Mozambique - Second National Water Development Project - Supplemental Credit

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 27268 SUPPLEMENTAL CREDIT DOCUMENT INTERNATIONAL DEVELOPMENT ASSOCIATION PROPOSED SUPPLEMENTAL CREDIT OF SDR 10.2 MILLION (US$l5 MILLION EQUIVALENT) TO THE REPUBLIC OF MOZAMBIQUE FOR THE SECOND NATIONAL WATER DEVELOPMENT PROJECT January 26,2004 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENT Currency Unit = Mozambican Meticais (Mt) US$l .OO= 23250 Mt (as of September 30,2003) WEIGHTS AND MEASURES Metric System FISCAL YEAR January 1 to December 3 I ABBREVIATIONS AND ACRONYMS AdeM Aguas de Mocambique AdP Aguas de Portugal CAS Country Assistance Strategy CRA Conselho de Regulacao do Abastecimento de Agua DCA Development Credit Agreement EA Environmental Assessment EMP Environmental Management Plan EMS Environmental Management System FIPAG Fundo de Investimento e Patrimonio do Abastecimento de Agua GOM Government of Mozambique ICR Implementation Completion Report IDA International Development Association MOU Memoradum of Understanding MTR Mid-Term Review NWDP II National Water Development Project II PARPA Action Plan for the Reduction of Absolute Poverty PDO Project Development Objectives PO Private Operator RAP Resettlement Action Plan RFP Request for Proposal Vice President: Callisto Madavo Country Director: Darius Mans Sector Manager: Jaime B iderman Task Team Leader: Jane Walker  FOR OFFICIAL USE ONLY THE REPUBLIC OF MOZAMBIQUE SUPPLEMENTAL CREDIT TO THE NATIONAL WATER DEVELOPMENT PROJECT II PROJECT SUMMARY Borrower: Republic of Mozambique Implementing Agency: Ministry of Public Works and Housing Beneficiaries: Families and businesses that are not currently benefiting from safe and reliable water supplies in the target cities (Maputo, Beira, Quelimane, Nampula and Pemba) Credit Amount: SDR 10.2 million (US$l5.0 million equivalent) Terms: Standard IDA terms, with 40 years maturity Financing Plan: IDA: US$l5 million Government: US$l 5 million Economic Rate of Return: Not applicable (see Economic Assessment of the original Staff Appraisal Report) Poverty Category: Not applicable Project ID Number: PO83263 This memorandum is based on the findings of the supervision missions of the ongoing operation. The Bank supervision team includes, Messrs./Mmes. Jane Walker, Lead Water and Sanitation Specialist (Team Leader); Cathy Revels (Financial Analyst), Stephan von Klaudy (PSP Specialist), Martin Fodor (Environmental Specialist), David Weston (Engineer -Consultant), and Subhash Dhingra (Procurement - Consultant). This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.   INTERNATIONAL DEVELOPMENT ASSOCIATION PROPOSED SUPPLEMENTAL CREDIT TO THE REPUBLIC OF MOZAMBIQUE FOR THE SECOND NATIONAL WATER DEVELOPMENT PROJECT 1* This report proposes a supplemental development credit to the Republic of Mozambique, for SDR 10.2 million (US$lS million equivalent). The credit will supplement the ongoing National Water Development Project II (Credit Number 32470 MZ), and will assist with financing to adequately support the revised lease and management contracts with the private operator, Aguas de Moqambique (AdeM) supported under the project, as well as operating costs of the project executing agency FIPAG (Fundo de Investimento e Patrimonio do Abastecimento de Agua). The devastating floods in Mozambique in early 2000 and the withdrawal of the lead partner in AdeM, Saur International, coupled with the under-priced original bid from the consortium led by Saur International, resulted in the contract renegotiations. Consequent to the withdrawal of the lead firm (Saur International), Aguas de Portugal (AdP), took over the lead partnership in AdeM in December 2001 under an MoU which included revised rates, fees and costs that reflected more realistic market conditions. These new rates and fees are reflected in the revised contracts. The credit will also support increases in operating costs as a result of the revised agreements. The proposed credit will be on standard IDA terms, with a maturity of 40 years. Background 2 Country Context and Sectoral Background. Mozambique's growth rate has been 9% from 1997 to 2002, well above the African average and among the highest in the world, and is projected at between 7% and 12% annually until 2005. Growth has been driven mainly by megaprojects, foreign investment, and strong agricultural performance. Poverty, however, remains deep and may not have been reduced in the rural areas, where 70% of Mozambicans live. Improved quality of and increased access to safe water in urban and rural areas is among the six priority areas of the Government's poverty reduction strategy, known as PARPA, endorsed by the Board of Directors of the World Bank and the International Monetary Fund in August 2001. In April 