China - Chongqing Industrial Pollution Control and Reform Project : China - Chongqing Industrial Pollution Control and Reform Project

Document of The World Bank Report No: 27283-CHA IMPLEMENTATION COMPLETION REPORT (TF-22776 SCL-40450 TF-29174 TF-28471) ON A LOAN IN THE AMOUNT OF US$170 MILLION TO THE PEOPLE'S REPUBLIC OF CHINA FOR A CHONGQING INDUSTRIAL POLLUTION AND REFORM PROJECT June 17, 2004 Urban Development Sector Unit East Asia and Pacific Region  CURRENCY EQUIVALENTS (Exchange Rate Effective December 31, 2003) Currency Unit = Yuan (Y) Y1.00 = US$ 0.12 US$ 1 = 8.27 FISCAL YEAR January 1 December 31 ABBREVIATIONS AND ACRONYMS CAS Country Assistance Strategy C/DLP Country or district level projects CEPB Chongqing Environmental Protection Bureau CISGC Chongqing Iron and Steel Group Company CIPCRP Chongqing Industrial Pollution Control and Reform Project CLB Chongqing Labor Bureau CMG Chongqing Municipal Government CPC Chongqing Planning Commission CPMO Chongqing Project Management Office CSSC Chongqing Special Steel Company CUEP Chongqing Urban Environment Project (Ln. 4561-CHA) EAF Electric Arc Furnace EIA Environmental Impact Assessment ICB International Competitive Bidding LOC Line of Credit MIS Management Information System MLP Municipal level projects MOF Ministry of Finance PMO Project Management Office RAF Restructuring Advisory Facility SAR Staff Appraisal Report SARS Severe Acute Respiratory Syndrome SOE State Owned Enterprise SO2 Sulfur Dioxide TA Technical Assistance TSP Total Suspended Dust Particles ZICC Zhongxing Industrial and Commercial Company Vice President: Mr. Jemal-ud-din Kassum, EAP Country Director: Mr. Yukon Huang, EACCF Sector Director: Mr. Keshav Varma, EASUR Task Team Leader: Mr. Wiebe Moes, AFTU2  CHINA Chongqing Industrial Pollution Control and Reform Project CONTENTS Page No. 1. Project Data 1 2. Principal Performance Ratings 1 3. Assessment of Development Objective and Design, and of Quality at Entry 2 4. Achievement of Objective and Outputs 6 5. Major Factors Affecting Implementation and Outcome 14 6. Sustainability 15 7. Bank and Borrower Performance 17 8. Lessons Learned 19 9. Partner Comments 20 10. Additional Information 24 Annex 1. Key Performance Indicators/Log Frame Matrix 25 Annex 2. Project Costs and Financing 27 Annex 3. Economic Costs and Benefits 29 Annex 4. Bank Inputs 30 Annex 5. Ratings for Achievement of Objectives/Outputs of Components 33 Annex 6. Ratings of Bank and Borrower Performance 34 Annex 7. List of Supporting Documents 35  Project ID: P003646 Project Name: Chongqing Industrial Pollution Control and Reform Project Team Leader: Wiebe Moes TL Unit: EASUR ICR Type: Core ICR Report Date: June 17, 2004 1. Project Data Name: Chongqing Industrial Pollution Control and L/C/TF Number: TF-22776; SCL-40450; Reform Project TF-29174; TF-28471 Country/Department: CHINA Region: East Asia and Pacific Region Sector/subsector: Other industry (96%); Sub-national government administration (3%); Other social services (1%) Theme: Pollution management and environmental health (P); Environmental policies and institutions (P); Municipal governance and institution building (P); Social risk reduction (S); Technology diffusion (S) KEY DATES Original Revised/Actual PCD: 09/23/1993 Effective: 03/07/1997 Appraisal: 11/22/1995 MTR: Approval: 06/18/1996 Closing: 12/31/2002 06/30/2003 Borrower/Implementing Agency: PEOPLE'S REPUBLIC OF CHINA/CHONGQING MUNICIPALITY Other Partners: STAFF Current At Appraisal Vice President: Jemal-ud-din Kassum Russell Cheetham Country Director: Yukon Huang Nicolas Hope Sector Manager: Keshav Varma Katherine Sierra Team Leader at ICR: Wiebe Moes Neil Hughes ICR Primary Author: Neil Hughes; Herbert Boehm 2. Principal Performance Ratings (HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HL=Highly Likely, L=Likely, UN=Unlikely, HUN=Highly Unlikely, HU=Highly Unsatisfactory, H=High, SU=Substantial, M=Modest, N=Negligible) Outcome: S Sustainability: L Institutional Development Impact: M Bank Performance: S Borrower Performance: S QAG (if available) ICR Quality at Entry: S Project at Risk at Any Time: Yes  3. Assessment of Development Objective and Design, and of Quality at Entry 3.1 Original Objective: Introduction. For over two decades, China has been undergoing a transformation from a centrally planned economy to a market oriented one. By the early 1990s, it was evident that China's coastal provinces were the main beneficiaries of economic opening, so the government asked for