China - Inner Mongolia Highway Project

Document of The World Bank Report No: 23766-CHA PROJECT APPRAISAL DOCUMENT ON A PROPOSED LOAN IN THE AMOUNT OF US$100 MILLION TO THE PEOPLE'S REPUBLIC OF CHINA FOR INNER MONGOLIA HIGHWAY PROJECT April 30, 2002 Transport Sector Unit East Asia and Pacific Region  CURRENCY EQUIVALENTS (Exchange Rate Effective July 2001) Currency Unit = RMB Yuan RMB1.00 = US$0.12 US$1.00 = RMB8.30 FISCAL YEAR January 1 -- December 31 ABBREVIATIONS AND ACRONYMS CAS = Country Assistance Strategy CBMS = China Bridge Management System CPMS = China Pavement Management System CREMA = Contract for Rehabilitation and Maintenance EA = Enviromnental Assessment EAP = Environmental Action Plan EIA = Environmental Impact Assessment E&M = Electrical and Mechanical HNIP = Highway Network Improvement Program IST = Institutional Strengthening and Training IMCD = Inner Mongolia Communications Department LACI = Loan Administration Change Initiative LJH = Laoyemiao-Jining Highway MMS = Maintenance Management System MOC = Ministry of Comrnunications MOF = Ministry of Finance NTHS = National Trunk Highway System PAD = Project Appraisal Document PCD = Provincial Communications Department PIC = Public Information Center PMO = Project Management Office RAP = Resettlement Action Plan RDB = Road Data Bank SDPC = State Development and Planning Commission VOC = Vehicle Operating Cost Vice President: Jemal-ud-din Kassum, EAPVP Country Director: Yukon Huang, EACCF Sector Director: Jitendra N. Bajpai, EASTR Task Team Leader/Task Manager: Supee Teravaninthom, Senior Transport Economist, EACCF  CHINA INNER MONGOLIA HIGHWAY PROJECT CONTENTS A. Project Development Objective Page 1. Project development objective 2 2. Key performance indicators 2 B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project 2 2. Main sector issues and Government strategy 3 3. Sector issues to be addressed by the project and strategic choices 6 C. Project Description Summary 1. Project components 7 2. Key policy and institutional reforms supported by the project 9 3. Benefits and target population 9 4. Institutional and implementation arrangements 9 D. Project Rationale 1. Project alternatives considered and reasons for rejection 10 2. Major related projects financed by the Bank and other development agencies 11 3. Lessons learned and reflected in the project design 12 4. Indications of borrower commitment and ownership 13 5. Value added of Bank support in this project 13 E. Summary Project Analysis 1. Economic 13 2. Financial 14 3. Technical 14 4. Institutional 14 5. Environental 15 6. Social 17 7. Safeguard Policies 19  F. Sustainability and Risks 1. Sustainability 19 2. Critical risks 19 3. Possible controversial aspects 20 G. Main Loan Conditions 1. Effectiveness Condition 20 2. Other 20 H. Readiness for Implementation 21 I. Compliance with Bank Policies 22 Annexes Annex 1: Project Design Summary 23 Annex 2: Detailed Project Description 26 Annex 3: Estimated Project Costs 30 Annex 4: Cost Benefit Analysis Summary, or Cost-Effectiveness Analysis Summary 31 Appendix A 39 Annex 5: Financial Sunmmary for Revenue-Earning Project Entities, or Financial Summary 41 Appendix A: Laoyemiao-Jining Highway Income Statement 45 Appendix B: Laoyemiao-Jining Highway Assumptions for Financial Forecasts 48 Appendix C: Laoyemiao-Jining Highway FIRR Simulation and 49 Probabilistic Risk Analysis Appendix D: Highway Revenue and Expenditure During Ninth Five-Year Plan 50 Annex 6: Procurement and Disbursement Arrangements 52 Annex 7: Project Processing Schedule 61 Annex 8: Documents in the Project File 62 Annex 9: Statement of Loans and Credits 63 Annex 10: Country at a Glance 67 Annex 11: Summary of Financial Management System 69 Annex 12: Environmental Assessment and Action Plan Summary 74 Annex 13: Summary of the Resettlement Action Plan 81 Annex 14: Strengthening and Reforming Highway Maintenance 85 Annex 15: Implementation Plan 91 MAP(S) 1. IBRD 31682 2. IBRD 31683 3. IBRD 31684  CHINA Inner Mongolia Highway Project Project Appraisal Document East Asia and Pacific Region EASTR Date: April 30, 2002 Team Leader: Supee Teravaninthom Country Director: Yukon Huang Sector Manager/Director: Jitendra N. Bajpai Project ID: P070459 Sector(s): TH - Highways Lending Instrument: Specific Investment Loan (SIL) Theme(s): Poverty Targeted Intervention: N Project Financing Data [X] Loan [ ] Credit [] Grant [ Guarantee [ Other: For Loans/Credits/Others: Amount (US$m): $100.00 Borrower Rationale for Choice of Loan Terms Available on File: OI Yes Proposed Terms (IBRD): Variable-Spread Currency Loan (VSL) Front end fee (FEF) on Bank loan: 1.00% Financing Plan (USSm): Source Local Foreign Total BORROWER 168.73 0.00 168.73 IBRD 0.00 100.00 100.00 Total: 168.73 100.00 268.73 Borrower: PEOPLE'S REPUBLIC OF CHINA Responsible agency: INNER MONGOLIA COMMUNICATIONS DEPARTMENT Address: No. 68 Saihan District, Dizhiju South St. Hohhot, Inner Mongolia, Post code 010020, China Contact Person: Mr. Bao Jianshe, Deputy Director of IMCD Tel: (0471) 6968813 Fax: (0471) 6967588 Email: Estimated Disbursements ( Bank FY/US$m): ::IFY. 2003 2004 2005 2006 2007 2008 Annual 7.00 16.00 30.00 18.00 13.00 16.00 Cumulative 7.00 23.00 53.00 71.00 84.00 100.00 Project implementation period: April 2002 to September 2007 Expected effectiveness date: 09/01/2002 Expected closing date: 03/31/2008  A. Project Development Objective 1. Project development objective: (see Annex 1) The project aims to improve the efficiency, safety, and cost-effectiveness of the transport infrastructure to support the social and economic development of the Inner Mongolia Autonomous Region, and to improve accessibility to its poorer areas thus reducing social and economic disparity within the region. To meet this development objective, the project will produce the following outputs: a. Increased transport capacity and promoted market integration in the most important east-west corridor of Inner Mongolia linking its key industrial, administrative, and hub cities in Inner Mongolia b. Improved accessibility to poor areas in Inner Mongolia through the Highway Network Improvement Program (HNIP) c. Enhanced public sector management of the road network in Inner Mongolia by strengthening institutional and management measures and introducing a pilot program for road maintenance by contract d. Improved road safety. 2. Key performance indicators: (see Annex 1) The principal outcome or impact indicators selected for monitoring progress toward the project development objective are: a. Reduction in the time spent for interprovincial and intraprovincial trips through lower costs and shorter distances on a more efficient highway system b. Reduction in the number of days that the road network is closed to traffic c. Reduction in traffic accident fatality rates d. Strengthened capacity for managing road maintenance. B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1) Document number: 16321-CHA dated 1997/02/25, and Progress Report R-98-107 dated 05/28/1998 Date of latest CAS discussion: May 28, 1998 A new CAS is being prepared and is scheduled to be discussed by the Board in Spring 2002. The Bank's strategic objectives include promoting sound macroeconomic management and a market-oriented institutional and social-services delivery system, addressing regional inequalities, and making development sustainable. To reach these strategic objectives, the CAS identifies transport infrastructure development as a key area for Bank support. The sector-specific goals supported by the project, in line with the CAS objectives, are to: a. Promote macroeconomic growth and regional market integration by financing a key link to the National Trunk Highway System (NTHS), thus facilitating intraprovincial and interprovincial trade and commerce, especially in the Westem Region, where economic development lags far behind the country's average b. Address regional inequalities and reach the absolute poor through effective investment in improving accessibility to low-income counties c. Provide support to the introduction of market-oriented mechanisms for infrastructure construction, operation, and maintenance -2 -  d. Promote a sustainable agenda in this sector through continued attention to traffic safety and environmental and social considerations in highway design, construction, operation and maintenance. 2. Main sector issues and Government strategy: Main Sector Issues The Bank recently completed several key sector works on China, including: A Strategy for the Transport Sector (Forward with One Spirit, 1997/98) * China Review of Highway Technical Assistance (1998/99) * OED Report on China Transport (1998/99) * China Highway Sector Strategy Review (2001). The most recent work, the China Highway Sector Strategy Review, was completed and discussed with the Government in late 2001. This review identified the main challenges faced by China's highway sector: sector management, managing road expenditures, managing road revenues and financing, enhancing accessibility to remote/low income areas, and traffic safety. Sector management. Transforming the Government into a market-supporting institution is one of the largest transition issues facing China today. In the highway sector, the Government's role in providing infrastructure (construction and maintenance) and transport services is shifting gradually from that of owner, investor, and manager to one of regulator. As regulator, the Government must oversee and encourage the development of more independent enterprises (in some cases, not owned by the state) that can provide cost-effective civil works and services. The pace of such a transformation varies widely with the level of development of the provinces, especially between coastal and interior provinces. Managing road expenditures. The sector should strive to increase efficiency and minimize the costs of providing infrastructure. Efforts of the Provincial Communications Departments (PCD) to improve their operations, while rationalizing and minimizing the cost of operations, should cover all activities of a road administration, from planning to design, construction and maintenance of roads at all levels. Planning. There is a need for more discriminating investment analysis, starting with planning. It will be necessary for the country to be more selective when planning its road expenditures, even though there is still a strong demand for additional investments in the road network. The allocation of funds between maintenance and new construction remains a major problem. Balance of expenditures. At present, the NTHS consumes 60 percent of the resources of the highway sector. With the high-priority NTHS nearing completion, this balance of expenditures between classes of roads should be reviewed carefully to detennine whether it continues to be an efficient allocation of resources to support economic development. The need for careful analysis of future investments will be especially important for projects proposed in the westem provinces, where the types and scale of investments are likely to differ from those in the eastern provinces. Construction quality. Highway construction quality remains a serious concem. Incidences of bridge and road failings and premature wear and tear on highway pavement have raised high-level Government officials' awareness of the issue. The problem has both technical and administrative roots. Under some Bank-financed highway project, contractors, mostly domestic, are not always well managed, frequently receive payments irregularly, and often come under pressure to shorten construction periods. Although the central government values the Bank's involvement in improving the supervision of design reviews and construction quality, there is still a need for construction quality standards and their enforcement under future Bank loans. - 3 -  Managing road revenues and financing. Traditional resources are inadequate to meet the increasing demands placed on road infrastructure by a growing economy. Road user charges. At present, the main road user charge is the road maintenance fee, which brings in revenues of around RMB 30 billion a year. Other charges, including the vehicle tax, contribute probably half as much as the maintenance fee. Road users thus bear a relatively large portion, about one quarter, of annual road expenditures in the last two years. In addition, the road maintenance fee is inefficient because it is expensive to administer yet easy to evade and it generates less than 40 percent of its potential revenues. Fuel tax. China has discussed introducing a fuel tax for some years, and although the National Congress passed the Fuel Tax Resolution in November 1999, its implementation has been deferred indefinitely. Securitization. The sale of highway equity through initial public offerings (IPO) and private placements has been an innovative feature of mobilizing private resources for the highway sector. Unlike with build-operate-transfer projects, the securitization of highways already opened to traffic greatly reduces investors' risks. The question is: How long can the securitization of existing road assets continue, given the proliferation of road companies in all provinces? The