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IMPORTANT RISKS ON PUBLIC-PRIVATE PARTNERSHIP SCHEME

IN WATER SUPPLY INVESTMENT IN INDONESIA


Krishna, S. Pribadi
1
and M. Husnullah Pangeran
2



ABSTRACT: In order to achieve the target of the Millennium Development Goals (MDGs) 2015,
which include the improvement of water supply service coverage in Indonesia, investment in
water supply infrastructure need to be increased. On the other hand, Indonesia is faced with its
limited capacity in financing public infrastructure development. Despite government efforts in
encouraging private investment in infrastructure through public-private partnership (PPP) scheme,
private sector involvements in public water supply provision are still low. The major issues
perceived to be the cause of this situation are mostly related to the risk and uncertainty problem
inherent within the framework of a long term PPP contract. It is perceived that the effectiveness in
managing the risks is one of the key success factor of PPP scheme in infrastructure, and in
particular in water supply provision.
The paper tries to explore important risk factors in PPP water supply investment in Indonesia,
through a comprehensive study on the current practices in Indonesia as well as in other places in
the world. It can be said that political uncertainties, regulatory mechanism and other components
of the scheme contributing to the project revenue, in the local as well as global perspective, as the
major risk issues faced by the private sector when they decide to invest in water supply, in
particular in Indonesia. The study shows that exchange rate fluctuations, government controlled
water price and rate of non-revenue water are among the most serious risk factors faced by the
investors. The paper discusses also various possible risk mitigation tools to minimize the risk in
order to improve the willingness of the private sector in the scheme.
Keywords: public private partnership, water supply, important risks, Indonesia.
1. INTRODUCTION
As Indonesia survived the 1998 economic crisis, the government of Indonesia (GoI) is now refocusing
on infrastructure development to support the Millennium Development Goals (MDGs) 2015 target
achievement, which include also the improvement of water supply service coverage in Indonesia. A
massive investment in water supply infrastructure, estimated at approximately Rp. 43 trillions (PU
Cipta Karya, 2006), is launched to ensure that the coverage of drinking water services to the wide
communities is increased from 29 to 69 percent in 2015.
However, like many other developing countries around the world, the GoI is facing the limitation of
fiscal capacity to finance the infrastructure provision. Infrastructure development were traditionally
financed by the government funding originating from taxes, foreign loans or grants, but the recent
devolution of responsibility and authority to the local governments has severely limited the fiscal
capacity of most municipalities to effectively deliver adequate services. The situation has forced the
government to look for new funding methods and sources, which include public private partnership
(PPP) scheme to finance the planning, design, construction, operation and maintenance of public
infrastructure. PU Cipta Karya (2006) illustrates that if 70 percent of the required investment is
contributed by the private sector, until 2015 it will require private sector investment of around Rp. 30
Trillions (equivalent to $US 30 Billions).

1
Associate Professor, Construction Engineering and Management Division, Faculty of Civil Engineering and Environment,
Bandung Institute of Technology
2
Doctoral Student, Construction Engineering and Management Division, Faculty of Civil Engineering and Environment,
Bandung Institute of Technology
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The GoI has passed the Presidential Regulation No. 67/2005 concerning Cooperation Between the
Government and Business Entities in Infrastructure Provision (the New PPP Regulation) in
November 2005, which revoked the previous PPP law, Presidential Decree No. 7/1998. One of the key
points of the Regulation is dealing with risk management and government support for infrastructure
projects. It sets out the general principle that project risks will be allocated between the GoI and
investors based on which party is capable of best managing and controlling such risk. In particular, to
encourage private sector involvement in water supply provision, several related laws and regulations
have been revised and launched, i.e. Law No. 7/2004 Water Resources; and Government Regulation
No. 16/2005 the Development of Drinking Water System Provision. The GoI has also initiated the
Indonesia Infrastructure Summit (IIS) in 2005 followed by the Indonesia Infrastructure Exhibition
(IIE) in 2006, both are forum for promoting infrastructure investment, which include water supply
projects (20 in IIS 2005 and 3 in IIE 2006), to the private sector.
