Document ofThe World Bank

Report No: 16771 BR

PROJECT APPRAISAL DOCUMENT

ON THE

PROPOSED LOAN

IN THE AMOUNT OF US$150 MILLION

TO THE

FEDERATIVE REPUBLIC OF BRAZIL

FOR THE

SECOND WATER SECTOR MODERNIZATION PROJECT - PMSS II

February 6, 1998

Finance, Private Sector and InfrastructureCountry Management Unit 5Latin America and the Caribbean Region

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

CURRENCY EQUIVALENTS(Exchange Rate Effective June 1996)

Currency Unit = Reais (R$)US$1.00 = R $1.00

WEIGHTS AND MEASURESMetric System

FISCAL YEARJanuary 1 - December 31

ABBREVIATIONS AND ACRONYMS

BNDES Banco Nacional de Desenvolvimento Economico e SocialCAS Country Assistance StrategyEA Environmental AssessmentERR Economic Rate of ReturnFERR Financial Rate of ReturnIBGE Instituto Brasileiro de Geogrcifica e EsftStica - Brazilian National Statistical AgencyIBRD International Bank For Reconstruction and DevelopmentICB International Competitive BiddingIDB Inter-American Development BankIPEA Instituto de Pesquisa Econ6mica Aplicada - Institute for Applied Economic ResearchLCF Local Counterpart FundingMCL Minimum Consumption LevelMMC Minimum Monthly ChargeMPO Ministerio de Planejamento e Orqamento - Ministiy of Planning and BudgetMS Minimum SalaryN, NE & CW North, Northeast and Center-WestNCB National Competitive BiddingNGO Non-Goveemment OrganizationNPV Net Present ValueOD Operational DevelopmentOECF Overseas Economic Cooperation FundO&M Operation and MaintenanceOM Operational ManualPLANASA Plano Nacional de Saneamento - National Water Supply & Sanitation ProgramPMSS Projeto de Modernizagdo do Setor de Saneamento - Water Sector Modernization ProjectPMU Project Management UnitPSP Private Sector ParticipationSAAE Servi(o Autdnomo de Agua e Esgoto - Independent Provider of Water and SanitationSEPUR13B Secretaria de Politica Urbana - Secretary of Urban PolicySOE Statement of ExpensesSTN Secretaria do Tesouro Nacional - National Secretary of the TreasurySWCs State Water CompaniesTOR Terms of ReferenceUFW Unaccounted for WaterW&S Water Supply and SanitationWSM Water Sector Modernization Project - Projeto de Moderniza:do do Setor de SaneamentoWTP Willingness To Pay

Vice President: Shahid Javed BurkiCountry Director: Gobind T. NankaniActing Sector Director: Krishna ChallaTask Manager: Carlos E. Vdlez

BrazilSecond Water Sector Modernization Project

TABLE OF CONTENTS

Project Financing Data ............................................................... 1Block 1: Project Description

1. Project development objectives ............................................................... 22. Project components ............................................................... 23. Benefits and target population ............................................................... 24. Institutional and implementation arrangements ............................................................... 3

Block 2: Project Rationale5. CAS objectives supported by the project ............................................................... 46. Main sector issues and Government strategy ..............................................................S57. Sector issues to be addressed by the project and strategic choices ............................................58. Project alternatives considered and reasons for rejection ..........................................................69. Major related projects financed by the Bank and/or other development agencies ......................610. Lessons learned and reflected in the project design ............................................................. 711. Indications of Borrower commitment and ownership .............................................................812. Value added of Bank support ............................................................... 9

Block 3: Summary Project Assessments13. Economic assessment ............................................................... 914. Financial assessment .............................................................. 1015. Technical assessment .............................................................. 1116. Institutional assessment .............................................................. 1117. Social assessment .............................................................. 1118. Environmental assessment .............................................................. 1219. Participatory approach .............................................................. 1320. Sustainability .............................................................. 1321. Critical risks .............................................................. 1422. Possible controversial aspects .............................................................. 14

Block 4: Main Loan Conditions23. Effectiveness conditions .............................................................. 1524. Other .............................................................. 15

Block 5: Compliance with Bank Policies .............................................................. 15

List of AnnexesAnnex 1: Project Design Summary .............................................................. 17Annex IA: Key Performance Indicators .............................................................. 19Annex 2: Detailed Project Description .21Annex 3: Estimated Project Costs .33Annex 4: Cost-Benefit Analysis .35Annex 5: Financial Summary for Revenue Earning Project Utilities .52Annex 6: Procurement and Disbursement Arrangements .70Annex 7: Project Processing Budget and Schedule .73Annex 8: Documents in the Project File .74Annex 9: Status of Bank Group Operations in Brazil .78Annex 10 Country at a Glance .................... 84

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENTINTERNATIONAL DEVELOPMENT ASSOCIATION

Latin America and the Caribbean Regional OfficeLCC5

Project Appraisal Document

BrazilWater Sector Modernization II

Date: February 6, 1998 [ ] Draft [/] FinalTask Manager: Carlos E. Velez Country Director: Gobind T. NankaniProject ID: BR-PA43420 Sector: Water Supply & SanitationLending Instrument: Sector Investment and Maintenance Loan PTI: [ /] Yes [] No

Project Financing Data [/1 Loan [ ] Credit [ ] Guarantee [ ] Other

Amount (US$m/SDRm): US$150.0 million

Proposed Terms: [ ] Multicurrency [a/ Single currency[ ] Standard Variable [ ] Fixed [/] LIBOR-based

Grace period (years): 5 yearsYears to maturity: 15 yearsCommnitment fee: 0.75% on undisbursed balances, beginning 60 days after signing.

Financing plan (US$million):Source Local Foreign TotalFederal Govemrnment - - -Cofinanciers (OECF) 85.0 20.0 105.0IBRD 120.0 30.0 150.0Water Utilities 45.0 0.0 45.0

Borrower: The Federative Republic of BrazilResponsible agency: The Ministry of Planning and Budget through the Secretary of Urban Policy (SEPURB)

Estimated disbursements (Bank FY/US$M): 1999 2000 2001 2002 2003Annual 41.5 51.5 35.6 16.2 5.1

Cumulative 41.5 93.0 128.7 144.9 150.0

Expected effectiveness date: August 15, 1998 Closing date: June 30, 2003

Project Appraisal IDocument Page 2Country: Brazil Project Title: Water Sector Modemization 11

Block 1: Project Description1. Project dlevelopment objectives (see Annex 1 for key performance indicators):Strengthen regulation, increase private sector participation in investment and management, and improve the overallefficiency of ]Brazil's water supply and sewerage (W&S) sector and, within the north, northeast and center-west (N, NE &CW) regions, increase the coverage levels of W&S services of participating utilities and improve the quality of water bodieslocated in staltes and municipalities served by participating utilities.

2. Project components (see Annex 2 for a detailed description and Annex 3 for a detailed cost breakdown):Component Category Cost Incl. Contingencies % of Total

(US$M)Management & Promotion Project Management 7.5 2.5Water Sector Institutional and Policy, Institution Building 23.2 7.7Regulatory ReformOperational Development Institution Building, Physical 73.3 24.4Investment Physical 196.0 65.4Total 300.0 100.0

.............................................................................................................................................................................................................................................................3. Benefits and target population:Project benefits include an expansion of water supply and sewage collection and treatment services; an elimination ofintermittent provision and rationing (planned interruptions) of water service; a quality improvement of water supplied; and areduction of water pollution levels. The improved hygienic and environmental conditions that result from increasing thecoverage, quality and reliability of water and sewerage services translate into better quality of life. Better hygienicconditions lead to decreased infant mortality and reduced incidence of water-borne diseases. Improved environmentalconditions contribute to the recovery of beaches, enhance tourism activities and other water uses, and increase recreationalactivities. From an institutional point of view, project benefits focus on increasing economic efficiency in sector serviceoperations. Project benefits expected from encouraging private sector participation and a decentralized provision of waterand sewerage services, in a competitive and appropriately regulated environment, are: improved operational and financialperformance of participating utilities; reduced financial transfers from the public sector to water utilities; and a temporarybut significant generation ofjobs for unskilled workers.

Subprojects in six states and 24 municipalities are already under review. The municipalities with subprojects underpreparation are: Joao Pessoa, Campina Grande and Santa Rita (Paraiba); Fortaleza and Aracati (Ceara); Caruaru, Pesqueiraand Varzea do Una (Pernambuco); Pedro II, Altos, Piripiri and Floriano (Piaui); Cuiaba, Varzea Grande, Juara, Juina,Pontal, Pontes e Lacerda, Primavera, Sinop, Sorriso (Mato Grosso); and Juazeiro and Itabuna (Bahia). Projects for the lasttwo municipalities have been presented by their municipal companies, remaining projects have been presented by State WaterCompanies (SWCs). At project completion, the subprojects in these municipalities would benefit about:

* 1.17 million with new water in-house connections;* 1.84 million with fewer hours of rationing or intermittent water service;* 0.33 million with water supply of improved quality; and* 0.59 million with new in-house sewerage and 0.98 million with sewage treatment services.

After the end of the implementation period and until the full impact of these subprojects is obtained, about 1.30 million morewould benefit from water production and transmission projects, 0.92 million more would benefit from sewage collection, and0.71 million more would have their sewage treated (see Annex 2 for an evaluation of these subprojects and a detaileddescription of the selected project eligibility criteria).

Targeted popmr1ation: Project investment targets the poor. Estimates based on actual surveys in five localitiesrepresentative of the targeted population (Fortaleza, Joao Pessoa, Caruaru, Itabuna and Santa Rita), show that about 65%of the expected beneficiaries of water investments are in the poverty group (households earning less than 3 Minimum

Form

Project Appraisal Document Page 3Country: Brazil Project Thle: Water Sector Modemization II

Salaries [MS] per month), 3 1% are middle-income households (households making between 3 and 8 MS per month), andonly 4% are high income households (households making more that 8 MS per month). Meanwhile, estimates based onactual surveys of the expected beneficiaries of sanitation investments in the localities of Aracati, Cuiaba, Juazeiro and JoaoPessoa, show that about 59% of them are in the poverty group, 31% are middle-income households, and only 10% are highincome households.

.............................................. I..................................................................................................................................................I.....................................................4. Institutional and implementation arrangements:Implementation period: Five years, including 6 months start up and wrap up periods.

Executing agencies: Private and public water companies within the north, northeast and center-west regions.

Project coordination: Project management, promotion and coordination will be done by the Project Management Unit(PMU) of the ongoing Water Sector Modernization Project (WSMP). The PMU, established within SEPURB and IPEA, isled by a Coordinator financed under the project. Following the consolidation of the modernization projects into a singlemodernization program, the PMU was expanded, reorganized, and placed in charge of the entire program. The Coordinatoris now assisted by three full-time managers financed under the project, one in charge of WSMP coordination, another incharge of WSM II preparation and coordination, and the third manager in charge of the program's administrative andfinancial tasks. To avoid creating a large PMU, a team of qualified consultants (individuals and consulting firms, asneeded), assists the PMU managing the sector institutional and regulatory reform, monitoring the performance of utilitiesand supervising the execution of investment subprojects. The PMU's responsibilities are detailed in Annex 2, Section A.

Project oversight and policy guidance: The Secretary of Urban Policy (SEPURB) of the Ministry of Planning and Budget,assisted by qualified consultants, would provide the policy framework for sector development and overall guidance to theproject.

Onlending arrangements: Bank funds will finance the management, reform and operational components, and all watersupply investments. OECF funds will finance sewage collection and final disposal investments. Bank funds will betransferred from the Federal Government to local governments and publicly controlled utilities on the same terms andconditions as the Bank loan, including the foreign exchange risk; and to privately controlled utilities on market ternns andconditions. One half of OECF funds will be transferred from the Federal Government to local governments and utilities onthe same terms and conditions as the OECF loan, including the foreign exchange risk. The other half of OECF funds willbe transferred from the Federal Government to local governments and utilities as grants. On top of the Bank's terms andconditions, the financial agents (Banco do Brasil and Banco Nacional de Desenvolvimento Econ6mico e Social - BNDES)may charge an administrative fee smaller than 0.5% to participating utilities.

Flow of documents: Eligible local governments (any state or municipality for purposes of sector reform) or watercompanies (any water company within the N, NE & CW regions) may submit subprojects to the consideration of the PMU.Local governments eligibility will be evaluated by the PMU and sector reform projects will be initially evaluated by eitherthe PMU (regulation, primarily) or BNDES (privatization involving concessions) following agreed eligibility criteria (seeAnnex 2, Sections B). Financing of Operational Development (OD) and Investment subprojects will require a prioreligibility of the corresponding utility to that type of financing (see Annex 2, Section C). To judge a company eligibility, thePMU will conduct a detailed financial evaluation of the utility's financial health, with emphasis on how the proposed projectaffects its financial position and how the prospect of repaying the loan looks. Following a positive financial assessment, thePMU will check the project's per capita investment costs against agreed limits (US$120 per water projects and US$250 persewerage projects, including treatment). A positive answer would launch a detailed technical, environmental, economical,and financial assessment of the project (to be prepared and appraised in accordance with the agreed methodology presentedin the Operational Manual-OM). Eligible subprojects will then be submitted to the Bank for its approval and approvedsubprojects executed by the companies under the PMU coordination (BNDES in case of private concessionaires) (see OM).Bidding documents will be prepared based on agreed procurement rules (see Annex 6).

Formn

Projet Appraisal Document Page 4Country: Brazil Project Title: Water Sector Modernization 11

Flow offunis: Bank and OECF funds will be competitively allocated. The loans will be made to the Federal Governmentwhich, through the Banco do Brasil and BNDES, will make subloans to the water companies. These subloans, which couldbe used by the federal govemment to promote fiscal reform in local governments, will be made only to those utilities or localgovernments with one or more subprojects already approved for financing. Any utility or local government may receive anynumber of subloans during the lijFe of the project. However, to eliminate the risk of concentrating the loan in two or threelarge companies, the total amount of Bank and OECF funds available to each company will be limited by its size, asfollows: US$90 million to large-size companies and states (the SWCs and state governments of Bahia and Pernambuco);US$60 million to medium-size companies (the remaining SWCs and state governments within the north, northeast andcenter-west, and the municipal or regional companies with more than 100,000 water connections); and US$30 million tosmall-size companies (other municipal companies). Prior to signature authorization, STN will verify the sub-borrower's"adimpl8ncia" with federal agencies, appraise its indebtedness capacity, and ask for guarantees from the local government(federal transfers from the "fondo de participacao" and tax revenues) and the companies (own operating revenues). Toprovide the required guarantees, local governments should have legislative authorization and the utilities authorization fromtheir Board of Directors.

Accounting, financial management and auditing arrangements: The project will utilize the accounting and financialsystems of the ongoing WSMP. STN will audit the project's Special Account and the project account and SOE of theFederal Comjponent. External auditors acceptable to the Bank will audit the project accounts, SOE, financial statements,and operatioral performance of each of the subborrowers. The subborrowers will use the project account format developedunder the WSMP for financial reporting.

Monitoring and evaluation arrangements: Monitoring and evaluation will be done by the Bank and qualified consultants.Participating utilities will prepare and submit to the PMU quarterly reports on the progress of project implementation. TheBorrower, through the PMU, will prepare and submit to the Bank semiannual Progress Reports, in January and July of eachyear. The July Progress Report will include an Annual Operating Plan which will describe, inter alia, the project activitiesto be carried out during the next calendar year, including an adequate justification for the inclusion of each one; a completeappraisal of each new subproject; and a detailed description of how the relevant local government or utility meet thecorresponding eligibility criteria, including any environmental and resettlement requirements. The Bank will carry out atleast two full supervision missions and one partial supervision per year. The Bank supervision mission to take place in thethird quarter of the year 2000 will be the project's Mid-tern Review.

Block 2: Project Rationale5. CAS objectives supported by the project: Document number and date of latest CAS discussion:

Report No. 16582-BR; June 12, 1997Structural rejbrm of Brazil 's water supply and sewerage sector.Separation of regulatory and operational roles and ownership diversification, the main objectives of the reform, areexpected to reduce the size of fiscal transfers and public sector employment by increasing operational and financialefficiency of sector operations and capital in-flight to the sector. The 1995 Concession Law opened a window ofopportunity for accelerating reformns in the infrastructure sector. Making use of this opportunity, the project supports theCAS reform objective by lending to build institutional capacity to conduct the privatization and regulation processes, andphysical investments to address urgent rehabilitation and emergency needs. Physical investrnents selected to favor privatelyoperated companies and public companies willing to meet the high efficiency levels exhibited by privately operated ones.

Diminish poverty and inequity by improving health conditions and quality of life ofpoorer urban population and regions(E, NE & C, where service levels fall much behind the South and Southeast,).Access to water supply and sanitation translates into reduced levels of infant mortality and water-borne diseases, as well asmore years of life expectancy. Poor urban people benefit more than proportionally from improvements in the urbanenvironment and from reduced levels of water pollution, because they are the social group more affected by these problems.

Form _

Project Appraisal Document Page 5Country: Brazil Project Title: Water Sector Modemization 11

6. Main sector issues and Government strategy:Main sector issues are:* Heavily concentrated lack of services in the N, NE & CW regions and arnong the poorest population all over the country.

In 1991, while 86% of all urban households had in-house water connections, only 67% of households in the north, 78% inthe northeast, and 80% in the center-west had in-house water connections. In the same year, 37% of all urban householdsmaking two minimum salaries or less did not have in-house water connections and 56% did not have in-house sewerageconnections or even a septic tank.

* Increasingly poor provision of services, in particular in the poorer regions and to the poorest population. More than one-half of the population connected to a water system receives less than fully satisfactory services and suffers fromintermnittent provision and rationing of water service.

* Seriously deteriorated environment in the larger metropolitan centers and heavily industrialized areas partially caused bywater pollution. Water pollution that, in turn, is caused by inadequate levels of investment, lack of appropriate costrecovery, ineffective technology, insufficient coordination between different government levels, inadequate capacity toenforce environmental regulations and standards, and limited involvement of users and NGOs.

* Recurrent financial problems worsening during the last years, in particular in the N and NE regions where many utilitieshave become financially insolvent. Sector financial policies, in particular tariff and subsidy policies and their costcontrols, need to be urgently revisited. A lack of appropriate labor and commercial policies, as well as propermaintenance and rehabilitation of existing facilities, worsen the utilities' financial situation. A de facto grant policy viaperiodic goverunent assumptions of the utilities' long-term debt adds more confusion and lack of clarity to the sectorfinancial policy.

* The investment decision process is not governed by financial and economic principles but by a politically dominatedsystem that usually discriminates against rehabilitation and other less expensive solutions.

* Politicization of management and lack of accountability demand a new and more competitive institutional model. Despitethe substantial progress achieved by PLANASA, the model is now superseded and, to improve the sector's poorperfornance, a major institutional reform is required, including private sector participation.

* Allocation of regulatory functions and responsibilities between states and municipal governments is unclear regardingsystems of common interest. This lack of clarity is a permanent cause of political uncertainty and immobility. The lackof clarity is also responsible for long delays in the reform process, in most cases through the erection of legal barriers tothe reform itself.

The Government strategy, which follows the National Water Supply and Sanitation Policy, seeks to expand the provisionof W&S services to Brazil's entire population and improve service delivery efficiency by encouraging a more competitiveand better regulated environment. The following guidelines summarize the objectives and goals of the govemment's reformand modemization strategy:* separation of competencies between the concession-granting authority and the service providers;* promotion of different decentralized altematives for services provision;* promotion of wide social participation in the regulation and control of services;* implementation of low-cost technologies in efficiently operated systems;* provision of technically, financially and economically feasible services, with tariff schemes and subsidies for low-income

families adequate to assure universal access to basic services; and* participation, cooperation and integration of the Federal and local Govemments and the society for the solution of the

sector's problems.

............................................................................................................................................................................................................................................................7. Sector issues to be addressed by the project and strategic choices:* The strategic choice of limiting the scope of project investments to the N, NE & CW regions will focus the federal

investmnent effort in the poorer and less developed areas of the country.* The politicization of management and its lack of unaccountability are issues that will be addressed by supporting and

promoting private sector participation and helping to define and establish appropriate regulation. The introduction of aclassification system linked to the utilities' operational and financial performance, the rigorous enforcement of the system

Form

Project Appraisae Document Page 6Country: Brazil Project Title: Water Sector Modemization 11

(linking the utility's ranking to its eligibility to previously agreed resource pools), and the periodic publication of basicsector statistics by the federal government (a kind of yardstick competition) are actions planned to expedite institutionalreform through competition in the market.

* The project will also address the need for a new financial model, consistent with urban poverty alleviation. It is expectedthat successful reform in some states and municipalities will make sector reform more attractive and with wider popularsupport. Since inefficient pricing and ill-functioning utilities limit the benefits of poverty targeted programs, it is alsoexpected that sector reform will enhance the effectiveness of poverty targeted programs.

* The definition of subproject selection criteria providing incentives to the development and implementation ofunaccounted-for water control programs and other small but high return operational, financial and administrative actions,and urgent rehabilitation and emergency investments in drinking water distribution systems and largely delayedinvestments in sewage collection and treatment, attempts to replace the politically dominated investment decision process,currently in place, for a system governed by financial and economic principles.

i W o..je ctalte..r..native..s...co..n ider..ed..an..d..re..as..ns...fo..r ej..ectio"n................................................................................... ................... 8. Project alternatives considered and reasons for rejectionPrivatization (only) Project. Limit the Bank financial assistance to only those utilities and local governments with clearcommitment to private sector participation (PSP). This alternative was rejected. First, the Federal government does notagree with a "privatization only" strategy. It sees PSP as a very important tool, but not the only available tool to helpachieve efficiency and service expansion. Unlike in other developing countries, in Brazil public utilities deliver relativelygood water and sewerage services and, at least a number of them, are relatively well managed. Second, the project's focuson the poorer northern states makes the "privatization only" alternative difficult to implement.

A line of crea'it alternative was rejected because it does not provide appropriated economic incentives for resourceallocation, including the distribution and control of financial funds. In addition, adherence to project rules is very difficultto obtain through this type of project because of its requirement of large and, normally, unrealistic project preparation andsupervision capacity.

A conventional supply-driven investnent project was rejected because it is an alternative not conducive to an efficient useof resources, in both cost and size, Investment plans supporting this alternative are normally inefficient and the incentivestowards efficiency are too weak and vague. The underlying selection criteria is usually governed by political considerationswhich favors ]large and visible projects.

Technical Assistance. This alternative was rejected. Service coverage in N, NE & CW regions falls much behind southernregions. Besides intellectual leadership and consultants, financial support to expand basic sanitation infrastructure isessential in these regions.

The proposed project encourages PSP (by setting a lower eligibility hurdle for utilities committed to PSP), but does notdiscourage public utilities from trying to become more efficient. The proposed project allows public utilities to try toachieve higher efficiency targets within an agreed timefrane. When a utility fails to achieve the targets, furtherdisbursement will be suspended, until the utility and the responsible state/municipal government initiate a profoundinstitutional reform, including PSP and establishment of independent regulatory agencies.

......................................................................................................I..........................I.......................................I.................................................................................9. Major rellated projects financed by the Bank and/or other development agencies (completed, ongoing and

planned).Sector issue Proiect Latest Form 590 Ratings

(Bank-financed projects)IP DO

Bank-financedInvestment, envirornental management and institutional Espirito Santo Water and Coastal Pollution Management U Sstrengthening (orLgoing) Projectinvestments and institutional strengthening (ongoing) Water Sector Modernization Project S SWater quality and pollution control (ongoing) Wtr. Quality & Pollution Control in Sao Paulo & Parana S S

Form

Project Appraisal Document Page 7Country: Brazil Project Title: Water Sector Modemization 11

Water quality and pollution control (ongoing) Water Quality and Pollution Control in Minas Gerais S SInstitutional reform, regulation & privatization (ongoing) Rio de Janeiro State Reform-Privatization S SInstitutional refonm, regulation & privatization (ongoing) Rio Grande do Sul St Reform-Privatization S SInstitutional reform, regulation & privatization (ongoing) Mato Grosso State Reform-Privatization S SPoverty alleviation (planned) PROSANEAR IIApplication of analytical methods in the water & Valuing Direct & Indirect Benefits of W&S Projects:sanitation sector (ongoing) Application to Project Investmnent AnalysisInter-American Development BankWater quality and pollution control (ongoing) Saneamento do Salvador e Baia de Todos os SantosInvestment (ongoing) Abastecimento de agua potable, coleta y disposiv3o de

aguas servidas em BrasiliaInvestment (ongoing) Recuperaco3 da bacia do rio Guaiba em Rio Grde. do

SulInvestment (ongoing) Saneamento da bahia de Guanabara em Rio de JaneiroInvestment (ongoing) Descontaminaqao do rio Tiete em Sao Pauloinfrastructure investment (in particular W&S) (ongoing) Drenaje e saneamento de FortalezaInfrastructure investment (in particular W&S) (ongoing) Drenaje, vias e saneamento para BelemHarvard Institute for International DevelopmentProgram on Investment Appraisal & Management: Project Analysis and Policy Implications of the EspiritoAppraisal of water projects Santo Water and Coastal Pollution Managetnent ProjectMPOISEPURB under WSMPInstitutional organization Fundamentos e Proposta de Ordenamnento InstitutionalFinancial model Novo Modelo de Financiamento para o Setor

SaneamentoInstitutional organization Flexibilizasao Institutional da Prestacao de Servicos de

SaneamentoDemand Demanda, Oferta e Necessidades dos Servisos de

SaneamentoRegulation Proposta de RegulagAo da PrestaSAo de Servi9os de

SaneamentoRegulation Regulagao da PrestaqAo de Serviqos de SaneamentoInvestment needs Diagn6stico do Setor Saneamento: Estudo Econ6mico e

FinanceiroWillingness to pay for water of sewerage services Avaliago Contingente em Projetos de Abastecimento de

AguaSector statistical data Sistema Nacional de Infonnages sobre Saneamento

......................... I.............................................................................................................................................................................................................................

10. Lessons learned and reflected in the project design:The performance of even the best prepared project will turn out to be unsatisfactory if there is lack of local counterpartfunding (LCF). To minimnize LCF, a problem that has affected most water projects (including WSMP), the project will:* reduce LCF to 15% of the project cost (about the estimated sum of project-generated taxes, which the Bank does not

finance);* secure LCF financing by requesting from each utility to open an audited account, exclusively for LCF; and* limit to two the number of agencies financing each project.

Participation should be demand-driven. Companies selection by the Federal Government, as in WSMP, will be replacedby self-selection based on compliance with agreed eligibility criteria (see Annex 2).

Competitive allocation of resources should be promoted To avoid a rigid allocation of financial resources to a fewutilities, competition within targeted regions (N, NE & CW) will be promoted by allocating resources based on actualdisbursement (first request received, first disbursement made).

Strict adherence to loan covenants and project rules is necessary for project success. The classification of utilities intodifferent leve]s will facilitate a rigorous application of covenants and rules because of the opportunity to upgrade anddowngrade utilities according to their performance.

Form _

Projet Appraisal Document Page 8Country Brazil Project Title: Water Sector Modemization 11

Borrower commitment to and ownership of the project assures an efficient, smooth andfast implementation. Localgovernments' explicit commitment to sector reform will be a condition to project participation (see Annex 2). The earlierdialogue with local governments will continue throughout the entire period of project implementation.

Avoid over-dimensioning of the loan and make realistic implementation schedule. WSM II is much smaller than previousloans (US$150 mnillion for 19 states), and its implementation plan incorporates sufficient time for start-up and closing.

The poor performance ofpublic utilities normally results from weak implementation capacity. To avoid a slow start ofproject implementation, usually the first manifestation of weak implementation capacity, potential participants were askedto get involved in detailed preparatory work early during project preparation. As a result of this work, the project is front-loaded with aL significant pipeline of subprojects, including the 33 subprojects already appraised (see Annex 2).

Procurement risks should be minimized. Procurement planning has been a priority during project preparation. Projectswith bidding documents ready are worth about US$60 million, including all projects planned to start in the first year ofproject implementation.

As few as possible conditions of effectiveness improves quality at entry. No condition will be left to be met or completedbefore effectiveness. Participants will comply with this requirement thanks to the care taken in planning and implementingpreparatory vvork. The large number of potential participants makes this approach feasible.

