Saving Utilities During

the Asian Financial Crisis

By Bennett Parton
Chief-of-Party
Local Government Water Services Project
USAID

Introduction

In the summer of 1997, the Thai Baht came under attack from speculators. This sharp fall in the value of the Baht was to have dire consequences for all currencies and governments in the region. Very few currencies were spared this devastating fall. Probably the hardest hit of the currencies was the Indonesian Rupiah. While the drop did not start until more than three months after the Baht, its fall was precipitous. With an exchange rate to the US dollar of approximately Rp 2,500 in mid-1997, it fell to over Rp 17,000 in January 1998. The consequences would lead to the fall of the Soeharto led government in May 1998.

In the meantime, costs for all commodities in Indonesia were rising out of control. Official inflation rates in 1998 exceeded 100%. Banks suddenly were faced with a mountain of uncollectible loans. Businesses went bankrupt and banks became insolvent as the local currency was converted into dollars to stave off the disastrous effects of the currency devaluation. With rising prices, mounting job losses and an unstable political environment, the IMF was called in to assist Indonesia find a solution to this seemingly intractable problem.

The United States Agency for International Development (USAID) had been assisting the Government of Indonesia for many years. One of its programs, known as the PURSE Project, was assisting local water utilities (PDAMs) find suitable private sector partners to provide alternative funding for much needed new infrastructure. Although the project had some notable successes, such as the Jakarta water supply concession, it was unable to assist in closing on a number of projects that were much needed. The inability to close on transactions was attributable to inappropriate expectations and misunderstandings in the needs of private sector for complex financing arrangements as well as a high degree of corruption. Faced with the increasing uncertainty in political, social and financial conditions within the country, USAID was considering closing the project.

However, the National Development Planning Agency of Indonesia (Bappenas) approached USAID with a plan. Their goal was to find a way out of the problem by focusing on providing temporary assistance to PDAMs that were facing the immediate threat of bankruptcy. Almost all PDAMs were seeking immediate price increases for needed chemicals, electricity, spare parts and replacement supplies. Without immediate assistance, many of the PDAMs would be forced to close their doors at worst or at best curtail the hours of supply to minimize costs.

With extensive experience in assisting PDAMs, Bappenas suggested that the members of the PURSE Project would be well suited to provide this temporary assistance. With only limited amounts of funding and only one full time expatriate advisor, USAID established the Water Efficiency Team known as WET. WET's mandate was to determine the reasons for the PDAMs insolvency and suggest immediate measures that could keep the "water flowing" to the millions of Indonesians who relied on PDAMs for their daily water needs. This process led to a reform movement in water supply that will likely have very positive benefits for all citizens of Indonesia and more particularly, the millions of poor people.

The WET Project

The WET Project team began its program by developing a management audit procedure that included reviews of internal controls, coverage and demand, asset utilization, water technology, debts, tariff policy, management capability and PDAM financial condition. The consultants developed these audit programs for guidance but included sufficient flexibility to examine any and all areas of PDAM management appropriate under the circumstances.

The team's initial field visits included 12 PDAMs for review and examination. In approximately a two-year period, the WET team visited 56 PDAMs scattered throughout Indonesia as far west as Banda Aceh and east to Jayapura. By examining almost 20% of PDAMs in Indonesia, the WET team was able to draw a picture of consistent mismanagement of its water supply. Worse still, water was more likely to be used by the rich and the middle class rather than the poor.

Some of the findings were shocking. For example, in one Regency WET visited, levels of fecal colliform were beyond measurable limits. In another Regency, unaccounted for water exceeded 70% of the supply distributed. In still another Regency, staff wages had not been paid for over three months. It was clear that changes had to be made.

Within the WET team's review, it was clear that price increases had only a minor effect on the current circumstances. There was plenty of supply but only limited numbers of connections. Emphasis in the past on building new treatment capacity without building distribution systems and new connections made it impossible for the PDAMs to repay debts incurred to acquire the new assets. What supply was distributed was often lost through poor maintenance, leakage and illegal connections.

Clearly the problem was management. A major issue was that PDAM Directors were not necessarily water professionals but political appointees whose allegiance was not necessarily to the PDAM but to the politicians who were instrumental in their appointment. Staff ratios far exceeded levels needed to operate their organizations. Many of the people hired were at the request of the politicians who helped select the new directors. The nepotism and cronyism was strangling the resources that were critically needed by the PDAMs to fulfill their mandate.

