Philippines - Subic Bay Freeport Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 12773-PB STAFF APPRAISAL REPORT PHILIPPINES SUBIC BAY FREEPORT PROJECT MAY 10, 1994 Industry and Energy Operations Division Country Department I East Asia and Pacific Regional Office This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS (as of December 31, 1993) Currency Unit = Peso i 1 = US$0.035 US$1 = P 28.4 WEIGHTS AND MEASURES ha hectare km kilometer m meter m2 square meter m3 cubic meter MGD million gallons per day MW megawatt ABBREVIATIONS AND ACRONYMS ADB - Asian Development Bank ASEAN - Association of South East Asian Nations BCDA - Bases Conversion and Development Authority BOT - Build-Operate-Transfer CDA - Comprehensive Development Area CIF - Cost, Insurance and Freight COA - Commission on Audit DBM - Department of Budget and Management DENR - Department of Environment and Natural Resources DFI - Direct Foreign Investrnent DOJ - Department of Justice EPZ - Export Processing Zone GEF - Global Environment Facility GOCC - Government Owned and Controlled Corporation GOP - Government of Philippines IRR - Implementing Rules and Regulations JV - Joint Venture MOA - Memorandum of Agreement NPC - National Power Corporation PWC - Public Works Center SBF - Subic Bay Freeport SBMA - Subic Bay Metropolitan Authority SEZ - Special Economic Zone US - United States FISCAL YEAR January 1 to December 31  FOR OFFICIAL USE ONLY PHILIPPINES SUBIC BAY FREEPORT PROJECT STAFF APPRAISAL REPORT CONTENTS Page No. Loan and Project Summary ............................ I. BACKGROUND: THE BASE CONVERSION PROCESS ........... 1 A. The Freeport Concept ............................. 2 B. The Conversion Planning Process ...................... 2 II. THE SUBIC BAY FREEPORT ............................ 5 A. Endowments and Existing Facilities ..................... 5 B. The SBF's Competitiveness and Development Prospects 7 C. The Conversion Strategy. 9 D. Status of SBF Development and Privatization .12 E. Off-SBF Development Program and Priorities .14 F. Lessons from Previous Bank Involvement .14 G. Rationale for Bank Involvement .15 III. THE PROJECT .16 A. Objective .16 B. Description .16 C. Cost and Financing .18 D. Implementation .19 E. Environmental Aspects .22 IV. THE BORROWER .23 A. Background .23 B. Organizational Structure .24 C. Financial Management and Control .25 D. Environmental Management .26 E. Training and Technical Assistance Needs .28 This project was prepared by Messrs./Mme. Shilpa Patel (Task Manager), John Arnold (Transport Economist-Consultant), Aldo Baietti (Financial Analyst), Jack Fritz (Environmental Specialist), Kishore Rao (Institutional Consultant) and Leonard Schiffman (Transport Engineer). Mrs. Merle Mendis-Dennis processed the report. Peer reviewers were Messrs. Peter Long and Hoon Mok Chung. The project was cleared by Mr. Vineet Nayyar, Chief, EAIIE and Mr. Callisto E. Madavo, Director, EAI. This document has a rctricted distribution and may be used by recipients only in the performance of their |official duties. Its contents may not otherwise be disclosed without World Bank authorization.l  Page No. V. FINANCIAL ASPECTS .................................. 29 A. Overview of Past and Current Performance ................... 29 B. Investment Program and Financing Plan ..................... 31 C. Future Financial Performance ........................... 32 VI. PROJECT BENEFITS AND RISKS ............ .. ............ 34 A. Benefits ......................................... 34 B. Risks .......................................... 35 VII. AGREEMENTS AND RECOMMENDATION . .36 A. Agreements .36 B. Recommendation .37 ANNEXES Annex 1 Description of Infrastructure Components .................... 38 Annex 2 Indicative Timetable of TA Activities ...................... 40 Annex 3 Merchandise Control System ............................ 41 Annex 4 Zoning Regulations and Design Code ...................... 44 Annex 5 Automated Financial Management and Accounting System ......... 46 Annex 6 Privatizations Transactions Assistance ...................... 48 Annex 7 Enhancing SBMA's Institutional Capabilities .................. 50 Annex 8 Facilities Management Support .......................... 55 Annex 9 Environmental Baseline Survey .......................... 57 Annex 10 Institutional Support to the Ecology Center .64 Annex 11 Environmental Management Plan (EMP) .66 Annex 12 Total Project Cost .72 Annex 13 Disbursement Schedule .74 Annex 14 Project Supervision Plan .75 Annex 15 Implementation Schedule .76 Annex 16 SBMA's Financial Statements .78 Annex 17 Assumptions for Financial Projections .81 Annex 18 Economic Analysis .92 Annex 19 Selected Documents Available in the Project File .94 Organization Chart Map: IBRD No. 25499 and 25500R  PHILIPPINES SUBIC BAY FREEPORT PROJECT Loan and Project Summary Borrower: The Subic Bay Metropolitan Authority (SBMA) Guarantor: Republic of Philippines Amount: US$40 million equivalent Terms: 20 years, including 5 years of grace, at the Bank's standard variable interest rate. Proiect Objectives: The objective of the project is to attract private investors to the Subic Bay Freeport (SBF). This will be achieved by: (a) improving existing infrastructure; (b) improving access to the area for industrial, commercial and passenger traffic; (c) maintaining the SBF asset base, including protection of the environment; and (d) strengthening the capacity of the SBMA to manage and administer the facility. Project Description: The project consists of three components. The first is site improvement, which includes improvement of land access (road, bridge and entry gates); airport improvements (runway repair, strengthening of aprons and taxiway, airport communications and navigation equipment, and conversion of an existing building into a passenger terminal); port repairs; a pilot standard factory building development (6 buildings); and the provision of miscellaneous equipment for security and maintenance purposes. The second component is technical assistance and training to strengthen the institutional capacity of the SBMA and to provide appropriate systems for the implementation of freeport policies. The third is environmental protection, which includes the carrying out of an environmental baseline survey, the provision of monitoring equipment and institutional support to establish a sound environmental infrastructure at the SBF. Benefits and Risks: The major project benefits are: (a) economic benefits arising from increased economic activity and employment in the region, estimated to reach US$750 million over the next decade; (b) environmental benefits arising from increased protection of the forest lands and the bay; and (c) financial benefits to the SBMA arising from increased rental and other income from the SBF. In addition, institutional strengthening at the SBMA will result in significant human capital development. The major risks are political in nature. A policy reversal regarding the SBF's freeport status would nullify its competitive advantages, and inflows of foreign investment would likely diminish. To mitigate this risk, assurances were obtained that the SBF's freeport status will be maintained, and appropriate remedies against a potential policy reversal are be included in the proposed loan. Another risk relates to the relative lack of experience in freeport management at  the SBMA. To address this concern, the project will provide long-termn technical assistance to provide the expertise required while training SBMA personnel on-the-job so that they gain the necessary experience. The risk of delays in project implementation has been minimized through intensive project preparation activity. The project itself is not expected to have adverse environmental impacts. There is a risk of future environmental degradation if satisfactory maintenance practices are not followed. The project will address this concern. Project Cost: Local Foreign Total ------------------ US$ million Site Improvement 9.3 26.9 36.2 Institutional Support 0.2 4.8 4.9 Environmental Protection 0.0 1.0 1.0 Taxes and Duties 1.0 0.0 1.0 Total Cost 10.5 32.6 43.1 Physical Contingencies 1.5 4.6 6.0 Price Contingencies 1.0 1.9 2.9 Total Cost with Contingencies 12.9 39.1 52.0 Interest During Construction 0.6 1.5 2.1 Total Financing Required 13.5 40.6 54.1 FSinancng Plan: Local Foreign Total --------US$ million ------- IBRD 0.9 39.1 40.0 SBMA's Internal Cash 12.6 1.5 14.1 TOTAL 13.5 40.6 54.1 Estimated Disbursement: IBRD Fiscal Year 1995 1996 1997 1998 1999 --------------------US$ million------------- Annual 7.2 17.6 11.2 2.4 1.6 Cumulative 7.2 24.8 36.0 38.4 40.0 Economic Rate of Return: 12% to 37% depending on project component. Map: IBRD 25499 and 25500R.  I. BACKGROUND: THE BASE CONVERSION PROCESS 1.1 The Subic Naval Base was the largest U.S. military facility operating outside the United States. Located 80 km northwest of Manila (see Map IBRD 25499), the baselands covered 15,130 ha, within the territorial jurisdiction of the City of Olongapo, the town of Subic in Zanbales, and the towns of Moron and Hermosa in Bataan. Approximately 6,700 ha housed the area formerly leased by the U.S. Navy. Given its strategic location, and its role as the primary support for the U.S. Seventh Fleet operating in the Westem Pacific and Indian Ocean, the U.S. had invested heavily in the Base. Estimates of the replacement value of the facilities range from US$8-10 billion. 