Loaves, fishes and dirty dishes

Introduction

MANILA, Philippines — In thousands of poor homes in this sprawling tropical city that is as hot as it is Catholic, the privatization of the waterworks by two major foreign companies in 1997 at first seemed as miraculous as the loaves and the fishes.

The private companies quickly moved to expand service around the capital, and before long taps that had been mostly dry suddenly ran with cool water. Residents like Mely Gagalonia, 50, a housewife living in a Manila slum, had clean water for the first time.

No more fights in the water line, no more spending long hours waiting in line to buy water from vendors who charged her more than a third of the family’s income, said Gagalonia.

“Life has become easier for all of us,” she said, “since Manila Water came to our place.”

That was not the case for everyone. Still, there’s no denying that the pre-privatization water situation was grim.

Cora Concepción, 60, a former cleaning supervisor at a hotel who lives in a middle-class neighborhood connected to the public water utility, often went without water because the pressure would drop to such a low level her tap would run dry.

Water shortages were widespread. At the National Hydraulic Research Center in Diliman, Manila’s university suburb, leading water experts had to suffer right alongside the poor souls whose problems they studied. “It was ironic,” said Angel Alejandrino, a founder of the center. “We also had no water for our toilets.”

Low pressure and illegal water siphoning caused contamination in the pipes, and waterborne diseases were common, increasingly through the early 1990s. In 1995, there were 480 cases of cholera in Manila, compared with 54 cases in 1991, according to the Philippines Department of Health. Reports of severe diarrhea-causing infections peaked in 1997 at 109,483 — more than triple the 1990 number. Coupled with the prospect of water shortages, these disease outbreaks created an atmosphere of crisis that convinced people to accept a private sector role in the operation of the water utility. Indeed, the Metropolitan Waterworks and Sewerage System (MWSS) by the mid 1990s was perhaps the most unpopular government agency. In 1995, it served only about two-thirds of the nearly 11 million people living in Metro Manila and nearby towns, meaning that 3.6 million didn’t have running water. The utility lost more than half of its water — and millions of dollars in revenue — to leaks and theft. And service was erratic, often shutting off during the day.

Much changed when two private water companies won concessions to take over Manila’s waterworks in 1997, dividing the metropolitan area into western and eastern water zones. Although water regulators dispute exact figures, within five years the companies had connected about 2 million more people to the network.

Concepción could take a shower any time she wanted, rather than waiting for the water pressure to rise. In Alejandrino’s office, toilets flushed with abandon. Gagalonia had water piped into her home at a fraction of the cost she paid vendors. In poor neighborhoods like hers life improved: there was less illness, and women had more time for productive labor.

Six years after the private companies took over, however, the miracle is starting to look prosaic. Many of the old problems — debts, underfunding, broken pipes and water theft — have resurfaced and even worsened. And the system itself seems to be crumbling.

“When we initially got 24 hours of water service [following the privatization of MWSS], we could take a shower any time of the day or night,” Alejandrino recalled. “Now, by 9 o’clock in the evening, pressure is so weak water can’t reach the shower on the first floor of our house.”

Water losses, the decades-old bane of the MWSS that eventually prompted its privatization, have remained high and even worsened in the western half of the metropolis. This has perpetuated a chronic shortfall in water supply.

The cost of water is on the upswing again. Water prices tripled following a series of rate increases imposed starting in 2001, and in January 2003, rates were to jump a further 81 percent in the east zone and 36 percent in the west zone.

The private companies, officials say, increasingly make their own rules. Having privatized the water, government regulators say they are powerless to impose restrictions or demands on the companies who generally do as they please.

In December 2002, one of the companies, Maynilad Water, announced it was pulling out — essentially abandoning a concession serving 6.5 million people in the western part of metro Manila.

Debt-ridden and unable to raise more capital, Maynilad Water — owned by Ondeo, a subsidiary of the French water company Suez, and the Lopez family of Manila — said it intended to leave the concession in March 2003.

