Philippines - Second Subic Bay Freeport Project

Document of The World Bank Report No. 1 5956-PH REPUBLIC OF THE PHILIPPINES SECOND SUBIC BAY FREEPORT PROJECT STAFF APPRAISAL REPORT October 30, 1996 Infrastructure Operations Division Country Department I East Asia & Pacific Region  CURRENCY EQUIVALENTS (as of September, 1996) Currency Unit = Peso P I = US$0.039 US$1.00 = P 26.0 WEIGHTS AND MEASURES ha. - hectare KV - Kilovolt-ampere (1,000 volt-amperes) KVA - Kilovolt-ampere (1,000 volt-amperes) Kw - Kilowatt (1,000 watts) KWH - Kilowatt Hour MLD - Million Liters Per Day ABBREVIATIONS AND ACRONYMS ADB - Asia Development Bank APEC - Asia Pacific Economic Cooperation ASEAN - Association of South East Asian Nations CAS - Country Assessment Strategy COA - Commission and Audit EIA - Environmental Impact Assessment ESMO - Environmental Sanitation Management Office FIRR - Financial Internal Rate of Return FMIS - Financial Management Information System FRC - Freehold Services Company GIS - Geographical Information System JAIDO - Japanese Industrial Development Organization LGU - Local Government Units MOA - Memorandum of Agreements MOU - Memorandum of Understanding NBF - Non-Bank Financed NPC - National Poxver Corporation NWRB - National Water Resources Board O & M - Operation and Maintenance OCWD - Olongapo City Water District OECF - Overseas Economic Cooperation Fund PACP - Property Acquisition and Compensation Plan PHRD - Policy and Human Resources Development POL - Petroleum, Oils and Lubricants PWG - Public Works Group SAR - Staff Appraisal Report SBF - Subic Bay Freeport SBFZ - Subic Bay Freeport Zone SBMA - Subic Bay Metropolitan Authority SCF - Standard Conversion Factor SOE - Statement of Expenditures FISCAL YEAR January I to December 31  REPUBLIC OF THE PHILIPPINES SECOND SUBIC BAY FREEPORT PROJECT Loan and Project Summary Borrower: Subic Bay Metropolitan Authority (SBMA) Guarantor: Republic of the Philippines Implementing Agency: Subic Bay Metropolitan Authority (SBMA) Beneficiary: Not applicable Poverty: Not applicable Amount: US$60 million Terms: 20 years, including five years of grace, at the Bank's standard LIBOR-based interest rate for US$ Single Currency Loans Commitment Fee: 0.75 percent on undisbursed loan balances, beginning 60 days after signing, less any waiver Net Present Value: US$118 million Financing Plan: See paragraph 3.25 Staff Appraisal Report: No. 15956-PH Map: IBRD Map No. 28291 Project ID No.: 40981 Vice President: Nicholas C. Hope, Acting, EAP Director: Javad Khalilzadeh-Shirazi, EA1 Division Chief: J. Shivakumar, EAlIN Task Manager: Aloysius Ordu   i REPUBLIC OF THE PHILIPPINES SECOND SUBIC BAY FREEPORT PROJECT Contents 1. BACKGROUND.................................................................................................. A. INTRODUCTION ..............................................................1 B. THE SUBIC BAY FREEPORT .............................................................3 C. THE FIRST SUBIC BAY FREEPORT PROJECT ................................. .............................3 D. LESSONS LEARNED FROM PREVIOUS BANK INVOLVEMENT ................................................. 4 E. RATIONALE FOR BANK INVOLVEMENT ..............................................................5 2. THE BORROWER .......................................6 A. INSTITUTIONAL ................................................6 B. SBMA's STRATEGY ................................................7 3. THE PROJECT ....................................... 10 A. PROJECT OBJECTIVES ............................................................. 10 B. PROJECT DESCRIPTION ............................................................. 10 C. COSTS AND FINANCING ................................................. 16 D. PROJECT MANAGEMENT AND IMPLEMENTATION ............................................................. 17 E. PROCUREMENT AND DISBURSEMENT .................... ......................................... 18 F. SUPERVISION, MONITORING, REPORTING, ACCOUNTS AND AUDITING ............................. 21 4. PROJECT FINANCIAL ANALYSIS ...................................... 23 A. SBMA'S FINANCIAL POSITION ............................................... 23 B. FINANCIAL ANALYSIS OF PROJECT COMPONENTS .................... ........................... 26 5. BENEFITS AND RISK ............................................... 29 A. PROJECT BENEFITS .......................................... 29 B. SBMA OPERATIONS WITHOUT THE PROJECT .......................................... 29 C. ECONOMIC RATES OF RETURN AND SENSITIVITY .......................................... 30 D. PROJECT SUSTAINABILITY .......................................... 3 1 E. ENVIRONMENTAL AND SOCIAL IMPACTS .......................................... 31 F. RISKS .......................................... 32 This report was prepared by Messrs./Mmes. A. Ordu (Sr. Economist/Task Manager), A. Toft (Pr. Counsel), J. Arnold (Transport Economist), P. Long (Transport Engineer, consultant), P. Bulmer (Traffic Engineer, consultant), J. Irving (Sr. Power Engineer), C. del Castillo (Social Specialist), S. Cointreau-Levine (Solid Waste, consultant), F. K. Lee (Sanitary Engineer, consultant), M. Dijkerman (Institutional Specialist, consultant), A. Rychener (Financial Economist, consultant), C. Ohri (Procurement Specialist), K. Page (Analyst, consultant), and B. Brown, Task Assistant. It was cleared by Mr. Javad Khalilzadeh-Shirazi (Director, EAI) and Mr. J. Shivakumar (Chief, EAIIN).  ii 6. AGREEMENTS REACHED AND RECOMMENDATION ....................................... 34 A. AGREEMENTS ................................................ 34 B. RECOMMENDATION ................................................ 35 ANNEXES Annex 1: Profile of the Project Area .36 Annex 2: Freeport Concepts -- A Comparison of Subic and Other Freeports .40 Annex 3: SBMA's Organizational Chart .44 Annex 4: Detailed Cost Table .46 Annex 5: Performance Monitoring Indicators .53 Annex 6: Disbursement Schedule Per Semester .58 Annex 7: Project Supervision Plan .59 Annex 8: Financial Analysis of Project Components .61 Annex 9: Economic Analysis .74 MAP IBRD Map No. 28291  1. BACKGROUND A. INTRODUCTION 1.1 The Subic Bay Naval Base in the Philippines was the largest U.S. military facility outside the United States. Following the expiration of the 1947 Military Base Agreement between the Philippines and the United States, the U.S. Navy evacuated Subic Bay in November 1992. The Government of the Philippines (GOP) set up a Presidential Task Force, established the Subic Bay Metropolitan Authority (SBMA), and requested assistance from the World Bank to help the Task Force and SBMA to plan the conversion of Subic Bay to civilian use. This initial assistance assessed the feasibility and developed a strategy for converting the baselands into an industrial estate/freeport and tourism complex; identified specific actions required to execute an orderly transition; and proposed areas for technical assistance. The Bank further arranged a Japanese-funded Policy and Human Resources Development (PHRD) Technical Assistance that assisted the GOP and SBMA: (i) to formulate the implementing rules and regulations for the freeport; (ii) to prepare a land use and facilities use plan for the site; (iii) to initiate transportation planning; and (iv) to market and promote Subic Bay as an economic freeport. This culminated in the approval of the Bank's first Subic Bay Freeport Project (Subic I, Loan 3745-PH) in June 1994 with a total project cost of US$52.0 million, of which the Bank loan amounted to US$40.0 million. 1.2 The proposed project would be the Bank's second intervention to assist the Philippines in converting the U.S. Navy's former Subic Bay Naval Base into a freeport. The first Subic Bay Freeport Project (Subic I: Loan 3745-PH, June 1994) consisted of infrastructure rehabilitation and upgrading, and technical assistance to strengthen the Subic Bay Metropolitan Authority (SBMA) and develop an environmental management plan. 1.3 The Subic freeport has boomed: investment levels and job creation are more than two years ahead of the level anticipated under Subic I. As of end-1995, 201 firms had made investment commitments of almost US$1.3 billion. The 123 firms currently operational have already created 11,821 jobs. Employment creation is expected to be 39,733 at full operation of these firms. Investing firms represent manufacturing, tourism, services, warehousing, utilities, and banking. Table 1.1 shows the number of investors by sector, total investment commitments, and employment (actual/projected). By far the largest number of firms, about 54 percent, are Taiwanese. Other Asian firms include those from Singapore, Malaysia, Japan and the Philippines (about 13 percent) US/Canada (14 percent), Europe (12 percent), and others (seven percent). 1.4 SBMA has turned to the private sector to put much of the infrastructure inherited when Subic reverted to the Philippines in late 1992 into economic use. Most of the commercially exploitable space in the former Ship Repair Facility area has been leased to investors. SBMA has entered into long-term leases (25 years and over) for the golf course, the marina, industrial parks, the petroleum, oil and lubricant (POL) facility, recreational facilities, hotel buildings, and some residential properties. Only 1,400 ha. of unleased land remain within the 6,700 ha. "secured" naval station; a further 3,000 hectares is available in the Redondo Peninsula.  -2 - 1.5 Base conversion is, however, far from complete. Several rehabilitation and construction projects are in progress. The conversion of the airport hangar into a passenger terminal is underway and this will be followed by the privatization of airport management. The development of a master plan for seaport improvement and privatization is ongoing. Significant opportunities remain for the development of Redondo Peninsula, Grande Island and the naval magazine area. 1.6 The freeport's rapid expansion has put great pressure on Subic's infrastructure and the Subic Bay Metropolitan Authority's management capacity and maintaining the Freeport's development momentum will mean moving a number of investments forward in time. Subic II is designed to meet these pressures by providing new water supply, power distribution and transport infrastructure and institutional support to SBMA and the Subic Bay Ecology Center. Table 1.1: Economic Impact of the SBF Projected No. of Total Current Total Sub-Sector Firms Investment Employment Employment Manufacturing 81 $266.43 6,028 28,444 Operating 31 $70.10 6,028 13,441 Approved 50 $196.33 0 15,033 Tourism 35 $277.38 4,188 7,736 Operating 30 $221.40 4,188 5,573 Approved 5 $55.98 0 2,163 Services 43 $239.07 562 1,371 Operating 30 $231.58 562 1,121 Approved 13 $7.49 0 250 Warehousing 26 $140.52 496 1,780 Operating 17 $126.76 496 1,170 Approved 9 $13.76 0 610 Utilities 5 $342.76 395 250 Operating 4 $137.06 379 234 Approved 1 $205.70 0 16 Banks 11 $7.89 152 150 Operating 11 $7.89 152 150 Approved 0 0 0 0 Total 201 $1,274.13 11,821 39,733 Operating 123 $794.79 11,821 21,689 Approved 78 $479.34 0 18,044 Not1e: (i) "Operating Projects" are those registered by SBMA and have begun operations; (ii)"Approved Projects" are those registered by SBMA and not yet operational, or are under construction; (iii)"Total Investment" is the declared total value of the projects upon application to SBMA in US$ millions; (iv) "Current Employment" is the number of regular and contractual employees on each company's payroll as of end 1995 (of the 11,821 actual jobs generated by locators, 1,505 were contractual positions); (v) "Projected Total Employment" is the number of employees (regular and contractual) projected at full operation in investment applications submitted to SBMA; (vi) "Manufacturing" includes investments registered under the Subic Bay Industrial Park being developed by Taiwanese interests, which accounted for 39 companies of the 72 projects; (vii) all figures are as of 12/31/95; some figures may not total due to rounding. Source: SBMA.  -3 - B. THE SUBIC BAY FREEPORT 1.7 The 15,130 ha. Subic Bay Naval Base, the largest US military facility outside the United States, was turned over to Philippine jurisdiction in November 1992. The Subic Bay Freeport (SBF) regime was created by the Bases Conversion and Development Act (R.A. 7227; March 13, 1992), which established a "Special Economic and Freeport Zone" encompassing the City of Olongapo, the municipalities of Subic, Morong, and Hermosa, and the lands occupied by the Subic Bay Naval base, and created SBMA with sole authority to operate the SBF and implement the freeport regime. A profile of the project area is in Annex 1. See also IBRD Map No. 28291. R.A. 7227 defined a freeport regime as a "separate customs territory" with the following characteristics: * all goods and capital could be brought in and taken out, consumed, manipulated, and processed on a tax- and duty-free basis; * SBF-registered enterprises and residents could engage in any activity not specifically prohibited by the law; * SBF firms would have full access to the Philippine market, subject to full payment of customs duties and taxes as an importation into the customs territory; * Freeport enterprises would pay a five percent assessment on "gross income earned" in lieu of all local and national taxes; * Firms would be subject to no exchange controls, and would enjoy free markets in foreign exchange, gold, securities and futures, and liberalized domestic and offshore banking; and * Investors with a continuing investment of at least US$250,000 would be eligible for permanent resident status and liberalized working visas. C. THE FIRST SUBIC BAY FREEPORT PROJECT 1.8 In early 1992, the Government asked the Bank to help SBMA plan the conversion of Subic Bay to civilian use. This initial assistance assessed the feasibility and developed a strategy for converting the baselands into an industrial estate/freeport and tourism complex, identified specific actions required to execute an orderly transition, and proposed areas for technical assistance. Technical assistance was provided to SBMA to: (a) formulate the implementing rules and regulations for the freeport; (b) prepare a land use and facilities use plan for the site; (c) initiate transportation planning; and (d) market and promote Subic Bay as an economic freeport. This culminated in the approval of the Bank's first Subic Bay Freeport Project (Subic I, Loan 3745-PH) in June 1994 with a total project cost of US$52.0 million, of which the Bank loan amounted to US$40.0 million.' 'See the following reports - (a) Strategy for Conversion of the Subic Naval Base into a Special Economic Zone and Freeport, January 1993, and (b) Subic Bay Freeport Project, May 10, 1994 (SAR No. 12773-PH).  -4 - D. LESSONS LEARNED FROM PREvIOus BANK INVOLVEMENT 1.9 SBMA's priority has been to establish itself as an effective and well-structured organization, and significant progress has been made in a number of areas. Government procurement, compensation and other procedures are being followed. Progress has been made in establishing a more comprehensive accounting, finance, and budgeting system in line with Government regulations. A well-functioning Ecology Center has been established, and SBMA's senior staff are no longer acting in an ex officio capacity. The staff have remained dedicated and energetic; the young management team is maturing and SBMA is becoming more systematic in its operations. Implementation of Subic I has been highly satisfactory, and private sector activity/interest remains buoyant in the freeport. About 59 percent of the loan funds have been disbursed with over two years until loan completion. The outstanding balance under the loan has been fully committed. 1.10 The March 1996 Mid-Term Review of progress under Subic I showed that the project-while generally well implemented-had been constrained by SBMA's lack of familiarity with Bank procurement procedures. The proposed project includes technical assistance to strengthen procurement capability in the Office of the Project Director (see Chapter 3). Government-SBMA interaction has not been as smooth as expected: the legislation creating the freeport is broad, rather than detailed, and the Government has on a number of occasions changed regulations on such issues as the duty-free allowance of non-residents of the SBF.2 1.11 These issues were discussed with Government during the Mid-Term Review, which was an important step in developing a consensus between SBMA and Government departments on the practical constraints facing SBMA and the role of freeports in the Philippines. Agreement has also been reached that the Government and SBMA will establish an inter-agency task force to improve their dialogue and work together on revising the implementing rules and regulations for SBF. As Subic is seen as a prototype for further freeports, this dialogue will be of particular importance in developing a national legislative/regulatory package for freeports. E. RATIONALE FOR BANK INVOLVEMENT 1.13 The Bank's catalytic role in supporting SBMA's institutional strengthening and provision of the infrastructure services needed to make the Subic Bay Freeport attractive to private investors is fully consistent with the Bank's lending strategy for the Philippines, as outlined in the Country Assistance Strategy discussed at the Board April 4, 1996. 