GPOBA Commitment Paper:Expanding Piped Water Supply to Surabaya’s Urban Poor September 10, 2007

INDONESIA

GPOBA COMMITMENT PAPER

Project Name: Expanding Piped Water Supply to Surabaya’s Urban Poor (P105590)

Project Summary

The objective of the project is to increase and sustain access to piped water networks for poor households living in both formal and informal areas of Surabaya. The project will result in about 15,000 household connections to the utility’s piped water network and 500 household connections through a small number of innovative master meter schemes for informal communities not otherwise eligible for household supply. The total number of beneficiaries will be about 77,500 people (5 people per household).

The public water utility of Surabaya (PDAM) will be the implementing agency and ultimate recipient of the subsidy and the Grant Agreement will be signed with the Government of Indonesia. PDAM Surabaya will pre-finance, procure, and construct the systems. A City Government Committee headed by the Department of Public Works will act as the Scheme Manager to manage the project as a whole. In addition, a firm will be hired as the OBA Auditor to provide an annual assessment of progress and quality of works under the project; to undertake spot checks on connections made; and to certify the unit subsidies for extension connections and master meter schemes.

Total project size is $4.785 million of which $2.527 million is requested from GPOBA for subsidy payments, technical assistance, and Bank supervision. The project will be implemented over three years from 2008 to 2010 with a phased approach. In year 1 about 3,000 connections and three pilot master meter schemes will be provided. In years 2 and 3, the project will scale up. The 15,000 household connections will be a mix of in-fill connections to existing networks and expansion connections to new tertiary network subject to maximum average subsidy of $150 per household ($30 per person). In total about 7,500 in-fill and 7,500 expansion connections will be provided and about 10-15 master meter schemes.

Unit costs have been developed based on a random sample of recent PDAM contracts. They have been carefully verified by an independent consultant and compared with benchmarks. The unit cost per in-fill connection is set at $78 of which households will pay $33 (42%) and GPOBA will pay $45 (58%) for eligible connections. The unit cost for expansions schemes will vary according to length of tertiary pipe but is estimated at $283 on average of which households will pay $33 (12%) and GPOBA will pay $250 (88%) for eligible connections. However, assuming a 50 percent eligibility for reimbursement in expansion areas, GPOBA will only subsidize half of the network expansion costs. PDAM will bear the other half estimated at more than $1.5 million, in addition to all pre-financing costs. Unit costs for master meters have been developed in line with project practice for in-fills and expansions with a cap of $5,000 per scheme for the size of subsidy. All master meter and extension costs will be subject to review by the OBA Auditor prior to reimbursement.

Project beneficiaries will be targeted using proxy variables for income poverty. Specifically, the three eligibility criteria are: (1) building size 60 m2, (2) road width 6 m, and (3) formal installed electricity capacity 1,300 VA (with a preference for households 900 VA), or no formal connection.

Subsidy payment for eligible connections will only be made three months after the beneficiaries have gained access to piped water supply and the service has been delivered and paid for during that period. In addition, subsidies will be only disbursed provided the connection is new and made after signing of the Grant Agreement; the connection is of the approved specification; the connection is operational and in use at time of application for payment; and expansion and master meters schemes have been subject to the appropriate ex-ante and ex-post quality and unit cost reviews by the OBA Auditor.

Project Fact Sheet

Scope: Expanding piped water supply to low-income households in the city of Surabaya (East Java, Indonesia) through a combination of household connections to existing network, household connections to expanded network, and master meter schemes.

Total project costs: $4,785,000

Total GPOBA funding requested: $2,527,500

  • Subsidy funding for connections = $2,212,500 (W3)
  • Subsidy funding for master meters = $75,000 (W3)
  • Independent auditor = $95,000 (W3)
  • Recipient-executed special studies = $25,000 (W3)
  • Supervision funding for World Bank = $120,000

The GPOBA funding will come from the Dutch contribution to GPOBA, and will meet requirement that subsidy per capita is less than or equal to $30, and that no more than 25% of Dutch contribution is allocated to non-SSA countries.

