PROOF

11
The Market Turn in Jakarta’s
Water Supply: Vested Interests
and Challenges of Realising the
Regulatory State
Leong Ching

Market-building, particularly in network industries, has been a common

practice in many developed economies over the last few decades. Following
the abandonment of Keynesian interventionist state norms situated around
the state provision of public services, especially in electricity, water, energy
and transportation services, and the adoption of New Public Management
(NPM) agendas predicated on the private provision of public goods, numerous
countries adopted privatisation measures which effectively devolved state
monopolies to private sector owners and operators. The United Kingdom,
France, Germany, Canada, Australia, New Zealand, among others, led the
way with reforms that unbundled network industries. While highly conten-
tious, neo-liberal policy reforms gained a popular following and were often
invoked as a means of correcting what were seen as “bloated” public sectors
where unionised labour practices and poor customer service outcomes had
led to sector inefficiencies and increasing fiscal burdens on state treasuries.
Privatisation was thus seen as a means of reducing the fiscal burden on the
state while, at the same time, introducing market rationality that would
discipline network operators, incentivise the adoption of efficiency measures
and the efficient utilisation of financial resources. At the same time, with the
adoption of appropriately designed regulatory systems, these increased effi-
ciencies could be mutually shared by operators and consumers alike creating
a “win-win” situation for all stakeholders. Much of the 1980s and 1990s
thus witnessed the progressive adoption of neo-liberal privatisation meas-
ures with the aim of constructing markets to support private sector invest-
ment into the sector (see Carroll 2012a; Jarvis 2012).
While such marketising strategies were widely and often vigorously
adopted in industrialised economies, the outcomes they produced were
uneven. Issues associated with regulatory capture, poor regulatory design,

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The Market Turn in Jakarta’s Water Supply 235

contract renegotiation, as well as large increases in user-pay costs and

disputes over the capture and distribution of efficiency gains highlighted
the complexity of NPM models for the provision of public goods and serv-
ices. Indeed, despite these problematic outcomes and the complex govern-
ance issues associated with neo-liberal market-building activities, some of
which resulted in outright market failures, this did not stall such initiatives
or deter their policy adoption in developing economies. Multilateral devel-
opment agencies like the World Bank, Asian Development Bank and the
International Finance Corporation, among others, continued to champion
neo-liberal policy agendas, seeing privatisation and the private operation
of network utilities as instrumental reforms necessary to overcome poor
state capacity and persistent fiscal constraints endemic in many developing
economies. In Asia, for example, Thailand, the Philippines, Singapore, India,
Indonesia, China and Malaysia, all experimented with privatisation meas-
ures and market-building activities in network industries, attempting to set
in place the appropriate regulatory and sector designs that would facilitate
private sector participation while freeing-up finite state fiscal resources for
more pressing developmental needs.
This chapter explores one such attempt at neo-liberal reform and market-
building in the water sector in Jakarta, Indonesia. The privatisation of Jakarta’s
water utilities started out with much optimism and fanfare – the hope of
efficient, cost-effective services, water for all and a sorely needed injection of
investment into the city’s rapidly aging water infrastructure. As one of the
poorest performing sectors in the Indonesian economy, poor water coverage,
the limited availability of potable water and persistent under-investment in
the sector due to insufficient state fiscal capacity had left the sector with
long wait times for water connections, insufficient water pressure to ensure
reliable distribution, and haphazard planning and maintenance that led to
frequent breakdowns and long-term water outages across many of the city’s
suburbs. Compounding the situation was Jakarta’s rapid population expan-
sion. As the commercial centre of Indonesia, the greater Jakarta metropolitan
area now comprises over 27.9 million people, while the capital city of Jakarta
has grown to almost 10 million people. As the city’s population continues
to expand annually at around 3.6 per cent, the strain on water infrastructure
and the demands for ever more connections continues to rise (Firman 2011).
For a developing country rife with infrastructure problems, the introduction
of private water concessions was designed to rectify these mounting prob-
lems and provide the necessary investment to support one of Asia’s largest
and most rapidly growing megacities.
Almost two decades after the introduction of private water concessions,
however, Jakarta customers have poorer service than before, private opera-
tors have fallen short of their profit targets, while the fiscal liabilities of the
Indonesian state for shortfalls on the rate of return contractually obligated
to private operators has progressively escalated to tens of millions of dollars.

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What commenced as a promise of a revitalised, efficient and service focused