1.14 The Philippine CAS emphasizes investment lending operations to strengthen infrastructure (power, water supply, solid waste management and transport) to promote economic growth vital to rapid poverty reduction. The CAS also emphasizes private sector participation in providing infrastructure services, which is a major objective of the proposed project. The Freeport has, in a relatively short time, boosted the Philippines' reputation as an attractive investment location that has attracted major international corporations. Continued growth is expected with the completion of the three Taiwanese phases and JAIDO's industrial parks. Subic has become-as anticipated-a significant growth pole for the Philippine economy; it generates important foreign exchange revenues and creates jobs. 2 See Review of the Subic Bay Freeport Policy and Institutional Framework, Final Report May 1996.  -5- 1.15 The Freeport's very success over the past two years has meant, however, that its need to provide infrastructure has grown more rapidly than anticipated. Without the investments proposed under this project water supply, electric power and transport constraints that could slow Subic's growth momentum and harm its competitive position would soon emerge. The proposed transport rehabilitation/upgrading investments are the most critical: without them an estimated 13,000 to 16,000 new jobs would be lost over the next five years (Chapter 5). 1.16 The proposed project includes a package of institutional strengthening measures designed to enhance SBMA's capacity to regulate and administer the freeport. Its water supply component (Chapter 3) also represents an important step toward SBMA's goal of privatizing services delivery and infrastructure provision.  2. THE BORROWER A. INSTITUTIONAL 2.1 SBMA is a government-owned and controlled corporation whose mandate to convert the Subic Special Economic Zone (see IBRD Map. No. 28291) into a Freeport was legislated under the March 1992 Bases Conversion and Development Act (Republic Act 7227), which created the Bases Conversion and Development Authority (BCDA) with defined functions and powers, established the Subic Special Economic and Freeport Zone, and created SBMA-and the Clark Development Corporation, which oversees conversion of a former U.S. airbase-as operating and implementing arms of BCDA. In practice, the BCDA has little oversight over SBMA, as both organizations report directly to the Office of the President. The base conversion act created SBMA as the sole owner and developer of the 6,700 hectare "Secured Area" comprising the former U.S. Navy base. SBMA is directed by a 15-member board appointed by the President of the Philippines. 2.2 As a government-owned corporation, SBMA is subject to control and oversight from central government units including the Department of Budget and Management (DBM), the Commission on Audit (COA) and the Civil Service Commission. DBM approves SBMA's annual appropriation from the GOP budget and the number of its civil service positions, job descriptions, and salary grades. COA audits SBMA financial statements and ensures that receipts and expenditures are made according to GOP procedures. Oversight by the Civil Service Commission dictates that SBMA salaries must conform to salary caps legislated under the Salary Standardization Law. Taken together, the numeric and salary cap limitations impose, by far, the most critical impediments to SBMA's ability to carry out its organizational mandate. R.A. 7227, however, empowers BCDA to create quasi-private subsidiaries with much greater financial autonomy to carry out its mandate of converting former military installations to civilian use, and SBMA is exploring its legal ability to use this mechanism. 2.3 Most Freeports operate under detailed laws and regulations delineating the incentives they can offer investors-including the tax, trade, and financial regimes-the applicability of relevant national legislation, and the nature of transactions with the domestic economy. (See Annex 2 for a summary of the Freeport concept and a comparison of Subic with other leading freeports.) The legislative base for SBF, however, is contained in only three articles of R.A. 7227, leaving many issues to be worked out later. A Presidential Proclamation in September 1992 clarified SBMA's powers in terms of ownership and privatization of assets. SBMA itself further delineated the scope of its activities and the benefits of Freeport status through a set of implementing rules and regulations it issued in March 1993 after extensive discussions and negotiations with the government agencies exercising oversight. 2.4 SBMA began operations in 1993 with 298 approved civil service staff positions. In practice, however, SBMA employs slightly over 3,000 people, including casual laborers and consultants. Negotiations with DBM were concluded in June 1996; SBMA's organizational structure has been  7 - approved and corresponding civil service position allotment has been raised to 1587. SBMA's current organizational chart is presented in Annex 3. B. SBMA's STRATEGY 2.5 The continuing growth in the Freeport is generating employment for the surrounding communities within the zone, drawing in new job seekers and their families and necessitating an expansion of basic infrastructure and services. The rapid growth of the SBF and the increasing complexity of investor relationships has placed an enormous management burden on SBMA, raising fundamental questions as to its organizational role. In essence, SBMA acts as promoter, proprietor and provider of Freeport services--and is an investor in infrastructure in its own right. While it has developed considerable competence as a promoter and proprietor, SBMA has not achieved the same degree of competence as regulator of the Freeport. SBMA recognizes the need to strengthen this aspect of its operations, and has drawn up a 1996-2005 strategic plan which accords a great deal of emphasis on the governance of the Freeport. The strategic plan sets out SBMA's vision and corporate objectives, SBF's target sectors, and the proposed development strategy. These are summarized below. SBMA's Vision and Corporate Objectives 2.6 As a prelude to its second phase of development, SBMA has taken stock not only of its inherited infrastructure, but also its natural endowments and comparative advantage in devising its comprehensive strategy for the future. SBMA envisions the SBF and its environs as a major regional hub of broadly-based economic activity which will serve as a catalyst for national economic growth and will contribute to the integration of the Philippines in the global economy. Its desire is to create an environment attractive to service, manufacturing and tourism industries while imbuing it with core values of self-reliance, entrepreneurship, eco-industrial harmony and quality of life. 2.7 SBMA's corporate objectives include the achievement of rapid growth in terms of employment generation, investment, exports and skill creation. SBMA's vision and objectives are ambitious yet feasible. The SBF is endowed with natural assets (e.g., possession of a deep natural seaport), geography (proximity to Southeast Asian growth poles), and natural touristic beauty. Additionally, SBMA possesses an abundance of infrastructure not yet converted to civilian use. To achieve its objectives, SBMA must tap all these assets to strengthen the competitiveness of the SBF vis-a-vis other free trade regimes elsewhere. SBF's Target Sectors 2.8 Based on the competitive strengths that have emerged in the development of the SBF to date and on the investment and employment trends that have become apparent in the global marketplace, SBMA proposes to focus its promotional efforts in attracting investors in three major sectors-- services, manufacturing and tourism. The service industry will be attracted to the SBF by the communications and speed capability, the English speaking work force, the quality of life, the existing nucleus of support industry, and the fast market access offered by the SBF hub facilities. Target sub-sectors include software, training, consultancy, telecommunications and broadcasting, backroom services, publishing, servicing and distribution, financial services, shipping and transport equipment repair.  - 8- 2.9 Manufacturing industry will be attracted by the location of the SBF relative to the Asian marketplace; the cost competitiveness of producing in the SBF, the excellent linkages and speed of production, and the quality of life for senior and middle executives. Target sub-sectors include electronics assembly, components for the electronics and automotive industries, telecommunications hardware, and packaging including metalwork and plastics. Tourists will be attracted to the SBF because it offers a wide range of activities in one place, and suitable activities for a wide range of people. The natural environment, security and support services, and efficiency all add to the tourism product in the SBF. It is envisaged that the SBF will become a theme park over time--the theme being quality of life in an excellent environment. SBF as a tourism destination will appeal to local visitors seeking a multi-activity short term break, international visitors flown directly from regional destinations on specific package tours, two-location package tourists, meetings incentive conference and exhibition tourists. Development Strategy 2.10 The key elements of SBMA's development strategy are to: (a) invest in additional infrastructure and seek to attract support industries in order to increase the attractiveness of the SBF as a potential location for target industries. The infrastructure investments planned under Subic II are designed to address some of those needs, particularly in water supply, power distribution, and roads and bridges; (b) use the momentum and quality already developed at the SBF to increase value added by SBF enterprises, spinning lower value added activities into the wider region over time. This is the SBF as an engine for growth; (c) exert a unified planning and development role throughout the area covered by the metes and bounds of R.A. 7227 which defined the SBF zone, and solidify the role of the SBF through a series of institutional changes, backed by legislation where necessary; (d) develop the Central Area of the SBF for mixed use (commercial, tourism and residential) in line with the master plan currently developed for the area; and (e) restructure itself into three distinct units in order to effectively tackle three components of its mission: administrator of the freeport regime, exerciser of municipal authority and owner of the inherited assets in the secured area. 2.11 SBMA's strategy is to achieve efficiency in the delivery of services flowing from its inherited assets by devolving managerial control to the private sector through concession contracts. It's strategy for engaging the private sector as a development partner is thus a critical component of the corporate plan. To date the strategy has been to invite the private sector to participate directly with SBMA in various endeavors. Examples include the industrial parks, the golf course, the marina, telecommunications and--under the proposed project--water supply. 2.12 As regards its governance functions, SBMA has acknowledged the need to transform itself over time into a full-fledged regulatory and promotional authority, equipped to uphold the Freeport policy regime and to provide an attractive investment climate for the private sector. The institutional  - 9- support component of Subic II would strengthen SBMA's role as a Freeport administrator and public sector catalyst of private sector development. In particular, Subic II will enhance SBMA's regulatory capability while ensuring that it remains effective in promoting the Freeport. Completion of the corporate plan acceptable to the Bank--and that plan's acceptance by SBMA's Board of Directors--is a condition of effectiveness. Agreement was reached at negotiations that SBMA would furnish to the Bank, at mid-term review, a report on the progress achieved in carrying out the corporate plan.  3. THE PROJECT A. PROJECT OBJECTIVES 3.1 Subic I's objective was to attract private investors to the Freeport by improving its infrastructure and strengthening SBMA's management capacity. The Freeport has, however, grown much more quickly than anticipated, putting unexpected strains on SBMA's management capacity and accelerating its need to evolve institutionally and provide infrastructure services. The proposed successor Subic II Project would aim to continue strengthening SBMA's capacity to regulate and manage the growth of the Freeport, and support further infrastructure development-including SBMA's initial venture into partnership with the private sector through a water supply joint venture. B. PROJECT DESCRIPTION 3.2 The Second Subic Bay Freeport Project would utilize a US$60 million IBRD loan to support a US$108 million project to strengthen SBMA and its Ecology Center (five percent of project costs), provide treated water (36 percent), improve power distribution (29 percent), and improve transport infrastructure (31 percent). The Project would be carried out by SBMA over 3 1/2 years (January 1997-July 2000). Its components are described below: 3.3 Institutional Strengthening (US$4.6 million). The first Subic Bay Freeport Project included technical assistance to strengthen SBMA's institutional capacity in freeport administration and policy development including: (a) a merchandise control system to monitor duty-free purchases; (b) zoning regulations and a building design code for the SBF; (c) an automated computer-based, financial management system to track SBMA's revenues and ensure timely billing; (d) a privatization assistance fund for specialized advice on specific transactions, and (e) a team of freeport advisors to improve SBF administration. 3.4 While significant progress has been made in each of these areas, the March 1996 Mid-Term Review of Subic I showed that the Freeport's rapid growth requires further strengthening of SBMA's regulatory capacity for two reasons: (a) commercial/industrial growth has forced SBMA to concentrate more of its efforts than expected on promotion and property management, so that institution building has lagged, and (b) the growth itself has created a need for greater management competence in such areas as customs and taxation, banking and financial services, water supply, sewerage; labor, health and safety standards; environmental management and monitoring and the capacity to conduct social impact assessments, and human resources development and training. This component comprises: (a) capacity building on freeport policy through a package of short- and long-term technical assistance in key areas including customs, taxation, and incentives;  - 11 - (b) human resources management assistance to assess SBMA's skills mix needs vis-&-vis its corporate objectives and develop staff training programs; (c) commercialization, privatization, and planning support to further facilitate conversion through commercialization and privatization measures; (d) studies of critical technical issues identified during implementation; to qualify, the studies must relate to issues affecting the competitiveness of the SBF and its attractiveness to investors; (e) technical assistance support to SBMA's Foreign-Assisted Project Office for two advisors to strengthen its capability in procurement and financial management; and (f) Support to SBMA's Ecology Center to strengthen the Center's capacity for environmental management, monitoring and regulation, and impact assessment through recruitment of two social development specialists to facilitate property acquisition for the water supply component, community outreach assistance to provide technical guidance, equipment, and on-the-job training in community outreach practices to the Ecology Center, and development of community-based forest management, community development, and training and infrastructure improvements in Pastolan Village. 