Argentina - Water Supply and Sewerage Sector Project

Document of The World Bank FOR OMCIAL. USE ONLY Report . 8425-AR STAFF APPRAISAL REPORT ARGTIA WATER SUPPLY AND SEWERAGE SECTOR PROJECT NOVEMBER 26, 1990 .Infrastructure and Energy Operations Division Country Department IV Latin America and the Caribbean Regional Office ITh doamt bas a red d__ice add may be s_ by _ ozb in-am _ of theli.1. du_e Its conkext mayt jotg _rw be dbdosed Wad Boa n  CURRENCY EQUTVALENTS Currency Unit - Austral (A) November 12. 1990 US$Dollar Austral Free Market Rate US$ 1 5,375 WEIGHTS AND NEASURES Metric System P=ISCAL YC January 1 to December 31 ABBREVIATIONS AND ACRONYMS COFAPYS - Consejo Federal de Agua Potable y Saneamiento - Federal Council for Potable Water and Sanitation DIPOS - Direccima de Obras Publicas y Servicios de Santa Fe - Office of Public Works and Services of Santa Fe DNSA - Direccion Nacional de Saneamiento Ambiental - National Office for Environmental Sanitation EPOS - Empresa de Obras Publicas y Servicios de Cordoba - Public Works and Services Enterprise of Cordoba PENTOS - Federacion Nacional de Trabajadores de Obras Sanitarias - National Federation of Sanitary Workers PONAVI - Fondo Nacional de Vivienda - National Housing Fund IDB - Inter-American Development Bank MOSP - Ministerio de Obras y Servicios Publicos - Ministry of Public Works and Services NSP m Plan Nacional de Saneamiento - National Sanitation Plan OSN - Obras Sanitarias de la Macion - National Sanitary Works SNAP - Servicio Nacional de Agua Potable Rural - National Service of Rural Potable Water SVOA - Secretaria de Vivienda y Ordenamiento Ambiental - Secretariat of Housing and Environmental Management.  FOR OFFCIAL USE ONLY ARGENTINA WATER SUPPLY AND SEWERA6E SECTOR PROJECT STAFF APPRAISAL REPORT Table of Contents IAN AND POJCT M Y_ Paie 1. THE sBcRo 4. Water Supply and Sewerage Service Coverage ............. I B. Sector Institutional Development ....................... 2 C. Investment and Financial Policies ...................... 3 D. New Policy Directions ....................4 E. Sector External Financing .................................***.... S.5 F. Rationale for Bank Involvement ......................... 7 II. TIE PROJECT A. Project Origin ..................................... a S. Project Objectives ..................................... C. Project Description .... ..99...9.9...9999999999...9 D. Project Costs ........................................ 12 E. Financing Plan ........ **................. l F. Borrower and EZecuting Agency ......................... 15 G. Implementation ......................................... 17 B. Procurement ........................... *0 ... *0.0.....9 1. Disbursements ........................................ 22 J. Accounting and Auditing ....................... *9.... 23 R. Subproject Lending Policy and Eligibility Criteria.... 23 L. Annual Project Implementation Review .................. 26 II. PROJECT JUSTIFICATION A. Economic Benefits ........... ........... 26 B. Beneficiaries Impact ...................................... 27 C. Environmental Impact . ........................ 2? D. Risks and Safeguards ................................. 27 In. AGRRDIENTS -EACMI AND RE........ON. . This report is based on the findings of a post-appraisal mission consisting of Messrs. Bernardo Gomez (Mission Leader), Guillermo Yepes (Senior Sanitary Engineer) and Mark Dorfman (Financial Analyst), which visited Argentina in November 1989. Mr. Emanuel Idelovitch (Senior Water Engineer) and Mr. Klas Ringskog (Senior Economist, on leave) also contributed substantial inputs to the report, based on their participation in previous missions. Mmes. Maria Helena Carvalho and Leo Santelices assisted in the production of the report. This document has a rsricted diosibuon and may be ud by recipients only ir the poformnce of their offiiW duties Its contnts may not oterise be diclosed wiho Wodd Bank authoaizon.  -"1- Table of Contents (Continued) ANNEXS Annex 1 Concentrated Population Connected to Public Water Supply Annex 2 Concentrated Population Connected to Public Sewerage Annex 3 Water Production Annex 4 Sewage Treatment and Disposal Annex 5 Water Supply and Sewerage Institutions Annex 6 Water and Sewerage Utilities - Simplified Operating Situation, 1986 Annex 7 Project Implementation Schedule - Cummulative Completion (Z) Annex 8 Project Cost Estimate Annex 9 COFAPYS' Organization Chart Annex 10 COFAPYS - Financial Projections Annex 11 COFAPYS - Action Plan and Financial Targets Annex 12 COPAPYS - Terms of Reference for Consultants in Financial Management Annex 13 Conditions for COFAPYS/Subloan Agreements Annex 14 Subproject Evaluation Guidelines Annex 15 Target Performance Indicators for Water Entities Annex 16 Allocation of Loan Proceeds Annex 17 Loan Disbursement Schedule Annex 18 Selected Documents Available in Project File Map IBRD 12432R2  -iii- ARGENTINA WATER SUPPLY AND SEWERAGE SECTOR PROJECT LOAN AND PROJECT SUNMARY Borrowers The Argentine Republic. Executing Aaencvs Consejo Federal de Agua Potable y Saneamiento (COEAPYS). k&oUnts US$100.0 million equivalent. Tenmss Repayment in 17 years, including 5 years of grace, with interest at the Bank's standard variable rate. Proceeds of the Loan would be passed' on by the Argentine Republic to COFAPYS as a Loan, on t4e same terms and conditions as those of the Loan. Relendina Temss COFAPYS would make subloans denominated in dollars to public and private water and sewerage entities. COEAPYS would charge the same variable interest rate as the Bank loan, plus a spread, to be updated from time to time, for the financing of the project administrative expenses, the credit risk and the cross-currency exchange risk form the Bank's Currency Pooling System. The initial spread will be six -percentage points (four to cover administrative expenses and credit, and two to cover the cross-currency exchange risk). It would also charge a commitment fee at least equal to the one charged by the Bank. Proiect Obiectives: Overall project objectives, in line with Government policies, are to: (a) promote greater sector efficiency and financial viability; (b) expand service coverage; (c) improve the quality of the water artd sewerage services while protecting the environment; (d) encourage private sector participation in the water and sanitation sector. Proiect DescriDtions The operation would be a sector operation project managed by COFAPYS, which would onlend the proceeds of the Bank loan to water supply and sewerage entities in urban areas (15,000 inhabitants or more) meeting agreed eligibility criteria. The investments eligible for financing under the project consist of those required to: (a) improve the operations of water utilities (402 of project cost); (b) rehabilitate water and sewerage systems (30Z); (c) expand water and sewerage systems (25Z); (d) prepare studies and designs (AZ); and (e) improve COFAPYS operations (1?).  -iv- Benef its The proposed project would yield economic, fiscal, social, and environmental benefits. tconomic benefits include higher water sales and cost savings resulting from investments almed at promoting efficiency. By promoting water consumption metering, the project would enable currently wasted water to be saved at a cost of about 15? of the marginal cost of expanding production capacity. With tariff levels approaching this marginal cost, the investments in metering would have a high benefit-cost ratio. In addition, by promoting operational improvements and adequate system maintenance, the project would increase system capacity to provide services to more customers at one-fifth the cost of building new Installations. On the basis of the experience with other water and sewerage system rehabilitation projects in Latin America, most investments in this category show rates of return of 201 or more. Fiscal benefits would accrue as operational cash surpluses of the water entities and customer contributions resulting from policies implemented under the project begin to replace general tax revenue. Social benefits include expanding service coverage to low-income groups and creating employment in project-related activities. Also, under the project's commercialization program, tariffs that are now based on unmetered consumption will be replaced by a progressive tariff based on consumption levels, making it possible to cross-subsidize low-income users, which generally are low consumers. A beneficial environmental impact would occur through targetted investments to reduce water consumption, and thus the amount of sewage disposal. and through the disecipline induced by preparing environmental impact assessments for all projects financed by COFAPYS. Risks and Safeuaurds: The main project risks are financial, institutional, and political. The financial risk concerns the availability of domestic financing and the foreign exchange risk. The domestic finance risk has been greatly reduced by: (a) emphasis on investment for policy reforms to increase financial viability of the water entities: and (b) the relatively small local counterpart required. The foreign exchange risk to be passed on to the water entities represents a substantial challenge to the nsanagements, which lack experience in this area and are subject to price setting by provincial authorities which also lack requisite skill in this area. The risk is reduced by the project emphasis on strengthening the management of the water entities as well as their financial performance. COPAPYS' financial consultants would also provide advice to the water entities in managing the foreign exchange risk. The risk is also lessened by the &ational and provincial governments' policy to ensure that the provision of water and sanitation services is financially viable. Institutlonsl risks pertain  - y to project success depending directly ons (a) COFAPYS' ability to onlend under agreed economic, financlal, Institutional, and environmental criteriat and (b) the provincial utilities' ability to focus on Institutional reform and system maintenance and rehabilitation--areas where they are admittedly weak. These risks are offset by COFAPYS and the utilities hiring qualified consultants, acceptable to the Bank, financed out of project resources. Finally, there are political risks. These risks are deminished in the light of the broad political consensus that the neglected water supply and sewerage sector urgently needs to reorient its policies and practices. It is also miniuized by the conformity between the project objectives and the Government's policy to increase the efficiency of the public sector and to improve public sector finances at national, provincial, and municipal levels.  - vi - Table 1: PROJECT COST ESTIMATE (in US$ million) 8of Component Local Foreign Foreign Total Total I. IMPROVEMENT OF EXISTING OPERATIONS a) Institutional Development 2.8 6.5 70% 9.3 5% b) Commercialization of 9.0 20.9 70% 29.8 16% Water Service c) Operational Improvements 9.0 20.9 70% 29.8 16% d) Training of Personnel 1.7 3.9 70% 5.6 3% SUBTOTAL (I) 22.4 52.2 70% 74.6 40% II. REHABILITATION OF SYSTEMS 28.0 28.0 50% 56.0 30% III. EXPANSION OF SYSTEMS 28.0 18.7 40% 46.6 25% IV. PREPARATION OF STUDIES 2.2 5.2 70% 7.5 4% AND DESIGNS V. IMPROVEMENT OF COFAPYS' OPERATIONS 0.6 1.3 70% 1.9 1% TOTAL BASE COST (Oct. 1990 prices) 81.1 105.4 57% 186.6 100% PHYSICAI. CONTINGENCIES (10%) 8.1 10.5 57% 18.7 10% PRICE CONTINGENCIES 19.5 25.3 57% 44.8 24% TOTAL PROJECT COST 108.8 141.3 57% 250.0 134% Table 2: FINANCING PLAN (In US$ millions) % of Source of Funds Lcal Foreign total Iotal IBRD 29.4 70.6 100.0 40.0% IDB 29.4 70.6 100.0 40.0% Water Entities 50.0 0.0 50J0 _20.0 & Provinces Total 108.8 1JLU_ 250.0 lQQd.0  -vil- Kitsmated Disbursementst Bank n 1991 1992 1993 1994 199 1.996 j997 1998 Annual 1.2 2.7 6.7 15.7 23.1 24.0 19.1 7.5 Cumulative 1.2 3.9 10.6 26.3 49.4 73.4 92.5 100.0 Rt.e of Returns Individual subprojects In system rehabilitation and expansion are required to have an estimated financial rate of return of at least 12X, with revenues taken as a proxy for economic benefits.  