffs were increased by 38 percent to set them at the "correct level" prior to privatization. The increase was delayed for political reasons and was implemented during a visit of the Mexican singer Thalia who was famous in the Philippines. The media spotlight on Thalia was so intense that there was no complaint about the increase.^[23]

Bidding for the concessions was competitive. Despite the need to finance huge investments on a commercial basis and to service legacy debt, the government expected efficiency gains to be so great that water tariffs would go down. This was based on the experience of the Buenos Aires concession that had been awarded shortly before at reduced tariff levels. Lowering tariffs was politically important for the concessions to be accepted, and the government even included a provision that tariffs in the bids were not allowed to be higher than the tariffs at the time.^[23] Four prequalified bidders submitted eight bids, each bidding for both concessions. Each bidder was a joint venture between an international and a local company. The joint venture that bid the lowest tariff would be awarded the concession. If the same company submitted the lowest bid for both concessions, the second-lowest bidder would be awarded the other zone. On January 23, 1997, the financial bids were opened and, to the great surprise of those present, one bidder submitted an extremely low bid for both zones at 26 and 29 percent of the tariffs in East and West Manila respectively. The bid was so low that the evaluators asked the company if the bid was serious, which it confirmed. The company that submitted the extremely low bid was Manila Water led by the Filipino Ayala Group. Manila Water was the only company to submit a lower bid for East Manila than for West Manila. This may be explained by the fact that the Ayala group owned substantial real estate in East Manila and wanted be certain to win the concession there, which it did. The three other companies all submitted bids in the range of 50-60 percent of pre-privatization tariffs. They all submitted slightly lower tariffs for West Manila compared to East Manila, reflecting their assumption that West Manila was more profitable to run despite the fact that 90 percent of the legacy debt had been allocated to West Manila.^[24]

The concessions, which took effect in August, were awarded to the following Joint Ventures:

• The Maynilad Water Services, Inc., a joint venture between the French Suez and the Filipino Benpres Holding was awarded the concession contract for the West Zone;
• the Manila Water Company, Inc., consisting of the Filipino Ayala Corporation with the British United Utilities, the U.S. company Bechtel, and Japanese Mitsubishi was awarded the East Zone.

The financing behind the concession relied extensively on the anticipated cash flow and debt with a low share of equity. Mark Dumol, who played a leading role in the privatization process on the government side, estimated that out of USD 7 billion of investments only USD 200 million, or less than 3 percent, had to be financed through equity. Since the service area was split in two and the foreign partners would shoulder much of the equity local firms became very interested to participate when they were told of this arrangement: "Can you imagine having a significant share in a company that provided water to Metro Manila for only USD 10 million?", Dumol asked.^[25]

These prospects enticed some bidders to shoulder more financial responsibility than they could bear. The Benpres Group, the Filipino partner of Maynilad, was in a desperate financial situation when it entered the contract, providing little cushion for the first difficult years when much more equity was needed than anticipated. According to a study by the British NGO, WaterAid, both companies "appeared to have made particularly low bids, on poor foundations, with the assumption they would change the terms of the contract once it was won." This has been vehemently denied by Lyonnaise des Eaux emphasizing that its bid was much higher than the bid submitted by Ayala and very close to the two other bids.^[26]

After the concessions came into force, tariffs initially decreased substantially in conformance with their submitted bids. The Western zone the base tariff was set at 5 Pesos/m3, and the Eastern Zone tariff was set at only 2.3 Pesos/m3; before the concession award, the MWSS base tariff was 8.6 Pesos/m3 in all areas. In these early years however concessionaires were faced with both a severe drought and the Asian financial crisis. Because of the rapid 50 percent devaluation of their Peso income, and with legacy debts denominated in foreign currency, the concessionaires' debt service doubled.^[13]

Maynilad incurred high costs, in part because it awarded contracts to affiliates of Suez without competitive bidding. Maynilad also brought in new staff from its mother company Benpres that had no experience in water supply, which led to tensions and reduced the motivation of incumbent staff. Maynilad thus invested in expanding access in the Western zone, but due to its business model and the heavy load of inherited foreign-currency debt it soon ran into financial difficulties.^[13] It then slowed down its investments and in April 2001 it stopped paying the concession fee to the government.^[22] The government had to provide bridge financing from state-owned Filipino banks to save Maynilad from bankruptcy during its first years, because international banks were not willing to lend to the company after the financial crisis.^[27]

Manila Water, on the other hand, initially did not invest in system expansion in its Eastern Zone.^[2] It focused on reducing non-revenue water and initially borrowed only small amounts in local currency. It bid out works competitively and gained the trust of former MWSS employees which were trained in relevant fields. Only a few top positions were filled with outsiders seconded from its mother company Ayala or its foreign partners. Manila Water used a "territory management" approach to reduce non-revenue water under which decentralized operating units were given substantial responsibility to decide about appropriate actions. Evaluation and compensation of staff in the decentralized units was linked to their performance. With these policies Manila Water made a profit as early as 1999 and was thus able to gain the confidence of banks and to gradually increase its borrowing.^[13] However, as early as 1998 Manila Water requested an increase of the extremelylow 5.2 percent rate of return it had included in its own bid. The MWSS Regulatory Office refused to grant the increase. Manila Water then seized an international arbitration panel that granted an increase to 9.3 percent, which resulted in a substantial tariff increase. Civil society groups criticized the decision by the arbitration panel, saying it undermined the integrity of the original bid at the expense of customers and competitors.^[28]

