OCTOBER 30, 1997 INDONESIA URBAN WATER SUPPLY SECTOR POLICY FRAIVIEWORK MAIN REPORT By Alain Locussol Principal Water Supply and Sanitation Specialist, EASUR INDONESIA DISCUSSION PAPER SERIES NUMBER 9 EAST ASIA AND PACIFIC REGION 49944 V2 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized
Transcript
OCTOBER 30, 1997
INDONESIA
URBAN WATER SUPPLY
SECTOR POLICY
FRAIVIEWORK
MAIN REPORT
By Alain Locussol Principal Water Supply and Sanitation Specialist, EASUR
INDONESIA DISCUSSION PAPER SERIES NUMBER 9
EAST ASIA AND PACIFIC REGION
49944 V2P
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SUMMARY
URBAN WATER SUPPLY SECTOR
POLICY FRAMEWORK
MAIN REPORT
By Alain Locussol Principal Water Supply and Sanitation Specialist, EASUR
With only about 40 percent of the urban population of 70 million having access to piped water service in 1997, the Government of Indonesia (GOI) is seeking new directions to rapidly increase coverage, in particular through private sector participation in the delivery of service. This paper argues that the urban water sector could possibly "graduate" from Government financial assistance during the next ten years, provided that the many current obstacles to attracting commercial financing are removed. GOI may have no other option if it wants to free public funds to finance sewerage service and waste water treatment that are currently provided to less than 5 percent of the urban population.and unlikely to attract commercial financing in the near future.
DISCUSSION PAPERS PRESENT RESULTS OF COUNTRY
ANALYSES UNDERTAKEN BY THE DEPARTMENT AS PART
OF ITS NORMAL WORK PROGRAM. TO PRESENT THESE
RESULTS WITH THE LEAST POSSIBLE DELAY, THE
TYPESCRIPT OF THIS PAPER HAS NOT BEEN PREPARED
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FOR FORMAL PRINTED TEXTS, AND THE WORLD BANK
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OF THEIR USE.
INDONESIA
URBAN W ATERSUPPLY SECTOR POLICY FRAMEWORK
TABLE OF CONTENTS
Executive Summary ,-----------------------.,----------.,.-------------------:-------""------------------:.._______ i
1. THE URBAN WATER SUPPLY SECTOR
A. Introduction ------------------------------------------.,.----..,----~----------------------------1 B. Sector Organization ------------~----------------------------------------------------------1 C. Water Resources ___ _: ___________________________________________ :.. ____________________________ 2
D. The Water Supply Industry ---:---------------------'."--------------------------------------5
2. Managing Water Supply Operations A.. Introduction ---------------------:..-----------------.:.-------------------------------------- 13 B. Improvement of PDAM's Overall Management----------.,.-------------------------- 13 C. Improvement of PDAM Financial Management-------:.. __ ._ __________ ,_:--------------- 20
3. PRIVATE SECTOR PARTICIPATION (PSP) IN THE PROVISION
OF WATER SUPPLY SERVICES
A. Introduction ----------------------------------------"""'-------------------------------------- 3 5 B. Rationale for PSP in the Provision of Water Supply Services-----:---------------- 35 C. Options for Private Provision of Water Supply Services--------------------------- 36 D. Risk Analysis -- Option Selection -- Gradualism-----------------------------'------- 40 E. Regulatory Framework ---------------:---------------------------:---------------------..,-- 4 2 F. Private Sector Participation, Small PDAMs and the Poor-----.:---------------:----- 46
4. HUMAN RESOURCE DEVELOPMENT IN PDAMs/BP AMs . A. Introduction _______________ ._ ____ .,. _________________________________________ :.. _________________ 48
B. Summary of Current Status in Human Resources Development------------------ 48 C. Human Resources Development at the Water Industry Level "-------------------- 52 D. HRD at the Level of Individual PDAMs--------------------------:..------------------- 57 E. Implementation of Proposed Changes-----------------------------.--------:------------ 58
5.. IMPROVING QUALITY OF WATER SUPPLY PROJECTS
A. Introduction ----------------------------------------------------------.,-------------------: 60 B. PDAMs to Prepare and Implement New Projects---------------------------------:--- 60 C. Long Term Planning and Least Cost Solution-------------------:-------------------- 61 D. Implementation of Water Supply Projects------------:-------------------------------- 68 E. The Water Supply Sector and Projects and IUIDP --------------------------------- 70
6. PRICING WTER SPPLY SERVICES
A. Introduction. -".'--~--------------:---:---------------------..,----------::---------.:.------:---------: 72
B. Principles of Water Supply Pricing---------------------------------------------------- 72 C. Review of PDAM Water Tariffs------------------------------------------------------- 75 D. Recommendations for Water Supply Pricing----------------------------------------- 83 E. Case S.tudy -- PDAM Pontianak-------------------------------------------------------- 87
· 7. FINANCIAL WATER SUPPLY DEVELOPMENT
A. Introduction ------------------------------------------------------------------------------- 94 B. Current Arrangements for Financing Water Supply Investments----------------- 94 C. Recent PDAM Investment Levels and Sources-------------------------------------- 97 D. Financing Needs ----------..:--------------------------------------------------------------1 00 E. Financing the Investment Program ------------------------------------------------.. --110
1994 Service Level per Province---------------------------------------------------------7 Recent Evolution in Service Levels-----------------------;.------------------------------8 Water Supply Industry: Selected Performance Ratio------------------------------- 11 Comparison with Asian Water Supply Industry----------------------------------- 12 PDAM Financial Performance Monitoring Indicators------------------------------ 23 RD As Greater than Rp. 10 Billion by PDAM, 1990-1996 ------------------------- 31 Financial Indicators and Key Influences of These Indicators---------------------- 33 · Main Features of Various Contractual Arrangements
for Private Provision of Water Supply Services---------------------------;.. ______ 41 Educational Qualifications of PDAM Staff------------------------------------------- 49 Water Supply·Courses Conducted at Bekasi Center--------------------------------- 50 Average Per Capita Monthly Expenditure, 1995 ------------------------------------ 81 Connection Fees in Multiple Installments-----------------------------:--------------- 86 PDAM Pontianak: Calculation of Average Incremental Costs and
Other Costs 1995-2010-------------------------------------------------------------- 89 PDAM Pontianak- Water Tariff Revenues and Consumption 1995-------------- 90 PDAM Pontianak: Tariff Schedule (effective December 1995) ------------------90 PDAM Pontianak: Water Tariff Revenues and Consumptions
for October 1996 ___________________ ,.._. _____________________ _. __________________________ 91
PDAM Pontianak: Monthly Per Capita Expenditure Class (1995)--------------- 91 PDAM Pontianak: Proposed Tariff Schedule------------------------------..: ________ 91 PDAM Pontianak: Water Tariff Revenues and Consumption
for October 1996 Under the Proposed Tariff Schedule------------------------- 93 Repelita V and VI Investment in Urban Water Supply-------.,.--------------------- 98 Funding Structure of Urban Water Supply Sector Projects
by PDAM Size (1994/1995 - 199811999) ---------------------------------------- 99 PDAM Sources of Finance for Projects with Foreign Loans
( 1994/95 to 1996/96) --------------------------------------------------------------101 Distribution of the Urban Population (million) -------------------------------------102 Scenarios la and 1 b: Main Assumptions------------------:..-------------------------103 Scenarios la ani:l 1 b: Main Consequences ------------------------------------------104
Scenarios 2a and 2b: Main Assumptions--------------------------------------------106 · Scenarios 2a and 2b: Main Consequences -.:.----------------------------------------107
Scenarios 2a - Financing Sources by PDAM Size----------------------------------108 Scenarios 2a - Repelita VII and VIII Investment Program and
Financing Plan per Region and PDAM Size ( 1995 Rp billion) --------------109 Comparison of Scenarios 1 a, 1 b, 2a and 1 b Government Financial
Support (1995 Rp) ------------------------------------------------------------------109 PD AM Investments under Repelita VI and VII -------------------------------------110
Why PAM JAY A Has Failed to Reduce U f\V --------------------------------------- 16 A Water Supply Company with National Coverage:
SODECI in Cote d.Ivoire ---------------------------------------------------------- 19 The Case of Cote d'Ivoire - SODECI and Small Consumers ---------------------47 Completion among Water Resources in DKI Jakarta------------------------------- 62 Assessing deniand for Improved Water and Sanitation Services
in the Easter Islands---------------------------------------------------------------- 63 Background Information on RDA ----------------------------------------------------- 96
Number of Audited PDAMs, 1990-1995 --------------------------------------------- 21 PDAM Financial Performance, 1991-1995------------------------------------------- 24 U f\V Statistics, 1991-1995 -------------------------------------------------------------- 25 1995 PDAM Average Costs and Revenues (Rp/m3)-------------------------------- 26 PAM JAY A Dividend History and Coverage Ratios-------------------------------- 27 Funding Structure of Urban Water Supply Sector Projects
1994/95 - 1998/99------------------------------------------------------------------- 28 SLAs by Funding Agency, 1994/95 - 1998/99--------------------------------------- 29 SLAs by Debt Coverage Ratio --------------------------------------------------------- 30 Total RDA Loans Outstanding by PDAM Debt Coverage Category-------:.. _____ 32 PDAM Costs and Tariffs (1995) ------------------------------------------------------- 78 Costs and Tariffs of Water Supply----------------------------------------------------- 78 Examples of Average Water Tariffs --------------------------------------------------- 79 Connection Fees and Demand---------------------------------------------------------- 82 Funding Structure of Urban Water Supply Sector Projects
by Funding Sources by Year and by Grants by Type--------------------------- 99
This report was prepared at the request ofBAPPENAS by a team led by Alain Locussol (task manager) with major contributions from Messrs./Mmes.: Raja Iyer, Frida Johansen, Dong Liu, Jae So, Keiichi Tamaki, Risyana Sukarma (Bank staff), Imam Krismanto, Ian Wetherill and Michael Whitbread (consultants). Inputs were also provided by Messrs. Vincent Gouame, Klas Ringskok and Anjum Altaf who commented on the report's main recommendations.
ADB BAPPENAS BPAM Bintek BOOT BPKP DG Cipta Karya DG Pengairart DGPUOD FINPRO GOI KUDP ICB ITB IUIDP JICA
. JUDP LG Mo HA Mo HA MOU MPW NGO NSWA PAMJAYA PDAM PERPAMSI PJM pJp PLN PMDU PPP AB PVC Telkom Tk I; Tk II TNA WTP
PRINCIPAL ABBREVIATIONS AND ACRONYMS USED
Asian Development Bank National Development Planning Agency Non Autonomous Municipal Water Company Technical Directorate Build, Own, Operate and Transfer Government Audit Agency Directorate General of Human Settlements Directorate General of Water Resource Development Directorate General of Public Affairs and Local Autonomy Financial Projection Model Government of Indonesia Kalimantan Urban Development Project International Competitive Bidding Institute of Technology of Bandung Integrated Urban Infrastructure Development Project Japanese International Cooperation Agency Jabotabek Urban Development Project Local Government Ministry of Home Affairs Ministry of Home Affairs Memorandum of Understanding Ministry of Public Works Non Governmental Organization National Water Supply Authority Jakarta Municipal Water Supply Company Autonomous Municipal Water Company Indonesian Water Distributors Association Five Year Development Plan Government's Long Term Development Program National Power Company Provincial Monitoring and Development Units DG Cipta Karya's Provincial Water Supply Unit Polyvinyle of Chlorure National Telecommunication Company Provincial Level; Local Level Training Needs Assessment Willingness to Pay
URBAN WATER SUPPLY SECTOR POLICY FRAMEWORK
. EXECUTIVE SUMMARY
a. At the end of Repelita V in 1994, 36% of Indonesia's urban population of 67 million, or 24 million, had access to piped water. Aiming at serving 62% at the end of Repelita VIII in 2008, or 66 million people out of 106 million, could appear ambitious; It. · would however just reduce the unserved population from the 1994 level of 43 million to 40 million. To meet this objective about Rp7,000 billion andRpl0,800 billion would have to be invested during Repelita VII and Repelita VIII respectively, to be compared · with the Rp3,000 billion scheduled for Repelita VI. If the water supply sector is not able to attract commercial financing; because it is perceived as too risky, this level of investment would become an unbearable burden on the Government's budget.
b. Yet financial forecasts show that gradually phasing out of the Government financial support during Repelita VII, and financing development of the water supply sector only from cash generation and the capital market, as of2004, is affordable. To do this, the average tariffin large·PDAMs would have to be gradually increas~d from . Rp650/m3 in 1995 to only about Rp950/m3 in 2008. In smaller PD,AMs, the tariff would have to be gradually increased from Rp650/m3 to Rp800/m3. In DKI Jakarta, the average tariff could, in theory be decreased it efficiency gains could be achieved.
c. · However, the "graduation" of the water supply sector can be achieved only if an integrated set of policy changes is introduced to transform the current collection of municipal water supply companies into an autonomous and creditworthy customeroriented service industry. The Urban Water Supply Sector Policy Framework (WSPF) identifies six major policy changes, aiming at increasing the water supply sector's creditworthiness, with the ultimate goal to serve all customers better and at a lower cost. The Government may have no other option if it wants to free some public funds to finance sewerage service and waste water treatment, that are currently. provided to less than 5% of the urban population and unlikely to attract ·commercial financing in the near future.
Establish an Arm Length Relationship between the Owner of Water Supply·Assets and their Manager
d. Indonesia's municipal water supply industry currently counts some 300 companies. Their autonomy from their local governments is limited, so they cannot really be held accountable for their operating efficiency. Most PDAMs are far too small to attract good quality managers and staff. Their efficiency is typically low, as evidenced by high staffing ratios or high unaccounted for water. Their revenues are limited because of inadequate commercial policies reflected by low tariff.levels and tariff structures distorting consumption. Strict financial discipline is not enforced and the Government has recently made loans to poor performing and non creditworthy PDAMs. As a result, ·
EXECUTIVE SUMMARY
the financial health of most PDAMs, measured according to a set of criteria related to of efficiency, profitability and debt structure, is questionable. Finally, most local governments expect revenues from their PDAMs and extract dividends even if the level of service justifies that any profits be invested to improve and expand the service.
e. Separating ownership of water supply assets from their management could help limit political influence in the day-to-day management of the water supply operations. This move could be further supported through the participation of professional managers and user representatives in the Board of the operator. This action could also favor the setting and monitoring of performance objectives within the framework of enforceable "performance contracts". While worldwide experience with contracts between governments and companies they owned is not always encouraging, separating ownership and management functions would in fact lay the basis for private sector participation in the provision of water supply. Separation could allow for the consolidation of operations among neighboring local governments to take advantage of economies of scale. The notion of dividends to be paid by a PDAM to its only shareholder could be replaced by the notion of an operating fee to be paid by the operator to the owner of the facilities.
Establish a Regulatory Framework for Private Sector Participation
f. Private sector participation could be the main development in the water supply sector during the years to come. But under the present conditions, participating in the financing of the sector's development is perceived as a risky business by private lenders and equity investors. This perception is further supported by the absence of a transparent regulatory :framework, as evidenced by the many memoranda of understanding that have failed to lead to any significant deal.
g. Indonesia could take advantage of worldwide experience in private sector participation in water supply. The experience shows that all options -- from simple service contracts to sophisticated long term concessions -- must be envisaged with the assistance of independent consultants before soliciting proposals from private operators. Standard contracts and selection procedures, serve as the basis for the regulatory :framework, must be prepared urgently. Worldwide experience has also shown that transparent competition leads to lower prices and shorter transaction periods than direct negotiations. It also shows that even tightly specified contracts cannot remove the need for direct regulation, to provide a quick response to changing economic, social and technical conditions, and that an independent regulatory body should be operational as soon as contracts with private operators become effective. Since it is difficult to transform a former public utility into a regulatory body it could be advantageous to consider outsourcing some of the regulatory functions to reputable auditors or certification agents, at least in the short term.
ii
EXECUTIVE SUMMARY
Streamline Water Sector Financi~.l Management
h. PDAMs have so far financed their development mostly from Government grants and concessional ioans, .and very little through cash generation. Because of the indiscipline in Government lending and subsidized loan conditions, very few PDAMs may be considered creditworthy.
i. To finance extensions, the Government must emphasize PDAM cash generation, resulting from both efficiency gains and tariff adjustments. Access to ·Government grants and concessional loans could be clarified and PDAMs should compete for them, with the best performing having access to more favorable terms. In parallel, loans should not be made to PDAMs with weak debt service capacity, and lending conditions could be more strictly enforced. Decentralization of lending :functions to domestic ·banks could be envisaged, albeit cautiously, as a means to move lending conditions closer to commercial ones, increase flexibility in funding PDA:M projects and establish the needed discipline. Also, alternative financing means, such as bonds or securitization should be pursued,
j. To.reduce the current perception ofhighrisk,,it would be necessary to provide investors with reliable sectoral data, certified by independent auditors. A quality data · base could also allow the benchmarking of PDAMs performance and help local governments link tariff adjustments to a PDAM performance improvement plan and help the central Government direct its financial support first to PDAMs that improve their performance. Private sponsors of water supply projects would seek guarantees against a variety of risks (revenue, payment, termination and regulation), and the Government should focus mostly on providing guarantees only on termination and regulation risks.
Simplify Pricing Policy
k. PDAM tariffs do not meet any of the economic, financial, social equity and administrative simplicity principles of water tariff-setting. Current tariffs discriminate against lower income households by charging high connection fee and force large consumers to use substitutes such as ground water, thus depriving PDAMs of substantial revenues. They also invite manipulation of meter readings, a suspect in increasing commercial unaccounted for water.
1. An improved tariff structure could consist of a small fixed fee for covering administration and meter maintenance costs and a rate. per cubic meter of water consumed. The latter could include only two consumption blocks. The first could be a "life line" block of up to 10 m3 per month and a rate such that the first block would not .
· represent more than 4% to 5% of the total expenditure of an average low-income · household. The second one could be a "base.rate" set such that the overall average tariff represents a balance between economic'ally efficient marginal cost and financially viable average costs. Low-income households could be offered connections free of charge, provided that the tertiary distribution network is reasonably close by, in exchange for a refundable advance payment on their water bill.
iii
EXECUTIVE SUMMARY
m. While tariff negotiations could take place every four to five years only to encourage the operator of the water supply system to implement its performance improvement plan, tariff must be automatically adjusted between two negotiations, using a cost index formula reflecting actual cost composition. The economic cost of providing water could also take into account the cost of collecting and disposing of the waste water. Adding a sanitation surcharge to piped water could, under the current conditions, encourage some users to revert to poorly regulated alternatives. For now, a sanitation fee using the property tax as a basis appears more equitable.
Improve Planning, Design and Implementation of Water Supply Projects
n. As water supply systems are capital intensive, it is essential to develop them within the framework of systematic, long term planning with the objectives of seeking least cost solutions and reaching a broad consensus among all stakeholders on the technical, institutional, financial arid cost recovery options chosen. This practice is not yet part of the PDAM culture. An important way of reducing costs and enhancing project quality is to improve procurement practices by grouping works in larger packages to 'attract better quality contractors, by combining supply and laying of pipes, or by awarding design-andbuild contracts for water treatment and pumping plants; Reducing construction costs also means that real competition becomes the rule; since at present too many contracts seem to be awarded on a "rotatfonal" basis for predetermined prices. Finally, since the water supply sector depends very much on consultants for project identification, preparation, implementation and institutional development, it could be beneficial for all parties to take a step back and closely identify those current practices that limit access to the best available expertise.
Emphasize the Identity of the Indonesia Water Supply Industry
o. To help build the Indonesian water supply industry an identity, PERP AMSI could be given a larger role. PERP AMSI could take the lead in setting up the "quality" data base mentioned above. PERP AMSI could also be given enhanced responsibilities in human resource development, and it could assist PDAMs in improving recruitment, productivity and training plans, and in preparing and implementing medium-term staffing plans. PERP AMSI could update existing selection criteria for various key positions, and help develop a mechanism to advertise vacancies much more widely. PERP AMSI could also take the lead in carrying out independent testing and certification of new technologies, equipment and software available on the market, and support dissemination of best practice among PDAMs. Finally, PERPAMSI should actively "lobby" for the implementation of a water resource policy that addresses the main concerns of the water supply industry with regards to the timely availability of sources and the protection of water quality.
iv
Annex
Urban Water Supply Sector
Urban Water Supply Sector Main Assumptions for Future Scenarios
Scenario 1 a does not envisage major changes in the way the water supply sector develops; in particular efficiency of PDAMs would remain at its current level, the tariff policy would still discpurage .low income households to coim,ect because of high connection fee, and large businesses to connect because of too high tariff. ·With tariff increases of about 25% every three years, both cash generation and borrowing capacity would be limited. As result, the service ratio at the end ofRepelita VIII (2008) is likely to remain below 50%, and the unserved population would increase from 43 million in 1994 to 54 million in 2008. ·
. Scenario lb aims at serving 70% of the urban population in 2010, but with the same overall performance of the water supply industry. Public support to the sector would have to be about 70% of the investment program, and reach about Rp4,750 billion and Rp7,500 billion (at 1995 constant prices) during Repelita VII and VIII respectively.
Scenario 2a envisages a gradual improvement of the overall performance of the . water supply industry through increase private sector participation. This would allow access to the capital market and reduce the burden on the Government's budget. Despite more stringent financing conditions attached to privately sponsored projects, tariff levels. to service the debt and generate sufficient cash to contribute towards the investment program would remain affordable, even in smaller communities, according to willingness to pay surveys.
Scenario 2b is an hypothetical case that envisages that starting with Repelita VIII (2003) development of the water supply sector would be exclusively financed from cash generated from operations and the capital market; Repelita VII would be an transition period during which Government support would be gradually phased out Tariff levels needed to meet this objective would also be affordable.
UfW
Cost of Inputs
Residential Connection Fee
Tariff structure
2
Table I: Comparison of Scenarios la, lb, 2a and 2b Main Assumptions
Scenario la Scenario lb Scenario 2a
Remains at Remains at Decreases by one average current average current percentage point level of 40% level of40% per year
Remains at current Remains at current Minus 15% on all level level privately fmanced
and implemented project
Rp380,000 (at 75% of the new 75% of the new constant 1995 residential residential priees) connections would connections would
be provided free of be provided free of charge charge
Discriminates Two blocks only Two blocks only against non residential customers
Scenario 2b
Decreases by one percentage point per year
Minus 15% on all privately financed and implemented project
75% of the new residential connections would be provided free of charge
Two blocks only
3
Table 2: Comparison of Scenarios 1 a, 1 b, 2a and 2b Service .Ratio, Investment Program and Financing Plan
Repelita VIII RpS,300 bn Rpl0,800 bn Rp9,600 bn Internal cash generation 26% 25% 28% GOI grants 38% 41% 26% GOI loans on concess. terms 25% 28% 0% Loans on commercial terms 7% 4% 35% Private equity 2% 1% 6% PDAM bonds 2% 1% 5%
Scenario 2b
31% 38% 35% 41% 44% 48% 58% 62%
30mn 44mn 66mn
46mn 46mn 40mn
Rp6,200 bn 27% 13% 9%
42% 5% 4%
Rp9,100 bn 28% 0% 0%
60% 7% 5%
The first figure corresponds to the "connection" ratio, the second figure corresponds to the "service" ratio, that includes households served by residential connections and public standpipes.
Average Tariffs DKI Jakarta 1995 1998 2003 2008 Metropolitan PDAMs 1995 1998 2003 2008 Smaller PDAMs 1995 1998 2003 2008
GOI Financial Support
Repelita VII GO! grants
4
Table 3 : Comparison of Scenarios la, 1b,2a and 2b Tariff Increases Needed (1995 Rp/m3
Table 4: Comparison of Scenarios la, I b, 2a and 1 b Government Financial Support (1995 Rp)
Scenario la Scenario lb Scenario 2a
Rpl,500 bn Rp2,700 bn Rpl,800 bn GOl loans on concess. terms Rpl,000 bn Rpl,800 bn Rp 600 bn Total Rp2,500 bn Rp4,500 bn Rp2,400 bn Add'l population served 9.5 mn 13.3 mn 13.3 mn Per add' I pop. served Rp265,000. Rp340,000 Rpl80,000
Repelita VIII GO! grants Rp2,000 bn Rp4,500 bn Rp2,500 bn GOI loans on concess. terms Rpl,300 bn Rp3,000bn -Total Rp3,300 bn Rp7,500 bn Rp2,500 bn Add' I population served 12.2 mn 21.6 mn 21.6 mn Per add'I pop. served Rp275,000 Rp350,000 Rpl20,000
Scenario 2b
1,500 1,300 1;150 1,150
650 760 -780 950
650 670 680 800
Scenario 2b
Rp 800 bn Rp 500 bn
Rpl,300 bn 13.3 mn
Rpl00,000
---
2I.6 mn -
5
Table 5: Scenario 2a - Repelita Vil · Investment Program and Financing Plan per Region (1995 Rp billion)
DKI Metro Smaller Total Financ. Jakarta PDAMs. PDAMs· Plan
Cash GOI Comm. generat. Support Financ.
Region
Sumatra 530 540 1,070 290 470 310 Java 960 1,530 1,840 4,330 1,180 1,510 1,640 Bali 180 - 180 50 60 70 Eastern Islands - 190 190 5.0 100 40 Kali man tan 160 110 270 . 70 120 .80 Sulawesi 160 150 310 80 140 90 Total (Rp bn) 960 2,550 2,840 6,350 1,720 2,400 . 2,230 Total (%) 15 40 45 27 . 38 35
Table 6: Scenario 2a - Repelita VIII Investment Program and Financing Plan per Region (1995 Rp billion)
DKI Metro Smaller Total Financ. Jakarta PDAMs PDAMs Plan
Cash GOI Comm . generat. . Support Financ.
Region
Sumatra 750 880 1,630 450 470 ' 710 Java 870 2,450 3,230 6,550 1,800 1,700 3.050 Bali 320 - 320 100 30 190 Eastern Islands 290 290 70 130 90 Kalimantan 240 150 390 l 10 90 190 Sulawesi 240 210 450 120 120 210 Total (Rp bn) 870 4,000 4,760 9,600 2,650 2,530 4,420 Total (%) 9 42 49 28 26 46
6
Table 7: Scenario 2a - Evolution of the Financing Conditions
Repelita VII Repelita VIII (1999-2003) {2004-2008)
DKI Jakarta Internal cash generation 30% 30% GOI grants GOI loans on concess. terms Loans on commercial terms 48% 48% Private Equity 12% 12% Bonds 10% 10% Metropolitan PDAMs Internal cash generation 25% 30% GOI grants from 45% to l 0% 10% GOI loans on concess. terms from 30% to 0% 0% Loans on commercial terms 40% Private Equity 10% Bonds 10% Smaller PDAMs Internal cash generation 25% 25% GOI grants 45% 45% GOI loans on concess. terms from 30% to 0% 0% Loans on commercial terms 24% Private Equity 6% Bonds
1. THE URBAN WATER SUPPLY SECTOR
A. INTRODUCTION
1.1 Chapter I provides an introduction to the water supply sector in Indonesia, and is divided into three sections as follows. Section B introduces the sector organization, giving the various agencies involved in water supply and their respective responsibilities. Section C discusses Indonesia's water sources, the demand for water and its availability, water quality, water usage planning, management and operations, cost recovery and pricing. Section D describes the country's water supply industry. Included in this description are sources of information about the industry, service levels, substitute sources of water, the overall performance of the Indonesia water supply industry, and finally a comparison between the Indonesian water industry and that of Asia is made.
B. SECTOR ORGANIZATION
1.2 Local Governments (LGs) have been responsible for delivering water supply services in their jurisdictions since the enactment of Government Regufation 14/1987 (GRl 4/87) on decentralization of central government responsibilities-in public works. As
·of end 1994, 275 LGs had municipal water companies (Penisahaan Daerah Air Minum -PDAMs). These are financially autonomous, and their budget is distinct from that of the LG. By the same date, 19 interim water supply companies (BPAMs) still remained in.the provinces of Nusa Tengara Timar (NTT) and Timar Timur. They have been placed under the control of the Directorate General of Human Settlements (DG Cipta Karya) of the Ministry of Public Works. BPAMs' conversion into PDAMs.should take place as soon as they reach financial break-even. PDAMs are charged with developing and managing the water supply systems, and serving all categories of consumers at affordable prices. Although the main focus, so far, has been on day-to-day operations, PDAMs are now directly involved in planning activities, project preparation and implementation, and direct negotiations with the private sector to expand and improve service.
1.3 DG Cipta Karya assists LGs and their PDAMs in developing the water supply projects funded by the central Government, through its :flve directorates (program development, technical development and three regional directorates for implementation). At the provincial level, project. implementation is carried out through DG Cipta Karya's water supply preparation and management project units (PPPAB). The Directorate General for Water Resource Management (DG Pengairan) of the Ministry of Public Works has overall responsibility for surface water resource management, but the Ministry of Mining and Energy oversees groundwater. Through its provincial representatives (Kanwil), the Ministry of Public Works is responsible for the coordination of all infrastructure development at provincial government level. BAPPENAS, the national development planning agency, is in charge of preparing medium and long term national· development programs for all sectors, and of coordinating the ministries and evaluating program effectiveness. ·
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1.4 The Directorate General of Public Affairs and Local Autonomy (DG PUOD) of the Ministry of Home Affairs is responsible for supervising and monitoring local government enterprises including PDAMs, training in administration, in accounting, commercial matters, information management systems, and preparing business plans. PERP AMSI, the professional association of PDAMs, disseminates best practices in the operation of water supply services, promotes new management techniques and private sector participation and represents the Indonesian water industry outside the country. PMDUs (Provincial Monitoring and Development Units) have been set up under the guidance ofDG Cipta Karya and DG PUOD to monitor performance of the PDAMs and provide technical assistance to improve it.
C. WATER RESOURCES
1.5 Indonesia is .blessed with abundant rainfall and has approximately 6% of the world's fresh water resources equivalent to about 2,500 km3 of annual renewable water resources. Although this represents about 12,500 m3 per capita per year, the volume differs greatly between the various islands and regions. On Java, which has about 60% of the country's population of close to 200 million, the average annual water availability is about 1,750 m3 per capita, and it is distributed unequally both in space and seasonally. Many of the internal renewable water resources are provided by surface water from nearly 5,500 rivers. For the purposes of water resources planning and management, this archipelago nation is divided into 90 river territories comprised of a single and/or multiple river basins. Groundwater resources are limited and are mostly used for domestic, municipal and industrial purposes.
Water Demand and Availability
1.6 In some river basins, in particular those with large urban areas such as Jakarta and Surabaya, surface ~ater and ground water resources are reaching a.critical stage of maximum use. Probiems of water availability in terms of quantity and quality have increased rapidly over the last decade in response to demands from irrigation, industrialization, urbanization and population growth. Multiple purposes and competing users have already created critical situations, in particular on Java where by the year 2000, demand is projected to increase by some 70% over 1990 levels. In river basins with heavy urbanization (Jakarta, Bandung, Bogor, Cimanuk, Semarang, Surabaya and Tangerang) the competition between urban and industrial use~ and irrigation is particularly intense during the low flow season. Urban and industrial priorities have reduced supplies for irrigated agriculture (predominantly rice cultivation), which continues to be the biggest user by far of surf;:tce water. While municipal and industrial demands comprise a relative ly small portion of the total water balance, satisfying these demands will be crucial to accommodating continued industrial and urban growth. Management tools for water accouriting purposes include tradable water rights and real time water allocation systems that require considerable lead-time for development and target group assimilation. Real-time water allocation is being introduced ·and tested in selected river basins on Java.
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1.7 Usershortages are evident in several locations. Regions of Java, Bali and the Eastern Islands face serious vulnerability to water scarcity due to intensive and inefficient water usage. Significant contributing factors are the non-integrated, economic growth- · driven approaches to managing withdrawals, amplified by rapid urbanization and population growths. In 1990, the water deficiency on Java was reportedly at 5% during low flow periods. This figure is projected to increase to about 40% by the year 2000. Controlling or moderating this deficit growth requires robust and· effective resource management systems and innovative solutions which can rein in inefficiencies and provide sustainable supply. This means that a shift from development of water resources to one of management and improved maintenance is essential for the sustainability of planned socio-economic growth. For reasons of ·inadequate source development, inadequate delivery capacity and inefficient usage, industry and households face water shortages, which are expected to worsen. Current reservoir storage capacity in Indonesia, particularly on Java, is low and does little to smooth out seasonal and inter-annual variations of flows on the river systems, except for the Jatiluhur storage system on the Citarum river in West Java. Securing additional surface water availability is still possible through the creation of reservoir storage on rivers. While potential storage sites are limited arid their development often entails environmental and resettlement problems, ·· Government has identified and prepared several suitable projects on Java for development.