This could be extremely costly for the government, which faced the possibility of having to refund Maynilad at least $303 million in invested capital, reassume responsibility for $530 million in future loan payments to MWSS creditors, and spend for water and sewerage improvements.

Still, the MWSS says that if no other company shows interest in the concession, it is ready to take over.

“We can operate the water system and even turn a profit,” said Orlando Hondrade, the MWSS administrator. “Think of the savings we’ll be making because the utility will no longer have to pay millions of pesos in executive salaries and consultancy fees.”

Other MWSS officials said a temporary government takeover could prove more beneficial, in terms of cash flow for the state agency, by providing MWSS with a revenue stream it could use to repay debt.

An arbitration committee was to decide by February 2003 whether the government should be ordered to pay extra compensation to Maynilad. The decision turns on Maynilad’s allegations that the government is to blame for the failure of the concession. If the government loses, it may have to refund Maynilad for 18 billion pesos ($337 million) in outlays; MWSS is arguing that it should pay as little as 3 billion pesos ($56 million).

Selling water to the islanders

The heavy debt load of the MWSS was a key reason for privatization.

From 1993 to 1995, the utility’s net income plunged by 62 percent because of rising costs and interest payments. It needed about 7 billion pesos ($253 million) to launch a major pipe replacement plan, but the money could come only from international financial institutions.

Creditors such as the World Bank and the Asian Development Bank, which accounted for $249 million of the MWSS’ $307 million long-term loans as of 1995, pushed for private sector takeover of public utilities.

“I don’t think the World Bank has a style…of pressuring people,” Keshav Varma, the senior water supply official for the World Bank in Asia, told ICIJ. “We would rather have partnerships where we can support government decisions — in the right direction.”

Philip Cases, the MWSS’ former chief of corporate planning who now works for one of the private water companies, said the utility’s debt problems added a sense of urgency to the privatization of the agency. “MWSS had to be transferred prior to September 1997,” when a 550-million peso ($16.6 million) payment was due, he added.

In April 1996, the World Bank sent a Philippine contingent to Buenos Aires to study that city’s privatization. The team included top MWSS officials, labor union leaders and politicians, according to Mark Dumol, a chief of staff in President Fidel Ramos’ government. In Dumol’s diary of the privatization process, which was published by the World Bank under the title, The Manila Water Concession, he wrote that the group “met with numerous Argentine officials, all of them happy with the privatization.”

The French government gave Manila a $1 million grant to hire the French engineering company SOGREAH as a consultant.

The World Bank’s investment arm, the International Finance Corporation (IFC), contracted with the Philippines government to draft the concession agreement and designed the bidding process for selecting two private utility operators for the western and eastern sections of metro Manila. The auction was scheduled for January 1997.

The IFC had a vested interest in assuring the privatization process was successful. It had a clause in its contract that awarded it at least $1 million if the privatization bidding was successful. Some critics believe this meant it was not entirely neutral.

Cases said the outcome of the MWSS privatization process might have been different if the government got “consultants who had no agenda.”

“If [the IFC] had not successfully privatized the company, then they would not have become richer,” he said.

Vipul Bhagat, the IFC’s Philippine country manager, denied that the success clause caused a conflict.

For its part, the government tried to create a sense of urgency and overwhelming public support for the privatization process. President Ramos declared a “water crisis,” and in 1995 Congress enacted the “Water Crisis Act,” giving Ramos the legal power to privatize MWSS in whatever manner he saw fit. Ramos then allowed MWSS to increase water rates by 38 percent in August 1996, five months before the bidding. The bidding rules favored companies that offered the largest rate reductions, thus making it look like the public was getting a great deal through privatization. It was a tactic learned in the earlier Buenos Aires privatization.

“From the very beginning, we felt that it was essential that the bids be lower than the existing tariffs,” Dumol wrote in his diary of the privatization. “This way, we would have public support.”

What’s more, in 1996, Gregorio Vigilar, public works secretary and MWSS chairman at the time, promised the public no rate increases during the first 10 years of the contracts, or until 2007.