WATER SUPPLY AD SE SE=TOR PROJECT STAFF APPRAISAL RPORT I. MIE SET A. Water Sunplv and Sewerage Service Coverage 1.01 Overview. As a highly urbanized country, with 85% of its 31 million inhabitants (mid-1987) living in urban areas, Argentina needs to have a well managed water supply and sewerage sector. This is especially true given the deleterious social side effects that could occur in its absence, including grave public health risks. In fact, unsafe water and unsanitary conditions rank fifth among fourteen major causes of mortality, including infections, parasitic diseases, and related illnesses in Argentina. 1.02 Until 1980, Obras Sanitarias de la Nacion (OSN), a state-owned enterprise, had the responsibility for planning, constructing and operating most major urban water supply and sewerage systems in the country. OSN exercised its responsibility through provincial offices that were under the control of the central office in Buenos Aires. In 1980, the Government, dissatisfied with OSN's performance, took a bold step to improve the efficiency and effectiveness of the water supply and sewerage sector by decentralizing services and administration to the provinces and limiting OSN to serving the Buenos Aires Metropolitan Area. The initiative, however, was hastily implemented with little preparation for an orderly transition of responsibility to the provinces A short-term effect was that the percentage of urban and rural concentrated population with houses connected to a piped water system dropped from an already low 67* in 1980 to only 60% by 1986. 1.03 Other major contributors to weak sector performance in recent years were the country's economic recession of the 1980s, the hyperinflation, and the lingering debt crisis--all of which served to undermine Argentina's optimistic sector objective subscribed under the International Water Decade: complete coverage for the urban and rural concentrated population with safe water and sanitation by 1990. Due to the severely contracted government resources and the short-term effects of the decentralization effort, investments from national, provincial and municipal resources for maintenance, rehabilitation, or expansion of water supply facilities were not up to the needs of the sector. (See Annexes 1 and 2 for data on water supply and sewerage service coverage, respectively, in selected provinces). Water treatment plants continued to deteriorate and aging distribution system sustained increasingly higher losses. No metering, or insufficient metering, and water leakages placed unusually high demands on the water production installations, amounting to 400-640 liters per capita/day (Annex 3) compared to 300-400 liters per capita/day In well managed urban systems of the region.  1.04 Sewerage Service and Pollution Levels. Sewerage coverage, which is about half of the water supply coverage, rose from 31% of all dwellings in urban and concentrated rural areas in 1980 to 34% in 1986. The balance of the population resorts to individual sewage disposal systems, such as septic tanks, which can result in a serious public health risk. For example, in some major cities, like Mar del Plata and Tucuman, high ground water levels togetlher with septic tanks combine to increase the risk of contaminating aquifers that in some cases supply drinking water to the population through wells. Also, those communities with public sewerage generally discharge their effl. ints with little or no treatment: estimates indicate that 65% of all sewage is released directly into rivers and lakes, while 27% receives only primary treatment and a mere 8% secondary treatment. This results in: (i) deteriorating water quality and more costly water treatment; (ii) eutrophication of surface waters and the destruction of recreational resources; and (iii) disrupted ecological cycles with often unpredictable but always harmful consequences (sewage treatment data for selected provinces appear in Annex 4). 1.05 Comparison with Other Latin American Countries. With an estimated share of 60% of its urban and rural concentrated population having house connections to a piped water system, Argentina is in 14th place among the 21 major countries in the Latin America and Caribbean region. With 34% of its urban population connected to a public sewerage system it ranks 19th among the same countries. These are disappointing placements considering that Argentina's GNP per capita is the fourth highest in the region --nd that in many ways it was the pioneer of modern environmental sanitation in Latin America. This observation is true even taking into account that the evaluation of water supply arnd sewerage services by means of the percentage of house water connections and sewerage connections to central systems, respectively, does not reflect fully the quality of the services and can thus be misleading. B. Sector Institutional Development 1.06 Institutional Development. For over 100 years, public water supply and sewerage services in urban and rural areas in Argentina were administered by OSN. Under OSNs tutelage, by 1930, Argentina had taken the lead in Latin Ameriea in the field of environmental health; unfortunately, in subsequent decades accomplishments were not sustained. Abundant financial resources leu to overconfidence and eventually to economically inefficient investments, delaying the application of modern management techniques. This type of development was pursued as long as Argentina's robust economy could provide the necessary subsidies to the sector. When the economy stalled in the 1950s, the deficiencies of OSN began to surface and the Government eventually took actions to improve performance by decentralizing service provision. In 1966, the Government removed the rural sector from OSN oversight by establishing the Servicio Nacional de Agua Potable y Saneamiento Rural (SNAP), and in 1980 decentralized the water and sewerage services to the provinces (para. 1.02). Additional streamlining is being done by the Nenem administration by delegating the administrative and financial responsibilities of OSN from the National Government to a Board comprised of representatives of the National Government and the governments of Buenos Aires province and the city of Buenos Aires. The next step in the restructuring of OSN is the delegation to the private sector  of responsibility for the operation of OSN's infrastructure, Some provincial governments are also turning over the water and sewer systems to the municipalities. 