Despite the government efforts, only few private sector investments are involved in public water
supply provision. According to Kodri (2007), up to now only ten existing PPP projects have been
implemented, which are not significant compared to hundreds of existing PDAMs (local potable water
company) over the country (see Table 1).
Table 1. Existing PPP Activities in the Indonesian Water Supply Sector
Location Type of PPP Investor Investment (US$ Million)
J akarta 2 Concessions Lyonnaise +Thames 2 x 225
Medan BOT - Bulk Water; 500 l/s Lyonnaise 5
Batam Concession Cascal / Biwater 100
Tangerang J O, Bulk water; 3.000 l/s Tirta Cisadane n.a
Cikarang BOO - Bulk water; 150 l/s PT Bukit Indah 10
Bali, Nusa Dua BOT - Denpasar; 300 l/s PT Tirta Artha Buana 10
Bekasi BOT - Bulk Water; 50 l/s PT Kemang Pratama 10
Palembang Concession PT Bangun Cipta S. 5
J ambi BOT - Bulk Water; 200 l/s PT Noviantema 2
Pekanbaru BOT - Bulk Water; 600 l/s PT DAPENMA 10
In general, the major issues perceived to be the cause of this situation are mostly related to the risk and
uncertainty problem inherent within the framework of a long term PPP contract. It is perceived that the
effectiveness in managing the risks is one of the key success factors of PPP scheme in infrastructure,
and in particular in water supply provision. As the objective of project risk management is to identify
and manage significant risks, the paper tries to explore important risk factors in PPP water supply
investment in Indonesia, through a comprehensive study on the current practices in Indonesia as well
as on recent international experiences. Potential issues, challenges and lessons that may contribute in
developing water supply PPP projects in Indonesia are identified.
2. THE NATURE OF PPP IN THE WATER SUPPLY INDUSTRY
Involving the private sector in the water supply provision has been currently become a global trend.
Leman (1996) indicates that PPP is emergent as a viable strategy for water supply infrastructure,
where private companies bring managerial skills, new technologies and higher efficiency in the
delivery of treated water, new investment capital, and a responsive attitude to shifting market
demands. Although the terms PPP and privatization are often used interchangeably, they are not the
same (Water Partnership Council, 2003). Privatization involves the sale or transfer of ownership of
public assets to the private sector, whereas under PPP schemes, the public partner still owns the assets,
controls the management of the assets and establishes user rates. However, PPP is commonly
described as a long-term partnership in which there are key contractual arrangements between various
public bodies and private business entities, for the purpose of designing, planning, constructing,
financing and/or operating an infrastructure project.
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As an entity of physical and non physical systems, water infrastructure and facilities can be realized
under any possible form of partnership scheme. The contract may include different scope of services,
ranging from the provision of raw-water intake, water-treatment, transmission and distribution up to
revenue collecting service. The arrangement options are quite broad and involve a continuum of
options ranging from a relatively low level up to high level PPP, such as service contract, management
contract, leasing contract, BOT contract, concession contract, and divestiture under license or new
entry of private sector participants through a BOO arrangement (World Bank, 1997; Asian
Development Bank, 2000).
Service contract is the option where the private sector performs a specific operational service for a fee,
i.e. meter reading, billing and collection. Management contract is used when the private sector is paid
a fee for operating and maintaining a government-owned business and making management decisions.
