Nicaragua - Third Managua Water Supply Project

Document of 2t,E, t1S|?03 The World Bank FOR OFFICIAL USE ONLY Report No. P-2166-NI REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO ETMRESA AGUADORA DE MANAGUA WITH THE GUARANTEE OF THE REPUBLIC OF NICARAGUA FOR THE MANAGUA WATER SUPPLY III PROJECT November 15, 1977 Latin America and the Caribbean Regional Office This document has a restricted distribution and may be used by recipients only in the performance of their officiai duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS US$1.00 = 7 Cordobas (C$) c$l.oo = us$o.1429 FISCAL YEAR January 1 - December 31 ABBREVIATIONS AID - Agency for International Development CABEI - Central American Bank for Economic Integration CARE - Cooperative for American Relief Everywhere EAM - Managua Water Company (Empresa Aguadora de Managual DENACAL - National Department of Water and Sewerage IDB - Inter-American Development Bank MOH - Ministry of Public Health PLANSAR - National Plan of Basic Rural Environmental Sanitation  FOR OFFICIAL USE ONLY NICARAGUA MANAGUA WATER SUPPLY III LOAN AND PROJECT SUMMARY Borrower: Empresa Aguadora de Managua (EAM) Guarantor: Republic of Nicaragua Amount: US$10.1 million equivalent Terms: 17 years including 4 years of grace, with interest at 7.9 percent per annum. Project Description: The project would provide potable water require- ments for the population of Managua up to 1985, expand production, transmission and distribution facilities and provide most of the house connections to serve 215,000 additional persons (over half of which are urban poor, defined as those persons earning less than one-third of the national average per capita income); strengthen EAM opera- tional and administrative capacity; determine future water supply sources; and determine the most suitable institutional arrangements for the sector. It comprises construction and equip- ment of six deep wells, construction of three water tanks, installation of distribution mains and 20,000 house connections, acquisition of pumping equipment and a new computer, and consulting services. Since Managua is in an earthquake zone, the project works have been designed to withstand seismic effects.  Estimated Cost: US$ millions Local Foreign Total Las Mercedes Wells 0.2 0.8 1.0 Pumping Stations 0.1 0.2 0.3 Reservoirs 0.2 0.2 0.4 Downtown Mains 0.1 0.3 0.4 Network Improvements 0.5 0.1 0.6 Distribution Mains 0.6 3.6 4.2 House Connections 0.3 1.1 1.4 Subtotal 2.0 6.3 8.3 Computer -- 0.4 0.4 Training and Studies 0.1 0.4 0.5 Engineering 0.4 0.2 0.6 Subtotal 0.5 1.0 1.5 Total base cost 2.5 7.3 9.8 Contingencies - technical 0.4 1.1 1.5 - price 0.8 1.7 2.5 Total project cost 3.7 10.1 13.8 Financial charges -- 1.4 1.4 Financing required 3.7 11.5 15.2 Financing Plan: US$ millions Local Foreign Total Percentage IBRD Loan - 10.1 10.1 66 Commercial Bank - 1.9 1.9 13 Internal Cash Generation 3.2 - 3.2 21 Total Sources 3.2 12.0 15.2 100 Estimated Bank Disbursements: US$ millions by FY 1978 1979 1980 1981 Annual: 0.2 4.2 4.9 0.8 Cumulative: 0.2 4.4 9.3 10.1 Internal Rate of Return: 14.0 percent Staff Appraisal Report: 1669-NI dated November 9, 1977  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO EMPRESA AGUADORA DE MANAGUA WITH THE GUARANTEE OF THE REPUBLIC OF NICARAGUA FOR THE MANAGUA WATER SUPPLY III PROJECT 1. I submit the following report and recommendation on a proposed loan for the equivalent of US$10.1 million to Empresa Aguadora de Managua, with the guarantee of the Republic of Nicaragua, for a third water supply project. The loan would have a term of 17 years, including 4 years of grace, with interest at 7.9 percent per annum. Co-financing for this project will be provided by a commercial bank loan totalling US$1.9 million. PART I - THE ECONOMY 2. A memorandum entitled "Economic Memorandunm of Nicaragua" (Report No. 914-NI) was distributed to the Executive Directors in November 1975. An updating economic mission visited Nicaragua in June 1977 and a new report is now being prepared. The following discussion incorporates the main findings of the 1977 economic mission. 3. Nicaragua's major natural resource is its arable land, which is suitable for a variety of products. Although the share of agricultural production in total output has declined in recent years, agriculture con- tinues to be the main source of economic expansion, and is responsible for about 45-50 percent of employment and almost 70 percent of export earnings. The country is divided into three distinct agricultural zones: The Pacific Zone, where about 60 percent of the nation's 2 million population lives, is marked by a dual structure of farming -- a large number of small farms grow basic grains with conventional technology, and a few large farms specialize in cotton and sugarcane using modern technology; the mountainous Central District is devoted mainly to coffee and livestock; and the large Atlanti- Plain holds a largely unutilized potential for forestry and live- stock production. 4. Nicaragua's economic growth prior to the 1972 earthquake was impressive, although it was characterized by sharp cyclical changes. Real income grew at an average annual rate of 6.4 percent (3.5 percent per capita) during the 1946-1972 period. The strong upward trend'in income resulted from the expansion of production for exports, primarily of cotton, coffee, and beef, but also of simple manufactured goods. The substantial growth of the economy, however, did not mitigate the highly skewed distribution of wealth and income. Moreover, the rural sector is characterized by a dualistic  structure of agricultural production and the related, highly concentrated pattern of land ownership. The poorest one-third of the rural population, for example, holds only about 3.5 percent of the country's arable land. 5. Progress in reducing disparities in income and consumption has been delayed by the persistently low level of public expenditures. The slow growth of current expenditures -- and a consequent shortage of important public service facilities such as education and health -- largely reflects budgetary stringency dictated by insufficient revenues. Outside the field of transport and electricity, the process of project identification and preparation has been very limited in the past. As discussed below, however, progress has been made in both fiscal performance and project preparation in the last three years. 