1.07 Present Institutional Structure. The Ministry of Public Works and Services (MOSP) has responsibility for planning and general oversight of all the water resources of the country. The Consejo Federal de Agua Potable y Saneamiento (COFAPYS; para. 1.16), under the Ministry, enjoys responsibility for assisting in the financing of investments carried out by the provinces in both urban and rural communities. Provincial and municipal authorities have responsibility for the provision of water and sewerage services. 1.08 Provincial water and sewerage entities differ in administrative approach. For example, some are organized as public enterprises (Empresas Provinciales), with varying degrees of autonomy, while others take the form of ministerial dependencies, with little administrative and financial autonomy (a list of provincial institutional arrangements appears in Annex 5). In the case of the municipalities, some (usually small) manage their own sanitation services, the most significant of which is the city of Mar del Plata in the Province of Buenos Aires. OSN in Metropolitan Buenos Aires, which at present is wholly owned and managed by the National Government, is also being decentralized (para. 1.06). The dispersed rural population is under the aegis of the National Environmental Sanitation Directorate (DNSA) in the Ministry of Health and Social Welfare. DNSA also oversees water quality delivered to both rural and urban customers. C. Investment and Financial Policie 1.09 When the Government decentralized the water supply and sewerage services to the provinces in 1980, there were no financial policies to rationalize how new works would be financed or how on-going operations and maintenance costs would be met. Investment and financing plans extended no farther than the yearly budget. These plans served only to underwrite small, uncomplicated works to perform the basic service of connecting more consumers to the existing water and sewerage infrastructure. Larger works were not undertaken so that service levels eventually grew even more precarious. 1.10 Sector investments between 1971-75 totalled US$640 million (in constant 1984 prices), and in 1976-80 US$900 million. After the decentralization, between 1981-85, investment fell to only US$300 million. In fact, the water supply and sanitation sector investments decreased faster than any other sector, falling from 3 to 4% of total public investments in the 1970s to 2% between 1981- 85. This represents about US$3 per capita yearly for the total urban and rural concentrated population, which is clearly insufficient to keep pace with population growth or to ameliorate the condition of the unserved population. 1.11 Operations and investments were often financed by grants from the Central Government or the respective provincial governments. However, under such financing there was little guarantee that the economics of infrastructure design and construction or the recovery of the cost of works from operating surpluses would be considered. Also, grants.had become scarce due to the harsh  macroeconomic environment of the 1980s, which acted to curtail sharply investment potential as well as the funds available for systems operation and maintenance. 1.12 The absence of efficient financial and tariff policies also produced uneconomical operation. A survey of the major provinces shows that the sector is not covering its operating costs (Annex 6). Furc.hermore, the discrepancy between billings and collections is much too large, with the surveyed provinces collecting only about 62% of billing (well-managed utilities in the LAC region collect above 95%). As a consequence, water entities did not become more efficient. On the contrary, provincial water supply and sewerage agenicies often became overstaffed and productivity decreased to one-third of the most efficient enterprises in Latin America. Finally, in the absence of effective water metering, consumers had no incentive to control consumption or waste. 1.13 The present tariff structure dates back to 1963 and corresponds to an unmetered service. The tariff varies as a function of area, type of service, and lo ation of property--but not with the consumption level. Periodic adjustments are made for changes in input prices like chemicals, energy, and wages. This tariff structure is inadequate when judged by the degree to which it promotes efficient water consumption and on equity grounds. First, the fact that the system is umetered is equivalent to a zero marginal tariff to consumers; thus, it encourages consumption up to a level where the marginal value of the last cubic meter consumed is zero. Second, since water consumption is generally higher among high-income groups, an unmetered service tends to favor them instead of low-income groups. 1.14 In summary, reasons for weak investment finance have been: (i) the rapid decrease in grants from the Central and provincial governments, and (ii) the inability of provincial water entities to generate a surplus from their own operations or to take advantage of available external finance due to a lack of debt-service capacity. However, the fundamental reason for insufficient external support is the absence of institutional and financial policies that would turn the provincial agencies into viable instruments for water supply and sewerage sector development. D. New Policy Directions 1.15 The MOSP and the provincial governments have taken actions in recent years to reverse the long decline in service coverage and quality level. The MOSP assisted by the financial support of the Bank's First Water Supply and Sewerage Project (Loan 2641-AR), developed in 1988 a National Sanitation Plan (NSP), and began to implement a pilot program in three water companies (Buenos Aires, Cordoba and Santa Fe) aiming at: (i) rehabilitating deteriorating infrastructure, and replacing rundown facilities; (ii) extending water services to new urban areas; and (iii) initiating a national operational improvements program that promotes water conservation through physical rehabilitation of water systems, production and consumption metering, and institutional strengthening of the utilities (para. 1.25).  - S . 1.16 In addition, the Congress, to provide the institutional framework to carry out the NSP, in 1988 enacted legislation that transformed SNAP (para. 1.06) into the Consojo Federal de Agua Potable y Saneamiento (COFAPYS). COFAPYS now is the Government's financial agency responsible for assisting the provinces in developing the sector systematically both in urban and rural communities, in consonance with the Government's policies and priorities as follows: (a) increasing participation of the beneficiaries and the private sector in the proviston of water and sewerage services; (b) increasing the administrative responsibilities and the mobilization of resources at the municipal level; and (c) increasin- the autonomy, efficiency, and financial viability of existing public water and sewerage entities. 1.17 One important step in the direction of increased participation of beneficiaries in the provision of services was taken in 1989 with a concession tendered to a users' cooperative in a section of Metropolitan Buenos Aires for constructing and operating a sewer system. Several other initiatives of this type are being considered. These include delegating the operation of the water and sewer services to private concerns (Metropolitan Buenos Aires) or delegating selected sector activities (such as meter reading, billing, and collection) to private concerns as well. 1.18 The National Sanitation Plan (NSP). The NSP covers three areas: (i) it provides data on present service coverage and quality that could become the embryo of a sector data bank; (ii) it sets sector targets for the next 15 years and outlines the policies and resources necessary to reach theta; and (iii) it identifies the national programs that are considered priorities. The broad sector objectives of the NSP are to raise service levels and to increase the efficiency of both investment and operating expenditures. 1.19 The NSP specifies three sector investment priorities: (i) a national institution-building program to improve water supply and sewerage enterprise management, enhance commercialization, strengthen operations and maintenance, and assist in the development of human resources; (ii) a national program to expand the coverage of water supply and sewerage services through building both production and distribution systems; and (iii) a national program to control and protect the quality of services that supply water for human consumption. The necessary central financial and technical support to iplement the NSP will be provided by COFAPYS (para. 1.16). E. Sector External Financg 1.20 The main sources of external financing for the sector have been the Inter-American Development Bank and to a lesser extent the Bank. The 1DB-financed projects have played a major role in the development of the rural water sector, in the expansion of water and sewerage services in Metropolitan Buenos Aires, and in the provision of services for housing schemes financed by the Fondo Nacional de la Vivienda (FONAVI). The Bank, whose involvement in the sector began  - 6 - as recently as 1986, is assisting municipalities in five provinces in the execution of small water supply and sewerage networks (Loan 2920-AR). It is also assisting the National Government and two provincial governments in the formulation of new policies and plans for sector development as well as in the implementation of a pilot project for modernizing water entities and rehabilitating existing infrastructure (Loan 2641-AR). The execution of both IDB and Bank-financed projects has been adversely affected by the economic events of recent years. The following is a brief description of the IDB and Bank involvement in the sector and, particularly, of the status of ongoing projects. 1.21 SNAP, the predecessor of COFAPYS, received five loans from the IDB to support its rural programs. The first four loans were already disbursed while the disbursements for the fifth for US$70 million have yet to start. Between its creation in 1966 and its transformation into COFAPYS in 1988, SNAP and the communities invested about US$300 million to construct 960 rural water supply and sanitation systems. The total population benefitting is estimated at 1.4 million. The fifth IDB-financed project will be executed by COFAPYS and financed by the IDB loan, as well as by local counterpart funds of US$70 million provided by the Central and provincial governments, and by the communities; the latter providing not less than 10% of total project cost. The beneficiaries of this project are communities up to 15,000 inhabitants. 1.22 In 1986, the Secretariat of Argentine Housing and the Environment (SVOA) in the Ministry of Health received an IDB loan in an amount of US$122 million, to be used for infrastructure investments related to the housing schemes financed by the Fondo Nacional de Vivienda (FONAVI). 1.23 A recent IDB loan in the amount of US$98 million provides financing for a potable water project in the western zone of Buenos Aires. The loan agreement has yet to be signed. The local counterpart for this project would be comprised of funds internally generated by OSN. 1.24 Some municipalities (in the provinces of Buenos Aires, Cordoba, La Pampa, Neuquen, and Santa Fe) are benefiting from a World Bank Municipal Development Project (Loan No. 2920-AR), under which small water supply and sewerage works would be financed. As a rule, the municipal beneficiaries have populations of less than 15,000, and each investment costs less than US$0.5 million. The execution of this project has been slow as a result of the country's economic instability and attendant hyperinflation. 