India - Kerala Water Supply and Sanitation Project

Document of The World Bank FOR omcuL USE ONLY Report No. P-4114-IN REPORT AND RECOMMENDATION OF THE PRE SIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT IN AN AMOUNT OF SDR 42.7 MILLION TO INDIA FOR THE KERALA WATER SUPPLY AND SANITATION PROJECT June 17, 1985 * This dobsmaut ns a resrcted dlstbuto and way be used by reipients oly in the perfonmce of their officil dus s colutes myV not odhwzse be dilosed witbout World Bank thclutioo.  CURRENCY EQUIVALENTS (As of May 30, 1985) US$1.00 = Rs 12.44 Rs 1.00 = US$0.80 Rs 1 million US$80,386 The US Dollar/Rupee exchange rate is subject to change. Conversions in the Staff Appraisal Report were made at US$1.00 = Rs 11.00, which represents the average exchange rate at the time of appraisal. FISCAL YEAR April 1 - March 31 Abbreviations and Acronyms CCDA - Creater Cochin Development Area GOI - Government of India GOK - Government of Kerala IDWSSD - International Drinking Water Supply and Sanitation Decade Program KWWA - Kerala Water and Wastewater Authority lpcd - liters per capita per day PHED - Public Health Engineering Department, Kerala ROR - Rate of Return TAG - Technology Advisory Group UNDP - United Nations Development Program WHO - World Health Organization  FOR OFFICIAL USE ONLY INDIA KERALA WATER SUPPLY AND SANITATION PROJECT CREDIT AND PROJECT SUMMARY Borrower: India, acting by its President. Beneficiaries: The Kerala Water and Wastewater Authority (KWA) and participating. local bodies. Amount: SDR 42.7 million (US$41 million equivalent). Terms: Standard. Relending Terms: India to Kerala: As part of Central assistance for State Development projects on terms and conditions applicable at the time. Kerala to KWA, Quilon Municipal Corporation and Participating Local Bodies: About US$19 million, over 25 years including five years of grace, at 8.75Z interest per annum and about US$22 million as a grant. The foreign exchange risk would be borne by the Government of India. Project Description: The construction of treatment, transmission, and distribution facilities to provide a design supply of approximately 180 million liters per day (mld) of safe piped water to the Kottayam, Greater Cochin Development Area (GCDA) and Quilon rural Panchayats and the rural areas of Puthencruz, Adoor, Chithara, and Vilappil; the improvement and extension of facilities to augment the design supply of water by about 35 mld to the Quilon Municipal Corporation area, and the provision of low-cost sanitation to 10 medium-sized towns and selected rural areas. In addition to the consultant work undertaken as part of project preparation, the project would provide funds for technical support for the implementation of accrual accounting and financial management systems for KWWA and the project entities. Finally, the project would also assist in improving the opera- tional capability of KWA through the provision of central services including training, leak detection units and meter repair faciLities. The technical risks involved in this project are no greater than can normally be expected in operations of this type. Since KWWA is a newly established ThLs document has a restrictd distributon and may be used by recipients only in the performance of their offcial duti Its contents may not otherwise be discdsed withouL World Bank authorization.  -ii- institution, there is a risk that it may not function smoothly. Fortunately, KWWA's staff (previously PErD's) have had considerable experience in hAndling projects of similar scope and there is provision for the strengthening of KWHA to cope with project requirements. The achievement of financial objec- tives has been a major concern in most water supply projects. To minimize this risk under the project, realistic targets have been set and improved finan- cial and accounting systems are being implemented to ensure better financial management by KDWA. With the consultant assistance envisaged above and adequate monitoring, completion of the project within the plAnned implementation period seems feasible. (uss millions) Estimated Costs Local Foreign Total Rural Water Supply 28.98 11.79 40.77 Urban Water Supply 2.68 3.13 5.81 Urban Low-Cost Sanitation 2.96 0.19 3.15 Rural Low-Cost Sanitation 2.60 0.16 2.76 Loan Fund for House Connections 1.39 - 1.39 Training 0.62 0.09 0.71 Consultancy Services 0.14 - 0.14 Land Acquisition 0.85 - 0.85 Central Services 0.52 1.52 2.04 Taxes and Duties 2.81 2.81 Engineering 8.24 _ 8.24 51.79 16.88 68.67 Physical Contingencies 2.76 0.93 3.69 Price Contingencies 8.45 4.34 12.79 TOTAL PROJECT COST 63.00 22.15 85.15 Project Cost Net of Taxes and Duties 60.19 22.15 82.34  -lli- (US$ Millions) Financing Plan: Local Foreign Total IDA 18.85 22.15 41.00 GOK Loans/Grants 44.15 /a - 44.15 TOTAL 63.00 22.15 85.15 Estimated Disbursements of IDA Credit (USs Millions) IDA FY FY86 FY87 FY88 FY89 FY90 FY91 FY92 Annual 2.6 8.1 il.4 10.8 6.3 1.7 0.1 Cumulative 2.6 10.7 22.1 32.9 39.2 40.9 41.0 Rate of Return: About 8Z. Appraisal Report: No. 5397-IN, dated June 10, 1985. /a Includes US$2.81 million of taxes and duties.  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO INDIA FOR THE KERALA WATER SUPPLY AND SANITATION PROJECT 1. I submit the following report and recomnendation on a proposed develop- ment credit to India for SDR42.7 million (US$41.0 million equivalent) on stand- * ard IDA terms to help finance a water supply and sanitation project in the State of Kerala. The proceeds of the credit would be channeled to the Government of Kerala (GOK) in accordance with the Government of India's stand- * ard terms and arrangements for the financing of State development projects. GOK would relend about US$19 million of the Credit to the Kerala Water and Wastewater Authority (KWWA) for 25 years, including five years of grace, at 8-3/4% interest per annum and make available the balance of the credit (about US$22 million) as a capital grant. The foreign exchange risk would be borne by the Government of India. PART I - THE ECONOMY 1/ 2. An economic report, "India: Structural Change and Development Perspectives" (5593-IN, dated April 24, 1985), was distributed to the Executive Directors on May 1, 1985. Country data sheets are attached as Annex I. Background 3. India is a large and diverse country with a population of about 750 mil- lion (in mid-1984) and an annual per capita income of US$260. The economy is dominated by agriculture which employs more than two-thirds of the labor force. However, the land base is not sufficient to provide an adequate livelihood to everyone engaged in agricultural activities, especially those who own little or no land. Growth of value-added in agriculture -- 2.2% since 1950/51 -- has been slower than growth of industrial value-added (5.3% per annum). As a result, there has been a gradual decline in the share of agriculture in CDF (at factor cost) from 52% in 1950/51 to about 332 in 1981/82, while the share of industry rose from 20% to around 26%. But industrialization has not been rapid enough to absorb the growing labor force, or to bring about a rapid economic transformation, with significantly higher productivity and income levels. As a result economic growth has been slow over the past three decades, averaging about 3.6% per annum since 1950/51. 4. Nevertheless, there nas been steady progress, with per capita income rising by about 1.4Z per year in the period 1950 to 1980. Despite the large population base and its relatively rapid growth, India has been able to eliminate persistent dependence on foodgrain imports through significant improvements in agricultural production. Savings and investment have increased 1/ Parts I and II of the report are similar to Parts I and II of the President's Report for the NationaL Social Forestry Project (No.P-4094-IN), dated May 22, 1985.  -2- markedly since 1950/51: the gross national savings rate more than doubled from 10.8% of GDP (at factor cost) to 22.7Z in 1983/84, while the gross domestic investment rate rose from 12.5Z of GDP to 24.8% in 1983/84. Foreign savings (balance of payments deficit on current account) have never financed a major portion of domestic investment: a peak of about 20Z was reached during the early 1960s. Currently, foreign savings account for about 8% of investment. External assistance has been low both as a percentage of CDP and in per capita terms, never rising above 3% of GDP and averaging below 1Z for the past five years. Net use of foreign savings has never risen above 3X of GDP, and presently stands at 2.1%. 5. Before the 1970s, India placed relatively less emphasis on export promotion and more on import substitution. The volume growth of exports between 1950/51 and 1969/70 averaged only 2.2% per annum, while the volume growth of imports over the same period was 4.3Z. In the early to mid-1970s, however, India's terms of trade, which had remained roughly constant during the 1960s, deteriorated sharply. In response, the Covernment introduced various policy measures designed to stimulate exports. As a result, the volume of India's exports grew on average about 7.3Z per annum for the 1970s as a whole, a performance which demonstrates that sustained rapid growth is possible. While expanding world markets, particularly in the nearby Middle East, contributed to this growth, liberalized access to imported inputs and more effective export incentives played a major role. 6. Moving into the second half of the 1970s, the Indian economy was buoyed by higher levels of investment and an expanding level of foodgraii output. As a result, growth in real GDP and in agricultural and industrial value--added substantially exceeded the historical 30-year trends (paragraph 3) averaging 5.32, 3.3% and 8.1%, respectively, during the 1975176 to 1978/79 period. In 1979/80, however, this momentum was broken when the worst drought in recent years, combined with a doubling of international oil prices and domestic supply shortages, led to a sharp fall in foodgrain production, a dec'ine in GDP, and the opening up of a relatively large trade deficit. Severe inflationary pres- sures also emerged after several years of virtual price stability. These setbacks coincided with the preparation of the Sixth Five-Year Plan which laid down a program of adjustment that aimed at improving the trade deficit, remov- ing infrastructural bottlenecks and ensuring price stability with an overall growth of the economy of 5.2% per annum. Recent Trends 7. Despite the effects of two severe droughts in 1979/80 and 1982/83, India's economy in the early 1980s continued to grow at the faster pace of the second half of the 1970s. Between the two droughts (from 1979/80 to 1982/83), GDP growth averaged almost 5X per annum, while between the two recovery years (from 1980/81 to 1983/84), it was 4.5% per annum -- substantially higher than India's long-term growth rate of 3.6%. Continued rapid economic growth has resulted from a development strategy which includes higher investment Levels and liberalized policies on imports, industrial licensing, prices, and commer- cial borrowing. These policies, by easing constraints on the supply of infrastructure and basic commodities, were a determining factor in the improved performance of the economy and the industrial sector. This overall improvement in performance, combined with a more restrictive monetary policy in 1981/82 and 1982/83, resulted in a sharp decline in the rate of inflation. The growth rate  -3- of wholesale prices declined from over 182 in 1980/81 to only 2.6Z in 1982/83, but rose to over 9% in 1983/84, mainly due to the effect of the 1982/83 drought on food prices. Further improvements in the policy environment will be required to maintain these higher levels of economic growth and investment without putting undue pressure on the balance of payments or reviving infla- tionary expectations. 