Bank support in developing the country's lagging interior provinces. Chongqing Municipal Government (CMG) was selected because it was (a) the largest repository of accumulated capital and technical skills in the southwest; (b) was dealing with serious enterprise productivity and pollution problems; (c) had a municipal government committed to reducing industrial pollution and restructuring state-owned enterprises (SOEs); and (d) had the strong support of the central government to take a lead role in carrying out enterprise reforms. Both the government and the Bank felt that environmental pollution control and enterprise reform provided a sound basis for an industrial sector project which would help SOEs make the difficult transition to market-oriented operations. Both agreed that reform objectives needed to be closely allied to environmental pollution control objectives to ensure that project outcomes would be environmentally sustainable. Against this backdrop, the Chongqing Industrial Pollution Control and Reform Project (CIPCRP) was conceived to assist CMG in attaining three main objectives: Objective (a), to achieve a significant reduction in pollution and restructure productive facilities in Chongqing's most polluting industry, iron and steel, which was still using highly obsolete and inefficient 1940s and 1950s technology in steel making; Objective (b), to increase the effectiveness of Chongqing's environmental regulatory framework and pollution management capacity as part of a plan to reduce industrial pollution overall; and Objective (c), to assist industrial enterprises outside the steel sector to reduce pollution and modernize their facilities. Assessment of objectives. The project objectives were clearly defined and consistent with the Bank's evolving strategy in supporting SOE reform and industrial pollution control. They supported the Bank's Country Assistance Strategy (CAS) objectives and sector work recommendations, were responsive to both national and municipal government developmental priorities, and were realistic given the Borrower's firm commitment to carry out its economic reform program. 3.2 Revised Objective: Following the cancellation of the Line-of-Credit (LOC) component in 1999, Objective (c) was no longer applicable. Objectives (a) and (b) did not change because they did not depend on Bank financing. Schedule 2 of the Loan Agreement was not amended to reflect this change because it was felt that the project's overall objectives remained substantially the same. 3.3 Original Components: The Bank loan was approved by the Board on June 18, 1996 and became effective on March 7, 1997. Its four main parts are described below. - 2 -  PART A included economic and environmental policy agendas and action plans designed to assist CMG in implementing its economic reforms and in improving its monitoring and control of environmental pollution, and enforcement of environmental laws and regulations; PART B consisted of two parts. The industrial relocation subcomponent included closure of Chongqing's two obsolete and most polluting steel plants located in the center of Chongqing, and their construction of modern non-polluting productive facilities outside the city center. The Restructuring Advisory Facility (RAF) subcomponent was to assist SOEs in preparing restructuring plans and related investment strategies in order to meet the creditworthiness standards of banks wishing to finance such enterprises under Part D (see below) of the Project; PART C included a LOC to support industrial enterprises that had adopted a corporate structure, had a viable business plan prepared by the RAF or other certified entity, had completed an environmental audit by the Chongqing Environmental Protection Bureau (CEPB), and required financing to restructure productive facilities and clean up pollution; PART D provided for technical assistance to strengthen the CEPB's environmental monitoring and regulatory capability, to enable the Chongqing Labor Bureau (CLB) to train and re-employ surplus labor and assist the Chongqing State Asset Management Bureau to establish a new form of state asset management organization. Assessment of project design. The project components were reasonably well related to achieving the project objectives. However, the project was quite complex and involved numerous implementing agencies, none of which had any prior experience with the Bank's policies and procedures. Coordinating this project was recognized as a challenge for CMG. 