PR O V I S I O N O F P O TA B L E WAT E R S E RV I C E S F O R K A B U PAT E N B A N D U N G

PR O V I S I O N O F P O TA B L E WAT E R S E R V I C E S F O R K A B U PAT E N B A N D U N G

CONTENTS

EXECUTIVE SUMMARY I INTRODUCTION BACKGROUND MODEL PPP PROJECTS PURPOSE OF THE INFORMATION MEMORANDUM II III IV COUNTRY OVERVIEW SECTOR OVERVIEW LEGAL FRAMEWORK CROSS-SECTOR REGULATIONS FOR PSP SECTOR REGULATIONS V VI THE PROJECT MAIN ISSUES This information memorandum is based on information from the relevant sector ministry and contracting agency. The KKPPI Secretariat from the Coordinating Ministry for Economic Affairs and the National Planning Agency (BAPPENAS) was responsible for coordinating its production

VII NEXT STEPS VIII CONTACTS APPENDICES APPENDIX 1 : Risk Allocation Based on the Template of Water Concession Agreement APPENDIX 2 : Project Compliance with the Legal and Regulatory Requirements APBD (Anggaran Pendapatan dan Belanja Daerah) or the Regional Revenue and Expenditure Budget (Badan Pendukung Pengembangan Sistem Penyediaan Air Minum) or the Water Supply System Development Supporting Agency (Peraturan Presiden): Presidential Regulation (Perusahaan Daerah Air Minum) is the Regional Government-Owned Water Company Private Sector Participation APBN (Anggaran Pendapatan dan Belanja Negara) or the State Revenue and Expenditure Budget

ABBREVIATIONS

BPP SPAM

Perpres PDAM

PSP

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EXECUTIVE SUMMARY

The aim of this Information Memorandum is to provide preliminary information to prospective stakeholders and/or investors on potable water supply in Bandung Municipal (Kabupaten Bandung). As a consequence of development in the area, there is a need to increase the supply of potable water in Kabupaten Bandung. The Kabupaten Bandung authority planned to accelerate the development of its water supply to improve service quality, to expand its coverage, and to prevent over extraction of the ground water. The local government will be inviting domestic as well as international investors to participate in the bidding process to improve the water supply for part of the municipal area. The project includes: The development of bulk water supply and a water treatment plant (WTP); Development of a distribution system; Operation and maintenance during the concession period; The preliminary feasibility study shows that the project is expected to yield a financial IRR of 18-22%.

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INTRODUCTION
BACKGROUND Until the 1997 financial crisis, Indonesia successfully used infrastructure development to address poverty reduction and economic development. However, infrastructure investments, which accounted for more than 6% of annual gross domestic product (GDP) before 1997, have fallen to 2% in recent years, reflecting a sharp decline in public and private spending. As a result of the financial crisis, many planned public and private infrastructure projects were canceled or suspended. Only some basic preservation and maintenance of infrastructure, with very little expansion, have taken place since. Current quality and coverage of infrastructure services are therefore low by regional standards. The generally lower availability in rural areas, particularly outside Java, contributes to significant regional disparities in development. Following Indonesias first direct presidential elections in October 2004, the current Government set ambitious macroeconomic targets for the Medium-Term Development Plan (RPJM: 20052009). The Government recognizes that major infrastructure expansion is required to remove existing bottlenecks, increase service coverage, and attract private sector investment to help achieve and sustain the projected economic growth of 6-7% per annum. The Government has estimated that about $65 billion would be needed for infrastructure expansion during 20052009, with $25 billion (38%) to be met from the Government budget, $14 billion (22%) by domestic banks and insurance and pension funds, $10 billion (15%) by multilateral and bilateral development partners, and $16 billion (25%) by domestic and foreign private sector investors. At this level, infrastructure investments would again reach about 5-6% of GDP. The Government has been aware that such large-scale private sector participation (PSP) preferably through public-private partnerships (PPPs) cannot be taken for granted, unless serious structural and institutional reforms are implemented. Broad-ranging policy reforms are critical to improve the investment climate, including (i) liberalizing markets to allow competition and entry by new service providers, (ii) improving legal and regulatory certainty and strengthening regulatory arrangements, (iii) introducing tariff regimes based on full cost recovery or providing compensation to meet public service obligations (PSOs), and (iv) establishing effective mechanisms for dispute resolution. In January 2005, the Indonesia Infrastructure Summit provided a platform for the Government to articulate its commitment to reforms. The progress made since then in reform
BPJT - Indonesian Toll Road Authority; BPP SPAM - National Water Regulatory Agency; MEMR Ministry of Energy and Mineral Resources; MOT - Ministry of Transport; MPW - Ministry of Public Works; PLN - State Electricity Corporation

implementation will be reported at the Indonesia Infrastructure Conference and Exhibition in November 2006. MODEL PPP PROJECTS Because of inadequate project preparation, unavailability of Government support, and lack of strong central coordination, PPP project transactions have so far lagged behind the infrastructure reforms. With the new framework for PSP and risk management in infrastructure development that has been established as part of these reforms and that is based on international best practice (see Box 1), the execution of PPP projects is expected to accelerate. To demonstrate the benefits of PPPs and to show that full adherence to the new framework will lead to strong competition, favorable bid prices, and successful financial closings, the Government has selected 10 projects in different infrastructure sectors to be developed as models (see Table 1).