Additional funding sources: $2,257,500

  • PDAM Surabaya Investment + Supervision = $1,587,500
  • USAID ESP/ Eco Asia = $150,000
  • User contributions for household connections = $495,000
  • User contributions and NGOs for master meters = $25,000

Outputs:

  • About 15,000 working household connections
  • About 10-15 master meter schemes with 25-100 householdseach, target 500 households

Expected beneficiaries: 77,500 people (5 people per connection)

GPOBA subsidy “efficiency”: $30/person ($33/person with TA and Supervision costs)

Targeting: Households in poor areas that meet the three criteriaestablished by the project as proxy variables for income poverty: (1) building size 60 m2, (2) road width 6 m, and (3) formal installed electricity capacity 1,300 VA, or no formal connection.

Grant recipient: Government of Indonesia

Financial Management: GPOBA subsidies disbursed to incumbent service provider through designated account managed by the scheme manager. FM approach presented in this document has been prepared by FM team in Jakarta and will soon be cleared by the Regional Hub Leader (as part of process of finalizing the grant agreement).

Disbursement:

  • Household connections = 100% after receipt of verified evidence of 3 months water service and paid bills
  • Master meter schemes = 100% after receipt of verified evidence of 3 months water service and paid bills

Procurement:

  • Cleared by Regional Hub Leader
  • Competitive tendering of OBA Auditor through prior review
  • Post review of PDAM works contracts in line with Output Based Disbursement (OBD) guidelines and the Country Procurement Assessment Report (CPAR) for Indonesia

Safeguards clearance:

  • ISDS Concept Stage cleared by Regional Secretariat
  • ISDS Concept Stage disclosed in Infoshop on July 31, 2007
  • Project transferred to GPOBA for appraisal stage clearance
  • Category B for environmental safeguards
  • No other safeguards triggered

Government endorsement:

  • City of Surabaya—Mayor’s Office, Planning Agency, Financial Management Agency
  • Government of Indonesia—Ministry of Finance

Internal Rate of Return (IRR):

  • Economic IRR is 45% with subsidy including expenditure, time and health benefits
  • Financial IRR, even with subsidy,is -7%

Exchange rate: IDR 9,000 per 1 USD

Panel of Experts’ Issues raised at Eligibility Stage (March 2007)

1. Household Contribution

The Panel of Experts asked if the tariff could cover at least O&M costs and if household contributions could be increased to more than the currently proposed $20.

The tariff structure is set by the City of Surabaya, under regulations from the Ministry of Home Affairs, and cannot be adjusted for the project. Although some tariffs for residential customers do not cover O&M costs, the overall tariff structure (which contains a mix of different customer categories and consumption blocks) does cover both O&M and production costs. Such cross-subsidy schemes are common in Indonesia and accepted as a form of social redistribution.

The project has increased the household contribution for in-fill or expansion connections to $33. This new figure is based on the results of a large survey of poor households which confirmed that 57% of poor households in selected project areas would be willing to pay Rp.300,000 ($33) or more for a PDAM connection. This new figure increases the efficiency of the GPOBA subsidy.

2. Project Buy-In

The Panel raised the issue of the project’s continuity in the event that the current managing director of the PDAM left.

The OBA Team at the PDAM is a dedicated team with 15 members from the various departments of the utility, including Planning, Customer Service and Consumption, and Research and Development. Active participation by PDAM staff in the project to date (from the concept stage to detailed preparation) ensures an institutional commitment to long-term service delivery to the poor, organizational learning as to how to design new schemes in the future, and a vested interest in maintaining water service beyond 3 months.

In addition, the project team has met twice with the Mayor of Surabaya and multiple times with other city government agencies apart from PDAM. The involvement of a city agency as Scheme Manager now ensures that there is local support for the project beyond the PDAM. There is also support for the project from central government, including the Ministry of Public Works and the Ministry of Finance.

3. Grant Agreement

The Panel asked that the team clarify who the signatories to the Grant Agreement would be.

Several options for implementation arrangements were explored including signing the Grant Agreement with the Government of Indonesia, with an NGO, and with the PDAM directly. However, due to Indonesian regulations, it was found that it is not possible to sign a Grant Agreement on behalf of the World Bank either directly with a city government or with a PDAM. As an alternative arrangement, discussions were held with leading NGOs in Indonesia. However, the option to work with an NGO was ultimately rejected in order to develop a national government model that would be scalable elsewhere in Indonesia, and because of limited interest from the NGOs themselves. As a result, the Grant Agreement will be signed by the Country Director of the World Bank (on behalf of GPOBA) and the Ministry of Finance (on behalf of the Government of Indonesia). Subsequently, an On-Grant Agreement will be signed by the Ministry of Finance and the City of Surabaya.