Few, simple and practi cal performance indicators make supervision more objective and efficient. The experienceobtained from WSMP and the Espirito Santo Water project, together with the guidelines and facilities introduced by thenew appraisall documents, guarantees the achievement of this key lesson.

~~~~~~~~~~...............................................................................................I........ ................................................................................. ............................................11. Indications of borrower commitment and ownership:Borrower cornmitment to sector reform is indicated by:* its current efforts to separate sector operators from regulators, as exemplified by the financing of every request it has

received from local governments to study, define and implement independent water regulatory agencies in their politicaljurisdictions (i.e., the States of Rio de Janeiro, Mato Grosso, Para, Sao Paulo, Parana and Rio Grande do Sul, and theMunicipality of Recife); and

* its interest in innovative approaches to the institutional reform of the sector, including privatization, as exemplified by itsfinancial support to the sub-national governments seeking to define appropriate institutional models (e.g., to stategovernments participating in Reform-Privatization Projects.

Borrower ownership is indicated by:* the government's repeated requests for a follow-up to the WSMP, which the government sees as its best tool to improve

sector efficiency and expand service provision;* the importance attached by the Federal Government to replacing PLANAS.A (the old institutional model), with a

competitive and decentralized model reflecting today's new political reality; and* by the pressure on the MPO from states and municipalities not participating in WSMP, and by the utilities' willingness to

participate in a follow-up project.

Borrower commitment and ownership is explained by:* the prominence taken by the ongoing WSMP as the key federal program in the water sector, which has become the

federal "address" of the water sector in the country, mostly in recognition to the strong technical leadership the federalgovernment has developed throughout its implementation;

* the healthy and growing debate on the sector's main issues that has been generated by the policies and papers written foror in reference to the WSMP. The WSMP has financed the definition of key federal policies (including the NationalPolicy for Water and Sanitation), the preparation and discussion of a number of papers on subjects ranging from thesector's institutional reform to its financial model to specific demand studies (see Section 9), and planted the seed from

Formr

Propet Appraial Document Page 9Country Brazil Project Title: Water Sector Modemzation 11

which several new ideas, policies and programs have germinated; and* the importance attached by the govermment to the WSM IT as the key project in its effort to advance and consolidate a

lasting sector reform.

..-... ie ' ..........................................................................................................................................................................................................................12. Value added of Bank support:* Better chances of achieving strong PSP because of credibility and transparency of Bank work.* Worldwide experience in the definition and implementation of projects similar in both technical design and institutional

reform objectives.• Less political interference and better control of financial resources during project execution.* Multidisciplinary support to the federal and local governments and the utilities to formulate, design, appraise and

implement project policies and projects.

Block 3: Summary Project Assessments (Detailed assessments are in the project file. See Annex 8)13. Economic Assessment (see Annex 4):Cost-Benefit Analysis NPV (US$ million) ERR Fiscal Impact (US$ million)Water Supply Subprojects 182 61% 14Sewerage Subprojects 60 82% -2Total Sample 242 66% 12Total Project 438 22

The WSM 11 project's economic feasibility was determined using a sample of subprojects that account for 55 percent ofproject's cost. This sample represents all types of project interventions to be financed under WSM II, including theexpansion of water supply coverage, reduction in rationing and intermittent water supplies, improvement in (drinking) waterquality, and expansion of sewage collection and treatment systems. At the earliest stage of the project, the selectedsubprojects were chosen as the best alternative among different options using least-cost techniques.

The results show that all subprojects, with the exception of the water supply project in Caruaru, are economically viable, asthey will generate positive net benefits. The difference between financial and economic costs (taxes, subsidies and othermarket distortions) have been summarized in conversion factors. The economic benefits are estimated to be equal to thewillingness to pay for access to and/or improvements of the water supply and sewerage services. A so-called "short-cut"economic analysis, in which the financial analysis was adjusted for the impact of taxes and subsidies (but not for othermarket distortions), was conducted to determine the fiscal impact of the water supply and sewerage projects and the viabilityof the different componenets of the water supply projects. All operational development programs tumed out to beeconomically profitable. However, the rehabilitation and expansion water supply projects in Caruaru, Itabuna and JoaoPessoa are not "short-cut" economically viable, when appraised as projects independent from the operational developmentprograms. But when appraised considering that they are phased in time and take place after the implementation of theoperational development programs, only the project in Caruaru appears unfeasible. Although the expansion andrehabilitation project in Itabuna is "short-cut" economically viable, the risks associated with this project are very high (it isa highly unstable project with only 54% chances of generating a positive benefit) and it should not be implemented.

The fiscal impact of the project is positive and estimated at R$ 12 million (R$ 22 million extrapolating to the total cost ofthe project). The fiscal transfers to the government more than offset the large capital subsidies given to the sewerageprojects. The distributive analysis of the project shows that the consumers stand to gain the most from the project. Theyreceive about 64 percent of the externalities generated by the project, which are estimated at R$ 101 million (R$ 183 millionextrapolating to the total cost of the project). Society realizes also a significant share of the benefits because of the positiveexternalities involved in the treatment of sewerage. The government will also make an important gain and the labor forcewill benefit from the significant wage premiums that the water companies pay over the market price for equivalent labor.

The sensitivity analysis shows that the subprojects are robust. Changes in the major risk variables (unaccounted-for water,

Form

Project Appraisal Documernt Page 10Country: Brazil Project Title: Water Sector Modemization II

investment cost overruns, project delays, labor productivity and willingness to pay for new and or improved water supplyand sewerage services) have little impact on the feasibility of the project. After conducting the sensitivity analysis, a riskanalysis was conducted to test the impact of simultaneous changes in the major risk variables. The risk analysis showedthat all projects, with the exception of the water rehabilitation and expansion projects in Caruaru and Itabuna, are risk free.

~~~~~~~~~~...........................................................................................................................I.......................................I.....................................................................14. Financial Assessment (see Annex 5)Cost-Benefit Analysis NPV (US$ million) FRRWater Supply Subprojects 108 44%Sewerage Subprojects 33 102%Total Sample 141 58%Total Project: 255

Financial assessment was carried out on two levels: (i) at subproject level, to assess the financial viability of eachsubproject; and (ii) at utility level, to assess the financial viability of each utility. Sensitivity and risk analyses on criticalassumptions were conducted for both levels.

Subproject levelfinancial assessment. The analysis shows that all water supply projects -- with the exception of Caruaru --are financially viable. When the water supply projects are treated as two separate projects, the OD subprojects are highlyprofitable. The results for the investments in the rehabilitation and expansion of the water supply systems are less clear.The water supply project in Fortaleza is financially viable due to economies of scale and the presence of a relativelyefficiently run water company. Hence, the policy to make companies only eligible for investrnent financing once they haveachieved a certain level of efficiency seems to be justified, and the other projects should not be executed simultaneously withthe OD programs. The projects in Joao Pessoa and Santa Rita are viable when implemented after completing the ODprogram. The project in Itabuna is a bordercase. It is not financially viable when implemented after completion of the ODprogram, but it is economically viable; as such it is a marginal project. The investment project in Caruaru should berejected. Sewerage projects are all financially viable thanks to the large capital subsidy given to them and, because of thelarge positive externalities that they generate, they also present high economic rates of retum.

When testing the impact of changes in the major risk variables (collection efficiency, unaccounted-for water, laborproductivity, investment cost overruns and project delays), the project turns out to be rather robust. The financial riskanalysis confirmed the project's viability. With the exception of the water rehabilitation and expansion projects in Itabunaand Caruaru, all water supply subprojects have relatively high probabilities of generating positive net benefits. Thesewerage projects turn out to be virtually free of financial risk.

Utility level financial assessment. As analysis was carried out of the financial structure, efficiency and viability of theparticipating utilities. After experiencing several years of losses, most utilities are now profitable, thanks to lower inflationand recent taiiff adjustments. Financial efficiency of the utilities, however, leaves much scope for improvement. Mostutilities are characterized by high operating costs, low bill collection rates, relatively low employee productivity (a recentimprovement due to voluntary retirement plans and more aggressive downsizing programs). Tariff levels were adjusted inthe recent years to a level sufficient to cover operating and investment costs. Summary financial assessment of three of theutilities analyzed are presented in Annex 5 and the rest, including sensitivity analyses, are available in project files.

Financial Eligibility Criteria. The project will reward the utilities which achieve higher efficiency. Minimum financialviability is required for any utility to have access to resources allocated for the operational development component.Increasingly higher financial efficiency is required to access resources allocated to investment components. If utilities donot achieve thie efficiency targets within an agreed timeframe, further disbursements will be suspended. Alternatively, thecompanies can choose a "reform route". Under the "reform route", where a far-reaching transformation of the companies iscalled for, all financial and operational eligibility criteria are waived. The underlying assumption is that once transformedwith private sector participation, the companies would naturally become financially and operationally efficient. Under the"efficiency route" the companies must demonstrate through selected indicators that they have the sufficient financial and

Form

Project Appraisal Document Page 11Country: Brazil Project Title: Water Sector Modemization II

operational capacity to implement the investments (see Annex 2, Section B).

............................................................................................................................................................................................................................................................15. Technical Assessment:The three investment components to which the assessment is relevant are: (i) institutional development, predominantlygeared to control unaccounted-for water and improve commercial efficiency; (ii) water supply, investments geared towardsimproved operation of existing and future networks; and (iii), sewage collection and treatment, rehabilitation or expansionand new systems (see a detailed description in Annex 2, Section A). The technical assessment was conducted in a soundand competent method, taking into consideration all historical and socio-economic tendencies that are indigenous to Brazil.With this in mind, not necessarily the state of the art or the most expensive solution was sought when examining the diversealternatives for each subproject. Low-cost technologies, such as the use of the condominial system, were often found to bethe optimal solution. In addition, when applicable, the studies conformed to accepted agronomic, health, educational orother standards. See Annex 2, Section C for a detailed description of subprojects eligibility criteria. The appraisalconfirmed that cost estimates and engineering data were based on accurate information and that physical and pricecontingencies were adequately considered. The 12 sewerage subprojects (worth about US$102 million) and 12 out of the 14water supply subprojects (worth about US$134 million) reviewed at appraisal were found technically acceptable. Theaverage cost of eligible water supply subprojects is US$11.1 million and of sewerage subprojects is US$8.5 million.Eligible water supply subprojects cost between US$2.2 million and US$43.5 million, and have per capita costs betweenUS$22 and US$116. Sewerage subprojects cost between US$2.6 million and US$19.0 million, and have per capita costsbetween US$29 to US$248. See Annex 2, Section C for a summary of costs and beneficiaries (Tables 4 and 6) and mainphysical targets (Tables 5 and 7) of the subprojects reviewed at appraisal.

16. Institutio Assessment: ;;---...............................Executing agencies: Executing agencies are municipal and state water utilities. Executing capacity of these utilities vary.Utilities with previous experience with the World Bank and other multilateral financial institutions tend to have morecapacity than others without such experience. In general, however, these public utilities have limited planning andadministrative capacity. To assure satisfactory project implementation since its beginning, substantial assistance has beenand will continue to be provided to potential participants by the Bank and the PMU during project preparation, appraisaland implementation: companies were asked to submit subprojects very early during the project's preparatory stage;subproject identification was reviewed by the PMU; preliminary designs were extensively revised with the help of qualifiedconsultants hired by the PMU to assist the companies; 33 subprojects were appraised by the Bank and the PMU.Procurement will be facilitated by a detailed set of guidelines, instructions, standard forms and examples that will be madeavailable to the companies by the PMU. Utilities' staff in charge of handling procurement are being trained by the PMU.Biding documents have already been produced for works worth about US$45 million, including most projects planned tostart in the first year of project implementation. Few, simple and practical performance indicators have been agreed withpotential participants to make supervision more objective and efficient. Furthermore, an exchange of ideas with WSMPcompanies is being and will continue to be encouraged to take advantage of the lessons learned and best practices.

Project management: Overall project management will continue to be carried out by the PMU of the ongoing WSMP. ThePMU comprises a multi-disciplinary team experienced in the Bank project procedures and is routinely assisted byexperienced consultants (individuals and firms). The type of training and technical assistance that is currently offered tosector companies to support project execution in critical areas, such as procurement, accounting and audit, projectsupervision and monitoring of benchmarks, will be continued and strengthened in the institutional area.

YI --iocia]A..ssessm..e..nt:...............................................................................................................................................................................................................................17. Social Assessment:Detailed information about service conditions and beneficiary attitudes toward methods for improving service quality andcoverage, willingness and capacity to pay, and interest in participating in the design, construction and maintenance of civilworks was obtained from the willingness to pay (WTP) studies, the sectoral and project specific EnvironmentalAssessments, and a number of meetings held with a variety of project stakeholders (state and municipal governments,multilateral and bilateral donors, potential beneficiaries, NGOs and community-based organizations). Projects in which thecommunity involvement and participation is the key to their successful implementation and sustainability, such as the

Form

Pnolect Appraiaal Documwnt Page 12country. Braa Project Title: Water Sector Modemization 11

sewerage systems built with the community selecting the type of collectors to use for each set of houses ("condominial"system), were special targets for rigorous analyses of this type. In areas targeted for the construction of sewerage systemsto replace old makeshift solutions, sanitary education programs and financing of household connections up to the bathroomwere identified as necessary to increase the acceptance of the new systems.

Additional consultation and socio-economic studies were carried out for subprojects entailing resettlement. In Caruaru(Pemambuco) and Joao Pessoa (Paraiba), the number and current conditions of affected households were identified, andresettlement plans prepared (see specific Environmental Assessments and related documents in Project Files). Programs tostrengthen environmental management were discussed with beneficiary companies and the state agencies in charge ofenvironmental regulation.

Targetedpopulation: Project investment targets the poor. Estimates based on actual surveys in five localities representativeof the targeted population (Fortaleza, Joao Pessoa, Caruaru, Itabuna and Santa Rita), show that about 65% of the expectedbeneficiaries of water investments are in the poverty group (households earning less than 3 Minimum Salaries [MS] permonth), 31% are middle-income households (households making between 3 and 8 MS per month), and only 4% are highincome households (households making more than 8 MS per month). Meanwhile, estimates based on actual surveys of theexpected beneficiaries of sanitation investments in the localities of Aracati, Cuiaba, Juazeiro and Joao Pessoa, show thatabout 59% of them are in the poverty group, 31% are middle-income households, and only 10% are high incomehouseholds. ]Estimates are consistent with the fact that, in general, water coverage is much larger than sewerage coverageall over Brazil - an issue addressed by the project.

Affordability. Brazilian companies apply a minimum consumption level (MCL) to their residential customers, chargingincreasing block tariffs to the remaining consumption. The MCL is intended to provide households with enough water tosatisfy basic needs and maintain minimum health and sanitary conditions (usually 10 m3/month), and charged a minimummonthly charge (MMC). The residential MMC for water service varies from about 2% of one MS in the Ceara's SWC toabout 4% in Mato Grosso's SWC. The combined MMC for both water and sewerage services varies from about 4% of oneMS in Juazeiro's water company to 7.2% of one MS in Paraiba's SWC. These MMC are well within the range ofacceptability Iby Bank standards. (A standard often accepted by Bank projects has been to keep water and sanitationcharges under 5% of three MS or 15% of one MS.) In addition, most companies also have a special or "social" category fortheir poorest customers, which is easily affordable even for the poorest segment of the population. In Paraiba's SWC, forexample, the social tariff is sligthly higher than one half the ordinary residential (which is equivalent to about 4.1% of oneMS). Although the companies' social classification does not approximate very well the income distribution at thehouseholds level, they are in general, however, a good proxy for income distribution at the aggregate level (i.e., at the levelof a neighborhtood or a municipality).

The communities' initial interest in access to public water supply and sewerage systems was double-checked surveyingabout 50 households in each of the following towns: Sinop and Juina in Mato Grosso (to explore the demand for watersupply); and Crateus, Quixada, Maracanau, Maranguape, Aracati and Cascavel, six small-size localities in Ceara (toexplore the demand for sewerage services).

Tariffs affordability was also studied estimating the WTP for water and sewerage services. The WTP was estimated basedon surveys prepared for Fortaleza (Ceara), Joao Pessoa and Santa Rita (Paraiba), and Itabuna and Juazeiro (Bahia), where2,176 households were interviewed, and a Contingent Valuation study. The study shows that WTP is about four to sixtimes larger fcr access to water supply services than for improvements in water quality or reductions in water rationing. Onthe other hand, WTP for sewage collection (about the same than the WTP for access to water supply) is about three timeslarger than for sewage treatment. 'Ihe study consistently suggests that the poor are willing to pay about 1% of their incomefor improvements in water quality, reductions in water rationing or sewage treatment; and about 3% of their income forsewage collection. The WTP for access to water supply, however, oscillates abruptly between 3.5% and 11% of theirincome. Values are within the range of acceptability by Bank standards.

Form

Proect Appraisal Document Pag 13Country Brazil Projet Ttle: Water Sector Modrnization II

18. Environmental Assessment: Environmental Category [w/ A [ ] B [ I CThe project will finance a wide variety of water and sanitation infrastructure projects in participating states andmunicipalities. If free standing, a few of those subprojects would be category A for environmental purposes. Therefore, itwas agreed with the federal government that the project as a whole would have the same category. All subprojects will haveimportant positive impacts on the environmental quality of rivers and aquatic ecosystems. Improved provision of potablewater is expected to have positive impacts on health conditions. Rather than relying on a project-specific approach toEnviromnental Assessment (EA), thereby limiting the impact of the project on environmental issues associated with thesector, a sectoral EA for the water and sanitation sector was carried out in accordance with terms of reference agreed withthe Bank. Key sectoral issues related to the environment were identified including: (i) weak environmental mnanagementcapacity in state and municipal water and sanitation companies; (ii) weak enforcement capacity in state environmentalagencies; (iii) the need for environmental guidelines for the design, construction and operation of water and sanitationprojects; and (iv) the need for improving and streamlining environmental licensing procedures for water and sanitationprojects, and improving the quality of environmental assessment reports. These sector-wide issues will be addressedthrough an environmental strengthening program to be financed by the project through: (i) the provision of technicalassistance, training and some equipment to participating water and sanitation companies and state environmental agencies;(ii) the preparation of streamlined environmental screening and licensing procedures, to be agreed with the environmentalagencies; and (iii) the preparation of environmental specifications for the design, construction and operation of water andsanitation projects. Environmental criteria, procedures, and requirements will be included in the Operational Manual.

All 33 sub-projects proposed during preparation were subjected to a detailed screening for potential negative environmentalimpacts due to project siting, water use, or wastewater discharges. Full EAs were carried out for the most sensitive projectsfollowing TOR agreed with the Bank. A report with environmental summaries of these projects was prepared and isincluded as part of the sectoral EA. The sectoral EA was completed and discussed at a workshop with the participation ofsector companies and environmental secretariats. The final EA report, including complementary studies on the subprojectsin Carauaru and Joao Pessoa, is available in Brasilia, at each participating state capital and in project files. An executivesummary in English was prepared by the government and circulated to the Board on April 14, 1997.

Two projects (a wastewater treatment plant in Joao Pessoa and a water supply reservoir in Caruaru) require the resettlementof local populations. Specific resettlement plans for these two projects were prepared following Bank's policies onresettlement. A resettlement framework (including policies, procedures, and TOR), approved by the government for anyfuture project requiring resettlement, is included as a part of the sectoral EA and the OM.

19.Participatory Approach: Identification/Prevaration Implementation OperatiBeneficiaries/community groups IS, CON, COL IS, CON, COL IS, CON, COLIntermediary NGOs CONAcademic institutions IS, CON IS, CONLocal government IS, CON, COL IS, CON, COL IS, CON, COLOther donors IS ISPopulation affected for resettlement IS, CON IS, CON, COLPrivate operators IS, CON, COL IS, CON, COL IS, CON, COLIS (Information Sharing); CON (Consultation); COL (Collaboration)

Different strategies for public, institutional and community consultation and participation were developed and implementedduring project preparation. They will also be applied during project implementation. Sectoral issues related to theenvironment were discussed in two workshops with the participation of water and sanitation companies, state environmentalagencies, and professional associations. A broad community consultation program regarding communal-type sanitationservices, initiated during project preparation, will continue during implementation. Project-specific consultation withcommunities affected by the siting of two projects has been carried out with the participation of local organizations andmunicipal agencies (Joao Pessoa and Caruaru).

Form

Project Appraisal Document Page 14Country: Brazil Project Title: Water Sector Modernization II

20. Sustainability:The main challenge is to achieve and sustain good performance of the utilities (as measured by the operational and financialindicators on efficiency defined in Annexes I and 2). In the past the Bank has tried to improve the performance of publicutilities through "institutional strengthening programs". Many achieved results but sustaining the performance was oftendifficult. The main reasons were: (i) highly politicized company management; (ii) lack of competition for the market; and(iii) lack of economic incentives - lack of regulatory framework and contractual commitment to concession owners, i.e., themunicipalities.

The environment is now more favorable. Water public utilities are now subject to competition for the market, includingfrom the private sector, thanks to the Concession Law of 1995 and proposed projects of Law specific to the W&S sector.Furthermore, the proposed project would ensure performance sustainability by: (i) providing incentives to undertakeirreversible institutional reform including PSP or any other measures aimed to de-politicize company management; and (ii)establishing regulatory frameworks for the sector which separate regulation from service provision and provide economicincentives to become more efficient, through reforms in areas such as tariff setting, environmental and service standards,and rules and penalties.

The sustainability of each W&S system is achieved through rigorous application of project analysis and cost recovery rules.

............................................................................................................................................................................................................................................................21. Critical Risks (see fourth column of Annex 1):Project outputs to development objectives

Risk Risk Rating Risk Minimization MeasureLack of wide social and political support to Modest Open communication and accessibility to discuss reformsector reform and PSP, at federal and local objectives and expected results with representatives of society.level.Lack of credibility of legal system and Substantial Help to develop and implement a strong regulatory system basedjudiciary apparatus. on sound economic principles.Decreasing interest from local and Low Help to consolidate a number of important and well developedintemational investors and capital markets transactions involving PSP.in the water industry.Weak support for sector reform from Modest Promote a continuous dialogue on sector strategy, seekingmultilateral and federal financial agencies. agreement on key policy issues.Inappropriate pricing to access and use of Low Promote an early action on tariff reform.W&S services.

Project components to outputsRisk Risk Rating Risk Minimization Measure

Political support and commitment to reform Modest Promote and support an earlier involvement of different politicalweakening, in particular after Governors groups into the discussion of the reform process.election at endc-1998.Lack of local legislative support to private Modest Idemsector involvement.Lack of good working relations between Substantial Promote and support a continuous dialogue and, as far asfederal, state and municipal government possible, decision taking by consensus.levels.Inappropriate managerial and technical Low Trainingcapacity.

Overall project risk rating Modest

Form _

Project Appraisal Document Page 15Country: Brazil Projet Tid: Water Setor Modeniztion 11

22. Possible Controversial Aspects:Strong opposition to sector reform from selected public utilities and labor unions.

Block 4: Main Loan Conditions23. Effectiveness ConditionsAn agreement between the federal government and Banco do Brasil designating this bank as the financial agent of theBorrower in respect of subprojects to be carried out by public utilities should have become effective.

................. ................. . .................. ............................................................................................ ................. .......... ............... ........ ..............................................24. OtherAn agreement between the federal government and BNDES to re-lend to BNDES all funds necessary to finance subprojectsto be carried out by private utilities should have been signed not later than five months after the signing of the LoanAgreement.

Subject to the eventual suspension of the Bank loan, the OECF loan should become effective by December 31, 1998.However, the loan would not be suspended if adequate funds from other sources are made available for the project by theBorrower.

Company and project eligibility, as well as project implementation, will be governed by the criteria agreed between thefederal government and the Bank, as they are stated in the OM and the Resettlement Framework.

Based on the provisions and specific procedures set forth in the OM and not later than 18 months after the signing of theLoan Agreement, the Borrower will employ consultants to certify the financial and operational performance of theparticipating utilities and the progress achieved in implementing legal, institutional and regulatory reforms.

The PMU will prepare and furnish to the Bank semiannual Progress Reports and Annual Operating Plans.

Block 5: Compliance with Bank PoliciesThis project complies with all applicable Bank policies.

Task Manager: Car E. Velez Country IM'akm-Direvtcr;: Gobfn -T. Nankani

Form

17

Annex 1Water Sector Modernization II

Project Design Summary......... ........ ........ R.- ... "S .:M K - d rit I Asi......... ........ .. ...ti..... ... ..... .....

Narrative Summary Key Performance - Monitrng -and Critical Assumptionsi__ -__ -__ :-__-:_____lIndicators 1 S p ision:-

CAS Obiective (CAS Objective to BankMission)

Structural reform of * Separation of regulatory * IBGE's reports. * Stable macroeconomic andBrazil's water supply and and operational roles, and * SEPURB/WSMP annual political conditions.sewerage (W&S) sector. ownership diversification. reports and basic statistics.

* Borrower's and utilities'* Diminish poverty and * Access to water and quarterly progress reports.inequity by improving health sanitation (W&S) services ofconditions and quality of life households earning less thanof poorer urban population 3 minimum salaries (3MS) inand regions (N, NE & CW the N, NE & CW regions.regions, where service levelsfall much behind the Southand Southeast).

Proiect Development (Development Objectives toObiectives CAS Objective)

* Strengthen regulation, * Number of states and * SEPURBIWSMP annual * Competition's visible effectsincrease private sector municipalities with new legal reports and basic statistics. in services provision andparticipation in investment and regulatory frameworks * Borrower's and utilities' prices, boosting customersand management, and approved by the legislative. quarterly progress reports. confidence in and support toimprove the overall efficiency * Number of people in the N, * Auditors reports on project sector reform.of Brazil's water supply and NE & CW receiving W&S performance. * Increase confidence ofsewerage (W&S) sector. services from private sector private investors in new

operators (under concessions, regulatory frameworks andaffermage, management or agencies.BOTUBOOT contracts). * Strong and well developed

federal institutions (SEPURB,* Within the N, NE & CW * Additional number of others) committed to sectorregions, increase the coverage households in project areas reform objectives.levels of W&S services of receiving water supply and * Satisfactory portfolioparticipating utilities. sewerage services. performance.

* Within the N, NE & CW * Additional volume ofregions, improve the quality of sewage collected and treatedwater bodies located in states in project areas.and municipalities served byparticipating utilities.

l Baseline and targeted values expected at mid-term, end of project and full impact are shown in Annex IA.

18

: - --g-: p- Narrat v Sum yK tPformance M onito and Critic Assumptions_ _ _ _ _ _ _ _ - l-- E#E - --i i- -E E Ena -t .EI dicators Supe isionProiect OutpuL'i (Outputs to Development

Objectives)

* Improved operational * Labor productivity, labor * Borrower's and utilities' * Wide social and politicalperformance of participating cost as a % of total cost and % quarterly progress reports. support to sector reform andutilities. of metered water connections. * Auditors reports on project PSP at federal and local level.

accounts. * Increasing credibility on* Improved financial * Working ratio, debt service legal system and judiciaryperformance of participating coverage and liquidity ratio. apparatus.utilities. o Increasing interest from local

and international investors and* Water and sewerage service * Reduction of number of capital markets in the waterreliability improved in people subject to water industry.participating ulilities. rationing. * Strong support to sector

reforn from multilateral and* Expansion oi water supply * Length of water pipes and federal financial agencies.service in participating volume of water production * Appropriate pricing to accessutilities. capacity added to their and use of W&S services.

systems.

* Expansion of sewerage * Length of sewage collectorsservices (sewage collection and sewage treatment capacityand treatment) in participating added to their systems.utilities.

Project Components (Components to Outputs)[See Annex 2 for a detaileddescription.]

* Technical assistance to * Amounts of Bank loan * Procurement records. * Continuous political supportsupport water sector committed and disbursed to * Bank's disbursement data. and commitment to reform, ininstitutional and regulatory pay for consultant services in * Auditing records and reports. particular after Governorsreform at state, municipal and support of sector reform. * Borrower's quarterly election at end-1998.utility level. (physical and financial) * Local legislative support to

progress reports. private sector involvement.* Operational development, * Amounts of Bank loan * Utilities' quarterly (physical * Good working relationsincluding rehabilitation and committed and disbursed to and financial) progress reports. between federal, state andupgrading of water supply pay for civil works, goods and municipal government levels.systems. consultant services needed to * Appropriate managerial and

improve the operational and technical capacity.financial efficiency ofparticipating utilities.

* Investment tco expand water * Amounts of Bank loansupply distribution systems, committed and disbursed towater supply production pay for civil works, goods andsystems, and selwage consultant services needed tocollection, treatment and final expand water supply anddisposal systems. sewerage systems.