number of highway projects that can be marketed to private investors (those with strong traffic revenue potential) is insignificant compared to the sector's resource requirements. Under these conditions, the Govenmuent should focus on building a reliable and stable road user fee-based financing framework. At the same time, regulatory reforms are necessary to open opportunities for different modes of public-private partnerships, to mobilize domestic savings through the issuance of bonds and to broaden the investor base. Enhancing accessibility to remote and low-income areas. The geography of China creates great difficulties in providing basic road access throughout the country, particularly in inner and low-income provinces. Although the role of transport access in integrating the national economy, stimulating growth in remote areas, and ensuring the basic mobility needs of the poor has been emphasized, providing this access is an enormous task that requires significant public resources. The Bank's provincial highway program in China aims to have a favorable impact on poverty levels through targeted interventions in low-income areas. However, it is also understandable that government agencies often refrain from borrowing for this purpose because no dedicated revenue source for loan repayment is easily identified (unlike for toll roads). The Bank recommends a renewed effort to support road development in low-income areas as part of its future lending and non-lending services for the sector. Traffic Safety. Traffic safety remains a major issue. Although the death rate from traffic accidents has decreased from 100 per 10,000 vehicles in the late 1970s to about 57 deaths per 10,000 vehicles in 1994, the rate remains one of the highest in the world. In 1999, 83,500 people were killed and 286,000 injured in more than 400,000 accidents. Besides deaths and injuries, accidents cause property damage, and their overall economic and social costs are high. Improving road safety requires coordinated action in engineering, education and enforcement. However, the current diffusion of responsibilities in these different areas makes it difficult to address the problem in a comprehensive manner. MOC and the PCDs must continue working on the engineering aspects of road safety, which fall under their responsibility. MOC is planning systematic safety audits as part of project design, and a manual is being prepared that will be circulated to the provinces soon. PCDs should improve their collecting and analyzing of accident data and extend improvement programs for black spots (road sections with high accident rates). The Bank's role so far has been confined largely to matters under the jurisdiction of its project executing agencies, namely the engineering aspects of road safety. For traffic safety to improve dramatically, the matter must be elevated to the highest levels of Government. - 4 -  Government Strategy The main concem of the central and provincial highway authorities is to ensure that the highway system helps integrate China's national economy and facilitates the mobility of goods and services. This concem corresponds to the comparative economic and technological advantages of highways vis-a-vis other modes of transport and available financial resources. The investment priority for the highway subsector during the Ninth Five-Year Plan (1996-2000) was to develop the NTHS rapidly, and to develop some 130,000 km of provincial and rural roads that feed into the NTHS. Policy and regulatory reforms focused on financial issues aiming to ensure the efficient utilization of funds. Under the Tenth Five-Year Plan (2001-2005), apart from continuing the unfinished agenda of NTHS construction, the emphasis has moved toward economic development in the Westem Region. The 12 provinces making up the Westem Region cover 6 million square kilometers, about 60 percent of the country's total land area, and accounts for 25 percent of the population. In 1995, 66 percent of industrial output came from the east but only 10 percent from the west, with the remainder from central China. By 1998, per capita income in the east was three times that in the west. The west continued to be primarily a supplier of raw material. It is estimated that in this century, 60 percent of raw materials and 50 percent of the energy needs of the east will come from the west. There is great potential for processing primary material and agriculture products in the west. Massive investment in transport infrastructure is a key factor for realizing the economic potential of those provinces and integrating them into the national market. The Govemment is developing a long-term, three-pronged plan for the road sector: * East-west connections--MOC plans to develop eight corridors totaling about 15,000 km to link the Westem Region with eastem China. * Network improvements within the Western Region-This will include rehabilitating and upgrading the technical standards of about 180,000 km of the road network in the western areas. * Rural access--To alleviate poverty in rural towns and villages, about 150,000 km of rural roads have been identified for improvement This plan involves different types of works on 300,000 km of roads of various standards and classes and will require US$84 billion over 10 years. The Govemment is exploring opportunities for mobilizing funds for this plan, including ways to channel contributions from the eastem region and related budget transfer mechanisms. Because of low population densities, low incomes and generally difficult topographic and climatic conditions, costs of road development in the west will be high, and the potential for cost recovery will remain limited for some time. Highway sector institutional reforn is expected to intensify during the Tenth Five-Year Plan as the country moves toward a more open and competitive economy. The reform agenda should include the following features: * Adjust the role of govemment from that of highway builder and operator to one of effective regulator by increasingly relying on contracted works and services and introducing technologies and standards to improve supervision and control * Strengthen management efficiency in the decentralization process and reorganize the sector to maximize the use of scarce resources through planning and programming (including greater use of road databases, pavement management systems, and bridge management systems) * Identify highway financing methods to mobilize new sources of user charge-based revenues and promote public/private financing mechanisms, including asset securitization and the mobilization of national savings (bond issues) - 5 -  * Improve traffic safety while minimizing environmental and social impacts on people affected by highway development. 3. Sector issues to be addressed by the project and strategic choices: In addition to expanding highway capacity in the main east-west corridor of the province, the strategic focus of the proposed project is to work in the relatively underprivileged areas of the country, stimulate their economic growth and address trade and market integration by providing a cost-effective transport network with improved access to seaports. The institutional development and policy initiatives focus on improving the balance between road maintenance and new construction; introducing the market-oriented system of road maintenance by contract; construction quality assurance; poverty relief; environmental and resettlement requirements; and developing institutional capacity in provincial and local transport departments. The project will address sector issues described in Section B.2. Sector management. The project will pursue efforts to strengthen and modemize the institutional capacity of the implementing agency, the Inner Mongolia Communications Department (IMCD), and its affiliated agencies. The institutional strengthening and training (IST) component of the project aims to prepare institutions and build their human capacity in line with the emerging role of the govenmment according to national strategy. The IST component includes support for outsourcing, balancing of capital and maintenance budgets, planning and management framework, improving construction quality, and managing externalities such as environment and safety concems. It will help IMCD to establish a sound and balanced expenditures program by making its Road Data Bank (RDB) and its Chinese Pavement Management System (CPMS) operational. The full integration of both systems will make them more efficient management instruments. Improving construction quality. Strategic objectives of the physical construction components are to improve engineering designs during project preparation and to strengthen construction supervision during project implementation. These objectives will be met through the further enforcement of independent supervision, following more strictly the FIDIC conditions of contract management. They also will ensure the enforcement of all safeguard policies, including for the efficient procurement of works and services. Sustaining road maintenance. The Bank's dialogue with IMCD on road maintenance under the previous projects has raised awareness and understanding of the extent of the problem. The project will include a pilot program of road maintenance by contract that has the strategic dimension of supporting IMCD policy in changing its role in infrastructure works from direct execution to managing contracts. Under the pilot activities, contractors will become responsible for the overall maintenance of a road over a multi-year period. The pilot is expected to provide key insights to contract design and management issues and to set the conditions for expanding maintenance by contract. Enhancing accessibUity to remote and low-income areas. The project, through its Highway Network Improvement Program (HNIP) component, will assist in improving road access to selected areas in Inner Mongolia through maintenance, rehabilitation, upgrading and other improvements. Road Safety. The highway safety component will continue and intensify safety efforts launched under the ongoing Tri-provincial Highway project. The highway safety program under the Tri-provincial Highway project includes: (i) a study of the effect of highway design features; (ii) development of a highway design safety manual; (iii) a study of the factors contributing to traffic accidents; and (iv) a black-spot treatment pilot program. Lessons leamed from the Tri-provincial Highway project will be analyzed and applied to the proposed project. The black-spot treatment program will be institutionalized and standardized under the proposed project. -6 -  C. Project Description Summary 1. Project components (see Annex 2 for a detailed description and Annex 3 for a detailed cost breakdown): All components under the project have been designed to address the sector issues described in Section B.3. Expansion of highway capacity. The construction of Laoyemiao-Jining Highway (L1H), an approximately 90-km section of the NTHS, will link Laoyemiao and Jining in Inner Mongolia. The proposed highway will become part of the most important east-west corridor of Inner Mongolia linking its major industrial, administrative, and hub cities of Baotou, Hohhot, and Jining. Opening this section of the NTHS will link Beijing to the northwestem region of China via Hebei and Inner Mongolia, and from there to Ningxia, Gansu and Qinghai and will help accelerate economic growth in Inner Mongolia by integrating its regional market to the national economy. HNIP. Inner Mongolia is one of the poorest regions in China and is sparsely populated (see table below). With road density one-third the national average, and only 25 percent of roads all-weather roads, Inner Mongolia must increase its investment in lower road classes and all-weather roads. The HNIP component aims to provide poor counties and townships with reasonable access to other villages and to provincial and national highway systems. Of the 41 road sections that IMCD proposed, five were selected according to a set of economic and social criteria defined by the Bank and IMCD to be financed under the project. The selection criteria are summarized in Annex 2. The remaining road sections will be financed from domestic resources. Inner Mongolia China National Comparison Total Land Area (thousand kln ) 1,183 9,600 Third-largest Total Population (million) 23.6 1,242 2% of total (ranks 23rd) Population Density (person/kIn2) 20 130 28th GDP per capita (Yuan) in 1999 5,350 7,060 16th (25% below national average) Highway Network (Iam) 63,824 1,400,000 4.5% of country's network Road Density (km/100 In 2) 5.4 14.6 One-third of country average All-Weather Roads (kIn) 15,900 (25% of all One-fourth of country average roads in Inner Mongolia) Road safety improvement. Traffic safety in Inner Mongolia, as elsewhere in China, is an issue. The number of people killed per 10,000 vehicles is at least 10 times higher than the rates of Western Europe and North America, and traffic safety is expected to worsen unless action is taken to improve it. This project will build on road safety data, studies, and manuals prepared under the ongoing