8. Economic growth in the early 1980s has not been steady, mainly because of the effect of uneven rainfall on agricultural production during the period. In 1980/81 and 1981/82, the economy substantially recovered from the 1979 drought, with real GDP growing by 7.6% and 5.3Z, respectively. While industrial output expanded by 4% in 1980/81 and 8.6% in 1981/82, recovery was particularly robust in agriculture where normal weather helped output to rise by more than 15% and 5.5%, respectively. The supply of power, coal, and rail transport, already improved in 1980/81, was further expanded in 1981/82, recording growth rates of about 10, 9.6% and 12.5%, respectively. This over- all improvement in the Indian economy was halted in 1982/83 by a severe drought in mid-1982 which reduced agricultural production by 4Z, brought down the GDP growth rate to 1.8%, and put further strains on the already difficult balance of payments and domestic resource situation. The timely implementation of various economic policies relating to foodgrain imports, procurement and distribution, and the allocation of power to irrigation pumps mitigated the otherwise very distressing effects of the poor monsoon. The economy recovered in 1983/84, led by a robust agricultural sector - GDP grew by about 6.5% to 7% with agricultural production growth in the 9Z-10Z range and industrial growth of 4.52. The major factors contributing to the good economic performance during 1983/84 were the excellent monsoon, combined with adequate agricultural policies and programs, and satisfactory performance of the coal and transport sectors. The power sector, however, emerged again as a constraint on higher growth, especially in industry. 9. Agricultural production rebounded strongly in 1983/84 in response to the monsoon, improved use of inputs and continued expansion of irrigation. Overall foodgrain production rose by lOX-12% over the previous year, reaching a new record of 142-144 million tons, a substantial increase over the previous peak of 133 million tons in 1981/82. Corrected for weather variations, foodgrain production continues to grow at a trend of 2.6% per annum-sufficient to maintain a broad balance between supply and steadily increasing domestic demand. Nonetheless, the balance remains delicate, and the need for foodgrain imports to maintain consumer supplies or adeq"ate buffer stocks could arise from time to time. Thus, adequate management of foodgrain stocks and programs to expand irrigation, strengthen extension and encourage the efficient use of other agricultural inputs continue to receive high priority. 10. Basic infrastructure services had a mixed performance in 1983/84, partially because of sluggish demand from industry during the first half of the year but also due to a failure to maintain the productivity gains of 1980-82. Electricity generation grew only by about 3.7% due to low reservoir water levels during the first half of the year, delays in the commissioning of new capacity, and a deterioration of capacity utilization in thermal plants. As a resuLt, power generation was about 11.5% below requirements and con- stituted a major bottleneck ill the economy. Key industries which were adver- sely affected by power constraints included steel, fertilizers, cement, and coal. To improve performance in the power sector, the Government recently  -4- increased incentives for higher labor and management productivity in thermal plants. Railway freight traffic, measured in toa-kms, grew by only 0.5% in 1983/84, reflecting sluggish demand. Coal production increased by about 6.5% in 1983/84 reaching 139 million tons. When combined with stocks already avail- able this level of production was sufficient to meet the relatively slow demand growth. Infrastructural constraints would have emerged much more sharply had the pace of industrial growth and demand been more rapid. It is therefore critically important that India maintain the pace of investment in these key sectors, mobilize sufficient resources to do so, and implement programs to enhance productivity. 11. The Indian economy has reverted from a situation of resource surplus in the late 1970s to an aggregate resource deficit. The gap between gross invest- ment and national savings increased from negligible levels during the late 1970s to an average equivalent to 2.1% of GDP in 1980-84. India's gross national savings rate, which averaged 22.6Z of GDP in the last four years, is high by any standard, particularly considering India's low income and the large proportion of its population below the poverty line. The scope for a substan- tial increase in the savings rate is therefore quite limited. If India is to meintain investment at about 25Z of GDP, a major effort will be required to raise additional domestic resources particularly in the public sector. Future increases in savings will depend heavily upon the enhanced profitability of public nector enterprises which would require better utilization of capacity, more efficient operations and adequate pricing policies. This would also allow a marginal decline in the use of foreign savings from the recent 2.1Z-2.3Z of GDP to 1.5Z-1.8Z, to ensure a sustainable external debt service burden. 12. India's external resource position has changed notably since the late 1970s. The current account balance, which recorded surpluses from 1976/77 to 1978/79, reverted to deficits averaging US$3.5 billion and 2.1% of GDP during 1980/81 to 1983/84. Several developments contributed to these relatively larger current account deficits. First, the terms of trade deteriorated sharply in 1979/80 due to the second round of oil price increases and continued to move against India during the first three years of the 1980s. Second, a more liberal import policy towards industrial inputs was pursued. Third, net invisibles declined as travel receipts fell off, workers' remittances stagnated (reflecting slower development activity in the Middle East), and payment of interest on higher levels of foreign debt increased. Faced with severe infrastructural constraints and a deterioration in its balance of payments, India initiated an adjustment program in 1980/81 designed to raise the growth rate from its historical level of 3.6% to 5.2% while adjusting the country's external balance to the adverse price developments in the world markets. The main elements of this strategy, which is being successfully implemented, are export promotion, import substitution where economically justifiable, implemen- tation of a coherent energy policy designed to meet the energy needs of the economy while curbing the growth of oil imports, and continued movement toward a more liberal import policy aimed at providing producers with access to inputs for higher capacity utilization, greater efficiency, improved technology and capacity expansion. 13. A positive development in India's balance of payments is the reduction in the trade deficit from US$7.7 billion in 1980/81 to US$5.9 billion in 1983/84 despite unfavorable world market conditions and import liberalization. Export volume growth and import substitution of oil and petroleum products,  -5- metals and fertilizers more than offset the substantial increase in "other" imports. These "other" imports consist mainly of industrial imports and capi- tal goods which historically have been in chronic short supply and which are of critical importance to capacity utilization, product quality, and plant modern- ization and expansion. A major factor in the decline of the trade deficit was the lower net import bill for petroleum, which dropped from US$6.7 billion in 1980/81 to US$3.4 billion in 1983/84 in response to a successful oil develop- ment program that reduced import needs and allowed crude oil exports, which totalled about US$1.5 billion in 1983/84. These structural changes in the balance of payments are to a significant degree the result of India's develop- ment and adjustment efforts over the past three years. It is expected that the balance of payments will continue to be under strain for the next several years, since the adjustment strategy will continue to require high levels of imports. 14. Even assuming a favorable export performance, India will need external capital flows to augment its own resources for the foreseeable future, given the low pe- capita income level in the country, the already high savings rate, and the structural adjustment process. Faced with a growing need for external capital inflows and stagnation in the availability of concessional assistance, India decided at the start of the Sixth Plan to increase borrowings from the International Monetary Fund (IMF) and commercial banks to substantial levels. In the period covering the fiscal years 1981/82 to 1983/84, India drew SDR 3.9 billion from the Extended Fund Facility of the IMF. In addition, India bor- rowed significant amounts on commercial terms from the Euro-dollar market and increased the use of suppliers' and export credits. In the period 1980-84, India contractec' commercial loans totalling over US$6,000 million and suppliers' credits of over US$1,000 million. The bulk of this borrowing has been used for specific development projects in the public and private sector (mostly for petroleum exploration and development, steel, power, aluminum and shipping). India's favorable debt service position and the nature of its borrowings, for p-:oject-related purposes instead of direct balance of payments support, enabled it to tap commercial capital markets at favorable spreads. This larger commercial borrowing and transfer of funds under the arrangement with the IMF bas stemmed the use of foreign exchange reserves which had fallen to less than four months of import coverage in 1981/82. Development Prospects 15. The experience of recent years illustrates that India has the capacity to grow and develop at a more rapid pace. Although the industrial sector is small compared to the size of the economy, it nevertheless is large in absolute terms and has a highly diversified structure, capable of manufacturing a wide variety of consumer and capital goods. Basic infrastructure - irrigation, railways, telecommunications, power, roads and ports - is extensive compared to many countries, although there is considerable need for additional capacity as well as improvement in the utilization of existing capacity. India also has a wide range of institutions capable of fostering development and is well- endowed with human resources. Finally, India has an extensive natural resource base in terms of land, water, and minerals (primarily coal and ferrous ores, but also gas and oil). With good economic policies and reasonable access to foreign savings, India has the capability for managing these considerable resources to accelerate its long-term growth.  -6- 16. The Government is currently preparing the Seventh Plan which will lay down the development strategy for 1985/86-1989/90. This strategy is expected to continue the emphasis of the Sixth Plan on agriculture, energy development, export prX.motion, domestic import substitution where economically justifiable and the removal of infrastructural bottlenecks. Overall Sixth Plan performance has been encouraging, with aggregate real investment projected to be about 302 higher than in the period 1975-80--a creditable performance indeed. The Sixth Plan expenditure targets, however, will not be fulfilled as resource mobi- lization by the public sector will fall short of the financing requirements of planned public investment. Actual aggregate real investment is projected to be about 7% below the original target for the period 1980-85, private investment being 5% to 10X higher and public investment about 20X lower in rea'L terms than actually projected. In terms of meeting Plan expenditure targets, the perfor- mance of the Central Government is considerably better than that of the State Governments. The Central Government's Plan outlays are likely to reach about 80X to 90Z of the original Plan allocation in real terms, while the States' will probably achieve only about 50% of their targets, due principally to shortfalls in resource generation. Bottlenecks in key sectors such as power, transport and irrigation are likely to persist as a consequence of real invest- ment shortfalls relative to original Plan allocations. 17. Although Sixth PLan expenditure targets will not be met, India's capi- tal formation rates have increased from 22.6% in 1975-80 to 24.7% of GDP in 1980-84. Recent higher capital formation rates are encouraging for future income growth, but returns to investment have so far been relatively low. Much of this phenomenon relates to India's stage of development, in which a large and growing proportion of investment has been needed to buila up basic infrastructure services which have inherently high capital-output ratios. However, there is scope to reduce capital-output ratios through improvements in efficiency. As discussed in greater detail in our recent economic reports, performance in the basic service sectors can be improved through better plan- ning and management, thus leading to higher productivity and capacity utiliza- tion throughout the economy. At the same time, programs to expand domestic capacity are vital. In the case of tradeable commodities like coal, steel and cement, this is justified on the grounds of comparative advantage. For sectors such as irrigation, power and transportation, expansion of planned capacity in accordance with the requirements of the rest of the economy will be vital for sustained growth. 18. Under the Sixth Plan, India has an ambitious oil development program backed by substantial financial commitment. Performance under the program has been excellent with real investment and oil production levels running well ahead of Plan Targets. In 1981, and again in early 1983, resources for exploration and development were raised by successive price increases for domestic crude and products. While the gap between domestic consumption of petroleum and production rcnains large, India's dependence on oil imports dropped from 632 of consumption in 1979/80 to about 41X in 1983/84 and is expected to decrease to about 33% of consumption by 1984/85. The rapidly expanding level of exploration activity, combined with the possibilities for accelerated offtake from known fields, offers much encouragement for India's longer-term energy prospects. At the same time, the increases in domestic petroleum prices have helped encourage conservation and slow demand growth.  -7- 19. India's development prospects over the next few years will hinge on the extent to which the economy can be brought into both internal and external balance, while at the same time achieving more rapid growth than in the past. This will require the continuation of the current development strategy which assigns high priority to export promotion, public finance discipline, improve- ment of economic efficiency, and investment in infrastructure, supported by adequate flows of external borrowing and aid. In the short term, a relatively large level of external borrowing, including an increased emphasis on commer- cial borrowing, will be necessary to cope with the balance of payments conse- quences of such a growth strategy. However, an important element in providing India with the capacity to adjust flexibly vill be adequate flows of conces- sional assistance since India is still a very poor country with a large rural sector and enormous investment requirements for human development and basic infrastructure. Although India is currently in a position to increase borrow- ing on commercial terms from the very low levels of the past, there are, of course, limits beyond which India will choose to sacrifice growth objectives rather than accept debt on unfavorable or unmanageable terms. Nevertheless, with a more open trade policy and expanded efforts to remove constraints on the growth of productive capacity, supported by adequate mobilization of both foreign and domestic savings, India is demonstrating that it can sustain a rate of growth closer to 5.0% per annum than to the long-run trend of 3.6Z per annum. If the rate of population growth can be brought to below 2.0% per annum, a 5.0X growth rate would mean a doubling of the trend rate of growth of per capita income of 1.4% per annum. Success in these efforts would make a significant difference to the prospects of easing poverty in India. 20. A large and growing population and severe poverty underline the need to accelerate India's development efforts. The 1981 Census indicated there was no decline in the rate of population growth, which remained about 2.2Z per annum in the 1970s despite a measurable decline in fertility rates. The population growth rate failed to decline in the past lecade due to a reduction in the infant mortality rate and an increase in life expectancy, reflecting larger availability of food and health services. While this is a welcome development, it implies a greater strain on the economy and re-emphasizes the need for continuing efforts to strengthen the health and family planning programs in a broad rang,; of activities and services. These efforts are given high priority in the Sixth Plan, which aims at a rise in the proportion of protected couples in the reproductive age group from its estimated 1979/80 level of about 23Z to over 35Z by 1984/85. The Government is reviewing its population policy for the Seventh Plan, with indications of a determination to retain the emphasis on the implementation of family planning, health, education and literacy programs aimed at reducing fertility rates. 21. Reduction of poverty remains the central goal of Indian economic and social policy. More than one-third of the world's poor live in India, and more than 80% of the Indian poor belong to the rural households of landless laborers and small farmers. About 51% of the rural population and 40% of the urban population subsist below the poverty line. Significant reductions in poverty will depend primarily on an acceleration of economic growth, particularly in agriculture, combined with effective implementation of poverty alleviation programs. India's poverty alleviation strategy appropriately recognizes that production-oriented programs, which aim at accelerating the overall pace of economic growth, and poverty alleviation programs, targetted at those least able to participate in the general growth of the economy, can be mutually  -8- reinforcing rather than substituting for each other. Major poverty programs operating on a nationwide basis at present include: the Minimum Needs Program (NIP), the Integrated Rural Development Program (IRDP), and the National Rural Employment Program (NREP). The IRDP and NREP are targeted programs aimed at increasing the incomes of the poor rapidly, either through the transfer of productive assets or direct employment. The NIP, aims at broadening the provi- sion of social infrastructure and basic bEzvices which enhance the numan capi- tal of the poor and improve living standards. These programs represent a vitally important commitment of the Government to address the needs of the poorest. The scale of the poverty problem in India, combined with the inherent difficulties in implementing poverty programs in any country, imply the need for continued efforts to enhance the effectiveness of these programs. PART II - BANK GROUP OPERATIONS IN INDIA 22. Since 1949, the Bank Group has made 84 loans and 174 development credits to India totalling US$6,818 million and US$12,934 million (both net of cancellation), respectively. Of these amounts, US$1,465 million has been repaid, and US$5,909 million was still undisbursed as of March 31, 1985. Bank Group disbursements to India in the current fiscal year through March 31, 1985 totalled US$787 million, representing a decrease of about 27 percent over the same period last year. Annex II contains a summary statement of disbursements as of March 31, 1985. 23. Since 1959, IFC has made 32 commitments in India totalling US$265 million, of which a total of US$145 million has been repaid, sold, terminated or cancelled. Of the balance of US120 million, US$113 million represents loans and US$7 million equity. A su-mmAry statement of IFC disbursements as of March 31, 1985, is also included in Annex II (page 4). 