2003 the Government completed a first Progress Report. In June and July 2003 the Fund and Bank Boards found that Mozambique is committed to poverty reduction and that the PARPA continues to provide a sound basis for concessional assistance. The recent CAS was discussed at the Board November 20,2003. The CAS supports the PARPA and stresses the provision of sustainable access to water, a key MDG. 3 The Second National Water Development Project (NWDPII) was approved on June 17, 1999 and became effective on March 3,200O in the amount of US$75 million equivalent. The total cost of the project was US$ I I5 million and included a US$lO million grant from the Government of the Netherlands and US$30 million credit from the AfDB. The main objective of the project is to improve the quality, reliability and sustainability of water services for the cities of Maputo, Beira, Quelimane, Nampula and Pemba. The project had two major components. The first component made up the majority of the credit (US$l 10 m) and included support to private sector management and financing for major capital works for five cities. The second component included TA support for urban water supply policy and support to the Regulator. 4 The Government of Mozambique decided to improve the management and efficiency of water supply in the five cities by contracting out operations to a private operator. Oversight and control of the urban water sector and private operator were to be assured by the autonomous 1  public body, FJPAG, and the Independent Regulator (CRA). Both these institutions were created in 1998 under legislative arrangements and passed into law. 5 In October 1998 invitations for participating in a competitive international bidding process were sent out to four pre-qualified consortia of companies. Bidders were required to submit a bid for undertaking a I5-year lease contract in Maputo and 5 year management contracts in the other four cities. In April 1999 Aguas de Mozambique (AdeM) (a consortium of SAUR International, IPE Aguas de Portugal and a group of five local investors) was declared the successful bidder with the lowest bid. The bid was divided into two parts - 70% of the weighting of the bid was based on the operator tariff and the remaining 30% of the bid included unit rates for the delegated works, program fees, site supervision and procurement fees, and the management contract fees. On September 27t" the lease contract for Maputo and the management contracts for the four cities were signed. The official date of take over of the services was I December 1999. On 2 I February 2001, 15 months after take over, AdeM submitted a request for an interim review of the operator tariff and the tariff indexing formula in the water lease contract for Maputo. Negotiations over a revised operating tariff and requests for other cost increases under the lease continued but were unsuccessful. During this operating period financial problems of AdeM were exacerbated due to the extensive flooding of February 2000 in Mozambique. 6 As of December 14, 2001, Saur International, which was previously the majority shareholder in AdeM, terminated its involvement in the lease and management contracts. On December 15, 2001, FIPAG, together with AdeM, AdeP, and AdeM's other shareholders, signed an Amending Agreement whereby Saur International ceased to be a shareholder in AdeM; and a Memorandum of Understanding ("MOW) that sets out the basis on which AdeM would continue to operate under the lease and management contracts while FTPAG and AdeM negotiate long- term financial and contractual arrangements under the lease and management contracts. IDA gave its no-objection to the new arrangement provided that the new configuration of AdeM with AdeP as the majority operating partner met the originally set qualification requirements which were used to bid under the original JWP of 1998. The revised qualifications as submitted by the newly constituted consortium (led by AdeP) were reviewed by the Bank and found to be in line with the original JWP requirements. The MOU was initially to last 15 months but in fact continued until the end of October, 2003 for the lease and until mid November, 2003 for the management contract. Early in this process, and subsequent to the withdrawal of Saur International from AdeM, the possibility of rebidding the contracts was discussed. It was concluded, however, that the launching of a new competitive bidding process was unlikely to attract enough competition mainly because of the lack of qualified companies willing to take part in Mozambique. Under the circumstances, in order to avoid further delays in achieving the desired outcomes under the Project, it was concluded that the best available option was to renegotiate the contract with the reconstituted consortium led by AdeP, provided the reconstituted consortium fulfilled the minimum qualification requirements to ensure satisfactory performance under the contracts. 