Manila Water Co., a consortium composed of leading Philippine conglomerate Ayala Corp. (60 percent), UK’s United Utilities Ltd. and the Bechtel corporation of the United States, won the eastern concession by promising a huge 74 percent cut in rates. (By law, foreign companies could not own more than 40 percent of a utility.) This concession served 4.5 million people, but only about 3 million were connected.

Maynilad Water Services Inc., a consortium of the Lopez group and Ondeo, won the western zone with a promise to lower rates 44 percent. This zone serviced a population of 6.2 million, but only about 4.3 million were connected to the system. The Lopez group is an old Philippine business family and politically well-connected.

Both concessions would run for 25 years. By 2006, the companies projected that between 94 percent and 97 percent of the people in their areas would have running water.

Miracle or mirage?

Six years after they took over from the MWSS, the private water utilities have performed well below targets, according to government regulators. Many of the promises made to encourage public support for handing over Manila’s water to private enterprise have evaporated.

Even where the companies appear to meet or exceed targets, some critics claim the figures are overstated.

By 2001, Maynilad Water said it supplied water to 85 percent of its population of 6.5 million, slightly below a projected target of 87 percent, but an apparently major improvement from the performance of MWSS.

Manila Water’s figures indicate it did even better. It provided water connections to 93 percent of the 4.2 million people in its area, well over a 77 percent target.

The concessionaires do not count each individual user; they estimate coverage employing a ratio of 9.2 customers per connection. This figure was established by the French consultants to help the companies prepare their financial bids. The MWSS, however, argued that the companies cannot use it to assess whether they have met their service targets.

The 9.2-to-1 ratio provides for exaggerated claims, MWSS said, and the companies are counting customers who don’t exist. The companies disagreed.

For example, Maynilad reported it was serving 1.7 million people in Manila proper by the end of 2001 — based on 184,782 connections. But MWSS, using census figures, concluded there are only 1.4 million potential beneficiaries in Maynilad’s section of the city. Similarly, Manila Water said its total customers in Makati, the central business district, number over 450,000, based on 47,178 connections. MWSS, on the other hand, estimated about 250,000 potential customers.

The companies refused to change their calculations on the grounds that their figures are based on ratios used in bid documents. Basing their calculations on census figures would reduce their percentage coverage, the MWSS regulatory office claimed.

Using MWSS census figures, Maynilad Water’s estimated coverage at the end of 2001 would fall to 76 percent, while Manila Water’s coverage rate would drop to only 65 percent, according to an MWSS evaluation report.

Coverage figures also are ambiguous because of how the companies define a water connection.

The companies often provide a single water main into a subdivision, condominium complex or even a group of neighbors in a slum. It becomes the individual household’s responsibility to hire a contractor to connect the household to the water main. The neighbors set up committees to manage their mini waterworks. The company then bills the committee. But the companies count each of the households as a connection.

MWSS regulators say these residents should not be counted as connections made by the concessionaires. The private utilities insist they should be included because they are providing water mains, even though residents have to organize their own connections.

“We told them the way you are counting [population covered] is wrong,” said Angel Agustin, MWSS deputy regulator for customer relations. “Up to now, we have not agreed on the definition of ‘population served.'”

In Paris, Gérard Payen, senior executive vice president of Suez, blamed the Philippine government for the missed targets.

“The reality is that when you sign a contract as a private company, you commit yourself in order to get results anticipated in the contract. After that comes the real work. In many cases we discovered that the real situation was very, very different from the information given to us by the previous local government,” he told ICIJ.

Leaks and pilferage bedevil the system

Leaking pipes and water theft, which collectively the industry calls “non-revenue water,” accounted for major revenue losses for the MWSS. The private companies promised to solve the problem, but it seemed only to have worsened. Maynilad Water had projected to reduce non-revenue water in its service area to 31 percent by 2001, according to an MWSS report. Instead, it climbed to 66 percent from 64 percent in 1997. This means that the utility is not earning money on more than two-thirds of the water going through its pipes.

Manila Water had forecast that water losses would decline to only 16 percent by 2001. In fact it was still losing about half its water to non-revenue streams, according to MWSS.

In both cases, the companies claimed that MWSS had downplayed the rates of water loss from the system before privatization. But even if that were true, the companies showed little or no progress in improving the situation.

Government officials had hoped reduced leakage and theft would ease pressure to build new dams and reservoirs. That has not been the case.

The $200-million Umiray-Angat Transbasin Project water project in 2000 increased metro Manila’s raw water supply by up to 800 million liters a day. Yet the potential benefit of the new water was offset by increased leakage.

Maynilad’s water production rose by 242 million liters a day in 2000 and 2001 after the new reservoir was commissioned. But because increased leakage led to a loss of an additional 178 million liters per day, the amount of water sold at the tap actually increased by a mere 64 million liters per day.

The water companies blamed the ancient pipe network for the persistence of high water losses, saying new leaks appear as fast as old ones are patched.

“We inherited an antiquated system of pipes,” said Bert Ramirez, a spokesman at Manila Water. “We are trying to replace these old pipes [but] it cannot be done overnight. Not only will it disrupt basic service, you also have to spend so much.”

Macra Cruz, the MWSS deputy administrator, however, noted that about half the pipes were installed after 1982. Cruz, an experienced project engineer with MWSS, says the private operators’ failure to cut water losses is difficult to understand because their procurements are not subject to the many bureaucratic restrictions that bedeviled MWSS in the past.

“We [MWSS] partially succeeded in reducing non-revenue water with all the procurement restrictions,” she said. “The private sector can easily buy equipment and get people, unlike us. We have to follow civil service regulations. I don’t understand why they were not able to reduce it.”

The reason is simple, water expert Alejandrino said. Repairing water leaks offers no payback. Loopholes in the concession agreements allow the private operators to pass the financial costs of water losses to consumers by raising rates.

Finding and fixing leaks is expensive. “It’s still cheaper to develop a new source,” Alejandrino said – and to let the government pay for it.

Most of the leaks tend to be in poor areas. And the poor pay the price.

The companies connect the urban poor by extending a pipe into their neighborhoods. Then it is up to families in the neighborhood to pay contractors to extend pipes to their homes, which may be located as far as 100 meters from the main. The water companies usually install meters near the main. This means any leakage or theft between the main and the household is paid for by the customer, putting the onus on the customer to maintain the pipes.

Of the 238,000 new water connections installed from 1997 to 2001, the companies reported that 54 percent or 128,000 were in urban poor communities covered by special programs that the private utilities started to bolster service for depressed areas.

Apart from shouldering the cost of pipe connections to their houses, slum dwellers who buy water in groups pay up to three times more for each cubic meter of water compared to customers who enjoy direct or individual connections.

Gagalonia, for example, belongs to a group of 30 households that buys water from Manila Water. The group pays 15 pesos (28 cents) per cubic meter. A family with a direct connection to Manila Water pays only about 5 pesos (9 cents) per cubic meter.

Two factors account for the difference. First, Gagalonia’s group has to pay for a manager to manage and maintain the group’s water system.

Second, higher levels of water consumption fetch higher water rates. Consumption beyond 100 cubic meters per month costs 6 pesos (11 cents) per cubic meter. In contrast, consumption of 20 cubic meters or less costs only 1.60 pesos (3 cents) per cubic meter. The highest rate is thus being levied on groups of poor families even though each family in fact consumes less than 20 cubic meters.

Still, Gagalonia doesn’t complain about the higher rates. “It’s still very much lower compared to the 80 pesos per cubic meter that we used to pay the deep well operators until two years ago,” she said.

Despite the importance of leakage in any water system, the World Bank’s International Finance Corporation failed to make water-loss reduction a performance target on the part of the private concessionaires. The IFC also allowed the companies to pass on to customers the cost of non-revenue water.

Cases was head of the MWSS’ corporate planning office in the mid 1990s when privatization was still at the blueprint stage. He recalls the question arose in a meeting between water officials and IFC consultants.