19

Annex 1AWater Sector Modernization II

Key Performance Indicators

.. ... :1dicator - -nit Baline- -aTartte cteVal-....Mid.--, ue Mid- End:of Frull:

'-:__._:_:. .:: ....... ._ .- Tem Pr:'ect' in. 'act

Number of political jurisdictions served by W&S sector with Unitsseparated regulatory and operational roles, and private sectorparticipation (as defined by the actual provision of W&Sservices under concession, afferm age, management orBOT/BOOT contracts to, at least, 10% of the population).

Access to water supply (WS) and sewerage (S) services of % with WShouseholds (hh) earning less than 3 minimum salaries (3MS)in the N, NE & CW regions, measured as a percentage of the % with Stotal number of hh in those regions.

' W state n w Ieg... ala... n ............... ......... States........ ............................................................. ........................3......... .......................5.... ...... ................... .................. ... ..Number of states and municipalities with new legal and States 0 3 5 10regulatory frameworks approved by the legislative. Municips. 0 0 2 4

Number of people in the N, NE & CW receiving W&S Pop. (000) 0 200 1,000 2,000services from private sector operators (under concessions,affermnage, management or BOT/BOOT contracts).

Additional population in project areas with access to:* water supply" Pop. (000) NA41 410.6 1,034.9 2,783.2* sewage collection3 Pop. (000) NA4' 95.2 724.6 1,849.3

Additional population in project areas whose sewage iscollected and treated. Pop. (000) NA4' 100.9 1,208.1 2,077.7

.........................................................................C a... gece... C... E... ...................... .....cm... ployee............................. 2........................... 2..... ....................... 1...9. ....................... N .... ....Labor productivity: Cagece (CE) employee 2.3 2.0 1.9 NAAs measured by the number of Cagepa (PA) " 3.6 2.5 2.5employees per 1,000 water and Compesa (PE) . 3.5 3.2 2.8sewerage connections Sanemat (M) . 3.4 3.1 2.8

Agespisa (PI) 4.7 3.5 3.0SAAE (Juazeiro) 4.1 3.9 3.7Emasa (Itabuna) 4.3 3.5 3.5 01

Labor cost as a percentage of total Cagece (CE) % 57 56 54 NAcost: Cagepa (PA) it 63 56 57As measured by the ratio of labor Compesa (PE) " 54 51 50 Itcost over operating cost, excluding Sanemat (Mff) 72 66 65 Itdepreciation Agespisa (PI) 70 63 60 .,

SAAE (Juazeiro) . 41 47 48 ofEmasa (Itabuna) . 33 27 27 it

Percentage of metered water Cagece (CE) % 62 98 98 NAconnections: Cagepa (PA) . 62 91 90 ofAs measured by the number of Compesa (PE) 46 77 82 H

metered connections over total water Sanemat (MT) t 46 85 100 .,connection Agespisa (PI) i 68 86 86 If

20

-I. .n:: .: 5 dicator U ... nit - Baseline Ta tedV I tedat. .E E R . .. i,5E ,# E i,, LER -- .i, E, i i E idy TES- -- i .i. -i iE! .E. .. ... .. ...-

- -. ! .. --i ..,,:, i, ., ........... d i., i i i E .i .i i .... ---. ii ... ........... ....... ......

Percentage of metered water SAAE (Juazeiro) % 38 86 90 NAconnections Emasa (Itabuna) o 60 100 100 n

Working ratio: Cagece (CE) % 84 72 69 NAAs measured by the ratio of Cagepa (PA) 79 66 63 n

operating cost, not including Compesa (PE) 79 69 65 tdepreciation, over operating revenue Sanemat (MT) f 62 44 41 n

Agespisa (PI) n 87 69 61SAAE (Juazeiro) 65 65 63 n

Emasa (Itabuna) 91 66 62

Debt service coverage: Cagece (CE) times 3.0 4-.5 1.6 NAAs measured by the ratio of internal Cagepa (PA) of 4.1 23.8 3.0 n

cash generation over debt service Compesa (PE) of 12.6 15.5 3.0Sanemat (MIT) t 1.0 12.4 14.8Agespisa (PI) f 2.3 2.8 9.7SAAE (Juazeiro) of 2.4Emasa (Itabuna) to 1.6 2.8

Liquidity ratio (current ratio): Cagece (CE) times 0.7 0.7 2.0 NAAs measured by the ratio of current Cagepa (PA) N 1.1 2.4 1.8 ..assets over current liabilities Compesa (PE) 1.7 1.7 2.2 n

Sanemat (MT) . 0.4 4.7 8.0 itAgespisa (PI) 0.3 1.9 10.07SAAE (Juazeiro) " 6.75 10.50 6.60Emasa (Itabuna) 0.3 13.8 30.2

Reduction of number of people subject to water rationing in Pop. (000) NA 326.2 1,630.4 1,630.4project areas2e.

Length of water pipes (km) and volume of water production km. NA 406 1,023 1,023capacity (mn/s) added to systems in project areas2. m3/s NA 264 666 666

Length of sewage collectors (km) and volume of sewage km. NA 88 967 967treatment caipacity (m3/s) added to systems in project areas 3' m3/s NA 127 3,112 3,112

~~~~~~~~~~~~~~~~..,......i~ ................. ......... i g ........ ......................... . ................ .......................... ........ ............Amounts of Bank loan disbursed to pay for consultant US$services in support of sector reform. million NA 16.3 20.4 NA

Amounts of Bank loan disbursed to pay for civil works, goods US$and consultant services needed to improve the operational million NA 47.6 61.8 NAand financial efficiency of participating utilities.

Amounts of Bank loan disbursed to pay for civil works, goods US$and consultant services needed to expand water supply and million NA 24.8 61.5 NAsewerage systems.

1/ The mid-term review meeting is expected to take place at mid-2000.2/ Indicator based on the projected number of beneficiaries ofthe 14 water supply subprojects reviewed at appraisaL their total cost and the amount of funds

initially assumed to be invested in water supply.3/ Indicator based on the projected number of beneficiaries of the 12 sewerage subprojects reviewed at appraisal, their total cost and the amount of finds initially

assumed to be invested in sewage collection and treatment4/ Non Applicable

21

Annex 2Water Sector Modernization II

Detailed Project Description

The project is a US$300 mnillion sector operation that will fund technical assistance and investmentsubprojects designed as a catalyst of the structural reform of Brazil's water supply and sewerage (W&S)sector. Technical assistance will focus at building institutional capacity to conduct and consolidate theincipient process towards sector regulation and private sector participation (PSP). Subproject financingwill focus at improving overall provision of water supply and sewerage services in Brazil's poorer regions(north, northeast and center-west), supporting urgent rehabilitation and emergency investments in drinkingwater distribution systems and largely delayed investments in sewage collection and treatment.

The project consists of four components: (i) management & promotion, (ii) water sector institutional andregulatory reform, (iii) operational development, and (iv) investment. US$40.8 million (13.9% of projectcost) corresponding to physical and price contingencies will be available to project participants asunallocated funds. Project implementation is expected to take five years, including start up and wrap upperiods of six months. The closing date will be June 30, 2003 and the completion date December 31, 2002.

Section A below provides a detailed description of the project components, including objectives, estimatedbaseline cost, percentages of Bank financing, repayment responsibility and eligible expenditure categories.Section B describes selected project eligibility criteria and explains how they are expected to graduallyimprove the utility performance by linking the specific project components to either specific actionstowards private sector participation or certain financial indicators and actions. Section C summarizes themethodology followed during project preparation and the main physical characteristics of the subprojectsreviewed during appraisal.

A. Project Components

1. Management & Promotion

This component will finance the management costs of the project at the federal level, whose baseline cost isestimated at US$7.0 rnillion. The Management and Promotion component will finance up to 100% (net oftaxes) of the goods and consultant services needed for the day-to-day management of projectimplementation (execution of component two and supervision of components three and four) and thepromotion and dissemination of project experiences. This component will be 100% repaid by the federalgovernment.

Project management, promotion and coordination will be done by the Project Management Unit (PMU) ofthe ongoing Water Sector Modernization Project (WSMP). The PMU, established within SEPURB andIPEA, is lead by a Coordinator financed under the project. Following the consolidation of themodernization projects into a single modernization program, the PMU was expanded, reorganized, andplaced in charge of the entire program. The Coordinator is now assisted by three full-time managersfinanced under the project, one in charge of WSMP coordination, another in charge of WSM II preparationand coordination, and the third manager in charge of the program's administrative and financial tasks. Toavoid creating a large PMU, a team of qualified consultants (individuals and consulting firms, as needed),assists the PMU managing the sector institutional and regulatory reform, monitoring the performance ofutilities and supervising the execution of investment subprojects. The Secretary of Urban Policy

22

(SEPURB) of the Ministry of Planning and Budget, assisted by qualified consultants, provides the policyframework for sector development and overall guidance to project implementation.

Main responsibilities of the PMU include, inter alia:* coordination of the financial agents;* monitor overall project iLmplementation, including maintenance of all project files;* management of all consultant contracts related to the water sector institutional and regulatory reform

component;* review and approval of bidding documents and short-lists and, in accordance with Bank review

thresholds, submission to the Bank for no objection;* review and approval of operational development and investment subprojects and submission to the- Bank for no objection;* provide technical assistance to eligible utilities in preparing new subprojects;* maintenance and update of project implementation schedule, expenditure forecast and control systems;* review compliance of utilities and subprojects to agreed eligibility criteria and legal covenants;* collection, review and comment of external auditors' reports on utilities and subprojects financial and

physical performance;* preparation and submission to the Bank of semi-annual progress reports;* design and coordination of training activities;* assistance to state and municipal governments to prepare regulatory frameworks and prepare and

operationalize PSP transactions;* assistance to sector utilities during the transition from public to private management;* assistance to public and private concessionaires to design and implement low-cost and community-

oriented subprojects;3 act as focal point collecting data and disseminating information;* further development and update of the sector's information system, including initiatives to use it to

mobbilize project financing and establish a yardstick competition system; and* coordination of the preparation of the project's Implementation Completion Report.

2. Water Sector Institutional and Regulatory Reform

This component will finance technical assistance related to establishing sector regulatory frameworks andundertaking institutional transformation of Brazil's W&S sector, including financial assistance to contractout private management services. Funding from the Water Sector Institutional and Regulatory Reform,whose baseline cost is estimated at US$22.0 million, will be available to local governments' and utilities'comiitted to reform. The signature of an Agreement of Technical Cooperation between the Federal and thelocal governments, based on the local government conformity with the National Policy of Water andSanitation, has been defined as a reasonable demonstration of commitment to reform.

The Water Sector Institutional and Regulatory Reform component will finance up to 100% (net of taxes) ofthe studies, goods and consultant services needed to support:

a. programs of the federal, state or municipal governments aiming at the institutional and regulatoryrefoim of the water sector, including, inter alia:* technical assistance to states and municipalities for the formulation of the respective water policy;

ihe elaboration of the legal and regulatory framework related to the provision of W&S services;and the establishment of a regulatory entity for the sector, including training for its staff;

* the further development of sector programs and data banks;

23

* the development and implementation of a utility rating data base and a yardstick regulation system;* environmental management programs;* demand studies;* sector planning at the local level; and* preliminary studies on private sector participation and regulation.

b. Institutional reform programs of water utilities in the project area (Brazil's N, NE & CW regions)including, inter alia:

* technical assistance on institutional reform;* technical and legal studies for PSP, including contract preparation and negotiations assistance;* seed funds to contract out management services;* tariff and cost studies;* environmental management programs; and* technical assistance for the preparation of investment projects

Repayment of subcomponent (a) will be responsibility of the federal government and repayment ofsubcomponent (b) of the beneficiary utilities.

3. Operational Development

This component will finance the development and implementation of unaccounted-for water (UfW) controlsubprojects and other small but profitable operational, financial and administrative actions, in waterutilities within the project area with minimal levels of operational and financial efficiency (see SubprojectEligibility Criteria in Section C, below). The Operational Development component, whose baseline cost isestimated at US$63.5 million, will be available to finance up to 85% of the consultant services, goods andworks needed to support, inter alia:

* supply and instailation of water macro- and micro-meters;* pitometry;* upgrading of substandard connections;* supply of emergency and maintenance equipment;* energy conservation programs;* survey and rectification of physical losses;* review and update of technical and commercial cadastres;* update, review or development of commercial, financial, accounting and information systems;* decentralization of operational and managerial functions;* marketing and communication programs; and* training.

Funding from this component is expected to reduce costs, increase revenue and improve cashflows of theutilities, to enable them to access the Investment Component described below. Activities under theOperational Development Component will be 100% repaid by the beneficiary utilities.

24

4. Investment

This component will be available to finance the expansion, upgrading and revamping of water supply andsewerage systems of utilities, within the project area, which show given levels of operational and financialefficiency (see Subproject Eligibility Criteria in Section C, below). The Investment Component, whosebaseline cost is estimated at US$165.7 million, will finance up to 85% of civil works, goods andconsultant services needed to support, inter alia:

* expansion of water supply and sewage collection and treatrnent systems;* building of new sewage collection and treatrnent systems;* improving and extending services to the poor;* rehalbilitating and replacing aging and ill maintained pipes and collectors;* revamping water and sewage treatment plants and water intake facilities; and* repairing and replacing pumping and control equipment.

Funding from the Investment Component is expected to achieve higher operational and financial efficiency,the separation of operational and regulatory roles and, in most cases, the imnplementation of a proper tariffstructure for the poor. Water supply investments will be financed by the Bank and fully repaid by theutilities. Sewerage investments will be financed by OECF and repaid 50% by the utilities and 50% by thefederal government (a partial grant designed as an incentive to promote appropriate sewage treatment inBrazil's poorer regions).

B. Company Eligibility Criteria

1. Company Eligibility Criteria and Project Components

To be eligible for each of the project components described above, participating water companies mustcomply with certain criteria. The companies can choose either the "reform route" or the "operational andfinancial efficiency route". Under the "reform route", where a far-reaching transformation of thecompanies is called for, all financial and operational eligibility criteria are waived. The underlyingassumption is that once transformed with private sector participation, the companies would naturallybecome financially and operationally efficient. Under the "efficiency route" the companies mustdemonstrate through selected indicators that they have the sufficient financial and operational capacity toimplement the investments.

2. Selection of Financial Indicators for Eligibility Criteria

As described in Table 1 below, the companies which select the "efficiency route" must demonstrate theirfinancial capacity through a set of financial indicators (Table 2), to become eligible for the different projectcomponents. The financial indicators were selected based on the current financial and operationalperformlance of the utilities as described in Annex 5. The companies must improve the financial indicatorsto have access to the "higher levels" of investment components. Each project component is designed tohelp the water companies achieve a higher level of eligibility status. For example, the OperationalDevelopment Component (Level 1) would focus on high return investments, such as metering, cadastering,etc., that would help improve the financial performance. The better financial performance would allow thecomparny to attain higher levels of eligibility status (Levels 2 and 3'). The current eligibility status of theselected project companies is presented in Annex 5.

25

Table 1. Company Eligibility CriteriaCompoentP evels) Eligibilit Crtera................... .......... y, ....... ........................ .... ....

Water Sector Institutional and Open to all project participants, regardless of their financial and operationalRegulatory Reform Component performance, as long as the relevant state or municipality has entered into a(Level 0) technical cooperation agreement with SEPURB, consistent with Brazil's

National Water and Sanitation Policy.

Operational Development Reform Route: The relevant state or municipality has submitted to itsComponent (Level 1) legislature a Bill of Law proposing a regulatory framework conducive to a

competitive environment for public and PSP in the water sector, including theestablishment of a regulatory agency; or

Efficiency Route: The water company demonstrates a minimum level of______________________________ financial and operational efficiency (see table 2 below).

Investment Component (Level 2): Reform Route: The relevant state or municipality has approved a regulatoryWater Distribution and Sewerage framework conducive to a competitive environment for public and PSP,Investments. including the establishment of a regulatory agency; and contract or contracts

has/have been signed with a private operator or operators following a biddingprocess acceptable to the Bank; _

Efficiency Route: the relevant state or municipality has submitted to itslegislature a Bill of Law proposing a regulatory framework conducive to acompetitive environment for public and PSP in the water sector, including theestablishment of a regulatory agency, and the relevant company demonstratesa higher level of financial and operational efficiency (See table 2 below).

Investment Component (Level 3): Reform Route: the relevant state or municipality has approved a regulatorySame as above, and Water framework conducive to a competitive environment for public and PSP,Production Investments. including the establishment of a regulatory agency with functions and

administrative and financial structure acceptable to the Bank; and contract orcontracts, in form and substance satisfactory to the Bank, with a privatecontractor or contractors for the operation of at least 75% of the prospectivesystems of such utility has been or have been signed and entered into effect;or

Efficiency Route: the relevant state or municipality has approved aregulatory framework conducive to a competitive environment for public andPSP, the relevant utility is operating under a concession contract consistentwith such regulatory framework; the relevant investment subproject(s) has(have) complete technical, environmental, financial, and economicevaluations approved; satisfactory arrangements are in place for themanagement of the subprojects; and the utility meets, besides the level 2financial criteria, the following criteria: (i) installation of macrometers in allmajor production facilities; (ii) more than 70% of water connections metered;(iii) at least 50% of any previous Subloan disbursed; and (iv) evidence ofcompliance with the timebound benchmark indicators agreed upon in theSubloan agreements.

26

Table 2. F'inancial and Operati nal Eligibility Crit ria. ::- f -X - ii : i .: iE. : -:- - ; E f fi ;. g .......--.....-........-..-......................-...............:g; ggi

.a o s . pera ona.................. .......... Inves e, ff ,,7 , , f - 02-Developme'nt - -:S"Level 2" "Lve 3"i0i XgiFa:::E:::i0

Working Ratio < 85% < 75% Besides the "level 2" financialPersonnel Cost/Operating Cost < 65% < 60% criteria, timebound improvementsDebt Service Coverage > 1.0 > 1.2 to be agreed in SubloanCurrent Ratio > 0.5 > 0.7 AgreementsMacrometer n/a n/a 100% of major production facilitiesMicrometer n/a n/a > 70% meteredDisburseme-nts n/a n/a > 50% disbursed

Indicators DefinitionWorking ratio Operating cost excluding depreciation over operating revenue.Personnel cost Personnel cost over operating cost excluding depreciation.Debt Service Coverage Internal cash generation before debt service and investment over debt service.

Internal cash generation is defined as net income plus financial expenses plusdepreciation minus increase in working capital plus net monetary corrections (ifnegative, add back, if positive subtract).

Current ratio Current assets over current liabilities.

3. Selectioin of Benchmark Indicators

The target levels of these indicators were determined based on a rough benchmarking exercise. We usedthe indicators of selected Latin American water utilities -- Aguas Argentinas (the private concessionaireoperating Buenos Aires), EMOS (Santiago de Chile), Empresas Publicas de Medellin (Medellin,Colombia), and southeast of Brazil -- to define the benchmarks. We then set the project eligibility criteriaso the project participants will gradually work towards the targets.

Table 3. Financial Indicators of Selected Latin American Water Companies (Current Values as of 1995)Financia - -- s Selected Refer.ences ::: :ass: s c:, ; s; -.PoeaNp..-..-.............. ........- ..... ea v \9i EEEE R~~~~~~~~~~~~~~~~~~~~~~~~~~~. ..... .... ........ w, -'rss ,iidE;i.. .fiis SC EEsE-1iIndicators Aguas EMOS EPM,F: Brazil Brai Brazil Brail

:,,,, i-"::'-,- ''l} ,:,-''l...... ... .' j:''"'''i'-' ............. -....... . ... . . , .........-, , , , , , , ...... . ... .. ... .!' R E§ .E : - iE,E !SE.. .-- ' '-'',,,, .... ,,..-::-Ar, ent.......... Cl M 'd S'ouI ' - theas Cnr Nor theat No th

....... ............................... :C olombi, avera. a g a g -..

Working Ratio 70% 45% 41% 58% 89% 105% 115%Person. Cost/ Op. Cost 43% 43% 50% 62% 53 62 65Debt Service, Coverage 3.3 8.2 1.5 1.9 2.3 negative negativeCurrent Ratio4' 0.6 0.7 0.4 1.0 0.4 0.6 n/aSources: Bank ICRs, Audited financial statements, "Sistena de Infonnaqoes sobre Saneamento", PMSS11 SABESP. 2/ SANEMAT, SANESUL 3/ CAGECE, CAGEPA, AGESPISA, COMPESA4/ The low rate cf curent ratio, even for relatively efficient utilities, is due to the industry practice of obtaining supplier credit with terms much longerthan collection period.

27

C. Subprojects Eligibility Criteria

1. Selection Criteria

Once the N, NE & CW regions were defined as the project area and subproject eligibility criteria wasagreed, the water utilities within the N, NE & CW were invited to present their five-year investment plansand identify priority subprojects for consideration under WSM I1 financing. Subprojects estimated to costabout US$350 million (17% more than the US$300 million agreed as project cost) were presented. Thecriteria agreed for the selection of subprojects within the utilities' five-year investment plans was:* subprojects in systems operated by state water companies (SWCs) or in systems operated by municipal

water companies serving markets above 75,000 people;* service expansion subprojects to reach low-income areas;* water subprojects with expected high rates of return, preferably because of the inclusion of network

optimization, sectorization and rehabilitation components; and* subprojects with a large positive impact on the sanitary and environmental conditions of localities and

receiving water bodies.

In addition to these eligibility criteria, the project preparation unit prepared terms of reference to orientutilities in the preparation of the subprojects and, at the same time, provide a consistent framework for thesubsequent analysis and evaluation. Given the institutional weakness of most utilities in the targetedregions, the project preparation unit also made available the services of a number of consultants to assistthe utilities in preparing the subprojects within pre-established deadlines. Many of these consultants werechosen for the same geographical areas of the utilities and thus had previous knowledge of the utilities'activities. The technical orientation given to the utilities included the following guidelines:* subprojects should be a component of the utility's investment program and, in the case of major

subprojects, should be related to an existing master plan;* existing water production capacity should be sufficient to accommodate projected service expansion;* water supply subprojects should include an UfW control program when current level exceed 30%;* water supply subprojects should include micro and macrometering programs;* subprojects should be based on justifiable detailed projections of population and water demand;* per capita cost of water supply projects should not exceed US$135;* per capita cost of sewage collection and treatment subprojects should not exceed US$250;* subprojects should present a study of comparison of alternatives, both conceptual and technological,

for the various subcomponents of the project;* economic and financial evaluations of each subproject should be prepared; and* sewerage subprojects should ensure the proper disposal of the collected sewage and ensure the quality

of the receiving water bodies while taking into consideration the present and potential uses.

2. Highlights of Design Methodology

Projections of Population and Water Demand. Detailed thirty years population and demand projectionsare prepared for each subproject, using census data of 1970, 1980 and 1991. Population projections forthe base year (1996) are compared with and adjusted taking into consideration data from other sources,such as cadastral surveys and electricity connections. In parallel, a careful analysis of per capita waterdemand (consumption plus losses) is carried out. The per capita consumption is calculated from historicaldata from metered connections, except in areas of low level metering. A per capita consumption adjustedby including industrial and commercial water use is also calculated. Moreover, a stratification of thepopulation by income levels is carried out into three groups (less than 3 minimum salaries (MS), between

28

four and eighth MS and more than 8 MS) in order to determine the impact of the subproject on the variousincome groups and the consumption by income levels. The per capita consumption level of subprojectsevaluated during preparation varies from 107 l/d to 152 l/d when only residential use is taken intoconsideration; and from 118 I/d to 192 Vd when non-residential use is also taken into consideration.

Least-Cost Alternative. The technical design for each subproject is based on the determination of thealternative which provides the least cost over the life of the subproject, taking into consideration allconstruction and operational costs. Similarly, with the objective of rnaximizing its rate of return, eachsubproject is studied in function of possible phase construction and optimization of the existing capacity.Specifically, the comparison of alternatives is based on the following guidelines:* water supply subprojects should be always accompanied with operational improvement components

such as reduction of UfW;* when possible, subproject implementation should be scheduled in stages to optimize the use of

investments;* the optimum investment plan for expansion should be determined postponing investment in water

production as much as allowed by the demand projection, making full utilization of existing capacity,and minimizing resulting idle capacity; and

* altenmatives should be selected after taking into account all social and environmental externalities.

Specific Guiding Criteria for Operational Development. It is recommended that, based on thecompany's medium-term strategic vision, a group of actions designed to improve its operational efficiencybe packaged as a single operational development program. Main issues addressed by this type of programsare descibed in Section A.3 of this Annex.

Specific Guiding Criteria for Water Supply. The economic diameter of a water main is based on acomparison that takes into consideration the size of pipes (for different acceptable flow velocities), cost ofenergy (for each size of pipe), type of pipe material and maintenance cost, all brought to present values.For treatment plants, phased construction is recommended.

Specific Guiding Criteria for Sewage Collection and Treatment. For the treatment plant, the type andlevel of treatment are based on the conditions of the receiving body. Moreover, the topography and theavailability of the required land determine the level of decentralization that is feasible. The pumpingstations and force mains are designed based on the optimization of the economic diamneter including thelong-termr cost of operation. For the collection network, both the conventional and condominial systems,when applicable, are considered. In the case of condominial systems, costs are compared for theinstallation of pipes in backyards, in front yards and under sidewalks.

3. Main Physical Characteristics.

Water SSupply. Fourteen (14) subprojects were developed during project preparation in Fortaleza (CE);Caruaru (PE); Joao Pessoa, Campina Grande, Santa Rita (PB); Cuiaba, Varzea Grande, Sorriso, Pontes eLacerda, Sinop, Juara, Juina(MA); and Juazeiro and Itabuna (BA). In these localities, the water supplyservice can be described as follows:

* in all of them, the existing system does not satisfy the water demand, requiring a strengthening of theprimary network and expansion of the secondary network and house connections, in addition to areorganization and redefinition of the distribution and pressure zones;

* in all of them, UfW levels are very high varying between 42% and 67%;

29

* in at least eighth of these localities (Fortaleza, Caruaru, Joao Pessoa, Campina Grande, Cuiaba,Varzea Grande, Itabuna and Juazeiro), especially in their peripheral areas, water supply service isintermnittent;

* in at least seven of them (Fortaleza, Santa Rita, Pontes e Lacerda, Juina, Juara, Sinop and Sorriso),large segments of the population without service are using sources of water of dubious quality atrelatively high prices; and

* in most of them, water demand exceeds production.

Following this diagnosis, the adopted solutions in all subprojects emphasize improving the distributionnetwork, trying to regularize the distribution network and increase the number of connections using theexisting capacity. The guidelines for the development of the subprojects follow three basic criteria:

* the reduction of UfW as a means of increasing the availability of water without having the augment theproduction;

* the sectorization of the distribution network with the definition of distribution sectors and pressurezones, through the rehabilitation and construction of water mains and reservoirs, eliminating the need topump directly through the distribution network; and

* the optimization of the installed capacity of the entire water supply system with the phased modulationof the various components.

Table 4 shows the objective, cost (total and per capita), population size, expected coverage after projectcompletion, and number of beneficiaries of each of the fourteen water supply subprojects reviewed atappraisal (details are available in project files). Table 5 summarizes their main physical targets. Atvarious times during project preparation, Bank missions reviewed and commented on the development ofthese subprojects, all of which were prepared based on the agreed guidelines. Except for the subprojects atJuina and Caruaru, both with per capita costs above the preset limit of US$120, all subprojects were foundtechnically viable. Both subprojects will be redesigned. Besides, the subproject at Caruaru is notenvironmentally viable, and additional mitigatory measures to remedy detected environmental problems arebeing defined and will be incorporated into the final design.

Sewage Collection and Treatment. Twelve (12) subprojects were developed during project preparation inAracati, Quixada, Crateus, Maranguape, Maracanau (CE); Joao Pessoa, Campina Grande, Santa Rita,Souza (PB), Cuiba (MA); Juazeiro, Itabuna (BA). In these localities, sewage collection and treatmentservices can be described as having:

* very low levels of coverage, some using septic tanks and the rest discharging directly into water waysand drainage canals, seriously threatening public health and the environment;

* no public sewer system (as in Aracati, Maracanau and Maranguape); or low collection and treatmentcoverage (as in Crateus, Quixada, Souza and Itabuna); or low collection coverage and not treatment(as in Santa Rita);

* a relatively high collection coverage but treatment available for a only a part of the population (as inJoao Pessoa and Campina Grande);

* low coverage but high treatment capacity (as in Cuiaba and Juazeiro);

All subprojects reviewed at appraisal emphasized increasing the coverage of sewage collection and thetreatment capacity for all collected sewage, and the majority of them adopted the condominial system forsewage collection and stabilization ponds for sewage treatment. The condominial system was selectedbecause of its low total cost, despite its requirement of heavy community involvement and health education.

30

After contemplating alternatives ranging from stabilization ponds to communal septic tanks with anaerobicfilters to upflow anaerobic sludge blanket filters, the stabilization pond in its various combinations was themost commonly adopted option for sewage treatment, partially due to the familiarity of the utilities withthis technology. Other guidelines followed for the development of sewerage subprojects suggested to fullyutilize any existing treatment capacity before attempting a system expansion; and whenever possible, toadopt a decentralized treatment approach, in order to minimize the size of the plants and the cost ofinvestment and operation.

Table 4. Costs and beneficiaries of water supply su bprojects reviewed during a praisal...lit .. b.ec.i...Populatio...Total Per Capita Etiated Benekiciares at:Proj........~~~~~~~~~~~~~~~~~~~~~~~~. .. ...a ... ..... -..

"'.''"'.g.'.2 ... ;:"::0 f:4 C,ffffA,;;T:StTtSt fX,; 0fffAS; f;2 --- ..W . . . -...........,..,.,.

a f1996 Cot' Cot:Cierge Comlto 00millin Copeto .. ductionSeic

i .... .:0 .;gi i 200522i i00 i:ii :.i ; ;7i i .i. g ............................ ..: ! f t: :d:j:: i2i)i.gi00 i:i:. .... ..i ...........I:. ..............

Fortaleza Optimize distribution to eliminate 2,441 43.50 29 83 674.8 460.3intermittent provision and expand

____ ___ ____ ___ service provision_ _ _ _ _ __ _ _ _ _ _

Caranu Increase product. and optimize 205 33.16 125 98 417.2 23.6distrib. Includes a 35kmtransmission main from a newly______________ constructed dam _________ C po_dt_r

JoaoPessoa Optinize waterdistribution to 741 23.12 25 91 238.7 178.7eliminate intermittent provision andexpand service provision _ _

Cainpina Grande ibid 367 9.63 _ _22 98 101.0 _ 65.9Santa Rita Increase water production to extend 9 3.00 30 92 125.4 46.9

_____________ service and improve water quality .____ _____

Cuiaba Optimize water distribution to 594 13.88 34 95 220.6 150.1eliminate intermittent provision andexpand service provision

Varzea Grande ibid 226 6.38 22 95 77.9 74.1Sorriso _ ibid 24 2.17 108 95 17.4 6.6Pontes e Lacerda Increase product and optimize 40 4.27 116 95 15.8 25.0

distrib. to eliminate intermittent____ ___ ___ ___ supply _ _ _ _ _ _ _ _ _ _

Sinop ibid 45 3.58 95 95 14.7 29.8Juara = ibid 27 2.81 113 95 11.1 15.7Juina ibid 22 2.70 134 95 3.8 17.4Juazeiro Optirnize water distribution to 136 7.11 59 96 54.9 36.2

distrib__to eliminate intermittent provisionItabzira Optimize water distribution to 230 14.15 64 9 197.4 38.0L_____________ partially eliminate rationingI/ Total cost includes investment and operational development programs focused in the given locality, as well as 20% physical contingencies.2V The per capita cost is measured as the ratio between the present value of the flow of project costs (initial investment plus additional costs due tononnal population growth, building of fulture phases and reposition) and the present value of the flow of annual incremental project beneficiariesup to fHU impacL3/ The beneficiaries from reducion in water rationing in Caruaru and Santa Rita include the beneficiaries from improvement in water quality (apopulation of

about 220,400 in Caruaru and 109,700 in Santa Rita).

31

Table 6 shows the objective, cost (total and per capita), population size, expected coverage after projectcompletion, and number of beneficiaries of each of the twelve sewage collection and treatment subprojectsreviewed at appraisal (details are available in project files). At various times during project preparation,Bank mnissions reviewed and commented on the development of these 12 subprojects, whose main physicaltargets are summarized in Table 7. During appraisal, all were analyzed and found to be technically viablewith the exception of the treatment subprojects of Joao Pessoa and Campina Grande which will beresubmitted after redesigning for the least cost alternatives. All subprojects present costs which fall belowthe per capita limit set at the initiation of the preparation. All subprojects have also been evaluated from asocial and environmental perspective and some mitigation actions are included in the cost structure. Allsubprojects will include environmental monitoring of the discharge and the receiving water body and healtheducation of the beneficiaries. In the case of Joao Pessoa, the subproject will also include funds for theprotection of ecologically-sensitive areas, resettlement of affected people, and a study on the impact of anearby solid waste landfill.

Table 5. Physical targets of water supply subpro iectsLocality Water Transmission Treatment Reservoirs Pumping Distribution Connections

Intake, Pipea Cpacity Stations ip l p...::___:.:. __:_ /s : - km - - -- : :: ls- . m F km : _-_units_.---:B-n-

Fortaleza - 12.3 _ - 1,200 530 73,700Caruaru 379 35.6 442 6,000 1,900 80Joao Pessoa - 18.2 - 7,000 307 85 39,100Campina Grande - - - - - 66 19,850Santa Rita 176 0.8 179 - 300 28 10,400CuIaba - 6.8 - 9,000 20 69 31,600Varzea Grande -8.2 19,500 40 32 15,500Sorriso - 3.9 - 1,500 50 37 1,250Pontes e Lacerda 67 4.1 64 2,500 17 36 4,650Sinop - 4.2 - 3,700 200 42 5,900Juara 32 3.5 32 1,000 140 30 3,250Juina 37 3.4 35 1,000 125 27 3,200Juazeiro - 12.6 - 1,200 390 Itabuna 1.8 14,000 140 31

32

Table 6. iCosts and beneficiaries of sewage collection & treatment subprojects reviewedduring a pr isal

Lcallity ig : : ij:::: j::g: Objective --:- -0-i0:tiggiti0 lt |jjCurrent. i,Total :i ::,,Per 2oU&Tiat Beneficaries000)Population Cost i a p.ita.C...a... .... ...... . : EEssEEZEEsE jEE............ - -:-. .. ... E..... ... r:i ;:E e : r ::E:::+ aw l :Se ISe............... |0.l:il!ii00|00 : -i ii (0 0 iSS Ci , i th Pr . Sewage Sewage.... , ., :: :.:... ....... : :. :02.:f:::....

........ _..._-....._..... _...._. ........ i-___- miflli usS o . iollectioni Treatment-

Aracati New collection and treatment 33 5.17 202 95 31.3 31.3systems; treatment is throughstabilization pond system

Quixada ibid. 39 5.41 169 95 28.4 28.4Crateus ibid. 41 5.81 243 95 21.2 21.2Maranguape ibid. 38 7.28 199 95 33.4 33.4Maracanau ibid. 146 3.96 248 20 15.7 15.7Joao Pessoa Extension of sewerage service and 741 14.10 28 51 68.8 279.5

use of existing quarries asstabilization ponds

Canpina Grande Extension of sewerage service and 367 12.68 19 67 105.9 105.9rehabilitation of existing ponds

Santa Rita Extension of sewerage service and 98 7.87 57 50 50.1 56.5new stabilization ponds

Souza ibid. 52 2.64 29 68 22.1 22.1Cuiaba Extension of sewerage service and 594 18.95 52 61 92.2 196.8

rehabilitation of existing treatmentplant

Juazeiro Extension of sewerage service 136 7.87 61 72 81.8 81.8Itabuna Extension of sewerage service and 230 9.95 32 56" 38.8 110.6

_ new stabilization ponds I I I Ii/ Total cost includes investment and operational development programs focused in the given locality, as well as 20% physical contingencies.2/ The per capita cost is measured as the ratio between the present value of the flow of project costs (initial investment plus additional costs due tonormal population growth, building of future phases and reposition) and the present value of the flow of annual incremental project beneficiaries up tofull impaA

Table 7. Physical targets of sewage collection & treatment subprojects........................ ...... ........ ...... ...... ..... -__-- alit Y - Outfall Pumping Treatment Collectors Connections