Tri-provincial Highway Project. This project also includes a more extensive program of black-spot. - 7-  Institutional strengthening and training (aST). The large increase in highway investment in recent years, which is expected to continue, and the reform agenda that IMCD envisages, require that IMCD substantially strengthen its institutional capacity. The IST component, designed with input from IMCD and the Bank during project preparation, combines technical assistance, training, and technology equipment upgrading into a program designed to continue the IST activities under the Tri-provincial Highway project. External funding arrangement for the IST activities will come from two sources: * IBRD loan under the project will be used for staff training activities, and * Technical Cooperation Credit 4 (TCC-4) will be used for the Technical Assistance (T/A) activities to be implemented in parallel with the project. The most challengingfeature of the T/A activities is the development of the maintenance management system aiming to improve the maintenance budgeting and planing process of IMCD, and the pilot program for maintenance-by-contract. This pilot program will take a road length of 100 kilometers that IMCD has identified in Ulanchabu League, of which 40 lan requires rehabilitation. A multi-year contract will require the contractor to rehabilitate this 40-km road section and carry out routine maintenance for the entire 100-km length. The contract will be awarded competitively. The pilot is tentatively scheduled to be launched during 2003. The timing is intended to ensure that the pilot is well prepared and the timing does not affect other project activities. Before launching competition, IMCD, with consulting assistancefinanced under the TCC-4, will need to carefully study the characteristics of the contract, including its terms, performance targets, penalties, financing approach, and other details. Indicative Bank- % of Component Sector Costs % of financing Bank- (USSM) Total (US$M) financing 1. Expand highway capacity by Highways 185.84 69.2 77.85 77.9 constructing approximately 90 km of the NTHS, connecting the major cities of Inner Mongolia and its interconnecting roads 2. Improve the highway network Rural Roads 61.08 22.7 20.00 20.0 system, including the rehabilitation and maintenance of the lower-class highway network in poor areas 3. Improve road safety by upgrading Transportation 2.10 0.8 0.63 0.6 selected dangerous key sections of road Adjustment network 4. Strengthen highway management Institutional 0.77 0.3 0.52 0.5 capacity of IMCD through training./Il Development Total Project Costs 249.79 93.0 99.00 99.0 Interest during construction 17.94 6.7 0.00 0.0 Front-end fee 1.00 0.4 1.00 1.0 Total Financing Required 268.73 100.0 100.00 100.0 /I The indicative cost in the above table does not include the T/A program totaling US$1.5 million to be financed under the TCC-4 financing arrangement and implemented in parallel to the project. - 8 -  2. Key policy and institutional reforms supported by the project: Reform of road maintenance management, financed in parallel to the project but under TCC-4 funding arrangement. The most interesting and challenging feature of the project is support to policy reform, on a pilot basis, by the practice of maintenance by contract mentioned above. This practice recently has been promoted by MOC and has already commenced in some provinces. In Inner Mongolia, contract works has been limited to road rehabilitation and covers only 10-15 percent of the network. The pilot program of maintenance by contract parallelly financed under the TCC-4 could help speeding up the implementation of MOC's policy. The policy is in line with the recommendations of the recent Highway Sector Strategy Review, which indicated that reform in maintenance management is currently one of the most critical aspects of highway sector reform. 3. Benefits and target population: The project will accelerate economic growth and thus improve living standards in Inner Mongolia and the neighboring Ningxia Autonomous Region and Gansu Province, which are among China's lowest-income areas. The major quantifiable benefits are reductions in vehicle operating costs (VOC) and time costs of road users. The estimated distribution of the project benefits shows that traffic that diverts to LJH constitutes the majority of the road user's benefits (61.4 percent), and that car and truck traffic will benefit the most from the project (73.5 percent). The nonquantified benefits include a reduction in traffic accidents and improved accessibility to poorer areas of Inner Mongolia (summary in Annex 4). Improved accessibility, in turn, will generate both direct and indirect benefits of improved access to job opportunities, education and health-care facilities. It is estimated that an additional 20 percent of school age children will be able to attend school following the rehabilitation of the roads under the HNIP component. Furthermore, the project aims to improve the quality of construction by introducing improved technology and stricter supervision of construction. The project also will foster improved practices in environmental protection, land acquisition, resettlement of affected people, and participatory approaches to project preparation and implementation. 4. Institutional and implementation arrangements: IMCD has overall responsibility for project preparation and implementation. It will be directly responsible for formulating and implementing institutional and policy reforns, including training and the road traffic safety program. It will oversee the overall development and implementation of the environmental and resettlement components. A Project Management Office (PMO) has been established under IMCD and is headed by deputy director of IMCD. The PMO will assume overall implementation and coordination responsibility for all components and every aspect of the project, especially the preparation and implementation of the LJH component, including its design, procurement, construction, supervision, environmental and resettlement aspects. The PMO will also assume the leading role in the implementation of the HNIP component, although day-to-day responsibilities of HNIP execution will lie with the Baotou Municipal Communications Bureau and the Ulancabu Prefecture Communications Bureau where the five HNIP road sections are located. The project will be implemented during 2002-2007. Overall direction of the project at the central level will rest with the Ministry of Communication (MOC) in Beijing. The Bank loan will be lent to the Borrower, the Ministry of Finance (MOF), which in tum will on-lend the loan proceeds to Inner Mongolia Autonomous Region on the same conditions as the Bank loan. -9-  D. Project Rationale 1. Project alternatives considered and reasons for rejection: Main highway component The feasibility study considered four alternatives: doing nothing, upgrading the existing main road (NRI 10) to a Class I highway, building an expressway in two stages, and building an expressway in one stage. The altematives were compared on the basis of costs, benefits, services to rural cities, and relationship to future economic development. NRI 10 is a two-lane Class II road that runs parallel to the proposed highway alignment and connects Inner Mongolia and Hebei province, with a hazardous traffic mix including slow-moving farm vehicles and heavy industrial trucks. With the rapid growth of traffic in recent years, the existing Class II road is expected to be congested by 2006, and so the doing nothing option was rejected. Upgrading NRI 10 to a Class I four-lane was one alternative considered. This altemative offered the lowest cost, but could not meet transportation capacity needs, would have required more resettlement, and would have caused more environmental impacts on residential areas than the expressway alignment. Furthermore, because both sections adjacent to the project expressway section are planned as four-lane expressways, and the proposed section is part of the NTHS, maintaining continuity was considered important from a technical viewpoint. For these reasons, the expressway standard was considered more appropriate. Building the expressway in one or two stages offered no distinct difference in terms of environmental impact, but because the total cost of two-stage construction would be higher, one-stage expressway construction was the alternative selected. The proposed expressway alignment was chosen primarily on the basis of topographical and geological conditions after the review of five alternatives. An intemational expert was hired to review the technical justifications for the selected alignment and found them satisfactory. HNIP component. IMCD proposed 41 road sections totaling about 2,300 km as candidates for Bank financing under the HNIP component. After the 41 road sections were screened through these criteria: (i) linkage to poverty areas; (ii) engineering classification; (iii) traffic volume; (iv) economic rate of retum; and (v) special circumstances such as a high accident rate (see Annex 2 for details), about 15 percent of them were accepted as top-priority candidates to be financed under the project. IST component. The Contract for Rehabilitation and Maintenance Approach (CREMA) was considered the most suitable model for the maintenance-by-contract pilot after other models were reviewed during project preparation and specific IMCD conditions were taken into account. The training program and its objectives and focus are based on IMCD's analysis of its weaknesses and takes into account the training program under the ongoing Tri-provincial Highway project as well as the need to prepare IMCD personnel for the organizational reform currently envisaged. Priority training topics include transport planning and budgeting, project management, construction quality, maintenance management, environmental protection, and highway safety. -10-  2. Major related projects financed by the Bank and/or other development agencies (completed, ongoing and planned). Latest Supervision Sector Issue Project (PSR) Ratings l (Bank-financed projects only) Implementation Development Bank-financed Progress (IP) Objective (DO) 1. Remove highway capacity Shanghai-Zhejiang Highway S S bottleneck (ongoing) 1-3, 5 2. Institutional strengthening & Second Shaanxi Provincial S S training Highway (ongoing) 14, 6 3. Rural road and poverty alleviation Second Henan Provincial S S Highway (ongoing) 1-6 4. Highway Safety Second Xinjiang Highway S S (ongoing)1-5 5. Operation and maintenance of Second Nat'l S S high-grade highways Hwy:Guangdong/Hunan (ongoing)l, 2,4-6 6. Cost recovery Fujian Provincial Highway S S (ongoing) 1-6 Third Nat'l Hwy: Hubei S S (ongoing)l, 2, 4-6 Tri-Provincial Highway S S (ongoing)1-6 Anhui Provincial Highway: S S (ongoing)1, 2,4-6 Forth National Highway: S S HubeilHunan (ongoing) 1, 2, 4-6 Second Fujian Highway S S (ongoing)1, 2,4-6 Third Henan Provincial S S Highway (ongoing)1-6 Guangxi Provincial Highway S S (ongoing)1-6 Second Jiangxi Highway S S (ongoing)1-6 Xinjiang mU Highway (planned)1-6 Hubei Highway Project (planned) 1-6 . Other development agencies Asian Development Bank ONGOING PROJECTS Hebei and Liaoning Expressways Liaoning and Jilin Expressways - 11 -  Hebei Roads Development Chengdu-Nanchang Expressway Chanchun-Harbin Expressway Shanxi Roads Development Southem Yunnan Road Development Chongqing-Guizhou Roads Development PLANNED PROJECTS Shanxi Expressway Chongqing-Guizhou Expressway Guangxi Highway Development Shanxi and Shaanxi Roads Westem Yunnan Road Development Southem Sichuan Roads Development Japan Bank for International ONGOING PROJECTS Cooperation (formally Overseas Hainan Development Economic Cooperation Fund of Japan Qingdao Development Guiyang Xinzhia Highway Hangzhou-Quzhou Expressway Wanxian-Liangping Highway Liangping-Changshou Highway Hainan East Expressway Xinxiang-Zhengzhou Highway IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory) 3. Lessons learned and reflected in the project design: Although the overall performance of the Bank highway portfolio in China has been satisfactory, a number of issues that have arisen during the implementation of earlier projects have been taken into account in the design of the proposed project. These issues include rushing to bid with preliminary engineering designs, resulting in sizable variations during project implementation; lack of quality control of construction; and starting the construction of electrical and mechanical facilities late. The project design also attempts to ensure that the highway network is balanced between high-growth areas and high-poverty areas by apportioning a substantial share of investment to lower classes of roads. The project design also attempts to spur policy and institutional reforms of road maintenance in line with a 1999 OED assessment of the China portfolio, and the recommendations of the recent Highway Sector Strategy Review. It includes a pilot maintenance-by-contract program, financed under the TCC4 funding arrangement. - 12 -  4. Indications of borrower commitment and ownership: Discussions between the Bank and the Borrower indicate that national, provincial, and local governments support the proposed highway because it is the main artery linking Beijing and China's northwestern region and is also the most important east-west corridor of Inner Mongolia The government of Inner Mongolia has shown an especially strong commitment to this project. The project is an integral and key component of the master plan that calls for connecting Hohhot and Inner Mongolia's secondary cities. For their part, MOC and the government of Inner Mongolia have already approved RMB 728 million (US$88 million) and RMB 672 million (US$81 million), respectively, as the state and provincial contributions to the project. 