1.25 The first Bank-financed project in the sector (Loan 2641-AR) is a pilot project that addresses issues similar to the ones under the proposed project. Three of the -four project components (MOSP, OSN and DIPOS) address exclusively policy issues, operational improvements of the water entities, and minor infrastructure rehabilitation, while the fourth (EPOS) also includes a relatively large investment in building a water treatment plant to replace a rundown facility. Total project cost amounts to US$120 million and the Bank loan to US$60 million. 1.26 Project execution has been slow (loan disbursements three and a half years after loan signature amount to only US$13 million) as a result of the  difficult economic and political situation of recent years in Argentina. This, in turn, has been reflected in the slow pace of introducing recommended reforms in the water entities, and in delays in procurement, the latter as a consequence of the hyperinflation and of the virtual paralysis of public investment during the last year. This unfavorable situation, however, has changed in recent months and the prospects for an improved pace in project execution are satisfactory. First, the project enjoys strong support of the National and provincial governments since it is an example of the kind of approach and actions required to translate the Government's broad macroeconomic policies and public sector reform programs into actions at the sector and enterprise level. And, second, the work already done by the project entities in the diagnostic and design phases of their operational improvement programs and in completing bidding documents for purchasing required materials and equipment are allowing a substantial acceleration of project execution. F. Rationale for Bank Involvement 1.27 Key aspects of the Bank's strategy in Argentina include assisting the Government to: (i) strengthen public finance at the national and provincial levels; (ii) improve the allocation of public spending; and (iii) increase private sector participation in providing public services. To this end, the Bank is supporting reform of state-owned enterprises and of provincial and municipal finances. The proposed project is an important element in this strategy, since it is part of a set of actions being taken by the Government to strengthen the provincial government's capacity to plan, finance and execute financially sustainable and institutionally manageable investment programs. These actions are being supported by the Bank through the proposed Provincial Development Project. Within this context, the project would help to strengthen public finances by committing water and sewerage utilities to implement financial policies that will enable them to operate without government subsidies, and it would provide Incentives for the participation of private concerns in sector activities. 1.28 Continued Bank support for the Argentine water supply and sewerage sector is particularly timely on several accounts. First, for several years, the Government and the Bank have been discussing policy and institutional arrangements required to overcome the serious constraints affecting sector development. The agreements reached during this dialogue are embodied in the ongoing Water Supply Project (Loan 2641.-AR; para. 1.25), which was the first Bank operation in the sector in Argentina, as well as in the sector study conducted by the Bank and the Government in 1987 (IBRD Report No. 6768-AR). The proposed project is a direct outcome of this dialogue. Secan, Bank participation in the project has encouraged the use of foreign cofinancing, since the Bank loan would be compiemented by an IDB loan for an equal amount. Third, Bank support for the project would complement and build on previous Bank efforts to assist Argentina in the implementation of stabilization and structural adjustment measures. It also would help to alleviate the social costs of adjustment by providing services to low- income groups and by generating employment in project-related activities. zourth, Bank participation in the project would eneourage the adoption of measures to improve the environment.  II. THE PROJECT A. Project-Origin 2.01 The proposed project grew out of an on-going dialogue initiated in 1983 between the Government and the Bank, which sought to formulate and implement a comprehensive water and sewerage sector reform program. This dialogue has resulted so far in the First Water Supply Project (Loan 2641-AR), approved in December 1985, and a sector study conducted by the Bank and the Government (para. 1.28). This second project, based on the experience of the first, and on the findings and recommendations of the sector study, would help to continue the modernization of sector activities by extending its coverage to all the water entities that meet the eligibility criteria established (paras. 2.35 to 2.45). The project would be cofinanced by the IDB. B. Project Oblectives 2.02 Overall project objectives, in line with Government's policies, are to: (i) promote greater sector efficiency and financial viability; (ii) expand service coverage; (iii) improve the quality of the water supply and sewerage services while protecting the environment; and (iv) encourage private sector participation in the water and sanitation sector. 2.03 The project would assist in meeting these objectives by: (i) strengthening sector organizations; (ii) committing the utilities to implement financial policies that allow them to self-generate funds for system modernization and expansion and to obtain funds from capital markets; (iii) increasing the efficiency of water use; (iv) fostering the preparation of cost- effective investment programs; (v) encouraging decentralization of services to the municipal and community level as well as the participation of the private sector; and (vi) developing sound environmental protection policies. 2.04 First, to make the sector organizations more efficient, COFAPYS, the proposed project executing agency, would receive financial and technical assistance to enable it to discharge its expanded responsibilities. The strengthening of COFAPYS' administration would be done in parallel with developing the capacity of the water supply and sewerage enterprises. This ultimately will raise the efficiency of both capital and current expenditures in the sector. 