Towards better water governance : Solutions of regional actors 3rd International Conference of Local and Regional Authorities 6th

World Water Forum 14th-15th March 2012, Marseille, France Improving cooperation between infra-state levels to prevent conflicts related to water resources Federalism and Inter-governmental Conflict: Water Management in the state of Selangor, Malaysia 14th March, 5.30-7.00pm Mr. Michel Vauzelle, Chairman of Regions United/FOGAR ; Mr. Dominique Ramard, Vice-Chair for Europe of nrg4SD, Regional Counsellor for energy and climate and President of the Environment Commission of the Regional council of Brittany ; Loic Fauchon, President of the World Water Council ; Benedito Braga, Chairman of the Forums International Committee; My fellow speakers from around the world, representatives of ministries, states, authorities and water associations from Canada, Mexico and other countries ; delegates, friends, and members of the media. Good afternoon. I would like to firstly thank the organisers of the conference, the World Water Council, the United Cities and Local Governments (UCLG) and Regions United-FOGAR for inviting me to speak at this important session on conflicts related to water resources. Although it is my first time attending the World Water Forum, I am aware of the tremendous progress you have made

over the years. I am pleased that the issue of local and sub-national authorities is being emphasised with regard to managing water resources. Water knows no boundary lines, and spans across geographical borders that governments artificially draw up. Local, state, regional and national level authorities are forced to work closely together in ensuring water resources are managed efficiently, and sustainably for the long-term benefit of our citizens. I am here today representing the State of Selangor in Malaysia. As Chief Minister, I am proud to note our state is the lifeline of the country it forms the major portion of the Klang Valley, the central hub that is the primary contributor to Malaysias economic growth. As the most industrial, urban and thriving state, within which Kuala Lumpur our capital also lies, we are a state that needs the best water management possible. But today I would like to present a case study to you, an ongoing case of conflict that we are still in the middle of resolving. This is a classic case of the countrys failed attempt at privatising a public utility, made worse by two factors : the inextricable nexus between the political and business sectors, where private individual profitability is prioritised, and conflicting political interests. Allow me to trace the historical roots of this conflict. Malaysia is by constitution a federated nation, consisting of 13 state governments and three federal territories. The water services industry in Malaysia was originally under the helm of the individual state authorities. But following a wave of privatisation under former Prime Minister Dr. Mahathir Mohamed, the decision was made to privatise water services as well. Although Selangors water authority was doing well financially at the time, bringing in profits to the state, the government at the time decided to change this model. Over the years between 1997 and 2005, water treatment and distribution services were corporatised and then privatised to four separate concession companies. They were given lucrative contracts, lasting up to 30 years.

Now, privatisation as a theoretical model itself is not wrong. Many governments around the world have also gone through a similar process. The reasons for privatisation are plentiful : by transferring the decision rights and ability to profit to a private owner, this ensures the private owner responds efficiently to the positive incentives of financial gain. This was meant to address the budgetary constraints of government, removing the burden of capital expenditure from state authorities. Second, the assumption is that privatisation promotes competition, which is the major driver of improved efficiency. Driven by market-determined forces, privatisation would ensure government, and therefore public, funds are not used to bail out or subsidise any losses faced by a public utility body. But this did not happen in Selangor. The private concession companies chosen to treat and distribute water were not skilled nor experienced in the water services industry itself. Without sufficient injected equity, the water distribution company began to compromise on its water quality and service delivery, forcing high tariffs on consumers. Some of the other problems arising included a nonholistic water planning and management system, ineffective regulatory structures, unsustainable funding structure, low cost recovery, high capital expenditure (CAPEX), inefficient operations, lack of maintenance, poor asset conditions and high non-revenue water (NRW). These companies began to undergo huge unpaid bills, as the business model was simply not feasible. Although the water treatment companies were making money, the water distributor experienced severe losses. The federal government recognised the failure of the privatisation model and the fragmented situation in the state. In 2006, the Parliament passed the Water Services Industry Act, which would consolidate the water industry. All water-related assets would be transferred to a newly formed body, and the constitution was also amended to transfer the jurisdiction over water services from the state governments to both the federal and state governments. Another new body was formed, the National

Water Services Commission, to regulate all water resources and services in the whole country. The idea behind these changes was that the private companies operating water services would have greater restrictions imposed on them, and ideally be bought over so operations would return to the state authorities. This was a positive move, and an acknowledgement of the failure of the private concession companies to deliver on their promises as outlined in their agreements. However, because the state of Selangor was won by the opposition coalition in 2008 during Malaysias 12th General Elections, which I am part of, this created further tension. It is largely believed that the water companies were chosen due to their political connections with the ruling federal government coalition. So when the time came for the state government to negotiate to buy over the shares of the private companies, they responded with increasingly hostile attitudes. The state has had at least three rounds of negotiations and formal offers presented to the concession companies, but to no avail. The private companies demand for a higher compensation for their assets and equity. We have calculated their returns based on an extremely lucrative compensation of 12 percent of injected capital, which is by all means a reasonable industry standard. Any higher would mean bowing to the interests of private individuals. This situation has not yet been resolved, but I would like to bring to your attention several important points. First, that the privatisation model has not worked in Malaysia. Half of the 13 states experienced financial deficits in water operations and by 2008, the water sector as a whole had a RM1 billion operating deficit. Total debts related to water services and sanitation owed to the federal government by state governments amounted to RM7.6 billion in 2006 (Pengurusan Aset Air Berhad, 2008). The outsourcing of water services has not only reduced efficiency in water services, it has not adequately addressed the challenges of funding.

