China - Hubei Shiman Highway Project

Document o f The World Bank FOR OFFICIAL USEONLY Report No: 27681-CHA PROJECTAPPRAISAL DOCUMENT ONA PROPOSEDLOAN INTHEAMOUNT OFUS$200MILLION TO THE PEOPLE'SREPUBLIC OF CHINA FORA HUBEISHIMANHIGHWAY PROJECT May 25,2004 Transport Sector Unit East Asia and Pacific Region This document has a restricteddistributionand may be usedbyrecipients only inthe performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS (ExchangeRate Effective May 2004) CurrencyUnit = RMB RMB 1.00 = US$0.12 US$l.OO = RMB 8.28 FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS AAA Analytical and Advisory HPHAB HubeiProvincialHighway Services Administration Bureau CAS Country Assistance Strategy HPHDI HubeiProvincialHighway Design CITC China International Tendering Institute Company HPSEC Hubei Provincial Shiman EIA Environmental Impact Expressway Company Ltd Assessment HPSECH Hubei Provincial Shiman EMDP Ethnic Minorities Expressway Construction Development Plan Headquarter EMP Environmental Management ICB International Competitive Bidding Plan LRIP Local Roads Improvement Program E&M Electrical andMechanical LIBOR LondonInterbankOfferer Rate F M S FinancialManagement MOC Ministry of Communications Specialist MOF Ministry of Finance FSL Fixed-Spread Loan NDRC NationalDevelopment andReform GDP Gross Domestic Product Commission GOC Government of China NTHS NationalTrunk Highway System HCTC Hubei Communication OED Operations EvaluationDepartment Technical College RAP Resettlement Action Plan HERO HubeiExpressway SCCB Shiyan City Communications Bureau Resettlement Office Sh4E Shiyan-Manchuangan Expressway HPCD HubeiProvincial TBL Tendering and RiddingLaw of China Communications Department TOR Terms of Reference HPFD HubeiProvincialFinancial VSL Variable-Spread Loan Department WBFPO World BankFinanced Project Office Vice President: Jemal-ud-din Kassum Country Managermirector: YukonHuang Sector Manager: Jitendra N.Bajpai Task Team Leader: Michel Bellier  FOROFFICIAL USEONLY CHINA HubeiShimanHighwayProject CONTENTS Page A STRATEGIC CONTEXT AND RATIONALE . ................................................................... 1 1. Country and sector issues.................................................................................................... 1 2. Rationale for Bank involvement ......................................................................................... 1 2 B PROJECTDESCRIPTION .3. Higher level objectives to which the project contributes .................................................... ................................................................................................... 2 1. Lendinginstrument ............................................................................................................. 2 2. Program objective and Phases ............................................................................................ 2 3. Project development objective andkey indicators.............................................................. 2 4. Project components ............................................................................................................. 3 5. Lessons learned andreflected inthe project design............................................................ 5 6 C IMPLEMENTATION .6. Alternatives considered andreasons for rejection.............................................................. ............................................................................................................ 7 1. Partnership arrangements (ifapplicable) ............................................................................ 7 2. Institutional and implementation arrangements.................................................................. 7 3. Monitoringand evaluation o f outcomesh-esults.................................................................. 8 4. Sustainability....................................................................................................................... . . . 9 5. Critical risks andpossible controversial aspects................................................................. 9 10 D APPRAISALSUMMARY .6. Loadcredit conditions and covenants............................................................................... ................................................................................................... 11 1. Economic and financial analyses ...................................................................................... 11 2. Technical........................................................................................................................... 12 3. Fiduciary ........................................................................................................................... 12 4. Social................................................................................................................................. 13 5. Environment...................................................................................................................... 14 6. Safeguard policies ............................................................................................................. 15 7. Policy Exceptions and Readiness...................................................................................... 15 This document has a restricted distribution andmay be used by recipients only in Itheperformance of their official duties I t s contents may not be otherwise disclosed . without World Bank authorization .  Annex 1: Country and Sector or Program Background ........................................................ 16 Annex 2: Major RelatedProjectsFinancedby the Bank and/or other Agencies ................24 Annex 3: Results Framework and Monitoring ........................................................................ 26 Annex 4: Detailed Project Description ..................................................................................... 35 Annex 5: Project Costs............................................................................................................... 46 Annex 6: Implementation Arrangements ................................................................................ 47 Annex 7: Financial Managementand DisbursementArrangements .................................... 49 Annex 8: Procurement ............................................................................................................... 56 Annex 9: Economicand FinancialAnalysis ............................................................................. 63 Annex 10: SafeguardPolicy Issues ........................................................................................... 84 Annex 11:Project Preparationand Supervision ................................................................... 101 Annex 12: Documentsinthe Project File ............................................................................... 103 Annex 13: Statement of Loans and Credits ........................................................................... 105 Annex 14: Country at a Glance ............................................................................................... 109 MAPS IBRD33072 IBRD32920 IBRD32921  CHINA HUBEISHIMANHIGHWAYPROJECT PROJECTAPPRAISALDOCUMENT EAST ASIA AND PACIFIC EASTR Date: May 25,2004 Team Leader: Michel Bellier Country Director: YukonHuang Sectors: Roads and highways(97%);Sub- SectorManagermirector: JitendraN.Bajpai nationalgovernment administration(3%) Themes: Infrastructure servicesfor private sector development (P);Rural servicesand infrastructure(P);Administrative andcivil service reform(P);Trade facilitation and marketaccess (S);Injuries andnon- communicablediseases (S) ProjectID: PO81749 Environmentalscreeningcategory: Full Assessment [XILoan [ ] Credit [ ] Grant [ ] Guarantee [ ] Other: For Loans/Credits/Others: Total Bank financing (US$m.): 200.00 RECONSTRUCTIONAND I I I DEVELOPMENT Total: 329.00 200.00 529.00 Borrower: People'sRepublic of China China ResponsibleAgency: HubeiProvincialCommunicationsDepartment No. 428, JianShe Ave. Hankou Wuhan Hubei  China 430030 Tel: (027) 8346-0753 Fax: (027) 8386-0754 projectoffice@hbjt.gov.cnn Estimateddisbursements(BankFY/US$m) FY 5 6 7 8 9 0 0 0 0 Annual 60.0C 60.0C 40.0C 30.0C 1O.OC 0.OC 0.OC 0.OC 0.oc Cumulative 60.0C 120.0C 160.0C, 19O.OC 200.0C 200.0C 200.0C 200.0C 200.0( Project implementation period: Start July 1,2004 End: December 31,2008 Expectedeffectiveness date: October 29,2004 Expectedclosingdate: June 30, 2009 Does the project depart from the CAS incontent or other significant respects? Ref. PAD A.3 [ ]Yes [XINO Does the project require any exceptions from Bank policies? Ref. PAD 0.7 [ ]Yes [XINO Have these been approved by Bank management? [ ]Yes [ IN0 I s approval for any policy exception sought from the Board? [ ]Yes [XINO Does the project include any critical risks rated "substantial" or "high"? Ref. PAD C.5 [ ]Yes [XINO Does the project meet the Regional criteria for readinessfor implementation? Ref. PAD D.7 [XIYes [ ]No Project development objective Ref. PAD B.2, TechnicalAnnex 3 The main objective of the project i s to support socioeconomic development of Hubei province by enhancing its access to other provinces, particularly the western region of China, improvinglocal mobility within poor, remote western parts of the province, and strengtheninggovernanceof the provincialroad sector. Project description [one-sentencesummary of each component] Ref. PAD B.3.a, Technical Annex 4 The project has three components: highwaycapacity investment (the SME), the LocalRoad Improvement Program (the LRIP), and institutionalstrengthening, policy development and road safety initiatives. These activities aim to strengthenHPCD's capacity to manage the provincial highway network efficiently and improve the sustainability of provincialhighway sector financing. Expected improvements inthe quality of roads will leadto lower transport costs throughout the province and lower life-cyclecosts for roadmaintenance. Adopting more efficient practices for managing road will promote effective use of public funds, thereby enhancing the contribution of the highway network to economic development and its responsivenessto social needs. Finally, roadtraffic safety initiatives will reduce accident rates, thereby saving lives and addressingnegative road impacts. Which safeguardpolicies are triggered, if any? Ref. PAD D.6, TechnicalAnnex 10 Environmental Assessment (OP/BP/GP 4.01) Cultural Property (OPN 11.03, beingrevised as OP 4,ll)Involuntary Resettlement (OP/BP 4.12)  Significant, non-standard conditions, if any, for: Ref. PAD C.7 Boardpresentation: Loadcredit effectiveness: Issuanceof acceptable legal opinions Covenants applicable to project implementation: - Quarterly reports on the progress of S M E andLRIP works and highlightingany environmental issues. - Annual report on results of monitoringandevaluation activities andprogressof the project. - Semi-annual and annual environment monitoringreports. - Semi-annual and annual internal resettlementmonitoringreports, and semi annual and annual external resettlement monitoring reports. - Analysis andrecommendations on the structure of toll rates on the S M Eby June 30,2007. - Operations risk managementplanon the S M E by December 31,2007. - Social assessment and if necessary Resettlement Action Plan andEthnic Minorities Development Plan on eachLRIP road section. - Annual report on training activities by January 31of each year commencing inJanuary 2005. - Study on group managementof projects by January 31,2006. - Study on new technologies inmaintenanceby June 30,2007. - Study on capital mobilizationby December 31,2007. - Pilot study on expressway asset managementby December 31,2007. - Study on the safety of commercial transport operations by December 31,2007. - Highway safety managementplanby December 31,2007.   A. STRATEGICCONTEXTAND RATIONALE 1. Countryandsector issues Despite the significant expansion of China's National Trunk Highway System (NTHS) in support of domestic market integration since the 1980s, the road network i s sparse and logistics costs are high compared to developed countries because of inadequate modal integration and service sector response. Furthermore, western and central regions continue to suffer from poor accessibility, causing isolation andincome inequality. Finally, sector governance at both national and provincial levels needs strengthening to make institutions responsive to market needs for transport services, able to better manageroad assets, develop a sustainable financing mechanism, and address externalities of the sector such as safety and environment. The length of Chinese highway has doubled since 1980, reaching 1.76 million km in 2002. Yet the highway network remains one of the sparsest inthe world (0.19 kmper square km) and does not meet trade and transport needs. Logistics costs in China, at 18 percent of GDP (2000), are high in comparison to developed countries like the United States (9.5 percent in the mid-l990s), and transport costs make up about 50 percent of logistics costs-twice the percentage of those in developedeconomies. Despite China's accomplishments in reducing poverty in the past 20 years, more than 200 million people still live on less than $1 a day. In addition, economic growth has not been equally distributed among China's regions-the per capita income in the 12 western and central provinces i s less than half that in the coastal provinces. Many people in the lagging regions lack access to basic health and education services becausetransport infrastructure i s inadequate. China has increased road sector funding significantly in recent years-to approximately $167 billion during 1997-2002. However, current funding sources-taxation and issuance of public debt-cannot meet demand for the highway network, and these modes of financing are not sustainable. China is likely to face major reconstruction costs in the future if funding for periodic maintenance continues at the current low level. Provincial communication departments need to transform themselves into managers of road assets providing more cost-effective construction and operation services to roadusers. Finally, the combination of fast expansion of the highway system, increasing traffic, and a lack of coordinated safety efforts led to almost 110,000 traffic fatalities in 2002, three times the U.S. figure but with a fraction of the number of vehicles. Without improved safety measures, fatalities are estimated to increase by more than 90 percent inthe next 20 years. 2. Rationalefor Bankinvolvement The Bank's involvement in the highway sector at the provinciallevel aims at: sharing global knowledge and improving provincial road sector governance in resource management, project selection, design and quality of execution, asset management, externality management (safety and environment), and sector regulations to better serve emergingmarket needs; and supporting the government's effort to develop western and central provinces by further integrating these economies with the rest of the country.  The Bank's steady involvement over time is essential for improving the province understanding o f highway management issues and building institutional capacity and ownership for change, so that best practices can have demonstration effect on other provinces. This project builds on the results o fthe three previous Bankprojects inthe Hubeihighway sector. 3. Higher level objectivesto which the projectcontributes The Bank's Country Assistance Strategy for China calls for: 0 improving the business environment and helping accelerate the transition to a market economy; 0 addressing the needs o fpoorer and disadvantaged people and regions; and 0 facilitating an environmentally sustainable development process. Furthermore, the Country Assistance Strategy identifies the strengthening o f regional integration and competitiveness through a well-functioning multimodal transport system as a key objective, entailing the facilitation o f trade and support to the development o f lagging western regions. Within that framework, the Bank's highway strategy is to help the government meet its transport sector objectives and at the same time support the achievement o f the Millennium Development Goals. The project will facilitate trade, support China's transition to a market economy, address the transport needs o f less-developed areas, and help open up western provinces by increasing road capacity to meet demand for road transport and enhancing the efficiency o f the highway sector. B. PROJECTDESCRIPTION 1. Lendinginstrument The Bank will finance the project through a specific investment loan. The Borrower has selected the variable-spread loan (VSL) option in which the spread over LIBOR i s reset every semester. The Borrower's mainreason for selecting a VSL rather than a fixed-spread loan (FSL) is because FSL charges are slightly higher than VSL charges and because the Borrower does not foresee using the conversion options o f the FSL. VSL repayment terms are govemed by standard country terms. 2. Programobjectiveandphases Not applicable 3. Projectdevelopmentobjectiveand key indicators The main objective o fthe project i s to support socioeconomic development o f Hubeiprovince by enhancing its access to other provinces, particularly the westem region o f China, improving local mobility within poor, remote westem parts o f the province, and strengthening govemance o f the provincial road sector. The project will produce the following outputs: The construction o f Shiyan-Manchuangan Expressway (SME), which will increase transportation capacity ina corridor connecting Hubeito westem provinces. 0 A program o flocalroadimprovements (LRIP) inthe poor northwesternpart ofHubei. 0 A series o f institutional strengthening and policy development activities for road management and improvements inroad safety inHubei. 2  The following key results indicators havebeen selected: 0 SME: traffic levels on the expressway and on the parallel national highway (NH316); percentageof long distance traffic andbreakdown by users category on SME. 0 LRIP: average daily traffic, transport costs and daily bus-services on improved local roads, numbers of days they are closed, GDP per capita, employment rate and population underpoverty threshold inareas servedby LRProadsections. 0 Institutionalactivities: -Increasedskills of HubeiProvincialCommunication Department (HPCD) staff through skills assessment -Adoptionofassetmanagementprinciples ensuringbetter managementofHubei expresswaynetwork -SustainablemodelforfinancingtheHPCDroadnetwork -Adoptingnewtechnologiestoimprovetheefficiencyandeffectivenessofhighway management and operations -Improvedmanagementofnewhighwayprojectsthroughinstitutionalchanges -PercentageofClass1andClass2roadssystematicallytreatedinaccordancewiththe HPCD safety managementplan -Percentageofroadfreightandpassengertransportenterprisessystematicallyscreened in accordancewith the safety review processes. 4. Project components The project has three components: highway capacity investment (the Shiyan - Manchuangan expressway), the Local Road Improvement Program, and institutional strengthening and policy development and road safety initiatives. These activities aim to strengthen HPCD's capacity to manage the provincial highway network efficiently and improve the sustainability of provincial highway sector financing. Expected improvements in the quality of roads will lead to lower transport costs throughout the province and lower life-cycle costs for road maintenance. Improved sustainability of financing will promote effective use of public funds, thereby enhancing the contribution of the highway network to economic development and its responsiveness to social needs. Finally, road traffic safety initiatives will reduce accident rates, thereby saving lives and addressingnegative roadimpacts. Highway Capacity Investment (US$414.88 million) The project will improve highway capacity innorthwestem Hubei province with the construction of the 105.1 km long Shiyan - Manchuangan expressway (SME) between Shiyan in northwestem Hubei and the border with Shaanxi province. In Shiyan, S M E will link to the Xiangfan-Shiyan (Xianshi) Expressway, which opened for traffic in December 2003, thereby completing the corridor between Hubei capital, Wuhan, and Shaanxi. There S M E will connect to an expressway section planned to reach Xi'an, the Shaanxi capital, and eventually Yinchuan in Ningxia province farther north. S M E will support and integrate urban and rural economic activities in Hubei. Moreover, S M E will facilitate interregional trade and passenger movement to and from western provinces by makingshorter itineraries possible, thus reducing transport costs for long-distance traffic. 3  Local Road Improvement Program (US$50.70 million) The LRIP aims to improve the competitiveness of the local economy and bring socioeconomic benefits to roadside communities by enhancing people's mobility and ability to access education, health, and other social service. A series of Class 111, Class IV and unclassified roads will be rehabilitated or upgraded in Shiyan City, which i s comprised of several poor counties, in a remote area in the mountainous northwest of Hubei province. That area was selected becauseof the low-income (in 2002 GDP per capita was RMB 2,201 [US$266] outside urbanized zones in 2002, 26 percent of the provincial average), the condition of local roads, the high priority the province gives to improving accessibility in this area, and the potential for leveraging the benefits of the SME, which will traverse Shiyan City. The LRPcomponent will have two phases. The first phase, estimated to cost $21.3 million, has been identified: the upgrading of Baoxia-Zhushan road (85 km) to Class I11standard and the construction of the Jiangjunhe bridge over the Han River. Additional local road sections comprised into a secondphasewill be identifiedduring project implementation. Institutional strengthening, policy development and road safety (US$6.36 million) The Bank has supported a number of institutional strengthening and roadmanagement initiatives in its ongoing highway projects in Hubei province, and this project will build on that work. It will assist HPCD in adopting more efficient practices for managing the road network. The following activities will be undertaken: Trainingprogram. The project will finance a program of domestic and overseas training for staff from HPCD, dependent organisms, and entities involved in the project, in areas identified during a training-needs assessment review, with the support of the Hubei Communications Technical College (HCTC). Pilot study on expressway asset management. HPCD will pilot-test total asset management for an expressway. This study will cover the complete range of asset management issues, address the applicability of asset management in Hubei Province, and identify the steps necessary to implement that approach on the entire HPCD road network. Capital mobilization study. This study will determine a strategy for mobilizing capital for meeting highway sector needs for construction, maintenance, and management at 5-, lo-, and 20-year horizons. Study on new technologies for road maintenance. This study will identify and test technologies that offer possibilities for improving the quality and efficiency of road maintenance. Study on Expressway Project Group Management. This study will investigate ways for the HPCD to improve the efficiency of executing large projects by consolidating activities, streamlining operations, or usingnew IT solution. HPCD safety managementplan for Class 1 and Class 2 roads. The project will prepare an HPCD safety management plan that sets out its road safety goals, objectives, policies, and priorities for Class Iand Class I1 roads and the organizational processes and measuresthat it i s taking to effectively implement them. 4  Safety review processfor road freight and passenger transport enterprises. The project will develop a safety review process for road freight and passenger transport enterprises inHubei Province, specifying mandatory safety requirements, proceduresandmonitoring arrangements for the granting, continuation and removal of freight and passenger transport operating licenses. Procurement of equipment. The project will procure equipment for (i)construction quality control and environmental monitoring, (ii) operation and maintenance of S M E after opening and the highway network, (iii) strengthening the institutional capacity of HPCD. 5. Lessons learned and reflected inthe project design Operation Evaluation Department (0ED)'s assessments of the Bank's highway portfolio in China highlight a high level of client satisfaction with investment components that have contributed to the fulfillment of many of the sector and macroeconomic objectives of the Bank's assistance strategy. Nevertheless institutional initiatives of projects undertaken with provinces have hadless impact. Issues with coordination among ministries and levels of governments, such as for road safety matters, have been found especially detrimental to the policy agenda. OED's evaluation and the Bank's earlier road projects also have found issues with the design of some projects. The following lessons are reflectedinthe designof the current project. Develop innovations in project design. The development and testing of an asset management approach on part of the provincial expressway network could introduce a way for road agencies to transform themselves into policymakers and regulators. Ensure client ownership of institutional components. HPCD has built on its experience under the ongoing highway projects to determine the priorities of the institutional strengthening, policy development, and road safety component. For example, the asset management study draws on the results of a roadmaintenance study and the development of roadinformation systems funded by the Bank. Avoid giving sole priority to the construction of expresswaysbecause that affects provinces' financial capacity to improve roadaccessibility in poor areas and the condition of existing roads. S M E will serve a remote and less-developed area of Hubei province and the LRIP will rehabilitate andupgrade lower-class local roads inone of the poorest areas of Hubei. Avoid design changesand variations during construction. In many past projects in China, the technical complexity of highway construction and operation was underestimated, which led to substantial cost overruns and construction delays. To address technical risks, especially high for SME, which will cross a mountainous area, HPCD has followed a highly interactive process in designing alignment alternatives, assessing technical, environmental, and social impacts, and cross-validating design results by engineering firms and other experts. Implement resettlement operations on time. HPCD established the project resettlement organization at the beginning of feasibility studies and carried out comprehensive field surveys to prepare the resettlement action plan (RAP), and resettlement operations have started. Avoid setting toll rate levels too high. High toll rates deter would-be users from diverting from other roads to the toll expressway and affect the economic and financial viability of the project. During preparation, an economic and financial evaluation of the impact of toll rates on the 5  project's economic return concluded that the rate considered by HPCD, U S cents 6.02 per km, is inthe rangeof similar projects inChina (see SectionD.1andAnnex 9 for more details). Internalize and disseminate study recommendations. HPCD and the Bank held an in-depth dialogue during project preparation that led to a good understanding of issues and of how to tailor the scopes of institutional studies. The studies are a compromise between improved approaches with potential for scaling up (asset management study and road safety management plan) and pragmatism aiming to take the local situation and institutional constraints into consideration. 6. Alternatives considered and reasons for rejection Project objectives. To enhance development impact, the scope of the project includes a local mobility component for poor areas and a program of institutional strengthening and road safety initiatives along with the originally proposed expresswayconstruction. S M E design. At the request of the Bank, HPCD compared a Class Ior I1highway alternative to the expresswayoption. HPCD retained the expressway standards for the following reasons: Maintain consistency with sections already built or planned on the rest of the Wuhan- Yinchuangan corridor, which serves provincial capitals; Meet the medium- to long-term demand forecast by HPCD (and confirmed by a Bank study), although lower standards may be sufficient inthe first years of operation; 0 Avoid revisitingthe long-termneed for an expressway, when building a Class Ior I1road instead of an expressway saves relatively little compared to overall construction costs because of the mountainous terrain and other topographic constraints; 0 Maintain the project's economic benefits, which will be achieved only with higher (expressway) vehicle speeds. HPCD also assessed the feasibility of a phased construction of SME. However, doubling the numerous tunnels and bridges in the mountainous terrain and organizing civil works with traffic on the completed carriageway would pose technical challenges and raise costs. Furthermore, attempts to phase works inother provinces have increasedroadaccidents significantly. S M E alignment. In the feasibility study, HPCD compared two main corridors: one along the valleys where the existing provincial Class IIhighway runs, and a more direct alignment across remote and less-populated areas more to the south. The first alternative was found to be a better compromise in terms of servicing urban areas and reducing environmental impact and investment costs. Furthermore, HPCD and its design institutes have progressively refined the alignment of the S M E through several rounds of identifying and comparing alternatives according to economic, technical, financial, environmental, and social criteria. Private financing. S M E will be a toll facility and will generate income from users. HPCD discarded the private financing alternative at the feasibility study stage because the financial assessment showed that the project could not be viable without a large government contribution to investment costs; the level of traffic expected at opening and during the early years of operation is too low to make project returns high enough to attract private investors. Thus, HPCD made the decision to provide the infrastructure from public funds, establish a 6  government-owned company to operate the expressway, and pursue the possibility of commercializing the asset when income increases. Area for the LRIP. HPCD decided to improve rural road sections in Shiyan City, a poor and remote area in western Hubei Province because the other area where development lags-Ens'hi prefecture-has benefited in the past three years from significant highway investments under national programs to support westernregions. Institutional strengthening, policy development and road safety. The main institutional alternative considered was to apply asset management to the full HPCD network and use the results to prepare a business plan for HPCD. Although this i s a desirable outcome, the Bank and HPCD decided it was too difficult for HPCD to undertake in a single step. Pilot-testing asset management while conducting complementary studies will bring together efforts and greatly improve HPCD's management of the network. As for road safety, the following alternative components drawing on outputs of ongoing projects were appraised, taking into account the acknowledged need for a long-term vision and strategic objectives for safety improvements in the province: safety at road-works sites, safety audit procedures for improved road management, road safety villages, speed monitoring tools for expressways, and truck and bus safety. The first three were rejected as duplicative of previous projects' objectives, and the fourth because it did not fit comfortably within the scope of HPCD's responsibilities and spheres of influence. Furthermore, a highway safety managementplan component was addedto integrate and optimize the safety components of previous and ongoing projects andbringthe necessarylong-term vision and strategic focus to HPCD roadsafety initiatives. C. IMPLEMENTATION 1. Partnershiparrangements(ifapplicable) Not applicable. 2. Institutionalandimplementationarrangements HPCD, the provincial agency responsible for road management in Hubei will implement the project. The Bank-Financed Project Office (WBFPO), an HPCD department that has worked on three ongoing Bank-financed highway projects, i s responsible for coordinating project preparation and will remain the Bank's main counterpart during implementation. Similar arrangementshave proven effective under the previous projects. HPCD has created a dedicated project headquarter, the Hubei Provincial Shiman Expressway Construction Headquarter (HPSECH), to implement and manage the SME. HPCD has also established the Hubei Provincial Shiman Expressway Company Ltd. (HPSEC) to operate the expressway after its opens; HPSEC will assist HPSECH during the project implementation. HPCD has hired experienced domestic design institutes to carry out SME design studies. HPSECH, as the client and project management office, will manage construction works with the assistance of a supervision organization made up of domestic firms and an international consultant. HPSEC will take over the operations of S M E after it opens. With respect to resettlement, a dedicated Hubei Expressway Resettlement Office (HERO) has been established and will lead resettlement operations under the oversight of the provincial resettlement leading group. The HERO has prepared the Resettlement Action Plan (RAP). The resettlement organization also comprises resettlement local units established along the alignment with local governments at City, countyhanner, and township levels, whose staff will receive 7  training under the project. Other provincial agencies will also be involved according to their responsibilities. HPCD will issue regulations for the approval and use of resettlement funds and streamline the payment process to avoid the allocation of funds to other purposes. On environment, the Environmental Management Plan (EMP) includes the practical and cost- effective measures necessary to mitigate project-related impacts and specifies monitoring plans, training, institutional arrangements, implementation schedule, and budget needs. An environmental unit of HPCD will supervise the implementation of the EMPs with the cooperation of environmental protection agencies during construction. The Borrower has developed ample in-house capacity to address environmental issues under previous projects. With respect to the LRIP, the HubeiProvincial Highway Administration Bureau (HPHAB), the HPCD agency in charge of managing the provincial highway network, i s responsible for identifying and preparing specific projects with the assistance of a design institute selected on S M E for design issues and WBFPO for safeguard issues. HPHAB has designated the Shiyan City Communications Bureau (SCCB) as the implementing entity for the LRIP. For the procurement of contractors this bureau will report directly to HPSEC which is preparing tender documents. SCCB will be assisted by domestic firms for the supervision of works. The implementation of EMPs prepared on each road section will also be supervised by the environmental unit of HPCD under the oversight of the WBFPO. Finally, the WBFPO is preparing the institutional strengthening, policy development, and road safety component and will coordinate the implementation of these activities. Other HPCD units may contribute to some of them. The Bank loan will be signed between the People's Republic of China and the Bank through the Ministry of Finance (MOF), and on-lending arrangements will be signed between MOF and the Government of Hubei Province. Hubei Provincial Finance Department (HPFD) will make funds available to HPCD and one special account will be established at HPFD. The Bank's financial management assessment concluded that the project will have in place an adequateproject financial management system. 3. Monitoringand evaluation of outcomes/results Under the coordination of WBFPO, monitoring and evaluation data will be collected by HPCD or other project agencies during project implementation, with the assistance of firms hired specifically for some instances. Baseline information and target values were agreed with HPCD during preparation (see Annex 3). Result indicators and their evaluation, when required, will be provided to the Bank in the annual progress reports that HPCD will prepare. No task will entail specific costs to be financed by the project S M E HPSEC will provide information about the progress of S M E works. The WBFPO will coordinate the collection of traffic data, to be provided by HPHAB for counting stations on highways and by HPSEC for S M E after it opens to traffic. Environmental monitoring will be entrusted to the environment unit reporting to WBFPO, which i s also responsible for coordinating the preparation of information on resettlement required by the RAP; in addition, HPCD will hire an external resettlement monitoring entity. 8  LRIP Indicator data will come from three sources: 0 WBPFO for overall implementation indicators andcivil works progressreports 0 Stations managedby HPHABor local communications authorities for traffic count 0 Provincial statistics bureau or county statistics bureau for social indicators. Institutional strengthening, policy development,and roadsafety WBFPO will provide monitoringresults for all activities. 4. Sustainability The sustainability of project financing is ensured by the strong support from both Hubei provincial government and central government agencies, including the Ministry of Communications (MOC), National Development and Reform Commission, and MOF. The project i s specified in Hubei province's Tenth Five-year Plan and has been approved by the provincial government. S M E i s also included in one of the eight high-priority expressway corridors planned by MOC to foster the development of western provinces and therefore will benefit from an MOC grant. Finally, the State Council approved the project feasibility study in February 2004. HPCD has assembleda strong team to prepare and implementthe project. HPSECH, responsible for S M E and overseeing the procurement of LRIP works, i s managed by experienced staff transferred from the Xiangfan - Shiyan Expressway headquarters. Finally, the WBFPO, responsible for institutionalactivities, has very good experience with Bank-financed projects. Toll revenues are expected to reimburse the debt incurred to finance SME, which representsthe bulk of project costs. Ingeneral, the level of maintenanceof toll highways financed by the Bank at openinghas been adequate for initial volumes of traffic, andincreasing operating expenses can be financed easily from toll income when traffic grows. Furthermore, the financial assessment has concluded that toll income will be sufficient to service S M E debt. 5. Critical risksand possiblecontroversial aspects Events may adversely affect Hubei province's ability to meet project financial commitments. Nevertheless, experience from completed and ongoing Bank-financed highway projects indicates that counterpart funds for capital investment components are generally available on time. In addition, the Bank conducted a comprehensive financial analysis of the project and reviewed HPCD's budget forecasts duringproject preparation. The risk that the expressway section in Shaanxi province reaching the border with Hubei is not constructed on time i s mitigatedby the province's confirmationthat it plans to open that section at the same time as SME, as well as by MOC support. Special attention has been given to traffic risks on SME, of special concern for this project because another expressway between Xi'an and Hefei through Henan i s planned and will run about 150 km north of SME. Many feasibility studies from other expressway projects have made optimistic traffic forecasts and overestimated diversion rates from alternative roads. However, HPCD traffic forecasts were thorough and based traffic projections on the current situation, past development, best estimates of future provincial and national economic trends, and planned network capacity investments. In addition, a Bank-hired consultant assessed traffic studies 9  preparedby Hubei and Henan provinces for the Xi'an-Wuhan-Hefei corridor and concluded that Hubei's assumptionsfor traffic growth anddiversion ratesto SME are acceptable. To address the risk that design standards and cost estimates of S M E are not relevant, HPCD conducted the preliminary design on a larger scale than usual on the basis of detailed geotechnical investigations. Specific traffic safety risks, due to the long, steep and curvy slopes found in mountainous sections, will be addressed by emergency facilities, like parkingbays or emergency deceleration gravel bed and reinforced signaling. Fire risks in the long tunnels will be mitigated by a series of design features, specific equipment and through operating procedures agreed with fire fighters. To identify resources required for managing the expressway and address operating risks, HPCD will prepare an operations risk management plan. Experts hired by HPCD and the Bank successively reviewed the engineering design before appraisal and confirmed the relevance of design options, and tendering documentation i s based on the completed detailed engineering design. The financial evaluation confirmed that toll income will generate enough revenue to finance S M E operation and maintenance and allow HPCD to repay the loan. Furthermore, HPCD has confirmed its full financial support to the expresswaycompany. On institutional activities encompassing policy development, especially the expressway asset management initiative and road safety management plan, the risk of ineffective implementation i s reduced as study goals have been determined by HPCD and discussions with the Bank have identifiedrealistic objectives. 6. Loadcredit conditions andcovenants The effectiveness condition is the issuanceof acceptable legal opinions. The legal covenants specify the following stipulations: 0 The proceeds of the loan will be on-lent to Hubei Province on the same terms and conditions as the Bank loan, with the province bearing the foreign exchangerisk. 0 The following reports will be submittedto the Bank for its approval andcomment: -ForSME o EMPandRAPon S M E andconnecting roads. o Quarterly reports on the progressof works and any environmental issue. o Analysis and recommendation on the structure of toll rates on SME by June 30, 2007. o Operations risk managementplanbyDecember 31,2007. -ForLRIP o Beforecommencing works on any rural roadsection >>> An EIA andEMP Incase landacquisition is required, aresettlement action plan A social assessment to determine the necessity of a Ethnic Minority Development Plan (EMDP), and if necessary,the EMDP. o Quarterly concise reports on the progressof works and any environment issues. o Assessment of the social impacts of the LRIPby December 31,2008. -Forinstitutionalstrengthening,policydevelopment,androadsafetycomponent o Annual trainingreport. 10  o Study on expressway group managementof projects by January 31,2006. o Study on new technologies inmaintenanceby June 30,2007. o Study on capital mobilizationbyDecember 31,2007. o Pilot study on expressway asset managementby December 31,2007. o Study on the safety of commercial transport operations byDecember 31,2007. o Highway safety managementplanby December 31,2007. -Reportingandmonitoring o Semiannualenvironmental monitoringreport o Semiannual and annual internal and independent monitoring reports of the resettlement activities o Semiannual progress reports on the implementation of all project components. o Annual monitoringand evaluation report of project implementation. 0 Hubei Province must maintain a financial management system and provide semiannual unaudited project consolidated financial statements in accordance with accounting standards acceptable to the Bank. Hubei Province also must meet standard annual auditing requirements. D. APPRAISAL SUMMARY 1. Economicandfinancial analyses Economic (Cost benefit) ERR = 16.9%; NPV =US$222.6 million The economic evaluation covered two project components: the 105.1kmSME and the first phase of the LRIP. The principal measuredbenefits of the project are savings in vehicle operating costs (VOC), time savings for vehicle occupants, and enhanced road safety. The estimated overall economic internal rate of return (EIRR) for the project i s 16.9 percent. The ERR for the S M E is 16.5 percent and for the LRIP, 24.3 percent. The overall economic net present value (NPV), based on a 12 percent discount rate, i s estimated at RMB 1,847.5 million, of which the S M E is estimated to contribute RMB 1,795.7 million and the LRIP, RMB 244.2 million. The expected traffic on the S M E in 2009 ranges from AADT 3,674 to 6,329 assuming ari annual growth rate of five percent until 2009. The evaluation results are summarized inthe following table. Summary of Economic Evaluation Results EIRR ("A) NPV (RMB million,12%) SME Section 1: Shiyan-Yunxian 14.4 211.3 Section 2: Yunxian-Yunxi 16.5 767.2 Section 3: Yunxi-Manchuanguan 17.5 755.9 Subtotal 16.5 1,795.7 LRIP 24.3 244.2 Total 16.9 1,847.5 A detailedassessmentanda description of the methodusedare providedinAnnex 9. 11  Financial FIRR= 1.1%; NPV=US$ -152.3 million S M E construction constitutes about 91 percent of total project cost. HPCD i s planning to use the toll revenue from S M E to cover amortization charges of the Bank and domestic loans. Although the highway will generate enough total revenue over the loan period to finance operations, maintenance, and debt service, profits will be low in the early years of operation. The traffic levels at project opening combined with high construction costs (because of the mountainous terrain) affect the financial rate of return of the investment, expected to be about 1.1 ercent. As the proposed toll rate is in the upper range in China and its affordability rate compares P unfavorably to other countries, increasing it further would adversely impact traffic diversion to SME. For the non-revenue-earning LRIP, the financial evaluation confirmed the availability of sufficient counterpart funds and the capacity of HPCD to finance operating expenses. All indicators show that financial risks are modest. A detailed assessment i s providedin Annex 9. 2. Technical S M E design and standards are the result of in-depth technical and traffic studies reviewed by the Bank; standards have taken into consideration the difficult mountainous terrain of the project area. The following issues need special attention from a technical point of view: proper review of traffic safety and fire hazards introduced in the final design and development of an operations risk management plan, especially given the long steep slopes andnumerous tunnels; sufficient geological investigations on technically challenging locations to minimize the risk of encountering major problems at the construction stage, given the mountainous terrain; and fully operational electrical andmechanical works at the opening of the highway to traffic, especially given the length of tunnels. The design was reviewed by an international consulting firm under a Spanish Trust Fund grant and was found satisfactory. Cost estimates reflect December 2003 prices and are based on the latest available engineering studies, prevailingunit rates for civil works checked against effective rates in similar works under Bank-financed projects in Hubei and other provinces in China, recent costs of foreign experts from highway projects, and recent price quotations for equipment. Costs also include physical contingencies, calculated at 8 percent of the baseline cost of civil works, and price contingencies at 4.9 percent of all baseline costs (excluding land acquisition) on the basis of forecasts of domestic andforeign inflation rates during project implementation. 3. Fiduciary Financial Management The Bank concluded, on the basis of guidelines issued by the Financial Management Sector Board June 30, 2001, that the project meets minimum Bank financial management requirements (stipulated in BP/OP 10.02). The assessment found that the project will have in place a project 'To assess toll rates and quantify toll affordability for road users, the Bank has developed an affordability indicator. The rate is the cost for a private car to travel 1,600 kmon toll roads as apercentageof the average annual income per person. A higher value means that the toll level is less affordable and will discourageuse of the road. 12  financial management system that can provide, with reasonable assurance, accurate and timely information on the status of the project in the reporting format agreed with the Bank (see Annex 7). Procurement A procurement capacity assessment of the implementing agencies was carried out during appraisal (Annex 8). The assessment concluded that the overall risk of the procurement process i s average. HPCD and dependent involvedentities have allocated adequate resources, including experienced staff, to implement the project. These agencies are familiar with Bank procurement procedures. An action plan to strengthen the procurement capacity of the implementing agencies has been discussed with HPCD and agreed on. The plan calls for the preparation and dissemination of a project-specific procurement manual, training workshops, and measures to avoid excessive cost overruns and improve procurement economy and efficiency. Ways in which the Tendering and Bidding Law (TBL) of China differs from Bank guidelines were addressed in the assessment, and clarifications for the procedures to be followed for Bank-financed NCB procurement have been included into the Loan Agreement. 4. Social The major social impacts of the project stem from land acquisition and residential demolition associated with S M E construction. The project will affect 46 villages and 9 townships in 4 counties or districts, through (i)the permanent acquisition of 12,605 mu (840 hectares) of land. In addition, structural demolition of private residential housingi s expectedto total 41,256 square meters, with 1,619 households (6,699 individuals) affected. A total of 3,683 households with 14,477 individuals will be affected only by land acquisition. A detailed landreclamation plan has been designed. It calls for the use of construction waste materials to create new landequaling 43 percent of the required farmland. HPCD preparedthe RAP to mitigate resettlement impacts. It summarizes applicable policy principles and regulations, determines measures for restoring the income of affected people when necessary, compensation rates, and the resettlement budget; it also identifies institutionaland monitoring arrangements. The upgrading of the LRIP road sections is not expected to involve land acquisition or house demolition. Nevertheless, HPCD has prepared a resettlement policy framework, and a RAP would be developed for any road section that might end up requiring land acquisition A social assessment has beenconducted by BeijingUniversity on the SME and first phase of the LRIP. It has not found any minority community affected by the expressway, and therefore no Ethnic Minorities Development Plan (EMDP)is required.. Social assessments will be carried out on the second-phase road sections for LRIPwhen they have been selected. If an assessment finds that national minority communities are affected, EMDPs will be prepared. Information dissemination. The RAP, social assessment, and resettlement policy framework were advertised in the major local newspaper, Changjiang Daily, on January 13, 2004. Information is also available at the Hubei provincial library, in local counties served by the project and at Shiyan county public library. Project information has beenprovided to the affected villages through newspaper reports, posters, and public meetings. A resettlement information booklet will be distributedto affected people before resettlement operations. 13  Participation strategy. During project preparation, village committees and farmer groups were consulted about the planning of resettlement operations, among other things. Local views on resettlement impacts and preferred mitigation measureswere taken into account in the RAP, and the majority of potentially affected persons agree that rehabilitation measureswill be adequate. Local banks in each county will be involved in the implementation of resettlement operations and will supervise the use of land compensation funds. The resettlement program will be monitored regularly, and the living standards of project-affected people will be evaluated during the course of project implementation. Internal and independent monitoring reports will be preparedtwice a year. 5. Environment The project involves major expressway construction on a new alignment, at-grade connecting roads to be upgraded partially on a new alignment and partially on existing ones, and the rehabilitation of local roads. The environmental impacts will involve occupation of both fertile and barren land by the expressway; an increase in dust, noise, and motor vehicle emissions; disposal of excess waste material; community severance; soil erosion; resettlement; and safety. Alignment selection. DuringS M E design, three long distance corridors were evaluated to select the most environmentally and socially benignalignment in Hubei. The selected corridor had the least land occupation andresettlement; relatively stable geology with lower soil erosion; and the least cuts and fills, resulting in minimal disturbance and lower disposal requirements. The corridor hadalso received the widest support from local people and governments. Within the selectedcorridor, two alignments were selected and compared according to technical, economic, environmental, cultural property, political and social factors. The preferred alignment was selected considering less soil erosion, land requirement, biodiversity impact, biomass disturbed, river crossing and in-water construction, cuts and fills, and tunnels resulting in less disposal material, and low impact on culturalrelics. Nonetheless, the alignment has a higher number of sensitive receptors to noise and higher numbers of housing relocation and displaced persons. However, it will result in less community severance and social impact during construction and operation and has received more support from local governments. To further minimize environmental and social impacts, nine sub- alignments were identified, analyzed, and compared with their corresponding main-line sections. Inthe final analysis, some sub-alignments were selectedbecausethey: (i) minimized disturbance to the existing highway (G209); (ii) shifted the alignment away from the Qinglongshan dinosaur egg reserve; (iii)accommodated the growth needs of Qingqi township while reducing resettlement; and (iv) reduced spoils, avoided unstable geological condition, and reduced land occupation. As regards the LRIP, rehabilitation works will involve strengthening and minor widening and realignment of existing roads. Public consultation. A first round of public consultation followed the preparation of the terms of reference for the environmental assessment (EIA), and a second round took place during the preparation of the draft of the EIA. The public participated either through filling in one of the 2,759 questionnaires or by attending one of the 21 public meetings or 85 group interviews. Appropriate compensation for land acquisition, resettlement and relocation; timely rehabilitation andor restoration of damaged irrigation systems; construction safety; noise at schools; better 14  access to and exits from SME; and sufficient passagewaysto cross the expressway were some of the main environmental and social concerns that the public had. The rural public was concerned about road blocks and access to services during road works, as well as the safety of studentsand convenient links with access to SME. Project design responded to these concerns by: (i)developing plans for irrigation system restoration; (ii)conducting public education programs and erecting warning signs for construction safety; (iii)constructing passageways and crossings for pedestrians and farm vehicles at about every 740 m to mitigate community severance; (iv) installing safety barriers at selected locations along the rural road to provide protection to students, residents, and livestock; (v) installing noise insulation windows and plantingtrees to minimize the impacts of noise; and (vi) situating access ramps and interchangesinthe most practical places. To mitigate environmental concerns, the stand-aloneEnvironmental Management Plan (EMP) on S M E includes environmental standards, mitigation measures, monitoring plans for the construction and operation phases, health and safety measures including to detect and control possible diseases (SARS, HIV...) on the construction field, and an environmental training and institutional building and strengthening plan. The implementation of the EMP will be supervised by the Environmental Office of the Ministry of Communications, HPCD, the WBPFO, and HPSEC. The State Environmental Protection Administration and the local Environmental Protection Bureaus inthe project area will also monitor EMP implementation. EMPspreparedon each local road also include mitigation measures on noise, soil erosion, surface water and air pollution, health and safety, and monitoringplans. 6. Safeguard policies Safeguard Policies Triggered by the Project Yes No Environmental Assessment (OP/BP/GP 4.01) [XI [ I Natural Habitats (OPBP 4.04) [ I [XI PestManagement (OP 4.09) [ I [XI Cultural Property (OPN 11.03, beingrevised as OP 4.11) [XI [ I InvoluntaryResettlement (OP/BP 4.12) [XI [ I Indigenous Peoples (OD 4.20, being revised as OP 4.10) [ I [XI Forests (OP/BP 4.36) [ I [XI Safety of Dams (OP/BP 4.37) [ I [XI Projects inDisputedAreas (OPBP/GP 7.60)* 11 [XI Projects on International Waterways (OP/BP/GP 7.50) [ I [XI 7. Policy Exceptions and Readiness The project will comply fully with Bankpolicies. The project meets regional criteria for implementation. * By supporting theproposed project, the Bank does not intend to prejudice thefinal determination of theparties' claims on the disputedareas. 15  Annex 1: Country and Sector or ProgramBackground CHINA: HubeiShiman Highway Project Country and sector issues Studies undertaken by the East Asia and Pacific Region and Operations Evaluation Department of the Bank in the past five years have highlighted several issues in the highway sector in China: capacity bottlenecks in the highway network affecting its ability to meet increasing transport demand; difficulties created by geography hindering the provision of basic road access, particularly in poor inland areas and western provinces; the prospect of insufficient funding of the highway sector; necessity of maintaining the assets of a rapidly growing road network ;and the need to strengthen sector governance, especially by developing the role of the market and improvingroadtraffic safety. Highway Capacity Expansion to SustainDevelopment, Trade, and Regional Integration For the past 20 years, the Chinese economy has grown remarkably fast, averaging 8 to 10percent per year, which enabled the country to join the WTO in 2001. As a result of that growth, increases in the number of motorized vehicles and traffic have put a heavy demand on infrastructure. The number of registered vehicles, currently 20.5 million, i s expected to reach 34 million by 2010, and both passenger and freight traffic have grown rapidly-7.1 percent (in passenger-km) and 5.5 percent (inton-km) respectively per year inthe past five years. Such rapid economic development has created a need for an appropriate road network. The length of highways has doubled since 1980 to 1.76 million km, including a 25,130 km expressway network located mainly in the coastal areas and on the heavily traveled north-south corridors in eastern and central-eastern China. During the past five years, the length of expressways has tripled, the length of Class Iroads has almost doubled, and the length of Class I1roads has increased by more than half. At the core of the government highway policy is the construction of the $150 billion NTHS,a 35,000 kmexpressway network connecting China's 100 major cities to be completed by 2007. Despite China's massive investment in the construction of new highways (an average of 2.8 percent of GDP per year during the 1997-2002 period), funding resources are still insufficient to meet increasing demand. The road network still ranks among the sparsest in the world in terms of both geographic area and population (0.19 km per square kilometer and 1.38 km per 1,000 population). Furthermore, expressways and Class Iand I1roads account for only 14.1 percent of the whole network, yet carry most of the traffic. Bottleneckfor Trade, and Regional Integration The road transport sector constitutes a serious obstacle to sustainable economic growth, and domestic and international trade. InChina, logistics costs, at 18 percent of GDP (2000), are high in comparison to those in developed countries like the United States (9.5 percent in the mid- 1990s), and transport costs are higher, about 50 percent of total logistics costs in China-twice the percentage of those in developed economies. Reducing logistics costs to 15 percent of GDP, a feasible target for a five-year period, would generate more than $30 billion annually in direct savings. 16  Inthe coming years, economic growth and the risingmodal share of roadtransport will continue to place heavy demands on the highway network and intensify the need for capacity expansion. Furthermore, and especially for western and central provinces, highway networks have to connect large urban centers and rapidly developing areas to coastal regions to integrate lagging provinces into the mainstreameconomy. Therefore, China intends to maintain heavy investments in the road sector. B y 2010, the length of the entire Chinese road network should exceed 2.1 million km; in the following decade the length of the highway network is extended to reach 2.6 million km and the expressway, 70,000 km,to link all cities with populations of 200,000 or more. Road Sector Bottleneck in Hubei Province Hubei province, with a population of 59.9 million people, is located incentral China. Hubeiis a communication node for north-south and east-west traffic, and a gateway to the less-developed western provinces. Since 2000, passenger traffic (in passenger-km) has increased by 3.2 percent per year. Road transportation accounts for 94 percent of passenger traffic (inpassengers) and 74 percent of freight volume (intons). The length of the highway network in Hubei has increased by 62 percent since 1998, reaching 86,000 km in 2002. The provincial network includes a total length of 943 km of expressways, 822 kmof Class Iroads, and 11,105 kmof Class I1roads (2002). The total length of expressways and Class Iand I1roads has increased by 71 percent since 1998 and accounted for 14.9 percent of the provincialroadnetwork in2002, a figure close to the national average. Despite significant investment in the construction of new highways (an average of 2.3 percent of Hubei's GDP per year for the past two years), funding i s still insufficient to meet demand for both construction and maintenance. Road density by population i s comparable to the national average, although road density by area (0.46 kmper square kilometer) i s more than twice that of the whole country because the large western provinces are significantly under-equipped in comparison to easternand central provinces. 