1.2 The earliest predecessor to the base was an unfinished Spanish Naval Station, acquired by the U.S. in 1898 following the Spanish American War. Following World War II and the achievement of Philippines independence, a decision was made to establish a U.S. Naval Base at Subic. Much of the area occupied by the U.S. was previously occupied by the City of Olongapo. The control of the baselands was governed by the 1947 Military Bases Agreement between the Philippines and the United States. Following the expiration of that agreement and the failure to negotiate a longer withdrawal schedule, a 1 -year termination notice was served on the U.S. Navy to evacuate the premises by December 31, 1992. The Navy evacuated the premises in two phases, turning over the central base area and related facilities on September 30, 1992, and the remaining facilities on November 24, 1992. During the transition period, most of the moveable assets were removed by the Navy. 1.3 The major concern of the Government was the economic dislocation that would ensue upon the Navy's withdrawal. The Subic Base directly employed over 37,000 Filipinos, and the nearby communities were almost exclusively dependent on the Base for their economic livelihood. The Presidential Task Force for the Bases Conversion Program was set up in January 1992 to implement a base conversion and redevelopment program. The creation of a freeport at Subic was an idea originally espoused by the local leadership and citizens of Olongapo City as far back as 1971. The idea was concretized through the introduction of three articles in the Bases Conversion and Development Act (Republic Act 7227), signed in March, 1992; these articles established the Subic Special Economic and Freeport Zone, and created the Subic Bay Metropolitan Authority (SBMA) to operate, administer and manage it. 1.4 In early 1992, the Government requested assistance from the World Bank to help develop a strategy for the conversion of the baselands to civilian use. This assistance was provided in two phases. An initial Bank mission, fielded in March 1992, confirmed the basic feasibility of the redevelopment of the site as a mixed-use industrial, commercial and tourism facility under the favorable economic incentives accorded to it as a freeport. It also identified a number of areas where technical assistance (TA) was required to implement the freeport regime, including formulating the implementing rules and regulations for the SBMA; physical planning and formulation of a land and facilities use plan; and transportation facilities planning. This TA was provided over the August 1992-January 1993 period.' The Government subsequently requested Bank assistance in financing the critical infrastructure and equipment needs, as well as further TA for institutional strengthening and environmental protection, to jump-start the freeport and attract private investors. This assistance is described in the present report. The TA was financed by a grant from the PHRD Fund (Japan), and approximately 80 person-months of assistance was provided to the SBMA. A report entitled Philippines: Strategv for Conversion of the Subic Naval Base into a Special Economic Zone and Freeport, January 1993, contains the various analyses and studies undertaken as part of this TA.  -2- The remainder of this chapter discusses the general principles guiding the conversion, followed by a description of the facilities and proposed conversion strategy for the area in Chapter II. The proposed project is described in Chapter III. Chapters IV and V present an assessment of the borrower from both an organizational and financial viewpoint. Chapter VI analyzes the benefits and risks associated with the proposed project, and Chapter VII contains a summary of actions to be agreed between the borrower and the Bank in connection with the proposed project. A. The Freeport Concept 1.5 The International Convention on the Simplification and Harmonization of Customs Procedures of 1979 (Kyoto Convention) defines free zones as being "part of the territory of a State where any goods introduced are generally regarded, insofar as import duties and taxes are concerned, as being outside the Customs territory and are not subject to the usual Customs control. " Export Processing Zones (EPZ) and Special Economic Zones (SEZ) are recent variants of the traditional freeport or free zone concept, the earliest example of which was Gibraltar (1704). Free zones were established to encourage trade between harbors among international trade routes and can play an important role in attracting foreign investment. All free zones share certain basic elements. First, they are limited to a physically defined area, which in the case of an EPZ is usually an industrial estate, and in the case of a freeport, could be ports, cities, islands (Bataam Indonesia or Labuan, Malaysia) or even entire countries (Hong Kong or Singapore). Second, they are considered to be extra-territorial, physically or administratively located outside the national customs territory. Third, merchandise may be freely stored indefinitely within the zones, re-exported or imported into the host country's customs territory upon payment of applicable taxes and duties. However, free zones differ in the extent of the area covered by the zone; the activities and processes that are allowed to take place; and the end-user markets where free zone products may be sold. 1.6 Freeports differ in several regards from EPZs. First, they tend to cover larger areas, and therefore offer greater flexibility to firms in terms of the location of their plants. Second, the range of permissible activities in a freeport tends to be broader than in an export processing zone (EPZ): firms can undertake any legal activity, and individuals can reside within it. Third, registered enterprises and residents can freely import all types of merchandise and are not restricted to those used directly in the manufacturing process, as in an EPZ. Fourth, duty- and tax-free merchandise can be sold at the wholesale or retail level and/or consumed freely within the freeport area, unlike in an EPZ where retail sales or on-site consumption of duty- and tax-free products are not allowed. Finally, freeport enterprises are not required to export a certain percentage of their production, and are free to sell to the local market upon payment of any applicable duties and taxes by the importing party. B. The Conversion Planning Process 1.7 In contrast to a traditional physical facilities development, where facilities are designed to meet the desired use, an infrastructure conversion process changes the use of existing space based on an analysis of the highest use of the space. Military bases are examples of infrastructure that has been developed to meet the highly specialized requirements of military applications, and whose unique characteristics pose several challenges to the process of conversion. They are generally located in remote areas, away from major population centers and transportation hubs. However, these disadvantages are often offset by the fact that base complexes tend to be self-contained, with most components of support infrastructure already on-site. They generally contain special purpose buildings and structures which are more difficult to adapt to new uses. Older bases have often not observed the highest standards of environmental practices, and clean-up efforts are an important consideration. They are usually highly  -3- secured facilities, with limited points for entry and exit. Furthermore, since bases are not configured for use by individual companies, their layout may not be conducive to immediate civilian use. 1.8 Freeport Regime Requirements. Converting the former U.S. Naval Base into a freeport has several implications on physical planning. A freeport needs to be highly secure in order to prevent the leakage of duty-free goods into the national economy. This translates into the need to separate traffic for industry from traffic related to residents and visitors; provide additional entry/exit points to ease traffic flow; and allow for additional security inspection procedures required for effective control. The existing road network and transportation facilities need to be enhanced to permit rapid processing of import and export shipments. The layout of the complex needs to be flexible enough to accommodate diverse activities as they locate in the freeport. 1.9 Community Goals. Community goals and objectives are an important consideration in the base conversion strategy. Studies of successful military base conversion in the United States have clearly indicated the fundamental and critical role played by the local community in determining base reuse plans. The issues of most concern to community and regional leaders in the Subic area were: (i) replacing jobs lost by the Filipino base workers, as well as the indirect jobs in activities providing goods and support services to base employees; (ii) utilizing the conversion process as a catalyst for the economic diversification and re-development of the region; (iii) integrating the base with Olongapo City to reduce the disparities between base and off-base facilities and infrastructure; (iv) protecting the unique natural environment and resources of the base; (v) operating the freeport as a self-sustaining, profitable entity, without the need for continuing support from the national Government; and (vi) maximizing the role of the private sector in operating and managing the freeport's facilities, without giving any one private company disproportionate control over freeport operations. 1.10 Tarzet Industries. A clear understanding of industry sectors likely to locate within the freeport is equally important for planning the conversion. The potential market response to the Subic freeport was developed through an overall assessment of the competitiveness of various industries in the Philippines relative to its ASEAN neighbors, an evaluation of the competitiveness of the freeport concept relative to competing export processing zones, special economic zones and freeports elsewhere in East Asia, and an assessment of investment patterns in the Philippines.2' This analysis indicated that a diverse group of industrial and service activities would be potentially attracted to the freeport (see para. 2.13). The needs of the target market would, in turn, dictate the physical, administrative and promotion planning process. 