Colombia - Water Supply and Sewerage Sector Project

Document of The World Bank FOR OFFICIAL USE ONLY 4-A 2- 6 / - Report No. 7120-CO STAFF APPRAISAL REPORT COLOMBIA WATER SUPPLY AND SEWERAGE S..CTOR PROJECT May 26, 1988 Department III Infrastructure and Energy Operations Division Latin America and the Caribbean Region This document has a restricted distribution and may be used by recipients only in the performance of t % >;r { '~" ' ' ~ I '~ V '  CURRENCY EQUIVALENTS Currency Unit = Peso Colombiano (Col$) US$1 ' Col $287.75 I/ Col$l = US$0.003475 / ABBREVIATIONS ACODAL Associaci6n Colombiana de Ingenieria Sanitaria y Amb;ental (Colombian Asfiociation of Sanitary and Environmental Engineers) BCH Banco Central Hipotecario (Central Mortgage Bank) CENAGUAS Centro Nacional de Adiestramiento de Aguas (National Training Center for the Water and Sanitation Sector) CONPES Consejo Nacional de Politica Econ6mica y Social (National Council for Social and Economic Policy) DBRS Divisi6n de Saneamiento Bhsico Rural (Division of Basic Rural Sanitation) DNP Departamento Nacional de Planeaci6n (National Planning Department) DWSS Directorate of Water Supply and Sanitation (Direccion de Agua Potable y Saneamiento Basico) EMPOS Empresas de Obras Sanitarias (Sanitation Works Corporation) EPM Empresas Ptlblicas Municipales (Municipal Works Corporation) FFDU Fondo Financiero de Desarrollo Urbano (Urban Development Fund) FONADE Fondo Nacional de Proyectos de Desarrollo (National Fund for Development Projects) INS Instituto Nacional de Salud (National Institute of Health) 1/ As of May 24, 1988.  FOR OFFICIA UE ONLY INSFOPAL Instituto Nacional de Fomento Municipal (National Institute for Urban Development) IVA Impuesto al Valor Agregado (Value Added Tax) JM Junta Monetaria (Monetary Board) JNT Junta Nacional de Tarifas (National Tariff Board) LCB Local Competitive Bidding MOH Ministry of Health (Ministerio de Salud) MOPT Ministerio de Obras Pdblicas y Transporte (Ministry of Public Works and Transport) NPBRS National Program for Basic Rural Sanitation (Programa Nacional de Saneamiento Basico Rural) SRP Sector Reform Program (Programa de Reforma Sectorial) UDB Urban Development Bonds (Bonos de Desarrollo Urbano) UFB Urban Formation Bonds (Bonos de Fomento Urbano) FISCAL YEAR January 1 - December 31 This document has a restricted distribution and may be used by recipients only in the perfo.nnance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - iii - COLOMBIA WATER SUPPLY AND SEWERAGE SECTOR PROJECT TABLE OF CONTENTS Page No. I. PROJECT SUMMARY .................................. 1 II. THE WATER SUPPLY AND SANITATION SECTOR ................ 3 Service Coverage and Pu'1Llic Health .... .......... 3 Sector Development Targets and Priorities ....... 4 Sector Financing ................................ 4 Tariff Policy ................................... 5 Manpower Aspects and Training .... ............... 6 Sector Performance and Prospects for Improvement ................................... 7 Sector Reform ................................... 8 III. BANK INVOLVEMENT IN THE SECTOR ....................... 9 Past and Ongoing Activities ..................... 9 Sector Strategy ................................. 9 IV. THE WATER AND SANITATION SECTOR REFORM PROGRAM (SRPF) . 10 Objectives .......................... 10 Reform of Sector Organization and Institutions-.. 11 Decentralization Initative ..................... 11 National Institutions .......................... 11 Local Institutions ............................. 12 Rural Water Supply ............................. 13 1988-1992 Sector Investment Program .... ......... 13 Investment Levels .............................. 13 Service Coverage Targets ....................... 13 Financing Plan ................................. 14 Subproject Lending Policy and Eligibility Criteria .................................... 15 Eligible Institutions .......................... 15 Institutional Strengthening .................... 16 Project Types .................................. 16 Tariff Policy and Cost Recovery ................ 17 Tariff Setting Mechanisms and Approvals ........ 19 Service Cross-subsidies ........................ 19 Payment of Other Public Services ............... 19 This report is based on the findings of an appraisal mission which visited Colombia in October 1987. The mission comprised Messts. Walter Stottmann (Sr. Engineer), Thomas Zearley (Financial Analyst) and Luis Pisani (Sr. Education Specialist).  - iv - TABLE OF CONTENTS (Cont.) Page No. Management Stability ........................... 19 Financing Arrangements and Conditions .......... 19 Project Eligibility ............................ 20 Project Supervision ............................ 20 Design and Technology Improvements ............... 20 T;-aining ......................................... 21 V. THE BORROWER AND EXECUTING UNIT ...................... 21 Introduction ....... ............ ................. 21 The Borrower - BCH ............................ 21 The Executing Unit - FFDU ....................... 22 Current Portfolio . . 22 Sources of Funds ............................... 22 FFDU On-lending Procedures and Conditions ...... 23 Organization and Institutional Capacity .. 24 Financial Analysis of BCH/FFDU . . 25 Potential Creation of Regional Development Bank . . 26 VI. THE PROJECT .......................................... 26 Origin ......................... ................ 26 Project Objectives .26 Rationale for Bank Involvement .27 Project Description .28 Project Cost .29 Foreign Exchange Risk and BCH/FFDU Relending Arrangements and Terms .31 Legal Instruments for Relending .31 Implementation Specifics ......................... 32 Investment Program Review .32 Subproject Lending Policy and FFDU Operating Manual Statements ............................ 32 Strengthening of BCH/FFDU's Operating Capacity .32 Establishment of DWSS and Execution of Component C .32 Establishment of CENAGUAS and Execution of Training Program .33 Tariff Policy .33 Institutional Reform .33 Monitoring of Sector Company Performance 33 Preparation and Maintenance of Subproject Pipeline .33  TABLE OF CONTENTS (Cont.) Page No. Monitoring FFDU's Performance . . 34 Reporting .................. 34 Annual Program Assessment . .34 Auditing . .35 Subproject Approval and Monitoring by the Bank . .35 Procurement . .35 Disbursments . .37 Environmental Aspects ....................... 38 P-oject Benefits and Justification . . 38 Risks ........................................... 39 VII. AGREEMENTS TO BE REACHED AND RECOMMENDATIONS .40 ANNEXES Annex 1 Sector Policy Letter .43 Annex 2 Sector Organization .50 Annex 3 National Program of Basic Rural Sanitation 54 Annex 4 1988 - 1992 Sector Investment Program .58 Annex 5 Target Performance Indicators .73 Annex 6 Terms and Conditions of FFDU Loans .74 Annex 7 Program for Strengthening FFDU's Operating Capacity .76 Annex 8 BCH/FFDU Finances .78 Annex 9 Project Investment Schedule .89 Annex 10 Conditions to be Included in Subproject Agreements ..................................... 90 Annex 11 Plan of Action for the Establishment of DWSS and the Execution of Component C of the Project 91 Annex 12 Sector Training .93 Annex 13 Monitoring Indicators for BCH /FFDU .100 Annex 14 Documentation Required for the Review of Subprojects by the Bank ........................ 101 Annex 15 Limits on Type of Procurement and Prior Review Thresholds .105 Annex 16 Loan Disbursement Schedule .106 Annex 17 Allocation of Loan Proceeds .107 Annex 18 Selected Documents and Data Available in the Project File ....... .................... 108 Map IBRD No. 18370  COLOMBIA WATER SUPPLY AND SEWERAGE SECTOR PROJECT I. PROJECT SUMMARY Borrower: Banco Central Hipotecario (BCH) Guarantor: Republic of Colombia Amount: US$150 million equivalent Terms: Repayment in 17 years, including five years of grace, with interest at the Bank's standard variable rate. Proj ect Description: To meet one of its major policy objectives--alleviation of poverty through increased provision of social infrastructure services--the Government has decided to invest, in addition to US$820 million in sector investments already under execution, US$600 million between 1988-1992 for boosting water supply and sewerage coverage in medium-size and small cities and towns and in rural areas. In an effort to overcome a generally unsatisfactory sector performance in the past and to adjust sector management to its decentrali- zation policy, the Government is introduzing major reforms to the sector's institutional and policy environment. The objective of the proposed project is to underpin the sector reforms being undertaken by the Government and to finance a US$430 million slice of the Government's aforementioned US$600 million additional 1988-1992 investment program. The Project would have the following components: (a) a line of credit, administered by the Urban Development Fund (FFDU) of BCH to finance about 80 subprojects involving the rehabilitation and expansion of water supply and sewerage systems in some 400 conmunities and the upgrading of solid waste services in about 10 cities, where water, sewerage and solid waste services are provided by the same municipal utility; (b) a program to strengthen the operating capacity of FFDU; (c) execution of studies to improve sector efficiency; and (d) establishment of a national sector training institution and sector wide training. Total