reform effort has actually resulted in worsening sector outcomes. By 2012,
for example, only about 43 per cent of Jakarta’s households enjoyed water
connections, and of these households water services are available only about
two-thirds of the time. Worse still, non-revenue water now stands at a stag-
gering 50 per cent, with illegal connections ravaging the system, lowering
system-wide pressure and compounding revenue shortfalls in the sector. At
the same time, water quality has deteriorated, with tap water unsafe to drink
unless boiled before consumption, while in North Jakarta, home to some of
the poorest city-dwellers, there are frequent reports of public health problems
such as cholera and other water-borne diseases. Perhaps most alarming of all,
however, since the introduction of private water concessions in Jakarta, the
price of water in one of the world’s poorest cities (in terms of average GDP
per capita) is now among the highest in Asia, only surpassed by the price
of water in Singapore and Hong Kong – two of the region’s richest econo-
mies (Bey and Trapp 2009). For the vast majority of Jakarta’s poor, water
has become too expensive a commodity to purchase and too dangerous to
consume.
This chapter traces the story of market-building in the water sector in
Jakarta, mapping the “ideological shift from politics towards the market”
(Pierre and Peters 2000: 55) to embed markets into state utilities. As this
chapter notes, this effort was driven largely by two forces – internally,
there was a wave of political ferment demanding changes in Indonesian
governance, greater accountability and better provision of essential serv-
ices – particularly for Indonesia’s poor and marginal communities. At the
same time, external pressure for water privatisation came from the World
Bank, which for several decades impressed upon developing nations the
importance of involving the private sector in utility provision in order to
overcome state fiscal constraints and rapidly expand water infrastructure.
As the chapter notes, the key ideas underlying the privatisation of Jakarta’s
water supply were based upon neo-liberal assumptions of the political and
economic benefits derived from harnessing market forces and aligning these
to a developmental agenda. In doing so, the hope was for a transition from a
governance system based on patronage and political connections to a policy-
making environment and set of processes that were insulated from political
interests and driven by market rationality and efficiency.
This chapter details how these assumptions were invoked at the outset
of the privatisation process, and traces the attempt to realise the benefits
accorded to markets through particular contractual and regulatory outputs
associated with the “regulatory state”. As the chapter also notes, however,
these broad elements are not just formal institutional arrangements
comprised of legal contracts and partnership structures, but also of informal
norms and values which ultimately serve as legitimation devices that support
regulatory forms of governance. But, as the chapter also demonstrates the

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very institutional forms that were supposed to curb political opportunism,

boost public service capacity and improve access to public utilities actually
worked to the reverse.
The findings of this chapter are related, but not wholly identical, to critiques
of neo-liberal agendas about the role of markets and the relationship between
states and markets (inter alia, Haughton 2002; Bakker 2003; Goldman 2005;
McDonald and Ruiters 2005; Carroll 2010). By contrast, this chapter takes a
more discursive lens to the problem by framing the market-building effort
in Jakarta as part of the movement towards realising a regulatory state. The
chapter thus reflects the thinking of Craig and Porter (2006) who argue for
“heterodox solutions” as a departure from the market-embracing neo-liber-
alist agenda. A balance is needed, they argue, to the dominant “unrealistic
Liberal, market-oriented hopes around allocative efficiency, service delivery
and consumer voice”. Such a heterodox approach would involve stronger
accountability relationships through better funding of government agencies
and officials as well as “smart repoliticising”. The heterodoxy required in
Jakarta, I thus argue, can be revealed by using a regulatory state paradigm
which allows us to have a greater appreciation of how the formal institu-
tional structures react with, and are conditioned by, the social and political
environment in which they operate.

Organisation of the chapter

The first section of the chapter gives a broad theoretical overview of the
reforms within the neo-liberal movement and the search for a new form of
governance that was to coalesce around concepts of the “regulatory state”.
The second section translates these ideas into the Indonesian context,
including the adaptation of the global rhetoric of neo-liberalism and the
regulatory state and how both were used to champion local political decen-
tralisation in Indonesia, an outcome that both enabled and deepened, ironi-
cally, the role of political patronage at the expense of emergent forms of
regulatory governance. The analysis covers events over the past two decades
leading up to the current financial and operational crisis facing the current
Jakarta administration. Further, this section also outlines how the attempt
to realise a regulatory state was confounded by the introduction of key
market-making institutions; specifically, the flawed design of the concession
contracts, the constituting nature and impaired operational capacity of the
regulatory bodies, and the adoption of ad hoc mediation procedures for the
resolution of disputes between the state and concessionaires.
In the second section, the chapter addresses the failure to transition
successfully to regulatory modalities of governance, and argues that this
failure is a product of the specific characteristics of embedded social relations
in Indonesian, that is, the unique and patrimonial nature of social, economic
and power relations that pervade the Indonesian state, state-market relations

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238 Leong Ching

and private economic activity. As the chapter argues, these socio-political

and economic forms of patronage derailed the realisation of independent,
technocratic, impartial and politically insulated institutions demanded by
regulatory modalities of governance, effectively stalling the prospects for
formalised markets to emerge in ways that would be sustainable. As the
chapter notes, the nature of patronage in Indonesia is such that while the
formal institutions appear to be in place, the informal norms and values that
impact governance and condition social relations remain unchanged.

The privatisation debate: market-building in the

regulatory state

A large part of government activity and institutional change in the last few
decades of the twentieth century can be ascribed to the rise of neo-liberalism
(Berger and Dore 1996; Boyer and Drache 1996; Crouch and Streek 1997).
Broadly, this has meant three things: market deregulation, state decentrali-
sation and a reduction in the size and role of the state in economic affairs
(Lash and Urry 1987; Albert 1993; Przeworski 1995; Jarvis – this volume).
In this it finds traction within a larger dialogue associated with the
modernisation school, including Keynesian theories and the Washington
consensus of the 1980s and 1990s, where the process of development was
surmised to be technical and largely apolitical. In the 1990s, with the rising
interest in governance, the regulatory nature of state authority became a
focal point, in particular the ability of the state to shape and facilitate the
operation of markets (Hout and Robison 2009). Markets could deliver public
utilities it was increasingly thought if only the state learnt how to govern
them properly and only if states learnt how to set in place those conditions,
rules and procedures that would create enabling environments for markets
to establish and thrive.
The history of “governance” and governance innovations in the late twen-
tieth century was thus as much about setting in place the rules by which
markets would operate in newly created commercial domains as it was about
getting states “out of the way” of markets and allowing markets to do what
they do best: seek out profits and returns on capital through the provision
of goods and services. That various states learnt these governance lessons
is borne out by the growth in private sector participation in all facets of
economic activity over the last few decades. Empirically, for example, we
find more non-state actors, including private sector groups, taking part
in public life (Rosenau and Czempiel 1992; March and Olsen 1995; Peters
1996; Rhodes 1997; Lynn and Ingraham 2004). As Kettl observes, the forces
transforming governance such as “the diffusion of administrative action, the
multiplication of administrative partners, and the proliferation of political
influence outside government’s circles” (2000: 159) has provided policy
learning and, in the process, the development of new governance tools for