3.5 Outline terms of reference for the above activities are in the project implementation plan. 3.6 Water Supply (US$32.6 million). This component is designed to increase the quantity of treated water available in the Secured Area, Olongapo City, and Subic Town through a public-private joint venture-Subic Water & Sewerage, Inc.-involving SBMA, Biwater International (a UK-based water supply firm), and a Filipino construction firm. Subic Water would also be responsible for sewage collection within its franchised area. 3.7 The 66 million liters a day (MLD) produced by the separate water supply and distribution facilities now operated by SBMA-for the Secured Area-and the Olongapo City Water District-serving Olongapo and Subic Town-are being fully absorbed. Demand is projected to rise to 230 MLD by 2010. Capacity will have to be raised an additional 175 MLD-including an allowance for drought years-to meet this demand. 3.8 Performance testing, trial production wells, and geophysical and geological investigations have shown that a well field in the vicinity of the confluence of the Pamatawan, Camachile, and Laglaboson Rivers could produce the required 175 MLD. A model was developed to guide the selection of locations for the individual wells and assess potential impact on other users (see Chapter 5, Environmental and Social Impact). SBMA has applied to the National Water Resources Board for a water permit for the proposed withdrawal, and initiated a program to monitor streamflow at the Pamatawan River near the proposed well field sites during the dry season. 3.9 Subic Water & Sewerage Inc. (Subic Water) will set the water rates for its domestic, commercial, industrial and institutional customers. Over the four years 1997-2000, capital investments by the joint venture will total about US$88.5 million, of which SBMA would finance installations worth US$32.6 million under Subic II. This private-public joint venture is a pilot initiative which may well be replicated in other parts of the country.  - 12 - 3.10 There is no national regulatory board at present in the Philippines. As a transitional arrangement, SBMA intends to regulate for Subic Water until a National Water Regulatory Board is established. Although Bank financing of the water supply component under the proposed project is limited to the development of the well field, water treatment and raw and treated water transmission mains, the economic viability of the investment is impacted by the commercial viability of Subic Water. The Bank has reviewed the terms and conditions of the legal agreements covering the regulatory arrangements between SBMA and Subic Water, and found them satisfactory. 3.11 The component would involve: (a) detailed engineering and the development of the Pamatawan well field. Twenty wells with an average capacity of 450m3/hour will be dug. Initially, 12 of the 20 wells south of the Pamatawan River will be equipped. Provision will be made to accommodate future connections for the remaining 8 wells; (b) construction of approximately 7,600 meters of raw water transmission main from the Pamatawan well field to a water treatment plant at Castillejos. The routing of the raw water transmission main will be totally within the roadway right of way. No easement acquisition will be required (see Environmental and Social Impacts, Chapter 5); (c) construction of electrical power transmission lines to the well field and treatment plant; (d) construction of a water treatment plant and a booster station. The proposed treatment process consists of aeration, sedimentation, and chlorination. The booster station will deliver the treated water to the water distribution system through the treated water transmission main; (e) construction of approximately 19,400 meters of treated-water transmission main from the treatment plant to a pool of storage reservoirs located just inside the Kalaklan Gate of the secured area. The routing of the transmission line will be within the highway right-of- way and will include eight river crossings; (f) installation of a ground water monitoring network for monitoring the ground water table and water chemistry at the Pamatawan well field; (g) reforestation in the Pamatawan River basin to improve the aquifer recharging process; and (h) consulting services for a hydrological study of the Morong River and the Hermosa- Dinalupihan aquifer to identify water supply sources to meet the long-term water supply needs of Hermosa and Morong. 3.12 The assets and debts resulting from these investments will be owned entirely by SBMA; no on-lending is involved. Details of the water supply component, including the structure for privatizing the water and sewer facilities and outline terms of reference for the technical designs, construction supervision and studies are in the project implementation plan. Agreement was reached at negotiations that SBMA will conclude a water sales contract with Subic Water by December 31, 1998. Further, a condition of effectiveness is that the Subic Water Joint Venture Agreement shall have become effective in accordance with its terms.  - 13 - 3.13 Power Distribution (US$26.1 million). This component would merge the Olongapo City Public Utilities Department (PUD) and SBMA's Power Services Department (PSD). There is considerable scope for combining resources to achieve efficiencies by sharing manpower and common facilities. Merging Olongapo's PUD and SMBA's PSD operational and administrative functions will relieve their space constraints by moving to a new headquarters building, establishing common storage, maintenance and training facilities, and rationalizing existing facilities. The merger will also strengthen commercial operations, and improve revenue opportunities and customer service. The proposed rationalization and consolidation of these two small power distributors under the proposed project will bring about significant economies of scale and are in line with the recommendations for power sector reforms in the Bank's November 1995 Power Sector Restructuring Report. Electricity demand in SBMA, while lower than it was when the Naval Base was in full operation, is growing rapidly as new industries come into operation. This has not, however, translated into a corresponding increase in revenues, as most facilities at the base lacked electric meters and it is estimated that more than half of water and power consumption is not billed. Meter installation in those facilities under Subic II is, thus, expected to lead to a significant increase in SBMA's revenues. 3.14 The National Power Corporation (NPC) now supplies 16 MW in Olongapo City and 10 MW to SBMA, and their joint demand is expected to increase about 14 percent a year to around 55 MW in 2002. If the respective hourly demands are combined to be metered as a single NPC consumer, studies show total demand will be lower by about ten percent. This growth rate is the basis for the design of the system reinforcement plans under Subic II. 3.15 About 200 km of the network is overhead, with 100 km underground. Most of the overhead network in the Secured Area is in good condition, with some sections requiring upgrading to carry the forecast area loads. About 20 km of new underground cable is required to replace sections which have deteriorated and to improve the environmental character of the system in waterfront areas. The switchgears are old and need to be replaced and an inventory of spare parts is needed to effect proper maintenance of existing equipment. 3.16 The two power distribution agencies have high non-technical losses that urgently need to be monitored and reduced. This will require a major review of metering requirements to (a) establish a method of accounting for administrative consumption (currently estimated to be about 40 percent of SBMA's total consumption), (b) provide individual meters on all domestic consumers in SBMA housing areas, and (c) undertake a systematic re-calibration and, if necessary, replacement of all consumer owned meters in the Olongapo franchise area. In addition, it will be necessary to upgrade the existing Olongapo computer billing system to process the bills for all consumers in the supply area and to provide basic information for management and monitoring of the loss reduction program. 3.17 The Olongapo distribution system is over 40 years old and shows signs of rapid deterioration. Many of its wooden poles have been attacked by termites and are in danger of collapsing during typhoons. Conductor sizes are generally too small, with high technical losses (estimated at about 15 percent of consumption) and serious voltage regulation problem. Most of the original power factor correction capacitors have failed and are out of service. The lack of adequate maintenance facilities makes repair work impossible, and when failures occur, the lack of replacements is increasing the incidence of overloading of adjacent equipment. While the situation has not yet reached intolerable levels, it is evident that as demand increases, serious failures are likely to become a chronic problem. The project would consist of:  -14- (a) construction of about 23 km of overhead and about 3 km of underground 69 kV sub- transmission circuits, together with the expansion of five existing 69/13.8 kV substations and the construction of one new 69/13.8 kV substation, to effect the interconnection of the Olongapo and SBMA franchise area; (b) installation of about 20 km of 13.8 kV cables to replace damaged cables and to enhance the environment of prime waterside locations in SBMA's area; (c) rehabilitation and extension of about 50 km of 13.8 kV and 50 km of LV systems, including replacement of 4.1 kV system in Olongapo City; (d) provision of facilities and equipment for the integrated power distribution network, including electric meters and meter test equipment, storage and maintenance facilities, administrative office, meter test and repair facilities, office equipment, and MIS and billing systems. (e) engineering services for the supervision of installation, including strengthening the technical capability of the merged operations; and (f) technical assistance, training, and management services to establish commercial operation in the integrated organization including billing, accounting and administration. 3.18 The assets and debts resulting from these investments will be owned entirely by SBMA; no on-lending will be involved. SBMA has agreed to enter into a contractual relationship with Olongapo City to establish a legal basis for SBMA to undertake investments in power distribution outside the secured area. A satisfactory power distribution contract between SBMA and Olongapo City was concluded and submitted to the Bank prior to negotiations. Details of the power distribution component, including outline terms of reference and the contractual agreement, are in the project implementation plan. 3.19 Roads, Bridges and Related Infrastructure (US$28.1 million). The roads and bridges under SBMA's jurisdiction need increased maintenance and must be expanded and upgraded to prevent traffic congestion from becoming a major constraint on Subic's continued development. While SBMA intends to carry out road maintenance and construction by contracting to the private sector, its ability to plan, supervise, and manage these functions needs strengthening. 3.20 Under the U.S. Navy maintenance and construction activities were carried out by force account, and SBMA did not inherit a functioning maintenance system. As SBMA's immediate priority was to get the Freeport functioning, little maintenance was carried out in the initial period and many roads are exhibiting signs of structural fatigue and failure. During project preparations consultants identified a limited program of emergency maintenance that is to be contracted out with SBMA funding. 3.21 SBMA's Public Works Group (PWG) has only recently obtained a recurrent budget to begin a routine maintenance program in 1996. The initial program is small and constrained by lack of adequate resources-funding is only P 4.8 million-but a critical institutional precedent of providing an annual recurrent budget for road and bridge maintenance has been set. 3.22 This component is designed to improve road capacity and access, retrofit and construct bridges, establish a maintenance program, and strengthen SBMA's capacity to procure and supervise  - 15 - works to enable industrial and commercial development of the SBF. These would be accomplished through: (a) road improvement, including (i) widening Rizal Highway to four lanes plus turning lanes from Kalalake Bridge to the SBMA Expressway, (ii) widening Argonaut Highway from the Industrial Park (Phase I) Access Road to Boton Road to three lanes, (iii) widening the link from Tipo Road to Binitican Bridge to four lanes, and building a new SBMA expressway extension from Binitican Bridge to join Argonaut Highway near Boton bridge, and (iv) improving signalization and channelization at key intersections in the SBF; (b) rehabilitation and retrofitting (including design, construction and construction supervision of works) four existing bridges-Kalalake, Malawaan, Boton and Binitican-to meet the latest seismic design codes; (c) provision for a new bridge to replace the Kalaklan bridge, including studies, detailed engineering, construction supervision and construction under the project; (d) carrying out a road maintenance study and establishing a maintenance management system for roads and bridges and training of SBMA's PWG in its use and in the procurement and supervision of the contractors who would carry out both recurrent and periodic maintenance; (e) a road alignment study for the SBFZ By-Pass to improve traffic flow in the long term in the freeport by ensuring that through traffic on the national highway between Dinalupihan and Castillejos would bypass the SBFZ; (f) improvements in related infrastructure including (i) conducting detailed surveys of jurisdictional boundaries and installation of metes and bounds monuments, (ii) construction of a security fence along part of the SBFZ boundary, (iii) aerial photography and mapping of the SBFZ, and (iv) establishment of a geographical information system; and (g) consulting services for detailed engineering and construction supervision for the civil works components and a TA Road Advisor to strengthen the PWG's capability to implement this component of the project. 3.23 Details of the Roads, Bridges and Related Infrastructure component, including outline terms of references are in the project implementation plan. Agreement was reached atnegotiations, that SBMA will review the conclusions and recommendations of the maintenance management study with the Bank by March 31, 1998, with a view to defining the routine and periodic maintenance works programs and corresponding budgets to be implemented during the remainder of the project.  -16- C. COSTS AND FINANCING Project Costs 3.24 The estimated base cost of the proposed project is P 2,377 million (US$91.4 million equivalent) with total project costs, including contingencies, being P 3,068 million (US$108.0 million equivalent) with a foreign exchange component of about 60 percent or P 1,854 million (US$65.4 million). Physical contingencies represent about 12 percent of base costs, while price contingencies amount to about six percent in the US$ cost estimates. Physical contingencies of 15 percent have been applied on base costs for civil works and equipment and 10 percent on operating costs. Price contingencies were applied on base costs plus physical contingencies as shown in Table 3.1 below. Table 3.2 summarizes the cost estimates, details of which are presented in Annex 4. Constant purchasing parity exchange rate was used to convert US Dollar amounts to Peso equivalents. Table3.1: Price Contingencies Contingencies: 1997 1998 1999 2000 Local Costs 7.0% 6.0% 6.0% 5.0% Foreign Costs 2.4% 2.4% 2.4% 2.4% Table 3.2: Project Cost Summary -------Million Pesos--------- ---------Million US$-------- Components: Local Foreign Total Local Foreign Total % Base A. Institutional Strengthening -Institutional Support 18.6 87.0 105.6 0.7 3.3 4.0 4 -Ecology Center 1.8 12.0 13.8 0.1 0.5 0.6 1 B. Water Supply 365.4 481.9 847.3 14.1 18.5 32.6 36 C. Power Distribution 271.6 407.7 679.3 10.4 15.7 26.1 29 D. Roads and Bridges 275.4 455.9 731.3 10.6 17.5 28.1 31 Total Base Cost 932.8 1,444.5 2,377.3 35.9 55.5 91.4 100 Physical Contingencies 111.5 170.0 281.5 4.3 6.5 10.8 12 Price Contingencies 169.4 240.0 409.4 2.4 3.4 5.8 6 Total Costs 1,213.7 1,854.5 3,068.2 42.6 65.4 108.0 118 Percent: 40 60 100 40 60 100 Financing 3.25 Total project costs will be financed as follows: a Bank loan of US$60.0 million is projected to cover 100 percent of the estimated foreign exchange of investment costs plus 100 percent of local costs for consultants for the project. SBMA will finance the remaining local costs. The Bank loan will be for a period of 20 years, including five years of grace, at the Bank's standard LIBOR-based interest rate for US$ Single Currency Loans. SBMA will bear the foreign exchange rate risk of the loan. The loan will be guaranteed by the GOP. Agreement was reached at negotiations that the GOP will provide this guarantee. The financing plan is summarized in Table 3.3 below.  - 17- Table 3.3: Financing Plan (US$ Million) Project Year 1997 1998 1999 2000 TOTAL Percent Annual Project Costs Investment costs 6.0 36.8 36.2 10.5 89.5 82.9 Operating costs 0.1 0.2 0.2 18.1 18.5 17.1 Total Financing 6.0 37.0 36.4 28.6 108.0 100.0 Required Bank Loan 2.2 14.0 24.2 19.6 60.0 55.6 SBMA 3.8 23.0 12.2 9.0 48.0 44.4 D. PROJECT MANAGEMENT AND IMPLEMENTATION Overall Management and Project Implementation Plan 3.26 The detailed elements of the organization and management of Subic II are set out in SBMA's project implementation plan (PIP) which has been submitted to the Bank. As indicated in the PIP, the proposed project would be carried out by SBMA. Under Subic I, SBMA has developed a structure wherein the Deputy Administrator of Finance serves as Project Director supported by component managers. This arrangement has been generally satisfactory and SBMA wishes to maintain this structure for Subic II in order to take advantage of the knowledge already gained by core staff. Nonetheless, based on lessons learned, the following enhancements would be made to increase the effectiveness of project management. 3.27 The Deputy Administrator for Finance would continue to fill the role of Project Director for the purposes of policy interface with the Bank. An individual will be assigned to the foreign assisted projects office to function as Project Manager to perform the day to day tasks of project management and oversight. The project manager will implement the project in conjunction with managers assigned by SBMA to supervise specific components. Additional counterparts are required in the areas of human resources management, freeport policy, incentives and regulatory interface, community outreach and social impact. SBMA has finalized its proposed project staffing plan and structure as part of the PIP and this was agreed at negotiations. Provision has also been made for two advisors, one for procurement and the other for financial management. Agreement was reached at negotiations that SBMA will maintain a project management structure acceptable to the Bank for the overall implementation of the project, and will identify and assign personnel from its core staff to the Project. Performance Monitoring Indicators 3.28 SBMA's PIP includes performance monitoring indicators for each aspect of the proposed project. In particular, there are three categories: (a) performance indicators relating to the institutional strengthening component; (b) indicators relating to other components--power distribution, water supply, and roads and bridges; and (c) general indicators of performance for the SBF as a whole. The general indicators cover SBMA's projections of investments, employment creation by investors, population, industrial buildings, and tourists for the period 1996-2005. The project-specific indicators  - 18 - cover the objectives of each component of the project, the major activities and inputs required, the expected outputs, and the results/impacts to be monitored during project implementation. Details of the performance monitoring indicators are in Annex 5. Financial Management 3.29 SBMA would be responsible for financial management of the project. The new, integrated, PC-based Accounting/Management Information System (financed under Subic I), will allow SBMA to establish separate project accounts which would provide management with key financial indicators that are needed for effective monitoring of the project. Such indicators would include cost comparisons that would provide early warning of the need for any corrective actions relating to over/underruns, and compliance with legal agreement covenants. The cost accounting feature of the new financial management system will further permit SBMA to assess costs associated with maintaining its infrastructure. Knowledge of such costs would help SBMA to determine the tariffs that clients would be charged for water supply, power distribution and other services provided. 3.30 Based on the lessons learned from Subic I (see Chapter 1), a further innovation will be introduced to ensure effective implementation of Subic II. To ease the workload of the Deputy Administrator for Finance, the respective component managers will be made more accountable commensurate with their level of responsibilities. Accordingly, it is proposed that checks for payment of goods and/or services under the project would be signed by the component managers. The Deputy Administrator for Finance would then countersign those checks in his capacity as Project Director. This would afford component managers improved control as well as budget monitoring capacity while at the same time maintaining the Project Director's oversight of project activities. E. PROCUREMENT AND DISBURSEMENT Procurement 3.31 Procurement arrangements for the project are summarized in Table 3.4 below. The cost of items described includes respective pro rata shares of physical and price contingencies. Acquisition of land is the only project cost element entirely financed by SBMA and is under NBF. Land will be procured according to applicable GOP procedures which have been reviewed and are satisfactory to the Bank. 3.32 A majority of the Bank financed procurement for Civil Works, Goods and Services will follow ICB procedures in accordance with Bank Guidelines for procurement of January, 1995 and revised in January, 1996. Pre-qualification of contractors will be carried out for the laying of water supply transmission mains and essential roads and bridge civil works contracts. A margin of preference equal to 15 percent of the CIF bid price of imported goods, or the actual custom duty whichever is lower, will be allowed for domestic manufacturers. A few contracts of relatively small value such as bridge rehabilitation, reforestation, security fence and miscellaneous equipment - computers, office equipment, etc., will follow NCB procedures acceptable to the Bank, as these are unlikely to attract foreign competition. Miscellaneous works costing less than US$10,000 equivalent per contract with an aggregate value not exceeding US$50,000 may be procured with lump sum fixed price contracts on the basis of three quotations from qualified contractors. Some urgently needed miscellaneous equipment will be procured on the basis of national shopping as appropriate on the basis of a minimum three quotations for individual contracts of less than US$50,000 with an  -19 - aggregate value not exceeding US$0.3 million. As per the recent Country Procurement Assessment report, NCB procedures are acceptable. However, SBMA has agreed to the use of appropriate Standard Bidding Document (SBD's) issued by the Bank for ICB and to the use of SBD for Smaller Civil Works. Consultancy services such as the detailed design, engineering, technical assistance, including project management, construction supervision and studies will be carried out in accordance with the Bank's Consultants Guidelines for the use of Consultants; the Bank's standard form of contract will be used for consultancy services. Further details of the procurement and implementation arrangements by component are in the project implementation plan. 3.33 SBMA is the principal implementing agency responsible for carrying out the project, including all procurement. This is the second project and the staff of SBMA has benefited from the procurement experience gained in the earlier project. Consultants will be retained by SBMA to prepare designs and bidding documents; and additionally supervise all major road, water supply and power contracts. Provision has been made for appropriate technical assistance in procurement to strengthen the existing SBMA staff as proposed in paragraph. 3.27. For all TA activities financed by the proposed loan, SBMA will retain consultants according to terms of reference and selection procedures acceptable to the Bank, and an action plan and timetable for carrying out studies and the implementation of agreed recommendations. 3.34 Bank financed contracts above a threshold of US$0.5 million will be subject to the Bank's prior review procedures. The review process will cover about 95 percent of total works and goods contracts procured by ICB and NCB procedures. For consultancy contracts, the threshold for prior review will be set at US$100,000 for firms and US$50,000 for individuals. In any event, all TORs, including sole source selections of consultants regardless of the value of the contract, will be subject to prior review. The post review of contracts will be carried out on the basis of one (1) in four (4) contracts for goods and works. 3.35 Procurement information will be collected and recorded from comprehensive quarterly reports to the Bank by SBMA indicating revised time schedule for procurement actions including advertising, contract awards and completion time for individual contracts.  - 20 - Table 3.4: Procurement Arrangements (US$ Million) ----------------- Procurement Method--------------------------- Items to be Procured ICB NCB Other NBF TOTAL Land Acquisition 1.1 1.1 Works Water Component 13.8 5.5 19.3 (8.0) (3.3) (11.3) Power Component 15.0 4.8 .3 20.1 (9.9) (3.1) (13.0) Roads Component 18.6 7.7 3.2 29.5 (11.5) (4.7) (16.2) Goods Water Component 3.3 3.3 (3.3) (3.3) Institutional Component 3.9 3.9 (3.9) (3.9) Consultants' Services Engineering Supervision 8.0 8.0 (8.0) (8.0) Technical Assistance 4.0 4.0 (4.0) (4.0) Training 0.3 0.3 (0.3) (0.3) Operation and Maintenance 18.5 18.5 54.6 18.0 12.3 23.1 108.0 TOTALS (36.6) (11.1) (12.3) (60.0) Figures in Parentheses represent anount financed by the Bank Loan. NME: Non Bank Financed. Disbursements 3.36 It is assumed that the loan will become effective by January 1997, and that the project will be completed by June 30, 2000. The scheduled disbursements are shown in Annex 6. The Bank loan will be disbursed against the categories shown in Table 3.5 below. 3.37 Disbursements for all expenditures would be based on full documentation except for (i) contracts for works and equipment that cost less than US$500,000 equivalent, and (ii) contracts for consulting services for US$100,000 equivalent for firms and US$50,000 equivalent for individuals. Supporting documents for disbursements based on statements of expenditures (SOEs) would be kept by SBMA for review by external auditors and Bank supervision missions. As under Subic I, SBMA will open a US$ denominated Special Account in a commercial bank to facilitate payments for eligible expenditures.  -21 - Table 3.5: Disbursement Categories Amount Category (US$ Million) % Expenditure Financed 1. (a) Civil Works Water 10.0 60% (b) Other Civil Works 26.3 60% 2. (a) Equipment Water 2.9 100% of foreign, 100% local (ex- factory cost), and 70%, of local expenditures for other items procured locally (b) Other Equipment 4.2 Same as (a) 3. (a) Consultants for Water 3.1 100% (b) Other Consultants 8.1 100% 4. Unallocated 5.4 TOTAL 60.0 3.38 There are two conditions of disbursement against the water supply component, Categories l(a), 2(a) and 3(a): (a) obtaining a water permit from NWRB for the proposed abstraction of water from the Pamatawan well field; and (b) that SBMA will enter into a"heads of agreement" with Subic Water satisfactory to the Bank establishing the principal terms and conditions for the water sales agreement. The Account would have an Authorized Allocation of US$2.0 million; however, the Authorized Allocation shall be limited to an amount of US$1.0 million until the aggregate amount of withdrawals from the Loan Account plus the total amount of all outstanding special commitments shall be equal to or exceed US$30.0 million. F. SUPERVISION, MONITORING, REPORTING, ACCOUNTS AND AUDITING Supervision and Monitoring 3.39 The proposed project will require greater than average supervision resources. This is principally because of three significant and distinct investment sub-components: water supply, power distribution, and roads and bridges. Moreover, the progress on complex freeport policy and institutional issues will need close supervision. As regards the sub-components, water supply, for instance, cannot be supervised in isolation from Subic Water's on-going activities as this company would execute the operation and maintenance on behalf of SBMA as well as purchase the bulk water produced by the component. Similarly, for the power distribution component, Bank missions will have to monitor the activities relating to the proposed consolidation of power distribution in the OlongapolSBMA franchise area. 3.40 The key indicators of performance in SBMA's PIP-see paragraph 3.28-would be monitored closely during supervision missions to facilitate decision making by management, both SBMA and the Bank. Project supervision by the Bank will follow the supervision plan presented in Annex 7. Bank supervision will require an estimated 79 staff weeks over the life of the project. These estimates have taken into consideration provisions for supervision of the first project as both Subic I and II will be jointly supervised. Supervision would be carried out by Bank staff and consultants with expertise in infrastructure development (water supply, power distribution and roads and bridges), Freeport policy and institutional development, financial and environmental management. The teams  - 22 - would also be complemented by a privatization specialist to assess progress with the conversion of utilities. SBMA will supervise the project on an ongoing basis through a designated project manager, assisted by technical and financial staff within the institution as required. Further details of the planned implementation schedule are in the project implementation plan. 3.41 A mid-term review of the project would be carried out after the second project year, estimated in December 1998. The review would be carried out jointly by the Government/SBMA and the Bank, with SBMA's project manager responsible for preparatory arrangements and coordination. The main purpose of the review will be to assess progress accomplished in carrying out the project and SBMA's Corporate Plan. Agreement to this effect was reached at negotiations. Reporting, Accounts and Auditing 3.42 The integrated financial and management information system, currently under installation, will give SBMA the capacity to systematically report key indicators of progress of all foreign financed development projects. This will include provision for separate accounting for each individual project, including Subic I and II. The system will permit SBMA to generate progress reports tailored to the needs of the Bank and, in particular, visiting supervision missions. 3.43 SBMA's consolidated accounts (Balance Sheet and Profit and Loss Statement) will be audited annually by The Commission of Audit (COA), an arrangement which is acceptable to the Bank. Separate project accounts indicating the various sources of funds received and expended would be maintained ensuring that proper accounting and auditing procedures are followed. As part of the audit process, the project's annual financial statements, together with the auditor's report and opinion on the financial statements and the Special Account, and the auditor's separate opinion on the statement of expenditures would be sent to the Bank within six months of the close of each fiscal year. While provisional financial statements should be submitted to the Bank no later than a month after the closing of the fiscal year, the audit report should reach the Bank no later than six months after the close of each fiscal year. Agreement to this effect was reached at negotiations. Agreement was also reached that SBMA would carry out satisfactory procedures for monitoring the progress of the project in accordance with agreed performance indicators in terms of physical execution and financial reports and furnish the Bank semi-annual progress reports.  4. PROJECT FINANCIAL ANALYSIS A. SBMA's FINANCIAL POSITION Recent Financial Results 4.1 As a Government owned organization, SBMA follows standard GOP financial management procedures. Those include an accounting plan that must be approved annually by the Commission and Audit (COA), and procurement methods and financial management practices that are slow and cumbersome. While accounting entries are still done manually, an improved financial management information system, including automated billing, is being installed and will be operational by end- 1996. 4.2 In its three years of existence, SBMA has had little time to focus on fine tuning its in-house capacity to manage income and expenditures generated by infrastructure assets (including land) estimated to be worth P 22 billion (US$830 million). SBMA is, however, retaining consultants to help it design a cost accounting system with the capacity to account separately for individual development projects, including Subic I and II. This system will also permit SBMA to generate detailed monthly financial progress reports, including key financial indicators. 4.3 Although SBMA's income from operations has steadily increased over its first three years (Table 4.1) revenue growth has been slower than projected at appraisal of Subic I, largely because the Authority has not yet developed the infrastructuresuch as electric and water meters-needed for full cost recovery under its lease arrangements. These issues will be addressed under the proposed project (Chapter 3). Revenues, nonetheless, doubled in SBMA's second year of operations, and rose 37 percent in the third. Lease income from facilities, including residential housing, remains SBMA's main source of revenue. Overall revenues from operations, however, were not sufficient in any of the three years to cover operating expenditures, as SBMA's asset base is very large and the resulting, estimated annual depreciation charges represent about 50 percent of annual operating expenditures. Fixed assets are carried on the books at the value imputed as a result of a GOP authorized capital of P 20 billion, consisting of a P 1.0 billion in cash capital infusion from GOP and P 19 billion representing the estimated value of transferred assets from the former naval base. SBMA's income generating capacity at this juncture is significantly underdeveloped and its potential to raise additional revenue is considerable. 4.4 The current market value of SBMA's fixed assets taken over from the naval base is unknown, as none of them have been revalued (except those assets related to the water supply system). SBMA has opted to incur the expense of asset revaluation only if and when deemed necessary for corporatization. Water supply assets were revalued because negotiations for such an undertaking are in progress (Chapter 3).  - 24 - Table 4.1: SBMA Income Generation (Peso Million) % over % over Income From: 1993 1994 1993 1995 1994 Leases 146.0 311.7 113 298.4 -4 Business Operations 27.2 66.2 143 224.9 240 Services (including Utilities) 19.6 32.5 66 124.6 283 Other 35.3 67.0 90 6.9 -92 Total: 228.1 477.4 109 654.8 37 4.5 SBMA's principal expenditures are for Depreciation and Salaries and Benefits, which together account for 70 percent of the total. Table 4.2 below indicates the latest trends. As SBMA has grown, Salaries and Benefits have increased the fastest, with the biggest portion of the increase attributable to additional staff rather than salary increases. This category of expenditure is expected to decline in line with the DBM-approved civil service allotment of 1,587 in contrast to SBMA's current staff of 3,000 (Chapter 2). The cost of power, although accounting for only 11 percent of expenditures, is also steadily increasing with the chief consumption going to the operations of the airport and the water treatment plant. Table 4.2: Operating Expenditures and Loss (Peso Million) Category of % over % over Expenditures: 1993 1994 1993 1995 1994 Salaries and Benefits 93.8 179.9 92 209.1 16 Depreciation 218.4 224.3 3 279.6 25 Power 48.1 55.8 16 85.3 53 Other 52.4 89.1 70 189.4 113 Total: 412.7 549.1 33 763.4 39 Less Income Tax 228.1 477.4 109 654.8 37 Operating Loss: 184.6 71.7 -61 108.6 52 Financial Projections 4.6 The projections in Table 4.3 represent SBMA's five-year 1996-2000 investment plan. The Subic I and II projects are an integral part of investments and account for about 80 percent of investments through 2000. SBMA's projected threefold increase in revenues over 1996-2000 is largely due to the impact of Subic I and II. Although in 1994 and 1995 revenues fell short of estimates by 12 and 34 percent, respectively, the projected increases are well within reach. During appraisal of Subic II, the ten-year estimates contained in the Subic I Staff Appraisal Report (SAR) were reviewed and revised in light of the experience gained during the first three years. With the assistance that will be provided under Subic II to manage power distribution and the contracting out  - 25 - of water supply operations and management to Subic Water, income from the sale of utility services will assume an increasing importance in SBMA's income statement. Other services represent chiefly income from operating the airport, distribution of power within the secured area to industrial and commercial investors, hotels and other tourism-related concerns and private households. It is anticipated that by end-1997 the majority of enterprises in the Taiwanese industrial park will begin operations. SBMA recognizes the need to maximize income from its assets and Subic II will provide electric meters and support an aggressive campaign to install them. 4.7 Although tariff calculations for power were done during appraisal on an indicative basis using incremental investments proposed under Subic II, the residual value of previous investments needs to be known to allow SBMA to recalculate tariffs to provide full cost recovery for the electricity it provides. SBMA, therefore, will undertake a major effort to increase efficiency in power distribution to its investors and private households. This will include a valuation of existing assets, installation of meters and corresponding tariff adjustments. This process has begun for water supply. Assets have been revalued and were contributed as a 20 percent share in kind to Subic Water, which will install individual water meters in residential quarters under Subic II. Table 4.3 below indicates SBMA's projected key financial indicators over the next five years. Table 4.3: SBMA's Projected Key Financial Indicators 1996 - 2000 (US$ million) Key Indicators 1996 1997 1998 1999 2000 Revenue - From Existing Leases 11.1 10.0 8.9 6.9 6.6 - Other Services 28.1 44.1 60.0 70.3 66.5 - Utilities (Subic II) 7.7 15.5 36.2 Total Revenue 39.1 54.1 76.6 92.7 109.3 Operating Expenditures - Utilities (Subic II) 11.0 21.9 24.8 - Other 47.5 49.8 52.3 53.0 61.3 Total Operating Expenditures 47.5 49.8 63.3 74.9 86.1 Net Income (Loss) (8.4) 4.3 13.3 17.8 23.2 Net SBMA Cash Surplus - (consolidated) 0.5 9.2 19.1 2.4 7.0 Net Equity 729.3 717.4 712.9 711.0 709.5 Long-term Debt 75.4 80.4 101.5 147.2 151.2 Ratios: - Debt Service Coverage (times) 7.47 2.51 2.64 1.99 2.86 Debt/Equity (%) 20.6 28.6 33.7 32.8 31.4 4.8 Given the dynamic situation with respect to potential privatization of SBMA's commercially oriented activities, medium-term projections are only indicative and were carried out under the assumption that SBMA retains control over its 1996 asset base through the year 2000. Because of the  - 26 - unique nature of SBMA's business as it evolves from a multi-purpose authority, combining commercial and regulatory activities, to a lean regulatory agency, traditional key financial indicators such as "current ratio" and "return on assets", which are mainly designed to measure commercial operating performance, are of little significance. More important are ratios that measure SBMA's capacity to absorb debt; for example, the debt service coverage and the debt equity ratios. As indicated in Table 4.3, these ratios remain very healthy throughout the life of the project. With 2.86 times and 31.4 percent, respectively, in the year 2000, for the debt service coverage and debt/equity, these ratios are well within internationally acceptable limits. Further, although the incremental project cash flow--see Annex 8, page 10--is not positive until the year 2003, as the costs of roads and bridges are included, SBMA's consolidated cash flow remains positive throughout the project period (see Table 4.3). Details of SBMA's cash surplus, projected revenue schedule and balance sheet are in Annex 8 (pages 11-13). While these figures suggest that SBMA's current financial health is satisfactory, SBMA needs to be vigilant to keep costs from rising faster than revenue generating activities. Therefore, it will be necessary to continue to carefully review the five-year investment plan with the Bank no later than March 31 of each fiscal year. Agreement to this effect was reached at negotiations. Agreement was also reached that SBMA will continue to maintain appropriate insurance coverage, or adequate reserves for, and proper maintenance of its facilities, and continue to maintain a debt/equity ratio of no more than 70:30; of a debt service coverage of at least 1:5 from 1996 onwards. B. FINANCIAL ANALYSIS OF PROJECT COMPONENTS 4.9 A financial analysis has been undertaken for the water supply and power distribution components of the project. Additionally, an analysis has been undertaken of SBMA to enable an assessment of cash needed by SBMA to finance capital works, operating expenses, interest commitments and capital repayments of the project. The latter analysis is necessary as the roads and bridges and institutional strengthening components are not covered by either the water supply or power distribution financial analyses. The financial rate of return has been assessed for these two components but not for the overall project because a large part of the overall project cost is non- revenue generating. 4.10 Operation and maintenance of SBMA's utility services is managed by the Public Works Group (PWG). Within the PWG, the Utilities Department is split into three divisions: power services, water services and utility planning. The Utilities Department is staffed by 131 persons divided 57, 48, and 16 between water, power, and planning, respectively. Key staff of the Utilities Department were taken over from the U.S. military. However, owing to difficulties in procuring operating and maintenance equipment, the department is only performing maintenance services on an ad hoc basis. There is no routine, preventive maintenance being carried out on installations. Given the rapid economic expansion within the SBF, it is SBMA's intention to pool its resources, including operation and maintenance of utilities with those of Olongapo City to achieve economies of scale. At this juncture, the institutional arrangements have already been determined for the distribution of water (Subic Water), including utility ownership. Subic Water will absorb all of SBMA's personnel associated with operating the water supply installations. For power distribution, the City of Olongapo's Power Utility Department (PUD) will coordinate its operations with those of SBMA under a contractual agreement (See Chapter 3). 4.11 For the water supply component, the financial analysis is based on incremental investment and operating costs for the provision of treated water in bulk to the newly created Subic Water.  - 27 - Agreement was reached at negotiations that SBMA will conclude a water sales contract with Subic Water by December 31, 1998. For the power distribution component, the financial analysis is based on the incremental investment and operating costs and on tariffs currently charged by SBMA and Olongapo City. These rates will be reviewed following the completion of tariff studies and cost recovery options to be financed under the project. 4.12 The overall design of the service provision components (water, power and roads) is based on the population projections in Annex 1. Population growth of 8.7 percent a year has been assumed-compared to about 5.7 percent for other urban centers in the Philippines-to reflect the attraction of Subic's rapidly expanding economic activity to job seekers and their families. Summary of Financial Analysis 4.13 Annex 10 provides details of the underlying assumptions for the financial analysis of the water supply and power distribution components of the project, including the bulk and retail water tariffs, power distribution tariffs for commercial and domestic consumers, the billing and collection efficiency for both water supply and power distribution, and interest costs. Below is a summary of the financial analysis. 4.14 Water Supply Component: Total investment capital cost of the water supply component, including physical contingencies, is estimated to be P 698 million (US$26.9 million). Incremental operating and maintenance costs are estimated at about P 200 million in 2000 rising to about P 400 million by 2010. (Power is estimated to make up about 80% of total operating costs.) Revenue generation from the sale of treated bulk water is based on proposed tariffs as outlined in Annex 8 and projected incremental consumption rates: (i) domestic 240 I/day; (ii) industrial 19 I/m2 of floor space; (iii) commercial (office) 2.5 1/m2 of floor space daily; (iv) commercial (retail) 15 1/m2 of floor space daily, and (v) hotels 2.5 I/m2 floor space daily. This projected demand is net of non-revenue water costs. Non-revenue water is estimated at five percent of total water pumped. System losses are expected to be zero. The analysis assumes that construction of the water installations will be completed by 1999 and that 2000 will be a full revenue producing year. Annex 8 shows the incremental costs and revenues. 4.15 Financial Rate of Return: Based on these assumptions, the FIRR for the water supply component is 14.8 percent. The analysis shows that this component should generate a positive cash flow (after interest) in its first full year of operation (the year 2000). 4.16 Power Distribution Component: Total investment capital cost of the power distribution component, including physical contingencies, is estimated to be P 581 million (US$22.3 million. To determine incremental unit costs per kWh, three activities were taken into consideration for operating and maintaining the transmission and distribution system: (a) operating the 69 KV lines including management of NPC billings; (b) costs of power purchases from NPC; and (c) personnel, administrative, and direct operating and maintenance costs (fuel and lubricants for vehicles including repairs) for the consolidated distribution activities of SBMA and Olongapo City. For purposes of determining gross incremental revenue from SBMA and Olongapo City's sale of power, a domestic consumer rate of P 3.18 per kWh was used, and P 4.6 per kWh was used for commercial consumers. It should be noted that SBMA now charges its customers a uniform rate per kWh of P 2.75 and Olongapo City P 3.50. Thus, while the new rate would represent a substantial increase for the secured area, it is considered well within the capacity of domestic consumers to pay, especially as these are mostly international clientele. The rate for domestic consumers in Olongapo City would be  - 28 - nearly 10 percent lower than at present, thus increasing affordability and the potential customer base. Annex 8 shows the incremental costs and revenues. 4.17 The analysis of SBMA's power distribution proposals revealed important financial concerns which will play a critical role in the overall financial viability of the power distribution enterprise. The major concerns are: (i) the current high level of usage and live losses; (ii) the current high level of SBMA administrative usage; (iii) the current dependence of SBMA on NPC and their planned tariff increases; and (iv) the retail cap which SBMA can charge for power. If SBMA charges excessive rates, consumers will convert to their own generators. The analysis thus highlights the importance for SBMA to structure its tariffs to extract maximum revenue without inhibiting demand. It also highlights the importance of minimizing losses and bad debts and establishing a procedure for minimizing administrative consumption. 4.18 Financial Rate of Return: Based on these assumptions, the FIRR for the power distribution component is 18.7 percent. It is anticipated that this component will not show a positive net operating revenue until the third full year of operation (the year 2002).  5. BENEFITS AND RISK A. PROJECT BENEFITS 5.1 The proposed project will increase the SBF's attractiveness to overseas investors and encourage existing investors to expand their operations. This should speed job creation, raise SBMA revenues, provide much-needed services to residents of Olongapo City and Subic town, and improve administrative efficiency/governance throughout the Subic Bay metropolitan area. It is estimated that as a direct result of project interventions SBF will create many new jobs most of which will occur in industry with the balance in tourism-related services, commerce and administration. Judging from similar development experiences in the sub-region, incremental export earnings per industrial employee/year of about US$12,000 can be expected. Thus, by the turn of the century, SBMA estimates that some US$600 million in export revenues would accrue to the Philippines. The type of light industrial activity likely to take place in SBF will typically attract value added ratios of around 40 percent, which would translate into net foreign exchange earnings of about US$240 million by the year 2000. This does not include income generated from such activities as tourism and commerce. 5.2 Direct benefits (annual incremental revenue) to SBMA from improved and expanded provision of services for water, and power will be significant. The project will also improve the administrative and operational efficiency of the power and water utilities which is a necessary step toward corporatization and eventual privatization of these utilities. The provision of cleaner drinking water to the population of Olongapo City and the associated improvements in the city's sewerage system, would have an immediate, beneficial impact on the overall health of the population. B. SBMA OPERATIONS WITHOUT THE PROJECT 5.3 SBMA's water, power, and roads and related infrastructure installations and equipment were built to serve the needs of the U.S. Navy. The infrastructure was in relatively good condition when it was handed over to SBMA in November 1993. Since then, however, only perfunctory maintenance work has been carried out and more than half of water and power consumption is not billed as meters are not installed in most facilities in the former Naval Base. Without the road widening and extension under the project, the planned development of industrial estates on the southeastern side of the Freeport would be seriously constrained. This could reduce the number of jobs generated by the industrial sites by 13,000 to 16,000 over five years; given the stiff competition within the ASEAN region for industries seeking to locate in duty free zones, it is estimated that half the employment which would be lost if the roads were not developed would also be lost to the economy as a whole. 5.4 There is almost no domestic term financing in the Philippines, and it would be difficult for SBMA to assemble the integrated Subic II project package without a major multilateral lender such as the Bank. SBMA's alternative would have been to continue to undertake patchwork repairs and expansion work on an ad hoc basis. Although private firms have joined in a water supply/sewerage joint venture with SBMA, there is no indication that the private sector is ready to participate in major  - 30- investments to upgrade other utilities and infrastructure. Without the Subic II project framework the urgent sewer works improvement under the water supply component would have been delayed to 2000, with negative environmental and health impacts. C. ECONOMIC RATES OF RETURN AND SENSITIVITY 5.5 This project includes three key infrastructure components which are collectively necessary for the continued development and expansion of the SBF. From the perspective of the economic analysis, these three components (roads, water supply, and power distribution) cannot be evaluated separately as each component is a necessary part of a total development program if the SBF is to expand at the rate projected by SBMA (see Annex 5). 5.6 Benefits from a development similar to SBF are substantial and they range from direct visible benefits such as increased employment and output to improved living standards and conditions. In this project there will be two basic benefits: (i) an increase in development (and output) in planned industrial parks and surrounding metropolitan areas; and (ii) the maintenance of existing businesses and population in the SBF and surrounding metropolitan areas. For the economic analysis, only estimated benefits from the increase in development were included. If the project were not to proceed and existing businesses left SBF because of poor infrastructural services it is unlikely that they would relocate outside the Philippines. Benefits from an increase in development have been measured in terms of an increase in the number of people employed and their subsequent wages and water and electricity sales from the facilities to be built under this project. It should be noted that a facility such as SBF provides a total service so it is difficult to realistically isolate all benefits which may accrue from this project which includes a number of works to upgrade and maintain existing facilities. 5.7 Annex 9 provides details of the underlying assumptions for the economic analysis of the project, including an assessment of the employment benefits, benefits from the sale of water and electricity and other assumptions used in the analysis. Based on these assumptions, the economic intemal rate of return (EIRR) of the project is 29.6 percent. 5.8 The analysis in Annex 9 also illustrates the project's sensitivity to variations in benefits and recurrent costs. A range of possibilities incorporating maximum and minimum expectations, are covered. For the "maximum", or the base case, it is assumed that full benefits are obtained from increased employment as outlined and tariff revenue for electricity and water. If however, water and industrial development (employment) are - as for the base case, and live losses power increase from 8 percent to 30 percent, the EIRR falls from 29.6 percent to 20 percent. The EIRR is further reduced-to 17.1 percent-if live losses (power) are increased from 8 percent to 20 percent, billing efficiency (power) is lowered from 95 percent to 80 percent, and industrial development (employment) is down by 20 percent. The other scenarios explored are in Annex 9. The analysis assumes that affordability is not a problem for water and power. In the unlikely event that tariffs for both water and power have to be increased simultaneously, affordability will become a problem for a maximum of 30 percent of the population of Olongapo, the segment that lives below the poverty line. 5.9 Crossover (switching) values for the project are also provided in Annex 9. These indicate a combination of changes in benefits and costs required to reduce the net present value (NPV) to zero (or, alternatively, the rate of return to 12 percent, the estimated opportunity cost of capital in the Philippines). Given the conservative assumptions used in the analysis the project is not particularly sensitive to changes in revenue and costs. If benefits are reduced 25.3 percent and expenses maintained at the base level the NPV falls to zero at a discount rate of 12 percent. If benefits are  - 31 - maintained at the base rate recurrent expenses need to be increased by 41 percent to obtain a zero NPV. Benefits need to be reduced by ten percent and recurrent expenses increased by 24.7 percent simultaneously to obtain zero NPV. 5.10 Affordabilit. A demographic analysis of Olongapo City's population shows that some 20 percent of its families cannot afford water and electricity . The project's power and water supply components are expected to generate savings from metered billing in the Secured Area, more efficient administration, and economies of scale that will lead to lower tariffs for small consumers-the base rate for small consumers is projected to drop from P 3.72 to P 3.18 per kWh-and should increase affordability. Both Subic Water and the consolidated power utility will look closely at making power and water available to the entire population of Olongapo City through appropriate rate structures. The project provides for tariff studies for both water and power distribution. The discussion on power tariffs in the financial analysis should be noted in the overall economic context of the project. D. PROJECT SUSTAINABILITY 5.11 The Bank's Subic I Project was designed to rehabilitate essential infrastructure to attract private investors and provide institutional support to provide the basis for sustainable growth. The major part of SBF's development is being undertaken by the private sector, which has led to increased inflows of investment, rental and lease income for SBMA, and employment in the Freeport area. It has also brought rapid population growth, estimated at 8.7 percent a year, and increased demand for essential services. Water distribution is already in the process of being privatized. The project would further assist SBMA to respond to the increased demand for services through privatization support which would enhance efficiency, improve cost recovery and provide sustainability. At the same time, the project would enhance SBMA's managerial, administrative and regulatory capabilities, to create a viable and sustainable institution. The protection of the environment, necessary for sustainable development of the SBF, also continues to be a key concern of SBMA. Environmental sustainability would be addressed through ongoing master planning of the SBF (to take account of the faster than expected growth), and the proposed project interventions, including the creation of GIS as well as continued support to the Ecology Center. Finally, the improvements in the road network, together with those initiated under Subic I will continue to enhance the development of the SBF. E. ENVIRONMENTAL AND SOCIAL IMPACTS 5.12 The proposed project has been given a "B" rating and an Environmental Impact Assessment (EIA) has been carried out by SBMA's Ecology Center, established under Subic I. The EIA was reviewed by the Bank and was found to be satisfactory. 5.13 The EIA shows that most of the project's impact will be temporary as a result ofphysical construction (as in the roads and bridges and the renovation of power transmission lines), and will result in some loss of cover vegetation, tree cover, and some disturbance to the urban population as power lines are rehabilitated. The impact of the well field serving the water supply component has been carefully assessed and satisfactory mitigation measures are included in the component design. tPhilippines: Power Merger Studies of Olongapo City and SBMA. March 1996, Chapter 3.  - 32 - 5.14 The main environmental issue in this component is preventing the withdrawal of large volumes of water from the aquifer from lowering the water table and affecting local wells. To mitigate this risk the design calls for the wells to be spread out over a sufficiently large area to avoid creating a deep cone of depression in the water table. The project will also finance the planting of about 100,000 trees in the Pamatawan watershed to prevent erosion and maintain the local ecosystem. There may be some decrease in groundwater levels, and financial provisions were made under the project to replace the irrigation pumps of farmers with deeper-drawing models. The well field will not involve resettlement, although land acquisition and compensation for lost assets, including crops, are anticipated. SBMA has completed and submitted a property acquisition and compensation plan (PACP) for the water supply component. This has been reviewed by the Bank and found to be satisfactory. 5.15 The power distribution component will be confined largely to refurbishing and extending transmission lines. National environmental codes for power transmission are precise and designed to mitigate adverse effects. No resettlement is anticipated. The roads component will have no lasting environmental impact. 5.16 SBMA is committed to environmental protection under the legal agreements of Subic I, which requires the formulation of an environmental management plan, including the management of Subic Forest and its small population of Aeta indigenous inhabitants. SBMA is drawing up an expanded environmental management plan to include an indigenous peoples development plan, which includes provisions for the development of community-based forest management, community development and training, infrastructure improvements, and studies to formalize the Aetas' rights to Subic Forest. These arrangements are consistent with Bank guidelines. F. RISKS 5.17 There are financial risks and other risks that need to be mitigated in this project. Perhaps the greatest risk relates to the financial viability of SBMA's bulk water supply and power distribution components. The financial analysis (Chapter 4) highlighted the importance of addressing: (a) the adequacy of both water and power tariffs; (b) billing and collection efficiency; and (c) usage and live losses. In the case of bulk water, the financial analysis is sensitive to the tariff charged by SBMA to Subic Water. For instance, the FIRR of 14.8 percent is based on a tariff of P 9.5 per cubic meter. If this tariff is reduced by 15 percent to P 8.0 per cubic meter, the FIRR falls to around 4.5 percent. This risk has been taken into account in the draft commercial agreement between SBMA and Subic Water and will be closely monitored by the Bank. 5.18 As regards the power distribution component, the financial analysis assumes that usage and live losses and billing efficiency will improve significantly between 1996 and the year 2000. Sensitivity analysis show that the FIRR will be reduced from 18.7 percent to 6.8 percent if the usage and live losses were increased to 15 percent. A similar result was obtained if the billing efficiency or the tariff level is reduced. These risks are being reviewed as part of the tariff studies and cost recovery options to be financed under the project. 5.19 Other risks: There is some risk that the development of the Freeport policy regime from the Secured Area to the wider freeport boundaries may encounter political resistance that could lead to slippages in implementing the revenue-generating water, and power components that would increase costs and require higher tariffs that would affect affordability. This is considered unlikely, however, as the central Government has repeatedly reaffirmed its commitment to Subic's development and the  - 33 - project will promote institutional linkages with neighboring government units through water districts and the joint power distribution arrangement. In addition, the creation of an intergovernmental task force to revise the implementing rules and regulations for eventual signature by the President should strengthen SBMA's role as the administrator of the freeport zone. 5.20 The possibility of losing SBMA leadership, in the form of its visionary chairman or his managerial front line, also poses a risk to the project. The inclusion of additional institutional strengthening elements into Subic II is designed to address this need. It is essential that the strength of the institution not be dependent upon the presence of a small group of individuals. 5.21 Continued flow of lahar (mud flows) from Mt. Pinatubo presents an additional risk to the project. Flows precipitated by rains have blocked road access to the SBFZ for domestic tourists and freeport shopping clientele on occasion. This is being mitigated by raising the San Fernando- Dinalupihan road and building a high dike to stop lahar flows. In the longer term, completion of the Northern Expressway-Tipo link will offer an alternate route. SBMA further expects to mitigate this risk by improving air links and attracting a high speed ferry company to provide service between Subic and Manila. A third airline recently began operations out of Subic, and the ferry is expected to become operational shortly. The risks of lahar flows interfering with the physical components of the project, i.e., water supply, is very low as a result of careful design and site selection. 