Lease contract allows private sector to lease the facilities and responsible for operation and
maintenance. On the other hand, BOT and concession contract is more complex. Bennet, et.al. (1999)
stated that the Build-operate-transfer (BOT) contracts are designed to bring private investment into the
construction of new infrastructure. The private sector finances, builds and operates a new
infrastructure facility or system according to the performance standards set by the government. The
operations period is long enough to allow the private company to pay off the construction costs and
realize a profit, typically 10 to 20 years. The government retains ownership of the infrastructure
facilities and becomes both the customer and the regulator of the service. BOT contract is generally
issued by governments for the construction of specific facilities, such as bulk supply reservoirs, water
treatment plants. BOT typically involve the construction and operation of only one facility and not the
entire system. At the high spectrum, under concession contract, the government awards the private
partner (concessionaire) full responsibility to delivery infrastructure services in a specified area,
including all related operation, maintenance, collections and management activities. The
concessionaire is responsible for any capital investments required to build, upgrade, or expand the
system, and for financing those investments out of the tariffs paid by the users. The public sector is
responsible for establishing performance standards and ensuring that the concessionaire meets them.
International experience shows that different countries have adopted different options for PPP.
Ouyahia (2006) stated that there are two main models available in the water supply sector i.e. the
English model of full privatization where ownership and management are private, and the French
model of delegated management (lease and concession contracts) where the ownership is in public
hands and the management is a mix of public and private system. Management and BOT contracts are
usually of French type. The World Bank data for water sector projects initiated in developing
countries during 1990-2001 (Baumert and Bloodgood, 2004) shows that from 203 PPP contracts
included in the database, concessions accounted for 44 percent, followed by BOT greenfield project 28
percent, management contract and leases 20 percent and privatization or divestitures 8 percent. It
indicates that PPP in water infrastructure in most countries exists and concession contract is preferable
in order to improve the existing facility.
However, despite its benefit to the public sector, international experiences have shown that there are
many issues affecting the successful implementation of PPP scheme. Private water infrastructure
projects in developing countries were increasing in the 1990s with a peak in 1997, but declining since
1999. Although the annual investment grew by 36 percent in 2004, in recent years it is evident that the
private activities have slowed. Private investors are increasingly becoming more selective in choosing
where to invest and are more concentrating on the higher end of emerging markets. Marine and
Izaguirre (2006) indicate that risks in the water supply sector are driving changes in the profile of
private projects. Only water projects with sound project finance structure allowing attractive cash
flows and risk profiles can secure long-term private capital. Direct link between project cash flow and
its funding should be provided to give project sponsors, investors, and lenders strong incentives to
ensure that projects are structured and operated to generate stable revenue streams.
In addition, Haarmeyer and Mody (1997) argued that financing water and sanitation projects has been
a special challenge because of their unique risks: (i) Expensive to transport but cheap to store, water is
essentially a local service and subject to control by local government, which can be more politicized
and have weaker credit than state or federal government; (ii) Most of the assets are underground, their
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condition is hard to assess, which makes investment planning difficult, posing risks for contract
renegotiations; (iii) Inadequate provision is associated with health and environmental risks, so
government has a strong interest in extending access to service, regardless of ability to pay; and (iv)
Significant currency risk arises because customers pay in domestic currency that does not match the
currency of international debt and equity financing.
The nature of PPP in infrastructure projects, including water supply sector, is characterized by the
sharing of investment risks, responsibilities and rewards between the public and private partners. They
have been widely discussed by many researchers. Zhang (2005) stated that the various problems and
even failures of PPP projects are caused by the broad range of risks and uncertainties in long-term PPP
contract, whereas the appropriate risk allocation is one of critical success factors of such project. Kwak
(2002) indicates that various risks or uncertainties are the main causes of failure or cancellation of PPP
projects in Asian countries. Therefore risk management process, which include identification, analysis,
mitigation and allocation of risk, is crucial to the planning and success of every PPP project, in other
word, risk transfer and allocation is the heart of PPP.
3. IMPORTANT RISKS IN INDONESIAS WATER SUPPLY INVESTMENT
As there are many uncertainties which can be identified as risk factors in PPP projects, a
comprehensive risk identification as one of key steps in risk management process must be conducted
in order to find what risks are important and to be prioritized by project stakeholders. In the context
of water supply investment through PPP schemes in Indonesia, Pribadi, et.al (2006) has identified a
number of potential risks factors, shown in Table 2 which summarizes them from various related
sources, i.e. World Bank (1997), Asian Development Bank (2002), etc.