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the management of markets. Dunleavy and Hood (1994) describe this new
paradigm emerging along two lines – first the public sector is “less distinctive
as a unit from the private sector” than it used to be historically, and second
public officials work through a less dense grid of rules and regulations and
have more discretionary powers. Such outcomes have, in turn, allowed
for more flexible state-market arrangements, differing forms of authority
structures, including new legitimisation processes, and different forms and
systems of accountability and transparency (Garvey 1997; Kettl 2000). As a
result, such governance innovations have precipitated the increasing use of
third parties (Salamon 2002), seen as explosion in outsourcing of govern-
ment services, or the outright withdrawal of government from service provi-
sion in some sectors. As the same time, these more flexible governance
modalities have engineered what some have described as an absolute decline
of hierarchy within government (Frederickson and Smith 2003).
As will be recognised, this new paradigm is not just an argument about the
scope and scale of government, but also its basic forms (Jessop 1997; Pierre
2000). Part of this new paradigm consists of what the editors of this volume
have termed “market-building” efforts. With reference to the provisions of
public utilities, in the United States (Bardach and Kagan 1982) and in Europe
(Majone 1994, 1997b; Moran 2003; Vogel 2003), this conversation has taken
place within the discourse of the “rise of the regulatory state” a discourse
that has now ascended to a dominant mantra and aligned with neo-liberal
policy prescriptions.

What is a regulatory state? Regulatory discourse and

legitimisation

In the regulatory state the concerns are mainly with the role of competi-
tion, markets and privatisation (Vogel 1996; Jordana and Levi-Faur 2004).
Regulation as commonly understood today is a set of rules administered
typically by an independent regulatory agency (IRA), which governs public
behaviour and sets in place the procedures, processes and systems by which
the sector operates, articulates the rights and obligations both of private
actors in the sector but also those of government, and establishes the mech-
anisms for mediation in the event of disputes arising between stakeholders
(commercial operators, consumers, government) (Baldwin et al. 1998;
Braithwaite et al. 2007). Whatever definition is used, however, is to some
degree immaterial since regulation might be better appreciated as a catch-all
ideal whose motif is singular: the construction of an environment condu-
cive to private sector participation − principally through the protection of
property rights, guarantees of probity, stability in the rules that govern the
operating environment and investor protection against government oppor-
tunism and nefarious political intervention. In essence, the ideal behind the
regulatory state is, first and foremost, the de-politicisation of the sector and

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its commercial “normalisation” so that efficiencies associated with private

sector activity can be channelled into the provision of public goods. Notions
of regulation might thus be understood as technocratic attempts to supplant
politics and replace inherently political processes with commercial and
procedural norms.
Writing specifically on market-building efforts in the water sector, Mary
Shirley, in a case study of six urban water systems, captures this notion of regu-
lation and the reciprocity that the instigation of commercial norms instils not
just among private sector operators but the governments who oversee them.
As she notes, “contracting out water services to private operation may be most
useful to countries with weak institutions. The concern of global operators
with their worldwide reputations, local relationships and their responsive-
ness to the incentives under contract can propel improvements that would
not have occurred under a public operator not subject to these motivations.
Governments’ concerns about its international reputation function more
strongly when there is an international operator present ... ” (2002: 37).
In terms of market-building, the first legitimation device of the regulatory
state is thus a straightforward one of capturing private sector efficiencies by
creating governance systems that define and normalise commercial practices,
build technocratic oversight processes and insulate the sector from politics.
A second legitimation objective of regulation arises from fiscal prudence.
Regulatory governance arises out of a series of procedural and technocratic
processes designed to capture fiscal efficiencies and deliver to consumers
better, more responsive services delivered in the most efficient, cost-effec-
tive manner. The political debate about who should provide public services
(the state versus private operators) is thus replaced by a “value for money”
discourse premised on fiscal prudence, best use of tax payers’ money and
notions of managerial efficiency: that whoever serves the interests of the
community more effectively should take over the provision of such services.
If commercial firms can serve this interest, there is no reason for the state
to perform the same function. Indeed, under this rationality, the involve-
ment of the state in the provision of such services is variously depicted as
cost ineffective, managerially inefficient and less competent. On this view,
politicians and bureaucracies do not have the time, expertise or capacity
to design and administer complex policies, or oversee complex industries
owned by the state. Special agencies, such as IRAs, with highly trained and
expert staff, should be allowed to assume this oversight (Majone 1999).
Salamon (2002), for example, argues that “problems have become too
complex for government to handle on its own, because disagreements exist
about the proper ends of public action, and because government increas-
ingly lacks the authority to enforce its will on other crucial actors without
giving them a meaningful seat at the table”.
For a government with little financial resources, poor technical capacity
and a mounting crisis in public utilities, as was the case in Jakarta in the late
1990s, fiscal prudence thus became an appealing means that both justified