~~~~~~~~~~. .........................t . ........ . ... .....---ER EEEE:--:- -......... Ef r E E E:! EEEEE E::E:ze... 0 .. : .................St ations.... capacl W..... . . ...it...m ~~~~~~ ~ ~~~~~~~CV I/ munits

Aracati 4,500 157 78 38 6,000Quixada 6,600 167 53 39 6,200Crateus 3,100 140 43 59 4,800Maranguape 6,500 107 66 82 6,600Maracanau 8,200 73 32 48 3,200Joao Pessoa 7,300 130 1,024 87 13,800Campina Grande -- - 330 81 21,200Santa Rita 2,500 100 128 48 11,900Souza 1,500 50 70 16 4,700Cuiaba 6,100 574 433 176 19,400Juazeiro 6,300 62 - 75 15,200Itabuna -- 277 276 38 7,000

33

Annex 3Water Sector Modernization II

Estimated Project Costs

A. By Origin

Project Component Local Foreign Total----------------- US $ million-------------------

Management and Promotion 5.5 1.5 7.0Water Sector Institutional and Regulatory 15.5 6.5 22.0ReformOperational Development 47.0 16.5 63.5Investment 141.7 24.0 165.7

Total Baseline Cost 209.7 48.5 258.2

Physical Contingencies 18.5 4.4 22.9Price Contingencies 15.3 3.6 18.9

Total Proiect Cost 243.5 56.5 300.0

Annex 3Water Sector Modernization IIB. Detailed Cost Breakdown

Component 1998 1999 2000 2001 2002 TOTAL

Management & Promotion 1.00 1.50 1.50 1.50 1.50 7.00Project management and supervision 1.00 1.50 1.50 1.50 1.50 7.00

Water Sector Institutional and Regulatory Reform 4.35 8.80 6.95 0.95 0.95 22.001. Federal Level 2.75 5.80 3.95 0.55 0.55 13.60Technical assistance on institutional and regulatory reform 1.00 2.00 2.00 - 5.00Training for regulatory agencies 0.20 0.40 0.40 _ 1.00Iormulation of sector policies 0.05 0.10 0.05 0.20Environmental management 0.50 1.50 0.50 2.50National system of sector information 0.20 0.20 0.20 0.20 0.20 1.00Database for sector costs 0.20 0.40 0.05 0.05 0.05 0.75Parameters of yardstick competition 0.25 0.50 0.25 - - 1.00Demand studies 0.20 0.40 0.20 _ - 0.80Other studies 0.15 0.30 0.30 0.30 0.30 1.352. Water utilities level 1.60 3.00 3.00 0.40 0.40 8.40Technical assistance on institutional reform 0.30 0.60 0.60 - - 1.50rechnical & legal studies for concession contract negotiatio 1 0.20 0.40 0.40 _______ 1.00rariff and cost studies 0.30 0.60 0.60 1.50Environmental management 0.50 1.00 1.00 2.501'echnical assistance for preparation of investment projects 0.10 0.20 0.20 0.20 0.20 0. 90Other studies 0.20 0.20 0.20 0.20 0.20 1.00

Operational Development 9.85 27.50 21.50 4.65 - 63.501. OD consultants 3.10 7.00 6.00 0.65 - 16.75'echnical cadastre 0.50 1.75 1.75 - 4.00

Commercial cadastre 1.00 2.00 1.00 4.00Commercial system 0.75 1.25 1.25 3.25Financial and accounting system 0.25 0.75 0.75 1.75information systems 0.25_ 0.50 0.50 0.25 1.50Marketing and communication 0.10 0.25 0.25 0.15 _ 0.75Training 0.25 0.50 0.50 0.25 1.502. OD goods 6.75 20.50 15.50 4.00 46.75Energy Conservation programs 0.50 1.50 1.50 0.75 4.25Micrometering 5.00 15.00 10.00 2.50 - 32.50Mlacrometring and Pitometry 0.50 2.00 2.00 0.50 - 5.00Surveys of physical losses 0.75 2.00 2.00 0.25 5.00

ivestment in Water Supply 0.45 18.58 19.92 15.15 7.49 61.59CAGECE (CE) - Fortaleza - 11.78 10.35 9.40 4.22 35.75COMPESA (PE) - Caruaru - - -CAGEPA (PB) - Joao Pessoa - - - -Campina Grande 3.52 1.68 1.26 6.46Santa Rita SANEMAT M -Cuiaba _ 3.16 3.16 3.02 1.34 10.68Varzea Grande 1.72 1.32 1.05 0.67 4.76Sinop _Pontes LacerdaJuaraSonisoJuinaAGESPISA (PI)Itabuna (BA)Juazeiro (BA) 0.45 1.92 1.57 3.94

Investment In Sewerage 12.47 35.40 32.80 23.47 104.14CAGECE (CE) - Crateus 1.62 2.27 0.92 0.03 4.84Quixada 1.69 1.98 0.81 0.03 4.51Aracati 1.44 2.06 0.78 0.03 4.31Maracanau 1.16 1.36 0.75 0.03 3.30Maranguape 2.42 2.49 1.13 0.03 6.07CAGEPA (PB) - Joao Pessoa - 377 4.11 3.87 11.75Campina Grande 2.85 3.24 3.55 9.64Santa Rita 2.01 2.87 1.68 6.56S_uza 0.74 0.76 0.70 2.20SANEMAT (MT) - Cuiaba 5.23 6.14 3.72 15.09Itaibuna (BA) 2.08 2.61 1.89 6.58Jwazeiro tBA) 2.01 2.26 1.53 0.76 6.56To Be Ident'#ied 2.13 6.30 7.15 7.15 22.73

Baseline Cost 15.65 68.85 85.27 55.05 33.41 258.23Phrysical Contingencies (10%) 1 1.03 5.86 7.68 5.26 3.10 22.92Price Contingencies (2.5% annual) 0.36 3.20 6.02 5.24 4.02 18.85

Tctal Cost 17.04 77.91 98.97 65.55 40.53 300.00

34

35

Annex 4Water Sector Modernization II

Cost-Benefit Analysis

The Second Water Sector Modernization (WSM II) project, which comprises a large number of subprojectscompeting to be financed under the project, is financially and economically viable. This conclusion isdrawn from detailed financial, economic and distributive analyses, enhanced by elaborate sensitivity andrisk analyses, practiced on a sample of five water supply and four sewage disposal subprojects. Selectedsubprojects include systems affected by the major problems faced by water utilities in Brazil's north,northeast and center-west regions.

L. Objectives

The objectives of the WSM II project are: first, to strengthen regulation, increase private sectorparticipation in investment and management, and improve the overall efficiency of Brazil's water supplyand sewerage (W&S) sector and, second, within the north, northeast and center-west (N, NE & CW)regions, to increase the coverage levels of W&S services of participating utilities and improve the quality ofwater bodies located in states and municipalities served by participating utilities. On the basis of theseobjectives, the cost-benefit analysis was used to determine: (i) the financial and economic viability of theinvestment subprojects that will be partially financed by the Bank; (ii) the distributive impact of thosesubprojects; and (iii) the risk profile of each subproject.

II. Methodology

Tlhe cost benefit analysis began with the selection of a representative sample of subprojects to be appraisedfrom three perspectives: financial, economic and distributive analysis. Before embarking on the process ofdata collection and the preparation of cash flow tables, each subproject was jointly revisited by economicanalysts and engineers. The purpose was to get acquainted with the subproject's technical characteristics,and the justification for its selection, including alternatives considered, the use of least-cost analysis and thetiming of the investments. The definition of the "with" and "without" project scenarios; the identificationof separable components; and the preparation, execution and analysis of willingness to pay (WTP) surveyswere steps in the process of data collection. The final step consisted of the preparation of the financial,economic, distributive, sensitive and risk analyses.

Sample Selection

A multidisciplinary team identified the environmental, social, financial and economic factors that couldaffect the group of subprojects initially proposed for Bank and OECF financing. Following the analysis,33 subprojects in 23 municipalities (14 water supply subprojects and 19 sewerage subprojects) wereselected as possible candidates for financing. Size, per capita and total costs estimates, as well as theenvironmental, economic, and financial impacts of each technical alternative were further refined based onadditional and more detailed studies (see Project Files).

The major operational problems, identified based on a quick diagnosis of the five state and two municipalcompanies that submitted the selected initial group of 33 subprojects, are:

36

In the wiater supply systems:* lackc of access to public water supply in some neighborhoods;* a large number of rationing hours in some service areas;* water quality levels below recommended standards.* large unaccounted-for water levels, often accompanied by rationing and poor service quality (low

pressure, for example); and

In the sewerage systems:* generalized lack of access to sewage collection and treatment; and* sewage treatment plants with low operational efficiency and significant idle capacity.

In view of the time and costs involved when preparing full-fledged economic analyses, a sample of ninesubprojects was selected (see Table 1). This sample accounts for 55 percent of the total costs of the project(US$ 300 million) and represents all major problems affecting water supply and sewerage (W&S) systemsin the N, NE & CW regions.

Table 1. Selected Sample

Caruaru water supply rationing 30,400Fortaileza water supply lack of access to water supply 42,600Itabuna water supply rationing 15,450Joao Pessoa water supply rationing (intermittent supplies) 22,350Santa Rita water supply lack of access to water supply, 3,200

= __________ __________________ poor water qualityAracati sewage collection lack of sewage collection in areas 5,100

with acceptable water supply serviceCuiaba sewage treatment lack of sewage treatment 20,900Joao Pessoa sewage treatment lack of sewage treatment 17,850Juazeiro sewage collection lack of sewage collection in areas 7,750

ITo-tal_Sample with rationed water supply service 165_600Tota Sample _165,600

Alternatives

Each subproject included in the sample is the best alternative among several options formulated at theearliest stage of project preparation (see Annex 2, Section C). Different technologies, planning horizons,quality sitandards, and timing of investments were considered to select the subprojects. The technical andenvironmiental feasibility of 'the selected alternatives were checked and subprojects adjusted if required.Subprojects with expected net present benefits larger than zero are considered eligible for financing. Butinstead of selecting from a pool of subprojects until financing funds are reduced to zero, subprojects will beapprovedl and financed based on a first come, first served basis. Competition will replace the usualselection process based on a comparison of net present values (NPVs). Comparison would only be used ifthe cost of a group of subprojects simultaneously requesting financing exceeds available funds.

37

Components

Every subproject was initially prepared and presented as either a water supply or a sewage disposalinitiative. The water supply subprojects, in particular, were presented as comprising two different butinterdependent components: operational development (OD) and rehabilitation and expansion investments.It is however clear that they are indeed separable components. An OD component, designed to finance thedevelopment and implementation of unaccounted-for water (UFW) control prograrns and other small buthighly profitable actions (see Annex 2, Section A), may always be built independently from the investmentcomponent. Each component was then financially and economically appraised as a self-standing watersupply project and both of them as elements of a single water supply project.

Scenarios

To identify the incremental costs and benefits resulting from each subproject, "with" and "without" projectscenarios were built for each one of them. The "with" project scenario considers the proposed investmentplan and its associated targets. The "without" project scenario considers that the service would continueunchanged, that is, the current performance, coverage, UFW levels and other operational and financialindicators will remain the same during the projects' expected life. Investments needed to keep theseindicators unchanged are of course considered in the flow of costs in the "without" project scenario.

Incremental Costs and Benefits

Costs and benefits associated with the "with" and "without" project scenarios are projected for 30 years,that is, during the implementation period and until the full impact of the subprojects is obtained. The cashflows were discounted using a discount rate of 12 percent which is estimated to be a proxy of Brazil'sopportunity cost of capital'. Benefits from the water supply subprojects include the reduction or eliminationof rationing and intermittent water supplies, water quality improvements, and service coverage increases.Benefits from sewerage (sewage collection and treatment) subprojects include a reduction of water pollutionlevels and service coverage increases. The improved hygienic and environmental conditions that result fromincreasing water supply and sewerage coverage, and the quality and reliability of these services translate intobetter quality of life. Improved hygienic conditions lead to decreases in infant mortality and a reduction inthe incidence of water-borne diseases. Improved environmental conditions contribute to the recovery ofbeaches, enhance tourism activities and other water uses, and increase recreational activities. However, noeffort is made to quantify specific health benefits. It is assumed that all benefits resulting from a betterenvironment are captured in the willingness to pay for sewage disposal services. Additional benefits, thatwere not included in the analysis, comprise a reduction of financial transfers from the local governments tothe water utilities and a temporary but significant generation of jobs during project implementation.

Evaluation

The project is evaluated from three different perspectives. The financial viability of each subproject isappraised measuring its flows of costs and benefits in market prices, which focus the evaluation on thesubgroup of the population directly affected by the project. Under a financial perspective, benefits areassumed equal to the estimated flow of financial revenues. That is, financial benefits are defined as equalto expected tariffs times estimated consumption. The economic viability is appraised measuring the flows

See Kim, Jin-Goon and Migara Jayawardena, Project Analysis and Policy Implications of the Espirito Santo Water andCoastal Pollution Management Project in Brazil, April 8, 1997. A case study on analysis of water projects, underpreparation by the Harvard Institute for International Development.

38

of costs and benefits in shadow prices, which aggregates all benefits and costs to the entire economy(particularly important in this project because of its intangible environmental effects, which are often notefficiently allocated by the imarket). Under an economic perspective, benefits are assumed equal to theWTP for water supply and sewage disposal services (estimated through surveys designed to measure theuse and non-use value of these services) for each project beneficiary. The flow of financial costs istransforned into a economic costs through the use of conversion factors. The definition of a third streamof costs and benefits allows a "short-cut" economic analysis. Under this method, the calculation ofeconomic costs is reduced to subtracting taxes from and adding subsidies to the financial costs, whileeconomic benefits are assumed equal to the financial benefits. The distributive analysis identifies winnersand losers among the different groups in society with interests and stakes in the project: the federal andlocal governments, the water companies and their customers, labor, and the inhabitants of the region ingeneral. Finally, the sensitivity and risk analysis enhances the accuracy of financial and economicanalyses by incorporating uncertainties of the real world into the analyses.

III. Assumptions

The primary source of data are the water companies which have supplied the Project Management Unit(PMU) with market demand and supply, project specifics, comprehensive cost and investment data, projectfinancing, details, expected financial returns, and market distortions. The PMU, with the collaboration ofthe companies and based on terms of reference agreed with the Bank, evaluated the project from differentperspectilves: technical, environmental, economic, financial, social and participatory analysis. The PMUalso provided us with the results of an extensive WTP survey, and additional data on the currentperformance of Brazil's water supply and sewerage sector, including data on present trends and costs.

Investment costs include project preparation, transportation of equipment and materials, environmentalcompensatory actions, physical contingencies, and supervision. "With" and "without" project scenariosinclude connections cost generated from population growth, but only the "with" project scenario includesthe connections cost generated from larger coverage. The "with" project scenario also includes theinvestment cost of the project's future stages, and the replacement cost of meters and electromechanicalequipmenit.

Operational and maintenance (O&M) costs include the cost of labor, chemicals, power, third partyservices and general costs. O&M costs for the "without" project scenario are based on current unit costs.O&M costs for the "with" project scenario are estimated analyzing the opportunities to increase cost-efficiency in the operations of the companies. This analysis is carried out by examining the expectedimpacts of a company's proposed operational development program, and the company's current operationalperformance and trends vis-a-vis national and regional indicators and trends. Labor cost are calculated asthe number of employees per 1,000 water and sewerage connections (labor productivity) times the numberof connections times the average cost per employee. In the "without" project scenario, labor productivityremains constant and the number of connections increases so as to keep the coverage level constant. In the"with" project scenario, labor productivity and the number of connections increase in accordance with theproject's targets. Social contributions, including labor related taxes, are assumed at 70 percent of nominalsalaries. One half of the social contributions are assumed to return to the workers through the retirementpension plans, factory lunches, and other social programs. Chemical costs are calculated as projectedwater production volumes times the chemicals' unit prices times the amount of chemicals required per m3.Chemical use is kept unchanged, except in Caruaru where it is expected to increase. Electricity costs arecalculated as projected water production volumes times the estimated installed demand and electricityconsumption (as calculated for each subproject) times projected electricity tariffs. Costs of third partyservices and general costs are calculated as percentages of labor costs and total O&M costs, respectively.

39

The opportunity costs of raw water are assumed equal to zero.

The implementation schedule of each subproject varies from 2 to 5 years depending on its complexity andthe company's technical and administrative capacity.

Current andprojectedpopulation in the project areas are based on the 1991 IBGE census, the most recentcadasters of the water and power utilities operating in the project area, and the number of households perconnection served by the water company. Coverage levels were estimated by the companies based on theirown planning and resources availability. The annual targets for the installation of new service connectionsresult from the projected coverage levels.

Per capita water consumption was calculated as the weighted average of the current per capitaconsumption of metered and non-metered households. The actual per capita consumption of meteredhouseholds was estimated by income level (less than 3 minimum salaries (MS), more than 3 and less than 8MS, and more than 8 MS), based on statistical representative samples selected among metered householdsand monthly records during a calendar year. Using the 1991 IBGE census, the actual consumption ofmetered households by income level was extrapolated to estimate the average per capita consumption of thewhole locality (see Revisao dos Estudos de "per capita" in Project Files). Per capita water consumptionof non-metered households was assumed equal to that of metered customers, after adjustments for price andincome elasticity. Non-residential water consumption is calculated as a percentage of residentialconsumption, based on historical records. The discharge factor to collectors and interceptors was assumedas 0.85 and the infiltration factor between 1.17 and 1.10.

Water billed. Water billed differentiates between metered and non-metered consumption. Non-meteredwater billed was assumed equal to the water volume given by the number of non-metered households timesthe water volume allocated to each one in the tariff structure as "minimum consumption" (usually 10m3/household/month, except in CAGECE, Ceara, where it is 16 m3/household/month)2.

The metering index was projected based on a gradual increase up to 100 percent (95 percent in Caruaru,and 72 percent in Fortaleza) in 3 years (4 years in Joao Pessoa and Santa Rita).

Unaccounted-for water, defined as water billed over water supplied, was estimated to gradually decreaseduring 10 years until reaching 30 percent. The physical losses are assumed to be 40 percent of total UFW.The division between commercial (60 percent) and physical (40 percent) losses was based on companies'estimates and the results of recent studies in CESAN, SABESP and CASAN. Water production wascalculated as water consumption adjusted by physical losses and estimated illegal consumption (part of thecommercial losses).

The tariffstructures and levels were assumed to remain unchanged for both the "with" and "without"project scenarios. A 10 percent tariff increase that is recommended to CAGECE, Ceara, was not included.Price and income elasticities were estimated as -0.30 and 0.19, respectively. The annual average householdincome was estimated to grow at 2 percent during the next 5 years. The collection efficiency rate, definedas sales collected over total sales, was assumed to remain unchanged in the "without" project scenario andgradually increase up to 95 percent in the next 5 years in the "with" project scenario.

2 The analysis as conducted assumes that the benefits of metering are reflected without any delay in the benefits of installationand hence actual consumption.

40

Taxes on services (applicable to civil works, projects and supervision), industrial products (applicable tomaterials and industrialized equipment) and the circulation of goods and services (applicable to materialsand equipment, including electricity and chemicals)are, on average, 4 percent, 6 percent, and 17 percent,respectively. Subsidies to electricity consumption and the capital cost of the sewerage projects of,respectively, 17.6 percent and 50 percent were also considered. No multiplier effects on the local economywere considered.

IV. Financial Analysis

The financial analysis of each subproject measures the flow of costs and benefits in market prices. Thefinancial viability of each subproject is appraised from the total investment point of view which, excludingthe cost of financing, allows a more accurate assessment of the financial returns of the project. Cost andbenefits are measured in market prices and calculated based on the assumptions presented in the lastsection. The project horizon is set at 30 years and the annual cash flows are discounted at a rate of 12percent, which is assumed to be Brazil's opportunity cost of capital.

Complete Project

The water supply project in Caruaru is not financially viable (see Table 2), but all other water supply andsewerage projects are highly profitable. The entire sample of nine subprojects would generate net benefitsof about R$ 141 million.

Table 2. Results of the Financial Analysis

.~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~ ... .. .. .E .