4. Mechanisms for Master Meter Tariff Collection

The Panel expressed some concern over the risk element of the master meter scheme. It felt that the design of a plausible mechanism to safeguard/ensure tariff collection would be important for replication.

The master meter scheme has been designed such that subsidy disbursement for the portion of the costs of the system pre-financed by PDAM will be contingent on three months of billing and collection for the bulk meter. This is different from the concept stage in which 80% of the costs were to be reimbursed once the bulk meter was simply in place. In this new arrangement, PDAM’s reimbursement will thus be contingent on a successful tariff collection mechanism downstream of the bulk meter. This will put pressure on PDAM staff to take an interest in community mobilization and in the way the local NGO or CBO has designed the payment system, without putting such stringent safeguards in place that the project becomes a supply driven rather than a community driven scheme.

Experience with similar schemes elsewhere, such as in Medan in Sumatra, Indonesia, has shown that there have not been any problems with revenue collection in either metered or non-metered downstream systems, and that in general community management does not appear to be an issue. To ensure that well-designed and sustainable tariff collection systems are in place, our project partners USAID ESP and ECO-Asia, both based in Indonesia, will work closely with local NGOs and have set aside significant funds to support them and transfer knowledge from Medan and elsewhere.

LIST OF ABBREVIATIONS

BapemasCity Poverty Agency

BIBank Indonesia

BOQBill of Quantities

BPKPGovernment Financial Auditor

BRIBank Rakyat Indonesia

CASCountry Assistance Strategy

CBOCommunity Based Organization

DGDirectorate General

ESPEnvironmental Services Program

GOIGovernment of Indonesia

GPOBAGlobal Partnership on Output-Based Aid

KelurahanUrban section/ward, comprising on average 10 RWs

KeppresPresidential Decision (Keputusan Presiden)

KotaMunicipality

KPPNLocal Office of National Treasury

KTPNational Identity Card

MDGMillennium Development Goal

MoFMinistry of Finance

MoHAMinistry of Home Affairs

NGONon Governmental Organization

NRWNon-Revenue Water

OBAOutput-Based Aid

PIMProject Implementation Manual

PDAMLocal Water Supply Company (Perusahaan Daerah Air Minum)

RPJMNational Medium-Term Development Plan

RSSecond Lowest Water Tariff for “Simple House” (Rumah Sederhana)

RSSLowest Water Tariff for “Very Simple House” (Rumah Sangat Sederhana)

WalikotaMayor

1 USD = Indonesian Rupiah(IDR) 9,000

A. STRATEGIC CONTEXT AND RATIONALE

A.1. Country and Sector Issues

Indonesia

Indonesia is classified as a DAC III country although, from a World Bank perspective, it is an IDA/IBRD blend country. Some key national statistics are provided in the table below:

Table 1: Key Country Indicators

2005
Population growth (annual %) / 1.36
Population, total (millions) / 220.56
Life expectancy at birth, total (years) / 67.79
Mortality rate, infant (per 1,000 live births) / 28
GNI (current US$) (millions) / 278,236
GNI per capita, Atlas method (current US$) / 1,280
GDP per capita (PPP US$) / 3,600
Population living below national poverty line (%) / 16.6 (2007)
Population living below $2 per day (%) / 49.9
Prevalence of HIV, total (% of population ages 15-49) / 0.13

Source: World Development Indicators Database, April 2007.