He said the IFC claimed it would result in the companies being penalized twice: once for not meeting the target and again because they are losing revenue because of the water losses. But, in fact, the companies simply pass the cost onto the customer.

Bhagat, in the IFC Manila office, defends the organization’s recommendation. The private companies should decide whether to increase water supply by fixing leaks or developing new sources, he said.

“The private operator is best placed to make the trade-off between the two, and has every incentive to increase water sold, since this results in new revenue,” he said in a written response to questions from ICIJ. “There is no need to impose ‘artificial’ goals for NRW [non-revenue water] reduction: these would only distort economic incentives that are already in place.”

Other lenders make water loss a performance target in return for capital loans. In fact, the Asian Development Bank required MWSS to reduce water losses as a condition for the release of loan money.

Utilities such as power companies are not permitted to pass on to consumers the cost of lost power beyond a minimum level. MWSS regulators now want non-revenue water to be a performance target under the concession agreement.

“This time in the [rate setting discussions] we’re making [it] a key performance indicator,” MWSS chief regulator Eduardo Santos said.

A mixed picture

MWSS surveys indicate that customers in general are not convinced privatization has improved the water system.

In a 2000 survey of residents of 100 barangays, or districts, 55 percent thought there had been no change in service, while 12 percent claimed the service was worse. Thirty-three percent noticed an improvement.

Throughout this vast metropolis, residents continue to have completely different experiences with the private water companies, much as they had with the public utility.

Concepción, who lives in a middle-class subdivision not far from Gagalonia’s slum village, says that water service has improved a lot since the private operators took over in 1997. “I can take a shower anytime I like,” she said. Gone are the days when she had to stay up late or wake up early to wait for the water to flow.

But Concepción is angry with Manila Water for refusing to take over the water distribution system inside the subdivision where she and 66 other families live. “It wants to take our money but refuses to give us any services,” she complained. “We have to pay the company to read our meters. Every time it plugs a leak, we’re charged 2,500 pesos [$50] per repair job.”

In another part of the city, a few hundred yards from Malacanang Palace, official residence of the Philippine president, Roger, a 67-year-old customer of Maynilad Water, said his taps frequently run dry.

Roger, who did not want to be further identified, lives in a poor neighborhood where the water often flows only late at night or early in the morning. So he turns on an electric motor that pumps water directly from a main through a crude illegal connection. He pays more in electric bills that way, but he gets water when he needs it.

“I know this is illegal but why should I pay the company for poor service?” Roger said.

Mark Dumol now acknowledges that privatization is only half successful.

“It succeeded in the east zone under Manila Water but failed in the western zone under Maynilad,” he told ICIJ. This was contrary to his own expectations, Dumol said. In 1997, he felt that Manila Water faced the greater risk of financial ruin because of its extremely low bid.

About half of the 2 million people added to the water network after privatization belonged to poor households, who wouldn’t have been connected if the MWSS remained in charge, Dumol said.

“This is unprecedented in the whole world – a million poor people given direct water connection in five years,” he said.

New service connections, which averaged only 17,040 a year from 1991 to 1995, tripled to 53,921 a year after privatization, according to data gathered from the MWSS.

To be sure, altruism did not drive the concessionaires to focus greater attention on the poor. It was more of a business strategy than anything else. The bulk of water losses incurred by the MWSS had been traced to illegal water connections in the slums. Addressing the needs of the urban poor was key to reducing non-revenue water, although cutting these losses has turned out to be harder than expected.

Underspending for repairs and rehabilitation

The companies claim they have run out of money to repair and expand the system. Neither company has spent the money it promised for infrastructure upgrades.

Maynilad Water’s capital expenditures of 3.3 billion pesos ($82 million) from 1997 to 2001 were less than half the 6.8 billion pesos ($170 million) it assumed in its contract bid, according to an MWSS report.

Manila Water has also underspent. It allocated 1.2 billion pesos ($30 million) for plant, property and equipment during the five-year period, compared to 1.7 billion pesos ($42 million) specified in its business plan, the same report showed.

