Document of The World Bank

FOR OFFICIAL USE ONLY

Report No: 27180-IN

PROJECT APPRAISAL DOCUMENT

O N A

PROPOSED LOAN

IN THE AMOUNT OF US$39.5 MILL ION

TO THE

REPUBLIC OF INDIA

FOR THE

KARNATAKA URBAN WATER SECTOR IMPROVEMENT PROJECT

March 12, 2004

Energy & Infrastructure Sector Unit South Asia Regional Office

T h i s document has a restricted distribution and may be used by recipients only in the performance o f their official duties. I t s contents mav not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

(Exchange Rate Effective March 09, 2004)

Currency Unit = Indian Rupees (Rs.) INR1 = US$0.022 US$1 = INR45.24

F ISCAL YEAR April 1 -- March 31

ABBREVIATIONS AND ACRONYMS

A C A Additional Central Assistance ADB Asian Development Bank APL Adjustable Program Lending CAS Country Assistance Strategy CEEPHO DEA Department o f Economic Affairs DffD Department for International Development DMA Department o f Municipal Administration ECOP Environmental Codes o f Practice EMP Environmental Management Plan FMR Financial Management Reports G O Government Order GO1 Govemment o f India G o K Government o f Kamataka IRR Internal Rate o f Return KPTCL Kamataka Power Transmission Corporation L imi ted

Central Public Health and Environmental Engineering Organization

KUIDFC KSUWSC K U W S D B LEA M&E NGO NPV NRW oc O&M P M U PPP PSP SEMF SHP swc TA UDD

Kamataka Urban Infrastructure Development & Finance Corporation Kamataka State Urban Water Supply Council Kamataka Urban Water Supply and Drainage Board L imi ted Environmental Assessment Monitor ing & Evaluation N o n Governmental Organization Net Present Value N o n Revenue Water Operator Consultant Operation and Maintenance Project Management Unit Public Private Partnership Private Sector Participation Social and Environmental Management Framework Sanitation and Hygiene Promotion State Water Council Technical Assistance Urban Development Department

FOR OFFICIAL USE ONLY

UGD ULB U S AID U W S WASIS WSS W&S WSP-SA

Underground Drainage Urban Local Bodies Uni ted States Agency for International Development Urban Water Sector Water and Sanitation Information System Water Supply and Sanitation Water and Sanitation Water and Sanitation Program - South Asia

Vice President: Praful C. Pate1 Country ManagedDirector: Michael F. Carter

Sector ManagerDirector: Sonia Hammam Task Team Leader/Task Manager: Oscar E. Alvarado/Christophe Bosch

This document has a restricted distribution and may be used by recipients only in the performance of their official duties. I t s contents may not be otherwise disclosed without W o r l d Bank authorization.

INDIA KARNATAKA URBAN WATER SECTOR IMPROVEMENT PROJECT

CONTENTS

A. Project Development Objective

1. Project development objective 2. K e y performance indicators

B. Strategic Context

1. Sector-related Country Assistance Strategy (CAS) goal supported by the project 2. M a i n sector issues and Government strategy 3. Sector issues to be addressed by the project and strategic choices

C. Project Description Summary

1. Project components 2. K e y pol icy and institutional reforms supported by the project 3. Benefits and target population 4. Institutional and implementation arrangements

D. Project Rationale

1. Project alternatives considered and reasons for rejection 2. Ma jo r related projects financed by the Bank and/or other development agencies 3. Lessons learned and reflected in the project design 4. Indications o f borrower commitment and ownership 5. Value added o f Bank support in this project

E. Summary Project Analysis

1. Economic 2. Financial 3. Technical 4. Institutional 5. Environmental 6. Social 7. Safeguard Policies

F. Sustainability and Risks

Page

3 3

4 4 6

6 9 9

10

10 11 12 13 13

13 15 17 18 20 22 25

1. Sustainability 2. Critical r isks

26 26

3. Possible controversial aspects 27

G. Main Conditions

1. Effectiveness Condition 2. Other

H. Readiness for Implementation

I. Compliance with Bank Policies

Annexes

Annex 1: Project Design Summary Annex 2: Detailed Project Description Annex 3: Estimated Project Costs Annex 4: Cost Benefit Analysis Summary Annex 5: Financial Summary for Revenue-Earning Project Entities, or Financial Summary Annex 6: (A) Procurement Arrangements

(B) Financial Management and Disbursement Arrangements Annex 7: Project Processing Schedule Annex 8: Documents in the Project F i le Annex 9: Statement o f Loans and Credits Annex 10: Country at a Glance Annex 1 1 : Photographs o f existing Water and Drainage Services in Participating Cities Annex 12: Summary o f Environmental Assessments Annex 13: Urban Water and Sanitation Sector Policy in Karnataka

27 28

28

29

30 34 45 46 52 65 74 83 84 85 89 91 92

103

MWS) IBRD 32942: Karnataka - Location o f Three Participating Urban Local Bodies.

INDIA Kamataka Urban Water Sector Improvement Project

Project Appraisal Document South Asia Regional Office

SASE1

[BRD rotal:

late: March 12,2004 Sector ManagerDirector: Sonia Hammam Zountry ManagedDirector: Michael F. Carter 'roject ID: PO82510 Lending Instrument: Specific Investment Loan (SIL)

Team Leader: Oscar E. Alvarado Sector(s): Water supply (95%), Sub-national government administration (5%) Theme(s): Other urban development (P), Access to urban ~ r v i c e S for the Poor (PI, Pollution management and environmental health (S), Decentralization (S), Administrative and civ i l service reform (S)

[XI Loan [ ] Credit [ ]Grant [ ]Guarantee [ ]Other:

For LoanslCreditslOthers: Loan Currency: United States Dollar Amount (US$m): $39.5 Borrower Rationale for Choice of Loan Terms Available on File: Yes Proposed Terms (IBRD): Variable-Spread Loan (VSL) Grace period (years): 5 Commitment fee: 0.75%

Years to maturity: 20 Front end fee (FEF) on Bank loan: 1.00% Pavment for FEF: Catitalize from Loan Proceeds

35.41 4.09 39.50 47.44 4.09 5 1.53

1 Exdected effectiveness date: 0513 112004 Expected closina date: 1213 112008 I

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A. Project Development Objective

1. Project development objective: (see Annex 1)

T h e Vision: The long-term vision for the urban water sector (UWS) in the State o f Kamataka i s to tum i ts performance into high quality and sustainable services in al l i t s urban local bodies (ULBs). The strategy to achieve th is vision i s to carryout a phased program, including incremental steps towards full service coverage and high-quality service provision in an efficient and fmancially sustainable fashion.

In the medium-term, the strategy envisages achieving water supply and sanitation (WSS) service provision models that would be provided by autonomous, customer responsive, and commercially-oriented utilities, including effective public-private partnerships (PPP). In the short term, a state level sector policy reform would be implemented and at the local level, demonstration cities would be selected to participate in testing such initial reforms.

Project Development Objective: The main objectives o f the proposed project are to: (a) launch Government o f Karnataka (GoK)'s UWS reform process based on the "Urban Drinking Water and Sanitation Policy Statement of GoK" (approved by the cabinet o f GoK in M a y 2003); and (b) improve U W S services in the participating ULBs (Hubli-Dhanvad, Belgaum, and Gulbarga) and demonstrate that sustainable, efficient, and commercially-oriented service provision can be achieved. The detailed objectives o f each project component are described in section C.

2. Key performance indicators: (see Annex 1)

Component A. The progress in GoK's sector reform process will be measured through the following: At the State Level: 0 Establishment and operationalization o f the Kamataka State Urban Water Supply Council

(KSUWSC). 0 Implementation o f capacity strengthening activities to support the ULB level reform. 0 Development o f the State Water and Sanitation Information System (WASIS). 0 Establishment o f urban WSS sector investments and tariff frameworks. 0 Establishment o f legal and regulatory framework. 0 Preparation o f WSS legislation. At the ULB Level: 0 0

0

Completion o f city-wide engineering feasibility studies. Implementation o f transition plans, including ringfencing o f WSS accounts and improvements in billing and collection system. Definition o f the scope and scale o f follow-on Private Sector Participation (PSP) and scaling-up in other ULBs.

Component B. Improvement in services will be measured against the following: For each ULB: 0 Improved overall water supply availability and quality resulting from priority investments for

bulk water supplies and distribution network improvements.

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0

For each demonstration zone: 0

Implementation o f the social awareness and communication strategy.