Project cost would be US$435 million: US$430 million for water supply and sewerage; US$5 million for solid waste; and US$5 million for Project components (b), (c) and (d). Benefits: Project investments would provide water service to an additional 1.9 million people and sewerage service to an additional 1.3 million people. The implementation of the Sector Reform Program (SRP) would bring significant benefits to the country's economy through internal sector savings. Risks: The reform of the sector's institutional and policy framework is an ambitious and complex undertaking and will require a sustained effort in the years ahead. The maJn risk is that political  -2- pressures might undermine the new de.tanding sector lending policy. Although the risks are lessened by the conditionality and rcview mechanisms built into the Project and the commitment of the Government and FFDU to tne objectives of the SRP, it is likely that not all of the policy objectives will be achieved in full and that some subborrowers will not succeed in meeting institutional strengthening and financial performance targets. Even so, the Project wovld contribute signifirantly to the development of a more efficient water supply and sewerage sector in Colombia. Z of Prolect Costs Local Foreign Total Total -------------US$ million----------- Investment Subprolects 281.5 148.5 430.0 98.9 Water Supply 137.5 112.5 250.0 '7.5 Sewerage 97.5 32.5 130.0 29.9 Solid Waste 2.0 3.0 5.0 1.1 Institutional Development 11.7 0.3 12.0 2.8 Supervision of Construction 16.0 - 16.0 3.7 Pre-Investment Studies 14.0 - 14.0 3.2 Training 2.8 0.2 3.0 0.7 Strengthening of FFDU 1.5 0.5 2.0 0.5 Studies by DWSS 1.0 0.5 1.5 0.3 Training Center 1.0 0.5 1.5 0.3 Total Project Cost 285.0 150.0 435.0 100.0 Financing Plan: Operating Companies 55.8 - 55.8 12.8 Local Government 55.4 - 55.4 12.7 National Government 50.0 - 50.0 11.5 BCH 68.5 - 68.5 15.7 Financial Intermediaries 41.3 - 41.3 9.5 FONADE 14.0 - 14.0 3.2 IBRD - 150.0 150.0 34.5 Total Financing 285.0 150.0 435.0 100.0 Estimated Disbursementsat Bank FY 89 90 91 92 93 94 95 -----------------US$ million---------------- Annual 4.5 15.0 33.0 51.0 31.5 12.0 3.0 Cumulative 4.5 19.5 52.5 103.5 135.0 147.0 150.0 Rate of Return: Individual subprojects are required to reach a Financial Rate of Return of at least 1OZ, with revenues taken as a proxy for economic benefits.  -3- II. THE WATER SUPPLY AND SANITATION SECTOR Service Coverage and Public Health 2.01 Of Colombia's current estimated population of about 30.6 million, about 572 has access to water supply through house connections and about 412 has sewerage services. Service levels and quality of service tend to be directly related to community size. They are highest in the country's large Metropolitan Areas (Bogota, Cali, and Medellin), where more than 962 of the people have access to piped water and are connected to a public sewerage service. In the medium-size cities and small towns, service levelb are considerably less with about 65% for water and 502 for sewerage. With only about 26Z of the population served through house connections, Colombia's rural population 1 is affected most by the lack of a safe and convenient water supply. Likewise adequate excreta disposal is lacking most in rural areas. People without piped water generally bel~ng to the poorer segments of the population. In urban areas, they rely on purchases from private vendors which tend to provide water of deficient quality at high costs. In rural areas, people without service draw water from often cortaminated and distant sources. 24)2 Throughout the country, the quality of se-_vice to those connected to water and sewerage is uneven. In the larger cities, safe water is generally available, but service tends to be irregular, especially in poor neighborhoods. In the medium-size and smaller cities and towns and in rural areas, the bacteriological quality of water provided is often unsatisfactory and service is frequently intermittent. Surface runoff of sewage, because of malfunctioning individual disposal facilities and overloaded sewers frequently creates health and nuisance problems. Waste water is generally discharged without treatment, causing pollution in rivers and streams downstream of major population centers. 2.03 While the current level of service in Colombia is similar to that found in other middle-income Latin American countries, it is notable that over the past two decades little progress has been made in improving service coverage in terms of proportion of population served. In Colombia's urban areas, service levels for water have not changed much from those reported for 1969, when service levels for water were estimated at 77? (81% in 1986). Sewerage service levels appear to have actually declined since 1969. There has been significant service improvement in rural areas, although existing information does not allow a clear documentation of the progress made. On balance, sector investments during the past 20 years were just about enough to keep pace with population growth, but were not sufficient to bring about a significant increase in overall service coverage. 2.04 Although substantial progress has been made in the past two decades in reducing mortality and morbidity in Colombia, infant mortality with about 50/1,000 live births remains high. Diseases associated with unsafe water and lack of adequate sanitation are still prevalent, with diarrheal diseases and enteritis being among the five most important primary causes of deaths in all age groups up to 14 years. They account for almost two-thirds of deaths among infants in their first year and over one-third of deaths among children below five. The provision of safe water and adequate sanitation is essential to 1/ Communities with less than 12,000 inhabitants are classified as rural.  -4- complement other efforts by the Government in the Public Health field, if the incidence of mortality and morbidity from water and sanitation related diseases is to be reduced to acceptable levels. Sector Development Targets and Priorities 2.05 Colombia had subscribed to the targets of the International Water Decade that implied complete coverage oi its population with safe water and sanitation by the year 1990, a target which obviously will not be achieved. Recently, the Government has established a new set of ].ong-tetm targets which call for connecting, by the year 2000, 95Z of the country's urban and rural concentrated population to piped water systems and 80% to public sewerage. About 50Z of the dispersed rural population is to be provided with low-cost water and sanitation facilities. About 50Z of sewage generated is to be treated. Achieving these targets would require supplying an additional 13 million people with water and 11 million with sewerage in urban and rural concentrated areas and another 3 million people with water and sanitation facilities in dispersed rural areas. To meet these objectives the total invest- ment needs in the Colombian water supply and sewerage sector over the 1988-2000 period would be about US$4600 million in 1988 prices. Annual future invest- ments required would average about US$350 m'llion, more than twice as high as those in the past (para. 2.07). To reach these targets, the Government and sector institutions would have to place more emphasis than in the past oi' sector growth and remove the obstacles which have hampered more accelerated sector development. 2.06 In accordance with the Government's policy of poverty alleviatior., the first sector priority is to expand water and sewerage service coverage in medium-size and small cities and towns and to provide services to the poor neighborhoods on the fringes of the country's large metropolitan areas. A second priority is to address the needs of agglomerated rural communities, followed by providing water/sanitation services to the dispersed rural popula- tion. Sewage treatment, the last among the sector development priorities, ini- tially concentrates on correcting the most severe existing environmental degra- dation (Rio BogotA, Rio Cauca downstream of Cali). The introduction of low-cost sewage treatment is to be promoted whenever the financial capacity of operating companies allows such investments. Sector Financing 2.07 Over the past ten years, average annual sector investments have amounted to about US$150 million equivalent (1987 prices), or about 0.4Z of GDP. In 1987, total sector investments were about US$150 million. About 65Z of past investments were for water supply, the remaining 35Z for sewerage. A disproportionately large share of investments (55% of total) took place in the large metropolitan areas of BogotA, Cali and Medellin, where efficiently run water companies had the managerial, technical and f'nancial strength to prepare and carry out large investment programs. About 35Z of total investments were made in medium-size cities and small towns and 10% in rural areas. The continuing dominance of the large city companies in preparing investment packages and in attracting investment funds is reflected in the existing sector investment program. Of the about US$820 million of sector investmerLts already underway for the 1988-92 period, about 90Z are destined for projects in the country's four largest cities which have 30Z of the total population. For the  -5- rest of the country assured financing for future investments for the same period amounts to only about US$80 million. Unless this lopsided balance in investment levels is corrected, service coverage for water and sewerage in the medium-size cities, small town and rural subsectors will fall further behind the service situation found in the large cities. 