Maynilad Water said money for capital expenditures was diverted to pay MWSS loans, which ballooned in peso terms after the currency fell from 26 to 50 to the dollar during the Asian financial crisis of 1997. The firm reported foreign exchange losses outstanding of $120 million by the end of 2001. (Maynilad assumed 90 percent of the outstanding MWSS loans because that percentage was spent in Maynilad’s western section.)

Cases, the former MWSS planning chief who now works as regulatory liaison for Maynilad Water, said the bulk of the company’s funds for capital expenditures went into expansion projects instead of non-revenue water reduction. The main concern soon after the company took over in August 1997 was to finish pending expansion projects of the MWSS so they could hook up new customers, he said.

“That took us the good part of more than two years,” the Maynilad executive said. “After that, we had run out of money because in addition to all our expansion efforts, we had to pay for concession fees based on the new exchange rate.”

Concession fee payments, in peso terms, however, remained almost the same as originally projected, according to figures made available by the MWSS financial regulation division. Between 1997 and 2001, they stood at 10.9 billion pesos ($27 million), only slightly higher than the 10.3 billion pesos ($25 million) assumed in the firm’s business plan.

The massive currency devaluation of 1997 could have at least doubled the peso value of Maynilad’s projected U.S. dollar-denominated concession fee payments. But in practice, it did not. Not all loans were billed by creditors, and not all of the loaned cash had been disbursed before the devaluation, according to MWSS chief financial officer Estrellito Folloso. Maynilad’s Cases said the loan money was not spent because the projects were not among Maynilad’s priorities.

What really hurt Maynilad Water’s capital expenditures, according to financial regulators, was its inability to secure long-term loans from independent creditors. In promoting privatization, the World Bank had claimed private companies have greater access to capital than public utilities. But this has not been the case in Manila.

Maynilad Water had planned to borrow as much as $238 million in long-term money by 2001 but managed to raise only $16.7 million, advances from its two owners Benpres Holdings and Ondeo. In fact, talks on a $350 million long-term loan from a group of banks stalled shortly after they began in early 1999 and now have been abandoned.

Maynilad Water has steered capital spending on technical assistance, consultancy services and management fees to companies such as Safege Consulting and Montgomery Watson, an affiliate of Ondeo, and First Balfour Beatty Inc., a company owned by the Lopez family.

In Manila Water’s case, almost 70 percent of capital expenditures went to fees of consultants and experts, which included the shareholders Ayala Corp. and United Utilities. The company also entered into a capital works program agreement with Bechtel Overseas Corp. and Bechtel International Inc., which are units of the Bechtel Group, an investor in Manila Water.

Water rates rising

After an initial rate cut, the companies received permission to triple and quadruple the water rates.

As of January 2003, Manila Water’s basic rate in the east zone had gone up 496 percent since 1997, to 12.21 pesos a cubic meter, from 2.32 pesos. Maynilad Water’s customers were paying 15.46 pesos — more than twice the 1997 rate — and faced an increase to 21.11 pesos in January 2003.

About two-thirds of the rate increase during the six-year period happened between October 2001 and January 2003, after the government permitted changes in the concession agreement by allowing the companies to recover foreign exchange losses in the same quarter they are incurred. Originally, the losses were to be recovered over the 25-year period of the contract.

Despite the hefty rate increases, one of the concessionaires, Maynilad Water, continues to pass on the responsibility for paying nine-tenths of the maturing MWSS loans to the government. It stopped servicing the obligations in March 2001 because of severe cash flow shortfalls that it blamed on foreign exchange losses. It did not resume payments on those loans after October 2001 when it was allowed to increase water tariffs.

An agreement signed by Maynilad and the MWSS in October 2001 allowed the private water company to postpone payments for the loans until June 2002 or when its cash flows permit and after several other conditions have been met. These loopholes allowed Maynilad to continue to suspend their loan payments while boosting its revenues from the higher rates.