3.4 Revised Components: At the request of the central government, a total of $104 million was cancelled in 1999 in two separate increments of $42,000,000 and $62,000,000 from Part B (industrial restructuring and relocation) of the project. The three participating banks under Part C (LOC) withdrew from the project, and the $50 million allocated to this component was cancelled in two separate cancellations of $16,000,000 and $34,000,000, at the request of the central government in 1999. In 2000, the central government requested cancellation of $10,828,690.48 including $10,000,000 that was unallocated, $630,000 for the surplus labor re-deployment and $120,000 to establish a model cross-sectoral state asset operating company from Part D (institutional strengthening), and $78,690.48 for interest during construction for CSSC. Total cancellations amounted to US$166,149,161.40 at closing. The legal documents were not formally amended, but the cancellations were likely reported in the Monthly Report to the Executive Directors. The reasons for the cancellations are summarized below. Cancellation of Steel Plant Restructuring and Relocation (Part B): Initially, investments in new plant and equipment for both the Chongqing Iron and Steel Group Company (CISGC) and the Chongqing Special Steel Company (CSSC), were not allowed to proceed because the central government was concerned about excess capacity in the steel industry, and central government objected to CSSC's intention to establish its new steel plant in a rural area (there was a freeze on using agricultural land for nonagricultural purposes). During the East Asia financial crisis of - 3 -  1997-1998, declining demand and falling international steel prices led to increasing competition from low-priced imports, and the financial performance of the two companies suffered. With its 1950's steel making technology and many redundant workers, CSSC was a very high cost and inefficient operation. It could not match competitors' prices, and between 1993-1996, its regional market share in special steels declined from 60 to 35 percent. By 1998, in spite of drastic cost-cutting, the outlook for CSSC looked grim, and the Bank and the Borrower decided to cancel this part of the project. CISGC was listed on the Hong Kong stock exchange in 1997 and raised $85 million in new equity. The company actually increased its sales volume during the difficult 1997-1998 period. However, severe competition resulted in much lower margins on sales, and it could not meet its debt service coverage requirement with the Bank. In 1999, the Bank temporarily halted implementation of the entire project. It informed CMG that the project could restart once: (a) CMG furnished the Bank with a financial restructuring plan demonstrating that CISGC would meet its financial obligations under the project; and (b) CMG would commit to providing the equity financing required by CISGC. The Bank further required that CISGC prepare an appropriate study of its restructuring needs which the Bank could then use as the basis for its appraisal of the company's restructuring. As the financial outlook and thus the long-term sustainability of the company remained uncertain and, in addition, local currency loans became available markedly below the Bank Loan's interest rates, it was decided that cancellation of Part B and most of Part D of the project was the rational and preferred option under the circumstances. Cancellation of Line-of-Credit Component (Part C). Cancellation of this component occurred because participating banks could provide local currency financing at lower interest rates than the Bank loan without having to meet Bank requirements governing enterprise eligibility, project appraisal and procurement. By borrowing in local currency, enterprises could also avoid the foreign exchange risk which they had to assume on Bank sub-loans. Cancellation of Surplus Labor Re-employment Support (subcomponent of Part D). The magnitude of Chongqing's surplus labor problem became apparent only in 1997, when Chongqing doubled in size and population and the Asian financial crisis affected SOE performance. CLB therefore decided to expand its job training and re-employment facilities from one center to 43 centers, and to create a management information system (MIS) dealing with the whole social security system. The Bank was asked to agree to use $10 million of unallocated Loan proceeds to finance this effort. When project implementation was temporarily halted by the Bank in 1999, senior Ministry of Finance (MOF) and CMG officials requested the Bank to allow work to continue on this component. The Bank, however, suggested this component be included in a new Chongqing project focused on social protection issues. CMG eventually requested cancellation of this component, citing the ready availability of local currency at low interest rates as the reason. 