Sri Lanka - Water Supply Project

Document of The World Bank FILE COPY FOR OFFICIAL USE ONLY Report No. P-2051-CE REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO TBE EXECUTIVE DIRECTORS ON PROPOSED CREDITS TO THE REPUBLIC OF SRI LANKA FOR A WATER SUPPLY PROJECT April 21, 1977 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS On May 24, 1976, the Sri Lanka Rupee was officially linked to a basket of currencies with the initial parity rate based on the Rupee/Pound rate at that date. Both the composition of the basket and the weights assigned to the currencies were revised on March 12, 1977. The current Rupee/US Dollar rate below, in effect during the preparation of the report, has been used throughout the report, except where stated to the contrary. US$1 = Rs 7.28 Rs 1 = US$0.137 Rs 1 M = US$137,363 Most non-foodgrain imports have to pay a surcharge through the purchase of Foreign Exchange Entitlement Certificates (FEECs), and most non-traditional exports receive a premium over the official rate through the sale of FEECs. The premium is now fixed at 65% of the Rupee parity rate, resulting in the following current exchange rates including FEECs: US$1 = Rs 12.01 Rs 1 = US$0.083 ACRONYMS AND ABBREVIATIONS CIDA - Canadian International Development Agency DCA - Development Credit Agreement FEEC - Foreign Exchange Entitlement Certificate GDP - Gross Domestic Product GNP - Gross National Product GOSL - Government of Sri Lanka MC - Municipal Council NDI - National Institute of Management, Sri Lanka ODM - United Kingdom Ministry of Overseas Development PA - Project Agreement TC - Town Council UC - Urban Council UNDP - United Nations Development Programme UNICEF - United Nations International Children's Emergency Fund WDB - National Water Supply and Drainage Board, Sri Lanka WHO - World Health Organization FISCAL YEAR Government of Sri Lanka: January 1 to December 31  FOR OFFICIAL USE ONLY INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON PROPOSED CREDITS TO THE REPUBLIC OF SRI LANKA FOR A WATER SUPPLY PROJECT 1. I submit the following report and recommendation on two proposed credits to the Republic of Sri Lanka totalling the equivalent of US$14 mil- lion on standard IDA terms to help finance a water supply project. One credit of US$9.2 million would be made from IDA resources; a second credit of Canadian $5.0 million (US$4.8 million equivalent) would be made from Canadian funds administered by IDA in accordance with the terms of the recently ap- proved Agreement between the Government of Canada and the Association. The proceeds of these two credits would be relent to the National Water Supply and Drainage Board (WDB) for 24 years, including five years of grace, with interest at 9% per annum. PART I - THE ECONOMY - 2. The latest economic report, "Sri Lanka: Country Economic Memo- randum" (Report No. 1425-CE, February 28, 1977) was distributed to the Exe- cutive Directors on March 1, 1977. Country data are provided in Annex I. 3. The economic difficulties that presently beset Sri Lanka can be traced principally to two basic characteristics of the country's economic and social system: first, the dependence of the economy on three export crops -- tea, rubber and coconut -- and, second, a political commitment to the welfare state. This commitment found its expression in two policy tenets which, for the past quarter century, successive Governments have followed in varying degrees: the supply of mass consumption goods, prin- cipally food and textiles, at low prices, and the provision of public ser- vices -- mainly education, health and transport -- free of charge or sub- stantially below cost. 4. Sri Lanka's progress in social fields has been noteworthy. Public services are widely available at little or no cost and a more equal distri- bution of income has been achieved by maintaining relatively high wages, subsidizing services, and distributing food free or below cost. The welfare state has been based mainly on the earnings of the export sector. This base, however, has been eroded by the pronounced weakening in the market for tea and rubber that began in the mid-fifties. Its effects on the earnings of the traditional tree crop exports, combined with the failure to establish new sources of growth, seriously affected the ability of the economy to gener- ate a surplus in the form of savings and exports, which in turn was one of the main reasons for the low economic growth in the past two decades. Between 1969/70 and 1975/76, GNP at constant prices increased at an annual rate of about 2.8%. With population growing at a rate of about 1.7% p.a. 1/ Part I - The Economy is identical to that in Part I of the Mahaweli Ganga Development Project II (P-2031-CE). This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without Worid Bank authoriution.  - 2 - between 1969/70 and 1975/76, there was only a slight improvement in per capita income. 5. Against this background, Sri Lanka had to face the shocks generated by the oil crisis and worldwide inflation. In response to the changed world economic conditions, during 1974/75 the Government of Sri Lanka (GOSL) took a series of measures to reduce the burden of subsidies on food and transport, and adjusted prices of key consumer goods such as petroleum products. How- ever, the impact was small, and the major economic problems -- increasing domestic savings, improving the price structure, and reducing unemployment (now estimated at 20% of the labor force) -- remain. These problems have been compounded by severe drought in recent years. 6. As in the previous year, 1976 was also a year of severe drought. Nevertheless, paddy output in 1976 was about 5 million bushels above the previous year's level of 55 million, which was the lowest since 1970. This was ascribed to the availability of adequate water from tank irrigation in the eastern rice growing districts. Over the past several years, a basis has been established for a substantial rise in paddy production by improvements in irrigation works, institutions, pricing, seed varieties, fertilizer avail- ability, and rural roads. With good weather conditions, Sri Lanka now has the productive potential to meet at least three-quarters of its rice require- ments. 