Volumetric tariff adopted according to agreed principles in order to recover no less than 50 percent o f Operation and Maintenance (O&M) costs at init ial stage and no less than 80 percent by the end o f the Project. Weighed average o f 75 percent or higher achieved for the following eight indicators: 0

(1) continuous (aiming at 24-hour, 7 days per week al l year) supply to the zone - emergency stoppages not to exceed 12 hours and no more than one emergency stoppage per 3 months (20 percent weight);

(2) water quality as per norms and monitored through testinghampling (5 percent weight); (3) supply to the zone to be metered both in respect to f low and pressure and continuous records

(4) physical losses within the Demonstration Zone not to exceed 10 l i ters per connection per hour maintained (5 percent weight);

based on average pressure within the Demonstration Zone o f 10 meters, adjusted proportionately in respect to the actual average zone pressure (10 percent weight);

receiving the lowest pressure in the period 6 a.m. to 10 p.m.) (10 percent weight);

street storage tanks, adoption o f volumetric tariff structure (20 percent weight);

(5) minimum pressure 6 meters (i.e. measured at the customer meter o f the property connection

(6) 100 percent metering o f property connections (individual and shared), standpipes and feeds to

(7) billing/collection rate to exceed 70 percent (10 percent weight); and (8) high level o f customer satisfaction (70 percent) measured by polls (20 percent weight).

B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1) Document number: : 25057-IN Date of latest CAS discussion: December 5, 2002

The proposed project i s consistent with the Bank Group Country Assistance Strategy (CAS) for India, discussed by the Executive Directors on December 5,2002. The CAS l is ts support for PSP in the UWS as a program priority and recognizes that provision o f adequate infrastructure would be critical in promoting private sector growth. The project i s also consistent with India's Tenth Five Year Plan, which recognizes that infrastructure bottlenecks have become a major constraint on growth and, therefore, poverty alleviation. The Bank's plan to support the reform-minded states through programmatic interventions i s also consistent with the project approach which envisages a long-term involvement in the U W S in the state o f Karnataka.

Sustainable access to WSS services i s a high priority that i s now well-recognized in the international development agenda. Access to safe water has been declared as a basic human right by the United Nations and i s widely recognized to directly contribute to poverty alleviation, the main focus o f the CAS. The project would also contribute to achieving the Millennium Development Goals, which emphasizes safe and sustainable drinking water and sanitation as well as their important health impacts.

2. Main sector issues and Government strategy:

Key pervasive issues that affect the UWS in Karnataka are discussed below:

- 4 -

Gaps in Sector Performance: The sector suffers from some chronic inefficiencies, including unreliable service quality, and limited coverage. At the technical level, problems include sub-optimal resource allocation, mismatched capacity investments, and poor (O&M) practices. These are compounded by uneconomic tariff structure/levels, poor collection efficiency, and high levels o f leakage and non-revenue water. While sector information systems are deficient, service coverage with authorized connections in all three participating ULBs i s estimated to be less than 50 percent. In addition, the state experienced severe drought conditions during the summer o f 2002.

Inadequate Institutional Framework: Urban WSS provision in the state o f Karnataka i s the responsibility o f the ULBs, except for Bangalore, which has a water utility. However, the functions for WSS services, e.g. O&M, sewerage services, billing and collection o f the tariffs, and capital development works etc. are fragmented among different departments within the ULBs and outside agencies l ike KUWSDB (Kamataka Urban Water Supply and Drainage Board) with little coordination. This set-up does not fully address the issues for efficient service management or proper asset maintenance.

Limited Capacity and Financial Sustainability at the ULB level: Since WSS operation and accounts are not separated from other municipal services and there i s l imited capacity to track costs and capital expenditures accurately at the ULB level, the magnitude o f deficits incurred by the water sector i s difficult to assess. However, studies indicate that al l ULBs show operating losses, and normally the tariffs only cover one-third or less o f O&M costs. The increasing deficits encountered by the ULBs are covered by general revenues. Lack o f funds also leads to deficient services (maintenance neglect, only a few hours per week o f service). The amount and sources o f these subsidies, which presumably come from the statehational level, have not been estimated but are likely to be significant.

Weak Enabling Environment for PSP: Several factors inhibit PSP in the sector: low tariffs that lead to poor cost recovery; lack o f a credible regulatory framework; and lack o f a legal framework permissive to PSP. A more conducive environment requires policy and legal changes in the institutional, regulatory, and legal frameworks.

Government Strategy -- Karnataka's Fiscal Reform Program and Sectoral Reforms: GoK has begun a wide-ranging reform program, combining fiscal, govemance and sectoral reforms, which have been supported by the Bank through the Second Karnataka Economic Restructuring Loadcredi t during 2001/2002. Several elements o f this reform program support the proposed urban water sector reforms. GoK recently released a comprehensive state water policy, which envisions adopting a river basin approach for al l future water resource management in the state, restructuring government functions for more effective management, and revising water tar i f fs to meet O&M needs. GoK has already embarked on th is process through creating the "Urban Drinking Water and Sanitation Policy Statement" that covers the key reform elements for the sector (Annex 13) and through preparing a strategy and action plan for the implementation o f this policy statement. In addition, G o K has announced plans to increase PPPs in the sector and in December 2001, increased water tariffs in Bangalore by 50 percent, the f i rst such increase in five

- 5 -

years. These developments are good indications o f GoK's commitment to carry out sector reform and to reduce the fiscal burden that the sector imposes on state finances.

3. Sector issues to be addressed by the project and strategic choices:

The proposed project would: 0

0

0

support GoK's overall U W S reform process, which envisages the creation o f sound institutional and regulatory frameworks and an enabling environment for PSP; improve U W S service quality in the three participating ULBs; develop reliable mechanisms to measure sector performance in terms o f quantity and continuity o f service delivery, efficiency improvements, tariff levels, cost recovery, as well as progress made in reform; and facilitate capacity building and financial management at both the state and local level. 0

C. Project Description Summary 1. Project components (see Annex 2 for a detailed description and Annex 3 for a detailed cost breakdown):

The project comprises three components: (A) Sector Development and Technical Assistance; (B) Physical Investments in three ULBs to improve their water supply services and demonstrate the feasibility o f continuous safe water supply in pilot areas; and (C) Project Implementation Support.

A. Sector Development and Technical Assistance Al. Policy Implementation and State Level Institutional Strengthening A2. Strengthening o f Service Delivery and Preparation of follow-on Project in three Participating ULBs B. Physical Investments B 1. Priority Investments B2. Works in City Distribution Networks in all three ULBs B3. Demonstration Projects

0.89

1.66

27.63 5.77

13.79 1.39

0.0 1.7 0.80

3.2 1.50

0.0 53.6 19.53 11.2 4.62 26.8 11.61

2.7 1.04 C. Project Implementation Support Total Project Costs 5 1.13 99.2 39.10 99.0

Front-end fee 0.40 0.8 0.40 1 .o Total Financing Required 5 1.53 100.0 39.50 100.0

0.0 2.0

3.8

0.0 49.4 11.7 29.4 2.6

Component A. Sector Development and Technical Assistance The objectives o f this component are to: (i) assist GoK in finalizing i t s policy reform agenda and to carry out initial implementation steps o f staged sector reforms; and to (ii) prepare business model and PSP process for service provision in the three participating ULB and other cities in Karnataka.

Al. Policy Implementation and State Level Institutional Strengthening (US%0.89 million) The following activities will be carried out to initiate the implementation o f the "Urban Drinking Water and Sanitation Policy Statement of GoK".

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a Establishment and operationalization of KSUWSC: The Kamataka State Urban Water and Sanitation Council (KSUWSC) i s envisaged to be established by the end o f 2004, to oversee and be responsible for policy definition and implementation, planning and programming, technical assistance, development o f sector information system, norms, and certain regulatory functions for the UWS in Karnataka. Urban Development Department (UDD) o f GoK wil l manage the sector reform component through i t s policy/technical cell housed within KUIDFC until the KSUWSC i s operational.

b Strengthening of Service Delivery in ULBs: The following capacity strengthening activities will be carried out to support the ULB level reform in the state: (i) institutional options for service provision; (ii) technical assistance strategy and action plan to enable UWS reform at the ULB level; (iii) revenue collection action plan; and (iv) public awareness and communication strategy.

c Development of the WASIS: This activity would assist GoK in designing a sector Management Information System (MIS) and in supporting the actual setuphnitial implementation phase, and consist of: (i) task A: development o f an information system, collection o f data from al l ULBs, training o f the primary users, and development o f formats for periodic information updates; and (ii) task B: benchmarking o f the service provision levels.

d Water and Sanitation Sector Investment and Tariff Frameworks: This activity would assist GoK in better managing its UWS finances, and consists of: (i) task A: study to establish an integrated state UWS sector financial policy, which would look at several financial scenarios and sources o f funds to help comply with the state sector goals; and (ii) task B : study to develop a framework for WSS pricing through tariffs, which would examine the WSS pricing policies, taking into account the regulatory, financial, and social aspects o f service delivery.

e Review and establishment of legal and regulatory framework: This activity would assist GoK in designing the regulation strategy, legal basis and action plan, and starting up o f essential but basic regulatory functions, including pricing, service accounting and benchmarking.

f for the sector, recommend necessary changes to the existing legislation, and prepare the corresponding legislative (or in some cases executive) proposal.

Preparation of UWS Legislation: This study would assess the current legal framework

A2. Strengthening of service delivery and preparation of follow-on project in the three participating ULBs (US$ 1.66 million)

a City-wide Engineering Feasibility Studies: This would include a short-term service improvement plan, network mapping and modeling, master plans for longer term rehabilitatiodexpansion, and environmental and social assessment. Sanitation strategies and business plans would also be developed, including analysis o f fmancial feasibility and strategic plan, and proposals for the selection o f alternative institutional modalities and PPP options for each city;

- 7 -

b Transition plans: This study would help assure a smooth transition from the Operator Consultant (OC) to the subsequent operator, and include ringfencing o f WSS accounts, improvements in billing and collection system for WSS tariffs, and designing o f new roles and functions at the ULB levels;

C

communication strategy, and other financial, legal environmental, and social studies. Other studies related to the PPP preparation: This includes asset evaluation,

d Strategy to scale up thisproject to other cities in Karnataka: This would include engineering feasibility studies, development o f business plans, and other studies required to define institutional modalities for service delivery in about four or five medium-sized cities in Karnataka.

Component B. Physical Investments The objectives o f this component are to: (i) improve the service provision and attain continuous service in selected demonstration zones

subcomponent will also facilitate: (i) awareness creation and communication between and across stakeholders within and outside the demo zone; (ii) formation o f local level forums for stakeholder interactions; (iii) customer education on proper use o f 24/7 supply systems and healthhygiene behavior, and (iv) participatory monitoring o f outcomes in the demo zones.

Component C. Project Implementation (US$1.39 million) This subcomponent will finance the project's incremental operational costs and studies related to project management and implementation, including; (i) incremental, short term consultants for KUIDFC for the duration o f the project; (ii) preparation and establishment o f a monitoring and evaluation system; (iii) costs related to the financial management systems within KUIDFC; (iv) training for staff o f the Project Management Unit o f KUIDFC; and (v) incremental operating cost at KUIDFC, including supervision costs.

2. Key policy and institutional reforms supported by the project:

As described above in project description, the KSUWSC will be established to articulate all policy and institutional elements required to promote UWS reform at the State and ULB level. The KSUWSC would be responsible for sector planning, funds allocation, initial regulatory functions, and technical assistance/training to ULBs. In addition, the existing legal and regulatory framework will be reviewed and UWS legislation be prepared. Wi th regards to sector financing, an integrated WSS sector financial policy will be established and a fi-amework for WSS tariffs will be developed.

The project would also support ULB level reform through exploring institutional options for service delivery, developing action plans to improve revenue and collection performance, and implementing the public awareness and communication strategy.

3. Benefits and target population:

The target beneficiaries o f the sector development and technical assistance component would be the general urban population in Kamataka, totaling approximately 16.8 mil l ion (approximately 33 percent o f the state population o f 53 million). The general physical investment component would benefit al l water consumers in the three participating ULBs, totaling 1.8 mil l ion as o f 2001 (940,000 in Hubli-Dhanvad, 425,000 in Belgaum, and 430,000 in Gulbarga). The demonstration project would target the people in the demonstration zones, which correspond to 7 - 14 percent o f the population in each city, totaling about 230,000.

Immediate benefits outside the three participating ULBs will be mostly related to better fund allocation for investment and some improvement in U W S service performance. In the long term, it i s envisaged that the reform measures taken under this project would be the driving force for the ULBs in Kamataka to become the real catalyst to turn around the current situation o f generalized poor performance into sustainable high quality services for all.

The major benefits in the three ULBs would include; increased hours (currently one to two hours supply every two days in Belgaum and Gulbarga, and one to two hours supply every three to five days in Hubli-Dhanvad) and more equitable water supply; higher water pressure which would make the current practice o f pumping directly from the mains unnecessary; and customer

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satisfaction which provides incentives for the ULBs to provide sustainable service. These benefits would lead to broader access to sanitation facilities; higher standards o f cleanliness, and reduced pollution. Broader access to adequate water supply on a reliable basis would also benefit industrial consumption thus support economic development. The investments in the three ULBs would have a demonstration effect and serve as a stepping stone to scaling up reform. A successful implementation o f the project would open the door to widespread and quicker sector reform in Kamataka, and quite probably in other Indian states. See also cost benefits analysis in Annex 4.

4. Institutional and implementation arrangements:

KUIDFC will be the implementation agency for this project. Other important participants include: (i) GoK, which has constituted a State-level Committee for overall steering o f the project throughout i t s cycle; (ii) GoK’s UDD which will drive and manage the sector reform component (AI) through i t s policy/technical cell housed within KUIDFC until the proposed KSUWSC i s operational; (iii) KUWSDB, which will act as an agent o f KUIDFC for the design, technical aspects o f procurement, and constructiodsupervision o f the priority investments (component B 1); and (iv) the ULBs which, as main beneficiaries, will follow-up, participate, and facilitate implementation o f components A2, B I, B2, and B3.

To carry out i t s responsibilities, KUIDFC has established a Project Management Unit (PMU) which will provide for project technical and financial follow-up, coordinatelcarry out al l project procurement, prepare reports, coordinate al l financial management tasks including audits, and in general become KUIDFC interlocutor with the ULBs, other participants in project execution, and the Bank. See detailed implementation arrangements for each component in Annex 2 table.

To assure clear responsibilities and ru les o f the game, “Guidelines for Project Implementation” will be issued by GoK in the form o f a Government Order (GO), specifying the roles and responsibilities o f all project participants. This GO will be back-to-back with the OC’s contract with KUIDFC, KUWSDB and the ULBs. The GO i s a condition for project effectiveness, and detailed in section G. 1.

D. Project Rationale 1. Project alternatives considered and reasons for rejection:

The current project concept has evolved from previous proposed approaches to UWS reform and developments in Karnataka. The main alternatives considered are described below.

Combination of Urban Management and WSS: The original project concept envisaged covering both urban management and WSS under one project. Ths approach was too complex and created confusion for GoK on the nature o f policy and institutional reforms required in the sector, which requires separate dynamics. Therefore, the scope was revised to separate the two sectors and to develop two stand-alone projects.

Management Contract for I 3 ULBs: The stand-alone water project was init ially developed to introduce PSP through a management contract for 13 ULBs selected by the GoK. Since most o f

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the ULBs are scattered over more than two-thirds o f Kamataka, clustering water operations to attract private operators was proposed, However, the feasibility o f such a complex institutional arrangement was questioned and the scope was later narrowed to fewer ULBs and a step-wise PSP approach.

Sector Issue

Adjustable Program Loan (APL): Reviewing the nature o f reforms to be undertaken and given the timeframe required for such reforms to take place, an APL was proposed to be used. However, because the GoK i s at an early stage o f developing an agreed action p lan to implement reform in the sector, the definit ion o f milestones and triggers for subsequent loans was problematic, and thus th is approach was rejected.

Project

Stand-alone Investment and Technical Assistance: Finally, it was decided that the f i rst phase project will be supported through a specific investment loan that wou ld finance urgent investments and technical support to GoK and the participating ULBs. Progress will be reviewed and evaluated during the implementation o f this f i rst phase project. Additional analysis will be undertaken, as necessary, before the subsequent phase projects are initiated. A three-phase program over 8-10 years i s envisaged.

2. Major related projects financed by the Bank and/or other development agencies (completed, ongoing and planned).

Bank-financed Improvement o f state urban governance/decentralization and soundness o f municipal finance and accountability Provision o f water supply, sanitation and flood protection

Provision o f water supply and sanitation services

Improvement o f Urban Management Capacity and Support Basic Urban Service Investment

Provision o f water supply and sanitation system

Promotion o f Private Infrastructure Investment

Provision o f water supply and waste

Karnataka Urban Sector Reform Project (under preparation)

Andhra Pradesh Urban Reform & Municipal Services Project (under preparation) Delhi Water Supply and Sanitation Project (under preparation) Tamil Nadu Urban Development Project I (Cr. 18234" completed September 30, 1997) Hyderabad Water Supply and Sanitation Project (Cr. 2115-WLn. 3181-IN, completed March 31, 1998) Private Infrastructure Finance (IL&FS) Project Ln. 3992-IN completed June 30,2003 Andhra Pradesh District

Latest Supervision (PSR) Ratings

(Bank-finance Implementation

Progress (IP)

wojects only)

Objectiie (DO)

S

S

S

S

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disposal systems

Provision of sewerage disposal services

Provision of water supply and sewerage

Improvement o f Urban Management Capacity and Support Basic Urban Service Investment Other development agencies Asian Development Bank

USAID

iP/DO Ratings: HS (Highly Satisfactory), S (Highly Unsatis

Poverty Initiatives Project (Ln. 33324" ongoing) Bombay Sewage Disposal Project (Cr.27563lLn. 3923-IN, completed December 3 1,2003) Madras Water Supply Project I1 (Ln.39074"Ln. 39076-IN, ongoing) Tamil Nadu Urban Development Project I1 (Ln. 44784" ongoing)

Karnataka Urban Development Project (ongoing) Karnataka Urban Development and Coastal Environment Management Project (ongoing) Rajasthan Urban Infrastructure Development Project (ongoing) Financial Institutions Reform and Expansion Project (FIRE I) (completed) FIRE I1 (ongoing)

(Satisfactory), U (Unsatisfactory), I- ICtOry)

3. Lessons learned and reflected in the project design:

The Bank has supported few urban water supply projects in the past 10 years, all o f them in big cities, and since 1996 there have been no new projects in the sector. Past Bank supported projects in India's UWS have proven to have sustainability problems largely due to: (i) lack o f a long-term vision and o f a step-wise approach considered to tackle the complex sector; (ii) uneven improvements in the sector policy and institutional reform aspects o f the project; (iii) lack o f adequate beneficiary involvement in the project cycle; and (iv) predisposition o f UWS institutions towards construction rather than creation o f an enabling environment for improved service delivery. In addition to the lessons learned from previous Bank projects, key elements from the economic and sector work during the fiscal years 2001 through 2003, including the Bank's urban water strategy, capacity building and learning initiative, and the Bank's rules o f engagement, have been incorporated in the project design. Given the project's emphasis on future private sector involvement , lessons learned from an Operations Evaluation Department review, "An evaluation o f private sector participation in water supply and sanitation under projects assisted by the Wor ld Bank" have also been incorporated in the project design. Based on these lessons, the key principles o f project design agreed wi th the client include:

(i) Implementation strategy and action plan for the "Urban Drinking rater and Sanitation Policy Statement of GoK" will be carried out with a long term vision and step wise approach; Municipal-level reform, including ring-fencing o f WSS operations and adoption o f a (ii)

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computerized billing and collection system, will be implemented to ensure that sufficient capacity i s built at the local level to manage WSS operations in preparing for future PSP; The project will start with a small-scale demonstration project to ensure that up-front reforms are undertaken before major expansion and management transformation take place; and A communication strategy will be developed and the local-level planning processes would be participatory and include full consultation with the municipal managers, community and other stakeholders to ensure their ownership and commitment to the project.

(iii)

(iv)

The project wil l take into account and draw lessons from reforms o f the state-level UWS carried out in other federal countries such as Mexico and Brazil.

4. Indications of borrower commitment and ownership:

GoK's commitment to reform i s high, as evidenced by actions already taken. Despite the delays experienced in considering earlier concepts o f the project, GoK has remained keen on working with the Bank based on the new concept. GoK has also made PSP in the urban water sector as one o f i t s priorities and it i s fully aware that a significant amount o f upstream work i s necessary for successful PSP schemes. Demonstrated interest and commitment to reform include issuance o f the "Urban Drinking Water and Sanitation Policy Statement of GoK" and preparation o f a strategy and action plan for implementation. Commitment and ownership o f the participating ULBs appears to be high, as demonstrated by the active participation o f al l Mayors, Municipal Commissioners, and senior engineers from al l the ULBs throughout project preparation.

5. Value added of Bank support in this project:

Since the Bank has a long history o f involvement in India's water sector, the lessons learned will be put to good use in the proposed project. In addition, the Bank can make available to the state i t s considerable knowledge on international experience and best practices in the sector.

GO1 has requested the Bank to assist in a few select states in operationalizing sector reforms mandated under the 74th Constitutional Amendment. I t believes the Bank will provide a strong demonstration effect nationwide. Furthermore, given the long-term nature o f implementing institutional reform statewide and the sizeable investments required to meet the needs in this sector, the Bank i s uniquely positioned to support both the reform process and the potential future investments associated wi th it.

Other agencies active in the sector include the United States Agency for International Development (USAID), the Asian Development Bank (ADB), and the Department for International Development (Dff D). Lessons leamed from the institutional framework adopted by ADB will be incorporated into the project.

E. Summary Project Analysis (Detailed assessments are in the project file, see Annex 8) 1. Economic (see Annex 4):

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Cost benefit 0 Cost effectiveness 0 Other (specify) An economic analysis has been carried out to determine the project's economic viability. A cost-benefit framework has been applied on the project as a whole and on the main sub-projects individually. 'with' and 'without the project' scenarios have been defined to identify the project's incremental costs and benefits. Cost effectiveness criteria has also been applied to all major sub-components as part o f project design. Project altematives have been screened for their economic viability, priority level, cost effectiveness, and other social and environmental criteria. Sensitivity analysis has been done on the major r isks identified during project preparation.

NPV=US$4.4 million; ERR = 16 % (see Annex 4)

Belgaum

In the base scenario, the net present value o f the project i s Rs. 202.7 mil l ion (US$4.4 million). The internal rate o f return i s 16 percent, above the discount rate o f 12 percent. The findings are detailed in the table below:

8.3 1 13% I NPV IRs. Million) I IRR

Guibarga Hubli-Dhanvad

Demonstration zones (coping costs approach) TOTAL

54.7 16% 114.0 21% 25.7 14%

202.7 16%

For the Investment Component, the objective was to assess the costs and benefits o f the priority investments and o f improving service levels in the demonstration zones from the current extremely low baseline up to continuous supply levels. To this end, the analysis has established baseline indicators wherever possible including private coping costs, costs to the utility, and externalities. Using the revealed preference approach, the analysis has attempted to estimate benefits such as reduction in private coping costs and system efficiency gains, and contrast them to the incremental investment and O&M costs required to improve service levels. Benefits have also been assessed using the stated preference approach, drawing upon the willingness-to-pay information gathered as part o f the social assessment.

Economic analysis will also be carried out during project implementation on the TA component. The proposed private sector contract and associated investments to improve the UWS situation on a city-wide basis will also be assessed using the data generated in the demonstration zones. The analysis will assist in setting both the performance targets (e.g., non-revenue water (NRW) reduction, energy savings) and the investment levels required to achieve the economic and financial viability o f the possible follow-on project. The economic analysis will also cover issues such as tariff levels and structure, cost recovery and affordability, subsidies, fiscal impacts, cross-subsidization among users, and the economics o f investing in wastewater collection and treatment.

Although the Social Assessment study has provided indications o f coping costs and willingness to pay, a more detailed demand assessment and analysis needs to be carried out during

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implementation, to establish a baseline against which improvements would be measured at regular intervals. The demand assessment (to be funded by the Water and Sanitation Program - South Asia) for the three ULBs will analyze the ‘demand side ’ perspectives, including consumer preferences and affordability aspects for 24/7 and other improvements in water supply services. The study will analyze the baseline situation including the existing coping costs and consumer satisfaction; additional services desired and the acceptable tar i f fs for improved levels o f services.

The 24/7 demonstration project will initiate a move towards metering and volumetric pricing, with tariff rationalization as an instrument for financial sustainability and demand management. As part o f the project institutional component, a tariff policy for urban WSS services will be designed, including possible cross-subsidies for the poor, for the 3 ULBs and at the State level.

Although the ”Urban Drinking Water and Sanitation Policy Statement of GoK“ highlights the need for Monitoring and Evaluation (M&E) as well as reporting arrangements, at present there i s no customer interface and no monitoring system in place. Recognizing the need to supply urban water services in accordance to what consumers want and are willing to pay for, an M&E program for the 3 ULBs (including the non-demo zones) will be designed. The design o f a M&E template will be the first step in institutionalizing customer surveys as instruments o f public accountability and the information will be useful as inputs into operations and planning process, including the design o f effective tariff policies. A pilot program will be carried out over a period o f six months, and lessons to be incorporated for a broader ro l l out. Alternate institutional arrangements, including local institutions (colleges, schools etc.) could be involved in the M&E program and the dissemination o f information.

2. Financial (see Annex 4 and Annex 5): NPV=US$ million; FRR = % (see Annex 4)

The long term objective set by GoK through i t s “Urban Drinking Water and Sanitation Policy Statement” i s to “establish an appropriate cost recovery mechanism through adequate tari f f to ensure that revenues cover O & M costs, debt service plus a reasonable retum on capital”. In view o f this, the financial health o f the ULBs have been analyzed. Preliminary results show that none o f the ULBs currently cover even hal f o f their O&M costs through tariff revenues, and when depreciation and interests are taken into account, the results deteriorate significantly. The table below shows that a large portion o f the deficit i s covered by state subsidies, including grants, share o f salaries, grants adjusted by KUWSDB and Kamataka Power Transmission Corporation Limited (KPTCL), which are categorized as revenue in the ULB accounts. GoK has recognized that in the medium term, subsidies and grants will continue to be needed, but their plan i s to focus more on targeting the poor and providing sanitation.

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Table 1: Cost recovery levels in the participating ULBs: H D M C Belgaum Gulbarga

A. O&M cost recovery level in 200 112 19% 39% 17% B. Full cost recovery level in 2001/2 16% 24% 11% C. Full cost recovery including grants in 200112 87% 83% 49%

Where: A. B. C.

includes WSS tar i f f and tax revenues/O&M costs. includes WSS tariff and tax revenuedfull cost including O&M, depreciation, and interests. includes WSS tariff and tax revenues plus share o f SFC salary, grants adjusted by K U W S D B loan and KPTCL/ fu l l cost including O&M, depreciation, and interests.

Wi th regards to financing o f the UWS at the state level, the project envisages to assist GoK in carrying out the state sector development strategy/action plan, including detailed fiscal allocation o f state resources. With regards to ULB level reform, the project envisages to assist the ULBs through the following studies:

(i) Ring-fencing the WSS Operations: To improve the efficiency and accountability for the sector, the ULBs will separate their WSS accounts from rest o f the municipal services using a workbook developed during project preparation. As a first step, operating revenues and expenses for the WSS activities, as well as the demo zone accounts will be recorded separately. Capacity building o f 2-3 municipal staff in each ULB to perform th is activity will be conducted in close coordination with a state-wide initiative undertaken by GoK, aiming at computerizing the municipal accounts.

(ii) Improvement in U W S Billing and Collection: To improve the bill collection rate which has been deteriorating during the past four years, down to only 37 percent for Hubli-Dharwad, 53 percent for Belgaum, and 30 percent for Gulbarga, a computerized customer database and a billing and collection system will be developed and implemented. These systems will also separate the demonstration zone bills which will be different for each consumer depending on their consumption level, and have a more frequent billing cycle. The bill collection target by project closure i s set for 70 percent in the demonstration zones.

(iii) Defining the Water Tariff Structure: Using the project cost estimates, data collected from the ULBs, KUWSDB, and KPTCL and revenue and cost related assumptions, a simple analysis was done to estimate the level o f tariff increase necessary to achieve cost recovery in the medium to long term.

Table 2: Annual Tariff Increase Necessary to Reach Cost Recovery in Five/Ten Years: H D M C Belgaum Gulbarga

O&M cost recovery by 2007 52% 18% 61% O&M cost recovery b y 2012 25% 7 yo 25% Full cost recovery (incl. depreciation and debt ) by 2007 28% 35% 80% Full cost recovery (incl. depreciation and debt) by 2012 26% 12% 29%

The TA component o f the project will assist GoK and the ULBs to develop sound tari f f policies at the municipality level and a volumetric tariff system in the demonstration zones. In summary,

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the following methodology and principles will be used for water pricing in the demonstration zones: (i) There will be careful transition to volumetric pricing by using both flat rate and volumetric

billing in parallel for a few months, accompanied with social intermediatiodcommunication activities; The volumetric rate will be at least Rs.lO/m3, which corresponds to what the users are actually paying now for 30 liters per capita per day (lpcd). The detailed tariff structures in the demonstration zones wil l be finalized by June 30, 2005; Connection subsidy policy will also be examined; and Init ial target for the tariffs will be to cover no less than 50 percent o f O&M costs and progressively increases to no less than 80 percent O&M costs by the end o f this project.

(ii)

(iii) (iv)

In the rest o f the ULBs, there will be a step wise tariff increase along with service improvements resulting from the priority/distribution network investments.

Fiscal Impact:

GoK has confirmed their intention to pass the Loan proceeds to the ULBs as grants due to the pi lot nature o f the project. Since the project, through i t s sector development components, envisages to develop and adopt state financial policies that include WSS tariffs that aim to gradually achieve cost recovery and reduce state subsidies to the sector, i t i s expected that there will be positive fiscal impact on the state finances in the medium to long run.

3. Technical: The project faces several technical challenges mainly in attempting to provide high quality 24-hour service in demonstration zones. The main challenges stem mostly from the unknown, but presumed very poor condition o f the distribution systems, lack o f proper system maps, current practice o f intermittent supplies, possibility o f providing sufficient water to demonstration zones without affecting the supplies to other areas, availability o f bulk water, lack o f metering o f supplies, lack o f proper sewerage systems, quality o f water, and the current limited technical capacity o f the ULB WSS departments. These challenges are addressed through three separate sub-components, and are discussed in the project description summary section above and in Annex 2.

Under components B 1 and B2, priority investments and works in city distribution networks will be implemented to benefit the whole population in al l three ULBs. This would address the potential social issues associated with the demonstration projects.

Under component B3, demonstration projects will be carried out and show a programmatic improvement o f distribution systems and customer connection arrangements in limited parts o f the city (called demonstration zones, covering 7- 14 percent o f city’s population). This init ial process would reveal the challenges, provide scope to identify appropriate solutions, demonstrate that 24/7 water supply i s achievable, and show the benefits. Ultimately, the goal i s to expand the 24/7 supply regime to the whole distribution system in subsequent projects, based on the lessons learned in the current project.

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Init ial Diagnostic Studies identified feasible demonstration zones in each o f the three ULBs, and provided a basis (for preliminary identification o f works needed and developing performance criteria etc.) for drafting the Terms o f Reference for the OC. The OC develops a strategy for achieving the performance targets demanded o f them, identifies works required, procures contractors, implements works and operates the zones for 2 years using ULB staff. During this operation, subsequent project would be prepared to expand the 24/7 supply to the whole o f the ULBs.

City Wide Engineering Feasibility Studies for the 3 participating ULBs would be carried out under Component A 2 to roll-out the 24/7 water supply to the entire ULB. In the f i rst phase, detailed network mapping and modeling, and identification o f critical bottlenecks in the city-wide distribution system to be implemented as Component B 2 would be taken up. In the second phase, addressing engineering issues related to scaling up the project to cover the entire ULB, development o f strategy for roll ing out 24/7 supply to the entire ULB and addressing waste water collection and treatment would be taken up. Similar studies would also be carried out in 2-3 additional ULBs in Kamataka under Component A2.

4. Institutional:

4.1 Executing agencies:

As described above under project description summary section, overall implementation responsibility will l i e with KUIDFC, a company registered under the Companies Ac t and fully owned by GoK. Other important participants in project implementation include: (i) The State-level Steering Committee for overall steering o f the project throughout i ts entire cycle, comprising (inter alia) Principal Secretary, UDD; Secretary, MUDA; Managing Director, KUIDFC; Managing Director, KUWSDB; Director, Municipal Administration, and Director, GoK Project Monitoring Cell;(ii) UDD, which will drive and manage the sector reform component through i t s policy/technical cell housed within KUIDFC unti l the KSUWSC i s operational; (iii) KUWSDB, which will act as an agent o f the KUIDFC for the design, technical aspects o f procurement, and constructiodsupervision o f the priority investments; and (iv) the three ULBs, which will permanently participate as part o f the State-level steering committee and through the ULB-based Project Implementation Units (PIUs), and wil l be consulted and informed throughout project implementation.

Deep engagement and participation o f the ULB staff would be important for institutional strengthening, particularly with regards to the demonstration projects for several reasons: (a) to gain ownership by the ULB, which i s responsible for the service; (b) to transfer knowledge o f local engineers; and (c) to use the acquired knowledge to upgrade and train other municipal staff.

4.2 Project management:

To carry out i t s responsibilities, KUIDFC has established a P M U which will provide for the technical and financial follow-up, coordinate/carry out a l l project procurement, prepare reports, coordinate all financial management tasks including audits, and in general become KUIDFC interlocutor with the ULBs, other participants in project execution, and the Bank. The PMU's organization, staffing, functions, procedures, manuals and costs have al l been agreed. The P M U i s

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headed by KUIDFC's Managing Director and i s composed o f a field-based PIU, with divisions located in each ULB, and HQ-based departments including: (i) project coordination and procurement, (ii) finance, accounts, disbursement and reporting, (iii) social and environment, (iv) legal, (v) land acquisition, and a policy/technical cell reporting to GoWUDD. Strengthening measures o f the P M U are planned during project implementation, e.g. on social and environmental management, and procurement. Detailed implementation arrangements by component i s described under section C, Project Description. 4.3 Procurement issues:

The project would support procurement o f consultancies for the Sector Development and Technical Assistance (Component A) and the Project Implementation Support (Component C), as well as the procurement o f Goods, Works and Consultancies for Physical Investments (Component B).

The investment component envisages selection o f an OC who would be responsible for an engineering consultancy and operation o f the demonstration zones for a period o f about three years. For procurement o f goods and works in such zones, the OC will prepare an investment plan for review and agreement with KUIDFC and the ULBs, be responsible for preparation o f the bidding documents, invitation o f bids, and award o f contract (on behalf o f KUIDFC). For the priority investments and works in city distribution networks, KUIDFC wil l procure the required goods and works, with the technical assistance o f KUWSDB throughout the process including planning, assistance in preparation the bidding documents, follow-up the bidding process, elaboration o f evaluation reports and assistance during negotiations. KUIDFC will be permanently accompanying the process and will take key decisions including call for bids, bid awards, and contract signing.

All procurement o f goods and works shall be in accordance with the Guidelines for procurement under IBRD Loans and IDA Credits; January 1995, Revised January and August 1996, September 1997, and January 1999. The procurement o f Consultancies for the project shall be in accordance with Guidelines for Selection and Employment o f Consultants by Wor ld Bank Borrowers; January 1997, Revised September 1997, January 1999, and May 2002. The capacity and capability o f KUIDFC to carry out the procurement for the project as per the Bank's Guidelines was assessed during the preparation o f the project and strengthening measures agreed as per details in Annex 6A. 4.4 Financial management issues:

Although this will be the f i rst Bank project to be implemented by KUIDFC, the accounting function i s adequately staffed and fully computerized. The company maintains accounts project wise using the customized software 'Tally". Financial management systems and procedures that require strengthening have been addressed during project preparation. Capacity building initiatives include the adoption o f a financial management manual, which will document the accounting policies and procedures o f the organization. The internal control mechanisms within the organization are being strengthened by the setting up o f an internal audit department in KUIDFC.

A Manager Finance will be deputed to the P M U and work under the oversight o f the Executive Director Finance to handle all aspects o f project accounting, payments, financial reporting and

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audit. The P M U will receive funds for the project (on behalf o f KUIDFC) from GoK, make project expenditures, record transactions, and maintain project accounts. I t wil l also be the nodal agency for ordering, receiving and paying for goods. All payments to contractors will be localized in KUIDFC to avoid procedural delays and bottlenecks. Payments will be made on the basis o f certified bills submitted by them as per contractual terms. In the demonstration zones, the contractors will submit their bills to the OC who will check the technical specifications, record them in the measurements book, and certify for payment. Thereafter, the bills will be routed to the P M U where they will be checked by the Manager Finance and paid. A similar process will be followed for the priority investments where contractors’ bills will be routed through KUWSDB. The OC and KUWSDB will assist the P M U in the preparation o f works budgets for the upgradation o f networks in the demonstration zones.

The audit o f project expenditures wil l be carried out by a firm o f Chartered Accountants. The project will produce quarterly Financial Monitoring Reports (FMRs) in formats that will be agreed with the Bank. (further details in Annex 6B). 5. Environmental: 5.1 Summarize the steps undertaken for environmental assessment and EMP preparation (including consultation and disclosure) and the significant issues and their treatment emerging from this analysis.

Because o f the nature and the small size o f the investments considered under the project, no significant environmental impacts are expected. However, a Limited Environmental Assessment (LEA) o f the envisaged works was undertaken to assess the extent and significance o f environmental impacts o f the proposed physical investments in three ULBs. In order to mitigate adverse environmental impacts during planning and implementation o f works, an Environmental Management Plan (EMP), including Environmental Codes o f Practice (ECOPs), has been prepared by an independent environmental consultant, working closely with the engineerinddesign consultant. The EMP will be h l l y integrated in the contract for implementation and operation o f the demonstration projects and will be the responsibility o f the OC implementing the works.

Environmental Category: B (Partial Assessment)

The significant adverse environmental issues during the construction phase in the demo zones include:

a. Temporary disruption o f water supplies including possible flooding and leakages during the isolation o f demo zones, leak detection and replacement o f mains;

b. Increased dust and noise levels during earth excavation activities; and c. Temporary disruption to traffic during construction.

Most o f the above mentioned environmental impacts during construction would be temporary and reversible, and will be addressed using the recommendations in the ECOPs and EMPs. Other construction phase impacts such as disruption to water supplies and possible flooding would be addressed by providing alternative water supply through tankers during the period o f construction, and by providing alternative bypasses and leak control system (for details see the EMP) .

The significant adverse environmental impacts expected during the operational phase include: a. Generation o f additional quantity o f waste water from zones leading to possible

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contamination o f surfacehub surface water source; and b. Possible flooding o f low lying areas due to overflow o f storm water drains

I t i s expected that the increased water supply (and per capita consumption) in al l the demo zones (and wards) wil l be primarily due to reduced leakages from the distributiodtransmission lines and wastages from the public stand posts. The demonstration project does not propose to strengthen the existing sanitation facility, and would use the existing sewerage system in the three cities for disposal o f additional quantity o f waste water, which i s not likely to create major problems such as flooding or overflow. However, the issue o f sewage collection and disposal including a feasibility study to analyze various alternative solutions will be considered and costed as a significant priority during the subsequent phases o f this project.

The significant positive environmental impacts during the operational phase include: a. Possible improvement in water quality and, improved health and hygiene due to reduction

in leakages and cross contamination with sewer lines; and b. Better control and management o f environmental issues due to improved monitoring.

The LEA has pointed out interesting findings on water quality at supply end and consumer end. The report finds high bacteriological contamination (or microbiological pathogen number (MPN) count) in water samples collected for each demo zone. I t i s assessed that the water quality problems at the consumer end may be largely due to ingress o f contaminated water to the system, which the low residual chlorine levels cannot deal with. The project i s likely to result in improved water quality and health and hygiene in the demo zone. (See Additional Annex 12 for details on the results o f the LEA). 5.2 What are the main features o f the EMP and are they adequate?

For each expected environmental impacts, the EMP outlines the mitigative measures to manage impacts arising out o f proposed activities during the construction and operational phase o f the project. I t also assigns responsible agencies for coordinating respective mitigative measures. The E M P also includes the that uses the Central Public Health and Environmental Engineering Organization (CEEPHO) manual as the basis. The ECOPs i s expected to be a usefu l guidance tool to OC and design engineers for integrating environmental aspects in planning, design, construction, operation and management o f water supply sub-projects. The ECOPs may be helpful to mainstream environmental aspects and broadly covers the recommendations on:

a) Project Planning - environmental screening and scoping; b) Design Phase: basic design considerations, quality standards, selection of source,

development of source, transmission of water, treatment of water, distribution system; c) Construction: source development and intake works, conveyance and transmission

mains, pumping stations/booster stations, treatment plant, storage reservoirs, distribution network; and

d) O&M: source and intake works, transmission main, pumping/booster stations, treatment plant, storage reservoirs, distribution network.

Overall environmental implementation supervision would be the responsibility o f KUIDFC, the

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implementing agency. However, KUIDFC wil l coordinate with designated local engineers at the ULBs in Hubli-Dhanvad, Belgaum and Gulbarga for planning and ensuring effective implementation o f EMPs. The implementation arrangement for the EMP and ECOP requires an engineer to be designated at each ULB, who will be responsible for ensuring the implementation o f the requirements. The OC implementing the project would have an environmental specialist on the team who will prepare a plan to operationalize the EMPs and will be responsible for ensuring that contractors strictly adhere to EMP and ECOPs provisions.

5.3 For Category A and B projects, timeline and status o f EA: Date o f receipt o f final draft: August 1 1,2003

The project EA was completed and thereafter disclosed at the Bank Infoshop, by GoK at KUIDFC's web site, and in public libraries in the three participating ULBs.

5.4 How have stakeholders been consulted at the stage o f (a) environmental screening and (b) draft EA report on the environmental impacts and proposed environment management plan? Describe mechanisms o f consultation that were used and which groups were consulted?

As part o f the Environmental Assessment (EA) and in coordination with the social intermediation activities (see section 6 below), public consultations were held in the ULBs to identify environmental issues seen by communities and stakeholders. Project beneficiaries and local NGOs were consulted about the project's environmental aspects during project preparation and will be consulted again during implementation. LEA and EMP reports are made publicly available in Karnataka Urban Department and public library.

5.5 What mechanisms have been established to monitor and evaluate the impact o f the project on the environment? Do the indicators reflect the objectives and results o f the EMP?

Environmental performance indicators have been identified as part o f the overall project indicators, to monitor and evaluate the impact o f the project on the environment. The plan prepared to be prepared by the consultant operator will include, a program, indicators, estimated budget and institutional measures necessary to monitor and evaluate project's impacts on the environment.

6. Social: 6.1 Summarize key social issues relevant to the project objectives, and specify the project's social development outcomes.

The desired social development outcomes expected out o f project interventions are: (i) Substantial positive effect on women (time and effort) and better health for the entire family through assured supply o f safe water in adequate quantities made available to all households; (ii) Improved and equitable coverage o f un-served and under served poor house holds at reasonable cost; and (iii) Empower users through mechanisms for voice and choice (redress o f complaints, easier methods for tariff payment, etc.).

A participatory Social Assessment has been undertaken as part o f the project preparation activities. Findings from the Social Assessment and interactions and observations o f Bank missions during the field visi ts to the three selected towns indicate:

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Oualitv o f service: Water supply service i s poor in terms o f quality, quantity, and reliability. The intermittent supply combined with unsanitary conditions around water supply points ensure contamination o f the water supply. In households with private connections (between 70 to 90 percent o f the population in each city), water collection engages the entire family during the unreliable hours o f supply. Given the low pressure in the system, most households have built pits in front o f their houses to tap the water at a lower level. This results in unsanitary conditions at the water collection point. Households compete with each other by using powered pumps connected to the supply line. There are visible (time spent, water purchased from tankers) and not so visible costs (cost o f electricity for pumping water f iom supply line and from primary collection point to elevated reservoirs, loss o f productivity and expenses for medical treatment and investment in subsidiary sources) incurred by households. Substantial private investments (drilling o f bore wells) are taking place each year in extension areas, causing undesirable environmental effects. However, even such households in extension areas are willing to switch to public supply if quality o f service delivery could be assured. There i s an alarming amount o f waste o f water from public stand posts.

Poor households: Locations o f vulnerable groups (slums and resettlement colonies o f slum dwellers) are un-served or often grossly under-served. Poor households, which depend on stand posts, waste time and effort in collecting water, often under unsanitary conditions, with women being the main sufferers.

Tariff collections: Tarif f collection from registered connections lag from six months to two years. Often the arrears i s not due to unwillingness to pay current tariffs but rather a lack o f follow-up by the ULB and/or additional effort needed from the customer to pay the bill. Substantial number o f unregistered users draw water from the system without having to pay either the connection charges or the monthly tariff. In the absence o f political will to take penal action, the errant households continue to draw water.

Willinmess to pay: Prima facie, consumers are willing to pay a higher tariff for a better service level. Even stand post users and s l u m dwellers were willing to pay tariff for a better level o f service, though they may want to negotiate the tariff. However, this willingness to pay i s adversely affected by crisis o f ULB credibility in the mind o f consumers. The ULB’s “willingness to charge” seems to be a major hurdle, more than willingness to pay (by consumers).

Crisis o f institutional credibility Consumers have little or no say on the timings and fiequency o f water supply. While the service levels at the 3 ULBs are varied, in general, people have very little faith in the ULBs to deliver reliable and quality supply. They seem to be happy to get regular supply (even once in two days) and perceive 24/7 supply as a hypothetical dream.

Awareness o f health issues: While the communities keep their indoors ‘clean” and their water vessels sparkling, there i s little awareness among communities on adverse health impact o f the present intermittent supply.

The findings from the Social Assessment indicate that a comprehensive set o f interventions are needed. In addition to institutional, technical and managerial interventions, substantial social

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intermediation and communication efforts are needed supported through actual demonstration o f the feasibility (technical, economic, institutional and managerial) o f high quality services.

6.2 Participatory Approach: How are key stakeholders participating in the project?

Getting stakeholders together and building consensus i s one o f the biggest challenges o f the project. The thrust o f the proposed approach i s to keep stakeholders informed o f sector reform and i t s benefits, consulted in developing plans and implementation arrangements, and enlisted in the reform process to ensure their proactive and beneficial engagement. Lessons from successful (or otherwise) results o f past reform efforts that have been incorporated include: clear public understanding o f reform measures and their benefits, transparency, building consensus and support for reform, addressing stakeholder concerns, and a credible and coordinated communication and consultation process.

Wi th th is in view, the preparation efforts have focused on carrying out a detailed stakeholder analysis, public consultations with all key stakeholders, focus group discussions with identified groups (women, poor households, elected representatives etc.). A communication strategy has been prepared and this strategy, in turn, has been presented and discussed in stakeholder forums in each o f the three participating ULBs before finalization. The communication strategy emphasizes stake holder participation and outlines a strategy for their continued participation at al l stages o f the project and thereafter (including institutional arrangements to facilitate the process) during post-implementation.

6.3 How does the project involve consultations or collaboration with NGOs or other civil society organizations?

NGOs and c iv i l society organizations have been associated with the preparation o f the project. The Bank preparation teams have been regularly meeting with many o f these organizations during missions, and the response received has been very encouraging. NGO services would continue to be utilized for community consultations and social intermediation efforts. Local community-based and professional organizations have volunteered to assist in creating awareness and monitoring implementation processes.

6.4 What institutional arrangements have been provided to ensure the project achieves i t s social development outcomes?

A Social Assessment has been undertaken as part o f project preparation to design the project processes and institutions. Some important features o f the exercise include emphasis placed on: (i) stakeholder analysis; (ii) communication strategy; (iii) extensive stakeholder consultations; (iv) continuation o f the Social Assessment in the form o f social intermediation efforts in the demonstration zones; (v) putting in place an institutional framework for continued stakeholder involvement consistent with the 74th constitutional amendment; (vi) specific measures for inclusion, transparency, and accountability o f key stakeholders; (vii) 24/7 customer complaint centers for grievance redressal; and (viii) participatory monitoring systems.

6.5 How will the project monitor performance in terms o f social development outcomes?

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As part o f the Social Assessment, baseline data for the demonstration zones has been collected and monitoring indicators developed on a participatory basis. The proposed institutional arrangement at the ward level, (leading ultimately to the ULB level as the project i s scaled up during subsequent phases) will enable communities to monitor performance. Norms have been laid out for service standards and the OC would be held accountable for performance against norms. The proposed 24/7 customer complaint centers wil l provide continuous access to local communities to voice their grievances and seek remedial action.

7. Safeguard Policies: 7.1 Are any o f the following safeguard policies triggered by the project?

7.2 Describe provisions made by the project to ensure compliance with applicable safeguard policies.

Environmental Assessment: OP 4.0 1 on environmental assessment i s triggered. Because o f the nature and the small size o f the investments considered under the project, no significant environmental impacts are expected. The LEA o f the envisaged works, and an EMP including ECOPs will be fully integrated in the contract for implementation and operation o f priority works and demonstration projects and will be the responsibility o f the consulting firm implementing the works.

Indigenous Peoples: The project will not cause any adverse impact to indigenous people. The Social Assessment has examined the applicability or otherwise o f the Bank's Operational Directive on Indigenous Peoples (OD 4.20), taking into account the key characteristics o f identifying such groups as defined in the Operational Directive. Findings from the Social Assessment (based on surveys o f the demonstration zones, consultations with scheduled tribes (STs) and other potential groups and discussions wi th knowledgeable professionals and academia) indicate that O D 4.20 i s not triggered.

Cultural Property: The LEA noted that there are no cultural properties along the right o f way o f the proposed investment activities in the demo zones. However, the possibility o f a chance find can not be ruled out. Therefore, procedures for addressing a chance find o f cultural properties are included in the E M P and the environmental codes o f practice. A contract clause would be inserted in the agreement for construction activities in the demo zones.

Involuntary Resettlement: The project envisages to optimize the bulk supply pipeline routes to

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derive maximum benefits to the end users. Some o f these benefits are increased technical soundness o f the project, reduced leakages, cost savings (due to reduced length o f pipelines and lengths o f service roads to be built) and uninterrupted supply for 24/7 to demonstration zones and improvement in water supply tb rest o f the city in the selected ULBs. Land acquisition under the current project i s l ikely to be minor and impact on individual farmers i s not expected to be substantial. No resettlement i s contemplated as no structures would be acquired or demolished. Social assessment has also indicated that share cropping i s not practiced in the project areas. In view o f land acquisition involved, OP 4.12 on involuntary resettlement i s treated as triggered. In this context, a land acquisition framework has been prepared to apply for any minor land acquisition that may take place under KUWASSIP I. The project will make every effort to minimize land acquisition and also attempt to minimize temporary adverse impacts and compensate affected persondfamilies for such temporary effects. The project will also ensure that affected persons are consulted well ahead and are involved in planning remedial actions. The project will adopt transparent procedures for determination o f compensation based on market prices and a resettlement action plan would be prepared consistent with this frame work. Vulnerable groups will receive additional support to ensure that their livelihood i s not affected adversely. Investments under future potential follow-on projects may warrant land acquisition depending on the nature o f investments proposed and a more comprehensive resettlement and rehabilitation policy would be developed, if needed, during the implementation o f the current project .

Risk From Outputs to Objective

Other safeguard policies such as OP 4.04 Natural Habitat and OP 4.36 Forestry are not triggered by the proposed project and th is has been confirmed in the LEA.

Risk Rating Risk Mitigation Measure

F. Sustainability and Risks 1. Sustainability:

Because o f the project's demonstration nature and phased approach, i t s overall sustainability wil l be gauged by the depth o f sector reform and maintenance o f service provision in the three participating ULBs. I t i s crucial that key sector reforms-legal, institutional and regulatory frameworks-be h l ly implemented to reinforce the enabling environment to improve financial, managerial, administrative and technical performance o f participating ULBs, ultimately leading to better modes o f service provision. The adoption o f a qualified OC to manage the demonstration zones and the training o f ULB personnel for such functions will help sustain the services over the long term. Also, the demonstration projects will test elements o f the sustainability o f a subsequent larger project.

2. Critical R i s k s (reflecting the failure o f critical assumptions found in the fourth column o f Annex 1):

M Counterparts have been nominated for each project componentkpecialty, and strengthening needs identified. Consultants can be engaged to supplement KUIDFC staff where required.

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Lack o f commitment and ownership o f the project.

ULBs' lack o f willingness to achieve proposed levels o f cost recovery.

Administrative and procurement difficulties and delays to procure goods and works necessary to implement the priority works and demo projects by the Operating Consultant. ULBs/GoK will not accept private operator (follow-on project).

From Components to Outputs State water sector reform advances

Resistance from U L B s to advance in service level reform. Resistance o f ULBs to PSP.

slowly.

Overall Risk Rating

i isk Rating - H (High Risk), S (Substantial Ri!

M

S

M

M

S

M

S

S , M (Modest Risk),

Proper implementation and supervision mangements made for the project. Communication strategy established to increase project awareness at ULB level. Communication strategy. A selection criteria for the demo areas would be the stated willingness o f the beneficiaries to pay a higher tariff in return for substantially improved levels o f service. As a condition o f further support beyond the first phase, tariffs would be restructured and increased to a level that covers high percentage o f O&M costs. The contract will clearly indicate that procurement o f goods, works, and services under the contract are the responsibility o f the Operating Consultant.

Communication strategy, continuous involvement o f ULBs in initial project's preparatiodimplementation process.

Sector development component. Permanent dialogue and close follow-up. Permanent dialogue, awareness campaign and workshops. Participation in implementation. Permanent dialogue, dissemination o f advantages o f PSP, support f rom state policy.

Negligible or Low Risk)

3. Possible Controversial Aspects:

None identified.

G. Main Loan Conditions 1. Effectiveness Condition

The following events are specified as additional conditions to the effectiveness o f this Agreement within the meaning o f Section 12.0 1 (c) o f the General Conditions:

a. The Project Agreement has been duly authorized or ratified by Kamataka, and i s legally bindmg upon Karnataka in accordance with i t s terms.

b. Guidelines for project implementation has been issued by G o K in the form o f a GO, specifying roles and responsibilities o f project participants

c. The Project Implementation Plan has been adopted.

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2. Other [classify according to covenant types used in the Legal Agreements.]

Financial Covenants

In addition to the standard financial covenants, the following apply: a. KUIDFC shall submit FMRs to the Bank showing actual versus budgeted expenditures,

forecasts o f cash requirements, physical and financial progress and procurement contract management information within 45 days o f the close o f every quarter beginning with the first quarter after project effectiveness in the format agreed with the Bank.

b. KUIDFC shall submit an audit report o f the continuing entity to the Bank within 6 months o f the close o f each financial year including the period o f retroactive financing agreed with the Bank. The f i rs t audit report shall be submitted to the Bank in the six months following the year o f project effectiveness.

c. KUIDFC shall submit to the Bank an audit report on project expenditures no later than six months o f the close o f the financial year starting with the year o f loan effectiveness.

Other Covenants

GoK shall ensure that, no later than June 30,2005: a. a proposal for the creation o f the KSUWSC shall have been presented to the competent

authority for adoption; and b. an investment framework and tariff policy for the urban WSS sector o f Karnataka shall have

been adopted.

H. Readiness for Implementation 1. a) The engineering design documents for the first year's activities are complete and ready for the start

of project implementation. c] 1. b) Not applicable.

E 2. The procurement documents for the first year's activities are complete and ready for the start o f

Ed 3. The Project Implementation Plan has been appraised and found to be realistic and o f satisfactory

17 4. The following items are lacking and are discussed under loan conditions (Section G):

project implementation.

quality.

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I. Compliance with Bank Policies 1.: I. This project complies with a l l applicable Bank policies, ir. 2 The following exceptions to Bank policies are recommended for approval. The project complies with

all other applicable Bank policies.

Team keader Sector ManagerlDirector Country ManagerlDirector

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Annex 1: Project Design Summary INDIA Karnataka Urban Water Sector Improvement Project

Sector Indicators: 1. Urban water sector reform implemented by the Government o f Kamataka (GoK) and the participating ULBs.

2. Improved urban water service delivery in the participating ULBs.

jector-related CAS Goal: 'overty alleviation through mproved and sustainable irovision o f water supply and anitation (WSS) services in he urban local bodies (ULBs) if Kamataka.

Sector/ country reports: Status reports o f Department o f Economic Affairs (DEA) and municipal statistics produced by GoK.

'roject Development lbjective: . Launch G o K s urban water ector reform process based in the state urban water )olicy.

Outcome I Impact Indicators: 1.1, The reform base i s established and initial reform activities are camed out. 1.2 The ground for Private Sector Participation (PSP) i s prepared as a realistic option for water and sanitation provision. 1.3 An enabling legal, regulatory, and financing frameworks are established for the sector. 2.1 Possibility o f continuous water supply i s demonstrated. 2.2 Priority bottlenecks to improve quantity o f water supply are solved. 2.3 Increased consumer awareness, commitment, and ownership for reform are

!. Improve urban water upply and sanitation services n participating ULBs and lemonstrate that sustainable, :fficient, and commercially riented service provision can )e achieved.

Project reports:

1.1 Progress reports from implementing agencies, mid-term-review evaluation, Implementation Completion Report (ICR), Operations and Evaluations Department (OED) end o f project evaluation.

2.1 Progress reports from implementing agencies, mid-term review evaluation, ICR, OED end o f project evaluation. 2.2 Customer satisfaction surveys.

from Goal to Bank Mission) nplementation o f state and x a l level reforms w i l l ontribute to improved erformance o f urban water ector and i t s long te rm ustainability .

From Objective to Goal)

. GoK, State l ine agencies nd ULBs maintain ommitment to urban water ector reforms. ,. No major natural disaster lr political disturbance would lccur during the mplementation period.

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lutput from each Zomponent: :omponent A l : State water iolicy implementation i s nitiated.

:omponent A2: krengthening o f Service Ielivery and Preparation o f :ollow-on Project in the 3 'articipating ULBs

2omponent B 1 : Priority nvestments are completed.

2omponent B2: Distribution ietworks are improved.

:omponent B3: lemonstration projects are ompleted.

Output Indicators:

A 1 (i) Establishment and operationalization o f the Kamataka State Urban Water Supply Council (KSUWSC). (ii) Establishment o f a policy framework for allocation o f funds and investment and pricing o f WSS services. (iii) Establishment o f a State Water and Sanitation Information System. A2 (i) Implementation o f financial management pilots in the participating ULBs, including separation o f WSS accounts and computerized bil l ing and collection systems. (ii) Definition o f the scope and scale o f follow-on private sector participation and scaling up in other ULBs. B 1 Improved overall water supply availability and quality in the three ULBs. Satisfactory technical audit and third party inspection o f priority investments. B2 Improved overall water supply availability and quality in the three ULBs. B3 (i) Volumetric tari f f adopted according to agreed principles in order to recover no less th