.Caruaru ._water supply 17,510 24,000 (6,489) 8%Fortaleza water supply 128,809 70,776 58,033 33%Itabuna water supply 11,718 2,022 9,695 31%Joao Pessoa water supply 58,512 15,576 42,937 57%Santa Rita water supply 7,882 4,163 3,719 48%Aracati sewage collecton 3,552 2,997 555 16%Cuiaba sewage treatment 8,509 5,078 3,431 48%Joao Pessoa sewage treatment 28,319 2,115 26,205 118%Juazeiro sewage collecton 12,623 9,838 2,784 32%Total Sample 277,434 136,565 140,870 42%

Operational Development

All water supply subprojects are defined as comprising an operational development (OD) and arehabilitaLtion and expansion (investment) subcomponent. The OD subcomponent is conceived as a prioritygroup of actions addressing key operational problems, whose solution is essential to achieve the proposedlong-run objectives of the complete project. As a result of its conception, OD subcomponents are supposedto generate large benefits with relative lower costs. The financial analysis shows that this is indeed thecase. All OD subcomponents generate large positive NPV and internal rates of return (IRR) much largerthan those of the corresponding rehabilitation and expansion investment subcomponents and of thecomplete subproject (see Table 3).

41

Table 3. Separable Water Supply Components - Financial Analysis

Caruaru 2,362 39% (15,825) -3%Fortaleza 6,983 139% 59,450 34%Itabuna 5,578 49% (2,620) 4%Joao Pessoa 42,913 315% (5,401) 1%Santa Rita l 2,616 1 108%, (266) 10%

Rehabilitation and Expansion lnvestments

The rehabilitation and expansion (investment) subcomponent of Fortaleza is financially viable due toeconomies of scale and the presence of a relatively efficiently run water company. The investmentsubcomponents of Caruaru, Itabuna, Joao Pessoa and Santa Rita generate negative financial NPV (seeTable 3). However, this is the result of evaluating the investment projects as independent alternatives.When the investment projects in Joao Pessoa and Santa Rita are appraised considering that they are phasedin time and take place after the implementation of the operational development (OD) projects, they arefinancially feasible. The NPV of the net benefits are R$ 1.21 million in Joao Pessoa and R$ 3.13 million inSanta Rita, and the financial rates of return increases are 20% and 32%, respectively.

In other words, the financial viability of investment projects is underestimated when they are appraised asindependent alternatives. But the investment components are actually dependent from the results of theoperational development components. An investment project can only take place simultaneously with orafter the implementation of an OD program. As such, the benefits of the operational development programshould be included in the definition of the "with" and "without" rehabilitation and expansion investmentproject scenario.

The investmnent projects in Caruaru and Itabuna, even when evaluated including the benefits expected fromthe corresponding OD projects, continue to be financially unfeasible. Itabuna's case is the most interesting.Water supply is currently rationed during a large number of hours in large areas of Itabuna. The project'sOD component reduces total hours of rationing through the improvement of Itabuna's system andredistribute the remaining hours of rationing among the entire population. EMASA, Itabuna's watercompany, expects to delay the beginning of the expansion work of its water production system until theyear 2000, by reducing the rationing problem to a manageable size. The company expects that properlysupported by appropriate water conservation and other demand management actions, this strategy ofrationing reduction and "democratization" will allow it to gain enough time to, later on, attempt a long-termand final solution to Itabuna's water supply problems. However, the company also asked financing for ashort-term investment program. The financial analysis shows that such a program is financiallyunprofitable (would result in losses of R$83,000) and should not be implemented.

42

V. Economic Analysis

The economic viability of each subproject is appraised converting financial cash flows into economic cashflows by using conversion factors and WTP estimates (that include the use and non-use values of watersupply and sewerage services), and then discounting these cash flows using a discount rate of 12 percent3.

Conversion factors

Conversion factors eliminate market distortions created by taxes, tariffs and subsidies, add a premium onforeign exchange on the tradable components of each input, and account for any changes in domestic pricesthat may occur as a result of the project. All economic costs of the project inputs are lower than the marketcosts due to the high taxes and tariffs charged in Brazil that offset the impact of subsidies and foreignexchange premium (see Table 4). Only energy costs have a conversion factor that is close to one, and thatis not because of lack of market distortions but because the different impacts cancel each other out. Theproject suffers substantially from market distortions as is reflected in the low conversion factors, withunskilled labor as the most illustrative example. Labor's low conversion factor is mainly explained by thehigh premium received by employees of the Brazilian water sector (in 1995, the annual gross salary ofseveral water sector companies exceeded US$ 40,000). The land market was assumed undistorted, with afinancial price equal to the economic price (a conversion factor equal to one). Since taxes and tariffs aremerely transfer payments from consumers to the government, they are not treated as a resource cost tosociety (they have a conversion factor equal to zero).

Table 4. Conversion Factors

Labor- unskilled 0.46- semi-skilled 0.81- skilled 0.81Materials 0.88Equipment 0.80Chemicals 0.83Electricity 0.97Transport cost 0.78

Willingness to Pay

A contingency valuation study based on willingness to pay (WTP) surveys was conducted: (i) to capturethe non-use value of sewage disposal services, the intangible value that is not captured by the market anddoes not. generate financial returns, including any recreational and environmental benefits that could beattributed to the project; (ii) to estimate the benefit of other project interventions whose value is notcompletely captivated by the market, such as the reduction or elimination of rationing; and (iii) to study theperceived value of water supply and sewerage services vis-a vis their current prices.

3 The conversion factors were provided by the PMU based on the above quoted case study by Kim and Jayawardena (1997)and their own research, in particular with reference to the cost of non-qualified labor in the northeast. The economicpremium on foreign exchange is assumed to be 12.06 percent above the current market exchange rate based also on Kim andJayawardena.

43

The non-use economic value of clean water is negligible because consumers are aware of most of itsbenefits. Nevertheless, the total economic value of water is noticeably greater than the total financial valuebecause of the value placed on unpaid and illegally acquired water. In other words, the companies' waterrevenues underestimate the true value of water to society. Commercial losses represent water that isactually used free of charge. On the contrary, the non-use economic value of sewage disposal services islarge due to externalities and benefits that are not typically attributed to the service. Externalities to theentire society, such as the benefits that arise from living in a cleaner environment; and benefits toconsumers, such as the benefit of maintaining the purity of water sources.

The WTP for water supply and sewerage services were estimated based on how the services are expected toimprove as a consequence of the projects. Water supply related surveys were prepared differentiatingbetween: (i) households that have access to rationed water supply and will enjoyed a non-rationed service;(ii) households that have access to rationed water supply and will enjoyed an improved but yet rationedservice (that is, less hours of rationing); (iii) households that do not have access to water supply service andwill have it without rationing; (iv) households that do not have access to water supply service and will havea rationed service; and (v) households who now enjoy service of poor quality and will see this qualityimprove. Sewage collection and treatment related surveys were prepared differentiating between: (i)households whose collected sewage is not treated; (ii) households that do not have access to sewagecollection in areas with in general acceptable water supply service; and (iii) households that do not haveaccess to sewage collection in areas with large pockets of water customers affected by rationing. In total,2,176 households were interviewed.

Table 5. Absolute and Relative Willingness to Pay for Water and Sewerage Services

..... . ......... . . . . . . .. : . of ncom

Caruaru water supply elimination of rationing, 5.13 0.71 1.3%water quality improvement 3.55 0.49 0.9%

Fortaleza water supply access to water supply, 24.67 3.25 6.8%elimination of rationing 6.79 0.89 1.9%

Itabuna water supply access to water supply, 12.87 2.46 2.6%elimination of rationing 6.49 1.24 1.3%

Joao Pessoa water supply access to water supply, 26.90 2.44 3.4%elimination of rationing 6.14 0.56 1.0%

Santa Rita water supply lack of access to water supply, 26.57 4.65 11.2%elimination of rationing 4.09 0.72 1.1%

I_______ lwater quality improvement 3.92 0.69 0.9%Aracati sewage collection lack of sewage collection and 16.61 NA (1) NA (1)

treatmentCuiaba sewage treatment lack of sewage treatment 8.97 4.50 1.0%Joao Pessoa sewage treatment lack of sewage collection 26.15 NA (1) 2.7%

lack of sewage treatment 9.67 NA (1) 1.0%Juazeiro sewage collection lack of sewage collection 16.71 3.801 3.3%

Note:(1) Non-applicable (NA). This service is currently not provided in this municipality.

The main issue affecting the water supply or sewerage, the estimated WTP and the WTP relation to themunicipality's average income are identified in Table 5. WTP estimates for provision of water supply andsewage collection and treatment are 2.4 to 4.6 times higher than current tariffs. WTP to eliminate rationingand improve water quality is lower than current tariffs (56 percent to 72 percent), except in Itabuna wherethe large number of rationing hours faced by almost the whole population resulted in a WTP 1.24 timeshigher than current tariffs. Joao Pessoa's WTP for sewage collection is high (2.4 times the current bill)because the project area comprises high and medium-level income neighborhoods. The preservation of the

44

estuary of the Paraiba River, the main benefit of sewage treatment in Joao Pessoa, accrue to and satisfy theentire population of the city. However, to avoid overestimating WTP for this service in this city, the surveytook place in areas that already have sewage collection service. Hence, the interest in having collection iseliminatud and, perhaps more important, the survey took effect in relatively poorer neighborhoods.

For Canraru and Aracati, no WTP studies were available. WTP estimates were taken from the surveylocalities most similar to those project areas, and hence adjusted for income levels.

Results

The introduction of willingness to pay and shadow prices to correct the financial flows of benefits and costsimprove the previous financial estimates. The entire sample would generate net benefits of about R$ 242million. Apart from the water supply project in Caruaru, all water and sewerage projects are economicallyviable (see Table 6).

Table 6. Results of the Economic Analysis

jCaruaru water supply 22,517 23,225 (708) 12%!Fartaleza, water supply 177,291 56,402 120,888 61%Itabuna water supply 14,009 1,692 12,317 41%Joao Pessoa water supply 50,252 12,179 38,073 54%Santa Rita water supply 14,470 2,950 11,521 95%Aracati sewage collecton 6,950 3,279 3,671 29%Cuiaba sewage treatment 20,146 5,105 15,041 91%Joao Pessoa sewage treatment 32,245 2,443 29,802 99%Juazeiro sewage collecton 19214 7,958 11,256 44%|Total Saimple X 357,0941 115,233 241,861 [ 56%

With the exception of the water supply project in Joao Pessoa, the economic NPV is higher than thefinancial NPV, due to the large positive externalities of the project which are not internalized in the marketprices of the services provided.4

VI. "Short-cut" Economic Analysis

As conversion factors not only include the impact of taxes and subsidies, but also other market distortions(such as the high premiums received by water companies' employees), a so-called "short-cut" economicanalysis -was conducted to determine the net fiscal impact of the project. Under this method, economiccosts are calculated simply by subtracting taxes from and adding subsidies to the financial flow of costs,while economic benefits are assumed equal to the financial flow of benefits. The 12 percent discount rateused for both the financial and economic analyses is also used for the "short-cut" economic analysis.

4 The separation of OD and investment components of the water supply projects has not been conducted for the economicanalysis. A full fledged analysis could not be carried out due to the lack of data on the WTP for operational developmentimprovements. It is possible that the WTP for such improvement could be zero as customers have to pay (more) foressentially the same level of service. For example, illegally connected customers have to pay the full price of water insteadof getting it for free

45

The results for the "short-cut" economic analysis confirm the results for the financial analysis (see Table4). The entire sample would generate net benefits of R$ 153 million. With the exception of Caruaru, allwater supply projects improve in relation to the financial analysis.

Caruaru gets worse as a result of adding the R$ 5.4 million capital subsidy received from the state ofPernambuco to complete the Vila de Prata dam. The estimated cost of this complementary work, which isabout 25 percent already built, has been added to the economic flow of costs because the benefits ofbuilding the water transmission pipe (the main component of the Caruaru subproject) will only materializeif the dam is completed. The profitability of all sewerage subprojects decreases. The impact of addingelectricity subsidies and, in particular, the capital subsidy to built these projects, more than offset the gainsobtained from removing taxes.

Table 7. Results of "Short-cut" Economic Analysis

itp~y' i y -.m Net re5ent aue(R .

Caruaru water supply 17,510 23,581 (6,070) 8%Fortaleza water supply 128,809 60,348 68,461 40%ltabuna water supply 11,718 2,241 9,477 33%Joao Pessoa water supply 58,512 12,696 45,816 68%Santa Rita I water supply 7,882 3,506 4,376 68%Aracatf sewage collectfon 3,552 3,714 (162) 11%Cuiaba sewage treatment 8,509 5,799 2,709 28%Joao Pessoa sewage treatment 28,319 2,647 25,672 86%Juazeiro sewage collection 12,623 9,993 2,630 21%Total Sample 1 277,434 124,525 152,909 39%

When the water supply projects are separated into the two different components, the conclusions drawn inthe financial analysis do not significantly alter. The OD projects are all feasible. When evaluated asindependent alternatives, the investment projects in Fortaleza and Santa Rita are viable, but the projects inCaruaru, Itabuna and Joao Pessoa generate negative NPV (see Table 8). When the expansion andrehabilitation (investment) projects are phased over time, and executed after the implementation of theoperational development components, the projects in Itabuna (net present benefit of R$ 0.50 million and afinancial rate of return of 15%) and Joao Pessoa (net present benefit of R$ 2.00 million and a financial rateof return of 25%) are economically feasible. Once again, as in the financial evaluation, only the investmentproject in Caruaru remains unfeasible.

Table 8. Separable Water Supply Components - "Short-cut" Economic Analysis

-. - Net Internal Net . .4nternal~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~...... ... .....

Caruaru 2,486 44% (15,529) -2%Fortaleza 7,045 162% 69,862 41%Itabuna 5,821 410% (1,823) 5%Joao Pessoa 43,148 385% (2,625) 6%Santa Rita 2,657 128% 329 15%

46

Fiscal Impact

The impact on government finances is positive. The nine subprojects in the sample have a positive netfiscal impact equal to R$ 1:2 million (see Table 9). Although the subsidies are large, in particular thecapital subsidies for the sewerage projects (estimated at about R$ 5 million for the sample), the fiscaltransfers to the government through taxes during the construction and operation of the water and sanitationfacilities (estimated at R$ 25 million) more than offset them. Itabuna's water supply project, where thetransfer from taxes is negative due to higher O&M costs in the "without" project scenario than in the"with" project scenario (in particular labor), is the only water supply project with a negative net fiscalimpact. In Joao Pessoa's sewerage project the electricity subsidy is zero as -- because of the chosentechnology -- no electricity consumption is expected.

Table 9. Net Fiscal Impact

. . ...~~~~~~~~~~~~~~~~~~~.. ........a~~~~~~~~~Caruaru water supply 5,102 (586) (4,097) 419Fortaleza water supply 12,525 (2,097) 0 10,428Itabuna water supply (206) (12) 0 (218)Joao Pessoa water supply 2,862 17 0 2,879Santa Rita water supply 761 (104) 0 657Aracati sewage collection 675 (21) (1,371)1 (717)Cuiaba sewage treatment 943 (331) (1'334' (722)Joao Pessoa sewage treatment 462 0 (995)1 (533)Juazeiro sewage collecton 1,894 (20) (2,028) (154)TotalSaimple [ | 25,018[ (3,154) 9,825)1 12,039

Note:* Capital subsidies are comprised of a federal subsidy equivalent to 50 percent of OECF capital financing for sewerage

subprojects, and in the case of Caruaru, a state subsidy of R$5.428 million (50 percent of the subproject cost) tocomplete the "Vila do Prata" dam.

VII. Distributive Analysis

The distribution of positive externalities, the difference between the economic and financial cash flows, isanalyzed to determine who benefits from and who pays the cost of the project. The big winners are theconsumers, but society, government and workers also realize a good share of benefits from the positiveexternalities (see Table 10).

Consumption externalities benefiting the consumers of water supply and sewage disposal services,estimatod at R$ 64 million, result from the difference between the prices actually charged and the WTP forthese services. Consumption externalities arisen from the benefits realized by households who illegallyconsume services were assumed to be negligible.

Society, which includes the customers of water supply and sewerage services and others inhabitants ofsubproject areas, benefits primarily from the project's expected effect on curtailing environmentalpollution. Society benefits are estimated at about R$ 16 million based only on the expected impact of JoaoPessoa's and Cuiaba's sewage treatment projects on the water bodies involved. Joao Pessoa's project will

47

help preserve the Rio Paraiba's estuary, a region full of mangroves with great touristic attractiveness.Cuiaba's project will help preserve the Rio Cuiaba's beaches and the touristic neighborhoods that live fromthe river. The importance that Joao Pessoa's and Cuiaba's inhabitants assign to the recuperation of thewater quality of their rivers explain their relative high WTP for sewage treatment. Society benefits arehowever underestimated because only benefits accruing to households gaining access to sewage treatmentservices have been quantified. Lack of information on how others inhabitants of subproject areas(including the population living downstream of the rivers) would benefit from reduced water pollution didallow to a more precise calculation.

Table 10. Distribution of Positive Externalities

E i y 'tiSt~ '~ xi~9SIf i .M I . . El. QWn. :.

Caruaru water supply 5,007 419 355 0 5,781Fortaleza water supply 48,482 10,428 3,945 0 62,855Itabuna water supply 2,291 (218) 549 0 2,622Joao Pessoa water supply (8,260) 2,879 517 0 (4,864)Santa Rita water supply 6,588 657 557 0 7,802Aracati sewage collection 3,398 (717) 435 0 3,116Cuiaba sewage treatment 0 (722) 695 11,637 11,610Joao Pessoa sewage treatment 0 (533) 204 3,926 3,597Juazeiro sewage collection 6,591 (154) 2,035 0 8472Total Sample 1 64,097 1 12,039 i 9,2921 15,563 1 100,991

The large environmental benefits generated by sewage disposal projects justify the federal policy ofawarding capital grants. The government decided to encourage both sewage collection and treatmentbecause of the large social benefits that result from a cleaner environment. A decision that already hasgenerated enthusiasm and new stakeholders in favor of protecting the water bodies of the region.

The government reaps direct financial benefits through the collection of taxes and tariffs that are imposedon the inputs of the projects. Besides the direct fiscal impact, estimated at R$ 12 million, the utilities'expected efficiency gains will certainly reduce the need of fiscal transfers to them. During the 1987-1996decade, the first five state governments interested in the project (Ceara, Mato Grosso, Paraiba, Pemambucoand Piaui) transferred an annual average of US$ 113 million to their water utilities. This remarkably largeamount of fiscal transfers illustrates the potential that exist for significant fiscal gains by improving waterutilities' efficiency.

The benefits to workers, estimated at R$ 9 million, come mostly in the form of wage premiums that publicwater companies pay over the fair market for equivalent labor. In 1995, for example, the average annualremuneration per employee paid by the state water companies was R$ 20,669 (about R$ 23,000 as of 1996prices). As some subprojects are more labor-intensive than others, labor benefits differ across subprojects.

VIII. Poverty impact

It has been attempted in the distributive analysis to distinguish the consumer and society benefits accruingto the poor and non-poor customers. This so-called poverty impact analysis measures how much ofconsumer benefits and society benefits accrue to poor consumers.

Based on income data collected for the project areas during the willingness-to-pay surveys, calculationswere made assuming: (i) the income distribution will not change during the life of the project, (ii)

48

consumption differentials between poor and non-poor customers are negligible (that is, the lower per capitawater consumption of poor customers is largely offset by their larger household size); (iii) the net benefit to

5poor consumers does not significantly differ from that of non-poor customers

As shown in Table 11, 67% of the benefits will accrue to the poor, 28% to the middle-income groups and5% to the rich. This compares to a current income distribution in which the poor account for about 65% ofthe population, the middle-income group for 31% and the rich for 4%. The poverty impact for the watersupply investments follows the pattern of the income distribution of the population. Yet, the povertyimpact of sewerage investments tends more to the poor. In the sewerage projects, 71% of the benefitsaccrue ta, the poor, although they make up 64% of the population.

Table 11. Poverty Impact of the Project

HZ ..i...... .. ....... t wo

Caruaru water supply 3,405 601 1,001 5,007Fortaleza water supply 31,028 15,999 1,454 48,482Itabuna water supply 1,650 458 183 2,291Joao Pessoa water supply (5,286) (2,726) (248) (8,260)Santa Rita water supply 4,612 1,647 329 6,588Aracati sewage collection 2,039 1,019 340 3,398Cuiaba sewage treatment 7,448 3,840 349 11,637Joao Pessoa sewage treatment 2,827 785 314 3,926Juazeiro sewage collecton 5,734 593 264 6,591,Total Sample __________53,455 22,217 3,987 79,660

IX. Sensitivity and Risk Analysis

The sensitivity analysis shows that the WSM II project is a very robust project. The variables identified asconveying major risk to the subprojects are: collection efficiency, changes in the unaccounted-for waterlevel, investment cost overruns, project delays, willingness to pay for new or improved services, and laborproductivity (as measured by the number of employees per 1,000 connections). Nonetheless, based onsingle variable alterations, the sensitivity analysis shows that the NPV of feasible subprojects is unlikely tobecome negative. For example, only the financial NPV of two subprojects becomes negative when thecollection rate (the most sensitive variable) remained unchanged during the entire life of the project; and tohave a negative financial NPV, the unaccounted-for water level of the less robust water supply projectshould increase at least twelve percentage points. Table 12 summarizes the impact and risk significance ofthe major risk variables.

The sensitivity analysis, however, works based on single variable changes in a static world. To enhance theaccuracy of the financial and economic analysis, the uncertainty of the real world is incorporated by usingthe Crystal Ball risk analysis software. This software measures the extent of various risks and their effecton the project, modeling a probable distribution for each risk variable and the resulting outcome. The

5 This assumption is likely to result in an underestimation of the benefits accruing to the poor, because of the reduction ofcross-subsidies expected from lthe project. Although the poor have a lower absolute willingness to pay for water andsanitation services, the current tariff schedule benefits the poor through large cross subsidies. The water and sewerage billspaid by the rich are 2 to 15 times as large as those paid by the povr, while the willingness to pay of the rich is about 1.5 to 7times the willingness to pay of the poor.

49

assumptions and the corresponding probability distributions for the various risk variables have beendescribed in detail in the Project Files. Based on a simulation of 1,000 trials, the model recalculated theresults of the financial and economic analyses by changing the major risk variables all at the same time.

Table 12. Risk Variables and their Impact and Risk Significance

.... ....;. ,, ,,,,,, ,,........ , ,. .,,,IpC n kinfc ''. :............... ............................ . .. . ... .R.sk.V .riable... .. Imact and Risk Sijnificance: .....

Collection Efficiency Direct impact on revenues and profitability. Largely under managementcontrol, this variable conveys a moderate risk to the projects.

Unaccounted for Water Direct impact on operation and maintenance costs, indirect impact onrevenues as a decline in unaccounted for water has an impact similar to acapacity increase. Largely under management control, conveys a variablerisk level to the projects. High in Itabuna, where the project's benefits arehighly dependent on a reduction of current levels. Very low in mostsubprojects.

Investment Cost Overrun Direct impact on investment costs. Largely under management control,conveys a very low risk to the projects.

Project Delay Direct impact on timing of investment costs. Largely under managementcontrol, this is an almost risk-free variable in water subprojects and verylow risky in sewerage subprojects.

Willingness to Pay Direct impact on benefits. Based on consumer's preferences and hence_ largely beyond management control, this is a low risk variable.

Labor Productivity Direct impact on operation and maintenance costs. Under managementcontrol, is a very low risk variable.

Assumptions

An overrun of investment costs has a direct impact on the cost of the project. For this variable, a triangledistribution is used. Assuming that the engineers accurately estimated the investment cost, the most likelyvalue for overruns is 0 percent. The minimum value is -20 percent, and the maximum value is 20 percent.

Project delays have an impact on benefits and costs. Because of project delays, benefits materialize laterthan anticipated. The impact on costs occurs through the project's operation and maintenance costs, sinceit has been assumed that a project delay does not affect expected investment costs. Because of projectdelays, the expansion of capacity takes longer while the results of the project in the form of lowerunaccounted-for water occurs later than originally anticipated. Project delays are modeled according to thefollowing custom distribution:

Delay Probabilino delay 50%1 year delay 35%2 years delay 15%

Changes in the unaccounted-for water (UFW) have an impact on the operation and maintenance costs ofthe project. A decline in UFW has a similar impact than an increase in capacity. Assuming a standarddeviation that is dependent on the period under review, a lognormal distribution is used for this variableaccording to the following schedule:

50

Period under review Stindiard d eti1996 - 1999 5%2000 - 2004 10%2005 - end of project 15%

Changes in the labor productivity have an impact on the operation and maintenance cost. For this variable,a triangle distribution is used. The most likely value is determined by the engineers and varies from oneproject to another. The minimum variable is the lowest company estimate (for the period between 1996 to2004) minus 10 percent. The maximum variable is highest company estimate for the company plus 20percent. For treatment projects, labor requirements are rather low (due to the selection of stabilizationponds as the most favored technology) and the assumptions for labor productivity have been adjustedaccordingly.

Changes in collection efficiency are only used when determining the financial net present value. Thisvariable has a direct impact on the benefits of the project. A custom distribution has been used whichdiffers for each project due to the wide variances between the collection efficiency indices for the differentcompanies.

The willingness to pay for access to new or improved services is only used to determine the economic netpresent value. A lognormal distribution has been used in this case, as WTP is expected to be positivelyskewed. The WTP value can not drop below zero.

Financial Risk Assessment

The financial risk analysis confirms the robustness of the project. With the exception of the water supplyproject in Caruaru, all water supply and sewerage projects show a very large probability of generating apositive iNPV (the water supply project in Santa Rita showing the lowest probability of 80 percent), andhave large expected net cash flows (see Table 12). The sewerage projects are, in general, virtually risk-freeand will generate large positive net present values. The unusual result of having the sewerage subprojectsexhibiting a financial viability higher than that of the water supply projects is due to the 50 percent capitalinvestment subsidy given to these projects by the federal government.

Table 13. Financial and Economic Risk Assessment (R$ 1,000 of 1996)

.~~~~~~~~FnnIIM si l. E.OIA i _~~

. .' ~~~~~~~~~~~~~~JPV '~~~~~~~~~~~~~~~~~QtpQSIUV8 ~~~~~~~~~~~~~~~..............

C.ru _ i. |water supply 18% (6,452) 53% 306Fortalezae water supply 85% 52,749 100% 117,538Itabuna water supply 85% 9,010 100% 11,437Joao Pessoa water supply 92% 42,111 100% 43,267Santa Rita water supply 80%1 1,534 100% 9,725Aracabi sewage collecton 1 98% 4661 100%J 3,191Cuiaba sewage treatment 100% 3,084 100% 14,197Joao Pessoa sewage treatment 100% 18,300 100% 23,433Juazeiro sewage collecton | 99% 2,317 100%1 10,512

51

The financial risk analysis indicates that when all risk variables are analyzed simultaneously in a dynamicworld, the two most important variables impacting the projects' financial net cash flow are laborproductivity and collection efficiency. This is an important finding since these two variables can andshould be controlled by the management of the water companies. Cost overruns, project delays andunaccounted for water (in water supply projects) are less important.

Economic Risk Assessment

The economic risk analysis shows that all projects, again with the exception of the water supply project inCaruaru, are risk free (all of them have a 100 percent probability of generating a positive NPV) and havevery large expected net present values (see Table 13).

In contrast to the financial risk analysis, in the economic risk analysis the relative importance of riskvariables show large differences between projects. In the water supply projects, labor productivity is themost important variable in Caruaru, Fortaleza and Itabuna. In Joao Pessoa and Santa Rita, project delayshave the most impact. The willingness to pay for new and/or improved services turns out to be animportant assumption. And the impact of cost overruns is in general negligible with the exception ofCaruaru and Itabuna. Meanwhile, for the sewerage projects, the results are most sensitive to changes in thewillingness to pay.

When the different project components are evaluated as interdependent alternatives under a "short-cut"economic analysis (instead of a full-fledged economic analysis), the expansion and rehabilitation projects inCaruaru and Itabuna should not be implemented. Although the project in Itabuna generates a net benefit,the risks associated with the execution of this project are very high.

X. Conclusions

Based on the results of the analysis, the criteria for undertaking the different type of activities that can befinanced under the project were defined. Operational development programs should be financially viable toundertake as the major reason to undertake these programs is to improve the financial viability of thecompany. The criterion for undertaking rehabilitation and expansion water supply and sewage collectioninvestments is that these investments should be "short-cut" economically viable, because in general thesetype of investments will generate large individual benefits. The externalities associated with the provisionof water supply and sewerage services to the poor and sewage treatment are in general expected to be large.The criterion for these types of projects should therefore be that they are economically viable.

When applying these criteria on the sample of projects that were evaluated, the operational developmentprograms are all financially viable, and hence can be implemented. Except for the water supply project inCaruaru, all water supply and sewerage projects are "short-cut" economically viable. Yet, although thewater supply project in Itabuna is viable, the risks associated with the execution of this project are veryhigh, and it is therefore recommended not to implement this project. The two sewage treatment projects areeconomically viable, and hence because of the large external benefits they generate, should be implemented.