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PURPOSE OF THE INFORMATION MEMORANDUM The Provision Potable Water services for Kabupaten Tangerang, which is one of the ten model PPPs, is not ready for bidding yet. There is still preparatory work to be done before the Project can be put on the market. The purpose of this Information Memorandum that has been prepared for the Indonesia Infrastructure Conference and Exhibition is to: Present the currently available information to potential investors Identify gaps in project preparation that need to be filled in order to comply with the new framework for PSP and risk management Indicate the timeline for the additional preparatory work and the subsequent transaction execution The Information Memorandum is not legally binding, nor does it purports to be all inclusive or to contain all the necessary information that a prospective investor may desire to investigate the Project.

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COUNTRY OVERVIEW
INTRODUCTION Since the beginning of 2005 Indonesia has been experiencing strong external pressures from the increase in international interest rates and the unprecedented global oil price hike. In spite of these, the Indonesian economy managed to grow slightly faster in 2005, at 5.6%, though lower than the expected 6%. For Indonesia, the combination of these external factors seriously threaten monetary stability. The government of Indonesia (GOI) had to make necessary adjustments to its domestic fuel price. To reduce the ballooning budget deficit in 2005 the price of fuel was increased twice within a year, firstly, by an average of 29 percent in early March, and then by an average of 127 percent in early October 2005. The weakening of the Rupiah and the increase in the domestic fuel price triggered a significant increase in inflation by October 2005 (17.1 percent year-on-year). To reduce the high economic costs caused by the fuel price increase, and to improve business competitiveness, the GOI announced on 1st October, 2005 an incentive package for the trade and transport sectors. Other policy measures and prudent monetary policy enforced by Bank Indonesia manage to strengthen the Rupiah exchange rate and stabilize inflation to 3.3 percent between January to July 2006, (compare to a target inflation of 8 percent for 2006). During the first two quarters of 2006, the economy grew at the rate of nearly 5 percent with a slight increase from 4.7 percent in the first quarter to 5.2 percent in the second quarter. The trend is expected to continue. Foreign exchange reserves are expected to reach US$ 43 billion by the end of 2006, a 24 percent increase from US$ 34.7 billion in 2005. The US$ 43 billion figure is net of the loan repayment to IMF of US$ 3.75 billion in June 2006 and final repayment of US$ 3.2 billion in October 2006. Between January and July 2006, imports (of non-oil-and-gas commodities) amounted US$ 23.44 trillion, a 7.9 percent year-on-year increase while total exports accounted for US$ 55.77 trillion, an 11.3 percent year-on-year increase. Consequently, there was a balance of trade surplus of US$21.51 billion for the period. The balance of payments financial accounts also show a US$ 3.42 surplus in the first semester 2006. The interest rate has declined to nearly 10 percent by October 2006 and is predicted to reach single digit by end 2006. A low interest rate will facilitate further expansion of the economy. ECONOMIC PROSPECTS FOR 2007 The 2007 prospects for the Indonesian economy are predicted to be better than 2006, although the external pressures remain strong (the international price of oil is likely to remain high and the US government will likely continue a tight money policy). However, economic stability is likely to improve, as the exchange rate will be relatively stable, with inflation under control and interest rate declining. The achievements of the Indonesian economy in 2006 and the implementation of the economic reforms currently undertaken by government form the basis for the 2007 macroeconomic assumptions as follows. First, the export price of Indonesias crude oil is assumed at an average of US$65/bbl. Second, the exchange rate is assumed at Rp9300 per US$. Third, the year-on-year inflation rate is estimated at 6.5 percent. And finally, the average interest rate for 2007 is assumed at 8.5 percent. With effective policy coordination and activities in the real sector, especially in managing aggregate demand, the 2007 Indonesian economy is expected to achieve a 6.3 percent growth. Public sector investment and government expenditure remains the main economic driving force.