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and legitimated privatisation of the water sector (World Bank 1997b: 1).
Indeed, the World Bank supported both the push towards privatisation and
forcefully articulated the fiscal prudence of privatisation measures.
A third legitimising rationale that supported the advent of regulation
derived from the need to provide “credible commitments”. Scholars locate
this need in the alleged decline in public trust in major political and social
institutions. As Moran (2000) notes, “we audit and we regulate, when we
cease to trust”. Majone (1999) argues this is the main reason for delegating
policy powers to what he calls “non-majoritarian institutions” (non-elected
regulatory bodies such as IRAs). As he observes:

Under the expectation of alternation, democratic politicians have few

incentives to develop policies whose success, if at all, will come after
the next election. Moreover, because a legislature or a majority coalition
cannot bind a subsequent legislature or another coalition, public policies
are always vulnerable to reneging and hence lack credibility.

For Majone, “short-termism” has long been recognised as an intrinsic

problem of democratic governance, where politicians drive policy in ways
aligned with election cycles rather than in ways that deliver efficient,
rational, fiscally prudent policy outcomes. In such an environment, however,
the trust factor diminishes, governments and politicians change or reverse
policy, political commitments are abandoned and the credibility of the
public sector is reduced. In an era of increasingly mobile capital and interde-
pendence, credible governmental commitments thus assume a heightened
intrinsic value necessary for effective market-building. This is especially so
in a regulatory state context, where much depends on the private investors’
perception of the credibility of the government and, in turn, on the conduct
of government and the regulator in terms of upholding the (contractual)
commitments entered into. Save for positive perceptions of a government’s
credibility, mobile capital will invest elsewhere.
The case of Jakarta’s water privatisation initiatives can be viewed as an
attempt to realise these three key elements of the regulatory state: enhance
private sector efficiencies in the provision of a public good, instil fiscal
prudence as a cornerstone of service delivery and erect a governance frame-
work that assured credible commitment in the sector in order to entice private
investment. Indeed, these three key pillars undergirded the Jakarta govern-
ment’s approach to privatisation, providing not just an ideational framework
for the move towards private investment in the sector, but a genuine belief
that enjoyed widespread acceptance that beneficial outcomes for consumers,
the government and investors would rapidly emerge. As Bremer noted of the
move towards the privatisation of Jakarta’s water:

If water access is a right, as recently confirmed by the United Nations, then

it is governments’ responsibility to make water available as efficiently as

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242 Leong Ching

possible ... If mobilisation of private investment is the only way that water
systems can be put in place to meet community needs, then governments
have a duty to do precisely that. The question is not whether this option
makes sense – it is the only option. (2003: 11)

Water privatisation, it was popularly believed, was about to solve the crisis
of Jakarta’s water, a crisis that was palpable among the city’s residents (see
also Ehrhardt 2000).

Jakarta: the market turn

Since 1922, Perusahaan Daerah Air Minum DKI Jakarta or PAM JAYA, the
government’s water company, operated Jakarta’s water supply system (Lanti
2006). The outflow, or the resulting waste water and sanitation, operated
under the purview of PALYJA. Amid rapid urbanisation and ever-increasing
demands for more water provision and sanitation services, the strain on
Jakarta’s water supply system and its public utilities had been evident for over
a decade, with the sector suffering from poor service quality and high water
losses. By the late 1980s, these losses reached breaking point – the service
coverage ratio, for example, was a mere 23 per cent while non-revenue water
stood at some 51 per cent (JBIC 2001). By the 1990s and with ongoing urban
expansion, less than half of Jakarta’s population received water from the
public supply. Rectifying this situation was going to require massive public
expenditures and an urban works programme the likes of which few cities
had experienced historically (Tutuko 2001).
Clearly, however, the infrastructure works programme for Jakarta’s water
sector was beyond the financial reach of the Indonesian government,
particularly when coupled with competing financial demands from other
domestic constituencies. In 1995 President Suharto thus ordered his Public
Works Minister, Radinal Moochtar, to privatise Jakarta’s water. Given the size
and scale of the infrastructure deployment that was needed, it was decided
to divide the city in half, creating two separate water sectors (West and East),
each of which would be offered to private operators as separate concessions.
By 1998, the government had contracted Jakarta’s two water zones to Suez
(from France) and RWE Thames (from the United Kingdom). Both were
multinational companies, taking the Western and Eastern Sectors, respec-
tively, with 25-year concession contracts.