24. The thrust of Bank Group assistance to India has been consistent with the country's development objectives in its support of agriculture, energy and infrastructure. Of particular importance have been investments in irrigation, extension and on-farm development designed to increase agricultural productivity, and efforts to improve the availability of basic agricultural inputs to farmers through credit, fertilizer, marketing, storage, and seed projects. Major elements of the lending program have also been directed at helping to meet the energy needs of the economy while curbing the growth of oil imports, and to ease the infrastructure bottlenecks which have hampered economic growth in India, particularly through power generation and distribution, and railways and telecommunications projects. The Bank Group has also provided financing for a broad range of medium- and small-scale industrial enterprises, primarily in the private sector, through its support of develop- ment finance institutions. Recognizing the importance of improving the ability to satisfy the essential needs of urban and rural populations, the Bank Group has supported nutrition and family planning programs, a rural roads project, as well as water supply and sewerage and other urban infrastructure projects. 25. This pattern of assistance remains highly relevant, and consonant with Government priorities, as reflected in the Sixth Plan and in the approach being taken by GOI in the preparation of the Seventh PLan. First, high priority will continue to be given to GOI 's agricultural program. While India has made  -9- significant progress in agriculture, productivity growth will have to be sus- tained to improve the balance between food demand and supply and to contribute to poverty alleviation and empLoyment. Thus, the Bank Group will continue to support irrigation, fertilizer production and distribution, and agricultural extension and credit. Second, alongside GOI's efforts in promoting greater efficiency and faster development of the industrial sector, increased assis- tance will be provided for industrial development. Third, the review of per- formance under the Sixth Plan confirms the high priority that should continue to be given to the expansion and more efficient use of basic infrastructure capacity and to the development of India's indigenous hydrocarhnr resources. Accordingly the Bank Group will continue to support the development of the energy, transport and telecoununications sectors to alleviate critical shortages which constrain output in both agricultural and industrial sectors. Fourth, support of urban development and other COI basic social services programs for the poor will also continue in light of the growth in population which, despite successes in lowering birth and death rates, still increases by about 16 million each year. 26. The need for a substantial net transfer of external resources in support of the development of India's economy has been a recurrent theme of Bank economic reports and of the discussions within the India Consortium. Thanks in part to the response of the aid community, India successfully adjusted to the changed world price situation of the mid-1970s. However, India continues to require a substantial level of foreign assistance both to offset the overall deterioration in the world trade environment, and to sustain the relatively higher investment and growth rates achieved during the first four years of the Sixth Plan. As in the past, Bank Group assistance for projects in India should aim to include the financing of local expenditures. India imports relatively few capital goods because of the capacity and competitiveness of the domestic capital goods industry. Consequently, the foreign exchange component tends to be small in most projects. This is particularly the case in such high-priority sectors as agriculture and irrigation. 27. India's poverty and needs are such that whenever possible, external capital requirements should be provided on concessional terms. Accordingly, the bulk of the Bank Group assistance to India in the past was provided from IDA. However, IDA lending to India is declining from a peak of US$1.6 billion in FY82, mostly due to funding constraints related to IDA. The amount of IDA funds available to India is likely to remain small in relation to India's needs for external support. Thus, this requirement for additional assistance will have to be met, in part, through larger Bank lending. Given its development prospects and policies, India is judged creditworthy for Bank Lending to sup- plement IDA assistance. A continuation of efforts already underway to achieve growth in productive capacity, trade expansion, higher levels of savings, foodgrains self-sufficiency and a reduction in the rate of population growth should result in continued economic growth and improvement in the balance of payments. India's debt service ratio is estimated at about 15.2% in 19E4/85. This ratio is projected to rise to around 20% by 1989190, mainly due to the hardening structure of India's debt; and to increase slightly over this level through the mid-1990's. Although the projected debt service ratios are con- siderably above historical levels, they are still manageable and will not adversely affect India's creditworthiness.  -10- 28. Of the external assistance received by India, the proportion con- tributed by the Bank Group has grown significantly. In 1969/70, the Bank Group accounted for 34% of total commitments, 13% of gross disbursements, and 12% of net disbursements as compared with 62%, 33% and 37%, respectively, in 1983/84. In 1983/84, about 19.0% of India's total debt service payments were to the Bank Group. On March 31, 1984, India's outstanding and disbursed external public debt was estimated to be about US$26.9 billion, of which the Bank Group's share was US$9.6 billion or 36% (IDA's US$7.8 billion and IBRD's US$1.8 billion). As of March 31, 1985 outstanding loans and credits to India held by the Bank totalled US$18,288 million, of which US$5,909 million remain to be disbursed, leaving a net amount outstanding of US$12,379 million. PART III - THE WATER SUPPLY AND SEWERAGE SECTOR 29. Although the Central Government provides financial support to the water supply and sewerage sector in India, State Governments have primary respon- sibility for the development of this sector. They execute their respon- sibilities through various implementing departments and agencies which, in turns may delegate part or all of their duties to local authorities. In a number of cases, municipal authorities or other local agencies have been given responsibility for pLanning, design, construction, operation and maintenance of water supply and sewerage services within their jurisdictions. 30. Due to competing resource demands from other sectors, as well as the lack of management and planning skills, and shortages of key materials and equipment, only about 1-2% of total public expenditures was invested in the sector prior to 1975. Investments in urban water supply and sewerage during India's Fifth Five Year Plan (1974/7B) averaged Rs 1,100 million per annum, or about 1.5% of the total Plan investment; the corresponding figure for the rural areas was Rs 750 million, or about 1.0% of total Plan investments. Although these investments represented a significant commitment to development of the sector, they were still quite inadequate to achieve a substantial improvement in overall service lev4ls. In 1980, it was estimated 1/ that about 287 million people, or about 42Z of India's population of 683 million, had access to reasonably safe drinking water and that only some 43 million people (6Z of the population) were provided with sanitary services. These levels were among the lowest for all developing countries. 31. The Government of India (GOI) has recognized the importance of raising present service levels and is seeking to achieve the targets set for the International Drinking Water Supply and Sanitation Decade (IDWSSD) 2/ by making substantially increased funding available to the sector. In the Sixth Plan (1980-85), 4% of the total Plan investments (Rs 975,000 million) has been allocated to the sector. The rural sector receives an average of Rs 4,300 1/ World Health Organization, South East Asia Regional Organization (SEARO) Regional Health Papers No. 1, Decade Commencement Report, 1983. 2/ The COI Decade goals are: Urban and Rural Water Supply, 100Z coverage; Urban Waste Disposal, 80% coverage; Rural Sanitation, 25Z coverage.  -11- million per year, about 2.2% of Plan investments. The corresponding figure for the urban water supply and sanitation sector is Rs 3,500 million, or about 1.8X of Plan investments. These figures represent approximately six times and three times, respectively, the investments made in the individual sectors under the previous Plan, and reflect the importance that GOI attaches to the Decade program. The increased emphasis on the rural sector is particularly evident. The proportional allocation to the sector under the Seventh Plan (1985/90) is expected to be higher than that of the Sixth Plan. 32. While these investment levels represent a substantial increase in proposed sector expenditures, it is unlikely that the Decade goals would be fully realized by 1990. A WHO Study 1/has concluded that there would still be a substantial shortfaLl in funds and a lack of sufficiently qualified manpower. An equally important factor affecting the achievement of targeted goals is the efficient operation and maintenance of existing systems. The latter has always presented a serious challenge, and institutional strengthening and intensive training of personnel at all levels in the sector would be needed to achieve required standards. Kerala 33. The State of Kerala is located on a narrow stretch of land along India's southwest coast. Its area of 38,864 sq km is divided among coastal plains, midlands and highland regions. The estimated population of Kerala in 1981 was 25.5 million (a density of 650 people per sq km), of which about 17% lived in urban areas. The State's economy is dominated by agriculture which accounts for about 44Z of its net domestic product. The principal crops grown in Kerala are tapioca, rice, rubber, and cashew. Nearly 25,000 sq km, or two-thirds of Kerala's land area is farmed, and of this, approximately 7,000 sq km are irrigated. The average annual per capita income in the mid 1970's was approximately 10% below the all-India average of Rs 988. 34. Unlike many other states in India, Kerala has adequate water resources. Forty-one rivers flow down from the ghats on the State's eastern border. These yield an average of 64,300 million cubic meters (Mm3) of water annually, of which about 57% is presently utilized. During periods of low flows, these rivers are subject to tida'1 and saline intrusions, which make them unsuitable for either irrigation or domestic consumption in the coastal areas. In most areas of the coastal region, groundwater yields are low and unreliable, and the quality is poor. In the rocky inland zone, the potential for groundwater development is also limited. 