6. The earthquake which struck Managua on December 23, 1972 took a toll of about 10,000 lives, and destroyed or rendered unusable practically all the central zone of the city, including most government offices, hospitals and schools, the financial and commercial buildings and perhaps 2,500 shops engaged in small-scale manufacturing and retail trade. About 32,000 housing units, or about 45 percent of the housing in the Managua area, were destroyed. The impact of the earthquake on productive capacity, however, was considerably lower than initially feared, and the economy has recovered at a much faster pace than originally estimated. Growth in GDP was 4.2 percent in real terms in 1973 and reached 13 percent in 1974. The impressive growth of the latter year was mainly attributable to construction activity in Managua. Unemploy- ment, which had increased very steeply in 1973, moved down to pre-earthquake levels of about 6 percent in 1974. However, as a result of slackening recon- struction activity, compounded by a weak external demand for some of Nicaragua's industrial exports, 1/ GDP grew by less than 2 percent in 1975. During 1976, improved world market conditions for Nicaraguan exports gave new impetus to economic expansion and GDP is estimated to have grown by over 6 percent during the year and by a somewhat higher rate in 1977. As far as the accomplishment of physical reconstruction is concerned, most public service facilities were back to, or exceeded, preearthquake levels by 1975, but much remains to be done to rebuild housing and commercial outlets for the poorer segments of the population. 7. The emergency taxes introduced after the earthquake reflected a major fiscal effort which resulted in the increase of the tax ratio to GDP from 8.9 percent prior to the earthquake to almost 11 percent in 1973-74. While new, permanent taxes were approved in late 1974 to replace the emergency measures, the yield of the new taxes has fallen short of expectations, and the tax ratio has declined slightly. The authorities are currently studying a new program to increase fiscal revenues. These increased domestic revenues are urgently required to finance the completion of reconstruction and the projected levels of investment in the Government's development program. 1/ E.g., exports of metal manufactures and chemical products, which to- gether accounted for 38 percent of manufactured exports in 1974, declined in real terms by 13 percent and in nominal terms by almost 18 percent in 1975.  - 3 - 8. Some progress in overall planning and project preparation has taken place in recent years. The public investment plan prepared by the Government for 1975-79 assigns priority to expanding agricultural production and improv- ing health, education and housing facilities for the rural poor. While a major effort is still required to improve project preparation in the fields of rural and social development, several projects have been developed recently or are in preparation in these fields; for example, in addition to the Bank's second education project (Loan 1244, signed on June 15, 1976), the IDB recently approved a loan for rural electrification. Also, the Government is proceed- ing with the reorganization of public sector agricultural institutions with financial and technical assistance from USAID. The main focus is on the implementation of an integrated rural development program -- INVIERNO -- which is supplying credit and technical assistance to low income producers in the Central Pacific and Central Interior regions and is also coordinating public activities in education, health, housing and infrastructure for the same target groups. The INVIERNO program became operational in 1976 and has so far provided credit and technical assistance to over 5,000 rural families. 9. In the years following the earthquake, cotton, coffee and beef have continued to be the leading traditional exports and constituted on the average 29 percent, 13 percent and 9 percent respectively of total merchandise exports over the period 1973-75. Relatively simple manufactured exports (e.g. tex- tiles, animal feed, chemical and wood products) have been rising rapidly and already represent over one-third of total exports. While imports averaged less than 30 percent of GDP until 1972, the post-earthquake reconstruction process, rapid credit expansion and higher import prices drove this figure up to 45 percent in 1974. The value of imports increased by almost 150 percent from 1972 to 1974, while earnings from exports increased by less than 60 percent; the resource balance changed from a surplus of US$23.0 million to a deficit of US$200.0 million. This deficit was covered by heavy borrowing during the period (much of it on commercial terms) and international reserves remained unchanged. The balance of payments situation improved substantially in 1975 when, largely as a result of slackening economic activity, imports declined by 10 percent, while export proceeds remained virtually unchanged. The resource gap declined from 14 percent of GDP in 1974 to 9 percent in 1975. 1/ A further improvement took place io 1976 and 1977 when the unusually favorable prices for exports of coffee and cotton reduced the gap to substantially lower levels. 10. Since the earthquake, Nicaragua's external public debt outstanding and disbursed has increased rapidly -- from about one-fourth of GDP in 1972 to over one-third in 1975. The average terms of the debt have hardened considerably because of heavy borrowing from private commerciaL sources. In the immediate future, because of high coffee prices, this may not result in too high a debt service ratio (the ratio for 1976 is estimated at 12.6 percent). However, as coffee and cotton prices decline from their present unusually high 1/ Derived from data at current prices.  - 4 - levels, the debt service ratio will tend to increase. However, if the country successfully undertakes a serious effort to further expand and diversify exports while keeping to a minimum additional external borrowing on commercial terms, the debt service ratio should not exceed 17 percent during the re- mainder of the decade. 11. The overall prospects for the country's future economic expansion will thus depend heavily on movements in international prices of its major exports (cotton, beef and coffee) and imports (especially petroleum and fertilizers), as well as on the success of policies in the following fields: (a) export diversification, which is most likely to be achieved through the promotion of resource-based exports such as wood products, fruits and vege- tables; (b) substitution of imports such as corn and some processed food products which could be produced efficiently in the country; (c) holding overall imports down to a reasonable level through appropriate domestic credit management; and (d) restraining external borrowing on hard terms. If these policies are implemented, the Nicaraguan economy may be expected to continue to grow at a satisfactory pace. External Finance 12. External official finance is provided principally by the IDB, USAID, the Bank and CABEI. Recently, the Venezuelan Investment Fund (VIF) has begun providing assistance to Nicaragua through a US$16.1 million equivalent loan for electric power. USAID has made loans for agriculture, highways, industry, rural electrification, housing, education and health. In agriculture, it has played an important promotional role in developing the INVIERNO program to assist rural development in some of the more depressed areas of the country. CABEI is financing projects with regional impact, principally in transpor- tation, industry and power. In addition, CABEI has lent for housing and in lesser amounts for education and agriculture. IDB is financing agriculture, water supply and sewerage, industry, housing, transportation and higher education. The lending of the principal external lending agencies from 1950 through 1976 is summarized below:  IBRD IDA USAID IDB CABEI TOTAL -------- (In millions of ITS dollars) --------- Total 126.7 23.0 166.1 181.8 121.1 622.7 Cumulative Lending 1950-65 35.6 3.0 20.7 42.4 13.3 115.0 Cumulative Lending 1966-76 91.1 20.0 145.5 139.4 111.8 507.7 Transport 16.0 - 2.8 3.5 52.3 74.6 Power and Telecommunications 44.3 - 15.0 16.5 19.7 95.5 Education 15.4 - 7.3 9.3 0.7 32.7 Health, Water and Sewerage 6.9 - 11.2 37.7 - 55.8 Housing - - 3.7 6.0 6.8 16.5 Agriculture 8.5 - 31.4 48.7 0.7 89.3 Industry and Commerce - - 5.0 16.7 26.5 48.2 Reconstruction - 20.0 45.0 - - 65.0 Other - - 24.0 1.0 5.1 30.1 PART II - BANK GROUP OPERATIONS 13. To date, Nicaragua has received 22 Bank loans and two IDA credits, totalling US$171.9 million. As of September 30, 1977 a total of US$43.6 million remained to be disbursed on six loans for education, power, agriculture and ports, and on the 1973 Earthquake Reconstruction Credit. The most recent operation was a loan for the equivalent of US$22.0 million for the Ninth Power Project, signed April 22, 1977. In general, progress on most of these projects has been satisfactory, although cost overruns in the past three and one-half years have hampered execution of several projects, particularly ports and electric power. With respect to the Earthquake Reconstruction Project: the power and water supply components were implemented without significant problems; a portion of the education component and the sites and services component were delayed initially, largely because of difficulties in acquiring sites, but are now nearing completion; and the industrial component suffered initial delays in the submission of acceptable projects by sub-borrowers, but has now been completely disbursed. Annex II contains a summary statement of Bank loans, IDA credits and IFC investments as of September 30, 1977, as well as notes on the execution of ongoing projects. 14. In the past, Bank Group lending was heavily weighted towards assisting Nicaragua develop basic infrastructure, through loans for electric power, ports and highways. More recently, an increasing share of Bank lending has been directed towards agriculture, water supply, education and earthquake reconstruction. The Bank's current lending program is designed to respond to Nicaragua's development requirements in several different ways. Given the importance of efforts to strengthen the balance of payments, one objective  - 6 - is to support Government programs for export diversification through loans for agriculture and industrial credit; another is to help reduce the country's dependence on imported fuel, possibly through a project for the development of Nicaragua's geothermal energy resources. Another major objective is assisting the Government to improve productivity and living conditions in the rural sector, which would be supported by the proposed Rural Sanitation Project, and by rural development projects designed to complement activities in progress under the INVIERNO program. In this connection, the Bank has agreed to send an FAO/CP mission to help identify and prepare a project for the first stage of a program for the development of the Atlantic frontier; the program will include feeder roads, land distribution, credit and technical assistance as well as necessary social infrastructure. The Bank also intends to assist the Government in improving living conditions in urban centers through a sites and services, urban upgrading and small business credit project, as well as through the proposed Managua Water Supply III Project. 15. The Bank's share of total external public debt disbursed and out- standing is likely to remain at about 10 percent on the average through 1981. The Bank and IDA's share of debt service in 1974 was about 11 percent; it is projected to decline during the remainder of the decade because of Nicaragua's substantial increase in relatively hard-term commercial borrowing in the past few years. 