52

Annex 5Water Sector Modernization Project II

Financial Summary for Revenue Earning Project Entities

Objective

The objective of the financial analysis at the level of utilities is threefold: (i) to determine the financialcapacity of the utilities to service the Bank loan and to provide counterpart funds in a timely manner; (ii) todetermine the utilities' eligibility levels today and in the future, which are determined by a group offinancial. indicators; and (iii) to identify the additional actions which need to be taken by the utilities toimprove the eligibility levels. In addition, in the case of SANEMAT, the state water company of MatoGrosso, which will be dismantled and privatized (most likely municipal concessions), we conducted anadditional analysis to measure the long-term incremental benefit of such reforn to different stakeholders.

Methodology

During A4ppraisal, we carried out a detailed analysis of a sample of seven utilities, the initial group ofutilities which expressed interest in participating in the project. The following tasks were carried out for thesample utilities:

* analysis of historical and current financial status* determination of eligibility level today* preparation of financial projections (base scenario)* sensitivity analysis* identification of main risks and recommended actions by utilities* analysis of long-term incremental benefit from reform/PSP of SANEMAT

The future project participants within the scope of the project (North, Northeast, and Centerwest) will beanalyzed by the project management unit following the same methodology.

Table 1. The Main Characteristics Of The Seven Utilities Analyzed _

Utility Name As Stat,' Popu!ation Water Sewe1ae Anua B'il colected..fi ............ t ilgW400ii0tte..................... 4 :07Anlt- ficodfof J9~~~6 municiplit (000); coeragea~ coverage~ revene .... .il ........~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~........ ... . ... ... .W t lzM

CAGECE Ceara 3,346 74 15 105 96 (91)COMPESA Pernambuco 5,675 82 16 210 164 (78)CAGEP4 Paraiba 3,358 88 21 81 59 (73)AGESPiSA Piaui 3,130 94 2 56 47 (84)SANEM4T Mato Grosso 1,780 89 13 98 64 (65)EkL4SA Itabuna, Bahia 224 84 49 10 8 (80)SAlAE Juazeiro Juazeiro, Bahia 130 95 30 4.1 3.5 (85)

Histori,cal and Current Financial Status of the Water Utilities

Recent history. Most Brazilian water utilities experienced financial difficulties during the hyperinflationaryperiod during the late 1980s and early 1990s. Frequent tariff freezes imposed by the Government made itimpossible for the utilities to recover rapidly increasing costs. To make the ends meet, most utilities stopped

53

paying taxes and energy bills, while debts in arrears snowballed. Meanwhile, strong labor unions andoutdated salary structure increased the personnel costs steadily.

Changing environment. With the implementation of the Real Plan, most utilities were allowed to increasethe tariff levels by 20% to 60% in real terms between 1993 and 1996. Despite a more favorable operatingenvironment, however, the financial situation of the utilities remains difficult. The long period of economicinstability left the utilities with a large amount of debts and payments in arrears, and with very limitedfinancial management and planning capacity.

The Brazilian water utilities (especially state water companies) today are characterized by the following:

a) High operating costs. Cost control is weak at best. Many functions are centralized in theheadquarters, one of the reasons for high administration costs. In the recent years, cost of third-partylabor increased substantially, as the utilities started to reduce the number of regular employees.

b) High personnel costs and aginz employees. Although many of the utilities reduced the number ofemployees through voluntary retirement plans in the recent years, personnel costs still account formore than fifty percent of the operating cost (except for the municipal utilities). Many utilities arereviewing the salary structures which are based on years of service, and not on performnance, tocorrect the problem.

c) Tight liquidity/cash situation. Although operating margins of the utilities improved in the recent yearsthanks mainly to the increase in tariff, most utilities still suffer from tight cash situation. Billcollection rates are not ideal (between 65% to 90%/o), and payments for the accumulated taxes andenergy bills remain high.

d) Increasing debts and large investment needs. The debt-equity ratios of these utilities today are low.T-his represents the fact that the utilities have long depended on government transfers for investments.Most of the utilities' long-term debts were assumed by the state governments (and accounted for ascapital injection). With tighter budgetary control exercised by the government in the recent years, theutilities can no longer depend on government transfers for investments. Facing a large investmentbacklog, the utilities are starting to look for other sources of financing.

Eligibility Levels of the Utilities Analyzed. The eligibility status of the companies based on 1996proforma financial statements are as follows. (See Annex 2 for eligibility criteria). Of the three companieswhich are currently not eligible for any investment components, SANEMAT has already taken the decisionto opt for the "reform route".

54

Table 2 Selected Financial Indicators (1996)~~~~......... .......... =.......... . . . . ................ .. .. . -.........Utility Name Working- Peronnel Curret. Debt Long-term W - tarff

Ratio ) ost! E : Ratio;: Servi debt Se - a - - m3). ... .... ... , . ... .: :. i. : S-- -f-0-ig,::::::; tSt:St .S,.i ,, i,., ,.::.:--. E : LE..... ... ..1op:.e:-:---i---iE, ,ratma ingE ES :: -:. -- Coverage .Eq I)u.ity

_____ c :::: ::::::::: ost (%); (; ;: :: :-: times):; t S t ratiotr: 00:0

CAGECE 84 57 0.7 3.0 0.16 0.51COMF'ESA 79 54 1.7 12.6* 0.23 0.67CA GE.PA 79 63 0.5 4.1 0.05 0.64AGESPISA4 87 70 0.3 2.3 0.06 0.83SANEMAT 62 72 0.4 1.0 0.06 1.10EMVA9 91 33 0.3 1.6 n/a 1.00SAAEJuazeiro 65 41 6.75 n/a 0 0.59

* The debt service coverage is 3.3, if monthly payment of recently renegotiated debts in arrears (mainlytaxes and energy bills) is included as "debt service" instead of as increase in working capital.

Table 3. Financial Indicators and Eli*bility Level Based on 1996 EstimatesS~~~~~.M :.k . . . .. .. ..._

............ WorkingR io ers.Cost! DebtSc.Coy. Current Ratio lityt .............. ................... ...... OnCot% i2 i...... Co..t timies j Lvl*............ ................................ .......... .......... ...... ........... . ...... .............. .......... ............ .......................eE -- e :: -:EE-X:-

AG~2fCE E 84% 1 57/ 2 30 7 2 1*COMPE:SA 79% 544 2 12.6* 2 1.7 2 1.CAGEP.4 79% 1 . 63% 1 4.1 2 0.5 1 1V , . .................. ................ ....... .............................. ........ ................ -.,.............. . ..........................................A4GESP1'SA . 87%6 0 . 70% 0 2.3 2 0.3 0'SANEM4T 62% 2 . 72% 0 1.0 l 0.4 0 0E4AASA 91% 0 33% 2 1.6 2 0.3 0 0~~~~~~~...... -. - ...... - . ........ ......... ...................... .. . . ............. ............................. .............. .. ......

JJuazeiro 65% 2 41% 2, n/a 2 6.8 2 2* The debt service coverage is 3.3, if monthly payment of recently renegotiated debts in arrears (mainly taxes andenergy tills) is included as "debt service" instead of as increase in working capital.** All four indicators must qualify for a certain level of eligibility.

Financial Projections (Base Case)

Based cn the historical data and 1996 estimates, we prepared the financial projections for the seven utilitiesfor years 1997-2003. The projections were prepared on a conservative estimate of gradual efficiency gainsand considering the benefits from the investment programs, including those financed by the project. Thefinancial projections and financial ratios of selected utilities are presented in Attachment 1.

Main Assumptions. The main assumptions for the financial projections are summarized below. The moredetailed assumptions specific to each of the utilities are presented in the financial assessment reportavailable in the Project Files together with the diskettes containing the financial projections model.

Sensitivity Analysis

Sensitivity analysis was conducted on selected critical factors affecting the utility operations. We measuredthe impact of the changes in these factors to: (i) the utilities' financial eligibility status (the combination ofthe four indicators); and (ii) the utilities' self financing capacity. The scenarios we analyzed are:

Results and Recommendations. Selected results of the sensitivity analysis are presented in Attachment 2.The detailed results of the analysis are available in the Project Files. As a result of the sensitivity analysis,we could identify specific actions the utilities need to take to achieve better financial performance, and

55

hence obtain a better eligibility status. A summary of the recommendations for each of the seven utilitiesare presented in Attachment 3.

The sensitivity analysis indicates that the companies financial capacity (internal cash generation, and otherselected indicators) is most sensitive to the changes in revenue and operating costs. In reality, however,further increase in tariff level is not possible. Except for CAGECE, which has one of the lowest levels oftariff in Brazil, most water companies analyzed have already raised the tariff levels to the limit.

Table 4. General Guidelines orAssumptions Across UtilitiesExternal (dollar) inflation 3.5% peryearDomestic inflation 5% peryearExchange rate Based on local currency devaluation of 3% per yearRevenue:* Tariff Maintain current level in domestic currency terms (inflation adjusted)* Volume billed Based on estimated consumption perfamilyPersonnel costs:* Number of employees Calculated based on labor productivity indicator estimated by the utilities* Salary and benefits per Calculated based on utilities' historical amount plus legally permitted are

employee annual real increase as agreed with the unions. Benefits is estimated atabout 140% of monthly salary.

Operation and maintenance costs:* Unit costs of electricity and Based on historical data. No change.

chemical materials* Water production volume Based on estimated demand and water losses.Income tax 30%, if no accumulated losses. If accumulated losses exist, then tax base

can be adjusted downward according to the law by 30%, afler payingminimum social tax.

Investment Programs Based on utilities' estimates and availability offinancing. Many utilitiessubmitted very ambitious investment plans. We used a more conservativeestimate, taking into account utilities'financial and execution capacities.

Debtfinancing As estimated by utilities.

__- _| ___________-: __- _:-- __ -- Upside D ow nsideOperating cost -10% +10%Revenue +10% -10%Collection rates Faster improvement Maintain 1996 levelUnaccountedfor water Faster improvement Maintain 1996 levelInvestment schedule not analyzed Investment delayed

Note: In addition to these standard scenarios, we analyzed additional scenarios specific to each utility,where deemed necessary.

For most companies analyzed, reduction of operating cost is the most effective way to improve the financialperformance. Fixed costs, including personnel and administrative overhead costs, account for nearly 80%of the total operating costs (not including depreciation). The companies can become substantiallyfinancially self-sufficient, if they can reduce such fixed costs.

Although reduction of unaccounted-for water helps improve the financial performance, the impact is not asimmediate and large as reduction in operating costs. Unaccounted-for water (UFW) reduction wouldreduce the cost of production, and allow the water companies to postpone large investments in theproduction capacity. However, since the cost of production is not so large (about 20% of total operating

56

cost), cornpared with administrative overhead costs, and UFW programs in fact increases the cost ofoperation and maintenance in the short-run, the impact of UFW reduction to the companies' cashgeneration is minimal.

Tariff collection rates can have a considerable impact to the internal cash generation when the currentcollection rates are extremely low. In the case of COMPESA, which collects 82% of the bills from theprivate sector, and mere 10% from the public sector (public sector accounts for about 10% of totalrevenue), the impact of improving collection rates are sizable (US$60 million in 10 years). For others withfairly high collection rates, the impact is minimal.

Incremenital Benefit of Reform/PSP to Different Stakeholders -- The Case of Cuiaba, the State ofMato Grosso

SANEMAT, the state water company of Mato Grosso is a candidate for the "reform route" (see projecteligibility criteria in Annex 2). The state government decided to dismantle its state water company,SANEMAT, and to reform the sector through municipalization and private sector participation. Since themain outcome of the project in this case is "reform", we attempted to measure the benefit of reform, ratherthan conclucting a conventional ratio analysis. The parallel objective of this exercise was to determine howeach grotup of stakeholders benefit differently depending upon how the concession contract is awarded andstructured. The stakehoders analyzed are: the Government (municipal, state, and Federal), company as abusiness, company shareholders, and the existing customers. Table 5 presents the main stakeholders in thereform process, and their costs and benefits.

We realize that there are some other stakeholders not analyzed here, such as employees, new customers,etc. We also realize that there may be some benefits that are shared by more than one stakeholders. Themain puipose of this exercise, nonetheless, was to measure the magnitude of the direct financial impact ofreform to the major stakeholders.

Me tho do , o

Tle tasLks we developed were as follows:

a) Construct the financial statements of the water company of Cuiaba (the most likely target forprivatization) by allocating assets, liabilities, income, and costs that pertain to the respectivemuricipality.

b) Prepare the financial projections for the next 30 years under five scenarios: four with Reform/PSP andone without Reform/PSP.

c) Allocate the costs and benefits to different stakeholders, under each scenarios (see table below).d) Calculate the incremental net benefits from reform for each of the four "reform" scenarios.

57

Table 5. Main Costs and Benefits to the Stakeholders from RefonWPSPStake holders Costs :Be:efr=Company (concession as a Cash outflow from operations Cash inflow from operationsproject) ~. .-......... ... .

Shareholders Equity investments and "canon" Dividends (Any cash in excess of(license fee) payments, if any. minimum requirements)

Federal Government Federal Grants/Transfers Income taxes and general socialcontributions (approx. 35% ofprofitbefore tax).

State Government Budget transfers. Income tax allocation to the state(approx. 2% of the Federal tax), value

_______________________ ~~~~~~~added tax( (7% of the bills).

Municipal Government Transfers to the utilities to cover any Monthly canon (license fee from thelosses, if no PSP. concessionaire)

Customers Costs o,f rationing Reduction in tariff if any.*Cost of rationing was calculated based on the assumptions that: (i) low income customers pay the water truck (estimated atR$5. 7/rn) when there is rationing; (ii) middle to high income customers install and maintain water tanks (cost estimated atRgO. 77/rn in addition to tariffpayment). A more detailed description of how we determined each cost and benefit componentis available in the Project Files.

Scenarios Analvzed

We analyzed four different scenarios which are the likely outcome of SANEMAT's reform, in comparisonwith "without" PSP/reform scenario.

SANEMAT debts paid by:Concessionaire Municipality

Economic bid based on: License fee Base Scenario Scenario 2Tariff Scenario 3 Scenario 4

Under all scenarios, the water and sanitation service currently provided by SANEMAT will become theresponsibility of the municipality of Cuiaba. The municipality of Cuiaba will then bid out the water andsewerage utility concession to the private sector under reform/PSP scenarios. For all reforn/PSP scenarios,we assumed that the investors (shareholders) of the concession company will expect to earn at least 25% oninvested capital. We assumed therefore, that the winning concessionaire would offer an annual license feepayment or a tariff reduction that equates their return on capital to 25%.

Under the base scenario, the concession will be bid out on annual "canon" or license fee payment to themunicipality, not on tariff discount. SANEMAT's existing debts (which corresponds to Cuiba) will be paidby the winning concessionaire in ten years. Scenario 2 is the same as Base scenario, except thatSANEMAT's existing debts will be paid by the municipality.

Under Scenarios 3 and 4, the concession will be bid out on tariff reduction. SANEMAT's debts are paidby the concessionaire under scenario 3, and by the municipality under scenario 4. Under "withoutreform/PSP scenario", we assume business as usual with SANEMAT's existing inefficiency carriedforward to the municipal utility.

58

Table 6 Main Assumptions Under Different Scenarios,,, ,,,i..ith. ........ Refir S P WitouMtReform/PS ;

Tariff Scenario I and 2: Maintain 1996 level. Maintain 1996 level.Scenario 3 and 4: Reduce to a level whichgives investors (shareholders) return oninvested capital of 25% (free of inflation).

Labor prodluctivity** Improve to 1.9 by 2003. Maintain 1997 level = 2.2Days accounts receivable Reduction to 52 days by 2003. Maintain 1997 level = 243 daysUnaccounted for Water Reduction to 25% BY 2003. Maintain 1997 level = 53%Working Ratio Reduction to 53% by 2003. Increase to 100%from 84% in 1997.SANEAM4T debts (R$69.9 Scenario 1 and 3: Paid back by the new Paid back by the water company. Themillion) water operator over 10 years. resulting cash shortfall will be

Scenario 2 and 4: Paid back by the coveredfrom municipal budget.municipality over 10 years.

License Fee ('canon') Scenario I and 2: An amount that leaves None.Payments to the investors (shareholders) 25% FPR.municipality. Scenario 3 and 4: None.Budget transfers. There are no budget transfers from the Budget transfers from the municipal

government. Investments are financed by government to cover operating losses_capital injection and basic investments

*General assumptions are the same as those presented in Section 3 above.**Employees per 1000 connections

Summary of Results

The results of the analysis confirmed that all main stakeholders benefit from reform (see Attachment 4).Without reform/PSP all stakeholders incur losses, except for the state government which collect some valueadded tax from water sale. The results also showed that depending upon how the bids are structured, somestakeholders benefit more than others. It also showed that overall financial gains can be maximized bychoosing a certain option over others.

The municipality must make a decision on how much of the efficiency gains it wants to share with thewater users (customers). If the concession is bid out on a license fee (canon), and no tariff reduction isgranted, then the water users' benefits are limited to reduced rationing and perhaps better service (scenarios1 and 2). If, on the other hand, the concession is bid out on tariff reduction, this in effect implies that themunicipality is passing on most of the efficiency gains to the water users (scenario 3 and 4). The resultsindicated that the customers' benefits can double, if tariff reduction is granted, even though overall benefits,especially the benefits to the Government, are reduced. Alternatively, the municipality can use the licensefee to create a "subsidy fund" to extend the service to the poor. In this case, although the benefit to theexisting customers may be reduced (compared with the tariff reduction scenario), the efficiency gains aretransferred to the new and generally poor customers.

Another critical decision the municipality must take is the issue of SANEMAT's outstanding debts. If themunicipality makes the winning concessionaire assume the debts, then the cost is eventually passed on tothe customers (scenario 3 vs. scenario 4).

The speciific results can be summarized as follows:

* Of the four reform/PSP scenarios, base scenario and scenario 2 - bid on license fee -- maximizes thetotal benefits to the stakeholders. The difference between the two scenarios are minimal in terms of

59

overall benefits. The municipality gains more under the base scenario because it does not have to paySANEMAT's debts, even though annual license fee income is higher under scenario 2. The benefitsto the customers are the same under both scenarios, and are limited to benefits arising from not havingrationing.

* The benefits to the customers are the highest under scenario 4, even though the overall benefits are thelowest. Under this scenario, the concessionaire will bid at a 15% discount to the existing tariff, andstill earn 25% return on invested capital. Larger tariff discounts are granted, because the winningconcessionaire does not have to pay back SANEMAT's debts. The reduction in tariff increases thebenefits to the customers, but reduces the benefits to the Government at all levels. The lower tariffreduces the revenue from income tax and value added tax. In addition, there will be no license feeincome to the municipality under this scenario.

60

Attachment 1Water Sector Modernization Project II

Financial Summary for COMPESA (State Water Company of Pemambuco)

Years Ending December 1995 through 2003(In Millions of Current Real)

1995 1996 1997 1998 1999 2000 2001 2002 2003 AverageAnnualGrowth

Actual Estimated ForecastIncome Statement Hems

UnH Volume (000 m3)Water 214,689 220,061 224,462 234,935 246,112 256,492 267,003 277,683 288,791 4%Sewerage 60,333 61,012 62,958 66,735 70,740 74,984 79,483 84,252 89,307 5%

Tariff (RS/mr 1995)Water 0.60 0.67 0.70 0.70 0.70 0.70 0.70 0.70 0.70SewFerae 0.54 0.69 0.70 0.70 0.70 0.70 0.70 0.70 0.70

Revenues (Total) 169,360 209,906 234,955 251,393 269,170 287,062 305,887 325,730 346,883 9%Operating Inoome 8,928 30,803 45,204 58,648 66,942 76,923 87,099 98,455 111,161 37%Net Income 14,109 26,670 35,234 42.395 48,156 55,547 63,249 62,688 72,756 23%

Funds Stleme it HemsInternal Souces 37,285 39,905 51,158 62,390 72,878 84,520 96,085 111,458 124,619Borrowngs 0 0 31,816 78,741 37,653 14,553 0 0 0Equity Investments 16,213 1,453 11,598 17,039 17,694 1,301 0 0 0

Total Sources 53,498 41,358 94,572 158,169 128,226 100,374 96,085 111,458 124,619Capital Expenditures 16,213 23,221 65,696 144,606 96,027 67,536 70,055 59,767 74,105(of which capitalized interest and costs) 0 4,508 6,982 11,518 14,790 16,642 17,533 5,331 5,491

Working Capital Increase (Decrease) 24,225 11,235 12,643 17,051 12,606 45,175 22,922 20,215 20,963Debt Service 6,773 2,280 825 3,351 5,085 5,455 6,014 30,130 29,778

TotalApplications 47,211 36,736 79,164 164,908 113,718 118,166 98,991 110,112 124,845Change in Cash 6,287 4,623 15,408 -6,739 14,507 -17,792 -2,906 1,346 -226

Balance Sheet HernCurremtAssets 68,773 88,038 117,088 112,075 118,171 104,229 108,829 120,076 130,705 8%

Les Curent Liabilities 50,341 50.614 67,970 70,679 68,017 44,503 53,447 55,846 58,463 2%

Net Fied Aets 572,731 670,878 768,651 933,648 1,054,401 1,148,576 1,246,023 1,334,224 1,437,361 12%Total Assets 591,163 708,303 817,769 975,044 1,104,555 1,208,302 1,301,405 1,398,454 1,509,603 12%

Debt 127,147 132,560 150,018 212,806 234,327 233,544 211,062 187,911 164,058 3%Equity 464,016 575,743 667,752 762,238 870,228 974,758 1,090,343 1,210,543 1,345,645 14%

Total Liabilities and Equiy 591,163 708,303 817,769 975,044 1,104,555 1,208,302 1,301,405 1,398,454 1,509,603 12%

Financil Ra &c,

OperatIng Income as a% of Ravenue 5.3% 14.7% 19.2% 23.3% 24,9% 26.8% 28.5% 30.2% 32.0%

NAet kcome as a% ofRevenue 8.3% 12.7% 15.0% 16.9% 17.9% 19.4% 20.7% 19.2% 21.0%

Retum onAvage Invested Capital (ROE) 3.6% 5.1% 5.7% 5.9% 5.9% 6.0% 6.1% 5.4% 5.7%

Desb Sevke Coverage^ 1.9 12.6 52.7 15.6 15.5 9.3 14.2 3.0 3.5Percent of Total Capital Expendtures

flminced by Inermal Sources 38.8% 94.2% 46.7% 21.1% 42.1% 25.5% 70.8% 93.3% 92.3%Current RaUo 1.4 1.7 1.7 1.6 1.7 2.3 2.0 2.2 2.2Debt as %oflotal Capitalization 27.4% 23.0% 22.5% 27.9% 26.9% 24.0% 19.4% 15.5% 12.2%

Main Ef1kheov Rafo

Unaccounted iRr WaterodWalerProduced 48% 48% 48% 45% 42% 36% 33% 31% 30%

Opeting Rato (incl. depecIaons) 94% 85% 81% 77% 77% 76% 75% 74% 73%W-,n Rato (excl. deprechaions) 86% 79% 74% 70% 69% 67% 66% 65% 64%Personnel CostOperang Cost- 55% 54% 53% 51% 51% 51% 50% 50% 49%LaborPduclY(typer 1000 connections) 3.9 3.5 3.5 3.4 3.2 3.1 3.0 2.8 2.7Collecon Rates

p*ate sector - btal sales: 82% 82% 82% 86% 94% 96% 96% 96% 96%pubic setor- %totalsales: 7% 10% 10% 10% 10% 10% 10% 10% 10%

Total 75% 75% 75% 78% 86% 87% 87% 87% 87%Cash avalable for Invesments 6287 21883 30708 30470 40398 17248 49616 55782 68388' Eligibilty Indicatom

61

Attachment IWater Sector Modernization Project II

Financial Summary for CAGECE (State Water Company of Ceara)

Years Ending December 1995 through 2003(In Millions of Current Real)

1995 1996 1997 1998 1999 2000 2001 2002 2003 AverageAnnualGrowth

Actual Estimated ForecastIncome Statement Items

Unit Volume (000 m3)Water 131,728 146,239 159,719 170,829 181,226 189,810 195,378 198,895 202,475 6%Sewerage 33,388 35,627 42,303 59,346 78,296 88,347 89,596 91,208 92,850 14%

Tariff (R$/m3 1995)Water 0.51 0.51 0.53 0.53 0.53 0.53 0.53 0.53 0.53Sewerage 0.61 0.58 0.61 0.61 0.61 0.61 0.61 0.61 0.61

Revenues (Total) 84,226 104,924 130,219 156,911 186,972 210,911 226,777 242,402 259,103 15%Operating Income 547 -4,518 -3,629 1,895 8,797 16,062 18,483 19,136 20,140Net Income -9,679 -4,973 -10,235 -6,448 -3,755 1,127 -1,704 -615 1,142

Funds Statement ItemsIntemal Sources 18,098 17,880 18,849 26,990 36,110 45,480 51,611 54,999 58,453Borrowings 21,039 0 26,176 85,036 45,930 13,786 2,444 0 0Equity Investments 8,697 5,662 13,879 23,350 17,099 5,216 417 424 432

Total Sources 47,834 23,542 58,904 135,376 99,139 64,482 54,472 55,423 56,885Capital Expenditures 21,975 8,930 51,550 137,384 107,303 40,002 14,631 5,670 18,160

(of which capitalized interest and cost) 0 0 4,731 6,732 8,922 9,972 4,707 4,848 4,994Working Capital Increase (Decrease) -3,097 3,605 2,105 -13,061 -22,766 1,791 13,608 14,814 6,711Debt Service 3,521 4,726 8,686 10,653 14,177 19,950 25,850 34,293 33,561

Total Applications 22,399 17,261 62,342 134,976 98,713 61,743 54,088 54,778 58,432Change in Cash 25,435 6,281 -3,437 400 426 2,739 384 646 453

Balance Sheet ItemsCurrent Assets 27,006 19,756 18,580 21,224 23,686 27,137 28,977 31,138 33,369 3%

Less Current Liabilities 32,274 27,385 28,866 44,826 74,764 74,371 71,895 59,468 55,298 7%

Net Fixed Assets 630,194 578,685 645,324 786,863 899,083 945,035 966,006 977,848 1,001,441 6%Total Assets 624,926 571,057 635,038 763,261 848,006 897,801 923,087 949,518 979,511 6%

Debt 82,367 78,074 105,782 193,047 238,158 251,468 244,461 234,496 224,022 13%Equity 542,559 492,984 529,257 570,214 609,849 646,333 678,627 715,023 755,490 4%

Total Liabilities and Equity 624,926 571,058 635,039 763,262 848,007 897,801 923,088 949,518 979,512 6%

Financial Ratios

Operating Income as a%of Revenue 1% -4% -3% 1% 5% 8% 8% 8% 8%

Net Income as a% of Revenue -11% -5% -8% -4% -2% 1% -1% 0% 0%

Return on Average Invested Capital (ROE) -2% -1% -2% -1% -1% 0% 0% 0% 0%

Debt Service Coverage* 6.0 3.0 1.4 3.1 3.5 1.7 1.3 1.0 1.4Percent of Total Capital Expenditures

financed by Internal Sources 80% 107% 6% 16% 33% 34% 51% 18% 73%Current Ratio 0.8 0.7 0.6 0.5 0.3 0.4 0.4 0.5 0.6Debt as%of Total Capitalization 15% 16% 20% 34% 39% 39% 36% 33% 30%

Main Efficiency Ratios

Unaccounted for Water% of Water Produced 39% 34% 34% 30% 27% 25% 25% 25% 25%

Operatng Ratio (inc. depreciations) 99% 104% 103% 99% 95% 92% 92% 92% 92%Working Ratio (excl. depreciations) 77% 84% 85% 83% 80% 77% 77% 77% 77%Personnel Cost/Operating Cost - 58% 57% 56% 56% 56% 54% 54% 54% 54%Labor Productivity (per 1000 connections) 2.8 2.3 2.2 2.1 2.0 2.0 1.9 1.9 1.8Collection Rates

private sector - % total sales: 90% 94% 94% 95% 96% 97% 98% 98% 98% 98%public sector - % total sales: 10% 95% 95% 95% 96% 97% 98% 98% 98% 98%

Total 94% 94% 95% 96% 97% 98% 98% 98% 98%Cash available for investments 17674 9549 3327 22666 35778 13767 7446 1043 13187