2.08 The mairn sources of funds for sector investments over the recent past have been: 452 from external sources; 30% from National Government contribu- tions; 152 from the internal generation of operating companies; and 10! from local sources (municipalities, departments) and domestic credit. There were considereble variations in the sources of investment funds among subsectors. The large-city companies (Bogota, Medellin, Cali) relied heavily on external credit (about 502) and internal generation of funds (about 352) and needed only minor support from national and local governments and domestic credit. In contrast, financing of investments in the medium-size city, small town and rural subsectors depended predominantly on direct or indirect central government con- tributions (about 45Z) and external financing (about 40Z). The origin of remaining funds were grants from local governments (about 102) and internal generation (about 52). The excessive dependence in these subsectors on scarce central government contributions and their inability to generate internally significant amounts of funds for investment partially explain the large discre- pancies in service coverage between the large cities and other parts of the country. Tariff Policy 2.09 Tariff setting for public services (water, sewerage, electricity, tele- communications, solid waste collection and disposal) is controlled by the Government through its National Tariff Board (Junta Nacional de Tarifas, JNT). JNT is composed of the Director of Planning, the Ministers of Finance and of the corresponding sector and a representative of the President. Its staff, adminis- tratively part of the National Planning Department (DNP), is headed by an Execu- tive Secretary. Decree 3069 of 1968, founding JNT articulates the following general tariff policy: "Tariff levels should cover the cost of service and provide a return sufficient to facilitate appropriately the financing of invest- ment programs. To this effect, tariffs should be adjusted to changes in real cost which alter the financial balance of a company and the cost of meeting future demands". Operationally, JNT's mandate is limited to the review and authorization of requests for tariff adjustments submitted by operating companies. It has only limited power to impose tariff increases on operating companies unwilling to adjust tariff levels. 2.10 In the absence of an effective monitoring and control capability tor water and sewerage tariffs, the principles of the general tariff policy stated in Decree 3069 of 1968 have been violated more often than not in the past. Many operating companies, often `or political reasons, were able to maintain tariff levels unchanged over extended periods of time with obviously disastrous effects on their finances. Other companies wbich submitted requests for tariff adjustments to JNT found their requests denied, delayed or severely cut during periods when the Government considered tariff increases inopportune for political or economic reasons. As a result, water and sewerage tariff levels have been kept generally low and vary widely among operating companies, often bearing no relationship to the financial needs of a company and the cost of service or its customer's capacity to pay. The overly political management of  -6- water and sewerage tariffs over the past two decades is one of the reasons for the chronically deficient financial performance of rnany operating companies and responsible for their inability to adequately maintain and operate their facilities and generate sufficient funds for service expansions. 2.11 Alarmed by the poor financial state of many sector companies and the large discrepancies in tariff levels and structures, the Government recently has embarked on a series of actions to make water and sewerage tariffs more rational. First, sector companies were encouraged to submit requests for tariff adjustments and a more responsive JNT has approved over the past six months substantial tariff increases for imany water and sewerage companies. Secondly, JNT introdXced the indexation of tariff levels and now authorizes automatic monthly tariff adjustments ranging from 1.5Z - 2.5Z. Thirdly, JNT issued, under Decree 394 of 1987, a unified tariff structure to be adopted by all water and sewerage utilities. The new structure is adequate, making a basic consumption affordable to all strata of the population and introduces progressively higher tariffs with increasing consumption. The new structure, however, does not make any statement on the absolute tariff levels to be charged. It is also disturbing that JNT in recent tariff authorizations has approved the low water consumption bracket up to an unacceptable high level 40 m3/connection month. These levels should preferably be in the 15-25 m3/connection/month range. While the recent actions by the Government are an important step towards rationalizing tariff levels and have already contributed substantially to a better financial performance of many operating companies, the Government has no effective regulatory mechanisms at its disposal for enforcing the introduction and collection of adequate water and sewerage tariffs by operating companies. Clearly, one of the most important elements for improving the financial performance of the sector is the application of a consistent and adequate tariff policy followed by national and local governments. Manpower Aspects and Trairiing 2.12 Total staff in the water supply and sewerage sector numbers about 25,000. The share of professionals in total sector staff stands at about 82. On the average, operating companies employ about five workers/l,O0O connections, which by regional standards is quite satisfactory. Staff productivity varies widely among companies. There are companies (Bogota, Medellin, for example) which have built up an excellent staff capacity in all areas of operations and manage efficiently large water and sewerage systems with less than three employees/l,000 water connections. On the other side of the spectrum, there are companies with poor staff resources and inefficient operations employing more than 10 employees/l,000 water connections. 2.13 The quality and number of professional manpower vary widely amcag the different areas of exDertise reR.uired in the water sector. Although it will be necessary to sensitize the engiA;eering community to the need for more economy and realism in the formulation of projects, Colombia has in place a compara- tiv6ly strong engineering capacity in the sector. With regards to other equally important professional expertise (facility operation and maintenance, finance, administration, management), there are serious deficiencies in terms of number and quality of personnel. The upgrading of the professional capacity in these disciplines is an essential priority for accelerated and more efficient sector development.  -7- 2.14 Training of sector personnel has been largely neglected. In the past, a minimal amount, less than 12 of the sector's annual operational budget was spent on staff training. During tne last five years, only about 4,600 sector personnel received any kind of training. In comparison, Brazil, which has one of the most advanced training programs in the region, offered sector personnel four times more training opportunities than Colombia. Training in the sector is impeded by four major constraints: (i) lack of training policy and objectives; (ii) inadequate mechanisms for the coordination, planning and implementation of training programs; (iii) insufficient managerial knowledge of personnel administration and training; and (iv) lack of training resources. The development of a sufficiently large base of qualified sector personnel is essen- tial for improved sector development. Therefore, the establishment of an adequate permanent training capability in the sector must have high priority. Sector Performance and Prospects for Improvement 2.15 With some notable exceptions (Bogota, Medellin, Bucaramanga), most operating companies are weak. Many of them do not have the necessary financial and managerial resources to fully satisfy demand for services and to properly operate and maintain existing systems and facilities. The combined effects of low tariffs, poor commercial practices and fast rising costs are key obstacles to achieving and sustaining financial viability and generating sufficient resources for investments. Frequent, mostly politically motivated changes in top and middle management positions and the absence of adequate control systems contribute to ineffective management. These shortcomings manifest themselves in the poor upkeep and inefficient operation of facilities. High levels of unac- counted-for water, often in excess of 50Z, are common. Investment projects tend to be overdesigned and tie up scarce financial resources. The application of low-cost technologies and the rehabilitation of existing infrastructure receive insufficient attention. The strong political influence to which most companies are subject often prevents the implementation of unpopular measures (tariff increases or reduction in staff, for example), which would be necessary to transform them into financially healthy and operationally efficient public utilities. Water and sewerage utilities providing other services (solid waste, public markets, slaughterhouses, etc.) practice cross-service subsidy. Particu- larly, deficits attributable to solid waste collection and disposal strain the overall financial performance of many companies and divert funds needed "or the operation, maintenance and expansion of water supply and sewerage services. 