MWSS regulators estimate that Maynilad is building up its cash reserves at the rate of 100 million pesos (about $1.8 million) a month under the October 2001 agreement.

“This bonanza of favors” shows that the administration of Gloria Macapagal Arroyo was “bending over backwards for the Lopezes at the expense of consumers,” said the left-of-center political party Akbayan, in a statement. “Evidently, they have chosen to bail out Maynilad instead of ensure the integrity of the privatization program and look after the welfare of consumers at this time of economic crisis.”

Regulators in strife, regulation a mess

Sharp increases in rates have brought charges that the water regulators favor the companies.

In 2001, two regulators, Elena Alojipan and Virgilio Ocaya, accused the chief regulator, Rex Tantiongco, of attempting to exclude them from deliberations after they refused immediate approval of the companies’ demands for rate increases.

“As I can still recollect, we had a public consultation meeting and a Christmas party,” Alojipan said, “and after that we had a meeting and he was saying that this [automatic rate adjustments] was a done deal.”

Claiming he was fed up with internal conflict in the regulatory office, Tantiongco resigned in July 2001 and was replaced by lawyer Herman Cimafranca.

Now a consultant of the World Bank for its water sector loans in the Philippines, Tantiongco said the split in the regulatory office when he headed it stemmed largely from differences of opinion on the nature and function of the MWSS regulatory unit.

The regulatory commission was created by the concession agreement rather than by law, Tationgco said. Therefore, the commission must implement agreements and decisions reached by the MWSS board of trustees and the private concessionaires, he said.

“It’s a mistake to think of the concessionaires as public utilities that we have to regulate,” he argued. “It’s still the MWSS that is the utility and the concessionaires are merely its agents or contractors.”

The MWSS, however, is virtually powerless to enforce its orders and decisions, Cimafranca said.

“This is, to tell you frankly, almost a spineless and toothless paper tiger,” he said. “If we tell them to cease and desist from implementing these rates…they will not follow because the concessionaires will say that we have no right to do that.”

The concessionaires also can contest the regulators’ decisions and submit these issues for arbitration by an independent panel, which is expensive.

Arbitration proceedings in 1999 and 2000 on rate increases cost 40 million pesos ($800,000), divided between Manila Water and the MWSS, said Cimafranca, who argued the case on MWSS’ behalf as a lawyer of the Office of the Government Corporate Counsel. MWSS is at a disadvantage in such proceedings because it operates with a fixed budget, while the concessionaires can eventually recover the arbitration costs and legal fees from customers through higher rates.

Manila Water’s legal counsels, including a British lawyer, were paid about $200,000, Cimafranca recalled—noting that he was to have received about $120—until state auditors disallowed it. They said it constituted “double compensation” since Cimafranca was already getting a regular salary as government lawyer.

Despite its many weaknesses, the MWSS regulatory office recently has shown flashes of independence in the just-concluded rate setting process. The regulators have penalized the companies for not reducing water losses, claiming the missed targets violate the concession agreement. Maynilad Water has appealed the regulator’s decision, but Manila Water has not.

Concessionaire in trouble

While audited financial statements indicate Manila Water is making a modest amount of money, Maynilad Water was hit hard by the Asian financial crisis and since then it has cut spending for expansion and maintenance and has even fallen behind in payments to contractors, according to an MWSS report.

Maynilad Water blames its losses on the heavy debt burden assumed by the company upon privatization in 1997. This, however, was the price for gaining control of the MWSS’ water distribution assets. Neither company paid any money for the dams, reservoirs, water treatment facilities and the pipeline network – assets that generate their revenues.

Suez’s Payen said the concession contract is “overloaded with the debts” from MWSS. “This debt is in U.S. dollars and after currency devaluation the burden of this debt has been too big. And we have far more than the other [concession] – we had to take on board 90 percent of this former debt, and the other concession had only 10 percent. It had a very big difference.”

Inefficiency and possible mismanagement also may play a part.