Table 1. Potential risk factors relevant to water supply concession
No Type of Risk Source of Risk
R01 Design/Development Risk Defect in tender specifications
R02 Cost overrun Inefficient work practices and wastage of materials
R03 Delay in completion
Lack of coordination of contractors, failure to obtain standard planning
approvals, failure to grant contractual land use rights or rights of way
R04 Failure to meet performance criteria Quality shortfall/defects in construction
R05 Raw/bulk water quantity Poorly defined rights to water
R06 Raw/bulk water quality Potential for pollution and salinity upstream
R07 Operating cost overrun
Unexpected breakdown, Industrial relations-friction caused by staff
reductions, Change to license conditions
R08 Interruption in operation Operator fault, Interrupted electricity supply
R09
Shortfall in service quality &
quantity
Operator fault
R10 Operating cost overrun Increase in bulk water charges, Operator failure
R11 Non revenue water Increase in non revenue water (operator fault)
R12 Change in tariff rates. Increase in water charges not accepted by regulator
R13 Water demand Level of water demand within the concession area
R14 Exchange rate Exchange rate fluctuations
R15 Foreign exchange Nonconvertibility or nontransferability
R16 Interest rates Fluctuation in interest rates
R17 Force Majeure Floods, earthquake, riots
R18 Change in Government Unexpected change to contract
R19 Political interference Cancellation of license, Restrictions on overseas remittance
R20 Legal and regulatory Changes in tax law, customs practices, environmental standards
R21 Institutional legal Risks Complex Government bureaucracy
R22 Insurance risk Uninsured loss or damage to project facilities
R23 Environmental Risks Site remediation, pollution/discharge, Pre-existing liability
Source: Pribadi et.al (2006); Note: R1, R2...etc is risk number and not its ranking.
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A survey conducted in the study found that the non revenue water (NRW), rate of tariff changes, and
foreign exchange fluctuation are the important risks factors which have mostly influencing the
attractiveness of PPP concession contract investment in water supply in Indonesia. In a broader sense,
those findings are generally in line with the factual condition of both local and global perception. For
example, Chereer, et.al (2005), in their report as post-IIS-2005 recommendation for Europe investors,
addressed the following issues on water supply sector:
The Water Resources Law stresses a comprehensive approach to water management, but it is
not clear how this will impact municipal water management which is presently fragmented;
Most PDAMs are neither financially nor organizationally ready or open even in principle for
genuine public-private partnerships;
The pay-back of most water infrastructure investments is very uncertain due to the financial
condition of most PDAMs, but also due to the absence of independent arbitration mechanisms
in relation to tariff setting and for attributing responsibility in case of service failure;
Due to the weak credit worthiness of PDAMs but also of local administrations (which cannot
give viable multi-year commitments), the guarantees on repayments are likely to be more
political than strictly financial;
All revenue is in local currency.
3.1. Non Revenue Water Related Risks
Water tariff has been acknowledged as a guarantee of projects revenue. However, insufficient
investment payback is most probably contributed by the high non-revenue (NRW) level in many local
potable water companies (PDAMs). According to International Water Association (IWA) definition
(McIntosh, 2003), NRW is the difference between system input volume and billed authorized
consumption, and it consists of unbilled authorized consumption (usually a minor component of water
balance), apparent losses, and real losses. In case of Indonesia, based on a sample of 68 PDAMs,
PERPAMSI (The National Association of Potable Water Companies) has estimated that the average
NRW is 44%, with a standard deviation of 17%, again suggesting a wide variation in operational
performance (World Bank, 2004). The problems are not only limited to physical assets, but also a
great deal of leakage and informal payment which occurs in the large market of unrecognized on-
selling and a lack of control over the non-connection water provision. It can be said that if the entire
NRW can be completely eliminated, which is unlikely, the PDAMs can absolutely increase their
income by more than 40% at the current prevailing water tariffs.
