Document of The World Bank Report No. 15361-CHA STAFF APPRAISAL REPORT CHINA YUNNAN ENVIRONMENT PROJECT May 28, 1996 Environment and Municipal Development Division China and Mongolia Department East Asia and Pacific Regional Office CURRENCY EQUIV.ALENTS (as of May 1,1996) Currency = Renminbi Currency Unit = Yuan (Y) Y 1.00 = 100 fen Yl.00 = SO.12 Sl.00 = Y S.3 FISCAL YEAR January I - December 31 WEIGHTS AND MlEASURES I millimeter (mm) = 0.0394 inch (in) I centimeter (cm) = 03937 inch (in) I meter (m) = 3.2808 feet (ft) I kilometer (km) = 0.6214 mile (mi) I square meter (mi2) = 10.7639 square feet (ft 2 I square kilometer(km') =0.3861 square mile (miL) I cubic meter (mi3) = 35.3147 cubic feet (ft3) cubic meter (m 3) or ton of water = 284 US gallons I hectare (ha) = 2.4711 acres (ac) I liter (1) = 0.2642 US gallon (gal) liter per capita per day (I/c/d) = 0.2642 US gallon per capita-day cubic meter per second (m'/sec) =3 5.3145 cubic feet per second PRINCIPAL ABBREVIATIONS AND ACRONYiMS USED CAS - Country Assistance Strategy CIDA - Canadian Intemational Development Authority CNIITC - China National Instruments Intemational Tendering Company DEAP - Dianchi Environmental Action Plan DRA - Design Review and Advisory (Consultant) EPB - Environmental Protection Bureau EPCSL - Environmental Pollution Control Subloans GMG - Gejiu Municipal Government GWSDC - Gejiu Water Supply & Drainage Company ICB - Intemational Competitive Bidding KDC - Kunming Drainage Company KFB - Kunming Finance Bureau KM - Kunming Municipalit! KNMG - Kunming Mlunicipal Government KWSC - Kunming Water Supply Company LAR - Land Acquisition and Resettlement LIBOR - London Interbank Borrowing Rate MTS - Medium Transfer Station NCB - National Competitive Bidding NEPA - National Environmental Protection Agency ODA - Overseas Development Administration (of the UK) QMG - Qujing Miunicipal Govemment QWSDC - Qujing Water Supply & Drainage Company RAP - Resettlement Action Plan SLMO - Subloans Mvlanagement Office STS - Small Transfer Station STW - Sewage Treatment Works TVE - Township and Village Enterprise WTP - Water Treatment Plant YEPB - Yunnan Environmental Protection Bureau YEP - Yunnan Environment Project YEPO - Yunnan Environment Project Office YFB - Yunnan Finance Bureau YP - Yunnan Province YPG - Yunnan Provincial Government - i - CHINA YUNNAN ENVIRONNIENT PROJECT LOAN/CREDIT AND PROJECT SUMMARY Borrower: The People's Republic of China. Beneficiaries: Yunnan Province; the Municipalities of Gejiu, Kunming and Qujing; the water supply companies of Kunming and Qujing; the wastewater companies of Gejiu, Kunming and Qujing; industrial enterprises. Poverty: Not applicable. Amount: Loan: $125 million. Credit: SDR 17.4 million ($25 million equivalent). Terms: Loan: 20 years including 5 years of grace, at the standard interest rate for LIBOR-based US dollar single currency loans. Credit: Standard, with 35 years' maturity. Commitment Fees: Standard Onlending Terms: From the Government of China through Yunnan Province through the Municipalities to implementing water and wastewater entities: 15 years, including 5 years of grace at the standard interest rate for LIBOR-based US dollar single currency loans, and a commitment charge at the Bank's standard rate, with the entities bearing the foreign exchange risk. From Yunnan Province and Kunming Municipality to industrial enterprises: up to 10 years including up to 3 years of grace at the standard interest rate for LIBOR-based US dollar single currency loans, plus a spread of no less than 1.5 percent per year and a commitment charge at the Bank's standard rate, with the enterprises bearing the foreign exchange risk. From Yunnan Province to participating enterprises for environmental pollution control: up to 5 years including up - ii - to 2 years of grace at the standard interest rate for LIBOR- based US dollar single currency loans, plus a spread of no less than 1.5 percent per year and a commitmnent charge at the Bank's standard rate, with the enterprises bearing the foreign exchange risk. Financing Plan: See Table 3.2. Net Present Value: The water supply, solid waste and wastewater collection and treatrnent investments in the project were determined through least-cost analysis. Project ID Number: CN-PE-3599 - iii - CONTENTS 1. URBAN ENVIRONMENTAL MANAGEMENT .............................................1 A. Urban Environmental Conditions ...............................................1 B. Regulation Of Point Source Pollution ...............................................2 C. Collective Waste Handling and Treatment ............................................... 3 D. Bank Group Sector Strategy ...............................................4 2. THE PROJECT AREA ...............................................7 A. Economic Setting ...............................................7 B. The Project Areas ...............................................8 C. The Provincial Government's Environmental Strategy .................................... 12 D. Formulation of the Proposed Project .............................................. 13 3. THE PROPOSED PROJECT ............................................... 15 A. Project Objectives ............................................... 15 B. Project Description ............................................... 15 C. Project Monitoring .............................................. 17 D. Project Cost Estimates .............................................. 17 E. Financing Plan .............................................. 19 F. Procurement .............................................. 21 G. Disbursement .............................................. 24 H. Land Acquisition and Resettlement .............................................. 25 1. Environmental Impact Assessment ............................................... 26 J. Project Reporting and Supervision ............................................... 27 This report is based on the findings of an appraisal mission that visited China in March 1996. Project team members included Mr. Geoffrey Read (Municipal Engineer and Task Manager), Mr. Chris Bros (Cost Engineer Consultant), Mr. Jack Fritz (Environmental Engineer), Mr. Lee Travers (Environmental Economist), Mr. Terry Hall (Sanitary Engineering Consultant), Mr. Patrick McCarthy (Financial Consultant), and Dr. George Taylor (Environmental Consultant). Assistance was also provided by Ms. Meredith Dearborn, Ms. Gillian Houston and Ms. Socorro Manila (Report Processing), and Mr. You Ji (Interpreter). Peer reviewers for the project were Ms. Adrienne Nassau (EC3IV), Mr. Heinz Unger (ASTEN), and Mr. Neil Boyle (SA3IE). The managing division is EA2EM. The Division Chief is Ms. Katherine Sierra and the Department Director is Mr. Nicholas C. Hope. - Iv - 4. PROJECT MANAGEMENT AND IMPLEMENTATION ..................................... 29 A. Project Management ........................................................... 29 B. Implementation Responsibilities ........................................................... 30 C. Status of Engineering ........................................................... 34 5. FINANCE ........................................................... 35 A. Financial Management ........................................................... 35 B. Accounting ........................................................... 35 C. Audits .......................................................... 36 D. Provincial Finance .......................................................... 36 E. Prefectural Finance .......................................................... 37 F. Municipal Finance .......................................................... 37 G. Public Utilities .......................................................... 38 H. Solid Waste and Nightsoil Management ........................................................... 42 I. Industrial Pollution Control .......................................................... 42 6. ECONOMIC, SOCIAL AND ENVIRONMENTAL CONSIDERATIONS ........... 44 A. Project Justification ........................................................... 44 B. Economic Analysis .......................................................... 44 C. Environmental Impact .......................................................... 49 D. Affordability and Poverty Assessment ........................................................... 50 E. Project Risks ........................................................... 50 7. AGREEMENTS REACHED AND RECOMMENDATION ................................... 54 ANNEXES Annex 1: Background to Yunnan Province and Project Cities .59 Annex 2: Detailed Project Description .64 Annex 3: Detailed Project Cost Estimates .95 Annex 4: Schedule of Contract Packages .106 Annex 5: Schedule of Disbursements .109 Annex 6: Land Acquisition and Resettlement Action Plan .110 Annex 7: Environmental Assessment Summary .124 Annex 8: Project Implementation Schedule .142 Annex 9: Proposed Monitoring Indicators .144 Annex 10: Proposed Supervision Plan .................................................... 146 Annex 11: Yunnan Provincial and Municipal Organizations ........................................ 147 Annex 12: Industrial Pollution Control .................................................... 153 Annex 13: Municipal Finances .................................................... 163 Annex 14: Financial Analysis Assumptions ................................................... 165 Annex 15: Economic, Social and Environmental Considerations ................................. 174 Annex 16: Selected Documents and Data Available in the Project File ........................ 201 v - TABLES IN TEXT Table 3.1: Summary Cost Estimates ............................................... 18 Table 3.2: Project Financing Plan ............................................... 19 Table 3.3: Procurement Arrangements ............................................... 22 Table 4.1: Implementing Agencies ............................................... 30 Table 5.1: Water and Wastewater Average Tariffs ............................................... 38 Table 5.2: Key Water Supply Financial and Operating Indicators ................................... 39 Table 5.3: Key Wastewater Financial and Operating Indicators ...................................... 41 MAP IBRD 27911 Yunnan Environment Project I - 1 - 1. URBAN ENVIRONMENTAL MANAGEMENT A. URBAN ENVIRONMENTAL CONDITIONS 1.1 The mid-1970s loss to pollution of a major urban raw water supply near Beijing first drew China's attention to the damage pollution could cause. Over the ensuing 20 years China has developed an environmental protection system employing a broad set of control instruments administered through environmental protection bureaus now found in all cities and virtually all rural counties. A national environmental action plan has been developed to coordinate domestic environmental improvement efforts. China has also been a responsive partner in international efforts to control pollution and was one of the first countries to finish their Agenda 21 program after the Rio conference. 1.2 Despite this activism, China has had mixed success in implementing environmental policy over the past two decades. Some aspects of the record are quite good-airborne total suspended particulate (TSP) concentrations have been markedly reduced in cities in both north and south China and state-owned enterprise discharges of toxic metals in wastewater have fallen substantially. In line with rapidly increasing urbanization and economic growth, the demands made on water resources are exceeding supply. Water pollution continues to grow. The percentage of urban aquifers found to be polluted has risen from 20 percent in 1983 to 45 percent today. In the most recently published water quality survey, sections of rivers in 54 of 58 reporting cities failed to meet even the lowest acceptable standard, leaving few economic uses-except as waste sinks. 1.3 The human cost of this pollution is high. Over 400 million Chinese live in cities, a number expected to jump to some 800 million by 2010. The health costs of water pollution are more difficult to measure. Raw water pollution has forced cities to move to increasingly distant and more expensive raw water sources; farmers have had to switch from irrigation with surface water to pumping groundwater, and fisheries have been damaged. 1.4 The reasons for the growing pollution are not difficult to identify. A coal-based fuel system firing a large stock of inefficient boilers and power plants contributes to air quality problems, as does widespread dependence on coal stoves for household cooking and heating. With urban growth and rising personal incomes have come rapid increases in the volume of municipal wastewater flows-they grew from 7 billion m annually in 1984 to 13 billion m3 in 1992. Those came with the growth of inhouse water connections and of washing machines and flush toilets. Industrial wastewater discharges in urban areas declined over that same period, as reuse and other water-saving techniques increased water use efficiency. Solid waste generation has grown rapidly, and only some 25 percent of the municipal solid waste and nightsoil are disposed of to national - 2 - standards. The remainder is dumped at uncovered dumping sites without leachate or gas control facilities. 1.5 The nature of the discharges affecting the urban environment dictate a mix of regulatory and investment responses by different levels of government. These have been discussed in two Bank studies, the first analyzing overall environmental circumstances and policy (China. Environmental Strategy Paper, Report No. 9669-CHA, April 1992) and the second that specific to the urban sector (China: Urban Environmental Service Management, Report No, 13073-CHA, December 1994). As described in those reports, municipal governments must seek an efficient mix of point source control through regulation and collective treatment of wastes. B. REGULATION OF POINT SOURCE POLLUTION 1.6 The regulation of point source pollution falls to the National Environmental Protection Agency (NEPA), as the secretariat of the State Council Environmental Protection Committee. NEPA drafts national regulations and other aspects of environmental policy for consideration by the State Council and National People's Congress. NEPA has the power to interpret national environmental regulations and standards, including those governing the operations of the local environmental protection bureaus (EPBs) that work at provincial and municipal level. However, NEPA lacks implementation authority, a power left to local governments and the EPBs under them. 1.7 Provincial governments are authorized to set local environmental standards in the absence of preemptive national standards, or to impose more stringent standards than those required by the national government. Provincial EPBs coordinate these policies and, in contrast to NEPA, may play a direct role in implementation. However, the municipal, urban district and county EPBs bear the main burden of enforcement for both national and provincial regulations. The budgets, personnel appointments, and work plans of each level EPB derive from the government of that level. To aid quality control, performance must be reported to the next higher administrative level EPB, which also sets testing protocols and other performance criteria. 1.8 China's regulatory approach has focused on three instruments: environmental assessment before approval of new projects; the "three simultaneous" licensing strategy that requires integration of pollution control in project design, inclusion of the abatement measures in the actual investment, and proper operation of the abatement equipment; and a pollution levy fee chargeable against waste streams that have concentrations of pollutants above permitted levels. More recently, governments have been authorized to levy a small charge on wastewater discharges within standards. 1.9 The pollution levy fees fund operation of the environmental protection system. Local EPBs retain approximately 20 percent of the fees to cover operating costs, while earmarking the remaining funds to finance pollution abatement in eligible enterprises. The handling of the earmarked funds has shifted over time from being granted directly back to the enterprise paying the fee to lending the funds on concessional terms for eligible pollution control investments. 1.10 NEPA now recognizes two problems with the pollution levy fee system. First, fees are typically set considerably below the marginal cost of effluent treatment, which encourages enterprises to pay the fee rather than operate or invest in treatment facilities or cleaner production technologies. Second, by setting fees on the basis of concentration- based standards may lead to dilution as a means of compliance or reducing fee rates, and surface waters receiving discharges could fail to meet standards even though all enterprises in a watershed individually meet standards. Conversely, if assimilative capacity is high and enterprises few, the concentration standard could force compliance costs far above the damage done by the discharge. 1.11 Two more regulatory issues originate in structural features of the economy. The first arises from the fact that local governments usually own the major enterprises within their boundaries, leading to pressures to relax regulation or fee collection in the interest of employment and profits. The second is that the enterprises operating on the periphery of cities may have a large impact on municipal environmental quality, yet fall outside municipal control. This latter problem is particularly acute with the small-scale township and village enterprises (TVEs). Individual TVE enforcement costs are high relative to output, yet in the aggregate TVE pollution has a large impact on the downstream environment. 1.12 NEPA has a large research and experimentation program under way to identify new approaches to overcome these and other regulatory problems. Among these initiatives is the use of catchment-specific mass-based pollution permits to replace the concentration-based standards and fees. More generally, NEPA seeks effective market- based pollution control mechanisms to complement the national shift to a market-based economy and avoid many of the problems of enterprise-specific regulation. The Bank supports NEPA's program through the Environmental Technical Assistance Project (Credit 2522-CHA) and investment projects such as the one now proposed. C. COLLECTIVE WASTE HANDLING AND TREATMENT 1.13 Urban environmental services, which include wastewater collection and treatment systems and solid waste collection and treatment, fall under the purview of the Construction Commissions found in every Chinese city. Overall regulatory guidance and standard setting is provided by the Ministry of Construction and the provincial Construction Bureaus. The Ministry and Bureaus set national and provincial policy for urban and regional planning, infrastructure development planning, and facility operating standards. They also specify financial accounting procedures and goals. Based on those policies and standards, the municipal commissions provide or regulate providers of the actual service. The municipal commissions are typically among the largest and most powerful of the municipal administrative bodies, having under them bureaus or companies directly providing key urban services. 1.14 Chinese cities are characterized by a good correspondence between expenditure responsibility and control over revenue. This sets them apart from cities in many developing countries, which have been characterized by inadequate funding to meet - 4 - mandated services. Chinese cities also tend to have well-staffed administrations, with their broad control over the local economy making them an attractive employer. These advantages have helped China achieve piped water supply to nearly 90 percent of all urban residents, but has not automatically led to high levels of service in every field. The low level of adequate solid waste disposal was cited earlier and local watercourses continue to serve as both drains and sewers for nearly 40 percent of the area of Chinese cities. Wastewater treatment levels are low, with only 4.5 percent of municipal flows treated in 1992. Cities have given priority to water supply, roads, and enterprise investment over environmental services. Yet rapidly growing problems with raw water quality are forcing recognition across cities that wastes need to be adequately handled. 