Indonesia has achieved remarkable economic development success over the past decade and was, until the Asian economic crisis struck, considered to be among the best performing East Asian economies. Indonesia grew at an annual rate of 7.1 percent between 1985 and 1995, and attained real Gross Domestic Product (GDP) growth of 7.8 percent in 1996. Between 1970 and 1996, the proportion of the population living below the official poverty line declined from 60 percent to an estimated 11 percent—about twenty-eight million people – reflecting the government's strong commitment to poverty reduction.[1]

During the 1997 financial crisis, GDP growth declined from 7 percent to negative 13 percent and inflation surged to nearly 60 percent. Since then, Indonesia has made a strong economic recovery and its transition to democratic governance and decentralization continues with President Susilo Bambang Yudhoyono making important reforms on several fronts. Indonesia has graduated from the IMF program, its macro economy has strengthened, and development spending and poverty levels have returned to pre-crisis levels. While governance issues remain an impediment to progress on some fronts, prospects of genuine reform are better now than in decades.[2]

Since mid 2006, Indonesia has been showing signs of a solid recovery from the dramatic fiscal and monetary policy adjustments in late 2005 which slowed the economy and increased poverty.[3] The 2005 economic slowdown was due in part to interest rate increases and in part to administered fuel price increases. Although the economic adjustments were designed to put Indonesia on a solid footing and were well received, the resulting slowdown was unfortunately accompanied by more natural disasters, including an earthquake in Yogyakarta, a tsunami in West Java (separate from the tsunami in 2004 that devastated Aceh), and a mud volcano in East Java south of Surabaya. Moreover, poverty rose from 16 percent to 17.75 percent between 2005 and 2006. The key economic challenge now facing the country is to turn the recent cyclical upturn into sustained growth, while addressing poverty and improving disaster preparedness.

The Urban Water Sector

The Indonesian water sector is in a precarious position. It suffers from, inter alia, tariffs set well below full cost recovery levels, low coverage, declining service ratios, high non-revenue water (especially from physical losses), poor levels of service, high indebtedness, political interventions and poor management capacity.[4] These problems have led to a vicious cycle of negative cash flows, underinvestment in assets, insufficient maintenance, increasing indebtedness and defaults/arrears on loans. The situation has been exacerbated by the absence of any supporting national water strategy to accompany the 2001 decentralization of responsibility for service provision to local governments.

Prior to the 2001 decentralization program, the Ministry of Finance (MoF) used to provide financing to the country’s hundreds of local water supply companies (PDAMs) by means of sub-loan agreements, bearing much of the risk and burden of any unpaid loans. Although fiscal accountability has now been transferred to local governments, the PDAMs remain heavily indebted to central government. Current PDAM indebtedness stands at around IDR 5.2 trillion ($570 million). Of the 338 PDAMs, less than ten percent are deemed financially “healthy.” Most generate insufficient funds to cover operating costs, let alone invest in network expansion and/or in service improvements to increase cash flows in order to service debts.

Currently, only 17 percent of households have access to piped water. For Indonesia to achieve its Millennium Development Goal (MDG) for water, sector investment must increase from IDR 450 billion ($50 million) to at least IDR 4.15 trillion ($450 million) per year until 2015. Unsurprisingly, Indonesia is below the coverage required to be on track to fulfilling the MDGs for both water and sanitation in 2015. Disaggregated data for urban and rural areas show that urban water coverage has fared particularly badly with coverage actually regressing from 1990 (92 percent) to 2004 (87 percent).[5]

In the absence of a connection to piped supplies, households rely on shallow and deep wells. Ongoing use of such sources is becoming increasingly unsustainable, particularly in urban areas. Lack of adequate sanitation has led to contamination of shallow groundwater sources and an increase in the associated incidence of water-borne diseases. The over-pumping of deep wells has led to salt water intrusion in coastal aquifers and ground subsidence. In addition to wells, poor households buy water from small-scale vendors and from neighbors with access to piped supply. Vended water costs many times more than piped water and poor households can spend more than 20 percent of their income on vendor-distributed water.

In general, ability and willingness to pay is not an issue in terms of water tariffs, but steep connection charges can, and often do, constitute a barrier to entry for the poor. There is evidence that most unconnected households that would like to connect are poor, with a large proportion of them being “very poor”[6]. A recent customer satisfaction survey of 12 PDAMs across the country revealed that nearly half of the unconnected poor would like to become PDAM customers if they could afford to.[7]Connection fees are typically USD $50, but are sometimes as high asUSD $400—particularly in cities like Surabaya and Bandung where the price of new connections includes the cost of expanding the tertiary network in addition to the stated connection fee. Most poor people do not have the disposable income to pay such fees unless they are spread out over 3 to 5 years.