Eligibility Indicators

62

Attachment IWater Sector Modernization Project I1

Financial Summary for AGESPISA (State Water Company of Piaui)

Years Ending December 1995 through 2003(In Millions of Current Real)

1995 1996 1997 1998 1999 2000 2001 2002 2003 AverageAnnualGrowth

Actual Estimated ForecastIncome Iement Kems

Unit Volume (000 m3)Waler 57,061 59,999 65,587 70,538 73,955 76,766 79,683 82,711 85,854 5%Sewerage 2,686 2,779 3,884 5,169 5,300 5,475 6,861 8,184 8,495 15%

Tariff (RS/m3 1995)Water 0.83 0.83 0.83 0.83 0.83 0.83 0.83 0.83 0.83Sewerage 0.84 0.85 0.85 0.85 0.85 0.85 0.85 0.85 0.85

Revenues (Trotal) 45,381 56,163 66,540 76,155 83,709 91,205 100,799 111,181 121,176 13%Operating; Income -4,991 -2,405 -815 3,282 6,046 8,808 13,369 18,499 22,955Net Income -9,818 -12,200 -1,889 2,208 4,656 5,809 9,680 14,038 17,848

Funds ;Stament ItemsIntemal Sources 4,098 3,544 10,710 15,921 19,604 23,473 28,506 33,966 38,852Borrowings 0 9,347 18,517 2,293 1,047 761 0 0 0Equity Investments 2,804 1,047 4,527 0 0 0 0 0 0

Total Sources 6,902 13,938 33,754 18,214 20,651 24,235 28,506 33,966 38,852Capital Expenditures 2,576 7,810 33,967 5,633 4,966 3,043 2,749 2,892 3,044(ofwhichcapiftizedinterestsandcosts) 0 1,267 1,987 2,524 2,806 1,155 1,190 1,225 1,262

Working Capital Increase (Decrease) -6,723 -12,367 -3,282 8,826 15,825 1,696 4,343 5,103 2,425Debt Sevice 5,266 6,307 1,074 2,393 2,220 3,584 3,452 3,301 3,571

Total Applications 1,119 1,750 31,759 16,852 23,011 8,323 10,544 11,296 9,040Change iin Cash 5,783 12,188 1,995 1,362 -2,360 15,911 17,962 22,670 29,812

htalnce ht ItemsCu!rent Assets 13,931 17,546 19,400 21,984 19,608 34,678 53,021 76,668 108,025 29%

Less Current Liabilities 46,505 56,894 61,998 54,627 38,990 36,656 32,898 29,409 28,747 -6%

Net Fbie Assets 467,872 474,445 534,701 557,700 580,398 601,681 623,234 645,614 668,946 5%Total Assets 435,298 435,098 492,103 525,057 561,016 599,703 643,357 692,872 748,224 7%

Debt 9,514 24,587 42,866 44,072 44,036 43,711 42,598 41,025 39,397 19%Equity 425,784 410,511 449,237 480,986 516,980 555,992 600,759 651,847 708,827 7%

Total iabilities and Equity 435,298 435,098 492,103 525,057 561,016 599,703 643,358 692,872 748,224 7%

F inancial Ratbs

Opeating hicone as a%ofRevenue -11.0% -4.3% -1.2% 4.3% 7.2% 9.7% 13.3% 16.6% 18.9%

Not Income as a% ofReivenue -21.6% -21.7% -2.8% 2.9% 5.6% 6.4% 9.6% 12.6% 14.7%

Reurn on Average Invested Capital (ROE) -2.5% -2.9% -0.4% 0.5% 0.9% 1.1% 1.7% 2.2% 2.6%

DebtSeeviceCoverage' 2.1 2.3 11.2 1.9 0.4 5.8 6.7 8.4 9.8Percent of rotal Capital Expenditures

financed by Inrnal Sources 215.7% 106.7% 32.2% 38.7% -25.1% 559.9% 710.2% 841.4% 1037.8%CurrentRalio' 0.3 0.3 0.3 0.4 0.5 0.95 1.61 2.61 3.76Debt as%of Total Capitalization 2.2% 6.0% 9.5% 9.2% 8.5% 7.9% 7.1% 6.3% 5.6%

Main Eticgcv Rto

Unaccounted for Water%of Witer FPrduced 48% 48% 48% 45% 41% 38% 35% 32% 30%

Operating Ratio (kid. depreciations) 111% 104% 101% 96% 93% 90% 87% 83% 81%Woil Rstio (excl. depreciations) 92% 87% 84% 79% 75% 73% 70% 67% 65%PFersonre CostCOperating Cost - 72% 70% 66% 64% 63% 62% 61% 60% 59%Labor PFtdudivity or 1000 cnnections) 5.2 4.7 4.1 3.8 3.5 3.4 3.2 3.0 2.8Colection fRates

peA ate sector - % total sales: 85% 93% 93% 93% 94% 95% 96% 96% 96% 96%pubilic sector - % totalsals: 15% 73% 73% 75% 80% 85% 90% 90% 90% 90%

Total 90% 90% 90% 92% 94% 95% 95% 95% 95%Cash Avaiable for Investment 5555 8336 10931 2177 -1247 17038 19521 24337 31594

* Eligibility Indicators

63

Attachment IWater Sector Modemization Project II

Financial Summary for SAAE (Municipal Water Company of Juazeiro)

Years Ending December: 1995 through 2003(In Millions of Current Real)

1995 1996 1997 1998 1999 2000 2001 2002 2003 AverageAnnualGrowth

Actual Estimated ForecastIncome Statement Hems

Unit Volume (000 m3)Water 4,586 4,778 4,902 5,302 6,007 6,764 7,048 7,344 7,652 7%Sewerage 1,187 1,550 1,618 2,022 3,118 4,263 5,459 5,699 5,938 22%

Tariff (R$1m3 1996)Water 0.61 0.59 0.59 0.59 0.59 0.59 0.59 0.59 0.59Severage 0.43 0.45 0.45 0.45 0.45 0.45 0.45 0.45 0.45

Reven'nes (Total) 3,178 4,093 4,276 5,007 6,439 8,073 9,487 10,386 11,363 17%Operating Income 1,231 1,440 340 731 1,339 1,928 2,242 2,301 2,468 8%NaetIncome 1,334 1,464 340 731 1,339 1,207 1,472 1,536 1,738 2%

Funds Statement hemsIntemal Sources 1,334 1,464 938 1,380 2,083 2,821 3,294 3,502 3,808Borrovings 0 0 748 6,096 3,416 828 0 0 0Equity Investments 0 0 0 2,178 2,287 0 0 0 0

Total Sources 1,334 1,464 1,685 9,654 7,786 3,649 3,294 3,502 3,808Capital Expenditures 294 294 1,080 9,256 6,725 1,362 1,026 528 566Working Capital Increase (Decrease) 554 617 -694 15 130 136 138 50 90Debt Service 0 0 0 0 0 720 770 1,540 1,528

Total Applications 848 911 387 9,272 6,855 2,218 1,934 2,118 2,184Change in Cash 486 553 1,299 383 931 1,431 1,361 1,385 1,624

Balance Sheet ItemsCurrent Assets 975 1,631 2,339 2,792 3,888 5,542 7,148 8,696 10,492 35%

Less Current Liabilities 36 242 345 401 435 523 1,406 1,542 1,649 61%

Net Fixed Assets 19,172 19,466 21,319 30,992 38,522 40,917 42,937 44,410 45,856 12%Total Assets 20,110 20,855 23,313 33,384 41,975 45,937 48,679 51,564 54,699 13%

Debt 0 0 794 7,096 10,827 12,005 11,590 11,139 10,650Equity 20,110 20,855 22,520 26,288 31,148 33,932 37,090 40,425 44,049 10%

Total Liabilities and Equity 20,110 20,855 23,313 33,384 41,976 45,937 48,680 51,564 54,699 13%

FinancialRatios

Operating Incorne as a% ofRevenue 38.7% 35.2% 8.0% 14.6% 20.8% 23.9% 23.6% 22.2% 21.7%

Net Income as a% ofRevenue 42.0% 35.8% 8.0% 14.6% 20.8% 15.0% 15.5% 14.8% 15.3%

Retum on Average Invested Capital 6.9% 7.1% 1.6% 3.0% 4.7% 3.7% 4.1% 4.0% 4.1%

Debt Service Coverage* 3.7 4.1 2.2 2.4Percent of Total Capital Expenditures financed by Intemal Sources

265.2% 288.0% 151.0% 14.7% 29.0% 144.3% 232.6% 362.5% 386.9%CurrentRatio 26.78 6.75 6.78 6.97 8.93 10.60 5.09 5.64 6.36Debt as % or Total Capitalization 0.0% 0.0% 3.5% 27.0% 34.8% 35.4% 31.2% 27.6% 24.2%

Main Eficiency Ratios

Unaccounted for Water% of Water Produced 67% 67% 67% 58% 53% 48% 43% 40% 38%

Operating Ratio (cin. depreciations) 61% 65% 92% 85% 79% 76% 76% 78% 78%Wcorking Ratio (excidepreciations) 61% 65% 78% 72% 68% 65% 65% 66% 66%Personnel Cost/Operating cost* 45% 41% 45% 46% 48% 48% 49% 49% 49%Labor Productivity (per 1000 connections) 4.1 4.1 4.1 4.0 3.9 3.8 3.8 3.7 3.6Collection Rates

pnvate sector- %Xtotal sales: 99% 86% 87% 90% 92% 94% 95% 95% 95% 95%pub/k sector.- %total sales: 1% 5% 5% 10% 20% 30% 40% 50% 50% 50%

Total 85% 86% 89% 91% 93% 94% 95% 95% 95%Eligibility Indicators

64

Attachment 2Selected Results of Sensitivity Analysis

CAGE-PA (1997-2003)Scenarios Intemal Invest- Contri- Min Debt Min Year Year

Cash ment bution to service Current eligible eligible_Investmt cover Ratio for Lvl I for Lvl 2

Base Case 179 364 49% 2.78 0.5 97 never.____ ____ _____ _________ _ __ ____drop 2001

Upsidfe__ _ __ _ __ _ _ _ _ _

Operating cost -10% 225 364 62% 3.19 0.6 97 2003Revenue +10% 240 364 66% 3.4 0.5 97 99Colleclion improvement 187 364 51% 2.8 0.5 97 never

_ ____________________ .______ drop 2001VFW better (less) 188 364 52% 2.9 0.5 97 never

Downside l

Operating cost +10% 134 364 37% 1.9 -0.1 never neverRevenue -10% 119 364 33% 1.4 -0.3 97 never

drop 98Collection no improvement 120 364 33% -4.8 0.4 97 never

_ ___________________ _______ _ _ _ _ _ _ _ ______I drop 98UFW no improvement 165 364 45% 2.6 0.3 97 never

__ _ _ _ _ _ _ __ _ _ _ _ _ _ _ _ _ _ _ __ drop 99Delay investments 173 365 470/o 2.8 0.4 97 never

drop 2001RecommendedReduce contingent liability, reduce 202 364 56% 3.0 1.3 97 98operating cost by 5% 9_

Note: "never "- never becomes eligible for the level during the Project implementation period"drop" - drops out of the program by not maintaining the eligibility ratios.

COMPESA (1997-2003)Scenarinos Internal Invest- Contri- Min Debt Min Year Yewar

Cash ment bution to service Current eligible eligibleInvestmt cover Ratio for Lvl 1 for Lvl 2

Base Case 293 578 51% 3.0 1.6 96 97Upside__ _ ___ _ _

Operat4ing cost -10% 429 578 74% 7.1 1.9 96 97Revenue +10% 438 578 76% 7.3 2.0 96 97Collection improvement 353 578 61% 4.5 1.6 96 97UFW less 302 578 52% 3.1 1.6 96 97Downs,ideOperating cost +10% 148 578 26% 2.2 -0.2 96 never

.______ _______ ________ drop 2001Revenue -10% 147 578 26% 2.2 -0.5 96 never

_ ___________________ _______ _______ _______ _______ drop 2001Collect.ion no improvement 243 578 42% 2.9 1.6 96 97UFW no improvement 267 578 46% 2.8 1.6 96 97Delay investments 366 571 64% 3.4 1.8 96 97No reduction in personnel cost 181 578 31% 2.3 0.3 96 never/

drop 97

RecommendedGradual Reduction in personnel cost (same as base case)

65

CAGECE (1997-2003)Scenarios Internal Invest- Contri- Min Debt Mn Year Year

Cash ment bution to service Current eligible for eligibleInvestmt cover Ratio Lvl 1 for Lvi 2

Base Case 97 375 26% 1.03 0.3 96 neverUpsideOperating cost -10% 201 375 54% 1.57 0.8 96 98Revenue +10% 192 375 51% 1.4 0.6 96 2000Collection Improvement 97 375 26% 1.0 0.3 96 neverllFW better (less) 98 375 26% 1.0 0.3 96 neverDownsideOperating cost +10% -22 375 -6% 0.33 -1.4 96 drop 97Revenue -10% -3 375 -1% 0.5 -1.3 96 never

I______ _______ ________ _______ drop 98Collection no improvement 86 375 23% 1.0 0.3 96 never

I_______ _______ drop 99UFW no improvement 88 375 24% 1.0 0.3 96 never

drop 98Delay investments 90 384 23% 1.0 0.1 96 never

drop20Recommended5% inc in tariff, 5% decrease in operating cost

1 198 T 375 53% 1.6 0.7 96 98

AGESPISA (1997-2003)Scenarios Internal Invest- Contri- Min Min Year Year

Cash ment bution to Debt Current eligible for eligible forInvestmt service Ratio Lvl I Lvl 2

_______________________________ ________ _ ______ _ coverBase Case 104 56 185% 0.44 0.3 2000 2003Upside X _ _ _ _ _ :Operating cost -10% 135 56 240% 2.8 0.4 98 2002Revenue +10% 144 56 256% 3.3 0.3 98 2002Collection improvement 108 56 191% 0.6 0.3 2000 2003UFW better (less) 108 56 193% 0.7 0.3 2000 2003DonsideOperating cost +10% 70 56 124% -1.9 0.2 2001 neverRevenue -10% 61 56 108% -2.6 0.2 2001 neverCollection no improvement 94 56 167% -0.5 0.3 2000 2003UFWno improvement 95 56 170% 0.1 0.3 2000 2001Recommended I I X XRenegotiation of energy bills, 140 56 248% 2.8 0.6 98 2002personnel reduction by 15%, andoperating cost reduction by 10%

66

Attachment 3Main Problems by Utilities and Recommended Actions (to be presented to the utilities)

Eligibility Main Problems Recommended Actions/ commentsStatus in

_______ '96CAiGECE 1 * High working ratio. For eligibility level 2 in 1998:

* At R$0.51/m3, tariff level of * 15% tariff increase; 10% cost reduction;CAGECE is one of the lowest or a combination of 5% increase in tariffamong state water and 5% reduction in operating cost.companies, hence some scope * If no action taken, CAGECE will face afor tariff increase. major liquidity problem during years

1998-2000, and become non-eligible for_ ______ _________ __________________________ any levels.

COIMPESA 1 * High operating cost. For eligibility level 2 in 1998:* Most of the payments in a Implement the policy to reduce personnel

arrears (taxes and energy cost by 10% in 1997 and 7% in 1998bills) are already through voluntary retirement plan.renegotiated. * If this policy is implemented as planned,

COMPESA will not become eligible forlevel 2 until year 2000.

CAIGEPA 0 * Low current ratio. For eligibility level 1:. R$50 million worth of . Reflect the resolution of the contingency

contingent liabilities for liability in balance sheet.workers' compensation For eligibility level 2:resolved but still accounted * Reduce operating costs by 5%.for in current liabilities.Cause won by CAGEPA.

AGESPISA 0 * High operating cost Reform with private sector participation.* High personnel cost Or* Low current ratio. For eligibility level 1:

* Reduce personnel cost by 15%* Reduce overall operating cost by 10%. Renegotiate the payments in arrears with

energy company (R$21 million).For eligibility level 2:a Reduction of operating cost by 30%

SANEMAT * High personnel cost. Reform with private sector participation.* Low current ratio, which (PSP process in process).

reflect low collection rates Orand high current liabilities. For eligibility level 1.

* High tariff. * Reduce personnel cost by 30%* Renegotiate payments in arrears with the

energy company of R$75 million.

67

Eligibility Main Problems Recommended Actions/ commentsStatus in

'96EMASA 0 Extremely high operating For eligibility level 1:

costs, despite low personnel * Reduce operating cost by 5%costs. * Regularize fixed assets.Fixed assets not formally * Renegotiate energy bills in arrears (R$21transferred from EMBASA million).after spin-off. For eligibility level 2:

Keep operating cost at 1997 level.

Juazeiro 2 Operating cost is expected to To stay at eligibility 2:rise in 1997. * Reduce operating cost by 5%.High level of unaccounted forwater.

68

Attachment 4Incremental Benefit of Reform/PSP to Different Stakeholders

Scenario 1: Concession bid on license fee (no tariff reduction); Concessionaire assumes the payment ofS4NEMAT's debts in arrears

, g ,, -- 'Incremental Benefltj0 0 A-N1~PVR,40%* RRj

1. Company 162 278%2. Shareholders 80 25%3. Government

3.1 Federal 70 **

3.2 State 51 **3.3 Municipal 66 **

3.4 Subtotal 187 **

4. Customers 98 **

Total 527 _

*1996 US$ million; ** all cashflow positive

Scenario 2: Concession bid on license fee (no tariff reduction); Municipality assumes the payment ofS&NEMAT's debts in arrears... ., .:'"-..... :Incr,eentalBei-

NV .,1,%* IR-?1. Company 191 n/a2. Shareholders 68 25%3. Government

3.1 Federal 70 **

3.2 State 51 **

3.3 Municipal 53 **

3.4 Subtotal 174 **

4. Customers 98 **Total 531 _ _

Scenario 3: Concession bid on tariff reduction (no license fee); Concessionaire assumes the payment ofSANEMAT's debts in arrears

_______ ;gt:fii ::fSrT:t Incre:mental Beefl__--________- L- ii. i iM VEIRR. -IRJ

1. Company 155 196%2. Shareholders 78 25%3. Government

.3.1 Federal 67 **

3.2 State 50 **

=3.3 Municipal 63 **3.4 Subtotal 179 *

4. Customers 108 **

Total 520

69

Scenario 4: Concession bid on tariff (no license fee); Municipality assumes the payment of SANEMAT'sdebts in arrears

Incremental Beneit:. .. _ ...... NPV@.O%* .JPR.1. Company 136 n/a2. Shareholders 55 25%3. Government

3.1 Federal 44 **

3.2 State 38 **

3.3 Municipal 29 **

3.4 Subtotal 112 **

4. Customers 175 **

Total 478

Widhout Reform Scenario_______________Without Rfrm Scenario

____-____:_-.:: . NPV@ %-*: IRR=1. Company -56 n/a2. Shareholders 0 n/a3. Government

3.1 Federal 0 **

3.2 State 43 n/a3.3 Municipal -63 n/a3.4 Subtotal -19 n/a

4. Customers -106 n/aTotal -181

70

Annex 6Water Sector Modernization II

Procurement and Disbursement Arrangements

A. Procurement

Procurement of consultant services will be done according to the provisions of the "Guidelines for the Selectionand Employment of Consultants by World Bank Borrowers" (January 1997) and of goods and works according tothe provisions of the "Guidelines for Procurement under IBRD Loans" (January 1995, revised January and August1996).

All contracts which can be packaged to exceed the equivalent of US$5 million for civil works and US$350,000 forequipment or materials will be procured on the basis of international competitive bidding (ICB) following theabove mentioned guidelines for procurement. All other contracts for civil works and equipment or materials notexceeding the aggregate amounts of about US$32.0 million and US$2.9 million, respectively, will be procuredunder nationally advertised national competitive bidding (NCB) and shopping procedures acceptable to the Bank.Shoppingt will be an accepted method of procurement of goods estimated to cost less than US$100,000 per contract,up to an aggregate amount of US$1.2 million. Three quotations will be an accepted method of procurement ofsmall works estimated to cost less than US$350,000 per contract, up to an aggregate amount of US$1.5 million.Table A and Table B present the procurement arrangements and thresholds, respectively. Shopping and threequotations are presented under Other Procurement Methods in Table A.

Subloans to finance goods, works and consultants services will be available to private operators selected under ICB.The private operators would be responsible for the procurement of works and goods under their own procedures.

Table A. Project Costs by Procurement Arrangements (in US$ million equivalent) 1/

Expenditure Categ ry- . :..- Procurement Method Total Cost~~~~~~~~~........ ..... ........... . ....... .. ...... .... . R .i....... ...7::-RR iiiu--EiiSSS d T. i_________________ -- IC I NCB Otheri (includin -continBgencies

1. Works 78.2 30.5 1.5 110.2(34.2) (13.4) (0.7) (48.3)

2. Goods 141.9 1.7 1.2 144.8(62.2) (0.7) (0.5) (63.4)

3. Services 45.0 45.0(38.3) (38.3)

'Total 220.1 32.2 47.7 300.0(96.4) (14.1) (39.5) (150.0)

1/ Fiigures in parentheses are the amounts to be financed by the Bank.

71

Table B: Thresholds for Procurement Methods and Prior Review (in US$ thousand equivalent)

Expenditure ContractNValue Procurement Contracts Subjet toCategory (Threshold) Method Prior Review

1. Works > 5,000 ICB All350 to 5,000 NCB First two contracts

< 350 Three Quotations None

2. Goods > 350 ICB All100 to 350 NCB First two contracts

< 100 Shopping None

3. Servicesa. Firrns > 200 Quality- and Cost-based All

100 to 200 Least-cost Prior review restricted to TORsand short-list only. "

50 to 100 Consultants' Qualifications Prior review restricted to TOR& short-list only. "

<50 None

b. Individuals > 50 Consultants' Qualifications All25 to 50 Consultants' Qualifications Prior review restricted to TORs

and short-list only. t'<25 None

1/ Exemption from prior review does not apply to consultants contracts below the thresholds in case of single source selection of firms,assigmnents of critical nature, and arnendments to contracts raising original contract value above the thresholds.

B. Disbursement

Of the total US$300 million project, 85% is being financed by the Bank, with respect to the water supply andservices components, and 85% by the OECF, regarding the sewerage component. The water utility companies willfinance the remaining 15% of all the components, as the required counterpart funding.

The Government through the executing agencies will establish a Special Account in the amount of US$ 10 million,in order to expedite project execution. The relatively large size of the Special Account is justified by about US$45million of bidding contracts already submitted to the Bank, all of them 85% financiable. The executing agency, byuse of the Special Account, will make payments directly to consultants and suppliers. Expenditures for individualcontracts of goods and services, for which prior review by the Bank is not required will be disbursed againstStatement of Expenditures (SOEs). Detailed supporting documentation, including certification, for expenditureswill be kept by the PMU and submitted to the Bank. Full documentation for all contracts requiring the Bank'sprior review will be submitted. Detailed documentation will be retained by the companies and PMU for inspectionduring supervision missions and for audit by the external auditors of MAS and SWCs. No force account isenvisaged and the Closing Date will be June 30, 2003. Allocation of loan proceeds is presented in Table C.

C. Advance Contracting and Retroactive Financing

Advance contracting, about US$20.0 million, and retroactive financing, about US$10.0 million, which represents13.3% and 6.7% of the total loan, respectively, will be provided for eligible expenditures incurred after March 14,1997, or a date twelve months before the signing date of the Loan Agreement. The eligible expenditures willconsist of services which support the objectives/components of the project, as stated in Block 1, Sections 1 and 2and Annex 2. Advance contracting and retroactive financing must follow Bank procurement and consultantguidelines. In order to ensure timely implementation of the project and loan disbursement, SEPURB provided to

72

the Bank with bidding documents for subprojects expected to be eligible for retroactive financing and terms ofreference for selected studies and technical assistance.

Table C: Allocation of Loan Proceeds

.'. p -enditre .Ca'tegr A ount inUS$ illion Financing Percentage ofPrect",- c iS!db00 tO tE EiT tSlbT t ty: E:iE }iE d : iE i

Goods and Consultants' 19.5 100% of foreign expenditures and 85%Services under Institutional of local expendituresReform Subprojects

Goods, Works and 54.0 100% of foreign expenditures and 85%Consultants' Services lunder of local expendituresOperational DevelopmentSlabprojects

Goods, Works and 52.5 100% of foreign expenditures and 85%Consultants' Services under of local expendituresInvestment Subprojects

Goods and Consultants' 6.0 100% of foreign expenditures and 85%Services for Project of local expendituresManagement & Supervision

Unallocated 18.0

Total 150.0

1/ Excludes OECF financed conunitments (sewerage component)

73

Annex 7Water Sector Modernization II

Project Processing Budget and Schedule

AL Project Budget (US$000) Planned Actual(At final PCD stage)

Departure Appraisal 179.8 181.4Board Approval 272.7 326.0

B. Project Schedule Planned Actual(At final PCD stage)

Time taken to prepare the project (months) 10 13First Bank mnission (identification) 11/27/1996 11/21/1996Appraisal rnission departure 2/24/1997 4/22/1997Negotiations 4/28/1997 11/17/1997Planned Date of Effectiveness 11/15/1997 08/15/1998

Prepared by: Secretary of Urban Policy/ Ministry of Planning and Budget

Preparation assistance: PHRD Japanese Grant (TF29517)OECF: Cofinancier

Bank staff who worked on the project included: Carlos E. Velez, Yoko Katakura, Caroline Van der Berg,Alex Bakalian, and Adrien Campbell (LCSFP); Juan D. Quintero (LCSES); and Alberto Ninio (LEGLA).

74

Annex 8Water Sector Modernization Project II

Documents in the Project File

A. PROJECT IMPLEMENTATION PLAN

1. Ministerio de Planejamento e Orcamento, Secretaria de Politica Urbana (1997). Politica Nacional deSaneamento. Brasilia, Agosto.

2. PMSS 11 (1998). Manual de Operac,o, Revisao 01/22/98. Brasila.3. PMSS II (1998). Plano Operacional Anual 1998. Brasilia, Janeiro 30.4. PMSS I (1998). Planejamento de Licita,ces e de Sele,ao de Consultorias. Brasilia, Janeiro 30.

B. BANK STAFF ASSESSMENTS

1. The World Bank (1997). Results of the Risk Analysis for the Second Water Sector ModernizationProject, August 25.

2. The World Bank (1997). Avalia,ao Econ6mica e Financeira dos Projetos de Agua em Caruaru,Itabuna, Santa Rita, Joao Pessoa e Fortaleza e de Esgoto em Juazeiro, Cuiaba, Aracati e JoaoPessoa. June. Electronic Files.

C. PROJECT PREPARATION

Environmental Studies

1. PMSS 11 (1997). Environmental Report Assessment - Summary. Brasilia, March.2. PMSS II (1997). Informe Ambiental. Brasilia, Marco.

Anexo A. 1 - Resumos Ambientais dos Subprojetos Propostos.Anexo A.2 - Resumos dos Seminarios Realizados.Anexo A.3 - Licen,as Ambientais dos Subprojetos.Anexo B. 1 - Programa Ambiental e Social do Subprojeto de Esgotamento Sanitario de Joao Pessoa.Anexo B.2 - Programa de Fortalecimento da Gestao Ambiental em Saneamento.Anexo B.3 - Proposta Metodol6gica de Procedimentos e Criterios de Classifica,ao Ambiental deProjetos de Sanearnento.Anexo B.4 - Termo de Referencia de Manual de Especifica,6es Ambientais para Projeto, Construc,o eOperac,o de Projetos ide Saneamento.

3. PMISS 11 (1997). AvaliasAo Ambiental. June.4. PMSS II (1997). Plano Preliminar de Remanejamento e Reassentamento de Familias - Termo de

Referencia. June.5. PMSS 11 (1997). Planos de Reassentamento de Familias da Barragem do Prata no Municipio de

Caruaru (PE) e do P]rojecto de Esgotamento Sanitario do Municipio de Joao Pessoa (PA) -Relatorio de Avalia,cIo. June.

6. CC)MPESA (1997). Relat6rios de Pesquisa Socio-Econ6mica Realizada na Area que SeraAtingida pela Barregem do Prata.Annex 1. Relat6rio da Pesquisa S6cio-Economica Realizada na Area que Seri Atingida PelaBarregem do Prata, Janeiro.Annex 2. Documetagao.Annex 3. Levantamento Cadastral des Propriedades Elaborado Pelo Funtepe, Municipio de SaoJoaquim do Monte.