1.15 The major policy problem identified in China: Urban Environmental Service Management was the failure to charge, or charge adequately, for environmental services. Although cities have long charged for water delivery, residential wastewater charges are virtually unknown, while charges to enterprises have been rare, and where collected, fall far below operating needs. Solid waste collection fees are charged more often, but those services still require substantial subsidies. An important consequence of this failure to charge adequate user fees is that service investment programs have failed to meet goals due to lack of finance. The Ministry of Construction estimates that two thirds of the municipal wastewater treatment plants either do not operate, or operate far below capacity due to lack of funds. Moreover, when users do not have to pay they have no incentive to reduce waste volumes. This creates the need for larger service systems when they are provided. D. BANK GROUP SECTOR STRATEGY 1.16 The Bank Group highlighted enhancing environmental protection and alleviating infrastructure bottlenecks as two of the four areas of concentration under the China Country Assistance Strategy (CAS) presented to the Board in June 1995. Our close collaboration with the Chinese govermnent covers both the regulatory and service provision aspects of urban environmental management. The China: Environmental Strategy Paper sector study led to the Environmental Technical Assistance Project noted earlier, which assists NEPA in its efforts to find more efficient regulatory methods, improve staff capabilities, and bolster environmental monitoring. That project complements Bank-administered, Japanese Government-financed technical assistance to NEPA covering (a) the environmental impact assessment process; (b) waste minimization and pollution control in rural industries; (c) hazardous/toxic waste management; (d) economic/financial mechanisms for environmental management; and (e) environ- mental information management systems. The Global Environmental Facility has supported studies and projects on the reduction of greenhouse gas emissions, the loss of biodiversity in China, and ozone-depleting substances. Finally, Beijing Municipality has joined with four other Asian cities as members of the Metropolitan Environmental Improvement Program financed by the United Nations Development Programme and the World Bank. 1.17 In addition to national regulatory assistance, we are currently involved in six urban environmental projects in 12 cities, which incorporate policy, financing and organizational strategies for improved environmental regulation and service delivery at the provincial and municipal levels. Another five ongoing investment projects in another 12 cities include related issues such as municipal water supply and sanitation. The initial round of projects focused on China's largest cities-Shanghai, Beijing and Tianjin-and those located primarily in the wealthier northeast and coastal provinces. Environmental pressures remain high in those areas and cooperation will continue, as with the recently approved Second Shanghai Sewerage Project (Ln. 3987-CHA) and the Shandong Environment Project now being prepared. However, the recently approved Hubei Urban Environmental Project (Loan 3966/Credit 2799-CHA) marks a shift in geographic focus, moving toward inland and poorer areas. Hubei, a medium-income province, is located in central China, while operations in poor areas, like the proposed project in Yunnan and another being prepared in Guangxi Province, will further test the feasibility of policy and institutional solutions. 1.18 A review of ongoing Bank Group projects in the sector in China and elsewhere presents relevant lessons in the provision and management of urban environmental services and in industrial pollution control. 1.19 Bankwide municipal management sector work (Urban Sector Delivery: Finding the Right Incentives) emphasizes the need to assign functional responsibilities appropriately and link revenue to expenditures. In China's case, environmental services are fittingly provided at the municipal level, where a high percentage of government revenue is also captured. China: Urban Environmental Service Management concludes that the major failing in environmental services has been dependence on municipal budget transfers to fund services, while greater reliance on user charges would be affordable, induce resource conservation, and create a more dependable income stream. Similarly, the Operation and Evaluation Department's review of Bank-financed water and sanitation projects (Water Supply and Sanitation Projects: The Bank Experience 1967- 1989) found generally good physical performance but less successful financial viability and overall sectoral development. For that reason, increasing tariffs was a focus of the policy dialogue during preparation of this project, with the result that water supply tariffs were adjusted prior to project preappraisal and appraisal. This openness to introducing improvements was seen during preparation of the Urban Environmental Service study, for which Kunming and other Yunnan cities were used as case studies. Urban managers from Kunming acted on some of the ideas exchanged during the study even before study completion. 1.20 The Bank's experience of industrial pollution control includes projects in China, as well as in Mexico, Brazil, India, Indonesia and the Russian Federation. A review of completed projects (Industry and Environment: Pattern in World Bank Lending) emphasizes the need for political commitment, clear standards and regulations, incentives to comply, and institutional capability to monitor and enforce standards. When industrial pollution abatement subloans are involved, the following conditions increase likelihood of success: a profitable and growing industrial sector, flexibility in choice of technology, - 6 - availability of funds at close-to-market terms, and targeting on sources that can yield significant improvement in the arnbient environment. 1.21 The industrial pollution control component of the proposed project draws on these lessons and those in the two recent environmental sector studies. The latter stress issues of political commitment, appropriate standards and incentives, and institutional monitoring and enforcement capabilities. This project addresses those issues by improving the monitoring and enforcement capacities of Yunnan's provincial and municipal EPBs by providing training, institutional development and equipment. Competent enforcement of regulations would be enhanced by requiring the Kunming Environmental Protection Bureau (KEPB) to carry out a time-bound Action Plan for collecting pollution levies in Kunming. 1.22 The proposed project therefore responds to Bank Group experience and CAS objectives for the environment and infrastructure development. Environmental amelioration would be enhanced by an improved regulatory environment, protection of critical water and land resources, and reduction of current pollution loads. Infrastructure expansion would benefit from investment in wastewater and solid waste collection and treatment as well as in water supply expansion, commercialization of operating agencies, an improved tariff policy to fund maintenance of the existing systems as well as their future expansion, and modem operating techniques. The Bank Group's strategy flows from and supports China's Environmental Action Plan and Agenda 21, which provide the basis for joint Government and Bank action in the environmental sector, especially in regard to the urban environment. The provincial focus recognizes the effective decentralization of regulatory and investment authority in China, and draws on local political power and commitment to induce wider use of the solutions to be demonstrated under the project. 1.23 Further, the project supports the Bank Group's increasingly sharper focus on China's poorer areas, where environmental challenges often go unaddressed for lack of resources and expertise. It complements a range of other Bank Group-assisted projects targeted at the poorest part of Yunnan's population, including $62 million under the Southwest Poverty Reduction Project (FY95); and lesser arnounts under the Comprehensive Maternal and Child Health Project (FY94), the Education Development in Poor Provinces Project (FY92); Rural Water Supply and Sanitation Project (FY92); the Third Rural Credit Project (FY88); and the proposed Fourth Basic Education Project, now being prepared. While the project proposed here is not expected to directly affect the very poorest, it is likely to benefit relatively poor rural migrants to the project cities. Without project interventions to protect the water resources needed for sustained economic growth, the absorption of poorer rural migrants by Kunming and the other project cities would slow. Furthermore, continued economic growth at the municipal level would generate provincial tax revenues to fund programs for the province's neediest inhabitants. -7 - 2. THE PROJECT AREA A. ECONOMIC SETTING 2.1 Yunnan Province in southwestem China shares intemational borders (and rivers) with Myanmar, Lao PDR and Viet Namn (Map IBRD 27911). The province has a current population of 40 million, with the eastem half-a plateau-twice as densely populated as the mountainous, riverine west. About a third of the population belongs to minority groups, the largest proportion of any province in China. Yunnan is China's third poorest province, with an average annual per capita income of about $134 equivalent in 1992. Poverty is most severe in the mountainous areas where the inadequate resource base keeps many inhabitants in absolute poverty, i.e., with annual per capita incomes below Y300. 2.2 From a weak base, Yunnan's overall economy has been developing rapidly in the past 15 years, with recent annual real growth rates of about 10 percent, largely owing to growth in industry and services in the more prosperous eastem half. Agriculture, employing most of the population, registered a respectable 5.4 percent growth rate during 1980-92, despite the generally mountainous topography and difficult growing conditions. The industrial sector, employing about 10 percent of the labor force, showed robust growth during the 1980-92 period, at an average 11.1 percent a year, and now accounts for about 41 percent of the provincial gross domestic product (GDP). The service sector grew even faster over this period, at an average 11.5 percent a year, and now contributes almost 18 percent of GDP and employs another 10 percent of the labor force. During the 1990s, increased tourism to the province's striking natural and cultural endowments has contributed to this development. Improvements in provincial road and rail transport and opening of intemational borders with the three neighboring countries and thus to all of Southeast Asia, with which Yunnan shares ethnic ties, should help sustain the momentum for industrial and service sector growth in the province. 2.3 Yunnan's 1993 urban population was a relatively low 17 percent of total population, and officially grew only 0.9 percent a year from 1980 to 1993. However, those growth rates do not capture the large influx of migrants who have not gained official urban status, nor do they reflect the dynamic growth of small towns. If town and city populations are combined, nearly 43 percent of Yunnanese live in, or near, population centers with 3,000 or more people. With Yunnan's rapid industrial and service sector growth, urbanization should continue at a high rate through the next decade and beyond. Currently, about 38 percent of all economic output is generated in the province's 11 cities, with Kunming, the provincial capital, generating more than 15 percent of gross provincial output. -8 - 2.4 The combination of rapid urbanization and income growth has put great pressure on urban environmental services. Flush toilets are replacing pit latrines and indoor water connections encourage the use of washing machines and other water-using appliances. Thus, to the water demand that comes with an expanding population and industrial base is added that from higher per capita incomes. But for most Yunnan cities, additional water must come from ever more distant sources and at ever increasing real cost. The same forces leading to higher water demand have increased effluent loads on receiving waters. While nightsoil from latrines is composted for use on fields, that from flush toilets settles in septic tanks, with the overflow draining to urban waterways or, more rarely, sewers. Only Kunming has sewage treatment-two plants-that currently handle about 20 percent of Kunming's wastewater. Domestic solid wastes are increasing in volume and shifting from a combination of coal ash and household organic wastes to an ever more difficult to handle mix of traditional materials and packaging, plastic, and other modem materials. Heretofore, Yunnan has lacked the sanitary landfills designed to safely handle the leachate and methane generated in waste dumps. Urban services have lagged urban and economic growth, but cannot continue to do so without slowing that growth. 2.5 Yunnan's industrial development has been based on a combination of agricultural product processing and exploitation of abundant tin, iron ore, coal, and phosphate resources. Although concentrated on urban areas, rural areas with rich resources have developed township and village enterprises (TVEs) to exploit them. The dispersed nature of some of this development, and the relatively high absorptive capacity of the environment in the early stage of industrialization, led to relaxed application of national industrial pollution control standards. But now the combination of urban and industrial pollution loads has, in key population centers, destroyed potable water sources, reduced agricultural and fishery output, ended recreational water use and led to human illness. Environmental controls have tightened, but with the historical legacy of pollution intensive industrial plant and lack of wastewater treatment, deterioration has only slowed, not been reversed. B. THE PROJECT AREAS 2.6 The cities and their rural hinterlands selected to benefit from the proposed investments exemplify the development successes and environmental problems in Yunnan (see Annex 1). Kunming, the provincial capital and engine of provincial economic growth, holds some 1.2 million people and generates more than 15 percent of gross provincial output. Lake Dianchi, source of half of the city's water supply, has been reduced from a pristine Grade II quality to below Grade V, the lowest usable level, in only 20 years. Qujing, Yunnan's fastest growing city, with over 210,000 people, generates an additional 4 percent of gross provincial output. Irrigation water from the Nanpanjiang, which cuts through Qujing, began killing crops in downstream villages in 1990, and had to be abandoned for that and drinking water use by villagers, who were forced to turn to much more expensive well water for drinking and unreliable rainfall for field crops. Gejiu, an industrial city of 215,000 built around a tin mining and smelting operation, adjoins a lake formed by a 1954 landslide. Industrial and domestic pollution - 9 - always prevented the use of the lake for drinking water, although it has continued as an industrial water source despite falling to Grade V in the 1970s. Gejiu, which is growing more slowly than Kunming and Qujing, produces about I percent of gross provincial output. Kunming and Lake Dianchi 2.7 Virtually all of Kunming lies upstream of Lake Dianchi, and historically those wastewater discharges drained to the lake, with those from the city proper going largely to the small Caohai (or inner lake) connected by a narrow neck of water to the much larger Waihai (or outer lake). The discharges included domestic waste and that from such industrial operations as nonferrous smelting operations, steel mills, fertilizer plants, a pesticide plant, and some 10 paper mills. Over 5,000 industrial enterprises now operate in Kunming. Most plants include some type of wastewater treatment, but most of the treatment facilities operate below capacity or only part time. A municipal wastewater treatment plant commissioned in 1991 captures and treats about 10 percent of the domestic wastewater, but the rest discharges untreated. The lake itself discharges into the Tanglangchuan River, still within Kunming's political boundaries, from which paper, steel, and other industries draw river water and to which they discharge wastes. 2.8 Although discharges of toxic heavy metals and other industrial byproducts have led to episodic closure of raw water intakes and a concern with eating lake aquatic products, those toxic discharges have been largely controlled. Today, massive algae blooms give the most visible evidence of lake pollution and, along with water hyacinth, cause the greatest problems for lake use. Investigation into the nutrient cycle feeding the algae has shown phosphorus to be the limiting nutrient, and hence strategies to control lake pollution now focus on reducing phosphorus. As a measure of lake pollution, total phosphorus stayed stable and below 0.03 mg/l through 1970, then began an accelerating increase, but remained below 0.05 mg/l until nearly 1980. By 1995 the level had reached 0.2 mg/l, and if inputs continue unabated, will reach an estimated 0.3 mg/l by 2000 and nearly 0.6 mg/l by 2010. Eutrophication, the loss of dissolved oxygen due to algae blooms, typically begins at phosphorus concentrations of about 0.2 mg/l, and did so in Dianchi. 2.9 As late as 1975, water quality across the lake held within Grade II. At that time, Kunming residents swam in the lake, the fishing industry harvested 10,000 tons of fish annually, rural villagers on the lake margin used it for cooking, washing, and irrigation water, and a modest tourist industry was built around lake cruises. The city drew water for municipal supply for a treatment plant on the north shore of the lake and built another in 1990 on the better situated eastern shore. By 1995, fish harvests were down to 6,500 tons of lower grade species, swimming and other water contact had ended, as had the lake cruises. The northern water intake has been permanently closed and the eastern one provides supplementary supply to higher quality reservoir water. - 10- 2.10 The destruction of Dianchi cannot be attributed to industrial and domestic waste alone. Here, as in many areas of China, political campaigns began as early as the 1950s to expand cultivated land through massive infilling of the wetlands that once girded the lake. This reduced the Caohai area from 12 km 2 before 1970 to only 8 km' by 1990. Losses were not as drastic in percentage terms for the Waihai, but the loss of nutrient absorptive capacity and aquatic nurseries represented by the wetlands has played a critical role in the water quality decline and the decline of aquatic diversity. 2.11 The Yunnan and Kunming EPBs are charged with enforcing the environmental laws and regulations that have, since the mid-1970s, been continually developed. In recognition of the special problems of a lake basin, another institution, the Dianchi Lake Protection Commission, was formed in 1988 to enforce a basinwide management strategy over which the EPBs have no authority. For example, the Protection Commission enforces the restriction against any further landfill of the lake. It reports to the People's Congress in Kunming. 2.12 The EPBs and the Protection Authority have had mixed success. Any attempt by them to shut down a heavily polluting operation, or to impose punitive fines or other sanctions, must be agreed by the municipal authorities. Because severe regulatory action typically means the loss of jobs or income to urban workers, or, worse, to their poorer rural brethren, agreement can be hard to obtain. Rather, the authorities attempt first to identify sources of capital that will allow enterprise renovation sufficient to bring it within discharge standards. Years might pass before they achieve this, and in the meantime discharges continue. Nonetheless, much has been done in recent years. One highly polluting smelter has routed treated discharges past the lake and into a downstream reach of the Tanglangchuan River. The Caohai has been isolated from the Waihai by a dike and gate, and a tunnel 4 meters in diameter built to route Caohai water-which receives 50 percent of all urban wastes-to the Tanglangchuan downstream of the major industries. And funding has been identified for a number of environmental investments. 2.13 Wastewater System. The Kunming Drainage Company (KDC), a government- owned but autonomous agency, is responsible for collection and treatment of sewage discharged by residents and businesses in the municipal area. A sewerage master plan for Kunming was prepared with technical assistance from the Government of Switzerland, and approved in 1990. The city center has four drainage areas, all sewered. About 55 percent of the population have plumbing in their homes and another 25 percent use communal toilets connected to the sewerage system. One wastewater treatment plant was constructed in 1991 and another, built with Swedish Government assistance, was just commissioned. Two other plants are being built, one with Australian Government support, the other self-financed. Total treatment capacity of these four plants is 365,000 m3/day, compared to current discharges of 400,000 m3/day and projected wastewater flows of around 600,000 m3/day by the year 2010. 