Malaysia’s Water Supply Restructuring: A Ten-Year Scorecard

In the early 2000s, water supply was a looming problem for Malaysia. The country’s rapid development in the preceding two decades had driven an increase in the demand for water, especially in the main economic centres of Kuala Lumpur and Selangor, and Johor in the south. Water supply and sanitation infrastructure, however, had failed to keep pace and restrictions on water supplies in the capital region were imminent.

At the time, the water sector was an organisational, institutional and policy patchwork and financially unsustainable. Tariffs, efficiency and quality of service differed hugely across the country. The states had built up debts to the federal government which they were unable to service. Some states had also signed bulk water supply and concession contracts with private companies and were finding it difficult to meet their contractual commitments.

To address this situation, the government began a major restructuring exercise of the water supply sector. The reforms were innovative and carefully designed, drawing upon international policy models adapted to the particular context and needs of Malaysia.

These reforms were far-reaching: the national constitution was amended and two new laws were brought in. One law created a national water asset-holding company, PAAB, responsible for financing capital expenditure. The second law created a national regulator (SPAN) to promote efficiency and set tariffs.

Central to the reforms is the transfer of assets from the states to PAAB, a process known as “migration”. Each state must transfer assets to PAAB with a value equivalent to the outstanding debts owed to the federal government; the assets are then leased back to state-level operators.

Future capital investment would be financed by PAAB, which would be able to take advantage of government backing to raise low-cost finance on the capital markets and pass on low rates of interest and long tenors (30-45-year) to the water operators.

After migration, operators’ performance is monitored by SPAN. The operators submit business plans every three years. SPAN reviews these, sets performance targets (Key Performance Indicators), establishes tariffs and monitors performance. As a national institution, SPAN is able to benchmark the 12 state water operators against each other to compare performance and to incentivize efficiency.

The new policy was designed to meet the twin goals of achieving financial sustainability and boosting efficiency, but the challenge of implementation lay ahead. “We have developed an effective strategy in reforming the water services industry in Malaysia. However, we must appreciate that success is 10% strategy and 90% execution,” Peter Chin, consultant and one of the main architects of the reform, commented in 2008.

Ten years on, researchers from the Institute of Water Policy returned to Malaysia to assess the impact of the reforms. Have the reforms been implemented as originally envisaged? And to what extent have the changes brought Malaysia closer to achieving its overarching policy goals for water supply.

Migration: a long and arduous process

Migration has proved to be a long and in some cases tortuous process. As of March 2015, 8 of the 11 states in peninsular process have signed an agreement to transfer assets to PAAB. The first states to migrate were Melaka and Negeri Sembilan, both of which had urgent investment needs. The early completion of the migration process made it possible for them to get access to PAAB finance to reduce non-revenue water (NRW, the amount of water delivered to the supply system for which no revenues are collected) and to increase water treatment capacity.

The next state to migrate was Johor, but the process was complicated by a 25-year water supply concession contract signed in 1999. Under the contract, the state had committed to periodic tariff increases that were proving politically unfeasible. The issue was resolved by the state buying an equity stake in the operating company; the concession was terminated and transformed into a short-term, renewable operating contract.

In these three states, Johor, Melaka and Negeri Sembilan, there have been noticeable improvements in efficiency indicators, including the reduction of NRW and greater cost recovery, suggesting that the reforms did create efficiency incentives.

In other states, the impact of the reforms has been slower and less clear-cut. In Penang, the state utility company, PBA, already had a high level of operating efficiency along with the lowest tariffs in the country. The company had listed on the Kuala Lumpur stock exchange in 2000 and had been paying out regular dividends.

PBA had an advantage over other state water utilities as it enjoyed access to low-cost debt finance from the state government. Penang agreed to the transfer of assets in 2011 when the federal government committed to fund a major new dam and pipeline project which would increase water resource access for the state.

Perlis and Perak, two of the lesser developed states, reached an agreement on asset valuation and transfer in 2010 and 2012 respectively. But the utilities in those states are not corporatised (structured as a company) and lack the data necessary for putting together a viable business plan for consideration by SPAN.

Without such a plan, the utilities cannot access PAAB financing, and SPAN cannot impose performance requirements on them. Not surprisingly, no efficiency improvements have been seen in these two states. In fact, performance in Perlis has worsened, as new leaks spring from ageing infrastructure.

The most protracted negotiation has been Selangor and the capital region due to the competing interests of public and private stakeholders.

The state had awarded several bulk water contracts in the 1990s and a 30-year concession contract to Syabas in 2004. Under the concession contract, the state committed to raising tariffs to allow Syabas to cover costs, including payments to the bulk water supply companies. However, the state government resisted tariff increases after the sector restructuring commenced. Syabas’ debts to the bulk suppliers mounted and the company froze investment, exacerbating water leakages which already stood around 40 percent.