However, the varying NRW performance, as showed by the large standard deviation, is a sign that
there is an opportunity for prospective private investors. The rationale is that by involving private
sector investment, improvement was already seen in terms of the lower tariffs and the general
perception of the consumers of better service and availability of water. However, in several cases of
PPP scheme in Indonesia (i.e. J akarta), the NRW issue is still a problem (51%) and concessionaires are
still addressing losses from both commercial pilferage and leakage. NRW problem is also experienced
in most Asian cities developing PPP schemes (Asian Development Bank, 2004), such as Manila
(62%), Colombo (55%), Delhi (53%). The data indicates that the operational efficiencies of the water
supply systems need to be improved, and the level of NRW should be significantly reduced from their
current high levels, for both existing and new projects.
Technically reducing NRW is not difficult. McIntosh (2003) has addressed some prospective
solutions: (i) Governance and tariffs must be tackled first; (ii) Leak detection equipment comes last,
not first; (iii) Repair visible leaks; (iv) Make utility staff responsible for small zones (caretakers); (v)
Meter all production and consumption properly; (vi) Add district metering; (vii) Provide incentives for
utility staff performance; (ix) Explore links to water vendors. It is, however, challenging in a
governance sense, as illegal connections can only be eliminated when utilities have autonomy and
discipline, and when they are accountable to regulators and the public. In addition, utility employees
need genuine incentives to do their jobs and replace the incentives they have made for themselves
through illegal connections, false meter reading, etc. Finally, reducing commercial losses will help in
improving the revenue stream almost immediately.
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3.2. Change in Tariff Rates Related Risks
A sufficient level of tariff is essential for sustaining infrastructure services. However, water tariff is
still remaining a critical issue in nearly all developing countries, notwithstanding the evidence that in
most cases people have been willing to pay for water supply above existing tariff levels and that tariff
can be structured to appropriately blend equity and efficiency objectives. The difficulty has been that
there is general political resistance to tariff increases and to maintaining tariff levels in real terms. The
tariff structure should be sufficient to cover operation and maintenance (O&M) costs, enable debt
servicing, and support development plans while at the same time providing low lifeline rates for low
consumption and a penalty rate for high consumption. McIntosh (2003) stated that an experience in
developing countries showed that increasing tariff and improving billing and collection cannot be
achieved solely through loan covenants.
In seeking to attract private investment in water supply infrastructure, it is a must to understand
investors expectations and concerns. Infrastructure investment is characterized by large and lumpy
initial investments with correspondingly long pay-back periods. Despite the realization that tariff is a
main guarantee to the return of the investment, tariff increases are generally socially sensitive. As
quoted from World Bank (2004) report, Indonesias infrastructure sectors are unattractive for many
investors because risks are perceived to be too high, and the underlying causes for this include
regulatory arrangements and tariff policies which are not conducive to private investment.
The final decision to increase the water tariff in Indonesia is primarily political considerations, rather
than technical and financial requirements, and as a consequence, tariff increase requested by operator
may or may not be considered and approved by (local) politicians (DPRD-local parliament). In current
regulations, PDAM tariff structures are usually based on the rising block tariff systems in which high-
consumption customers cross-subsidize the low-consumption, -normally poorer, customers. As quoted
from World Bank (2004), a report from PERPAMSI indicates that most PDAMs have negative
profitability and nearly half of them charge tariffs below the cost of O&M, making network expansion
too difficult. Therefore, the reform of regulation for mechanism of automatic tariff adjustment is
important. In England and Wales, five-year tariff adjustment process by independent regulator has
been practiced as one of mechanisms to mitigate uncertainty in tariff changes (Haarmeyer and Mody,
1998). However, it is important to implement a set of tariff reforms which is clearly articulating
consumers need and addressing consequent social and distributional impacts, in a clear and
transparent way. From the writer perspective, the PPP project should emphasize performance based
contract where tariff increases must ensure that the private sector will mobilize not only funding, but
also their managerial skill, expertise and technology to improve operational efficiencies of the
infrastructure.
