Indonesia: Privatization of Jakarta water: How far can it go?
Both private firms in the Jakarta Water Services concession contract, TPJ and PALYJA, have failed to meet the investment levels required by their coverage ratio targets.
The fact is not only that the targets have been missed in Jakarta, but also that a similar trend has occurred in other Indonesian cities where water is not privatized, such as Surabaya and Malang, the two biggest cities in East Java.
Likewise, the examples of Brazil, Argentina and Bolivia show that in some cities private sector involvement has indeed increased coverage ratios. But at the same time, coverage ratios have also increased in Latin American cities without any private sector involvement.
Developing-nation cities, such as in the Dolphin Coast and Nelspruit in South Africa, Kelantan State in Malaysia, and Manila in the Philippines, have also witnessed the failure of private companies to meet investment targets. Aguas, a SUEZ-led local firm in Buenos Aires, Argentina, has also been guilty of under-capitalization.
Comparing customer growth before and after the privatization of Jakarta’s water supplies also supports the argument that it has been a failure. Average annual customer growth before privatization (in the years 1988 to 1997) was 11.68 percent, or 31,246 customers. After privatization, growth in the years leading up to 2005 dropped to about 5.61 percent. Consequently, as of 2005, around 41.89 percent of Jakarta’s population was without piped water.
Scholars tend to pin privatization’s failure on the inability of the government — and its regulatory framework — to provide sufficient incentives and to minimize the risks for private firms. Little attention has been devoted to providing a more balanced perspective by investigating the failures of private firms using behavioral analysis.
In the case of Jakarta’s water privatization, water charge mechanisms and price setting are the most important components of the existing regulatory framework. Both components provide sufficient incentives that should be able to stimulate firms to invest.
Although the real tariff did not always increase as scheduled, the cumulative (total) real tariff increase for the period between 1998 and 2005 was 154.95 percent. That was higher than the water charge target (125.75 percent), and higher than the scheduled tariff (138.54 percent). This reflects government commitment to providing an adequate tariff level for private firms.
The rate-of-return regulation — with a fixed 22 percent annual rate — places the risks of macroeconomic fluctuations mostly on PAM Jaya and its customers through, respectively, increased shortfalls and price hikes. Local financial markets also provide secure and sufficient external financing sources, as witnessed by PALYJA’s successful Rp 650 billion bond issue in 2005.
Similarly, risk expropriation is less likely to occur given that, politically and legally, the Indonesian government introduced its water privatization agenda via the national law on water resources (Law No.7/2004). The national infrastructure development policy also includes options for private firms to finance water infrastructure development.
Given that the Jakarta water firms face minimal risks, and have been provided with security and sufficient incentives, we have to ask why private firms keep underinvesting.
Considering the nature their contracts, it is difficult for the contracting parties to specify every ex post facto contingency. Consequently, continuous negotiations on the making of adjustments following unexpected ex post facto events, and haggling over disagreements, leads to rampant uncertainty. This means that private firms eventually prefer to hold back investment until they see a potential gain, rather than complying with the requirement for greater investment contained in their coverage ratio targets.
The combination of incomplete contracts and asymmetric information provides the opportunity for private firms to bargain for more favorable regulations, for example, by threatening to pull out or reduce scheduled investments.
Furthermore, the poorly defined right to determine tariffs has resulted in the parties who bear the costs (PALYJA and TPJ) not being the same parties as those who decide the real tariffs (the government and parliament).
This situation has to potential to prolong a problematic situation. It means that investment decisions that depend heavily on market-based calculations and predictions are not supported by the tariff-setting mechanisms since these are mostly made outside the market. Eventually, underinvestment problems become inevitable.
Unfortunately, due to the fact that water is a natural monopoly, it is clear that the right to set prices cannot be fully surrendered to private firms. Even in developed countries, such as the UK, there are price-cap regulations under which tariffs are determined by OFWAT (an independent regulatory body for the water industry).
Economic crises affect not only private firms’ service-provision capabilities (on the supply side), but also hit the affordability of water (on the demand side). However, after macroeconomic conditions stabilized in 2000, the private firms’ investment has stayed under the target levels.
Thus, the regulators must not only focus on providing incentives and minimizing risks, but must also be aware of private firms’ investment behavior in terms of failing to fulfill contracts, costly transactions, influential macroeconomic circumstances and global trends in the water business.
Source: Jakarta Post
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