Philippines - Second LGU Urban Water and Sanitation Project (APL)

Report No. PID8867 Project Name Philippines-LGU Urban Water and (@) Sanitation Project (APL2) Region East Asia and Pacific Region Sector Urban Water Supply Project PHPE69491 Borrower(s) DEVELOPMENT BANK OF THE PHILIPPINES Implementing Agency Address DEVELOPMENT BANK OF THE PHILIPPINES DBP Building, P.O.Box 1996, Makati Central Post Office 1200, Philippines, Contact Person: Marietto Enecio, Vice President DBP, Tel: DBP:(632) 818-9511, Fax: DBP: (632) 817-1639 Email: MAEnecio@epic.net, PDLazaro@devbankphil.com.ph Environment Category B (Partial Assessment) Date PID Prepared August 25, 2001 Projected Appraisal Date March 26, 2001 Projected Board Date September 18, 2001 1. Country and Sector Background i. General issues affecting the sector: (a) Lack of adequate coverage: A substantial population in Metro Manila lacks adequate water supply and sanitation. In the 1000 small towns where municipal agencies are responsible for water supply and sanitation, approximately 37% of the population does not have access to safe water and sanitation. These residents pay unit rates for water at 10-15 times higher than what residents with access to public sector services pay. Financing existing service deficits will run into the billions of dollars. (b) Unreliable services: Even among those with piped water, services are often restricted to less than one hour a day. Residents often have to privately invest in wells, arrange for contracts with water vendors etc. to mitigate the risk of unreliable supply. (c) Inefficient management of water utilities: The general standards of efficiency have been low throughout the country in LGU-managed water utilities. Tariffs have often been set based on political considerations rather than on operational efficiency. Further, only a few have any metering in place, and the constructed water supply systems are managed by poorly trained staff.  ii. Specific issues to be addressed by the project: (d) Unsustainable service provisioning, especially in small towns: Water supply services have been unable to meet demand because the past investments have been based on programs and generic designs, rather consumers demand and willingness to pay. Communities could see major welfare gains if reliable and adequate water supply is available based on consumers demand. Such changes would also reduce the water utilities' dependence on financial subventions from the LGUs concerned. (e) Low institutional and technical capacity in LGU-managed water utilities: LGUs lack trained technical and financial management staff to run the water utilities as commercial enterprises. Additionally the small size of the respective customer bases makes these utilities generally unattractive to qualified professionals and to infrastructure financing institutions. iii. Government Strategy: Since 1994, the Government of the Philippines (GOP), with donor support, has been instituting a series of measures to develop a policy and financing framework aimed at (a) rationalizing the water sector, (b) promoting private sector participation (PSP), and (c) improving water and sanitation service delivery to low-income, urban communities. In 1996 GOP devolved planning and implementation of water and sanitation services to LGUs, with the Department of Interior and Local Government (DILG) being responsible for building LGU capacity. In order to facilitate PSP, the Bank provided technical assistance to GOP to develop a water sector framework for PSP and a set of operational guidelines for accessing national government guarantees. 2. Objectives Program Objectives. In the short-term (APL1 and APL2), the objective is to finance investments in water supply infrastructure, and attract sufficient numbers of private sector operators to operate and maintain LGU-managed water supply systems more efficiently, while being responsive to its customers. In the long term (APL3 and beyond), the objective is to create a sufficiently large market for LGU-based water utilities, so that private financing institutions supplement the meager public financing. The program objective will be accomplished if safe, reliable and sustainable water supply and sanitation services are provided in approximately a quarter of LGU-managed water utilities by 2010. APL 2 Objectives. The project objective of APL2 is to scale-up the outreach of the project under APL1 (see PID Project No. PH-PA-39022) into approximately 40 more LGU-managed water utilities, with considerably reduced implementation periods. The project development objective is, therefore, to confirm that the project design concept in APL1 -- that with appropriate technical and financial designs, pricing rules and institutional incentives, water supply systems, irrespective of size, can be made both viable and sustainable. APL2 will confirm that the design is robust enough to be mainstreamed into the water supply sector of the Philippines. 3. Rationale for Bank's Involvement The World Bank is assisting GOP in implementing two such innovative, demand- driven projects, this one and the Water Districts Development Project (FY98, Lns. 4227, 4228). The value-added of Bank involvement is the global experience and multi-disciplinary support it brings to both the project design and implementation phases. There is also value-added to the Bank's own -2 -  learning experience of implementing this first APL in the water sector. 