2.16 The generally poor performance of operating companies and the slow and inequitable sector growth can be traced to a number of, often interrelated, constraints brought on by the lack of commitment by the Government to formulate and enforce appropriate sector policies and to develop strong national institu- tions capable of guiding and supervising sector development. Inadequate plan- ning at the central level has prevented a more balanced allocation of resources for sector investment based on identified needs and priorities. The absence of a clearly defined lending policy conditioning the provision of credit on efforts by credit recipients to become more efficient and the availability of unconditional grant funds from the Government resulted in the lack of incentives for operating companies to improve their operational and financial performance and generally stifled initiative. Excessive political interference in the day- to-day management and staffing of sector institutions on all levels has prevented continuity. This, together with low level of salaries, makes these institutions an urnattracti:s place of employment for experienced and qualified  -8- professionals. Finally, the sector has been without strong technical and financial lead institutions capable of promoting improvements in the operational efficiency and financial viability of operating companies and the design and execution of more cost-effective investment projects. In particular, the National Institute for Urban Deveiopment (INSFOPAL), the agency responsible for executing national sector policy in the urban subsector, was unable to discharge adequately its technical and financial leadership role. 2.17 The assessment of sector performance presented in the preceeding para- graphs depicts a sector with serious structural and attitude related problems. It is apparent that accelerated sector growth as envisioned by the Government (para. 2.05) will not be possible without major adjustments to the existing policy framework and institutional environment. Fortunately, there is consider- able potential for improved sector development since Colombia is generally bles- sed with ample water resources; the great majority of the country's pol' lation has the capacity to pay the cost of services; a re'.atively large ool of qualified sector professionals and technicians is available; and several exam- ples exist of sector companies operating efficiently and providing good service. Most importantly, however, there is growing awareness among Government and sector officials of the key sector issues and constraints and of the need for sector reform. Sector Reform 2.18 The awareness of the need for change and pressure to deliver on one of its major development objectives--poverty alleviation through increased invest- ments in social infrastructure sectors--prompted the Government to develop over the past three years, with the assistance of the Bank, a Sector Reform Program (SRP). This Program (described in detail in Chapter IV of this Report) is designed to carry out additional investments in water supply and sewerage of about US$600 million during the 1988-1992 period targeting those sector segments which in the past have received less attention and where needs are greatest, i.e. the poor neighborhoods of large and medium-size cities, small towns and rural areas. In parallel with its investment objective, the SRP introduces major reforms to the existing sectoral policy and institutional environment to correct the deficiencies which have been at the root of the sector's past poor performance. Among the main reforms are: (a) major changes to the sector's institutional setup in line with the objectives of the decentralization policy introduced by Law 12 of January 1986; (b) the adoption of a 1988-1992 Sector Investment Program based on clearly defined objectives and priorities and financed with high emphasis on local resources and less reliance on Central Government grant and external loan funding; (c) the introduction of a new sector lending policy linking the provision of credit for sector investments to a commitment by credit recipients to improve their operational efficiency and financial performance and specifying criteria for the cost-effectiveness and feasibility of investment projects; (d) the review and update of technical design criteria and norms to promote the formulation of more cost-efficient and technically more appropriate and affordable projects; and (e) the establishment of a permanent training capacity for sector personnel. With these reforms, the Government expects to create the conditions necessary for meeting the sector development targets described in para. 2.05.  -9- III. BANK INVOLVEMENT IN THE SECTOR Past and Ongoing Activities 3.01 Since 1968, the Bank has made 12 loans totalling about US$425 million for water supply and sewerage sector investments in Colombia. The Bank funds account for about 70Z of all external resources made available to the sector. The remaining external funds were made available predominantly by the Inter- American Development Bank. About 80Z of total Bank loan funds (US$340 million) were granted to five municipal water companies (BogotA, Cali, Barranquilla, Cutcuta, Palmira) through nine separate operations. The Bank made three loans totalling US$67.1 million to INSFOPAL to finance investments in intermediate- size and small cities and to help INiSFOPAL develop into an effective technical and financial intermediary. The operations with INSFOPAL involved 36 subpro- jects in thirty different cities and towns. The remaining US$ 20 million supported rural water supply through water supply components in various integrated rural development and health and nutrition projects. 3.02 At present the Bank supports sector development through projects with the EPMs in Bogota (Loan 2512-CO), CGrcuta (Loan 2470-CO) and Barranquilla (Loan 2637-CO). A US$16 million rural water supply component under the Health Inte- gration Project (Loan 2611-CO) has been cancelled because of the imminent abolishment of the component's executing agency under the institutional reorganization and would be included in the proposed sector project. 3.03 The Project Completion and Performance and Audit Reports prepared for five projects 2 and the supervision of ongoing projects show that in large measure, projects have been successful in achieving their physical objectives and, thus, have contributed importantly to the development of the water supply and sewerage sector. The operations with the Bogota Water and Sewerage Company were particularly successful and the Bank can be credited with helping this company develop into a strong and efficient water utility capable of serving nearly all of Bogota's 4.5 million inhabitants. Most beneficiaries of past Bank loans, however, did not attain, or were unable to sustain, the institutional and financial performance goals envisioned at appraisal. Most disappointing was the inability of INSFOPAL to develop into a strong and efficient intermediary. This prevented the Bank from helping shape more efficient sector policies and from channeling more resources to the intermediate-size and small cities and town subsector. Sector Strategy 3.04 Given the still immense investment requirements of the sector and the Government's increased emphasis on improving service coverage in its quest for alleviating poverty, the Bank plans to continue its role as primary external supplier of finance for sector investments. However, continued lending for the 2/ Loan 738-CO, Palmira Water Supply Project: Report No. 4589, June 1983; Loan 1523-CO, Second Cali Water Supply and Sewerage Project; Report No. Sec. 85-029, December 1984; Loan 536-CO, Bogota Water Supply Project; Report No. 2003, March 1978; Loan PU-30,-CO, Cali Water Supply Project; Report No. 2638, * August 1978; Loans 860-CO and 1072-CO, Medium-size Cities and Second Multi- City Water Supply and Sewerage Projects; Report No.6594, January 1987.  - 10 - sector should be contingent on the Government's commitment to sectoral institutional and policy reforms which would allow more efficient and sustain- able sector growth within the context and constraints of overall macro-economic development and public sector investments. The aforementioned Sector Reform Program (para. 2.18) has been designed with the assistance of the Bank to bring about the reforms required to address the sector's many problems and cons- traints. It would be supported by the Bank through the provision of financing for sector investments and continued advice. The proposed sector investment loan covering external resource needs of all sector segments through 1991 would be the most appropriate tool for assisting the Government in improving and expanding service and in implementing the reforms being introduced under the Sector Reform Program. The sector loan approach would be continued in the future as a means of Bank support to sustain and deepen the adjustment process currently being undertaken by the Government. To complement the sector loan approach, the Bank may consider continuing the provision of finance for major investment projects for the country's largest municipal companies (Bogota, Cali, Medellin) through independent operations. 