Ukraine - Ukraine Highway Project

Report No. PIC4318 Project Name Ukraine-Ukraine Highway Project Region Europe and Central Asia Sector Transportation Project ID UAPA9110 Borrower Ukravtodor, guaranteed by the Republic of Ukraine Implementing Agency Ukravtodor Mr. Victor Guts, President 9 Fizkultura Street, Kiev, 2005 Fax 227 71 93 Date PID Prepared September 4, 1996 Projected Appraisal Date July, 1997 Projected Board Date July, 1998 Country and Sector Background 1. Country Situation: Ukraine, with a population of 52 million people with an estimated per capita income of US$1,632 in 1995 and rich agricultural land, has the potential for rapid economic development. However, the dissolution of the centrally planned economy has proceeded at a slow pace, and the disruption of the economic links associated with independence has led to a 50 percent decline in output since 1990. Inflation rose sharply during this period, reaching 65 percent per month in the last quarter of 1993. Since that time, stabilization measures have reduced the level of inflation to 4-5 percent per month at present. Also, starting in 1995 the Government began taking serious steps toward reform of the economy through improvements in its macro-economic structure, privatization and decentralization, and the decline in output now appears to have stopped. The exchange rate has been unified, and convertibility for most purposes has been established. An open trade regime has been put in place except for a few commodities, and subsidies for energy, transport, and housing rents have been reduced or eliminated. Also, privatization has begun, but overall progress has been slow. 2. Road Network: The national road network consists of 167,802 km of roads divided into: Federal Roads- 12,486, National Roads- 18,6, Regional Roads- 22,585, and Local Roads- 114,108, with hard surfacing on 69 percent of the entire public road network. The overall road network generally appears adequate for the present traffic levels, with a road density considerably higher than in Russia, reflecting Ukraine's higher population density and more intensive level of agricultural production. Since independence in 1991, financing available for road maintenance has declined, resulting in a buildup in deferred maintenance requirements and declining conditions of the road network. Also, quality control has been inadequate to assure good workmanship, and the use of inferior bitumen has also contributed to the declining road conditions. If allowed to deteriorate further, the increased cost in terms of increased  vehicle operating costs and highway reconstruction will be a major burden on the economy. 3. Road Institutions: In September 1994 the Road Corporation, also called Ukravtodor, was established as a State corporation, with responsibility for both road policy and executive functions for road maintenance and construction. The new organization was created by transforming the previous Road Department of the Ministry of Transport into an independent agency reporting directly to the Cabinet of Ministers, thereby removing these functions from the Ministry of Transport. In late 1995, this action was partially reversed when Ukravtodor was put back under the Ministry of Transport. Ukravtodor remains as a State corporation with its own Board of Directors, with authority over all of the previous road organizations, including the Oblast Offices, the several road and bridge construction organizations, the organizations responsible for the supply of road building materials, and the research and design institutes, some of which are in the process of being privatized. 4. Sector Problems: The most serious problems facing the road subsector are the reduction in financing available for financing road maintenance caused by the slowdown in economic activity related to the breakup of the Soviet Union, and the need for improving the technical competence and institutional capacity of the road maintenance organizations. Financing for the national road network comes from a Road Fund financed by an enterprise turnover tax, a fuel tax, contributions from the central budget, and miscellaneous smaller taxes and fees. While the Road Fund still provides a substantial level of financing compared to other CIS countries, the amount is substantially less than was available before Independence and only about 40 percent of what Ukravtodor estimates is needed to maintain the network adequately. Also, 85 percent of the taxes collected for the Road Fund are collected by the Oblast organizations, which leads to difficulties in allocating resources to the Oblasts based on need, and in the ability of the central Ukravtodor administration to exercise effective control of the Oblast operations. 5. The technical and institutional problems include the lack of adequate inspection and enforcement of the road maintenance and construction standards. This is due in large part to the previous organizational arrangements that did not provide for separation of responsibilities between the construction companies and the institutions responsible for enforcement of the standards. This led to poor construction practices and inadequate materials, resulting in road surfaces of poor quality. Ukravtodor was aware of the need for an improved organizational structure, and an internal study was carried out in 1995 that led to the privatization of some of the construction companies. Also, repaving technology has not kept up with recent developments, the equipment used in the maintenance and construction work is often not up to an adequate standard, and