3.5 Quality at Entry: Quality at entry is rated satisfactory. The Project was consistent with the Bank's CAS objectives of supporting the Chinese government's efforts to develop China's interior provinces, improving environmental protection, and advancing SOE reform. This approach was validated by Bank sector work ("Policy Options for Reform of Chinese State-Owned Enterprises", World Bank - 4 -  Discussion Paper No. 335 of 1996, and "China's Management of State Assets: the State as Shareholder" (1997).) The project also incorporated lessons learned from industrial restructuring projects in China, as well as world-wide. Its design of a pollution control strategy was based on the results of four studies carried out under grant financing from the Japanese government. A World Bank Project Management Office (PMO) was established to coordinate implementation of the project, and a Leading Group under a vice mayor was formed to provide direction and leadership to PMO. The project's compliance with Bank safeguard policies was satisfactory. The project was correctly determined to be a Category "A". Environmental assessments were prepared by the Chongqing Iron and Steel Design Institute, reviewed by the Bank, approved by the National Environmental Protection Agency, and submitted to the Bank's Board. The steel companies committed themselves to implementing the environments mitigation plans at negotiations. In addition to tackling air pollution, the project can be credited with making a head-start in addressing water pollution and hazardous waste management and disposal, as part of its overall industrial pollution control plan. With regard to involuntary resettlement, the project included a resettlement action plan (RAP) for the CSSC. The RAP covered resettlement of some 3,018 individuals in 1,014 households. A socioeconomic survey of all 1,014 households on the affected site (Jinkou Farm) was carried out, and the RAP revised accordingly. The project had available agreed terms of reference, selection criteria and procedures for an external monitor for the RAP. The project's resettlement policy framework was provided in the SAR (Annex 3.10). Finally, the PMO had established a resettlement unit to ensure that resettlement policies and procedures would be followed, to coordinate with stakeholders, to supervise the mitigation actions, and to provide periodic reports to the government and the Bank. Risk assessment. The project's risk assessment was mixed. The first major challenge cited was CMG's possible inability to maintain the political will to carry through the full range of reforms. In fact, CMG has sustained its will for environmental reform steadily to the present. The second significant risk relating to the commitment by the financial institutions to implement the line-of-credit component was also correctly identified as the banks would be unwilling to carry the financial risks of high priority environmental projects. Another major risk cited, the CMG's lack of experience in implementing a Bank project, particularly CEPB, was borne out in implementation. In contrast, the risk that there could be a shortage of counterpart funding never became an important issue. Demand for project outputs. The assumption that the Chinese economy would continue to grow along established patterns, thereby maintaining demand for steel and iron products, seemed reasonable at the time of appraisal in November 1995. However, that assumption turned out to be incorrect, particularly with regard to the steep decline of the iron and steel markets in the late 1990s when the East Asia financial crisis hit. 4. Achievement of Objective and Outputs - 5 -  4.1 Outcome/achievement of objective: The overarching goal of the project was to assist CMG in significantly reducing air pollution in the metropolitan area. Despite cancellation of most of the Loan amount, the project's key development objectives were substantially achieved. However, as it is exceedingly difficult to determine the project's actual contribution to achieving these objectives, its performance is cautiously rated moderately