3.05 The Bank's support of the SRP would complement, on the sector level, many of the economic and policy adjustments currently being pursued by the Government with the advice of the Bank. These include: (a) reduction of fiscal deficit and less reliance on external funding for public sector investments through improved domestic resource mobilization; (b) enhancement of public sector efficiency through institutional reform and stimulation of internal sector savings; (c) more effective use of existing resources through the design and execution of more cost-effective investment projects; (d) more socially- oriented allocation of resources for public sector investments to meet basic needs of the country's poor; and (e) creation of a more effective and responsive sector organization taking into account the ongoing decentralization effort. IV. THE WATER AND SANITATION SECTOR REFORM PROGRAM (SRP) Objectives 4.01 The outline of the SRP was approved first by the Government's National Council for Economic and Social Policy in February 1986 and was reconfirmed by the present Government in November 1986. It has been discussed extensively between the Government and the Bank over the past three years and incorporates many of the recommendations made in the Bank's Sector Report of March 4, 1985. The main objectives and the policy framework of the SRP are contained in the Government's sector development policy letter dated May 5, 1988 (Annex 1). The SRP policy is to: (a) rationalize overall sector investment policy by adopting a medium- term (1988-1992) sector investment plan with clearly identified targets, priorities, investment levels and financing arrangements within the constraints imposed by the restrictions on the sector's capacity to generate resources and the public sector investment program; (b) adjust the financing policy for sector investments to reduce reliance on central government contributions and external debt and, in accordance with the policies of the decentralization  - 11 - process, increase the share of domestic and local resources and internal cash generation of operating companies; (c) establish a more responsive and effective sector organization on the national level with institutions capable of providing leader- ship to the sector, being able to provide assistance to operating companies and enforce policies conducive to improving sector per- formance and sparking accelerated and efficient sector growth; (d) upgrade the performance of operating companies through the intro- duction of a more efficient institutional framework on the local and regional level and a new sector lending policy linking the provisior. of credit to a commitment by credit beneficiaries to strengthen their management, administration, operations and finances and setting standards and more selective criteria for project selection and eligibility; (e) reduce the per capita costs of sector investments through the formulation and implementation of more cost-efficient and appro- priate design standards and technologies; and (f) upgrade the level of skill of sector personnel through the crea- tion of a sector training center and the execution of appropriate training programs. 4.02 The main elements of the SRP described below include the: (a) institu- tional reorganization; (b) 1988-1992 sector investment program; (c) project lending policy; (d) design and technology improvement program; and (e) training of sector personnel. Reform of Sector Organization and Institutions 4.03 Decentralization Initiative. The passage of Law 12 of January 1986 has transferred the responsibility for decision making and administration from the Central Government to municipalities. Over the next five years, the Central Government will allocate about US$500 million of value added tax revenues to the treasuries of primarily smaller municipalities with populations under 100,000. With the transfer of these new resources, municipal governments are expected to progressively assume more responsibility for the financing and management of municipal infrastructure, including water supply and sewerage. As the municipalities assume these responsibilities, the present strong involvement of Central Government institutions in the financing and execution of municipal infrastructure projects is to be discontinued. Law 12 provided the Government with wide authority to make adjustments to the institutional framework of sectors dealing with municipal infrastructure. By passing Decree 77 of 1987, the Government made substantial changes in the organization and institutions of the Water Supply and Sanitation Sector. The changes in the sector's organization are depicted in Annex 2 and described in paras. 4.04 - 4.06. 4.04 National Institutions. The adjustments to the sector's national organization mandated by Decree 77 of January 15, 1987, and regulated by Decree 1723 of September 4, 1987, constitute a major break with the past. While the National Planning Department (DNP) continues to have responsibility for planning and coordinating sector and overall development policy, the Sector's overall  - 12 - management is transferred from tne Ministry of Health (MOH) to the Ministry of Public Works and Transport (MOPT). The National Institute for Urban Development (INSFOPAL) which was at the helm of the sector for the past three decades, but was unable to bring about satisfactory sector development and growth is being abolished as of January 15, 1989. Likewise the Division of Basic Rural Sanitation (DBRS) of the National Institute of Health (INS), in charge of rural water supply and the administration of the National Program for Basic Rural Sanization (NPBRS), is to be dissolved by the same date. In replacement of INSFOPAL and DBRS, a Directorate for Water Supply and Basic Sanitation (DWSS) is being established in MOPT as the primary technical sector support agency with sector wide responsibilities for planning, setting and enforcing of technical norms, research, assistance to operating companies and training. The Central Mortgage Bank (BCH), through its Urban Development Fund (FFDU), will take over as primary intermediary for sector investments with responsibilities for mobilizing domestic and external resources for sector investments and identifying, preparing, evaluating, approving and supervising sector projects (Chapter V). 4.05 Local Institutions. Consistent with the Government's decentralization initiative, Decree 77 places the responsibility for managing water supply and sewerage services into the hand of individual municipalities. Existing autono- mous municipal works companies (Empresas P6iblicas Municipales, EPM) providing water, sewerage and at times other municipal services in the country's largest 35 municipalities (covering about 40% of the total population) are not affected by the reorganization. The abolishment of the INSFOPAL owned and controlled system of Sanitation Works Companies (Empresas de Obras Sanitarias, EMPOS) which provides services to about 460 smaller municipalities (covering about 16X of the total population) and the abolishment of INS' regional offices in charge of rural water supply development (covering about 30X of total population) will leave about 1000 mostly small municipalities free to decide how to organize the management of their water and sewerage systems. Many of these municipalities are too small to have the financial, managerial and technical capacity to carry out their new responsibilities by themselves. The great challenge and opportunity of the institutional reform on the local level lies, therefore, in the creation and development of an efficient institutional framework on the departmental or regional level to provide satisfactory services. To manage water supply and sewerage service in communities too small to justify the establishment of an independent municipal water company, and too large to use the National Program of Basic Rural Sanitation (NPBRS) methodology (Annex 3) as the vehicle for sector development and management, the Government promotes the transformation of the INSFOPAL controlled EMPO's into autonomous departmental or regional companies. The establiqhment of these companies, to be owned by associated municipalities, is essential to avoid the fragmentation of service management into too many and excessively small independent operating units and to allow the efficient and professional management and operation of water supply and sewerage services in small municipalities. The success of the institutional reform on the local level will depend, therefore, on the willingness of small municipalities to ioin together in departmental or regional companies of sufficient size to take advantage of the economies of scale inherent in the management of water and sewerage services. The credit policy being introduced under the SRP provides guidance wnd incentives to departmental and municipal governments to develop and implement appropriate and workable institutional arrangements based on the regional company concept.  - 13- 4.06 Rural Water Supply. Decree 77 of December 1987 stipulates that rural water supply projects will continue to be executed in accordance with the principles of the National Program for Basic Rural Sanitation (NPBRS) which has proven to be an excellent strategy for rural water supply development in the past (Annex 3). With the abolition of INS' regional offices, the administration of the NPBRS must be continued on the departmental or regional level. The creation of strong and responsive departmental or regional rural water supply agencies throughout the country is key to the successful implementation of the Government's ambitious rural water supply investment program contemplated under the SRP. Likewise, the establishment of a rural water supply unit in DWSS of MOPT capable of providing technical back-up, assistance to and control of local NPBRS executing units will be essential. 1988-1992 Sector Investment Program 4.07 The Government has defined, with the Bank's support, a sector invest- ment program for the 1988-92 period with specific annual targets for service coverage, investment lev.ls and financing sources (Annex 4). These targets distinguish between major subsectors (large, intermediate and small cities and towns and rural areas) and service type (water, sewerage). The program provides a base line against which the Government and the Bank would be able to monitor short- and medium-term sector investments. It would be updated annually by DNP and reviewed by the Bank. 4.08 Investment Levels. An investment program of about US$820 million (current prices) for the 1988-1992 period is currently under execution. About US$730 million (902 of total) finance projects in the country's four largest cities. The remaining investments are destined for medium-size cities, small towns and rural areas. 4.09 Under the SRP, the Government plans to invest an additional US$600 million (current prices) over 1988-1992 to be allocated among subsectors as follows: about 712 (US$423 million) for medium-size cities and small towns; 132 (US$79 million) for large cities; and 162 (US$98 million) for the rural popula- tion. About 652 of the resources to be provided under the SRP would support water supply and 352 sewerage projects. In total, about US$1,420 million would, thus, become available for sector investment over the 1988-1992 period. It would cover about 30Z of the investment needs up to the year 2000 and represent a major step toward the achievement of Colombia's long-term sector development targets (para 2.05). Average annual investments would be about US$370 million over the 1988-1992 period, more than twice the annual sector investment levels in the recent past. The sector would be one of the major beneficiaries of the increased social emphasis in the country's Public Investment Program. It's share of total public investments would rise from about 6.5Z in 1986 to almost 13Z in 1990. In relation to GDP, sector investment would almost double, from about 0.5Z in 1986 to about 0.92 in 1990. 4.10 Service Coverage Targets. As a result of the Government's total 1988-1992 sector investment program, service levels on a country-wide basis are projected to increase from a current 57Z to 632 for water supply and from 41Z to 50Z for sewerage. About 3.8 million additional people would receive water supply and about 4.4 million, sewerage services. The US$600 million SRP investment program alone would allow the connection of about 2.5 million individuals to a safe water supply and about 1.8 million to sewerage. The great  - 14 _ majority of the SRP beneficiaries would live in medium-size and small cities and towns and in rural areas. The above figures clearly reflect the Government's objective of improving services in long neglected sector segments. Without the SRP investments, service levels in the large cities would remain stable at already acceptable levels, while they would decrease slightly in other sector segments. 4.11 Financing Plan. The financing plan for the 1988-1992 SRP investment program (Annex 4) aims at decreasing the role of Government transfers and external credit for sector investments and increasing the availability of local funds and domestic credit. The proposed SRP investments would be financed as follows: Amount 2 of Sources of Funds US$ Million Total Cash Contributions 155.2 25.9 Operating Companies 77.9 13.0 Local Government 77.3 12.9 BCH/FFDU Loans 444.8 74.1 National Government 50.0 8.3 External Loans 210.0 35.0 BCH Domestic Borrowings 98.8 16.5 Financial Intermediaries 66.0 11.0 FONADE 20.0 3.3 TOTAL 600.0 100.0 4.12 Given the poor financial position of the majority of the country's sector operating companies, the Government has decided to provide grant funds totalling US$50 million. These funds would be used to soften the terms of BCH/FFDU loans for subprojects benefitting the poorest segment of the population. In addition, local governments are encouraged to provide equity contributions to operating companies in accordance with the tariff and cost recovery principles established in the Sector Lending Policy (paras. 4.21-4.26). These equity contributions would come from direct cash contributions from revenueis or from loans provided by BCH/FFDU. In relation to total SRP investments, equity contributions from local governments would account for 40.8Z of total SRP investments, 12.92 in cash and 27.9Z through BCH/FFDU loans (Annex 4, Attachment 10). 4.13 A comparison of the SRP financing plan and historic sources of financing for the medium-size cities, small towns and rural subsectors (para. 2.08) illustrates the adjustments to the sector financing policy being intro- duced under the SRP. While external credit, with 35Z remains an important source of financing, reliance on central Government contributions decreases from 45Z to below 10Z, domestic credit amounts to 27.5? as compared to negligible in the past, local governments are expected to contribute about 36Z vs. 5? before, and internal generation from operating companies increases from 5Z to about 13?. Compared with past levels of Government support for the sector, the SRP investments are being funded without requiring any additional appreciable burden on the Government's public sector investment budget.  - 15 _ Subproject Lending Policy and Eligibility Criteria 4.14 To introduce the policy objectives and the reform measures of the SRP on the subproject level, the Government has defined a set of criteria and conditions which would be used by FFDU in the selection and appraisal of sub- projects. These conditions and criteria are based on the policies and principles set forth in the Gov2ernment's sector development policy letter (Annex 1). They would be contained in a new Operating Manual Statement which BCH/FFDU would adopt as its guideline for evaluating future water supply and sewerage operations. The most important of the conditions, criteria and provisions of the SRP lending policy are described in the following paragraphs. 4.15 Eligible Institutions. As a general principle, the SRP adopts the public utility arrangement as the most appropriate vehicle for the management and operation of water supply and sewerage services in urban areas. Therefore, one of the most important objectives of the SRP is to promote the establishment of autonomous, operationally efficient and financially viable municipal, departmental or regional water supply and sewerage utilities. Of particular concern is the establishment of institutional structures for the provision of water supply and sewerage in small municipalities, commensurate with: (a) the decentralization policy introduced by Decree 77 of 1987; and (b) the need for concentrating service management and operation in order to take advantage of the economies of scale inherent in the delivery of water supply and sewerage services. The SRP lending policy introduces a framework of criteria and incentives to bring about the institutional framework described above. To this end, the policy distinguishes between: (a) entities responsible for the execution of investment projects and the management and operation of water supply and sewerage services; and (b) sponsor institutions (municipalities and department, for example) which assist a project executing entity by providing equity contributions to cofinance investments. 4.16 To qualify as beneficiaries of SRP financing, project executing entities will be required to meet the following criteria: (a) managerial, administrative and financial independence; (b) technical capacity and financial strength to ensure an efficient and adequate management, administration, operation and maintenance of services and facilities; and (c) efficient size of operations. With these criteria in mind, FFDU would determine whether or not a proposed project executing entity has the capacity to carry out investment projects and maintain and operate systems and facilities independently. In the absence of such capacity, FFDU will not finance a proposed subproject unless the entity affiliates itself with a departmental or regional company of sufficient size and operating capacity. 4.17 The execution of Rural Water Supply Projects will require the existence of departmental or municipal entities capable of carrying out the National Program for Basic Rural Sanitation (NPBRS). The most convenient organization for this purpose would be the Departmental Health Service as executing agency and the Department as borrower and intermediary of loan funds. 