7. In the tree crop sector, tea production in 1976 was down 9% and at the lowest level for the 1970's. Severe drought again was the main cause, but the change-over in management after the recent land reform also played a role. The drop in output was sharpest in the mid-elevation tea areas which were most poorly managed before the land reform. However, the production of rubber rose 5% in 1976. Both tea and rubber benefited from substantially higher prices. The coconut sector, on the other hand, continued to suffer from both declining output and low prices. 8. The tree crop sector, after the 1972 and 1975 land reforms, is in a state of transition. As might have been expected, difficulties have emerged, but the take-over has been orderly and, by and large, the productive capacity of the sector seems to have been preserved. Among its major problems are the fragmentation of management arrangements after takeover; political pressures to disperse lands to villages and landless farmers; the backlog of maintenance and investment by previous owners anticipating nationalization; and poor manage- ment conditions on a substantial number of estates, especially those run by cooperatives. For some of these and other problems no easy solutions are in sight; however, there are some positive developments. The two most important estate management units are the State Plantation Corporation and the Janatha Estates Development Board (Janawasama) which was formed after the 1975 land reform. These organizations have in part decentralized management through regional offices and are in the process of drawing up investment plans. Financing of these plans will be facilitated by the prevailing high tea and rubber prices. In particular, Janawasama realized substantial profits in  - 3 - 1976. Also, plans are being prepared for the amalgamation of a large number of estates, managed by electorate level cooperative societies, with these two major organizational units and possibly with a third group, the Samupakara Janawasas (individual cooperative agricultural/settlement schemes, formed after the 1971 land reform, now in the process of being grouped together under one organization). This would be a healthy step towards arriving at a more efficient pattern of management. 9. The budgetary position in 1976 deteriorated considerably as compared with 1975. Revenue was down and both current and capital expenditures were up from the original budget estimates. Consequently, there was a current account deficit of Rs 474 million as compared to the previous year's deficit of Rs 305 million, and the total cash deficit rose by Rs 200 million to Rs 2,427 million. The result of this increase in the cash deficit is that expansionary financing was needed in the amount of at least Rs 440 million. The main reasons for this worsening of the 1976 budget situation were: (i) lower than expected imports, resulting in a substantial shortfall in revenue from Foreign Exchange Entitlement Certificates (FEECs); (ii) the poor performance of many public sector corporations; (iii) increase in the net food subsidy resulting from the reduction of bread and flour prices; (iv) expenditures related to the Non- Aligned Conference; and (v) drought relief. The 1977 budget shows a current account deficit of Rs 87 million. Capital expenditures are expected to remain virtually unchanged and the cash deficit to decline by about Rs 400 million to slightly over Rs 2 billion. The estimated increase in revenue of about 10%, however, will be vulnerable to any shortfall in the import program, as was the case in 1976. No additional revenue measures have been proposed. The recent revaluation of the Rupee is likely to worsen the budgetary deficit in 1977 (see para. 17). 10. A significant feature of the 1976 budget was the effort to encour- age economic activity in the private sector. Together with measures such as the removal of the restriction on transport of rice, the budget signaled a change in the Government's attitude towards the private sector. However, announced plans for follow-up measures were held in abeyance. Thus, uncer- tainties remain and the signals are still unclear. 11. An encouraging development in 1976 was the apparent improvement in Sri Lanka's terms of trade, possibly reversing the steady deterioration over the previous decade. Tea and rubber prices rose strongly over the year, while the price of food imports declined sharply. The improvement in tea prices came too late in the year to offset fully the decline in the volume of tea exports which followed a reduction in output. The rise in rubber prices was, however, sharp enough to offset the fall in volume of rubber exports. Coconut exports did not share the improvement in commodity prices, and also declined in volume. The share of tree crop exports in Sri Lanka's export earnings declined in 1976 to 71% from 76% in the previous year. 12. The share of non-traditional exports in total exports has been rising. In addition to measures taken in 1970 to promote minor export crops, the Government's policies since 1973 have been providing fiscal and financial incentives to export-oriented industries. Tourism and gem exports, which have good prospects for further development, have now become  important sources of foreign exchange earnings. Manufactured exports, after a temporary pause in 1975, resumed the upsurge that began in 1972/73. This was due primarily to exports of sea foods and ready-made garments. These non-traditional exports will be, however, adversely affected by the recent revaluation (see para. 17). 13. The decline in the cost of imports in 1976, due mainly to lower food prices, made possible a substantial reduction in the current account deficit to an estimated $46 million. The deficit was more than offset by net capital inflows and this caused Sri Lanka's net reserves to rise for the first time since 1973. The import program for 1977 implies a strong deterioration in the current deficit due to a major increase in imports of items other than food, fertilizer and petroleum. 14. An Aid Group for Sri Lanka, for which the Bank acts as the Chair- man, was formed in 1965 and has held twelve meetings. At the twelfth meet- ing, held in Paris in April 1976, the members recognized Sri Lanka's need for continued assistance, particularly in agriculture, and indicated their intention to contribute aid of about US$180 million. However, aid group members' actual new commitments in 1976 totalled $120 M, due, in part, to the decline in the value of food aid caused by lower food prices. Disburse- ment of aid from all sources in 1976 totalled $161 M, as against $202 M in 1975. 15. Slow progress in the development of new exports and the long-term deterioration in Sri Lanka's terms of trade, compounded by the rise in food and petroleum prices since 1973, have greatly increased the country's require- ments of foreign capital. Although concessional aid flows to Sri Lanka have risen significantly, they have not been sufficient to prevent a sizeable in- crease in the country's resort to short- and medium-term borrowing in the early 1970s. Outstanding debt with one to five years maturity increased from a negligible amount at the end of 1972 to $96 M (16.5% of total external debt) at the end of 1974, and then declined to $83 M. This has been largely responsible for the marked deterioration in the debt service ratio from 12% in 1974 to 20% in 1975. 16. Concessional aid flows are needed to help finance imports of main- tenance and capital goods, which remain inadequate in relation to the economy's requirements, without a further deterioration in the debt service ratio. Aid is also needed to supplement the country's meager domestic resources available for investment, and must, therefore, involve local cost financing. The import program for 1977 provides for a sizable increase for imports of capital goods under project aid. If this should materialize it would lead to a considerable depletion of the project aid pipeline. Fresh commitments are needed to re- plenish the pipeline. 17. Following the sharp upsurge in tea and rubber prices in early 1977, the Government revalued the rupee by an average of 20% against major curren- cies on March 12, 1977, in order to translate what it considered to be exces- sive windfall profits to the producers of these commodities into benefits to the consumer in the form of lower prices for imports. This measure has been followed by an increase in the rice ration, the increase being subject to the  - 5 - availability of stocks. As the volume of imports remains tightly controlled, the immediate effects of these moves on Sri Lanka's economic and financial position seem manageable, although the budgetary deficit will be larger, and consequently inflationary pressures stronger, than estimated at the time the budget was presented. However, it is difficult to reconcile the revaluation with the developmental needs of an economy that has suffered from inadequate savings to finance investment; that must diversify its exports; and that demands continuing attention to the adequacy of incentives for agricultural production. Resolution of these conflicts between short-term benefits to the consumer and the longer-term developmental needs of the economy will have to be left to the new government that takes office after the national elec- tions due to be held by late September. PART II - BANK GROUP OPERATIONS IN SRI LANKA 18. Since the beginning of its operations in Sri Lanka in 1954, the Bank Group has made eight loans totalling US$73.4 million (net of cancel- lations) and eleven credits totalling US$103.2 million (net of cancellations and exchange adjustments) in support of 17 projects. About 34% of Bank Group assistance has been for power, 52% for agriculture (irrigation and agricultural and dairy development), and the remainder for Development Finance Company (DFC) operations, highways, and a program credit (mainly involving the import of raw materials for industry). Three early power loans, the two loans to the De- velopment Finance Corporation, the credit for the Mahaweli Ganga Development Project I, and the program credit were satisfactorily completed and fully dis- bursed. At the request of the Borrower, a loan/credit for highways was can- celled in 1970 following the Government's decision to make major changes in the scope of the project; US$0.8 million of the credit had been disbursed. The IFC's only investment in Sri Lanka, US$3.25 million to the Pearl Textile Mills, Ltd. (Ceylon), was made in January 1970, but cancelled the same year at the request of the Company. Annex II contains a summary statement of Bank Group operations as of March 31, 1977, together with notes on the execution of ongoing projects. 19. The Bank Group's current strategy is focussed heavily on the agri- cultural sector in order to support government efforts to increase food pro- duction and to improve productivity in the tree crops subsector. However, projects in basic infrastructure are also included. A proposed project for diversification of crops on marginal lands now under tea and rubber is being prepared by the Government and an FAO/UNDP team with IDA assistance. Prep- aration has begun on an integrated rural development project for the Kurune- gala District and on a tree crop rehabilitation project aimed at maintaining quantity and quality of Sri Lankan tea ouitput as some tea lands are diverted to other uses. Projects in other fields including drainage and land recla- mation and dry farming are being prepared for possible IDA financing. 20. The Bank Group presently accounts for nearly 13% (and the Bank alone for about 5%) of Sri Lanka's total external debt outstanding, and about 5%  - 6 - (with IDA negligible) of debt service. It is projected that the Bank Group's share in total external debt will decline to about 9% by 1980 (and the Bank's share alone to fall to less than 2%). The Bank and IDA shares in the debt service will also show a slight decline. PART III - WATER SUPPLY AND SEWERAGE IN SRI LANKA 21. The most densely populated area of Sri Lanka is the southwestern coastal strip where some 25% of the population is located on 2% of the country's total land area. There are no adequate groundwater sources; however, large rivers flowing westward from the highlands provide ample water sources for the fifty or so towns and communities located in the area, together with five larger urban centers including Colombo, the capital city. Shortages of whole- some piped water in this region result largely from a lack of financial re- sources to implement pumping, treatment and distribution of the abundant al- though polluted river waters. 22. The present water service to the southwest coast urban and tourism centers supplies only part of the population for part of the time; some areas have no service at all, and the quality of piped water is sometimes doubt- ful. Because the supply of piped water in the metropolitan area of Colombo is intermittent, particularly in times of drought, there is an increased risk of polluted ground water being drawn into the mains during periods of shutdown. Both the interruption of supply and the absence of a piped water supply in some areas, encourage the use of water sources of unsatisfactory quality, including shallow wells frequently polluted by inadequate sanitation facilities nearby. Health statistics show that water-borne diseases are present in the area, and their transmission among resident population and foreign tourists is more likely in the absence of a safe water service. 23. In order to address the water supply and sewerage needs of this southwest coastal area, studies for a Mfaster Plan were prepared under a UNDP project executed by WHO in 1972 (UNDP project area, see map IBRD 12531). The first phase of the Master Plan recommendations comprised a series of components designed to improve water supplies to urban centers to meet water demands of tourism and industry as well as growth of domestic water consump- tion which these developments help to promote. Although some of these water supply components have been completed with bilateral assistance, implemen- tation in general has been limited by lack of financial resources. For ex- ample, severe water shortages have prompted the Government to proceed with planned improvements to the head works for the water system serving Colombo and adjacent towns. However, the additional treated water from these head works cannot be conveyed to consumers unless foreign exchange is made avail- able for the improvement of associated pumping and transmission facilities, permitting full benefit to be derived from the previous investment in the head works. 24. Nationwide, a summary of water services data from the 1971 census indicates that about 2.0 million people (77%) of the 2.6 million urban  -7- population have access to piped water but that the quality and quantity of a large portion of these supplies are unsatisfactory. Of the 8.8 million rural population, only some 0.4 million (5%) have access to piped water. The situation is somewhat different on agricultural estates where about 75% of about 1.1 million estate dwellers have piped water. However, the more sparsely populated, rural northern and eastern areas of the country rely heavily on ground water from individual family or small community wells, although Government, with financial assistance from UNICEF, is undertaking a program to improve water supplies in rural areas. 25. Government policy has traditionally required that sanitation pro- grams be coordinated with water supply programs and supported by health education. This ideal has not always been achieved and much still needs to be done to improve and extend water-borne sewerage systems particularly in urban areas. For example, the city of Colombo is the only urban area served by such a system, and this system was identified in the Master Plan as requir- ing substantial improvement and expansion. In rural areas, over half the population have sanitation facilities, and a Government-sponsored project is under way to provide simple but adequate facilities for the remainder. 26. The National Water Supply and Drainage Board (WDB) came into being in January 1975 under legislation enacted in 1974, superseding the government Department of Water Supply as the agency primarily responsible for planning, design, and construction of water supply systems throughout Sri Lanka. Distribution systems are usually operated and maintained by local authorities, although in a number of cases WDB operates and maintains head works or entire systems; both the WDB and the local authorities are under the control of the Minister of Local Government. The 1974 law, which provides the statutory framework governing the sector for the entire country, also deals with general operational matters, including rates for water supply and sewerage, and prescribes penalties for pollution of water courses used for water supply. 27. The Government and WDB are presently preparing a formal investment plan for the sector to be financed by Government and supplemented by foreign exchange grants or loans. The plan includes: urban water supply projects for the southwest region, for which the Government has requested IDA participa- tion; a further rural water supply program, for which UNICEF financial assist- ance has been requested and which is a continuation of the first UNICEF pro- gram now being implemented; water supply and sewerage works in further urban areas, possibly to be assisted by IDA; and continuation of present small rural sanitation programs. The major constraint on development, however, continues to arise from the inadequacy of foreign exchange allocations for some of the vital elements of the water supply and sewerage systems. 28. Hlistorically, the responsibility for water supply and sewerage systems rested with local councils; more recently WDB assumed responsibility for a number of these systems, either at the request of local authorities or through their reluctance or inability to efficiently operate their systems. Almost all of the systems are dilapidated because of the lack of foreign exchange to obtain replacement machinery and parts and due to low standards  - 8 - of maintenance. Thus, WDB is faced with day to day operational problems, in addition to its responsibilities for improving national standards of operation and maintenance, renovating a number of systems, and planning and developing new systems. Although currently staffed with capable engineers, WDB's task of achieving an acceptable level of operation and maintenance of existing and proposed facilities may become more difficult because of increasing losses of skilled staff to overseas markets. In order to strengthen WDB, the Govern- ment is reviewing programs for providing incentives to retain the services of WDB engineers, training programs for newly recruited and less experienced engineers and for providing increased amounts of foreign exchange for purchas- ing spare parts. 29. Government financing policy for the sector is presently changing from one in which water was regarded as a free good to one in which specific charges will be levied for both water and sanitation. The Government's intentions to make direct consumer charges for water are evident from the metering and water tariffs established in the water systems in the cities of Galle and Kandy and in its stated intention to meter all new systems implemented in the southwest coastal area. Although the eventual structure must await the completion of further tariff studies, it is envisaged that any future tariff system will provide protection for the poor in that quantities of water essential for the health and welfare of the people will be provided free or at very low charge. It is expected that considerably higher charges will be made for water in quantities exceeding this level and that the long- term goal will be to make the operation of the various systems financially self-supporting. PART IV - THE PROJECT 30. The proposed project would be the first Bank Group operation in the Water Supply and Sewerage Sector undertaken in Sri Lanka. The project was identified and prepared as a component of the UNDP/ WHO Master Plan (para 23). Engineering design of the project was updated by the Government of Sri Lanka and prepared with assistance of IDA missions in December 1975 and April 1976. It was appraised in September/October 1976. A report entitled "Sri Lanka: Appraisal of the Water Supply Project" (No. 1424-CE) is being circulated separately to the Executive Directors. A credit and project summary is attached in Annex III. Negotiations were held in Washington, D.C. from March 16 to March 23, 1977. The Government of Sri Lanka was represented by a negotiating team led by Mr. C. Ameresekere, Secretary, Ministry Local Government. Project Description 31. The project contains two major construction elements. One element consists of interconnected systems centered on Colombo and includes: (i) the improvement of existing piped water supplies to five adjacent towns, i.e.,  - 9 - Towns South, peripheral to Colombo and south of a major river, the Kelani Ganga; (ii) the improvement of water supplies to Colombo; and (iii) provision of piped water to five Towns North, adjacent to Colombo but north of the Kelani Ganga. The second element would provide new piped water supplies to two towns, Ambalangoda and Kalutara, located some 40 miles south of Colombo. The project also includes provision for expenditures for spare parts and equipment, technical assistance and training. 32. The Kelani Ganga is the source from which 20 million gallons per day of additional water is to be obtained for the Colombo-based element of the project. Abstraction and treatment of the river water will take place at Ambatale, where the necessary expansion of an existing intake and treatment plant is presently under construction; the project will provide associated pumping, transmission and distribution facilities. In addition to direct river abstraction from the Kelani Ganga at Ambatale, present supplies to the Greater Colombo area are obtained from two impounding reservoirs (Kalatuwawa and Labugama). The Master Plan recommends that these sources continue to supply the water needs of the Greater Colombo area and that the projected increase in water requirements be met by increasing abstraction from the Kelani Ganga. 33. Besides the staged expansion of pumping and water treatment facil- ities at the Ambatale works, a reorientation of the existing treated-water transmission system is proposed. This reorientation will involve an "inte- gration" of the three existing sources of supply and associated transmission systems in the Colombo area to achieve the least cost solution recommended by the Master Plan Report (since retention of the existing allocation of water would immediately entail additional transmission mains). The integrated system will necessitate a redistribution of some of Colombo's less expensive, gravity-fed water to Towns South, and its substitution by more expensive pumped water. 34. Each of the two towns remote from the Colombo system, Kalutara and Ambalangoda, will be supplied from separate sources to be developed as part of the project. The cost of these systems per head of population will be relatively high and financial viability is not expected to be realized until population and water demands reach projected, higher levels, probably after 1990. However, the continued growth of these communities, and the already active tourist industry in the area, will be adversely influenced by a con- tinued dependence on existing shallow well sources. The provision of piped water is therefore essential if the health and welfare of these communities are to be preserved. 35. The project would improve the existing piped water supply system to approximately 1.2 million people in Colombo and the five Towns South. The project would also provide new water supply systems for some 410,000 people in five Towns North and in Ambalangoda and Kalutara. 36. Because of the need to provide improved sewerage services (para 25) and at Government's request, a technical assistance component under the proj- ect would provide engineering services for preparation of a further package of  - 10 - works comprising the improvement of existing sewerage facilities in Colombo and provision of sewage collection and disposal facilities in areas which have piped water supplies, including Towns South, Negombo and Galle. Consulting engineers would be employed to complete detailed engineering designs and tender documents for sewerage and drainage improvements in the selected areas (PA Section 2.03); this would enable WDB to implement the construction work under a subsequent program beginning in 1981. A training program for WDB personnel has also been included under the project which would include finan- cial and accounting as well as engineering staff. A tariff study (para 43) to provide a basis for a well-structured system of retail water charges has also been included. 37. A major objective of the project is institution building. The newly formed (January 1975) National Water Supply and Drainage Board (WDB) has nation- wide responsibilities in planning, developing and operating water supply and sanitation facilities (para 26). It would be the bulk supply agency in the Colombo area and the beneficiary of the Credit. The Credit will assist WDB in becoming an effective national agency. Organization and Implementation 38. The Government has taken several major steps toward implementing the Master Plan's institutional recommendations. These steps have included the formation of WDB and the completion of a study and report by the National Institute of Management (NIM) to identify the most acceptable institutional reform that would enable one agency to operate the integrated system of water supply facilities serving Colombo Municipality and adjacent towns. In Sep- tember 1976 the National Planning Council, under the chairmanship of the Prime Minister, decided that the integrated system should be implemented and that the system would be operated by WDB. Based upon this decision, the Ministry of Local Government proposes to implement the following institutional organ- ization within the project area: (a) WDB will operate the integrated facilities to supply water in bulk to Colombo Municipality and Towns South. (b) Colombo Municipality and Towns South Municipalities will operate and maintain their respective distribution systems. These authorities will also render bills and collect all water revenue. (c) The proposed project for Towns North, Kalutara and Ambalangoda will be operated and maintained by the WDB which will also render bills and collect revenue in res- pect of these areas. 39. As executing agency for the project, WDB will form a separate group of engineers under the supervision of an Assistant General Manager to imple- ment the project. The Government has recognized the possibility that WDB may  - 11 - lose a number of experienced engineers to overseas markets during the course of the project (para 28), and proposes to make available additional competent engineers from other government agencies to supervise the project if the need should arise; alternatively, the Government would engage local consulting engineers to carry out the work of construction supervision (DCA Section 3.05). In addition, WDB will take actions to strengthen its financial oper- ations through: filling senior financial positions and adequately staffing the accounting department; ensuring coordination between the Engineering and Finance Departments; implementation of recommended financial control systems; and establishment of appropriate financial rules/regulations (PA Section 4.04). 40. Although Colombo Municipality and local authorities in Towns South are responsible for operation and maintenance of their own distribution sys- tems, it is envisaged that WDB will assist the small authorities with any major distribution works and also periodically examine all distribution sys- tems in the project area to ensure that there is no undue leakage. For this purpose, WDB proposes to establish a leakage detection unit, with the assist- ance of a training component under this project. WDB will carry out distri- bution inspections, provide assistance as required, and assume responsibility for systems in which the Minister of Local Government considers that the standards of operation and maintenance are below a satisfactory level (PA Section 3.05). 41. WDB also proposes to extend consumer metering to reduce the present high levels of waste of water and to establish and maintain adequate meter testing and repair facilities for the project area (DCA Section 3.03). It is estimated that connections to all consumers (excluding standpipes), throughout the project area will be metered by 1986. The program requires the installa- tion of some 70,000 meters, and will be supported by ongoing assistance from the United Kingdom in meter testing and repair facilities. 42. WDB's bulk tariffs for the project area would be increased from the present low average rate of Rs 0.60 (US$0.07)/1,000 Imperial Gallons (Ig), which has not permitted WDB to cover its operating expenses, to an average rate of Rs 0.96 (US$0.13)/ 1,000 Ig in 1978, and to successively higher levels thereafter to enable WDB to cover its operating expenses and debt service and to begin financing a portion of the capital investment from internal cash generation. As a first step, WDB has agreed to implement an interim tariff increase satisfactory to IDA not later than October 1, 1977. WDB would there- after maintain tariffs in the project area at a level to produce, within the project area, a minimum rate of return on reasonably valued average net fixed assets in operation of 5% in 1978, 6% in 1979, 1980 and 1981 and 7% thereafter. For operations outside the project area, WDB would be required to ensure sufficient revenue to completely sustain those operations so that they are not subsidized from the project area (PA Section 4.05). The Government will ensure the payment of future bills rendered by WDB for water supplied to the local authorities (DCA Section 4.02). Under these arrangements WDB would, commencing in 1981, be financing about 30% of its capital investment programs from internal sources. In addition, WDB has agreed not to incur any long-term debt unless  - 12 - the 12-month net revenues (before depreciation) would cover maximum future debt service at least 1.5 times (PA Section 4.07). 43. With regard to retail tariffs, the status of currently available records and accounts at the local distribution level preclude the introduction, in the short term, of a properly structured and adequate tariff system. In order to begin to evolve a rational system for Sri Lanka, a tariff study for the project area has been included under the project which will take into account such factors as: (i) differing costs of providing water supply; (ii) the different categories of consumers, i.e. domestic, commercial, industrial, and their ability to pay; (iii) the need to provide minimum quantities of water to low income groups; (iv) the alternatives to full subsidization of standpipe supplies; (v) reduction of waste; and (vi) the extent to which it would be feasible to self-finance capital investment and to move toward a tariff level based on marginal costs. The study will be completed by March 1, 1978, after which recommendations mutually agreed with IDA will be implemented (DCA Section 3.07). In the interim, the Government will cause local authorities to maintain tariffs at a level to produce sufficient revenue to cover cash operating expenses and debt service. Except as the Association may otherwise agree, the Government will cause each local authority distributing water in the project area: (i) to establish separate accounts for its water supply operations not later than December 31, 1977, (ii) to assure prompt payment of consumer water bills, and (iii) to refrain from diverting water revenues to other purposes in such a way as to prevent efficient operation and maintenance of its water, sewerage and drainage systems in accordance with generally accepted engineering and management standards (DCA Section 4.02, 4.04(a)). In addition, the Govern- ment will ensure that the principal repaid and interest paid by WDB on loans incurred by WDB for construction of assets in the project area, subsequently handed over to local authorities, are fully recovered (DCA Section 4.03). 44. At present no agency has responsibility for monitoring water quality, although the Colombo Municipality and WDB have the capacity and facilities to carry out the requisite examinations. To improve water quality monitoring, the Government will implement an appropriate system of routine water examination by an agency independent of WDB and distribution authorities (DCA Section 3.04). Cost and Financing 45. Total project cost is estimated at US$42.5 million equivalent in- cluding FEECs (US$9.0 million), custom duty (US$3.1 million), and allowances for physical and price contingencies. The proposed IDA credit of US$9.2 mil- lion together with the proposed IDA administered credit of Canadian $5.0 (US$4.8 million) would finance the total foreign exchange requirements of US$14.0 million or about 46% of total project costs excluding FEECs and custom duties. Details of project cost are included in Annex III. The IDA administered credit would be in accordance with the terms of an agreement between the Government of Canada and the Association which was approved by the Board on April 12, 1977 and pursuant to a Development Credit Agreement  - 13 - between the Republic of Sri Lanka and the Association acting as administrator on behalf of the Government of Canada. Conditions of IDA credit effectiveness would be the effectiveness of the IDA administered credit (DCA Section 6.02) and the execution of the Project Agreement on behalf of WDB (DCA Section 6.01 (b)). A special condition of effectiveness of the IDA administered credit would be the effectiveness of the IDA credit. 46. Funds from the credits would be onlent to WDB as a government loan at an annual interest rate of 9% and a term of 24 years, including a five-year grace period during which payment of interest would be waived. Execution of the subsidiary loan agreement between the Government of Sri Lanka and WDB would be a condition of effectiveness (DCA Section 6.02). In addition, the Government will make loans to WDB in order to assist the latter in carrying out the distribution works at an annual interest rate of 5% over a term of 30 years, including a five-year grace period during which payment of interest shall be waived (DCA Section 3.02). The Government will also provide equity contributions toward the cost of headworks. Procurement and Disbursement 47. All contracts to be financed under the IDA and IDA administered credits would be awarded under international competitive bidding procedures in accordance with the Association's Guidelines, with the exception of contracts under US$100,000 and totalling not more than US$0.5 million which would not justify the more complex procedures of international competitive bidding. Such contracts would be awarded under local bidding procedures acceptable to the Association. Foreign bidders are expected to win all contracts for treatment plant equipment, pumping equipment, specialized work of mains renovation and for a large portion of the pipes. Sri Lankan contractors are expected to win all other contracts. It is probable that PVC or cast-iron pipes that are manufactured in Sri Lanka will be appropriate for some distrib- ution mains; a 15% margin of preference (or applicable tariffs, whichever is less) would be allowed for these, and any other locally-manufactured items, in evaluating bids. A margin of preference of 7.5% would also be allowed for local civil works contractors. 48. The proceeds of the IDA and IDA administered credits would be dis- bursed over a five-year period. Disbursements would be made against 100% of the foreign exchange costs for directly-imported equipment or ex-factory costs of locally-manufactured goods and 60% of local expenditures for imported goods procured locally. Disbursements for civil works would be made against 100% of foreign expenditures for foreign contractors and 36% of local expenditures for local contractors for construction of headworks and transmission mains. Disbursements would also be made against 100% of foreign expenditures for consultant services and training. The IDA and IDA administered credits would be disbursed in a ratio of 9.2:5. A disbursement schedule is included in Annex III. 49. In order to expedite procurement under the project, final engineering designs, together with associated tender documents, have already been prepared.  - 14 - Benefits and Risks 50. Hardships imposed by the present water shortages tend to affect the poorer section of the community more than the middle or higher income groups. The latter are more able to provide their own means of alleviating shortages and are not forced to rely entirely on the public system. While the poorer sections of the urban community will benefit most from improved water supply systems, industrial, commercial and tourist establishments will also benefit. 51. In Colombo, and adjacent towns, water shortages have prompted the Government to proceed with improvements of headworks at Ambatale, despite the inadequacies of the system to convey water from the improved headworks to consumers. These inadequate links would be strengthened under the proj- ect and interdependent components of facilities presently under construction would be completed, permitting full benefit to be obtained from previous investments in the Ambatale works. 52. In addition to realizing benefits from recent investments, the improved Ambatale works together with associated transmission and distribu- tion improvements would bring water to 250,000 new consumers in Towns North, in addition to providing a 24-hour daily service to 1.2 million consumers in Colombo and Towns South in 1981. Without these works, the standard of service would decline further as the population grows. 53. The new systems proposed for Kalutara, Ambalangoda and adjacent communities would provide adequate, safe water to 160,000 new consumers in 1981. Without these works the growth of commerce, industry and tourism in the area will be restricted. Continued use of existing shallow well sources, and their proximity to inadequate sanitation facilities, constitutes a danger to public health and a consequent risk to the potential growth of the tourist industry in this area. 54. In addition to providing a safe and continuous supply of water to all sections of the community, the project will extend consumer metering and will introduce tariffs that are financially adequate and which discourage waste and excessive consumption yet provide sufficient water to meet the essential daily requirements of the poor at affordable cost. 55. The ability of various income groups to pay for water will be thoroughly investigated as part of the proposed tariff study (para 43). In the meantime, however, existing data indicates that the impact of real- istic tariffs on consumers in Colombo and smaller urban areas may impose some hardship on the lowest income groups although higher income groups should experience little difficulty. Thus a small portion of the cost of water may have to be absorbed by the higher income categories and larger consumers, through suitably structured tariffs. If the Government chooses to relieve the consumers of a portion of this burden through an operating subsidy to the retail distribution authorities, such subsidy would not exceed the estimated cost of water supplied through standpipes except in the case of drought or extreme emergencies (DCA Section 4.01).  - 15 - 56. Project risks are no greater than can normally be expected with operations of this type. Some financial risk may arise from political and social pressure to avoid tariff increases as needed in the future to achieve the rates of return required for the financial viability of WDB. However the proposed tariff study would recommend tariffs which maximize revenues with- in the consumers' ability to pay and provide an equitable tariff structure. PART V - LEGAL INSTRUMENTS AND AUTHORITY 57. The draft Development Credit Agreement between the Republic of Sri Lanka and the Association, the draft Development Credit Agreement between the Republic of Sri Lanka and the Association as Administrator on behalf of the Government of Canada, the draft Project Agreement between the Association, the Association as Administrator on behalf of the Government of Canada, and the National Water Supply and Drainage Board, the Recommendation of the Committee provided for in Article V, Section 1(d), of the Articles of Agreement and the text of a Resolution approving the proposed credits are being distributed to the Executive Directors separately. 58. Conditions of special interest of the project are listed in Section III of Annex IV. Special conditions of effectiveness for the IDA credit are the execution of an acceptable subsidiary loan agreement between the Government of Sri Lanka and the WDB (DCA Section 6.02), the effectiveness of the IDA administered credit (DCA Section 6.01 (a)), and the execution of the Project Agreement on behalf of WDB (DCA Section 6.01 (b)). A special condition of effecitveness of the IDA administered credit would be the effectiveness of the IDA Credit. 59. I am satisfied that the proposed IDA credit would comply with the Articles of Agreement of the Association and that the IDA administered credit would comply with the criteria established by the recently approved agreement between the Government of Canada and the Association. PART VI - RECOMMENDATION 60. I recommend that the Executive Directors approve the proposed credits. Robert S. McNamara President April 21, 1977   ANN EX I WToi101 I. pages SRI LANKA - SOCIAL INDICATORS DATA SHEET LAND AREA (THOU ER2)......................... I---------- ~~~~~~SRI LANKA REFERENCE COUSoTmIES I11910, ToTAL 65.6 'jilT RECENr AS9IC. 24,.2 1 960 1910 VI r IMNAIE IMNZNAI A PHILIPPITNES 1ALAYOIEA** uNt' e<A CAPITA U SU) 6 0.0 Io0. 1 50. 0 124.0 23 0 .0 I440.0 POPiILATIIT AND VItAL STATISIICS POPULATION 1M1LThYR. MILLIC,N) 9 .9 1 2.5 13.6* t2.9 At 3 6 .9 10. 4 PUPULATIUNA OCNSITT PER )oJAHT hM.II. 15. 91.0 707.0) 14.0 12 3.0 32 .0 PER Si. KM. AGRICULTURAL LAND .- 5 06. 0 5 45.') 24.0 21 9. 0 2 91. 0 AIIAL STATISTICS CRUODE BIRTH RATS (/T'HOU, AV. 31.6 33.1 286 50.5 4 4.2 42.2 CRUDE DEATH RATE (/THOU. AV.) 10.? 6.0 6.53 0 40 1 3.2 12.9 INF ANT MOR TA L ITY R'. tE I ITHDOU) 52. 0 5 0.0 49.0 160.04 6ba0. 0 60.6/a LIF EXCPECTANCY At AIRTR 1YR5) 6 0.5 6 5.86 61.0 41.6 ,.A6 56. 7 GROSS `tEPROOUCtIJN RATE 2.5 2.3 Z.e 3.2 3.3 2.6/a eOPULArION GROWITH RATE (Z) TOTAL 2. 6 2. 4 1.1 3.0 IA 3. 0 2.6 GRBAN 5. 0/a 4. 5 U.t 5 .6 4 .0 3. 0 AURUNA POPULA TION I t OF TUOIAL) 19.11%/ 2 2.0 22. 4/a 6.0 27I.6b 26.8 AGE STRUCTURE (PERCENT) 0 TO 14 TEARS 41'. 5 4 0.0 091a 4 4.4A/ 4 5.6 AA . I/a 15 TO 64 TEARS 543/ 56.0 536. 4 j ,.o7 5 1. 6 52 7a 65 TEARs AND OVRC 4.ZZF 4.:0 4.3 a 2 .6 S 2 .68 3 .27 AGE OEPETtOENCT kATIO 0.8B/b 0.0 a O.A/a 0.-9/A 0. 9 0 .9 /a ECONOMIC DEPEADENCT RATIO 1. 57 1. 4 I.LZE 1.2 7-at 1. 5 FAGAILY PLANINRIG ACCEPTORS ICUR4ULATIVE. rAe H. . 215.3 441.5 .. 35 4 .0