satisfactory. The project achieved its primary goal of eliminating the two major sources of air pollution in Chongqing's iron and steel industry. This goal was achieved even though Bank support to construct modern non-polluting steel production facilities, to replace those being closed down, was no longer available. Chongqing's improved air quality has been confirmed by Bank supervision missions and is further substantiated by the project's development objective indicators (see tables below). Two of the three project institutional objectives have been achieved in spite of the loan cancellations. Both CMG and the central government have taken steps to ensure that Objective (a), pertaining to reducing air pollution, was carried out. Objective (b), which involved strengthening pollution monitoring, regulation and control at CEPB, has been achieved now that monitoring data is available to enable CEPB to establish a pollution control plan covering the entire industrial sector. Objective (c) pertaining to the utilization of the LOC was no longer applicable after cancellation of the LOC component. Achievement of Objective (a). The project outcome, in terms of the satisfactory rating for CMG's efforts to control and regulate environmental pollution, was achieved because CMG's commitment to carry out the environmental policies and action plans included in the project, remained firm throughout project implementation. This level of commitment was sustained even when the project was in abeyance between May 1999 and March 2000 because project action plans were such an integral part of CMG's own policy reform agenda, and because the central government provided strong leadership support and enacted key legislation for strengthening the pollution control regulatory framework. Most of all, this was due to CMG's realization that economic growth had to be environmentally sustainable if permanent damage to the environment and its inhabitants was to be avoided. The project's development objective indicators measure the degree to which air pollution, in the form of ambient concentrations of particulate matter, were reduced in the Jiangbei and Shapingba urban districts, where CISGC's and CSSC's most polluting facilities were located. To achieve the targeted particulate reductions, CISGC and CSSC agreed to shut down their steel making plants in the two districts. The development objectives also sought to measure whether particulate air pollution would increase in the districts in which new steel making facilities were to be built. Air quality measurements at Jinkou Farm are no longer required, because the new steel making facilities, which were expected to be built there, were not constructed (See sections 3.4, 5.2 for details). - 6 -  CISGC closed down all steel making facilities at Jiangbei, except for a steel pipe rolling mill powered by natural gas, which has a negligible impact on air quality. The project's objective of eliminating air pollution at the Jiangbei plant has therefore been effectively met, and this is confirmed by monitoring tests required to meet the project's development objectives. CSSC closed down eight of ten highly polluting electric arc furnaces (EAFs) at its Shapingba plant, installed dust control equipment on the other two EAFs, and added one new EAF with dust control equipment, which was financed by the Government through its technical reform investment company. The positive impact of these actions has been confirmed by air quality monitoring tests carried out in accordance with the project's development objectives. CSSC did not go ahead with its intended expansion and has reduced its steel-making capacity by 67 percent and its workforce by 88 percent. 4.1: DEVELOPMENT OBJECTIVE INDICATORS Ambient air quality: micrograms of total suspended dust particles (TSP) per normal cubic meter (uNm3) OBJECTIVE A 1995 1996 1997 1998 1999 2000 2001 2002 Shapingba District 570 310 300 290 330 310 270 260 Jiangbei District 520 310 330 260 200 290 240 260 Dadukou District 360 250 260 220 220 210 240 290 Jinkou Farm not applicable (see section 5.2 on prohibition of agricultural land for industrial development) In 1995, CSSC's steel making facilities were responsible for 44 percent of ambient TSP levels in Shapingba District and CISGC's steel plant in Jiangbei was responsible for 22 percent of ambient TSP levels there. CISGC also had a steel plant at Dadukou, and the new facilities, which were to have been financed by the project, were to have relocated