1.11 Physical Facility and Infrastructure. A survey of the existing facilities to determine their condition, quality and reuse potential was then undertaken. This evaluation indicated that: (i) the base's general-purpose buildings are suitable for use by light manufacturing, non-polluting operations, or for storage and warehousing purposes; (ii) special-use facilities are less suitable for immediate conversion, and may require more extensive renovation and modification; (iii) most of the officers' quarters are adaptable for use as a hotel/motel or office space with minor modifications; (iv) raw land parcels are suitable for the development of industrial estates; (v) electricity and water supply are sufficient for the short-term, but will need to be augmented as demand increases; individual meters will have to be installed to each building for appropriate billing; (vi) sewage treatment facilities are inadequate and additional This analysis was undertaken as part of the Bank's initial mission (Philippines: Subic's Industrial and Tourism Conversion Strateey and Action Proeram, May 1992, Informal Bank Report), and followed up through the subsequent technical assistance provided to the authorities. The tight timeframe of the U.S. withdrawal meant that a very short transition period was available to the authorities to define and implement the conversion strategy. The resulting time pressure precluded the carrying out of a detailed market survey to identify the potential market response to the SBF.  -4- liquid and solid waste disposal facilities are needed; (vii) the airport facilities need to be upgraded; port facilities need some repair but do not need to be developed in the near-term; and (viii) existing roads connecting Subic to Manila are sufficient up to volumes of a few thousand tons per day, but critical portions of the road need to be improved to accommodate container trailer and tourist vehicular traffic. 1.12 Alternative Development Scenarios. There are a number of trade-offs and potential conflicts between the various objectives and possibilities of the conversion. For example, limiting the freeport area to a small, secured area to reduce the potential leakage of duty-free goods into the national customs territory goes against one of the major stated interests of commnunity leaders, which is to integrate the freeport with the adjoining community and ensure maximum access to freeport benefits. A set of redevelopment principles against which to assess alternative conversion strategies was then developed, based on the various findings, objectives and requirements discussed above. Three development concepts were evaluated and ranked according to how well they fulfilled these redevelopment objectives: * maritime industry. This is the most obvious reuse concept given the site's former use as a naval facility. The advantage of this approach would be the utilization of existing buildings and facilities immediately, with minor modifications. The skilled workforce previously employed in the former U.S. Naval Base's ship repair and maritime-related activities would be absorbed by like industries. However, this approach would not maximize the long-term potential of the complex, and would not meet the objective of diversification of activity. The potential adverse environmental impact would be a threat. - tourism and recreational complex. This concept capitalizes on Subic's attractive location and scenic beauty. The advantage would be the high employment generation potential of tourism, and the revitalization of Olongapo's entertainment industry. The disadvantage would be the potentially limited impact of tourism as a means to upgrade the capabilities and long-term potential of the workforce; in addition, this concept would not meet the objective of economic diversification. Tourism demand would also be an issue, given the attractiveness of other sites in the Philippines. Finally, existing facilities would require considerable upgrading in this scenario. 3 multi-sectoral growth pole. This concept meets the requirements for economic diversity and flexibility, and maximum use of existing structures. This approach would target compatible, non-polluting industries with a capacity to generate high levels of employment, as well as warehousing and logistics, tourism, recreation and convention center activities, and offshore financial services. The drawback would be the administrative complexity of promoting, regulating and securing the complex. 1.13 Selected Approach. Clearly, no one approach is likely to meet all the objectives and goals of different interest groups. The redevelopment approach selected was that of a multi-sectoral growth pole, since this concept best met the various redevelopment objectives retained. Recognizing the administrative complexity of applying the freeport regime over the large physical area of the freeport (as allowed for in R.A. 7227), a phased implementation is foreseen. At present, the freeport regime is to be implemented in the former base area, and the conversion strategy accordingly targets this area. The focus of the TA activities to date has been on defining a physical facilities and infrastructure plan which meets the requirements of target industries and which represents the best and highest use of existing assets, and a comprehensive policy and institutional framework for streamlined implementation of the freeport regime.  -5- H. THE SUBIC BAY FREEPORT A. Endowments and Existing Facilides 2.1 Physical Characteristics. The Subic Bay Special Economic and Freeport Zone, as established by R.A. 7227 (former U.S. Naval Base and surrounding municipalities) covers an estimated total land area of 60,000 ha, and water area of 9,525 ha. However, in the initial phase, the freeport concept is limited to the area occupied by the former U.S. base (referred to as the Subic Bay Freeport - SBF). The SBF covers an area of around 15,000 ha, of which 6,658 ha house the former Naval Base, and is situated in the northwestern corner of Bataan Peninsula, sandwiched between the area's two major natural features: the Zambales Mountain Range and Subic Bay. The mountain range separates the SBF from the Central Luzon Plain, and protects the base from the monsoons and trade winds from the northeast. Subic Bay provides an excellent, well-protected harbor which opens up to the South China Sea. The terrain around the SBF is mountainous, with relatively steep slopes extending almost to the water's edge. The developed areas have been carved out of hills or created by filling in low areas. 2.2 The broad-leafed evergreen rain forest in the SBF (3,500 ha) represents the only relatively large area of undisturbed forest in Central Luzon. This type of forest, identified as Diptocarp, is the most commercially valuable of the forests in the Philippines. The most common species is the Lauan family, which includes the famous Philippine mahogany, although U.S. Navy records indicate that there are many representatives of the more than 3,000 varieties of trees that have been identified in the Philippines. There are also mangrove swamps along low-lying waterfront areas. Many of the more than 10,000 species of flowering plants and ferns that have been identified in the Philippines are also said to be found in the SBF area. The areas off-base are generally coarse wild grasslands, mostly the result of slash-and-burn agriculture. There are about 760 different species of birds in the Philippines; rodents are numerous, including over 50 known species of rats. Several varieties of poisonous snakes exist. Saltwater fish are abundant, and mollusks occur in large numbers. However, an inventory of the flora and fauna found in the Subic forest is not available. Threatened or endangered species in the Subic area include the green sea turtle and the hawksbill turtle. In addition to its international ecological significance, the forest is also the lifeblood of the SBF in terms of water availability, since it covers five water catchment areas. 2.3 Historical Sites. Few pre-World War II structures remain in the SBF. The Spanish Gate, located in the Central Area, once guarded the western approaches to the old Spanish Naval Station, and dates from the 19th Century. A museum/memorial in a 19th Century Philippine-Spanish theme is housed in a restored Spanish storage facility. Remnants of the earliest American construction are a coaling station and bunkers that housed an anti-aircraft battery prior to World War II. The Chapel in the Central Area was originally known as the St. Roques Parish Church of Olongapo, and occupies a site that has been used for religious purposes since 1885. No sites of archaeological significance have been discovered despite intensive construction efforts in areas most likely to support human settlements. 2.4 Existing Buildings and Structures. The facilities at the former Subic Naval Base complex were developed and operated to meet the unique needs of the military: the storage of large volumes of petroleum products and ammunition; specialized facilities for the needs of a largely transient population; and tightly secured and limited access to adjoining Olongapo City. The Base had nearly 2,000 buildings with a total covered area of around 970,000 m2. These buildings include industrial structures for workshops and storage, commercial-type buildings for office and retail activities, special areas/buildings for the airport, ammunition and fuel storage, residential areas for family housing and bachelor accommodation, as well as community facilities for education, health care and recreation. The vast majority of the buildings in the complex are less than 50 years old, and were designed and maintained in accordance with U.S. Navy standards. Many of the buildings and structures require a high level of maintenance, and with the exception of certain special buildings such as hangars, warehouses and recently  -6- built housing units, the projected remaining life of the structures is 10-15 years. Table 2.1 presents a summary of the existing facilities in the complex. Table 2.1: Inventory of Eidsting facilities and Previous Use Activity No. of Gross Land Previous Uses Bldgs. Floor Area Area (ha) (m2) Naval Station 473 213,760 326 administration, housing, commercial, recreation, temporary camps Ship Repair 68 