The tender process and “birth defects” in contracts

One of the most distinctive aspects of the privatisation process concerned
the award of the concessions. Typically, due process involves the award
of concessions on the basis of competitive bidding in an open and trans-
parent process. Atypically, however, both of Jakarta’s water concessions

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were awarded via negotiation and behind closed door discussions that were
not subject to scrutiny by an independent party. Indeed, the negotiation of
the concessions was a highly political affair, even involving the President
himself. In the case of the Eastern sector, for example, the negotiations
went on for two years from 1995 to 1997, until Garuda, the local partner
of Thames, bought the case directly to the Governor of Jakarta to try and
achieve contractual closure. Garuda argued that “technically speaking, there
were no fundamental problems to be solved by the negotiating team and
the private party” (Letter to Governor, 14 April 1997, cited in Boomgaard
2007: 303) and urged the Governor to intervene and speed up the process.
By contrast, the government raised issues about expenditure projections and
the rate of water infrastructure deployment, manpower and staffing levels,
and sundry other contractual issues. Extraordinarily, these issues were raised
at the Presidential level, with the President then appointing a Minister who
took over the negotiations, travelling to London himself to discuss the issue
with Thames water. In turn, the Minister responsible formed a negotiation
team to deal with the two companies consisting of representatives from the
Jakarta administration as well as PAM JAYA . While the PAM JAYA representa-
tives openly acknowledged concerns about the terms of the concessions, the
concessions were concluded and the contract closed on 7 June 1997 amid
political pressures to reach closure.
Further, and of most concern, questions about the probity of the award
of the concessions were raised since both concessionaires were companies
known to have close ties to the President. The London-based Thames Water
Overseas Ltd, for example, had formed an alliance with Harjojudanto, the
eldest son of the President, who held one-fifth of the company. Thames
explained its decision in strategic terms, noting that “at the time, any
company dealing with Indonesia would have to deal with some element of
the Suharto family because of the way the government was set up” (Peter
Spillett, head of environment, quality and sustainability for Thames as
quoted in Harsono 2005).
Similarly, the other concession held by Suez had formed a close working
relationship with the Salim Group, at that time the largest conglomerate in
Indonesia, to negotiate and operate the Western concession. Sudono Salim,
the founder of the Salim Group, was a close political ally of President Suharto
and known to have privileged access. Indeed, political access in the case of
concession negotiations was openly acknowledged by Bernard Lafrogne, a
Suez representative in Jakarta, who noted that “access to politics is essential.
The water business is always political” (Harsono 2005).
Regardless of the questionable process leading to the award of the conces-
sions, however, privatisation of Jakarta’s water proceeded. On 1 February
1998 the assets of PAM JAYA including the network and treatment plants
and related equipment were transferred to the private operators on the

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understanding that they would be returned to PAM JAYA at the end of the
concession period on 1 February 2023 (PALYJA 2005).

Birth defects: contracts, negotiations, and the devil in the details

As Andrew McLernon, an urban development consultant for the World
Bank observed, from the outset the process and design of the concessions
suffered from “birth defects” − a lack of transparency, the failure to raise
water rates prior to privatisation and the lack, initially, of an independent
regulator made for a malformed set of governing instruments. These failures
in contract and regulatory design, however, should be contextualised amid
a palpable state of crisis in Jakarta’s water sector, where popular pressure for
political intervention to fix Jakarta’s water problems invited political inter-
vention at the highest levels, in the process creating a space for ill-conceived
contractual design, the absence of regulatory oversight or the identifica-
tion of regulatory mechanisms for dispute resolution. Indeed, emblematic
of these “birth defects” was the fact that while the privatisation effort was
initially supported by the World Bank, when it realised that the contracts
were to be awarded on a non-competitive basis, it dropped support of the
project (World Bank 1997b: 177).
The details contained in the concession contracts also reveal much about
the inevitable legacy such privatisation measures would have on the sector.
Several weaknesses were immediately apparent in the contracts and, indeed,
would come to hinder the development of the sector.
First, the contracts provided for a “water charge”. This was to be paid to the
water companies by PAM JAYA. The water charge was essentially a guaran-
teed revenue stream paid annually to the concessionaires. It was designed to
ensure the concessionaires would receive a contractually agreed internal rate
of return (IRR) of 22 per cent annually for the life of the contract (25 years).
From the position of the concessionaires, the water charge was set in place
to offset what they argued would be revenue shortfalls due to the large inci-
dence of non-revenue water (illegal connections), water tariffs that were
set at below the cost of water provision and the infrastructure roll-out that
would be required to address both the decayed state of existing infrastruc-
ture and the rapid expansion in Jakarta’s population (new connections). The
water charge and the agreed IRR of 22 per cent thus provided the conces-
sionaires with a gold-plated, guaranteed return, devolving financial liability
in terms of revenue shortfalls to the government.
Second, the mechanisms for revenue and tariff management were cumber-
some, burdening financial liability on to PAM Jaya rather than the conces-
sionaries. Under the terms of the concessions, for example, PAM Jaya was to
pay the water charge guaranteed to concessionaires from revenues generated
by the water tariff paid by consumers. While the tariffs would be collected
by the private operators of the concessions, the concessionaires would
deposit tariff revenues into an escrow account. In theory, the monies would