2.14 Cost recovery on wastewater and drainage services is low. Charges imposed on large industries do not cover even the operating and maintenance costs of providing this - 11 - service, and domestic consumers pay no charge. However, the Provincial Government has recognized the need to make progress toward full cost recovery on enviromnental services, and is expected to make tariff adjustments. Tariffs on industrial wastewater are expected to rise from Y 0.08/m3 on 80 percent of water consumption to Y 0.35/m3 on 100 percent of water consumption, and the same tariff of Y 0.35/m3 would be levied on households. The break-even financial performance target for KDC under the proposed project will require further tariff increases (para. 5.21). 2.15 Water Supply System. Apart from a minor groundwater source, Kunming draws its water supply about equally from Lake Dianchi and from the Songhuaba Reservoir on the Panlong River, 13 km northeast of Kunming. (The Reservoir was originally constructed for irrigation, but agriculture, industry and domestic users now compete for its water.) About 85 percent of the city's population is connected to the water supply system, which includes six water treatment plants, with a design capacity of about 480,000 m3/day. Four of these plants treat water for Songhuaba Reservoir and two treat Dianchi Lake water; one of the latter has been closed due to difficulties in sustaining treatment processes because of poor water quality. The system is operated by the Kunming Water Supply Company (KWSC), discussed further in Chapter 4. The system's most pressing physical needs are for expansion of connections into still- unserved suburban areas, rehabilitation of existing facilities to reduce leakage (unaccounted-for water is reported at 10 to 12 percent but is thought to be considerably higher), protection of current raw water sources, and identification of new ones. 2.16 Even more important is the introduction of demand management measures, since water demand now exceeds economically sustainable supply in dry years, and will do so increasingly in the future. With no special measures taken, by the year 2020, demand is expected to increase from the current 538,000 m3/day to 953,000 m3/day. Current demand is driven by two factors: a recent fall in the real cost of water due to inflation and increasing real incomes. The Provincial Government, spurred by discussions with the Bank Group during project preparation, recently authorized the first water tariff increase since early 1993, and domestic tariffs rose from Y 0.32/mr to Y 0.60/m3. Despite the tariff doubling, the new rates are considered affordable, representing only about 0.6 percent of per capita income. To meet Yunnan Provincial Government's (YPG's) financial objectives for the water supply sector in Kunming, further tariff increases, complemented by measures promoting water conservation and leakage reduction, are still needed, and are proposed under the project (para. 5.17). 2.17 Solid Waste Management. The city currently disposes of its domestic and commercial solid waste at two dumps, neither of which meet national sanitary treatment standards. Another five dumps containing large quantities of waste have been virtually filled, giving rise to continuing leachate pollution and requiring urgent remediation. Disposal of industrial solid waste is the responsibility of the generating enterprise, under the supervision of the Kunming Environmental Protection Bureau (KEPB). - 12 - Qujing 2.18 Qujing, Yunnan's fastest-growing city with a population of some 220,000, lies on the Nanpanjiang River, a tributary of the Pearl River (Map IBRD 27911). The city is undergoing swift expansion and expects to double its population over the next decade. Like Kunming, Qujing is a water-short area, but with little treatment of the increasing amounts of domestic and industrial wastewater. The Qujing portion of the Nanpanjiang is already heavily polluted, with water quality rated worse than Class V in the dry season. Recently, use of the river water for even irrigation was curtailed because water contamination was so severe that it killed crops. The causes of these problems are similar to those in Kunming, although here the river removes the wastewater from the city boundaries. Municipal growth has also generated greatly increased quantities of solid waste, which is disposed of at a poorly managed dump. Gejiu 2.19 Gejiu, a city of some 134,000 people, is physically built around a lake and economically built around a large state-owned zinc mine and tin smelter. It also suffers from severe environmental strains due to the lack of any wastewater treatment facilities (Map IBRD 27911). The water quality in Lake Gejiu is now worse than Class V standard. Flood control is also a problem, and the threat of flooding constrains the city's development. Decades of mining, pollution by nonferrous industries, and rapid growth of TVEs have caused great destruction to the Gejiu environment, and have intensified problems of water supply, soil erosion and lake sedimentation. C. THE PROVINCIAL GOVERNMENT'S ENVIRONMENTAL STRATEGY 2.20 Recognizing the problems exemplified above, YP in 1993 issued a strong statement on the need to reverse the province's environmental decline and initiated various actions aimed at achieving this goal. Among other things, the Yunnan Environmental Protection Bureau (YEPB) and EPB offices at the prefectural, municipal and county levels supplemented their normal duties (i.e., monitoring environmental conditions, enforcing environmental laws and regulations on industrial activities, and collecting pollution levies) with measures to reverse the environmental deterioration that has accompanied growth. 2.21 First, the Province prepared and began to implement the "1722" Project to: (a) control 100 serious industrial polluting sources by 1997 (of which 42 have been addressed thus far); (b) control gaseous emissions over 70 km2 of urban area (now completed); (c) add capacity to treat an additional 0.2 million tons per day (tpd) of domestic wastewater; and (d) reverse the pollution of two water bodies-Lake Dianchi and the Nanpanjiang River. Second, Kunming Municipality established the Lake Dianchi Protection Authority, which has overseen construction of the tunnel, intended to increase the lake's flood protection capacity and to prevent the polluted waters of the Caohai from entering the Waihai, thus protecting the water supply intakes on the lake and the upper - 13 - reaches of the Tanglangchuan River. The Caohai, which accounts for 2.5 percent of the lake area, receives about 50 percent of Kunming's wastewater. 2.22 Third, Dianchi Lake water will be pumped 19 km for irrigation use, freeing the high quality Songhuaba Reservoir water for Kunming's water supply. Fourth, water demand management initiatives have been introduced, including tariff increases to reflect the production cost of water, the establishment of a Water Conservation Office to help reduce wastage, and limited network rehabilitation to reduce unaccounted-for water. Finally, other regulatory actions and incentives have been implemented to protect the catchment, such as encouraging the relocation of industry outside the catchment and banning the further establishment of polluting industries inside the catchment. With response to some of the environmental issues, these actions have proved sufficient. A long-term solution requires effluent reductions at source, or, where more economic, collective treatment. D. FORMULATION OF THE PROPOSED PROJECT 2.23 To build on these initiatives and to follow up studies funded by the Government of Norway, the Province secured assistance from the Overseas Development Administration (ODA) of the United Kingdom, which funded design review and advisory (DRA) consultants, to develop a Dianchi Environmental Action Plan (DEAP) and similar plans for Qujing and Gejiu, and support YP in project preparation. Support for the preparation of the Environmental and Water Quality Monitoring component of the proposed project was also provided by the Canadian International Development Authority(CIDA). Bank Group support for the proposed project, to implement priority measures included in the plans, was then requested. The overall objective of the project is to tackle the immediate and underlying causes of environmental degradation in the project cities. In Kunming and the Dianchi Catchment, this focuses on the protection of Lake Dianchi and ensuring its use as a continued source of potable water for Kunning. In Gejiu and Qujing, improved wastewater management would be the focus of project support, with the aim of preventing untreated waste entering water bodies. The water supply systems of Kunning and Qujing would also be expanded. 2.24 As recommended in the DEAP, reducing the rate of growth of phosphorus concentrations in the lake, which result from domestic waste and industrial effluent (particularly from two large fertilizer factories), is the first priority and would therefore be the project's chief physical goal. Phosphorus, and to a lesser extent nitrogen, is considered the limiting factor in Dianchi's eutrophication. Other nutrients and toxic nutrients, including organic matter and heavy metals, would also decline. To this end, the proposed project would expand the sewer system in Kunming and link it to treatment plants now being constructed; provide the additional wastewater treatment capacity still needed; extend the water supply system to the city's expanding suburban areas; and provide sanitary landfills to reduce leachate entering water sources from existing unregulated dumpsites. Reducing industrial pollution from the fertilizer plants and other major polluters identified in the area would also be supported, as would key institutional - 14 - improvements and policy reforms required for long-term environmental amelioration. Similar physical and institutional measures would be carried out in Qujing and Gejiu. 2.25 The proposed interventions in domestic and industrial wastewater treatment are expected to reduce overall phosphorus loads to Lake Dianchi in 2010 by 50 percent, bringing the loads to 30 percent below those in 1995, despite the substantial population growth in the catchment over the intervening period. 2.26 The subsequent phase of environmnental actions and investments in Yunnan would be identified from the DEAP and from a Dianchi Watershed Management Plan covering rural areas in the catchment, including mines and the now largely unregulated TVEs. The plan is being updated with ongoing assistance from ODA through the DRA consultant. - 15 - 3. THE PROPOSED PROJECT A. PROJECT OBJECTIVES 3.1 The project is part of a phased development program of Yunnan Province (YP) to improve environmental conditions and sustain urban services management. The principal objective of the project is to provide a sustainable environmental framework for the long term economic and social development of the Province, while providing a conducive foundation for industrial growth. Specific objectives of the project are to: (a) strengthen policies, regulations and institutional arrangements for pollution control, and municipal water, wastewater, solid waste and nightsoil management; (b) support the improvement of the lakes environment in Gejiu and Kunming in order to allow the waters to be used for potable supply, industry or agriculture, as appropriate; (c) facilitate complementary sustainable investments in pollution control and municipally-provided urban environmental services; and (d) introduce a comprehensive approach to planning, prioritization, management, and financing of urban environmental infrastructure investments. B. PROJECT DESCRIPTION 3.2 The project would comprise a mix of policy and investment initiatives. The policy initiatives would support a stronger market orientation for municipal service pricing, and the concerned utility enterprises and EPBs would be strengthened through technical assistance and training. Investments would support municipal strategies for environmental recovery and sustained use of natural resources, principally water. A detailed description is given in Annex 2. A summary description of the five core project components is given below. The indicated costs include physical and price contingencies. (a) Lake Dianchi Basin Water Quality Recovery. Investments would support the Dianchi Environmental Action Plan (DEAP), and would include control of point and nonpoint pollution in the Dianchi Lake Basin, through improved catchment management, wastewater and stormwater collection, treatment and disposal, including wastewater treatment in the county towns of Chenggong and Jinning; improved collection, transport and disposal of municipal solid waste and nightsoil; remediation of polluting practices causing lake eutrophication; and measures to strengthen Dianchi Lake basin management and safeguard the long-term quality of water resources; and improvements to basin water resource allocation, to ensure that the highest quality water is used for the most quality-sensitive uses such as for potable supply. The latter would be supported through investments in upgraded - 16- trunk and distribution water mains, water treatment, and associated actions and facilities including rural sanitation investments in the Songhuaba Reservoir and Dianchi basin catchment areas to protect and increase the water supply in Kunming; $199.6 million (b) Industrial Pollution Control. Direct investment financial support would be provided to abate industrial pollution from enterprises identified in the DEAP as most threatening to Dianchi Lake basin resources. Enterprises have been ranked according to environmental impact. The cleanup would focus on two fertilizer plants, found to be the top-ranked industrial polluters in terms of phosphorus load to Dianchi Lake. Support to abate pollution from lower-ranked enterprises requiring smaller investments would be through an Environmental Pollution Control Subloans (EPCSL) Facility; $34.1 million (c) Provincial Urban Environmental Services. Investments in catchment management, wastewater and stormwater collection and treatment systems for the protection of Gejiu Lake and Qujing's Nanpanjiang River; selective investments in water supply system extensions in Qujing; and improved collection, transport and disposal of municipal solid waste and nightsoil in Qujing; $48.6 million (d) Environmental and Water Quality Monitoring. Support for upgrading and modemizing environmental management and water quality information and monitoring systems. $6.2 million (e) Institutional Development, Training and Construction Supervision. Strengthening provincial, municipal, project, and financial management; construction supervision services; training in utility operations; updating of city environmental action plans and feasibility studies; and future project preparation. $19.1 million TOTAL ESTIMATED PROJECT COST $307.6 million 3.3 The financial, urban environment service delivery and utility management policy initiatives would concentrate on (a) operational efficiency improvements; (b) resource mobilization and cost recovery measures; (c) underpinning of long-term financial and economic sustainability; and (d) industrial pollution reduction through focused time- bound Action Plans with respect to pollution from paper, steel and pesticides. The institutional development and training component would enhance policies and operational experience in environmental protection and water, wastewater, municipal solid waste and nightsoil management. Support to these initiatives has been grouped into a number of main composite packages for the various executing agencies, covering institutional development, financial management improvement, construction supervision and training. The component would also support provincial and sector city agencies, master planning, future project preparation, and other programs of assistance to be defined. - 17 - 3.4 YP has prepared and updated a strategy and time-bound Implementation Schedule for the Institutional Development and Training component for implementation according to an agreed schedule. Assurances were obtained during negotiations that YP would implement the Institutional Development and Training component in accordance with a schedule acceptable to the Bank/IDA, and discuss and agree any revisions to the schedule with the Bank/IDA. The signing of contracts with consulting firms for institutional development, financial management improvement, construction supervision and sector institutional strengthening for the executing agencies is a condition of disbursement of loan/credit proceeds (see para. 3.25). C. PROJECT MONITORING 3.5 Project impact would be monitored with respect to the project objectives, for which the key indicators are shown below. The physical progress of implementation would be monitored against the detailed schedules given in Annex 2 and summarized in Annex 8. Base Objective Indicator Unit CY96 CY97 CY98 CY99 CYOO CY05 Objective A Water Supply Quality & quantity % 80 80 90 90 95 95 Wastewater Management Interception ratio % 20 20 40 80 95 95 Connection ratio % 30 40 55 70 80 95 Consumer Survey % 40 40 50 60 60 70 Objective B Lake Water Quality Lake Dianchi improvement Class IV IV IV III In II] Aquatic life quality Index base to be established Phosphorus mgAi 0.28 0.28 0.28 0.25 0.24 0.20 Objective C Complementary investments Achievement of DEAP % completion 0 25 40 60 65 70 Objective D Operational performance Financial indicators compliance (%) - 70 80 90 100 100 Operational efficiency No staff per 1,000 customers 5.0 5.0 4.8 4.6 4.5 4.4 Phosphorus removal % phosphorus removal at % 0 10 20 30 60 60 all STW Institutional development Achievement of action % 0 30 60 90 95 100 plans 3.6 A tentative list of proposed monitoring indicators for environmental improvement is included in Annex 9. Operational and Financial monitoring indicators for the water and wastewater entities are discussed subsequently (para 5.14) and included in Annex 14. The format and content of project progress reports and project impact monitoring indicators and methodology would be discussed and confirmed during negotiations. Parameters, baseline and targeted values would be developed by the Yunnan Environment Project Office-YEPO (para. 4.1) and the relevant participating agencies for review during the proposed Project Launch Workshop (see para. 3.37). D. PROJECT COST ESTIMATES 3.7 The estimated cost of the project, including contingencies and local duties and taxes, is Y 2,966.0 million ($307.6 million). The foreign exchange component is Y 951.8 - 18- million ($99.1 million), or about 32 percent of project costs. Local customs duties and taxes are estimated at Y 123.2 million ($12.5 million). Land acquisition costs are estimated at Y 158.8 million ($17.3 million), or about 6 percent of project costs. A summary of cost estimates is given in Table 3.1 below. Interest during construction is estimated at Y 118.6 million ($12.3 million) and the total financing required would be Y 3,084.6 million ($319.9 million). Detailed cost estimates are provided in Annex 3. TABLE 3.1: SUMMARY COST ESTIMATES % % Total Y Million S Million Foreign Base Local Foreign Total Local Foreign Total Exchange Costs A. Lake Dianchi Basin Water Quality Recovery Kunming Wastewater 584.68 211.28 795.96 70.44 25.46 95.90 27 37 Kunming Water Supply 191.41 90.74 282.15 23.06- 10.93 33.99 32 13 Kunming Solid Waste 161.39 29.02 190.41 19.45 3.50 22.94 15 9 Small Towns 74.09 28.54 102.63 8.93 3.44 12.37 28 5 Rural Sanitation 12.33 2.74 15.07 1.49 0.33 1.82 18 1 Subtotal 1,023.90 362.32 1,386.22 123.36 43.65 167.01 26 65 B. Provincial Urban Environmental Services Gejiu Wastewater 38.35 16.32 54.67 4.62 1.97 6.59 30 3 Qujing Wastewater 68.83 30.50 99.33 8.29 3.67 11.97 31 5 Qujing Water Supply 115.58 28.08 143.66 13.93 3.38 17.31 20 7 Qujing Solid Waste 24.82 4.77 29.59 2.99 0.57 3.57 16 1 Subtotal 247.58 79.67 327.25 29.83 9.60 39.43 24 15 C. Industry and Environment 123.06 126.60 249.66 14.83 15.25 30.08 51 12 Pollution Control D. Environment & Water Quality 22.50 19.52 42.02 2.71 2.35 5.06 46 2 Monitoring E. Technical Assistance and Training 26.00 104.00 130.00 3.13 12.53 15.66 80 6 Total Baseline Costs 1,443.05 692.10 2,135.15 173.86 83.39 257.25 32 100 Physical Contingencies 175.75 79.82 255.57 21.17 9.62 30.79 31 12 Price Contingencies 395.33 179.92 575.25 13.42 6.13 19.55 31 8 Total Project Costs 2,014.13 951.84 2,965.97 208.45 99.14 307.59 32 120 Interest during construction La 10.61 108.00 118.61 1.10 11.20 12.30 Total Financing Required 2,024.74 1,059.84 3,084.58 209.55 110.34 319.89 la Interest during construction is based on: (i) onlending rates for projected disbursements of Loan/Credit proceeds and locally secured loans; and (ii) payment of commitment and service charges. 