In 2001 a conflict erupted between various members of the MWSS regulatory office. The chief of the office, Rex Tantiongco, resigned in July 2001 after he was not supported by other members of the office in approving a tariff increase. His successor, Herman Cimafranca, called the office a "toothless paper tiger" with no role in approving tariff increases, as evidenced by the earlier referall to increase the rate of return to an arbitration panel instead of the regulatory office.^[21] In October 2001 the Board of MWSS approved the first amendment to the concession contracts. It allowed tariffs to be changed quickly as a result of on exchange rate fluctuations, instead of recovering losses from exchange rate fluctuations only through gradual adjustements. This led to an immediate tariff increase.^[29]

In 2002 the first regular "rate rebasing" was untertaken. The concession contract foresaw an adjustment of the water tariff every five years to take into account changes in the weighted cost of capital and in investment requirements. As a result, water tariffs were increased substantially for both concessions in 2002. The new tariffs exceeded their pre-privatization level, as measured in current Peso terms, but were significantly lower in dollar terms because of the 1997 devaluation. By 2003 tariffs had reached 11.4 Pesos in the Western zone and 10.1 Pesos/m3 in the Eastern zone. Initial targets concerning coverage and non-revenue water also were adjusted downwards with the agreement of the regulatory agency.^[13] A critical study of the two concessions concluded in 2002 that they both were a "failure" and a "corporate muddle, whereby the supposed benefits of private sector participation disappear, and government and public administrators are seemingly unable to prevent it."^[26] After the tariff increase of 2001 Manila Water began to invest in expanding the water network, including in poor neighborhoods, and achieved a significant increase in access.^[2]

Maynilad, however, was not satisfied with the result of the fist amendment of the concession contract. It still refused to pay concession fees to MWSS, which the latter needed to repay its legacy debt. The amount of unpaid concession fees reached Pesos 5 billion. Eventually Maynilad requested the early termination of the contract in December 2002. Despite the tariff increases and the lowered targets, Maynilad thus went bankrupt in 2003. The government did not call on Maynilad's performance bond, but rather took on three new foreign currency loans with a total vaule of USD 431 million to finance the MWSS debt service. The government then agreed to convert a small part of the unpaid concession fees, USD 22.67 million, into a 84 equity share of Maynilad, with the bulk of the unpaid fees to be repaid over a longer period.^[30] The government did not return West Manila under public management, nor did it accept Manila Water's offer to take over the management of the entire metropolitan area. Instead the concession was bid out again and was bought in 2007 by a consortium of the Filipino construction company DMCI Holdings and the Filipino investment firm Metro Pacific Investments Corporation (MPIC).^[31] Suez continues to hold a 16 percent-minority share in Maynilad.^[32]

In 2009 Manila Water's concession was extended by another 15 years until 2037 instead of 2022.^[33]

Between 1997 and 2002 improvements in access were limited and water losses even increased in West Manila. However, subsequently performance improved in both halves of the city. As of 2009, access had increased substantially, and efficiency as well as service quality had also improved significantly. The improvements were faster and more significant in the Eastern Zone compared to the Western Zone. Both companies made efforts to reach the poor in slums. However, tariffs also increased significantly, improvements remained far below the contractual obligations. Almost no improvements were reached concerning sanitation.

In East Manila between 1997 and the end of 2009 the population served more than doubled from 3 to 6.1 million (2009) and the share with access to piped water increased from 49 percent to 94 percent (2006).^[4][2] In West Manila Maynilad claims to have connected 600,000 people to the water supply system until 2003, including many poor in slums.^[22] The share of the population with access to piped water increased from 67 percent in 1997 to 86 percent in 2006.^[2] The initial contractual target had been 100 percent access within 10 years.^[29]

Initially the concession contracts foresaw an increase of access to sewerage from less than 10 percent to 66 percent in West Manila and 55 percent in East Manila until 2021. This would have implied investments of more than USD 1.8 billion, resulting in a doubling of water tariffs. When faced with bankruptcy Maynilad had asked to reduce its target to 31 percent.^[21] As of 2008, in the East Zone only 10 percent of the population had sewerage connections, with the other 90 percent relying on septic tanks, which Manila Water is obliged to empty.^[34] Manila Water plans to invest USD 1 billion in sanitation between 2011 and 2018 to bring sewerage coverage to the contractual target.^[4]

In East Manila between 1997 and the end of 2009 non-revenue water ("water losses") declined from 63 percent to 16 percent according to Manila Water.^[35] However, loss reduction during the first years was far below what had been planned. The 31 percent level of water losses that Manila Water had planned to reach in only one year, was achieved only in 2005. The 16 percent target reached in 2009 had initially been envisaged to be reached in 2001, according to Manila Water's financial model used to bid for the concession.^[36] In West Manila, according to MWSS, non-revenue water actually increased during the first years of the concession from 64 percent in 1997 to 69 percent in 2002, compared to a target of 30 percent.^[29]