7 During the implementation of the MoU, certain cost increases were negotiated between the FIPAG and AdeM. These included the increases in the operators tariff, increases in the unit rates for the delegated works, and subsequent oversight costs for the PO including program management, procurement, and site supervision, and management fees for the four cities contracts. Further the increased operators tariff had the effect of reducing the variable rental fee for FIPAG thus squeezing its operating budget and therefore limited FIPAG's ability to support the 4 cities with necessary operating costs. The deficit on operating costs as a result of this is estimated at US$7.15 million over the next 4 years. 2  8 While IDA gave a no-objection to enable AdeP to take over the equity participation formally held by Saur International in AdeM, IDA did not recognize the MOU with respect to the DCA, PA and disbursements. The short-term nature of the MOU was not in keeping with the implementation of a long-term solution. The project was rated unsatisfactory for implementation performance until the longer term agreements were in their final stages. Both the revised I2 year lease contract and 3 year management contract (the remaining balance period under the two contracts) have been signed and have received procurement and legal clearances in October and November 2003, respectively. Given these events, the project is now fully back on track and well positioned to continue delivery benefits of improved water supply to the 5 cities. 9 During the 23 months of the MOU period and until Bank agreements are amended, the GOM is meeting the shortfall between the original contracts and the revised contracts for the increased costs in the unit rates on delegated works, increased rates for program management, procurement and site supervision and for the management contract fees. It was agreed in the MOU that these revised rates would be back dated to January 200 1. The value of the delegated works program plus other costs that were in the original bid represented about 30% or US$23 million out of the total IDA credit component of US$75 million. Given the revised contract rates and fees, the funds necessary to undertake the work originally envisioned to be undertaken by the private operator (PO) amounts to about US$32 million, an increase of US$8.5 million (net of taxes). Market based comparisons have been used to establish the creditability of the revised negotiated rates. The credit will also support operational costs for FIPAG and the four cities. These costs mainly include unfunded costs of electrical power, which make up to 50% of total operational costs, chemical costs and system reinstatement costs. 10 During the MTR in September 2003, it was concluded that an extension of the project closing date would be necessary to achieve the project's development objectives. The successful implementation of the private sector contracts - the 12 year lease and the 3 year management contract - remain the most important activity in order to achieve these goals. It is expected that some of the works contracts will not be completed until 2006. Further, the renegotiated management contracts would only be able to operate for just over 18 months given the current closing date. 11 Project Development Objectives (PDO). The proposed supplemental credit is consistent with the main development objective which is to improve the quality, reliability and sustainability of water services for the cities of Maputo, Beira, Quelimane, Nampula, and Pemba through promoting greater private sector participation in the provision of these services. During the Mid- Term review of October 2003, it was concluded that the PDOs continue to be both relevant and achievable, give an extension to the closing date to September 30, 2007 to allow for 3 years of the management contract. It was concluded that the progress that had been made would increase greatly at the revised long-term contracts had been signed and were being implemented. 12 Implementation Experience. Overall project implementation has been negatively affected by'the withdrawal of the original private operator and the subsequent protracted contract renegotiations. Despite the difficult operational conditions implied by the temporary contract arrangements for almost 2 years, there has been significant positive progress on various technical and financial management aspects of the project, which are reflected in the key performance indicators. Noteworthy is the provision of water to both Pemba and Nampula on a 24 hour basis. Duration, quality and reliability of water supply service to all the cities continues to improve. Revenues have doubled due to tariff increases and improved collection performance in Maputo, Nampula, Pemba and Quelimane between 2001 and 2002, with revenues in Beira also increasing very significantly. FIPAG's financial management also continues to improve with appointment 3  of additional internal contra 1and accounting staff at the head office and in the 4 cities and the introduction of more timely and relevant financial reporting. 