3.8 Base cost estimates reflect preliminary engineering designs and price levels expected to prevail in June 1996, based on current inflation rates. The unit prices were derived from the following sources: (a) quotations obtained from manufacturers and suppliers; (b) prices of goods and works from recent contracts; and (c) construction costs according to prices published by the Central and Yunnan Governments, all adjusted for inflation. Physical contingencies have been applied to all components except environmental pollution control subloans (EPCSL). Physical contingencies of 15 percent have been applied to base costs for most components, except for vehicles and mechanical equipment of the solid waste and nightsoil management components, and priority water - 19- supply and wastewater contracts, where 10 percent has been adopted to reflect the confidence level of the estimated costs of these components. Construction Supervision Services costs estimated at 2.5 percent of the civil works and materials and equipment costs of the water and wastewater component, and 1.25 percent of the civil works of the environmental services improvements component, have been included in the project cost estimates. Project management and engineering overhead costs of 10 percent are also included. 3.9 Price contingencies have been applied to expenditures at projected global foreign and local inflation rates. In view of the large variation between foreign and local price contingency projections, the dollar/yuan exchange rate has been assumed to vary in order to maintain purchasing power parity. The inflation rate projections used are as follows: Parameter 1996 1 1997 1 1998 l999 2000 2001 2002 Foreign (MUV) I 1.2la Z 2.4 1 2.4 1 2.4 1 2.4 I 2.4 1 .4 Local l53t 1 .5 | 7.0 6.5 6.2 6.2 6.2 la One half (July to December 1996) of the annual foreign inflation rate of 2.4 percent. /b One half (July to December 1996) of the annual local inflation rate of 10.6 percent. E. FINANCING PLAN 3.10 The financing plan for the project is shown in Table 3.2. TABLE 3.2: PROJECT FINANCING PLAN ($ million) Source Local Foreign Total Percentage Yunnan government, prefectural & municipal 154.4 11.2 165.6 51.8 governments Industrial enterprises 4.3 0.0 4.3 1.3 IBRD/IDA 50.8 99.2 150.0 46.9 Total Financing Required 209.5 110.4 319.9 100.0 3.11 China is eligible for single currency loans under the Bank's expanded program. The Government of China and the Yunnan Provincial Government have selected LIBOR- based US dollar single currency loan terms for the project in order to facilitate management of the foreign exchange risk of their borrowings by more closely matching the currency of their liabilities with that of their net trade flows, about 60 percent of which are US dollar-denominated. The LIBOR-based product was selected in order to preserve the full maturity of the loan, compared to the fixed-rate option that would have resulted in a 15-year loan. The Borrower judges that it can manage any interest rate risk. - 20 - This loan, when added to previous single currency loans made to China in FY96, is within the 50 percent volume guideline approved by the Bank's Board. 3.12 The IBRD loan and IDA credit would be made to the People's Republic of China. The loan of $125 million would be for a 20-year term, including a 5-year grace period at the standard interest rate for LIBOR-based US dollar single currency loans. The IDA credit of SDR 17.4 million ($25 million equivalent) would be for a 35-year term, including a 10-year grace period on standard Association terms. The proceeds of the loan and credit would be made available through YP to the municipalities on the following terms and conditions satisfactory to the Bank/IDA: the loan at the standard interest rate for LIBOR-based US dollar single currency loans, for a 17-year period including a 5-year grace period, and a commitment charge of 0.75 percent per year, and the credit at the Association's standard service charge for a 20-year period, including a 5-year grace period, and a commitment charge of 0.50 percent per year. Yunnan Province, and then the municipalities, would bear the foreign exchange risks. Assurances were obtained during negotiations from YP that (a) it would onlend to Kunyang Phosphate Fertilizer Factory, and cause Kunming Municipality to relend to Kunming Chemical Fertilizer Factory part of the loan/credit proceeds for the Industrial Pollution Control component, on the following terms: at the standard interest rate for LIBOR-based US dollar single currency loans plus a spread of not less than 1.5 percent per year, with the enterprises bearing the commitment charges of 0. 75 percent and the foreign exchange risks, the maturity would be for 10 years, including a 3-year period of grace; subsidiary loan agreements would be entered into between Yunnan and Kunming and the two enterprises; and (b) it would cause Gejiu, Kunming and Qujing Municipalities to relend part of the loan/credit proceeds onlent to them to their water and wastewater utility companies on the following terms. at the standard interest rate for LIBOR-based US dollar single currency loans, with the entities bearing the commitment charges and the foreign exchange risks; the maturity would be for 15 years, including a 5-year period of grace. 3.13 Execution of subsidiary loan agreements between the project municipalities and their water and wastewater utility companies, satisfactory to the BanklIDA, is a condition of effectiveness. A separate Project Agreement, including operational, financial and monitoring covenants, would be executed between YP and IBRD/IDA. 3.14 About $5.0 million equivalent of the loan/credit proceeds would be onlent by YP from a revolving credit facility (Environmental Pollution Control Subloans-EPCSL) to participating enterprises for eligible small-scale pollution control subprojects. Assurances were obtained during negotiations that (a) YP would onlend to participating enterprises at the standard interest rate for LIBOR-based US dollar single currency loans plus a spread of not less than 1.5 percent per year, with the enterprises bearing a commitment charge of 0.75 percent and the foreign exchange risk The maturity would be for three to five years, including a one to two year period of grace. Subloan repayments would be recycled for additional pollution control subprojects to the extent not needed to repay the loan to China; and (b) YP would allocate to the account of EPCSL a total of about Y 42.0 million over the - 21 - three fiscal years commencing 1997, annually depositing to the Account at least Y 14 million by June 30 of each such year. F. PROCUREMENT 3.15 Procurement procedures and arrangements satisfactory to the Bank/IDA were agreed upon with YP. All procurement would be undertaken in accordance with the Bank's Procurement Guidelines, January 1995 and revised in January 1996. Activities would be organized through the China National Instruments International Tendering Company (CNIITC), which has been contracted by the Yunnan Environment Project Office (YEPO) on behalf of the implementing agencies and YP to carry out the work. CNIITC is an experienced and competent procurement agent that is familiar with, and has had recent and relevant experience in international competitive bidding (ICB) work on Bank/IDA-financed projects. The tender documents to be used in the project would be based on the current version of model bidding documents agreed between the World Bank Group and the Government. All works contracts would be grouped whenever practical into bid packages estimated to cost the equivalent of $6 million or more each, and contracts for goods shall be grouped into packages estimated to cost the equivalent of $250,000 or more each, to attract maximum international competition. Prequalification of bidders would be undertaken for goods contracts for treatment equipment with an estimated value over $4.0 million equivalent each. For all contracts estimated to cost $10 million or more, invitations for prequalification or for bids would be advertised as Special Procurement Notices published in Development Business and/or well-known technical magazines, newspapers and trade publications of wide international circulation. Annex 4 lists the Schedule of Contract Packages and the method of procurement, and Table 3.3 summarizes the procurement categories and the expected procurement methods. The contract packages and the method of procurement have been agreed with YEPO and the implementing agencies. 3.16 Civil Works. Excluding the industrial pollution control revolving credit facility, there is a total of about $154.5 million of civil works of which about $73.8 million (48 percent) would be procured using ICB procedures. Qualified domestic contractors under ICB will be eligible for a 7.5 percent preference in bid evaluation, in accordance with the Guidelines. ICB procedures would be used for all civil works contracts of estimated value over $6.0 million (i.e., 5 contracts). All remaining civil works are too small, scattered or scheduled too far apart to be packaged to be of interest to foreign firms. Of the remaining works, about $79.6 million would be awarded through national competitive bidding (NCB) procedures, acceptable to the Bank/IDA. The NCB procedures recently adopted by the Government have been reviewed and approved by the World Bank Group. Interested foreign bidders would be allowed to bid for NCB contracts. 3.17 Equipment and Materials. Excluding the industrial pollution control revolving credit facility, there is a total of about $81.4 million of equipment and materials in the project, of which about $74.4 million (92 percent) would be procured using ICB procedures. Qualified domestic bidders will be eligible for a preference in bid evaluation of - 22 - 15 percent of the CIF price or customs duties and import tax payable by a nonexempt importer, whichever is less. All equipment and materials with individual contract values of $250,000 or more equivalent would be procured using ICB procedures. Equipment and materials with individual contract values less than $250,000 equivalent would be awarded using NCB procedures acceptable to the Bank, up to an aggregate amount of $1.5 million. Contracts costing $50,000 equivalent or less up to an aggregate amount of about $1.5 million, would be procured through national shopping procedures with at least three price quotations. TABLE 3.3: PROCUREMENT ARRANGEMENTS ($ million, including contingencies) Procurement Method Category ICB NCB Other La NBF lb Total Civil Works 73.8 79.6 0.0 1.1 154.5 (33.2) (35.8) (0.0) (0.0) (69.0) Equipment & Materials 74.4 1.5 1.5 4.0 81.4 (54.6) (1.2) (1.2) (0.0) (57.0) Industrial Pollution Control /c 0.0 0.0 10.1 0.0 10.1 (0.0) (0.0) (5.0) (0.0) (5.0) Institutional Development & Training 0.0 0.0 12.6 0.0 12.6 (0.0) (0.0) (12.6) (0.0) (12.6) Construction Management Services 0.0 0.0 6.4 0.0 6.4 (0.0) (0.0) (6.4) (0.0) (6.4) Land Acquisition 0.0 0.0 0.0 17.3 17.3 Administration & Project Management 0.0 0.0 0.0 25.3 25.3 Total 148.2 81.1 30.6 47.7 307.6 (87.8) (37.0) (25.2) (0.0) (150.0) La Other procurement methods include those under EPCSL, national shopping, consultant services (recruited in accordance with the Bank's Guidelines) and training. lb NBF = Not Bank/1DA-financed. /c The Industrial Pollution Control would be disbursed through subloans of YP's EPCSL revolving credit facility. Note: Figures in parenthesis are amounts to be financed by IBRD/IDA. 3.18 Direct Contracting. Direct contracting (not Bank/IDA-financed), amounting to about $5.1 million, will be used for: (a) contracts to be made with the local power companies to provide electricity supplies to the pump stations, buildings and facilities under the project; (b) railway crossings; and (c) other utility services. 3.19 Industrial Pollution Control Subloans. Under this subcomponent, which would be operated by the Yunnan Finance Bureau-YFB (see para. 4.13), no subloan will exceed $500,000. Contracts for equipment and materials financed through subloans up to a facility total of $10.0 million would be awarded, after solicitation and evaluation through national - 23 - shopping procedures with at least three written price quotations from eligible suppliers (see Annex 12 for details of EPCSL operations). This is consistent with procedures that the Bank Group has reviewed and found satisfactory. These contracts would be subject to postreview by the Bank/IDA, and YEPO would maintain all relevant documents in its records for this purpose. 3.20 Technical Assistance and Training. All consultants to be retained under the project would be recruited in accordance with the World Bank's "Guidelines for the Use of Consultants by World Bank Borrowers and by The World Bank as Executing Agency- August 1981." National consultants and counterpart staff would be engaged or assigned by the concerned agencies of Yunnan Province. Consultants would be engaged using the Bank's Standard Formn of Contract for Consultants' Services-June 1995. Drafts of Letters of Invitation, Terms of Reference and a short list of consultants for institutional and financial technical assistance, construction supervision services, and sector institutional strengthening for Packages A and B (for the Kunming Drainage Company, and the Kunming Water Supply Company respectively) were reviewed and found satisfactory prior to appraisal. Details of the institutional development and training component are set out in Annex 2. The signing of contracts between YP and consulting firms for such assistance is a condition of disbursement of loan/credit proceeds (para. 3.25). The Terms of Reference for these consultancy services are in the Project File (Annex 16). 3.21 Review of Bid Documents and Contracts. All civil works packages (about 17 contracts, 80 percent of the works) of $2.5 million or more, and all equipment and materials contracts (about 15 contracts, 92 percent of the equipment and materials) of $0.5 million or more, would be subject to the Bank/IDA's normal pri-,r review, including prequalification, notice of invitation to bid, bid documents, bid evaluation and contracts. The threshold for prior review of contracts for consultants would be $100,000 equivalent for firms and $50,000 for individual contracts, including the approval of budgets, short lists, selection procedures, letters of invitation, proposal evaluation reports and contracts. Other contracts would be subject to selective postaward review. An estimated 80 percent of the value of all contracts proposed to be financed by the Bank/IDA would be subject to prior review. However, all terms of reference for such contracts, any single-source selection of consultants, assignments the Bank considers to be of a critical nature, and any amendments to contracts that result in the contract exceeding the above-mentioned two thresholds would require Bank/IDA prior review. 3.22 Prequalification. The Standard Prequalification Document for the People's Republic of China, issued by the Ministry of Finance and approved by the World Bank Group, would be used for preparing the invitation document. YEPO and CNIITC hold copies of this document (together with standard bidding documents for ICB and NCB works and goods invitations). - 24 - G. DISBURSEMENT 3.23 The proposed IBRD loan of $125 million and IDA credit of SDR 17.4 million ($25 million equivalent) would be disbursed over a period of about six and a half years, one year longer than the China disbursement profile for the water and sanitation sector. The longer disbursement period for this project is considered justified given Yunnan is a first-time borrower in the sector. IDA Credit Loan Amount Amount Category ($ million equiv.) ($ million) Expenditures to be Financed (%) Civil Works 8.3 56.0 45% of expenditures Goods (a) EPCSL 1.0 4.0 100% of foreign expenditures, (b) Other 8.5 49.2 100% of local expenditures (ex- factory), and 75% of other items procured locally Consultant Services 7.2 10.8 100% of expenditures and Training Unallocated - 5.0 Total 25.0 125.0 3.24 To expedite disbursements, a Special Account with an authorized allocation of $8.0 million, representing about four months' average disbursements, would be established. It would be replenished monthly or whenever the Special Account is drawn down to 50 percent of its initial value, whichever occurs first. Disbursements would be made against statements of expenditure (SOEs), confirmed by YEPO, for: (a) contracts for (i) civil works valued at less than $2.5 million; and (ii) equipment and materials costing less than $0.5 million equivalent; (b) contracts for consulting services costing less than $100,000 equivalent for firms and $50,000 equivalent for individuals; and (c) training. Documents supporting the SOEs would be retained by YEPO and made available for inspection during the course of Bank/IDA supervision missions and by external auditors. All other disbursements will be made against fully documented expenditures. A Schedule of Disbursements is given in Annex 5. The project is expected to be completed by December 31, 2001, and, therefore, the Loan/Credit Closing Date would be December 31, 2002. 3.25 The approval by the Bank/IDA of (a) operational regulations governing EPCSL processing and approvals, and (b) the execution of an acceptable financial agency agreement between YP and a bankfor EPCSL processing (para. 4.13 and Annex 12), would - 25 - be conditions of disbursement for the loan/credit proceeds allocated to the Environmental Pollution Control component. The execution of acceptable subsidiary loan agreements between (i) Kunming and Kunming Chemical Fertilizer Factory, and (ii) Yunnan and Kunyang Phosphate Fertilizer Factory (para. 3.12) would be conditions of disbursement for the loanlcredit proceeds allocated to these investments. It will be a condition of disbursement of the Lake Dianchi Basin Water Quality Recovery component that the Bank/IDA receive (a) copies of signed contracts, acceptable to the Bank/IDA, between YP and consulting firms, for institutional and financial technical assistance, construction supervision services, and sector institutional strengthening with respect to KDC and KWSC (para. 3.20); and (b) a financial forecast of KDC's operations for fiscal year 1997, acceptable to the Bank/IDA, together with written confirmation that all wastewater tariff increases included in the forecast have been approved by YP (see para. 5.14). H. LAND ACQUISITION AND RESETTLEMENT 3.26 The project entails permanent acquisition of 215 hectares of land affecting 3,090 persons in Kunming, Qujing and Gejiu municipalities and some of the smaller towns in Yunnan province. During project preparation, surveys of affected persons and properties were carried out by the respective municipalities/counties with the involvement of affected persons and their representatives. In addition to permanent land acquisition, about 100 hectares of land would need to be leased temporarily during project construction. The project would also affect four enterprises with 70 workers. A preliminary socioeconomic survey of the affected persons has been conducted by the project preparation team. Detailed socioeconomic surveys of affected persons will be carried out before the initiation of the land acquisition and resettlement program. 3.27 Resettlement Action Plan (RAP). In order to ensure mitigation of adverse impacts related to land acquisition and to facilitate the implementation of resettlement/rehabilitation activities as a development program, YEPO has prepared a comprehensive Resettlement Action Plan (RAP), covering all project components. The RAP, submitted to the Bank for review before project appraisal, has been found to be generally in accordance with the Bank's guidelines on resettlement. It was updated during appraisal. The RAP sets out: (a) land acquisition and resettlement policies and principles; (b) baseline surveys; (c) description of resettlement sites; (d) resettlement institutions; (e) implementation schedule; (f) job creation; (g) costs and budget; (h) participation of project affected persons; (i) grievance redress; and (j) monitoring and evaluation of RAP implementation. 3.28 Resettlement Strategies. A majority of the project affected persons (2,200 out of 3,090) would be rehabilitated through land redistribution within the same village unit. About 600 new jobs would be provided for the economic rehabilitation of the remaining 890 affected persons. Elderly affected persons would be offered old-age pensions. Workers in affected enterprises would be paid a transition allowance in lieu of wages until reconstruction of the affected enterprises. Compensation for all affected assets will be paid at their full replacement value without any allowance being made for depreciation. - 26 - 3.29 Resettlement Costs. The cost of implementation of the RAP has been included as a part of the project budget. The total cost of RAP implementation is estimated at Y 171 million in January 1996 prices, including physical and price contingencies. 3.30 Implementation Arrangements. A Resettlement Coordination Group (RCG), headed by the provincial Vice-Governor and with members from all the implementing agencies has been formed by the provincial government to oversee the implementation of the resettlement required. YP has given overall responsibility of RAP coordination to YEPO, while the local municipal governments/counties, would be responsible for implementing the RAP. A Resettlement Unit within YEPO would coordinate the implementation of the various activities under the RAP. 3.31 Implementation of the RAP will be carried out in consultation with, and with the participation of the affected persons and their representatives. A mechanism for redress of grievances of affected persons and avenues for appeal have been established specially for the project. 