Finally, approval for tariff increases was a consequence of a political process and not a regulatory or economic process. Local assemblies were required to approve tariff increases. Unfortunately, none of the members of the assemblies had the capability to regulate tariffs. While they demanded increased coverage they would not supply the PDAM with sufficient resources to accomplish this. This vicious cycle was compounded by the inability of PDAM Directors to clearly articulate a plan to meet consumer needs and increase the productivity of the operations to achieve this coverage.

The result was that the Central Government, who with the cooperation of multilateral lenders, had lent millions of dollars to the PDAMs and local governments and were unable to collect any debt repayments. The Ministry of Finance was looking for solutions. WET formulated a recovery plan that it provided to the World Bank, the Asian Development Bank, and the Ministry of Finance.

WET's proposal was to work with a number of PDAMs to assist them prepare "work-out" plans that focused on utilizing excess capacity, reducing water losses, increasing productivity, reducing staffing ratios and enacting tariff increases consistent with these plans. Two initial areas of concern arose from our findings. First, many parties were concerned that tariff increases would most severely affect those least able to afford it, namely the poor and indigent. The second source of concern was reducing staff ratios. Many people pointed out that at a time when job losses were exacting a very heavy toll on Indonesia, it would be unconscionable to recommend cutting staff.

As a result of theses concerns, WET tailored its plans to allow for phased in tariff increases and hiring freezes to avoid layoffs. The hiring freezes allowed for reductions in staff ratios as new connections were added.

The idea of developing a "work-out" plan was initially met with skepticism. However, as the project progressed with dramatic results it soon became a universally accepted practice. The Ministry of Home Affairs issued a decree to provide guidance in developing and preparing what they called Corporate Plans. In essence, this introduced the same guide to all PDAMs as proposed by WET.

However, in working discussions with USAID and Bappenas it became abundantly clear that there were some missing elements. In order for the new planning capability to be effective, staff at each PDAM needed new skills to become true water supply professionals. Directors needed to be professionals who understood their business and would promote policies that ensure their PDAM would become profitable and could invest in new needed supply. Furthermore, employee incentives needed to be developed for employees to remain honest, to seek advancement and provide better service to their communities. Finally, there needed to be an increased focus on customer service.

Local Government Water Services Project (LGWS)

In 2001 USAID developed a project know as the Local Government Water Services Project (LGWS) (www.lgws.or.id). In October 2001, LGWS began assisting 12 PDAMs develop their Corporate Plan. The plan's emphasis was aimed at supporting and encouraging greater efforts at customer service. To that end, a Customer Satisfaction Survey was used to determine consumer attitudes toward each PDAM. The consultants carefully trained PDAM personnel and enumerators on how to conduct and analyze results. The customer service focus led to important findings and improvements in performance.

In addition, changing incentive structures gave a new sense of purpose to employees of PDAMs. They no longer viewed themselves as powerless within a huge bureaucracy. Employees were given freedoms and rewards that had never before been envisaged. Managers could now act as business owners with consequent risks and rewards consistent with the best-managed organizations within the country.

Finally, the new philosophy altered the way in which local government perceived each PDAM. Working structures often outside of pure legislative control freed PDAMs to deal directly with their communities. This in turn took the burden of approval for tariff increases off the shoulders of political forces and placed them in the hands of the people.

Needless to say the results have been dramatic. In the first two years of LGWS assistance, 9 of the 18-assisted PDAM have turned a profit after being near bankruptcy a few short years ago. Over 350,000 people now have access to clean water that did not only two years ago.

Bappenas has written to USAID to express their appreciation. Mr. Suyono Dikun the Deputy Minister for Infrastructure of Bappenas states: "Based on responses from local governments, we believe that the LGWS Project is the government's most successful project in water supply." Mr. Dikun goes on to say, "This is the only project that has gone into the heart of water problems in Local Water Enterprises and has produced tangible and useful results."

Praise for LGWS has also come from the World Bank's Water and Sanitation Program. Mr. Richard Pollard the Regional Team Leader for East Asia and the Pacific states, "of the many activities aimed at supporting PDAM, very few have made a sustained impact. LGWS is one of those few and is often raised as an example in Working Group discussions on PDAM reform."