4. Description APL2 has four main components: water supply, sanitation, drainage and capacity building. Water supply (including on-lending to private operators) - construction of new systems, source works, as well as the rehabilitation and expansion of existing systems, equipment and supervision for improved water supply systems in LGUs and regional water utilities (US$23.84 million); Sanitation - investments in household toilets, on-site sanitation systems (US$1.67 million); Drainage - investments and consultant services for micro-drainage infrastructure (US$1.11 million); and Institutional Capacity Building - The institutional components will support technical assistance to facilitate the formation of regional and subregional water utilities, training utility staff to plan and manage the water utilities and local environmental concerns in a sustainable manner, and undertake feasibility studies to prepare future batches of water supply and sanitation projects. This component will also assist DBP to monitor and evaluate project performance, in order to develop the succeeding phases of the Adaptable Program Loan (i.e., APLs 3 and 4) (US$1.65 million). 5. Financing Total ( US$m equivalent) Local Governments 5.26 IBRD 30.0 Total Project Cost 35.26 6. Implementation The loan will be channeled through the Development Bank of the Philippines (DBP) , a Government financing institution. Operational management of the project will be undertaken by a Project Management Office in DBP (DBP-PMO). Actual investments (first three components of the project) will be implemented by Project Management Units (PMUs) established by the participating LGUs. Cofinancing of SDR 5 million from the Nordic Development Fund continues to be available for the institutional capacity building component (of APL1 and APL2), and is being coursed through the Development Bank of the Philippines. The Water Supply and Sanitation Project Management Office in DILG, (WSS-PMO) will continue to exercise supervision over the project preparation phase, and for institutional capacity building. The policy oversight role will continue to be exercised, as in APL1, by the Department of Interior and Local Government and Department of Finance through a Technical Working Committee comprising members from these two Departments and the GFIs. This Committee will be responsible for overall coordination among the various components, with its working arrangements as defined in the Memorandum of Agreement. 7. Sustainability The sustainability of project benefits depends on four key factors: (a) the full participation and ownership of stakeholders in the design, implementation and operation of the project; (b) clarity in fund channeling rules, particularly with regard to LGU commitments, contributions, and responsibilities of LGUs, communities and households; -3-  (c) flexibility in engineering design in order to meet specific service requirements of communities in a sustainable manner; and (d) outsourcing of operations and maintenance responsibilities to the private sector, as much as possible. 7. Possible Controversial Aspects There are two possible controversial areas. First, lease contracts may eventually lead to operators negotiating exclusive rights to develop other raw water sources in the LGU. Greater coordination and consistency between the water resource management aspects and water supply management aspects are urgently needed, so that pricing of raw water reflects its opportunity costs. Second, locally elected officials may attempt to interfere in the bidding process. The experience in APL1 suggests that the three-year election cycle produces incentives among politicians to generate controversy and conflicts with utility operators during the operational phase. This highlights the urgent need to create an impartial arbiter through appropriate water utility regulatory legislation, and issue that the Philippine Government has taken up as priority legislation. 8. Lessons learned from past operations in the country/sector The lessons from APL1 and other ongoing operations are summarized under the seven headings below. (a) Selection Criteria: The initial list of LGUs identified for project participation was drawn on a "first come-first serve" basis, and an initial preliminary assessment of technical and financial viability. The argument was that the submission of application and the required financial and technical information by an LGU was a sufficient manifestation of its willingness to participate in the project, and therefore justified priority in funding. By using this criteria, the first batch of towns selected ended up being located in different parts of the archipelago. There were two consequences of this "first-come-first -serve" rule. First, drop-out rates were quite high (about 50 per cent in participating towns so far). Second, project preparation costs were relatively high because of travel and logistical costs. The selection criteria resulted in a highly dispersed set of towns selected in the first batch. This led to relatively higher project preparation costs, and operational difficulties in project supervision. Of the initial list of 21 towns, eight were located in Isabela province, four in Laguna province, four in Bicol province, all scattered in Luzon island and five in Mindanao island. In the final list of ten towns in Phase 1, six were located in Isabela province, while the remaining four were in Laguna, Bukidnon and Misamis Occidental provinces. The