16. In FY 1968, IFC made a loan and equity investment totalling US$2.1 million equivalent to help establish a new cotton and synthetic fiber textile company (FABRITEX). IFC's equity has since been sold to local investors. FABRITEX was hampered in its early years by marketing problems associated with the difficulties experienced by the Central American Common Market, further aggravated by the 1972 earthquake in Managua. The company has now reorganized its operations and financial structure. In FY1976, IFC made a loan of US$6.5 million to Nicaragua Sugar Estates Limited to help expand its sugar production capacity, and a loan and equity investment totalling US$900,000 equivalent to help finance construction and equipment of the Camino Real Hotel in Managua. PART III - THE SECTOR Sector Background 17. The improvement of Nicaragua's water supply system during the 1960s contributed substantially to bettering health conditions in the country, but serious problems still exist as evidenced by a high infant mortality rate (146 per thousand births), high percentage of deaths among young children caused by enteritis and other diarrheal diseases (37 percent) and low life expectancy (52 years) relative to other Latin American countries. Sewage and industrial wastes are untreated and contaminate water resources, especially Lake Managua. The Government is preparing, for IDB financing, a sewage treatment project to resolve the lake's contamination problem. By 1975, about 100 percent of  Nicaragua's urban and 14 percent of its rural population had access to potable water. Of the urban population, 72 percent had house connections for water and 38 percent for sewerage; another 38 percent were served by latrines. Of the rural population, only 24 percent had access to latrines. Sector Organization 18. Public water and sewerage services in Nicaragua are provided by Empresa Aguadora de Managua (EAM), Departamento Nacional de Agua Potable y Alcantarillado (DENACAL) and the Ministry of Public Health. Four municipali- ties and some large industrial users have their own water sources. 19. EAM (discussed in detail in Part IV) is the capital city's main supplier of potable water. In 1976, it was serving 435,000 persons (90 percent of the city's population) with house connections; almost all others had access to community standpipe services. DENACAL is a national agency, dependent on the Ministry of Public Health, that operates sewerage systems in all urban areas as well as all urban water systems throughout the country, except in Managua and the four municipalities which have their own systems. In 1976, it served 62,000 water and 48,000 sewer houLse connections, reaching 320,000 and 390,000 inhabitants respectively. DENACAL has received financial assistance from the IDB, to which it is now presenting a Managua sewerage treatment project for financing. In the Managua area, the separation of responsibilities for water supply and sewerage between EAM and DENACAL has not caused serious problems in the past, but contamination problems could arise if the development of these two services is not coordinated and if the construc- tion of sewerage facilities is allowed to lag much behind the water supply house connections. This project, therefore, includes a study of the organi- zational arrangements for the coordination of these services in Managua (see paragraph 39). 20. The Ministry of Public Health has responsibility for rural water supply and excreta disposal. To develop these services, it created a new unit in 1976 called PLANSAR (Rural Health Program) responsible for planning and constructing rural sanitation systems. PLANSAR has initiated an ambitious program with AID assistance and would be the executing agency for the Bank's proposed Rural Sanitation Project, which is being presented separately to the Executive Directors. Sector Development 21. Investment for water and sewerage during the last six years (1971-76) reached US$38.2 million, or 7.8 percent of public fixed investment, with 95 percent of this investment being concentrated in urban areas. The Govern- ment now plans to extend, improve and integrate services, particularly in rural areas, thereby improving the living standards of low-income groups. Its target for 1981 is to serve 80 percent of the urban population by water house connections and 70 percent with sewerage connections, and in the rural areas, to serve 40 percent of the population with safe water and to provide 48 percent with latrines. In rural areas, the Government is aiming at integrated  - 8 - development, including education, sanitation and house improvements. These efforts are expected to increase life expectancy, reduce child malnutrition, increase productivity of the rural population, improve environmental and health conditions and help slow migration to urban areas. 22. External assistance has financed over half (53 percent) of urban and rural water/sewerage investment over the past five years. The IDB, AID and World Bank/IDA have supplied major aid for urban areas, while CARE has been a source of assistance for small rural communities, working with DENACAL to develop water supply for several towns below 3,000 inhabitants. An AID loan, approved in 1976, is financing the training of personnel for rural health, improving rural health care and providing water and excreta disposal services for rural communities in three regions which will not be covered under the Bank's proposed Rural Sanitation Project. In order for the Govern- ment to continue its program in the sector and achieve its targets for the country by 1981, it is estimated that public investment in the sector would have to grow on average at about 10 percent per year in real terms. Certain measures are being undertaken to help ease the financial burden of investment in this sector. In urban areas, the Government is trying to make DENACAL more self-sufficient by phasing out a program of giving foreign loans to it as grants. It is also recognized that efforts should be made to increase DENACAL's tariffs to cover operating costs in the urban areas and revise its tariff structure, which now consists of more than 60 categories which are cumbersome to administer and are characterized by little or no progressivity. Tariff increases and structural improvements have already been undertaken by EAM (see paragraph 32). In rural areas, the Government is emphasizing the development of simple designs and the participation of the community, in cash and labor, which will bring costs for construction, operation and maintenance of the systems to levels which will enable the country to readily duplicate the program in the future in additional communities. 23. The proposed project would support Government objectives by increas- ing the service level in Managua, mainly in the poorer sections of the city. The Rural Sanitation Project being presented separately would provide basic sanitation services (including water supply, latrines, sanitary house improve- ments, health education and child immunization) to the rural population in 3 of the country's 8 regions, to serve 250,000 additional people by 1988. Both would give strong impetus to the current Government policies of improving sanitary conditions and living standards of the poor. Prior Bank Projects 24. Bank Group lending for water supply in Nicaragua has included one loan, one IDA credit and a component of the 1973 Earthquake Reconstruction Project, all for the Managua area. The first operation in 1962 (First Managua Water Supply Project, Credit 26-NI) for US$3 million helped finance a US$6 million water supply project, which was successfully completed in 1966. Under this project, water supply capacity was expanded to allow an eventual increase in the number of house connections from 15,300 to 39,200 by 1972. The second operation in March 1972 (Managua Water Supply Project II, Loan 808-NI) for US$6.9 million helped finance a US$10.0 million project designed to develop and expand EAM's water sources, transmission and distribution facilities. It  - 9 - also included the construction of a new administration building and the provision of management consultant services. EAM was in the early stages of this project when the earthquake struck, and the project was subsequently modified to meet the new conditions in the service area resulting from the shift of a substantial part of the population from downtown to suburban areas. Because of earthquake damages to EAM's network, resulting in a loss of revenue, and the increased unit operating costs caused by the greater dispersion of Managua's population and their movement to higher areas on the outskirts of town which were more expensive to serve, it was forecast that EAM's financial situation would remain weak at least through 1978. To assist EAM under these circumstances the Bank agreed to amend Loan 808-NI to use US$850,000 (which were made available through deletion of certain project items no longer of high priority due to the changed circumstances) to finance loan interest and commitment charges, extend the closing and maturity dates by one year, waive the rate of return requirement through 1976, and lower it for future years (Board presentation R73-67, dated April 10, 1973). It is now estimated that EAM will achieve a 1.6 percent rate on unrevalued assets for 1977, approaching the 2 percent of the present covenant, and that tariff action to be taken in connection with this project will assure a 4 percent rate on revalued assets for 1978. Both the Second Managua Water Supply Project and the water supply component of the Earthquake Reconstruction Project have been completed. Bank/IDA experience with previous lending operations to EAM has been good, and consequently no particular problems are expected with the proposed Managua Water Supply III Project. PART IV - THE PROJECT 25. A report entitled "Staff Appraisal Report - Managua Water Supply III Project" dated November 9, 1977 is being distributed separately. The project was appraised in March/April 1977. Negotiations were held in Washington from October 18 to October 19, 1977. The EAM Delegation was headed by Mr. Luis Pereira Denueda, General Manager. The Government was represented by Mr. Raul Chavez, Economic Adviser of the Nicaraguan Embassy in Washington. 26. The objectives of this project are to provide potable water require- ments for the population of Managua up to 1985 (and peak summer requirements up to 1983), expand production, transmission and distribution facilities and provide most of the house connections to serve 215,000 additional persons (over half of which are urban poor, defined as those persons earning less than one-third of the national average per capita income), to strengthen the managerial and operational capabilities of EAM, to determine future water supply sources, and to determine the most suitable institutional arrangements for the sector. Although 90 percent of the population is currently served by house connections for water, Managua is growing rapidly and without this project the percentage of population thus served would decrease to 60 percent by 1985. The project aims to increase the proportion of the population served by house connections to 95 percent by 1982.  - 10 - Prolect Description 27. The project comprises: (1) construction and equipment of six deep wells (150 meters) with an aggregate capacity averaging six million gallons per day (Mgd); (2) additional pumping equipment with 3,000 gallons per minute (GPM) capacity for the Rafaela-Herrera, and 2,800 GPM for the Altamira, booster-pumping stations, and construction and equipment of three additional minor pumping stations; (3) construction of three 0.5 million gallon water tanks and one 0.126 million gallon tank south of Villa Fontana; (4) installation of 14.0 Km of secondary distribution mains (6" to 16" in diameter) in the downtown streets - Momotombo, Sa Avenida Este, Colon and Bolivar - to replace pipes and valves damaged by the 1972 earthquake and provide the new water distribution system required for the expansion and reconstruction of the area to be served by these streets; (5) replacement of malfunctioning valves (200) and hydrants (70), and elimination of 10,000 abandoned house connections; (6) installation of 86.3 Km of distribution mains (4" to 24" in diameter) outside the downtown area of Managua; (7) installation of 20,000 house connections to provide domiciliary services to cover 96 percent of the population by 1982; (8) a new computer to replace the present rented one, which has excessive maintenance problems and is no longer adequate for company needs; (9) a study to identify new water sources for the next expansion stage; (10) technical assistance and personnel training in preventive mainte- nance, pumping optimization, billing and inventory control, long- term planning and management of the commercial department; (11) a study of the organizational arrangements for water and sewerage services in Managua; and (12) consulting services for engineering design and supervision of the project. The construction of water mains in the downtown area (component 4) is designed to support Government plans to rebuild priority portions of this area (des- troyed by the earthquake) following a new Master Plan prepared by the Vice  - 11 - Ministry of Urban Planning. The Government is planning to reconstruct certain streets in this area, beginning in 1978, in order to improve through traffic in the center of Managua and to provide the required infrastructure for build- ings already in this area as well as for new commercial and official construc- tion being planned. The installation of water lines along these routes must be coordinated with the street construction. It has been agreed that no dis- bursement will be made for distribution mains in each of these streets until satisfactory evidence is received by the Bank that the construction work on that street has been undertaken (Loan Agreement, Schedule 1, para. 4(c)). Project Cost 28. The total cost of the project is estimated at US$13.8 million, with a foreign exchange component of US$10.1 million. Interest on loans during construction would add US$1.4 million, bringing total foreign financing re- quirements to US$11.5 million. Physical contingencies have been calculated at 15 percent for all project components. Base costs have been estimated at January 1977 prices, with an allowance for annual price increases of 7.5 percent during 1977-79 and 7 percent thereafter for foreign costs, and 12 percent in 1977, 9 percent in 1978 and 7.5 percent thereafter for local costs. The average cost of consultants (about 152 man-months are required) is esti- mated at US$5,100 per man-month (January 1977 prices). Details of project costs are presented in the Loan and Project Summary at the beginning of this report. Financing Plan 29. The proposed Bank loan of US$10.1 million would cover the foreign exchange component of the project. A commercial bank would provide co- financing for interest during construction and a portion of local costs of the project in the amount of US$1.9 million equivalent. It would be a condition of effectiveness that the commercial bank loan be signed (Loan Agreement, Section 7.01(a)). Net internal cash generation would finance the remaining US$3.2 million. Details of the financing plan are presented in the Loan and Project Summary at the beginning of this report. The Borrower 30. EAM has been a government-owned utility since 1932 and is tax exempt. Although the Ministry of Public Works has de Jure authority over it, FAM operates with considerable independence. Its new by-laws, enacted in February 1972, were developed in consultation with the Bank. Management is entrusted to a General Manager appointed by the Government and two Assistant Managers, one responsible for technical operations who replaces the General Manager in his absence and the other handling financial and administrative matters. As in previous projects, it has been agreed that the Government will request Bank views on any future appointment to the post of General Manager (Guarantee Agreement, Section 3.06). The present General Manager joined EAM in this capacity in 1974 and has performed well, both in execution of earlier projects and in administration. Reductions in operating costs are being  - 12 - implemented; 30 percent of the employees have received training at different levels; and budget control is well established. EAM bill collection is effective, with only one percent of the bills to private customers in arrears. However, there are some accounts overdue from Public Entities, and during negotiations assurances were obtained that prior to effectiveness the approxi- mately C$6.5 million owed by the Government to EAM as of August 31, 1977 would be paid or set off against existing Government loans to EAM in a manner accept- able to the Bank (Loan Agreement, Section 7.01(c)). In addition, it was agreed that by June 30, 1978 and at all times thereafter accounts due from Public Entities will not be more than two months in arrears (Guarantee Agree- ment, Section 3.02). Although EAM's management has been generally satisfac- tory, there is still need for further technical assistance and personnel training in preventive maintenance, pumping optimization, billing and inventory control, long-term planning and management of the commercial department. It was agreed that this assistance, totalling 16 man/months, will be contracted not later than June 30, 1978 (Loan Agreement, Section 3.02(b)). 31. EAM's level of spare parts inventory (9 percent of gross revalued fixed assets) is excessive, and it has been agreed that this level will be maintained within limits to be agreed between the Bank and EAM from time to time (Loan Agreement, Section 4.01(c)). EAM has indicated that it intends to lower the inventory level to 3 percent by December 31, 1979 and to 2 per- cent by December 31, 1981. EAM has a staff of 541, or 10 employees per 1,000 connections, which is high compared with the USA (3/1,000) but similar to other Latin American countries (average 9/1,000). This is in part due to the large number of production well fields and pumping stations controlled manually. EAM has agreed to maintain the employee/connections ratio within limits to be agreed with the Bank (Loan Agreement, Section 4.01(c)), and has stated the intention to achieve a ratio of not more than 8.5 employees per thousand con- nections by December 31, 1979 and 8 per thousand by December 31, 1981. Financial Position of the Borrower 32. Despite the earthquake-related problems described in paragraph 24, EAM's financial management has been sound and its financial position is expected to improve in the future. It has been agreed that EAM will maintain a rate of return of at least 4 percent on annually revalued average net fixed assets in operation during project construction (through the end of 1980) and 6 percent thereafter (Loan Agreement, Section 5.05(a)). This rate of return would enable EAM to finance 25 percent of its investment program for 1978-80 from internally-generated resources, and at least 30 percent of projected investments during 1981-85. In order to obtain the 4 percent rate of return through July of 1978, EAM raised its average tariff by about 25 percent in November 1977. At the same time it instituted a number of structural changes which provided for a reduction from 12 to 9 categories, for greater progres- sivity (for most residential categories the ratio of maximum to minimum charges per unit volume was increased from 2.5:1 to 3.75:1), and for a reduction of the minimum consumption to 5,000 gallons for all categories (minimum consump- tion for some residential categories had previously been 8,000 gallons), thus  - 13 - easing the burden on low-income users who currently consume less than the minimum amount. EAM has agreed not to change this structure except in agree- ment with the Bank (Loan Agreement, Section 3.07(a)). EAM is currently carry- ing out a study of its tariff structure and rates, which is to be presented to the Bank for review after its completion on February 28, 1978 (Loan Agree- ment, Section 3.07(b)). This study will form the basis of discussions of possible further structural changes. EAM has also agreed to implement a second tariff increase no later than July 1, 1978 in order to achieve the 4 percent rate of return for the entire year (Loan Agreement, Section 5.05(b)). In addition, it has been agreed that EAM will (1) revalue its fixed assets in service annually, using the consumer price index reported by the Nicaraguan Central Bank or such other methods of revaluation as the Bank and the Borrower shall determine from time to time (Loan Agreement, Section 5.05(a)), (2) obtain Bank concurrence before contracting further debt at any time that its debt service coverage falls below 1.5 (Loan Agreement, Section 5.04), and (3) control its operating costs within limits to be agreed between the Bank and EAM from time to time (Loan Agreement, Section 4.01(c)). On the third point, EAM has indicated that it intends to limit the average increase to no more than 3 percentage points over the percentage increase in consumer prices. 33. In order to assist its low-income customers, it has been agreed that EAM will maintain a revolving fund of at least US$1.0 million equivalent, on terms and conditions satisfactory to the Bank, to provide long-term loans to low-income households for financing water house connections (which for low-income households amounts to about $80, the approximate installation cost to EAM) (Loan Agreement, Section 4.03). Although the drilling of new wells in Managua is now controlled by EAM, there are still several industries using private wells which reduce the amount of water available to public service. It has been agreed, therefore, that the Government will implement, and cause EAM to implement, a system of water charges acceptable to the Bank for users of private wells no later than December 31, 1978 (Guarantee Agreement, Section 3.04). Project Execution and Procurement 34. The project will be carried out in three years. As a condition of effectiveness, EAM will contract consultants acceptable to the Bank, in accor- dance with procedures agreed with the Bank, to provide technical assistance in design, procurement and construction supervision of project works (Loan Agreement, Sections 3.02(a)(i) and 7.01(b)). It has also been agreed that consultants will be hired by June 30, 1978 to carry out the Water Sources Study for future expansion (Loan Agreement, Section 3.02(b)). 35. All contracts will be awarded through international competitive bidding in accordance with Bank Guidelines, except that civil works contracts under US$200,000 (other than for well construction) and contracts for purchase of equipment and materials under US$25,000, all up to an aggregate amount of US$1,000,000, may be awarded on the basis of local competitive bidding pro- cedures satisfactory to the Bank. Interested foreign firms would be permitted to participate. In accordance with the Central American Common Market (CACM)  - 14 - Agreement on Fiscal Incentives for Industrial Development, manufacturers from the CACM, including those in Nicaragua, will be allowed a preference of either 15 percent of the CIF price, or 50 percent of the tariff payable by non-CACM manufacturers, whichever is lower. It is expected that most civil works con- tracts will be won by Nicaraguan firms and almost all the equipment and material supply contracts by foreign firms. 36. It has been agreed that a system of monitoring indicators acceptable to the Bank and the Borrower will be established by March 31, 1978 to assess target accomplishment and project execution (Loan Agreement, Section 3.06). Disbursements 37. Disbursements would be made over a three and one-half year period for the percentages of costs shown below: (i) 100 percent of the foreign exchange cost of imported equipment and materials and 62 percent of total expen- ditures for civil works (representing the estimated foreign cost) for pumps, wells and pumping stations; (ii) 100 percent of the foreign exchange cost of imported equipment and materials and 43 percent of total expendi- tures for civil works (representing the estimated foreign cost) for distribution and transmission lines and water tanks; (iii) 100 percent of the foreign exchange cost of imported equipment and materials for house connections; (iv) 100 percent of the foreign exchange cost of the computer equipment; and (v) 100 percent of foreign expenditures for consultants' services. 