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SECTOR OVERVIEW

Water is a finite and vulnerable resource, essential to sustain life, development and the environment. One of The United Nations Millennium Development Goals is a target of reducing by half the number of people who do not have access to clean water and sanitation by 2015. However, Indonesia-wide the water and sanitation sector faces the prospect of having to make large investments in water provision, primarily because coverage of water and sanitation services is presently much lower than envisaged by the MDGs, and secondly because of an increase in the scope and stringency of water and sanitation quality standards. The water and sanitation sector (WSS) in Indonesia was in crisis even before the 1997/ 1978 Asian crisis. Because many regional water enterprises (PDAMs) are financially unsound and because of uncertainty in the legal framework during the early stages of decentralization, there has been no significant investment in the sector in recent years. Only 8 percent of the water supply system in Indonesia is currently under public-private partnership. Aging infrastructure, budget constraints (central and local government), and escalating demand have shifted policy towards private sector involvement in water service provision. Treatment and distribution of clean water in urban areas is the responsibility of about 318 water enterprises (PDAMs) under the ownership/jurisdiction of local government. In Jakarta, Batam and 20 other locations in Indonesia (BPP SPAM, 2005), concessions for water supply have been awarded to the private sector. Elsewhere, the role of the private sector in piped water is limited to that of supplier or contractor. The PDAMs supply water to customers through house connections (presently about 39% of the urban population). About 61% of the population receives water through informal distribution networks and various water vending operations. PDAM distribution in rural areas is estimated at 8%. Approximately 40.15 million people live in the urban areas served by the PDAMs. Based on 2005 data, only about 40% of the urban communities are served. The remaining 60% of the urban population, of which many are low-income, rely on other sources of water that includes self-provision and commercial on-selling. In rural areas, that community-managed systems are estimated to meet the needs of about 30% of the population, most of which have been established in rudimentary forms by the communities themselves. In most regions, tariffs are not set at full-cost recovery levels, so that PDAMs can barely meet operating costs. Many PDAMs are unable to cover depreciation costs on fixed assets, and do not generate sufficient funds to finance new investments. A difficulty that continually plagues the planning of some new or expanded water supply systems is the lack of water in one local government area, while adequate supply is available in a neighboring one. Despite the principles of regional cooperation under government

regulation, many areas have yet to implement them. However, Government has promulgated the drinking water tariff policy through Permendagri 23/2006. Law 7/2004 on water resources is the main governing law for this sector. Under this law, PSP in water supply is through cooperation with a PDAM or on the basis of a concession granted by a local government. Law 7/2004 provides also more clarity on roles and responsibilities, establishing the legal framework for use of water and resource protection. Few urban local governments on Java have access to sufficient raw water in their region to serve existing and expanded water supply systems. Watershed management and conservation are considered to be a high priority. This would sustain the water supply sector in the long run. As mentioned in Law 7/2004 and PP 16/2005, the development of Drinking Water Supply System can be carried out by a SOE and/or ROE specifically. Nevertheless, PP 16/2005 provides that if the SOE or ROE is unable to improve the service quantity and quality of

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drinking water supply system in their regional services, it may involve cooperatives, private entities, and/or the community within their services areas. PP 16/2005 on the Development of Water Supply System stipulates the establishment of BPP SPAM, a consultative body for water supply at the national level. BPP SPAM is a ministerial body established by and responsible to the Minister of Public Works. BPP SPAM is not a contracting authority, this being the role of the local governments or PDAMs, nor a regulatory body. Funding and secretariat support comes from within the MPW. Local government is expected to appoint a water regulator and to adopt the standard recommended by BPP SPAM in respective areas. Several local government that have implemented PSP in the water supply sector (such as Jakarta) have established a local regulatory entity. However, there is no provision in the law for the establishment of a regulatory body for the sector. This is a deficiency that needs to be rectified if PSP is to materialize. The contracting authority would be the local government, excluding the PDAMs. Policy, as usual, would be under the ministry. The PDAMs, other ROEs and the private sector could be the operator. However, for new PSP projects, in the interest of transparency, the local PDAMs (owned by the local government contracting authority) should desist from bidding for projects tendered by their local government.