Water Quality
1.8 Water quality has declined rapidly in the past ten years due to massive industrialization, urbanization and a lack oflegislated institutional capacity to control or remedy water pollution. Water quality, in certain watersheds, has deteriorated drastically from in-stream and off-stream pollutants. Some water storage reservoirs on Java have reached eutrophic conditions. Even in the countryside, where population clusters are often concentrated along canals and streams, water of appropriate quality for domestic use is becoming increasingly scarce. Improved and more focused government, private and public sector participation and commitment are needed to ensure environmentally responsible management of water quality.
Water Usage Planning, Management and Operations
1.9 Water use planning, management and real-time operations are hindered by institutional arrangements (or lack thereof) and legal frameworks which are not tailored to effectively promote or support integrated planning and management approaches across ministries and departments participating in water resource developm~nt. Water sector activities within national plans (Repelita) are treated on a sub-sector basis, with some eleven ministries sharing a part. This leads to competing priorities or counter-productive water usage, tension and contrariety among program proponents (ministries, special interest groups, NGOs) with adverse effects on national strategies. Decreed utilization of legislation and policies is required to evoke awareness and cooperative management responses from the ministries involved, and public and private interests in order to
4
implement efficient, effective and environmentally sustainable water usage administrative systems within the framework of the national socio-economic development plans. A national level body or commission may be needed to serve as an umbrella organization to direct such activities and to coordinate and prioritize management programs and investment plans of the various ministries.
Cost Recovery and Pricing
1.10 While the Government is responsible for water resource management, it faces fiscal constraints on its capability to cover all water management and infrastructure costs. The fiscal constraint means that often essential infrastructure investments are slow in coming, and that operation and maintenance needs are general_ly not fully met. Government has largely focused on developing water supplies and has given insufficient attention to demand management and conservation. Government has developed several initiatives to address cost recovery and water pricing. Costrecovery and water pricing are within the context of national development goals (PJP II). Forthcoming five year plans (Repelita VII) should continue to increasingly recognize the need for economic efficiency in supporting the financing of water resource development costs. The five-year plans should embrace water service fee concepts based on the "Economic Good" principle rather than the currently active socio-political concept which treats water as a "Public Good". Cost recovery for investment and public services will be necessary to attain and sustain economic growth targets. The adoption and introduction of water service fees in the public and private sectors will be of fundamental importance.
5
D. THEW ATER SUPPLY.INDUSTRY .
Sources of Information
1.11 It is not easy to get an accurate pictirre of the' Iridonesian water industry or to assess past trends, in particular because many documents fail to refer to a specific date. Several data bases have been devefoped'by DG Cipta Karya and DG PUOD, using data collected from the PDAMs by the PMDUs or by the Government's auditors (BPKP). The directory issued in 1995 by PERP AMSI, and supposedly to giving data updated as of end 1994, has been the main source for this part of the report. It giv~s consistent information for all PDAMs, and in particular, differentiates between residential arid non-residential connections, includes data on production capacity, unaccounted for water (UfW), total staff employed, average production costs, annual sales, value of assets and outstanding debt. It does not, however, give data on volumes of water produced and distributed, length of distribution network or storage capacity all of which are could help assess the level of service arid performance of the industry. Updating a data base on the Indonesian water supply industry~ an important monitoring and planning tool that should become PERPAMSI's main responsibility. It would be useful to redesign slightly the current format used to include data such as production and distribution and actual gro\.vth during the fast five years, length of the distribution network, storage capacity, tariff structure, cost and revenue structure and a simplified balance sheet. These data are often available from the PDAMs, but almost always need to be checked.
1.12 Data obtained from the above directory have been complemented with the results of a survey conducted among more than 150 PDAMs as part of the "Water Tariff Structure and Financial Policies of Water Enterprises" financed by the Asian Development Bank (ADB) in 1996, and a more limited survey carried out for the preparation of this report among about 30 PDAMs.
Service Level
1.13 At the end of 1994, of a population of 192 million, about 67 million, or 35% lived in urban areas. At the time, piped water was provided through some 2,850,000 residential connections serving probably 20 million people, or 29% of the urban population and through 36,500 public standpipes serving an additional 4.5 million people. Altogether, only about 24.5 million people or 36% of the urban population had access to the public· piped systems. (These figures do not include those people who obtain their water from vendors or illegally from the distribution networks.) Service ratios are difficult to estimate with accuracy, since they depend in particular on an estimate of the number of households served per connection and per standpipe. It is usually admitted that an average of seven people, or 1.6 households, are served by a domestic connection as a result of collective housing, sharing of a connection by two or more households and purchasing from neighbors. Obviously these figures vary widely from large metropolitan areas to small semi-urban centers. An estimated 125 persons or.about 30 households on average are served per standpipe. If the above figures were increased to eight person per
6
connection and 150 persons per standpipe, the total population with direct access to the public piped network would be 28 million or 42% of the urban population.
1.14 Only some 350,000 connections served administrations, businesses and industries. Table 1.1 below shows service ratios below 25% in the provinces of Riau, Lampung, Yogyakarta and Central Sulawesi and above 40% in North, West and South Sumatra, Bengkulu, East Kalimantan, North and South Sulawesi, Bali, NTT and Nusa Tengara Barat (NTB). The very high ratios of North Sulawesi may result from rural connections and public taps serving populations not counted as urban. On the island of Java, service ratios are always low, reaching only about 32% in Jakarta. This does not mean that the water supply situation is critical, but often reflects the availability of substitute sources of water, mostly groundwater, that can be tapped in acceptable conditions at a reasonable price.
1.15 The above data implies that about 4.5 million households were directly served by connections and an additional one million by public taps at the end of 1994. These figures are to be compared with the ones deriv~d from the 1980 and 1990 censuses and Susenas figures. Although the urban population with access to piped water greew by almost 40% between 1989 and 1994 at an average rate of 6.5% per year from 17. 7 to 24.3 million, the size of the unserved population increased by almost 25% at an . average rate of 4.3% per year. It is estimated that, at the end of 1994, about 10 million households or 43 million people, had no access to piped water, of which 30 million were on Java alone.
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.7
Table 1.1-1994 Service Level per Provi11ce
End 1994 Total Urban Urban Po11. Total Dom. Public Urban hh. Conn. Served Urb. Po11. hh. Servctl Unscrv. Ith. Po11.
Served Situation Po11. Po11. Ith. per Conn. Conn. Taps Pop. per 11cr Ratio Conn. Taps Total Total conn. taps total Tolal Total
Urb. hh. with access to piped water % 26.4 33.7 . 36.1
Urb. hh. with access to piped water 000' . 1,628 3,648 5,574 53% 8.85% Urb. pop. with access to piped water mio 8.7 17.7 24.l 37% 6.52%
Urb. hh. with no access _to piped water 000' 4,539 7,178 9,866 37% 6.57% Urb. pop. with no access to piped water mio 24.l 34.9 43.0 23% 4.30%
Substitute Sources of Water
1.16 Many households, businesses and industries are forced to develop their own water . supplies because reliable public service is not available. In Jakarta, for example, most
commerce, industries and households, even very wealthy ones, obtain water throu~h individual shallow wells and deep boreholes. The recently completed "Jabotabek Water Resource Management" study estimates that in 1990, about 8.6 m3/s (750,000 m3/day) are pumped from shallow and deep aquifers in Jakarta alone, while PAM JAY A, Jakarta's PDAM, distributed about 450,000 m31day (5.2 m3/s). For Jabotabek the total abstraction from aquifers is estimated to reach 18.5 m3 Is (1.6 million m3 /day). Individual water· supplies often affect health, since most shallow aquifers are heavily polluted by on-site sanitation, and sometimes have environmental consequences, such as intrusion of saline water for over exploited aquifers in coastal cities and land subsidence. The above mentioned study identifies overabstraction of deep aquifers in the northern part of Jakarta as one of the major issues to be addressed, since land subsidence in a city barely lying above sea level leads to flooding problems that are extremely costly to solve.
1.17 Street vendors are often the only source of water used for drinking and coo king purposes in lower income neighborhoods. In 1991, a survey estimated that up to 32% of
·the population of Jakarta bought water from street vendors. Depending upon the distance from the public taps where the water is obtained, the price of water can evolve from Rp150 for two jerricans of20 liters to Rp350 for the same quantity (US$1.5/m3 to $3.75~m\ This study also estimated that water vending generated revenues about twice those collected by PAM JAY A.
1.18 Many households use several sources of water even when connected to the public · distribution system. In lower income areas, people tend to limit piped water consumption
for drinking and cooking purposes, and still rely on their wells or surface water _for
9·
bathing and laundry. Even in the wealthiest areas of Jakarta and other large cities, households tend to use water from their deep well for most purposes, except drinking for which bottled water is preferred, while piped water is often a stand-by source. As part of this exercise, a survey of cons.umers was carried out in five small urban centers of NTT, Sulawesi and Kalimantan (see Chapter 5: Improving Quality of Water Supply Projects). This study interestingly revealed that households thatare not connected to the piped network are as satisfied with their current water supply as those connected.
1.19 Water from most PDAMs is considered below potable quality by users. Pollutants accumulating in water bodies tapped for supplies cannot be removed by existing treatment plants at a reasonable cost, and intennittent distribution allows suction of pollution into empty pipes. Almost everybody boils their drinking water, whether from their own wells or the public facilities. This practice is so much part of the Indonesian way of life that it is unlikely to change in the near future, even if water distributed by a PDAM is perfectly potable. Thus, improving quality of water may not reduce energy consumption. The low quality of piped water perceived by consumers, has favored a booming bottled water market, believed to grow 20% annually. According to the Ministry of Health, about 175 companies are registered and distribute bottled water under 275 brand names .. Twenty-three of these companies are located on Sumatra and 132 on Java.
1.20 ·There are no global statistics on the chemical and bacteriological quality of water distributed, either by piped systems or in bottles and in particular, on how many times per year Indonesian water quality standards have not been complied with by a particular PDAM. However Ministry of Health statistics on incidence and death caused by ' diarrhea, as the most common water-related health problem, tend to show a situation unchanged during the last five years with about 20 to 24 cases of diarrhea per thousand people and 0.25 to 0.30 cases of death per thousand cases of illness. Altogether about 3.5 million cases of diarrhea were reported in 1995, and 1,100 people died of it. The provinces ofNTB and Timor Timur have higher rates of morbidity: between 30 to 50 cases of illness per thousand people and above 1.0 case of death per reported illness. There are no separate data available for the urban and rural sectors.
·Overall Performance of tlie Indonesian Water Supply Industry
1.21 As of end 1994, the 296 municipal water companies (of which 275 were PDAMs) managed about 1,600 piped systems (of which 1,000 were IKK (Ibukota Kecamatan), i.e. simple piped systems in semi-urban areas serving mostly standpipes. Total installed production capacity was about 6.25 million m3 /day (72 m3 /s ). Data collected for the water tariff study for the year 1995 allow an assumption that on average about 80% of the installed production capacity is used, and that the volumes of water produced and distributed were in the range of 5 .0 and 3 .0 million m3 /day respectively, leaving about 40% of the water produced unaccounted for and generating no revenue. For 3.25 million connections served, this corresponds to an average consumption of about 0.92 m3/day per connection or 335 m3/year per connection. If90% of the water distributed is consumed
10
through 2.85 million residential connections, then average domestic consumption would be in the range of 130 liter/day per capita.
1.22 . The Indonesian water supply industry is a collection of small businesses: at the end of 1994, only four PDAMs served more than 100,000 connections, four between 50,000 and 100,000, 58 between 10,000 and 50,000; 230 PDAMs and BPAMs served less than 10,000 connections. The industry employed a total of 33,200 staff, or an average of 10.3 staff per thousand connections; the four largest PDAMs (Jakarta, Surabaya, Bandung and Medan) serving 850,000 connections (or 26 % of the total), employed about 6,300 staff (or about 7. 4 staff per thousand connections).
1.23 Total net assets in operation were estimated at Rp2,365 billion (US$ l ,OOO . million), total operating costs (O&M plus depreciation and interest on debt) Rp875 billion (US$380 million) and total revenue Rp855 billion, of which Rp750 million; or 88%, were from water sales (US$370 and 325 million) on average. As part of the ADBfinanced water tariff study already mentioned, financial data were obtained for about 150 PDAMs and allow the computation of simple financial ratios such as the operating ratio and the account receivable. Table 1.3 gives some performance indicators by province.
Comparison with the Asian Water Industry
1.24 The overall performance of the Indonesian water industry can be compared with the one of several other water utility companies as presented in the Data Book prepared by the ADB in 1993 (Table 1.4). The Indonesian Water Industry scores rather poorly on service ratio, which averages 35 to 40%, even for its four l<')!gest cities of Jakarta, Surabaya, Bandung and Medan. Cities of similar size such a.S Kuala Lumpur and Penang in Malaysia, Bangkok in Thailand, Manila and Cebu in the Philippines and Singapore have much higher service ratios. While this could result from a production shortage, as in Surabaya, it also results from piped water competing with substitutes of acceptable quality that can be tapped at reasonable cost, as in Jakarta. Domestic water consumption levels, in the range of 175 liters per capita and per day (led) for large Indonesian cities are comparable with the ones of other large cities in Asia and throughout the world. While the Indonesian water industry has a high level ofUfW, far worse than Singapore for example, it is comparable with that of several other large Asian cities; Manila even has a higher UfW (58%) than Jakarta (53%). Another criterion that is commonly used to measure efficiency of a water utility is the number of staff per 1,000 connections; with an average of 10.3, it is comparable with major cities of the Philippines but far above Singapore and Kuala Lumpur. There are still several cities in Asia where water may be and is drunk directly from the tap without boiling.
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Table 1.3 - Water Supply Imlust1y: Selectetl Performance Ratio
End 1994 Total Urban Total PDAMs PDAM Size (000') Staff Assets Assets Sales Sales Prod.
Situation Po11. Pop. Conn. +BPAMs 50 to fo to Total I conn. I conn. Ca11.
2.1 Chapter 2 discusses the management of water supply operations. It is divided into three sections as follows. Section B describes how the overall management of PDAMs may be improved. It makes a number of recommendations that are centered around four main topics: (a) separating ownership of assets from the management function as a means to establish contractual relation between the owner and the operator; (b) limiting political influence by including user representatives in PDAMs' Boards of Supervisors ( c) introducing an incentive framework either through "performance contracts" or through private sector partiCipation; and (d) regrouping certain functions of the PDAMs to increase efficiency. It also discuss the possibility of creating a national water supply authority. Section C highlights ways to improve the financial management of PDAMs through effective performance measurement. It elaborates on the existing financial performance and incentives of the PDAMs and suggests that the notion of a "dividend" to be paid by the PDAM to its only shareholder be replaced' by that of an "operating fee" to be paid by the operator to the owner of the assets. ·
R IMPROVEMENT OF PDAMs' OVERALL MANAGEMENT
Separate Ownership of Assets from Their Management·
· 2.2 A local government, ultimately responsible for the provision of piped water, should be mainly concerned with the rapid expansion and reduCtion of the cost of service to make water affordable to all consumers. These two objectives can be better achieved if their are linked to financial incentives within the framework ofenf orceable contracts. By separating ownership of the facilities from the management function not only can such contracts be more easily implemented, but also some of the main issues identified below can be addressed. In particular, separating ownership from management could help: (a) limit ad-hoc local political interference in the management of the water supply service; (b) facilitate implementation of "performance contracts" and private sector participation in the delivery of water supply service; and (c) allow "managing.companies" to group themselves to more efficiently address issues common to adjacent water supply systems.
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Limit Political Influence
23 Defining good development and pricing strategies for water supply service in a particular local government (LG) is the main responsibility of the Board of Supervisors of the PDAM. These Boards are typically chaired by the head of the LG (Bupati or Walikota), and include the heads of the Bureau for Infrastructure Development, Dinas Public Works, Dinas Health and Bureau of Local Government Development, in accordance with MoHA's decree nol/1984. Few Boards have the capacity to provide clear guidance to PDAM management and to efficiently monitor their performance. Too often, Boards have the tenden~y to "micro manage" by interfering in day to day operations, project design, selection of contractors or recruitment of staff. They also tend to treat PDAMs as a potential source of cash, although the obligation of paying the local (Tk II) level government 55% of the PDAM net profit as dividends to the LG is mandatory only when 75% and 60% coverage of the urban and rural population· respectively is reached, and this contribution is often returned as equity to the PDAM (para. 2.31 ).
2.4 Although the above mentioned decree 111984 allows the head of the LG to name Board members, it is rare that representatives of user groups - residential and businesses - and professional managers are selected. This limits transparency and affects the quality of decisions, in particular regarding hiring key managers, selecting options for private sector participation, and designing a tariff structure. Expanding the composition of Boards to include people accountable to domestic and business consumers and to professional managers from the private sector is likely to be a needed counterweight to further decentralization of the decision making process; it should be implemented systematically, at least in large and medium-sized PDAMs. Transparent selection and remuneration procedures of Board members should be prepared by MoHA.. Also, although the same decree envisages that the Chairman of the Board need not be the head of the LG, this is almost never the case. It is desirable to give the Boards, at least in large and medium-sized PDAMs, more independence from political influence; therefore, Chairmen of the Boards should be selected for their managerial and technical competence. Finally, training of Board members should be developed with the assistance of management consultants familiar with the public water sector, and should focus on policy issues such as planning, procurement, pricing, private provision of public services and regulation.
Introduce an Incentive Framework
2.5 In order to improve the performance of the PDAMs, in particular with regards to UfW and staff efficiency and collection ratio, the Boards of Supervisors could .consider entering into medium term peiformance contracts with PDAM management and agree on short term (four to five years) performance objectives. This proposal should be given serious consideration at the time that heads ofLGs are made responsible for allocating the block grants received through INPRES from the central government to the various municipal services. Such "performance contracts" could include a clause that would
15
allow sharing of the PDAM profit with its staff on a performance basis, for example. Performance contracts have been implemented in many developed and developing- . countries between governments and the companies they own. While only a few provide success stories, many are failures as the result of: (a) an insufficient understanding of· incentives needed for improving performance and thus its indicators, and (b) non compliance by the governments themselves with their contractual obligations, for example timely allocation of water rights, approval of tariff increases, agreement on a staff reduction program or timely payment of its water bills. Performance contracts could . be tested in Indonesia on a sample of representative PDAMs of various sizes. However, in designing a profit shanng arrangement, it would be necessary to carry out independent and detailed analyses of the ''perverse incentives" that are at the origin of poor performance and identify a set of "right incentives" to be introduced.
Unaccounted/or Water
2.6 A good example of a misunderstood incentive framework is that for Utw reduction. Despite being one of the stated goals of most water supply projects under RepelitaV and VI, the objectives set were and still are seldom realistic and thus never achieved. The main causes of high Utw are (a) inadequate metering and commercial procedures (including illegal connections.and theft of water), and (b) physical leaks.
2.7 In most PDAMs, metering is deficient. Water production is often estimated on the.basis of the capacity of the production facilities and sometimes voluntarily overstated, for example to justify the need for new projects. Residential meters are u~ually · inaccurate and rarely checked. Also, it is surmised that illegal under-reporting of water consumption, a widespread practice, is implicitly encouraged by the current block tariff structure (chapter 6) in order to artificially reduce the bill to be paid by certain categories of customers. However, if a PDAM can increase the water tariff to increase its revenues, regardless of improvement of its performance, it is unlikely to improve metering and commercial procedures. Experience worldwide with utilities. with high UjW show that the first step for a comprehensive reduction program is the complete overhaul of . commercial activities, including customer files, customer service, metering, billing, collection and commercial planning. In order to place the commercial function of the PDAMs in an incentive framework that would favor reduction of commercial UfW, they should consider subcontracting commercial activities, either as part of a comprehensive concession, lease or management contracts, or simply as part of a
. service contract (chapter 3) with part or:·ali of the remuneration linked to actual performance:
2.8 ·. · PDAMs are more likely to fix the physical leaks if this significantly decreases their operating costs; for example, if bulk water is plentiful and can be obtained at low cost, reducing physical leaks would have more a cosmetic effect than a financial impact. Also PDAM are more likely to fix leaks'ifthis could lead to the postponement of, for example, a lumpy water production investment; but, long term planning and search for the least cost solution is seldom part of the PDAM culture. Many PDAMs seeking to
16
reduce UfWfocus their attention on leak detection rather than on commercial procedures. They often sub-contract leak detection to consulti~gfirms and sometimes envisage linking their remuneration to actual pelf ormance. This type of contract is unlikely to succeed because: (a) PDAMs will be reluctant to let a private company manipulate the distribution network for leakage detection and repair because this could disturb water service; (b) service companies are unlikely to accept their performance being subject to that of their client, who may or may or not authorize manipulating the network or issuing digging permits; and ( c) there are too many perverse incentives to artificially improving UfW data.
Box 2.1- Why PAM JAYA Has Failed to Reduce UJW
PAM JAY A's U:fW remains above 50% after five year of a systematic leak detection and distribution pipes rehabilitation program supported by a World Bank-financed project. This program, which was carried out during the last five years by consultants but with limited followup by PAM JAY A itself, is a good example of misunderstanding the issues to be addressed: (a) raw water is purchased at Rp28/m3 and treated water is sold at an average Rp 1,450/m3
, and thus it makes little difference in PAM JAY A's incomes whether 1.5 or 2.0 m3 ofraw water have to be purchased to produce one m3 of clean water; {b) there is currently surplus production capacity and no pressure to postpone water production investment, which anyway would not be under PAM JAY A's responsibility; and (c) a 54% tariffincrease was granted by DK.I Jakarta in 1994 without any conditionality. Retrospectively, it seems that it would have been more appropriate to (a) first focus on an overhaul of the metering and commercial procedures, possibly through a comprehensive service contract with a specialized company; (b) increase the bulk water price to reflect the long term marginal cost of water to encourage water conservation by PAM JAY A, even ifthe high price to the consumer does this already; (c) introduce a flat tariff for all customers to lessen suspected manipulation of meter readings; (d) monitor U:fW by independent certification agents; and ( e) possibly propose a profit-sharing arrangement to PAM JA YA management and staff linked to independently measured performance. The concession contracts that are currently being negotiated are supposed to include most elements of this incentive framework.
Cost Reduction
2.9 . Cost recovery of operations and development of a water supply service have almost always been taken by the Government and its lenders as the need to increase tariffs and seldom as the need to reduce costs. This undoubtedly results from the way water supply projects have been designed, i.e. mostly as "public works" projects focusing on the construction of new facilities and cost-plus arrangements rather than as "public utility" projects focusing on improving the quality of service and reducing costs. The standard approach to managerial problems has almost systematically been to finance technical assistance and training of PDAM staff, rather than to identify which "perverse incentives" limit pelformance and which "good incentives" would have to be introduced to improve. it. The problem has been exacerbated by the limited
17 ,
implementation capabilities of PDAMs and of DG Cipta Karya and their consultants who. rarely have operations and management experience.
2.10 Subcontracting part or the entire management of the water supply service to specializedpr.ivate companies is the easier way of introducing an incentive framework · (chapter 3). Service contractors are paid on the basis of outputs rather than inputs, and management contracts often include a profit-sharing clause. Concession and lease contracts have built-in incentives that encourage the contractors to reduce their costs in. order to maximize their profits. Coming back to· UfW, reduction can be expected only if it translates in increased profits: in a ten-year lease contract, the private company will mostly watch short term operations and maintenance (O&M) costs, while in a 30-year concession it would look rather at long term marginal co"st.
PDAMs to Address Common Issues Jointly
2.11 According to GR 14/87, PDAMs own water supply assets and are responsible for their technical and commercial operations. So far, GR 14/87 has been translated as "one PDAM per LG"; this principle leads sometimes to the splitting of one PDAM into two when the capital of the kabupaten becomes a kotamadya (such as is planned for Tangerang, West Java). Where managerial ci;ipacity is scarce, particularly in Tk II level agencies, and the consumer base is limited, this practice is difficult to justify, other than on local political grounds. Increased efficiency through economies of scale and least cost solutions should be sought. Managem~nt of water supply operations by Tk II PD~s . can be adequate when facilities are within the LG boundaries, and the operations are large enough to justify a full range of services and attract good quality managers and staff. Worldwide experience suggests that the minimum size of a water supply company .is 50,000 to 100,000 connections. Public water supply service could be more efficient through a -limited number of regional water companies, say 50 to 100 for all of Indonesia.
2J2. For many larger urban areas, reliable water sources, i.e. sources that can be efficiently protected from pollution, have to be developed outside LG boundaries. Also, in are.as where water sources are scarce and their development costly, common facilities serving several LGs may be preferable .. According to GR 14/87, Tk I LGs can create bulk water supply companies, as has been the case iµ Tegal and Brebes in Central Java, or for the greater Surabaya region in East Java. There are some successful examples (as in Morocco) of separation of water production/transmission from the distribution function, in particular when long and costly transfers are necessary. Provincial governments need not create provincial water production companies to sell bulk water to individual
. PDAMs, hut rather should encourage PDAMs dependent on a common water produ'ction source, to create,finance and manage a joint water production company, or to subcontract these functions to a private developer1
• Water distributors are always
In retrospect, it would have been more appropriate that PDAM Tangerang and PAM JAY A jointly create a company to finance, build and operate the Cisadane Water Production unit for West OKI
18
concerned with the timely availability of adequate quantity and quality of bulk water and prefer to be responsible for their development. Adjacent PDAMs seldom carry out combined planning exercises with the objective of defining more efficient schemes, and facilities are sometimes duplicated. Provincial agencies responsible for assisting PDAMs in developing their operations (chapter 4) should take an active role in (a) supporting the preparation of regional master plans where needed, and in (b) seeking technical and institutional options that lead to least cost solutions.
PDAMs to Regroup Certain Functions to Increase Efficiency
2.13 As mentioned earlier, of the 296 water companies, only 71 (24%) served more than 10,000 connections at the end o~ 1994. But there is obviously no need to assemble 296 management teams and 296 commercial, procurement and inventories of spare parts systems to provide the servic.e for 296 LGs. Many examples, throughout the world, show that water supply services can efficiently be provided by public or private companies that serve areas much larger than municipal territories, or even cover the entire national territory (Box 2.2). Already, DG PUOD envisages the eventual transformation of the BP AMs of Timor Timur into a provincial PDAM because the smallness of each does not justify creating one PDAM per kabupaten. Also, several PDAM managers in Bali think that a single provincial water company would be more efficient, taking into account the small size of the province (about 10,000 km2), long term water resource issues, overall size of the operations - currently just over .100,000 connections - and the need for providing technical and financial support to some PDAMs.
Is There a Need/or a National Water Supply Authority?
2.14 Successful decentralization of full responsibility for development of water supply service to the PDAMs would require, as described above, that: (a) user groups and professional managers become members of PDAM Boards to increase transparency and quality of decisions; (b) incentives to improve quality of service and reduce its cost be introduced; ( c) a comprehensive and detailed regulatory framework to ensure that PSP is implemented on a sustainable basis; ( d) provincial technical assistance units to help PDAMs define their development and managerial needs and seek appropriate solutions; and (e) increased discipline in the financing of water supply projects. PSP and financing issues are discussed in chapters 3 and 7 respectively.
Jakarta; this problem could find an acceptable solution as part of the PDAMs' effort to involve the private sector in a comprehensive management and development scheme of the water facilities in West DKI Jakarta.
19
Box 2.2-A Water Supply Company with National Coverage: SODECI in Cote d'Ivoire
In Cote d'Ivoire (West Africa); SODECI, a domestic private company under a concession contract with the central government, owner of the assets, distributed l 00 million m3 (3 .2 m3 /s) in 1994 through 320,000 connections to an urban population Of five million located in more than 400 cities and towns ranging from two million to less than I 0,000 people and scattered over a
2 ' territory of320,000 km .. In 1994, SODECI employed only 1,300 staff(4.06 staff per thousand connections); SODECI has kept down UfW levels to about 15% for the last 15 years.· The average water tariff (US$0.65/m3 equivalent) is sufficient to cover operation and maintenance costs, service the debt, finance part of the extension program and remunerate SODECI's shareholders. Seventy percent of the 320,000 connections have been provided to small residential customers, free of charge, as part of a Government policy to favor access to piped water (box 3.2). SODECI is contractually required to implement this policy. Thanks to limited cross subsidies provided by profitable operations in the capital city, Abidjan, and a few other large cities, SODECI is able to provide a high quality service in small rural towns, and is still regularly expanding its customers base. Had each secondary center or each province been responsible for providing the water supply service, it would have been impossible to achieve this impressive performance ratio.
2.15 If full responsibility is to be transferred to the PDAMs, the role of central agencies would be the definition and enforcement of policies and quality standards, guidance on planning and institutional issues and overall monitoring of sector development. As in many countries where responsibilities for overseeing financial and technical performance of the water supply industry are split among several departments with limited · coordination, it is legitimate to consider consolidating these responsibilities into a "national water supply authority"? ·
2.16 One of the first issues to address would be its "tutelle" or supervisory ministry. In some countries, such an agency has been placed under a "neutral" ministry, such as the planning ministry to improve the dialogue between the key technical ministries such as MPW and MoHA. If created, a national water supply authority (NSWA) would have three main functions:' (a) defining, updating and enforcing pc>'licies; mostly regarding quality of service and of water, pricing, financing options, and private sector
. participation; (b) monitoring the water supply industry technical and financial performance, and its competitors (such as bottled water); and (c) "lobbying" for. implementation of water resource management policies that address the piped water supply industry's concerns in particular with regards to raw water quality and timely availability. NWSA would also be respon5ible, in close collaboration with the professional association PERP AMS!, for closely supervising the functioning of the provincial technical assistance units, at least during the initial years (para. 5.3). Only a small part of the current DG Cipta Karya would be transferred to the NWSA. Most of the unit would be seconded to the provincial technical assistance units.
20
2.17 PERP AMSl, which should remain a professional association, could see its role strengthened and focused on (a) improving the industry's technical and management standards in particular through testing and certifying equipment (pipes, meters ... ), technologies (treatment plants), ID:anagement software, preparing standard specifications for equipment, and disseminating best practices in O&M, including through PSP; and (b) implementing a human resource development policy focusing on the establishment of an active "market" for and certification of managers and technicians, and developing or updating curricula and training modules adapted to the water industry (chapter 4) including planning, project cycle Gustification, preparation and implementation) and operations.
C. IMPROVEMENT OF PDAM FINANCIAL MANAGEMENT
Performance Measurement
2.18 Currently, three mechanisms are involved in measuring the financial performance of PDAMs: (a) accounting principles; (b) audits which verify the accounting results; and ( c) a rating system which benchmarks PDAM performance. This section explores issues of accounting, auditing and the PDAM rating system.
Accounting
2.19 In 1991 MoHA issued an accounting manual that defined the accounting policies which the PDAMs should follow. These practices have been implemented in a majority of PD.A.Ms. However, LGs grant a wide range of discretion in the accounting methodologies on calculation of corporate income tax, dividends, depreciation, asset valuation, asset transfer methodologies from the central government to LGs, treatment of investments in new connections, and interest capitalization rriethods. This.makes comparison and benchmarking of PDAM performance across the board more difficult.
Auditing
2.20 Responsibility for auditing PDAM financial statements falls on GOI's Development and Financial Control Board or BP.KP (Badan Pengawa Keuangan dan Pembangunan). BPKP has been able to audit an increasing number of PDAMs each year since 1990; however, it is not able to audit them all. At the end of 1995, out of 275 PDAMs, 236 PDAMs or 86%, had been audited. The remaining PDAMs were not audited because of limited capacity either with the PDAM or with BP.KP. Of the 236 PDAMs audited, 219, or 90%, had sufficient data to generate MoHA financial ratios. Chart 2.1 below shows the number of PDAMs not audited or audited and the outcome of the audit by BPKP ..
21
Chart 2.1-Number of Audited PDAMs, 1990-1995
300 .....------~-------------"-----'--
250 .
200 I 150 r
I
100.
1990
Source: BPKP ·
•. 1991 1992 1993 1994 1995
• Not Audited
, Cl Unqualified
OQualified .
•NoOpinion El Adverse
2.21 The focus of some of the BPKP audits seems to be on verifying the mechanics of the accounting methodology. For example, in 1995 PAM JAYA revised its accounting policies to classify new connections from expense to investments, a more responsible accounting treatment. BPKP auditors were prepared to issue a qualified audit because of the inconsistency of the methodology from previous accounting statements. Therefore, P ~ JAY A was forced to maintain the less satisfactory accounting methodology in order to receive an unqualified audit.
2.22 While there has been rapid growth in the number of audits condueted from 1990 to the present, the depth of the audits may have suffered to accommodate the increased quantity. With the existence of a large public auditing profession in Indonesia, it seems that BPKP would benefit from outsourcing some of the excess audit demand to these public accounting firms. Also, private investors in other industries, telecommunications, energy, and other industrial companies, have also preferred financial statements audits by public accountants. The private investors interested in PAM JAY A
· have also requested a public accountant audit, to the extent legally possible, to replace the BPKP audits. Moreover, the public auditor has been able to uncover accounting irregularities which had not been raised by BPKP audits. If PDAMs were to opt for more traditional private project financing on a wider scale, there would be increased demand from private investors to have public accounting firms auditing the financ'ial statements.