Since 2008, the federal government and state government have been led by opposing political parties, a situation that has led to the intense politicisation of the negotiations. An agreement was finally reached in 2014 when the state government agreed to the asset valuation and termination payment between Syabas and one of the bulk water suppliers.

Yet as of March 2017, agreement with the other bulk water company, SPLASH, has still not been reached. Some sections within the state government argue for adopting an uncompromising stance, refusing to pay and waiting until the end of the contract term; others claim that the negotiations should be wound up so that capital expenditure plans can be restarted, and improvements are made to service standards in the utility.

Kelantan is the latest state to migrate – the terms were finalised in 2016. The state is the only state in Malaysia where coverage is far from universal. Statewide, 40 percent of people in Kelantan do not have a piped connection. PAAB financing will be central to extending coverage, and the state’s business plan is already under review by SPAN.

Three more states are still at the negotiating table: Kedah, Pahang and Terengganu. All three are predominantly agricultural. These state governments argue that historical capital expenditure went towards rural water supply and are calling for the federal government to write off these debts so that they do not drive up the PAAB leasing fee beyond the bounds of affordability for the customers in these states.

These implementation issues may be more serious than foreseen by the policy designers but they are not inseparable. SPAN’s CEO Dato’ Ridhuan takes the view that reforms were well conceived but should have included more details on the migration process and what the process entailed for states.

Institution-building

Alongside the state-by-state developments, SPAN and PAAB have been building their own capacity.

SPAN is focusing on harmonising the way that financial and operating data are collected and analysed. In 2016, SPAN issued detailed guidelines for tariff-setting and is currently consulting state governments on these guidelines before making them public. However, SPAN is far from being an independent regulatory agency.

Its Chairman is an elected official, and other board members are political appointees. SPAN’s Chief Executive hopes that in the long-run SPAN can achieve autonomy but recognises that while the restructuring process goes on, it is useful for the agency to be led by a politician who can engage with state governments.

PAAB, meanwhile, has been successful in raising financing on the capital markets through sukkuk (Islamic bonds) issues.

However, these funds are under-utilised as PAAB is funding projects in only four states. States are reluctant to borrow from PAAB as it means that they lose control of the procurement process. PAAB has a small team and limited experience which slows down the award of contracts. States are also concerned about the cost of financing; even if PAAB offers a discount on the market rate.

Macroeconomic factors are driving up PAAB’s own cost of capital, and this will be passed through to its customers – the water operators.

Have the reforms contributed to achieving over-arching policy goals? Sector stakeholders agree that a major disappointment is that sanitation issues have been sidelined. The original reforms envisaged that water and wastewater would be financed and regulated jointly under SPAN and PAAB. Linking the two would allow for joint billing for water and wastewater, thus raising money for much-needed investment in the country’s sewerage and wastewater treatment infrastructure.

Ten years on, the two sides of the sector are managed separately, and cost recovery for sanitation needs remains a distant goal. In 2016, the piloting of joint billing in the territory of Labuan for the two sectors was a first small step. An evaluation of the pilot will be made in 2017.

A second vital concern is the country’s declining levels of water security and resilience over the last decade. Selangor and Johor, the country’s largest urban and industrial centres, have water supply reserve margins of zero. In other words, there is no buffer in supply to keep water flowing through the taps if there is a contamination incident or even during routine maintenance works.

The lack of a supply buffer has resulted in repeated water supply shut-offs affecting thousands. In 2014, when the country experienced an extended period of dry weather, water supply restrictions lasted several months. Again, in 2016, 85,000 people in Johor faced water rationing due to low water levels at the treatment plants.

These shortages are due to a backlog of under-investment in water supply infrastructure and the disconnect between water resources, which are still under the purview of state governments, and water supply, which is a shared responsibility.

Those involved in designing the reforms were well aware of this disjuncture but realised that more far-reaching constitutional amendment encompassing water resources was politically unfeasible. By restricting the scope of reforms, they were able to secure the amendment and the passage of the legislation. This leaves a major challenge for Malaysia’s water supply unresolved, and no policy design process is currently in place to address it.

The reforms began a decade ago, far-reaching as they were, have turned out to be just the start in addressing Malaysia’s pressing water problems. Policy-makers now have an opportunity to turn imminent water supply shortages to their advantage by using them to raise citizens’ awareness of the value of water and the need to invest for the future. The risk is that instead of taking forward the national reform agenda, politicians will instead blame each other for past failures, leaving Malaysia to face greater water risks than ever before.

Olivia Jensen is a senior research fellow at the Institute of Water Policy, Lee Kuan Yew School of Public Policy, National University of Singapore. 

 

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