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be sufficient to pay for the water charge, as well as pre-existing debts and
payments to the city government. In practice, however, PAM Jaya was to find
that the tariffs collected were not sufficient to pay the water charge, partly
because of the difficulties of raising tariff rates due to concerns about afford-
ability, equity and political intervention. Indeed, subsequent discussions
on tariff rate rebasing proved to be an arduous process, effectively creating
mounting fiscal liabilities on PAM Jaya and the Indonesian government.
Third, structured into the concessions had been provisions for currency
hedging in order to indemnify foreign operators from currency risks due
to exchange rate fluctuations. Further, the contracts also stipulated provi-
sions for interest rate variations, effectively insulating the operators against
potential increases in the cost of capital in the case of capital raising for
infrastructure provision. In essence, currency and interest rate risks would
be borne by the government; that is, all external shocks would be compen-
sated for by the government, in the process devolving substantial liability to
the Indonesian state that would escalate enormously during the subsequent
Asian Financial crisis.
Fourth, on top of the water charge was a “management know-how” fee
that was to be paid annually to the parent companies of the concessionaires.
This was meant to offset the consulting and advising costs of parent and
local partners in the management of the concessions.
Fifth, and perhaps most importantly, was the regulatory architecture built
into the concessions. The implicit regulatory model adopted was the French
one in which the contract itself was assumed to be sufficient to guide the
conduct of business – and that the government and private operators could
rely on the legal system to adjudicate disputation. There was no independent
regulator that would be able to balance interests, no non-legal mechanism
for dispute resolution and no regulatory mechanism or IRA to govern rate
rebasing and tariff adjustment.
From a regulatory perspective, where effective regulation is meant to
balance the interests of stakeholders (private operators, consumers and
government) equally, these contracts displayed a biased division of the risks,
revenues and profits. Clearly, financial risks in the sector were “socialised”
and to be disproportionately borne by PAM JAYA and the Indonesian govern-
ment, while the economic benefits were to be reaped by the private opera-
tors. As many observed at the time of the announcement of the contracts,
the operators of the concessions had negotiated a winning deal; guaranteeing
returns and offloading revenue, currency and interest rate risks. Regardless
of what happened in the sector the private operators were guaranteed a 22
per cent IRR.
More broadly, however, the concessions also represented a general failure
for the sector. For example, the concessions created a great deal of uncer-
tainty (which the contracts failed to address), including the employment,
employment security and rate of pay for staff of PAM JAYA who, in effect,

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246 Leong Ching

had become reliant on the concessionaires. These staff formed 90 per cent
of the total workforce and yet were not certain who they actually worked
for, the terms of their employment, the prospects for salary progression and
renegotiation, or career progression.
All these contractual defects were to be exposed in the tumultuous first
three years of the operation of the concessions. Indeed, a mere month after
the contracts were signed, the Asian financial crisis began to hit Southeast
Asia, first in Thailand which witnessed massive runs on the Thai baht and
then Indonesia, with equally devastating runs on the Indonesian rupiah.
For the Indonesian economy, the external shocks were devastating, causing
huge increases in the price of food, medicines and other imported commodi-
ties as the rupiah fell in value. The extent of the currency depreciation was
unparalleled, with the rupiah to U.S. dollar falling from 2,300 in July 1997
to more than 14,000 in February 1998. The ensuing economic dislocation
created widespread protests as tens of millions of people were thrown into
abject poverty and unable to afford basic necessities, including food as rice
prices rose dramatically. With mass political unrest, President Suharto was
forced to step down in May 1998.
Against this backdrop, the impact on the recently privatised water conces-
sions was equally devastating, albeit not for the operators who enjoyed
contractual indemnity against currency and interest rate risks. Thus, while
the water charge levied by the private operators (and payable in US dollars)
remained in place, the revenue to the government (levied in rupiah) fell
correspondingly (Bakker 2006), escalating at an alarming rate the finan-
cial liability of the Indonesian government. As these liabilities were widely
reported to a now mobilised civil society a popular backlash erupted against
the water privatisation projects. Indeed, so violent were these protests that
the foreign operators were forced to flee Jakarta, leaving the water utilities
unattended and PAM JAYA to run the sector (Bakker 2006). Jakarta’s water
supplies were subsequently disrupted as Pam Jaya workers went on strike
and walked out in protest against foreign ownership and the terms of the
concessions that had been granted. More detrimental to the sector, however,
was the intervention by the Indonesian government, who in an attempt
to contain political unrest and anti-government sentiment ordered PAM
JAYA not to increase water tariffs for the first three years of the concessions.
For PAM JAYA, however, this decision was a costly one, squeezing revenues
levied in rupiah while still obliged to service the water charge payable in US
dollars. At the same time, PAM JAYA’s operating costs escalated out of control
amid a national annual inflation rate that ran at 120 per cent.
PAM JAYA’s financial situation was an unsustainable one, finally forcing
it to break with government policy and increase water tariffs three times (1
April 2001 by 35%, 1 April 2003 by 40% and 1 January 2004 by 30%). News
reports at the time showed the public unrest and fears over the drinking
water supply. PAM JAYA officials feared that the Jakarta water network might

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The Market Turn in Jakarta’s Water Supply 247

be poisoned because of protests at the water tariff increases. Others even

predicted a cholera outbreak (Harsono 2005).
As the crisis subsided, the foreign operators returned. By that time,
however, the contracts had been cancelled after demands by local opposi-
tion groups to revoke the concessions. The operators responded by calling on
their respective governments to put pressure on the Indonesian government
and pursue international legal means to recover losses and damages. Under
the threat of lawsuits from large multinational corporations, the contracts
were subsequently revived, despite popular opposition. The Suharto-linked
Indonesian partners, however, were bought out and the names of the compa-
nies changed from PT Kekar Thames Airindo (KTA) to PT Thames PAM JAYA
(TPJ), and from PT Garuda Dipta Semesta (GDS) to PT PAM Lyonnaise Jaya
(PALYJA).