75

Annex 4. Termo de Referencia para Elaboragao dos Projetos de Esgotamento Sanitario de Bonito eAlto Bonito.Annex 5. Parecer Arqueol6gico Emitido pelo Laborat6rio e Museu de Arqueologia de UniversidadeCat6lica de Pernambuco - UNICAP, Marco.

7. COMPESA (1997). Plano Preliminar de Reassentamento de Familias - Barragem do Prata.Revisao, Marco.

8. COMPESA (1997). Relat6rios de Andamento dos Trabalhos de Monitoramento Ambiental naBarragem do Rio Prata, Recife. Abril.

9. PMSS 11 (1997). Proposta de Diretrizes e Procedimentos para Reassentamento de Familias.Junho.

Engineering Studies

1. PMSS II (1997). Estudo de Viabilidade dos Subprojetos de Agua, Esgotos Sanitirios eDesenvolvimento Institucional - Relat6rio Sintese dos Estudos Tecnicos de Engenharia.

2. PMSS 11 (1996). Estudo de Viabilidade dos Subprojetos de Agua e DesenvolvimentoInstitucional. AgostoVolume 1. Relat6rio GeralVolume 2. AGESPISA, Aguas e Esgotos do PiauiVolume 3. CAGECE, Companhia de Agua e Esgoto do CearaVolume 4. CAGEPA, Companhia de Agua e Esgotos do ParaibaVolume 5. COMPESA, Companhia Pernambucana de SaneamentoVolume 6. SANEMAT, Companhia de Saneamento do Estado de Mato GrossoVolume 7. EMASA, Empresa Municipal de Aguas e Saneamento de Itabuna (BA)Volume 8. Servico Autonomo de Agua e Esgoto de Juazeiro (BA)

3. PMSS II (1996). Estudo de Viabilidade dos Subprojetos de Esgoto. JulhoVolume 1. Relat6rio GeralVolume 2. AGESPISA, Aguas e Esgotos do PiauiVolume 3. CAGECE, Companhia de Agua e Esgoto do CearaVolume 4. CAGEPA, Companhia de Agua e Esgotos do ParaibaVolume 5. COMPESA, Companhia Pemambucana de SaneamentoVolume 6. SANEMAT, Companhia de Saneamento do Estado de Mato GrossoVolume 7. EMASA, Empresa Municipal de Aguas e Saneamento de Itabuna (BA)Volume 8. Servi9o Autonomo de Agua e Esgoto de Juazeiro (BA)

4. PMSS 11 (1996). Termo de Referencia para Estudos de Viabilidade. Maio.5. PMSS 11 (1997). Projeto de Modernizasio e Desenvolvimento Institucional. Abril

Volume 1. AGESPISAVolume 2. CAGECEVolume 3. CAGEPAVolume 4. COMPESAVolume 5. SANEMATVolume 6. EMASAVolume 7. Servigo Aut6nomo de Agua e Esgoto de Juazeiro (BA)

6. AGESPISA (1996). AvaliacAo da Populaqao das Cidades do Piaui para Estudos Relativos aAbastecimento de Agua. Novembro.

7. AGESPISA (1996) MicromedisAo na AGESPISA - Bases para um Projeto de Resgate a suaEficacia. Julho.

8. CAGECE (1997). Pesquisas Realizadas em Maranguape, Maracanau, Aracati, Cascavel, Quixadae Crateus - Estado de Ceari. Subprojetos de Esgotamento Sanitirio. Marco.

76

9. Silva, Salomao Anselmo (1997). Estudo de Aproveitamento Integrado das Lagoas Projetadas deCambba de Tambia Grande com as Pedreiras Adjacentes para Tratamento das AguasResiduarias Domesticas de Joao Pessoa e Sistema de Lagoas de Estabiliza9Ao para Tratamentode Aguas Residuarias Domesticas de Campina Grande. CAGEPA. Campina Grande, Janeiro.

10. Silha, Salomao Anselmo (1997). Estudo de Alternativa de Conversao das Lagoas Aeradas daCaltingueira Para Utiliza,Ao como Lagoas de Estabiliza,ao no Tratamento das Aguas ResiduariasDoinesticas de Campina Grande. CAGEPA. Campina Grande, Margo.

11. CAGEPA. (1997). Estudo de Concep,ao da ETE de Joao Pessoa. Abril.12. CAGECE, CAGEPA, COMPESA, SANEMAT, EMASA e SAAE de JUAZEIRO (1997). Estudo de

Consumos "Per Capita". Fevreiro e Mar0o.13. SA.NEMAT (1997). Pesquisa nas Cidades de Sinop e Juina (Mato Grosso). Margo.14. EMASA (1996). Estado Preliminar de Availa,Ao do Regime Hidrico da Qualidade da Agua e das

Fontes de Contaminagao da Bacia do Rio Cachoeira. Outubro.15. EMASA (1996). Estudo de Ampliasao do Sistema de Produ,cao - Piano Diretor para

Abastecimento de Agua da Cidade de Itabuna (Bahia). Novembro.16. CAGEPA, EMASA, SAAE Juazeiro (1997). Revis6es e Complementa,ces de Engenharia. Abril.

Economic and Financiial Analysis

1. PMSS 11 (1996). Factores de Conversao dos Pre,os Financeiros a Preqos de Eficiencia.Novembro.

2. PMSS 11 (1997). Analise Econ8mica e Financeira de Projetos de Sistemas de Abastecimiento deAguia. Analise em Separado de S6 Desenvolvimento Operacional e S6 Investimento. Maio

3. PMSS 11 (1997). Projeto Desenvolvimento Operacional. Maio4. PMSS 11 (1997). Projetos da Amostra. Resultados da Avaliasao Financeira, Econ8mica e

Econ6micalDAP. Maio5. PMSS II(1997). Projetos da Amostra. Analises de Sensibilidade da Avaliaao Financeira,

Economica e Economica/DAP. Maio6. PMSS 11 (1997). Informe de Avaliaao Financeira das Companhias: Dados Hist6ricos

Operacionais e Financeiros e Outras Informa8es. MaioAnexo I. AGESPISA (PI)Anexo II. CAGECE (CE)Anexo III. CAGEPA (PA)Anexo 1V. COMPESA (PEAnexo V. EMASA (BA)Anexo VI. SAAE DE JUAZEIRO (BA)Anexo VII. SANEMAT (MT)

7. PMSS 11 (1997). Informe das Avaliaoes Econ6micas e Financeiras dos Projetos - RelatonoGeral. JunhoVolume 1. TextoVolume 2. Avaliag6es dos Projetos de AguaVolume 3. Avalia96es dos Projetos de EsgotoVolume 4. Avaliag6es ComplementaresVolume 5. Metodologia de Avaliagao Contingente

8. PMSS II (1997). Avalia,cao Econ6mica - Cruzamento dos Bancos de Dados. Esgoto SanitArio(Redle e Tratamento) e Agua Potaivel. Abril.

77

Annex 9Water Sector Modernization II

Status of Bank Group Operations in BrazilA. Bank Loans and IDA Credits in the Operations Portfolio

Lo:. .ban ... .Fisca - - ..Borrower - -- -Purpose Original Amount in i US$ MllionsIBIII). Year IBRD: C--celadons Undibured

.......... .... ,, .- . ........ ............ N a: ~ ...... .:--..-:..

Number of Closed Loans: 193

28100 1987 Fed. Rep. of Brazil Skills Formation 74.50 58.90 0.3529500 1988 Fed. Rep. of Brazil Irrigation 195.00 26.00 0.4630430 1989 Comgas, Sao Paulo Natural Gas Distr. 94.00 0.00 9.1930130 1989 Fed. Rep. of Brazil NE Irrigation Jaiba 71.00 0.00 6.8131700 1990 Fed. Rep. of Brazil NE Irrigation 210.00 69.00 50.7931730 1990 Fed. Rep. of Brazil Nat. Environment 117.00 0.00 29.6128831 1990 Eletrobras Itaparica 100.00 0.00 1.8331350 1990 Fed. Rep. of Brazil NE Basic Health Srv II 267.00 50.00 15.7733760 1991 Petrobras Hydrocarbon Trans/Pro 260.00 0.00 17.4233750 1991 State of Sao Paulo Innov Basic Ed. 245.00 0.00 62.1334920 1992 Fed. Rep. of Brazil Mato Grosso Nat. Res. 205.00 0.00 96.0334570 1992 Fed. Rep. of Brazil Metro Transp. S. Paulo 126.00 0.00 7.5534420 1992 Fed. Rep. of Brazil Water Sector Modern. 250.00 0.00 81.4236330 1993 Fed. Rep. of Brazil Metro Transp. Rio 128.50 0.00 47.8335050 1993 S.Paulo & Parana States Wtr Quality & Poll Ctr 117.00 0.00 56.9835040 1993 S.Paulo & Parana States Wtr Quality & Poll Ctr 119.00 0.00 43.7135030 1993 S.Paulo & Parana States Wtr Quality & Poll Ctr 9.00 0.00 6.3835540 1993 Minas Gerais State Wtr Quality & Poll Ctr 145.00 5.00 46.0336040 1993 Min. of Education NE Basic Educ II 212.00 0.00 66.3535480 1993 State Govemments State Hwy Mgmt 38.00 18.00 9.9535470 1993 State Governments State Hwy Mgmt 50.00 0.00 7.6137660 1994 Fed. Rep. of Brazil Par B Edu 96.00 0.00 51.7637150 1994 State Governments State Hwy Mgt II 79.00 18.00 21.6337140 1994 State Governments State Hwy Mgt II 87.00 0.00 4.4337130 1994 State Governments State Hwy Mgt II 54.00 18.00 22.4236590 1994 Fed. Rep. of Brazil Aids Control 160.00 0.00 24.5437330 1994 Fed. Rep. of Brazil M Gerias Basic Educ 150.00 0.00 84.9036390 1994 State of Minas Gerais Municipal Development 150.00 5.00 46.4937670 1994 State of Espirito Santo Wtr & Pollution Mgm. 154.00 0.00 98.4036630 1994 Min of Education NE Basic Educ III 206.60 0.00 99.5239160 1995 Fed. Rep. of Brazil B. Horizonte Metro Trs 99.00 0.00 83.4737890 1995 State of Ceara Ceara Urb. Dev. & Wtr. 140.00 0.00 117.2639190 1995 Fed. Rep. of Brazil Rural Poverty - Sergipe 36.00 0.00 24.9339180 1995 Fed. Rep. of Brazil Rural Poverty - Ceara 70.00 0.00 58.4439150 1995 Fed. Rep. of Brazil Recife Metro Transport 102.00 0.00 98.7239170 1995 Fed. Rep. of Brazil Rural Poverty - Bahia 105.00 0.00 71.5140470 1996 Fed. Rep. of Brazil Health Sector Reform 300.00 0.00 264.7539240 1996 CVRD Environm & Conserv 50.00 0.00 35.9440460 1996 Fed. Rep. of Brazil Railways Restructuring 350.00 0.00 167.6940600 1996 State of Parana (PR) R. Poverty 175.00 0.00 175.0041400 1997 State of Bahia Bahia Mun. Dv 100.00 0.00 94.98

78

~~~~~~~~~~~~~~~~~~~~~~~~~........ ......... - - - ........................... ............. ........... .... .

Loan Fiscal orrower Purpse i~Original t.Amout it~in..USS.Million_B J Year DR) C .a i:''''':' :'weUtlt Unisu........ -. sc.- . -- r o e- . .......... OFF- Or. :::rrotX ugnnu---u ............... ....... ......aiiln................ ............. ........ ... ... .... .... ............... . ... ....irtlL f f j FiFFFF FFi FFiEEF BXn 'Y>rE E E E .~........... .. i. iE El ...- ....... i

......... .. ..i E.iE.E. .. ........................ ...... i R.iEEEEii.i. E.d.No...~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~.........

41880 1997 Fed. Rep. of Brazil Fed Hwy Decentr 300.00 0.00 300.0041470 1997 Fed. Rep. of Brazil Land Rfm Pilot 90.00 0.00 90.0041890 1997 State of Mato Grosso ReformlPrivatization 45.00 0.00 45.0041900 1997 State of Ceara Water Resources Pilot 9.60 0.00 9.6041690 1997 Fed. Rep. of Brazil Ag Tech Dev. 60.00 0.00 60.0041210 1997 State of Piaui Rural Poverty 30.00 0.00 30.0041480 1997 State Rio Grande do Sul Land Mgt/Poverty 100.00 0.00 100.0041220 1997 State of Pernambuco Rural Poverty 39.00 0.00 39.0041390 1997 State Rio Grande do Sul Reform/Privatization 125.00 0.00 75.0041200 1997 StateR GrandedoNorte RuralPoverty 24.00 0.00 24.0041650 1997 State Rio Grande do Sul Highway Management 70.00 0.00 70.0042110 1998 State of Rio de Janeiro ReformilPrivatization 250.00 0.00 250.0042320 1998 State of Bahia Water Resources 51.00 0.00 51.00Total 6,890.20 267,90 3,454.58

Active Loans Closed Loans.... Total.. ....... .... ... .. .. .... ... .......................~, .. ... . .. .

. . . . r. . . ... .. ...... ....... ........ f. ....

Total Disbursed 3,167.69 14, 987.93 18, 155.62of which has been repaid 338.94 11,870.41 12,209.37Total now held by IBRD 6,283.36 3,192.86 9,476.22Amount sold 0.00 45.83 45.83of whicl repaid 0.00 45.83 45.83Total Undisbursed 3,454.58 75.38 3,529.96

79

Annex 9Water Sector Modernization II

Status of Bank Group Operations in BrazilB. Statement of IFC's Committed and Disbursed Portfolio as of 31-Dec-97

US$ Millions

..... ~ ~~~~~~ ~~~~~ P u y C O ............ ... .............................. - . -.FY Approval Company Co......mitte......Di.....burComm..ed Du ed , ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~......... ....... .. .. ......... ................. .............................................

Lo; an Eq ity 04ai i Quasi Pa.t... Loan....i...Quasi .ai1973/78/83 CODEMIN 0.00 4.34 0.00 0.00 0.00 4.34 0.00 0.001975/96 Oxiteno NE 30.00 0.00 0.00 0.00 30.00 0.00 0.00 0.001980/87 Ipiranga 0.00 6.32 0.00 0.00 0.00 6.32 0.00 0.001980/92 DENPASA .29 1.00 .12 0.00 .29 .96 .05 0.001981 Brasilpar 0.00 .04 0.00 0.00 0.00 .04 0.00 0.001982/84/86 PISA 0.00 3.90 0.00 0.00 0.00 3.90 0.00 0.001982/86 Cimento Caue 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.001983 SOCOCO 0.00 0.00 2.50 0.00 0.00 0.00 2.50 0.001984 ALQUIM 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.001987/92/96 MBR 12.67 0.00 10.00 14.83 12.67 0.00 10.00 14.831987/96 Perdigao 35.00 10.00 0.00 20.00 35.00 10.00 0.00 20.001987/96/97 Duratex 22.00 0.00 0.00 78.00 22.00 0.00 0.00 78.001987/97 SP Alpargatas 25.00 0.00 5.00 0.00 20.70 0.00 5.00 0.001989 COPENE 4.55 0.00 0.00 0.00 4.55 0.00 0.00 0.001989 ELUMA 0.00 0.00 3.00 0.00 0.00 0.00 3.00 0.001989 Politeno Linear 3.10 0.00 0.00 0.00 3.10 0.00 0.00 0.001990 ENGEPOL 1.53 0.00 0.00 0.00 1.53 0.00 0.00 0.001990 Ripasa 7.14 5.00 0.00 0;00 7.14 5.00 0.00 0.001990/91/92 Bahia Sul 18.57 20.97 0.00 10.00 18.57 20.97 0.00 10.001991 Bradesco-AL 26.03 0.00 0.00 0.00 0.00 0.00 0.00 0.001991 Bradesco-Bahia 6.00 0.00 0.00 0.00 6.00 0.00 0.00 0.001991 Bradesco-Eucatex 7.50 0.00 0.00 0.00 7.50 0.00 0.00 0.001991 Bradesco-Petrofl 7.50 0.00 0.00 0.00 7.50 0.00 0.00 0.001991 Bradesco-Romi 2.38 .40 0.00 0.00 2.38 .40 0.00 0.001991 Rhodia-Ster 10.00 5.95 0.00 0.00 10.00 5.95 0.00 0.001992 CRP-Caderi 0.00 2.00 0.00 0.00 0.00 .75 0.00 0.001992/93 TRIKEM 0.00 12.86 0.00 0.00 0.00 12.86 0.00 0.001993 BACELL 13.00 10.70 0.00 28.80 13.00 10.70 0.00 28.801993 Coteminas 0.00 4.00 0.00 0.00 0.00 4.00 0.00 0.001993 CEBRACTEX 2.40 0.00 0.00 0.00 2.40 0.00 0.00 0.001993 Macedo Alinientos 17.67 0.00 0.00 0.00 17.67 0.00 0.00 0.001993 Votorantim 15.57 0.00 0.00 1.29 15.57 0.00 0.00 1.291993/96 CEVAL 56.21 20.00 0.00 131.29 56.21 20.00 0.00 131.291994 GAVEA 10.31 0.00 5.50 0.00 10.31 0.00 5.50 0.001994 GP Capital 0.00 18.50 0.00 0.00 0.00 18.46 0.00 0.001994 Para Pigmentos 30.00 9.00 0.00 35.00 25.50 8.14 0.00 29.751994 Portobello 15.79 5.00 0.00 0.00 15.79 5.00 0.00 0.001994/95/97 Sadia 52.00 10.00 10.00 206.66 52.00 10.00 10.00 206.661994/96 CHAPECO 25.00 0.00 0.00 5.00 25.00 0.00 0.00 5.001994/96 S.A.I.C.C. 0.00 7.85 6.87 0.00 0.00 7.70 6.87 0.001995 Bradesco-Hering 7.50 0.00 0.00 0.00 7.50 0.00 0.00 0.001995 Brahmaa-BRA 32.50 0.00 0.00 86.10 32.50 0.00 0.00 86.10

80

~~~~~~~~~~~~~~~~~~...... t .P. ...... ... ........ - -............. ..................... .... .. .- .. ...................................................

FY Approval Con ai iffmm td Dis ursed.... ... .............. .. . . ................ .............

~~~~~~~~~~~~~~~~~~~~~~~....... .... ....... ..... . EEEE......... .. ....... .................... .......... .... iFFiFFFii... .. ~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~.......... ..... , .....,,EE .:::

........ .. Loan- qu.y Quai artic ........... Equi.t Quasi Pat1995 Politeno Ind. 17.54 0.00 0.00 0.00 17.54 0.00 0.00 0.001995 Rhodiaco/PTA 27.50 0.00 0.00 27.00 27.50 0.00 0.00 27.001995/96 Globocabo 35.00 18.06 0.00 118.00 35.00 18.06 0.00 118.001996 Banco Bradesco 40.00 0.00 0.00 60.00 0.00 0.00 0.00 0.001996 Banco Liberal 10.00 0.00 0.00 0.00 0.00 0.00 0.00 0.001996 Mallory 8.00 3.96 0.00 0.00 8.00 3.96 0.00 0.001996 TIGRE 25.00 0.00 5.00 23.50 25.00 0.00 5.00 23.501996/97 Lightel 25.00 18.17 0.00 0.00 25.00 18.17 0.00 0.001997 Copesul 40.00 0.00 0.00 180.00 0.00 0.00 0.00 0.001997 Rodovia 35.00 0.00 0.00 79.50 15.28 0.00 0.00 34.721997 Samarco 18.00 0.00 0.00 16.00 10.59 0.00 0.00 9.411997 Sucornco 15.00 0.00 0.00 0.00 15.00 0.00 0.00 0.001997 Wentex 15.00 10.00 0.00 20.00 15.00 10.00 0.00 20.001998 BSC 14.00 0.00 0.00 7.50 14.00 0.00 0.00 7.501998 Empesca 25.00 0.00 10.00 0.00 5.00 0.00 10.00 0.00Total Portfolio: 914.75 208.02 62.99 1,169.97 742.79 205.68 62.92 873.35

~~~~~~~~~~~~~~~~~...... ... .. .......

..... . ... t . t t t t t . ~~~~~~~~~~~. ........... ........ ........ ................... ................. ........... ......... . ..... ........... ..... ....... .......... ................ ppro... :- . e C i-- ::-:-i..tnt..

~~~~~~~~~~~~~~~~~~~~~~~~~~~.. ....................... ,............. . . 1 I . : :~ .... .......... .. ............Loan- EquEityv Qus ggParticg f 1996 AGUAS LIMEIRA 17.00 1.00 0.00 23.001998 BANCO ICATU 30.00 0.00 0.00 0.001997 BOMPRECO 25.00 0.00 5.00 0.001997 COPESUL BLINC. 0.00 0.00 0.00 45.001997 CTBC 35.00 0.00 0.00 150.001996 GLOBOCABO II 0.00 0.00 0.00 38.001997 GUILMAN- 30.00 0.00 0.00 90.00

AMORIM1998 ICATU EQUITY 0.00 30.00 0.00 0.001997 IPIRANGA 35.00 0.00 5.00 150.00

EXPANS.1997 IPIRANGA RI 0.00 .32 0.00 0.001997 NOVA DUTRA 0.00 0.00 0.00 10.00

BLINC1996 OXITENO/ETHYLO 0.00 5.00 0.00 0.001998 SARAIVA 15.00 3.00 0.00 0.001997 SP ALPARGATAS II 0.00 0.00 0.00 30.001998 TRIKEM II 25.00 0.00 0.00 0.001997 UNIBANCO 50.00 0.00 0.00 0.00

LIVESTO1998 VARGA 20.00 0.00 3.00 15.00

Total Pending Commitment 282.00 39.32 13.00 551.00

81

Annex 10Water Sector Modernization HI

Brazil at a Glance 8128/97

Latin Upper-POVERTY and SOCIAL America middle-

Brazil & Carib. Income Dvelopm ntdiamond

Population mid-I 996 (millions) 161.2 485 479GNP per capita 1996 (US$) 4,360 3,710 4,540 Life expectancyGNP 1996 (billions US$) 702.9 1,799 2,173

Avege annual growth, 1990-91

Population (%) 1.4 1.7 15 GNP GrossLabor force (1) 1.6 2.3 1.8 pe I < primary

Most recent timate (latest yew available since 1989) capita enrollment

Poverty headcount index ( of population) 17Urban population (lX dtaipopuabbon) 78 74 73Life expectancy at birth (years) 67 69 69Infant mortality (per 1,000 ive births) 44 37 35 Access to safe waterChild malnutrition ( of children under 5) 18Access to safe water (X olpopubtion) 92 s0 86Illiteracy (6 ofpopulaion age 15+) 17 13 13Gross primary enrollmert (%'A ofschoagepopulaion) 114 110 107

Mate Upper-middle-incomne goupFemale

KEY ECONOMIC RATIOS and LONG-TERM TRENDS

1975 1985 1995 1996

GDP (billions USS) 121.8 222.9 716.9 748.7 Economk rZhsGross domestic investment/GDP 26.8 19.2 20.1 19. 5Openness of eoonomyExports of goods and serviceslGDP 7.5 12.2 6.7 6.6Gross domestic savings/GDP 22.9 24.4 19.2 18.2Gross national savings/GDP 21.1 19.3 17.6 16.3

Current account balance/GDP -5.8 -0.2 -2.5 -3.2Interest payments/GDP 1 7 3.3 1.2 1.7 Savings investmentTotal debt/GDP 22.4 46.5 22.2 23.8Total debt service/exports 43.5 39.1 43.1 46.7Present value of debttGDP 22.1Present value of debt/exports 270 7 Indebtedness

1975485 198646 1999 1996 1997-05(average annual growlh) -BrazilGDP 3.1 1.2 4.1 2.9 4.8 Upper-middh-income groupGNP per capita 0.2 -0.4 2.8 1.6 4.0Expots of goods and services 10.5 6.5 -14 6.1 7.0

STRUCTURE of the ECONOMY

(6 of GDP) 1976 19S6 1996 199S Growth rates of output and Invetment (%)Agriculture 121 115 144 144 10Industry 40.2 45.3 36.5 36.4 s.-

Manufacturing 30.3 33.7 23.8 ,Services 47.7 431 491 492 44 93 S4 S 9

Private consumption 66.5 65.8 64.9 65.7 -1-General govemment consumption 10.6 9.9 15.9 16.1 Ga GDPImports of goods and services 11.5 7.1 7.6 7.9

1975-85 1986696 1995 1996(average annual growth) Growth rates of exporte and import (%Agriculture 4.3 2.6 4 9 3.1 40Industry 3.0 -1.1 2.1 2.3

Manufacturing 2.6 -1.5 21 . 2 . 2 \Services 29 2.8 5.3 3.3

Private consumption 3.0 1.8 11.0 4.1 0 _ .

General govemment consumption 1.2 0.7 2.4 0.8 91 93 94 95 9eGross domestic investment -2.9 -0.6 9.4 0.0 xeImports of goods and services -4.0 8.9 36.8 5.9Grossnationalproduct 2.5 1.1 4.2 29 -Epcfs h s

Note: 1996 data are preliminary estimates. Figures in italics are for years other than those specified.The diamonds show four key indicators in the country (in bold) compared with its income-group average, If data are missing, the diamond willbe incomplete.

82

Annex 10Water Sector Modernization II

Brazil at a Glance Brazil

PRICES and GOVERNMENT FINANCE1976 1985 1995 1996

Domesstf pres Inflation (%)(t% change) 3,0o0Consumer prices 25.0 226.9 67.0115.5Implicit GDP deflator 33.9 231.7 74.9 11.1 ZOCO

(9 odGDP) o - -Current revenue .. .. 31.5 32.4 91 92 93 94 9s 96Primary surplus/deficit .. .. 0.4 -0.1Operational surplus/deficit .. 4.8 -3.9 GOP def. -- CPI

TIRADE1975 1985 1995 1996

f(niWions US$) Export and Import levels (mill. USS)Total exports (fob) . 25,638 46,508 47,746 t

Coffe .. 2,607 1,970 2,059Other food .. 2,545 3,896 4,665Manufactures .. 13,356 25,568 26,247 40,000

Total imports (cif) .. 13,153 49,663 53,286Food . .. 3,535 6,044 28,009Fuel and energy 6,176 4,649 5,752Capital goods .. 2,480 19,688 19,804 °

Export price index (1987=100) .. 97 128 126 90 91 92 93 94 96 esIniportpriceindex(1987=100) .. 79 124 125 JEOrts m sk1o1sTerms of trade (1987=100) .. 123 103 101

ILANCE of PAYMENTS1975 1986 1995 1996

(millions USS) Current account balance to GDP ratio (%)Exportsofgoodsandservices 9,418 27,713 47,960 49,558 IImnports of goods and services 14,323 16,928 54,306 59,355Resource balance -4,905 10,785 -6,348 -9,797 o

Net income -2,106 -11,213 -15,419 -17,402 LJ 2 s 8 NMtcurrenttransfers -10 16 3,973 2,899 t ICurrent account balance, .2

I2efore official capital transfers -7,021 -412 -17,792 -24,300

Financing items (net) 5,956 1,826 30,779 32,935Clianges in net reserves 1,065 -1,414 -12,987 -8,635 -4

MeN.:Reserves including gold (mill. US$) 4,166 11,613 51,469 59,663Conversion rate (locab'US$) 3.OE-12 2.3E-09 0.9 1.0

EXTERNAL DEBT and RESOURCE FLOWS1975 1985 1995 1996

(millions US$) Composition of total debt, 195 (mill. USS)Total debt outstanding and disbursed 27,329 103,601 159,130 178,131 A c

IBRD 1,045 5,274 6,038 5,876 G 6038 142 DIDA 0 0 0 0 30494 3327

Tctal debt service 4,320 11,470 22,328 .. EIBRD 98 796 1,868 1,638 / 51IDA 0 0 0 0

Composition of net resource flowsOfficial grants 9 34 64Official creditors 1,059 935 -1,378Private creditors 4,213 149 9,827Foreign direct investment 1,302 1,348 4,859Portfolio equity 0 0 4,411 .. F

World Bank program 99678Commitments 538 1,525 404 858 A- IBRD E - Blbtle |Disbursements 249 765 838 1,500 - IDA D - Othw nvAtlatal F - PrivatePrincipal repayments 26 406 1,377 1222 C - IMF G - ShortetrmNet flows 224 359 -539 278 1 _

Interest payments 72 391 491 416Ne transfers 152 -32 -1,031 -138

Development Economics 8f28/97