While praise has come from many sources, individual successes speak much louder than words. Three communities in particular have seen exceptional benefits as a result of the cooperation between LGWS and local managers. These local managers have been able to use their initiative to create innovative solutions and ideas to improve their service in each community. In addition, each PDAM is now financially healthy, each turning a profit and using generated cash flows to increase coverage, improve maintenance and provide increased incentives for their employees.

Case Review: PDAM Jember

At PDAM Jember in East Java, WET's initial foray found morale at a startling low. Protests by staff and customers were a regular feature. WET first suggested to local government that a local professional manager was needed rather than the existing group of directors. With the selection of a team of managers drawn from the PDAM the morale of staff suddenly shifted. These highly capable managers started making dramatic changes to improve customer service. The first change that they made was to form a partnership with PT Telcom, the local telephone company, and three local banks. PDAM Jember changed its billing procedure from a system of printed invoices to an electronic system that allows the customer to telephone the PDAM, dial in his five digit customer number and immediately get his outstanding balance. Once having obtained this, the customer could now go directly to one of the three banks and make a direct payment from his bank account to PDAM Jember. This system eliminated customers waiting in line to get an invoice and then wait in another line to pay the bill. Customer reaction has been so positive that PT Telcom and PT PLN (the electricity company) have joined forces to create a new prepaid system known as Telisa. The improved cash flow to the PDAM has been critical for funding operations and new investment.

Jember also knew that their existing supply was insufficient to support the growing needs of their community. While tariff increases went in part to pay for existing operations and improved salaries, PDAM realized that their cash flow must be reinvested in new assets in order to meet community needs. While they sought loans from Central Government they were fearful that the high cost of these loans would make any project potentially unsupportable. Generally, when obtaining Central Government financing, multilateral financing requires pre-feasibility and feasibility studies. Designs must go through a series of approvals all of which add cost and time to the project. In addition, hiring contractors and supervising their work would be out of the hands of the PDAM. PDAM Jember found these conditions unacceptable. They felt that the project needed to be fast-tracked and that since they were to be the ones to both benefit and be at risk, then the PDAM should control the selection of contractors and provide on-site supervision.

With the help of LGWS engineers, PDAM Jember designed a treatment plant in-house. When satisfied with the design, PDAM hired their own contractors and with further assistance from LGWS provided their own on-site supervision. The plant went into operation in early 2003 and PDAM Jember has been able to increase connections by almost 20% since the plant has been operational. The cost of the plant is estimated to be less than half of what it would have cost under a Central Government program.

Case Review: PDAM Banjar

PDAM Banjar, located in the South Kalimantan province, was in dire circumstances when WET first arrived. Its revenues were just sufficient to cover out-of-pocket costs, water was only flowing 12 hours per day and water losses approached 40%. In two years from the arrival of WET and later LGWS, Banjar's operating ratio was a healthy 120% (revenues were 120% of all costs including interest and depreciation).

Upon LGWS' arrival a new PDAM Manager was highly skeptical of what could be achieved with LGWS' help. After 18 months of assistance, that same manager, in meetings with their Mayor and community leaders heaped praise in LGWS saying, "with LGWS' assistance, morale of PDAM staff and our customers has never been higher."

LGWS worked with Banjar to assist them develop a plan to improve service for their community. In particular, the plan detailed steps to be taken to improve the quality and quantity of water distributed to their customers. The plan, however, was dependent on increased revenue from tariff increases. Tariff increases that the PDAMs local assemblies refused to grant.

LGWS, working with PDAM Banjar senior managers, articulated a plan to take the pressure off of the local assembly and place it squarely on the PDAMs shoulder. The PDAM would meet directly with the community to appeal for tariff increases. Those tariff increases would be coupled with major improvements in both the quality and quantity of its water supply. In a series of meetings with university professors and graduate students, community organizations, religious organizations and NGOs, the PDAM accompanied by LGWS, was able to appeal for tariff increases. However, to affect these increases, the PDAM made a "contract" with their community. The contract required the PDAM to implement real changes to improve customer service.

