MELAMCHI: ADB'S $350 MILLION DREAM IN JEOPARDY

UNCLAS SECTION 01 OF 04 KATHMANDU 001142 SIPDIS SIPDIS MANILA FOR ADB E.O. 12958: N/A TAGS: PREL PGOV ETRD EAID SENV NP SUBJECT: MELAMCHI: ADB'S $350 MILLION DREAM IN JEOPARDY REF: KATHMANDU 3228 Introduction -------------- ¶1. (SBU) The future of the Asian Development Bank's (ADB) USD 350 million Melamchi Water Supply Project has grown increasingly uncertain since the new Maoist Minister for Physical Planning and Construction, Hisila Yami, decided in early May to postpone awarding the contract for the management of the Kathmandu Vally Water Utility to a private British firm, Severn Trent Water International (STWI). Yami announced on May 8 that she intended to review the cabinet decision of the previous government to follow ADB's recommendation to award the contract to STWI. Despite strong statements by ADB that if the contract were not awarded by May 15, ADB would terminate its loan commitment, the GON failed to act. STWI, which had already extended the deadline for the award nine times, pulled out on May 21. On May 22, ADB announced that it would not extend the loan commitment for the project beyond June 30. On June 6, Paul Heytens, the new Nepal Asian Development Bank (ADB) Director, told the Ambassador that the Melamchi Water Supply Project was a very important project for the ADB. However, Heytens stated that the ADB had to consider the larger issue of continuity of reforms. The GON's refusal to honor its reform commitments sent, he said, a very negative message to donors and investors. On June 8, the GON decided to ask ADB not to pull out, but instead explore new alternatives, including rebidding the management contract. The Project Outline -------------- ¶2. (SBU) The scheme for the Melamchi Water Supply Project was first adopted in 1992 as a comprehensive, long-term solution to the chronic water shortages in the Kathmandu Valley. (Note: The daily supply of water in the Kathmandu Valley meets only 50 percent of the demand (reftel A) End Note.) Despite the high cost, bringing water from the Melamchi Valley through a man-made tunnel appears to be the only realistic and sustainable means to supply drinking water to the Kathmandu Valley. The current Asian Development Bank (ADB) project actually consists of two projects; one for the construction of the tunnel, infrastructure and water supply system, "The Melamchi Water Supply Project" (MWSP),and the second for the improvement of the water supply utility in Kathmandu, "The Kathmandu Valley Water Services Sector Development Program" (KVWSSDP). The second project was initiated in recognition of the fact that the supply infrastructure and lack of bulk water sources was not the sole cause of Kathmandu's chronic water shortage: The poor performance of Nepal Water Supply Corporation (NWSC) was also a major problem. Management reforms and restructuring were deemed necessary to justify investment in the supply infrastructure. The Reforms -------------- ¶3. (SBU) Despite repeated efforts over a number of years, including the provision of extensive capacity building technical assistance, the NWSC did not succeed in providing better service. As a result, the ADB re-designed the project to link investments in physical infrastructure with major institutional reforms. The Bank considered engagement of the private sector water service management company essential for the success of the project due to the likely politicization of a public company. On December 18, 2003, the Asian Development Bank approved loans of USD 15 million for the Kathmandu Valley Water Services Sector Development Program (KVWSSDP) for institutional reforms and the introduction of private sector participation through a performance-based KATHMANDU 00001142 002 OF 004 management contract for managing water supply and wastewater service delivery in the Kathmandu Valley. These reforms included restructuring of the NWSC and the establishment of three new entities: the Kathmandu Valley Water Supply Management Board (KVWSMB),the water authority responsible for policy setting and asset owning; Kathmandu Upatyaka Khanepani Limited (KUKL),the water utility operator responsible for the operation and management of the water supply and wastewater systems; and the Water Supply Tariff Fixation Commission (WSTFC),the board responsible for regulation and protection of consumer interests. Background: A Rocky Road -------------- ¶4. (SBU) The initial estimated cost of the total Melamchi project was more than USD 464 million. A coalition of donors and investors was formed to support the large and complex undertaking. In 2005, two of the investors, the Norwegian Agency for International Development (NORAD) and the Swedish International Development Cooperation Agency (SIDA),pulled out due to the King's seizure of political power, leaving a funding gap in the project of approximately USD 100 million. Despite the adverse political environment and serious funding issues, the ADB extended its loan commitment into 2007 to give the GON time to make the necessary institutional reforms. To date, the GON has carried out most of the difficult reform measures, including the establishment of the three new entities. The signing of a management contract (MC) with a private sector water service management company was the final step in the lengthy reform process that the GON committed to more than three years ago. Hisila Yami Kills the Deal -------------- ¶5. (SBU) On May 8, the new Maoist Minister for Physical Planning and Construction, Hisila Yami, refused to award the water utility operator management contract to UK's Severn Trent Water International (STWI) as recommended by the ADB. Yami cited concerns about STWI's record and complained that the contract had been sole sourced. (Note: A few of STWI's misdeeds include: the company was found guilty of over charging British consumers; the company was expelled from Guyana before completing its contract, and the company's contract in Trinidad and Tobago was terminated due to local public protests. End Note.) In his June 6 meeting with the Ambassador, Paul Heytens, the new Nepal ADB Director, acknowledged that STWI did not have a perfect record, but defended ADB's decision, explaining that STWI had been selected through a rigorous international competition. Heytens told the Ambassador that claims that the contract had been sole sourced were incorrect. Four bidders, who were all international companies, were pre-qualified and short listed. However, Heytens explained, due to the political instability and related