there. The reductions in ambient TSP levels, reflected in table 4.1 above, show steep drop-offs in TSP, and vividly indicate CMG's serious commitment to reducing air pollution from the steel sector. The closure of two-thirds of CSSC's outmoded and highly polluting facilities in Shapingba, and the installation of pollution control equipment on the rest, clearly had the biggest impact on TSP levels, especially as CSSC was responsible for almost one-half of dust emissions in the district. CISGC's contribution to reducing TSP levels in Jiangbei was also very significant. Since both these districts contained a large urban population, the positive impact on human health was immediate and is one of the major benefits resulting from reducing pollution from Chongqing's most polluting industry. CISGC's facilities in Dadukou District were more modern and less polluting. Nevertheless, the effects of pollution control efforts there are also quite notable. - 7 -  Achievement of Objective (b). Objective (b) was satisfactorily met. Four priority actions were required to improve CEPB's pollution monitoring, regulatory capacity and control. CEPB's compliance with these four actions, comparing percentage targets to actual percentages achieved, is noteworthy: l priority polluting firms monitored for SO2 emissions - fully met l registered firms completing environmental impact assessment - fully met l cumulative increase in pollution levy revenues - fully met l firms completing "third synchronization" approval - fully met Tables 4.2 and 4.3 below give institutional targets at appraisal and actual achievements. The paragraphs on "environmental regulatory reform program and action plan" in section 4.2 below provide further details. 4.2: INSTITUTIONAL PERFORMANCE INDICATORS (APPRAISAL ESTIMATE) 1997 1998 1999 2000 2001 2002 OBJECTIVE A: CSSC and CISGC/ZICC Net profit before taxes as % of total sales revenue Measured against performance indicators in 5-year rolling financial projections debt-to-equity ratio 70:30 debt service coverage 1:2 OBJECTIVE B: CEPB % of priority polluting firms reporting/monitored for 20 35 55 75 90 100 SO2 emissions % of registered firms completing EIAs 75 85 95 100 100 100 % cumulative increase in pollution levy revenues 10 20 30 40 50 60 (based on all pollutants) % of firms completing "third synchronization" approval 30 50 75 100 100 100 OBJECTIVE C % line-of-credit commitment 50 75 100 % line-of-credit disbursement 15 35 65 85 100 % EIA mitigation plan compliance 25% (as percentage disbursements) Net profit amount, and as % of sales Measured against performance indicators in enterprise restructuring plans - 8 -  4.3: INSTITUTIONAL PERFORMANCE INDICATORS (ACTUAL) 1997 1998 1999 2000 2001 2002 OBJECTIVE A: CSSC and CISGC/ZICC Net profit before taxes as % of total sales revenue n/a n/a n/a n/a n/a n/a debt-to-equity ratio 70:30 n/a n/a n/a n/a n/a debt service coverage 1:2 n/a n/a n/a n/a n/a OBJECTIVE B: CEPB % of priority polluting firms reporting/monitoring for SO2 emissions 70.0 98.0 98.0 100.0 100.0 100.0 % of registered firms completing EIAs MLP* 100.0 100.0 100.0 100.0 100.0 100.0 C/DLP** 80.0 84.0 86.0 91.4 99.7 100.0 % cumulative increase in pollution levy revenues 30.6 66.2 73.0 89.0 99.0 100.0 (based on all pollutants) % of firms completing MLP* 97.0 98.0 100.0 100.0 100.0 100.0 "third synchronization" approval C/DLP** 70.0 73.0 94.0 95.7 99.9 100.0 *MLP: municipal level projects **C/DLP: county or district level projects OBJECTIVE C Not applicable after cancellation of LOC component. Achievement of Objective (c). After the cancellation of the Loan proceeds for the Line of Credit component, this objective was no longer applicable. 4.2 Outputs by components: Part A: Economic Reform and Environmental Pollution Control Action Plans The Chongqing Municipality Economic Policy Reform Agenda and Action Plan was used as both a planning and implementation tool by CMG during project implementation. Specific objectives monitored during Bank supervision missions were: (a) achieving corporatization and management autonomy of SOEs; (b) divesting SOEs of social welfare functions; (c) facilitating mergers or bankruptcy of nonviable SOEs; (d) retraining and redeployment of redundant labor; (e) developing a residential housing market by selling public housing to private owners and increasing public housing rents; and (f) establishing a municipality-wide social insurance system. CMG's progress in carrying out these reforms has been mixed because: