Nicaragua - Municipal Development Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 3465c-NI NICARAGUA STAFF APPRAISAL REPORT MUNCIPAL DEVELOPMENT PROJECT December 11, 1981 Projects Department 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 official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit = Cordoba (C$) US$1.00 C$10.00 US$0.10 C$ 1.00 US$100,000 C$1 million UNITS AND MEASURES Metric System 1 Manzana = 0.699 hectares ABBREVIATIONS BCN Central Bank of Nicaragua (Banco Central de Nicaragua) BND National Development Bank (Banco Nacional de Desarrollo) BI National Mortgage Bank (Banco Inmobiliario) CABEI Central American Bank for Economic Integration (Banco Centroamericano de Integraci6n Econ6mica) FED Special Development Fund (Fondo Especial de Desarrollo) FINAPRI Preinvestment Fund (Financiera de Preinversi6n) FIR International Reconstruction Fund (Fondo Internacional para la Reconstrucci6n) IDB Inter-American Development Bank (Banco Interamericano de Desarrollo) INAA Nicaraguan Water and Sewerage Institute (Instituto Nicaraguense de Acueductos y Alcantarillados) INE Nicaraguan Energy Institute (formerly ENALUF) (Instituto Nicaraguense de Energfa) JRM Managua Municipal Reconstruction Board (Junta de Reconstrucci6n de Managua) MINCON Ministry of Construction (Ministerio de la Construcci6n) MT Ministry of Transport (Ministerio de Transporte) MINVAH Ministry of Housing and Human Resources (Ministerio de la Vivienda y Asentamientos Humanos) SAMU Secretariat for Municipal Affairs (Secretarfa de Asuntos Municipales) USAID United States Agency for International Development FISCAL YEAR January 1 - December 31  FOR OFFICIAL USE ONLY NICARAGUA MUNICIPAL DEVELOPMENT PROJECT STAFF APPRAISAL REPORT Table of Contents I. SECTOR BACKGROUND .............................................. 1 A. Urbanization Trends in Nicaragua ........ .................. I B. Previous Responses ......................................, 3 C. Recent Actions and New Policy Directions. 4 II. PROJECT COMPONENTS, COSTS, AND FINANCING .. 7 A. The Project ................................................ 7 B. Project Costs .............................................. 10 C. Financing .................................. 12 D. Detailed Project Description .-.---------------.13 III. EXECUTING AGENCIES AND PROJECT IMPLEMENTATION ... 19 A. The Reconstruction Board of Managua (JRM) ................. 19 B. The Agency for Municipal Affairs (SAMU) ......... ............ 21 C. Implementation Schedule ................................... 23 D. Procurement ......................................,,. 23 E. Disbursement ............................................. 25 F. Accounting and External Auditing ........ I. ................. 26 G. Supervision ....................................,.,.,,... 27 H. Monitoring and Evaluation ................................. 28 IV. FINANCIAL ANALYSIS .................................. 28 A. Cost Recovery .................. 28 B. The Reconstruction Board of Managua--JRM .................. 29 C. The Agency for Municipal Affairs--SAMU .................... 33 V. SOCIAL AND ECONOMIC JUSTIFICATION .. 35 A. Economic Benefits ......................................... 35 B. Economic Rate of Return and Poverty Impact ................ 37 C. Project Risks ............................................. 39 VI. AGREEMENTS AND RECONMENDATIONS.............................. 40 This report is based on the findings of an appraisal mission which visited Nicaragua in February 1981. The mission consisted of G. Gattoni (mission leader), E. Echeverria, M. Sarris (LCPUR); D. Jones (Financial Advisor); J.E. Alba (Consultant); and R. Chavez assisted in finalizing this report. 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.  TABLE OF CONTENTS (Continued) - 11 - Page ANNEXES 1. Detailed Cost Estimates and Disbursement Schedules ......... 42 2. Detailed Project Financial Analysis ........................ 47 3. Implementation Charts and Organization Diagrams ............ 57 4. Detailed Description of Subprojects and Participating Municipalities--SAMU Component ........................... 61 5. Storm Drainage Studies for Managua ......................... 67 6. Key Indicators ...................................... 68 7. Status and Evaluation of the Urban Reconstruction Project.. 72 8. Draft Guidelines Discussed and Left with SAMU and JRM ...... 75 9. Selected Documents and Data Available in the Project File.. 87 MAPS IBRD 15696--Municipal Infrastructure Improvement IBRD 15697--Municipal Infrastructure Upgrading  NICARAGUA MUNICIPAL DEVELOPMENT PROJECT STAFF APPRAISAL REPORT I. SECTOR BACKGROUND A. Urbanization Trends in Nicaragua Urban Growth and Spatial Distribution 1.01 Approximately one half of Nicaragua's population lives in urban areas. A network of small- and medium-sized cities concentrated along the Pacific coastal area (in which agriculture and industry have been most dev- eloped) is characterized by accelerated growth rates (most cities are like- ly to double in population by the year 2000), widespread poverty, deficient infrastructure, and an inadequate financial base. Nicaragua's urban popu- lation has been increasing at a rate of about 4.5% per annum during the past two decades, compared to the growth in rural areas of approximately 2.8%. While urban centers have a fundamental role in supporting agricul- tural and industrial production, they have traditionally been neglected and inefficient. 1.02 Managua dominates the urban sector. Its 600,000 inhabitants account for half the urban population and 22% of the national population. Managua is also the most important productive center with 30% of the econo- mically active population generating 26% of GDP, 40% of all commercial activities, and 70% of all industrial output. Prior to the massive earth- quake in late 1972, Managua was growing at a rate of 7% per annum without a development plan or an adequate fiscal policy. The earthquake (which completely destroyed the city's center) temporarily decanted Managua's pop- ulation. However, by 1975, notwithstanding considerable efforts to decen- tralize growth, Managua's population surpassed the pre-earthquake level, and it became evident that it was the only dominant urban center that could attract, support, and activate major industry. 1.03 In spite of Managua's continuing primacy, a secondary and terti- ary urban system has also been developing, particularly in the Pacific region. Four cities have populations over 40,000; 10 others are between 10,000 and 30,000; and 21 are between 4,000 and 10,000. The average growth of all urban areas is 4.4% per annum; the 36 most dynamic municipalities have an average growth rate of 5.1%, and several have growth rates of 8% and 12%. This dynamic growth has taken place under the most difficult cir- cumstances: municipal governments have had a long tradition of being weak and poorly managed. A fundamental imbalance between revenue authority and expenditure responsibility has resulted in deficiencies in infrastructure and services, and kept some of the key municipalities from coping with ex- panding economic activity and rapidly growing populations. Municipal rev- enues went to Central Government and few, if any, were apportioned back to the cities. Municipal capital outlays have normally been significantly smaller than current expenditures. Government grants on average account  -2- for about 8% of municipal revenues. Thus, most municipal revenues are derived from locally levied taxes, fees, licenses, and sales taxes. Pro- perty tax is collected by municipal authorities for transfer to Central Government. There have been occasional suggestions to strengthen the local fiscal base and increase the autonomy and the capability of local authori- ties to deliver support to the local economy by first improving property registration and taxation and second, by adjusting apportionment to each municipality. However, little has actually happened. What limited munici- pal infrastructure and services investment occurred was confined to higher income cities and to higher income areas within cities, without regard to national investment planning for growth, equity, or efficiency. 1.04 Nicaragua's main urban problems are environmental and infrastruc- tural and are related more to the service deficiencies than to housing stock inadequacy. For example, a survey by the Ministry of Housing and Human Settlements (MINVAH) in 1980 indicates that, in ten of the largest urban centers outside Managua, between 56% and 93% of the population had deficient basic infrastructure; about 38% of the population in these muni- cipalities did not have even minimum infrastructure (see para. 1.07). In the past, there has been a concentration of public investment in Managua. This has included 21% of all investment in water supply, 91% of all invest- ment in sewerage networks, 32% of investment in education, 24% in health, and 85% in construction of public works. However, despite these public investments, MINVAH estimates that almot 70% of Managua's population (about 420,000 persons) does not have access to basic infrastructure and services and lives in extra-legal subdivisionsl or substandard shelter. The per- centage of infrastructure deficit is even higher in the 10 largest second- ary cities. Urban Employment, Incomes, and Poverty 1.05 Although there is strong evidence linking the rapid growth of Nicaragua's capital and other major urban centers to the growth of the modern sector in the national economy, there is also some indication that open unemployment is greatest at the principal destination of the migrants, particularly Managua. Since the revolution, only partial analysis of the employment situation has been attempted,2 but from this and from previous studies it emerges that open unemployment in Managua is higher than the national average and that, within the city, unemployment is highest among the poorest.3 Perhaps more significant is the extent of underemployment /1 Subdivisions wherein speculators sold plots without provision of water and sewerage networks and have no paved streets, storm drainage, or public lighting, in violation of municipal ordinances. /2 Encuesta de Hogares: Instituto Nacional de Estadistica y Censos August-September 1980. This survey reported 13.7% open unemployment in Managua; 9.3% for Leon, 5.3% for Masaya, 6.6% for Rivas, and 12% for Esteli. /3 Empleo y Salarios en Nicaragua, ILO (PREALC), September 1980. This study estimates open unemployment in Managua at 17.2% and underemploy- ment at 25%.  -3- among the urban poor. Although nominally employed, mostly in the informal sector, many work part-time, below their skill levels or at low productivi- ty jobs all leading to earnings below or near the poverty line. Incomes and productivity are also adversely affected by lack of access to markets and disproportionately long trips to and from places of work. This is true both for the self-employed and for those employed in the formal sector. Recent reliable income distribution data are not available, but in 1977 at least 20% of the urban population was estimated to be below the poverty line (about US$150 per month per family) while, according to a 1980 house- hold survey, about 50% of the urban families have monthly earnings of no more than US$300. B. Previous Responses 1.06 The 1972 earthquake damaged 27 km2 (over 80%) of the capital city's total area, including all of the central commercial/administrative center. The resulting damage and loss of physical assets was in excess of US$300 million (in 1973), of which about half represents public facilities and infrastructure. However, the impact of the earthquake on levels of output and employment was less than might have been anticipated considering the magnitude of the city's destruction, main:Ly because manufacturing and large-scale industries were located almost entirely on the city's periph- ery, outside the major destruction zone. The catastrophy generated, for the first time, attention to the urban sector. Several lending agencies and massive grant assistance contributed to the reconstruction effort.4 The earthquake reconstruction also brought massive planning efforts and technical assistance in the reconstruction of Managua. The reconstruction process, however, resulted in a wasteful extension of the city's infra- structure networks and uncontrolled land speculation. Almost no municipal services or infrastructure reached the low-income neighborhoods (barrios) of Managua or any of the secondary cities. Little was done to improve municipal management or to reform the municipal revenue structure. The reconstruction effort also diverted attention from the growth problems and needs of the smaller urban centers. 1.07 In the 1972 to 1979 period, most of Nicaragua's urban centers experienced rapid growth and a dearth of attention to the mechanisms and resources needed to keep pace with the resulting demands place on them. As is the case throughout Latin America, Nicaragua has had a long and con- tinuing tradition of weak municipal government, resulting primarily from anemic revenues and management and neglect from central government. The provision of municipal services and infrastructure reflects local govern- ment's shortcomings and Central Government's inattention: by 1976 only 65% /4 Almost US$56 million of the estimated US$84.8 million reconstructioa expenditures for infrastructure, public facilities, and public shelter programs was from lending agencies, including US$15.5 million from the IDA reconstruction credit.  -4- of the population of the 20 largest urban centers was served with water (in Managua 68%) and only six had any sewerage networks; those systems served only 32% of the population of the six cities. 5 Less than 12% of these services had been provided since the earthquake. While there is no survey or data of other municipal infrastructure, such as street paving, storm drainage and municipal services and facilities, a measure of overall effec- tiveness of local government response to urban needs is reflected in a review of local government finances (see Annex 2, Table XI), which clearly shows that few of these improvements could have been made. 1.08 By comparison with the earthquake, the 1979 civil war had an even more substantial impact because it affected almost all of the Pacific coastal urban centers. Damage to public structures, infrastructure and equipment is estimated at US$85 million, most of which was to the secondary urban centers which even prior to the war were unable to meet the needs of their rapidly growing populations. While much has been done to repair or replace municipal infrastructure damaged and lost, and the newly created local municipal governments have proven to be effective (see Annex 7), a great deal remains to be done to overcome the original basic infrastrucrure deficit and original city-management deficiencies. C. Recent Actions and and New Policy Directions 1.09 The present Government is actively reversing previous policy in the sector, and has put into effect a substantial reorientation of urban and municipal development policies. In its first year, the Government initiated major reconstruction and employment-generating programs in urban centers directly affected by the war. Simultaneously, the Government enacted legislation to provide for municipal autonomy and to improve muni- cipal revenues. Five-member Municipal Reconstruction Juntas created to be responsible for administration of all cities and towns have provided extre- mely dynamic, enthusiastic and effective local governments. Although the Juntas are somewhat inexperienced, their ability to rebuild and manage most of the country's urban centers over the past year and a half has been impressive. Legislation reforming all municipalities' planes de arbitrios (the schedule of taxes and fees levied by municipalies) has been enacted, increasing revenues substantially. In October 1979, the Secretaria de Asuntos Municipales (SAMU) was created to foster a more balanced municipal development and to direct investments to municipalities that have been traditionally neglected. The Bank Urban Reconstruction Project--Credit 965-NIC--(due to be completed in June 1982), is being implemented through the newly created MINVAH (Ministerio de la Vivienda y Asentamientos Humanos), and emphasizes the need not only to rehabilitate six of the larger urban centers destroyed in the war, but to provide the basis for future regional development planning. The credit was signed in June 1973, its closing date was in September 1979. The project included a sites and services component and industrial, education, water supply and power com- ponents, all designed to meet emergency needs not covered by programs of other aid agencies. The sites and services component provided safe shelter /5 Source: DENACAL statistics, 1977.  -5- and adequate services to low-income families affected by the earthquake, albeit of somewhat higher standards than originally intended; it also prov- ided for successful mutual aid/self-help sites and services. The project, however, had little impact on reactivating the economy or contributing to the orderly development of Managua, as it was an emergency operation and was executed during a period of increasing po:Litical turmoil and adminis- trative instability. The experience gained in this project was an impor- tant basis for instituting new programs and policy directions for the urban sector (see Annex 7 for a summary of project--Credit 965-NI). MINVAH moved quickly to provide planning and project preparation for a wide range of municipal development programs. Six regional project implementation teams put in place to implement the project have been an important part of this process. Managua's local government (the Junta de Reconstruccion de Managua--JRM) has also effectively carried out a major reconstruction effort, part of which was the repair and paving of bus routes through the public transport rehabilitation component of the Urban Reconstruction Pro- ject. In the process, JRM consolidated its in-house capacity to carry out large-scale municipal projects, and is now considered to be one of the public sector's most capable implementing agencies. 1.10 Responding to the reconstruction thrust and new policy direc- tions, MINVAH has assisted JRM and SAMU in defining new development strategies linked to an efficient and equitable allocation of resources for the sector. MINVAH and JRM have reassessed previous earthquake reconstruc- tion and, in May 1980, put into effect new zoning, land use, and develop- ment plans to regulate Managua's future growth. In order to contain waste- ful sprawl and maximize use of existing infrastructure and usable land, a redensification strategy has been established. A development boundary has been defined (see Map IBRD-15697) limiting future investments. Within this perimeter, JRM plans to upgrade infrastructure and services and thus promote residential densification and intensify commercial, industrial, and support activities, all with a view to increasing the efficiency of the existing urban systems. MINVAH has been assigned responsibility for managing several neighborhoods in which land speculators had subdivided and sold (or rented) residential plots, but had refused to provide the essen- tial infrastructure. Residents of these areas, called barrios intereni- dos,6 are now making their mortgage payments to MINVAH, which, using these payments to recover investments, will eventually provide legal tenure, basic infrastructure and services. A staged program is envisioned: once basic infrastructure (water and sewerage) is installed, JRM is to up- grade paving and public lighting and to provide municipal services. Simul- taneously, JRM has initiated the consolidation process with neighborhoods already having water and sewerage networks. 1.11 JRM's strategy is to promote the infill of extensive vacant areas left by the earthquake and the resultant sprawl. This redensification would ultimately accommodate a population increase of over 50% by the year 2000--all of the city's projected growth. Given the continuing seismic /6 MINVAH is preparing a shelter project for Bank consideration which will include a component to upgrade these barrios intervenidos in about seven cities.  -6- risk in Managua, the Government is developing, with the assistance of the US geological service, a new building code which would reduce the risk of major damage with fatalities in the event of another major quake. As part of the consolidation, two large district centers are being developed; muni- cipal markets and shops are already under construction; administrative, cultural, and recreational facilities are to be added over the next five years. 1l12 Similarly, MINVAH and SAMU have been developing a strategy for all other municipal development outside Managua. Because Nicaragua's economy is based predominantly on agricultural exports, a major proportion of all investment has been concentrated in the Pacific Coastal Region, re- sulting in extremely concentrated spatial investment and growth.7 While the long-term objective of Government is to correct this disequilibrium and tap .he resources of the Atlantic Coastal Area, it is also clear that the development of the Pacific Zone is, and will continue to be, a high priori- ty. However, even within the Pacific Coastal Region, concentrated produc- tive investments in certain areas or cities have resulted in strong migra- tion tendencies, for the most part following employment opportunities. 1.13 With a view to orienting short- and medium-term investments and actions in the sector, the spatial development strategy proposes first allocating investments within the agro-industrial productive centers (the Pacific Coastal Region); strengthening the newtwork of secondary cities to support industrial and agro-industrial investments and then giving atten- tion to hitherto isolated and neglected centers where economic potential exists (such as the rapidly expanding urban centers located along the access route to the Atlantic Region); all within a long-term development plan. The planning process has been based on an extensive analysis of urban centers and subregions (networks of related secondary cities) and their growth potential within the framework of the national economy. A list of highest priority urban centers has been identified, using the following criteria: (a) relationship of the urban centers to national production; (b) cross-sectoral investment plans; (c) potential for generating new, permanent, employment; (d) growth trends and potential; and (e) degree of existing infrastructure and support services (installed capacity). L-14 Four subregions outside the Managua region have been selected for immediate attention (see Map IBRD-15697): /7 The Pacific Coastal Region accounts for only 15% of Nicaragua's land area, but has over 53% of the national road network, 95% of investments 4n water and 77% of new housing investments (1970-1975). Over 65% of the country's population (including 58% of the economically active population) lives in the region.  -7-- (a) The Chinandega Subregion, the second largest industrial center in the country, has a diversified industrial base of chemical, textile, furniture, mechanical, electrical, and canning indus- tries. In addition, it is the marketing and processing center of the largest cotton producing area. It is the richest and most productive region in Nicaragua and the prospects for continued economic growth are good. (b) The Leon Subregion, with Leon as its focus, has a strong commer- cial base. It is the third largest industrial center with glass, milk, mechanical, and canning plants. The presence of the UNAN (University) School of Basic Science and numerous secondary educational facilities have given Leon added importance as an educational center for the country. (c) The Masaya Subregion is the most densely settled and has the highest concentration of small-scale farmers. The city of Masaya is the market center for the major coffee-producing region as well as the major artisan center of the country. Over a dozen tertiary municipalities are within a 40 km radius of Masaya. (d) The Threshold Area to the Atlantic Coastal Region consists of several very rapidly growing municipalities along the major high- way from Managua. II. PROJECT COMPONENTS, COSTS, AND FINANCING A. The Project Objectives 2.01 This first Municipal Development Project has been designed to address some of the highest priority and chronic problems affecting Nicaragua's productive urban centers. The Managua component focusses on two major aspects: (a) improvements to basic infrastructure constraints in large parts of the city that affect transport and services; and (b) the city-wide problem of storm drainage. Both programs would benefit from a Municipal Management component intended to assist municipal governments and Central Government in developing the skills and capacity to efficiently address the needs of Nicaragua's rapidly growing urban system. A pilot program focussing on developing the institutional mechanism to provide an efficient allocation of resources to Nicaragua's secondary cities is also included. The prime objectives are to eliminate constraints in the functioning of these urban centers and increase their efficiency, at the same time supporting and strengthening institutional and policy develop- ment. Particular emphasis will be given to raising adequate local revenues in contrast to past practices of relying on the Central Government's budget. Specifically, the project will: (a) protect large areas of Managua from seasonal flooding;  -8- (b) densify development in Managua within a newly defined city-growth boundary that will permit rational utilization of the existing infrastructure network. This process of consolidation will increase transportation efficiency and accessibility and will contribute to an increased level of health and safety. It will also permit the provision of basic urban services, such as refuse collection, to areas that could not previously have been served comprising more than one-third of the city's population, many of which are low-income households; (c) strengthen SAMU (Government's agency responsible for Municipal Development) so that it may confront urban development issues and provide policy assistance and resources to correct past deficien- cies of local governments, while helping to put in place a rational and efficient allocative strategy of investment in the sector; (d) assist SAMU in the above by providing financing for a pilot learn-by-doing investment program that will support an evolving, replicable mechanism for generating, financing, and implementing municipal works in harmony with urban and national spatial dev- elopment priorities. The project will strengthen SAMU's ability to select and evaluate municipalities and specific subprojects for financing through a carefully selected start-up investment program illustrating the criteria and analysis required for resource allocation between and within municipalities. Through the involvement of the financial system, the project also aims at institutionalizing the local government aspects of the national government's objectives for regional development; and (e) increase JRM and SAMU capacity to plan, execute and control public works and improve municipal finances, thereby raising the efficiency and productivity of Nicaragua's urban areas. Managua Component 2.02 The project will include two programs for Managua: (a) Upgrading for Low-Income Neighborhoods of Managua. The neighbor- hood upgrading program will provide, where appropriate, improve- ments to the basic infrastructure in 26 of the 52 neighborhoods planned to be upgraded by JRM in the next five years, as follows: (i) Local Storm Drainage. The neighborhood storm drainage system will eliminate localized annual flooding and permit uninterrupted bus service on local roads. (ii) Street Paving, Curbs, and Gutters. The street network serv- iced by public transportation will be paved to provide con- tinuous and efficient circulation and facilitate refuse collection. Secondary streets will be surfaced and compact- ed with select materials within concrete curbs and gutters, so as to control erosion and provide localized flood protec- tion.  -9- (iii) Walkways and Public Lighting. Walkways and public lighting to improve vehicular flow and pedestrian safety will also be provided. Walkways provided under the project form an integral part of the local storm protection system by chan- neling storm run-off to gutters and the drainage mains. In certain areas, they are needed to control erosion and prevent obstruction of the storm drainage system. (b) Major Storm Drainage Improvements. Five storm drainage channels that presently flood the city will be lined with masonry; veloci- ty check dams and energy dissipators to improve hydraulic gradients. Pilot Municipal Development Component 2.03 A pilot program to demonstrate and test technically and finan- cially feasible approaches to address the needs of Nicaragua's secondary cities will be administered by SAMU. The component aims at improving the capacity and efficiency of SAMU's operations (planning, appraising and supervising subprojects) by establishing measurable tests and preparing a future larger investment program. Part of this proposed institutional strengthening will be through the implementation of an on-lending mechanism to 15 selected municipalities for specific municipal infrastructure- services subprojects. 2.04 Subloans will be limited to those projects normally implemented by municipalities: (a) markets, transport terminals, and a slaughterhouse; (b) storm drainage; and (c) street paving and improvements. Municipal Management Component 2.05 The establishment of an institutional framework for the manage- ment of municipal development is a key objective of the project. Consider- able work remains to be done in order to improve the quality and efficiency of the JRM and SAMU operations. This work will be structured in four areas of analysis and reform: (i) legislation and policies related to municipal development; (ii) institutional reinforcement and reorganization; (iii) municipal finances; and (iv) monitoring and testing institutional capacity. The following will be provided: (a) Technical assistance and training for JRM to strengthen the basis for sound financial management in areas such as debt collection, financial planning and control, cadastral and valorization im- provements, efficient budgeting and reporting, and designing and operating improved accounting and internal audit systems, as well as external auditing. Assistance in management planning, staff training, and operations monitoring and evaluation will also be provided.  -10- (b) Technical assistance, vehicles, and training for SAMU to develop recommendations for establishing municipal development policies and reforms to strengthen the financial base of municipalities; urban and spatial development strategies; and developing munic- ipal management training programs to be offered by SAMU. Also included will be funds for SAMU to train staff, improve appraisal and supervision procedures and management systems, monitor on- going and prepare future projects. Vehicles, equipment, and special consultant services will be provided to SAMU to strength- en its implementation capacity. B. Project Costs 2.06 Total project costs are estimated to be C$ 228.0 million (US$22.8 million equivalent) excluding taxes and duties, of which US$16.0 million (70%) will be lent by the Bank. A summary breakdown of project costs is given in Table II.1 and the detailed breakdown in Annex 1. The cost esti- mates for physical works for Managua Municipal Infrastructure Upgrading are based on final engineering designs. February 1981 unit prices were used to estimate construction materials and labor and reflect JRM bi-weekly con- struction cost control data sheets of similar on-going construction. Unit costs were verified with those of the Ministry of Construction. Labor costs include the national social insurance contribution; field administra- tion is calculated at 10%; professional services at 8%; and administrative overhead at 1.5% of direct cost. About 330 staff-months of consulting services will be provided for the project. The average consultant-month for technical assistance services is estimated to be about US$8,000 for foreign personnel (which would be open to international recruitment), including salary, fees, overheads, international travel, housing, and subsistence, and would be about US$2,000 for Nicaraguan consultants (see Annex 1). JRM and SAMU are to provide office space and support services. 2.07 For the Pilot Municipal Infrastructure Improvements component, the cost estimates for buildings were calculated from final engineering of prototype designs. Unit prices were based on actual costs verified in the field (including those of the ongoing implementation of the six-city Urban Reconstruction Project). The allocation for professional services varies with the number of building repeats from 6.2 to 7%. For streets, bridges, and storm drainage, cost estimates were based on bills of quantity and unit prices from the current cost of similar work in the Urban Reconstruction Project and verified with the Ministry of Construction. For both compo- nents, physical contingencies were estimated at 5% because of the high quality and degree of detailed engineering and the similarity to on-going construction. The base costs are expressed in prices of February 1981. Price contingencies for local costs are calculated on the basis of the following percentages: 15% for 1981, 15% for 1982 and 10% for 1983. Price contingencies for foreign costs were estimated at: 10% for 1981, 9% for 1982 and 8% for 1983. Overall annual inflation rates are estimated to be higher. Recent experience indicates, however, that prices for construction works identical to the ones proposed under the project tend to rise at several percentage points below overall inflation rates. The foreign exchange component is estimated at 61% (see Table IT-1). The exchange rate is assumed to remain constant at its current level of US$1 = C$ 10.  Table II-1: Summary of Project Cost (February 1981 Prices) C/Million US$Mi1lion LOCAL FOREIGN TOTAL LOCAL FOREIGN TOTAL A. Managua Municipal Infrastructure Neighborhood Improvements 46.9 70.4 117.3 4.7 7.0 11.7 Major Storm Drainage 9.0 13.5 22.5 0.9 1.4 2.3 Subtotal, A 55.9 83.9 139.8 5.6 8.4 14.o B. Pilot Municipal Infrastructure Improvements Municipal Buildings 3.1 7.7 1l.8 0.3 0.8 1.1 Infrastructure 4.5 6.8 11.3 0.4 0.7 1.1 Subtotal, B 7.6 14.5 22.1 0.7 1.5 2.2 C. Municipal Management Assistance for JRM 0.9 1.4 2.3 0.1 0.1 0.2 Assistance for SAMU 1.9 3.5 5.4 0.2 o.4 o.6 Subtotal, C 2.8 4.9 7.7 0.3 0.5 o.8 D. Contingencies Physical Contingencies 3.3 5.2 8.5 0.3 0.5 o.8 Price Contingencies 19,5 30.4 49.9 2.0 3.0 5.0 Subtotal, D 22,8 35.6 58.4 2.3 3.5 5.8 Total Project Cost 89.1 138.9 228.0 8.9 13.9 22.8  -12- C. Financing 2.08 The proposed Bank loan of US$16.0 million will finance the entire foreign exchange cost, estimated at about 61% of total project cost (US$13.9 million). It is also proposed that about US$2.1 million of local costs be financed from the Bank loan. The JRM confirmed that it will pro- vide its own counterpart funds (US$5.7 million), and other municipalities will provide US$0.3 million (para 6.01 (d) (i)), while the participation of the Government in the entire project will be limited to about US$0.8 million. The loan will be made to the Government of Nicaragua and will have a term of 20 years, including 5 years of grace, at the prevailing interest rate. Government will pass on the proceeds of the Bank loan in local currency to: (a) JRM at 15% for 20 years, including a grace period of 3 years; (b) SAMU at the interest rate of the loan for 20 years, includ- ing a grace period of 3 years. The Government's contribution to SAMU will be without a financial charge. Government will pass on counterpart funds for technical assistance to both agencies as grants. SAMU will on-lend to participating municipalities at a rate of 15% during the first year of the program, when all subloans are expected to be approved and funds committ- ed.8 Should there be slippages, the on-lending rate will be subject to annual review by the Government and the Bank in light of changing economic conditions (para 6.01 (d) (iv)). The loan terms will depend on the nature of the subproject, the expected life of the structures being financed and the projected capacity of the municipality to repay. They are not expect- ed, however, to exceed 10 years. Grace periods will range from 6 months to 3 years. The Government will bear the foreign exchange risk. The 15% on-lending rate compares with a projected rate of inflation of about 25% for 1981 which is expected to decline to about 20% in 1982 and to about 15% in 1983. Inflation is expected to stabilize at rates considerably below 15% for the remainder of the life of the project, resulting in a positive interest rate for that period. Although during the commitment period, the SAMU on-lending rate is likely to be negative, it does represent signifi- cant progress from the historical rates of between 6% and 8%. 2.09 Table II-2 summarizes sources and uses of funds for the project; a detailed financing plan for the project is shown in Annex 2. Table II-2: Summary Financing Plan (US$ million) Government of Uses of Funds Bank JRM Municipalities Nicaragua Total JRM 13.2 5.6 - - 18.8 SAMU 2.1 - 0.2 0.7 3.0 Municipal Management 0.7 0.1 0.1 0.1 1.0 TOTAL 16.0 5.7 0.3 0.8 22.8 /8 SAMU will pass on 1% to each of the financial intermediaries to reimburse them for their administrative expenses (see para 3.05); the remaining differential will cover SAMU's own administrative expenses.  -13- D. Detailed Project Description Managua Municipal Infrastructure Upgrading Component--JRM 2.10 Two subcomponents will be financed: (a) the upgrading of munic- ipal infrastructure in 26 low-income neighborhoods and (b) a city-wide pro- gram of storm drainage improvements. The Neighborhood Upgrading Program will support JRM's ongoing efforts to provide basic municipal infra- structure and transport services. The program responds to a policy adopted by MINVAH and JRM over the past year to redensify the present dispersed pattern of the city (created by earthquake reconstruction) through the upgrading of basic infrastructure and municipal services deficiencies within a defined limit and to be complementary to ongoing municipal invest- ments (see para. 1.10 and map IBRD 15697). Large areas of the city within this expansion limit correspond to the lower income residential neighbor- hoods that have not been provided with municipal infrastructure or ade- quately serviced. These gaps cause a discontinuity of the city's circu- lation network, aggravate storm flooding throughout the city and affect the delivery of maintenance services. The proposed program will be a major contribution in implementing the plan to orient municipal investments to- ward improving the efficiency of the city's infrastructure networks and re- duce maintenance costs as well as to ultimately bring improved living conditions to 52 neighborhoods identified by JRM in its five-year plan. That plan will not only directly benefit about 65% of the urban population representing about 45% of the city's poor, but will also have a major impact on the economic efficiency of the entire city. JRM selected the 26 priority low-income neighborhoods (with a total population of about 220,000) for this stage of the project. While all of these have had tenure status resolved and basic water needs provided, they have neither paved streets nor storm drainage, and are subject to continual flooding. Health problems are created by stagnant surface water. Inaccessible streets during the rainy season make refuse collection impossible. Electricity and public street lighting is nonexistent or iniadequate and represent a considerable safety problem. The neighborhoods vary in size from 8 ha. with 1,000 persons to 128.5 ha. with over 39,000 persons; the densities vary from 80 to 303 persons per hectare. The proposed improvements in basic infrastructure are based on least-cost design standards and are limited to items that will eliminate functional constraints. The improvements will facilitate densification of up to 300 persons per hectare by developing vacant building plots. This JRM program is complementary to a program presently being developed by MINVAH to deal with the problems of other neighborhoods (barrios intervenidos) developed by speculators without basic infrastructure. These are now to be provided with water and sewerage by MINVAH and INAA9 using funds collected by residents' monthly payments to MINVAH. MINVAH is preparing a project to be submitted for Bank consid- eration in the future to deal with this upgrading on a large scale. Once those neighborhoods are provided with water and sewerage, JRM will provide upgrading similar to that included in this project. The program will include the following: /9 "Instituto Nicaraguense de Acueductos y Alcantarillados".  -14- (a) Local storm drainage along 30 km of local streets, which have been designed to eliminate annual flooding and to permit uninter- rupted bus service through the neighborhoods. Drop inlets, catch basin and erosion control devices will be provided with connec- tions to the major drainage channels of the city. A tolerable amount of temporary flooding (maximum one hour) of local streets in the lower sections of the city will be permitted on the basis of a probability of flooding once every 15 years, but the system is designed to permit continuous bus service. Drop inlets and catch basins will be provided with connections to the city's major storm drainage system. (b) Street paving, curbs, and gutters. About 44 km of secondary streets that form part of the network served by public trans- portation will be paved to provide continuity of circulation throughout the city and provide access to refuse collection serv- ices. The paving will consist of pre-cast "adoquin" blocks that are easily laid by hand. Tertiary streets will be surfaced with select material and compacted into water-bound macadam, con- tained within a concrete curb and gutter so as to control erosion and reduce maintenance costs. (c) Walkways and public lighting. Walkways, which are an integral part of the local storm drainage system, will be provided within the streets rights-of-way of major streets throughout each neigh- borhood for safe and convenient pedestrian circulation. Since it is the predominant means of circulation, a minimum level of public lighting--500 light standards--will run parallel to the walkways (at 80 m spacings). The walkways are to be located so as to control storm run-off and check erosion that would block the storm drainage network. Major Storm Drainage Improvements Program 2.11 Five major natural storm drainage channels that are not adequate to contain and divert run-off, presently cause flooding of large parts of the city. These will be enlarged and upgraded to eliminate major flooding. The five priority drainage channels were selected on the basis of a 1975 study by DEPLAN (Mexican consultants) which was revised in 1977 to conform to the 15-year storm data base.lO Because the city is on a sloping plain that drains toward Lake Managua, the natural topography has created 8 drainage areas (and flood plains) 15 to 20 km long by 2 to 3 km wide (see map, IBRD 15697). During normal rainfall, the natural gullies become rivers and overflow their banks. The proposed flood protection works should eliminate the annual flooding, which destroys housing, vegeta- tion and obstructs major traffic arteries and results in the costly clean- up of debris (see map, IBRD 15697). With the protection in place, resi- dents of the affected areas would be able to make permanent house improve- ments and upgrade the usable flood plain. /10 This is an appropriate minimum standard that will be surpassed when diversion interceptor channels are constructed above the city (see Annex 5).  -15- 2.12 The component consists of 7.1 km of natural drainage gullies that will be enlarged and reshaped as open channels and lined with dressed ma- sonry and reinforced concrete beams and base. Box culverts and bridges will be provided for vehicular and pedestrian crossings; and along one section, 2.7 km of large diameter reinforced concrete culverts and pipes will be provided. The hydraulic gradient will be improved by constructing 25 velocity check dams with retention basins, 19 energy dissipators and soil erosion control devices, including desiltation chambers. Pilot Municipal Development Component--SAMU 2.13 The Secretaria de Asuntos Municipales (SAMU) has selected a priority list of 15 of the 136 municipalities throughout the country to be eligible to participate in the pilot municipal infrastructure and improvements program. The selection has been made on the basis of criteria developed jointly with MINVAH. This pilot program is designed to strengthen the institutional capacity of SAMU and participating municipali- ties as well as generating a financial base for future municipal develop- ment, through the establishment of a municipal development fund at the Fondo Especial de Desarrollo (FED) to be operated on behalf of SAMU. For the immediate programs, SAMU will make loans to participating municipali- ties upon joint review and approval with the FED (see para. 3.05). Through this project, SAMU will assist municipalities by (a) providing programs to help them in assessing needs, developing better administrative procedures and improving financial management; and (b) helping define a short range (4-5 years) plan for each municipality to meet their most urgent infra- structure, services, or management needs. The primary objective of this component is to develop the capacity of SAMU to carry out such programs by implementing this first small, pilot lending operation for 15 municipali- ties. 2.14 SAMU and the Bank reviewed and appraised all the subprojects to be financed in the pilot program for each of the 15 participating munici- palities (see Annex 1). For this round of lending, 15 municipalities clustered in four subregional/administrative zones (see map, IBRD 15696) have been identified, and financial analysis for all 15 municipalities has been completed. Three of these zones are the cities that have developed subregional technical teams in the course of implementing the Urban Recon- struction Project. The fourth will operate from SAMU headquarters in Managua. The participating municipalities have been selected because they: (a) are in the country's most productive regions; (b) have strong financial bases; and (c) exhibit highest present growth rates and have demonstrated that this growth is likely to continue in the future. Both the municipali- ties and subprojects have been selected to provide SAMU with a sound basis for expanding its planning and implementation capacity in the near future. All subloans and costs are detailed in Annex 1 and summarized in Table II-3.  -16- Municipal Management Component 2.15 For the economies and supportive infrastructure of Nicaragua's urban centers to be strengthened, their local governments will have to respond more effectively in providing services and promoting development. The new government has taken important steps in that direction: in general, local governments have been given more autonomy and their financial needs are being addressed by recent measures to reformulate municipal taxes and fees (see para. 1.09). SAMU was created to regulate and assist in the process. However, much needs to be done to overcome past inequities and inefficiencies. Most significant among immediate concerns are the weak, inflexible revenue bases and the heavy dependency on Central Government grants. While the local governing boards are dynamic and reform oriented, they lack the experience and administrative framework to bring about major improvements in the delivery of infrastructure. 2.16 The Municipal Management Component will address this constraint by improving the effectiveness and efficiency of the Municipal Government of Managua (JRM) and the National Agency for Municipal Development (SAMU). JRM and SAMU agree on the need to strengthen municipal performance. Whilst Managua has different constraints than other municipalities, all could ben- efit from improvements in three broad areas: (a) the local administrative framework will be supported to allow for better planning, budgeting, and financial monitoring; (b) the municipalities' financial bases will be strengthened by increasing locally generated revenues, especially through an effective mechanism to apportion property taxes; and (c) municipal re- sources (physical plant and staff) will be strengthened and local manage- ment practices, especially financial planning and control, will be improv- ed. The management assistance program will focus on these improvements by providing about 330 person-months of local and foreign technical assis- tance, vehicles, and equipment (see Guidelines in Annex 8; and Annex 1) as follows.  Table 11-3: Municipal Infrastructure Improvements Gomponent Summary of Participating Municipalities, Subloans and Cost Estimates a/ (CS million) S U B P R O J E C T S Urban Percentage population Annuial Growth Rate Intermunlicipal f4unicipal Bus Municipal StreetStr (19-8Q Eqtimate) (1971/78) Slaughterhouse Markets b1 Station Building Improvements Drainage Bridges Total Chinandega Subregion [8,3301 1. Chinandega c/ 48,200 5.6 2,400 2,400 2. Chichigalna 20,500 3.8 200 200 200 600 3. Corinto 18,000 2.6 900 500 1,400 4. El Viejo 14,100 6.0 2,000 1,600 330 3,930 Leon Subregion [6,5001 l. Leon c/ 88,000 5.7 2,400 2,300 4,700 2. Paz Centro 9,900 5.0 400 400 3. Nagarote 10,500 4.6 1,400 1,400 Managua Subregion 15,4001 1. TivitaDa Z1,900 9.0 300 700 100 1,100 2. Mateare 2,000 5.5 300 1,200 1,500 3. Juigalpa 19,500 5.9 700 1,000 1,700 4. El Rama 3,300 12.0 500 600 1,100 Masaya Subregion 19,8001 1. masava c/ 52,300 6.0 700 1,600 1,000 3,300 2. Diriamba 18,500 8.0 1,800 2,000 500 4,300 3. Nandaime 9,200 6.1 300 200 900 300 1,700 4. Nindiri 4,000 8.3 500 500 TOTAL 339,900 1,800 10,400 2,200 300 12,900 1,100 1,330 30,030 TOTAL US$ 3,003 a! February 1981 costa plu-' -ritnvencies. bW Includes repairs. c/ Cities from which, technical units would supervise implementation; supervision for the Managua subregion would be done from SAMU hieadquarters.  -18- 2.17 Assistance to JRM (a) about 74 person-months of consultants and specialists to strengthen its financial management will be provided in the areas of accounting, billing, collections, financial planning and con- trol, cadastral and betterment studies, improvements in budgeting and financial reporting, restructuring of the internal audit system, and review of the role of departmental forces in terms of future operation; and (b) training for JRM staff in the specialized areas described above and in municipal engineering will also be provided. 2.18 Assistance to SAMU. Because SAMU is a new and relatively inexpe- rienced institution, its participation in administering a pilot program of municipal infrastructure development is in itself a way of preparing and building an efficient institution that could consolidate municipal develop- ment in the future. Thus, the project will provide a broad range of assis- tance to SAMU. First, a detailed examination of the tasks that SAMU should perform relative to its role of coordinating municipal development will lead to a proposal for future reorganization of the institution. This will include a review of, and proposals for, more streamlined operating proce- dures and appropriate staffing. The review will cover three major areas of SAMU's operations: (a) policy and planning--including allocative investment strategy, and research; (b) programming, subproject appraisal--both tech- nical and financial; and (c) subproject supervision, monitoring, and the delivery of assistance to participating municipalities. A second area of assistance will be in the review and proposals leading to improving the financial position of municipalities and the legislative review of munici- pal operations. The third field of assistance will be primarily through the provision of physical plant and training to carry out the pilot program and then prepare future lending operations. A total of 196 person-months of local and foreign specialized assistance and training has been planned for SAMU. Vehicles and equipment will also be provided (see Annex 1). 2.19 Because developing SAMU's institutional capacity is the main ob- jective of the Municipal Development Component of the project, a specific assistance plan detailing the goals necessary to bring about the institu- tional improvements was outlined with SAMU at appraisal (see Annex 8). SAMU has further refined the plan and has started reorganizing and increasing staff along those lines; the plan's implementation process was reviewed and agreed to with SAMU during negotiations (paras. 3.04 and 6.01 (d)(ii)). The plan should enable SAMU and Bank staff to monitor changes and evaluate its readiness for future operations. 2.20 The multisectoral (integrated) nature of municipal development requires coordination and cooperation among the municipalities and Govern- ment's autonomous agencies responsible for the planning and provision of infrastructure, support services, and industrial promotion. To assist SAMU in its key coordinating role, a coordinating committee chaired by SAMU's Vice Minister, and consisting of representatives of the relevant agencies will meet on a regular basis to monitor implementation progress. Part of the proposed technical assistance will be to define and advise on effective  -19- mechanisms for this coordination to take place. Preliminary terms of ref- erence (in Annex 8) for this and other aspects of the Municipal Management Component were drafted, discussed, and agreed to during the appraisal mission and will form the basis for the assistance program. These are now being finalized with the help of experts from FINAPRI (Government's pre- investment agency responsible for technical assistance) now assisting SAMU (para. 3.04) and the search for consultants has started. III. EXECUTING AGENCIES AND PROJECT IMPLEMENTATION A. The Reconstruction Board of Managua--JRM 3.01 The Junta de Reconstruccion de Managua (JRM--the Reconstruction Board of Managua) will be the main executing agency for the Managua com- ponent.11 In May 198012 JRM was officially created (Decree No. 400) by transforming the Distrito Nacional (the district which was administered as the nation's capital, and was presided over by a cabinet minister) to an autonomous municipality, governed by a five-member board, the president of which is a cabinet minister. While its organizational structure (Chart 1 in Annex 3) was changed somewhat, it retained most of the previous staff. JRM has built on the Distrito's long-established implementation capacity and has, in the past 12 months, become a powerful and dynamic institution. JRM has instituted significant policy and operational changes, but recogni- zes that while its policy directions are clear, it needs to increase effi- ciency and is actively adjusting to meet those objectives. In September 1981, a decree was passed which would integrate the budget of JRM into the national budget as of January 1, 1982. While preserving JRM's functional autonomy, the measure is intended to streamline and reduce the costs of some administrative functions, to allow for closer budgetary monitoring of JRM's operations, and to transfer any net surplus of those operations to a municipal development fund to be administered by SAMU. The main practical effects of the decree will be as follows: (a) JRM's principal source of revenue, the sales tax, will be col- lected by the Ministry of Finance and maintained in a separate account. (b) JRM's permanent staff will be paid through the Ministry of Fi- nance's computerized system as a charge against JRM's budget. (c) Certain purchases, for which the Central Government is able to obtain discounts through bulk buying agreements, will be made for JRM through the Central Government. (d) JRM will prepare its budget and submit it to the Ministry of Finance for approval. Funds will then be made available from JRM's revenues to various revolving funds at the disposal of JRM. (e) Funds remaining in JRM's special revenue account at the end of the year, after allowing for all outstanding obligations, will be transferred to the Municipal Development Fund. /11 JRM's policies and programs are described in para 4.01 and its financial policies and position are reviewed in paras 4.02 and 4.05. /12 The functional change from Distrito to Junta actually took place in August 1979.  -20- 3.02 JRM has a large and well qualified staff, organized in five ex- ecutive departments, the principal ones being: Municipal Operations (man- agement, policy and design); Urban Services (maintenance and provision of services); and Legal/Financial (see Annex 3, Chart 1). Design and imple- mentation will be under the responsibility of the Municipal Operations Department (OM) through the Planning and Implementation Division, which has a staff of 36 experienced professionals with an additional 40 junior engi- neers. During 1980, the Division demonstrated its ability to design and execute infrastructure works valued at C$106,000,000. The proposed Bank project has been dimensioned to be well within the capacity of the present organization. JRM has an extensive fleet of vehicles and construction equipment--in fact, JRM is considered to be Nicaragua's largest and best equipped implementation force, and has, on occasion assisted the Ministry of Construction (Public Works). The proposed project would not tax JRM's in-house capacity, and the proposed annual civil works expenditures of C$20 million (1981), C$74 million (1982), and C$56 million (1983) are about half of the estimated value of work carried out in 1980. Financial supervision and reporting (see paras. 3.17-3.19) will be carried out by the Financial Department. All of the above units are well staffed and experienced in carrying out similar on-going operations. Work will be implemented by departmental forces, as has been standard practice for JRM (see para. 3.10). Similarly, procurement, accounting, and control will be managed through JRM's existing structure. However, a project manager and support staff will be assigned to coordinate the implementation of the project. JRM will enter into a subsidiary contract with the Government satisfactory to the Bank. B. The Agency for Municipal Affairs (SAMU) 3.03 In its plan for reconstruction, the present Government has stated its policy to influence urban growth trends by implementing a policy of rational and equitable allocation of resources which would be part of a comprehensive national development plan. The Government has directed efforts in all sectors to this approach, and the municipal system is con- sidered an important part of this strategy. In order to both reinforce the capacity of local governments and coordinate the reconstruction and devel- opment process, Government created the Secretaria de Asuntos Municipales (SAMU) in December 1979 as a secretariat of Central Government with the special role of coordinating the different economic and administrative pro- grams and functions of the new Municipal Reconstruction Boards. SAMU's role is not only to assist activating the local boards but also to assist in planning and financing for their longer range needs. In early 1980, SAMU used its limited funds (transferred from Central Government) on highest priority reconstruction programs. By late 1980, SAMU had realized that a coherent and comprehensive development plan needed to be instituted and began an analysis of the country's 136 urban centers under its juris- diction. In the process SAMU has begun to consolidate its inter-agency co- ordinating function--but with marginal success. This task, in itself, is extremely difficult in a context where ministries, autonomous public agen- cies, and private institutions have traditionally operated independently and where municipal governments were always too weak to bring about co- hesive development actions. SAMU has been overwhelmed by requests for assistance in municipal development and realizes its shortfall of capacity  -21- to effectively deal with them. SAMU has received assistance from IDB- financed specialists and an ongoing AID-financed program to study municipal development policy being carried out jointly by SAMU, INCAE (the Central American Institute of Business Administration), and the University of Cali- fornia at Berkeley. This program is complementary to the assistance en- visioned in the Municipal Management Component, and together aim to increase SAMU's capacity. 3.04 SAMU's executive director is a cabinet member of Central Govern- ment. SAMU has a staff of 52 professionals, but is in the process of re- organization and increasing its staff. SAMU has four main departments: (a) Programming, Planning and Design; (b) Projects (which is responsible for subproject evaluation and supervision); (c) Municipal Coordination (which identifies and monitors subprojects and provides technical assist- ance and training programs to municipalities); and (d) Administration. There are presently 14 professionals in the Projects Department, but SAMU proposes to increase that staff to 20 (especially for supervision and financial operations), and that of other departments as necessary (see Annex 3, Chart 2). The technical assistance to municipalities consists mainly in identifying and planning projects, and management training in areas such as accounting procedures, etc. The appraisal mission discussed with SAMU and Central Government (see paras. 2.19 and 2.20) additional organizational and staffing requirements for increasing the institution's capacity and implementing the component. Assurances were given that all counterpart resources would be made available to do so and agreement was reached on SAMU's organizational structure (para. 6.01(d)(ii)). A major part of the reorganization will come about through the assistance to be provided in the Municipal Management Component of the proposed project. These agreements were reaffirmed during negotiations. 3.05 SAMU will have the responsibility for implementing the secondary cities component. This includes selection of priority municipalities in accordance with national regional development strategy, assistance to muni- cipalities in organizing themselves for the preparation and execution of subprojects, and appraisal and supervision of subprojects. For the selec- tion of priority municipalities, a set of criteria has been developed re- flecting the growth potential of municipalities and the need to efficiently serve existing industrial and other types of economic activity. These criteria were utilized for the selection of the cities included in this project and are to be used in all of SAMU's parallel and future operations (see Annex 4). During appraisal, Bank staff assisted in the SAMU appraisal of the subprojects to be financed with the proposed loan. These subproj- ects have been shown to be feasible (para. 2.14). A format has been developed for the documentation of this analysis and for its presentation to the SAMU Credit Committee for final approval. The committee members are the Vice-Minister and the Department Directors of SAMU and a representative of the Fondo Especial de Desarrollo (FED) which will handle the financial aspects of the program for SAMU (para. 2.13). The participation of the FED representative is in line with the Government's policy of involving the financial system in all investment decisions. The financial system will be further involved through the participation of the country's financial intermediaries, which have branches in every municipality, as the financial  -22- agents of SAMU.13 Once a subproject has been approved by SAMU, one of the intermediaries will be authorized to disburse against statements of expend- itures certified by SAMU staff and will also be in charge of loan repay- ments. The FED and the participating intermediaries will receive 1% each from SAMU to cover their expenses as financial agents for the component. SAMU' and FED will enter into a subsidiary contract with the Government defining the terms at which the funds will be passed on and the responsibi- lities of the various participating agencies, subject to Bank approval. During negotiations, draft agreements, lending policies and manuals were agreed to. The SAMU subloans are to be approved and committed not later than December 31, 1982. C. Implementation Schedule 3.06 The project will be implemented over a three-year period from mid-1981 to mid-1982.14 Part of the storm drainage works carried out after March 1, 1981, are proposed for retroactive financing (see para. 3.16). Annex 3, Charts 3 and 4 show the implementation schedule for various pro- ject components. 3.07 For the Managua Upgrading Component, implementarion priority was given to flood protection works (as shown in the schedule of implementa- tion, Annex 3, Chart 3). In January 1981, JRM started emergency work on two major storm drainage canals that serve the eastern and western edges of the city. However, a large velocity check dam which was programmed could not be started because of heavy rains. All three are proposed for retro- active financing and all of the work, except the check dam, were completed on schedule. Other localized storm drainage works that can be built during the rains are being carried out as a substitute for the dam. The remaining drainage works to commence in January 1982 (after the rains) are scheduled for compLetion by mid-1982. 3.08 For improvements to the 26 neighborhoods, JRM plans to have started work in 10 neighborhoods by April of 1982. During 1982, work on 12 neighborhoods should be well underway, with work on another 4 neighborhoods scheduled to start in January of 1983. 3.09 The implementation of the 34 subprojects in 15 municipalities will be phased over three years (see Annex 3, Chart 4). Six municipalities plan to start implementation of subprojects by mid-1982, and work in another five should start shortly thereafter. The first works to be carried out are in three of the six cities of the Urban Reconstruction Pro- ject, where the technical units are already functioning. About half of the work in all municipalities is expected to be implemented during CY1982. Most of the remaining work is expected to be completed by the end of 1983. D. Procurement 3.10 For the Managua Upgrading Component, JRM will carry out the works financed under the proposed loan through the use of its own departmental forces (force account). The proposed works are similar to those that these forces have been executing efficiently since late 1979. In fact, in the case of major storm drainage improvements, the loan will finance the con- tinuation of an ongoing program which the Bank has carefully reviewed in the field. Similarly, the proposed neighborhood improvements will be /13 In practice, the Banco Nacional de Desarrollo (BND) and the Banco Inmobiliario (BI) are expected to do most of the on-lending. /14 Including the period eligible for retroactive financing.  -23- carried out using the same methods (low/intermediate technology), materials and labor used successfully in the reconstruction effort and JRM's ongoing neighborhood program.15 As the initial phase of reconstruction is coming to an end, there will be an excess capacity of equipment and manpower which will be utilized in the proposed works. Whilst there is probably suffi- cient excess capacity of equipment, in the case of labor, some new hiring will be needed for the duration of the new project. At the conclusion of the project, part of JRM's labor force increase will be transferred to do badly needed street maintenance and refuse collection services, another part will continue with future stages of upgrading, and the rest is expect- ed to be released.16 The loan will include technical assistance to JRM for improved accounting, costing, and monitoring, which is expected to in- crease the efficiency of carrying out works through force account. 3.11 The construction industry suffered serious damage during the civil war and has been recovering only slowly because the largest contrac- tors left the country. Those construction firms that did manage to reactivate have been working at close to capacity levels and are expected to continue to be fully occupied over the next two to three years. In this respect, the Ministry of Construction (MINCON) has taken action so that for the public sector's 1981 construction program of 283 projects, 81 (29%) will be let out to private contractors for bidding while 26 (9%) have been allocated to JRM (mainly the works under the proposed Bank project). MINCON intends to increase the participation of private contracting in the future to over 60% of the Government's construction program. However, during the first half of the project's implementation, it appears unlikely that contracting firms will be in a position to participate on a sufficient scale to warrant the risk and time required for local competitive bidding. Furthermore, of the 27 contractors registered with the National Construc- tion Chamber, only 15 have expressed a willingness to prepare bids for works valued at more than US$100,000; and then only on a "cost-plus" basis.17 Also, the financial position of most contractors is such that commercial bank guarantees for such works are virtually impossible to ob- tain. Nevertheless, after a period of consolidation, it may be possible to mobilize other firms in response to the prospect of increased construction activity generated by the project, if the time and cost of this mobiliza- tion would not create unwarranted risks for the project. With a view to having the project assist in its reactivation, the possibility of the private construction industry participation in implementing part of the upgrading component was discussed during negotiations; and JRM agreed to present a plan for doing so by June 30, 1982 (para. 6.01(c)(ii)). /15 JRM maintains daily field records (time and cost sheets) on each work gang, and bi-weekly cost reports are prepared for each construction job. These actual costs were used in estimating the components' costs. /16 The management assistance component will also make recommendations as to the future of JRM's department forces. /17 Except for one neighborhood, all improvements are estimated in excesxs of US$100,000 with the average US$596,000.  -24- 3.12 Procurement of construction materials, such as cement, steel, re- inforced concrete, pipe, pre-cast paving blocks, and box culverts, will be by local competitive bidding under procedures accepta Ae to the Bank, which includes notification to potential foreign suppliers. 3.13 SAMU will supervise the tendering of the 14 buildings (markets, a slaughterhouse, bus stations, and municipal office building) totalling US$1.47 million (49% of this component) using local competitive bidding, which is appropriate in view of the small size of the works involved. A minimum of three prequalified local contractors will be invited to bid for each contract. Where there are two or more buildings proposed per munici- pality, bid packages will be prepared. Experience has been that contrac- tors are most likely to bid on the construction of buildings. To the extent possible, the street, storm drainage, and bridge work will be exam- ined for appropriate competitive bidding on a case-by-case basis depending on the availability of local contractors. In cases where contractors would not bid, the works will be carried out using the municipalities' depart- mental forces. All municipalities have installed capacity to do so. E. Disbursement 3.14 The implementation plan for the JRM component (see paras. 3.07 and 3.08 and Chart 3, Annex 3) calls for implementing the upgrading work in 6 to 10 neighborhoods simultaneously (in addition to the storm drainage works) each quarter. This represents an average quarterly expenditure of almost US$1.8 million. In order for JRM to keep pace with the resulting rapid (and prolonged) succession of expenditures, it is proposed that a Working Fund be established. This Fund would avoid unnecessary funds flow restraints that could occur should there be prolonged processing time for expenditure reimbursements. The Working Fund will be established in the Central Bank to reimburse JRM for the Bank's share of eligible local expenditures for civil works under this component. An initial disbursement of US$1.2 million equivalent, estimated as the Bank's share of 3 months' expenditures, will be made subject to receipt of a withdrawal application supported by documentation indicating that the Special Account for the Working Fund had been established in the Central Bank. The procedures for subsequent reimbursement will be that, after payments for 100% of expend- itures have been made, JRM will present withdrawal applications to the Central Bank for the withdrawal of the Bank share. After payment, the Central Bank will forward these applications to the Bank for review and subsequent replenishment of the Special Account. Details of the operation of the Working Fund were discussed and agreed during negotiations. The Government also agreed to open a project account in the Central Bank for SAMU and to deposit initially in this account the amount of US$300,000 equivalent in Cordobas and to deposit annually thereafter the counterpart funds required. 3.15 For JRM, disbursements will be made for 70% of expenditures for civil works and of construction material procured for the project, 100% of /18 Estimated amounts to be procured are: cement US$2,300,000, steel US$167,000, and street lighting US$200,000.  -25- foreign technical assistance and training expenditures and 64% of local ex- penditures. For SAMU, disbursements will be made for 70% of amounts disbursed for subloans to participating municipalities; 100% of foreign expenditures for equipment and vehicles or 85% of expenditures for those locally procured; 100% of foreign technical assistance and training expend- itures, and 64% of local expenditures. Expenditures for those works carried out by force account will be submitted against a certified state- ment of expenditures (SOE). The documentation for these expendituresand for subloans made by SAMU will not be submitted to the Bank but will be retained by JRM and by SAMU for review by Bank project supervision missions. Disbursements for civil works carried out through contracts let under local competitive bidding (about 25% of the loan), as well as all others, will be fully documented. 3.16 Retroactive financing, in the amount of US$1.4 million equivalent (9% of the proposed project), for amounts paid before the date of the Loan Agreement, but after March 1, 1981, is proposed for the storm drainage and neighborhood improvement works of the Managua component. These improve- ments are scheduled during the dry season to avoid the cost of building diversion canals around each construction segment which would increase the cost by 40%. The cost of the main storm drainage work to be retroactively financed with loan funds is estimated at slight]Ly less than US$1.1 million; the related local neighborhood storm drainage works to be similarly financ- ed (about US$300,000) relate to the continuation of ongoing work, will avoid loss of momentum and start-up costs and will also optimize the effec- tive utilization of the JRM labor force. One of the appraised subprojects- -bridge repairs totalling US$33,000 equivalent for the municipality of El Viejo--will be eligible for retroactive financing. In April, a flood des- troyed the bridge and emergency repairs as appraised were carried out using procedures acceptable to the Bank. Retroactive financing is therefore recommended for up to US$1.4 million equivalent. The closing date of the project is expected to be December 31, 1984. F. Accounting and External Auditing 3.17 Analysis of JRM's historical financial information reveals a high degree of past disorder in municipal administration, especially character- ized by tax evasion. Not all liabilities have been adequately recorded and there is even some doubt as to the obligation to repay others. Nor have all fixed assets been consistently controlled and recorded, and as a result of all this, financial indices of the past are not very useful. A major effort has been undertaken to correct this situation. The activities of the JRM are now recorded and controlled on the basis of an internally con- sistent accounting system. 3.18 JRM will maintain separate project accounts in accordance with accounting principles consistently applied. For the Pilot Municipal Devel- opment Component each municipality will maintain adequate project records and accounts and make them available to SAMU which will maintain a consoli- dated project account. 3.19 The project accounts and related financial statements will be audited annually in accordance with generally accepted auditing principles  -26- consistently applied by independent auditors acceptable to the Bank. Audited comparative financial statements will include a balance sheet, a statement of income and expenses, a statement of source and application of funds and the transactions of the project account and the special account. The auditors' report will express an opinion as to JRM's and SAMU's finan- cial condition, as well as the reliability of the statements of expend- itures to support claims for disbursements and specifically whether such claims are supported by adequate documentation and reflect properly expend- itures eligible for financing under the loan agreement, and the adequacy of associated internal controls. Supplementary data on operations, financial position and scope of work carried out by auditors and such other addi- tional information as the Bank might from time to time reasonably request will also be provided. All annual audit reports and financial statements will be submitted to the Bank not later than four months after the end of each fiscal year. G. Supervision 3.20 The Fondo Internacional de Reconstruccion--FIR, the Government agency responsible for managing international lending, will monitor the project's implementation on behalf of the Government. JRM and SAMU will supervise each respective component for the Government as follows: (a) The Department of Planning and Design of JRM will supervise the storm drainage and upgrading works. Qualified design and field engineers will be assigned to a supervision unit to provide quality, quantity, and cost controls. As is JRM's current practice with ongoing works, the daily progress records of mate- rials and labor will be checked in the field and analyzed on a weekly basis for performance; in addition, monthly progress reports will be prepared for review by the Director of Operations of JRM. Quarterly progress reports will be compiled for the Bank. (b) For Municipal Infrastructure Improvements, SAMU will establish a technical unit to provide adequate control on all works. The technical units established by MINVAH (as part of the Urban Reconstruction Project) in the three subregions of Chinandega, Leon, and Masaya will be transferred to SAMU to provide the daily supervision of 25 subproject in 11 of the muinicipalities. The remaining nine items in four municipalities will be supervised by SAMU's technical unit based in Managua. Daily progress records of materials and labor will be checked periodically in the field and analyzed on a weekly basis by the (subregional) technical units. Quarterly progress reports and key indicators (the formats of which have been discussed with each agency--see Annex 6) will be prepared by the headquarter's technical unit for review by the onlending agency, FIR, and the Bank. 3.21 It is estimated that no more than normal supervision by Bank staff will be required. This has been the case with the Urban Reconstruc- tion Project which is similar in terms of scope and content, but with a more compressed implementation schedule.  -27- H. Monitoring and Evaluation 3.22 JRM will be responsible for the routine monitoring and evaluation of the Managua component. The project manager will prepare monthly reports on the cost analysis and construction progress based on key indicators of the cost breakdown for each item; a monthly analysis of expenditures for Bank disbursements will be maintained. Quarterly reports with an analysis of progress to date will be prepared by the project manager with an update of the projected targets for completion. 3.23 SAMU will be responsible for the routine monitoring and evalua- tion through its Projects Department. Monthly reports on the analysis of cost and construction progress will be prepared using key indicators of cost breakdowns for each item, and a monthly analysis of expenditures to Bank disbursements will be maintained. Quarterly reports with an analysis of progress to date will be prepared by the Projects Department with an update of the projected targets for completion. 3.24 Technical assistance funds (see paras. 2.17 to 2.20) will be available to JRM and SAMU to establish and maintain special project moni- toring and evaluation capabilities. In the case of JRM, the emphasis will be on (a) force account implementation, and (b) financial operations. For SAMU, the focus will be on benchmarks for determining increased institu- tional capacity in preparation for future expanded programs. The appraisal mission discussed draft key indicators (see Annex 6) for supervision and for monitoring project implementation. During negotiations targets, dates, implementation schedule and the final format for presentation were agreed to. IV. FINANCIAL ANALYSIS A. Cost Recovery 4.01 JRM will recover the cost of the proposed investments through general revenues. This is justified for works which benefit a large proportion of the population (such as the major storm drainage and some of the bus routes). Other works are more suitable for direct cost recovery. However, although JRM is empowered to recover the cost of such works through betterment taxes, it has not done so in the past. In anticipation of its new initiatives in infrastructure investments, JRM has recently adopted a revised schedule of municipal excise taxes and fees which, along with a more efficient collection system covering both past delinquency and the identification of activities that should have been paying taxes but were never assessed, has increased its revenues substantially. (In the following paragraphs these developments are analyzed in greater detail.) JRM does not at present have the administrative capability to implement betterment taxes. Part of the municipal management technical assistance, however, will be directed towards building up this capability for those cases where costs and benefits can reasonably be isolated and linked (para. 2.16). Terms of reference for this work were drafted during nego- tiations. Failure to utilize direct cost recovery for the proposed invest- ment would not have a negative effect on the city's ability to carry out  -28- similar works elsewhere in the city: all 56 neighborhoods in need of up- grading have been scheduled for assistance over the medium term. The finan- cial forecast outlined below, however, indicates that, with a reasonable set of assumptions about the real growth of the city's financial resources and about increasing recurrent expenditures, which are expected to accom- pany the expansion of capital investments, a further revision of the schedule of municipal taxes might well be necessary after project comple- tion. For the Pilot Municipal Development Component, municipalities will repay the SAMU loans for revenue-earning subprojects such as markets and transport terminals through revenues derived directly from these subproj- ects. For other infrastructure works, which benefit a large part of the population, subproject costs will be recovered through general municipal revenues. B. The Reconstruction Board of Managua - JRM Financial Position and Policies 4.02 The major source of revenue for Managua is a tax on the sale of goods and services (at rates between 1 and 2%). Such a tax is levied on the same tax base as taxes collected by the central government. As des- cribed in para. 3.01, the collection of both taxes will now be undertaken by the Ministry of Finance. Other sources of municipal revenue, including licences and fines, taxes on public entertainment and fees for refuse collection and other municipal services make up about 20% of the municipa- lity's revenue. These will continue to be collected by JRM. The major source of revenues, the tax on the sale of goods and services, is regulated by a schedule (Plan de Arbitrios) which has been revised in mid-1980, some 15 years after its last revision. During the last few months of 1980, tax receipts from this source rose dramatically. JRM has prepared a report on the effectiveness and impact the new schedule, a preliminary draft of which was reviewed during negotiations. This report indicates that the revenue targets in 1980 and 1981 have been realized and in some cases exceeded and that the collection system is functioning satisfactorily. Until this year, the internally generated revenues of JRM have been mainly used to cover operating costs and maintenance work while, for the most part, new works were carried out with funds transferred from the Central Government or from other government bodies. In contrast, financial projections indicate that the JRM will be able to finance future capital investments and to service the corresponding debt through its own revenues. 4.03 Table IV-1 contains a summary of JRM's actual and projected financial data. As noted in para. 3.17, the historial figures should be treated with some caution because of past inadequacy of JRM accounts. In 1978, the first year of widespread civil war, revenues did not rise as com- pared to 1977, while in 1979 they actually fell; 1980 revenues rose by 94%. In 1981, the application of the new schedule for a full year combined with the ongoing recovery of economic activity is expected to raise tax revenues by 84%. Operating expenses rose throughout the period, and JRM registered deficits in 1979-80. In 1981 operating expenses are expected to be 69% of JRM's revenues, which would enable the municipality to service its debt and make a substantial contribution to investment.  Table IV-1: Selected Financial Data--JRM (C$ million) Actual Projected 1978 1979 1980 1981 1982 1983 1984 1985 1986 Revenues 71.9 67.1 130.4 240.3 281.2 330.9 389.5 458.8 540.5 Operating and other Expenses (less depreciation and amortization) 48.4 68.5 130.7 166.6 196.8 246.0 298.3 383.4 480.5 Operating Interest - - - 5.9 6.9 6.7 15.3 24.9 23.3 Repayment of borrowings - - - 3.5 9.0 9.3 12.1 19.7 18.2 Net Internal Cash Generation 23.5 (1.4) (0.3) 64.3 68.5 68.9 63.8 29.8 18.5 Operating Expenses/Revenues 0.67 1.02 1.0 0.69 0.75 0.8 0.77 0.91 0.95 Revenue Ratio 1/ 1.49 0.98 1.0 1.23 1.19 1.17 1.16 1.07 1.04 Debt Service Coverage - - - 7.8 5.3 5.3 3.3 1.7 1.5 % Contribution to Investment - - - 59.7 67.6 61.1 72.8 N.A. N.A. 1/ Revenue divided by the sum of expenses, debt service, and the counterpart contribution required for the proposed project.  -30- Financing Plan 4.04 JRM has recently prepared a satisfactory investment program for the period 1981-1985. While the works are within JRM's implementation capacity, the sources of financing for this program have not yet been iden- tified. The JRM financial plan for 1981-84 (the project implementation period) is shown in Table IV-2. It indicates that almost 60% of JRM's US$44.4 million investment program will be financed by internal cash generation which is very satisfactory. The proposed Bank loan would con- tribute 29.6% and the balance will be covered by payments of other govern- ment agencies for works, carried out on their behalf, and by a small loan from Banco Inmobiliario (the Mortgage Bank). Future Finances 4.05 The assumptions underlying Tables IV-1 and IV-2 are presented in Annex 2. They indicate significant improvements in the financial position of JRM, with sufficient revenues in the 1981-84 period to cover operating expenses, debt service and a substantial share of investments. These improvements may take longer to materialize than is assumed in the projec- tions and despite the projected rapid increase in the value of output in Managua (both because of inflation and increases in production) tax receipts may rise at a slower pace than was assumed. In such a case, how- ever, the financing plan for the proposed project would not be affected and the most likely outcome would be to forego some of the additional, lower priority municipal investments included in the projections. As is evident from Table IV-1, additional revenues may be required starting in 1985. The municipal management assistance provided under this project should enable JRM to identify new services of revenue and to plan its finances in an orderly fashion. Table IV-2: Financing Plan 1981-84--JRM (C$ million) Source of Funds C$ Internal generation 334.2 - Less debt service 68.7 - Net internal generation 265.5 59.8 IBRD loan 131.8 29.6 Mortgage Bank loan 15.0 3.4 Contribution 31.9 7.2 Total 444.2 100.0 Use of Funds IBRD Project a/ 205.9 46.4 Other works 159.4 35.9 Working capital 78.9 17.7 Total 444.2 100.0 a/ Includes Capitalized Interest.  Table IV-3: Selected Financial Data--SAMU (C$ million) 1980 1981 1982 1983 1984 1985 1986 Interest Revenues 0.1 1.5 4.1 7.1 7.5 7.9 8.6 Financial Charges - 0.8 1.7 3.2 4.1 4.1 4.0 Net Financial Income 0.1 0.7 2.4 3.9 3.4 3.8 4.6 Expenses a/ 5.1 6.4 8.0 10.0 12.5 15.6 19.5 Repayments 0.4 1.9 5.0 7.0 9.6 12.7 13.4 Government Allocations 13.6 6.4 8.5 10.3 12.7 15.6 19.5 Borrowings 11.4 17.9 13.8 16.1 4.4 - - Less: SAMU Repayments - - - 1.2 1.2 Net Loanable Funds 19.3 29.5 25.5 31.7 30.7 31.0 32.8 Disbursements to Municipalities 10.4 25.7 21.1 18.6 15.0 15.0 17.0 a/ Covered by budgetary allocation  -32- 4.06 To ensure that JRM will have the resources required to carry out the project, agreement was reached that: (a) JRM will adjust revenue sources to cover all expenses of operat- ion and maintenance as well as debt service and to provide the necessary counterpart funds for the project; and (b) the Government will at all times allow JRM to establish the taxes and fees required to comply with (a). 4.07 JRM also agreed that before undertaking any investments in excess of US$8 million in 1981 and US$2 million in subsequent years (until project completion) over and above those included in the proposed project, it will demonstrate that such investments are within its implementing capacity and that sufficient funds are available to carry them out without adversely affecting the project. C. The Agency for Municipal Affairs (SAMU) 4.08 Since it began its operations in December 1979, SAMU has received from the Government's "employment creation fund" a donation of C$8.5 million of which about half was passed on to municipalities at no financial charge and the rest at an interest rate of 6%. SAMU has also received C$11.4 million from the USAID reconstruction funds lent to the Government of Nicaragua in 1980. These funds were onlent to municipalities at interest rates of 6% and 8%. Because SAMU has been operating as a Central Govern- ment branch, all its operating expenses have been covered through budgetary allocations. The financial projections (presented in Annex 2 and summa- rized in Table IV-3 below) have been prepared on the assumption that SAMU will continue to provide services to municipalities transcending its finan- cial role. The Government has agreed to continue to cover SAMU's operating costs and provide the counterpart funds required for the project, estimated at US$0.8 million equivalent (para. 6.01 (a) (i)). 4.09 SAMU's 1981-84 financing plan (Table IV-4) assumes that 43.2% of necessary funds would be provided by Government allocations and resources generated by operations. The balance would come from borrowings and the remaining from payment of loans already made to municipalities. Loans to municipalities are assumed to be made at an interest rate of 15% per annum with 2% going to the FED and participating intermediaries for their serv- ices as the financial agents.  -33- Table IV-4: Financing Plan 1981-84--SAMU Sources C$ million % Internal Funds Generation (16.7) (21.0) Municipalities Amortization 23.5 29.5 Subtotal 6.8 8.5 Budgetary Allocations 37.9 47.7 Less Debt Service (10.3) (13.0) Net Funds and Allocations 34.4 43.2 Borrowing - IBRD 21.0 26.5 Other 24.0 30.3 Total Sources 79.4 100.0 Applications Loans to Municipalities - Proposed Project 28.0 35.3 Other 45.1 56.8 Other Investments 7.6 9.5 Working Capital ( 1.3) ( 1.6) Total 79.4 100.0 4.10 The SAMU lending policy documents (para. 3.05) provide that it will include in its subloan agreements covenants to ensure that each muni- cipality operates in a financially viable manner within the limits of stable and sustainable revenue sources. This would complement SAMU's statutory authority to review and control municipal investment and borrow- ing decisions. These provisions should result in sound financial develop- ment of the municipalities benefitting from the project, in line with the projections summarized. V. SOCIAL AND ECONOMIC JUSTIFICATION General 5.01 Given the existing structure of employment opportunities and the constraints on business locations, Managua is likely to remain the major center of population concentration. For this reason, the project will pur- sue policies and physical investments designed to improve the internal efficiency of this city while at the same time preparing the ground work for longer term resource allocation, in keeping with national economic dev- elopment objectives. The economic efficiency of a city may be defined in terms of the benefits of urban concentration (economies of scale), which lower the average cost of producing and delivering most goods and services, net of the losses created by inadequate urban infrastructure, especially for transportation, congestion and pollution and other diseconomies. Because of Managua's location, climatological conditions, and development patterns since the earthquake (see paras. 1.06 and 1.08), relatively simple  -34- physical improvements would lead to rapidly increasing economies. Further- more, as the poor have had to bear a disproportionate share of the burden of infrastructure inefficiencies, the planned investments will improve both the efficiency and equity of Managua's development, without compromising either of these goals. The economic benefits of measures which will make urbaa government more effective will also be substantial. Given the pre- dominance of Managua, where a large share of the economically active urban population accounts for significant parts of GDP, industrial output and overall commercial activity (para. 1.02), improving its efficiency will have a positive impact on the economy at the national level. The nature of the economic benefits from the proposed Managua investment program is ex- plained in greater detail below, followed by a presentation of the economic rate of return, which is estimated at about 17%. 5.02 Investments in urban areas outside Managua have also been select- ed in order to parallel overall economic development. They will be imple- mented in areas where the country's most important export commodities are produced and can thus be expected to have a positive impact on national productivity. Perhaps more significant than the actual physical works financed through the SAMU component, is the setting-up of a mechanism for financing economically feasible municipal investments in support of national spatial priorities. Measures to raise the efficiency and effectiveness of secondary city government, will also have a significant economic impact on these cities. A. Economic Benefits 5.03 The benefits from the proposed investments will derive first from the prevention of loss of production, of the costs of erosion, and of the destruction of private property and public infrastructure caused by fre- quent serious flooding. Secondly, the neighborhood street paving program will help realize the benefits of an efficient link between employment and residence and between producers and consumers of goods and services. These benefits will include a reduction in travel time and costs, the opening up of new employment possibilities and the opportunity to locate on cheaper land previously unavailable because of inadequate transportation. They will manifest themselves in higher land values, increased profits for transport service operators; lower costs for renters elsewhere in the city; and lower costs to consumers of products originating in areas with improved access. Urban transport services are already a serious constraint to Managua's efficiency and hence to its economic development. The city requires extensive motorized transportation to permit the movement of people and goods among various locations. Indeed, for historical reasons (see para. 1.06) the importance of motorized transport for Managua is greater than the size of its population would suggest. Accordingly, the streets which will be paved under the project already carry sufficient volumes of traffic to justify the investment, on the basis of vehicle cost savings on these streets along. In addition, there will be savings on vehicle operating costs on existing paved arteries as congestion is relieved.  -35- 5.04 Accessible and well serviced land for industrial, commercial, and residential use is important not only to the efficient but also to the equitable growth of Managua. Thus, the poor who have been pushed to loca- tions where access is most difficult, costly and time consuming will be among the major beneficiaries of the proposed investments. The proposed road improvement program, emphasizing bus penetration routes as opposed to general purpose arterial road construction benefiting mainly private cars, combined with a well functioning bus system (which has benefited from a Bank-financed bus acquisition program--Reconstruction Credit 965-NI) will have a more direct impact on the residents of the neighborhoods to be im- proved under the project, many of whom are very poor. It is not easy to precisely determine the incidence of urban transport improvements. How- ever, given the keen competition among small car operators and the heavy public sector involvement in bus transport, much of the benefit is likely to go to transport users and landowners in the improved neighborhoods and to the public sector. Better roads for the relatively poor neighborhoods will further benefit the poor because in Managua, as in many cities, the accessibility of a neighborhood by road also determines to a considerable extent whether other urban services such as solid waste collection, police and fire protection and public utility maintenance are also made available and whether schools and health care are within reach of the inhabitants. 5.05 Following the recent adoption of a revised schedule of municipal taxes and fees and increased collection efficiency, the JRM, unlike most urban authorities, is entering a period in which it will have at its dis- posal considerable resources for investment (see para. 4.05). No revenues from the national budget will be used for the JRM. component, in line with the principle that only revenues raised in Managua be used for investments in the city thus avoiding a long-standing bias against secondary cities and rural areas. In general public sector resources in Nicaragua are scarce and institutional efficiency in the planning and implementation of public investments can therefore be a major source of economic benefit. Currently there is considerable institutional inefficiency due to widespread fragmen- tation of public responsibility along hierarchical and functional lines stemming from the existence of various levels of government and autonomous public agencies with overlapping responsibility. The objectives and priorities of these agencies rarely coincide and this has often led to long delays and uncoordinated and contradictory actions. Through the project, the JRM will consolidate its position as a strong metropolitan government taking the lead to develop and finance action plans and to enforce the necessary interagency coordination for their efficient execution. SAMU will fulfill a similar role in the secondary cities. Assistance from the municipal management component for financial and land use planning and for project management and control and manpower training is expected to assist this process and thus help realize substantial longer-term benefits from efficient city government. B. Economic Rate of Return and Poverty Impact 5.06 The economic rate of return for the Managua component was calcu- lated on the basis of the increase in the imputed rental value of existing housing units that would likely result from the proposed investments. Although rents and, to some extent, property values in Managua have been  -36- distorted following the war and the introduction of stringent price con- trols, relative rental values are still a useful indicator. The housing units to benefit from the proposed works are of various sizes and standards and, in the case of paving, would benefit in proportion to their distance from the paved road. Comparisons of these various types of situations with dwellings under similar conditions elsewhere in the city indicate that, on the average, rents in the latter areas are about 25% higher (the average rent in the project areas is currently about US$30 per month). Since, how- ever, the proposed project will increase significantly the supply of land with reasonable bus access and freedom from frequent flooding, the project economic benefits were approximated with only a 20% increase in rental values.19 Although significant amounts of unskilled labor, not all of which would likely encounter alternative employment during the same period, would be employed in the project, no adjustments were made to the invest- ment costs.7O A weighted average of 3% was used for maintenance costs. On the basis of these streams and an economic life of 30 years (with no resid- ual value taken into account), the internal economic rate of return for the entire Managua investment program is about 17%. 5.07 Although the above estimates of the economic rate of return pro- vide an assurance of a positive present value of the project's net bene- fits, evidence from other similar projects, where data availability per- mitted a more direct estimate of benefits, indicates that returns from well-desi ned investments to improve urban transport are even more subs- tantial.2f In Brazil, for example, where it was possible to quantify savings in vehicle operating costs and travel time and to convert the oper- ating cost savings into petroleum import savings, economic rates of return of over 50% and substantial net benefit values were estimated. Similar re- sults are reported for other Central American capital cities (Churchill, pp. 109 and 131; and San Josg Urban Transport Project, SAR pp. 30 and 31). In Managua, where passengers and goods have to travel over relatively long distances on a very poor urban road system, the savings from basic road improvements are likely to be even higher and only to a limited extent /19 Although it is difficult to be certain about the demand elasticity for the services provided, the demand curve is assumed to slope downwards, meaning that a share of the beneficiaries would demand similarly serviced land only at a lower price. /20 Similarly, although the use of foreign exchange is at substantial premium, no adjustments were made for the foreign component of investment costs. This reflects the presumption that reduced petroleum consumption resulting from more efficient transport will generate sufficient foreign exchange savings to offset the initial use o1 foreign resources. /21 See, for example, Johannes F. Linn: Policies for Efficient and Equitable Growth of Cities in Developing Countries (World Bank Staff--WP 342) and Anthony Churchill: Road User Charges in Central America (World Bank Staff OP15); San Jose Urban Transport Project Staff Appraisal Report (Report No. 1702a-CR).  -37- reflected in increased property values.22 Nor are the full production savings from the control of flooding likely to be reflected in these values. 5.08 Given the city-wide scope of the project's benefits, an estimate of the proportion of benefits chanelled directly to the urban poor as de- fined by the Bank, can only be approximate. In some areas where physical works will be executed, as much as 80% of the families are below the pover- ty line, while in others the percentage drops to 20%. Based on an overall estimate of the income levels of the families residing in these areas, about 50% of project expenditures are expected to directly benefit the urban poor. Similar results are obtained from estimates of the proportion of project investments going to improve public transport, adjusted by the proportion of public transport users that are poor. 5.09 Because of the large number and variety of relatively small sub- projects to be financed through the SAMU lline of credit, an overall economic rate of return was not calculated for the SAMU component. For the non-revenue earning subprojects such as bridges, streets, and storm drainage, the analysis was primarily based on a qualitative evaluation of investment priorities within a city from the point of view of improving its functioning, a comparison of competing alternatives, and the establishment of the least-cost solution both in terms of initial and maintenance costs. Until now SAMU has not been carrying out an economic analysis of subproj- ect. Detailed lending criteria for subprojects financed by SAMU using sub- loan recoveries appear in the agreed statement of lending policies and credit manual (para. 3.05). These criteria include the demonstration that there is a demand for the services to be provided by the project, level of technical preparation necessary before a subproject can be presented, a requirement that least cost solutions are adopted, and that all revenue earning projects earn a financial rate of return of at least 15%. 5.10 In the future, and with the help of technical assistance (para. 2.18), SAMU will develop procedures to incorporate an economic rate of return analysis for all subprojects beyond a size to be determined, taking appropriate account of the opportunity cost of capital. C. Project Risks 5.11 The proposed project has been formulated while the country is well into a period of intensive reconstruction and will be implemented by institutions which either have successfully participated in the early stages of reconstruction or will be done with staff experiencd in this type /22 Recent theoretical analysis suggests that for reasonable assumptions for the elasticity of supply of labor and output, and for the interaction of residential and production space, urban improvements can be expected to lead to increases in wages and profits, in addition to rents; concentrating on rents would, therefore, tend to underestimate the true benefits from these works. See Malcolm Getz: A Model of the Impact of Transportation Investment on Land Rents, Journal of Public Economics 4 (1975), pp. 57-70.  -38- of work. The scale will, however, be larger and some of the experience entirely new. The risks will, therefore, be considerable and this has led to the incorporation of several safeguards in project design. Although preparation time has been relatively short, the actual works are suffi- ciently uncomplicated, and in many cases standardized, to facilitate execu- tion. In the case of JRM, which will be executing works almost identical to those it has been carrying out successfuly since late 1979, the risk derives mainly from weaknesses in financial management and control which could lead to delays and cost overruns as well as the possibility that revenue collections may not meet projections. Allowing for the possibility of delays and some inefficiency leading to cost overruns does not affect significantly the economic rate of return. In order to reduce this rate below the opportunity cost of capital it would take such a degree of inefficiency on the part of the JRM as cannot be reasonably contemplated given its recent record. The technical assistance proposed through the municipal management component is designed to minimize this risk, and the assumptions used in calculating revenues are in line with recent experi- ence. In the case of SAMU, the institution is new and untested. It will, however, benefit first from the six regional teams which are successfully guiding the implementation of the Urban Reconstruction Project and second, from substantial technical assistance. The subprojects to be financed under the SAMU component were appraised with the help of Bank staff. This provided the opportunity to apply the selection criteria developed by SAMU, and it has also demonstrated the staff and training needs that would assure successful implementation of this project. New staff has already been hired and training is included under the project. VI. AGREEMENTS AND RECOMMENDATIONS 6.01 During negotiations, agreement was reached on the following matters: (a) From Government: (i) that it will provide all necessary counterparts, in- cluding SAMU's operating costs, and that each year these would be deposited in a project account at the Central Bank and are at the disposal of SAMU (paras. 3.04 and 4.08); (ii) that the funds will be onlent by the Central Bank to JRM at the same rate of interest as to the municipalities participating in the SAMU component (para. 2.08); (iii) that the funds will be onlent by the Central Bank to SAMU at the same terms as the IBRD loan, and that SAMU will onlend these at a rate of not less than 15% (para. 2.08); and (iv) that it will at all times allow JRM to establish the taxes and fees required to comply with 6.01 (c)(iii) (para. 4.06 (b)).  -39- (b) From each of the participating agencies: (i) that separate project accounts will be kept and promptly audited (paras. 3.18 and 3.19); and (c) From JRM: (i) that financial management policies will be reviewed and a timetable of reforms to be implemented furnished to the Bank as part of the management assistance program (paras. 2.16 and 2.17); (ii) that a plan and timetable for incorporating the con- struction industry's particiLpation in implementing the upgrading work be furnished by June 30, 1982 (para. 3.11); (iii) that it will at all times carry on its operations to ensure that its revenue sources will be adequate to provide for all expenses of operation, maintenance and debt services, and to provide the necessary counterpart funds for the project (4.06 (a)); and (iv) that before undertaking any investments in excess of US$8 million in 1981 and US$2 million in the subsequent years of project execution, over and above those in- cluded in the proposed project,, it will demonstrate to the satisfaction of the Bank that such investments are within its implementing capacity and that sufficient funds are available to carry them out without jeopard- izing the completion of the project (para. 4.07). (d) From SAMU: (i) that participating municipalities will provide the necessary counterparts for the subprojects to be financed under the component (para. 2.08); (ii) that SAMU will have the appropriate organizational structure and adequate staffing for carrying out the component (para. 3.04); (iii) the statement of lending policies, the credit manual and the model participating contract between the FED and participating banks to be used in carrying out the component (paras. 3.05 and 5.09); and (iv) that SAMU will, each year until the Project has been completed, review with the Bank, the adequacy of the interest rate to be charged to participating munici- palities (para. 2.08).  -40- 6.02 Special conditions of effectiveness will be: (a) the establishment of a separate project account for SAMU in the Banco Central de Nicaragua and the deposit by the Borrower therein of US$300,000 equivalent (para. 3.14); (b) the establishment of a Special Account in the Banco Central de Nicaragua in the name of JRM (para. 3.14); (c) the execution of subsidiary loan agreements between the Borrower and JRM and between the Borrower and SAMU. The latter will define the FED's role as fiscal agent for the Pilot Municipal Development Project (paras. 3.02 and 3.05). 6.03 With the agreements outlined above, the project is suitable for a US$16.0 million Bank loan to be repaid over 20 years, including a five- year grace period.  NICARAGUA MUNICIPAL DEVELOPMENT PROJECT SUMMARY DISBURSEMENT SCHEDULE (in US$'000) June '82 December '82 June '83 December '83 June '84 December '84 1st. 2nd. 3er. 4th. 5th. 6th. Total Semester Semester Semester Semester Semester Semester A. Managua Component 1. Neighborhooa Improve- ments 1,618 a/ 1,994 1,687 2,657 2,084 1,165 11,205 2. Major Storm Drainage 1,421 a/ 297 255 1,973 Subtotal (3,039) (2,291) (1,942) (2,657) (2,084) (1,165) (13,178) B. Pilot Municipal Development Component 71 677 723 470 161 2,102 C. Municipal Management 50 110 140 140 140 140 720 TOTAL 3,160 3,078 2,805 3,267 2,385 1,305 16,000 CUMMULATIVE 6,238 9,043 12,310 14,695 16,000 a/ Includes retroactive financing of US$1.4 million - US$0.4 million for Neighborhood Improvements and US$1.0 million for Major Storm Drainage. (DA mx 0  ANSNEX I Table 2 of 5 -4Z- NICARAGUA MUNICIPAL DEVELOPMENT PROJECT AANAGUA MUNICIPAL INFRASTRUCT1'RE UPGRADING COMPONENT SUMMARY COST PER DWELLING BY NEIGHBORHOOD Ueighborhood Total Cost Per Cost Per Neighborhood Area In Number Of Density Neighborhood a/ Dwelling No. (Barrio) Hectares Population Dwellings D.O/ha. (in C$'000) (in C$) 1. Venezuela (Meneses) 30.3 7,114 1,227 234.8 5,649 C$4,604 1. Monsenor Lezcano (II etapa) 75.8 17,864 2,978 235.7 9,822 3,298 3. San Cristobal 13.5 3,051 382 226.0 2,513 6,579 4. Waspan 31.4 4,639 725 147.7 4,487 6,189 5. Santa Rosa 44.2 6,235 1,023 141.1 11,260 11,007 6. Tenderi - Paraisito 27.0 5,843 928 216.4 3,598 3,877 7. Nicarao 22.0 5,712 907 259.6 4,738 5,224 8. Blandon (Costa Rica) 34.0 7,000 1,148 205.9 7,271 6,334 9. San Judas - El Pilar 128.5 38,995 4,496 303.5 11,820 2,629 10. San Jose Oriental 34.0 3,944 658 116.0 5,940 9,027 11. Cuba (Gadala Maria) 25.0 3,225 512 129.0 18,487 36,107 b/ 12. Berta Calderon (Andres C.) 86.0 6,827 1,138 79.4 8,055 7,078 13. El Horizonte (C. Chamorro) 55.5 6,202 955 111.7 4,441 4,650 14. Riguero Sur (Revolucion) 29.5 8,280 1,205 280.7 3,427 2,844 15. Santa Elena Fatima 9.5 1,522 220 160.2 3,827 17,396 c/ 16. Santa Clara (Doritila L.) 30.5 4,411 729 144.6 5,299 7,269 17. Ar4el Darce (La Fuente) 58.2 8,387 1,296 144.1 8,614 6,693 18. Rptos. Shick 1, 2, 3, 4 60.0 17,498 2,366 291.6 7,904 3,341 19. Seminaric - Miraflores 45.6 8,522 1,356 186.9 7,830 5,774 20. Silva - San Luis 31.8 7,448 1,207 234.2 3,293 2,728 21. Larreynaga 26.5 6,531 1,059 246.5 2,745 2,592 22. El Tempisque (S. Shieble) 21.0 3,074 518 146.4 3,273 6,319 23. Camro Bruce 37.7 5,623 860 149.1 3,958 4,602 24. Alta Gracia 89.6 18,946 3,013 211.5 7,308 2,426 25. Santa Barbara 8.2 1,013 172 123.5 1,119 6,506 26. Acahualinca 38.0 9,111 1,215 239.8 3,022 2,487 TOTAL 1,092.3 217,017 32,293 198.7 159,502 4,939 a/ February 1981 costs plus contingencies b/ Ad2acent residents downstream increase total benefits to 1,800 dwellings or C$10,087 per dwelling _/ Riguero Sur and Santa Elena Fatima comprise a single integral zone with an average cost of C$5,090 per dwelling  ANNEX 1 -43- Table 3 of 5 NICARAGUA MUNICIPAL DEVELOPMENT PROJECT Managua Municipal Infrastructure Upgrading Component Disbursement Schedule (in US$'000) June '82 Dec. '82 June '83 Dec. '83 June '84 Dec. '84 1st. 2nd. 3rd 4th. 5th bth Total Semester Semester Semester Semester Semester Semester Neighborhood Improvements 1. Barrio Venezuela (Meneses) 395 275 120 2. Barrio Monse-or Lezcano 618 432 186 3. Barrio San Cristobal 175 135 40 4. Barrio Waspan 314 236 78 5. Barrio Santa Rosa 718 430 288 6. Colonia Tenderini y 252 26 226 Barrio Paraisito 7. Barrio Nicarao 332 40 292 8. Barrio Costa Rica (Blandon) 439 44 307 88 9. Barrio San Judas y Barrio El 757 227 250 280 Pilar 10. Barrio San Jose Oriental 416 90 326 11. Barrio Cuba 1,133 110 220 803 12. Barrio Berta Calder5n - 564 364 200 Barrio Andrgs Castro 13. Barrio El Horizonte 311 311 14. Barrio Riguero Sur 240 80 160 15. Barrio Santa Elena - Fatima 268 48 190 30 16. Barrio Domitila Lugo 371 297 74 (Santa Clara) 17. Barrio Ariel Darce (La Fuente) 560 100 300 160 18. Repartos Schick 1, 2, 3, 4 500 92 230 178 19. Barrio Seminario - Miraflores 548 50 334 164 20. Barrio Silva - San Luis 230 110 120 21. Barrio Larreynaga 192 92 100 22. Barrio El Tempisque 228 100 128 Barric (Selim Shible) 23. Barrio Campo Bruce 277 30 247 24. Barrio Alta Gracia 442 133 309 25. Barrio Santa Barbara 713 713 26. Barrio Acahualinca 212 212 Subtotal 11,205 1,618 1,984 1,687 2,637 2,084 1,215 % (100) (15) (18) (15) (23) (19) (10) Major Storm Drainage 1. Waspan 791 791 2. 25 Avenida Suroeste 485 485 3. Portezuelo 161 86 75 4. Jocote Dulce 138 28 110 5. Prolongacion Ramal Nejara 128 77 51 6. Check Dam - Jocote Dulce 59 59 7. Check Dams - El Arroyo Etc. 157 87 70 8. Erosion Control Ramps 54 30 24 Subtotal 1,973 1,421 297 255 % (100) (72) (15) (13) TOTAL 13,178 3,039 2,261 1,942 2,637 2,084 1,215 % (100) (23) (17) (15) (20) (16) (9)  -44- .NICARAGUA ANNEX NICARAGUA ~~~~~~~~~~~Tabl-e 4 of 5 MNICIPAL DEVELOP92NT PROJECT Pilot Municipal Infrastructure Improvements Component Ditursetment Schedule (in tlSS'000 Junie 82 Dec. 82 June 83 Dec. 83 June 84 First Second Third Fourth Fifth Total Semester Semester Semester Semester Semester Chinandesa Market 28 6 22 Market 140 50 50 40 Chichigalpa Market 14 7 7 Storm Drainage 14 7 7 Streets 14 3 7 4 Corinto Streets 63 19 44 Storm Drainage 35 35 El Viejo Market 140 30 s0 30 Bridges 23 3 a/ 20 Streets 112 2 50 50 10 Leon Market 168 22 87 59 Streets 161 7 50 64 40 Paz Centro Market 28 14 14 Nagarote Streeta 98 25 53 20 Tipitapa Bus Station 21 3 19 Storm Drainage 7 7 Streets 49 20 29 Mateare Streets 84 20 44 20 Municipal Buildings 21 8 13 Juigalpa Market 49 7 25 17 Streets 70 17 35 18 El Rama Bus Station 35 11 24 Streets 42 14 28 Masaya Bus Station 49 10 39 Bridges 70 14 56 Streets 112 7 40 43 22 Diriamba Slaughterhouse 126 40 74 12 Market 140 26 40 40 34 Bus Station 35 20 15 Nandaime Market 21 17 4 Bus Station 14 14 Streets 63 44 19 Storm Drainage 21 15 6 Nindiri Streets 35 _ 25 10 TOTAL 2,102 71 677 723 470 161 (M) (100) (3) (32) (35) (22) (8) a/ This amount will have been disbursed by December 31, 1981.  NICARAGUA MUNICIPAL DEVELOPMENT PROJECT MHinTeipa1 Management Componert Cost Estimates (in uS$ '000) J R N SAMU JRM Grand Local Technicians Foreign Technicians Total Local Technicians Foreign Technicians Total Total //MM Cost/MN Total 1/MM Cost/MM Total #/M Cost/MM Total #/MM Cost/MM Total Technical Assistance 1. Public Admin/Manag. 24 2 48 6 8 48 96 24 2 24 4 8 32 56 2. Public Finance/Taxes 24 2 48 6 8 48 96 24 2 24 6 8 48 72 3. Public Lawyer 12 2 24 24 12 2 24 4 8 32 56 4. Regional Planner 18 2 36 36 5. Municipal Engineer 12 2 24 24 Sub-Total 90 180 12 96 276 60 72 14 112 184 Institutional Reinforcement 41 1. Systems Analysis 24 2 48 6 8 48 96 18 2 36 2. Management Training 24 2 48 10 8 80 128 12 2 24 3. Staff Training 30 1 30 O 30 30 1 30 Sub-Total 78 126 16 128 254 60 90 90 Equipment 1. Vehicles 4 vehicle 9 36 36 2. Office Equip/Instr. 2 50 50 86 86 Base Cost 306 310 616 162 112 274 890 Contingencies 15% 139 Total 1,029 015 0  -46- ANNEX 2 Page 1 of 10 NICARAGUA MUNICIPAL DEVELOPMENT PROJECT Detailed Project Financial Analysis Background Information and Assumptions Used in the Financial Analysis A. Introduction 1. This note relates mainly to the project executing agencies - JRM and SAMU. In the case of the SAMU component, however, separate analyses have also been made for the 15 municipalities selected as beneficiaries under the loan. B. Background Institutional Aspects 2. Recent events in Nicaragua and their impact on public services, together with the present stabilization and reorganization stage, imply certain constraints on the analysis used here. As might be expected, there is still some disorganization and uncertainty and the data sources are incipient. This situation, aggravated by the absence of historical data, has important repercussions for JRM's financial administration and for the analysis of past performance. The financial functions are not consolidated as a system in any one place; capital expenditure plans and the pertinent budgets are received from a higher level, the (theoretical) control of JRM's operating income is performed by the Collection Division and control of the operating expenditures is the responsibility of the Finance Divi- sion. Overall coordination is not fully effective. Nature of Revenues and their Use 3. Taxes on sales and commercial enterprise operations are JRM's chief source of finance. JRM also receives income from (a) the issue of bonds; (b) tax evasion fines; and (c) other lesser national taxes and fees that are collected by the Finance Ministry and subsequently transferred to the municipalities. The application of the sales taxes and other local taxes is governed by a schedule of local fees and taxes which was updated for the first time in 15 years in 1980. Revenues have doubled in recent months, largely due to the application of this updated plan (beginning in mid-1980). However, it will only be possible for this improvement to be maintained and improved to the extent that the list of taxpayers is duly kept up to date and is flexible and efficient (conditions that, in the past, have not been met). The internal resources generated by JRM are used to cover operating expenses, the provision of some urban services and the maintenance of certain infrastructure facilities. Implementation of new works is financed for the most part by funds allocated by other government agencies.  -47- ANNEX 2 Page 2 of 10 Past Financial Performance 4. The analysis of the data furnished by JRM for this study point to the difficulties and deficiencies under which the municipal administration has been working. A major problem has been tax evasion, either through incorrect declaration of sales by taxpayers or because the taxpayers them- selves are not listed by JRM; a recent survey carried out by JRM has made it possible to determine past due taxes and to issue corresponding notices for those omitted in previous years in the amount of approximately C$130 million, of which C$4 million was collected in 1980. Similarly, not all liabilities are recorded, and there is still uncertainty whether JRM is obligated to meet others. The fixed assets, such as administration and operating premises and public service and infrastructure facilities have lacked proper record-keeping and control, so that the financial data relat- ing to the past are misleading and inconsistent (see Table IV-1 in text). 5. In the three-year period (1978-1980) used for past data and the first year of projections, fundamental changes are observed in the main operating revenue item (taxes on sales and/or services), which can be ex- plained as follows: for 1978, the first year of the civil war, the same level of collections is shown as for 1977; the 1979 figure is 38% down com- pared with 1978, because 1979 was the critical year of the war; for 1980 there was an increase of 136% over 1979, though in relation to 1978 (a more normal year), the increase was 47%--this increase being attributable to the partial application of the new schedule of taxes. The estimated 1981 figure is 104% higher than 1980, based on fu:Ll application of the plan, including potential taxpayers formerly ommitted, and growth of tax-revenue generating activities (Table 1). Financial Future 6. On the basis of the Fees and Taxes Plan implemented in part in 1980 and made fully operational in 1981, an increase in revenues equal to 18% p.a. has been projected, assuming the progressive recovery of tax- revenues' operating activities. The results for 1981-86 are considered acceptable (0.79 operating ratio before depreciation and interest). It must also be borne in mind that JRM receives no revenue from property or from betterment resulting from infrastructure works (paving, drainage, etc.). C. Criteria and Assumptions Used in the Projections 8. Revenues (a) all revenue headings for 1981, the first year of the projection, were calculated separately;  Table I: Calculation of Sales Tax Revenues for 1981 (C$ thousands) Taxpayers With Sales With Sales Greater than Less than C$100,000/ C$100,000/ month month (75Z) (25x) Taxes collected in 1980 81,500.00 Growth of economic activity: 20% a/ 16,300.00 Base for 1981 97,800.00 73,500.00 24,450.00 No. of taxpayers according to 8,520 620 7,900 current tax roll Annual sales per taxpayer 11,830.60 309.50 Amount of tax, taxpayer/year (a) 1% of first C$100,000/month x 12 12.00 3.09 (b) 2% on sales over C$100,000 212.60 - Subtotal 224.60 3.09 Revenue from present tax roll 163,702.00 139,252.00 24,450.00 Additional revenues from inclusion of 2,615.00 1,392.50 1,222.50 potential taxpayers Total revenues 166,317.00 140,644.50 25,672.50 a/ The growth in the critical years 1977-80 was 12.2% p.a. 00 0 - 991