Isabela subprojects turned out to be naturally a regional cluster as the towns are within a few kilometers of each other, while the others are isolated systems catering to between 900 and 3000 connections each. Involving the provincial level had its advantages and disadvantages. On the positive side, the provincial LGU played a key mediatory role in bringing together the Mayors and Municipal Councils of the participating towns. The role of the latter often turned out to be critical in defusing inter- jurisdictional disputes and resolving political conflicts between the towns (each town had signed a separate subloan with DBP). In addition, when six systems were offered under a lease contract, the combined number of connections was around 15,000, making the system potentially far more attractive to the private sector than each town by itself. On the negative side, involving one more layer of the political structure has exposed -4 -  subprojects to problems of interference (discussed in Section 6 on Sustainability and Risks). From phase 2 of APL1 onwards, and LGUs that had the potential of forming subregional clusters were given priority by the project, while minimizing the role of the provincial LGU. In APL2 projects LGUs are required to confirm their intention to participate by paying an initiation fee of P50,000, apart from obtaining an endorsement of the Mayor and their respective Municipal Councils. The endorsement must explicitly indicate LGU agreement with the project rules of pursuing (full) cost recovery, considering private sector management of the water utility, and borrowing at the terms set by the DBP. To sum up, the lessons learned were several. A major factor for the relatively high drop-out rate was the community's unwillingness to accept the suggested tariff. This arose because the proposed tariff rates was unacceptable by Council members and beneficiaries (mostly because cheaper options, such as groundwater extraction was easily available). In addition, many Mayors and Municipal Councils deferred decision-making because project preparation involved no cost to them (as these were financed from grants). The third reason was because the LGU had other financing options (e.g. Congressional grants, unsolicited Build-Operate-Transfer or BOT proposals from the private sector), which offered, in their view, better terms than the project. (b) Estimation of budget envelope: The initial estimates of the budget envelope were undertaken using the long term financial planning model developed for this purpose. These initial estimates were extremely useful in limiting the size of investments to what was affordable to the LGU. (c) System management options: During project consultations in the first phase, LGU officials expressed a preference for outsourcing management of constructed systems to private operators. They recognized the risk of water tariffs becoming a campaign issue in the three-year LGU election cycle. There was widespread agreement - among elected and career officials - that a solution required the management of the water supply systems separated from the municipal administration, so that the issue of tariffs did not get entangled into election politics. Two management options identified and evaluated. The first option, which was the preferred one, was for the LGU to undertake a fifteen-year lease contract with a private sector water utility operator, who would be fully responsible for demand risks. A lease contract was accordingly drafted incorporating global best practices, and bids were invited for all participating towns. So far 16 lease contracts are at various stages of finalization for APL1 subprojects. The second or fall-back option (in case there are no bidders for a long-term lease arrangement), is the establishment of a Securities Exchange Commission (SEC)-registered water utility. The company will be provided technical assistance to outsource its principal operational functions through management and service contracts. The SEC-registered water utility's rules have been finalized with technical assistance provided by the Water and Sanitation Program. (d) Streamlining the process of concluding PSP transactions: The experience with implementation of the first phase LGUs indicated that the lead time caused by separate bidding processes for feasibility studies, detailed design, selection of an operator, and actual construction was almost 20 months. In the second phase of APL1, the transaction process has been streamlined by reducing preparation activities to two stages. The first is the feasibility study stage, in which the basic project concept, preliminary design, tariffs and financing arrangements are developed, and the second is the "design-build-lease" stage, in which the entire responsibility for detailed design, construction and management of the system through a fifteen - 5 -  year lease contract is awarded to the private sector. The estimated time saved is about eight months, which could bring water supply to the community substantially earlier than what has taken the project in the first phase towns. As a result, about 25 APL2 subprojects will be ready for actual implementation by loan effectiveness in September 2001. (e) Improving the management of project implementation: Experience with implementing the project in nine towns has been extremely useful in highlighting project management problems. These have been occurring at three stages. First, the flow