35. Substantial progress has been made in improving urban water supply since 1974, and at present about 76% of the urban population receives piped sup-ly. Although the provision of water to rural areas has also increased considerably, the proportion of the rural population receiving safe piped supply is still only about 31%. The remainder of the population (both urban and rural) depend on wells or streams. The average per capita supply of piped water in towns with populations of 35,000 or more is currently about 135 liters per day (lpcd). In medium-sized towns (20,000 to 35,000 population), the corresponding figure is about 90 lpcd; and in small towns and rural areas, about 25 lpcd.  -12- 36. Urban sanitation has improved with the steady increase in the number of septic tanks (serving about 40% of the population) and latrines (serving about 53%), with the result that very few people are now without some type of permanent disposal facility. Waterborne sewerage systems have been provided in only two cities, Trivandrum and Cochin, serving about 26Z and 2% of their respective populations and a sewerage tax is collected from users of the system. The provision of rural sanitation is much less satisfactory. About 37% of the population use pit latrines and, apart from some waterseal latrines, the remainder of the population has no sanitary facilities at all. Sectoral Organization 37. Up to March 1984, the planning, design and construction of all water supply and sewerage works in Kerala were the responsibility of the Public Health Engineering Department (PEED). PHED was responsible for the operation and maintenance of all schemes, with the exception of ten municipalities which own and operate their own distribution systems, set tariffs, and collect revenues. PHED however operated the production facilities for these municipalities and was reimbursed by them for the cost of this service. In other towns where assets are owned by the individual local authorities, PHED acted as agent and collected directly from connected consumers and billed the local bodies for the full cost of production and distribution of water and for standpost usage. As PHED's operations were subsidized through the State Ministry's budget on a regular basis, it had little incentive to minimize its operational costs or to set up effective accounting and cost control systems. 38. In March 1984, GOK passed an Ordinance transforming PHED from a govern- ment department into a semi-autonomous authority - the Kerala Water and Wastewater Authority (KWWA). The Ordinance gives the new Authority respon- sibility for planning, design, implementation, operation, maintenance, and financial control of Kerala's water supply and sewerage systems. With a Board of senior GOK officials, KWWA enjoys autonomy in the sector with the power to initiate tariff revisions and to deal directly with local bodies. KWWA is also responsible for implementation of the State's Seventh Plan for the sector and would own all new water supply schemes to be constructed. The ten municipalities which currently operate their own distribution systems and the towns which currently own their own assets would continue to do so for the time being. KWWA would be reimbursed the full cost of operations performed on their behalf. However, at any time after three years, COK is empowered under the Ordinance to assign to KWWA full responsibility for the supply and distribution of water in these municipalities and towns. GOK is expected to exercise this authority if they do not improve their current performance in operations, maintenance, billing and collection, or meet their financial commitments to KWWA within the three year period. Sector Investment and Finance 39. COK has adopted GOI's targets for IDWSSD (see para 31) and has made a heavy commitment to improving water supply and sanitation conditions in the sector. Under the State's Sixth Plan an allocation of Rs 1,277 million has been made to the sector representing about 7% of total Plan investments (double the amount provided in the previous Plan) as compared with the corresponding national figure of app-oximately 4%. The emphasis in GOK's investment program has been on water supp;y rather than sanitation. GOK's Sixth Plan has given  -13- priority to rural water supply, which has received some 65Z of the sectoral allocation. A substantial investment of funds and management effort would however be needed in this sector if GOK is to meet the Decade water supply target of providing 100X coverage of its population by 1990. Details of the State's Seventh Plan have not yet been finalized, but it is understood that GOK intends to continue to emphasize its investment in rural water supply. Sector investments under the Seventh Plan are estimated to be Rs 2,750 million, about 50% higher than Sixth Plan investments in real terms. OOK's funding to the sector is on a loan/grant mix of 50X-50Z for urban water supply schemes and 25Z-75Z for rural schemes. Approximately 2/3 of GOK sector investments under the Sixth Plan has been in the form of grants. World Bank Operations in the Water Supply and Sanitation Sector 40. Since 1974, the Bank Group has made eight credits totaling US$602 million for water supply and sewerage projects in India and has provided a further US$190 million for water supply and sewerage as part of a broader program of infrastructure development in urban areas. 1/ Credit 390-IN (Bombay Water Supply and Sewerage Project of January 22, 1974) and Credit 585-IN (Uttar Pradesh Water Supply and Sewerage Project of September 1975) have been completed. The major conclusions of the Project Completion Reports for these projects are discussed in the following paragraphs. Apart from two projects in the Bombay Metropolitan Area, the other projects have assisted statewide programs that have included design and construction activities conducted by semi-autonomous state agencies. Sectoral Objectives and Performance 41. The World Bank's goals in the sector are: to support the certral and state government's overall objective of extending water and sanitation services to the population; and to assist in improving the efficiency of sector operations. In pursuit of these goals, Bank projects seek to: (a) promote institutional development; (b) encourage sound financial management; (c) assist in the formulation of tariff policies to promote conservation, equitable access to water, and cost recovery; and (d) foster the reevaluation of design stand- ards and the adoption of lower-cost technologies. Physical works under Bank-financed projects have been implemented satisfactorily with moderate delays in implementation. Efforts to reduce costs through the judicious selec- tion of service standards and use of lower-cost technical options have been increasingly successful. Several programs to deveLop, test, and promote low- cost sanitation technologies have been undertaken by state governments and by the UNDP Technical Assistance Project (UNDP GLO/78/006) administered by the 1/ The projects cover services for Bombay (Credit 390-IN and follow-up project, Credit 842-IN), Uttar Pradesh (Credit 585-IN), Punjab (Credit 848-IN), Maharashtra (Credit 899-IN), Rajasthan (Credit 1046-IN), Gujarat (Credit 1280-IN) and TamiL Nadu (Credit 1453-IN, Special Fund 16-IN). Rural water supply schemes were also included in the two Haryana Irrigation projects (Credits 841-IN and 1314-IN). The First, second, and third Calcutta Urban Development Projects (Credits 427-IN, 756-IN and 1369-IN) and the Madras Urban Development Project (Credit 687-IN) have provided water supply and sewerage facilities as part of a composite program to develop urban infrastructure.  -14- World Bank. While the physical progress of works under water supply projects has been generally satisfactory, institutional and financial weakness of such projects is a cause of concern. There is a growing recognition among policy makers that in order to extend water and sanitation services to the majority of the population, the sector must strengthen its institutions and generate a larger portion of its funds through direct user charges. 42. GOI is collaborating with IDA in a review of past project performance. The objectives of this ongoing study are to identify the reasons for not achieving agreed targets, and to work out a mutually acceptable action plan for improving future performance. The review has revealed that the inability to fully achieve project financial and institutional goals has contributed to inadequate cost recovery and thus to the under-financing of operations and maintenance. In retrospect, the difficulties appear to have stemmed from several interrelated problems. First, the goals were ambitious. The projects have sought the reorganization of participating agencies, and have introduced new concepts and targets for cost recovery and new systems for reporting and accounting. Second, the reforms and the detailed operating procedures needed to impLement them have not been developed in sufficient detail. In several cases, the agencies have relied heavily on local consultants with limited experience in sector finances or operations. Third, the process of innovation has itself been poorly managed. Realistic schedules needed for phasing in and implementing new procedures have not been planned nor coordinated with the training and technical assistance needed to facilitate the changes. 43. While the review suggests that sector performance can be improved substantially over the medium to long-term, it must be recognized that the attitudinal and institutional adjustments underway will take time and that project objectives need to be tailored accordingly. The review also supports the rationale for further Bank Group involvement at the sector and project levels in order to assist GOI in the achievement of the objectives discussed in para 41 above. PART IV - THE PROJECT 44. The proposed project was prepared by KWWA with assistance from Bank staff and consultants and was appraised in May/June 1984. The Staff Appraisal Report No 5397-IN dated June 10, 1985, is being distributed separately. A Supplementary Project Data Sheet appears in Annex III. Negotiations were held in Washington D.C. in March/April 1985 with Mr. C. K. Ramachandran, Deputy Secretary of the Department of Economics Affairs, Ministry of Finance, as coordinator of the Indian Delegation. Project Description and Objectives 45. The proposed project would be implemented over five years (1985/90) and represents a significant portion (about 31%) of GOK's sector investment program under its proposed Seventh Five Year Plan (1985/90). It aims at providing piped water to seven rural areas that currently depend on distant or  -15- unsafe sources of supply. 