Labor productivity of Manila Water increased substantially, as evidenced by a decline of the number of staff per 1000 connections from 9.8 to only 1.4.^[4] Before the concessions were awarded, according to the Asian Development Bank, MWSS had been one of the most overstaffed utilities in Asia, with four times more employees per connection than the water utility of Singapore. During the preparation of the privatization, the government reduced the number of staff singificantly through measures agreed to with the labor unions. In a first step, 30 percent of employees took early retirement taking advantage of a compensation plan. In a second step, all remaining employees were actually terminated and received severance pay, only to be rehired for a probation period by the private companies. Those who were not retained after the probation received full early retirement benefits.^[37] Further improvements in labor productivity were achieved during the concession by increasing the number of connections without hiring new employees.

The concession contracts obliged the private companies to achieve an uninterrupted water supply at a pressure level of 16 pound per square inch (psi), and compliance with drinking water as well as effluents standards by the year 2000.^[29] While these targets were not achieved there were some notable improvements. For example, in East Manila between 1997 and the end of 2009 the share of customers with continuous water supply increased from 26 percent to more than 98 percent.^[4] The percentage of people judging Manila Water's performance as "very good" increased from 28 percent to 100 percent, according to a survey by the University of the Philippines.^[4][34] A 2000 survey by MWSS had shown that 33 percent of residents had perceived an improvement in service, while 12 percent said that service has worsened, with 55 percent stating it had remained unchanged since privatization.^[21]

In West Manila, after Maynilad's ownership changed in 2007, the company increased its investments. One of the results is that the share of customers that enjoys 24-hour water supply increased from 32 percent in 2007 to 71 percent in early 2011.^[3]

Many poor in Manila do not have access to piped water supply because the land where they live is occupied illegally and the private utilities are thus not allowed to connect them to the network. However, innovative solutions have been found to overcome this problem.

In East Manila, Manila Water's approach to connect poor communities usually involved no pipes inside the communities, but included a single bulk meter for up to 100 households. It was the responsibility of the community to connect its members and any losses beyond the bulk meter were not incurred by the utility.^[13]

In West Manila, Maynilad initiated early attempts to connect the poor in slums through the construction of piped networks by a small local company called IWADCO (Inpart Waterworks and Development Company) using its own funds and buying water in bulk from the utilities. Local banks initially refused to lend to the company even when it already had 25,000 paying customers.^[38] A NGO called Streams of Knowledge, which is associated with the Philippine Center for Water and Sanitation and was supported by UNDP, helped to set up the arrangement together with the local government and Maynilad which provides water at a discounted bulk rate. Users pay their water bills to water coordinators from the respective communities, which in turn pay Streams, which in turn pays a salary to the coordinator, pays the bulk water bill and returns part of the funds to the community.^{[39] [40]} Maynilad built the piped network only to supply points at the entry of narrow alleys, from where residents distributed it among themselves with rubber hoses. A connection fee of 5000 Pesos (about USD 90) was paid in instalments, resulting in monthly payments of about 200 Pesos (USD 3.70) per household. This was about four times less than what the poor had paid to water vendors before.^[22] Maynilad pursued an approach to connect poor communities that included laying pipes in slums, which made it difficult to control theft. Indeed, non-revenue water even increased in West Manila.^[13]

Tariffs charged to many of the poor remained higher than for residential customers who lived in single-family houses. Homeowners' associations and community groups, including those living in slums, are charged the highest residential block rate for bulk water provision, which is about three times the lowest block rate.^[41]

As mentioned before, the two concessionnaires submitted bids with tariffs that were much lower than the previous tariffs: 26 percent of the previous tariffs in the East Manila and 57 percent in West Manila. In West Manila the base tariff was 5 Pesos/m3 and in East Manila it was only 2.3 Pesos/m3, compared to 8.6 Pesos/m3 before the concession. Tariffs remained close to these low levels for five years until the first rate rebasing took place in 2002, followed by further significant tariff increases. By the end of 2006 the tariff was, in real terms, 150 percent higher than the pre-privatization tariff in the West Manila and 23 percent higher in East Manila.^[1] After further increases, the average tariff for all customer groups in East Manila was 32 Pesos/m3 and in West Manila 27 Pesos/m3 at the beginning of 2008.^[5] Concering residential customers in the East Manila, their monthly water bill was lower than the average that includes commercial users as well. The residential bill for a consumption of one cubic meter per day was 395 Pesos (USD 10) or 13 Pesos/m3 (USD 0.33/m3) as of 2008.^[42]

Connection fees for water or sewer connections also increased substantially. For example, the residential connection fee increased from Pesos 3,722 in 2000 to Pesos 7,187 in 2008 in the East zone.^[43]

• Water supply and sanitation in the Philippines

• Metropolitan Waterworks and Sewerage System - Regulatory Office