92,940 27 drydocks, ship repair and conversion Facility Naval Supply 72 102,230 224 petroleum, oil, lubricant storage facility, Depot warehouses Public Works 900 343,866 1,161 administrative, housing Center Naval Air 261 167,300 800 2.744 km runway, 260,000 ml apron Station parking Naval Magazine 116 37,175 3,300 193 magazines and 50,186 m2 of open pads Naval Hospital 29 13,940 322 90 hospital beds Grande Island - - 47 integrated hotel and recreational facility Other - - 451 recreational facilities, miscellaneous Total 1,919 971,211 6,658 2.5 Utilities. Electrical power for the SBF is purchased from the National Power Corporation (NPC). A private company operates the existing on-base generation plant (26 MW) which it has leased from the SBMA. The same private operator is constructing another, larger plant (108 MW) on a BOT basis, expected to be commissioned in early 1994. The main supply of potable water is from the Binictican, Boton, Malawaan, Triboa and Binanga rivers, filtered and chemically treated in an on-base water treatment plant, with a capacity of 12 million gallons per day (MGD). The water distribution system is comprised of antiquated clearwell pumps with a maximum capacity of 10 MGD, and several inter-connected sub-systems located throughout the complex. The sewage collection and disposal for the complex consists of four separate systems, of which three provide primary and limited secondary treatment prior to discharge in rivers or the bay. The former U.S. Naval base produced some 23 to 27 million liters of domestic effluent per day, of which around 20 million liters were discharged as untreated sewage directly into the bay. Sewage from adjoining Olongapo City is also discharged without treatment into Subic Bay. These practices are unsatisfactory, and are currently under review by the SBMA with a view to defining adequate solutions for the future. Solid waste was disposed off in a landfill on-base; however, this landfill was closed in 1992 and the SBF's present solid waste is disposed off in Olongapo City's landfill, which is reportedly adequate for the next 10-15 years. Nonetheless, the SBMA intends to review solid waste management practices and future needs in light of the anticipated economic activity  -7- in the SBF. The former Naval base had a sophisticated network of telecommunications facilities for international and domestic voice and data communications. The complex's local area network of fiber optic and copper cable provided a total subscriber line capacity of over 13,000 lines. However, most of the telecommunications equipment was removed by the U.S. Navy upon evacuation. The two remaining PABXs have a total capacity of 1,400 lines, which is adequate for the SBF's very limited needs at present. Capacity will, however, have to be increased to keep pace with SBF development. 2.6 TransRort Infrastructure. The SBF port facilities are configured to handle a mix of container and breakbulk cargo. The layout of the facilities dates from the early 1960s and does not lend itself to modern cargo handling operations. In addition, repairs are required at several wharves. The airport has a single runway and requires weight limits on wide-bodied planes both landing and taking off; the runway, taxiway and aprons require strengthening in view of the anticipated activity. Passenger terminal facilities are inadequate: the present terminal building can accommodate only 79 passengers, based on the gross floor area per passenger used in the Civil Aviation Master Plan of the Philippines. The most convenient route from Manila to the SBF is via the North Luzon Expressway to San Fernando (57 kIn, 4-lane, good surface condition); from San Fernando to the Layac junction in Dinalupihan (48 Ian, 2-lane, fair surface condition); and, finally, the Bataan-Zambales national road (24 Iam, of which 12 km is a zig-zag portion with a maximum grade of 6%, 3-lane sections on critical curves, good surface condition). The Mabayo-Tala-Mabiga-Naparing road is an alternative road, currently under construction, starting near the Layac junction in Dinalupihan and ending near the southern gate of the SBF. Traffic forecasts indicate that an additional road connecting the SBF to Metro Manila will be required in the next 10-15 years. 2.7 There are three main vehicular entry routes to the SBF. The first is through the Main Gate and Magsaysay Bridge, connecting the SBF to Olongapo City. The second is through the Kalaklan Gate, which connects with the national road to the left of Olongapo City. The third is the Kalayaan Gate, connecting the SBF to the national road at the outskirts of Olongapo City. These access points are inadequate for the increased traffic flows into the SBF, and even with the limited activity taking place in the SBF at present, cause traffic back-ups during rush hour and on weekends. Within the SBF, there are 92 road sections with a total length of 79.6 kmn. All the roads are in good condition with the exception of the perimeter road going to Kalayaan Gate, and are not likely to require major investment for the next 5 years. There are 66 parking lots, all in good condition, distributed throughout the SBF; aggregate parking areas are capable of handling 11,300 cars, which is adequate for the anticipated activity over the next 5-10 years. B. The SBFs Competiiveness and Development Prospects 2.8 Over the last decade, the Philippines has captured a very small part of the boom in direct foreign investment (DFI) compared to its ASEAN neighbors: around 5 % in 1990 and 1991. DFI has also accounted for a very small percentage of total private investment in the country. In contrast to the marked export orientation of DFI in most other ASEAN countries, about 75 % of DFI in the Filipino manufacturing sector is in domestic market oriented industries. A noteworthy aspect of DFI is the increasing importance assumed by Newly Industrializing Countries of Asia as a source of foreign investment. The share of foreign investment from Hong Kong, Taiwan, South Korea and Singapore have been rising, particularly in the last few years. 2.9 The low private investor response to the reformed incentive structure in the Philippines can be traced to the negative investor perception regarding sustainability of reform efforts and, more recently, poor conditions of infrastructural services. Although the accumulated impact of reforms taken so far (relating, inter alia, to the financial sector, trade policy, the tax system and investment incentives) has been significant, slow and piecemeal implementation, at times aggravated by the judiciary, has created a persistent perception among potential investors that reforms in the Philippines might not have been owned by the GOP and thus could not be effectively implemented and might even be reversed. Foreign  -8- investor confidence has been further eroded by recent short-falls in electricity supply, crumbling transportation and telecommunications infrastructure, and continuing concerns over the personal security of foreign executives. Many of these problems are well on their way to resolution. Nonetheless, the Philippines faces strong competition in the region. In the Asian region, lower-end import-dependent operations, reliant on attractive and stable policies, and productive and stable workforces, are increasingly locating in emerging investment locations such as China, Indonesia and now Viet Nam. Higher-end activities, requiring critical basic infrastructure and support services, educated workforce and competitive intermediate goods industries, are choosing Malaysia, Thailand and Singapore. 2.10 The SBF Incentives Regime. The freeport concept holds the potential to offset many of the competitive disadvantages of manufacturing in the Philippines. It can offer world class infrastructure in a secure and self-contained environment. The SBF also provides a number of attractive incentives for business: * no restriction on foreign or local ownership of enterprises; * duty-free imports and exports of raw materials, intermediate and finished goods; * ability to import, store, process, manipulate, consume or re-export merchandise duty- and tax-free; * no foreign exchange controls, and free markets for gold, securities and futures; i unlimited sales to the domestic economy, subject to payment of applicable import duties and other charges; * no taxes except for a 5 % corporate tax on gross income; and * ability for the SBMA to issue work permits, with permanent resident visa provided for a minimum investment of US$250,000. 2.11 The SBF's Competitive Position. The market potential of the SBF depends on its ability to successfully compete for international investment with the large and increasing number of SEZs, EPZs and freeports in the East Asian region. There are currently 62 operational EPZs or industrial estates and another 40 under various stages of development in the region. Within the highly successful SEZ development in China, export-oriented, high technology bonded industrial parks and commercial free trade zones are being established along the coast and in Hainan island. In addition to the long-established freeports of Hong Kong and Singapore, Malaysia and Indonesia have designated a number of islands as freeports. The SBF will directly compete with these locations as well as the large number of free zones in Mexico and Latin America in attracting private investment. In addition, the liberalization of Viet Nam poses a strong and immediate competitive threat. 