Renegotiated contracts
On 22 October 2001, a new contract was signed between PAM JAYA and the
private operators. Both Thames and Suez established new companies: PT
Thames PAM JAYA and PT PAM Lyonnaise Jaya, were 95 per cent owned by
their parent companies in London and Paris, with the shares held by the
subcontractors of these international companies. Under the new contract,
the multinational companies agreed to give PAM JAYA joint control of the
escrow bank account. At the same time, the five service standards and five
technical targets monitored by the contract were reset. Notably, under the
new contract, targets for coverage and leakage reduction were relaxed to
levels so low they were even below those achieved by the local water utility
pre-privatisation.
The new contract did, however, provide for a regulatory body, the Jakarta
Water Supply Regulator Body (JWSRB). Its terms of reference were “to protect
the interest of the consumers and also the interest of the Parties in the Restated
Cooperation Agreement (RCA) between PAM JAYA and the two concession-
aires” (PAM JAYA and PALYJA 2001: 1; PAM JAYA and TPJ 2001: 1). In practical
terms, the main roles of JWSRB were to review tariffs and make proposals to
the Governor, to monitor the performance of the companies in terms of service
and technical standards, and to meditate disputes between the operators,
customers and the government. After its first three-year term, the government
strengthened the independence of the regulatory body by specifying that the
chairman and members of the Board must be independent from the govern-
ment and publicly recruited.
An important duty of the JWSRB, as in most regulatory bodies, was to
resolve conflicts and balance the interests of stakeholders. Most immedi-
ately, JWSRB needed to consider the issue of regular rate rebasing, particu-
larly in light of inflationary pressures. All of this, of course, should have
been relatively straightforward since such increases were to be regular, auto-
matic and already set out both in the original contract and the RCA. But the

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248 Leong Ching

first rate rebasing exercise in November 2003 demonstrated how intractable

tariff adjustment had become, and how little real power the regulatory body
held.
In preparation for the tariff rebasing exercise, ministry officials set up
an Independent Combined Expert (ICE) team, including the JWSRB. In
mid-February 2004, the ICE presented its results, setting out the increases
expected. Under its terms of reference, the JWSRB could recommend a
certain level of tariff but had no power to enforce it; the Governor of
Indonesia would still need to give final approval for the increase (Iwanami
and Nickson 2008). Not surprisingly, the Jakarta governor declined to
implement the increases given their politically sensitive nature and the
popular backlash that would result. As a result, the Jakarta government
then consulted with the Ministry of Public Works and a joint team was
formed to try and forge an agreement for new water charges. Again,
this attempt ended in failure. Finally, both parties came to JWSRB and
requested mediation. In December 2004, PAM JAYA and PALYJA reached
an agreement for a new rebased water charge. TPJ, however, refused to
sign on. Not until the end of November 2005, more than three years after
the 2002 deadline, was an agreement finally struck. Indeed, it took a High
Executive Meeting of the Jakarta Provincial Government chaired by the
Governor himself, before the first implementation of a supposedly auto-
matic tariff adjustment could proceed.

Market-building in the Indonesian water sector: contractual

and regulatory failures

The difficulty of reaching a negotiated agreement for tariff rebasing

demonstrates the weakness of both regulation by contract and also of the
ineffective nature of the regulator once established. In part this was inevi-
table, since the design of the contract created asymmetrical interests that
essentially condemned the sector to gridlock. Indeed, such was the severity
of the gridlock and the delay in tariff rebasing that the resulting finan-
cial disparity between tariff revenues and the water charge payable to the
concessionaires had reached USD$ 100 million by 2005. As an example of
market-building in a network industry, the Jakarta water sector demon-
strates the considerable obstacles to successful marketisation and, more
importantly, the institutional dilemmas in harnessing the rewards that
supposedly stem from market-driven efficiencies. While privatisation and
the contractual specification of performance and technical standards was
popularly held to be a tangible means of improving water sector perform-
ance by replacing what, historically, had been a system of patronage
prone to poor levels of probity, in reality it proved much more difficult
to achieve. Indeed, each of the three elements privatisation promised to
deliver (capturing private sector efficiencies, fiscal prudence and credible

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The Market Turn in Jakarta’s Water Supply 249

commitments) failed to materialise. Realising a regulatory state and the

associated institutional, environmental and procedural norms necessary
to sustain it proved overly onerous in a political context where regula-
tion and technocratic practices were mostly absent. Each of these failed
elements necessary to the realisation of a regulatory state can be briefly
examined.

1. Capturing private sector efficiencies.

As originally designed, the concession contracts were to capture private
sector efficiencies in two key ways – price and competition. The first was
to have been captured through the process of selecting the operator, and
through the use of key performance indicators and competitive bench-
marking. In practice, however, both concessions failed to achieve any effi-
ciency gains. Indeed, what was notable in the case of Jakarta is the way
in which such efficiencies were jettisoned. First, for example, the selection
process, one of negotiation rather than open tender, was a key factor in
eroding potential efficiency gains. The “birth defects” showed that even as
privatisation sought to dispel personal ties and political influence in public
service provision, these very elements became embedded in the market-
building processes.
Equally, the attempt to instil in the sector competitive processes and a
series of technical and customer service delivery benchmarks to increase
sector performance also fell short. Both operators failed to live up to the
contractually stipulated performance indicators – with relative impunity.
Much of this stemmed from the lopsided nature of the contracts, where the
government had little leverage or recourse in the case of poor performance
standards. The financial implications to the operators who failed to attain
the performance benchmarks as set out in the contract, for example, were
financially insignificant, making it more cost-effective to pay the penalty
rather than meet the performance benchmarks.