the bitumen and other materials used are of inferior grades, leading to the need for more frequent resurfacing than should be necessary. Resolution of these problems holds the prospect of substantial improvements in efficiency in the use of Road Fund resources. -2-  6. Another problem for the road sector is the poor level of traffic safety due to excessive speed traffic limits, insufficient road markings, failure to eliminate accident black spots, and inadequate coordination between the various organizations with responsibilities in this area. Government and Bank Strategies 7. The Government has only recently begun to make the transition to a market economy, with reforms starting in October 1994, and does not seem to have a clearly articulated Government policy other than the general objectives of stabilization, making the transition to a market economy, and economic recovery. 8. The Bank's strategy for Ukraine is to support Ukraine's efforts to accelerate structural reforms, and to promote efficient investments in high priority sectors in order to complete the transition of the country to a market economy, accelerate the rate of economic growth, and increase efficiency. This will require strengthening key financial institutions, accelerating privatization, expanding the openness of the policy environment, rehabilitating Ukraine's physical infrastructure, and extending the social safety net and delivery of social services. This project is consistent with that strategy since an efficient and functional road network is essential for the attainment of accelerated economic growth. The project's expected high economic rate of return would indicate that this investment ranks extremely high on the scale of investment priorities as compared to other investment choices. Also, as the first highway project in Ukraine, it will address urgent technical and institutional issues that will have an important effect on the sector's future operations and costs. Project Objectives 9. The project would have the following objectives: (i) to help preserve the Ukrainian national road network by expanding and improving the quality of road maintenance operations to reduce transport costs; (ii) to increase the efficiency of road maintenance operations through the use of improved materials, equipment and repaving techniques, better organizational arrangements, the use of economic analysis for the planning of road maintenance, and the use of competitive bidding procedures for periodic maintenance operations; (iii) to assist in assuring an adequate level of financial support for road maintenance through financing for the project and through a review of the needs of the system and the possible means of meeting those needs through appropriate road user charges; (iv) to assist in developing an effective private road construction and engineering industry; and (v) to improve road safety. Project Description 10. The proposed Highway Project would have the following components, designed to accomplish the above objectives: (i) Road Rehabilitation of the most important parts of the State road network, including surface dressings, overlays, reconstruction and -3 -  elimination of traffic bottlenecks and accident black spots, at an estimated cost of US$244.5 million; (ii) Technical Upgrading through the introduction of improved design and materials standards, the introduction of a Pavement Management System (PMS) for carrying out economic evaluations of alternative maintenance solutions, the use of competitive bidding procedures for periodic maintenance, improved quality control and an expanded program of pavement research, the provision of modern laboratory equipment to support the quality control and research program, and training for the evolving private road construction industry for a total of US$ 3.5 million; (iii) Institutional Improvements through the provision of technical services to introduce modern cost accounting practices, office equipment, exchange programs for Ukravtodor to become familiar with organizational arrangements and maintenance techniques in other countries, and for a study of the required level of financing needed to maintain the road network and possible financing and collection mechanisms for obtaining it for a total cost of US$ 1.5 million; (iv) a Road Safety Program, including equipment, technical assistance, and training for improved traffic management, vehicle inspection, improved road markings, and black spot identification and analysis for a cost of US$ 1 million; and (v) Support for One Oblavtodor to serve as a model at the Oblast level, including civil works for repaving on a competitive bid basis (US$ 5.0 million), laboratory equipment for the local branch of the Design Institute needed to assure adequate quality control at the Oblast level (US$ 0.5 million), routine maintenance equipment (US$ 2.0 million), and technical assistance for improving the organizational arrangements in the Oblast, for the extension of an adequate data bank and Pavement Management System (PMS), support for the introduction of adequate quality controls and material standards, introduction of improved technology including the use of emulsions, establishing an adequate accounting system, support for introducing competitive bidding procedures, and training in support of all of these improvements and for the local road construction industry (US$ 1.0 million), for a total cost of US$ 8.5 million. The project cost estimate also includes physical contingencies as well as price contingencies calculated on the basis of estimated worldwide