2.12 The SBF offers several potential advantages over EPZs, and its incentives regime is comparable to that of the many freeport and commercial free zone projects under development. The advantage of the SBF lies less in its incentives framework, and more in the ready availability of world class infrastructure, facilities and other amenities. Unlike freeports that are being developed from scratch, the SBF requires limited financing and time for commercialization. The primary advantage to the prospective manufacturer of locating in the SBF is that operations can begin almost immediately. The SBF can also offer financial advantages, derived from the fact that the carrying cost of the facilities is very low: the fixed assets turned over to the SBMA at virtually zero cost create a huge capital base with minimal corresponding outlays of either equity or borrowed funds. Offsetting these strategic advantages are certain constraining factors, such as the present lack of commercialized airport and port facilities. _ ---- ----_ ---  -9- However, the SBMA is in a sound position to contract debt for facilities improvements and many of the constraining factors can be alleviated. 2.13 Potential Investors. In light of the SBF's incentives framework, and the benefits and constraints of location in the SBF, several industrial and service activities were identified as potential locators in the SBF. These are: * light manufacturing/assembly, including apparel, footwear, toys, textiles, jewelry, leather products, sporting goods, electronic components, electrical appliances and equipment, electro-mechanical devices. The SBF's comparative advantage is the availability of unskilled labor and under-roof space at competitive prices. * light engineering, such as industrial and analytical instruments, industrial equipment and general components. The SBF's comparative advantage is the good (but diminishing) technical and industrial skill availability and several specialized buildings that would be suitable with minor modifications. * information services, including data entry, image processing, voice center operations, multi-media and software development. The SBF's comparative advantage is the availability of basic literacy and keyboarding skills, telecommunications potential, and suitable buildings, including the availability of good housing. - warehousing and distribution. The SBF's basic transportation facilities are well suited for cargo operations; significant warehouse space is available as-is; and telecommunications potential exists. * tourism and recreation, including accommodation, duty-free shopping, retirement housing, business conventions and marina and other recreation. The SBF's major advantage is the natural beauty and clean environment of the site. Several recreational facilities exist and are easily upgradeable. 3 fimancial services, such as offshore banking and other services, as well as offshore corporate registry. These activities are expected to develop in the medium-term, once manufacturing activity picks up in the SBF, and as the telecommunications potential is developed. 2.14 In terms of the source and nationality of investment, the largest number of initial investments in the SBF is likely to come from Filipino firms, investing primarily in light manufacturing or tourism and retail trade projects of small size. Foreign investment will tend to concentrate on larger projects. Investment from the East Asian NICs is expected to increase. In particular, the SBF is likely to attract significant investment from Taiwan (Taiwanese investors are reportedly seeking to diversify their holdings away from China), once SBMA finalizes its negotiations with a Taiwanese company to develop and manage an industrial estate within the SBF. The Export-Import Bank of Taiwan has already provided a loan on soft terms for site and services improvements for this green field site. C. The Conversn Strtegy 2.15 The strategy for the conversion of the Subic Bay Naval Base complex, and development of the SBF, is based upon careful consideration of various factors (described in Chapter I). The strategy is predicated on the maximum utilization of existing buildings and structures by private locators immediately, and the development of new buildings and facilities by predominantly private developers in the medium-term. This approach was chosen because it capitalized on the SBF's fundamental cost advantages: since buildings and facilities were turned over to the SBMA at no cost, the SBMA has the  -10- unique advantage of being able to under-cut the competition in terms of lease rates for buildings and facilities, thereby achieving rapid occupancy. The role of the SBMA is seen to be that of a facilitating, promotional, and regulatory authority, with limited involvement in the development and operation of facilities. This notwithstanding, it is recognized that the SBMA may have to operate certain facilities and undertake the renovation and construction of certain buildings to catalyze private sector interest and participation; however, this is viewed as an interim arrangement to be turned over to private operators as soon as possible. The privatization approach distinguishes between the SBF's "core productive assets" (assets such as land and existing buildings for use by private locators directly, thereby generating income for the SBMA), and "support facilities" (facilities such as the port and airport, demand for which is derived from users of core assets). The privatization strategy also differentiates between areas for the development of private "business complexes" and other areas reserved for the development of individual buildings by individual locators. In order of priority, the privatization of core assets would precede privatization of support facilities, which would require a certain mass of economic activity to be in place prior to privatization. 2.16 Land Use Plan. The focus of SBMA's land use plan is a multi-use complex at a central location on the waterfront (see Map IBRD 25500). The revitalized Central Area will house commercial, trading, tourism-related and light industrial activities, while ensuring the conservation of important monuments and historic landmarks. An allocation of 284 ha of land has been made for light and medium industry development in several pockets, including larger land parcels for the development of integrated industrial estates. Housing occupies 358 ha, encompassing existing areas and densification or redevelopment of selected pockets for a planned increase of approximately 6,000 dwelling units. Around 2,000 ha of the Naval Magazine area is reserved as a Nature Park; however, detailed, environmentally- friendly land use proposals could be developed for this area. The conversion of the military airport into a civilian international airport requires 285 ha. An area of 29 ha is reserved for the future development of a cargo port in the former Naval Supply Depot. An allocation of 263 ha has been made for community facilities. Special areas, such as the tank farm and areas reserved for the Philippines Armed Forces, occupy 193 ha. Some 146 ha are designated as green buffers, while the remainder are Land Reserves to provide flexibility in time and space. The 3,500 ha of intact tropical forest are scheduled for inclusion in the Global Environment Facility (GEF) Conservation of Priority Protected Areas project, negotiated recently (see para. 4.22). The publication of SBMA's land use plan is a condition of effectiveness of the proposed project. Agreements were reached at negotiations that this land use plan will be implemented. 2.17 Privatization. The SBF conversion strategy foresees an important role for the private sector in the future development and operation of the SBF. The outright lease of the entire facility to a private operator was rejected as a privatization mechanism by the authorities at the very outset.3' The privatization approach distinguishes between different categories of assets. Existing assets can basically be classified into two basic categories: core productive assets and facilities which will generate income for the SBMA, and support facilities, which will provide services to support the income generating activities. In addition, a differentiation must be made between areas zoned for general industrial, commercial or tourism use, and areas specifically designated as Comprehensive Development Areas (CDA). Existing buildings within a CDA are expected to be levelled or significantly modified in the medium-term, to allow for the development of the CDA. This implies that they can only be leased on a short-term, non-renewable basis. 2.18 Several privatization mechanisms are available to the SBMA. These range from outright divestiture; simple or capital leases for land and buildings; joint ventures for the operation of utilities or in the form of property development companies; build-operate-transfer (BOT) arrangements (whereby a private entity would develop a project, operate it for a fixed period and then transfer the asset to SBMA); This would have amounted to replacing one dominant controlling presence with another, which would have been politically unacceptable.  -11- management contracting (where a private company is hired by the SBMA to operate certain facilities for a fee); and public or private offering of shares. Given the diversity of SBF assets, a single privatization approach is not feasible. Thus, different mechanisms have been developed for each major category of asset, as summarized in Table 2.2. In most cases, with the exception of standardized building leases, the assistance of privatization and financial advisors would be required. Table 2.2: SBMA's Privatization Approach Type of Property Privatization Mode Procedures Comprehensive Development Areas General Use Buildings short-term, fixed lease with fixed lease term on first-come, first-served limited renewal basis Business Complexes long-term lease, JV or revenue bidding process sharing Non-Comprehensive Development Areas Raw Land long-term lease or JV bidding process development Developed Land long-term lease; lessee must fixed lease term on first-come, first-served construct building to SBMA basis standards General Use Buildings long-term lease fixed lease term on first-come, first-served basis Special Use Buildings long-term lease with technical bidding procedure provisions Support and Specialized Facilities Airport operating agreement negotiate with local or foreign operators Port management agreement bid and negotiation with local or foreign operators Power long-term lease, management negotiation with NPC or private company agreement or JV Water/Sewerage BOT, JV or operating bidding process or negotiation with private agreement operator Telecommunications iV bidding process Specialized Facilities long-term lease, JV or revenue financial advisor on a commission basis sharing  -12- 2.19 Institutional Aspects. The SBF's conversion strategy has significant institutional implications. The freeport regime is administratively complex to implement; this complexity is compounded by the fact that the legislative base of the freeport is contained in only three articles of R.A. 7227, in contrast to the detailed and comprehensive legislation typically associated with freeport regimes. As a result, the SBMA has had and continues to expend much effort in clarifying some of the ambiguities of the legislation. Appropriate systems are required to implement the freeport regime, including adequate customs procedures and monitoring of SBF purchases and sales for Treasury revenue purposes. The SBMA is a very young organization whose focus and work program are evolving. In the early days of the U.S. withdrawal, its primary preoccupation was the orderly transition from U.S. Navy to civilian use. Having secured the premises, it has begun to implement the broad conversion strategy outlined above. However, it will need more experienced staff in freeport management to undertake many of the tasks it has set for itself. The SBMA will continue to require multi-disciplinary technical assistance to refine its conversion strategy, implement its privatization agenda, and develop its own institutional capabilities. 2.20 The conversion strategy also has significant implications on the SBMA's environmental management function. One of the major objectives of the SBMA is the protection of the environment. This implies that future industrial, commercial and tourism activity must be carefully vetted to ensure that it is environmentally benign. The presently good environmental conditions of the SBF must be preserved; this implies that a baseline of information has to be developed on existing conditions, appropriate standards have to be established, and compliance on the part of SBF locators monitored on a regular basis. The SBMA will need to urgently build up a sound environmental management infrastructure within its institution. Here, too, technical assistance and other institutional support is required. D. Status of SBF Development and Privatization 2.21 Getting the SBF off the ground will involve efforts in three broad areas. The first is to operationalize the freeport regime. This involves defining the SBF policy regime and regulatory procedures and implementing an appropriate institutional framework to administer the SBF. These aspects are discussed in Chapter IV. The second is to implement the physical conversion strategy. In addition to privatization, this involves identifying critical areas for continued SBMA investment and management. The third is to undertake strategic planning for future SBF growth. This translates into the definition of a multi-year development program, including regular fine-tuning of the conversion strategy. As can be expected, effecting the SBF conversion will take time, and must be viewed as an on-going process. Quite apart from the time required to structure SBF development and privatization deals, the SBMA itself is in a start-up phase. Nonetheless, much progress has been achieved in these areas in the one year that the SBMA has been operational, as described in the paragraphs below. 2.22 As of November, 1993, the SBMA had received over 500 expressions of interest from prospective investors. Of these, 32 proposals had been accepted and are presently being implemented. Of the remainder, 16 proposals are under contract negotiations and 42 are under active review. In terms of sectoral breakdown, commercial activities (including retailing and banking) take the lead at 50%, followed by 22% for manufacturing, 12% for hotels and restaurants, with the balance for support services and infrastructure, such as telecommunications and power. As expected, the vast majority of these initial investors are Filipino (over 75%). However, the number of foreign investors is expected to increase as the industrial estate (para. 2.23) is developed. Total employment created as of November, 1993, is 5,195 employees. The projected investment of these 32 firms at full development (in most cases, over the next 1-2 years) is over US$350 million; employment projections stand at 12,800. In terms of value, over 90% of the investment commitments are from foreign investors. The projected investment of the 58 proposals currently being negotiated or actively reviewed is around US$125 million, whereas the projected employment is close to 4,000. Here, too, the vast majority of interested investors is Filipino (or Filipino subsidiaries of foreign firms). A significant event has been the recent agreement between the SBMA and a major air freight and courier service to establish a regional hub at the Subic International Airport. A large, world  -13- class tenant such as this one provides an anchor for promotional activity, and holds the potential to attract higher-value, air freight-dependent activities to the SBF. 2.23 Industrial Development. The areas slated for industrial development in the land use plan cover both green field sites and existing developed sites. For the former, the SBMA has been in active discussion with a Taiwanese company as well as the Taiwanese Government. A 262 ha site will be developed in three phases. The Export-Import Bank of Taiwan has provided a loan on concessional terms to finance the site development costs of the first phase. The SBMA expects to enter into an agreement with a private Taiwanese company to develop, manage and promote the estate, and some 75 firms have reportedly expressed an interest in locating in the estate in the first phase. The first phase development (approximately 120 ha) is expected to be completed in 1997. For the latter, the SBMA has entered into leases on existing buildings with 8 firms (as of November, 1993). The problem now is that the SBF is rapidly running out of buildings that would be suitable for small-scale industrial activities. The buildings available require extensive reconfiguration and conversion; alternatively, new buildings need to be constructed in the designated industrial areas of the land use plan. The SBMA's experience is that small investors, who are mainly local Filipino firms, are interested in immediate occupancy and are unwilling, or unable financially, to undertake the necessary renovations or construction. 2.24 Commercial Development. The commercial development to date has concerned the leasing of existing buildings to operators providing support services to SBF residents and tourists. Amongst such services are banks and shops. Other activities include gas trading, message handling services and a laboratory. Warehousing and transhipment services are also taking place. 2.25 Tourism Development. Hotel development, including one casino resort, has been quite spectacular in the SBF, attesting to the high interest in the site on the part of tourists. There has also been substantial interest in restaurant and retail trade activities. Local tourism tends to be concentrated on week- ends, whereas foreign tourists (mainly from Taiwan) seem to be mainly of the package tour variety. Considering that the SBF has not actively promoted the site to the tourism industry, the growth in tourism (some 440,000 visitors since January 1993) is remarkable. In addition to these private-sector financed activities, the SBMA has been involved in the provision of tourism-related services (operating some of the recreational facilities, for example) pending their privatization. These services have been provided primarily through ex-Base employees in a volunteer capacity. Facilities slated for privatization in the 1994-95 period include the golf course and the marina. 2.26 Svecial Use Areas. One of the early and notable successes of the SBMA has concerned the privatization of the petroleum, oil and lubricant facility, a 181 ha complex of underground storage tanks and dedicated pier. This facility has been leased to a U.S. company on a 25-year, renewable lease. The privatization arrangement was undertaken with the help of financial advisors. 2.27 Utilities. The existing 26 MW power plant has been leased to a private operator, who operates the plant under an arrangement with the National Power Company (NPC). The same operator is also constructing a 108 MW plant on a BOT basis on land that has been leased by the NPC from the SBMA. SBMA purchases power from NPC and is responsible for power distribution within the SBF; however, power distribution is high on the list of SBMA's privatization priorities. SBMA's agreement with NPC provides for satisfaction of SBF power needs from these plants in priority over provision of power to the national grid. 2.28 A Memorandum of Agreement with the National Telecommunications Commission provides the SBMA with a great deal of flexibility to issue telecommunications franchises within the SBF. More significantly, the SBMA can enter into arrangements with any local or foreign entity, and is not restricted to dealing with existing franchise owners. With the assistance of privatization advisors, the SBMA is currently in the process of evaluating bids for the creation of a joint venture for the provision of telecommunications services within the SBF. SBMA's stake in the joint venture would be between 20% and  -14- 30%, subscribed to through the provision of existing telecommunications equipment and the franchise. In the initial phase, 2,000 new lines will be added to the SBF by mid-1994. 