3.32 Monitoring and evaluation of RAP implementation will be carried out both internally and externally. Intemal monitoring will be carried out quarterly by YEPO and the respective municipal/county governments in formats that have been agreed with the World Bank and have been included in the RAP. Specific monitoring indicators for intemal monitoring have also been specified. Extemal monitoring and evaluation will be carried out by the Southwest Jiaotong University on a biannual basis until one year after the completion of the project. Extemal monitoring would concentrate on the qualitative aspects of monitoring based on the monitoring indicators described in the RAP. The first external monitoring report will be submitted to the Bank for review on October 1, 1996. Each monitoring report will be discussed by the Resettlement Coordination Group (RCG) and each report would summarize the progress of follow-up action initiated as a result of the previous reports. 3.33 YP submitted an updated and acceptable RAP to the Bank prior to negotiations. The framework for land acquisition and resettlement is presented in Annex 6. During negotiations, assurances were obtainedfrom YP that it would cause YEPO, the municipal and county governments and all other concerned agencies to (a) carry out the resettlement and rehabilitation of affected persons in a manner and according to a plan (the RAP) that is satisfactory to the Bank/IDA; and (b) report quarterly on the progress in carrying out the resettlement plan using monitoring indicators satisfactory to the Bank/lIDA. I. ENVIRONMENTAL IMPACT ASSESSMENT 3.34 The proposed project is classified as Category A for purposes of Environmental Assessment (EA), principally because of the three proposed landfills and the industrial pollution control component. In accordance with Chinese regulations a comprehensive EA was prepared covering all project components. This EA has been reviewed by NEPA and the Bank/IDA and found to be satisfactory. The findings of the EA are summarized - 27 - in Annex 7. The environmental impact of the project is, on balance, substantially positive and the project will, in particular, result in major improvements in water quality. The comprehensive program of removal of phosphorus from wastewater discharges to Dianchi Lake will have substantial benefits in terms of arresting the eutrophication of lake and permitting its sustained safe use for water supply and avoiding costly import of water from distant catchments. 3.35 There are, however, some negative impacts that require mitigation. In particular, the proposed landfill sites are to be lined and equipped with leachate collection systems. Landfill gas will be collected and flared for safety reasons and to convert methane, a potent greenhouse gas, to carbon dioxide. Appropriate arrangements have been made for the beneficial use, wherever possible, of construction spoil and for the disposal of sludge from wastewater treatment. During negotiations, assurances were obtained from YP that it would carry out, or would cause to be carried out, in a manner satisfactory to the Bank/lIDA, the mitigation plans specified in the environmental assessment (EA). J. PROJECT REPORTING AND SUPERVISION 3.36 The proposed project implementation schedule is shown in Annex 8. Reports on project progress based on agreed monitoring indicators would be prepared by each implementing agency and consolidated by YEPO, then sent to the Bank/lIDA by the thirtieth day of January, April, July and October of each year, commencing in July 1996. Assurances to that effect were obtained during negotiations. The last progress report of each year would include the latest project cost estimate and financing plan for the following year, including YP' draft budget for local counlerpart funds. An implementation completion report, reviewing the planned objectives and the achievements of the project, including costs and benefits derived, and performance and contribution of all parties associated with project execution, would be prepared by YP and submitted to the Bank/IDA within six months of the Closing Date. 3.37 To facilitate implementation, a Project Launch Workshop would be held in late 1996. Project supervision would monitor impact with respect to the objectives (para. 3.5), and focus on key sector issues such as utility pricing and environmental regulatory effectiveness. Bank Group experience with supervision of the ongoing Urban Infrastructure and Environment Project in Liaoning Province, which, like the proposed project, are multicity projects, suggests that Bank/IDA supervision would require about 95 staff-weeks over the life of the project, of which about 25 staff-weeks would be at headquarters for the review of progress and audit reports, procurement actions and correspondence, etc., and 70 staff-weeks would be in the field. More intensive supervision would be required during the first three years of the project, during which time the technical assistance would be made operational and many procurement contracts would have been tendered, evaluated and awarded. Supervision would be provided by environmental engineering and financial staff, as well as other specialists, as needed. The Project Supervision Plan is shown in Annex 10. 3.38 A mid-term (mid-1999) review would be held to assess critically the progress in implementation of the various components of the project. A key issue for the review would - 28 - be the possible reallocation of loan/credit proceeds from underperforming municipalities to better performing municipalities, as an incentive for strong municipal performance. The mid-term review mission would pay particular attention to utility tariffs, environmental regulation, and associated policy issues critical to project and sector success. During negotiations, assurances were obtained that a mid-term review of project progress would be undertaken by June 30, 1999, and the agreed recommendations implemented - 29 - 4. PROJECT MANAGEMENT AND IMPLEMENTATION A. PROJECT MANAGEMENT 4.1 A Leading Group, headed by a Vice Govemor, was set up to guide and give policy direction for the preparation, and subsequently, implementation of the proposed Yunnan Environment Project (YEP). Members of the Group include representatives from the Yunnan Planning Commission, Yunnan Construction Commission, Yunnan Finance Bureau, Yunnan Economy and Trade Commission, Yunnan Environmental Protection Bureau, Yunnan Foreign Trade and Economic Cooperation Department, People's Construction Bank of China, Yunnan Branch, and cadres from the Kunming Municipal Government. The Leading Group designated the Yunnan Environmental Protection Bureau (YEPB) as the agency responsible for managing the project. This Bureau organized and staffed the Yunnan Environment Project Office (YEPO) to prepare and execute the project, including the supervision and monitoring of contracts, maintenance of project records, and the submission of progress reports to the Bank (para. 3.36). Leading Groups were also set up in each of the project municipalities of Gejiu, Kunming and Qujing, under which municipal project offices were established. During project preparation, YEPO and the municipal project offices received regular policy guidance from their respective leading groups. The municipal project offices in tum created and staffed subproject offices in each of the implementing agencies listed in Table 4.1 below. 4.2 YEPO, which has provided functional guidance to the municipal project offices, has interacted well with them and with its consultants and design institutes, expedited resources to undertake preparation, and arranged for the project preparation work to be completed to the satisfaction of YP and the Bank/IDA. YEPO would have the following responsibilities during project implementation: (a) overall project coordination, macro-level project management and monitoring; (b) annual budget preparation; (c) project-wide quality assurance; (d) progress reporting to YP and the Bank/IDA, including cost management, project impact and environmental improvement assessment; (e) interagency coordination and procurement support; and (f) sectoral training facilitation. - 30- 4.3 To enable YEPO to undertake this work effectively, it has been strengthened, and the personnel skill mix adjusted to reflect the needs of the implementation and construction phase of the project. During negotiations, assurances were obtainedfrom YP that YEPO and the participating municipalities' project offices would be maintained throughout implementation with functions and responsibilities satisfactory to the Bank/IDA, with competent staff in adequate numbers. B. IMPLEMENTATION RESPONSIBILITIES 4.4 The institutions designated by YP and its municipal governments to implement, and finance, the various components of the project are listed in Table 4.1. TABLE 4.1: IMPLEMENTING AGENCIES Project Component Implementing Agency Onlending Agency Gejiu Wastewater Gejiu Water Supply & Drainage Company Gejiu Municipality Kunming Water Supply Kunming Water Supply Company Kunming Municipality Wastewater Kunming Drainage Company Kunming Municipality Solid Waste and Nightsoil Kunming Appearance Bureau Kunming Municipality Qujing Water Supply/Wastewater Qujing Water Supply & Drainage Company Qujing Municipality Solid Waste and Nightsoil Qujing Maintenance Section Qujing Municipality Industrial Pollution Control Enterprises Kunming Chemical Fertilizer Factory Kunming Municipality Kunyang Phosphate Fertilizer Factory Yunnan Province Subloans Yunnan Finance Bureau Yunnan Province Smal Towns & Rural Sanitation The Chenggong County Urban Construction, Kunming Municipality Environmental Protection and Land Administration Bureau The Jinning County Urban Construction and Land Administration Bureau The soil and fertilizer station of Kunming Municipal Agricultural Bureau Environmental Monitoring Yunnan Provincial, Prefectural and Municipal Yunnan Province and Governments benefiting prefectures and municipalities Technical Assistance and Training Yunnan Provincial Govemment Yunnan Province 4.5 Provincial and Municipal Institutions. YP is headed by a govemor assisted by six vice-govemors, who oversee several commissions and/or departments. Various provincial commissions, departments and bureaus provide supervision and guidance to the municipalities on matters relating to infrastructure, planning, development and operation, including environmental protection works. Organization charts of YP and the interrelationship of the project implementing agencies with the provincial government are given in Annex I11. - 31 - 4.6 The organization of the municipal governments of Gejiu, Kunming and Qujing is similar. Municipal affairs are overseen by the municipal economic and planning commissions, and municipal urban and rural construction commissions. The latter commissions supervise a number of bureaus which are responsible for the physical planning, design, construction, operation and maintenance of urban infrastructure, and for environmental protection. In addition, several bureaus concerned with urban infrastructure report directly to the office of the mayor. These include the Finance Bureau, the Water Conservancy Bureau, the Bureau of Public Health and Public Security Bureau. 4.7 As part of China's and Yunnan's policy of reforms in the public utilities sector, the participating municipalities established self-accounting, and self-funding state-owned enterprises to implement the wastewater components of the project (para. 4. 10). The water supply components would be implemented by the municipalities' water supply agencies established earlier. Prior to negotiations, the Bank/IDA received (a) conformed copies of the charters, and (b) business licenses of these enterprises and the Kunming Chemical Fertilizer Factory and the Kunyang Phosphate Fertilizer Factory. Solid waste and nightsoil management subcomponents would be implemented, operated and maintained by the municipalities' Sanitation Departments/Divisions. 4.8 Water Supply. The Kunming Water Supply Company (KWSC) was established in 1915 as a financially autonomous enterprise. It reports to the Kunming Public Utilities Bureau. KWSC employs a staff of 866 who are responsible for construction management, production, operation and maintenance, consumer service and administration of the Kunming water supply system. The Gejiu Water Supply Company and the Qujing Water Supply Company were both established in 1994 and report to their respective Construction Commissions. Prior to 1994, water supply operations in these cities were provided by the water sections of their municipal facilities management divisions (MFMDs), which reported to the their respective Urban and Rural Construction Bureaus (URCB) within the municipal construction commissions. 4.9 Wastewater. Until the creation of wastewater entities in Gejiu and Qujing (para. 4.10), wastewater collection, treatment and disposal were generally provided by the sewerage sections of MFMDs, which are also responsible for the operation and maintenance of roads, bridges, parks and street lighting. The Kunming Drainage Company was formed from four organizations (the tariff, sewerage treatment preparation, sewerage treatment management, and drainage preparation departments) of the Kunming Public Utilities Bureau. The sewerage sections did not operate on a financially autonomous basis, transferring, instead, all tariff revenue collections to the URCB. Funds were consolidated at the URCB level and allocated to the various sections for operation, maintenance and capital works, on the basis of budgets prepared and submitted by the sections. The wastewater entities created for the project will account for their own capital and operating costs, and existing wastewater assets have already been transferred to the entities' books. While the new entities in Gejiu and Qujing are still required to remit their revenues to their respective municipal governments, such funds are earmarked to finance the operation and maintenance of the sewerage facilities, and service debt. The remitted revenues, therefore, are returned - 32 - in their entirety to the entities. While less desirable than full autonomy, some water companies function efficiently under such a system. The water and wastewater companies of Kunming, however, retain their revenues to finance their operations. Staff from the existing sewerage sections in the three project cities were transferred to the recently-formed wastewater entities and have the skills needed to maintain and operate them, with training provided under the project. Small towns and villages' investments in pollution control measures in the Dianchi Lake Basin would continue to be provided and maintained by the government departments responsible for such services. 4.10 Kunming Municipality established the Kunming Drainage Company (KDC) in 1994 as a self-accounting, self-funding state-owned enterprise to implement its wastewater component. It officially started operations in May 1995. KDC reports to the Kunming Public Utilities Bureau. It has a sanctioned staff strength of 502, of which about 392 are currently on the payroll, responsible for construction management, collection, treatment and disposal of wastewater and stormwater, operation and maintenance, consumer service and administration. In June 1995, Gejiu established a self-accounting, self-funding wastewater unit within the Gejiu Water Supply Company which then became the Gejiu Water Supply and Drainage Company (GWSDC). The present total staff strength of the company is about 160, with 100 assigned to water supply, 40 to wastewater, and 20 to joint administration. They are responsible for water, wastewater and drainage construction management, water supply production and distribution, wastewater and stormwater collection, treatment and disposal, operation and maintenance, consumer service and administration. In January 1996, Qujing Municipality established a similar wastewater unit within the Qujing Water Supply Company, the new company-The Qujing Water Supply and Drainage Company (QWSDC)-having similar responsibilities to those of GWSDC. The sanctioned staff strength of the company is about 177, of which about 157 are currently on the payroll. 4.11 Solid Waste and Nightsoil Management. Domestic, municipal and nightsoil collection and disposal are the responsibility of municipal appearance/maintenance (sanitation) departments. Domestic waste and nightsoil collections are usually performed by subdistrict street teams who collect the waste from the residential units and transfer it, usually by handcart, to transfer stations around the cities. From there it is collected by the sanitation departments and disposed of at landfills or dumping grounds, or, in the case of nightsoil, to storage tanks, into the sewerage system, or to farmers. Neighborhood committees collect fees to offset collection costs. Other domestic costs are covered by a flat tax per employee and through general government revenues. Industrial (including hazardous/toxic) and commercial wastes are disposed of by the enterprises themselves, or by the sanitation departments, against payment of fees or service charges. Infectious hospital waste is normally incinerated by the hospitals themselves; the domestic hospital waste is disposed of in the same manner as other domestic waste. Recycling is practiced widely in all the project cities. The recyclable substances are mainly ferrous and nonferrous metals, rubber, plastic, glass, paper and textiles; these are usually brought to municipal-run collection points by the waste producers themselves, and by informal sector operators. The latter collect material from producers, from collection points, transfer stations or the - 33 - disposal sites. Some of the recyclable materials collected by the informal sector are sold directly to enterprises. 4.12 Industrial Pollution Control. The Industrial Pollution Control (IPC) component relies on a three part strategy: (a) direct onlending to clean up two fertilizer plants (the Kunming Chemical Fertilizer Factory and the Kunyang Phosphate Fertilizer Factory) that are major polluters; (b) lending for a number of smaller pollution control investments through an Environmental Pollution Control Subloans (EPCSL) Facility, with initial capital equivalent of Y 84 million (about $10 million), comprising equal amounts of Bank/IDA and local funds; and (c) instituting time-bound environmental management improvement action plans for pollution reduction measures at the Kunming Iron and Steel Plant and the Yunfeng Paper Mill, financed through non-Bank sources, as well as ceasing operations in the manufacture and handling of pesticides and other toxic materials at the Kunming Pesticide Plant by not later than June 30, 1999, to protect municipal wastewater treatment facilities. The IPC component, including the adverse impact the above enterprises have on the environment, is described in detail in Annex 12. During negotiations, assurances were obtainedfrom YP that it would carry out, or cause to be carried out, time-bound action plans for environmental management improvements at Kunming Iron and Steel Plant and at Yunfeng Paper Mill. Assurances were also obtained from YP that it would cause the Kunming Pesticide Plant to implement a time-bound environmental management action plan. 4.13 Environmental Pollution Control Subloans. Environmental Pollution Control Subloans (EPCSL) will be operated by YFB as a government facility, although with segregated accounting and special operating procedures. The management and operation of EPCSL are summarized in Annex 12. The purpose of EPCSL will be to provide funds for environrnental pollution control, targeted to small-scale industries. Project selection, appraisal, both technical and financial, and environmental and resettlement criteria have been proposed and generally follow those of similar funds in operation elsewhere in China. Projects will be selected according to cost effectiveness and financial viability, with the first three appraisals and all appraisals for proposed subloans of over $300,000 receiving ex-ante review by the Bank/IDA and the remainder subject to ex-post review. The principal funding sources for EPCSL will be funds allocated by YP (para. 3.14), and the proceeds of the Loan/Credit and recycling of loan and interest payments. 