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LEGAL FRAMEWORK

CROSS-SECTOR REGULATIONS FOR PSP

Perpres 67/2005 This is the cornerstone of the new PSP framework that aims at establishing a clear and predictable environment within which private investors will operate. Perpres 67/2005 defines two forms of PSP: partnership and licensing agreements. These agreements should specify, among other things, the project scope, period of partnership/license, implementation/operation warranty, tariff and tariff adjustment mechanism, risks and obligations, performance standards, dispute resolution, and supervision method. PPP projects can be identified and prepared either by the Government or the private sector, but the sponsors must be selected through open and transparent bidding. Perpres 67/ 2005 describes in detail the rules and procedures for the bidding process, and calls for tariffs to be set at full cost recovery. If this exceeds the affordability of consumers to pay, the Government must compensate for the difference with a PSO subsidy. Perpres 67/ 2005 recommends that risks be allocated to the party that is best able to manage and control them. Relevant Ministerial Regulations To ensure that risks of individual PPP projects are appropriately allocated between the public and private sectors, and that the Governments overall exposure is well managed, the Minister of Finance issued Regulation 38/2006. The dual objective of the new risk mitigation and management policy is to support infrastructure development while maintaining fiscal sustainability of the Government budget. Regulation 38/2006 describes the types of risks the Government may consider sharing (those related to political events, project performance, and demand), the main principles for providing such support (legality, project quality in terms of technical and financial feasibility, fiscal prudence in terms of total exposure and annual budget, and transparency), and approval procedures. Regulation 38/2006 has been complemented by two Regulations issued by the Coordinating Minister of Economic Affairs. Whereas Regulation 3/2006 describes the procedure and criteria for prioritizing all PPP projects, Regulation 4/2006 focuses on the evaluation of those that require Government support. While reiterating the project quality, fiscal prudence, and transparency principles, Regulations 3/2006 and 4/2006 outline the roles of the National Committee for the Acceleration of Infrastructure Provision (KKPPI) and its secretariat; and specify in detail the documentation needed and criteria to be met, such as the pre-feasibility study, environmental impact analysis, socio-economic benefit-cost analysis, risk analysis, bidding documents (including draft concession agreement), and the projects compatibility with the RPJM, sector strategic plan, and regional spatial plan. As to the transparency principle, Regulation 4/2006 stipulates that requests for Government support must be submitted before bidding. SECTOR REGULATIONS PPP in the water supply sector is governed by Law 7/2004 on Water Resources, which serves as the umbrella for management and development of water resource, including water supply. In March 2005, the government issued Government Regulation 16/2005 on Development of Water Supply System, as the implementation regulation for Law 7/ 2004.

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THE PROJECT

Rancaekek and Cicalengka in eastern part of Bandung are the main industrial areas in Kabupaten Bandung. This leads to a high growth of population in the areas within 5 years which counts to be more than 2%. Originally the clean water requirement for household and industries are supplied by ground. However, due to overexploitation, natural ground water is predicted no longer available in the near future. Nowadays, around industrial areas during the dry season, people difficult to find clean water. The existing clean water requirement is supplied by water handcarts and truck with the price is approximately Rp. 15,000 to Rp. 25,000 thousand per cubic meter.

This suggests that there is a high demand potential for a piped water supply. However, Kabupaten Bandung, has limited budget for construction water supply infrastructure have the need for private sector participation in the provision of water supply systems. ECONOMIC ANALYSIS The social cost-benefit analysis for the project has not been conducted. This will be undertaken before the project is put out for tender. FINANCIAL ANALYSIS The total project cost is estimated of USD 30.7 million. A preliminary financial analysis shows that the Financial IRR is 18 - 22%.

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MAIN ISSUES

Land has not been acquired. About 1 Ha land is required for the 450 lps water treatment plant and an additional parcel of land for the reservoirs. The land cost will be borne by the investor. There are 3 (three) potential sources of water for the proposed project: East Bandung : Springs , 100 l/s Curug / Cinulang River, 100 l/s West Bandung : Saguling Dam, 200 l/s North Bandung (Lembang): Springs, 50 l/s Since this is a Greenfield project, government financial support, either from the local government or central government, may be made available. The type of support envisaged is a sharing of the demand risk, which is permissible under the MOF decree PMK 38/ 2006. However, the provision of this form of government support is expected to be recovered in later years when actual demand is more than what is projected.

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NEXT STEPS

The next steps in this poject is figured in the table below:

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CONTACTS

KKPPI Secretariat Menara Ravindo, 17th Floor Jalan Kebon Sirih Kav. 75 Jakarta 10340 Tel: +62-21-390 8850; 390 8845 Fax: +62-21-390 8489 Attn: Mr. Wahyu Utomo (wutomo@kkppi.go.id) The Chairman of Bandung Regency Jalan Raya Soreang Km. 17 Tel: +62-22- 589 1159 Fax: +62-22- 589 1159 Attn: Mr. Tatang Rustandar (tatangwiraatmadja@yahoo.com)

Supporting Agency For Development of Drinking Water Provision System Jalan Wijaya I No. 68 Kebayoran Baru, Jakarta Tel: +62-21-72789126 Fax: +62-21-7260520 Attn: Mr. Rahmat Karnadi (karnadi1@hotmail.com)

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APPENDICES

APPENDIX 1 RISK ALLOCATION BASED ON TEMPLATE WATER CONCESSION AGREEMENT

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APPENDIX 2 PROJECT COMPLIANCE WITH THE LEGAL AND REGULATORY REQUIREMENTS

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