2.29 Transport Infrastructure. At present, the airport is being operated by SBMA employees with assistance from staff seconded from the Air Transportation Office. SBMA's strategy is to retain ownership and control of the airport in the short- to medium-term, but to enter into a management contract with a qualified operator. Several improvements to the airport are required in terms of terminal facilities, navigational aids and air traffic control equipment, as well as repairs to the runway, taxiway and aprons. These improvements are needed urgently, in view of a recent agreement between the SBMA and an air freight service that intends to establish a regional hub at the Subic International Airport. General maintenance of the port facilities is undertaken by SBMA staff, who also operate the facilities on an occasional, as-needed basis. Full privatization of the port is not foreseen in the near-term, but the SBMA intends to enter into a management contract for port operations. In order to maintain the extensive port infrastructure, several repairs to the wharves and piers are required. The road network in the SBF is in good condition, and no major rehabilitation is required at this stage. 2.30 Residential. Although there has been substantial interest on the part of investors in some of the housing units in the SBF, no units have yet been leased on a long-term basis. The SBMA is currently in the process of devising a housing privatization strategy. The basic approach is to package the housing units in lots, which would be offered to real estate management companies for management and individual leasing. It is expected that the first lots will be bid out by mid-1994. E. Off-SBF Development Program and Priorities 2.31 The conversion strategy to date has focussed on redevelopment of the former U.S. Naval Base, which represents the first phase of freeport implementation. The Zone, however, is considerably larger (see para. 2.1) and encompasses surrounding municipalities. The SBF will not remain a restricted enclave in the long-term, and indeed, should not be viewed as such for planning purposes. It is linked to Olongapo City and is an integral part of the sub-region. An urban master planning exercise for the surrounding municipalities is currently underway, financed by a TA grant from the Asian Development bank (ADB). This study is expected to provide: (i) an urban development strategy for the area; (ii) infrastructural development plans for transportation, water supply, power and telecommunications, drainage and sanitation, and housing; and (iii) prefeasibility studies for critical infrastructural development projects required to support SBF development in the next five years. One such priority would be the improvement of the highway infrastructure connecting the SBF to Metro Manila. 2.32 The long-term vision for the development of the Central Luzon (one of the objectives of R.A. 7227) is the establishment of 50-100 ha industrial estates along highways in the Central Luzon provinces, and shipping the manufactured goods through the SBF port. This strategy is guided by the fact that the land available for industrial development is limited in the SBF, whereas it possesses a good, natural harbor where port operations can be developed. The development of the Central Luzon provinces will provide livelihood for lahar-devastated areas (as a result of the Mt. Pinatubo eruption) and ease the demographic and industrial congestion in Manila. This strategy is also consistent with the development of the Clark Air Field as a SEZ (per R.A. 7227). The infrastructural requirements of translating this vision into reality are many: the existing road network in the region will have to be improved in order to facilitate the trucking of goods into the SBF; industrial estates will have to be developed off-base; and the SBF port will have to be improved to handle modern cargo operations. F. Lesons from Previous Bank Involvement 2.33 The Bank has played a major role in the Philippines through a lending program involving some 140 operations, but has no direct experience in freeport or EPZ development in the country.  -15- Experience from Bank involvement in similar activities in other countries4' indicates that EPZs are most successful when they are part of a coherent incentives and trade policy regime; further, that key factors for success include appropriate location, the availability of suitable physical trade infrastructure, site development consistent with investor demand, and a policy environment that fosters private sector development. The country's trade, investment and foreign exchange regimes are now at par with those of its more dynamic East Asian neighbors; furthermore, the SBF's incentives package is comparable to that offered by its competitors in the region. The SBF's proposed regulatory framework, its location and physical infrastructure are consistent with the success factors commonly cited for EPZs. Project interventions are designed to fill in the gaps in the regulatory framework, particularly with respect to the environment, and to ensure a phased development of the SBF. G. Rationai for Bank Involvement 2.34 As described in the Country Assistance Strategy, discussed by the Bank's Board on February 3, 1994, the Philippines is at a critical juncture in its economic history, and needs to seize the opportunity to break out of its low economic growth cycle. Foreign direct investment will be very important if the Philippines is to catch up with its more affluent neighbors. The SBF has the potential to kick-start this process. Improving the business environment for private enterprises is a key element of the GOP development agenda. The SBF provides a model base for the implementation of concerted and sound business-friendly policies. The SBF has already attracted considerable investor interest; however, certain institutional and infrastructural bottlenecks prevent the SBMA from realizing the full potential of the SBF's considerable asset base. In a competitive environment such as that facing the SBF, rapid accommodation of interested investors is essential: a lack of adequate facilities or administrative delays can create negative perceptions, dampen investor confidence, and generally undermine the SBF development strategy. At the same time, the SBMA must avoid a haphazard development of the SBF, guided by short-term financial considerations rather than the long-term maximization of economic, financial and environmental benefits, if it is to effectively act as the custodian of this important asset. 2.35 The Bank can play a catalytic role in helping the GOP and the SBMA effect an orderly conversion of the facility, and its presence provides a measure of comfort to private investors. The proposed project touches on a multiplicity of sectors. The Bank has considerable experience in and is well-equipped to deal with the issues related to all these sectors. The bulk of the proposed financing concerns infrastructure, for which the terms of Bank funds are more appropriate than the shorter maturity finance that would be available commercially. The overall financial needs of the SBF are large, and the available commercial funding would be more effectively channeled if it supports commercial ventures. Finally, the Bank has already been involved in the provision of technical assistance to the SBMA to help strengthen the policy, regulatory and institutional framework and define a conversion strategy for the baselands. The Bank's continued involvement will help implement this conversion strategy, and, in particular, ensure that the emphasis on environmental protection and institutional strengthening is maintained. Export Processing Zones, Policy and Research Series 20. As discussed in Chapter I, a freeport can be considered an EPZ with free trade and other equal footing export policies.   -16- m. THE PROJECT A. Objecive 3.1 The objective of the project is to attract private investors to the Subic Bay Freeport (SBF). This will be achieved by: (a) improving infrastructure and access to the area for industrial, commercial and passenger traffic; (b) maintaining the SBF asset base, including protection of the environment; and (c) strengthening the capacity of the SBMA to manage and administer the facility. B. Description 3.2 The project consists of three components: (a) Site Improvement. Several infrastructural improvements are required at the SBF, consisting of new construction, conversion of existing facilities for civilian use, selected repairs to existing facilities, and replacement of critical equipment that was removed by the U.S. Navy upon evacuation. Detailed engineering studies and construction supervision for these components will also be included. A detailed description of the improvements is contained in Annex 1. Land access to the SBF will be improved through: (i) the construction of a 4 Iam, two-lane access road from Kalalake Bridge to Kalayaan Gate (see Map IBRD 25499). This road will link the main industrial area of the SBF (presently being developed) to the outskirts of Olongapo City and the national highway, thereby diverting heavy traffic away from the tourism and commercial areas of the SBF as well as the narrow streets of Olongapo City; (ii) the construction of an 82 m, two-lane bridge with pedestrian walkway linking Rizal Avenue in Olongapo to the SBF. This bridge will be used for incoming traffic to the SBF; outgoing traffic will pass through the existing Magsaysay Bridge. This system will improve traffic flows in Olongapo City as well as in the SBF; and (iii) construction of security plazas at the Main Gate Complex (Rizal and Magsaysay Bridges) as well as at Kalayaan Gate to process incoming and outgoing traffic. Air traffic access to the SBF will be improved through: (i) strengthening of the runway in order to accommodate the size of aircraft which are forecast for the next 10 years. The study and mitigation of a subsidence problem at the northeast end of the runway are also included; (ii) the reconstruction of the southeast taxiway, including its strengthening and widening, in order to accommodate aircraft expected to be used by the freight hubbing operation; (iii) apron strengthening at both the passenger and freight operations areas to accommodate the forecast aircraft sizes; (iv) providing adequate airport communications equipment and air traffic control equipment suitable to provide a minimum