Keeping your word

We have talked often of the sanctity of contracts and the need for government to maintain consistency in what it does, particularly as it transitions from one administration to the next. But disruptions can also happen within an administration.

Under the Aquino administration, there were too many worrying violations of contracts where they were changed, reinterpreted or rescinded. Added up, they sent a very negative image of that government. One that didn’t keep its word, one that didn’t honor contracts or obey court orders.

And one that I do not expect this President to emulate. He’s a lawyer, so I am confident he won’t. The review of all government-private sector contracts he has called for will only result in change where it can be clearly and legally justified.

Contracts are inviolate, especially sovereign ones with a country’s government.

Investors look for stability, a consistency and predictability in the business environment. Rules must not be changed on a whim, midgame. Contracts must be honored.

One concern today is the Aquino-era Metropolitan Waterworks and Sewerage System (MWSS) revision violating the agreements with Maynilad Water Services and Manila Water, putting a hugely successful turnover at risk.

The privatization of water supply has been a success. Maynilad and Manila Water have totally reversed the system from a disaster to a huge success at an enormous cost. They have spent over P100 billion, which they have every right to expect will be repaid to them by us as we use the water that they supply.

The contract between MWSS and the water firms was a contract designed by the government, in which there was no negotiation, meaning the bidders had no say. The outcome of this privatization was not even expected 20 years ago, but it has become such a major success story that it has been featured in various fora.

It was a contract that had been implemented faithfully for 16 years, until the MWSS, under Gerry Esquivel, reversed it in January 2013 to change the formula in computing the water firms’ rate adjustment. MWSS said that corporate income tax must be excluded as part of the firms’ expenditures, citing a 2003 Meralco case as an excuse. However, the 2003 Meralco case applied only to public utilities under an asset-based rate-setting system. The concessionaires are not public utilities, they are service providers created by and governed by a contract. The MWSS is the public utility.

Whether you include income tax in the pricing calculation or not, the net effect must be the same. The investor must get a certain percent return AFTER TAX. That’s what investment is all about; you take money out of your pocket to put money into an investment to (hopefully) get more money back—in your pocket.

The MWSS did not seem to understand this simple fact. Worse, it violated the contract, which MWSS itself and the national government unilaterally drafted and imposed on the concessionaires, and decided to set aside what the contract clearly stipulated.

Are the water contracts too financially attractive? We shouldn’t begrudge success, but we only see a partial picture. How soon we forget the default, bankruptcy and consequent loss of the concession in 2006 by one of the two concessionaires then. That was a 50-percent failure rate!

The water privatization and concession agreements have provided economic, social and health benefits over the past two decades to the entire Metro Manila and neighboring towns within the concession areas.

The water public-private partnership allowed the recovery of more than 1,500 million liters per day of water that used to be lost through system leakages over the years, as the concessionaires poured in massive investments in pipe replacement and attained much improved efficiencies. This volume is the equivalent of a major dam, and its recovery averted what could have been a series of disastrous water shortages much earlier than what happened in the first quarter of 2019.

If this contract were further changed today under the mass review of contracts ordered by the Duterte government, it would send a very negative signal to future potential investors.

In sum, the Philippines is lagging behind in attracting investment; it is last among its Asean peers. One of the reasons is the changes of policy made from one administration to the next, or even within an administration. This includes changes in contracts.

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