1/ The project would also provide an improved supply of water to the Quilon Municipal Corporation. Approximately 75Z of project funds would be allocated to the rural component. Low-income groups would be provided with assistance to connect to the water supply system, or would alter- natively be served with standpost water. Pilot low-cost sanitation programs would be introduced for both urban and rural areas. The project would consist of the following components: (a) Rural Areas: the construction of intake, treatment, transmission, and distribution facilities to provide a design supply of approximately 180 million liters per day of piped water to the rural areas of Puthencruz, Adoor, Chithara, Vilappil, Quilon Panchayats, 2/ Kottayam Panchayats, and the Greater Cochin Development Area (GCDA); (b) Urban Area: the construction of intake, treatment, transmission, and distribution facilities (including metering) to provide a design supply of an additional 35 million liters per day of piped water for the Quilon Municipal Corporation area; and replacement of a deteriorated transmission pipeline to reduce wastage; tc) Low Cost Sanitation: a pilot low-cost sanitation component for 10 medium-sized towns, and a similar component for selected rural areas; and Cd) Central Services: the provision of centralized services for KWWA, including leak-detection units, meter-repair facilities, workshops, Laboratories, and funds for a sector-wide training program. 46. In addition, KWWA would be provided with consultant services for the implementation of accrual accounting systems and the training of staff in these systems, for valuation of KWWA's assets, and a study of costs and revenue sources. To monitor the implementation of a number of interrelated project activities aimed at improving the operational efficiency and financial viability of KWWA, an Action Plan has been agreed with GOK and KWWA. The Action Plan would be reviewed annually and updated by KWWA in consultation wi' l IDA (Schedule 2 to the draft Project Agreement). Project Implementation 47. KWWA would implement the project except for the urban and rural low- cost sanitation components, which would be implemented by the participating local bodies with support from KWWA. Established in March 1984, KWWA is managed by a Board of Directors, the Chairman of which is the State Minister responsible for the water supply and sanitation sector. The Managing Director, l/ About 80Z of the schemes would cover "problem villages", i.e. villages which lack a reliable supply of water within a depth of 15 m or a distance of 1.5 km; or those in which the supply has either a high incidence of water-related disease or contains excessive fluorides, iron or chlorides. 2/ The Quilon Panchayats would share the produccion facilities of the Quilon Municipality.  -16- a full-time public health engineer nominated by the Government, acts as Chief Executive. The remainder of the Board comprises two Government nominees and three ex-officio members (the secretaries to the departments of finance, local administration, and public health engineering). 48. As a part of project preparation, consultants reviewed KWWA's organiza- tional structure, staffing and procedures. A proposed organizational structure, which takes into account the consultants recommendations and the appraisal missions suggestions was reviewed with KWWA during negotiations. COK would ensure that KWWA is fully staffed and all senior posts (four positions at Chief Engineer level) sanctioned and filled by August 1, 1985 (Section 2.05 of the draft Kerala Agreement). In order to coordinate, implement, and monitor the proposed project, KWWA would establish a Project Management Unit, by August 1, 1985, headed by a senior engineer, of the rank of at least Deputy Chief Engineer (para. 6, Schedule 2, to the draft Project Agreement). 49. The technical aspects of the project are well conceived and the overall concept of the schemes represent least cost solutions. KWWA staff have prepared all feasibility reports and by appraisal preliminary engineering design had been completed in sufficient detail. The detail engineering is sufficiently advanced and bid documents for the first year's schemes are expected to be ready on schedule. Consultants, with experience in other Bank-financed water supply projects in India, have prepared detailed recommen- dations on systems of accrual accounting, performance budgeting, and management information for KWWA. They have also recommended staffing requirements at the divisional levei for accounting, and billing and coLlection activities. KWWA intends to implement these recommendations, including the appointment of suitably qualified financial staff to all corporate and divisional posts. The Financial Adviser and Chief Accounts Officer's post would be filled by August 1, 1985 (Action Plan), and consultant services would be used to assist in implementing the accrual accounting systems (Schedule I, Section II, para. l(i) to the draft Project Agreement). As an integral part of the consultants' assignment in implementing KWWA's centralized financial and information manage- ment systems, a specific progress report format would be developed by August 1, 1985, and quarterly progress reports would be submitted to IDA, starting with the quarter ending December 31, 1985 (Action Plan). Low-Cost Sanitation 50. Under the proposed project, ten medium-sized towns for which feasibility studies have been completed under the UNDP Global Low-Cost Sanitation Project would be provided with pour-flush waterseal-type latrines. A selected number of rural areas for which feasibility studies would be com- pleted by October 1, 1985 under the UNDP Project would also be provided with similar units (para. 3, Schedule 2 to the draft Project Agreement). The con- struction of these units would be commissioned by the local bodies with KWWA support. KWWA would establish a cell for this purpose by August 1, 1985 (para. 3, Schedule 2 to the draft Project Agreement). The construction of these units would be confined to areas where pollution of groundwater sources would not present a problem. To ensure that this requirement is met, each participating local authority would be required to pass by-laws by December 31, 1985 as a condition of disbursement of its portion of the credit. (Section 2.06 of the draft Kerala Agreement and para 3 (b) of Schedule I to Zhe draft Development Credit Agreement). The financing plan and cost recovery  -17- measures for this component would be based on affordability criteria estab- lished under the UNDP Project which is acceptable to IDA. Manpower and Training 51. The total staff of all categories employed in the water supply sector in Kerala is about 5,500 including the staff of municipalities currently operating their own water distribution systems. Manpower projections for the remainder of the Decade, indicate an annual average recruitment rate of about 440 staff members. Systematic in-house training of the technical staff is not currently provided by KWWA. As a component of the project, KWWA would develop a comprehensive scheme of training and establish training facilities. Initially, training priority would be given to: needs arising from institu- tional reorganization; the introduction of new management, financial, and central support services; and the upgrading of operation and maintenance skills. The training component would include a Stage I preparatory phase and a Stage II implementation program and evaluation mechanism. KWWA would design Stage I of the training component by January 1, 1986 (para. 4, Schedule 2 to the draft Project Agreement). Consultants would not be invited to submit proposals for Stage II until KWWA's Training Steering Committee has confirmed the satisfactory completion of Stage I. The timing of Stage II would be agreed with KWWA during project implementation (Action Plan). Project Costs and Financing 52. The estimated cost of the proposed project is about US$85.2 million equivalent, including about US$2.8 million in taxes and duties. Physical contingencies (US$3.69 million) have been estimated at 10% of base costs for civil works, and 5% for materials and equipment. Price contingencies (US$12.79 million) have been added for local costs at 8% for fiscal year 1984/85; 7% for 1985/86 through 1987/88 and 6% for 1988/89 onwards, and for foreign costs at 8% for 1984/85; 9% for 1985/86 through 1987/88 and 6.5Z for 1988/89 onwards. Details of project costs are included in the Credit and Project Summary. Approximately 48 man-months of local consultancy services are required to implement the accounting systems, and the proposed cost and revenue study under the project. 53. The proposed IDA Credit of US$41.0 million equivalent would finance about 50% of project costs, net of duties and taxes. The Credit would finance all direct and indirect foreign costs (approximately US$22.15 million) and US$18.85 million of local costs. The balance of funding required for the project (approximately US$44.2 million) would be provided by GOK as a loan/grant mix. For urban schemes, the loan/grant mix would be 50X-50, and for rural schemes 25-75%. Central services would he funded on a 100% grant basis. 