Maynilad’s operating expenses are much higher than Manila Water’s. According to a report of the two concessionaires’ operating expenses by MWSS consultants, Maynilad’s total cost per cubic meter of water sold was 10.45 pesos, or more than twice Manila Water’s 4.45 pesos in 2001.

The MWSS report of Maynilad’s spending patterns reveals operational inefficiency and weak management controls. The report states that staff numbers are “29 percent higher than originally considered in the bid.” The report goes on that say that “efficiency savings in staffing…have been missed.” While Maynilad cut the number of supervisors, professional and technical staff, and rank and file employees by 378, it hired 46 new top managers.

The report also claimed that Maynilad spent twice as much on vehicles per water connection and employee as Manila Water. “The implication is that savings of 50 percent on vehicle asset value could be made if effective management of staff were to be achieved,” the report said.

The report found that expenses for contracted services – mostly management and technical fees paid to Maynilad shareholders Ondeo and a Benpres Holdings affiliate, grew at a faster rate than revenues in the first six years of the water concession.

“Should it have been considered at some stage that fee payments could be reduced because the investment is not adding value to the company and not compensating the shortfall in revenue?” the MWSS consultants asked. The MWSS consultants also noted that Maynilad Water abolished its engineering department and instead contracted out the job to two external parties, including a joint venture of the major shareholders. The MWSS consultants expressed concern over the “almost guaranteed level of work reflected in the monthly payments to each of the two consultants.” They wondered if the spin-off resulted in any savings for Maynilad, considering that more than half of the abolished engineering unit staff were redeployed within the company.

MWSS consultants also found that Maynilad purchased 80 percent more computers per employee than Manila Water. The consultants noted in their report that Maynilad bought the computers from IBM France, a company affiliated with Suez.

Dumol, one of the architects of the MWSS privatization in the mid 1990s, believes the worries about transfer pricing are entirely justified.

“If I can rewrite the privatization rules, I would put in tougher provisions against shareholder-related companies, especially the foreign partners, making a quick buck from transactions with the local concessionaire company,” he said.

Dumol now says that privatization advocates in the 1990s may have overstated the need for international water to run privatized water systems.

“They’re good with ideas on how to deal with emergencies, such as coping with the severe drought in 1998, but when it comes to day-to-day operations, Filipinos can be just as good,” he said in an interview.

Outlook: Balancing service and rates

The private concessionaires last year proposed rate increases in 2003 of between 66 percent and about 100 percent. MWSS regulators, fearing massive protests over high water rates, cut the approved rate hikes to between 36 percent and 80 percent. They further softened the impact of the rate movements by implementing them over the next four years.

In return for the lower rate increases, the regulators have permitted the water companies to reduce service targets.

Water operators are practically abandoning the target to achieve a 16-pounds-per–square-inch (psi) level of water pressure at the tap and will instead maintain the current level of 7 psi. The relaxation of this target will help them avoid capital investments and also cut water losses.

They are cutting the sewerage targets after realizing that installing large, centralized sewage treatment plants will cost at least 100 billion pesos ($1.8 billion) and result in a 50 percent increase in water rates.

For example, Maynilad Water, prior to its decision to withdraw from the concession, wanted to reduce the 2021 sewerage coverage target of 66 percent to only 31 percent, while Manila Water will lower its 55 percent target to below 15 percent.

Fiorella Delos Reyes Fabella, chief of Manila Water’s wastewater project management office, estimated that the company would require about 50 billion pesos ($940 million) in sewage treatment investment to meet the original coverage target of 55 percent. This would push up water rates by 10 pesos per cubic meter, more than doubling its current rate of 6.75 pesos (12 cents).

“That is impossible. Nobody will accept that,” she said.

MWSS regulators agree that people either have to pay higher rates or accept poorer service.

“You want water pressure that will reach the third floor, but you don’t want to pay,” said Ed Santos, the acting chief regulator. “Maybe only a few, the rich, want that criteria. But we have to think of the poor people.”

Dissatisfaction with privatization, said the World Bank’s Varma, is caused only by high expectations. The companies are to blame, he added, for “over-marketing the deal.”