Category 1 control; and (v) converting one of the existing hangars into a passenger terminal to create adequate passenger handling capacity. An existing building will also be converted to a freight warehouse for freight carried on passenger aircraft. In order to prevent further rapid deterioration of the underdeck structure at the Alava, Rivera and Bravo Wharves and at Pier 1010 (see Map IBRD 25499), and to ensure their continued availability for operations or commercial activities, existing cracks and damage to the concrete piles and deck structure will be repaired and sealed. A cathodic protection system will be installed to protect the steel components at Pier 1010 and Bravo Wharf. A pilot standard factory building development will be undertaken on a 10 ha site in the former PWC area (see Map IBRD 25499). Site development will include the basic infrastructure (roadways, water, electrical and sewer line connections). The initial phase will cover an approximate land area of 6 ha for 20,000 m2 of covered floor area. Three  -17- basic configurations, providing multiples of 1,000 m2 space, have been designed. Six buildings will be constructed in total. Miscellaneous equipment will be provided for security and maintenance purposes. Communications equipment and vehicles will be provided for security services. Electricity and water meters will be installed in existing buildings to permit appropriate billing for utilities to the tenants. Emergency equipment (generators, emergency pumps, etc.) will also be provided. (b) Institutional Support. Several actions are foreseen to strengthen the institutional capacity of the SBMA and to provide the appropriate systems for the implementation of freeport policies. Agreements were reached at negotiations that for all the technical assistance activities, the SBMA will retain consultants according to terms of reference and a selection procedure acceptable to the Bank. It was also agreed that the timeframe for the carrying out of the studies and the implementation of the agreed recommendations would follow the timetable shown in Annex 2. In order to monitor duty-free purchases such that the appropriate taxes can be collected,5' a merchandise control system will be designed and implemented. This computerized system will link each duty-free retail outlet to a central database. SBF visitors will be issued a pass card in which purchases will be recorded. Any purchases above the prescribed limit will be assessed the appropriate duties. The project will finance the design and implementation of the system, including hardware, software and training to SBMA staff in its use. Terms of reference are contained in Annex 3. Technical assistance will be provided to define appropriate zoning regulations and a building design code for the SBF. This will ensure a coherent future development, consistent with the agreed land use plan. Terms of reference are contained in Annex 4. The SBMA's present billing system is largely manual. In the future, with increased activity, an automated system will be required in order to accurately track SBMA revenues and ensure that billing takes place on a timely basis. The project will finance the design and implementation of this system. Terms of reference are contained in Annex 5. Several SBMA facilities are slated to be privatized within the next 2-3 years. The project will include a privatization assistance fund for the provision of specialized advice on specific transactions. Among the major items foreseen at present are water and sewerage services and solid waste management. In the case of water and sewerage services, a technical consultant has already been hired to define the basic technical parameters, and project interventions will concern assistance in the actual bidding process and negotiation with the chosen supplier. For solid waste management, terms of reference for the necessary services are being prepared by the SBMA. A tentative description of the services required is in Annex 6. Agreements were reached at negotiations that an action plan and timetable for the adequate provision of water and sewerage and solid waste management in the SBF would be provided to the Bank by December 31, 1994. In order to strengthen the SBMA's institutional capabilities and improve SBF administration, a team of 3 senior advisors will be provided under the project. The role of this team will be two-fold: first, to provide the necessary technical skills and experience currently missing from SBMA staff and second, to provide on-the-job training to SBMA counterparts. The Executive Order 97A, issued subsequent to R.A. 7227, sets duty-free purchase limits for Filipinos residing outside the SBF. Any purchases beyond the prescribed limits are subject to applicable taxes and duties.  -18- areas to be covered include planning and property development, customs and taxation policy and investment promotion. Terms of reference are contained in Annex 7. Short-Term Training: The project will provide short-term consultancies as required for training and workshops in freeport-related topics. Terms of reference for this assistance are contained in Annex 7. Given the sheer size of the SBF and the various facilities contained in it, and in light of the SBMA's key role as custodian of these assets, the facilities management function needs to be strengthened. The project will provide critical equipment required to operate and maintain utilities and other services until such time as they are privatized. It will also provide institutional support to adequately organize and structure the facilities management function at the SBMA. Terms of reference for this support are in Annex 8. (c) Environmental Protection. An Environmental Baseline Survey will be carried out to establish the basic environmental conditions within the SBF and develop a baseline of information on the forest lands and the bay. Terms of reference are in Annex 9. The project will also provide environmental monitoring equipment for the newly-established Ecology Center in the SBF, as well as institutional support to assist in establishing a sound environmental management infrastructure in the SBF (Annex 10 contains terms of reference). An Environmental Management Plan covering the organization and work plan for the SBMA's Ecology Center (terms of reference are in Annex 11) has been submitted to the Bank for review. The adoption of an agreed Plan by the SBMA's Board and its publication is a condition of effectiveness. C. Cost and Financing Projet Cost 3.3 The base project cost is P 1,207 million (US$43.1 million equivalent), and total project cost including contingencies is P 1,596 million (US$52.0 million), with a foreign exchange component of about 75%, or US$39.1 million. Physical contingencies represent around 14% of the base cost, while price contingencies represent 18%. Table 3.1 sunumarizes the cost estimates; details are presented in Annex 12. Base costs are in December 1993 prices, and are derived from the most recent equipment, material and labor cost data available. A relatively higher level of physical contingency has been included to allow for possible cost overruns on certain items for which detailed engineering has yet to be finalized. Price contingencies are estimated on the basis of escalation factors of 7% for local costs and 2.5% for foreign costs. Flnancing Plan 3.4 Table 3.2 summarizes the proposed financing plan for the project. Bank financing will account for about 74% of the total requirements of US$54.1 million, including interest during construction. The proposed Bank loan of US$40 will finance 100% of the estimated foreign exchange cost and will be at the standard variable interest rate for a 20-year term, including a five-year grace period. The SBMA will bear the foreign exchange and interest risks for the loan. The loan will be guaranteed by the GOP. Agreement was reached at negotiations that the GOP will provide this guarantee.  -19- Table 3.1: Summary of Project Costs -Million Pesos--- -Million USS--- Component % of % Local Foreign Total Base Cost Local Foreign Total Foreign Site Improvement 259 753 1012 84 9.3 26.9 36.2 74 lnsniutonal Support 5 133 138 12 0.2 4.8 4.9 97 Environiental Protecdon 0 28 28 2 0.0 1.0 1.0 100 Taxes and Duties 29 0 29 2 1.0 0.0 1.0 0 Total Cost 293 914 1,207 100 10.5 32.6 43.1 76 Physical Condngencies 41 128 169 14 1.5 4.6 6.0 76 Price Condngencies 66 154 220 18 1.0 1.9 2.9 70 Total Cost with Contingencies 400 1,196 1,596 132 12.9 39.1 52.0 75 Tomls may not Add up due to rounding. Table 3.2: Financing Plan (US$ million) % of 1994 1995 1996 1997 Total Total Tobi Project Cost 11.8 27.0 8.5 4.8 52.0 96.1 Interest During 0.3 1.2 0.5 0.1 2.1 3.9 Construction 12.1 28.2 9.0 4.9 54.1 100.0 Toatl to be Ibm_cod FUmd 1W: 4.7 23.3 7.6 4.4 40.0 73.9 World Bank 7.5 4.9 1.4 0.5 14.1 26.1 SBMA's Internal Cash 12.1 28.2 9.0 4.9 54.1 100.0 Total Ybhaancg totals may not add up due to rounding. D. Imple an Projed aggement 3.5 SBMA is fully responsible for implementing the project. The Deputy Administrator for Administration has been appointed as the project manager for SBMA; he is assisted by a team of SBMA staff drawn from the engineering, finance and corporate planning departments. This team has participated in project preparation and is therefore fully cognizant of detailed project content. The team of resident, long- tenn advisors will also be available to assist the project management team as appropriate. 3.6 SBMA has currently hired consultants who have assisted with the preparation of the physical components of the proposed project. To avoid implementation delays, the same consultants will continue to assist with final designs and procurement. Agreements were reached at negotiations that appropriately qualified consultants would be hired for the supervision of civil works. The SBMA's engineering staff would handle the procurement of goods and equipment; however, specialized assistance for the finalization of technical specifications for the communications equipment would be provided by appropriate consultants.