22
Rating System
2.23 A financial rating system can be an important tool for monitoring and even improving the financial management of PDAMs. At present, however, the rating system lacks the capacity to adequately monitor the financial information available. While BPKP audits PDAMs within two to three months after the end of the fiscal year, MoHA has not yet finished inputting the 1994 results into the rating system -. a three year delay. In addition, there seem to be inconsistencies between the BPKP individual PDAM ratings and the ratings published in the MoHA rating system. In 1994, out of the 158 PDAMs rated, 53 PDAMs received different ratings from MoHA and BPKP. Thirteen PDAMs received a higher rating from BPKP than from MoHA, with the greatest difference in PDAM Aceh Utara, which received a healthy (34) rating from BPKP and a less healthy (24) from MoHA. Forty-one PDAMs received a higher rating from MoHA than from BPKP, with the greatest difference in Pacitan, which received a very healthy (43) rating from MoHA, and a less healthy (25) rating from BPKP. Annex 3 gives a list of all the PDAMs with different ratings from MoHA and BPKP.
2.24 In addition, the applicability of the current MoHA financial ratings should be assessed in light of the existing accounting and auditing practices which will be described in more detail below. There are three issues to consider. First, because of the heavy LG influence in the operations and financial health of the PDAMs, it is not clear whether the existing rating system captures the financial health of the PDAMs or that of the LGs. Second, due to the limited capacity of audits, and in some cases their mechanical nature, it may not be possible to use_the audited statements to benchmark performance in the sector. Third, it is unclear what the financial consequences of the ratings are. At present BPKP auditors recommend corrective measures with qualified audits to the Governors of the province; however, it is unclear what consequences exist for these provinces if the corrective measures are not followed. To become more effective, the rating system should be accompanied by both positive and negative incentives.
Financial Performance
2.25 As can be seen in Table 2.1 below, 12 indicators are used to evaluate the financial • performance of PDAMs. These indicators measure efficiency, profitability and debt structure.
Efficiency Revenue per m3 Water Sold . Operating Income/ m3 Water Sold <=200 201 - 250 251 -400 >400 Accounts Receivable Turnover (Accounts Receivable/ Bills Issued)/ >=211 151 210 91 150 <=90
Average Daily Sales Expenditure per m3 Water Sold Operating Expenses/ m3 Water Sold >400 251 -400 201. 250 <=200 Working Ratio Operating Expenses Before >70% 61%-70% 51% -60% <'=50%
Depreciation/ Operating Income Employees per 1 ODO Total Number of Employees/ Total > 15 13. 15 11 • 12 <= 10 Connections Connections/ 1000 Unaccounted For Water (Volume Produced • Volume Sold)/ >=40% 30%-39% 20%-29% <20%
Volume Produced Current Ratio Current Assets/ Current Liabilities < 1.0 1.0. 1.4 1.4 1.9 >=2.0
Profitability Return on Sales Net Income After Taxi Operating <" 10% 11%-15% 16% 20% >20%
Income Return on Assets Net Income Alter T axl Total Assets <=10% 11% -15% 16,%-20% >20%
Debt Structure Debt to Equity Long T errn Debt/ Total Equity >70% 51%-70% 31% 50% <= 30% Debt Coverage Net Operating Income! (Interest + < 1.3 1.3. 2.2 2.3 3.2 >=3.3
Principal Repayment) Interest Share of Operating Interest/ Operating· Income >=20% 16%-19% 11%-15% <= 10% Income
Overall Rati,ng Not less Very Healthy Healthy Healthy Healthy 12-20 21·30 31 -40 41 -48
Source: MoHA
2.26 The financial performances oflndonesia's PDAMs range widely. As evident from Chart 2.2 below, between 1991and1995, the overall percentage of very healthy and healthy PDAMs dropped fromJ7% to 29% of all PDAMs rated; conversely the r
percentage of less healthy and not healthy PDAMs increased from 63% to 71 %. While the overall trend is gradual, the recommendations of the rating teams to the PDAMs on how to improve their financial performance are worth questioning. At this point, it is not · possible to determine whether the recommendations are being followed. The increasing number ofless healthy PDAMs, however, seems to indicate that financially the indqstry is not improving. A more specific breakdown of PDAM performance according to region· and number of connections is included in Annex 1.
,',·
24
Chart 2.2-PDAM Financial Performance, 1991 -1995
250 ,.....--------~----------------,
200 •
1991 . 1992 1993 1994 1995
Source: MoHA, BPKP
CVery Hea~hy
oHeallhy
•Less Healthy G No1 Healthy
The discussion below elaborates on the variables which are used to assess the ratings, in order to understand the implications of the ratings.
Efficiency
2.27 The efficiency indicators are based on operating income and expenses. A significant determinant of income is revenues, which is influenced by the level of tariffs and the billing. The level of tariffs, as discussed in Chapter 6, is determined by the LG and subject to review every two or three years, although some LGs have implemented shorter review periods and indexed tariff adjustments. The tariff increase decision is heavily influenced by political considerations, and while guidelines for establishing selfsufficient tariffs do exist, the interpretation and implementation of the tariff policy varies from LG to LG.
2.28 ·An important indicator of efficiency is UfW. Uf\V includes both technical losses and illegal connections as weli as billing inefficiencies. As can be seen in Chart 2.3 below, the reported data on Uf\V show fluctuations from year to year in UfW statistics. The number of PDAMs with less than 20% UfW fluctuates from 20 PDAMs in 1992 to 53 PDAMs in 1993 to 33 PDAMs in 1994 to 18 in 1995. These data seem to indicate that UfW statistics are more influenced by commercial losses and non enforcement of collections rather than technical reasons. The data and the absence of bulk meters or strict enforcement mechanisms seem to indicate the possibility of non-technical reasons for the fluctuations rather than the physical condition of the network.
25 .
Chart 2.3 - UfW StatiStics, 1991-1995
250 ~---------------------~
I
200
150 I
100
50.
1991 1992 199~ 1994 1995
Source: MoHA
0<20"k
02011/0-29% •30%-39% £1 >40%
2.29 The following components can influence the financial position of a PDAM: electricity; number and quality of employees; and quantity and quality of chemicals and materials. While in theory PDAMs are responsible for their operations, several of them have indicated that decisions other than those regarding electricity were not under their. control. Outside influence is more prevalent in the case of capital investment projects, but it is also a factor in the case of operating materials and inventory.
2.30 The above cost management practices have .two implications. First, since operating costs are influenced by factors beyond the efficient distribution of water, the policy that tariffs should cover operating costs, depreciation, and interest on debt (MoHA costs) is not necessarily cost effective. Tariffs should not have to c0ver the inefficiency costs of a PDAM. Chart 2.4 below illustrates that while small PDAMs are being granted the tariffs to cover only actual O&M costs, larger PDAMs seem to have tariffs which cover existing O&M, depreciation and interest on debt. Therefore, it can be seen that cost . control is a more significant issue for the larger PDAMs. Since PDAMs have limited control over their investments and operating costs, they cannot be held fully accountable for the overall cost. Such lack of control can create a lax mentality in the internal financial control environment.
1600
1400 -
1200 -
1000
51 800 0. "'
400
200
26
Chart 2.4-1995 PDAM Average Costs and Revenues (Rplm3)
Smallest (<5000)
Very Smar! (SOO[). 10000)
Small (1000[). SOOOO)
Medium (5000[). 100000)
PDAMs by Number of Connections
Large (>100000)
oO & M + Depreciation+ lnterest + Retum on Assets
•O & M + Depreciation + Interest on Debt (MOHA. costs)
oO& M
Source: Water Tariff Structure and Financial Policies of Water Enterprises Discussion Paper, October 1996
Profitability
2.31 The second set of indicators regards profitability. The Mo HA decree on dividends states that PDAMs can use 55% of their net income to distribute as dividends. The decree is accompanied by a letter Which requests that LGs not extract dividends until the PDAM reaches 75% coverage. However, it seems that LGs interpret this decree liberally. First, many LGs extract dividends from PDAMs which have not reached the 75% coverage target. Second, some LGs do not use the financial definition of net income; some use operating income, some use revenues, and some use operating cash flow. Finally, some do not base their dividends even on operating cash flow and require the PDAM to borrow from commercial banks to finance dividend payments. For example, PDAM Subang had been operating at a loss for several years (1992, Rp24 7 million; 1993, Rpl 15 million; 1994, Rp344 million; 1995 projected (Rp48 million). Nevertheless, PDAM Subang was required by its LG to pay a dividend, Rp75 million in 1995. This money was raised by the PDAM from a commercial loan from a local bank. In exchange the kabupaten built a road to the PDAM workshop site worth a reported Rp 100 million as an equity contribution to its shareholders.
2.32 Finally, a common practice is for PDAMs to calculate the expected net income for the year at the beginning of the year and extract monthly payments. As can be seen from Chart 2.5 below on PAM JA YA' s dividend history and coverage ratios, each year PAM JA YA distributes a monthly dividend to DKI, based on 40% of the projected net income after taxes from the beginning of the year and on PAM JAY A's cash flow position.
27
Reconciliation at the end of the year is based on audited results. However, neither the coverage target nor the PDAM' s end of year performance rating is used as a basis for reconciliation. In some extreme cases a PDAM extracts the entire annual dividend amount atthe beginning of the year. While the LG can then invest this money, the PDAM may be left without the necessary cash to pay its operating expenses.
~0.000
25,000
20,000
~ c 0
~ 15,000
<i a:
10,000
5,000
Chart 2.5-PAM JAYA Dividend History and Coverage Ratios
1992 1993 1994 1995
•Net Fiscal Income C Net Dividefid to Local Government
Coverage by Year 1992:42% 1993: 44% 1994: 44% 1995:46%
Source: PAM JA YA FINPRO
2.33 In principle, PDAMs should be left with 45% of net income after taxes and diyidends as cash for investment. In practice, many PDAMs rarely have any cash left over, and investment financing has historically been made available to LGs and PDAMs from central government budget allocations and donor financing on subsidized terms.
2.34 Since most LGs expect the water operation to generate revenues through the . payment of dividends by the PDAM it could be envisaged to replace the notion of a "dividend" to be paid by the PDAM to its only shareholder, by tire notion of an "operating fee" to be paid by the operating.company to the owner of the facilities, if the concept of separation of ownership of assets from the management function is implemented one way or the other. Such fee would come on top of the water tariff, and be collected by the operating company on behalf of the owner of the facilities. Operating fees would be set, on the basis of Mo HA guidance. In the case of a PDAM under a "performance contract'' with the LG, the fee should be at least sufficient to cover the operating costs of the. PDAM Board. In the case of a private operator under contract with the ·LG or the PDAM, the fee should be set at a level that w9uld at least cover all financial obligations of the former, in particular the debt that it would still has to service.
Debt Structure
2.35 Most of the lending to PDA.Ms has been through two Government mechanisms: (a) the Subsidiary Loan Agreements (SLAs) involve onlending funds provided by international development agencies such as the World Bank and ADB.; and (b) the Regional Development Account (RDA), which is financed by the Ministry _of Finance (MoF) through annual budget appropriations.
2.36 Of the total investment in water supply projects between 1994/95 and 1998/99, Rp. 2,238 billion, PDAM own funds have generated only Rp. 210 billion, 9%, of the total . investment. About half the total investment during the five year period was generated by concessionary loans, and the remainder, about 42%, has been provided through grants. The proportion of funding sources, grants qr concessionary loans, has remained steady over time, with the exception of the decrease of RDA loans during the later years. However, Chart 2.6 below shows the dramatic decrease over time of the total funding available for water projects, from Rp. 871.9 billion in 1994/95 to Rp. 260.9 billion in 1997/98. Data on grants will be discussed in Chapter 7.
800
700
600 .
.§ 500
~ ~ 400.
300
Chart 2.6-Funding Structure of Urban Water Supply Sector Projects 1994195-1998199
By 199411995 By 19951! 996 By 199611997
Year
By 199711998
Subsidiary Loan Agreements - SLAs
By 199811999
a POAM OWn Funds
ll!SLA
•RDA a Grants
2.37 SLAs have been used mostly to finance large municipal water sector investments under Integrated Urban Infrastructure Development Projects (IUIDP). From MoF data, during the period January 1, 1990 to March 31, 1997, 78 SLAs equivalent to Rp. 1,400
29
billion were signed with PDAMs. Out of this, Rp. 680 billion have been withdrawn as of end 1996. 20 PDAMs received loans exceeding Rp. 10 billion, which represented 93% of all SLAs granted during this period. By value, 43% of all SLAs during the eight year period were funded by IBRD; 22% by OECF; 21% by ADB, and 14% for by other funding agencies (Chart 2.7). Most of the APB loans funded water supply system projects for capitals of sub-districts (IKK), which explains their many small loans, to 58 PDAMs, compared to the fewer larger loans funded by IBRD and OECF.
Chart 2. 7- SLAs by Funding Agency, 1994195 - 1998199
OTHERS
2.38 Interest rates varied.from 9% to 9.65% in the early 1990s. They gradually increased to 10.75% until they become steady at 11.75% from 1994 onwards, except for PDAM Surabaya which had a floating interest rate as determined by Bank Indonesia on top of 11.75%. The grace period was generally five years (only six loans were granted with grace periods of3, 4, 6 or 7 years). The term was generally for 20years (13 loans have terms varying between·14 and 21 years). The loan terms were based on the specific PDAM's ability to repay, as evaluated during project appraisal. SLAs terms have sometime been softened to enable the PDAM to borrow more.
2.39 According to the data obtained from the Ministry of Home Affairs, 66% of the total SLAs by value were given to PDAMs that currently have strong debt coverage ratios (DCRs); while 22% were given to PDAMs that currently have weak DCRs. Out of this 22%, 5% of the SLAs were given to PDAMs with weak DCRs at the time the loans were granted (Chart 2.8). However, the average DCRs of these PDAMs were much better than those who received RD As.
30
· Chart 2.8-SLAs by Debt Coverage Ratio
0 = Insufficient Data
C = Weak Oeb1 Coverage Ratio When SLAs Were
Given 5%
B =Weak Debt Coverage Ratio 11%
12%
Total SLA Loans = Rp. 1,403.9 billion
A = Strong Debt Coverage Ratio 65%
2.40 In principle, PDAMs have access to many different types of financing, including grants and two different concessionary loans. However, in practice, it can be seen that during the past seven years covered in this analysis, roughly Rp. 660 billion, or more than 50% of all SLA and RDA loans given during this period, has been given to four PDAMs: DKI Jaya, Tangerang, Kotamadya Bandung, and Badung.
Regional Development Account - RDA
2.41 The RDA is a budget line financed by MoF for lending for urban investments, including water supply. According to the data provided by MoF, 156 RDA loans were granted to I 04 PDAMs between 1990 and 1996; an additional 22 RD As are currently in process. The average size of the RDA granted during this period was Rp4.8 billion. While the RDA does fund a large number of PDAMs, the total value of RD As granted has been granted to a small number of PDAMs. Table 2.4 below lists the 11 PDAMs which have each received more than RplO billion in RDAs, which accounts for 42% of all RDAs granted during this period.
31
. Table 2.4-· RDAs Greater than R.p. JO Billion by PDAM, 1990-1996
PDAM · Rp. Million Rate Term Grace OKI Jaya 112,805 . 9-11% 17 - 30 years 2 - 10 years
Tangerang 37,373 9% ,· 18 - 20 years 3 -5 years
Badung 31,414 9 - 11.5% 15 years 5 year
Gresik 31,227 10.5-11.5% 15 years 5 years " Kotamadya· Bandung 27,617 0-9.6% 20 - 25 years 5 years
Wonosobo 17,600 9-1.1.5% 3 to 20 years 1 to 5 years
Tirtanadi Medan 11,390 9 - 11.5%. 10 - 20 years 3 - 5 years
Mojokerto 10,200 9 - 11.5% 18 - 20 years 5 years
Source: MoHA, MoF
2.42 RDA loans are also granted to PDAMs to complement SLAs when PDAMs ·cannot generate sufficient self financing. The single largest RDA was granted to PAM JA YA for Rp64.4 billion in 1994. PAM JA YA has also received the largest amount of RDA loans during the same period, totaling Rp 112 billion. In 1992, PAM JA YA was granted an RDA loan of Rp6.5 billion for the Buaran II water treatment and distribution center to supplement an onlent OECF loan.
. .
2.43 In principle RDA loans have been granted based on MoHA approval and MoF verification of audited financial statements, debt coverage ratio (DCR) and cash flow projections. MoHA rat_ings have been used as an additional consideration for RDA loans since 1994. PDAMs which have received RDA loans between 1990 and 1996 can be grouped into five broad DCR categories: strong; weak; strong but weak after receiving a loan; no DCR rating; and PDAMs which were given RDAs at low rates or accompanied by grants (Chart 2.9). · · ·
2.44 According to these data; 39% ofthe RDAs (by value) have been granted to PDAMs with strong DCR ("3" or "4"), but the ratings has to be.verified case-by-case. For example, PDAM Tangerang was given a "4" DCR rating through 1995; yet in 1996 it was unable to repay the loans, and MoF had to assume the remaining debt service (probably as the grace period ended). If PDAMs with a "4" DCR rating are not able to service existing debt, then the DCR rating becomes less meaningful. Forty-four percent of the RDA loans by value have been granted to PDAMs with a weak DCR rating or whose DCR rating dropped immediately upon receiving the RDA loan. The final 17% were granted to PDAMs with no financial ratings available. ("No financial ratings" may mean that the PDAMs were not audited, since the ratings are derived automatically from audited financial statements.)
2.45 While financial projections are the primary basis for assessing whether a PDAM is able to repay a loan, historical financial performance should serve a~ a reality check on the financial projections. A PDAM with a "1" DCR rating (net income divided by
32
interest plus principal repayment below 1.3) is probably unlikely to be able to double its income to achieve a healthy DCR rating without a significant tariff increase. The existing information seems to indicate that the financial data on which loan decisions were based can be inadequate for a thorough financial appraisal since in 61 % of the cases, RDA loans granted between 1990 and 1996, financial information was not decisive.
Chart 2.9 - Total RDA Loans Outstanding by PDAM Debt Coverage Category
E = Rp. 123.9 billion (17%)
D = Rp. 24.9 billion (3%)
C = Rp. 106.1 billion (14%)
Total RDA Outstanding.1990-1996: Rp. 742.4 Billion Total RDA Under Consideration. 1997: Rp. 101.5 Simon
Source: MoHA
A= Rp. 283. 7 billion (39%)
t:l A Strong Debt Coverage Ratios
t:l 8 = Weak Debt Coverage Ratios
Ill C = Debt Coverage Ratio drops after RDA Is received
8 D = RDA given at very low rate
CJ E "' No financial rating available ·
2.46 The terms of the RDA have varied widely. PDAM Kotamadya Bandung's RDA loans range from 0 to 6% interest rate between 1990 and 1993 (later loans were made at 9.6% interest to this PDAM). No other loans have been granted at those terms to any PDAMs. The terms of PAM JA YA' s RDA loans range from 17 to 30 years with grace periods of2 to 10 years. The above examples are two extremes of RDA loans granted during the 1990/96 period. The significant range of loan amounts and terms indicates that RDA loans are based on considerations other than the PDAM's financial capacity. However, the MoHA decree (570-006) on RDA loans is unclear on non-financial considerations and how they should be factored into the decision. The decree states that loan applications must be supported with the necessary data but does not list the type of data; it also states that the DPRD (Provincial Assembly) can approve or·reject the application, but no criteria for approval or rejection are given. There seem to be no stated economic or social cri1:eria to evaluate who receives a RDA loan and the terms and conditions. The subjectivity applied to granting RDA loans may encourage PDAMs to develop their negotiating ability rather than their improve financial situation.
33'
· Existing Financial Incentives
2.47 Table 2.5 below outlines the·influence of the various government institutions on the financial .indicators which are used to evaluate the performance of the PD AMs. The previous discussion, however, raises the question of whether these can really be accurate indicators of the PDAM's financial management capabilities, since many of the key variables which affect efficiency, profitability and debt structure are beyond the full control of the PDAMs.
Table 2.5 - Financial Indicators and Key Influencers of These Indicators
Indicator Influenced by Local
POAM Government MOHA MOF Cipta BAPPENAS Karya
Operations Tariff Level x Operating Expenses x x
Dividends x x
Investment Grant x x x x Debt
Interest Rate x x x x Debt Service Scheduling x x x x Debt Restructuring x x x x x
Source: Interviews
2.48 There are two equally important incentives which a PDAM and its LG qre facing: first, to provide efficient water services to consumers; and second, to be profitable and provide dividends to its shareholders. Since the PDAMs' shareholder, the LG, affects the ability and effectiveness of the PDAM's delivery of water services, these objectives are reconciled and implemented at the LG level.
2.49 The existing incentive system has serious consequences for financial management in the sector.· Once investment financing is provided to a PDAM, the existing financial monitoring system is limited in its effectiveness to control the proper use of the financing to provide water services. Required tariff increases to finance increased investment are not enforced, and retained earnings from increased revenues are often distributed to LGs as dividends. Existing debt instruments seem to have limited effectiveness because a majority of the loans are not granted or implemented according to financial principles. If debt is not repaid or restructured, it becomes effectively a grant. If PDAMs have the possibility of transforming a loan into a grant by not repaying it, this may constitute a strong financial incentive motivating the PDAMs not to improve its financial position.
2.50 The existing financial management tools cannot accurately measure and control the extent to which the dividend policy undermines the water services coverage policy.
34
While well managed PDAMs have two characteristics which reinforce each other, good PDAM management capabilities and LGs which are willing to lefthe PDAMs fully pursue water service delivery incentives at the expense of its dividend maximization incentive. In practice, the majority of LGs maximize dividend distribution rather than reinvestment to reach coverage targets.
35
3. PRIVATE SECTOR P ARTICIP A TI ON (PSP) IN THE PROVISION OF WATER SUPPLY SERVICES
. A. . INTRODUCTION
3.1 Chapter 3 discusses the participation of the private sector ii{ the provision ~f water supply services, and is divided into five sections. Section B provides a rationale· for PSP in the provision of water supply services.and relates lessons learned world-wide .. Section C presents options for private provision of water ·suppiy services, including the different types of contracts, concessions, and ·other arrangements. Section D explores risk analysis; . option selection and gradualism. Section E presents the objectives of an appropriate . · regulatory framework including contract design, contractor selection, prequalification, approval procedures, and examines the need for a regulatory agency. · Finally Section F looks at private sector participation hi relation to small PDAMs and the poor.
B. RATIONALE FORPSP IN THE PROVISION OF WATER SUPPLY SERVICES
3.2 Limited technical and managerial capacities and inadequate commercial and cost recovery policies explain, in part, the poor performance and low productivity of many public water utility companies and the difficulties they experience in rapidly (a) expanding the service .to non served consumers; (b) improving the quality of service; and ( c) reducing the cost of service. Private companies are believed to be more efficient than public ones, because they react more to standard business incentives - i.e., the objective . is to maximize profit - and their participation is often sought to address the above issues. PSP is not an end in itself and must be understood primarily as a means to achieve the above objectives; seeking private funding for public water supply should be considered only a secondary objective.
Lessons Learned from Other Experiences ·
3.3 Although each country has its own set of issues to be addressed carefully, worldwide experience allows to draw some conclusions on what are the key points leading to a successful deal. Increased PSP in: water supply has better chances to succeed if (a) it is part of a comprehensive program of economic reforms; (b) political commitment at all levels of government is ensured; ( c) consensus has been reached among the many stakeholders -· various levels of governments, water utility · management and staff, users and potential private partners; and ( d) the public authority has defined clear objectives anci pudn place a clear decision making process. As a consequence, private sector participation cannot be accomplished overnight, and careful preparation Is necessary. All options for private participation must be analyzed; risks of all types (political, econdmic, commercial, technical and legal) must be assessed and appropriate mechanisms to mitigate them should be adopted. Technical and financial feasibility of more advanced options such as leases, concessions and BOOTs (see para 3 .14) should be carefully analyzed with the assistance of specialized independent consultants prior to requesting proposals. Participation of multilateral agencies such as
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the World Bank and the ADB could enhance the transparency and credibility of the process.
3.4 Establishment of clear rules concerning procedures to solicit and evaluate proposals, and to approve and enforce contracts is an essential element of the overall regulatory framework that helps private contractors assess the risk that they would be taking and the corresponding premium they would charge. Although contracts provide · self-contained regulations, it is clear that the set-up of a regulatory agency, independent and competent enough to neg~tiate and sup~rvise highly qualified and powerful. companies, is often a necessity. The current tariff levels and the track record in adjusting them are key factors in making a particular project attractive to private lenders .. Experience has shown that if the tariff has to be increased, this should happen before private proposals are invited. Labor redundancy may be the most sensitive issue to address from the very beginning of the analysis of options for PSP. Experience has shown that aggressive promotion and attractive early retirement packages to be financed by the Government, the private QOntractor or both, help solve this problem; however, often surplus staff are again required with expansion plans, and need not be dismissed. The role of the public agency which has been partially or totally privatized must be clearly defined, to avoid misunderstandings and/or overlapping responsibilities. Transitional arrangements, such as the collection of bills sent out before the function had been privatized, have to be well defined also.
c. OPTIONS FOR Pruv ATE PROVISION OF w ATER SUPPLY SERVICES
Service and Management Contracts
3.5 The simplest way to involve the private sector in the delivery of water supply takes the form of"service" contracts. Such contracts can be entered into for meterreading, billing and collection, construction of connections or O&M of a treatment plant. Service contracts, which require the contractor to provide short term assets only (vehicles, computers ... ) are typically of short duration (one to five years) and can easily he awarded after open competition among prequalified companies. Several PDAMs already have service contracts, in particular for meter-reading and preparation of bills. In Santiago (Chile), the public water company, as part of its reorganization, has successfully encouraged its staff to leave and to create their own companies to provide services such as meter-reading and maintenance, that were initially performed in house at a higher cost.
3.6 A "managemenf' contract is basically a comprehensive service contract whereby a private company is contracted to provide a full service, including O&M of water production and distribution facilities, meter-reading, billing and collection. Management contracts typically are/or five years and can also he subject to competition; among companies with relevant experience in the water sector ..
3.7 Under a service or a management contract (a) the customers remain under contract with the public water utility company, and the service or management
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contractor acts on its behalf, and (b) the service or management contractor is compensated by the public water utility company according to measurable quantities. While a service contractor is simply paid according to the quantity of work delivered (number of meters read or of bills issued), a management company is usually compensated proportionally to a mix of quantities (water produced, water sold, number of customers, length of pipes maintained). Often; management contracts also include an incentive payment linked to actual performance (collection ratio, reduction of operating costs ... ). There are many limitations to service and management contracts because contractors often have to wait for orders from the public water utility company, which would not be as efficient as they are. As a result, both parties could get frustrated:. the public water utility company because it may feel that it is not getting what it expected, and the contractor because he may feel thathe is not able to use all his know-how.
3 .8 There are no. management contracts for water supply in Indonesia; however, it . seems that several international water supply companies would favor this type of contract over the lease contract (see below), despite the above shortcomings - which they are well aware of-because the risk taken is minimum. Recently a five-year management contract for water supply and sewerage services was awarded after open competition by the Palestinian Authority for the management of water supply and sewerage services in Gaza.
Concession and Lease Contracts
3.9 The "concession" arrangement addresses the shortcomings of the management contract. A concession transfers to the private operator (the concessionaire), fypically for a 20 to 40-year period, the full responsibility for operation, maintenance and renewal of existing facilities, financing and construction of new facilities, billing and collection of charges from customers. The only revenue of the concessionaire is the charges collected from users, who are under contract with the concessionaire, and not with the public water utility company as is the case for service and management contracts.
3 .10 Existing assets are put in the concession by the granting public authority, but remain its property throughout the concession. Usually, the public authority also becomes owner of the assets financed by the concessionaire as soon as they are commissioned, although, this sometimes happens only when the debt attached to these assets has· been fully repaid. All assets, whether initially put in the concession,' or financed by the concessionaire are operated, maintained and renewed by the concessionaire and returned to the granting authority, in good working order, at the end of the concession. The concession contract includes special provisions to compensate the concessionaire for those assets financed by the concessionaire that are not fully depreciated at the end of the concession. Typically, a concession contract is perf o'rmance oriented and not construction-oriented; it is more appropriate to contractually request a concessionaire to meet service targets (number of connectioits, minimum pressure, water quality ... ) than physical objectives (a new treatment plant
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built by a given date). A concession contract should also spell out remedies the granting authority can have in case of non compliance with agreed upon performance criteria.
3.11 Concessions have been granted for water supply and sewerage services for many years in Europe (France and Spain in particular), and have recently become the preferred options for large cities in Latin America and East Asia. Both Jakarta and Manila are seeking similar solutions to their problems (high Utw, low service coverage, poor quality of water and service) through long term concessions with consortia including international professional water distributors.
3 .12 Because the water sector is very capital intensive and because financial viability of many water supply operations is not yet proven to commercial would-be lenders or equity investors, it is not always possible for a concessionaire to tap private financing. The "lease contract' ( affermage) is a concession where the granting public authority still is responsible for financing major extensions of the water production and distribution systems. In a lease contract, the private operator is often required to finance, in addition to the working capital, limited renewal of equipment, and sometimes extension of tertiary distribution networks. As in a concession contract, the customers are under contract with the lease contractor. The latter collects user payments and pays back to the public authority a rental fee set at a level sufficient to cover its operating costs, service the debt and contribute to the investment program. The performance of a lease contractor is directly linked to that of the public authority granting the lease. This may become an issue if, for example, delays occur in construction of a new system, or if the facilities built are inadequate.
3.13 Lease contracts have been and still are very common in Europe (France, Spain) and West Africa (Cote d'Ivoire, Guinea ... ). They have not often been envisaged in East Asia so far, but could become an option for operations that need to be improved but that are not altogether financially attractive, mostly because most governments are (sometimes inappropriately) seeking PSP with the main objective of attracting private funding. ·
BOOT and Reverse BOOT
3 .14 When a concession is granted for a facility to be built, rather than for extension of an existing one, it is called a "build, own, operate and transfer" (BOOT) contract. BOOT has several alternatives such as BOT, where ownership of the facility is transferred as soon as it is built, or BOO, where the ownership of the facility remains with the private concessionaire indefinitely. BOOT contracts are suitable for new production and transmission facilities, and not for existing distribution systems. There are some significant differences between a concession for an existing facility and a BOOT contract for a new facility. The demand analysis is often provided by the public authority and the promoter often requires a guarantee against the commercial risk under the form of"take
·or pay" arrangements. The latter could cause problems if demand is significantly lower than what was expected or if increases of user tariffs are delayed, and the revenues of the
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purchasing water distribution company are below forecast. Also, all the financing has to be provided upfront, while a significant part of it can be generated from operations in the case of concessions, Thus, financing conditions of BOOTs are critical since commercial loans, in particular on the local market, are not always adapted to the financing of facilities of long duration, typically 20 years or more. While construction risks are usually borne by the concessionaire, foreign exchange and interest rate variation risks, on which he has no influence, have to be carefully assessed and properly reflected in the price revision formula ..
3.15 BOOT is nothing new in the water industry; Casablanca, the largest city of Morocco, has been supplied with water by a 2 .. 0 m3 /s/80 km transmission line (Oum R'Bia scheme) that was entiiely de".eloped and financed by a private company (Societe Marocaine de Distribution or SMD) under a 50-year concession contract awarded in 1~9. ' ' ' .
3.16 "Reverse BOOT'' is an option that addresses the issue of very high premia the private sector may request in return to their participation in projects where risks, whether political or financial, are deemed to be high. In this case, the public authority still fimmces construction.of the facilities, but subcontracts their operation to a private company that is requested to pay an annual fee set a level sufficient to meet the debt service. Although similar to the lease arrangement described above, the difference resides in the transfer of ownership of the facilities to the private company at the end of the contract, while ownership remains with the public authority in the case of a lease contract..
Other Types of PSP Arrangements
3 .17 Often public authorities are reluctant to transfer full responsibility of delivering an essential public service to a private company, and seek possibilities of establishing "joint ventures" as an initial step of private involvement. For public water companies actively seeking financing for new facilities, the presence. of a well established private partner may provide the lacking creditworthiness. Joint ventures have sometimes been created for management or lease contracting companies, when the main objective is to improve management of the operations (Guinea). One of the main issues to be addressed is the potential conflict of interest of having the public authority as both the · ' superv~orlregulator and the provider of service and the transparency of the decisions
. made . . It is a solution that is generally not recommended.
3 .18 A water supply company Call also be sold on the stock market to private investors if the main objective is to generate revenues from the sale of public compariies. The sale
. value of a water supply business depends not that much on the book value of assets, but much more on the discounted value of the stream of revenues, i.e., the level of rates the utility is allowed to charge and its'track record in regularly adjusting them to reflect changes. In the case of outright sale, the role of the regulator. is critical since a typical public monopoly is fully transferred to a private company.
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D. . RISK ANALYSIS - OPTION SELECTION - GRADUALISM
3.19 Table 3.1 below compares the main characteristics of the service, management, lease, concession and BOOT ·contracts which are likely to be the most relevant options in · the water supply sector in Indonesia.
3.20 Selection of the option that meets best the public interest in a particular case is· a rather complex exercise that requires a detailed analysis of the risk allocation between the partners as well as the building of a strong consensus among the many stakeholders. In some cases, the most appropriate solution could simply be to encourage PDAM staff to resign and create their ovvn company that could operate under service contracts with the PDAM, initially through direct award and later through open competition. If operations need serious improvement but the likelihood of attracting private financing is limited (because of inadequate water tariffs), the best option could be a lease contract.
3.21 This analysis requires the participation of highly qualified technical,financial and legal specialists, but expertise in these fields is currently somewhat limited in Indonesia. There is an obvious need to develop this expertise within DG PUOD and PERP AMSI to assist the many PDAMs and local governments that have signed memoranda of understanding (MOUs), mostly for unsolicited BOOT proposals for new production facilities. Currently, they are unable to move forward because they cannot define what they really want to obtain.from the private sector, and the latter is unwilling to commit funds for preparing detailed proposals without the guarantee of signing a contract. It is not necessary to build all the capacity in house, but rather to establish a network of highly experienced technical, financial and legal advisors to assist whenever needed. Competition for this expertise is now very high in South East Asia, and fees charged by these experts are usually above what the Government is used to paying for more standard consulting services; they may however lead to substantial savings for the public authority and the users.
3.22 One of the issues to be addressed during analysis of the options is whether to follow a gradual approach or to aim at the immediate and maximum transfer of autonomy and, therefore, tisks to the private partner. It is probably adequate to directly aim at :full concessions with consortia including international partners iri the case of Jakarta, in particular because no major tariff increase is to be implemented to yield an acceptable return on private equity. It is more appropriate to envisage a series of service contracts with local companies, in the many cases where willingness to pay for piped water or willingness to increase tariffs is more limited, and later to consolidate them into a management contract or even lease or concession contracts. Obviously, a gradual approach will limit competition at each step of the process, because there will be some · rationale for directly negotiating contract amendments and extensions with companies already familiar with the local conditions, especially if they have provided good service.
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Table 3.1-Main Features of Various Contractual Arrangements for Private Provision of Water Supply Services
Opfo:m Service . Management Lease Concession BOOT(for Contract Contract Contract Contract production
facility)
Main Objective ·limited overall overall overall mobilization Pursued improvement of improvement of improvement improvement · ofprivate
. ·operations pperations of operations of operations capital (with transfer and of commercial mobilization risk) of private
capital
Typical 1. to 2 years 3 to 5 years 5 to 10 years 20 to 40 years 20 to 40 years Contract Duration
Contractual public authority . private lease concessionaire no direct Relations with manager on· contractor relation with Users behalfofpublic. users
authority Commercial public authority public authority lease concessionaire public Risk Taken by contractor authority
through "take or pay" arrangement ·
Financing of public authority pu.blic authority public concession a ire concessionaire Investment authority and
lease contractor
Financing public authority public authority lease . concessionaire concessionaire Working contractor Capital
Financing Risk public authority public authority mostly public concessionaire concessionaire Taken by authority
Remuneration lump sum, work cost-plus and . . part of user .user rate bulk water of Private done, unit price productivity rate rate Company bonus
Responsibility ·· public authority public authority public concession BOOT for Setting authority contract contract User Rates
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E. REGULATORY FRAMEWORK
3.23 The main objective of a comprehensive regulatory framework is to protect the public interest against inappropriate behavior when it comes to pricing and quality of service of private (qua.Si) monopolies. Instruction 21of1996 of the MoHA (Directives for Cooperation between a PDAM and a Private Party) is a first step towards establishing it. Experience has shown that it is essennal that the regulatory framework he designed and implemented in parallel with the PSP options chosen. In Indonesia, as in most other countries, private provision of water supply services will mostly be regulated. directly by one of the contractual arrangements described above. Therefore the first issues to be addressed are the feasibility, clarity and accuracy of the contracts, the award and approval processes and finally their enforceability.
Contract Design
3.24 Technical feasibility is an issue to be addressed carefully for performanceoriented contracts such as concession, lease and management contracts. The designer of a performance-oriented contract often has the tendency to set unrealistic objectives, and the contractor to accept them because. he feels that everything ca.Il be negotiated after the contract has been signed. UfW, whose reduction sometimes justifies involving a private company in day-to-day operations of a water system, is a typical issue. A similar remark could apply to the proposed objectives for service ratios, that depend in particular on the availability and cost of substitutes sources of water, such as ground water, and the willingness of the public authorities to tax them at their economic cost. Also,
· improvement of water quality at the tap is often dependent on a set of measures that are well beyond the contractor's responsibility, and too ambitious an objective may translate into frustration of both parties once confronted with results.
3 .25 The designer of a contract should also try to simulate the behavior of the contractor to identify right incentives that would encourage compliance with the required performance or perverse incentives that would allow generous profits without compliance. For example, a lease contractor is unlikely to engage in a costly rehabilitation program for the sole purpose of reducing UfW to the set level, if such program is unlikely to yield a positive return before the end of the contract. Also a concessionaire or a lease contractor could be encotiraged to focus more on profitable construction activities than onmaintenance activities if rules concerning procurement of
, works are not clearly spelled out in the contract.
3.26 Clarity and accuracy of contractual documents are essential. To achieve this objective, the best solution is likely for MoHA (or a national water supply authority, if created) to prepare standard management, concession and lease contracts, or at least strict guidelines for the preparation of such contracts. Standard contracts have been part of the French regulatory framework for many years. Such standard contracts or guidelines, together with transparent and streamlined bidding and approval processes, could provide private companies a clearer picture of the framework they would operate in
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and create the necessary confidence that would eventually reduce the risk premium they have to assess when preparing a proposal. 'Whatever the type, _the contract should be very precise concerning among others: regulatory arrangements, geographical limits; transitional arrangements; undertaking of the public authority granting the contract and of the contractor; design, construction and service standards; technical and financial recording; compliance with environmental regulations; price revision mechanisms; insurance; defaults by both parties; termination procedures; dispute resolution; independent arbitration; "force majeure"; liquidated damages; procurement rules (in case of a concession or a lease), taxes and import duties.
Contractor Selection
3.27 Open competition is often a preferred solution because it is the most transparent and encourages bidder participation; it also allows users to benefit directly from efficiency of the least cost bidder. Most public agencies are familiar with a process which imposes real discipline and is likely to lead to a deal all parties are satisfied with. However, it could be considered lengthy: it imposes preliminary- engineering, preparation of bidding documents, prequalification and bid evaluation. Also, competitive bidding may limit innovation since the scope of the contract, defined by consultants, can be rigid in particular to facilitate comparison of proposals. It does not really reduce the risk of corruption, since inside information can be provided to bidders in uneven manner, and the risk of collusion among bidders e:xists, especially in the water industry where the nwpber of key players is very limited. For complex projects, such as full concessions or large BOOTs, the cost of bid preparation can be very high and would have to be absorbed by bidders who do not win the contract, unless some funds are set aside to compensate them somewhat. Also, for long term projects, such as leases or concessions, it can reasonably be anticipated that economic realities of the business will significantly vary from those envisioned at the time of contract signing, thus leading to necessary periodic renegotiations. Finally, experience shows that long term concessions are.subject to a series of sub-agreements that often cannot be finalized before bids have to be submitted. This is often the case of detailed financing plans of the project, which may lead to renegotiation of some clauses that are no longer acceptable to the lenders of the concessionaire.
3 .28 Direct negotiations could be justified when innovative solutions have to be found or proprietary technologies chosen,fot complex water treatment plants, for example. However, direct negotiatiollS often are not transparent and are subject to criticism from sources external to the deal, and as such are often not politically acceptable. Its supporters (mostly from the private sector) argue that it leads to substantially lower costs in preparation of proposals, although experiences in Indonesia .. and other countries tend to demonstrate the contrary. In the absence of a regulatory framework that would impose a real structtire to the process, and with uneven sophistication and competence of public and private partners, the risk of misunderstanding is high, and direct negotiations are likely to be a lengthier process than open competition. In any case direct negotiations must be carried out with well
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established and reputable contractors with relevant experience and consultants if· necessary.
3 .29 Mid way between the above two approaches is the competitive negotiation which combines advantages and disadvantages of both. It allows for innovation, and leaves each side structure the project to take best advantage of its respective strength. It allows for competition, but still lacks the transparency of competitive bidding. Also it requires high level technical and legal assistance in particular to establish benchmarks and compare the various options on sound grounds.
3.30 It is usually admitted that competitive bidding should be the rule for simple service contracts or even management contracts, for example, it took only about eight months to prepare tender documents, evaluate the bids and negotiate the management contract for water supply and sewerage services in the Gaza strip (Palestinian Authority); competition was much fiercer than expected. Experience in several countries (Argentina, Guinea ... ) has als9 shown that successful bidding can be organized in a reasonable period of time and in a transparent manner even for much more complex lease or concession arrangements that require the firumcing of longer term assets. Altogether, it would have taken less than 18 months to select the two concessionaires of the Manila water supply and sewerage systems, after a very well structured competitive process; the tariff reductions that would result from the open competition are spectacular.
Prequalification
3.31 Prequalification for long term concessions would systematically have to be made among Indonesian companies that have the necessary financial depth in association with international private water distributors. Even in the USA, large municipalities looking for private expertise for the management and development of their water supply and sewerage systems have recently awarded contracts to joint ventures of US and European companies (Indianapolis, Puerto Rico). Prequalification criteria for water supply operators must always include relevant experience and expertise for operations of similar size, in particular outside of their own country, as well as a strong financial position. The number of international companies that can prequalify for large operations, i.e. cities serving 50,000 connections and more, is currently limited to about half a dozen worldwide. It appears, however, that many countries that do not have the French or UK tradition of PSP in water supply services are now looking at the possibility of organizing their water industry to take a share of the very large emerging market, in particular in South East Asfa. One favorable point in Indonesia is the existence of domestic private service companies that operate the utilities (power, water sewerage, waste water treatment ... ) of the large private estates which are developing very rapidly at the outskirts of major cities. Such companies should· be encouraged to enter the municipal market, at least initially for service and management contracts, through a transparent prequalification and bidding process.
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Approval Procedures
3.32 Approval procedures also have to he clearly indicated in the request for proposals, since it will help.the private company determine the cost ofthetransaction and reflect it in its proposal. Past Indonesian experience has not been very successful and many of the private companies that have submitted unsolicited proposals are unclear about whom they have to negotiate with. If a PDAM can certainly be the agency signing a service contract for operation of a treatment plant or preparation of monthly bills, it is not yet clear which agency has the right to enter into a more comprehensive management contract or to grant a concession or a lease. ·
Is There a Need for a Regulatory Agency?
3 .33 It is often argued that a tightly specified contract can remove all the need for direct regulation. For complex concession or lease contracts, if it is true that if a very detailed contract can help protect the private company from politically motivated changes in service requirement, specifications that are too rigid may also limit easy responses to changing economic, social and technical conditions which may be needed when the initial information base is limited. Even for simpler management contracts, there is always a need to closely monitor the performance of the private company against its contract to have the authority· to allow minor variations in contract specifications, to resolve disputes between the contractor and its customers, and to arbitrate disputes between the granting authority and the contractor. There is, therefore, a delicate balance to he struck between highly specified contracts, which reduce the regulator's role to monitoring compliance and more flexible arrangement which allow more regulatory discretion.
3.34 A regulatory agency's main duties typically are to determine allowable increases in water prices and appropriate service standards, monitor the private company's performance and contractual compliance, and arbitrate complaints between the private .. company and its customers and the imposition of sanctions for failure to meet agreed standards. To ensure accountability of the regulatory agency, the above duties.should be clearly specified by law. Also a transparent deeision-making process should be prescribed, the decisions made should be subject to review by the courts, and the activities of the regulatory agency should be subject to annual audits.
J.35 While some degree of regulatory discretion may be desirable for longer concession contracts, because a minimum of flexibility should be preserved, it would be necessary to ensure that the law and the contract provide assurances at the same time to· investors, consumers, stakeholders and elected officials that the regulatory discretion would be exercised in a way that protects their legitimate interests and would not be subject to undue influence from either politicians or the regulated industry. Adequate arrangements should be made to appeal the regulator's de.cisions. To ensure independence from pressure from politicians and/or the regulated industry, appointments to the regulatory agency must be made on professional criteria (not political appointment), and the staff should be protected against arbitrary removal from
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office. Also, the regulatory agency should be funded out of direct levies on utilities and consumers, not from a ministerial budget, and staff should be paid at a level competitive with the private sector to minimize risks of corruption. Of course staff must be barred from political activity and having financial interests in the water supply industry or its substitutes, e.g., bottled water;
3.36 Though all necessary conditions to ensure success of a regulatory agency may not currently be in place in Indonesia, it is recommended that the Government envisage the creation of a regulatory agency as soon as possible so that the demand that can be expected shortly for its services can be met on time. Since regulatory skills are scarce, it is advisable to consider establishing regulatory functions at a different level of jurisdiction from the area of PSP operations. These/unctions should be established at national level for private water supply services provided at the municipal level; experience (Argentina, Guinea .. .) has shown that it is very difficult to evolve a former public utility into a regulatory body overnight, in particular because it requires very different skills. It could also advisable to establish a multi-sectoral regulatory commission, covering for example power, telecommunications and water and sewerage. Finally, it should also be envisaged to contract out some elements of regulation, such as service standards and financial audits, to reputable private auditors and inspection/certification agents.
F. PRIVATE SECTOR PARTICIPATION, SMALL PD AMS AND THE POOR
3.37 A widespread belief is that PSP in water supply is to be limited to "enclave" projects, such as high standard housing, tourist and industrial areas, or large and "profitable" water companies. The same belief is that it is not possible to·attract private companies to provide the service in urban fringes or remote small towns to provide the service to poorer segments of the population. The case study described in box 3 .2, again drawing on the experience of Cote d'Ivoire, shows that if a concessionaire's contract is designed to reflect the Government's social preoccupation and properly monitored, it can lead to the provision of a good and affordable service to urban poor.
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Box 3.2 - The Case of C6te d'Ivoire -SOD EC/ and Small Consumers
In Cote d'Ivoire, the Government has successfully implemented a policy of providing water supply connections to small residential customers; so far, 70% of the 320,000 existing connections have been provided free of charge by SODECI, the private concessionaire operating all piped water systems in the country (box 2.1). Small customers, however have to pay a refundable advance of six months of the minimum water bill to demonstrate their commitment to use piped water .. The cost of construction of small residential connections is supported by a surcharge that applies to every cubic meter of water consumed. According to SODECI's concession contract customers must be connected when a minimum density of demand for connections is reached. Small customers are located mostly in urban fringes of large cities and in small towns scattered over the national territory. They consume typically less than 10 rn3 per month and because of the 1ow rate that applies to consumption below that level, generate little revenue. Had SODECI been left responsible for the definition of the "rule of the game", it would probably have limited its activities to wealthiest neighborhoods of the capital city. Despite the social role SODECI is requested to fulfill, it has been profitable and has distributed dividends since its inception more than 30 years ago.
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4. HUMAN RESOURCE DEVELOPMENT IN PDAMS/BPAMS
A. INTRODUCTION
4.1 Chapter 4 discusses issues relating to human resources development in PDAMs/BPAMs, where the vast majority of water sector staff work. Others working in the water sector include staff in Cipta Karya (Bintek, other departments and sections) and the public works departments (Dinas Pekerjaan Umum - DPU) in the provinces, and employees of consulting companies and contracting firms. Except for a few of these, e.g., Bintek Water Supply, the majority are engaged only partly in water supply-related activities, and it has been difficult to obtain reliable data on them. Section B summarizes the key features relating to the existing situation in human resource development (HRD) in the water sector. Section C discusses proposals for HRD at the industry level, while Section D discusses proposals at the level of individual PDAMs. Finally Section E relates proposed implementation changes.
B. SUMMARY OF CURRENT STATUS'IN HUMAN .RESOURCES DEVELOPMENT
4.2 About 25,000 staff are employed in the over300 PDAMs and public works units (BP AMs) that provide piped water supply in Indonesia. As in any utility sector, human resources play an important part in efficient service delivery in this sector. As is typical in most developing countries, the staffing situation in the Indonesian water sector is far from optimal.
4.3 Quantitatively, the water sector in Indonesia suffers from over staffing .. The· traditional indicator of productivity in the water sector - staff per thousand connections - for Indonesia is 10.3. Even water enterprises in metropolitan Cities such as Medan, Bandung, and Surabaya average a little over six staff per 1,000 connections, while the indicator is 8.4 in Jakarta. In the case of smaller water enterprises, serving dispersed areas, the indicator is almost 12. As is evident from Table 1.4, these numbers compare unfavorably with those in other East Asian cities, except Manila and Cebu in the .Philippines, and are much higher than the average of three to five iri Latin America and in developed countries. ·
4.4 Qualitatively also the picture is somewhat discouraging. The vast majority of staff have only high school or lower level educational qualifications. There are only about 100 qualified sanitary engineers working in the sector, accounting for less than 0.5% of staff. This works out to about one sanitary engineer for every three water enterprises; the situation is in fact even worse, because a.number of the kotamadya water enterprises have more than one sanitary engineer. Table 4.1 below indicates the numbers of staff at 'each level of educational qualification, from below high school level to master's degree level. The majority of staff with bachelor's degrees and diplomas are . non-technical staff.
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Table 4.1- Educational Qualifications of PDAM Staff
Below High School Some High School High School Diploma · Bachelor's/Master's Degree Total
Source: PERPAMSI!DG PUOD
6,935 15,744
941
Ll.IZ 24,957'
4.5 Lack of real autonomy/or PDAMs is a contributing/actor to the less than adequate quality of human resources in the water sector. It is generally accepted that PDAM staff selections, especially at the director and managerial levels, are influenced by local governments, and that established selection criteria, e.g., qualifications and experience, are not always adhered to. Further, while the majority of staff who originally transferred to the water enterprises from BP AMs have now become PDAM staff, about 10% of PDAM staff in 1996 were still civil servants. Even more important, it is understood that almost all PDAM staff at director level are civil servants, while about 20% of managerial and supervisory staff are civil servants. As these civil servants can be transferred out of PDAMs, uncertainty of tenure at senior levels hampers the creation of a strong water sector identity in the work force.
4.6 Staff training remains an ad hoc activity. Training needs have not been identified in a systematic manner, and most water enterprises do not have staff training plans. There is, however, generally a spike in the level of training in PDAMs during the periods when they are a part of water supply projects financed by foreign donors, both bilateral and multilateral. PDAMs in Central Java Province have recently established a training center for staff training.
4.7 The Department of Public Works' Water Supply and Environmental Sanitation Center (at Bekasi) is an important player in water sector staff training. It was established in 1988 under grant funding from Japan (JICA) and has received on-going JICA support for equipment and facilities, as well as Japanese experts for curriculum development, · training of counterparts and delivery of courses; it has recently received a further tranche of Japanese grant funding. In 1996 the Center was made a part of the structural organization of the Mi:riistry of Public Works (MPW), and will thus receive on-going government funding.
4.8 The Center has good facilities, which are underutilized, primarily because it has only limited funds (from donors and since 1996, some government funds) to cover the cost of programs; it does not recover the cost of operations from the participants of training programs. Lack of funds has resulted in some of the facilities not being properly maintained.
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4.9 Table 4.2 shows the water supply courses conducted by the Center during 1991-95. Course evaluations indicate that the courses were well received; however, some participants expressed concern about translating the learning into practice, as field conditions are often quite different from those assumed at Bekasi.
Table 4.2- Water Supply Courses Conducted atBekasi Center
Course Title Duration FY91 FY92 FY93 FY94 FY95* Total (Weeks) #, p #,P #, p #.P #.P #.P
* - As of August 1995 #-Number of times offered P -Total Number of participants
4.10 Other institutions have played a much smaller role in water sector staff training. These include leading Indonesian universities, e.g., the Institute of Technology, Bandung (ITB) and the Institute of Technology, Surabaya (ITS), which have provided training from time to time to a small n~ber of staff of some PDAMs through short term courses. Selected senior staff have also benefited from overseas study tours.
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4.11 Salaries of PDAM staff are governed by regulations issued by the Ministry of Home Affairs, and take into account the profitability of individual PDAMs. However, as the majority of the PDAMs are not profitable, in practice salaries are generally similar to civil service salaries, and incentives for performance are low. Salaries of staff in PDAMs earning profits, on the other hand, are significantly higher than civil service salaries, and are said to be comparable to those of other utilities and service sector organizations, e.g., the electric company (PLN), Telkom, banks etc., and in some cases, even the private sector. Further, as with the civil service, salaries of PDAM staff are supplemented by a variety of allowances and other payments, e.g., through membership of tender committees, etc. In some cases, especially in large PDAMs, these can add up to 100% of salary and more, and result in perverse incentives, in favor of ad hoc, rather than regular work.
4.12 PERPAMSI, the association oflndonesian water enterprises (and BPAMs), plays a fairly significant role in human resources development in the water sector, particularly through its HRD sub-committee. It is represented in a team (comprising representatives from the MoHA and LAN) which is developing a system of career planning for water sector staff. The team is working on proposals to develop training and certification programs for PDAM managers - from first line supervisors to President Directors, with the training to be conducted by LAN. In 1996 PERP AMSI organized a one month training program cum study tour (three weeks at the Research Triangle Institute, North Carolina and a week at Seattle) for 25 PDAM President Directors. Other initiatives of PERP AMSI include twinning arrangements between ten PDAMs and Dutch water companies, and staff exchanges between PDAMs, especially in Sumatra. Members of PERP AMSI' s Council of Leaders, however, agree that much more needs to be done in the area of human resource development.
4.13 PERP AMSI currently functions essentially as an arm of government. Its Advisory Council consists of senior officials of MoHA and the Ministry of Public Works (MPW), and its day-to-day activities are guided by PUOD. Its effectiveness is further limited ·as it has no staff of its own, although proposals are currently under consideration to appoint a water industry expert from ITB as a full time Executive Secretary.
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· . C. HUMAN RESOURCE DEVELOPMENT AT THEW ATER INDUSTRY LEVEL
An Enhanced Role for PERP AMS/
4.14 Over the past two decades, GOI has made significant efforts to provide greater autonomy to the water industry in Indonesia through the establishment of PDAMs. Nevertheless, government has retained control over key aspects. of the industry, e.g., funding for capital expenditure, tariffs. Human resources development is another such area. ·During Repelita VI, now in its final year, GOI has placed greater emphasis on commercialization and on cost recovery, and an increased role for the private sector in the water industry; these trends are expected to accelerate in Repelita VII. It is, therefore, desirable to move towards making the water industry responsible for human resource development in the sector, and minimize -perhaps even eliminate altogether over a periiJd of time, say by the end of Repelita ·VII- the role of government in this regard.
4.15 PERP AMSI is the logical choice for taking on enhanced responsibilities in this regard on behalfofthe water industry and should take the lead in matters of sector staffing, including: (a) optimization of staff costs, including staffing ratios and staff compensation; (b) recruitment guidelines; and ( c) training. In order to increase the role of sector experts in ·PERP AMSI, the responsibilities of the Council of Leaders (Dewan Pimpinan) have to be significantly enhanced. It may also be desirable to expand the Council's membership to include representatives from academia, the consulting industry, and contracting companies, to reflect the full range of professional interests. PUOD and Cipta Karya would continue to be represented in the Council, but with the same status as other members. A small full time staff, comprising a high caliber Executive Secretary and one or two other professionals, could support the Council of Leaders and be responsible for the day to day activities of PERP AM.SI, thus taking over these functions from PUOD. .
4.16 Atwo stage approach is likely to be appropriate when considering the future role of PERPAMSI. During the initial phase, i.e., from nowtill the end of Repelita VII, since the.water industry is still in its early stages of development, and most of the PDAMs (except for a handful) are quite small, PERPAMSI could play an important role in HRD. Over time, as the water industry is better developed, with a significant role for the private sector, individual PDAMs would take the lead on HRD issues of importance to them. PERPAMSJ's role could be scaled back to information sharing and to addressing selected HRD and other poliqiissues of sector wide interest at the request ofits members.
4.17 In the context of the suggested enhanced role for PERP AMSI, it would be desirable to establish a regular source of funding for PERP AMSI, especially as the current source - a commission for collecting water bills· from government agencies could dry up, as the PDAMs, ~specially the larger and more commercialized ones, take
. up this responsibility themselves. One possible method of funding that could be considered would be to levy a membership fee on each •PDAM, equivalent to a percentage
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e.g., one percent- of the PDAM's audited annual revenue. Similar fees could be set for consulting firms and contracting companies that choose to become members.
Staff Costs
4.18 Staff costs - salaries and related payments to staff- constitute an important part of PDAM operating costs. Efforts to minimize staff costs and increase productivity need to strike a balance between the need to reduce over-staffing, which is endemic in public sector water enterprises in most developing countries, and to enhance staff salaries, which are generally low. To achieve optimum results, it is desirable to address both issues.
4.19 Staffing Ratios. PERP AMS! could take the lead in addressing the issue of over , staffing in PDAMs. The current PUOD guideline of 10 staff per 1,000 connections is too broad for PDAMs which range in size from the very small (less than 5,000 connections) to the large (over 100,000 connections). PERPAMSI's analysis of PDAMs based on number of connections offers a possible categorization, i.e., large and medium (over 50,000 connections); intermediate (10,000 to 50,000 connections); and small (below 10,000 connections). Rather than prescribe fixed ratios for PDAMs in each category, it may be more appropriate for PERP AMS! to develop a desirable range for each category, e.g., three to five staff per 1,000 connections for large and medium PDAMs; five to eight for intermediate PDAMs; and eight to ten for small PDAMs. It is important that tlie categorization and the ranges be arrived at collaboratively, so that they are credible and individual PDAMs can be expected to make genuine efforts to attain them over a reasonable time frame.
4.20. Individual PDAMs, especially those which are outliers of the relevant ranges, should be encouraged by PERPAMSI to prepare a medium-term staffing plan (say five years) to minimize, if not eliminate, over staffing. Options that could be considered in this regard include: (a) not recruiting additional staff during periods of expansion in the number of connections~ (b) not replacing staff who retire or resign; ( c) contracting out certain services/functions to the private sector, but asking the private sector to absorb the staff, e.g., for meter reading and billing, maintenance etc.; ( d) early retirement schemes for those staff close to retirement who are unlikely to meet minimum qualifications in a reasonable period; and, (e) most likely, a combination of several of the above. It would also be useful to examine the degree of flexibility available with respect to the temporary (harian) and semi-permanent (calon pegawai) categories of staff, who together add up to about 2,600 (10% ).
4.21 In this context, as discussed in an earlier section of this paper, consolidating a number of the small PDAMs into more viable groupings is also likely to result in economies of scale and improved staffing ratios. For instance, the eight PDAMs in the island of Bali could be consolidated into a single medium-sized PDAM, with gains in staffing ratios through consolidation of functions; another example would be, the possible consolidation of PDAMs in the island ofLombok. ·
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4.22 It is unlikely .that most individual PDAMs would have the capacity to develop such staff plans on their own; a piecemeal, case by case approach, without an overall framework, is also not the optimal way of handling the issue. PERPAMSI could de.velop water industry wide approaches on matters such as nor.ms for consolidating PDAMs, contracting out specific functions with staff transfers, early retirement plans etc., and could offer the necessary guidance and implementation assistance to those PDAMs that seek it
4.23 Staff Compensation. Staff compensation in the water sector in developing countries, especially in the public sector, has generally been low. However; as the water industry becomes more commercialized, and especially when there is private sector participation, staff compensation has become more competitive and market-based, e.g., in Latin AmeriCan countries. In Indonesia too, competitive, market-based compensation for staff will become an important incentive to attract and retain high quality and productive
. staff in a commercial water industry. The compensation structure may also need to be rationalized, eliminating ad. hoc allowances that act as disincentives to regular work. Indeed one can anticipate such trends in PAM JAY A, once the concession contracts are in place.
4.24 Under the current .conditions of general over-staffing, and losses in the majority of· the PDAMs, it is difficult to foresee sector-wide improvements in staff compensation in the near term. Improvements are more likely in the larger PDAMs, especially those where some form of private participation.in PDAM management occurs. Nevertheless, it would be useful to establish market-based compensation benchmarks for PDAM staff, as a first step towards eventually moving away fromPUOD regulations.
4.25 PERP AMSI could begin work in this area by establishing comparators for the water industry in, say, the Java kotamadya, taking into account the experience of other countries, Typically, the comparators could be other utilities (PLN, Telkom), water sector consulting and contracting firms, commercial banks etc. Thereafter, a preliminary compensation survey could be commissioned to establish the current status of PDAM staff compensation with reference to the comparators. Revised compensation structures could then be prepared for selected kotamadya th~.t express an interest in improving staff compensation, linked to productivity. Increases in compensation could be linked to: (a) achievement of (or significant movement towards) target staff costs, including staffing ratios; (b) improvements in'operational efficiencies; and (c) PDAM profitability.
Staff Recruitment
4.26 _ PUOD has already established guidelines indicating the selection criteria for various key positions in PDAMs. PERPAMSJ could carry out a brief review to update them, and ensure that they reflect the needs of an autonomous water industry, rather than those of the civil service. In order to upgrade the quality of staff, qualifications and experience for key positions - especially those at director and manager levels - could be specified at two levels: (a) a required "full" level for all new appointments, including
55
promotions; and (b) an acceptable "minimum" level - which could be lower than (a) -for current incumbents. These position requirements would need to be developed collaboratively with PDAMs, reflecting special local conditions where appropriate, and would have to be widely disseminated to all PDAMs as industry guidelines.
4.27 In order to s.elect the most qualified persons for appointpient tci"vacant managerial and director level positions, PERP AMSI could develop a mechanism (e.g., through a PERP AMSI newsletter, through a water industry web site, etc.) to enable PDAMs to advertise vacant positions at these levels throughout the water industry. In addition, PDAMs should be encouraged to.advertise such positions in the media at least on a province-wide basis, to seek applications from qualified persons currently not working in PDAMs, e.g., consulting firms. While candidates from within the PDAM may be given preference in appointments, other things being equal, they ought not to be appointed unless they fully meet the position requirements, i.e., as indicated in (a) in the previous paragraph. PERP AMSI could make special efforts to attract qualified managerial and technical personnel to the water sector. In the case of technical personnel, the current internship programs could be expanded further to attract recent graduates f:om leading universities.
4.28 PERPAMSI would need to monitor appointments and promotions to director and manager level positions, at least during Repelita VII, to confirm adherence to agreed guidelines. Appropriate persuasive mechanisms (e.g., announcing selections to all director and managerial positions, along with the qualifications of selected persons, in the · PERPMASI newsletter) would need to be developed so that violations of guidelines are a rare exception and do not become the norm ..
4.29 PERPAMSI should encourage PDAMs to identify current incumbents of key positions who do not meet even the minimum requirements, as in (b) above, and assist them in preparing development plans to upgrade their skills over a three to five year period. Early retirement packages, developed by PERPAMSI (as indicated earlier) could also be used for those staff who are likely to be unable to meet even the minimum requirements over a reasonable period. Decisions on implementing such packages, and identifying individuals for participation, would, however, need to remain the responsibility of individual PDAMs.
4.30 In order to develop a dedicated water industry staff, as distinct from the-civil service, all new entrants to PDAMs should be re~ruited as PDAM employees; civil servants selected for positions in PDAMs should be required to resign from the civil service, with suitable mechanisms established for transferring their pension entitlements. Existing PDAM staff, who are civil servants, should be encouraged to consider taking up PDAM employee status through protection of their civil service pensions.
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Training
4.31 Training Needs Assessment. PERP AMSI is ideally placed to taice the lead in training in the water sector, building on the work it is already doing. Conducting a training needs assessment (TNA) for PDAM staff, based on position requirements and the qualifications and experience of current incumbents, is a high priority task. Given the large number of staff in over 300 PDAMs/BP AMs, it is essential to develop a simple methodology to conduct TNA in a decentralized fashion, using existing data as far as practicable. It might also be useful, in the firsfinstance, to focus on identifying the needs of key positions, rather than carry out a comprehensive survey of the training needs of each oftlie 25,000 plus staff. Critical training needs, which require immediate attention, could then be identified from a review ofTNA findings.
4.32 Curriculum Devefopment. PERPAMSI would need to work closely with MPW's Bekasi center, as well as leading universities and other agencies which currently provide water sector training (or are interested in doing so), to develop training curricula for critical needs. Curricula already developed, e.g., by the Bekasi Center, would need to be reviewed and updated as required. It is important to limit PERP AMSI's role to commissioning the work and reviewing (and approving) the curricula, rather than · establish in-house capacity for this purpose.
4.33 Management Training. ~ERP AMSI should pursue the initiative already underway to develop management training programs for water sector managers, keeping in mind the general principles discussed above. As discussed earlier, a program would also need to be developed for training members of the supervisory board. Curricula for
. the various management training programs would have to be tailored to meet the needs of commercially oriented water industry managers, (i.e., in addition to technical topics on piped water supply, it would also include subjects such as water resource management, water supply finance, economic aspects of water supply, business management, environmental issues, etc.) and not civil servants.
4.34 Although LAN is working with PERP AMS! and PUOD in developing the management training program, it ought not to be awarded the assignment on a sole source basis. Efforts would need to be made to identify other training providers interested in this work and they should be given an opportunity to compete for providing such training on a quality and cost basis. The prorated per participant costs of the program would need to be charged to the PDAMs which sponsor their staff to the program. As currently planned, managers should be certified on successful completion of the program.
4.35 Training Budgets. Experience with public sector training in developing countries has shown that in order to be efficient and cost effective, training should be demand driven, and the full costs of training should be paid for by the sponsoring PDAMs. PERP AMSI could develop guidelines on training budgets for the water industry based. on industry practice in developed and developing countries, practice in other utility sectors in Indonesia, e.g., power, telecom, as well as the results of the TNA. Such
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guidelines could indicate the number of training days per person for different categories of PDAMs (e.g., 10 days per person per annum in large PDAMs, eight days in intermediate PDAMs) and suggested annual training budgets, as a percentage of staff salaries, e. g., 5% of annual staff salaries.
4.36 Budgets for staff training and selection of staff to attend specific courses would have to be need-based and should be the responsibility of individual PDAMs. It would naturally be more efficient, budget-wise, to sponsor staff to local, non-residential courses, where feasible, in preference to residential courses in distant Indonesian or foreign cities.
4.37 Cost Recovery. Government-owned departmental training institutions in Indonesia (and elsewhere) have not functioned in an.efficient and cost effective manner, because of a lack of incentives and on the limited public reso'urces allocated to them. As with PDAMs, GOI should, therefore, consider converting the Bekasi Center into an autonomous agency with swadana status, requiring revenues from fees and other income to meet at least operating expenses; eventually, the Bekasi Center could even be privatized. Government could also encourage universities and other private sector training organizations to develop capacity for water sector training rather than establish such additional capacity in MPW.
4.38 Accreditation. PERP AMSI could evaluate the various providers of water sector training for different types of courses, as well as those interested in doing so, and accredit them based on the findings. It could also bring out an annual water sector training calendar, listing c.ourses offered by various accredited training providers in Indonesia; the training calendar could also be posted on the PERP AMSI web page. PERP AMSI should maintain contact with water training centers in other countries, e.g., Australia, the Netherlands, Belgium, assess the relevance of their course offerings to the Indonesian water sector, both from a quality and cost perspective, and advise PDAMs on their suitability.
4.39 Staff Incentives. Training should be job related, either for improved performance in the current assignment or in preparation for the next assignment. Successful completion of training programs would need to be recorded in the "personal file" of staff. Only those staff who have completed the pre-requisite training for a given assignment ought to be considered for that assignment. Staff participating in foreign training programs and in extended residential training programs in Indonesia would on their return be required to take up the assignment (for which the training was provided) for a preagreed minimum period.
D. HRD AT THE LEVEL OF INDIVIDUAL PDAMs
4.40 While PERP AMSI could take the lead role in developing industry-wide guidelines on various key aspects of HRD and providing the necessary guidance, ultimately, however, individual PDAMs will need to play an important role in implementing HRD policies and these guidelines on a day to day (and transaction by
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transaction) basis. The key to success in such implementation is the level of autonomy - both from their owner local governments and from PUOD - that PDAMs will operate under, epitomized by the composition,and role of the Board of Supervisors.
4.41 A proactive Board of Supervisors coul9 play an important role in HRD, ideally through an HRD Committee, which meets from time Jo time. The HRD Committee could be responsible for, inter alia:
(a) Appointment of Directors: Ensure that vacant director level positions are widely advertised, interview candidates who meet the position requirements contained in PERP AMSI guidelines, and recommend appointment of the most suitable candidate as a P DAM employee (i.e., civil servants, if selected, would be required to resign from government service.prior to an appointment in the PDAM).
(b) Other Senior Appointments and Promotions: Monitor appointment of staff at regular intervals, to ensure that only fully qualified staff are appointed/promoted to vacant positions.
( c) Staffing Ratios: Recommend and obtain Board approval for medium-term targets for staffing ratios (number of staff per 1,000 connections), consistent with PERP AMSI guidelines. Review management plans for achieving agreed ratios, and periodically monitor progress against agreed targets.
(d) Training: Review annual training budgets prepared by management, keeping in mind PERP AMSI guidelines, and periodically monitor implementation of the plan, with particular attention to management training, and on the impact of training on on-the-job performance.
( e) Staff Compensation: Review management proposals for revisions to staff. compensation, including compensation structure, against comparator compensation, achievement of target staffing ratios, improvements in operational efficiencies, and profitability.
The Finance and Administrative Director could be the person directly responsible for HRD, with the President Director having overall management responsibility.
E. IMPLEMENTATION OF PROPOSED CHANGES
4.42 Implementation of changes to HRD policies and practices in the water industry depends on the degree of their acceptance by key stakeholders. Of these, government -Ministry of Home Affairs (PUOD), Ministry of Public Works (Cipta Karya), BAPPENAS, - is obviously the most critical. Given that the general thrust of the
. discussion and the direction of the changes proposed are consistent with the Repelita VI objectives of commercialization and privatization of infrastructure service delivery
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(which are expected to be further emphasized in Repelita VII), GOI may wish to implement key aspects of the proposals after due discussion. Donor assistance, including from the World Bank, could be sought, focusing on strengthening PERPAMSI, assisting in the development/refinement of guidelines on staffing costs (staffing ratios, preliminary work on staff compensation), recruitment, and training. PDAMs volunteering to pilot the reforms could be provided special assistance under the package.
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5. IMPROVING QUALITY OF WATER SUPPLY PROJECTS
·A. INTRODUCTION
5 .1 The purpose of chapter 5 is to discuss ways of improving the quality of water supply projects. It is divided into four sections. Section B cites the need for PDAMs to become fully responsible for project identification, preparation and implementation to ensure service improvements. Section C examines long term planning and least cost solutions especially concerning the demand for piped water, water resources allocation, selecting technical, institutional and financing options, and water supply and waste water disposal. Section D discusses the implementation of water supply project, particularly as regards to technical assistance and procurement of goods and works. Section E relates the history of water supply project and experiences with Integrated Urban Infrastructure Develop:n:ent Projects (IUIDP).
B. PDAMs TO PREPARE AND IMPLEMENT NEW PROJECTS
5.2 Providing a sustainable public water supply service results from the right combination of quality day-to-day operations and adequately developing and financing the system. It is thus essential that PDAMs rapidly become fully responsible for project identification, preparation and implementation to ensure that "service improvement", rather than "construction" objectives becomes the driving force. Quite a few large PDAMs have now reached a level of expertise sufficient to prepare and implement good quality projects and performance actions plans; empowerment of all PDAMs in this field sho_uld be a main objective for the years to come. This raises a set of issues regarding PDAMs access to (a) financing sources.to fund project preparation activities; (b) competent technical assistance to prepare medium term development plans, feasibility studies, analysis of institutional options, including private sector participation, and commercial, pricing and cost recovery policies; and (c) routine financing sources, instead of sources linked to externally financed projects. Also, it would be necessary to create an efficient monitoring mechanism to detect and correct poor practices. Issues (a) and (c) related to financing of water supply are covered in chapter 7.
5.3 One way to provide technical assistance to PDAMs may be to evolve the existing PMDUs from what they are now, i.e. mostly performance monitoring units with limited budget and expertise, into units that could provide assistance to PDAMs to (a) prepare and implement performance improvement plans; (b) identify, prepare and implement construction projects; ( c) identify technical or managerial issues that need to be addressed· jointly by several PDAMs; and ( d) identify private sector participation options. Such units should not substitute for traditional engineering and management consulting firms, which would still assist PDAMs in their detailed preparation and implementation tasks, but would rather act as facilitators and advisors. PMDUs should be staffed to include experienced managers of water utility companies as well as engineers, financial analysts and economists with relevant experience in project preparation and implementation.
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Restructured PMDUs should work on a demand basis and obtain a gradual portion of their revenues from user fees. DG PUOD, DG Cipta Karya and PERPAMSI should. prepare detailed terms of reference and operating procedures. In particular it would be necessary to define how these units would charge fees to the PDAMs to finance part of their operating costs.
C. LONG TEDI PLANNING AND LEAST COST SOLUTION
5.4 It is costly to develop the water supply sector, which is very capital-intensive, without systematic long term planning, whose main objectives should be to seek the least cost solution and a broad consensus among all stakeholders on the technical, institutional, financing and cost recovery solutions. Many water supply projects, even. in large urban areas, have recently been designed without reference to well prepared master plans. As a result, initially envisaged solutions are questioned and project implementation is delayed, eventually at a high cost to the consumers.
5.5 Proper long term planning requires that several aspects be looked into thoroughly. A proper assessment of demand and willingness to pay for piped service must be carried out to avoid inadequate dimensioning, phasing or location of extensions. Water supply forecasts have to be prepared on the basis of achievable objectives. For example, set}:ing steep UfW reduction targets without linking them to institutional changes that would provide financial incentives would lead only to unsatisfactory results.· The same applies to expected drastic switches from ground water sources to piped water without first reviewing user satisfaction with their current supply or implementing regulations of
. ground water abstraction that are justified from an economic point of view (box 5 .1 ). The choice of new water sources often has to be made in a regional context taking into account the cost of compensating those affected; of course, water rights have to be secured by the PDAM before a particular project is designed. Finally, institutional arrangements such as regrouping PDAMs or some of their functions, or contracting out management and/or financing of the facilities to private companies have to be investigated thoroughly as part of the long term planning exercise. The Government should consider supporting financing water supply projects, even in small PDAMs, only if they refer to comprehensive long term development plans. Such plans should cover the 10 to 15 years to come and would have to be regularly updated to accommodate, in particular, changes in intensity and location of growth or in land use.
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Demand for Piped Water
5.6 Standards prepared by central agencies are almost always used to design new water supply systems or extend existing ones. Design criteria prepared by DG Cipta Karya propose service ratio' objectives (connection, public standpipes) per type of urban center, average daily consumption per category of consumer and U:f\V objectives~ DG PUOD also suggests a standard tariff structure. Before designing a project, a more appropriate approach would consist in reviewing the behavior of households and businesses to identify the technical and economic factors that affect, or even distort; their choice of supply and consumption pattern, and to find out. what they really want. These factors include continuity of service, initial cost of a connection, tariff structure or frequency of tariff collection, enforcement of ground water abstraction regulations.
5. 7 There is real merit to initiating the design process by a thorough assessment of the actual demand and willingness to pay of potentiai consumers for piped water, more especially as piped water often has to compete with substitutes that may be perceived as more convenient or less expensive. Real demand surveys are standard procedures of current project preparation, but they are often carried out in a somewhat mechanistic way and mostly to support the project economic. analysis rather than to help design the system extension or the tariff structure. They also seldom look thoroughly at the suitability of substitutes such as vendors, tankers, ground water or bottled water and which factors affect user choice.
Box 5.1 - Competition among Water Resources in DKJ Jakarta
In Jakarta, PAM JAYA hasto compete with insufficiently regulated ground water resources that are almost systematically 1;1se_d by comm.ercial and industrial consumers as well ·as by many of its wealthiest residential consumers. In the northern part of the city, grpund water abstraction from the deep aquifer has led to land subsidence that would eventually require major drainage and flood control investments, and thus should be discouraged by thorough monitoring and appropriate. pricing. In the southern part, where PAM JAY A is currently implementing a significant extension of its distribution network, ground water abstraction has no additional n'egative effect on the environment than any other source of water, i.e., pollution of water bodies by waste water so generated; it should not ,be discouraged by a discriminatory abstraction tax. The recommendation of the Jabotabek Water Resource Management Study to establish ground ~ater rates differentiated on the basis on the impact on the environment, has not been followed up by the provincial goyemment, although tariffs are differentiated on the basis of the availability of piped water in the area.
Water Resources Allocation
5.8 The urban water supply sector often has to Gompete with other users to obtain its allocation. The problem is obviously more acute in large metropolitan areas such ~ the Jabotabek or the greater Surabaya region, where comprehensive planning exercises have already been carried out and detailed action plans prepared, but not always implemer:ited. In smaller urban centers, the problem may not be as complex, but always n:eeds thorough
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consideration of three main aspects: timely availability, water quality and compensation to those affected by allocation of a source to urban water supply.
Box 5.2-Assessing demand for Improved Water and Sanitation Services in the Estern Islands
During July/August 1996 a household survey of 1,440 households, along with a series of participatory community meetings, were ·conducted in five towns oflndonesia's Eastern Islands. They included Soe (West Timor), Maros (South Sulawesi), Tomohon (North Sulawesi), Tenggarong (East Kalimantan), and Banjarbaru (South Kalimantan). Existing water supply conditions vary significantly among these communities. For example, the percentage of households with an in-house water connection ranges between 28% in Maros to 82% in Tenggarong. Almost all connected households have working meters and receive regular bills from the PDAM. Between 33% and 75% of PDAM customers surveyed in the five towns pay less than US$3.50 per month or US$42 per year for piped water .. On average households with connections in these communities reported paying between 1.9 and2.9% of their average monthly income for water service.1
·
Residents of each community were asked about their support and willingness to pay for improved water supply services. Demand was strong in each community for a system that provides potable water at sufficient pressure 24 house a day (see figure). At a price of Rpl,0002
per cubic meter ( ~US$0.43), between 39% and 94$ of respondents said they would utilize such a system. Even at a price ofRp3000 (~US$1.30)/m3 , a significant percentage ofrespondents said they would make use of an improved system. For most households, these prices represent a three to six-fold increase from current tariff levels (-US$0. l l-0.22). Demand for improved services as higher among wealthier households, respondents who have completed secondary education, households with access to credit, and households with existing PDAM connections.
Percentage of Respondents Who Would Utilize an Improved Water Supply System at the Indicated Tariff per Cubic Meter of Water
1 Self-reported average monthly household income ranged betwen US$123 (Soe) to US$230 (Barijarbaru).
2 During July/ August 1996, the exchange rate was US$ I =Rp 2300.
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In contrast to the varying water supply situations among these communities, household sanitation Conditions are quite similar. Greater than 90% of the households visited in each town have either a private water-sealed toilet or a private latrine, and satisfaction with existing services is quite high. At the same time support for a project to install sewer lines and a wastewater treatment plant was surprisingly strong across four of the communities (except Soe ). At a combination of the lowest assessment and monthly fees (-US$22·and ~l]S$2, respectively), more than 45% of individuals in each town said they would connect to the new sewer system. Demand for sanitation service was also found to be relatively price responsive·as compared to demand for improved water supply service.
Results of multivariate analysis .of the data suggest that the effect of factors such as service price, household income, education and access to credit on the demand for improved water and sanitation services varies by community.3
Effective policies to improve water supply service in this area will likely be those able to respond to such variations. Future research designed to inform policy formulation should thus obtain infomi.ation from communities about existing water supply and sanitation conditions; residents' attitudes toward and priorities for improving their current situation; and households' socioeconomic .and demographic characteristics. In addition, assessing demand for service improvements requires both that researchers provide a careful, thorough description of the proposed project outputs and their costs and benefits, and that individuals are motivated to provide sincere responses to questions about their willingness and ability to pay for such services.
If a household survey is employed to obtain such information, care should be given to ensure that as representative a sample of households as possible is drawn in each community. In addition, a sufficient number of households must be consulted in order to (1) allow generalization of findings to the community under study; and (2) permit multivariate statis.tical analyses of collected dRta. Group interview techniques such as neighborhood or focus group meetings are also useful means of obtaining information from communities, and are especially helpful at the start of a research exercise in identifying issues of particular interest in a community. Extrapolating findings obtained with such techniques to an entire community, however, is not appropriate. Using both types of data collection approach~s can allow for the exploration of new research themes without sacrificing the ability to conduct statistical analysis of collected data.
3 For a full dis~ussion.ofthe Eastern Island research an~·data analysis, see Davis, J. and D. Whittington, Household water supply and sanitation conditions and willingness to pay for improved services in three Eastern Islands (Timor, Kalimantan and Sulawesi), Indonesia. Report to the World Bank (EA3), April 1997. .
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· 5.9 During the planning exercise, it is necessary to gather enough information on water quality and its possible evolution to ensure that proper treatment costs are taken into account when compared with alternatives. In Kalimantan, for example, water is abundant but often of a salinity higher than permissible during high tide for those intakes that are located near the sea. The cost of locating intakes much farther upstream, and desalinating part of the water to produce "drinking" water, has to be compared with that of distributing bottled water for drinking and cooking purposes during shortage periods.
5.10 Another aspect that has to be looked into carefully is the compensation to be paid to those affected by the allocation of a given source of water to urban water supply. This applies in particular to springs that are almost always formally or informally used for irrigation purposes. Beyond that, it is also necessary to estimate the cost of externalities such as reducing water quality downstream of an intake or land subsidence for ground water abstraction-and its consequences on drainage. All these aspects have to be quantified and compared on economic grounds.
. . .
5 .11 In comparing water source allocation schemes, collection and disposal of additional waste water does not always have to be taken into account, because a.II solutions would have the same externality, i.e., they would generate the same additional quantities of waste water. However, it is essential to cost this externality when pricing the provision of water supply. This applies not only to the water produced and distributed by the PDAM, but to all its substitutes, and in particular to ground water tapped through individual wells.
Selecting Technical Options
5.12 Water supply is not "rocket science". The basic technologies it requires are relatively well known and evolve rather slowly. Drilling, pumping, piping or.metering techniques are well mastered in South East Asia, and the Indonesian industry has been able to meet a very significant share of the demand, in particular because of local preferences that apply to contracts financed from local sources and even international financing agencies, such as the World Bank. Since requirements in terms of drinking water quality are not yet stringent, standard water treatment techniques are also well mastered by local consultants and contractors operating in the country. Standardization of some type of small water treatment plants ("package treatment plants") is an option that needs to be investigated further, through a detailed market analysis that would require a detailed survey of PDAM managers on their actual needs and experience so far with operating such plants.
5.13 Ductile Cast Iron (DCI) pipes are usually the preferred technical option by most water utilities worldwide for large distribution pipes (above 400 i:run), and sometimes transmission because there is no need to install and monitor cathodic.protection. They are not manufactured in Indonesia and thus have not been installed recently in the country. It is likely that distribution steel pipes with cathodic protection using sacrificial anodes that are currently laid in most cities may not last as long as DCI pipes, (i.e., 30 to
66
40 years), and may have to undergo regular rehabilitation, that would lead to a solution that is not the least cos.tone. PERPAMSI should initiate discussions with the manufacturing industry and encourage a feasibility study of local manufacturing of DC/ pipes to meet an expected very large demand.
5 .14 ·One issue that has to be addressed during the years to come lies in the independent testing and certification of new technologies and products coming on the . market, and dissemination of best practices among PDAMs. The manager of a small PDAM should be able to rapidly evaluate the technical compliance with industry standards of a product proposed by a bidder by rapidly accessing a reference center. This should become PERP AMSI's main role, since it is essential that actual experience with particular types of meters, pipes, treatment processes or pumps be used as a basis for judgments and recommendations for improving the manufacturing industry.
Selecting Institutional and Financing Options
5.15 Seeking the least cost solution should not be limited to comparing technical options, their dimensioning or the phasing of their implementation. It should also focus on the most appropriate institutional and financing arrangements. In particular, solutions have to be sought and agreed upon during the planning exercise for the financing, implementation and operation arrangements of water production/transmission facilities that serve more than one PDAM. For example, at the time the new Cisadane water production facility developed byPDAM Tangerang was ready to deliver water to DKI Jakarta, there was still no clear agreement on bulk water supply/purchase conditions and management of the transmission line. Had this issue been looked at carefully at the time of project preparation, the technical design, ,implementation and operation arrangement could have been somewhat amended. Also, seeking· proposals for a BOOT contract for a new production facility should result from a very detailed comparison with a more traditional approach that would consist of having the PDAM financing, implementing and operating the facility; Furthermore, the advantage of seeking private implementation of the project could be totally nullified if the selection process is not properly organized and several years are lost in negotiations.
Water Supply and Waste Water Disposal
. . .
5.16 It is considered best practice to plan, develop and price the provision of a water supply service taking into account its "externalities", that is mostly the additional waste water generated by the additional quantities of water supplied. There are many examples worldwide, and in Indonesia as well, of attempts to develop water supply and water collection and disposal operations simultaneously. There are few success stories, because water supply and sanitation have different economies that often lead to different technical, institutional, pricing and financing solutions . .
5.17 Public water supply has many ofthe characteristics of a private good: (a) benefits from water consumed accrue directly to users; (b) users are usually charged for
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the quantities they consume, and ( c) those who do not pay for the service can be excluded from it. Willingness to pay generally exists and thus full recovery of the cost of providing the service is feasible. As a consequence, a water supply service can be run as a commercial operation either by a public or by a private utility company. Water supply, however also has some public good aspects, such as improved health, that justify regulation of its provision by the Government. The Government's intervention is often needed to ensure that those who do not have the capacity to pay for the service or may not , understand its benefits still can access it.
5 .18 Waste water collection and disposal have much more the characteristic of a public good. Typically, Indonesian urban households dispose their black waters (toilets) in septic tanks, that are seldom emptied, and their grey waters (kitchen, laundry and bathroom) in storm water drains; grey water usually generates 60% to 70% of the BOD (biochemical oxygen demand) load of domestic origin. Surveys tend to show that households often are satisfied with their current systems and are willing to contribute very little to a service that would take the waste out of their immediate environment and dispose it safely in the environment. They usually are willing to share the cost of a connection to th~ tertiary sewers -but very rarely to participate to the cost of building and operating trunk sewers and proper di&posal or treatment of effluent. Also, a sewerage customer disconnected from the sewer for non payment of his bill would simply discharge his effluent in the immediate environment, creating a nuisance to his neighbors. Cutting off his water supply instead of the sewerage connection could only apply to those of 40% of households currently connected to the piped system, while all water users, regardless of the source of supply contribute to the pollution load. Sewerage and waste water treatment are thus much more difficult to run as commercial operations because the commercial risk is much higher than/or water supply.
5 .19 Since storm water drains currently function as open sewers discharging the pollution directly in receiving water bodies, the main problems most cities are faced with are: (a) proper treatment or disposal of the dry weather flow of open channels, and (b) gradual separation of waste water from storm water. Not taking care of collection and disposal of effluent often has a huge cost to the economy, in terms of degradation of aquatic life, loss of revenue (fishing, for example) or increased cost of new drinking water supplies, by requiring more sophisticated treatment or more remote location of intakes for new water supplies. All this justifies substantial public/ unding to complement revenues that cannot be generated through user fees.
5 .20 In practice, the many projects that have tried to combine water and sanitation development under the same umbrella have almost always resulted in very limited: if not insignificant sanitation.components, whose additional benefits in terms of improved health and environment are difficult to quantify or even identify. This is even more true when the geographical coverage of the water and sanitation components of the project are different, as has often been the case in projects implemented in Indonesia. Large scale sewerage and sanitation services in developed and developing countries (Morocco, Cote d,Ivoire, Brazil ..• ) have almost always resulted from action plans and projects
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founded on specific sanitation sector policy frameworks. These frameworks and action plans addressed the technical, institutional, pricing and financing issues independently from those of the water supply sector. A policy framework for sanitation will be defined soon under an exercise to be funded by the ADB.
5.21 If more than lip service has to be paid to sewerage and sanitation, it is urgent to (a) rapidly prepare the policy framework for this sector and transform it into a realistic action plan.; (b) implement specific sanitation projects that cover the various aspects of the action plan; and (c) limit the "sanitation component" of water supply projects to actions such as the construction of micro drains in streets where tertiary water distribution networks are being installed or proper drainage in the surroundings of public standpipes.
D. IMPLEMENTATION OF WATER SUPPLY PROJECTS
Technical Assistance·
5.22 Project identification, preparation and implementation rely almost entirely on consultants hired by PDAMs and provincial agencies; only some technical assistance (TA) teams are still hired by central government agencies for the preparation of more complex projects. In addition, TA is also provided to improve technical, commercial and financial management capacities, mostly under externally financed projects. Altogether, development of the water supply industry depends very much upon the peiformance of the consulting firms that are awarded TA contracts, but it is not clear whether the Indonesian water industry, a very attractive market/or qualified international and local consultants, gets the best out of this TA.
5.23 Consultants often seem to be treated as a simple commodity providing "man months" more than expert advice or a well defined output. For example, those who prepare detailed designs and supervise construction are too often different from the ones who prepared the feasibility study; the former have the tendency to redesign the project they have to implement, sometimes rightly; leading to delays and additional costs. In many cases, it would be better to ensure a maximum of continuity and to hire a consulting firm/or the entire project cycle. Also, many unwritten or misinterpreted rules, such as a mandatory association between international and local consulting firms, "suggested" ceiling on billing rates or suggested team composition (70% of the total man month amount should go to local consultants), unclear criteria for shortlistings, lengthy negotiations and contract signing process, and foo much emphasis put on knowledge of local conditions seem to have limited injection of the best available expertise by top rated local and international firms into the water supply sector. This is perceived to be even more of a problem now that the Indonesian water industry needs TA with real experience in private sector participation to deal with international water companies that have been approached to submit proposals. Issues related to TA are often generic, and do not have to be addressed for the water supp~y sector only. They have been discussed many times with international financing agencies, such as the World Bank. However, the water industry, together with BA}'PENAS and DG Cipta Karya, must take a step back and
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look very candidly at these issues in order to eliminate the perverse effects of the above ·unwritten rules.
Procurement of Goods and Works
5 .24 The water supply sector is using procurement methods that are not optimal and often result in additional costs the consumer eventually has to cover. For example, for both steel and PVC pipes that are manufactured by several domestic companies, recent tenders have failed to attract international bids. \Vhile the two of three lowest bids are always very close to each other and to the owner's estimate, prices for the same item vary quite significantly among projects. One might suspect that true competition does not take place in such cases. It is always in the best interest of a PDAM to check that domestic bids are really competitive and the best way to achieve this is to ensure that international bids can he submitted and be used as a benchmark.
5.25 Most PDAMs still award separate contracts for supplying and then laying pipes. Sometimes a simple steel pipe construction project requires up to four contracts (supply of pipes, supply of valves and fittings, supply of cathodic protection equipment, laying of pipe). This multiplies the risk of delays in contract processing and increases the need for coordination.4 Also, the current practice of splitting supply and laying should he discontinued as soon as possible for both large and small diameters. Further, for larger diameter pipes, it is always in the best interest of a PDAM to compare proposals for several materials, such as steel, ductile iron, reinforced and prestressed concrete not only from the supply and construction point of view, hut also by taking into account expected life duration and maintenance costs. Already, the Indonesian manufacturing industry is able to submit competing proposals for reinforced and prestressed concrete pipes and steel pipes. It would only be by opening the market to other materials that local manufacturing ofDCI pipes, that is almost always the preferred option for water distribution, can be encouraged.
5.26 For water treatment and pumpingplants, the standard practice that consists of having a consultant responsible for the selection of the process and the preparation of the detailed design and in awarding a civil works contracts and a series of equipment supply and installation contracts would need to be revisited, in particular for larger plants. In this arrangement, it is unclear who is responsible for the final product, i.e. drinking water meeting standards produced in the specified quantity and at a guaranteed cost, and who has to be penalized in case of non compliance. Design and build contracts to he awarded after open competition among prequalified specialized companies should become a standardpractice. Of course, the tender documents should be very explicit on the process and technologies that are acceptable, on technical specification for the output,
4 This arrangement seems to have its roots in the perceived need to protect the.local steel pipe industry against imported ductile iron pipes. While the supply of steel pipes is usually less expensive than the
. supply ofDCI pipes, DCI pipes may lead to less expensive projects when compared on a combined supply and laying basis.
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the method used for comparing bids and the penalties that would apply in case of non compliance with the standards. ·
5.27 Because of budgeting practices that forbid award of multi-:year contracts for. project that are financed by the central budget, most PDAMs are forced to slice their projects in small packages; this rule does not apply to externally financed projects. For repetitive tenders such as the supply of meters, this could put the PDAM in the position · of having to select different brands every year, ifthe contraets have to be awarded each time to the lowest bidder. Also, because of the review process that is required, many· PDAMs.avoid awarding larger contracts that need review from central government agencies. As a result there is a general consensus that the water industry attracts few contractors with sufficient qualifications. Grouping. works in packages tha,t are large enough and enforcing strict prequali:fication are a means of improving the quality of contractors active in the water supply sector. ·
E. THE WATER SUPPLY SECTOR AND PROJECTS AND IUIDP
5.28 Most water supply projects, even very substantial ones in large cities such.as Surabaya, Bandung, Medan or Semarang, have recently been implemented as part of Integrated Urban Development Infrastructure Programs (IUIDPs) that also cover subsectors such as sewerage and sanitation, solid waste, drainage, road and traffic management, market and kampung improvement. IUIDPs, which have been the only channel of Central Government financing for the urban water supply sector since the late 1980s are primarily planning and budgeting tools aiming at coordinating development of urban sub-sectors. Under IUIDPs, proper institutional arrangements and cost recovery procedures are designed and implement~d in parallel to the physical construction activities.
5.29 Typically, an IUIDP exercise is carried out within the limits ofLG's administrative boundaries, because it is cmrently the best way to plan, program and budget milnicipal expenditures. From a LG' s point of view, IUIDPs are rather attractive fund channeling tools, that allow financing of activities in several sub-sectors at once since there is no guarantee that the same amounts of funding could be secured otherwise. This applies in particular to financing provided by international agencies such as the World Bank or the Asian Development Bank. As discussed above, the limitation of the planning, programming and budgeting exercise· to a LG 's boundaries is not always adequate for the water supply sector, especially in large urban areas, where reliable water sources are often located in neighboring LGs or when the need to improve qualit:y or reduce the cost of service should encourage LGs to merge parts or all of their PDAMs' operations. Similar remarks are likely to be valid, at least for large urban areas, for the sanitation sub-sectors because waste water treatment pfants and landfills often have to be located in neighboring LGs.
5.30 While integrated planning, one of .IUIDP's main objectives, is of prime importance, experience so far has shown that planning has often been deficient. The
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preparation of five-year investment programs (PJMs), that have often been used by LGs as a substitute for planning, would actually be a much easier exercise if each sub-sector had first undergone a comprehensive planning exercise, covering not only physical investment aspects, but also, as mentioned above, institutional development, including PSP, pricing and cost recovery issues. Also, planning has rarely been integrated and thus translated into projects with synergetic effects. For example, many water supply and sanitation components ofIUIDPs often have different geographical coverage and thus cannot lead to any quantifiable or even identifiable additional benefit, when compared with projects that would have focused on a single sub-sector.
5.31 Currently, IUIDPs include the preparation of Local Institutional Development Action Plans (LIDAPs), Revenue Improvement Action Plans (RIAPs), as well as Performance-Oriented Maintenance Management Systems (POMMS). This approach tends to address issues of commercially oriented sub-sectors, such as water supply, in a manner similar to non cominercial municipal services. As mentioned in chapter 2, commercial activities need a much more rigorous approach, if private domestic or international financing, either in the form of PDAM bonds or domestic commercial loans, is one of the objectives to be pursued in the near future.
5.32 While programming of water supply investment and institutional development could and should remain part of the PJM exercise, the very nature of the water supply sector justifies that support to (a) specific water supply policies be enforced and specific national and provincial water supply institutions be created to enable the various reforms suggested in this policy framework document, and (b) in large urban areas, at least, specific water supply projects be supported, either by Government financing or by the domestic and international capital markets. Actually, most countries have abandoned integrated ilrban projects because of their complexity and the limited implementation capacity of their agencies. Those countries that have recently been able to develop a strong urban water supply sector or a strong waste water sector, have done it by first defining a policy framework focusing on long term service improvement and financial sustainability, although the necessity to coordinate the two has been a constant concern of policy-makers.
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6. . PRICING WATER SUPPLY SERVICES
. ·A. · INTRODUCTION
6.1 Chapter 6 reviews the pricing practice of the water utilities (PDAMs) in Indonesia and makes recommendations on improving the current pricing policies. It is organized as follows: Section B discusses the pricing pririciples of economic and financial efficiency, social equity, and simplicity, and the practkal trade-offs among them. Section C reviews the pricing practices of PDAMs including'water tariff regulations, an evaluation of water tariffs and household connection fees. Section D makes recommendation for changes in tariff policies and outlines implementation measures. Section E presents a case study on restructuring tariffs. ·
6.2 This Chapter made use of the PDAM data collected under an ADB financed study, "Water Tariff Structure and Financial Policies of Water Enterprises," a technical assistance project for the Ministry of Home Affairs, Indonesia. The work has benefited from the ADB study, the PDAM tariff workshops and discussion with the ADB project team.