38. Retroactive financing up to US$50,000 would be allowed for consultant expenditures incurred after August 31, 1977. Environmental Effects 39. As mentioned in paragraph 19, Managua's water and excreta disposal problems should be pursued simultaneously. In general,the proposed DENACAL sewerage treatment project for the city should lessen the possibility of contamination, and help prevent any significant adverse effects on the environ- ment. With particular reference to the areas to be served by the Managua Water Supply III Project, ten neighborhoods with a population of about 40,000 have been identified as lacking appropriate sewerage (other than latrines). While the IDB-financed project is expected to provide services to these neighborhoods, it has been agreed that in any event the Government will carry  - 15 - out, or cause to be carried out, sewage disposal works in these neighborhoods under programs satisfactory to the Bank and EAM (Guarantee Agreement, Section 3.03). Before actual disbursement of funds for project works in any of these neighborhoods, EAM would be required to furnish the Bank with a specific sewage disposal program satisfactory to the Bank for the neighborhood (Loan Agreement, Schedule 1.4(b)). In addition, it has been agreed that the Govern- ment will take reasonable measures satisfactory to the Bank to ensure that sewerage facilities are constructed in such a manner as to avoid contamina- tion of EAM's water sources and that the project will be carried out with due regard to ecological and environmental factors (Guarantee Agreement, Section 3.05). In the longer term and in recognition of the fact that coordination of water and sewerage services is difficult when handled by two separate entities, it has been agreed that EAM will conduct a study of the organizational arrange- ments for water and sewerage services in Managua in order to optimize the coordination of the different agencies involved in providing these services. This study is to be made by consultants under terms and conditions satisfac- tory to the Bank and coordinated with DENACAL and such other agencies as the Government may indicate. The consultants will develop recommendations for the unification of the services in one company or for other appropriate arrange- ment and include the analysis of the financing requirements for water and sewerage and the meeting of these needs through tariffs or tariffs plus a general "environmental tax" to be levied on the population and used to finance some future sewerage works, especially those, like pollution control, which benefit the whole population. It has been agreed that the consultants for this study will be hired no later than June 30, 1978 (Loan Agreement, Section 3.02(b)), and that the study will be presented to the Bank for review not later than June 30, 1979 (Loan Agreement, Section 3.02(c)). Project Risks 40. Based on the experience of earlier lending operations with EAM, no particular risks connected with project execution are foreseen. Managua is in an earthquake zone and special precautions have therefore been taken in the design of the project works to make them more able to withstand seismic effects. In general, it is felt that the risk of not achieving project objectives is low. Economic Justification 41. This project is the least-cost solution for expanding Managua's water supply needs at any discount rate above zero. The Jose M. Moncada well field is the only remaining water source within the city, and all other alternatives are more than 26 Km away from downtown lManagua and would be more expensive in both initial investment and operating costs. The project's internal rate of return (based on projected tariffs at January 1977 prices) is 14 percent. Sensitivity analyses show that if capital costs are 20 percent higher than estimated, the rate of return would be 12 percent, and that if capital costs are 20 percent higher and benefits 10 percent lower, the rate of return would be 10 percent, which is still acceptable. Not included in these  - 16 - calculations are the health and welfare benefits to be derived from the pro- vision of safe water by house connections to Managua's growing population. Mforeover, this project will provide employment for 300 people during the project construction period. PART V - LEGAL INSTRUMENTS AND AUTHORITY 42. The draft Loan Agreement between Empresa Aguadora de Managua and the Bank, the draft Guarantee Agreement between the Republic of Nicaragua and the Bank, the Report of the Committee provided for in Article III, Section 4 (iii) of the Articles of Agreement of the Bank, and the text of the Resolution approving the proposed loan are being distributed to the Executive Directors separately. The draft Loan and Guarantee Agreements conform to the normal pattern of loans for water supply projects and their more important features have been included in Part IV and summarized in Annex III of this report. There are three special conditions of effectiveness of the Loan Agreement: (i) that suitable engineering consultants satisfactory to the Bank have been hired to provide technical assistance in design, pro- curement and construction supervision; (ii) that a commercial bank loan of at least US$1.9 million for the project has been signed; and (iii) that C$6.5 million owed by the Government to EAM will be paid or set off against Govern- ment loans in a manner satisfactory to the Bank. Disbursement of funds for project works in certain neighborhoods would be contingent upon the Bank's receipt and approval of a sewerage plan for those neighborhoods, and funds for water development in the downtown areas would be disbursed only upon receipt of satisfactory evidence that street construction in those areas has been undertaken. 43. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank. PART VI - RECOMMENDATION 44. I recommend that the Executive Directors approve the proposed loan. Robert S. McNamara President by J. Burke Knapp Attachments November 15, 1977  ANNE_X I TABLE S PagE 1 of 4 pages LAW ARE (THOUh.2,; IC*APAGUA SOCIAL_INOICATORN ONTA SHEET EANO ARiA I(rHou 60)