5. Value added of Bank support in this project: Through our continued involvement in project investment, the Bank can maintain and elevate policy dialogue and accelerate the pace of policy reform for the highway sector. It can build up-front client ownership, develop human resources, demonstrate quick but risk-free results through pilots, and improve dialogue by bringing consistency between national and provincial policies. Under the proposed project in particular, the added value of Bank support to Inner Mongolia includes, besides the physical investment, its experience with highway reform elsewhere and the know-how the Bank has gained in over 15 years of working on other relevant projects in China. Some of these projects have been in areas that were in the same stage of development that Inner Mongolia is in now, which means that the Bank can give due consideration to Inner Mongolia's stage of development and the level of sophistication and appropriate know-how the project should transfer to strengthen the management of IMCD. Bank experience with outsourcing highway maintenance will be valuable in this project. E. Summary Project Analysis (Detailed assessments are in the project file, see Annex 8) 1. Economic (see Annex 4): * Cost benefit NPV=US$118 million; ERR = 17.9 % (see Annex 4) O Cost effectiveness O Other (specify) This economic evaluation covers the two project components that account for 95 percent of project costs: (a) construction and upgrading of the Laoyemiao-Jining Highway, totaling 91.3 km and (b) upgrading of five rural roads under the HNIP, totaling 343.0 km. The principal measured benefits of the project are savings in vehicle operating costs (VOC), time savings to vehicle occupants, and enhanced road safety. Motorized traffic in the proposed LJH corridor increased rapidly, at an average of 15.8 percent per year between 1990 and 2000. By 2000 it had reached 6,000 AADT, while nonmotorized and other traffic added another 800 AADT equivalent. With a projected 8 percent annual growth, motorized traffic alone will reach about 10,000 AADT by 2006, the proposed opening year of the project. This would exceed the capacity of the existing Class II road. On the basis of this traffic growth estimate, the estimated overall economic internal rate of return (EIRR) for the project is about 18 percent--15 percent for LJH and 28 percent for HNIP. The overall economic net present value (NPV), based on a 12 percent discount rate, is estimated at RMB 979.7 million, RMB 429.6 million of which comes from LJH, and RMB 550.1 million from HNIP. An analysis of the evaluation results and a description of the method used to derive them are provided in Annex 4 and the results are summarized as follows: - 13 -  Summary of Economic Evaluation Results EIBR (in%) NPV (12%, million RMB) LaoYemiao- Jining Highway (LJHI: Jining - Xinghe 14.1 220.9 Xinghe - Laoyemiao 17.6 194.7 Subtotal 15.1 429.6 Highway Network Improvement Program (HNIP) 30.2 550.1 Total 17.9 979.7 2. Financial (see Annex 4 and Annex 5): NPV=US$ 16.5 million; FRR = 5.8 % (see Annex 4) The construction of LJH is the main component of the project, and only LJH will generate revenue. All five rural roads to be upgraded under the HNIP are toll free. IMCD plans to use the toll revenue from LJH to cover the loan amortization charges. The highway will generate enough total revenue over the loan period with a standard amortization schedule. With the toll at the proposed level, LJH may not need any external cash injection. The FIRR for LJH is expected to be 5.8 percent, with an NPV (at 5.0 percent) of RMB 135.1 million. For non-revenue-earning entities (the five toll-free roads under HNIP), the financial evaluation focused on the availability of sufficient counterpart funds and operating expenses, including the financial risks for the project roads. All the indicators show that the financial risks for these toll-free roads are modest. A detailed assessment is provided in Annex 5. Fiscal Impact: The project may significantly affect Inner Mongolia's budgets and capital investment programs during its implementation years. The counterpart fund issue has been discussed fully with the Inner Mongolia government to ensure that maintenance funds will not be sacrificed for capital construction. Tolls for different types of vehicles using the proposed LJH will be carefully detenrnined. However, for the purpose of evaluation, assumptions were conservatively set on a relatively low level of toll rates and a slow adjustment of the rates. Although the highway will generate enough revenue over the loan period, the low toll charges and the low toll growth assumption will lead to some impact on the FIRR. 3. Technical: The issues that need special attention from a technical point of view are: * The need for a proper review of selected design standards especially to take into consideration traffic safety on high speed road. * The need for adequate geological investigations at the design stage to minimize the risk of encountering major problems at the construction stage, as has occurred in other highway projects in China * An appropriate level of electrical and mechanical works at the opening of the highway to traffic 4. Institutional: All institutional issues related to capacity building will require special attention, in particular the strengthening of maintenance management systems and associated organizational arrangements. The successful implementation of the institutional components will require a continuing strong commitment from IMCD and its associated road sector agencies. - 14 -  4.1 Executing agencies: IMCD has been an executing agency for the Inner Mongolia component of the Tri-provincial Highway project for three years. It is familiar with Bank requirements and thus will not have problems executing the proposed project. 4.2 Project management: Overall project management will be handled by IMCD. IMCD also will be pimanrily responsible for the institutional and policy components as well as for the traffic safety components. PMO will be responsible for the construction management of both the LJH and HNIP components, including construction, supervision and quality control. PMO also will undertake environmental and resettlement aspects of the project. 4.3 Procurement issues: A project procurement capacity assessment was conducted during project preappraisal. The procurement capacity assessment report is available in the project files (see Annex 6 for a summary). The assessment confirmed that the provincial agencies are generally capable of managing highway projects. Although some shortcomings were identified, an action plan to overcome them has been drawn up. 4.4 Financial management issues: A financial management assessment was conducted during project preappraisal. The Financial Management Assessment Report is available in the project files (see Annex 11 for a summary). The assessment followed guidelines issued by the Financial Management Sector Board on June 30, 2001, and concluded that the project meets minimum Bank financial management requirements as stipulated in BP/OP 10.02. In the team's opinion, the project will have in place an adequate project financial management system that can provide, with reasonable assurance, accurate and timely information on project status in the reporting format agreed with the project and as required by the Bank. 4.4.1. Funding for the project comes from the Bank loan and counterpart funds. The Bank loan will be signed between the Bank and the PRC through its Ministry of Finance (MOF), and on-lending arrangements for the Bank loan will be signed between the PRC through its MOF and the Inner Mongolia Autonomous Region through its Finance Bureau of Inner Mongolia Autonomous Region (FBIMAR), and between FBIMAR and IMCD. The Bank loan proceeds will flow from the Bank into the special account maintained by FBIMAR for the project in respect of reimbursable expenditures incurred, or to contractors or suppliers through bank accounts with major commercial banks acceptable to the Bank. The project will disburse using traditional disbursement techniques and will not use PMR-based disbursements, in accordance with the agreement between the Bank and MOF. The counterpart funds will come from two sources: appropriations by the Ministry of Communication (MOC) and capital and domestic loan proceeds from IMCD, and will be contributed by MOC and IMCD directly to the project. 4.4.2. No outstanding audits or audit issues exist with the implementing agency. The task team, however, will continue to be attentive to financial management matters and audit covenants during project implementation. 5. Environmental: Environmental Category: A (Full Assessment) 5.1 Summarize the steps undertaken for environmental assessment and EMP preparation (including consultation and disclosure) and the significant issues and their treatment emerging from this analysis. - 15 -  Preparation of EIA and EAP. After the feasibility study report was completed by Inner Mongolia Transport & Traffic Design Institute, environmental assessment works started in January 1999 with the appointment of Chang'an University as Environmental Assessment (EA) consultant. For the HNIP component, a sector environmental assessment approach was implemented. Inner Mongolia Environmental Science Institute was entrusted with the task of conducting the EA according to Chinese national procedures and the World Bank's OP 4.01. The Bank reviewed the Environmental Impact Assessment (EIA), Environmental Action Plan (EAP), and EA Summary reports for the main highway component and the Initial Environmental Examination and Environmental Action Plan (IEE & EAP) for the HNIP and discussed them with IMCD, Chang'an University, and Inner Mongolia Environmental Science Institute during the preappraisal mission in September 2001. The second draft EIA, EAP, EA Summary, and IEE & EAP were submitted to the Bank in November 2001. Further comments from the Bank were provided and the final draft report was submitted to the Bank in January 2002. During the EA, local people in the project area received information and documents about the project and were intensively consulted. Their opinions are reflected in the project design and environmental mitigation measures, in particular the number of underpasses were increased. The draft EA reports were disclosed locally in January 2002 with an advertisement in the local newspaper and was sent to the World Bank's InfoShop for disclosure on January 28, 2002. The major findings on the two components are summarized below. More detailed information is given in Annex 12. a. Main Highway Component Potential Impacts. Major potential impacts during the construction phase include noise, dust, and soil erosion. The major potential impact during the operation phase will be noise. The alignment of the proposed highway is parallel to an existing Class II highway, an area that has been exposed to human activity for many decades. Agricultural land use prevails. There appear to be no environmentally protected areas, cultural relics, or critical natural habitats for precious fauna or flora found along the alignment. Mitigation Measures. The EIA recommended several mitigation measures, including resettlement, construction of green belts, barriers for noise mitigation, water-spraying and material covers for dust control, and appropriate allocation and rehabilitation of borrow pits for preventing land erosion. b. HNIP The HNIP includes no new construction or land acquisition. There appears to be no ecologically protected area in the program areas. The ecological and cultural environments were surveyed, and no important natural habitat or cultural property was found. The air and acoustic environments were monitored, and potential impacts were projected. Because construction works are made up of a limited scope of rehabilitating existing roads, no significant impacts are envisaged. To minimize the environmental impacts of the project, a variety of mitigation measures have been integrated into the EAP, including soil and vegetation protection; noise, air, and water pollution protection; and mitigation measures for borrow pits and construction camps. 5.2 What are the main features of the EMP and are they adequate? The EAP comprises an environmental protection plan and an environmental monitoring plan. Both plans specify responsible parties and supervising parties for their implementation at the design stage, construction stage, and operation stage. The protection plan involves practical and cost-effective measures necessary to mitigate project-related impacts, such as the construction of green belts totaling an area of 5,000 m'. The - 16 -  EAP, to ensure its implementation, includes training, institutional arrangements, an implementation schedule, and a budget. 