of documentation and communications between DBP and PMUs has been inadequate. In most of the LGUs visited by the Bank mission in February PMU staff did not have basic documentation such as the contracts, subsidiary loan agreements and even official receipts for payments made by DBP to the contractor. Second, within DBP the flow of information between the Technical Assistance Group, Loan Administration and Disbursement Departments needs to be improved. Applications for disbursements, for example have been lagging because of coordination problems between the three offices. Third, between DBP and the Bank the flow of paperwork has been slow and halting. DBP has since taken steps to improve management of its PMO. (f) Resolving boundary problems in transferring water rights: During preparation of APL1 subprojects in at least two provinces the project team had difficulty convincing neighboring LGUs to agree to regional water utilities, so that cost savings of constructing larger regional systems could be passed onto consumers. The difficulty arises because under existing Philippine regulations the transactions costs of concluding deals that transfer water rights from one LGU jurisdiction to another are high. In the case of the regional water utility Subicwater, for example, access to water rights from aquifers in two neighboring municipalities have been held up by endless negotiations - in which these transfers are viewed as exchanges of political favors rather than as a market exchange for water rights - for over four years. Technical assistance from the Global Water Partnership is being utilized to explore the feasibility of creating tradable water rights in the Philippines. (g) Maintaining a pipeline for potential PSP deals: Apart from streamlining the procurement process, implementation experience has signaled the need to maintain an adequate pipeline of subprojects for the design- build-lease deals. Traditionally in the Philippines, project preparation activities are undertaken through grant assistance (such as PHRD grants, Consultant Trust Funds etc.), and by convention LGUs do not borrow for this purpose. As the number of towns keeps expanding, it is becoming increasingly difficult to secure adequate grant assistance. In order to prepare APL2 and APL3 projects, the borrower will be accessing concessional credit available under the NDF cofinancing. If the flow of PSP deals is maintained, the costs of project preparation will be recovered from the selected PSP operator. 9. Program of Targeted Intervention (PTI) N 10. Environment Aspects (including any public consultation) Issues : The project is expected to have mainly positive environmental and public health impacts through the provision of affordable, clean and more reliable individual water supply connections to residents of small towns in the project LGUs. There is potential for some negative impacts, mainly resulting from the wastewater which needs to be disposed of in these small urban areas without a piped sewerage system. However, these potential negative impacts can be mitigated and managed through the Environmental Management Plans that local government are required to implement, and through mitigative actions by individual households concerned. - 6 -  Environmental assessments (EA) have been prepared by consultants for each of the LGUs, together with environmental management plans (EMP) which focus on individual sustainable on-site sanitation solutions plus mitigative actions by LGUs (will be available in project files for the EA and EMP for all the approved APL1 towns by Board presentation). In order to guide the preparation of EAs and EMPs for subsequent batches of LGUs, the operational manual for EA for APL1 towns has been updated. The emphasis of the EA process for this project is less on the assessment of the obvious, generic impacts but more on their ongoing management, including the protection of the raw water sources (mainly groundwater). These procedures are in compliance with Philippines regulations for sanitation and environmental protection which are consistent with the Bank's OD 4.01 (Environmental Assessment), OD 4.20 (Protection of Indigenous People), and OD 4.30 (Involuntary Resettlement). The borrower will submit an annual report of compliance to the above ODs. Mitigative actions will be supported through capacity building, in particular training of local health officers and sanitation inspectors. GOP will provide adequate funds for local capacity building, the project envisages that LGUs may on-lend a portion of their subloans to individual households for on-site sanitation improvements, based on full cost recovery. The NDF cofinancing will build municipal capacity for sound environmental management. A part of the cofinancing will also prepare future batches of sewerage projects in LGUs facing the most severe problems of municipal pollution. 11. Contact Point: Task Manager Vijay Jagannathan The World Bank 1818 H Street, NW Washington D.C. 20433 Telephone: (202) 473-1306 Fax: (202) 522-1787 Email: NJagannathan@worldbank.org 12. For information on other project related documents contact: The InfoShop The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 458-5454 Fax: (202) 522-1500 Web: http:// www.worldbank.org/infoshop Note: This is information on an evolving project. Certain components may not be necessarily included in the final project. Processed by the Infoshop during the week ending August 31, 2001. -7 -