4.14 Institutional Development and Training. As the above-mentioned wastewater entities have been created only recently and the solid waste bureaus lack financial management tools, the project's institutional development and training component has been designed specifically to address the accounting, management information, financial management, utility pricing, technical requirements and training needs of the implementing entities. - 34 - C. STATUS OF ENGINEERING 4.15 Project preparation and design work has been undertaken jointly by international and local consultants and design bureaus, and is well advanced. Final design and the preparation of draft tender documents for the following contracts representing approximately 20 percent of the municipal services investments was completed prior to appraisal. The remaining final design and bidding documents preparation will continue during the period prior to effectiveness. Contract Number Description and Contract Type DBM/2. 1 Kunming Sewerage Treatment Works Nos. 4B & 5 (Civil Works) DBM/20. 1 Nos. 4B & 5 (Mechanical and Electrical) DBMJ3.1 Kunming Water Supply Raw Water Pipelines (Civil Works) DBM/4.2 Beijiaochang Water Treatment Works and Reservoir (Civil Works) DBM/22.2 Beijiaochang Water Treatment Works and Reservoir (Mechanical and Electrical) DBM/5.2 Kunming East Landfill (Civil Works) DBM/25.1 Solid Waste Vehicles and Equipment (Mechanical and Electrical) - 35 - 5. FINANCE A. FINANCIAL MANAGEMENT 5.1 Since 1978, Chinese economic reforms have evolved gradually toward an increasingly decentralized financial system in China. Most industrial production and prices have become free of government control, and enterprises have to purchase most of their inputs at market prices. Enterprise reform has become a high priority of the Government. In this connection, the guiding principles of the recently promulgated "regulations on transforming the management mechanisms of state-owned industrial enterprises" are to separate government administration from enterprise management, increase the autonomy and accountability of state-owned enterprises, and increase competition and market-orientation. The reform efforts to improve economic policies and enterprise efficiencies are essential for sustaining both economic development and environmental protection in the longer run. 5.2 In order for the enterprises to assume their increased responsibilities efficiently and effectively, the strengthening of their financial management is essential. Toward this end, the proposed project would support the applications of modern management techniques and human resource development for the utility companies. B. ACCOUNTING 5.3 Different accounting systems are used by enterprises (autonomous units), construction units (which execute investment projects) and local government departments, in accordance with regulations prescribed by the Ministry of Finance. 5.4 Enterprise Accounting. All the state-owned enterprises in China follow a unified enterprise accounting system. The accounting framework was developed in the context of a highly centralized planned economy. With a view to complementing the ongoing efforts to deepen reforms in the financial sector and enterprise management, the accounting system in China needed modernization to permit satisfactory financial management in an increasingly decentralized and market-oriented environment. As a first step, the general principles of enterprise (the term to include public utilities such as water, sewerage, and district heating companies) accounting were revised by the Ministry of Finance from July 1, 1993 to be more consistent with internationally generally accepted accounting practice. As part of the reforms, enterprises are required to produce five reports for submission to Government: balance sheet, income statement, source and application of funds, profit distribution, and details of main business. The first two reports are required monthly, the remainder on an annual basis. All enterprise implementing agencies included in the project will be following the new accounting and reporting formats. - 36 - 5.5 Government Accounting. The regular government department accounts reflect expenditures incurred against budget allocations by YP or its municipal governments. Accounting is handled in a decentralized manner through transfers to subunits from which actual expenditures are made and recorded on a cash basis. Accounts are kept at all levels, and each subunit reflects in its accounts the budget allocation it receives from the unit above. 5.6 Project Accounts. Project accounts would be maintained by YEPO, the environmental sanitation departments of Kunming and Qujing, and for small towns and rural sanitation component in accordance with the State Construction Unit Accounting System. This system prescribes generally accepted accounting practices, including double- entry bookkeeping, subsidiary ledger accounting, and rules for capitalizing and expending various items of expenditure. It also sets out detailed accounting definitions for capital works, cash control, receivables and payables. In addition, it identifies a number of basic monthly, quarterly and annual reporting formats, including funds flow statements and balance sheets. The construction accounting system is comprehensive, and is adequate for the proposed project. Project-related expenditures incurred by enterprises (e.g., the water and wastewater entities and the industries to be included in the industrial pollution control component), would be reflected within their respective enterprise accounting systems. C. AUDITS 5.7 As with other Bank/IDA-financed projects in China, the Foreign Investrnent Audit Bureau of the State Audit Administration (SAA), established in 1983, would have overall responsibility for auditing accounts concerning the project. The actual auditing work will be conducted by the Yunnan Provincial Audit Department under SAA's supervision. This arrangement is satisfactory. During negotiations, assurances were obtained that the following annual audits would be submitted to the Bank/IDA within six months after the end of the financial year. (a) audit of (i) the project accounts maintained by YEPO, (ii) the environmental sanitation departments of Kunming and Qujing, and (iii) the bureaus responsible for the Jinning and Chenggong components, (b) audit of the Special Account; (c) audit of Statements of Expenditure (SOE); and (d) audits of the financial statements of (i) KWSC, (ii) KDC, (iii) QWSDC, (iv) GWSDC, and (v) EPCSL. Understandings were obtained during negotiations that audit reports would include opinions on whether implementing agencies were in compliance with their respective financial covenants, and whether these agencies had taken out adequate insurance on goods and works financed from loan/credit proceeds. The Bank/IDA would expect to receive the first such audit reports by June 30, 1998, covering project implementation activities commencing in fiscal year 1997. D. PROVINCIAL FINANCE 5.8 The Yunnan Provincial Government has two types of finance, on-budgetary and off- budgetary. On-budgetary revenues are provided through taxes, the base and rate of which are set by the Central Government. The Central Government directly controls the single largest tax source-the value-added tax-receipts from which are shared with local - 37- government. A variety of other taxes are collected and used directly by local government. Most off-budgetary revenues consist of special fees paid by enterprises, and fees and charges relating to construction activities. These are used for capital expenditures. On- budgetary and off-budgetary accounts are not consolidated. While information on off- budgetary revenues and expenditures is confidential, and was not, therefore, provided to the Bank/IDA, they are said to be at least as large as the on-budgetary data. 5.9 YP will recover the debt associated with the project as it is being passed on to the municipalities and industrial enterprises. YP will monitor municipal finances to assure that the municipalities and their respective agencies meet their debt service obligations. Should the municipalities and their subborrowers be unable to fulfill their obligations, YP would have no difficulty in covering debt service through its own resources, as the debt service represented by the project is small compared to total provincial budgetary expenditures. Provincial fiscal budgetary revenues and expenditures totaled about Y 23.8 billion ($2.8 billion) and Y 22.9 billion ($2.7 billion), respectively, in 1994. Between 1992 and 1994, revenues and expenditures increased on average by about 65 and 63 percent a year in current terms, respectively. Revenues are derived mainly from taxes on industry and commerce, which have been remitted by the municipalities. Revenues and expenditures are projected to grow between 7 and 10 percent a year in real terms during the project period. Projected receipts and expenditures for Yunnan Province and the participating prefectures, municipalities and counties are provided in the report on Provincial, Prefectural, Municipal and County Financial Projections for Fiscal Year 1992 to 2005 (on-budget), which is included in the Project File (AnnexJ16). E. PREFECTURAL FINANCE 5.10 There are 17 prefectures in Yunnan Province. They form an intermediate layer of government between the provincial and municipal administrations, except in the case of Kunming which reports directly to YP. The municipalities of Gejiu and Qujing report through Honghe and Qujing Prefectures, respectively. 5.11 Prefectures have similar sources of receipts and expenditures as the provincial and municipal levels of government. In 1994, the receipts and expenditures of Honghe and Qujing Prefectures totaled about Y 1.1 and Y 1.3 billion each, respectively. Each Prefecture will contribute about 25 percent of the counterpart funding requirements of the proposed project investments of Gejiu and Qujing. Each would be liable for repayment of the proceeds of the Loan/Credit onlent to the municipalities in the event the latter defaulted on their obligations. F. MUNICIPAL FINANCE 5.12 YP will, through the municipalities of Gejiu, Kunming and Qujing, provide all funding not met by (a) the proceeds of the Bank Loan and IDA Credit, (b) prefectural contributions, (c) municipal contributions, and (d) funds generated internally by the implementing agencies. During project implementation, the financial projections show that these requirements would be of the order of Y 80 million for Gejiu, Y 1,130 million for Kunming, and Y 335 million for Qujing. The municipalities, like YP, have two sources of - 38 - finance, on-budgetary and off-budgetary. The off-budget details are confidential, and were not, therefore, provided to the Bank/IDA. The municipal funding requirements would come from many more sources than municipal on-budget revenue. The Yunnan Finance Bureau (YFB) has independently assessed the municipalities' ability to generate the required counterpart funds from assured sources. 5.13 Summarized historical and projected on-budget revenue and expenditure statements of the municipalities of Gejiu, Kunming and Qujing for the period 1994-2002 are given in Annex 13, together with assumptions to the projections. Average annual project-related expenditures comprise between about 3 to 46 percent of the municipalities' annual total on- budget expenditures. G. PUBLIC UTILITIES 5.14 The salient features of the future finances of (a) Kunming Water Supply Company (KWSC), (b) Qujing Municipal Water Supply unit, (c) Gejiu Municipal Drainage unit, (d) Kunming Drainage Company (KDC), and (e) Qujing Municipal Wastewater unit, based on the indices and exchange rates mentioned in paras. 3.9, are highlighted in Tables 5.2 and 5.3. The assumptions used in the financial projections, and detailed operational and financial monitoring indicators are included in Annex 14. The projected financial statements are provided in the Report on Water and Wastewater Companies' Operational and Financial Projections 1993-2002 which is included in the Project File (Annex 16). Prior to appraisal, Gejiu and Qujing implemented revised wastewater tariffs, and Kunming and Qujing implemented revised water supply tariffs. Implementation of a wastewater tariff of no less than Y 0. 35/m3 by KDC is a condition of effectiveness of the loan/credit. It will be a condition of disbursement of the Lake Dianchi Basin Water Quality Recovery component that the BanklIDA receive (a) afinancialforecast relating to KDC's operations for fiscal year 1997, acceptable to the Bank/IDA, showing that KDC will meet the same financial performance targets required of it for fiscal year 1998 (para. 5.21), except that its operating revenues in fiscal year 1997 can be defined as revenues from operational and nonoperational sources; and (b) written confirmation that all wastewater tariff increases included in the forecast referred to above have been approved by YP. The previous and revised (where applicable) tariffs are set out in Table 5.1 below. TABLE 5.1: WATER AND WASTEWATER AVERAGE TARIFFS Utility Previous Tariffs Revised Tariffs Gejiu Wastewater /a Y 0.30/m 3 Y 0.373 Kunming Water Y 0.33/m3 Y 0.63/mi3 Kunming Wastewater lb Y 0.08/m3 (industry only) (proposed) Y 0.35/n3i Qujing Water Y 0.65/mi3 Y 0.93m Qujing Wastewater La Y 0.00 Y 0.45/mi3 Za Based on 80 percent of water consumption. Z2 Based on 100 percent of water consunption of domestic and commercial users, with an overall average of about 80 percent. - 39 - Water Supply Agencies 5.15 Kunming Water Supply Company. KWSC posted modest losses between 1993 and 1995, principally because it had not been permitted to adjust its tariffs since February 1993. As a condition of appraisal, enhanced tariffs went into effect on January 1, 1996. The financial objectives set for KWSC by YP and Kunming Municipal Government (KMG) are for it to make reasonable contributions to its capital investment program, after meeting its cash expenses. Projections made up to the year 2002 show that KWSC would post surpluses if it is permitted to maintain the relatively high tariff recently put in place as a condition of appraisal. 5.16 Qujing Water Supply Unit. Prior to the establishment of the Qujing Water Supply Company in 1995, the departmental water supply operation had managed to generate sufficient revenues to cover approximately the operations and maintenance costs. However, as is the practice in departnental operations, no provision for depreciation was made. Had depreciation been included, the operation would have run at a loss. As a condition of appraisal, Qujing revised its water tariffs, increasing them by an average of 43 percent. TABLE 5.2: KEY WATER SUPPLY FINANCIAL AND OPERATING INDICATORS (Y million, unless noted; current prices) 1994 1995 1996 1997 1998 1999 2000 2001 2002 Kunming Water Supply Company Production capacity (million m3) 169 175 175 175 212 237 237 274 274 Water Sales (million m) 150 154 154 154 178 182 205 209 213 Operating Revenue 51.5 60.8 109.4 109.4 126.4 148.9 177.4 192.0 207.8 Operating Expense L 41.1 47.8 60.2 67.0 79.6 86.8 93.1 94.8 96.9 Net Income 0 -10.5 7.9 3.5 4.0 10.5 12.4 10.1 9.2 Average Tariff (Yuan per m ) 0.34 0.34 0.59 0.59 0.59 0.67 0.72 0.76 0.81 Operating Ratio (%) 1.01 1.14 0.86 0.91 0.91 0.86 0.82 0.80 0.79 Capital Expenditures 48.1 0 5.4 33.7 80.8 105.8 84.9 64.9 19.9 % Contribution to Investment 60.8 81.6 84.3 55.7 28.6 21.0 27.4 54.5 77.7 Debt Service Coverage (times) N/A N/A 16.2 10.0 6.4 5.4 5.2 1.4 1.6 Qujing Municipal Water Supply Unit Production capacity (million m3) 33 33 33 33 33 44 44 44 44 Water Sales (million m) 18 22 22 23 24 25 25 26 26 Operating Revenue 7.2 9.9 19.9 24.8 32.2 35.7 38.4 41.6 45.2 OperatingExpensela 5.3 6.5 8.2 9.2 10.1 16.8 18.0 19.3 20.7 Net Income 0.3 0.2 4.4 6.0 8.9 5.3 2.7 0 -2.5 Average Tariff (Yuan per m3) 0.40 0.42 0.77 0.93 1.16 1.23 1.31 1.39 1.48 Operating Ratio (%) 0.96 0.99 '0.75 0.68 0.61 0.71 0.78 0.87 0.95 Capital Expenditures - - - 20.6 78.0 60.7 22.2 22.4 - % Contribution to Investment - - 79.4 50.4 20.7 20.9 33.4 63.2 83.8 Debt Service Coverage (times) - - - 9.7 6.4 3.0 2.9 3.4 1.7 La Excludes depreciation. - 40 - 5.17 Assurances were obtained during negotiations that, commencing in fiscal year 1997, YP would cause KWSC to (a) generate revenues from its water supply operations sufficient to cover its operating and maintenance costs (before depreciation), increases in working capital, debt service, and 20 percent of the average capital expenditures made in a three-year period (the year preceding the reference year, the reference year itself, and the year after the reference year); and (b) incur no additional debt without the Bank Group's agreement, unless a reasonable forecast shows that it would have a debt service coverage of at least 1.3 times. 5.18 Assurances were obtained during negotiations that, commencing with Fiscal Year 1997, YP would cause QWSDC to (a) produce revenues from its water supply operations sufficient to cover its operations and maintenance costs (including depreciation), and the amount by which debt service requirements exceed the provision for depreciation; and (b) incur no additional debt without the Bank Group's agreement, unless a reasonable forecast shows that it would have a debt service coverage of at least 1.3 times. Wastewater Agencies 5.19 As the wastewater agencies, which evolved out of the cities' departmental wastewater operations, were established only in the latter phases of the project preparation cycle, no assessment of their past performance was possible. Based on the limited data available, it was determined that departmental wastewater operations were not able to meet their operating expenses, excluding depreciation, in 1994. As is the practice in departmental operations, no provision for depreciation was made. Had depreciation charges been included, their operations would have run at a greater loss. As no departmental revenue data was made available, the financial projections were developed from the net historical value of investments made in the wastewater sector. The financial objective set by YP for the newly-established wastewater entities is to achieve full cost recovery, and, if possible, generate some funds for future capital investment. 5.20 Prior to appraisal, the Bank/IDA received written confirnation from YP of the implementation of enhanced wastewater tariffs in Gejiu and Qujing; the former with effect from August 1995, and the latter, from February 1996. The salient features of the future finances of (a) the drainage units of (i) Gejiu Water Supply and Drainage Company; and (ii) Qujing Water Supply and Drainage Company; and (b) Kunming Drainage Company are highlighted in Table 5.3 below. The assumptions used in the financial projections and detailed operational and financial monitoring indicators are included in Annex 14. 5.21 Assurances were obtained during negotiations that YP would cause the wastewater entities of GWSDC, QWSDC, and KDC, commencing with fiscal year 1997 in the case of GWSDC and QWSDC, and fiscal year 1998 in the case of KDC, to (a) produce revenues from their wastewater operations sufficient to cover their operations and maintenance costs (including depreciation), and the amount by which debt service requirements exceed the provision for depreciation; and (b) incur no additional debt without the Bank Group's agreement, unless a reasonable forecast shows that the entities would have a debt service - 41 - coverage of at least 1.3 times. An understanding was obtained during negotiations that YP would arrange for the municipalities of Gejiu, Kunming and Qujing to transfer to their respective wastewater companies, quarterly, one quarter of the wastewater companies' annual estimates of their stormwater operations and maintenance costs.. TABLE 5.3: KEY WASTEWATER FINANCIAL AND OPERATING INDICATORS (Y million, unless noted; current prices) 1994 1995 1996 1997 1998 1999 2000 2001 2002 Gejlu Municipal Drainage Unit Wastewater Total (MIn3) - 5.6 9.7 9.9 9.9 9.9 11.1 11.1 11.1 Water Consumption (4m) 9.3 9.3 9.3 9.3 9.3 10.5 10.5 10.5 Wastewater Billed (m) - 5.6 7.4 8.2 8.2 8.2 9.2 9.2 9.2 Operating Revenue - 0.9 2.7 4.1 7.0 8.1 9.4 10.0 12.0 Operating Expense Za - 0.1 0.4 0.4 6.1 6.5 7.1 7.6 7.8 Net Income - 0.3 1.9 2.3 0.1 0.6 0.4 -0.1 1.1 Average Tariff (Yuan per M3) 0.16 0.37 0.50 0.85 0.98 1.02 1.08 1.30 Capital Expenditures - - 4.8 26.0 35.0 16.9 5.7 1.5 - Operating Ratio (%) - 0.62 0.32 0.23 0.79 0.74 0.78 0.84 0.79 Debt Service Coverage (times) - - - 5.2 1.4 1.6 1.9 2.0 1.5 Kunming Drainage Company Wastewater Total ) 3 - 157 157 178 182 199 204 208 WaterConsUmption*m) - 154 154 177 182 201 206 211 WastewaterBilled(m) - - 138 148 171 175 194 199 204 OperatingRevenue - - 24.2 90.2 124.4 151.6 182.5 205.0 211.6 Operating Expense La - - 36.3 53.3 57.0 123.9 131.5 139.7 148.4 Net Income - - -31.6 15.0 39.7 -17.1 -27.3 -31.7 -20.5 Average Tariff (Yuan per 3) - - 0.18 0.61 0.73 0.86 0.94 1.03 1.09 Capital Expenditures - - 105.6 353.7 496.2 349.3 139.1 21.8 Operating Ratio (%) - - 2.00 0.79 0.62 0.98 1.00 1.01 0.98 Debt Service Coverage (times) - - - 19.4 8.1 2.7 3.0 3.3 1.8 3Qujing Municipal Wastewater Unit Wastewater Total (Mm3) 3 - 16.4 21.9 22.9 23.8 24.6 25.3 26.0 26.7 Water Consumption (mA) - 20.6 21.5 22.4 23.3 24.2 24.9 25.6 26.2 Wastewater Billed (m) 16.4 17.2 17.2 19.3 20.1 20.7 21.3 21.9 Operating Revenue - - 7.4 8.3 9.3 10.3 11.2 13.2 14.4 Operating Expense la - 0.2 0.2 0.3 0.3 0.3 4.3 4.6 4.8 Net Income - -1.5 5.6 5.9 6.6 6.6 0 -2.7 -4.7 Average Tariff (Yuan per M3) - 0.43 0.45 0.48 0.51 0.54 0.66 0.66 Capital Expenditures - - - 9.3 10.3 54.3 80.7 38.7 15.7 Operating Ratio (%/6) - 7.74 0.25 0.22 0.20 0.18 0.73 0.93 1.07 Debt Service Coverage (times) - - - 38.0 21.1 6.7 2.6 2.6 1.3 la Excludes depreciation. 5.22 Assurances were obtained during negotiations that KWSC, QWSDC, KDC and the wastewater unit of Gejiu would prepare, before September 30, 1997, and in each of the following fiscal years, forecasts satisfactory to the Bank/lIDA, (a) to review whether they would meet the covenanted requirements set forth above in such year and the following fiscal year; and (b) to furnish the results of such reviews to the Bank/IDA. If any such review would show that a water and wastewater entity would not meet the requirements set out above, the entity would take all necessary measures, including adjustments to the structure of its tariffs and charges, in order to meet the requirements. - 42 - H. SOLID WASTE AND NIGHTSOIL MANAGEMENT 5.23 These services are municipal environmental services that have traditionally been funded from the general revenues of local governments. However, where individual users of the services have been identified, local governments have, as a policy matter, charged such users for the services provided. In Kunming and Qujing, only large industries are currently paying charges for solid waste disposal. Tariff rates are not published and charging appears to be based on negotiation. As a result, only a small part of the costs of providing the service is covered. 5.24 Kunming and Qujing have considered increasing their fees and charges, and have already approved higher charges for some parts of the services. The cost recovery objectives for solid waste and nightsoil services for Kunming and Qujing are to recover the full unit cost of collection and disposal where user identification and billing is economically feasible. The balance of the cost for providing these services would be met from the general revenues of the municipality. 5.25 During the implementation phase of this component the cities have indicated that they anticipate charging fees toward meeting their operating costs. During negotiations, assurances were obtained from YP that it would ensure that Kunming and Qujing Municipalities would each: (a) not later than July 1, 1997, complete a study of the fees and user charges needed for the recovery of the full costs of providing solid waste collection and disposal services to industrial and commercial users; the report of that study shall include a detailed, time-bound action plan, acceptable to the BanklIDA, enabling such recovery as of January 1, 1998; and (b) thereafter implement said action plan taking into account the BanklIDA 's comments thereon. 5.26 As these services have been decentralized to the district and subdistrict levels, and because the accounting systems, particularly at the lower levels, are weak, accurate costs of providing these services have been difficult to determine. The project, therefore, includes technical assistance and training to help develop appropriate accounting, including unit cost accounting, and management information systems for determining accurate unit costs of the services at the various stages, e.g., collection, transportation, treatment (in the case of nightsoil), and final disposal. With such information, the cities would then be in a better position to (a) assess the efficiency and cost effectiveness of the services; (b) price their services to recover the full economic cost where user identification and billing is economically feasible; and (c) judge whether the services, or parts thereof, can be further commercialized or privatized. 1. INDUSTRIAL POLLUTION CONTROL 5.27 As some of the priority pollution control subprojects are, by nature, not financially productive, the financial appraisal would focus on the long-term financial health of the enterprises. The key considerations in this assessment include the enterprise's development goals and strategy, product mix and market analysis, investment requirements and related financing arrangements, and projected financial performance in terms of profitability, - 43 - liquidity and debt servicing capabilities. The two subprojects (Kunming Chemical Fertilizer Factory and Kunyang Phosphate Fertilizer Factory) that Bank/IDA staff have already appraised meet the above financial criteria and therefore are considered financially viable. With a view to promoting prudent financial management, the agreed subproject selection criteria call for the entity to maintain a debt service coverage ratio of not less than 1.4 times after the proposed subproject has reached full production capacity. -44 - 6. ECONOMIC, SOCIAL AND ENVIRONMENTAL CONSIDERATIONS A. PROJECT JUSTIFICATION 6.1 As described in Chapter 2, the project derives from the CAS in its support of provincial efforts to substantially reduce pollution within the province, especially within densely populated urban areas, by improving environmental regulation and providing new models for the efficient organization and financing of urban environmental services. Specifically, the project would support: (a) the more aggressive use of user fees to shift the burden of pollution abatement to the polluter and induce waste minimization, and new organizational forms for wastewater providers, to allow improved management tools and to help minimize the cost of abatement; (b) expansion of sewerage services, hence a reduction in water pollution, within the boundaries of Gejiu, Kunming, and Qujing, thus protecting the urban environment and the health of their people; (c) increases in water supply in the cities of Kunming and Qujing, to meet the needs of growing urban populations; (d) the first municipal solid waste landfills meeting national standards in the cities of Kunming and Qujing, with consequent protection of local land and water resources and flaring landfill methane to reduce greenhouse gas emissions; (e) abatement of two important industrial point sources of pollution affecting Lake Dianchi in Kunming and a pollution control revolving fund to address less costly pollution abatement efforts and provide a model for other such funds; and (f) the provincial and municipal EPBs in their efforts to implement more effective regulatory instruments. B. ECONOMIC ANALYSIS 6.2 During project identification, it became clear that Yunnan and its cities needed substantial changes in policy and institutional structures along the lines described in the report China: Urban Environmental Service Management. Policy problems included urban environmental services priced too low to discourage waste generation or provide the financing needed to build, maintain, and operate services such as water supply and wastewater collection and treatment. Government bureaus providing the services lacked the - 45 - financial tools to develop effective tariff strategies or the operating autonomy needed to encourage managerial innovation. Gaps in environmental regulation were also apparent. Therefore, investment choices were made with a view toward maximizing the impact of policy and institutional innovation within the province. Specific investment choices within sectors and cities responded to long-run municipal government strategies to bring ambient environmental quality or service standards up to national guidelines. In the case of augmented water supply in Kunming and Qujing, and the avoided damage to Kunming's water supply, explicit benefit analysis was possible and undertaken. For the wastewater investments in Qujing and Gejiu and the solid waste handling and treatment investments in Kunming and Qujing, least-cost analysis to meet specified standards was used. Based on that analysis, city leaders made decisions on their short-run goals and investments. 6.3 City and Sector Choices. In urban environmental service provision, cities were included in the project based on the size of the population potentially benefiting from improved services and considering their value as models to other provincial cities. Yunnan has one very large city, Kunming, with an urban population of some 1.2 million, and 10 smaller cities, the largest of which has about 180,000 people. After reviewing potential investments in some five provincial cities, three were selected for further project development. Kunming was given the top ranking because of its size and the major water quality and supply problem it faces. The other two cities are of a size and economic strength akin to most Yunnan cities and their experience under the project will therefore be more readily transferred. Each of the selected cities had already prepared environmental improvement plans that outlined priority service needs, both in terms of the type of service and areas of the city needing service. Work with Bank Group missions confirmed the choice to extend sewerage systems and provide treatment and to build or substantially expand sanitary landfills as the next step in environmental protection. Additional water supply needs had also to be met if their growing urban populations were to have access to safe water. 6.4 Credit market constraints [described much more fully in the China Department's 1995 Capital Markets Sector Study (No. 14501-CHA)] leave unexploited abatement opportunities in economically and financial viable enterprises that currently have a high pollution impact. Yunnan Province therefore sought to use part of the loan to fund such investments. The Province agreed with the Bank Group on a selection process to identify the highest-impact polluters, a process that has identified two chemical fertilizer plants for process change investments that will increase profitability as they abate pollution. These plants both discharge high levels of pollutants to Lake Dianchi, and their cleanup is far less costly than providing municipal treatment services removing the same mass of pollutants. To provide for such opportunities in smaller enterprises, the Province also established a pollution control loan fund, initially capitalized at $10 million, for which it requested Bank Group support. 6.5 Ideally, sector interventions would have been chosen based on the comparison of intersectoral costs and benefits. Unfortunately, current methodologies do not permit high- confidence benefit estimates for the proposed wastewater investments in Qujing and Gejiu, nor the solid waste collection and treatment in any of the cities. In Kunming, the fact that - 46 - all wastewater discharges into Lake Dianchi, which also serves as a primary water source for the city, does permit a benefit estimate at a reasonably high degree of confidence. In that case, the cost of doing nothing different from current practice will have an impact on lake water quality that forces increased treatment costs and an early shift to new, and more expensive, water sources. Those costs serve as a proxy for part of the pollution damage and averting them more than justifies the proposed investments. No attempt was made to value the aesthetic or health impacts that might be additional to the increased water supply costs. 6.6 Organizational and Financing Alternatives. Of the proposed investments, the solid waste will be managed by municipal environmental sanitation departments; the water by an existing municipally-owned enterprise; the wastewater by newly formed municipally- owned enterprises; and the fertilizer plant pollution abatement by the enterprises themselves. In each case, the enterprises or activities were judged unable to effectively compete for private financing at this stage in their development, though institutional reforms under the project will help them attain that goal in the future. None have a history of sufficiently profitable operation to attract private financing. In the case of the water and fertilizer enterprises, the lack of profits can be attributed to the fact that they continue to fall under a tightly controlled output price regime, while facing a largely deregulated input market. For water, the project commits the municipalities to regulating prices such as to allow a positive return. The fertilizer enterprises will shift production to unregulated markets, thus partially escaping the regulatory burden. The wastewater enterprises were created to provide a managerial structure facilitating efficient operation, something absent in their previous government bureau form. For wastewater, the municipalities have committed to a price structure that results in break-even operations. Only solid waste remains a government bureau operation. Here, the current collection operation works sufficiently well that emphasis was placed on providing technical assistance to properly cost the operation and allow adequate rates for commercial, industrial, and other system users. In all cases, a project goal is to help create the preconditions for greater nongovernmental involvement in service provision. 6.7 Wastewater. The economic analysis of wastewater collection and treatment programs generally presents challenging analytical problems on the benefit side. The range of impacts, on amenity, health, and commodity production uses, can be described but usually not easily quantified. However, in this project Kunming's Dianchi Lake water use for municipal supply creates a condition whereby pollution damage can be modeled and impacts quantified with a reasonable degree of confidence. That analysis was undertaken. In the case of Qujing and Gejiu, the least-cost analysis was linked to alternative water quality outcomes. Although municipal leaders originally set a goal of reaching Class IV surface water, the results of the least-cost analysis persuaded them to value the alternative goal of Class V. Details are discussed in Annex 15, with a brief summary given below. (a) Kunming. Because Dianchi Lake supplies half of Kunming's water, and because Kunming's pollution is causing lake water quality to deteriorate in a well-understood way, it is possible to value the damage from the pollution in terms of the increased cost of treated water supply from the lake, or the cost of going to new sources outside the lake. The proposed wastewater - 47 - treatment interventions under the project would treat part of the waste stream, reducing total pollution inflow. That impact can again be modeled and the net effect on Dianchi water quality, hence pollution damage, determined. Other impacts, including those on recreational, health and amenity values, also exist, but estimates of those values have a lower degree of confidence and have not been included in the analysis. The Dianchi lake water quality model identified phosphorus loads as limiting for this important raw water source. The economic analysis therefore concentrated on investments that would control that pollutant, and compared damage in a "do nothing" scenario of operating existing infrastructure and that currently under construction, under current practices, to damage with the reduced loads under the project. In the "do nothing" scenario, pollutant loads grow rapidly (see Annex 7, Figure 1), forcing first higher treatment costs for potable water, then, by 2002, investment in major new sources of supply. The project would allow sustained use of Lake Dianchi as the primary water source over the 25 year analytical horizon. The analysis of the water supply impact shows that the proposed wastewater investment would avert damage with a net present value of Y 2,761 million, at a net present value cost of Y 1,719 million, assuming a 12 percent discount rate. This result is most sensitive to the need for investment in new sources of supply. If that need were delayed five years, and costs dropped 10 percent, the averted damage would fall to Y 2,066 million, still well above the sub-component cost net present value. However, measured deterioration has been so rapid that even a five-year delay is highly unlikely, and were it to occur, project costs themselves would drop, as advanced water treatment could also be delayed. (b) Qujing. Qujing wastewater discharges to the Nanpanjiang River, thence downstream to the Pearl River. Wastewater pollution of the Nanpanjiang has already forced some downstream farmers to abandon this source of irrigation and drinking water and shift to more expensive groundwater pumping. Continued failure by Qujing to capture and treat wastewater will result in ever more rural communities losing their primary source of water. Qujing authorities therefore requested their design institutes to perform a least-cost analysis of treatment options that would maintain the Nanpanjiang at Class IV water quality, suitable for agricultural and industrial use. The treatment options considered include oxidation ponds, and three variants of activated sludge processes. The authorities judged this cost too high, requesting a separate analysis on treatment to reach Class V, suitable for irrigation but few other uses. Here an intermediate stage activated sludge process was selected that can readily be incorporated in the longer term proposals. (c) Gejiu. Gejiu wastewater discharges to Gejiu Lake, from which it serves as an irrigation water source, despite the below Class V quality of the water. - 48 - As in Qujing, the authorities initially sought treatment that would restore the lake to Class IV. Again, three treatment processes were considered, with two-stage activated sludge again least-cost. However, as with Qujing, this was deemed unaffordable and an intermediate stage biological system capable of incorporation into longer term proposals was again chosen. Despite the lower treatment level, Gejiu Lake water quality will be raised by discharging the treated Gejiu effluent downstream of the lake. 6.8 Water Supply. Under the project, the water supply for Kunming will be augmented by some 65 m3/year, supplying an estimated 500,000 new connections as coverage increases and urban growth continues. The average economic incremental cost of the new supply has been estimated at Y 0.60/m3. Two willingness-to-pay surveys, conducted at different times with different methodologies, showed 89 percent of households willing to pay at least Y 0.71/mr3 for potable water supply in one case and 72 percent willing to pay at least Y 0.60/mn3 in the other. The average tariff was raised from January 1, 1996, to above Y 0.60/m3 with no noticeable reduction of demand. The true test of consumer response to the new tariff will come in the summer, high demand, season. However, all the evidence supports the conclusion of a positive net present value (NPV) for this investment. More precise quantification would need evidence on the shape of the demand curve at prices above Y 0.60/m3, and that does not exist. 6.9 Solid Waste. Solid waste landfill options are also discussed in detail in Annex 15. Here, initial choices for both Kunming and Qujing were among potential solid waste disposal strategies that included recycling, composting, incineration, and landfilling. Recycling plays an active role in each of the cities, capturing more than 5 percent of the municipal waste stream that can be profitably recycled. The industry is highly competitive, with a combination of state-owned and private firms providing services, and little scope for additional useful municipal intervention. Composting, to recycle organic materials, has been tested in Kunming. Costs have been high and markets have not supported product sales. A major problem for composting and incineration is that over half of the waste stream is inorganic, with coal ash the dominant inorganic component. Analysis in other cities with similar waste streams has shown incineration to be substantially more costly than landfill. Based on that work, the two cities have elected to use landfilling to handle their municipal solid wastes. 6.10 The cities have accepted that such landfills must comply with national standards, so made no attempt to compare the cost of adding leachate and gas collection with the damage that would ensue from their absence. Given the long-run risks inherent in unprotected landfills, the Bank/IDA accepted without additional impact evaluation the municipal judgment on the need to provide leachate and gas collection and treatment. The least-cost site and design had, as one of the main decision criteria, minimization of the joint cost of transport and land acquisition. As land acquisition cost correlates very strongly with resettlement impact, this criteria also tends to minimize resettlement. 