13 Rationale for the Supplemental Credit. The Supplemental Credit will finance the increased cost of the delegated works program and support operational costs for the FIPAG as a result of the revised contract. The delegated works program is mainly made up of items to rehabilitate the water supply networks including meters, pipes and connections. Also included in the delegated works are program management fees, procurement costs and site supervision undertaken by the private operator for these works as well as the management fees and incentive fees for the management contracts for the 4 cities. 14 The proposed Supplemental Credit meets the requirements of OPl3.20 on supplemental financing as follows: 0a Cost Overrzkns: The cost overruns are due to exceptional circumstances beyond the borrower's control. The original amounts budgeted under the Credit were based on the winning bid for the lease and management contracts that included unit rates for the delegated works and the operators tariff. For the latter, the expectation of operating surpluses, derived from the difference between the operators tariff and consumers tariff, were used to provide for operating costs for the project executing agency (FIPAG) to support mainly the operating costs of the 4 smaller cities operating under a management contract. The Credit was not presented to the Board until the outcome of the bidding was known so that the amount allocated under the Credit could adequately reflect these results. Unfortunately the winning bidder, the AdeM consortium including Saur International, was unable to satisfactorily perform its required responsibilities under the contracts given that its bid was not well priced. The situation was further exacerbated by the catastrophic floods in early 2000 that caused higher than expected cost overruns. The purpose of the Supplemental Credit is to support the cost overruns as a result of the poor bid and unexpected floods in order to accomplish the original objectives in the credit. The funds required are US$SS million for delegated works and US$ 6.5 million for goods and operating costs. (W Compliance with Covenants. The NWDP II is being implemented in compliance with all covenants set forth in the Project's relevant legal agreement. 0C Reduction in the Scope. It is impossible to reduce the scope of the NWDP II to fit the available resources. The capital works and delegated works program are incorporated in the performance outputs of the private operator as agreed under the lease and management contracts. It would be unworkable to cut back on these investments without undermining the integrity of the contractual obligations by the Government and by the contractors. Reduction in the ability of the PO to perform would significantly impair the project's financial viability and the capacity to achieve its objectives. Additional Sources of Financing: The GOM continues to operate under difficult and restrictive macroeconomic constraints and is unable to continue to meet the unexpected increased costs for the higher rates and fees. Other donors are unable to provide funds for the specific purpose required in a short time frame.  0e Time Constraint: The total time to process a freestanding Bank Loan to continue NWDP II activities would take significantly longer to prepare and made effective than would a Supplemental Credit for the existing Project. U3 The Borrower Commitment and Competence in Implementation: Tile Government has steadfastly maintained its commitment to the project development objectives, and specifically to improving services through the use of private sector participation in the provision of water supply to the major 5 cities in Mozambique. This commitment has remained strong in spite of the extremely difficult operating conditions, with the premature departure of the ' original private operator and the use of temporary contract arrangement over the last 23 months. Counterpart funding has never lagged. Further, the project's main implementation agency has matured during the protracted length of the renegotiations. It has improved performance in all project management areas including financial management and procurement matters. 