In the months after the tariff increases were awarded, PDAM Banjar invested in improving treatment plant performance to remove impurities from their water supply. Second, they reduced water losses to less than 30% resulting in increased water flows in their system. Finally, they re-designed their billing and collection functions to virtually eliminate long lines and waiting periods. The new measures increased system flows to a 24-hour per day supply. Excess flow was used to support over 1,000 new connections adding further revenue to PDAM coffers. The funds were used to reward staff. Managers agreed to share in the profits that the company made. PDAM staff are now as conscious of the bottom line as their managers. They have been offering ideas for increased efficiency and productivity. More importantly PDAM staff feel empowered where before they only felt frustration.

Case Review: PDAM Banjar Masin

PDAM Banjar Masin turned an Rp 8 billion loss to a Rp 10 billion profit in just two years since the arrive of LGWS. While this improvement was solely attributable to tariff increases, the PDAM is working now to improve its service to its community.

Taking a cue from PDAM Jember, Banjar Masin sent four of their staff to Jember to see how the billing and collection system worked. They are now implementing this easy payment system to their customers on a trial basis. The results have been just as impressive as Jember with improved customer satisfaction and increased cash flow. LGWS introduced this idea in meetings held with the City's Mayor and PDAM Managers.

The PDAM's most important improvement has been reducing its water losses. When LGWS arrived, water losses exceeded 44% of all water produced. With LGWS assistance, PDAM reviewed their water pumping system and found major inefficiencies that caused much of this loss. With the replacement of three of their pumps and introduction of a flow capacitor system water losses were reduced to less than 35% almost immediately. Further reductions are anticipated shortly as other design and system flow corrections are being made. LGWS expects that these changes will add sufficient water into the PDAM's system to allow them at add 11,000 new connections. In the past 12 months alone, 4,000 connections have been added and revenues have continued to climb.

Implications for Public-Private Partnerships (PPP)

One might look at these results and think that water utilities in Indonesia no longer need assistance from the private sector. LGWS believes that with better management, better customer service and improved employee performance, PDAMs throughout Indonesia have now become more creditworthy candidates for partnership with responsible private firms.

To explain this apparent inconsistency we need to look at the results of past "privatizations" in Indonesia and elsewhere.

Privatization in Indonesia has almost exclusively been through private sector concessions to manage and distribute water under agreements drawn up under Central Government prodding. These agreements were suspected of being burdened with corruption and in fact have not demonstrated any greater benefits to those communities where private sector entered. Second, local staffs were discouraged by the constant use of foreigners who were paid ten times the salary of these local staff. Communities saw tariffs increase without their participation in determining how they were to benefit.

Financing for concession projects left many private water companies in a dilemma. Traditional project finance lenders have been unable to formulate a structure that will allow a project company to obtain project finance loans in the traditional sense. Instead, loans must be based upon creditworthy cash flows and have required Corporate guarantees by the parent company. This trend has increased risk and reduced the willingness of companies to enter into new projects. Typical stand-alone project finance structures are not available to concessions.

With improved PDAM management, public-private partnerships become real partnerships. No longer do we need to replace PDAM Managers with foreign managers. No longer do we need to find a skeptical community who do not participate in tariff decisions or benefits. No longer do we need to see staff feeling disenfranchised by foreign and local investors who view them with distrust. Finally we envisage new partnerships that will be based on project finance structures, based on proper planning on the part of both PDAM and private sector.

We believe that as PDAM's improve their management, they will have choices in financing projects. They could try to obtain traditional multilateral loans, find funding through their own cash flow, could borrow from commercial banks or through BOT, ROT, Lease or other structures contract with the private sector without having to spend their current valuable resources.

With creditworthy PDAMs, private sector contractors and lenders would be more favorably inclined to pursue projects. The IFC has had a presence in Indonesia for a very long time. They, however, have found they have been unable to lend to projects due in part to the limited number of project finance opportunities. The IFC, in discussions with LGWS, has come away very pleased that the reform of water enterprises will now offer increased private sector opportunities with both sides better understanding what is required to make a successful project.

Conclusion

In closing, it should be noted that the need for concessions would still remain. Those PDAMs that have been unable to reform could comprise the candidates for these concessions. New projects being developed by the World Bank and the Coordinating Ministry for the Economy and Investment will look at how to promote private sector cooperation. We fully expect a composite of projects will emerge that will promote strong partnership structures with PDAM owning a pivotal role.