5.3 For Category A and B projects, timeline and status of EA: Date of receipt of final draft: January 2002 The terms of reference (TOR) of the EIA, EIA report, and EAP were submitted to the Bank and were reviewed during the preappraisal mission in September 2001. The Bank reviewed the second draft of the EA reports in November 2001. The Bank received the third and final draft of the EIA, EAP, and EA Summary in January 2002. They were sent to the Bank's InfoShop for disclosure at the same time. 5.4 How have stakeholders been consulted at the stage of (a) environmental screening and (b) draft EA report on the environmental impacts and proposed environment management plan? Describe mechanisms of consultation that were used and which groups were consulted? A two-stage public consultation was carried out according to World Bank guidelines: (a) shortly after environmental screening and before the terns of reference for the EA were finalized (March and July 1999 respectively); and (b) after the draft EA report was prepared (August 2001 and February 2002 respectively). Meetings were held with local people at project-affected towns and surveys were conducted through questionnaires. Project-affected individuals, organizations of concemed villagers, and village committees were intensively consulted. Local government officers and other institutions such as NGOs also were consulted. 5.5 What mechanisms have been established to monitor and evaluate the impact of the project on the environment? Do the indicators reflect the objectives and results of the EMP? During the construction and operation phases, environmental monitoring will be carried out to verify the project's actual impacts on the environment, identify unexpected environmental problems at an early stage, and adjust environmental measures as appropriate. Environmental monitoring will be conducted by Envirommental Protection Office of IMCD at the construction stage. At the operational stage, environmental monitoring will be entrusted to local environmental monitoring centers. The results of the monitoring will be reported to the Bank and local environmental authorities. The environmental monitoring plans are provided in Annex 12, Table 2. 6. Social: 6.1 Summarize key social issues relevant to the project objectives, and specify the project's social development outcomes. The project targets one of the poorest areas of hner Mongolia. The project will complement the government's ongoing poverty alleviation efforts, particularly in agricultural development and rural roads, by providing easier, more efficient and less costly means of transportation. The HNIP component is designed as a poverty-reduction intervention to benefit the rural areas of the region. The major social issues of the project relate to land acquisition and resettlement. The project management office (PMO) carried out a census of the affected people, an inventory of affected assets, a socioeconomic survey and a social assessment within an extended corridor of about 10 km along the proposed LJH alignment to assess the general social and economic impacts of the project. The project will acquire 7,866 mu of land for the LJH component, including 3,871 mu of cultivated land. This will affect 12,693 people in 3,568 households. The project will need to relocate 37 people in 12 households. The HNIP will be implemented within existing road bases and will not require any land acquisition or house demolition. The PMO has developed a RAP, which details the census, inventory, project resettlement policy, compensation - 17 -  rates and budget, compensation and rehabilitation programs, and institutional and monitoring arrangements. The RAP is available in the project file and will be deposited in the Bank's Public Infonnation Center (Its summary is in Annex 13). One objective of the social assessment was to identify any ethnic minority population, develop an understanding of their socioeconomic situation, assess the impact of the project on them, and integrate their concems and suggestions into the project design. The social assessment found that there is a small Mongolian population in the project areas that makes up less than 4 percent of the local population. Unlike the Mongolian population in grassland areas in Inner Mongolia, they are scattered among the Han population and are well integrated into the Han culture. There is no distinctive difference between them and their Han neighbors in their social and economic activities. The project will affect 123 Mongolian farmers in 29 households. Based on the findings of the social assessment, it was concluded that the Mongolian households in the project area do not meet Bank criteria on indigenous people and therefore OD 4.20 does not apply. The alignment of the LJH runs along an existing highway, actually using parts of the existing highway. During the field surveys for the feasibility study and preliminary technical designs, the entire alignment was screened for cultural properties and relics. No above-ground cultural relics were identified as affected by the project. Consultations with cultural relics department and local govemments revealed no historical underground sites along the project aligrnent. The Chinese Cultural Relics Protection Law will be followed if underground historical relics are found during project construction. 6.2 Participatory Approach: How are key stakeholders participating in the project? All affected households and villages were identified through the census and social assessment. Project information was provided to the affected villages and local governments through newspaper announcements, posters, and public meetings. The consultation strategy used focus-group discussions and key informant interviews to disseminate project information, consult affected people about the resettlement and rehabilitation strategy, and note people's concerns and needs so that they could be incorporated into the project design. Information dissemination and consultations will continue during project implementation. A resettlement information booklet, including detailed entitlements for each household, compensation and entitlement policies, and grievance procedures will be distributed to affected people before resettlement implementation. The affected communities will play a key role in finalizing and implementing livelihood-restoration programs. Both intemal monitoring and independent monitoring of the resettlement program will be conducted regularly during project implementation. 6.3 How does the project involve consultations or collaboration with NGOs or other civil society organizations? China Resettlement Research Centre was contracted to head the social assessment exercise. Village commlittees and farmer groups have also been consulted and have participated in the resettlement planning process and the preparation of the project. 6.4 What institutional arrangements have been provided to ensure the project achieves its social development outcomes? The institutional arrangements for resettlement implementation are detailed in the RAP. East China Science and Engineering University, which is independent of the Inner Mongolia government and the project office, will serve as the independent monitoring agency for the resettlement program. The project will be monitored and the living standards of project-affected people will be evaluated throughout project implementation. The monitoring results will be reported regularly and, if and when needed, remedial actions will be designed. - 18 -  6.5 How will the project monitor performance in terms of social development outcomes? The borrower, the Bank, and the external monitoring institutions will supervise and monitor project implementation and the realization of the stated objectives. 7. Safeguard Policies: 7.1 Do any of the following safeguard policies apply to the project? Policy Applicability Environmental Assessment (OP 4.01, BP 4.01, GP 4.01) * Yes 0 No Natural Habitats (OP 4.04, BP 4.04, GP 4.04) 0 Yes * No Forestry (OP 4.36, GP 4.36) 0 Yes 0 No Pest Management (OP 4.09) 0 Yes 0 No Cultural Property (OPN 11.03) 0 Yes * No Indigenous Peoples (OD 4.20) 0 Yes * No Involuntary Resettlement (OP/BP 4.12) * Yes 0 No Safety of Dams (OP 4.37, BP 4.37) 0 Yes * No Projects in International Waters (OP 7.50, BP 7.50, GP 7.50) 0 Yes 0 No Projects in Disputed Areas (OP 7.60, BP 7.60, GP 7.60)* 0 Yes * No 7.2 Describe provisions made by the project to ensure compliance with applicable safeguard policies. For OP 4.01, Environmental Assessment, see Section E.5. For OD 4.30, Involuntary Resettlement, see Section E.6. F. Sustainability and Risks 1. Sustainability: Experience with completed and ongoing Bank-financed highway projects indicates a strong cormnitment among Chinese officials to implement the physical components of the project. Generally, counterpart funds are mnade available on time. However, the policy of speeding up investment in the sector tends to cause funds to be diverted from maintenance to construction. To ameliorate this situation, about 20 percent of project funds are allocated to improving and maintaining existing roads, especially those in poorer areas. The level of tolls must be reviewed periodically so that the project proves to be financially and economically viable and the province can repay the Bank loan and carry out maintenance when required. 2. Critical Risks (reflecting the failure of critical assumptions found in the fourth column of Annex 1): Risk Risk Rating Risk Mitigation Measure From Outputs to Objective The government lacks the commitment to M Maintain an effective dialogue with the central implement the final recommendations and Inner Mongolia governments from technical assistance. Trained staff lack the opportunity to apply M Continue dialogue with IMCD and coordinate acquired skills in the workplace. the work among the agencies There is insufficient accountability for the M Monitor resource utilization practices use of internal and external resources. frequently through regular supervision audits -19 -  From Components to Outputs Counterpart resources are not available in N Follow up regularly on all required budgets, a timely manner. which are already identified and committed Political pressures interfere with M Prequalify contracts properly to ensure that the implementation and adversely affect the best contractors are selected, ensure the proper quality of construction. external supervision of construction, and provide frequent Bank supervision Land acquisition and resettlement suffer M Provide frequent supervision, with a particular delays. focus on resettlement during the first year of implementation Overall Risk Rating M Risk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N(Negligible or Low Risk) 3. Possible Controversial Aspects: N/A G. Main Loan Conditions 1. Effectiveness Condition Issuance of acceptable legal opinions. 2. Other [classify according to covenant types used in the Legal Agreements.] 