15. Bene$ts of the Supplemental Credit. The benefits of the NWDP II and the proposed Supplemental Credit would be to support the full achievement of the PDOs. The project will continue to improve water supply coverage and service to communities of the five major cities of Mozambique or over 75% of the urban population in a sustainable way through private sector management and investments in water supply infrastructure. Successful implementation of the Project is expected to lead to safer and more reliable water supply services for about 1.3 million people living in urban and peri-urban areas as well as increased supply to service industrial, institutional and commercial users. 16 Implementation Arrangements. The proposed Supplemental Credit does not require additional implementation capacity beyond what is already in place. The NWDP IT project framework is executed by the Ministry of Public Works and Housing has performed satisfactorily and will oversee the execution of the Supplemental Credit. The Supplemental Credit will be subject to the same monitoring and reporting requirements of the project. No changes are needed in the Project Implementation Manual. 17. Amendments to the existing Credit. As part of this request for a supplemental credit, a concomitant extension of the closing date from September 30,2005 to September 30, 2007 is proposed. Without such extension of the closing date, the project would close at the end of September 30,2005 , which would make it impossible to continue implementation of the delegated work activities, including the fees for the extended management contracts and support operations costs to be financed by the Supplemental Credit. Accordingly, as part of the amendment of the legal documentation for the supplemental financing, the Credit Agreement will be amended to reflect the proposed new Closing Date. Further , as a result of the mid-term review, other amendments to the credit agreement include streamlining of the performance indicators, adjustment of the on-lending rate, creation of a second special account, and the reallocation of unallocated funds within Schedule 1. 18 Project Cost arzd Financing. The total project cost, net of taxes and duties, is estimated at US$15 million equivalent, of which an IDA Supplemental Credit of SDR 10.2 million (US$l5 million equivalent) is proposed. The Government contribution is estimated at US$l.5 million equivalent, representing about 10% of the total project cost. The breakdown of the project's cost, financing plan, and disbursement schedule is set out in Annex 1. 19 The Supplemental Credit will be effective in March 3 I,2004 and close on September 30, 20b7 . 5  20 Accounting, Financial Reporting and A~ditin% Arrangements. FIPAG has established an acceptable accounting and reporting system for the Project, which will continue for the Supplemental Credit, including the Special Account and the statements of expenditures. Auditing of the project is up to date and the reports submitted to the World Bank-Washington. Continued compliance is being closely monitored by Financial Accredited Staff of IDA in the Mozambique Country Office. 21 Independent auditors acceptable to IDA will audit the use of all funds available under the Supplemental Credit, including the Special Account and the statements of expenditures. Audit reports will be submitted to IDA no later than six months after the end of the fiscal year. The format and the frequency of periodic reporting will be maintained as defmed in the project implementation manual. An Implementation Completion Report (ICR) will be prepared within six months after Credit closing. 22 Environmental and Social Aspects (Safeguards). As part of the October MTR, the parent project was reviewed for compliance with the environmental and social safeguard policies, particularly on environmental assessment (OP/BP 4.01) and involuntary resettlement (OP/BP 4.12). It was agreed that the Project Implementation Manual would incorporate improvements suggested during the MTR with regard to environmental, water resources management and involuntary resettlement processes. The project is rated as environmental assessment category B based on the limited adverse environmental impacts associated with rehabilitation, expansion and operation of water supply infrastructure (intakes, pumping stations, transmission mains, etc.) In compliance with OP 4.01 an environmental assessment (EA) including a preliminary environmental management plan (EMP) for the entire project was prepared in July I996 and its second edition issued in August 1997. To reflect the modifications in project design and significant institutional and regulatory changes (e.g. Environmental Act, EIA regulations), the EMP was revised, updated and issued as a self standing document dated March/May 1999. While Category B rating is also proposed for the Supplemental Credit, the Supplementary Credit will not finance any new activities that have potential adverse environmental or social impacts, consequently the management measures put in place for the parent project are still in effect and are adequate for the Supplemental Credit. The ISDS was completed on December 16,2003 and was reviewed, along with the Supplemental Credit, and cleared by ASPEN on December l&2003. 