3.3. Exchange Rate Fluctuation Related Risks
Exchange rate risk exists where project revenues and costs are denominated in different currencies.
Matsukawa, et.al (2003) stated that exchange rate naturally has an upside as well as a downside risk,
but the experiences of most developing countries have been the local currency depreciation against
more stable industrialized country currencies. The real impact of this risk can be viewed in the past
1997 Asian crisis. As a result of the crisis, many Indonesian PDAMs suffered serious financial
difficulties due to the depreciation of the local currency. The projects typically generate revenues in
local currency, while their financing costs and fuel costs are denominated in U.S. dollars or other hard
currencies. Depreciation in the exchange rate can therefore result in revenues that are insufficient to
cover costs. The sharp decline of Rupiah has pushed many PDAMs to the verge of bankruptcy as the
crisis aggravated weak management, poor financial discipline, and deteriorating network systems.
In case of water supply project, Haarmeyer and Mody (1998), Matsukawa, et.al (2003) have discussed
the use of indexed tariff and escrow account to mitigate this risk. For simplicity, indexed tariff
represents a long-term contract for the sale of output from water treatment facilities and regulatory
agreement that determine water distribution prices generally provides a mechanism for adjusting tariff
on a periodic basis. In some instances the tariff may be adjusted by a single index (e.g., the foreign
exchange rate or local inflation). Escrow accounts are funded from a portion of the proceeds of the
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projects senior debt and constitute a self-insurance. The amount placed in a debt service reserve
account is typically equal to six months debt service (normally, the largest amount of interest and
principal to be paid in any semi-annual period). Debt service reserve accounts are drawn upon to cover
debt service shortfalls and therefore are exposed to all project risks, including the risk of adverse
exchange rate movements.
At last, McIntosh (2003) suggests several key points as lessons learned from PPP in water supply in
several Asian countries, i.e.: (i) A regulatory body must be in place prior to signing contracts; (ii)
Governments and water utilities should obtain expert advice; (iii) The appropriate PPP option should
be selected; (iv) Good relations between governments and private operators are needed; (v)
Transparency, public awareness, and public relations are beneficial; (vi) An integrated approach
(bundling from source to consumer) is best; (vii) Employee rights need to be protected, and staff
transfer needs to be planned; (viii) Good and reliable water sources are needed for long-term viability;
(ix) Appropriate tariff structures and tariff-setting mechanisms should be agreed upon; (x) Fair and
open competition is better than negotiated contracts; (xi) There is no blueprint for "privatization." Its
elements and processes should be adapted to the culture, political structure, and legal and regulatory
framework of a given city.
4. CONCLUSION
Although various efforts have been made by the Government of Indonesia, private sector involvement
in public water supply provision through Public Private Partnership (PPP) schemes is still low. The
major issues perceived to be the cause of this situation are mostly related to the risk and uncertainty
problem inherent within the framework of a long term PPP contract. It is perceived that the
effectiveness in managing the risks is one of the key success factor of PPP scheme, in particular in
water supply provision. Since the objective of project risk management is to identify and manage
significant risks, several important risk factors and their alternatives mitigation in PPP water supply
investment in Indonesia to be prioritized by project stakeholders have been explored.
The study shows that political uncertainties, regulatory mechanism and other components of the
scheme contributing to the project revenue, in the local as well as global perspective, are the major risk
issues faced by the private sector who are deciding to invest in water supply, particularly in Indonesia.
The study shows also that exchange rate fluctuation, government controlled water price and rate of
non-revenue water are among the most serious risk factors faced by the investors. Besides government
roles in reforming regulations framework, it is also important that PPP arrangement should emphasize
on performance based contract where tariff increase will ensure that private sector will mobilize not
only funding, but also their managerial skill, expertise and technology to improve operational
efficiencies of the infrastructure.
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