2.1 Agreement Reached with the Government: The borrower will ensure that the proceeds of the loan are on-lent to the beneficiary, Inner Mongolia Autonomous Region, on the same terms and conditions as the Bank loan, with the beneficiary bearing the foreign exchange risk. 2.2 Agreement Reached with the Beneficiary: (a) Laoyemiao-Jining Highway. IMCD shall undertake, complete and furnish to the Bank an analysis and recommendation for toll rates on LJH by June 30, 2005, taking into account the findings of studies about this issue under other Bank-financed highway projects in China, and the experience with toll rates on major roads. (b) Highway NetworkImprovementProgram. IMCD shall prepare and furnish to the Bank an annual monitoring report by May 15 of each year starting 2003, until two years after the program is completed. (c) Highway Safety. IMCD shall complete the black-spot improvements works by December 31, 2005. (d) Institutional strengthening and training. By November 15 of each year, beginning in 2002, IMCD will furnish to the Bank an annual IST report covering progress in implementing the IMCD maintenance reform program and training, including a training schedule for the future year and a description of the training carried out during the year of the report. - 20 -  IMCD will carry out the studies and maintenance-by-contract pilot financed under TCC-4 in the manner specified in the TCC-4 document, and will discuss with the Bank the conclusions and recommendations of the studies and report to the Bank on the implementation of the pilot and share the lessons learned from it. (e) Environment, Land Acquisition and Resettlement. IMCD shall carry out the EAP and RAP, in a manner satisfactory to the Bank, and furnish any proposed revision of these plans to the Bank for its prior approval. IMCD also shall maintain policies and procedures adequate to enable it to monitor and evaluate on an ongoing basis, in accordance with indicators acceptable to the Bank, the implementation of EAP and RAP. Under terms of reference acceptable to the Bank, IMCD will prepare and furnish to the Bank: (i) a quarterly report and an annual environmental monitoring report through the period of implementation, with the first report submitted by February 15, 2004; (ii) by May 15 and November 15 of each year, starting May 15, 2003 until two years after completion of the project, an internal resettlement report prepared by agencies of Inner Mongolia Autonomous Region responsible for resettlement activities on the implementation and results of such activities during the preceding six-month period; and (iii) by February 15 and August 15 of each year, starting February 15, 2003 until two years after completion of the project, an external resettlement report prepared by an independent entity acceptable to the Bank, on the implementation and results of the resettlement activities during the same six-month period referred to in clause (ii) above. (f) Reporting, Monitoring and Auditing Using guidelines acceptable to the Bank, IMCD shall prepare and submit to the Bank: * A monthly progress report on the civil works of LJH * A quarterly progress report on implementation of all project components * An annual monitoring report, in a form satisfactory to the Bank, that assesses the degree to which implementation and development goals were achieved for all components, by February 15, of each year, beginning in 2004, through 2007 * An implementation completion report, in a format acceptable to the Bank, within six months of the closing date of the Bank loan * Audited accounts for the project, statements of expenditures and special accounts prepared by independent auditors acceptable to the Bank, within six months of the close of each fiscal year. * Unaudited project financial statements on a semi-annual basis within 45 days of the close of each reporting period (i.e. prior to August 15 and February 15 of the following year based on a calendar year) H. Readiness for Implementation 1 1. a) The engineering design documents for the first year's activities are complete and ready for the start of project implementation. I 1. b) Not applicable. 1 2. The procurement documents for the first year's activities are complete and ready for the start of project implementation. 1 3. The Project Implementation Plan has been appraised and found to be realistic and of satisfactory quality. D 4. The following items are lacking and are discussed under loan conditions (Section G): - 21 -  1. Compliance with Bank Policies 1 1. This project complies with all applicable Bank policies. O 2. The following exceptions to Bank policies are recommended for approval. The project complies with all other applicable Bank policies. upee Teravthom Jitendra N. Bajpai ukon Huang Team Leader Sector Manager/Director Country Director - 22 -  Annex 1: Project Design Summary CHINA: Inner Mongolia Highway Project Key Performance Data Collection Strategy Hierarchy of Objectives Indicators Critical Assumptions Sector-related CAS Goal: Sector Indicators: Sector/ country reports: (from Goal to Bank Mission) Support social and economic Increase in Gross Output Annual economic reports and Increased economic activity development in Inner Value of Agriculture and statistics on Inner Mongolia and accessibility to all areas Mongolia Autonomous Industry (GOVAI) in affected in Region through effective counties and in a few control Country economic reports the region enhance infrastructure investment counties along the project opportunities in all sectors corridors and contribute to sustainable and equitable development. Project Development Outcome / Impact ProJect reports: (from Objective to Goal) Objective: Indicators: The project aims to improve Reduced time spent on Travel speed and average Economic conditions in the the efficiency, safety, and interprovincial trips through a daily traffic (ADT) on country and provinces remain cost-effectiveness of the more efficient highway system existing highway robust. transport infrastructure to involving lower costs and support the social and shorter distances Progress on network Counterpart funds are not economic development of the rehabilitation and over-stretched and Inner Mongolia Autonomous Reduction in number of days maintenance maintenance is sustained. Region, a poor, land-locked road network is closed to region in northwestern China, traffic Progress on traffic safety Results of the highway safety thus reducing social and TA are fully applied. economic disparity within the Lower traffic accident fatality region. rate, especially on the heavily traveled corridor Output from each Output Indicators: Project reports: (from Outputs to Objective) Component: 1. Approximately 90 km of - ADT on new expressway Project performance Sector organization, the Laoyemiao-Jining and existing road. monitoring reports operation, and management highway (LJH) constructed - Average vehicle speed on improve. the new expressway and existing road. 2. Existing road network, - ADT on local roads in Project performance Commitment to implement especially in relatively poor affected areas. monitoring reports TA's final recommendations areas, properly maintained - Number of days local on highway maintenance and improved roads are closed to traffic. management is sustained. 3. Traffic safety on existing - Number of traffic accident Report of traffic safety Commitment to implement network improved fatalities and their severity analysis TA's final recommendations on the traffic safety audit is sustained. -23 -  4. Technical and management - Qualitative evaluation Reports on implementation of Training programs prove capacity of IMCD and its reflecting sharing of new study recommendations, and relevant and managers willing related departments knowledge and exercising trainees' report to give opportunities to strengthened new skills by staff trained trainees to apply new skills. under the project, as well as Progress reports on social and improvement of performance environmental monitoring in specific functions and activities activities - Quality of project management of social and environmental aspects Project Components Inputs: (budget for each Project reports: (from Components to Sub-components: component) Outputs) Construction of LJH US$ 179.4 million Monthly reports for civil Political pressures do not works interfere with implementation and adversely affect the quality of construction. Highway Network US$ 61.1 million Quarterly progress report for Counterpart resources are Improvement Program the entire project made available in a timely manner. Highway safety component US$ 2.1 million Annual reports of traffic Traffic safety audit is safety analysis implemented. Strengthening of highway US$ 0.8 million Report on implementation of Opportunities are opened to management capacity through study recommendations trainees to apply new skills in training workplace. Provision of road maintenance US$ 6.4 million Disbursement progress report equipment Total Project Cost US$ 249.8 million Interest during construction US$ 17.9 million Front-end fee US$ 1.0 million Total Financing Required US$ 268.7 million -24 -  Annex 1-1 Ke Performance Indicators & Development Indicators Attainment of Project Monitoring Indictors 2001 2004 2006 2008 objectives Provide a more efficient, ADT on LJH(veh./day) safe and cost effective Laoyemiao-Xinghe 5,700 6,200 transport infrastructure Xinghe-Jining 5,500 5,900 NHI I0 ADT on existing class II Road Laoyemiao-Xinghe 6,600 8,300 4,000 4,200 Xinghe-Jining 6,500 8,200 3,900 4,100 NHI 10 accident rates on existing road (times/km) Laoyemiao-Xinghe 0.027 0.035 0.047 0.059 Xinghe-Jining 0.019 0.027 0.056 0.069 routine maintenance expenditure (million yuan/km) 6,000 8,000 12,000 20,000 Periodic maintenance (million yuan/lkn) 330,000 360,000 400,00 600,000 0 ADT on road under HNIP (AADT) (1) Huade-Anye 1,000 1,100 1,200 1,300 (2) Zuozishan-Liangcheng 900 1,000 1,100 1,200 (3) Kebuer-Baiyinchagan 900 980 1,030 1,070 (4) Bailinmiao-Xilamuren 2,070 2,390 2,600 2,830 (5) Tumuertai-Shangdu 860 1,000 1,090 1,180 Number of days road closed to traffic (1) Huade-Anye 10 3 (2) Zuozishan-Liangcheng 12 3 (3) Kebuer-Baiyinchagan 8 4 (4) Bailinmiao-Xilamuren 9 3 (5) Tumuertai-Shangdu 12 5 Tonnage of goods transported to coastal 2,350 3,608 4,655 7,227 provinces (100 t/yr) Average GDP in the project affected areas 9,100 10,290 14,410 16,280 (million yuan) Implementation Indicators 2003 2004 2005 2006 2007 2008 Total % of civil works completed on LJH 20 30 30 10 10 100 % of highways improve/rehabilitated under HNIP 30 40 20 10 100 Highway safety:% of improved blackspots 25 25 30 20 100 Number of person-month of completed training (%) 20 23 22 18 17 100 % of road under maintenance by contract (TCC-4) 60 80 100 100 100 - 25 -  Annex 2: Detailed Project Description CHINA: Inner Mongolia Highway Project By Component: Project Component I - US$185.80 million Highway Capacity Expansion ConstructionoftheLaoyemiao-JiningHighway: USS174.6million Construction of the approximately 90-krn Laoyemiao-to-Jining Highway (LJH) is the project's main component. The LJH is a divided, four-lane, access-controlled toll highway. The proposed LJH is a critical part of the national trunk highway system (NTHS) and of the east-west corridor of Inner Mongolia connecting its key industrial, administrative, and hub cities of Baotou, Hohhot, and Jining. The LJH will operate as a closed toll highway. It will include two interchanges, three toll stations, two service areas, and a facility for highway administration and maintenance. The component will also supply and install electrical and mechanical facilities (tolling, monitoring, telecommunications, and lighting systems). Equipment: US$6.4 million Equipment will be used to maintain national and provincial highways (including expressways) and other lower-class roads. Equipment needed for control of construction quality and environmental monitoring will be procured or supplied before commencement of civil works and will be locally financed. The equipment list, which includes cost estimates, is available in the project file. Supervision of construction: US$4.8 million Based on the experience gained from ongoing Bank-financed highway projects in China, a combined team of local engineers, technicians, and other personnel and international consultants will be created to supervise the construction of the LJH. The foreign engineers will be integrated with the supervisory organization and will help establish procedures at all levels, including on-site inspections and laboratory testing. They also will train local staff through formal sessions and on-the-job training. Three intemational experts for a total of about 72 person-months are envisaged to supervise construction, of which four person-months will be for training and five for contingencies. To supervise six ICB civil works contracts, one ICB contract for electrical and mechanical facilities, and three NCB contracts for buildings, two resident engineers offices will be created with 100 staff including site engineers. The estimated domestic supervision input will come to about 2,800 person-months. Project Component 2 - US$61.10 million Highway Network Improvement Program (HNIP) for Poverty Areas Inner Mongolia is one of the poorest regions in China by every standard of measurement. Inner Mongolia has 101 banners and counties, half of which are classified as poor (31 counties and banners are classified as national-level poverty and 19 as provincial-level poverty), and only 25 percent of total roads are all-weather roads. The need to increase investment in lower-class, all-weather roads in Inner Mongolia was therefore considered indisputable. - 26 -  IMCD proposed 41 road sections totaling about 2,300 km as possible candidates for the HNIP component. Five road sections were selected on the basis of the following criteria established by the Bank and IMCD: * The sections should link the poor to the developed areas of the province. * The engineering classification of these roads should be between Classes IV and II. * The sections must carry no fewer than 200-500 vehicles a day, depending on the proposed class of upgrade. * The economic rate of return on investment should be no less than 12 percent. * Special circumstances, such as a high accident rate also should justify consideration. The program includes roads totaling about 343 km, of which 85 km will be Class II highways and 258 km will be Class III. The EIRR ranges from between 18.1 percent and 40.6 percent. Feasibility reports on the five road sections as well as their EA reports are available in the project file. Implementation. Road sections will be packaged into 16 contracts with an average length of about 16 km and a total cost of about US$61.1 million, of which the Bank loan will finance 39 percent. All contracts will use the NCB procurement method. A group will be established in the PMO to supervise implementation. The sections will be improved from 2002 through 2005. The details are shown in Table A. Monitoring and performance indicators. Monitoring values will be estimated. The Bank and IMCD will review the implementation of the