More importantly, privatisation has failed in Malaysia due to a lack of understanding of the assumptions underlying privatisation. In every privatisation agreement, there should have been specific and detailed clauses providing penalties for the companies failure to comply to conditions within, or should the situation arise where the project itself does not accomplish what it sets out to do. In this case, the agreement itself was so flawed that when the water distributor got itself into financial difficulties, the government eventually would underwrite this debt, thereby parking itself as still being part of the federal governments liabilities. This way, privatisation has not only maintained responsibility of the water service industry with the government, but instead exacerbates the problem for them. Any private sector agreement with the government from here onwards should ensure that they are adapted according to present circumstances and contain a clause that would protect both the state and business concerned. Also included within the agreement should be a section that states explicitly that the capital expenditure should come from government, coupled with clear and transparent rules for the award of contracts for capital projects. In this way, costs would not be privatised. Meanwhile, operations may be privatised subject to stringent key performance indicators. Finally, the agreement has to also watch out for the cashflow arrangements with the private company involved, where in our experience crony companies would be intentionally conservative with their cashflow expectations, so that the concession itself would stretch over a period of many years. Second, that although in the 1980s and 1990s there was a trend to privatise public utilities in Malaysia, and in select countries around the world, the current broader global theme we experience today is that there is a need for a continued role for the public sector in the provision of water services. If there is a need to privatise, this would make more sense within the segments of infrastructure provision as opposed to service delivery itself.

Third, water operations have to be managed holistically. The sort of fragmentation experienced in the state of Selangor especially has shown that we cannot break up water services and farm out the more lucrative portions to privatised companies, whilst state authorities bear the burden of the loss-making parts. This is tantamount to cherry-picking, where the artificial segregation of the profit-making water treatment from the loss-incurring water distribution and consumer service facilities eventually reduced the financial viability of the entire water sector. For example, in Selangor while the private water treatment companies made annual profits of between US$10 million and US$47 million in 2001, the state-owned distribution arm made annual deficits of about US$100 million. This problem has continued till today, where the water distributor, having suffered losses in its operations, has even withheld payments to the three water treatment companies. I repeat, this business model has failed, and we are suffering as a consequence of these poorly thought-through decisions of the past. Fourth, the need to clarify the jurisdiction over water assets is crucial. In the case of Selangor, during the privatisation period, water-related assets are owned by the state but managed by the private company. However, because of the increased hostility between both parties, the state government was not given full access to its very own property. Although the concession agreement spells out clearly the concessionaires responsibilities over capital expenditure, this was not carried out according to schedule due to their claimed losses. Evidence indicates that capital investment has increased in Malaysia as a whole for total production capacity and length of pipes but not in terms of non-revenue water and replacement of old pipes. Fifth, because of the failure of water privatisation, the government had to step in to conduct bail-outs, where private concessionaires received federal government loans and grants. This, on top of numerous irregularities found within the private companies, which should have been reason enough for the agreements to be terminated. Breaches of the contract included breaching the ceiling for capital expenditure and operating expenditure, awarding 72 percent

of contracts through direct negotiations, paying exorbitant fees and allowances to its chairman, and so on. Sixth, the role of water regulators and operators should ultimately be to ensure the sustainability and affordability of water resources. Tariffs should be commensurate with the amount of water used, but also not so lucrative that this becomes an easy rent-seeking exercise for the private operators at the expense of consumers. Privatisation contracts created perverse incentives for private operators to increase capital expenditure selectively without necessarily improving coverage or performance (Jeff Tan, 2011). Seventh, political interests cloud all noble intentions of reforming the water sector. Instead of pushing for complete and wholesale buying over of the water services industry, and resolving it holistically once and for all, the federal government was unwilling to enhance performance standards. It has in fact extended the private operators leases. Under the Act, the Minister has powers to do what is needed for national interest, but no real action has been taken. Eighth, although a federation in name, the state governments jurisdictions have been watered down over the years. Because the federal government in Malaysia has now greater control over more fundamental policy matters, it is increasingly difficult for us as a sub-national government to make decisions on resources lying within our very state. Finally, in the ultimate analysis, privatisation of water services has been flawed in Malaysia due to numerous factors. The question for us as state, regional and national leaders going forward is whether privatisation can work, and if so, how ? Malaysia is a case in which water services was used by a rentier class, domestic drivers of privatisation and political kingmakers, through their welloiled connections. Whilst globally there may have been successful cases of privatised water operations, the case in Selangor is telling of its equivalent failure. The solutions

to these issues lies in ensuring that water services should not be unbundled and treated holistically. There is a continued role that public authorities must play in mitigating any negative effects of private sector involvement. For privatisation to work, it is my belief that extremely clear and rigid rules and regulations ought to be clarified at the outset. Terms and conditions in the concession agreements must be adhered to, and punishment must be meted out should these be breached. Federal, state and local authorities must co-operate to ensure services are efficient and standards kept, despite any political differences between leadership at each of these levels. Finally, transparency and accountability would demand that contracts are conducted via open tender a simple term but one that is relatively difficult to execute if corruption is not wiped out from its core roots. I thank you, Ladies and Gentlemen, for your kind attention. It is my sincere hope that the case study of Selangor will be of interest to your respective states and countries. I am happy to be here to learn from your experiences, and perhaps we can, together, seek out common solutions as we share the various issues and challenges faced with regard to managing water resources and the operations involved. On a personal note, I would seek professional expertise of those present at this conference of those interested in the Selangor problem. I look forward to having conversations with you after this session. With that, once again I thank the organisers of this important World Water Forum, and wish all of us the very best as we tackle the question of infra-state level conflict in the management of water. Thank You.