2.05 See the project, by its stress on improved operational, commercial, tariff, and financial policies, will enable the utilities to self- generate an increasing share of their investment needs and to become eligible to obtain financing from capital markets. Given the difficult macroeconomic environment currently in Argentina and the precarious financial conditions of the water companies, it will probably be some time before It becomes feasible  to finance water and sewerage investment through capital markets; nevertheless. the project encourages such an evolution. 2.06 Thir, to increase the efficiency of water use, the project would promote better commercial policies for water supply and sewerage services. These policies would be targeted to control consumption through effective metering (which is not now customary in Argentina). Metering consumption will reduce wastage of scarce water resources and reduce environmental pollution caused by the discharge of waste water. By introducing tariff policies that base water charges on the quantity consumed, the project would also help in rectifying the presently regressive tariff structure, where low-income, low-consuming residents pay a higher unit price and a proportionally greater share of their income for water use than nigh-income, high-consuming residents (para. 1.13). 2.07 Fourth, the project would support Government efforts to use funds first for maintenance and then for rehabilitation, with capacity increases receiving the least emphasis. The project will be based on selection criteria and design standards that promote least-cost designs (paras. 2.35 to 2.45). For instance, if water consumption were effectively controlled, excess water use could be redirected to satisfy the unmet demand of low-income, low-consuming users. The corresponding marginal cost is estimated at about 15% of the marginal cost of expanding production and distribution capacity. Moreover, insisting that existing installations be maintained or rehabilitated before new replacement investments are made, the project would safeguard existing capacity at about 20% of the replacement cost. By stressing shorter design periods (10 to 15 years maximum, instead of the present 30 years), excess capacity would be minimized, increasing economic savings and lowering financial requirements by 40 to 60%. 2.08 Fifth, the project would encourage provincial and municipal authorities to seek participation of the commun;les and the private sector in the provision of water and sewerage services, including activities such as meter reading, billing and collection, and system maintenance. The project would also assist in developing the policies and regulatory framework required to encourage private sector participation in sector activities. This is in line with the Argentine Government policy to reduce the size of the public sector. 2.09 Sixth, the project would support Government efforts to develop COFAPYS capabilities to assess the environmental impact of sector projects, and evaluate proposed actions to minimize adverse effects, if any. COFAPYS in turn will help develop these capabilities at the provincial level by requiring environmental assessments of the projects it finances (para. 2.38) and by assisting the water utilities in this task. To this effect, COPAPYS would hire an experienced environmental consultant (para. 2.23). The consultant would also help in establishing an environmental assessment unit in COFAPYS that should be fully operational by December 31, 1991 (para. 4.01). C. Proiect Description 2.10 The proposed project, to be implemented between 1990 and 1997 (Annexes 7 and 8), comprises five main components:  . 10 - I. Improvement of Existing Operations of Water Utilities, tnrough the contractIng of consulting services, acquisition of equipment and materials for: (a) Institutional Develooment, including: (i) improving financial, accounting and other information systems; (ii) providing of audit services; (iii) improving organizational, planning, administrative, and logistical systems; (iv) improving purchasing and inventory management systems; and (v) developing environmental assessment capabilities. (vi) technical assistance for defining and preparing plans for the structural changes in the provision of water supply and sewerage services at the provincial or municipal level, including measures to privatize such services, to transfer to the municipalities the provision of the services or to establish concessions; and the establishment of suitable government agencies to regulate such privately or municipally controlled services, and for the improvement of incentives for priority provision of public services. (b) Commercialization of Water Supply and Sewerage Services, including: (i) preparing detailed surveys of water consumers and water and sewerage connections; (ii) designing and implementing water metering systems; (iii) designing and implementing tariff policies for metered services; (iv) establishing a comprehensive system of meter readings, billing, and collection; and (v) improving customer services. (c) ORerational ImUrovements, including: (i) macrometering, micrometering and pitometry;  e 11 e (ii) surveying and mapping water distribution and sewage collection systems; and (iii) improving operational and maintenance systems and procedures. (d) Training of Personnel, including: (i) on-the-jib training; (ii) twinning arrangements with modern water supply companies; (iii) seminars, post-graduate studies, and courses of varying duration; and (iv) preparation or acquisition of training materials. II. Rehabilitation and Upgrading of Water and Sewerage Systems, consisting of: (a) repairing and replacing water distribution and sewer mains; (b) upgrading and optimizing water and sewage treatment plants; and (c) constructing and upgrading other facilities required for the operation of water and sewer systems. III. Establishment and Expansion of Water and Sewerage Systems, consisting of: (a) setting up or expanding water distribution networks