54. Due to the preponderance of rural schemes, approximately 73% (US$62 million) of project costs would be made available to KWWA and the local bodies in the form of capital grants. The 75% grant financing of rural schemes is below the 90% level provided by many other States in India. GOK loans would be at 8-3/4% interest per annum over a period of 25 years, including five years of grace for principal and interest payments during which time the interest due would be capitalized and added to the principal loan amount. The proposed relending rate is comparable with the current interest charged by financial  -18- institutions in India on loans for similar purposes and is expected to be positive in real terms, since the average annual rate of inflation in India over the project period is not expected to exceed 8%. The ownership of all works constructed under the project with the exception of those relating to the Quiton municipality and the low-cost sanitation components, would be vested with KWWA. KWWA, the Quilon Municipality and participating local bodies would be responsible for repaying their associated debts to COK. Procurement and Disbursement 55. Annex IV, attached, details the manner in which items would be procured under the project. Contracts for equipment and materials, estimated at US$32.9 million including contingencies, would be awarded on the basis of international competitive bidding (ICB) in accordance with IDA's guidelines for procurement. A preference margin of 15% of the c.i.f. value or current import duty, whichever is lower, would be granted to local manufacturers in bid evaluation. Other contracts for equipment and materials would involve either small items (below US$200,000) which cannot readily be grouped into larger bulk contracts or contracts involving concrete construction and other materials such as asbes- tos cement, and concrete pipes that are unsuitable for ICB because of high transportation costs and/or high risk of damage in transit. These contracts, (estimated at about US$9.1 million) would be awarded on the basis of local competitive bidding (LCB) in accordance with local bidding procedures satisfac- tory to IDA. 56. The civil works component of the project (US$31.4 million including contingencies) would consist of a large number of relatively small contracts. These works, which are widely dispersed throughout the project area, do not require any special equipment or techniques and are labor-intensive. They include labor-intensive pipe laying and the construction of pumping stations traditionally carried out by registered contractors established in Kerala or other Indian States and foreign bidders could not successfully compete with local bidders for works of this type and size. The treatment plants to be constructed would bs let on a turnkey basis. The value of these contracts (average base cost US$295,000 each) is unlikely to be large enough to attract foreign bidders and these would also be bid locally. Most of the contracts for equipment, materials, and civil works are likely to be won by local contractors. 57. The proceeds of the credit would be disbursed against 100% of the cost of imported equipment and materials or 100% of the ex-factory cost of locally manufactured goods procured under ICB; 20% of the expenditures of locally procured equipment and materials; 20% of the cost of civil works contracts subject to LCB; 100Z of the cost of contracts for consultant services and training, and loan fund expenditures. No disbursements would be made against administrative costs. Disbursements against small civil works contracts, for one or more progrcss payments not exceeding Rs 300,000 (about US$27,270), equipment and materials for payments not exceeding Rs 150,000 (about US$13,640) and loan fund expenditures on house connections would be on the basis of Statements of Exp-tnditures. The supporting documentation for these expendi- tures would be subject to independent audit and would be retained for inspec- tion by review missions. Disbursements against expenditures for all other items would be fully documented.  -19- Cost Recovery Targets 58. The cost recovery targets formulated for the Quilon Municipal area and the more prosperous rural panchayats of Quilon, CCDA and Kottayam in the KWWA service area, envisages the full recovery of all operation, maintenance and overhead costs plus deb: service from the commissioning of schemes 1/ in FY91. In the poorer and less developed rural areas of Puthencruz, Adoor, Chithara, and Vilappil under KWWA's jurisdiction, there would be a full recovery of operation, maintenance and overhead costs from the time of commissioning in FY90. On the basis of these targets, a tentative tariff structure has been developed for Quilon and the KWWA service area for 1990 (para. 59). The study of costs and revenues to be initiated in 1987 will reconfirm the proposed tariff structure (para 60). In the interim, tariffs and charges would be increased (para. 62) to help to reduce GOK's operating subsidy and to bridge the gap between prevailing and proposed tariff levels. GOK has confirmed the acceptance of the targets set for FY90 and FY91 for the rural areas and for FY91 for the Quilon Municipal area (Section 3.06(a) of the draft Kerala Agreement). Tariffs 59. A tentative tariff structure has been developed to meet the proposed cost recovery targets at commissioning of the project. The tariff rates proposed on the basis of the tentative tariff structure are within the limits of affordability (2Z of monthly average household income), established by the socio-economic survey undertaken as a part of project preparation. This affor- dability limit is similar to that found in other Bank water projects. It assumed that there would be graduated tariff slabs for all connected domestic users. The first slab would represent basic household needs of up to 5,000 liters/month priced at the lowest rate of Rs 1 per 1,000 liters. 2/ Commercial users and households consuming over 15,000 liters per month would pay double this rate and industrial consumers three times the domestic rate. Quilon currently levies a water tax of 4% of annual rental value which is expected to generate sufficient funds to pay for the supply of water through public standposts. In non-urban project areas, where there is no water tax, the financial analysis indicates that the cost of standpost water would be about Rs 1 per capita per month in 1990 prices. Local Panchayats would be required to meet these costs through their general tax revenues. Study of Costs and Revenues 60. KWWA has under implementation a commercial accounting system which would permit a better analysis of its operating costs and financial status. Over the next five years, KWWA may also be required to take over the ownership and distribution systems of the ten municipalities outside its purview. It I/ The commissioning of works in Kottayam is expected to be completed in March 1989 and the cost recovery measures would be operative from FY90 onwards. 2/ No domestic free allowance is envisaged, but a minimum charge could be levied against the first 5,000 liters per month.  -20- would therefore be appropriate to reconfirm the estimated tariff structure based on the cost recovery targets proposed for this project when better finan- cial information is available, when KWWA's future responsibilities become clearer, and when the time of project commissioning approaches. Consequently, by December 31, 1987, COK would initiate a study of costs and revenues as a part of the project, (Section 3.05(a) of the draft Kerala Agreement). In addition to evaluating the actual tariffs for the project area, this study would provide the basis for the development of a tariff structure for water supply throughout the KWWA service area (including rates for bulk supply, public standposts and private, commercial and industrial consumers) and of appropriate charges for KWWA's transmission and distribution services to local authorities outside its jurisdiction. 61. As project area finances form a part of KWWA's overall financial picture, future tariff policy must address the entire sector and not be limited to the project areas alone. Consequently, by April 1, 1990, GOK would cause KWWA to implement tariffs for its entire service area taking into consideration the findings of the cost and revenue study (Section 3.05 (b) of the draft Kerala Agreement). For those areas where KWWA does not set tariffs, it would establish charges to fully cover its operation, maintenance and overhead costs of providing these services. Interim Tariff 62. Tariffs were increased in Trivandrum and several other areas in 1984, but they need to be revised again before project commissioning to cover the current operating costs of the systems. Deficits due to existing low tariffs and inadequate billing and collection necessitate GOK operating grants to KWWA. To phase in future tariffs and to help alleviate the subsidy burden borne by the State, an interim tariff increase would be required for all cocnected users throughout the KWWA service area before the introduction of new tariffs in 1990 (para. 61). Within the project area, only Quilon Municipality would have a water supply system in operation before FY90. As an interim measure the cur- rent average tariff in Quilon of Rs 0.40/1,000 liters would be raised by 50% to Rs 0.60/1,000 liters for domestic usage, and Rs 1.20/1,000 liters for commer- cial and industrial usage by December 1, 1987 (Section 3.04(a) of the draft Kerala Agreement). 63. For all other connected consumers within the jurisdiction of KWWA an interim tariff increase of at least 20% above present levels 1/ of water rates for domestic, commercial and industrial usage would be implemented by December 1, 1987 (Section 3.04(b) of the Kerala Agreement). In order that KWWA would be able to meet its expenditures until FY90, COK would be required to undertake to compensate KWWA for any shortfalls in revenues on account of its operation, maintenance and debt service requirements from FY86 through FY89 (Section 3.06(b) of the draft Kerala Agreement). Municipalities outside the jurisdiccion of KWWA would continue to reimburse KWWA for the operation a:ad maintenance costs of their production facilities together with an appropriate overhead fee. The Cochin Municipal Corporation would be required to pay a bulk supply rate adequate to cover KWWA's operating expenditures. Accordingly, the 1/ About Rs 0.50/1000 liters.  -21- Cochin bulk supply rate would be increased to Rs 0.25/1,000 liters by December 1. 1987 (Section 3.04(b) of the draft Kerala Agreement). Billing and Collection 64. Billing and collection of water charges from private connections have not b,een stressed by either PHED or KWWA. With the introduction of the new accounting system, it would become easier to monitor this activity. Consultants have already recommended the staffing and bookkeeping procedures required to achieve acceptable billing and collection rates. KWWA would be required to meet agreed billing and collection targets under the project (para. 5, Schedule 2 to the draft Project Agreement). Benefits 65. The project to be commissioned in 1989/1990 would provide a piped water supply service for the first time to about 1.5 million people living in seven rural areas, most of whom have no safe supply at present. A further 190,000 people, mostly in the low income groups in the Quilon Municipal Corporation area, would also receive an improved service. By the time of commissioning, all households in the project area would receive a basic supply of at least 30 lpcd. Thereafter, the proportion of direct house connections to standpost usage is expected to grow steadily and net service levels are expected to increase. By the year 2000, about 60% of the population in the Kottayam and Quilon Panchayats and 40% of the population in the remaining rural areas, with the exception of GCDA, would receive about 60 lpcd of piped water. In the Quilon Municipal Corporation area and GCDA, 60% to 80% of connected households would be provided with approximately 112.5 lpcd of piped water. The remainder of the population served in both urhan and ruraL areas would receive about 30 lpcd through public standposts. The low cost sanitation program would provide 100% coverage of the population in the 10 mediumrsized towns and selected rural areas. 66. Careful consideration was given by KWWA to the selection of the project's water sources. Surface water resources are widely available in Kerala. Where groundwater is available, it is generally unreliable and of poor quality. Sample studies conducted for groundwater development have indicated that, whereas the capital costs would be comparable to those of surface water sources, the operating costs would be high, making the groundwater alternative Lneconomic. Surface water sources have therefore been selected for all seven of the water supply schemes. Where feasible alternative surface water sources weare available, the choice was based on the criteria of least-cost and reliability of water flows. Financial and economic analyses have been con- dccted on the assumption that industrial customers would be charged in 1990 about Rs 3.00 per 1,000 liters and commercial customers Rs 2.50 per 1,000 li:ers and that progressive tariffs would be applied to residential customers. Constraints on sales imposed by affordability and competition from alternative unsafe cupplies suggest that rates ranging from Rs 1.00 - 2.00 per 1,000 liters are appropriate for domestic usage. 67. The tariff structure would be finalized following completion of the cost and revenue study (para. 60). Whenever progressive tariffs are being applied, the benefits have been evaluated at the maximum rate to be paid by consumers since this represents their willingness to pay for incremental  -22- amounts of safe piped water. The estimated rates of return for each of the water supply subprojects are about 12% for the Quilon Municipal Corporatiou area, about 14% for the Kottayam, the GCDA, and Quilon Panchayats, and about 7% for the poorer rural areas. The overall economic rate of return for the project has been estimated to be about 8%. The estimated rates of return do not reflect the value of external effects on health or the general environment, nor do they capture any private benefits that consumers who have had no pre- vious experience with a safe water supply may attach to the provision of such a service. Environmental Health Impact 68. In the rural areas, where the existing water sources are poor in quality and unreliable, the availability of sufficient quantities of good quality water should lead to a marked reduction in the incidence of water- related diseases. The urban water supply component in Quilon would improve present service levels, provide more uniform distribution of piped water and meet the increased demand due to population growth. These factors are expected to produce improved environmental conditions in the urban areas. Finally, the pilot low-cost sanitation components would greatly improve the sanitary condi- tions in the selected towns and rural areas. Impact on Poverty Groups 69. The poorer groups in the rural areas of the project would benefit substantially from the provision of public standposts. The design criteria foz the standposts provides for a supply of water to 180 people per tap, sub- stantially reducing the walking and waiting time for water collection. A socio-economic study for the project area reported that households currently spend an average of 1 hour 40 minutes per day in fetching water, often from unsatisfactory sources. Conditions are worse during the dry season when many sources of supply dry up. The urban water supply component of the project would ensure that satisfactory service levels are provided at the standposts in Quilon Municipality. Under the project, soft loans would be provided to low- income consumers through a revolving fund to facilitate connections to the water supply system . The low-cost sanitation components would have a substan- tial impact on poverty groups, since the project provides a 100% coverage of the population in the selected communities. On a proportionate basis, about 60% of the project investments have been allocated to the coverage of the poor. Project Risks 70. Because the project is large and covers a sizable area, implementation would have to be well coordinated and monitored if the project is to be finished on time. However, KWWA's technical staff (in its previous role in PHED) has had considerable experience in handling projects of similar magnitude and scope. Furthermore, the organization, management, and staffing of KWWA are being strengthened as part of the project (para. 48), and consultants would be available to assist in the implementation of improved financial and management information systems and a project monitoring system. 71. Achieving the project's financial objectives has been a major concern in most water supply projects. To minimize the risk of failure, realistic financial targets have been set and improved financial and accounting systems  -23- are being implemented which would help measure and control KWWA's financial performance. Interim tariffs required to phase in the tariffs proposed for 1990 were agreed at negotiations. A study of costs and revenues would be undertaken as the basis for implementing a tariff structure and the application of tariffs to the entire KWWA service area (paras. 60 and 61). Finally, an Action Plan has been agreed upon to help improve cost recovery and operational efficiency and to facilitate close monitoring of the progress of project implementation. PART V - LECAL INSTRUMENTS AND AUTHORITY 72. The draft Development Credit Agreement between India anu the Associaticn, the draft Kerala Agreement between the Association and the State of Kerala, and the draft Project Agreement between the Association and the Kerala Water and Wastewater Authority, and the Recommendation of the Committee provided for in Article V, Section l(d) of the Articles of Agreement are being distributed to the Executive Directors separately. 73. Special conditions of the project are listed in Section III of Annex III. The passage of by-laws ensuring that the construction of sanitary units would be confined to areas where the pollution of groundwater sources would not present a problem would be a condition of disbursement of the Project (Schedule I, para 3(b) to the draft Development Credit Agreement). 74. I am satisfied that the proposed Credit would comply with the Articles of Agreement of the Association. PART VI - RECOMMENDATION 75. I recommend that the Executive Directors approve the proposed Credit. A. W. Claeisen President June 17, 1985  AlM= I Page 1 of 5 TARLE 3A INDIA - SOCL DICATOR DATA 3IIC15 InIA mawUr EGTED AVEASJ 1 NUT (MOST RECIT ESTMTE) RaT aW nin MIDDz Ln IM&! 1970&! ZM .TEATUk ASIA 6 PACIFIC ASIA 6 PACIFC Amflin am SQ. -) TOTAL 3267.6 3287.6 3287.6 ACIUCULTURAL 1763.5 1700.5 la2.L, ca - CAPITA (Is) 60.0 100.0 260.0 273.6 1091.2 -iBG conUUTEO Mm CAPIT (KILOGRAMS OP OIL EQUIVALT) 73.0 113.0 153.0 272.0 567.3 MPIATION AM VIX S D=w POPULATIu*HID -TIM (TCUSAJI) 434349.0 547569.0 716985.0 URBA POPULTION (I OF TOTAL) 13.0 19.3 24.1 21.7 34.7 POPULATION mIscons POrUlTION IN TER 2000 (CILL) 994.4 STATIOAY POPULATION (HILL) 1707.2 OPULATION HMWZf 1.7 POnULTIEON ENsm PER SQ. IN. 132.3 160.6 213.4 16b.6 261.9 PER SQ. ON. AGEI. LAW 246.6 307.5 367.1 345.5 1735.1 POPULATION AE STRUCTURE (Z] 0-LA YRS 40.9 42.7 39.3 35.3 39.0 15-64 ns 54.5 S5.2 57.6 59.8 57.6 65 AND AOM 4.6 3.1 3.1 4.3 3.3 POPULATION CROWTH RATE (E) TOTAL 1.8 2.1 2.2 1.9 2.3 URBAN 2.5 3.3 3.9 4.1 4.3 CRUDE BIRTH RATE (PER THOUS) 47.7 41.4 34.2 27.7 30.1 CRUDE DEATH RATE (Pt T110tlS) 23.8 17.6 12.7 10.1 9.5 GCOSS REPROOUCTION RATE 2.9 2.8 2.2 1.8 2.n FANILY PLlANINC ACCEPTORS. ANNUAL (THOUS) 64.0 3782.0 6126.0 USERS (2 OF oaR SIED WusS) ,, 11.7 28.0 ,, 52.7 roO AnD STrITIO INDEX OF FOOD PROD. PER CAPITA (1969-71-100) 98.0 102.0 101.0 112.8 123.0 PIR CAPITA SUPPLY if CALORIES (I OF REQURSIns) 96.0 91.0 8660 97.7 114.4 POTEINS (caai PER DAT) 544) 50.0 46.0 56.8 57.0 iF WHICH ANIAL AND PULSE 17.C 15.0 13.0 /a 14.9 14.1 CHILD (AGES 1-4) DRATN RAIE 26.2 20.7 11.0 9.8 7.2 LIFE EXPECT. AT SIMTH (YEARS) 42.5 47.5 54.6 60.0 60.4 INFANT HOT. RAxE (PER NUS) 165.0 139.0 94.0 83.8 66.3 ACCESS MO SAFE WATER (SPOP) TOTAL .. 17.0 33.0 id 32.9 37.0 URA .. 60.0 83.0 7d 70.9 54.8 RURAL 0. L20. o 7-1 22.1 2h ACCESS TO EYCRETA DISPOSAL (S OF POPULATION) TOTAL .. 18.0 20.0 le IL 41.3 URBAN .. 5.0 87.0 Te 72.8 47.4 RURAL .. 1.0 2.0 .- 4.6 33.3 POPUIATION PFM PISICIA 4685.0 4890.0 3690.0 Jf 3484.2 7749.4 POP. PER HISSING PERSON 10980a0 D A 7420.0 5460.0 W 4793.1 2460.4 POP. PR HOSnTAL RED TOTAL 2130.0 1650.0 1290.0 If 1066.5 1064.Z URBAN .. .. 370.0o7 298.0 651.2 RMAL *- *- 10410.07 5993.4 25b ASIZSSIONS PMR NOSPITAL RED .. .. .. .. 27.0 AVERAE SIZE OF KOUSEOD TOTAL 5.2 3.6 5.2 /le uRBAN 5.2 5.6 4.8 7. RURAL 5.2 5.6 5.3 7T. AVERA N. OF PERSONS/ROd TOrAL 2.6 2.8 URBAN 2.6 2.8 RURAL 2.6 2.8 ACCESS TO ELECT. (Z OF OWELLIS) TOrAL - ' - mn .. .. WRAL .. ..  ANNX I Page 2 of 5 TABLE 3A INDIA - SOCUL INIICATORS DATA SlKT IND1A REFRERENC GOUPS CWElIGHTED AVERACEB) 4j mOST CMOS?T R3Z0 ESTIMATE) /b Rd EL LOW rNCe NIBDDBLE INCaS i960& iob EiiizSTUtAT ASIA A PACIFIC ASIA A PACIFIC ADJUSTED ENROLLMENT RATIOS PRHARYt TOTAL 61.0 73.0 79.0 97.4 102.0 MAIE 80.0 90.0 93.0 110.5 105.9 FEPALZ 40.0 56.0 64.0 83.7 98.2 SECONDARY: TOTAL 20.0 26.0 30.0 35.9 46.0 HAIE 30.0 36.0 39.0 44.6 48.7 FEMALE 10.0 15.0 Z0.0 26.8 43.1 VODCATNAL (S OF SECONDARY) 2.8 1.0 0.7 Ie 2.2 17.5 PUPIL-TEACHER RATIO PRUMARY 46.0 41.0 54.0 38.5 31.8 SECONDARY 16.0 21.0 .. 18.7 23.5 ADULT LITERACY RATE (1) 27.8 34.1 36.2 53.4 72.9 PASSENCER CARS/THDUSAND POP 0.6 1.1 1.4 /h 0.9 10.1 RADIO RECEIVURS/TOUSAND lPOP 4.9 21.5 43.6 112.1 113.6 TV RECEIVERS/ITOUSAND POP 0.0 0.0 1.7 15.7 50.1 NEWSPAPER ("DAILY CENERAL INTEREST") CICUATION PEM THIUSAND POPULAOTIO 10.6 16.2 19.4 /h 16.2 53.9 CINMIA ANNUAL ATTERDANCE/CAPITA 3.2 6.2 3.7 7? 3.6 3.4 LABOR - TOTAL LABOR FORCE (THOiS) 185951.0 219194.0 282169.0 P8iALE (PERCENT) 30.7 32.5 31.8 33.3 33.5 AQICULTtiE (PERCEOT) 76.0 74.0 71.0 69.6 52.2 INDUSTRY (PERCENT) 11.0 11.0 13.2 15.8 17.9 PARTICIPATION RATE (PERCENT) TOTAL 42.8 40.0 39.4 42.6 38.7 HAWE 57.0 52.4 52.0 54.7 50.9 rE AIE 27.3 26.9 25.9 29.8 26.6 ECOFICC DEPENDENCY RATIO 1.1 1.1 1.1 1.0 1.1 tIM DISI3BUl PERCENT OF PRIVATE INCGE! RECEIVED BY RIGHEST 52 OF IOUSIILDS 26.7 26.3 /i 22.2 It 22.2 22.2 RICHEST 02 OF HDUSEEOLDS 51.7 *8.9 /1 49.4 re 48.0 48.0 LOWEST 20S OF HO0SEHDLDS 4.1 6.77? 7.077 6.4 6.4 DlAEST 402 OF EOIJSEUOLIS 13.6 17.2 7 16.2 li 15.5 15.5 POVEt TYUS? - ESTIMUATD ABSOLUTE POVERMT lUClEE LEVEL CUSS PER CAPITA) URBAN . .. 132.0 lb 133.9 188.6 RURAL .. .. 11i.0 111.6 152.0 ESTIMATED RELATIVE POVERTY INO1IE LEVEL CUSS PEI CAPITA) URBAN .. .. .. .. 177.9 RURAL .. .. .. .. 164.6 ESTIMATED POP. BELOW ASOLUrTE POVERTY liCn