23 * Sustainability. Great effort has been made to assess the financial sustainability of the project. FIPAG has developed a 20 year financial model, which projects operating revenues and expenses for the 4 cities, revenues from the Maputo Lease contract, office expenses and capital expenditures and investment financing for all assets under FIPAG's responsibility 5 cities. 24 Results. As FIPAG is a public entity without a profit motive, financial viability is l defined in this case as the ability to meet cash requirements associated with achieving specified service levels and efficiency targets, while maintaining acceptable financial ratios. The financial model shows that FIPAG can achieve financial viability within the time frame of the credit as tariffs are increased in real terms as agreed and FIPAG's capital investment program maintains its financing by a combination of GOM and donor grants and loans. The financial projection shows achievement of acceptable liquidity ratios, including current ratio and cost coverage ratios in excess of 1.O and operating profit ratio surplus 2007. 25 Risks. The proposed supplemental credit does not add to the risks already identified under the project. A major risk identified for the project was regulatory risk and backtracking on tariff policy for water. Tariffs have maintained an upward momentum and confidence in 6  the regulatory regime is high, Counterpart funding for the provision of working capital for the secondary cities was also identified as a high risk during appraisal of the project. Counter part funding has been timely and has in fact exceeded requirements from time to time. Further, the project management capacity of the implementation agency FIPAG was cited as a high risk. FIPAG however has matured significantly as an institution and has successfully renegotiated the revised new contracts with the private operator. 26 . Effectiveness Condition. The Supplemental Credit will become effective upon receipt by the Association of : (1) a satisfactory legal opinion confirming that the Agreement Amending the Development Credit Agreement is binding upon the Borrower in accordance with its terms, (2) a satisfactory legal opinion confirming that the Agreement Amending the Project Agreement is binding upon FIPAG in accordance with its terms, and (3) revised Project Implementation Manual that incorporates recommendations made in the mid-term review with respect to environment, water resources management and involuntary resettlement,  ANNEX 1 Page 1 of 4 THE REPUBLIC OF MOZAMBIQUE SUPPLEMENTAL - SECOND NATIONAL WATER DEVELOPMENT PROJECT ESTIMATED ADDITIONAL PROJECT COSTS AND FINANCING PLAN (in US$ million) Estimated Costs: COMPONENTS LOCAL FOREIGN TOTAL I 2. Consultinn Services & Audits 1 0.00 I 9.35 I 9.35 I 3. Goods 0.30 3.27 3.57 5. Operating Costs 3.58 0.00 3.58 I Total Proiect Costs I 3.88 I 12.62 I 16.50 I Financing Plan (in US$ million): COMPONENTS LOCAL FOREIGN TOTAL Government of Mozambique 1.50 0.00 I .50 IDA 2.38 12.62 15.00 1Total Project Costs I 3.88 I 12.62 I 16.50 I 8  ANNEX 1 Page 2 of 4 THE REPUBLIC OF MOZAMBIQUE SUPPLEMENTAL - NATIONAL WATER DEVELOPMENT PROJECT II SUMMARY OF PROPOSED PROCUREMENT ARRANGEMENTS (US$ million) Project Element Procurement Method TOTAL ICB NCB OTHER 2. Consultant Services and Audits GOM 85 85 IDA 8 50 s .50 l 3. Goods GOM 30 30 IDA 1.52 1.75 . i .27 5. Operating Costs GOM 35 35 IDA i 23 3'23 l l TOTAL 1.52 2.05 12.93 16.50 IDA 1.52 1.75 11.73 15.00 Procurement thresholds established for the NWDP will be maintained for the Supplemental Credit. 9  ANNEX 1 Page 3 of 4 ALLOCATION AND DISBURSEMENT OF IDA SUPPLEMENTAL CREDIT (US$ Million) Category Amount Percentage Financed 2. Consultant Services & 100% Audits 8.50 3. Goods 3.27 100% of foreign expenditures and 90% of local expenditures 5. Operating Costs 3.23 100% of local expenditures until December 31, 2005, and 70% thereafter. TOTAL 15.00 (No training in the Supplemental Credit) Estimated Disbursement Schedule: (US$ million) I I FY05 FYO6 I FY07 I 1Total I 5.00 I 5.00 I 5.00 I I Cumulative I 5.00 I 10.00 I 15.00 I 10  ANNEX 1 Page 4 of 4 THE REPUBLIC OF MOZAMBIQUE SUPPLEMENTAL - NATIONAL WATER DEVELOPMENT PROJECT II TIMETABLE OF KXY PROJECT PROCESSING EVENTS (a) Time taken to prepare: 4 months (b) Prepared by: Government with TDA assistance (c) Appraisal/Negotiations: October 2003/ January 2004 (d) Planned Date of Effectiveness: March 15, 2004 (e) Completion of work: March 3I, 2007 (f) Closing Date: September 30,2007