economic risk, the other three bidders had pulled out of the competition. Moreover, Heytens commented, the negations between the government and STWI had been difficult and protracted. STWI had extended the validity of its proposal nine times, with the last extension expiring on May ¶15. Privatization -------------- ¶6. (SBU) In defense of her decision to prevent the award of the contract, Yami also expressed concerns over "privatization," the placing the management contract for the distribution of drinking water in "foreign hands." Heytens stated that the label "privatization" was not accurate, as government assets were not being transferred to a private company. He explained that, in a market economy, it is common for the private sector to be involved in service KATHMANDU 00001142 003 OF 004 provision. The real issue, he stressed, was how to ensure proper governance (i.e. checks and balances) for better service delivery to the people. Governance arrangements had been very carefully prepared over the last three years for the KUKL, KVWSMB, and WSTFC through enactment of new laws, appointments of qualified Nepali managers, and broad-based representation at these entities. Heytens stressed that the appointment of a private management contract was a key covenant in ADB's funding commitment. While ADB was open to involving local consultants, no Nepali company met ADB's bid requirements for the management contract, and from the bank's perspective there was no alternative to a private management contract. At the end of the bidding process STWI was the only eligible company still at the table. A New Management Project -------------- ¶7. (SBU) On May 21, STWI released a statement that it was pulling out of the project. In response to the Ambassador's question about the possibility of rebidding the contract, Heytens replied that ADB did not have much flexibility given that the bidding process had already lasted nearly two years. Heytens explained that this was actually the third attempt in the history of Melamchi to recruit a private water supply operator. Two unsuccessful attempts has been made between 1998 and 2002 with World Bank support. Thus, the failure to complete the current tendering process is likely to complicate future efforts to attract international bidders in the water sector, and would significantly delay a comprehensive solution to the acute water shortages in the Kathmandu Valley. Is Melamchi Dead? -------------- ¶8. (SBU) Heytens explained that the ADB MWSP loan commitment would have expired at the end of March 2007, but was extended to the end of June 2007, with the expectation that final conditions, including the award of the management contract would be completed within this time frame. ADB's Melamchi Mission chief Keiichi Tamaki was then scheduled to request ADB's board in Manila to extend the loan commitment through ¶2013. However, without appointment of a private management contractor, there would be no basis to argue for an extension of the funding commitment. Heytens also emphasized that there was a larger issue of continuity of reforms and government. He stressed that the GON's refusal to honor its reform commitments sent a very negative message to donors and investors. Moreover, if the GON refused to come to the table prepared to sign the contract, it would be very difficult for ADB to ever find the same level of funding again. Yami Backing Down -------------- ¶9. (SBU) Since May 8, Yami has reportedly backed away from her initial hard-line stance opposing any private management contract, but she remains adamant on not awarding the contract to STWI. On June 8, the GON issued a statement asking ADB not to back out, but rather to work with the GON to find a way to implement the project through mutual agreement. Yami reportedly wanted to explore "new alternatives", among them the appointment of a new management contractor through re-bidding or the exploration of ways to implement the project without a management contractor. ADB officials on the other hand told Emboff June 8 that, if the GON wants Melamchi to happen, the GON will have to come back to ADB with a common vision and solid assurances and commitments. Future of Melamchi: Our Best Guess -------------- KATHMANDU 00001142 004 OF 004 ¶10. (SBU) ADB has given no indication that it would be willing to abandon the requirement for a private management contract. To the contrary ADB has repeatedly stated that the requirement for a private management contract was a key convenant in the loan agreement. Whether STWI would agree to come back to Nepal is also uncertain. Still our guess it that, if Yami backs down, the ADB will try to save the project. But that is a big "if." Melamchi's Effect On Future Development -------------- ¶11. (SBU) The controversy that Hisila Yami has generated around the Melamchi project will undoubtedly have long-term consequences for the people of Nepal and the future of aid from the ADB, as well as other donors. Yami's refusal to abide by the decision of the previous Cabinet sent a very negative signal to the outside world on the coalition Government's willingness to honor previous reform commitments, damaging its credibility with development partners and international investors. Political continuity is essential to long-term development, and Yami's decision has undermined Nepal's credibility. Future consequences are likely to include diminished overall development and reduced investment. Kathmandu Will Remain Thirsty -------------- ¶12. (SBU) The negative economic ramifications are huge. A substantially amount of money has already been spent on preparations for the project. This amount includes USD 8.6 million dispersed under an ABD loan which will have to be repaid regardless of whether the project is ever completed. In addition, the government has already spent over USD 14 million for the acquisition of land for access road and the supply infrastructure. And then there is the water crisis. As there are no alternatives to Melamchi, the abandonment, or even further delay of the project, means that the population of Kathmandu will continue to suffer severe water shortages and unsanitary conditions. Whether Yami's refusal to hand over Melamchi's management contract to Severn Trent is a demonstration of more anti-business, collectivist measures to come from the Maoists remains to be seen. Yami may have backed herself into a corner she does not like and may yet try to save Melamchi. Unfortunately, it is the people of Nepal who will likely suffer from Yami's lesson in real world economics. MORIARTY