and water system capacity through the construction or rehabilitation of production, treatment, transmission and storage facilities; and (b) setting up or expanding sewage collection networks and sewerage ssystems capacity through the construction or rehabilitation of treatment, disposal, conveyance and reuse facilities. IV. Prenaration of Other Studies and Prenaration of Engineering Designs by the Water Utilities, consisting of technical assistance for: (a) preparing water supply and sewerage master plans and feasibility studies and designs, including water quality assurance measures for the rehabilitation and expansion of water and sewerage systems of subborrowers; (b) carrying out research studies aimed at improving the operation of water and sewerage systems; and  * 12 * (c) carrying out studies to ascertain potential environmental impact of proposed projects and propose remedial actions to minimize adverse effects. V. Imrovement of GOFAYYS operations, consisting of: (a) Institutignl D 1ogg=t, including acquisitions and utilization of materials and equipment, and provision of technical assistance for developing and improving COFAPYS: (i) capabilities for subproject promotion, appraisal, and supervision, environmental assessment, and financial management; (ii) administrative and logistical systems; (iii) audit; and (iv) research capabilities. (b) Training of Personnel, including: (i) visits to water supply and sewerage companies; (ii) courses seminars, and post-graduate studies on water and sewerage utility management and operations or conducive to Improving such management and operations; and (iii) preparation, acquisition, and utilization of training materials. D. Project Costs 2.11 Total project cost at current prices (1990-97) is estimated at US$250 million equivalent, excluding taxes and Interest charges. The total foreign exchange cost (excluding interest on the Bank loan) is estimated at US$141.3 million or 57% of the total cost. A summary of project costs is presented in Table 2.1, and a detailed cost estimate is given in Annex 8.  * 13 . Table 2.1: PROJECT COST ESTIMATE (in US$ million) % % of Component Local Foreign Foreign Total Total I. IMPROVEMENT OF EXISTING OPERATIONS a) Institutional Development 2.8 6.5 70% 9.3 5% b) Commercialization of 9.0 20.9 70% 29.8 16% Water Service c) Operational Improvements 9.0 20.9 70% 29.8 16% d) Training of Personnel 1.7 3.9 70% 5.6 3% SUBTOTAL (I) 22.4 52.2 70% 74.6 40S II. REHABILITATION OF SYSTEMS 28.0 28.0 50% 56.0 30% III. EXPANSION OF SYSTEMS 28.0 18.7 40% 46.6 25% IV. PREPARATION OF STUDIES 2.2 5.2 70% 7.5 4% AND DESIGNS V. IMPROVEMENT OF COFAPYS' OPERATIONS 0.6 1.3 70% 1.9 1% TOTAL BASE COST (Oct. 1990 prices) 81.1 105.4 57% 186.6 100% PHYSICAL CONTINGENCIES (10%) 8.1 10.5 57% 18.7 10% PRICE CONTINGENCIES 19.5 25.3 57% 44.8 24% TOTAL PROJECT COST 108.8 141.3 57% 250.0 134%  - 14 - The total project cost was allocated to the different components, in accordance with the priorities established in the NSP and emerging from the project objectives and from the utilities investment plans reviewed during project preparation (the appraisal mission visited the water supply companies of Metropolitan Buenos Ai-is as well as those of 10 provinces that together represent more than 80% of the urban population). The relative size of the different categories is, then, a notional idea that reflects overall investment oriorities but without necessarily applying to individual subprojects. Provisions for physical and price contingencies have been made, which should serve as guidelines to COFAPYS in the management of the project when subprojects are identified and evaluated. The base cost of the project, expressed in October 1990 prices, is estimated at US$186.6 million, net of taxes. Physical contingencies include 10% for all project components. Price contingencies were calculated, assuming: (a) a project execution period of about 7 years (1991- 1997); and (b) projected international inflation of: 1991: 2.6%; 1992: 4.1%; 1993: 5.4%; 1994: 4.7%; 1995: 3.6%; 1996: 3.3%; and 1997: 3.0%. Variations in the exchange rate would compensate for the difference between the local and international inflation rates. E. Financing Plan 2.12 The project financing plan includes the proceeds of the proposed Bank loan, two IDB loans, the water entities internal cash generation, and contributions from the provinces to the water supply enterprises. The Bank and IDB would each cover about 40% of total project cost, and the local contribution would be 20%. The aggregate level of external financing (80%) is justified given the need to reactivate a sector whose performance has been deteriorating for years with negative implications for the standard of living of the poor, and on the availability of services for directly productive activities. The participation of the Bank and the IDB would take place through parallel operations. The IDB operations are scheduled to be presented to their Board in January 1991. IDB financing would be through one loan of US$70 million equivalent from the Ordinary Capital, and another loan of US$ 30 million from the Special Fund with concessionary terms - 3% interest rate. (Proceeds of both IDB loans would be passed on by the Government to COFAPYS as loans under the same terms and conditions as those of the IDB loans.) The Bank and the IDB have closely coordinated project preparation and there is a common understanding on project objectives, financing plan, and major project components and conditionality. In addition, the project establishes that approval of the IDB loan, or an alternative satisfactory to the Bank, should be a condition of effective-.ess of the Bank loan (para. 4.02). 2.13 The participation of the three sources of funds in the financing of the project would be as shown in Table 2.2 below. The Bank loan would be made at the standard variable interest rate with repayment in 17 years, including 5 years of grace.  I IS - Table 2.2: FINANCING PLAN (In US$ millions) 8 of Source of Funds Local Ersl nTotal Tota IBRD 29.4 70.6 100.0 40.0% IB 29.4 70.6 100.0 40.0% Water Entities 50.0