5.22 While a slowdown in the Freeport's industrial/commercial development could affect project sustainability, its infrastructure components are designed to lift the constraints that could lead to endogenous problems. Slowing regional trade or world trade, or diminished confidence in Philippine economic and political stability could, however affect Subic's growth. This would most likely reduce the job-seeking population inflow below the forecast 8.7 percent; this could affect cost recovery, as a one percent drop in the growth rate would lower annual utility revenues five to ten percent. Road and bridge improvements are also based on projected traffic levels that are dependent on forecast industrial development in the SBF. SBMA and Subic Water are, however, continually monitoring population growth in Olongapo and, given that detailed design of components will not be undertaken until spring 1997, adjustments in the light of most recent experience are possible.  6. AGREEMENTS REACHED AND RECOMMENDATION A. AGREEMENTS 6.1 During negotiations, agreement was reached with the Government that it will: (a) provide a guarantee on the proposed loan (para. 3.23). 6.2 Agreements was reached at negotiations that SBMA will: (a) conduct its affairs so as to ensure that major coTporate decisions with respect to its corporate structure, its management structure, each investment plan and plans specifying general civilian uses and related economic activities to be promoted in the SBF area, are consistent with the Corporate Plan; and furnish to the Bank, at mid- term review, a report on the progress achieved in carrying out the Corporate Plan (para. 2.12); (b) take all measures necessary to ensure that all persons whose property and other assets are adversely affected under the water and power components of the Project are compensated in accordance with the provisions of the Property Acquisition and Compensation Plan or the Principles for Property Acquisition and Compensation (para. 5.14); (c) maintain a project management structure acceptable to the Bank for the overall implementation of the project; including the assignment of experienced personnel from its core staff to the project (para. 3.27); (d) review the conclusions and recommendations of the road maintenance study with the Bank by March 31, 1998, with a view to defining the routine and periodic maintenance work programs and corresponding budgets to be implemented during the remainder of the project (para. 3.23); (e) not assign, amend, abrogate or waive the power agreement between SBMA and Olongapo City without the Bank's agreement (para. 3.18); (f) retain consultants according to terms of reference and selection procedures acceptable to the Bank for all TA activities financed by the proposed loan, and an action plan and timetable for the carrying out of studies and the implementation of agreed recommendations (para. 3.33);  - 35 - (g) undertake to obtain a water permit from NWRB for the proposed abstraction of water from the Pamatawan well field, and conclude a water sales contract with Subic Water by December 31, 1998 (paras. 3.12, 4.11); (h) carry out satisfactory procedures for monitoring the progress of the project in accordance with agreed performance indicators in terms of physical execution and financial reports and furnish the Bank semi-annual progress report (para. 3.43); (i) jointly review with the Bank, December 1998, its Corporate Plan and progress accomplished in carrying out the project (para. 3.41); (j) jointly review with the Bank its rolling, five-year investment plan on an annual basis no later than March 31 of each fiscal year, and its implementation, over the life of the project (para. 4.8); (k) provide annual audited financial statements to the Bank no later than six months after the close of its fiscal year, prepared by auditors satisfactory to the Bank; and provide financial statements one month after the close of the fiscal year (para. 3.43); and (I) continue to maintain appropriate insurance coverage, or adequate reserves for, and proper maintenance of its facilities, and continue to maintain a debt/equity ratio of no more than 70:30; of a current ratio of at least 1.2 and a debt service coverage ratio of at least 1.5 from 1996 onwards (para. 4.8). 6.3 Conditions of effectiveness are: (a) approval of SBMA's Corporate Plan by its Board of Directors (para. 2.12); and (b) the Subic Water joint venture Agreement shall have become effective in accordance with its terms (para. 3.12). 6.4 Conditions of disbursement against the water supply component are that SBMA will: (a) obtain a water permit from NWRB for the proposed abstraction of water from the Pamatawan well field (para. 3.38); and (b) enter into a "heads of agreement" with Subic Water satisfactory to the Bank establishing the principal terms and conditions for the water sales agreement (para. 3.38). B. RECOMMENDATION 6.5 Subject to the above agreements and conditions, the proposed project would be suitable for a Bank loan of US$60 million, for a period of 20 years, including a grace period of five years, at the Bank's standard LIBOR-based interest rate for US$ Single Currency Loans. The borrower will be SBMA, with the guarantee of the Republic of the Philippines.  - 36 - Annex Page 1 of 4 REPUBLIC OF THE PHILIPPINES SECOND SUBIC BAY FREEPORT PROJECT Profile of the Subic Bay Area The Subic Bay Area 1. Subic Bay is located on the western part of the main island of Luzon. The proposed project area is the geographic area whose metes and bounds were established by R.A. 7227, covering an estimated total land area of 60,000 ha, and water area of 9,525 ha. It includes the Secured Area (the former Naval Base), Olongapo City and Subic Town in Zambales Province, and the Municipalities of Morong and Hermosa in Bataan Province (see IBRD Map No. 28291). Olongapo has a long history of linkages to the Secured Area and strong relationship with SBMA prevails. Since the base conversion began, SBMA has taken steps to build alliances with the other local government units (LGUs) in the greater SBF zone. The launching of such a consultative initiative is significant and will improve SBMA's chances of serving as a sub-regional catalyst. Below are some of the key features of the proposed project area. 2. The Metropolitan Area of Subic Bay is rapidly changing and urbanizing. The effects of rapid urbanization are apparent in the industrial, commercial and residential growth, and in the increase in the number of squatter settlements surrounding the urban centers. The city of Olongapo is now 100 percent urban, however, the other municipalities of Subic, Morong, and Hermosa still maintain varying combinations of rural and urban development. This profile presents an overview of the area's characteristics which are of significance to this project. 3. The Secured Area. The fenced-in Secured Area encompasses the former U.S. Naval Facility which has formed the core of the Subic Bay development and was the main focus of Bank support in the first phase (Subic I). This approximately 6,000-hectare area is enclosed on its northern and southern boundaries by fences erected by the U.S. Navy and contains SBMA's offices, duty-free shops, hotels, seaports, airports, recreational facilities, residential housing and with physical life estimated from 10 to 15 years. The entire secured area is owned by SBMA and SBMA exercises its full authority over this portion of the Freeport. The area spans both Zambales and Bataan provinces. 4. Reverted Lands. The remaining 7,000 hectares of military facility that was turned over to SBMA in 1992 consists of two distinct areas. The Philippine Military Base (PMB) running along the southern and eastern edge of the secured area and the joint U.S. and Philippine Military Training Area (MTA) on the Redondo Peninsula. As former military reservations, the land is owned by SBMA, but the areas were not serviced by roads and not fenced by the U.S. Navy. As a result, SBMA does not exercise its full authority over the areas and existing private property exists within the area. The majority of the PMB lies within the province of Bataan and the existing municipal boundaries of Hermosa and Morong overlap with the PMB. 5. The construction of the Manila-Subic Tollway (see IBRD Map No. 28291) will traverse the PMB and open the area to development and potential squatting and customs leakage. Subic II will assist SBMA by extending the fence and establishing boundary markers to exercise its full authority over the PMB, including this area within the Secured Area. The completion of Subic II will permit the inclusion of this area within the "separate customs territory". The securing of the MTA at this  Annex I Page 3 of 4 time is not included in the Subic II project. The MTA lies entirely within the municipality of Subic and the province of Zambales. 6. Olongapo City. The adjoining city of Olongapo has a territory of 18,500 ha and is located in the province of Zambales. As a first-class municipality, Olongapo City is largely independent of its province and responsible for its development planning, property tax collection, utilities provision and operates an independent police force. The City is inextricably linked with the Secured Area and there are substantial economies of scale in closer integration of the infrastructure services. These have been taken into account in the design of Subic II. 7. Remaining Areas within SBMA's Metes & Bounds. The remaining areas of SBMA were fixed by Republic Act 7227 which established SBMA boundaries as co-terminus with the former U.S. facility as defined by the U.S.-Philippine Bases Agreement of 1947. The remainder of the municipality of Subic lies within this area as does the southern portion of the municipality of San Antonio. All of the municipalities have a Major-Council form of government. As second-tier municipalities, responsibility for governance functions are shared with the provincial government. Development planning occurs at the municipal level, while property tax assessment and collection can occur at the provincial level. Utilities may be provided by local districts or provincial franchises and collectives. Education, health, and social welfare services are provided by the municipality, but there are no independent municipal police forces. While the full jurisdiction of SBMA extends to these areas, SBMA does not exercise its authority over these areas. 8. Hermosa and Morong. The municipalities of Hermosa and Morong are mentioned in Republic Act 7227 as constituent elements of the Freeport, but the majority of their territory lies outside the metes and bounds of SBMA as defined by Presidential Proclamation. Under Republic Act 7277, "the President is likewise authorized to create Special Economic Zones" covering Hermosa and Morong upon recommendation of the Bases Conversion and Development Authority (BCDA). These municipalities are located within the province of Bataan. 9. CastilleJos. Dinalupihan and San Marcelino. Under Republic Act 7227, the Presidential authority to create Special Economic Zones also extends to the neighboring municipalities of Castillejos, Dinalupihan and San Marcelino, but these municipalities are not mentioned as constituent elements of the Freeport. The raw water source identified under Subic II lies in this area. Dinalupihan lies in the province of Bataan while Castillejos and San Marcelino are located in Zambales. Socioeconomic Characteristics 10. The Population. At the end of 1995, the secured area had an estimated population of 6,170. These are mostly expatriates and key officials of SBMA. While a national census was performed in 1995, the results have not yet been tabulated. As a result, the existing population estimates are based on projections prepared on the basis of the 1990 census and do not take into account the effects of the eruption of Mount Pinatubo and the withdrawal of U.S. forces in 1992. Olongapo's 1995 population is estimated at 212,786 and the population growth is the slowest in the region. Subic Town has an estimated population of 52,730 and is growing rapidly due to internal migration and a high rate of natural increase. The estimated population of Hermosa is 32,980, while Morong is relatively small at 17,060. In total, the secured area and the four municipalities included in the Freeport contain about 322,000 people. (Surveys undertaken by the Population Commission found the 1993 populations of San Marcelino and Castillejos to be 29,225 and 27,541, respectively. The 1995 population of  - 38 - Annex I Page 3 of 4 Dinalupihan is estimated at 68,918. These additional municipalities have a combined population of 126,000 persons.) Projected SBFZ Population by Community Estimated -----------------------Projected--------------------- Population 1995 2000 2005 2010 Secured Area 6,170 11,000 20,000 34,000 Olongapo 212,780 375,000 450,000 450,000 Subic 52,730 93,000 167,000 285,000 Morong 17,060 30,000 54,000 92,000 Hermosa 32,980 58,000 104,000 178,000 Total 321,720 567,000 795,000 1,039,000 11. Although a precise estimate of the current population of the SBFZ is difficult to establish, projection of the future population of the area is vital as the basis for projecting future demand for infrastructure services. Following a review of the widely differing population estimates for the area, the project preparation team concluded that conventional models of population projections would be meaningless in the special circumstances of the SBFZ. This is because wide swings in the population have occurred over the past few years to match the region's falling and now rising economy due to the closure of the U.S. Naval Base and the subsequent development of the freeport. While the SBFZ accounts for less than half a percent of national population, the SBFZ has accounted for 4.6 percent of new industrial employment and 2.8 percent of all new employment in the country from 1993 to mid- 1995. At the present time, there is still substantial slack in the local labor market - the 1995 survey of Olongapo City found an unemployment rate of 27 percent. While the Olongapo City labor supply is increasing by 7,600 annually, continued employment generation will exhaust this supply and encourage substantial in-migration. 12. Previous studies of urban migration in the Philippines have found that each additional urban employment opportunity leads to the short-term migration of 1.7 individuals. On this basis, the annual creation of 20,000 jobs within the Freeport in the typical Filipino context would have resulted in annual in-migration of 21,000 on top of a natural increase of 7,000 - resulting in an annual population growth rate of over eight percent. 13. The population projections prepared for this project were derived from the employment generated by the complete conversion of the U.S. Naval Facility. This intense economic development provides the basis for projecting an overall population growth rate of 8.7 per annum for the period 1995-2010. This rate of growth compares favorably with the annual growth rates of 5.5-6.5 percent in the other secondary urban centers of the Philippines, and is reasonable because of the economic activity and scale of foreign direct investment in the SBF - approximately US$1,250 annually per capita. The above table shows the projected population for the Secured Area and the adjoining LGUs. 14. Education and Literacy. Reliable current information is not available for the Subic Bay Metropolitan Area, but the average household size for Olongapo was five persons in 1990 with a high percentage of population in the 0-15 age bracket. This population has a relatively high degree of  - 39 - Annex 1 Page 4 of 4 literacy: ten years of schooling for about 98 percent of the population. This reflects the adequate numbers of learning institutions, the high value placed on education, and the success of adult and community education programs. Even the poorest segments of the Subic Bay area population, the refuse pickers at the New Cabalan landfill site had a significant level of primary education and could read and write in Tagalog. 15. Labor Force and Employment. Preliminary social impact assessment cites a labor participation rate of 53 percent and an employment rate of 89 percent for the metropolitan area. These figures are based on the 1990 Population Census, defining the economically active population as those between the ages of 15 to 64. The unemployment rate was 5.7 percent for the metropolitan area. 16. The informal sector has grown in the urban areas reflecting the formal sector's inability to absorb the growing labor force. Women and children from the poorer households account for 70 percent of this informal sector and this is a survival strategy. Although operating on the margins of the formal economy, the informal sector is nevertheless an integral part of the economy. In many instances it has developed strong supply and service links to the formal sector and operates in a highly competitive market using locally available resources and unskilled and semi-skilled labor. 