program during the yearly supervision missions, and results will be compared with those agreed the previous year. The monitoring indicators include the following: * Average daily traffic in MTE * Number of days the road is closed and not available for use * Increase or decrease in the county per capita GOVAI. Table A: Summary of Hlghway Network mprovement Program (HNIP) No. Location Highway Class of Highway Construction Total Cost Contract Class 2 Class 3 period (million yuan) package Total 85 258 429 16 1 Huade County Huade-Anye 85 2003-2005 160 5 2 Zuozi/Liangcheng Zuozishan- 48 2003-2004 54 2 County Liangcheng 3 Chayouzhong Kebuer- 70 2002-2004 75 3 Banner Baiyinchagan Chayouhou Banner 4 Damao Banner Bailinmiao- 86 2002-2004 86 4 Xilamuren 5 Shangdu County Tumuetail- 54 2002-2003 54 2 _ Shangdu Project Component 3 - USS 2.10 million Highway Safety Component (Black-Spot Improvements) 1MCD has undertaken a highway safety component under the ongoing Tri-provincial Highway project. The implementation of the ongoing highway safety component was reviewed and the review found that the current diffusion of responsibilities in different areas makes it difficult to address the problem in a comprehensive manner. Both MOC and the PCDs need to continue working on the - 27 -  engineering aspects of highway safety, which are within their area of responsibility. It was agreed that the proposed highway safety component would expand the black-spot improvement work under the ongoing project. Selection of black spots. The proposed black-spot improvement program will include 15 locations and be caried out within the existing right-of-way. The locations were selected on the basis of the following criteria: * Accidents are frequent and serious. * Local authorities had not planned improvements for the next few years. * Before and after analyses could be easily conducted. * Traffic volume is high (more than 2,000 veh/day). Implementation. Engineering solutions for the black-spot improvement works are estimated at RMB 15 million. Detailed designs of the first batch of civil works, including installing traffic safety facilities, will be completed by December 2002, and the entire program will be implemented from 2003 to 2006. Work on the 15 locations will be grouped into about seven contract packages and procured through NCB. Project Component 4 - US$0.80 million Institutional Strengthening and Training The IST component of the proposed project was designed to help IMCD strengthen its management of the road system, especially of maintenance activities. Although the major part of the IST component will be financed in parallel by the Technical Cooperation Credit 4 (TCC-4) and local counterpart funds, it was designed to complement the staff training financed by IBRD loan under the project. The IST component in a broader sense, therefore, includes the following: A. Training (financed by IBRD loan under the project ) B. Technical Assistance (T/A) Program financed in parallel under the TCC-4 financial arrangement a. Projectpreparation-feasibility study reports, Environmental Impact Assessment, Resettlement Action Plan, etc. b. Maintenance Strengthening Program * Software and hardware support for the Maintenance Management System (MMS) * Road expenditure allocation study * Pilot maintenance-by-contract program c. Research and engineering study * Design and construction of road under severe winter conditions to reduce parallel reflecting crack The total cost of the IST program including the T/A activities is US$4.6 million, of which US$1.5 million will be covered by TCC-4, US$ 0.5 million by IBRD loan under the project and the remaining US$2.6 million equivalent from counterpart funds. Details of the IST component are discussed in Annex 14. - 28 -  Table B: Overall Implementation Schedule 2001 2002 2003 2004 2005 2006 2007 GENERAL PROCUREMENT NOTICE (1013112001) Works 1. Laoyemiao-Jining lghway . - Civil Works - Buildings - Supply and 7-I-_-_-_-_- _-_-r Installation (E & M) 2. Highway Network Improvement (HNIP) - First Package _ - Second Package 3. Black Spot Improvements - First Package _ I Supervision of Construction - Laoyemiao-i Jining Highway Procurement of qulpment - Maintenance _ for National and Provincia Hlghways i ~ Pregualification/DreDaration of biddinq documents/rOR _ Construction/suDervision/deliverv/execubon of studies Bidding Drocesslcomoetition amona consultants Defects liabilitv oaerod 29 -  Annex 3: Estimated Project Costs CHINA: Inner Mongolia Highway Project Local Foreign Total Project Cost By Component US $million US $million US $million A. Works: 1) Civil works for LJH 78.89 53.70 132.59 2) Building for LJH 2.34 1.00 3.34 3) Electrical and mechanical facilities 1.49 3.49 4.98 4) HNIP 33.64 18.12 51.76 5) Black-spot improvement 1.24 0.54 1.78 6) Environmental Protection 0.47 0.47 Subtotal 118.07 76.85 194.9 B. Construction supervision: 1) LJH 3.12 1.44 4.56 2) HNIP 0.73 0.73 3) Environmental Protection 0.09 0.09 Subtotal 3.94 1.4 5.38 C. Equipment 0.00 6.00 6.00 D. IST /1 0.24 0.49 0.73 Total Baseline Cost 122.25 84.78 207.03 Physical Contingencies 11.76 7.7 19.46 Price Contingencies 9.97 6.52 16.49 Subtotal 21.73 14.22 35.95 Land Acquisition 6.81 6.81 Total Project Costs' 150.79 99.00 249.79 Interest during construcion 17.94 17.94 Front-end fee 1.00 1.00 Total Financing Required 168.73 100.00 268.73 Local Foreign Total Project Cost By Category US Smillion US $million US $million Goods 0.00 6.42 6.42 Works 139.48 90.52 230.00 Services 4.25 1.54 5.79 Training 0.25 0.52 0.77 Resettlement 6.81 0.00 6.81 Total Project Costs 150.79 99.00 249.79 Interest during construcdion 17.94 0.00 17.94 Front-end fee 0.00 1.00 1.00 Total Financing Required 168.73 100.00 268.73 1. This does not includes T/A totaling 51.5 million being arranged from TCC-4 to finance project preparation, technical assistance for Maintenance Management System and pilot program for maintenance by contract. - 30 -  Annex 4: Cost Benefit Analysis Summary CHINA: Inner Mongolia Highway Project [For projects with benefits that are measured in monetary terms] Present Value of Flows Fiscal Impact Economic Financial Analysis' Analysis _ Taxes Subsidles Beneflts: 15,256.8 10,317.9 2,784.0 RMB million Costs: 2,495.7 2,526.8 RMB million . Net Benefits: 12,761.1 7,791.1 2,784.0 RMB million IRR: 17.9 5.8 In %__________________ ________ 1 The value of financial benefits is lower than that of econornic benefits because of controls on the toll charges for the expressway and the non-revenue-eaming roads under the HNIP. If the difference between the present value of financial and economic flows is large and cannot be explained by taxes and subsidies, a brief explanation of the difference is warranted, e.g. "The value of financial benefits is less than that of economic benefits because of controls on electricity tariffs." Summary of Benefits and Costs: The overall EIRR of the project (including LJH and BNIP) is estimated to be 17.9 percent and the NPV (at 12 percent) is estimated to be RMB 979.7 million. The result is summarized as follows: Summary of Economic Evaluation Results EIRR (in%) NPV (12%, mnillion RMs) Laoyemiao- Jining Highway (LJH: Jining-Xinghe 14.1 220.9 Xinghe - Laoyemiao 17.6 194.7 Subtotal lai 4296 Highway Network Improvement Program (BNIP) 30.2 550.1 Total 17.9 979.7 Main Assumptions: 1. The economic evaluation of the project covers the following two project components: a. Construction of the 91.3-km Laoyemiao-Jining Highway (LJH) b. Upgrading and improvement of five rural roads (345 kIn) in the poor areas of Inner Mongolia under the Highway Network Improvement Program (HNIP) component 2. The analysis is based on the actual and forecasted operating data on traffic, vehicle operating cost (VOC) savings, project economic cost and transport user benefits. The main inputs and assumptions for the evaluation are: a. Capital investment and maintenance costs, revised to reflect February 2002 prices - 31 -  b. The benefit stream, also reflected in February 2002 prices, comprises savings in VOC, travel time savings through reduced congestion on the existing route, and reduction in accident costs c. An assumed project life of 20 years, a capital investment period of 2002-2007, depending on the road being evaluated d. Full benefits starting to accrue for LJH in 2007 and for the five rural roads from 2002 to 2005 (depending on the road). 3. This annex comprises three parts. Part I is the economic evaluation of L1H; Part H is the economic evaluation of the five rural roads under the HNIP component; and Part III is the overall economic evaluation of the project, including probabilistic risk analysis. PART I: LAOYEMIAO - JINIG HIGHWAY (LJH) 4. For purposes of evaluation, LJH has been divided into two sections: Length of the Length of the new eistIng road (km) expressway (Ian) Section 1: Jiing - Xinghe 69.29 70.00 Section 2: Xinghe - Laoyeniiao 21.27 21.27 Total 90.56 91.27 Highway Expansion Plan-Justification for Investment 5. Overview. Inner Mongolia Autonomous Region (IMAR) has a vast land area (1.18 million kmn). The IMAR is an inland transport hub in the north of China serving the east-west transportation needs and linking China's western provinces to the coastal areas in the east. The average altitude of this roughly rectangular region, which stretches about 2,500 km from east to west and 1,700 km from north to south, is 1,100 meters. Deserts, mountains, and plateaus constitute 90 percent of the terrain. Oasis and river basin land constitutes 10 percent of terrain, and more than 70 percent of the total population of 24.0 million inhabits this 10 percent. The National Road 110 crosses the southern part of the region, linlking Beijing and Tianjin port (on the east) to the westem provinces of China. About one-third of IMAR's population lives along the NR1 10 and produces about two-thirds of GDP of the region. Basically, the entire IMAR is classified by the Government as a poverty region. 6. The Government of China plans to build five north-south and seven east-west corridor highways, the National Trunk Highway System (NTHS), before 2010. NR110 (Dantong-Lhasa Highway, or DLH) is one of the seven east-west NTHS highways. The total length of DLH is about 4,669 km, of which about 20 percent (or 837 kIn) is in Inner Mongolia. Except for the project section, all other parts of DLH in Inner Mongolia are either completed or under construction. The proposed highway is not only a key section of the NTHS, it is also part of the crucial east-west corridor of Inner Mongolia linking its major industrial, administrative and hub cities of Baotou, Hohhot and Jining. Given the important role of this corridor in the rural economy, the proposed project has the highest priority in Inner Mongolia's regional highway development plan. Level and Timing of Investment 7. For the proposed highway conidor, motorized traffic increased an average of 15.8 percent per year between 1990-2000, and by 2000 had reached 6,000 motorized vehicles per day throughout its length. Non-motorized and other traffic (e.g., bicycles, animal carts, small farm tractors, and motorcycles) add the - 32 -  equivalent of 700-800 more vehicles per day. With a projected 8.0 percent annual growth, motorized traffic alone on this highway corridor will reach 9,400-9,800 vehicles per day by 2006, the proposed opening year for LJH. This would exceed the capacity of the existing road, which is about 4,500 vehicles per day. An economic assessment of the optimum opening year of the highway shows that all sections of the road reach capacity before 2000. When the more convenient highway connection from Gansu through Ningxia and Inner Mongolia to the seaport of Tianjin is completed, high traffic growth resulting from the Western Region Development Initiative of the government is anticipated. Section 1 Section 2 Jining - Xinghe Xinghe - Laoyeminao Road Class (old road / new road) II / Expressway I1/ Expressway Road Condition (old road / new road) Fair / Good Fair / Good Terrain Flat Mountain Capacity (AADT/day) (old road / new road) 5,000/30,000 4,000 / 25,000 Motorized Traffic - 2000 (AADT/day) 6,000 6,100 Year for Capacity Before 2000 Before 2000 Proposed Full Opening Year 2007 2007 Highway Corridor Traffic 8. Estimates of base-year traffic were made on the basis of routine traffic counts and a comprehensive origin and destination (O/D) survey that took place in October 1998 and was updated in November 2000 and July 2001). Projections of base, generated, and diverted traffic were made for 25 zones on the basis of a conventional growth model. A regression analysis was used to derive a relationship between economic growth and road transport demand. Rural economic growth and traffic demand indicate that traffic in the project corridor will grow an average of 8.0 percent per year between 2000 and 2006, 6.0 percent per year between 2006 and 2015, and 4.1 percent per year between 2015 and 2025. The overall traffic growth rates are summarized as follows: Annual Traffic Growth Rate Car Bus & Truck Average Actual: 1990-2000 18.2% 15.2% 15.8% Projection: 2000-2006 9.3% 7.6% 8.0% 2006-2015 7.3% 5.6% 6.0% 2015-2025 5.3% 3.7% 4.1% 9. Alternatives. The feasibility study considered three alternative alignments, i.e. the full expressway, staged expressway construction, and a Class I highway. Each alternative was compared on the basis of costs, benefits, services to rural cities, and relationship to future economic development. The full expressway was selected on the basis of cost and environmental and resettlement consequences (details are in the feasibility study reports available in project files). Traffic on the Highway 10. The new expressway should start operations in October 2006. Based on the information in the O/D survey and the feasibility study, the diversion ratios were calculated by using financial VOC for the road users as an independent variable, with due consideration given to the impacts of the proposed toll rates and travel distances, as well as experience from other recent Bank-financed highway projects in China. Calculations indicate that about 60 percent of motorized traffic on the corridor may divert to the new highway, depending on the road section and vehicle type, during the opening year of LJH. Sensitivity tests - 33 -  with lower diversion rates show that the LJH would still be justified with an average diversion rate of about 50 percent, a rate exceeded by most of the toll highways financed by the Bank in China. 