2. Fiscal prudence.
Privatisation was also championed on the basis that it offered fiscal prudence,
better management of financial resources and the delivery of public goods
in ways that were cost-effective compared with those delivered through
traditional state bureaucracies. Fiscal prudence, however, operates when
the contractor assumes financial liability for service delivery relative to an
income tied to tariff rates. But under the terms of Jakarta’s water concessions,
fiscal liabilities resided predominantly with the government and PAM JAYA,
reducing the incentives for the operators to pass on efficiency gains or even
to strive to achieve efficiency gains, indeed creating perverse incentives for
the operators in ways that were not aligned with productivity enhancement
or efficiency (Laurie and Marvin 1999; Finger and Allouche 2002; Johnstone
and Wood 2003; Swyngedouw 2005).

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250 Leong Ching

3. Credible commitment.
Regulation and regulatory states operate on the basis of the credibility
of commitments made by the government to private sector participants.
Without governmental credibility in terms of adhering to a set of rules and
procedures that govern the sector, private sector actors will not invest in a
sector if they judge that the rules of the game will change and thus impact
the security of the investment. Regulation, particularly the emplacement
of an IRA, is thus viewed as necessary in order to normalise practices that
support commercial activity through the assurance of impartial govern-
ance of the sector. In the case of the water sector in Jakarta, however, regu-
lation came after the fact and then only partially. Rather, regulation by
contract was adopted as the means to indemnify investors against govern-
ment opportunism and political risk. For investors, the sanctity of the
contract was assumed to be sufficient to protect interests, and the legal
system sufficiently impartial to ensure a fair resolution to disputes. In
practice, however, the utilisation of legal instruments is always a cumber-
some, costly and time-consuming affair. Perhaps because of this, there was
no attempt by either side (the private operators or the government) to use
the courts in the enforcement, or the mediation, of the contractual terms.
Rather, this process was devolved to a set of negotiations that were ad hoc,
effectively politicising issues around tariff rebasing. When the legal system
was invoked, ironically this was not to seek redress over contractual issues
but to prosecute the concessionaires on charges of corruption. Instead, the
process of contract enforcement thus proceeded in fits and starts through
negotiation and political bargaining.
More obviously, the termination of the concessions and their subse-
quent reinstatement after renegotiation also highlighted the fickle nature of
Indonesia’s political system and decision making, not least the highly volatile,
corrupt and unstable environment for those contemplating sinking invest-
ments into the country. While the contractual terms of the water concessions
can certainly be questioned in terms of their fairness and the allocation of
risks, costs and profits, at the end of the day capricious government decision
making, policy reversal and contract repudiation also represented sizable risks
for investors which, for over a decade, condemned Indonesia to net capital
foreign outflows as investors withdrew money and fled to safer jurisdictions.

Conclusion

Privatisation has clearly not brought Jakarta any closer to the promises of
higher efficiency, increased investments or better services in the water sector.
For consumers, it has been a clear failure. Complaints about the quality,
quantity and regularity of the water supply persist (Platts’ Global Water
Report 2002). As the Jakarta Post observed, “despite the entrance of two

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The Market Turn in Jakarta’s Water Supply 251

foreign companies [into the sector], people in Jakarta still complain about the
quality of the water they produce as well as disruption to water supply ... The
two companies have ... failed to expand their networks arguing that the city
administration had increased water rates only a fraction of the amount they
had requested” (Hall 2002: 7).
Consumer groups, meanwhile, have continued to protest the price rises
and the lack of service to the poor. Indeed, for the majority of Jakarta’s poor,
water remains an expensive commodity, with most forced to buy drinking
water from street vendors while about 70 per cent of the city’s poor still lack
access to running water.
For the private operators, by contrast, the renegotiated contracts remain
in place but the terms of the contracts not necessarily honoured. The prom-
ised tariff increases, for example, have not come about, and negotiations are
ongoing about the payment of debt that has accumulated through the water
charge.
For the government, by contrast, the promise of fiscal prudence has not
been realised; if anything fiscal liabilities have grown but absent any net
gains in the service quality or network coverage of the sector. Rather than
the win-win situation envisioned when the contracts were first issued, for
the government and consumers privatisation efforts have resulted in net
losses.
Such outcomes explain why there are persistent calls for the contracts to
be terminated. Such pressures, however, perhaps must be resisted, not least
because the public operators, after two decades of relative inaction, may
not have the wherewithal to operate the system. More obviously, contract
repudiation at this late stage would expose the Indonesian government to
liabilities and reputational issues that would have a negative impact on the
economy – not least in terms of perceptions among the international invest-
ment community. For the foreseeable future, the sector is thus condemned
to limp along much as it has done for the last decade.
As an effort in market-building there are few commentators that would
count the case of the Indonesian water sector as a successful story. Rather, its
legacy stands as a testimony to the inherent dangers of marketising sectors
absent quality institutional and regulatory design, transparent tendering
processes, and due process in the allocation of sector risks, costs and profits.

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