4.18 Institutions eligible for contracting SRP loan funds are all entities qualifying as project executing agencies, i.e. municipal, departmental and regional entities with a sufficient degree of autonomy and operating capacity. Departmental governments can enter into agreements for the execution of rural projects. Other public institutions, municipal and departmental goveraments,  - 16 - urban and regional development corporations, for example, would be eligible to obtain loan funds as sponsors for the purpose of providing complementary equity contributions to eligible project executing agencies. 4.19 Institution8' Strengthening. Project executing entities are expected to commit themselves to the execution of an insti utional strengthening effort to bring its performance up to acceptable levels. Annex 5 lists selected managerial, operational, administrative, and financial indicators generally associated with satisfactory performance of water and sewerage companies. These parameters will be used as a guide by FFDU and loan applicants to define jointly specific performance targets to be attained during the course of project execution and to design an Institutional Strengthening Program necessary to achieve them. In the formulation of these targets, FFDU will consider project type and view a company's potential for improvements taking into account factors such as its size, the socio-economic capacity of service beneficiaries, initial condition and the availability of human resources. As part of the institutional development process promoted under the SRP, operating entities are expected to improve their administrative systems and procedures. Special emphasis will be given to the introduction of adequate and appropriate systems for accounting, control, information, human resources development, and commercial operations. FFDU will promote and assist in the introduction of uniform, sector wide accounting and management information systems. The institutional development plan agreed to between an operating entity and FFDU would be reflected in the subproject description and a list of monitoring indicators to be included in the subproject agreement between FFDU and a beneficiary subproject executing agency. 4.20 Project Types. Given the wide discrepancies existing in the institutional capacity and financial conditions among the sector's operating entities, a distinction would be made between four subproject types with different conditionality in terms of subproject scope and expected financial and operational performance: (a) Type A - Regular Projects in urban areas carried out by existing municipal, and regional operating companies which have reached a reasonably efficient level of operational and administrative performance and an adequate level of financial viability. These companies would be eligible for receiving financing for major water supply and/or sewerage expansion projects. (b) Type B - Rehabilitation Projects carried out by existing financially and operationally weak municipal and regional companies which have to undergo a major institutional and financial rehabilitation before being able to qualify for a Type A project. The main element of a rehabilitation project would include the rehabilitation and repair of existing facilities and the execution of institutional and financial strengthening efforts. A rehabilitation project generally would have a duration not exceeding two years and total investments would be less than US$50 per connection existing at the time of project initiation. (c) Type C - Transition Projects designed specifically to facilitate the reorganization of the institutional framework for the management and operation of water supply and sewerage services in  - 17 - municipalities where services are provided by an EMPOS or directly by the municipal government. In some of the larger municipalities, the reorganization would require the establishment of a municipal water supply and sewerage entity meeting the afore- mentioned institutional eligibility criteria. In most cases, however, the reorganization would involve the transformation of an existing INSFOPAL-owned EMPOS into an independent, viable regional entity owned collectively by member municipalities. Transition projects would support the financing of: (i) inputs needed (studies, technical assistance, training, equipment) to establish a functional regional or municipal operating entity; (ii) water supply and sewerage infrastructure rehabilitation and expansi3n in selected municipalities; and (iii) studies and designs for follow- up projects. Transition projects would be executed by existing EMPOS or, in special cases, by departmental or municipal governments. A transition project would have an execution period not exceeding three years. Upon its completion, the new operating entity would be expected to be legally established and operationally functional. (d) Type D - Rural Projects carried out by departmental or municipal governments through an administrative unit capable of executing subprojects in rural communities in accordance with the NPBRS methodology and financing arrangements. A rural water supply project would finance: (i) strengtilening of the NPBRS unit; and (ii) the promotion and execution of projects in individual rural communities. 4.21 Tariff Policy and Cost Recovery. The financial policy to be pursued under the SRP reaffirms the principle of recovery of the cost of water supply and sewerage operation and of investments. Nevertheless, the present financial capacity, institutional strength and the quality of service provided by many water companies would not allow their full compliance with the cost recovery principle at this time. Particularly companies in smaller municipalities could not be expected to raise existing tariffs to the levels required to recover all investment costs, given the poor service provided, large investment needs to overcome decades of neglect and the limited capacity of the population to pay. Many of the newly elected Mayors, now directly responsible for the provision of water supply and sewerage services in their jurisdictions have indicated the immediate improvement of water and sewerage services as the most urgent priority and expressed their determination to use part of the value added tax (IVA) resources now becoming available to the municipalities under Law 16 to invest in water supply and sewerage system expansions. 4.22 In this situation, the Government has adopted a policy (Annex 1) of encouraging municipal governments to use IVA funds in support of the investments needed to bring water supply and sewerage services up to an acceptable level. At the same time, the Government has taken the position that IVA contributions to the sector should not substitute a reasonable tariff effort by operating entities. As a minimum, such entities would be required to adjust tariffs to levels sufficient to fully cover operation and maintenance costs, working capital needs and the higher of depreciation and payment of present debt. Each operating entity would also be required to make a cash contribution to project investments and assume a part of the debt service obligation. The size of these contributions would depend on an operating entity's present financial  - 18 - conditions, the potential for tariff increases, investment needs and quality of service provided. The Government expects that the use of IVA funds for spctcr investments would be discontinued after the mcst urgent initial investments have been completed and a reasonably adIequate service has been attained. The Government's policy has been accepted as the only realistic way to revive a severely undercapitalized sector and to bring rapidly acceptable services to the country's poor population. Based on this policy, the Government and FFDU have agreed on minimum levels of contributions to investments from the internal generation of project executing entities. These levels, to be reflected in FFDU's Operating Manual Statement, would vary depending on an entity's initial financial condition, project type (para. 4.20) and communitv size as an indicator of the socio-economic capacity of beneficiaries. 4.23 For Type A projects, the following levels of contributions would apply. For cities with more than 800,000 people (BogotA, Cali, Medellin, Barranquilla), the company would be required to contribute at least 252 from its internal contributions to total project cost and in addition assume loan obligations for at least 50? of total project cost. Local authorities would be allowed to provide equity contributions for up to 252 of total project cost, primarily to support investments in poor unserved neighborhoods (Agua Blanca in Cali and Zona Suroccidental in Barranquilla, for example). In intermediate-size cities (300,000-800,000), equity contributions by local governments would be limited to so5 of total project cost and project executing entities would be required to contribute at least 15Z of project cost from their internal generation. In medium-size cities (80,000-300,000) and small cities (30,000-80,000) equity contributions from local governments would be limited to 602 and 70Z of total project cost, respectively and minimum cash contributions to investments of 102 and 52, respectively would be required. Regional companies providing services generally to communities below the 30,000 population limit would be required as a minimum to contribute 52 of total project cost in cash and to repay 152 of BCH/FFDU loan. 4.24 For Type B projects, small and short duration projects designed to rehabilitate the institutional and financial capacity of particularly weak companies, financing would rely heavily on contributions from local governments. Equity contributions up to 902 of total project cost would be accepted. The executing entity would be required to contribute, over the life of the project, a minimum of 5? of total project cost from its internal generation. 