11. Generated traffic is assumed to be 10 percent of basic traffic. There is no railway line between Jining and Laoyemiao, so no diversion of traffic from railway to the new expressway has been taken into account. The highway corridor traffic forecast, by section, is summarized as follows: Normal Traffic, by Sections (AADT) Section 1 Section 2 Jining - Xinghe Xinghe - Laoyemiao The Existine Road: Actual 1990 1,436 1,380 1995 2,851 2,880 1998 4,396 4,572 1999 5,195 5.262 2000 6,086 6,126 Forecast 2006 3,947 4,031 2015 5,800 6,110 2025 7,375 8,042 The Expresswav: Forecast 2006 5,598 5,782 2015 10,131 10,795 2025 16,071 17,729 Economic Costs 12. Financial costs have been converted to economic costs by eliminating price contingency, interest payments during construction, and taxes and customs duty on imported materials, and by applying shadow prices. The overall average shadow price is 1.07, and the resulting overall economic cost is 89.3 percent of the financial cost. Economic Benefits 13. The economic analysis includes the benefits derived from: (a) VOC savings on the new expressway for normal and generated traffic (as summarized below); (b) time savings through relieved congestion on the existing road, and (c) lower accident costs. The benefits resulting from the lower level of congestion were quantified. The value of passenger time savings was estimated at RMB 1.5 per passengir-hour, on the basis of updated values from a report on feasibility study methodologies for highways in China (Rust PPK. Australia Feasibility Study Methodology Report, February 1996). The same source was used for vehicle accident rates on different classes of roads. The benefits of generated traffic were calculated using the standard demand-curve analysis and the assumption of a linear relationship between demand and travel cost over the relevant cost range. Economic Vehicle Operating Costs (RMB per km, February 2002 prices) Section I Section 2 Old road New road Old road New road Car 0.929 0.764 1.073 0.837 Medlumnbus 1.661 1.362 2.117 1.493 Large bus 3.499 2.923 4.391 3.192 Small truck 1.705 1.385 1.890 1.512 Medium truck 2.095 1.785 2.305 1.938 Large truck 2.774 2.344 2.995 2.503 Tractor/trailer 4.257 3.643 4.507 3.824 - 34 -  Sample of Economic Vehicle Operating Cost Calculation (RMB per 1,000 veh.-km, February 2002 prices) Medium Large Small Medium Large Traller/ Car bus bust ruck Truck truck container The Existina Road Fuel 408 544 1,125 800 928 990 1,140 Tires 39 40 149 61 140 540 1,188 Maintenance 367 490 1,013 720 835 891 1,026 Crew 22 45 45 45 45 45 45 Depreciation 29 113 310 79 147 308 858 Subtotal 865 1,232 2,642 1.705 2.095 2.774 4,257 Time value of passengers 64 429 857 Total 929 1,661 3.499 1.705 2.095 2.774 4.257 The New Exnresswav Fuel 306 416 900 576 736 750 840 Tires 35 35 130 55 130 480 1,073 Maintenance 330 441 912 648 752 802 923 Crew 17 35 35 35 35 35 35 Depreciation 26 102 279 71 132 277 772 Subtotal 714 1,029 2,256 1.385 1.785 2.344 3.643 Time value of passengers 50 333 667 Total 764 1362 2.923 1,385 1.785 2,344 3.643 Economic Evaluation 14. The overall EIRR for LJH is estimated to be 15.1 percent, with the results for each road section summarized as follows: Economic Evaluation of LJH NPV (12%, Extra children Extra people attending EIRR (in %) million RMB) attending school /i health services /_i Jining-Xinghe 14.1 220.9 370 850 Xinghe - Laoyemiao 17.6 194.6 205 590 Whole route 15.1 429.6 575 1,440 /1: Information was collected to establish baseline data on the indirect benefits derived from improved access to education and health care services. However, its quantifiable benefits were not included. 15 The estimated distribution of the project benefits shows that traffic that diverts to LJH constitutes the majority of the road user's benefits (61.4 percent), and that car and truck traffic will benefit the most from the project (73.5 percent). A summary of the breakdown of the benefits is as follows: Distribution of the Project Benefits (million RMB) Road user Road agency Society Total project 1,615.3 (1,185.7) 429.6 Of which: Road user a. By traffic: Diverted traffic Generated traffic Existing road traffic Road safet Total 991.2 49.6 527.0 47.5 1,615.3 61.4% 3.1% 32.6% 2.9% 100.0% b. By vehicles: Buses Trucks Trailer Total 428.1 254.5 758.4 174.3 1,615.3 26.5% 15.8% 47.0% 10.8% 100.0% - 35 -  Sensitivity Analysis 16. The basic evaluation of the project, by section and on the whole, indicates that the selected alignment is economically viable. The sensitivity tests with respect to higher costs, lower benefits and traffic projections, zero value of time, and zero generated-traffic benefits for LJH mnaintain this position. The analysis of the optimum year for opening the road shows that delaying the completion by two years would reduce the EIRR by about 3.6 percent. Sensitivity Tests on the Economic Evaluation of LJH EIRR (%) NPV (12%, million RMB Delay the completion by oneyear 13.3 184.4 Higher capital cost (+15%1a) (a) 13.6 237.6 Lower benefits (-15%) (b) 13.3 174.3 Combine (a) and (b) 12.0 -- Zero value of time 14.3 313.2 Zero generated traffic 14.7 365.1 Lower traffic projection 12.2 17.9 Switching values % increase Cost increase to reduce EIRR to 12% 136% Benefit reduction to reduce EIRR to 12% 73.0 % 17. The sensitivity evaluation also indicates that the conditions for the project to fall below the minimum acceptable level for viability, i.e., an NPV of less than zero at a 12 percent discount rate or an EIRR of less than 12 percent, are unlikely to occur. The benefits would have to fall to less than 73.0 percent of those in the base case, or the costs would have to increase to more than 1.36 times those of the base costs, or a combination of costs increased by 1.15 percent and benefits fallen to 85 percent simultaneously. PART II: HIGHWAY NETWORK IPROVEMENT PROGRAM (HNIP) Selection of Highways and Its Traffic 18. The HNIP component consists of the following five rural roads totaling 343 km. The main objective of the HNIP is to upgrade existing rural roads to Class II or Class III paved roads. Length Traffic Road width (m) Pavement (km) (AADT, 2000) (Old / new) (Old / new) 1. Huade- Anye 85.0 966 8.5/ 12.0 Yes / Yes 2. Kebuer - Baiyingzhagan 70.0 875 7.5 / 8.5 No / Yes 3. Tumuertai - Shangdu 54.0 823 8.5/ 8.5 No / Yes 4. Bailingmiao - Xilamuren 86.0 1,971 8.5/ 8.5 Yes /Yes 5. Zuozi - Liangcheng 48.0 906 7.0/ 8.5 No /Yes Total 343.0 19. Because all five roads are in the same region, the rural economic development and traffic pattems are quite similar. On the basis of actual traffic levels and rural economic growth rates, traffic growth rates have been estimated, depending on the location of the roads, to be 3 percent to 5 percent from 2000-2005, reduced by 1 percent for each year between 2005 and 2025. - 36 -  Economic Costs and Benefits 20. Financial costs have been converted to economic costs using the same method and factors as for the LJH, with the results given in the following table. Financial and Economic Cost For HNIP (million RMB) Financial Economic Construction cost cost period I . Huade - Anye 200.00 178.60 2003- 2005 2. Kebuer- Baiyingchagan 80.00 71.44 2002- 2004 3. Tumuertai - Shangdu 55.00 49.12 2002- 2003 4. Bailingniao - Xilamuren 100.00 89.30 2002-2004 5. Zuozi - Liangcheng 70.00 62.52 2003 - 2004 Total 505.00 450.98 21. The principal evaluated benefits of the rural roads would be VOC savings due to better road surfaces. The associated upgrading of road class would also result in higher traffic speeds and an improvement in the road roughness index. In most of these sparsely populated areas, it is assumed that there is no generated traffic. Economic Evaluation and Sensitivity Analysis 22. The best estimates of EIRRs for the five rural roads range from 19.3 percent to 37.8 percent. The overall EIRR for HNIP is 30.2 percent and the NPV is RMB 550.1 million. EIRR and NPV for EINIP NPV (12%, Extra children Extra people attendlnj EIRR (in %) million RMB) attending school /_i health services /I 1. Huade - Anye 19.3 73.7 450 120 2. Kebuer - Baiyingchagan 33.5 110.0 450 130 3. Tumuertai - Shangdu 34.6 90.0 450 120 4. Bailingmiao - Xilamuren 37.8 190.4 180 55 5. Zuozi - Liangcheng 33.4 86.0 450 110 Total 30.2 550.1 1.980 535 LI: Information was collected to establish baseline data on the indirect benefits derived from improved access to education and health care services. However its quantifiable benefits were not included. 23. The risks associated with the evaluation of the rural roads are that traffic may grow more slowly than projected, thus making VOC savings lower than expected, and construction cost may be higher than projected. These risks were analyzed through sensitivity tests, and the results were found acceptable. For the project component to be non-acceptable (i.e., an EIRR of less than 12 percent, or zero NPV), construction costs would have to increase by more than 280 percent, or the benefits would have to be reduced to about 35.7 percent of their expected value, or a combination of costs increasing by 152 percent and benefits falling to 54 percent of expected values. PART III: THE OVERALL ECONOMIC EVALUATION OF THE PROJECT Overall Economic Internal Rate of Return (EIRR) 24. The overall EIRR of the project (including LJH and HNIP ) is estimated to be 17.9 percent and the NPV (12 percent) is estimated to be RMB 979.7 million. - 37 -  Project Risks 25. All sections of the LJH and the rural roads under HNIP show acceptable economic returns. IMCD has experience in building and operating high-grade highways as well as in rural road projects, so the technical risks of implementing the project are minimal. Physically, the only tangible risk during implementation is a very tight construction schedule and budget. Probabilistic Risk Analysis for Economic Evaluation of LJH 26. To determine the degree of uncertainty for the project, a probabilistic risk analysis using Monte Carlo techniques was carried out. In a Monte Carlo analysis, each uncertainty factor is allowed to vary at random between set limits and all uncertainty factors are allowed to change simultaneously. Monte Carlo simulation provides probability distributions of the potential outcomes of decisions. By analyzing these distributions, we can assess the risk associated with making various decisions (or probabilistic risk analysis). The product of the analysis is a judgment on the possible range of the decision variable and on the likelihood of each value within this range. 27. For the five rural roads, the sum of capital costs constitutes only about 20 percent of the total capital investment. In view of their higher EIRR and lower capital investment, the probabilistic risk analysis for the project focused instead on the construction of LJH. The factors with the most uncertainty associated with the economic evaluation of LJH have been identified as follows: (a) traffic growth rate; (b) traffic diversion ratio to the new expressway; (c) the value of VOC, (d) capital investment; and (e) delaying the new highway opening to 2008. The results of the probabilistic risk analysis shows that the EIRR for the mostly likely scenario is 13.6 percent. The low scenario is 12.6 percent and the high scenario is 14.4 percent The standard error of the mean is 0.1 percent. The detailed results of Monte Carlo test and probabilistic risk analyses are shown in Appendix A and summarized as follows: Summary of LJH Probabilistic Risk Analyses Range of EIRR Most Hkely EIRR Standard Error of the Mean Jining-Xinghe 11.9%-13.7% 12.2% 0.1% Xinghe - Laoyeniiao 14.9% 16.8% 15.9% 0.1% Total route 12.6% -14.4% 13.6% 0.1% - 38 -  APPENDIX A INNER MONGOLIA: LAOYEMIAO- JINING HIGHWAY EIRR SIMULATION AND PROBABILISTIC RISK ANALYSIS Summary: Display Range is from 8.0% to 19.0% (in%) Entire Range is from 6.8% to 19.7% (in%) After 1,000 Trials, the Std. Error of the Mean is 0.1% Statistics: Value Percentiles: Trials 1000 Mean 13.5% Percentile (in