inflation over the project period for a total of US$ 45.0 million. Project Financing 11. The total project cost would be US$304 million. The World Bank would finance US$200 million, equal to 67 percent of total project costs, and the Government would provide US$100 million. Grant financing would be obtained from the EU, Germany, Japan and the Netherlands for the technical services components at a total cost of US$ 4 million. The World Bank loan would be made to the Ministry of Finance, with on- lending to Ukravtodor. The Government contribution, and the funds for repayment of interest and principal on the loan, would be made available - 4 -  from Ukravtodor's budget, including resources available to Ukravtodor from the Road Fund. Project Implementation 12. The project would be implemented by Ukravtodor over a three year period. A Project Coordinator supported by a small staff and reporting directly to the First Deputy Chairman of Ukravtodor would be responsible for project management and coordination. Ukravtodor would carry out the road rehabilitation component through contracts with qualified independent design firms on the basis of a review of competitive submissions and with independent local and international construction firms on the basis of competitive bidding procedures. Project Sustainability 13. Project sustainability is likely given the Government's awareness of the importance of the road network to Ukraine's future economic viability. Also, budget constraints appear to be less severe than in some other CIS countries, with the existence of a viable Road Fund that is likely to continue to expand (this will be carefully assessed during project preparation). Also, cost savings that should result from the introduction of improved technology would further relieve the budget limitations. Training of both Ukravtodor personnel and the private contractors would help to provide an understanding of the new methodologies, thus increasing the chances for sustainability. And the technological improvements to be introduced would likely be well received and adopted when they prove their effectiveness. Benefits and Risks 14. The principal benefits would be: (i) avoidance of costly reconstruction expenditures at a later date through more timely maintenance; (ii) reduced transport costs through lower vehicle operating costs; (iii) improved efficiency in the operations of Ukravtodor; (iv) improved financial support for future road maintenance operations; (v) reduced road accidents through the introduction of a Road Safety Program; and (vi) development of an effective private road construction and engineering industry. 15. The principal risks are: (i) Ukravtodor's ability and willingness to absorb all of the improved practices to be introduced such as competitive bidding, cost benefit analysis and improved quality control; (ii) an adequate level of financial support from the Road Fund; and (iii) possible diversion of resources for new road construction that would more appropriately be used for maintenance. A careful assessment will be made during preparation to be certain that Ukravtodor is willing to adopt the new methodologies, and is willing to give priority to maintenance over new construction. It is likely that the Ukravtodor personnel are able to absorb the new systems, given their level of training, and concerted efforts will be made during project implementation to reinforce these abilities through additional training as may be required. The prospects for an adequate level of financial support would be improved by the inclusion of a study of possible road user charges during project preparation, and by project conditionality - 5 -  relating to the implementation of its recommendations. Lessons Learned from Past Operations in the Sector/Country 16. The proposed project will be the first highway operation in Ukraine. However, the Bank has had considerable experience in financing highway projects in other parts of the world, including Eastern Europe, and is financing highway rehabilitation and maintenance projects in Estonia, Armenia, lithuania and the Russian Federation. The lessons learned from this related experience include the need to ensure an adequate level of maintenance expenditures, with priority given to maintenance over new construction since it frequently produces a higher return on investment up to the optimum level of maintenance expenditures; the need for a strong and effective road maintenance organization; the frequent need for improved technologies and methods; and the importance of a sustainable set of road user charges. These lessons have been incorporated into the design of this project. The Bank's experience with lending in Ukraine is limited since the first loan was made only about two years ago. To date the record has been mixed, with some delays in project processing and startup, and with a demonstrated lack of capacity to resolve processing problems expeditiously. However, this can be attributed to the normal process of becoming familiar with Bank procedures, and recent performance has improved. Poverty analysis 17. The introduction of private contracting for periodic maintenance would likely lead to higher levels of income for the work force carrying out the work. At the same time, this may lead to reductions in the number of workers as the inflated staffs of the regional road maintenance organizations are replaced by private contractors, thus releasing non-productive workers for more productive uses elsewhere in the economy. The improved condition of the roads should have a positive effect on the ability of rural people to bring their produce to market, both by assuring access and by reductions in transport costs. Reduced transport costs would also reduce the total cost of industrial production and distribution, thereby making Ukrainian industry more competitive , with positive effects on output and employment. This in turn should have a favorable impact on the poor as the general economy expands. Environmental Aspects 18. The project has been designated as Category B in view of its limited environmental impact. These mainly relate to the fumes emitted during the production of asphalt concrete, possible degradation due to the excavation of aggregate, and possible erosion due to grading or the reconstruction of a limited number of roadways. The project preparation will include an environmental review to make certain that the operational procedures followed by Ukravtodor are environmentally acceptable and that the proposed activities do not create environmental hazards. Mitigation measures identified through the environmental review will be included in the project. - 6-  Participatory Approach 19. The various stakeholders in the road system will be consulted during project preparation and involved in the project design through workshops and seminars. Since there are no private transport industry organizations in existence yet in Ukraine, participation will focus most heavily on the government organizations with an interest in the road network and the organizations that will make up the private road construction industry after privatization. Performance Monitoring Indicators 20. Performance monitoring indicators will be selected that provide a direct connection with the project objectives, to the extent possible. These would include such things as the change in the average road roughness, the change in the receipts from road user charges, the portion of the Ukravtodor budget spent through competitive bidding procedures, and the change in the level of road accidents and fatalities. Program Objective Categories 21. The project would contribute directly to the sustainable development of Ukraine by reducing transport costs and preserving the road network, which is an important part of the country's essential infrastructure. It would also make a significant contribution to the development of the private sector road construction industry in Ukraine, and to institution building through the introduction of economic analysis into the decision making processes of the transport sector as well as through the overall strengthening of the transport sector's management structure. Other Key Issues 22. Financial Viability: It will be necessary to get complete information on the revenue sources available to Ukravtodor, what income is expected to be available in future years, and how this relates to the needs of the road network for which Ukravtodor is responsible. Ukraine is still in transition in regard to its financial and budgetary relations, and the achievement of the project objective related to an adequate financial base for future maintenance of the road network will probably require conditionality relating to the need for revisions in the structure of the existing road user charges. 23. Economic Analysis. The economic analysis for the road repaving component is based on a feasibility study carried out by Ingeroute/BCEOM dated May 1996. It includes the calculation of IRRs and NPVs for the maintenance of individual road sections based on road inspection surveys, consideration of alternative road choices for repairs, and alternative pavement treatments for 7000 km of the road network with the highest traffic volumes. Over the longer run, the prioritization of maintenance choices between road sections would be re-evaluated each year for the entire road network using the Pavement Management System to be included in the project, but introduction of such a system will take several years. No new road capacity is included in the project. The - 7-  net present value of investments will be calculated on the basis of an opportunity cost of capital of 12 percent. The sensitivity analysis will be based on variations in the cost of the civil works and also on alternative future levels of traffic volume increases. Shadow pricing would be used if alternative opportunity costs are not adequately reflected at current prices. The project will also be compared to other possible investment projects for Ukraine, with the assistance of the Country Operations Division. 24. Institutional Structure. The Government has taken the first step in setting up an appropriate organizational structure for road maintenance by making Ukravtodor an independent State corporation. However, the internal structures of Ukravtodor and the Oblast organizations need to be revised to remove the conflicts of interest that presently exist in regard to quality control, and to introduce competitive bidding by independent contractors as the basis for carrying out periodic maintenance. These issues will be reviewed carefully during project preparation, and a study of the options for new institutional arrangements will be carried out in time to assure that a revised institutional framework is agreed upon prior to project implementation. Task Manager: Anders Bonde The World Bank 1818 H St., N.W. Washington, D.C. Telephone: (202) 473-9272 Fax: (202) 522-1500 Note: This is information on an evolving project. Certain components may not necessarily be included in the final project. Processed by The Public Information Center week ending September 27, 1996. -8-