17. Urban Poverty. One of the most visible dimensions of urban poverty is the existence of squatter settlements on public land. The growth of these settlements can largely be ascribed to the influx of skilled and unskilled migrants from the countryside and the lack of work opportunities. The host cities cannot absorb the influx of migrants, nor are they equipped to provide minimal housing and basic services. It is estimated that 90 percent of the urban poor are illegal settlers. Insecurity of tenure, fear of eviction and relocation, and fear of fire are constant preoccupations which add to the stigma of being poor and living in marginal conditions. The Presidential Commission on the Urban Poor estimates the income of the urban poor families at less thanI 5,000 a month (US$200). The minimum wage is P 4,000 a month. In the metropolitan area the urban poor are located on the margins of the cities and around garbage dumps or landfill sites from which they derive a livelihood as scavengers.  40- Annex 2 Page I of 4 REPUBLIC OF THE PHILIPPINES SECOND SUBIC BAY FREEPORT PROJECT Freeport Concepts -- A Comparison of Subic and Other Freeports 1. The rapid development of the Subic Bay Freeport is also impressive when contrasted to the development experiences of most freeports worldwide. Freeports are recent variants of the traditional freeport or free zone concept which have been in existence for several centuries. Free zones were established to encourage entrepot trade, mostly within harbors among international trade routes. Early examples of free zones include Gibraltar (1704), Singapore (1819), Hong Kong (1848), Hamburg (1888), and Copenhagen (1891). Today, free zones are found in virtually every trading country; leading examples include the 240-foreign-trade zones in the U.S., free zones and freeports in every trading center in Europe, and commercial free zones in Africa, Middle East and Latin America. Freeports are free zones that cover a larger physical area, such as cities (e.g., Hamburg); islands (examples include Batam Island, Indonesia and Labuan Island, Malaysia); or entire countries (Hong Kong, Singapore or Mauritius.) 2. Free zones and their variants continue to be internationally recognized Customs concept,I and share certain basic elements: (a) They are limited to a physically defined area. In the case of export processing zones (EPZs), this is usually an industrial estate; commercial free zones generally encompass a port area, freeports may be ports, cities, islands or even entire countries. (b) They are considered to be extra-territorial, physically or administratively located outside the national customs territory, where customs duties and taxes do not apply, and regulatory controls are simplified and kept to a minimum. (c) Third, merchandise may be freely stored indefinitely within the zones, re-exported or imported into the host country's customs territory upon payment of applicable import duties and taxes. Free zones differ in the extent of the physical area covered by the zone, what activities and processes are allowed to take place, and the end-user markets where free zone products may be sold. 3. Modern freeports closely resemble the classical free zone concept, but offer several unique advantages: * They tend to cover larger areas, and therefore offer greater flexibility to firms in terms of the location of their plants. The Labuan and Batam Island freeports, for example, completely encompass entire islands. Freeport, Bahanas covers a number of the Bahamian islands. The freeports of Singapore and Hong Kong encompass entire countries. * The range of permissible activities within freeport areas are much broader. Firms can undertake any legal activity including manufacturing, warehousing, transshipment, and re-packaging activities, among others. Individuals can reside within freeports, permanently or temporarily. 1The International Convention on the Simplification and Harmonization of Customs Procedures of 1979 (Kyoto Convention) defines free zones as being 'part of the territory of a State where any goods introduced are generally regarded, insofar as import duties and taxes are concerned, as being outside the Customs territory and are not subject to the usual Customs control. In commercial free zones, goods are admitted pending subsequent disposal; goods admitted to industrial free zones may be subjected to authorized processing operations."  -41- Annex2 Page 2 of 4 * All types of merchandise can be introduced duty- and tax-free within the freeport by registered enterprises or individual residents; enterprises can freely import in any merchandise in any quantity, and are not restricted to that directly used in the manufacturing process as in the case of EPZs. * Duty- and tax-free merchandise can be sold at the retail or wholesale level and/or consumed freely within the freeport area. This is in contrast to EPZs or even commercial free zones which do not permit retail sales or on-site consumption of duty- and tax-free products. * Unlike EPZ enterprises who are usually required to export at least 80 percent of their production, freeport enterprises are free to sell any amount to the export market, local market or to consumers located temporarily or permanently within the freeport. Sales to the domestic customs territory are unrestricted so long as all applicable import duties, taxes and other charges are fully paid by the importing party. 4. There are very few fully functioning freeports in existence; leading examples are profiled in the table below. Singapore, Hong Kong, Gibraltar, Macao are true freeports with low or no direct and indirect taxes, low or no import duties and charges, no foreign exchange controls, liberalized banking policies and very few controls on the types of economic activity permitted. Newer freeports such as Freeport, Bahamas; Labuan Island, Malaysia; Penang Island, Malaysia; province of Quintana Roo, Mexico; and Batam Island, Indonesia offer a much more competitive package of incentives, including low or no income taxes; duty- and tax-free importation of all goods including consumables; no foreign exchange controls; liberalized domestic and offshore banking; liberalized immigration and residency controls; and simplified business registration and other regulatory controls. 5. Several other freeports are under development at various locations. Assisted by Singapore, the Indonesian government is transforming Bintan and Karimun islands in the Riau island group into freeports, falling under the authority of the Batam Industrial Development Authority. Malaysia has reinstated freeport status to Penang island, which enjoyed the privilege for many years until the 1 980s, to take advantage of the Indonesia-Malaysia-Thailand Growth Triangle initiative. An entrepot zone is also being developed in Kuantan on the east coast of Peninsular Malaysia, and a huge bonded area in Shenzen, PRC. 6. Similar mechanisms have long been in operation in the PRC, and are expanding. The PRC introduced the Special Economic Zone (SEZ) concept in 1979 as part of its "open door policy" which consciously used the SEZs as proving grounds for market-oriented economic reforms. There are currently 11 SEZs, in addition to Open Coastal Cities and Areas. Although patterned after the freeport concept, SEZs contain several important differences. (a) They cover a much larger territory than any EPZ and most freeports, including major population centers. (b) They provide a greater range of permissible activities, embracing not only manufacturing, but also tourism, commercial activities, and real estate development. In fact, non-manufacturing activities (tourism and commercial real estate development in particular) dominate economic activity and account for a large part of foreign direct investment. (c) The SEZs are more of an administrative rather than policy concept. SEZs offer numerous differential incentives within their territory -- they do not provide a uniform set of incentives to enterprises located within their territory as in the case of EPZs, free zones and freeports. (d) Strict controls are placed on sales of SEZ goods into the Chinese customs territory, even upon full payment of import duties and taxes.  Profile of Leading Freeports and Special Economic Zones llainan Island SEZ Shenzen SEZ Xiamen SEZ Zuhair SEZ Batam Freeport Labuan Freeport Size 34,000 sq. km. 2,020 sq. km. 1,516 sq. km. 1,266 sq. km. 416 sq. km. 92 sq. km. Population 6.9 million 2.76 million 1.2 million I million 150,000 n/a Cumulative 7,000 firms; 8,000 firms; 2,400 firms; 5,600 firms; n/a n/a FDI Stock USS10.8 billion US$8.1 billion US$7.1 billion US$6 billion Exports USSI billion US$7.8 billion US$2.4 billion US$1.6 billion n/a US$283 million Infra- * 2 airports * I airport * I airport * I airport * 12 industrial parks * 2 industrial parks structure * 1,200 MW power supply * extensive road& * 2 ports, 1O berths * 2 ports * 28 hotels * international airport * 15,00 km highways rail network * good road & rail * 2 industrial districts * international airport * 20 hotels * 2 ports, 20 berths * 8 ports, 92 berths network * 800 MW power . 80 MW power supply * 2 ports . 30 sq. km. free zone at * 2 bonded zone * 3 Taiwan investment supply * 2 ports * high speed data telecom Yang Pu port districts zones * 48 sq.km. Henggin * teleports links via teleports * 6 economic development * 7 science & * 2 industrial districts Economic Development * offshore financial center zones technology parks Area 9.8 sq.km. Technology Development Zone Main * 15% flat tax rate . Same * Same * Same * 3% effective income . 3% flat tax on net income Incentives * 2 year holiday plus 50% tax rate * tax deductions & allowanc reduction for 3 years . 100% foreign * 50% personal income tax thereafter ownership break t. * 50% reduction in income * duty-free imports, * 100% foreign ownership tax rate for 70% exporters exports * duty-free imports, exports and high tech industries * unrestricted sales to * unrestricted sales to * I 00% duty /tax exemption Indonesian mkt Malaysian market on inputs & materials used in * national duties only on * special incentives for exports or sold within SEZs foreign content offshore banking * 50h/o duty/tax exemption on * automatic land lease * liberal work & residence materials sold in zones extensions permits without further processing * no foreign exchange or * subsidized land rents & * priority in obtaining Bank currency controls service fees of China loans for foreign * liberal work& JVs residence permits * exemption from building property taxes within SEZs * foreign exchange retention for exporters * no tax on profits remittances NoIt: Data is as of end-1994. The PRC is currently contemplating scaling back some incentives for coastal SEZs in favor of inland locations. Sourc: TSG, compiled from official publications. S i  - 43 - Annex 2 Page 4 of 4 7. In addition to these freeports and SEZs are the large number of EPZs and commercial free zones worldwide. Current estimates put the total number of industrial estates (lEs) and private and publicly owned EPZ industrial estates at over 200 in some 50 countries. In East Asia, there are at least 70 EPZs in operation, and another 25 under development. In the Philippines alone, the four public EPZ projects have been joined by some 11 private industrial estate-EPZs. Under the newly enacted Economic Zone legislation, some 35 locations around the country are expected to be developed into so-called ecozones; two locations have been provided freeport status similar to the Subic Bay Freeport (SBF). 8. There are several implications of these zones for the Subic Bay Freeport: (a) although the SBF is an innovative development in the Philippine context, the freeport is not a new concept. Free zones and their variants have well-accepted international definitions, and several, especially in East Asia, have been successfully operating for many years. (b) Many of the Asian freeports and SEZs pose significant competition to the SBF as they offer a superior package of incentives.  - 44 - Annx 3 Page 1 of 2 REPUBLIC OF THE PHILIPPINES SECOND SUBIC BAY FREEPORT PROJECT SBMA's Organizational Chart  NEW ORGANIZATION OF SBMA BOARD OF DIRECTORS I , | CORPORATE BOARD J~~~~~~~~~ SECRETARY OFFICE OF THE ADMINISTRATOR/ SR. DEPUTY ADMINISTRATOR |OFFICE OF THE LEGAL CORPOIRATE COUNSEL STRATEGIC PLANNING OFFICE PROJECT MANAGEMENT OFFICE IT C [INTELLIGENCE & INVESTIGATION OFFICE |MANAGEMENT INFORMATION SYSTEM OFFICE [PUBLIC AFFAIRS OFFICE ENVIRONMENTAL PROTECTION OFFICE MINISTRATION| FINANCE PUBLIC WORKS & TRANSPORTATION & TRADE & TOURISM GROUP GROUP TECHNICAL SERVICES COMMUNICATIONS GROUP LFAE GROUPOP U H UMANRESOURCES IINANCIAL PLANNING I ENOINEERINO DEPARtMENT| SEAPORT OP!RTONSDET. | PROMOTONS&MKTG.DEPT. |U.OR I MANAGEMENT DEPT. I I EUDOET DEPT. I I RECRUnMENT CTR. LANDTATE TREASURYDEPT. UTILTIESDEPARTMENT AlRPORTDErARTMENT E INVESTMENTPROC.NDEPT. |EALT d SECURITY DEPT. I ACCOUNTING DEPT. I H LAND TRMSPORTATION DEPT. | q RE31TrATION & LOCATOR AI AANCE DEPT. i |WDorc FIRE DEPARTMENT D TPROCUREENT A PROERTY I DEPARTMAENT I PASS PROCESSING &CONTftOE IiX CORP. SUPPORT S9CS.  - 46 - Annex 4 Page I of 7 REPUBLIC OF THE PHILIPPINES SECOND SUBIC BAY FREEPORT PROJECT Detailed Cost Table  PHILIPPINES Second Subic Bay Preeport Project Table 1. institutional Support Detailed Costs (US$) Ousntities Unit Base Cost (1000) Totals Tncludinq Contingencies (10001 _Un it 1997 1998 1999 2000 Total Coat _197_ 1998 A ~~2000 Fo~i i 1997 199 1999 2000 Tota~l I. Imyeutaent Costs A. ImstitutiomaI Streogthening /a T/A Freeport Policy sme 21 21 21 9 72 18,000 378.0 378.0 378.0 162.0 1,296.0 382.5 391.7 401.1 176 0 1,351.4 T/A (national) Freeport Policy PM 6 6 6 6 24 5,000 30.0 30.0 30.0 30.0 120.0 30.4 31.1 31.8 32.6 125.9 T/A Human Resource Mgmt PM 8 4 - - 12 18,000 144.0 72.0 - - 216.0 145.7 74.6 - - 220.3 T/A (local) Coemunity Outreach/social PM 6 - - - 6 8,000 30.0 - - - 30.0 30.4 - - - 30.4 T/A Coemmercjalisation Planning PM 6 6 6 6 24 18,000 108.0 108.0 108.0 108.0 432.0 109.3 111.9 114.6 117.4 453.2 T/A (local) Comsnercialisation Planning pm 9 9 9 9 36 5,000 45.0 45.0 45.0 45.0 180.0 45.8 46.6 47.8 48.9 188.8 Miscellaneous Studies lb Lumnpsum -agk.~Q0.. - - O ...1 ..il. - - Subtotal Institutional Strengthening 735.0 1,133.0 561.0 345.0 2,774.0 743.8 1,174.1 595.3 374.9 2,888.1 D. Support to PAP Office T/A Project M4gmt Advisor PM 9 6 6 3 24 18,000 162.0 108.0 108.0 54.0 432.0 163.9 111.9 114.6 58.7 449.1 T/A (local) PM Advisor PM 12 12 12 12 48 5,000 60.0 60.0 60.0 60.0 240.0 60.7 62.2 63. 7 6 5.2 251.8 Support Staff PM 12 1 2 12 12 48 2, 700 ......2.A 32.4.~L .......3A 3.....2.4A 12 3....2.8L 33.6... 34.j,4 --...I.2 .....L.0 Subtotal Support to rkp office ~~~~~~~254.4 200.4 200.4 146.4 801.6 257.5 207.7 212.7 159.1 836.9 C. I/S - Equipment Office Equipment HR Mgmt 1,umpsum 71.0 71.0 71.0 71.0 284.0 82.6 84.6 86.6 88.7 342.6 - Off ice Equipment Planning /c year 1 1 1 1 4 50,000 so5 g .......L. ..0. 0 50.0 ...20.0Q,. 59 ......2 6i.....0 __f.iZ.. ...2i.. Subtotal I/S - Xquipmeut 1..21-0 12...1.0. 2. 1...21.0. __I.A_Q __..J"... 144A 2 147.7L 151A-.2 583.9.t Total 1,110.4 1,454.4 882.4 612.4 4,059.6 1,142.1 1,526.0 955.6 685.2 4,308.9 \a Institutional Advisor. \b Includes local and international consultants. ~c CoeMuter, photocopier. supplies, etc. Tue Oct 29 16:36,31 1996  PHILIPPINBS Second SubiC Bay Preeport Project Table 2. Strengthening of Ecology Center Detailed Costs (US$ ) Totals Including Ouantities Unit Base Cost ('0001 Contingencies (P000) Unit 1997 1998 1999 2000 Total Cost 1997 1998 1999 2000 Total 1997 1998 1999 2000 Total I Investmnt Costs A. Institutional Straotheoiog T/A Ecology Center pM a - _ _ 8 18,000 144.0 - - - 144.0 145.7 - - - 145.7 T/A (local) Ecology Center pM 4 - - - 4 S,O00 20 0 - _ - 20-0 20-2 _ _ 20-2 Subtotal Institutional Strenth.ning 164.0 - - - 164.0 166.0 - - - 166.0 B. Equipsant Miscellaneous Equipment Luumpsum 200.0 - - - 200.0 232.8 - - - 232.8 C. Social Ipact Asasasmat /a Road and Bridge Rehab Lumpsum 20.0 - - 20.0 23.3 - - - 23.3 Deep Water Wells Lumpsum 75.0 - - - 75.0 87.3 - - - 87.3 Generator 10 KVA Unit 1 - I _ 1 15.000 15.0 - - 15.0 17.5 - - - 17.5 T/A for School pm 1 1 1 1 4 5,000 55 0.0 5 0 20-0 5L 5.2 __513 5L4 21 0 Subtotal Social Impact aseass.t 115 .0 -o 5 0 5.0 130 0 133.1 5.2 5-3 5 4JA 1490 Total Investaa nt Costs 479.0 5.0 5.0 5.0 494.0 531.8 5.2 5.3 5.4 547.7 II. Recurrent Costs A. Social De..lopent 1 Development Specialist Lumpsum 98 5 .90 94 9.9 36-8 9.5 10.3 11.0 1L.8 425L