B. PRINCIPLES OF WATER SUPPLY PRICING
6.3 There are four major principles· in pricillg water supply services. The first is the economic efficiency principle. This principle states that economic resources such as water should be allocated efficiently. The second is the financial viability principle. This principle requires that the water prices raise sufficient revenues to meet the financial requirement of the water utility. The third is the social equity principle. This is to ensure provision of a minimum level of water supply to people who may not. be able to afford the full cost. The fourth is the simplicity principle. It means that the water tariff must be simple in structure and stable over time so .that the users can understand and plan for the long term, and the water'. supply utilities can administer effectively. Water pricing should be designed in such as a way that these four important principles can be substantially met.
Economic Efficiency , ...
6.4 The principle of economic efficiency, as applied to water supply, requires that the price be set equal to the incremental (or marginal) costs of providing an incremental supply of water services. The costs consist of operation and maintenance costs, capacity expansion expenditures which are necessary to increase water supply to consumers, and environmental or other externality costs.
6.5 The rationale for setting the price equal to marginal costs is well known. On the one hand, if price is higher than marginal cost, inefficiency occurs because there are p'eople who value additional water more'than what it would cost to provide it, but they
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would not purchase that water because the price is too high. In this case, there would be an under-consumption of water. On the other hand, ifthe price is less than marginal cost, inefficiency also occurs because additional water is provided at a cost which is higher than the value placed by those who purchase it: Therefore, there would be an overconsumption of water. Only when price is set equal to marginal cost would the total social benefits, i.e., the sum of consumer and producer benefits,-be maximized.
6.6 Marginal cost pricing implies that pricing should be determined individually within each water utility, according to the individual costs, rather than imposed uniformly over all water utilities. What should be pointed out is that, ideally, the marginal costs used to set prices should be "efficient" marginal costs; they should not include certain avoidable operating costs which are passed on through higher prices to consumers. In other words, marginal cost pricing should be determined as if there is a competitive market at work, and the price is set according to the cost of the most efficient firm. An example of inefficient operating costs is the high rate ofUfW, on average some 40%. A reduction of about half of this is considered feasible and economical. Another example is that the number of staff employed is much larger than necessary in many water utilities. This part of the inefficiency costs, which can be realistically eliminated, should not be added to the marginal costs and charged to water users through higher prices. Rather, its elimination should be tied with schemes such as government equity contributions or salary bonus schemes, so as to create an incentive for the utility management to seek out efficiency improvements.
6. 7. The economic costs of water use also include costs of disposing and treating wastewater, or costs of cleaning-up external envirorµnental damage created by inadequate treatment of wastewater. For industries with particularly harmful effluent discharges, separate fees equal to the additional costs (above what is already covered by the water price) should be set. Adding a sewerage surcharge on water use would provide water users an incentive to use water and waste disposal facilities in a manner that is efficient from the society's perspective. The revenues collected to cover wastewater disposal and treatment costs should not accrue to the water utility unless the utility also provides sewerage, drains and treatment services.
Financial Viability
6.8 Financial viability requires that the water price be set at a level such that the revenues cover the O&M costs and depreciation expenses and also provide an acceptable return on assets. Depreciation charges provide for the recovery of the utility's capital investment over the useful life of the assets. The return on assets is to pay for the interest cost of debt capital as well as a fair rate of return for the equity capital.
6.9 A widely used criterion of financial viability is the utility's potential to earn an acceptable rate of return on assets (i.e., the net operating income after taxes given as a fraction of net fixed assets in operation). In the case of private utilities, the regulatory authorities traditionally impose a fair rate of return as an upper limit on earnings, a:nd
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therefore, on average unit price. In the case of government-owned utilities, as in most developing countries, the target rate of return is usually considered a minimum · requirement to help resist social and political pressures to keep the price too low.
6.10 Another criterion, which is useful when the utility expands rapidly, requires the utility to make a reasonable contribution to its investment program from its own revenues. This self-financing ratio .is often expressed by the amount of internally generated funds available after operating expenses and debt service as a fraction of capital expenditures.
6.11 A price that produces a desirable financial performance for the water utility may not be economically efficient: it is backward-looking; it uses costs that are.not relevant for long-term capacity ·planning. On the other hand, an economically efficient pricing policy may not lead to a satisfactory financial situation; either excessive surpluses or losses may accrue to the utility. 'When this happens, it is necessary to adjust the price so that it allows for an acceptable financial performance·while still maintains many efficiency advantages. It is also possible that in initial stages a public equity contribution may be required to bridge the gap between economic and financial flows.
6.12. "For example, when a marginal cost-based price generates a large revenue surplus, the surplus may be used to subsidize the poor in water and sewerage charges. When marginal cost pricing results in loss-making, a simple solution is to use a two-part tariff consisting of a variable charge based on consumption and a lump sum charge.' The · variable charge is set aceording to the marginal cost while the lump sum charge is set to cover the costs that do not depend on amount of consumption (e.g., connection, metering, billing, and administrative costs) so that a satisfactory financial performance can be achieved.
6.13 Another example regards the revaluation of assets at replacement costs when a · rate of return test is used to judge if the. utility is financially viable. This is because using historical costs for working assets, typically original book costs less depreciation, woUld tend to understate their value when capacity costs rise rapidly, or when there is no indexing to inflation, or when depreciation is on an accelerated schedule, etc.
Social Equity
6.14 The principle of social equity is advanced to ensure that the poor obtain an adequate amount of water and/or adequate waste disposal facilities. It is in favor of subsidizing water rates for the poor whose income levels restrict their consumption of clean water to levels below what is needed for health reasons, at standard tariffs. Given the presence of health externalities, there arti also efficiency grounds for subsidizing a minimum, quantity of water for low income consumers. ·
6.15 This principle can be achieved through a low subsidized "lifeline" rate for a small quantity of water, for example, the first 10 cubic meters per household per month .. As water connections are shown to correlate strongly with urban household income (see
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Table ), another major way to help the poor is through reduced initial connection fees combined with installments (by converting connection fees into a fixed monthly charge). Methods of deferred connection .payments have been particularly effective in encouraging the poor to connect to the piped water system.
6.i 6 A commonly used method in developing countries to help the poor is provision of subsidized community water standpipes. It has been estimated, however, that this method in fact costs more per user than shared household connections, in both economic and financial costs. This is due to the fact that the fixed cost of water from a standpipe is some 2.5 up to 17 times the cost of a metered house connection, depending on whether the standpipe is supervised or not; and moreover, the actual prices charged by the supervising attendants for standpipe water are much higher than the costs.
Simplicity
6.17 The principle of simplicity is to ensure that water prices are both simple in structure and stable over time. Tariff structure should be simple enough for the average consumer to understand so that individuals are able to respond to price signals and adjust their consumption accordingly. Moreover, the number of customer categories and consumption blocks should be few so as to allow the utility to administer effectively (e.g., forecasting revenues and credit needs, metering and billing, etc.).
6.18 The principle of simplicity also means that water prices should avoid significant fluctuations over time. This is because large price fluctuations are a source of uncertainty for consumers and create problems in cash flows and long-term investment planning in facilities with significant water usage. In water supply projects in Indonesia, it is usually the case that productive capacity is installed just to make up for current supply deficits or to meet future demand for only a few years. Investment costs are often lumpy, in relation to operating and maintenance costs. Due to this capital lumpiness, pricing on the basis of strict short-run marginal costs would result in sudden large price increases over time; as short-run marginal costs rise sharply when the capacity is reached and drop immediately after the capacity is expanded. To avoid this problem, marginal cost-based prices should utilize formulations oflong-run incremental costs averaged over the lifetime of the assets rather than short-run marginal costs.
C. REVIEW OF PDAM WATER TARIFFS
Water Tariffs Regulations
6.19 Prices charged by PDAMs for water services are set based on national guidelines, as currently defined in MoHA Decree No.690 06911992, which replaced the previous 1984 guidelines. Under the MoHA guidelines, PDAMs should pursue both commercial and social goals through tariff-setting and are required to recover O&M costs, depreciation and interest on loans.
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6.20 The tariff structure in general separates user groups into a number of categories: social (including public taps, schools, hospitals, etc.), non-commercial (including households and governments), small and large commercial, small and large industry, . · Under each category there may be some additional sub-categories, according to factors such as household income level, etc. This gives a total of some 10 to 15 user groups. Unlike the 1984. tariff structure which imposed strict progressivity factors (progressivity refers to the degree of tariff increases relative to consumption increases~ e.g., high · progressivity means a relatively large tariff increase for a relatively small consumption increase), the current Mo HA tariff guidelines indicate only that tariffs should be progressive with four consumption blocks. For kabupatens the four consumption blocks
3 3 3 ~ are 10 m or less, 10-20 m, 20-30 m, and 30 m"' or more. For kotamadyas they are 15 m3 odess, 15-30 m3
, 30-50 m3 and 50 m3 or more. The guidelines also indicate that, for a given quantity of water, commercial and industrial users should in general pay more than social and non-commercial users.
6.21 Tariff changes must be approved by lo~al governments, and the approval may also. need ratification by the next higher level ~uthority. At the discretion of the local governments, PDAMs may also be responsible for setting and collecting charges for private use of groundwater from deep wells.
6.22 On the use of groundwater, the current MoHA Ministerial Instruction 5/1995 specifies that any business, including reaj estate and industrial areas, should use PDAM water ~fit is available. In particular, it states that where PDAM water is available, groundwater licensing should be limited so as to avoid land subsidence and ground water salivation.
6.23 The current groundwater charges typically aim at non-domestic abstraction from deep wells. Abstraction is supposed to be registered with local governments, but there is no charge for the right to abstract deep groundwater. Similar to the piped water tariff structure, the groundwater tariff structure is divided into about 12 categories of user groups and five progressive water consumption blocks. Households that use shallow groundwater from their o'1VD wells are not charged. Households that depend on deep groundwater are exempted if their consumption is not excessive (e.g., less than 100 m3
per month).
Evaluation of Water Tariffs
6.24 Current PDAM tarifft in general do not meet the principles of economic efficiency, financial viability, social equity and administrative simplicity.
6.25 Economic Efficiencv: .The PDAM tariffs do not reflect the principle of economic efficiency: The relationship between PDAM costs and tariffs has been examined, and a detailed description of the data and estimation procedures is provided in the Annex (to be included). The costs examined include average and marginal full costs (including O&M, depreciation and 5%'retum on assets), MoHA defined cost (including O&M, depreciation
77
and 11.5% interest on debt), cash cost (including O&M and debt service on loans with 11.5% interest and 15 years maturity), and O&M cost. Chart 6.1 presents the averages of these costs and tariffs. Chart 6.2 illustrates how these costs and tariffs vary with the volume of water sold.
6.26 The vast majority of PDAMs (over 95%) are fairly small, selling less than 20 million m3 of water per year. Analyses show that these PDAMs exhibit significant economies of scale: average cost decreases as the volume of water sold increases. For the few large PDAMs, they experience dis-economies of scale; average cost increases as the volume of water sold increases. Lines A (average full cost) and C (marginal full cost) in Chart 6.2 illustrate how the average and marginal costs vary with the volume of water sold. The MoHA cost, represented by Line B, exhibits the same trend and lies between Lines A and C. Line D shows that the O&M costs enjoy economies of scale as well; larger volumes of water sold are associated with lower unit O&M costs. Line E indicates that the unit cash flow costs are almost constant, or increasing slightly, as the volume of water sold increases. Line F indicates that large PDAMs tend to charge relatively higher rates than small PDAMs.
6.27 Economic efficiency requires that the tariffs follow marginal costs. Yet as Chart 6.1 shows, average PDAM tariff is about Rp 484/m3
, 1 which is about 30% below the
marginal cost, estimated at Rp 709/m3. Chart 6.2 shows that the tariff, i.e., Line F, covers
only O&M costs for most of the PDAMs and cash flow costs for only large PDAMs. They do not at all cover the full cost or MoHA-defined costs. ·
6.28 Low tariffs encourage over-consumption of water: people use water to the point where its value to them is less than the cost of supplying the water. At the same time, those households who are not connected but who are willing to pay do not have access as most PDAMs are selling at capacity. The resulting welfare loss is estimated at a minimum ofRp 32 per m3 of water sold. This loss totals about Rp 34 billion per year for the total PDAM water sold (estimated at 1.1 billion m3 in 1994). In addition, the low tariff implies that those who are served by PDAMs are getting extra value at the expense of the PDAMs, the general public, and particularly those who are without· access to the PDAM water systems. The total expense is estimated at a minimum of Rp 323 per m3 of water sold, giving a total loss of revenues of about Rp 345 billion per year for the all PDAM water sold. This loss is about 40% of PDAMs total revenues.
1 The average tariff per m3 here is obtained through regression analysis, rather than si~ple or weighted
averaging: Regression analysis reflects the majority of tariffs per m3 and discounts the effect? of few extreme high or low tariffs per m3 (i.e., outliners). Neither simple nor weighted averaging can achieve this because they can not distinguish whether a tariff per m3 is too high or too low relative to the majority of the values. All the other average values in this Chapter are obtained through regression analyses.
;:.;-E Q. e:.
1,000 900,' 800 700 600 500 400 300 200 100 '
0
78
Chart 6.1-PDAMCosts and Tariffs (199~)
820
Average Marginal Full Cost Full Cost
MOHA
Cost Cash Cost
O&M
Cost
Note: Full Cost= O&M, depreciation and'5% return on assets MOHA Cost= O&M. depreciation and 11.5% interest on debt · .
Cash Cost=:= O&M and debt service ( 11.5% interest, 15 years)
Tariff
Source: PDAMs data set (with 185 PDAMs) and World Bank estimates
Chart 6.2- Costs and Tariffs of Water Supply
A c
B .B
c A
D F
~===-= E
·- D
10 100 Volume of Water Sold (million m3, log scale)
A: average full cost, B: average MOHA cost, c: marginal full cost D: :average O&M cost! E: average cash cost, F: average t;ariff
Source: PDAMs data set and World Bank estimates
1,000
6.29 The large variation of tariffs among user groups and the high progressivity with consumption volume is another aspect of efficiency distortion. While the unit economic costs of water supply are similar among all user groups and consilmption volumes, PDAMs ch.arge widely different tariffs. to different user groups and .different consumption . volumes.
79
6.30 Tariffs are based on the so-called "A" factor, which is the tariff rate for the first consumption block by household users. The typical ranges of PDAM tariffs for the various user groups are: Social: 80% of A; Non-commercial (including households and government): 100% to 300% of A; Small commercial: 200% to 500% of A; Large commercial: 400% to 800% of A; Small industry: 300% to 600% of A; Large industry: 500% to 1000%. (See Table 6.5 as an illustration) Chart 6.3 illustrates how the average tariffs vary with volume of water used for three user groups: households, large commercial and large industry.
6.31 Water tariffs paid by large water users such as large-scale industries and commercial business are usually much higher than the marginal costs. These high tariffs not only enable connected households to pay tariffs which are considerably below the marginal costs, but they also cause the industries and commercial operations to turn to alternative sources of supply such as deep groundwater. This reduces the PDAM revenue base from industry and business users. In areas where groundwater charges do not reflect the true economic costs of groundwater abstraction, this may lead to over-exploitation of deep groundwater, causing environmental damage such as land subsidence, salination and lowering of shallow groundwater tables. In addition, the high tariffs on industry and business users also increase their production costs, which are eventually passed on to consumers.
Chart 6.3 - Examples of Average Water Tariffs
8,000
7,000
C"l 5,000
-[ 4,000 a: 3,000
2,000
1,000
0 0 10 20 30 40 50 60 70
Consumption of Water (m3/month)
A: Large industry, B: Large convrercial, C: Households
Source: Tariff schedule of PDAM Pontianak, West Kalimantan.
6.32 Financial Viability: PDAM tariffs do not cover full financial costs (O&M costs, depreciation and a return on assets), neither do they cover cash flow costs (O&M costs and debt services). They also fail to meet the MoHA required costs (O&M costs, depreciation and interest on debt). This is illustrated in Charts 6.1 and 6.2.
80
6.33 The average tariff of Rp 484/m3 is about 40% below the'full financial cost, estimated at Rp 820/m3
. It barely meets the cash flow cost ofRp 509/m3 and falls about 36% short of the MoHA required costs ofRp 763/m3
. This is due to the low tariffs on households and the small revenue base from large scale industries and commercial operations. ·It is also attributed to significant operating deficiencies such as the high rate ofUfW, typically around 40%, of which nearly 70% is considered to be due to physical loss.
6.34 The poor financial performance makes PDAMs financially dependent on · government subsidies and reduces their capacity to fund necessary capacity expansion
investments. Moreover, if PDAMs are reasonably assured that their financial obligations will be met on a basis not related to performance (or even worse, negatively rel0;ted to performance), through government provided equity, etc., they will have l1Jl
strong incentive to improve their operating eQ1ciency and extend their service.
6.35 Social Equity: The water tariffs also have a negative effect on the intended goal of social equity. :Jt is primarily higher income households who have PDAM connections and benefit from subsidized water. The lower income households, who do not have PDAM connections, have to pay high prices for alternative sources of water supplies, such as bottled water from vendors, for their drinking needs. Table 6.1 shows that the·. average per capita expenditure by a PDAM customer is Rp 79,000 per month, while it is Rp 50,000 per month for a non-PDAM customer, only 64% of the former. Table 6.1.also shows that the expenditure on PDAM water by those with PDAM connections is mostly below 3% of per capita total expenditure, indicating that the water is very affordable to them.
6.36 In addition, the use of the minimum consumption of 10 m3 (or 15 m3) and the
large progressivity of water tariffs may also have adverse effects on the poor. As shown in Chart 6.3, those households whose consumption is within the first consumption block are paying high average rates because of the required minimum consumption in the tariff structure. Many of these households are poor. It is also often the case that many poor households living in densely populated urban areas either share water connections or purchase water from commercial vendors. Consequently, the progressive tariffs actually hurt them the most because they have to pay a high price for the large amount of shared consumption of water.
6.37 Simplicity: The tariff structure is also complex, with differentiated rates among numerous consumer categories and progressivity consumption blocks. The tariff schedule of PDAM Pontianak, West Kalimantan, as shown in Table 6.5, has over 60 different tariffs. This structure complicates the tasks of billing and increases administrative costs. It creates opportunities for corruption. Simplification of the tariff structure is necessary considering the weak managerial and technical capability of many PDAMs.
81
Table 6.1-Average Per Capita Monthly Expenditure, 1995
Province PDAM Non-PD AM Non-PD AM/ PDAM Customers
Customers Customers PDAM Water Water
Total Total Share Expenditure Expenditure
Expenditure Expenditure Share
(Rp 000) (Rp 000) (%) (Rp 000) (%)
·Aceh 91 46 51% 2.7 2.9%
Sumatera Utara 74 47 64% 1.9 2.5%
Sumatera Barat 85 55 65% 1.6 1.9%
Riau 117 63 54% 3.7 3.1%
Jam bi 74 50 68% 1.5 2.1%
Sumatera Selatan 73 44 60% 1.7 2.4%
Bengkulu 69 48 70% 1.3 1.9%
Lampung 69 42 61% 1.6 2.3%
DKI Jakarta 120 110 92% 7.6 6.4%
.TawaBarat 94 59 63% 2.0 2.2%
Jawa Tengah 71 40 56% 1.7 2.3%
Yogyakarta 96 73 76% 1.2 1.3%
Jawa Timur 94 42 45% 2.6 2.8%
Bali 74 63 85% 2.5 3.4%
Nusa Tenggara Barat 49 39 80% 1.0 2.1%
Nusa Tenggara Timur 60 33 55% 1.9 3.1%
TimorTimur 49 38 78%
Kalimantan Barat · 86 53 62% 1.7 2.0%
Kalimantan Tengah 80 58 73% 1.5 1.9%
Kalirnanan Selatan 83 46 55% 5.3 6.4%
Kalimantan Timur 98 62 63% 5.3 5.5%
Sulawesi Utara 70 43 61% 1.3 1.8%
Sulawesi Tengah 55 45 82% 0.8 l.4%
Sulawesi Selatan 66 41 62% 1.6 2.4%
Sulawesi Tenggara 63 37 59%
Maluku 70 43 61% 1.6 2.4%
Irian Jaya 103 42 41% 1.8 1.7%
Simple Average 79 50 64% 2.3 2.9%
Source: SUSENAS 1995 and estimates from PDAM data
82
Household Connection Fees
6.38 PDAMs charge a connection fee to those who wish to connect to the piped water system. The charge is supposedly cost-based, but this is difficult to confirm. The fees paid can incluqe unofficial items which increaso the cost to customers significantly. Demand surveys in Indonesia have shown that the connection.fees represent a significant deterrent to connection demand. In one survey of 45 towns in East Java, 28% of those surveyed (who were not connected to PDAM systems) said they would want a . connection~ Among them, all would be willing to pay Rp 100,000 for it. Only 36% would be willing to pay Rp 240,000. The propmtion fell to 7% when confronted with Rp 300,000 (see Chart 6.4). In a similar survey of 43 towns in Bali, 48% of those nonconnected said they would like a connection. Among them, only 28% would pay a fee of Rp 200,000.
6.39 The way the PDAMs haridle their connection fees is also not according to proper financial standards. The connection fees are entered on the revenue side in the income statement while the costS of connections are entered in the balance sheet as investments. The effect of this practice is to increase the PDAMs revenues and profits during the expansion period. This increases the corporation tax liability but also increases employee and local government profit shares .. But this practice delays necessary tariff increases. When the expansion period ends and connectionfees are no longer available, the PDAMs experience a large revenue shortfall and usually face great difficulties serving the debt. They would have to either raise tariffs significantly or rely on governments for financial assistance. For example, over 20% of the revenues for the eight PDAMs in Bali came from connection fees in each of the past three years. The expansion is now ending and significant reveriue drops· are expected. The PDAMs in East Java face a similar situation.
Chart 6.4 - Connection Fees and Demand
g · 100%
:z 90% Ill 2 80%" 8 ,. 70%
60% Ill
g> 50%. ; .c
3'.: 40%
30%. 20% ·-
0 0%.
100%
100 240 300
Connection Fees (RP.000)
Source: Demand survey of East Java·
83
D. RECOMMENDATIONS FOR WATER SUPPLY PRICING
6.40 The above review shows that the current PDAM water tariffs are not economically efficient in allocating demand and resources; do not raise enough revenues for the PDAMs to be financially independent; tend to benefit high-income rather than low-income households; and are complex and difficult to administer effectively. A simple tariff system is proposed below. It attempts to address these problems and follow the principles of economic efficiency, financial viability, social equity and administrative simplicity.
Water Tariffs
6.41 The major elements of the proposed tariff system are as follows:
a) a two-part tariff structure,.consisting of a small fixed fee for covering administration and meter maintenance costs and a tariff rate per m3 of water consumed; .
b) only two consumption blocks, the first consumption block is 10 m3 per month; c) the tariff rate consists of a lifeline rate for the first consumption block and a .
base rate thereafter;· d) no minimum consumption amount; e) the lifeline rate is set such that the water consumption within the first block
would not cost more than 4% to 5% of the total expenditure of an average low-income household;
f) the base rate is set such that the overall average tariff represents a balance between the economically efficient marginal cost and financially viable ' average cost; and
g) relatively lower tariffs can be charged for public taps and special groups such as schools and hospitals, and relatively higher tariffs can be charged for business and industry users.
6.42 The reduction in the number of user groups and extent of t~iff progressivity represents an improvement in economic efficiency as well as in siinpliCity. The lifeline rate for the first consumption block and for public taps and social groups ensures that low-income users can afford a sufficient amount of water for their basic needs. The relatively higher rates for larger consumption and for business and industry groups balance the needs for both achieving economic efficiency and financial viability. The following discusses each of these elements in more detail.
6.43 Persons per Connection: To determine an appropriate-lifeline rate and the volume of the first consumption block, the number of persons using a connection must be known. Note that this is slightly different from the number of persons in a household as some households share a connection. The Ministry of Public Works uses seven persons per connection. A recent survey of 43 towns in Bali shows the average household size ranges from 3.9 to 6.4 and the average nillnber of persons per connection ranges from 5.3
84
to 9.9. For _seven people per one connection, 10 m3.per month (30 days) would provide 48 liters of water per person per day. The amount of water considered essential for· human needs is typically estimated at 25 to 50 liters per capita per day; Available data also shows that between 20% to 30% of the households who are connected to the PDAM systems use less than 10 m3 of water per month.
6.44 Lifeline Rate: The lifeline rate can be set so that consumption within the first block would not cost more than 4% to 5% of the total expeµditure of an average lowincome household. Table 1 shows that the average expenditures of those non-connected households is about Rp 50,000 per capita per month (in 1995 prices). The 1990 regional· poverty lines estimated by the World Bank range from Rp 15,000 to Rp 20,000 per month, or about Rp 22,000 to Rp 29,000 per month in 1995 prices. In addition, the 1995 SUSENAS data show that except NTT, Timor Timur, Sulawesi Tenggara and Irian Jaya, the other provinces all have less than 3% of the population with expenditures below Rp · 15,000 per month.
6.45 Then, for seven persons per connection and a monthly expenditure ofRp 15,000 per person (i.e., total monthly expenditure ofRp 105,000), a lifeline rate ofRp 400/rn.3
·
would supply the first 10 m3 of water at a cost ofRp 4,000, whiCh is 3.8% of the total monthly expenditures;.a rate ofRp.500/m3 would mean a 4.8% of the total expenditures.
6.46 Av~rage Full Cost: The higher rate for consumption above 10 m3 can be set so that the overall average tariff is a compromise between marginal full (economic) cost -to achieve economic efficiency, and average full (financial) cost-· to ensure financial viability. The average financial full cost is obtained by dividing the total of O&M costs, depreciation, and an acceptable return on assets by the total volume of water sold. Depredation charge provides for the recovery of the i{iility's capital investment over the useful life of the assets. The PDAMs now follow th~ Tax Law of the Ministry of Finance which requires the' double declining balance method. This law replaced the previous straight line method recommended by the Ministry of Public Works. The return on assets. is used to cover the interest cost of debt capital as well as to provide a fair rate of return for equity capital. The rate.of return on equity should technically be commensurate with
. the return from other enterprises having similar risks. However, considering the weak :financial position of the PDAMs and large investment needs, returns on equity, if they ever exist, should be retained by PDAMs rather than distributed to local governments. They should be used to provide. capacity expansion, lower debt :financing requirements, repair environmental damages, and subsidize the poor. The assets, on which the return is. based, is normally called a rate base. It primarily consists of PDAM plant and property useful in serving the public. Some allowance for materials and supplies, working capital, and construction works in progress. can also be included in the rate base. On the other hand, contributions towards construction and customer advances for construction are generally deducted from the .rate base ..
85
6.47 Marginal Full Cost: Several fori:nulations exist to determine marginal full economic costs but the recommended one is the long-run average incremental cost (AIC) formulation. Technically, AIC can be defined as:
AIC =
T
I (LiCt +It) I (1 + r) 1•1
t=l T
LLiQt I (1 + r)t-I t=l
LiCt is the incremental O&M costs in year t as compared to the base year O; 11 is the capital investment in year t; Li Qt is the incremental water sold in year fas compared to the base year O; r is the discount rate; and T is the number of years for which investments are planned and water demand and supply is forecast, usually 10 to 15 years. Residual values of investments at the end of the estimation period should be taken into account. The AIC formulation appears complicated but, as illustrated in Table 6.7 of Section E, the process of using it is actually quite straightforward.
6.48 Wastewater and Other External Costs: Following the economic efficiency principle discussed in Section B, AIC, as an economic cost, should also include costs of disposing and treating wastewater, or costs of cleaning up external environmental damage
· created by a lack of adequate wastewater treatment. In practice this is often difficult due to a lack of a reasonable measure of wastewater costs. Moreover, considering the fact that uses of alternative water sources, such as groundwater, all incur wastewater costs, most of which are not charged at all, it may not be socially efficient to add wastewater costs to marginal cost pricing without first charging for the uses o:( alternative water sources. This is because it may simply drive more people to alternative water sources and cause higher total costs.
6.49 Base Tariff: As discussed in Section c; economies of scale exist for the majority of PDAMs; as these small PDAMs increase their water sold, their unit costs decrease. For these PDAMs, the marginal cost, or AIC, is lower than the average cost. As shown in Chart 6.2, the marginal cost Line C lies below the average cost Line A for PDAMs with less than 2 million m3 of water sold. On average, the marginal cost is about 13% below the average cost. For the few large PDAMs, dis-economies of scale prevail; larger PDAMs have higher average costs than smaller ones. In this case, the marginal cost is higher than the average cost. However, regardless of economies or diseconomies of scale, the MoHA defined cost, i.e., O&M costs plus depreciation and interest on debt, appears to fall between the average and marginal costs; that is, Line B in Chart 6.2 lies between Lines A and C. Consequently, in practical rate design, the MoHA cost can be used as a very useful reference when a tariff has to be set between the average full (financial) cost and marginal full (economic) cost. A case study is presented in Section E where the procedure of determining lifeline and the higher rates is illustrated.
86
Connection Fees
6.50 To make connection fees iess of a deterrent to demand, a simple approach is to make the connection fees payable in multiple installments over an extended period of time. This has been adopted by PDAMs with varying degrees.
6.51 As an example, Table 6.2 calculates the monthly fees for a connection fee of Rp 250,000 .. Depending on the interest charges and the repayment period, the monthly charges range from Rp 5,600 to Rp 8,700. For aii average-income household with seven people, this monthly charge represent less than 2.5% of their total expenditure (see Table 6.1 ). But for the very low-income families, this may still be a significant amount and may raise their water expenditure above 8% of the total expenditure.
Table 6.2 -. Connection Fees in Multiple Installments :
6.52 To further reduce the impact of the connection fees, another approach is to make the connection fees part of the tariffs. In other words, connections are providedfree of charges to new customers and connection costs are recovered from tariff revenues. The consequent increases on tariffs are very small because the tariff revenues are collected from both existing and riew customers, i.e., the existing customers share part of the connection costs of the new customers. ·
6.53 For example, consider a PDAM with 10,000 connections, with an average tariff at Rp 400 per m3 of water sold, and average water sold at 12 m3 per month per connection. If the PDAM increases its connections by 10% to 11,000, the total monthly tariff revenues at Rp 400/m3 would be Rp 52.8 million. If these 1,000 new connections are made at a cost ofRp 250,000 per connection, the total ~onnection costs would be Rp 250 million. At an annual.interest of 12%, the equivalent monthly costs would be Rp 2.5 million. Collecting this Rp 2.5 million through tariff revenues means that the tariff should be increased from .the current Rp 400/m3 to Rp 419/m3
, a 4.7% in.crease.
6.54 'While under this approach the existing custome~ share part of the connection · costs of the new customers, the required tariff increases are very small and the existing customers are generally wealthier than the new ones. To avoid inactive connections, however, the new customers should be asked to rµake some advance payment on their water bills, say between six months to a year.
87
Implementation
6.55 Before fully adopting the proposed tariff structure, the water tariff-setting may go through a transitional period (e.g., one to three years). During this period, the number of user groups and the degree of progressivity can be reduced to some intermediate levels.
6.56 . During the transition, PDAMs should improve their monitoring and reporting systems so that more timely and reliable operational, financial and general management information is available for evaluating performance, reducing costs, setting tariffs, and
. planning investments.
6.57 Efforts should also be made to improve operational efficiency; such as reducing Uf\\T and improving labor productivity. Savings can be passed on to consumers and the
. extent of tariff increases would be reduced, and part of it can also contribute to efficiency bonuses and to capital expansions.
6.58 Consideration may also be given to establishing a water supply regulatory agency at the provincial level to manage the tariff setting process. It should be a small, high level organization drawing on expertise from within existing agencies. Its main responsibilities should include overseeing pricing principles and price adjustments, reviewing compliance by government agencies and ent~rprises (e.g., PDAMs) with their contractual obligations under commercial contracts, coordinating with line agencies of the government on related water sector issues such as catchment area management, groundwater regulation, tariffs and collection of accounts, water quality rights allocation, etc.
6.59 ·Currently PDAM tariffs are increased about every three years. Consideration should be given to a mechanism where tariff reviews between PDAMs and the Board of Supervisors (or the regulatory agency) take place only every four to five years. Between the reviews, tariffs should be annually, and automatically revised on the basis of an agreed cost index formula. This process would provide sufficient incentives to PDAMs to improve their productivity, and would avoid erosion of PDAM revenues and subsequent lumpy tariff increases. Guidelines should be issued by MoHA on the basis of tariff reviews, information to be prepared by PDAMs, and the cost index formulation.
E. CASE STUDY -PDAM PONTIANAK
6.60 PDAM Pontianak., West Kalimantan, is used here as an example to illustrate the . process of establishing a new tariff structure and to examine its impact on water users and thePDAM.
6.61 As of September 1996, the PDAM had a total of29,400 connections, eovering nearly 40% of the city's population (population of 460,000 in 1995). It obtains raw water from the Kapuas river which can be of unacceptable salinity for up to two months per year. It also intakes from the same river 28 km upstream where the water is usually of
88
good quality. In 1995, water froduction was about 14.6 million m3, and the amount of
water sold was 6.5 million m . . .. , · · ·
6.62 The PDAM is currently implementing an investment program under the Kalimantan Urban Development Project (KUDP, Ln. 3854-IND). The program consists of: (a) reducing UfVI from the current level of 53% to 28% by the year 2000; (b) extending the production capacity of 300 l/s by constructing a water treatment plant · (WTP) IV in Imam Bonjol; (c) extending the distribution network and facilities; and (d) increasing connections by 25,515. The total capital expenditure of this program is Rp 35.6 billion. In addition, the PDAM is also carrying out a routine capital investment program for the period 1996-2000. This includes rehabilitation of distribution not covered by KUDP and upgrading WTP I, II, and III. The total cost is Rp 475. million.
6.63 Following the process described in Section D, Table 6.3 estimates the average (economic) incremental cost (AIC); average Q&M cost; average O&M plus depreciation and interest (MoHA defined cost); average O&M plus interest and debt repayment (cash flow cost); and average O&M plus depreciation and a 10% return on fixed assets (average financial full cost).
6.64 Table 6.3 shows that the average incremental cost is estimated at Rp 87 5 per m3 .of water sold, average O&M at Rp 555/m3
, average MoHA cost at Rp 956/m3, cash flow
cost at Rp 796/m3, and average financial full cost at Rp 1,050/m3
•
6.65 To examine how the PDAM tariffs match the costs, Table 6.4 shows the tariff revenues, volume of water sold, number of connections, average tariffs and average consumption for 1995. Houseqolds account for about 86% of the connections but only contribute about 50% of the revenues. On the other hand, business and industry users account for only 11 % of the connections but provide about 44% of the revenues .. Comparing the tariffs (in effect since May 1993) with the various average costs in Table 6.3, it is clear that the average tariff paid by the households, at Rp 540/m3
, does not even cover the average O&M cost. But the average tariff of the business and industry are about twice the average ·run :financial cost. The overall average tariff is Rp 798/m3
, about 9% below the average incremental (economic) cost and 24% below the average full (financial) cost.
6.66 In December 1995, the PDAM increased the tariffs by about 25%. Table 6.5 shows the new tariff schedule. The PDAM provided the Bank with a full set of the customer database for the month of October 1996. Table 6.6 presents the consumption and total and average tariffs for that month.
89
Table 6.3 - PDAM Pontianak: Calculation of Average Incremental Costs and Other Costs
III. Commercial a. Small 30 1200 1600 2000 b. Large 30 1600 2400 3300
IV. lndustry a.Small 30 1200 1600 2000 b. Large 30 1600 2400 3300
V. Special a. Harbor. 50 3500 4000
b. Tank Truck ·no limit 1600- 1600 1600 1600
Note: Household categories Illa to Illd refer to households in different areas (non-commercial and commercial) and different types of houses (permanent, semi-permanent, and simple).
91
6.67 While the new tariff schedule is much more complicated than the previous one, Table 6.6 does show that the tariff change raised the overall tariffs closer to the cost recovery level. But it also reveals the distortion of the very low average tariffs for the households (e.g., groups Ila and Ilb) and the very high average tariffs.for business and industry users (groups III and IV). In addition, average tariffs for those connections with monthly consumption below 10 m3 are extremely high, ranging from Rp 1,500/m3 to Rp 12,000/m3
. This is caused by the minimum consumption requirement (15 m3 or 30 m3)
in the tariff schedule.
6.68 Followi11g the recommendation in Section D, and considering the following. elements: (a) the incremental and average costs in Table 6.3; (b) the water consumption patterns of the user groups; and (c) the expenditure levels of Pontianak population in Table 6.7, a new tariff schedule is constructed and presented in Table 6.12.
Table 6.·6-PDAM Pontianak Water Tariff Revenues and Consumption/or October 1996,
b. Embassy ~nd no limit 1000 1000 Government. III. Commercial and Industry no limit 1000 1000
92 .
6.69 Table 6.9 presents the tariff revenues and consumption under the proposed tariff schedule. In estimating the consumption under the proposed tariffs, price elasticity estimates are used; -0.3 .for social groups, households and embassies and governments, and -0.6 for business and industry users. In addition, no consumption change is assumed for those connections whose consumption amounts are IO m3 or less, even though their average tariffs are reduced significantly under the proposed tariff schedule. This is because the consumption amounts of these connections are not constrained by the current tariffs (at least in the short run) due to the minimum consumption requirement.
6.70 The current fixed charges include a central government stamp charge at Rp 1,000, administration charges ranging from Rp 200 to Rp 2,000 per conliection, and meter maintenance fees ranging from Rp 1,000 to Rp 30,000 per meter. These charges don't follow the actual fixed costs incurred. For the current case study, the fixed charge can be set as. follows: From the estimated AIC (Rp 875/m3) and average full financial cost (Rp 1,050/m3) in Table 6.3, an estimated fixed cost can be obtained as Rp 175 (=1,050-875) per m3 ·of water sold. Then using the figures of average monthly consumption per connection in Table 6.4, estimates of fixed monthly charges can be obtained, e.g., Rp 3,150 for households; Rp 5,600 for business and industries, Rp 19,800 for embassy and government offices, etc. For simplicity, this case study assumes fixed charges ofRp 1,500 for public taps, hospitals and schools; Rp 3,500 for households; and Rp 6,000 for embassy and government offices, business and industries.
6.71 A comparison of Table 6.9 with Table 6.3 shows that the average tariffs paid by all groups, in particular, the households and business and industry users, are .much . closer to the average and marginal costs than he/ ore, there/ ore reducing price distortions and increasing economic efficiency. The tariffs on business and industry users are reduced, particularly for the large group of business users, making the charges more in line with the costs and encouraging more efficient choices of sources of water, types of technologies, etc. While the average tariffs are increas~d for households, many elements of the proposed tariff schedule, including the lifeline rate, the elimination of minimum consumption requirement, and the low rates for public taps and other social groups, significantly lower the average tariffs for consumption below 10 m3 and ensure that the water is affordable by the poor and low-income social groups.
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Table 6.9 -PDAM Pontianak: Water Tariff Revenues and Consumption/or October 1996
6.72 To further examine the financial and operational effects of the proposed tariffs on the PDAM Pontianak, the proposed tariff schedule is input into a financial model (FINPRO) for the Pontianak PDAM. The model incorporates the PDAM's investment program which would increase connections by 25,515 between 1996 and 2000 and reduce UfW from 45% in 1996 to 23% in 2005. Water consumption is estimated, taking into 'account the effects of changes in tariffs and income, and increased capacity. The volume of the water sold and the operating and financial costs shown in Table 6.3 are in fact some of the estimated results. Note that the operational and financial costs depend on the volume of water sold, which in turn depend on the tariffs. The tariffs, however, are set based on the operational and financial costs. Therefore, the determination of tariffs, costs and volume of water sold is an iterative process, requiring several rounds of calculation. The analyses by the financial model indicate that the proposed tariff schedule yields an acceptable operational and financial outcome.
6.73 The proposed tariff schedule is just one of many alternatives that can better meet ·the objectives of economic efficiency, financial viability, social equity and administrative simplicity than the existing tariff schedule. The purpose here is just to illustrate that it is quite feasible to shift from the current tariff schedule to a more efficient, sustainable and equitable, and much simpler tariff schedule.
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7. FINANCING WATER SUPPLY DEVELOPMENT
'A. , INTRODUCTION .
7.1 This chapter reviews the financing of PDAMs in recent years, and that foreseen under Repelita VI, and estimates the financing needs of the municipal water sector during the Repelitas VII and VIII, under alternative scenarios of service coverage, efficiency and cost of funds, and
·taking into account expected urbanization trends. Then the chapter reviews possible funding sources and their arrangements, while taking into account also the different levels of financial viability among PDAMs, parily·depending on their size, and by region. Finally, the chapter also identifies some possible improvements in financing arrangements.
B. CURRENT ARRANGEMENTS FOR FINANCING WATER SUPPLY INVESTMENTS '',
7.2 Currently the sources of finance for the PDAMs are:
(a) own resources, generated out of cash surpluses; . (b) contributions by their local governments in the forin of equity; (c) domestic commercial loans, and mainly, ( d) grants and loans from Central Government.
7.3 Own resources andloca/ equity . . Many PDAMs finance small scale investments themselves, but own resources do not constitute a significant source of investment funds. Municipalities contributed equity at the time of establishment of the PDAMs and continue to do so. In return, municipalities seek dividend payments for their shares, sometimes even when there is no profit, in which case there is a diminution of the PDAM reserves and self-generated funds. Overall, therefore, self-generated soiirces of finance for investment are strictly limited. Likewise, borrowing from domestic commercial banks is marginal and limited to bridge financing or working capital financing.
7.4·. . Central Government grants. PDAMs' investment needs are included in the five-year urban investment plans (PJMs) prepared by municipalities. Central Government has so far provided specific grants, but wishes to decrease these, .while increasing block grants to local · governments through the INPRES system, some of which would be passed on by LGs to the PDAMs. This mechanism ensures that some difficult decisions on grant allocations to the PDAMs are taken locally, where the impacts are felt.
7 .5 Central Government loans. Most of the lending to PDAMs has been ~hrough two · Government mechanisms: (a) the Subsidiary Loan Agreements (SLAs ), which normally involve the onlending of funds provided by international development agencies such as the World Bank and ADB; and (b) the Regional Development Account (RDA), which has been financed by the Ministry of Finance (MoF) through annual budget appropriations. There is a recognized need to 'improve these loan mechanisms. They have certain similar limitations. Operations are bureaucratic, with slow and cumbersome procedures. They are inadequate in size to meet the
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investment requirements of the sector and are susceptible to "shortages" of funds arising from the vagaries of the budgetary system (in the case of the RDA) and project funds availability from agencies (SLA). For instance, long and multiple approval processes which result in significant delays in disbursement have forced some PDAMs to borrow short term funds from commercial banks while the annual installment of the preapproved loan is being re-approved. Additionally, the RDA (in particular) has tended to be operated without strict adherence to financial lending criteria.
Subsidiary Loan Agreements - SLAs
7.6 SLAs have been used to finance large investments inthe municipal water sector under Integrated Urban Infrastructure Development Projects (IUIDP). The SLA system has several disadvantages. The preparation time is considerable before a SLA loan can be made available to a PDAM because of the need to complete the preparation of a comprehensive program, normally covering all sectors in various cities (the PJM) ifthe SLA is under an IUIDP project. Coverage is selective since funds are made available only to those specific cities and towns and their PDAMs that are included in the IUIDP project. SLA interest rates (currently 11.5%) are below the costs of capital as reflected in domestic commercial rates (about 18-20%). However 11.5% is well above the international rate. The lower SLA rate discourages PDAMs from borrowing on commercial terms; there are failures in the domestic banking system but also, lending to PDAMs is perceived as risky and carries higher premiums.
7. 7 Experience indicates that the operation of the SLA system has resulted in eligible PDAMs being encouraged to borrow to the limit of their short-term cash flow position, as government sought to reduce financing with grants. While typical SLAs provide a grace period during construction for the principal repayment, they often also accepted capitalization of interest payments during the grace period that could extend beyond into the construction period. At the end of the grace period there is then a need for a significant tariff increase to cover the debt service which, if not implemented, results in defaulting on the SLA. PDAMs' potential reserves, as· could be built up during the grace period, are normally used by the municipality. Thus, if a PDAM cannot pay even interest during the loan grace period, it will hardly be able to pay interest and principal afterwards. Moreover, SLA repayments have been scheduled with a·fixed principal installment and therefore a declining interest charge on the outstanding loan balance. This fixed principal repayment method strains the borrower's cash flows in the early years following the grace period and further increases defaults. The SLAs should be sized correctly according to creditworthiness and then he repaid through annuities to ease the impact on PDAM cash flows, and interest should not he capitalized during the grace period.
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Regional Development Account - RDA
7 .8 The current RDA is a budget line financed by MoF for lending for urban investments, including water supply (see Box 7.1). The RDA has been short of funds, but for those it had available disbursement performance has been go()d: Collec.tions performance is a little over 80% of dues, which is higher than might be expected given that the RDA loans are unsecured. An assessment of the RDA carried out in 1994 noted problems with operating efficiency, inadequate capitalization and delays. Delays were due to the RDA's tie-in to the annual Government budget process and, often, lack of funds to lend. Deficiencies were noted with the BPD intermediaries for the RDA arising from their lack of an adequate capital base, the shortage of qualified staff and sometimes, a legacy of bad debts.
Box.7.1 "".Background Information on RDA
RDA was established in Bank Indonesia (BI) by the Ministry ofFinance (MoF) in I 989 to provide credit financing to loca.l governments (LG), at less concessionary rates than were available hitherto (INPRES pasar at 0%; RDI for public enterprises at 9%; IPEDA for civil works at 0%). RDA lending criteria have been variable; but the . interestrate is normally 11.5% to be compared wii:h SBI's 14.75%. The national budget has provided funding of a total ofRp340 billion, currently some Rp74 billion per year. USAID has contributed US$50 million capital through the Housing G.uarantee Loan Program as well as techn!cal assistance; ADB has provided assistance also. Repayments into the RDA were Rp70 billion to 1996.
The Government intends that LGs increase self financing and borrowing (Urban Policy Action Plan, 31 Jan. 1996) .. LGs borrowing increased to Rp 400 billion in 1994/95; it was still less than 5% of their expenditures but was often constrained for lack of available RDA funds to borrow. Local taxes and user fees have increased some 13% p.a. between 1991 and 1996, mainly from improved administration rather than increased rates, and can · support increased borrowing.
156 loans have been issued since 1990 and 22 are in process. As of January· 1996, RDA has approved 306 · loans for Rp869 billion. More. than 80% of the approved amount has been for 114 water enterprises. Borrowers are concentrated in East Java ( 62 borrowers and 20% value), West Java ( 16 borrowers and 12% value); followed by North Sumatra, Central Java and North Sulawesi. The largest borrower is DKI Jakarta. Repayments have been over 80%, though there are no enforcement mechanism for timely repayment.
RDA normally finances projects costing up to $1.2 million equivalent although much larger projects have received funds. It finances up to 7 5% of the cost of a project, normally for a maximum of 20 years including 5 of grace for principal. The projects should be social infrastructure or services, financially sustainable through user charges or general revenues.
Local governments conduct their studies and request credit. The proposals (prepared following an unpublished manual prepared by the USAID Urban Finance Project) should include: (a) demand survey, including affordability, willingness to pay; (b) an outline of institutional and financial capabilities of the borrower. The borrowers have to contribute at least 25%; their debt service coverage should not be less than 1.5 for local agencies ~nd not less than 1.3 for PDAMs; (c) a socio-economic assessment including economic analysis for non-revenue generating components, including ERRs; (d) a technical evaluation, including cost-effectiveness; (e) an environmental assessment; and (f) a financial assessment; FRR should be no less than the cost of capital; tariff analyses. The RDA rules do not permit lending to projects receiving external loans. However, lending experience suggests that these crit.eria are not always strictly adhered to.
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Projects are reviewed by a Project Committee including representatives of PPP, BAPPENAS, provincial or central technical agencies; the Minister of Finance has to approve. After approval, projects are included in the next year budget. ·
The MoF's Subdirectorate ofOnlending Management has 15 staff, of which 3 with master degrees; none have technical background and they rely on engineering consultants hired by the borrowers. BPDs (Bank Penbangunan Daerah) transfer the RDA funds.
Source: RTI report on the RDA; April 1996 and data from MoF.
7.9 One of the characteristics of RDA lending has been the wide variation in terms given to borrowers, which has exceeded what might have been.e~pected for their different circumstances. There appears to have been no clear lending policy or approach. In December 1996, Bappenas issued a decree outlining the specific method ofreview ofloan performance, implying that this type of economic and/ or social monitoring has not been systematic to date.
7 .10 The 1994 RDA review, and further proposals that have been put forward since then, have resulted in a decision by the MoF as a "first stage" towards securing full access to the capital markets for its borrowers to convert the RDA into an autonomous financial entity. A draft Decree has been prepared, which should be issued in 1997, which will provide the details of the new scheme. The proposals are outlined in Section D below.
C. RECENT PDAM INVESTMENT LEVELS AND SOURCES
Repelita V and VI ·
7 .11 Under Repelita V, about Rp2 trillion were invested in PDAMs. Some 50% of this investment was financed through borrowing by the PDAMs, and most of the balance through substantial contributions (grants) from the Central Govemnient. The investment was much less than planned (Table 7 .1 ) ..
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Table 7;] - Repelita V and VI Investment in Urban Water Supply (Rp billion) ·
Planned·· O&M Expenditure (1) included in (1)
Repelita V ,. Investment 3,952 1,311 of which loans 2,387
Financing Source Central Government 2,984 392 Provincial' Governments 50 Local Governments 19 PDAMs (Internal Cash) 900
Total Urban Sector 9,277 . 3,130 of which.Central Gov.' 7,048' 990
Repelita VI Investment · 3,007 38 Total Urban Sector 8,106 100
Note: (e)- Estimate
Actual Expenditure
1,805 1,900 (e)
75
4,159 2,036
7,000 (e)
7.12 · Funding Sources. Actual funding sources for PDAM projects in 1994/5 and 1995/6, and forecast for 1996/7 till 1998/9, according to data from DG Cipta Karya, show the importance of SLA loans (55%) and of grants (27%), and the relatively lesser contribution of self financing (11%) and the RDA (6%). The total funding adds up to Rpl,776 billion, which is substantially less than planned for Repelita VI, apparently repeating shortfalls under previous Repelitas (but more projects may still be included). Large and medium PDAMs continue to account for about half the total funds, but relatively more from SLAs and self financing and less from grants than small PDAMs, as could be expected. The grants were 77% from central government (DIP, APBN/non-RPLN), 10% from APBNIRPLN, 11 % from APBD and only 2% from INPRES and other sources. Over time, self financing is expected to increase; little resort to RDA is shown for the future (Table 7.2 and Chart 7.1)
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Table 7.2 - Funding Structure of Urban Water Supply Sector Projects by PDAM Size (199411995 -199811999)
(Rp billion) PDAM Grand Total PDAM
SLA Large 750 59 533
8% 71% Medium 132 26 75
20% 57% Small 692 102 305
15% 44% Very Small 52 4 7
8% 14% Smallest 151 12 54
8% 36% Total 1776 202 974
11% 55% Source: DG C1pta Karya. Columns may not add exactly due to rounding. " Excludes APBN/Non-RPLN
Loans RDA Grants 11
62 95 8% 13% 3 27
2% 21% 34 251 5% 36% - 40
0% 18% 15 70
10% 47% 11 Ll 483 6% 27%
Chart 7.1- Funding Structure of Urban Water Supply Sector Projects by Funding Sources by Year and by Grants by Type
50% 1-
25%1
I 0% -~
,. CD
Funding Sources by Year
ill ... ~ .,
111 FOAM Olm Funds ., ., ,. ~ > ~ ,.~ ,. ~
co~ m; m; co<;; ~ ;l
Grants by Type GRANT TYPES
EIOIP
•APBN /NON-RPLN
ll!I A F'BO TK I& TK II
G A PBN /RPLN
DIN PRES, OTHER
7 .13 SLAs. From MoF data, during the period January I, 1990 to March 31, 1997, 78 SLA loans equivalent to Rpl,404 billion were granted to PDAMs. Out of this, Rp681 billion have been withdrawn.
7.14 By value, 43% of all SLA loans during 1990-97 given to 9 PDAMs were funded by IBRD; 22% for 3 PDAMs by OECF; 21% for 58 PDAMs by ADB, and 14% for 8 PDAMs by the other funding agencies. Most of the ADB loans funded water supply system projects for capitals of sub-districts (IKK.), which explains their many small loans to PDAMs compared to the fewer larger loans funded by IBRD and OECF.
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7.15 RDAs. According to the data provided by MoF, 156 RDAs were granted to 104 PDAMs between 1990 and 1996, and an additional 22 RD As are currently in process. The average size of the RDA granted during this period is Rp4.8 billion; the single largest RDA was granted to DKI PAM JAYA for Rp64.4 billion in 1994. DKI PAM JAYA has also received the largest amount of RDA during the same period, totaling Rpl 12 billion.
7 .16 Analysis of financing sources of PDAM projects assisted with foreign loans during 1994/5-1996/7 (Table 7.3), shows that grants accounted for some 40% but have been declining, that DIPs accounted for more than 70% of the grants and that grants from level II were small, except for DKI Jakarta. The Eastern Islands received the largest project finance share in grants, more than 80%; Sumatra had the second highest project finance share of grants, around 70%, and Java/Bali, the lowest share, around 30% (though Java/Bali had the largest absolute grant assistance, ofRp338 billion). Java/Bali's projects for Rpl,316 billion accounted for 64% of the total PDAM project value over the three years; the other regions had similar project value levels among themselves, between Rp184 billion and Rp196 billion. Kalimantan had the highest share of self financing, at 28%.
D. J[INANCING NEEDS
7.17 Urban Population Forecast. Indonesia's total urban population, estimated at 64 million at the end of Repelita V (end of 1993 - beginning of 1994), or about 34% of the total population, should reach 75 million at the end ofRepelita VI (end 1998), and 90 million and 105 million at the end ofRepelita VII (end 2003) and Repelita VIII (end 2008) respectively. The share of the urban population would gradually increase from 37% in 1998 to 45% in 2008. About 69% of the total urban population is currently located in Java, 17% in Sumatra and 14% in Kalimantan, Sulawesi, Bali and the Eastern Islands combined; the geographic distribution of the urban population is not expected to change significantly in the near future. Also, about two-thirds of the urban population is currently located in metropolitan areas or clusters of cities of more than half a million people; this percentage also is not expected to change in the near future. Between 1993 and 2008, the average annual growth rate of the urban population is expected to be about 3.4%, implying that an average three million people will be added each year to the Indonesian cities (See Table 7.4).
Table 7.3: PDAM Sources of Finance for Projects with Foreign Loans (1994/95 to 1996/96, in Rp. b)
·Region Total Project
Costs
Sumatra 194.489
Java/Bali 1318.136
Kallmantan 184.942
Sulawesi 100.879
Eastern Is. 197.012
Total 2075.458
Region Total Ptoject
Costs
Sumatra 100.00%
Java/Bali 100.00%
Kalimantan 100.00%
Sulawesi 100.00%
Eastern Is. 100.00%
Total 100.00%
Source: Cipta Karya
Grants: DIP
SPA BP
APBAN
APBO
rn:\alaln\watsectw\grantsfj.xls
Total spllt as follows: Loans split as follows:
Total Grants Own Funds Total Loans SLA RDA DIP SPABP APBN/RPLN
Table 7.4-· Distribution of the Urban Population (million)
Urban Population (million)
Period ending .. end 1998 end 2003 end 2008
Repelita ' VI VII VIII .. : ~
Sumatra metro 6.6 7.8 9.0 other 6.1 7.6 8.9. total ' 12.7. 15.4 17.9
DKI JaJrarta metro 9.6 11.0 .12.2
other 0.0 0.0 0.0 total 9.6 11.0 12.2
Java (excl. DK.I Jakarta) metro. 27.6 34.3· 41.2 other 14.6 16.8 ' 18.4 total 42.2 51.1 59.6
KaJimantan metro 2.1 2.5 2.9 other 1.4 1.7 2.0 total 3.5. 4.2 4.9
Sulawesi metro 1.8 2.0 2.3
other 2.0 2.6 3.1 total 3.8 4.6 5.4.
Bali metro 0.6 0.8 1.2 other 0.5 0.5 0.5 total 1.1· 1.3 1.7
Eastern Islands metro 0.3 0.4 0.4 other 2.1 2.6 3.0
total · 2.4 3.0 . 3.4
Total metro 48.6 58.8 69.2 other 26.7 31.8 35.9 total 75.3 90.6 105.1
7 .18 . Future Development Scenarios. In order to estimate the investment and financing needs of urban water sector during Repelita VII and VIII, as well as their consequences for the water tariffs, four inain policy scenarios have been simulated for the· period up to 2008 by using a financing, operations.and investment model. The model was run for major regions of Indonesia (Sumatra, DKI Jakarta, Java excluding DK.I.Jakarta, Bali, Kalimantan, Sulawesi and Eastern Islands) and for the entire country, and by category.of.RDAM (DKI Jakarta, metropolitan PDAMs and smaller PDAMs). For all scenarios, basic assumptions were made on consumption elasticity to tariff and income increases, UfW reduction, and re.duction of the cost of inputs and
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financing conditions1; for all scenarios, revenues are assumed to cover O&M costs and debt
service and to contribute at least 25% towards the investment program.
7.19 Scenario la - "Business as UsuaP'. Scenario la does not envisage any significant changes in the way the water supply business is conducted. In particular UfW would remain at about 40% and the cost of inputs would continue to suffer from the current procurement practices. Also, connection fees would remain at the current level, and limit the growth rate of residential connections to about 6.25% per year, also the current level. The tariff structure would continue to discriminate against non-domestic users, thus limiting commercial and industrial consumption. Tariffs would be increased by an average 25% every three years, as it is the current practice, with a first increase in 1998. Table 7.5 provides the main assumptions.
Table 7.5 -Scenarios 1 a and 1 b: Main Assumptions
Scenario la Scenario lb UfW Remains at average current Remains at average current
level of 40% level of 40%
Cost oflnputs Remains at current level Rema!ns at current level
Residential Connection Cost Rp380,000 (canst. 1995) 75% of the new residential connections would be provided free of charge
Service Ratio 49% by2008 63% by2008
Tariff structure Discriminates against non- Two blocks only residential customers
7.20 The Table 7.6 shows that despite investment levels of Rp4,300 billion and 5,300 billion, at 1995 constant prices, for Scenario la during Repelita VII and VIII, somewhat higher than is
The following assumptions were made for financial forecasts:
• consumption elasticity to tariff increase for domestic consumers: minus 0.3; • consumption elasticity to income increase for domestic consumers: plus 0.4; • consumption elasticity to tariff increase for non-domestic consumers: minus 0.1 • all earnings are retained by the PDAM for reinvestment in expansion programs, and thus no dividends
are paid out to local governments for their equity share throughout the projection period, because the service level would remain below 75%;
• concessional loans from the Central Government to PDAMs: repayable over 15 years, including three years of grace and 11.5% interest rate; ·
• private financing of water supply project: 20% equity investment, 80% commercial loan for Metropolitan PDAMs and 100% commercial loan for smaller PDAMs; ·
• return on private equity invested in water supply projects: 28%; • loans. on commercial terms: repayable over 10 years, including three years of grace and average 18%
interest rate; • PDAM bonds: maturity often years, with an annual coupon of 18%:
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currently planned for Repelita VI, the overall "service" ratio of 38% in 1995 would increase marginally to .43% and 49% in 2003 and 2008 respectively. However, the unserved urban population of 45.0 million in 1998 would reach to 51.3 and 53.6 million at the same dates. Government grants and loans on concessional terms would still cover about two-thirds of the investment needs and total Rp2,500 billion and Rp3 ,300 billion, at 1995 constant prices, for RepelitaVII and Repelita VIII respectively. Loans on commereial terms and private equity would be limited to DKI Jakarta and would represent a total of only 7 to 10% during the next two Repelita, while PDAM bonds would only make a marginal contribution of2% during the same periods.·There should be no need to increase water tariffs in Jakarta after 1998; tariffs would remain at Rp l ,350/m3 at constant 1995 prices. After the 1998 tariff increase, tariffs in metropolitan and smaller PDAMs would have to be marginally increased at constant 1995 prices from Rp680/m3 in 1998 to Rp740/m3 in 2008.. · · · ·
Table 7.6-Scenarios la and lb: Main Consequences
Scenario la Scenario lb w/o pub tap w/ pub tap w/o pub tap w/pub tap
Connection rate 1995 31% 38% 31% 38% 1998 (1) 33% 39% .35% 41% 2003 38% 43% 44% '49% 2008 (2) 44% 49% 58% 63% Invest. and Financing Plan Repelita VII Rp 4,300 billion Rp 7 ,000 billion Internal cash generation 26% 26% GOI.grants 36% 39% GOI loans on concess. terms 23% 26% Loans on commercial terms 10% 6% Private equity 3% 2% PDAM bonds 2% 1% Repelita Vlll (2) Rp 5,300 billion Rp 10,800 billion Internal cash generation 26% 25% GOI grants 38% 41% GOI 1oans on concess. terms . 25% 28% Loans on commercial terms 7%. 4% Private equity ·: 2% 1% PDAMbonds 2% 1% Average Tariffs (3)
Rp 650/m3 Rp 650/m3 1995 1998
·3 Rp680/m3 Rp680/m
2003 Rp 640/m3 Rp690/m3
Rp740/m3 3 2008 Rp740/m. (1) The first figure corresponds to the "connect10n" ratio, the second figure corresponds to the "service" ratio, that includes households served by residential connections and public standpipes. · (2) Investment needs at 1995 constant prices. · (3) Average tariffs aU995 constant prices for metropolitan and smaller PDAMs; excluding PAM JAYA. For PAM JAYA, the average tariff in 1995 is Rp 1,500/m3
, butafter 1998 the tariff would fall slightly to Rp l,350/m3
and remain constant in real tenns thereafter. ·
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7 .21 Scenario 1 h - "Business as Usual, hut with Higher Connection Rate". It is difficult to accept that the unserved population would increase during the next two Repelita, which would be a consequence of the "business as usual" scenario. Thus, scenario. I b aims at a 63 % service ratio in 2008, that would be translated into a reduction of the unserved population from 44.2 million in 1998 to 38.9 million at the end ofRepelita VIII (2008). For this however, a more aggressive commercial policy would have to be implemented towards residential customers, by providing small consumers with a new connection at a very low fee2
, as well as commercial and industrial customers by implementing a tariff structure that does not discriminate against them. If implemented, such a scenario would require investment levels ofRp7,000 billion and Rpl0,800 billion during Repelita VII and VIII respectively. An additional 5,000,000 residential connections would be provided during Repelita VII (between 1998 and 2008), at average growth rate of 8. 8% annum and non-residential consumption would increase three and a half times, from 230 million m3 /year between these two dates.
7 .22 However, With an overall sector performance remaining similar to what it is now, in particular with regards to UfW and cost of inputs, and tariff increases of an average 25% every . three years limiting the sector's borrowing capacity, the sector's cash shortfall would have to be met by a Government total financial support ofRp4,500 billion and Rp7,500 billion for Repelita VII and VIII respectively, at 1995 constant prices, to be compared to Rp2,500 billion and Rp3,300 billion for Scenario la.
7.23 Scenario 2a - "62% Service Coverage in 2008 with Increased Private Sector Participation". Under scenario I b, the level of Government support to the water supply sector becomes unsustainable, especially ifthe water supply industry does not improve its performance. Experience in countries that have had to face a similar situation shows that this cannot be achieved if major changes, supported by appropriate financial incentives, are not pursued. Thus, scenario 2a envisages an increased private sector participation in the delivery of service as this is the most direct way to implement improved performance. In scenario 2a, it is assumed that overall UfW would be reduced by about one percentage point per year, thus decreasing operating cost by the corresponding amount, and that all equipment or works procured under privately sponsored projects would be about 15% lower than those under publicly implemented projects. Obviously, the private sector would have to rely exclusively on commercial sources to finance its projects, and scenario 2a envisages that Government support for the metropolitan PDAMs would be gradually phased out during Repelita VII. However, significant Government support to smaller PDAMs would remain. As in scenario 1 b, adjustments in the current pricing policy would be made to favor new residential connections and increased consumption of businesses. Table 7. 7 provides the main assumptions for scenarios 2a and 2b.
2 A survey of 27 PDAMs of various size show that the average connection fee was about Rp 380,000 in 1995. In the proposed connection policy, about 75% of the new residential customers would be provided a connection free of charge; cost of construction would be financed by a small addition (about 5%) on the water tariff (see Chapter 5 Pricing of the main report on Pricing of Water Supply Services). However, new customers could be required by the PDAM to make a reimbursable advarice payment for up to six months of water consumption, to test their willingness to pay for piped water. .
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Table 7. 7 Scenarios 2a and 2b: Main Assumptions 11
' Scenarios 2a and 2b
UfW . Decreases by one percentage point per year
Cost of Inputs Minus 15% on all privately financed and implemented projects
Residential Connection Co~ 75% of the new residential connections provided free of charge
Service Ratio 63% by2008
Tariff structure Two blocks only LI
The differences between the scenarios 2a and 2b are m the financmg sources, shown in next tables.
7 .24 Scenario 2a envisages a tariff increase in 1998, that would be followed by annual adjustments sufficient to meet cash requirements (O&M, debt service and cash generation towards the investment program). Despite a much larger investment program than for scenario la, and a much larger share· of it financed on commercial terms, the tariff level required by scenario 2a would stillbe affordable. In fact, the water tariff in Jakarta in 1998 (at 1995 constant terms) would fall slightly and could even be decreased (at constant terms) further before the end of Repelita VII as a result of expected increased efficiency in operations. For metropolitan and small~r PDAMs, the initial.1998 tariff increases should be in the range of 15% and 3% respectively, and then to.reach an average Rp890/m3 and Rp680/m3 by 2008 (in constant 1995 terms) ..
7.25 Table 7.8 &.7.9 shows that the amount to be invested in the sector would reach Rp16 trillion during Repelita VII and VIII at 1995 constant prices. Table 7 .10 gives a breakdoWR of t.he investment program for the two next Repelita by region and size of PDAM, that shows that more than 85% of the investment would have to be in Sumatra (17%) and Java (69%, of which 12% for DKI Jakarta); DKI Jakarta, metropolitan and smaller PDAMs would absorb 11 %; 41 % and 48% of the investIDent program respectively.
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Table 7.8 - Scenarios 2a and 2b: Main Consequences
Scenario 2a Scenario 2b
Connection rate (1) 1995 31% 38% 31% 38% 1998 35% 41% 35% 41% 2003 44% 49% 44% 49% 2008 58% 62% 58% 62% Invest. and Financing Plan Repelita VII (2) Rp 6,350 billion Rp 6,200 billion Internal cash generation 27% 27% GOI grants 29% 13% GOI loans on concess. terms 9% 9% Loans on commercial terms 26% 42% Private equity 5% 5% PDAMbonds 4% 4% Repelita VIII (2) Rp 9,600 billion Rp 9,100 billion· Internal cash generation 28% - 28% GOI grants 26% 0% GOI loans on &~ncess. terms 0% 0% Loans on commercial terms 35% 60% Private equity 6% 7% PDAMbonds 5% 5% Average Tariffs (3) D.KIJakarta . 3 1995 Rp 1,500/m Rp 1,500 /m3
1998 Rp 1,300/m~ Rp l,300/m3
2003 Rp 1,150/m" . 3
Rp 1,150/m Rp l,150/m3 3
2008 Rp 1,150/m Metropolitan PDAMs
Rp 650/m3 Rp 650/m~ 1995 1998 Rp 750/m3 Rp 760/m"' 2003 Rp "770/m~ Rp 780/m3
2008 Rp 890/m". Rp 950/m3
Smaller PDAMs 1995 Rp 650/m3 Rp 650/m~ 1998 Rp 670/m3 Rp 670/m"' 2003 Rp 680/m3 Rp 680/m~ 2008 Rp 680/m3 Rp 800/m_, · (1) The first figures corresponds to the "connection" ratio, the second figure corresponds to the "service" rat10, that also includes households served by public standpipes. (3) Investment needs at 1995 constant prices. (4) Average tariffs at 1995 constant prices.
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Table 7.9-Scenario 2a - Financing Sources by PDAM Size
Until end of Rep. VII As of begin. ofRep. (begin. 1999) VIII (begin. 2004)
DKIJakarta Internal cash generation 30% 30% GOI grants GOI loans on concess. terms Loans on commercial terms 48% 48% Private Equity 12% 12% Bonds 10% 10% Metropolitan PDAMs Internal cash generation 25% 30% GOI grants 45% 10% GOI loans on concess. terms 30% Loans on commercial terms 40% Private Equity 10% Bonds 10% Smaller PDAM$ Internal cash generation 25% 25% GOI grants 45% 45% GOI loans on concess. terms 30% Loans on commercial terms 24% Private Equity 6% Bonds Source: Own estimates
7 .26 Scenario 2b - "62% Service Coverage in 2008 with Maximum Private Sector Participation". Scenario 2b tries to measure the consequences of the hypothetical case where, after transitional (phasing out) arrangements in Repelita VII, starting with Repelita VIII, the Government would stop subsidizing the water supply sector altogether. The main assumptions are provided in Tab le 7. 7 All other asslimptions being similar to the ones of scenario 2a, Table 7.8 shows that it would not be unrealistic to envisage such an option in the medium term, because the level of tariff required would remain within the range of what consumers say they are willing to pay if the water supply service is reliable3
.
3 A survey carried out in 1996 in five small urban centers ofKalimantan, Sulawesi and West Timor, (Tenggarong, Banjarbaru, Maros, Tomohon and Soe) show that depending upon current water supply conditions, between 50% and 100% of households with a connection are willing to pay Rp l,OOO/m3; these figures fall to 40% and 90% for a tariff ofRp 2,000/m3. Among households without connections about 50% are willing to pay Rp l,000/m3 and 40% Rp 2,000/m3. However, the main test will be on Java.
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Table 7.10 -Scenario 2a - Repelita VII and VIII Investment Program and Financing Plan per Region and PDAM Size (1995 Rp billion)
DK.I Metro Smaller Total Financ. Jakarta PDAMs PDAMs Plan
Region Cash . GOI generat. Support
Repelita VII
Sumatra 530 540 1,070 290 470 Java 960 1,530 1,840 4,330 1,180 1,510 Bali 180 - 180 50 60 Eastern Islands - 190 190 50 100 Kalimantan 160 110 270 70 . 120 Sulawesi 160 150 310 80 140 Total (Rp bn) 960 2,560 2~ 6,350 1,720 .2,400 Total (%) 15 40 27 38
Repelita VIII
Sumatra 750 880 1,630 450 470 Java 870 2,450 3,230 6,550 1,800 1,700 Bali 320 - 320 100 30 Eastern Islands 290 290 70 130 Kalimantan 240 150 390 110 90 Sulawesi 240 210 450 120 120 Total (Rp bn) 870 4,000 4,760 9,630 2,650 2,540 Total (%) 9 42 49 28 26
Table 7.11-. Comparison of Scenarios la, lb, 2a and lb Government Financial Support (1995 Rp)
GOI Financial Support Scenario la Scenario lb Scenario 2a
Repelita VII GOI grants Rpl,500 bn Rp2,700 bn Rpl,800 bn GOI loans on concess. terms Rpl,000 bn Rpl,800 bn Rp 600 bn Total Rp2,500 bn Rp4,500 bn Rp2,400 bn Add' I population served 9.5mn 13.3 mn 13.3 mn Per add 'I pop. served Rp265,000. Rp340,000 RplS0,000
Repelita VIII GOI grants Rp2,000 bn Rp4,500 bn Rp2,500 bn GOI loans on concess. terms ·Rpl,300 bn Rp3,000 bn -Total Rp3,300 bn Rp7,500 bn Rp2,500 bn Add'! population served 12.2 mn 21.6 mn 21.6 pm Per add'l pop. served Rp275,000 Rp350,000 Rpl20,000
Comm. Financ.
310 1,640
70 40 80 90
2,230 35
710 3,050
190 90
190 210
4,440 46
Scenario 2b
Rp 800 bn Rp 500 bn
Rpl,300 bn 13.3 mn
Rpl00,000
---
21.6 mn -
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7.27 Shifts in levels and share of financing sources. If the scenario 2a is pursued, the · investment level under Repelita VII would be.Rp6,350 billion compared to some Rp2,000 under Repelita VI (depending on the extent the Rp3;000 billion plan amount is implemented)--a very ambitious threefold increase. But, funds from commercial sources could be significant for the first time under Repelita VII, and cover some·35% of the investment needs, and self financing from PDAMs could reach on average 27% as opposed to the average 11 % under Repelita VI. · Therefore, the increase in the needed government funding is much smaller than the total investment figures suggest, from some Rp 1,600 billion to Rp2,400 billion. This could include an increase in grant fin_ancing of some Rpl,300 billion, to Rpl,800 billion, if grants are to replace part of the loans (See Table 7.12).
Table 7.12-PDAM Investments under Repelita VJ and VII
Rep. VI" Rep. vn-
Mill Share Own SLA RDA Grants Mill Share Own Govt Comm Rp Rp
II From DGCK data on project fundrng 21 Scenario 2a of this chapter
' 7.28 If the investment needs are to be met to reach an average piped water service ratio of 50% in urban areas by 2003 ·-not an ambitious target fot a country that will be in the middle income range--improvements are needed in the framework, as discussed earlier, and in the financing.
7.29 · The forecast shares of investment are in line with these rec.ent actuals; Java would continue to account for some 66% of the investments in urban water supplies (Table 7.12). Improvement on Java is therefore important, given that this could facilitate access to commercial funds. In most other islands, a larger public finance share will continue to be needed. Nevertheless, the same improved set of criteria would apply to all, resulting in different financial assistance simply because of the different financial situations, performance and potential additional.customer demand of the PDAMs.
E. · FINANCING THE INVESTMENT PROGRAM
7.30 The analysis indicates that the existing Government approach is unaffordable and perpetuates an ongoing set of problems. The move to commercial lending and private sector participation might not add to tariffs at all, or would do so by modest amounts, adding about 15
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percent on average, while achieving the improved standards desired. The analysis also suggests that private participation is not a high risk option, in the sense that even if the worst outcome occurs tariff increases remain in the feasible range of an average about 38 percent above "business as usual" and below current Jakarta rates. The public sector contributions to the program fall, with privatization, to about one-third of those in "business as usual;' for the same level of connections.
7.31 Some principles to be observed. For the efficient and equitable development of the seetor all justified water supply investments should have equal access to funds, and there should be no discrimination in the system of financing~ The supply of funds, and terms and conditions oflending, should reflect the demands for capital of the PDAMs, and not be arbitrary. It is clearly desirable that official and international agencies, in particular, provide funds with equal accessibility for all PDAMs. Similarly, Government equity should be made available according to criteria which are transparent and applicable to all PDAMs. Further criteria are suggested below.
7.32 Increasing PDAM internal cash generation. Self-financing of investments does not currently. occur on any significant scale. However, there is considerable scope for increasing this source of financing through tariff increases, revenue enhancement from increased sales, cost reductions and improved efficiency. These actions are also required to increase credit-worthiness for increased borrowing.
Tariff Increases
7.33 There is scope to increase revenues, particularly when PDAMs provide a more reliable or enhanced service, as discussed in Chapter 4. Water pricing policies of PDAMs need·to be more commercial in their orientation, and accept the principle that water is an economic good. With the exception of Jakarta and a few others, current tariffs .are too low for long-term financial sustainability of the industry. New criteria for setting tariffs, and the conditions for tariff revision, should be set by MoHA. Tariff increases of 10-20% are unlikely to reduce existing consumer demands to any noticeable extent if they are accompanied by service improvements, and are unlikely to moderate the currently unsatisfied demand. Safety nets for the poorest households would need to be considered, for example tariff discounts applied to the consumption of the first 10 m3 or so per month, and affordable connection charges (Chapter 6).
Additional Sales
7.34 A tariff structure that does not discriminate against non-domestic users could attract more of them to be customers, especially the larger commercial and industrial consumers which rely on self-provision. Attracting more commercial and industrial consumers could lead to enhanced consumption and increased revenues. The program of source enhancement and increased coverage, which constitute sector objectives for improved services, will have the same overall effect of generating revenues. Indeed; in the long term the program will be self-financing if tariffs are adjusted to reflect long-run marginal costs of supply.
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Cost Reduction Programs
7.35 Currently PDAMs .have limited control over their operating costs (Chapter 2). In the typical case, 50-60% of PDAM revenues go to pay for operations and maintenance expenses (O&M). which cat;t be compared to an average 30,-35% for the industry worldwide. This is an indication of the need to contain recurrent costs. If 45% of cash revenues is assumed to be required for O&M costs, 20% for debt service, and 5% for working capital, then about 30% of PDAM cash receipts would be available for replacement or new investments. Clearly, seeking cost reductions and efficiency improvements could add significantly to the resources available to PDAMs for investments. ·
7 .36 C::::urrently there. is little incentive for PDAM management and staff, at any level, to be more efficient. Incentives need to be changed to encourage a more proactive approach to improvements. One possibility is to permit staff to share either in profits, or cost reductions. Privatization experience in different parts of the world suggests that considerable efficiency gains in water. enterprises are achievable, and unit cost reductions of 15% in the short term and more in the lo.nger term, are likely to be possible in most PDAMs through improved operations and · procurement practices. The scope for cost reductions is discussed in Chapters 2 and 3.
7.3 7 A key factor will be the granting of increased autonomy to the PD AM management for day-to-day operational decisions, as outlined in Chapter 2, in the separation of ownership from management of operations. .One approach is to agree a performance contract between the municipality .and the PDAM management and staff with scope for profit sharing. Further reforms to improve efficiency could include: increased private sector participation in the delivery
. of services with the private provider selected after open .competition; stricter procurement procedures; long-term planning and improved project implementation and packaging of contracts; and, increased effectiveness of staff. Consumers could be associated with the decision-making process through their participation in the PDAM Board of Supervisors. Also as outlined elsewhere, independent technical and financial audits of the PDAM activities should be carried out.
Dividend Pay-Outs to Local Governments
7.38 Dividend payments from PDAM to its local government have been discussed in Chapter 2. They are a reverse flow of grant/equity funds. The greater are the dividend payments, the lower the self-financing amount available to the PDAM. Di~dend payments may even increase the nee4 for borrowing to finance the investment program. Ultimately this may lead to an increase in tariffs .. The dividend payments issue needs to be addressed by Government, and a realistic alternative put in plac~ along the lines of the management fee approach suggested in Section A above. It is evident, however, that clear, transparent rules are required on the flow of funds to LGs.
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Grants from Government
7.39 ·Local governments have given in the past, and will continue to give, equity and/or grants to the PDAMs. Central Government will have to continue to rely on making specific grants. The recently increased INPRES block grants to local authorities are too small to cover PDAM needs and they have to cover other sector needs as well.
7.40 Under traditional arrangements, the grants from Government tend to flow to poor. performers as "compensation" for their inadequate resources. This has served· only to perpetuate poor performance, and encourage it in others as they seek a larger share of the grants. It is recommended that Government should use its grant arrangements more pro-actively to reward good performance by adopting a policy which, to some extent, is the opposite of the traditional approach. Good performers should be rewarded with an increased share of the grant funds which are available. At the same time, budgetary constraints and financial prudence indicate that the total grant amounts should be reduced over time. Thus, good performers should receive the larger share of grants that are available, but this will be on a declining basis.
7.41 Whether government grants or government loans are preferable', depends on circumstances. "Concessionary" loans were a means for MoF to reduce grants and to introduce PDAMs to the healthy notion of borrowing and establish a creditworthiness record, since commercial loans were not available to PDAMs--these could seldom afford to borrow commercially and banks anyway perceived the risk to be too high. However, whether grant or loan, the choice is not indifferent to the Government, which prefers a higher proportion of loans even if at a low interest rate. With loans, it can recover the full cost of its borrowed funds (principal plus interest, though perhaps not fully the foreign exchange cost variation) and loans reduce the need to raise tax revenues for grants, thus decreasing the high economic cost of taxes beyond their yield. For a PDAM, what matters is the average cost of funds it can afford: a mix of· 50% grant with 50% concessional loan at 11.5% costs about the same as a mix of 70% grant and 30% commercial loan at 20%. PDAMs would logically prefer all grant financing, second, a mix of grant and concessional loans, and as last resort, commercial terms.
7.42 Possible criteria for Government contributions of equity include situations where: (a) the economic costs of expanding basic services are beyond consumers' current capacity to pay and for social reasons Government wishes to add a subsidy; (b) loans cannot be repaid from current revenues, at least for the initial expansion period, and Government proposes to reduce the borroWing requirement; ( c) re-capitalization is required, for similar reasons to (b ); ( d) there are important externalities to water supply projects, such as environmental concerns, where costs cannot readily be recovered. It can be argued that government loans and grants should not be provided on strictly financial terms but should on economic and social criteria. If so, these loans and grants should be matched against planned and actual economic and social performance.
7.43 This paper has proposed that concessionary loans be replaced by grants. This applies particularly to those PDAMs that with a grant/equity injection can be weaned altogether from public funds thereafter, because they become creditworthy. However, for those PDAMs that are not financially viable and could not access commercial funds for quite some time, even with
114
some grant funding, the government may prefer to continue to provide concessional loans rather · than grants. It may be noted that the "concessional" loans imply only small subsidies: they cover the full cost of the funds, at international levels of money costs, but government covers the repayment risk ~d thus these loans carrylower rates than the high commercial rates prevailing in Indonesia.
Loans from Government
7.44 The SLA mechanism will continue to exist for the time being to channel funds from external agencies to water supply projects. Government has indicated that it wishes. the SLA disappear in due course with the reform of the RDA, which would subsume the SLA, but the timing· for this remains uncertain. The intrinsic limitations of the SLA have been spelt out above. One of the most significant limitations is that the rate offered to .borrowers discourages them from seeking funds on domestic commercial terms, that are costlier. There is the incentive, instead, of encouraging borrowers to seek the maximum possible additional government resources or grants.
7.45 Many of.the problems of the SLA, including the perverse incentives, apply to the RDA also. An improved RDA mechanism is currently under consideration by Government. It is . anticipated that the RDA will be developed beyond its cuqent activities and established as an independent financial institution with access to the capital market. In this capacity, the RDA obviously has considerable potential: (a) to assist in expanding sector investments by widening the availability of capital; and (b) by acting as a "rediscounting" agency which would have the effect of reducing lenders' risks and in implementing the transition from existing funding, which is almost exclusively sourced by the public sector, to funding which in large measure obtained from the. private sector.
7.46 Based on the above, RDA review and further proposals, MoF intends in a "first stage" to convert the RDA into an autonomous financia}entity based on private commercial capital, that would onlend for urban infrastructure through existing retail financial institutions (BPDs) to local governments.and their enterprises; a decree should be issued in 1997. RDA staff would then evaluate "packages" ofloans submitted by the BPDs and monitor the latter; they would have a lighter workload that should be translated into faster approvals than under the current procedures ... Although a minimum annual budget allocation equal to the total commitment for loan disbursements of previously approved loans .is being discussed, MoF envisages to delink RDA project approvals from the Governinent's budget process. MoF also plans to increase the interest rate to commercial rates. BPDs. would be ·expected to cover costs, risk and a reasonable rate of return, and set their own interest rates, although a centrally imposed rate is being envisaged by MoF. MoF may provide liens to financial intermediaries on the PDAM's revenues or even ¢.e municipalities' property tax revenues. Finally the responsibility for. appraisal, supervision and c;:ollection would shift to BPDs; these would be expected to assume the lendiu'g risk.
7.47 However, it is believed that in the short-term the administration of the RDA would remain the responsibility of the MoF and that it woulq continue to rely for funds 'on the
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Government and external agencies, as well as the receipts from its earlier loans. The RDA cannot independently borrow from the capital market while remaining within Government. Short-term total funds availability will be limited to the amounts that can be provided from these sources, which constitutes a major limitation of the mechanism. In the medium term, the Decree would lead to the conversion of the RDA into an autonomous financial entity- a Municipal Development Fund (MDF) - owned and supported by Government and with access to the private capital market.
7.48 The appraisal of PDAMs and their project proposals will need to be significantly improved. The RDA may well revise its appraisal criteria following its reform. The BPDs and any other intermediaries will need to reflect these criteria in their own evaluation procedures. It is believed that consultants' studies are about to start to achieve this objective, as part of an ADB project. Improvements to the audit and other reporting requirements of the PDAMs will be essential if this improvement in evaluation is to be achieved efficiently and effectively.
7.49 The Decree is not expected to include a grant or equity facility for the RDA but this policy might be reconsidered so as to combine concessionary loans policy with a new approach to grant aiding, outlined above, whereby good performers are rewarded with an increased share · of the grants which are available. As long as there is a chance that loans will be rescheduled or forgiven, the tendency will be for the PDAM to lobby for restructuring rather than to serve the debt. The history of rescheduling may make any proposed conversion to commercial terms more difficult to implement. 4
·
7 .50 The principal recommendation is for the SLA and the RDA to move as rapidly as possible to "commercial" on-lending terms. These may still be lowe.r than alternative commercial bank rate if they come from low cost loans from international agencies. The strategy for Government will be to monitor the commercial lending terms offered by banks to PDAMs (see below), and to move to convergence on them, thus in the process also assisting in the development of the domestic financial market. Howeverfinancing growth with high debt is risky for the PDAMs because debt service is a required cash outflow; any shortfall in planned tariffs or growth will affect the PDAM' s ability to make debt service payments. Additional debt should not be provided to PDAMs which cannot service existing debt
7.51 Criteria for accessing grants directly from the central budget or loans on concessional terms would have to be defined. The respective share of the grant and loan elements should depend upon typical PDAM sizes; financial situation, but first of all performance. PDAMs should compete for Government funds. Those that have shown a performance improvement
4 For example, jn order to service its existing debt, PDAM Tangerang proposed a sale price for water of Rp
• 3 .. 550/m', to PAM JA YA. However, PAM JA YA and offered to pay Rp 450/m . In order to enable PDAM Tangerang to maintain a satisfactory debt rating, in 1996 the intenninisterial arbitration group, MoF, MoHA, MPW(Cipta Karya), resolved that MoF would assume the remaining debt service, without detennining the tenns under which this debt would be rescheduled, until PDAM Tangerang was able to assume it. Another example is PDAM Palembang, which has default~d on its RDA I.oan payments since 1989; however, the PDAM was given an SLA loan in March 1996, without MoF consultation or comment. BPKP gave an adverse audit to PDAM Palembang in 1995, and PDAM Palembang has recently requested rescheduling of this loan.
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and can demonstrate demand for expanded service should be able to access more favorable financing terms. In parallel, loan repayment to the Government should be enforced better. The current lending instruments, whether SLAs or RDA, are not always operated according to financial principles since some loans have been made to PDAMs with weak or non-existent debt service capacity, and some loans had eventually to be transformed into grants. Transferring the loan initiation and appraisal responsibility to domestic banks that would take the financial risk is an option that should be pursued during Repelita VII. Such banks could onlend funds borrowed by the Government, in particular from the ADB and IBRD as a means to (a) move lending conditions closer to commercial terms; (b) increase flexibility in funding PDAM projects; and (c) establish the needed discipline. However, dom~stic banks are still unfamiliar with the PDAM market and would need assistance to develop their appraisal capacity. Thus, initially, commercial banks' role should be limited to financing· smaller extension projects, while the SLA arrangements could be retained for larger loans, with conditions that should remain the same regardless of the ultimate source of funds.·
Commercial Finaneing
7 .52 Commercial bank lending to PDAMs currently is low and is for purposes of short-term · bridging finance or working capital requirements. Commercial banks perceive that creditworthiness in the water enterprise sector is low and have so far expressed little interest in lending. At the same time, the PDAMs have not actively sought to borrow commercially because it would not be affordable. Accessing the private capital market is essential if the service improvement objectives are to be met. On a significant scale this can only be achieved over a number of years as borrowers improve their credit-worthiness. In the short term some support will be needed to reduce the costs to borrowers on commercial .terms from sources other than international agencies. '
Facilitate Information to the Capital Market
7.53 Potential commercial lenders or equity investors perceive high risks in the water supply sector, and all proposals on this Policy Framework aim at reducing this risk. To further reduce the risk, there is also a need to produce more reliable data on the technical, commercial and financial situation of the PDAMs, past trends and expected revenues. Collecting these data ·should be one of the PERP AMSI responsibilities, however, certification of these data by independent technical and financial auditors is essential to provide comfort to potential private investors.
7.54 MoHA already practices some kind of"benchmarking" of PDAMs performance by classifying them in "very healthy" to "non healthy" categories~ using a series of 12 financial criteria. More elaborated benchmarking techniques should be introduced in particular to analyze costs and establish industry standards and best practices. This would help public or private investors make decisions on appropriate financing and attached conditionalities, and would help LGs negotiate performance contracts with the PDAM or private providers of service and, of course, tariff increase or adjustments. This task is typically that of the independent "regulator" of the public water supply sector, but such an agency does not exist yet
117
in Indonesia. The Government may want to consider the creation of a "National \Vater Supply Authority" that would regroup some of the responsibilities that are currently with DG Cipta Karya and DG PUOD. In the meantime, DG PUOD should be requested to initiate the benchmarking exercise by outsourcing it to independent technical and financial auditors or rating agencies.
Collateral and Guarantees.
7.55 Commercial borrowing costs reflect, inter alia, lenders' perceived risks. These include sector specific commercial risks and political risks. Risks could be reduced by appropriate action. Separation of ownership from management, referred to in Chapter 2 above, would reduce the political risks. Other options to support lenders' risk reduction include: larger equity contributions by local government to increase the financial soundness of the PDAM, and hence reduce borrowing requirements which would in turn reduce installments size; and reductions in risks arising from the use of liens, collateral or guarantees. As mentioned above, the Government could also consider the possibility of using the equity contributions to the PDAMs, as a matching grant system, either based on the actual disbursement of a commercial loan or on the actual repayment.
7 .56 Alternatively, the MoF could arrange for the refinandng of a specified proportion of the debt" in the event that the PDAM could not repay on the existing terms, The debt would be transformed from short-term to longer-term financing which would have the effect of reducing the installments. Such restructuring may not give the proper incentives for poorly performing PDAMs to seek commercial funding; in fact, the incentives may be perverse, poor performers m~ve "backwards", while good performers are "penalized" with higher cost financing.
7.57 There is little by way of fixed asset collateral that the PDAMs could offer to potential lenders. A possibility for collateral is the assignment of part of the PDAM's prospective revenues which might be placed in a "lockbox" or escrow account for the purpose. The concerned local government might offer such a "guarantee". It is not possible to determine the -market reaction to such a possibility ahead of specific proposals. Legal provisions would need to be investigated.
7.58 MoF (and BI) could offer full guarantees, and the provincial governments might have some potential. If offered, a way of ensuring that the full costs of a Central Government guarantee are felt at the local level would be for MoF to take, in effect, a lien on PDAM revenues or INPRES allocations which may allow debt repayment. But, if the PDAM was not able to pay the debt with its revenues, a lien on revenues would not help much. The issue of guarantees by Government has further problems: (a) they expose Government to increasing and difficult-tomeasure contingent liabilities; (b) they effectively count as borrowing in the system of public expenditure since they make "public" the_ debt; ( c) they have a tendency to become institutionalized (that is, become permanent features); and (d) they reduce the pressure for reform at the PDAM level which would lead the PDAM to become credit-worthy. Thus the Government is correctly reluctant to provide guarantees.
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7.59 Until the changes recommended.in this paper, regarding autonomy of PDAMs management and tariff level and structure, are implemented and a track record of improved management has been establish, private sponsors of water supply projects will seek guarantees
· . against, among other, the revenue risk (for example through "take or pay" contractual arrangement for BOOTs),payment risk by the purchaser (in particular for BOOTs where there is only one or a very limited number of clients), early termination risks and regulatory risk. Private· guarantors and insurers should primarily be providing guarantees against revenue and payment risks, while the Government should focus·the guarantees it would provide against termination and regulatory risks. Government owned banks or instruments put in place by international organizations such as the World Bank or its.affiliate MIGA can be used for this purpose.
Overseas Financing
7.60 It is likely that the major part of any overseas financing for PDAMs will continue to originate from the international development agencies. It is desirable that all foreign noncommercial sources act in unison in providing funds according to the same on-lending criteria, to avoid distorting PDAM choices.
7 .61 Based on the experiences of other countries, foreign companies which are interested in full concessions of municipal water services or in BOOT schemes, would contribute little foreign financing upon being awarded a contract.. Although foreign loans carry lower interest rates (often less than 10 points) than those prevailing in Indonesia, in the absence of guarantees provided by the Government, foreign companies have little chance of securing loans on the international capital market. Their only option, therefore, is to seek loans from the domestic commercial banks, up to 75% of their finan,cing needs in the case ofBOOTs. They may also seek the assistance of the IFC, the World Bank affiliate that invests in private companies, artd similar branches of other international development banks. Thus, not much net foreign funding should. be expected from a private foreign partners until perceived risks are reduced.
Bonds·
7.62 MoF has assessed the feasibility of bond issues for some PDAMs. Bonds could be issue.cl by the PDAMs, by local governments or by local banks on their behalf, or concessionaires but direct issues would be preferred; three or four PDAMs could also be combined in one issue. Candidates for bond issues could be metropolitan PDAMs such as Surabaya, Semarang, Malang, Badung (Bali) and probably only ·a few others. Domestic security firms have assessed the prospects of such bonds as reasonably good, with .a potential market of Rp 200 billion (US$85 million) a year. The preference is likely to be for floating rate bonds with 5-7 year maturities. The period could be lengthened with staggered issues. Emerging market funds could be potential buyers of local bonds. More interest is likely to come from domestic investors. · Current investment guidelines issued by the MoF for insurance companies and pension funds, limit holdings to 10% of any particular issue could perhaps be lifted for PDAM bonds, if it poses a constraint.
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7.63 As said above, very few PDAMs would be expected to place bonds in a national market in the near future. Stronger PDAMs could initially issue commercial paper and medium term notes using banks as managers or agents. It may be possible that future users of a PDAM water may agree to pay in a contribution towards the capital costs needed for providing the service; this could be investigated, even more so if participation of users in the Boards of Supervisors materialize. Users can become shareholders of the "management" company, not of the "investment" company .. Local contributions might also take the form of local bonds, subscribed by the future beneficiaries of the investments; however this would require additional investigation, both in terms of possible demand and in terms of enabling regulations.
7.64 Three PDAMs have taken steps to issue bonds to a total value ofUS$122 million equivalent value. For the foreseeable future this is likely to be only a limited source of supply of investment funds, until more PDAMs become creditworthy. This development needs to be watched carefully to se~ how it evolves.
Possible Financing Approaches
7.65 Some PDAMs are able to finance investments on commercial terms and others will join them as their creditworthiness is established. Many PDAMs are likely to continue to require grant/equity for future investments for some time but, with appropriate policy steps, this will be on a declining basis. Others may not be able to borrow at all because the operation is not financially viable without some structural changes, such as mergers. The industries' financing future structure needs to reflect these different PDAM circumstances. The following framework is proposed:
(a) for relatively simple and smaller PDAM sub-projects; such as extension of distribution networks, a flexible credit line from an improved RDA mechanism would provide a suitable funding mechanism. Smaller sub-projects are likely to constitute the bulk by number, if not value. The PDAMs undertaking such projects which are not creditworthy would require some support, which would reduce the PDAM's borrowing requirement, but would be phased out over time as steps are taken to establish the PD AM' s creditworthiness;
(b) for large PDAM projects, especially those projects which include new water supply sources and major transmission components, continued use of the SLA mechanism may be preferable in cases where international agencies are involved until the time when the improved RDA is fully tested. The SLA mechanism would allow for greater technical preparation and more stringent reviews and enable the complexity of problems to be effectively managed;
(c) larger projects where the PDAM is already creditworthy, or likely to become so soon, could be financed by the private sector through concession-type contracts or with bond issues and direct borrowing; and
(d) for either the smaller or the larger type PDAM water supply investment, a loan or possibly a grant could provide funding for technical assistance:
I
'1 I
J t ; } "
I ) I
\
( I
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(i) for technical preparation - in these cases the PDAMs would be expected to contribute part of the T.A. cost;
(ii) to assist PDAMs to prepare and implement business plans, prepare TORs for and review proposals by consulting firms, and review collateral arrangements; and
(iii) to permit eligible domestic banks, based on the CAMEL. rating, improve their technical appraisals of PDAM project submissions. ·
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INDONESIA. DISCUSSION PAPER SERIES
REDESIGNIN(! GOVERNMENT'S ROLE IN HEALTH:
LESSONS FOR INDONESIA FROM NEIGHBORING COUNTRIES (No. f)
SAMUELS. LIEBERMAN, I 996
INVESTING IN JU.NIOR SECONDARY EDUCATION IN INDONESIA:
RATIONALE AND PUBLIC COSTS (No. 2)
HANEEN SAYED, 1996
PROJECT QUALITY AT ENTRY: TEN KEY ELEMENTS (No. 3) RICHARD CALKINS, 1996
INDUSTRIAL TECHNOLOGY DEVELOPMENT
FOR A COMPETITIVE EDGE (No. 4)
DARIUS MANS, I 996
INDONESIA IN PERSPECTIVE: A COUNTRY BRIEFING (No. 5)
VARIOUS CONTRIBUTORS, 1996
POVERTY AND INEQUALITY IN ASIA: A SURVEY
OF REC.ENT LITERATURE AND RESEARCH AGENDA (No. 6)
MUlTUKRISHNA SARVANANTHAN, 1996
. EFFECTiVE PRIVATE PARTICIPATION IN TOLL ROADS (No. 7)
. JORIS VAN DER VEN, t 996
WHY DO DIFFERENCES IN PROVINCIAL INCOMES PERSIST
1.N INDONESIA? (No. 8)
JORGE GARCIA·GARCIA AND LANA SOELlsTIANINGSIH, I 997
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