4.25 For Type C projects, designed to facilitate the creation of new departmental, regional or municipal companies, participating municipalities and departmental Governments would provide 95Z of total financing. Tariffs in each muricipality would be required to be sufficient to contribute 52 of investment cost. In general, no assumption of loans would be required as the new departmental or regional companies would not yet exist at the beginning of the project. For Type D projects, communities with a population of less than 12,000 would be required to contribute 152 of project cost in form of cash, labor and materials. In addition, it would assume a minimum of 152 of the debt service. The rest would be financed through equity contributions from local governments. 4.26 Recovery of investments through revenues generated by operating companies would be, on average, about 602 of total SRP Program costs (Annex 4, Attachment 10). The remaining funds would be provided by local governments in the form of equity contributions. SRP financing and cost recovery policies would greatly require more financial discipline from operating entities compared  - 19 _ to pre-SRP practices. For the first time, all companies would be forced to cover operating costs, working capital needs, the higher of depreciation and aad debt service and contribute a minimum 5Z to investments in order to be eligible for loan funds from BCHIFFDU. Equity contributions wou]d be made entirely from the resources of local governments unlike in the past whei such contributions were distributed by the Central Government in an uncontrolled fashion. The use of financial intermediaries by BCH/FFDU, assures the repayment of loan funds made available to project executing agencies and local governments. Interest rates would be positive in real terms. Under pre-SRP conditions, debt service obligations often were not met, as financial intermediaries (INSFOPAL) were unable to fully collect amortization and interest payments and interest rates charged tended to be highly subsidized. 4.27 Tariff Setting Mechanisms and Approvals. In the past, delays in approving adequate tariff levels by JNT and the implementation of such tariffs were among the main reasons for the poor financial condition of sector companies and their inability to carry out inve qtment projects in a timely faahion. To avoid these shortcomings during the execution of the SRP Program, the Government (JNT, DNP) agreed during negotiations that: (a) BCH/FFDU during the subproject appraisal process would seek JNT's opinion on the viability of tariff action proposed in the financial projections submitted by the project entity, and (b) as a condition for subloan signature, it would be required that JNT has issued a satisfactory tariff resolution and the project entity has implemented in full the tariff levels authorized by JNT. 4.28 Service cross-subsidies. Operating companies providing services other than water supply and sewerage will be expected to attain financial self- sufficiency for the services provided. To this effect, operating companies providing other services would be required to commit themselves to adopt measures, including the adjustment of tariffs and fees, to meet the above condition. Loan funds would be mada available to assist operating companies in improving solid waste operations. 4.29 Payment of Other Public Services. Sector operating companies in the past have often failed to pay for other public services (electricity, social security, etc.). In particular, the electricity sector's financial performance has been affected deeply by the failure of sector operating companies to pay their electricity bills. Therefore, the SRP credit policy requires water supply and sewerage companies to strengthen their finances to the extent that they are able to pay in full and on time, rates and fees due other public enterprises. As a condition for disbursing funds under a sub-loan, FFDU would require that beneficiary companies enter into agreements to repay existing debt and are current on their payments to other public enterprises. The SRP policy encourages sector operating companies to bill and obtain payment for services provided to nitional, departmental and municipal institutions. 4.30 Management Stability. Frequent changes in the management and professional staff contribute significantly to the poor management and administration of sector companies. The lending policy requires sector companies to maintain stability in the companies' management and higher level professional staff. 4.31 Financing Arrangements and Conditions. Credit from BCH/FFDU or other sources to project executing agencies and cofinanciers will be limited to 80? of  - 20 - total projec'. cost. The financing gap is filled by cash contributions from operating entities and equity contribu,tions from local government in accordance with the limits established for each project type. Interest rates and terms applied by BCHjFFDU are those specified by the National Monetary Board (para. 6.11). The Government has provided US$50 million in support of the SRP investment program. These funds would be used to reduce interest rates for subprojects benefitting the poorest segment of the country's population. Interest rates will be adjusted periodically to ensure that they are sufficient to cover the cost of funds to BCH/FFDU and administrative expenses. BCH/FFDU loan funds would be rediscounted through financial intcrmediaries which would be responsible for loan collection and for that purpose would require the pledging of revenues of loan beneficiaries. 4.32 Project Eligibility. Projects would be eligible for financing if they are: a) technically sound, i.e present a least cost solution, are based on acceptable demand projections and design parameters, take into consideration adequately the rehabilitation of existing facilities and use cost-efficient and appropriate technologies; b) institutionally acceptable, i.e. the project executing entity must demonstrate sufficient capability to carry out the project and commit itself to the implementation of an institutional strengthening program; c) financially viable, i.e. the project financing plan must be assured and the project executing entity's financial performance must meet the conditions of the lending policy; d) economically justified, i.e. project design represents the least-cost solution; and Type A subprojects would ve required to yield a financial rate of return of at least 1OZ; e) socially acceptable, i.e. provides services at affordable costs to the poor segment of the population; and f) environmentally acceptable, i.e. major undesirable environmental effects are mitigated through appropriate remedial action. 4.33 Project Supervision. FFDU would be responsible for supervising the execution of physical project components and for monitoring compliance with the provisions in the subproject agreement between FFDU and project executing agencies. Most important among the provisions contained in the subproject agreement would be: (a) the project description, incluetng an institutional development and training component; (b) a list of annual administrative, operational and financial monitoring indicators; (c) financial covenants; and (d) a satisfactory management clause. The subproject agreement would state clearly FFDU's obligation to suspend disbursements, or even cancel subloans, in case subborrowers are in prolonged and substaatial incompliance with covenants in subproject agreements. Design and Technology Improvements 4.34 The current design standards and procedures are outdated and often lead to elevated per capita costs. Likewise the technologies employed are often  - 21 - inappropriate and more costly than necessary. The SRP, therefore, includes a program of review and update of design parameters and procedures (water consump- tion, demand forecast, staging of construction, design horizons, network design, etc.) and technologies (water and sewage treatment, sewage collection, etc.) with the objective of promoting the design of least-cost and technologically more appropriate projects. Training 4.35 The Government and sector officials are conscious of the need for more intensive and better focused training of sector personnel at all levels as a key element for the more efficient operation and administration of sector companies and the formulation of more appropriate and cost-effective investment projects. In response to the obvious need for upgrading training, the Colombian Associa- tion of Sanitary and Environmental Engineers (ACODAL) with the support of and in coordination with the Government and operating companies has created on June 19, 1987, the National Training Center for the Water Supply and Sanitation Sector (CENAGUAS). A priority objective of the SRP is to develop CENAGUAS into the sector's central planning and "nordinating agency for training, while making use to the extent possible of e%Jat:r; facilities and training materials. Under the direction of CENAGUAS, train