6.11 Industrial Pollution ControL The industrial pollution control component has two subcomponents, the first being direct investment in two chemical fertilizer plants producing - 49 - a very high proportion of the phosphorus loads in Dianchi and the second a pollution control fund targeting small investments and small-scale enterprises. The two fertilizer factories alone produce 16 percent of all available phosphorus discharged into the Waihai and 73 percent of the total industrial phosphorus loads. Their existing wastewater treatment facilities lack adequate design capacity for their loads and frequent equipment breakdowns reduce treatrnent still further. Price controls on much of their output force them to operate at a loss on those products, made up through government subsidies. The proposed investment in the factories (detailed in Annex 12) would radically change their production processes, intermediate, and some final outputs, allowing profitable operation and much cleaner production. Phosphorus discharges would drop from 93 tons annually to below 2 tons, and those of other pollutants would also decline. The estimated economic rates of return for the plants are 24 (Kunyang Phosphate Fertilizer Factory) and 36 (Kunming Chemical Fertilizer Factory) percent, independent of any continued environmental damage. The latter is too low to reflect in the lake water quality model, so the overall returns are judged to be positive. These investments represent win-win solutions unavailable through normal financing mechanisms due to the continued downward pressure on profits through price controls. The fertilizer price control policy itself, and possible overuse of fertilizer resulting from that policy, are national issues with possible repercussions on Dianchi Lake pollution loads, but are not addressed in this analysis. The second subcomponent-a subloan facility-would provide financing to assist small-scale enterprises within the Dianchi Basin to control pollution through waste minimization measures, modifications or renovations to existing plants to reduce waste outputs, or recycle waste generated during production. C. ENVIRONMENTAL IMPACT 6.12 The project would contribute significantly to the improvement of water quality in heavily populated areas of Yunnan. In particular water quality in Dianchi Lake, the principal focus of the project, will be substantially improved by a comprehensive program of interventions based on removal of phosphorus from wastewater discharges to the lake. The proposed project would reduce phosphorus loads to approximately half the "do nothing" loads, and two-thirds of current loads. This will arrest the eutrophication of the lake, which is reaching a critical stage, in particular in terms of water treatment problems, and will permit the sustained use of the lake for water supply, thereby avoiding costly import of water from distant catchments. The Environmental Assessment summary in Annex 7 provides details. 6.13 Although the balance of the environmental impact is substantially positive, potential adverse impacts from waste disposal and industrial pollution control components require the classification of the project as Category A in terms of the Operational Directive on Environmental Assessment (EA). Accordingly, a comprehensive EA has been prepared covering all project components and has been reviewed by the Bank/IDA and approved by NEPA. The complete EA report is in the project files (Annex.16) and a summary is given in Annex 7. Appropriate mitigation measures for the potential, but minor, negative project impacts have been identified in the EA. The resettlement impact of the project will be - 50 - managed through a resettlement action plan that is in the project files and is summarized in Annex 6. D. AFFORDABILITY AND POVERTY ASSESSMENT 6.14 The affordability issue arises only with the water and wastewater components of the proposed project. The industrial pollution interventions will proceed only if the enterprises can demonstrate that they will remain financially sound after the investment, and solid waste charges will rise only for industrial and commercial users of the new landfills. Affordability of the new water and wastewater systems was tested against current consumption patterns and average income of the poorest 10 percent of the urban population in the three cities. The proposed first-year tariff would consume an average of less than 2 percent of the income of the poorest 10 percent of the population, with wastewater fees based on 80 percent of water used in Gejiu and Qujing, and 100 percent in Kunming. Indeed, because the poor are less likely than other households to have water piped to the house (using standpipes instead, for which no fees are currently charges), even the 2 percent figure represents an upper bound. 6.15 The affordability of the higher tariffs anticipated in later years will clearly depend on changes in real income among the urban poor over time. In real terms, within five years the tariffs will increase to as much as 50 percent above the 1996 rate. With no change in real income and no consumption effect, the average water and wastewater bills would increase to about 3 percent of average income for the poorest 10 percent of households. However, over the past decade, the real incomes of the urban poor have risen in line with overall income increases. If that pattern, and overall real personal income growth, continues near current rates, water and wastewater tariffs as a percentage of personal income would climb only slightly above the first-year level. In absolute terms, the increase would be fully offset by first-year income gains. E. PROJECT RISKS 6.1 The proposed project faces or mitigates a variety of risks. Those risks are here grouped under three general headings: implementation and operational risks, regulatory risk, and risks to long-term sustainability. Each type of risk is discussed in detail in Annex 15. Those findings are summarized below. (a) Project financing presents a risk due to the need for municipal counterpart funding. Among the three cities, Qujing has committed the highest percentage of its on-budget resources to the project, with annual project- related expenditures reaching 47 percent of projected on-budget revenues in 1999. However, as noted in para. 5.12, on-budget revenues represent only one of many revenue sources by which the cities can support projects. The provincial finance bureau has undertaken an independent analysis of Qujing's ability to finance the planned works, based on their knowledge of the broader financial resources available to the city, and judged the plans feasible. - 51 - (b) The shift to new organizational forms of autonomous utilities managed as enterprises for wastewater management is critical to project success. Slow institutional innovation therefore becomes a project risk Each city is well along in the process, having successfully completed the transformation to an enterprise. In Kunming, wastewater assets have been revalued and that work is being reviewed by the State Asset Bureau, the last step before formal transfer to the books of the wastewater enterprise. Qujing and Gejiu have already transferred revalued assets to wastewater entity books. The groundwork is thus laid for introduction of the new accounting and management information systems needed to efficiently guide the work of these enterprises. In the long run, efficient operation will also depend on cities honoring the autonomy of the enterprises in financial, personnel and other management decisions. This element of risk cannot be divorced from larger efforts within the economy to reform government relations with the state-owned enterprise sector. These issues have recently received thorough analysis in the State-Owned Enterprise Reform sector study (currently in green cover). (c) The industrial pollution control component creates credit risk borne by the provincial government. Under the industrial lending, whether directly to the enterprises or through the pollution control fund, provincial government would be responsible for repaying any loan that an enterprise could not repay. To minimize this risk, an essential element of the project appraisal, which is subject to review and confirmation by the provincial finance bureau, is analysis of the firm's financial strength and the risk it faces in its input and output markets. The firm must meet a 1.4 debt service coverage requirement over the project life, providing that margin of safety to the government exposure. Furthermore, the loans are being made at no less than 150 basis points over the standard interest rate for LIBOR-based US dollar single currency loans, with the enterprise bearing the foreign exchange risk. With administrative fees of approximately 50 basis points for the two direct industrial loans, the provincial government will capture at least 100 basis points to cover their risks. In addition, they will enjoy the use of loan and interest payments in the interval between collection from the enterprise and repayment to the Ministry of Finance. Administrative costs are higher for the pollution control subloans, probably approaching 150 basis points, and this would be a revolving account, obviating the premium from early recapture of loan funds. Here, any risk premium would have to be added to the 150 basis points, or the risk absorbed by the provincial government. They have indicated a wish to hold the premium at the 150 basis point level, while seeking additional performance guarantees from the local government in which any benefiting enterprise is located. (d) Operational risks arise in the industrial pollution control component with the failure (documented in China: Urban Environmental Service - 52 - Management) of many enterprises to operate their pollution abatement facilities. The analysis addressed the risk that pollution abatement goals would not be met. However, the proposed investments involve process changes in which little of the treatment element can be isolated from the overall production process. The production process itself is inherently much cleaner than the original process, leading to the pollution control gains expected. (e) Major policy risks include possible resistance to timely implementation of the new tariff structure for water and wastewater. Failure to implement agreed tariffs would seriously impair the performance incentives of the utilities and their ability to finance ongoing investment programs. To mitigate this risk, a tariff increase before negotiation is being required and tariffs will be a supervision focal point. The latter will be aided by the fact that service providers are required to present annual accounts showing whether existing tariffs have met their financial needs and to project tariff levels needed in the following year. (f) Significant regulatory risks also arise because the pollution control results anticipated for the surface waters depend not only on sewerage technologies successfully constructed and operated by the cities. Many important pollutants must be controlled at source by the industries generating them. A failure to do so could threaten either the sewerage infrastructure or the quality of the various lakes and rivers, depending on enterprise discharge points. The principal means of mitigating this risk is a strong regulatory regime. The importance of this work was recognized during preparation of the project and is addressed under the technical assistance component (Ann 2). (g) The major risks to long-term sustainability are financial and regulatory, and have been discussed above. Additional risks arise from outside of the cities themselves and center on polluting inputs to the various water bodies from areas beyond municipal control. These additional pollutants could overwhelm any benefit that would otherwise be realized by the planned investments. In the case of the network of waterways within the cities, this risk is not great. Most of their watersheds are small, pollutants are of local origin, and their control will be a function of the proper operation of the project. However, Dianchi also suffers from nonpoint source pollutants, particularly agricultural, and substantial nutrient loads from upstream agriculture as well as poorly regulated township and village industrial enterprise pollution discharges. Satisfactory abatement of those polluting sources will depend on the actions of a large number of political jurisdictions, most of which would suffer no immediate harm from continued discharges to lake tributaries. The growing appreciation within China of the value of water as a resource and of the importance of water pollution abatement offers the best hope of inducing compliance with the - 53 - current industrial regulations. A similar appreciation of the risks from agriculture has yet to appear, and must become an element of long-run lake and river basin quality control. - 54 - 7. AGREEMENTS REACHED AND RECOMMENDATION 7.1 The following assurances were obtained at negotiations: (a) YP would implement the Institutional Development and Training component in accordance with a schedule acceptable to the Bank/IDA and discuss and agree any revisions with the Bank/IDA (para. 3.4); (b) Kunming Municipality would onlend part of the proceeds to Kunming Chemical Fertilizer Factory and YP, part of the proceeds to Kunyang Phosphate Fertilizer Factory, on terms and conditions satisfactory to the Bank/IDA (para. 3.12); (c) The municipalities would onlend part of the loan/credit proceeds to their respective water and wastewater agencies, on terms and conditions satisfactory to the Bank/IDA (para. 3.12); (d) YP would onlend to participating enterprises, on terms and conditions satisfactory to the Bank/IDA (para. 3.14); (e) YP would allocate to EPCSL about Y 42 million over the three fiscal years commencing 1997, depositing annually to the account of EPCSL at least Y 14 million by June 30 of each such year (para. 3.14); (f) YP would carry out or cause to be carried out the resettlement of persons affected by the project in a manner and according to the Resettlement Action Plan satisfactory to the Bank/IDA (para. 3.33); (g) YP would cause the project agencies to carry out, in a manner satisfactory to the Bank/IDA, the mitigation plans specified in the Environmental Impact Assessment (para. 3.35); (h) Each implementing agency would prepare quarterly project progress reports; YEPO would then send a consolidated report to the Bank/IDA by the thirtieth of the following month, commencing July 1996 (para. 3.36); (i) A mid-term review of project progress would be undertaken by June 30, 1999 and the agreed recommendations implemented (para. 3.38); (j) YP would maintain YEPO and the municipal project offices throughout implementation, with functions and responsibilities satisfactory to the - 55 - Bank/IDA, and with competent staff in adequate numbers for the duration of the project (para. 4.3); (k) YP would carry out, or cause to be carried out, (i) time-bound action plans for environmental management improvements, and (ii) the time-bound environmental management action plan for the Kunming Pesticide Plant (para. 4.12); (I) YP would arrange for the following annual audits to be submitted to the Bank within six months after the end of the financial year: (i) audit of the project accounts maintained by YEPO, by the sanitation departments of Kunming and Qujing, by the responsible bureaus of Jinning and Chenggong; (ii) audit of the Special Account; (iii) audit of statements of expenditure (SOE); (iv) audits of the financial statements of KWSC, KDC, QWSDC, GWSDC, and EPCSL (para. 5.7); (m) Commencing with Fiscal Year 1997, YP would cause the Kunming Water Supply Company to (i) produce revenues from its water supply operations sufficient to cover operations and maintenance costs (before depreciation), increases in working capital, debt service, and 20 percent of the average capital expenditures made in a three-year period (the year preceding the reference year, the reference year itself, and the year after the reference year), taking actions to meet requirements; and (ii) incur no additional debt without the Bank/IDA's agreement, unless a reasonable forecast shows that it would have a debt service coverage of at least 1.3 times (para. 5.17); (n) Commencing with Fiscal Year 1997, YP would cause the Qujing water supply entity to (i) produce revenues from its water supply operations sufficient to cover operations and maintenance costs (including depreciation), and the amount by which debt service requirements exceed the provision for depreciation; and (ii) incur no additional debt without the Bank/IDA's agreement, unless a reasonable forecast shows that the entity would have a debt service coverage of at least 1.3 times (para. 5.18); (o) Commencing with fiscal year 1997 in the case of Gejiu and Qujing, and fiscal year 1998 in the case of Kunming, YP would cause the wastewater entities of Gejiu, Kunming and Qujing to (i) produce revenues from their wastewater operations sufficient to cover operations and maintenance costs (including depreciation), and the amount by which debt service requirements exceed the provision for depreciation; and (ii) incur no additional debt without the Bank/IDA's agreement, unless a reasonable forecast shows that the entities would have a debt service coverage of at least 1.3 times (para. 5.21); - 56 - (p) The water supply and wastewater entities would prepare, before September 30, 1997, and in each of the following fiscal years, forecasts satisfactory to the Bank/IDA, (i) to review whether they would meet the covenanted requirements set forth above in such year and the following fiscal year, and (ii) to furnish the results of such reviews to the Bank/IDA; if any such reviews would show that the entity would not meet the requirements set out above, the entity would take all necessary measures, including adjustments to the structure of its tariffs and charges, in order to meet the requirements (para. 5.22); and (q) YP would ensure that Kunming and Qujing Municipalities each: (i) not later than July 1, 1997, complete a study of the user fees and user charges needed for the recovery of the full costs of providing solid waste collection and disposal services to industrial and commercial users; the report of that study shall include a detailed, time-bound action plan, acceptable to the Bank/IDA, enabling such recovery as of January 1, 1988; and (ii) thereafter implement the said action plan taking into account the Bank/IDA's comments thereon (para. 5.25). 7.2 The following are conditions of loan/credit effectiveness: (a) Execution of subsidiary loan agreements between the project municipalities and their water and wastewater utility companies, satisfactory to the Bank/IDA (para. 3.13); (b) Implementation of a wastewater tariff of no less than Y 0.35/m3 by KDC (para. 5.14). 7.3 The following are conditions of disbursement on the respective components: (a) Approval by the Bank/IDA of operational regulations for EPCSL, and the execution of an acceptable financial agency agreement between YP and a bank for subloan processing (para. 3.25); (b) The execution of acceptable subsidiary loan agreements between: (i) Kunming and Kunming Chemical Fertilizer Plant, and (ii) Yunnan and Kunyang Phosphate Fertilizer Plant would be conditions of disbursement for the loan/credit proceeds allocated to these investments (para. 3.25); (c) Signed contracts, acceptable to the Bank/IDA, between YP and consulting firms, for institutional and financial technical assistance, construction supervision services, and sector institutional strengthening with respect to the Kunming Drainage Company and the Kunming Water Supply Company (Packages A and B) (para. 3.25); and - 57 - (d) A financial forecast of KDC's operations for fiscal year 1997, acceptable to the Bank/IDA, together with written confirmation that all wastewater tariff increases included in the forecast have been approved by YP (para. 3.25). 7.4 With the above assurances, the proposed project would be suitable for a Bank loan of $125 million for a period of 20 years, including 5 years of grace, at the standard interest rate for LIBOR-based US dollar single currency loans, and an IDA credit of SDR 17.4 million ($25 million equivalent) at standard terns with 35 years' maturity. The borrower would be the People's Republic of China. - 59- ANNEX I ANNEX 1: BACKGROUND TO YUNNAN PROVINCE AND PROJECT CITIES 1. Yunnan Province is located in southwest China and is bordered, clockwise from the north, by the following: the Provinces of Sichuan and Guizhou, Guangxi Zhuang Autonomous Region, the countries of Viet Nam, Lao PDR and Myanmar, and Tibet Autonomous Region. The northwestem area has a temperate climate, being dominated by the southeastern Himalayas, where the upper reaches of three great rivers (the Jingshajiang, which discharges to the Changjiang [Yangtze]; the Lancangjiang [Mekong]; and the Nujiang [Salween]) flow southward barely 80 km apart. In contrast, the southern areas are tropical, while central and eastern areas comprise a plateau of red earth and lake basins at an elevation of about 2,000 m, and have a subtropical climate. The source of the Nanpanjiang (Pearl River) is in the northeast of the Province. The average annual rainfall is between 800 and 1,000 mm, with low precipitation in the northwest, high in the southeast; 60 percent of the rainfall occurs from June to August. The average temperature is 8 to 170C in January; 1 I to 29
Группа Всемирного банка · Staff Appraisal Report
China - Yunnan Environment Project
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