Politicized
FIRST PERSON - Alex Magno (The Philippine Star) - December 7, 2019 - 12:00am

President Rodrigo Duterte should pipe down and think through the complex consequences of what he threatens to do with the water concession contracts. Over the long term, what he intends to do will cause the economy more harm than good.

Last Tuesday, the President went into a furious rant over what he sees as defective contracts handed out to the water concessionaires. He overstated his case. He should listen less to the populists and consult more with the economists.

If the populists had their way, they would want water tariffs priced as close to zero as possible. These are incurable free-riders who think nothing about the realities of financing costs, business continuity and shareholder interests. If we do not deal with these things properly, the whole water distribution system will have to run on subsidies that the public sector can ill afford.

What set off the President, apparently, was the decision handed down by the international arbitration court commanding the Philippine government to pay Manila Water over P7 billion for reneging on the provisions of the concession contract. Maynilad earlier won its arbitration case where government was ordered to pay the concessionaire over P3 billion for the same reasons.

When the President ranted about the concessionaires turning a profit, he forgot that they were businesses. The concessionaires are now making only a little over seven percent from their huge investments. That is barely above fixed income investments. If they took their capital out of this highly regulated business and invested it elsewhere, they could make at least double the returns.

It is easy to demonize large corporations and, in doing so, overlook that some of them are actually in a business with lower returns on investment for patriotic reasons.

The day after the President ranted about the water concessionaires, their stock prices dropped substantially. Sometimes we forget that these corporations are actually listed companies reliant on the confidence of a large number of small investors in the viability of their businesses.

I recall a conversation I had with a technical adviser to one of the concessionaires. He recounted how he advised his principals to think about moving out of the water distribution business and investing their capital elsewhere. The water business is too politicized, he said. That makes observance of the terms of the concession contract vulnerable to political agitation.

True enough, both concessionaires had to run to the arbitration court to force government to observe the terms of the contract. Because the concessions are highly regulated, the concessionaires do not actually work to profit. They get what is called an “appropriate discount rate” (ADR) that is to be determined every five years. In the first years of privatization, the ADR stood at about 10.4%. The past few years, it has gone down to P7.39%.

If the concessionaires were not getting enough of a return, they would run into trouble with the banks that lend them money to invest in better distribution and the construction of a functioning sewerage for this overcrowded metropolis. Capital will dry up. Service will deteriorate.

When the President threatened to abrogate the concession contracts and rewrite them midstream, this sent worst signals to the investment community. Remember that among the major reasons we are not getting as much investments as the other economies in the region is the perception that contracts in this country are unreliable. Policy is constantly shifting. Large investments require long-term predictability.

Should the President rewrite the contracts in such a way that they make returns on investments unlikely, the concessionaires could cut losses by handing the concessions back to government. That will bring all of us back to the morbid conditions that forced us to privatize in the first place.

When government ran water distribution, water in the taps was unreliable to say the least. Many communities relied on water deliveries that cost many times more than the price of water that came through the taps. But there was no water coming through the taps.

In those bad old days, well over half of what was pumped out was “non-revenue water” --- water lost to illegal connections and to leakages in the antiquated pipe system. Government heavily subsidized what was then called the National Waterworks and Sewerage Authority (Nawasa) but there was little water delivered and no sewerage service provided.

The first task of the concessionaires was to bring down the non-revenue water rate by providing water meters even to informal settlers and by replacing the badly damaged pipes (a lot of which of pre-war vintage). The undertaking required hundreds of billions in investment that was raised through borrowing and through market capitalization (selling stocks to the public).

This first task was especially challenging for the west zone where the engineering maps were destroyed during the war. It was a severe test of corporate capacity. The Lopez group gave up Maynilad and the concession was re-awarded to the consortium made up of Metro Pacific and DMCI. 

The future is not very bright for the water distribution business. Since government neglected building new raw water sources, we are looking at shortages in the foreseeable future. There will not be enough water for the concessionaires to sell. Populist agitation is bound to intensify, making the business more prone to politicization.

If the concession contracts are cancelled arbitrarily, there will be panic in the business community. All the gains we made improving the ease of doing business will be cancelled.

Instead of terrorizing the concessions, it will be more constructive to work with them for better outcomes.

RODRIGO ROA DUTERTE
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