17  1998 1999 2000 2001 2002 Basic Provincial Data Total population 1,000people 59,072 59,38059,60059,746 59,880 As proportion of China's population % 4.8% 4.7% 4.7% 4.7% 4.7% Rural population 1,000people 42,81742,93542,92742,850 42,946 Rural population as proportionof total population % 72% 72% 72% 72% 72% Urban population 1,000people 16,25616,44616,67316,89616,934 Urban population as proportionof total population YO 28% 28% 28% 28% 28% GDP millionUS$ 44,74246,60451,65656,37660,165 As proportionof China's GDP % 4.7% 4.7% 4.8% 4.8% 4.7% GDP per capita US$ 757 785 867 944 1,005 As proportionof China's GDP per capita % 99% 99% 101% 102% 102% Road Length Length of roads km 52,98955,38957,85085,75786,098 As proportionof China's road network % 4.1% 4.1% 3.4% 5.1% 4.9% Length of Expressways km 428 538 569 805 943 Length of Class I roads km 502 557 611 812 822 Length of Class II roads km 6,580 7,326 7,911 9,152 11,105 Length of Class 111 & IV roads km 31,02735,69938,97155,27954,420 Length of Other roads (<Class IV) km 14,45211,269 9,788 19,70918,808 Expresswaysas proportionof total road network % 0.8% 1.0% 1.0% 0.9% 1.1% Class Iroads as proportionof total road network % 0.9% 1.0% 1.1% 0.9% 1.0% Class IIroads as proportionof total road network % 12.4% 13.2% 13.7% 10.7% 12.9% Class 111 & IV roads as proportionof total road network % 58.6% 64.5% 67.4% 64.5% 63.2% Other roads (<Class IV) as proportion of total road network % 27.3% 20.3% 16.9% 23.0% 21.8% Road Density Road density in terms of land area km/ 1,000km2 285 298 311 461 463 As proportion of China's road density in terms of land area YO 208% 206% 173% 253% 245% Roaddensity in terms of total population km/ 1,000people 0.9 0.9 1.0 1.4 1.4 As proportion of China'sroad density interms of total population % 88% 87% 73% 108Yo 105% Road density in terms of rural population km/ 1,000people 1.2 1.3 1.3 2.0 2.0 As Droportionof China'sroaddensity in terms of rural population YO 79% 78% 65% 95% 91% Sources: China Statistical Yearbooks, and China Transport & Communication Yearbooks Improving Road Accessibility in Low-Income Areas The benefits of rapideconomic growth have not been distributed equally among eastern, central, and western areas of China. In the 12 underdeveloped western and inland provinces, the per capita income is less than half that of the more developed coastal provinces. One reason for the disparity i s the lack of capacity on a series of major interprovincial trade corridors linking western provinces to the more economically dynamic central and eastern areas. The government gives high priority to accelerating development in lagging regions: by 2010 the expressway network should include a grid of five north-south and seven east-west trunk lines meant to 18  encourage economic growth, reduce disparities between rural and urban areas, and accelerate the opening up of western regions. Despite the impressive accomplishments China has made in reducing poverty in the past 20 years-accomplishments that have lifted hundreds of millions of people out of absolute poverty-more than 200 million people still live on less than $1 a day. Many of these people live inremote andresource-poor areas inthe western andinterior regions and often lack basic access to health and education services becausetransport conditions are inadequate. Many remote areas are too far from the main highway network to benefit from feeder roads that connect to the main provincial and national networks. In2002, 99.5 percent of townships and 92.3 percent of villages inChina were made accessibleby road, but still more than half of townships andvillages without access to rural highways are located inthe west. Road transport contributes directly to reducing poverty by improving poor people's basic access to education, health, and social services and to markets and employment opportunities. It also indirectly contributes to alleviating poverty by improving the efficiency of resource allocation, enhancing the performance of markets, and fostering economic growth. In China, central and local governments recognize the roles that providingbasic transport access in remote areas plays in stimulating growth and meeting the mobility needs of the poor. But ensuring that access is an enormous task that requires significant public resources. ZmprovingAccessibility in Hubei Province Hubei has experienced sustained economic development during the past 10 years, and its GDP per capita ($1,005 in 2002) is comparable to the national average ($989). However within the province, significant differences remain between the developed eastern area near Wuhan, the provincial capital, and the western areas where GDP per capita i s still less than RMB 2,000 ($242), and as little as RMB 1,000 in some counties. Among the 71 counties in Hubei, 38 are classified as poor on the provincial scale, and 25 on the national scale. All but one of these counties are in the mountainous western part of the province. The lack of infrastructure has been identified as a major constraint to their development: 2,500 villages in these counties were without highway access in 1995. There i s a strong demand for improvements incommunication infrastructure to ensure all-weather access, which i s a challenge inmany places becauseof the mountainous terrain. Resource Mobilization Sector funding has increased significantly during the past few years in response to financial stimulus. Cumulated investments in the construction of new highways for the 1997-2002 period reached $167 billion, with an annual budget of $39 billion in 2002, more than twice the annual budget in 1997. About 60 percent went to high-grade highways (including 30 percent for the NTHS), 25 percent to the improvement of existing roads and 15 percent to rural roads. In the coming years, investment levels in the road sector are expected to be maintained; road expenditures have been estimated at $205 billion for the Tenth Five-Year Plan (2001-2005) and $260 billion for the subsequentfive years. Although private sector participation in the growth of China's highway system is advanced in terms of development models and private capital flows, it contributed less than 10 percent of 19  China's total commitment to new construction during the 1980s and 1990s. More significant private investment will require that several conditions be met: further development of the legal and regulatory framework for private participation; development of the domestic bond market, which would open long-term funding sources to commercialized toll-road entities; and a wide range of public-private partnership models. As a consequence, the bulk of financing for the coming years will have to come from public funds, either through taxation or issuance of public debt. However, traditional funding resources are insufficient to meet increasing demand, and this mode of financing i s not sustainable. In China, road user charges include the vehicle purchase tax ($4.5 billion in 2002), the road maintenance fee ($10 billion in 2002), and the highway transport management fee ($2.5 billion in 2002). Only 60 percent of the road maintenance fee i s actually used for road maintenance ($6 billion in 2002), with the rest ($4 billion in 2002) being spent on new construction. This fee is inefficient, expensive to administer, easy to evade, and generates less than 40 percent of its potential. As a result, road user charges contributed only 28 percent of new construction expenditures in 2002 ($11 billion for a total of $38.9 billion). Consequently, the government needs to develop new sources of funding and builda reliable and stable financing scheme of road activities based on user fees. China has been discussing the introduction of a fuel tax for years, but no implementation has been decided yet, although the National Congress approved the tax in 1999, because of the difficult technical and political issues associatedwith it. Resource Mobilization in Hubei Province Hubei's roadsector funding has increased significantly inrecent years, although at a rate slightly lower than in China as a whole (2.3 percent of Hubei's GDP in the past two years compared to 2.8 percent of China's GDP). Annual investment in the construction of new highways in 2001 and 2002 reached $1.3 billion and $1.4 billion respectively. Inthe coming years, the investment effort inthe roadsector should be maintained. Institutional Reforms and Efficiency of Road Management Transforming the government into a market-supporting institution remains one of the largest transition issues facing China. In the highway sector, the government's role in providing infrastructure (construction and maintenance) and transport services i s shifting gradually from that of owner, investor, and manager to that of policymaker and regulator. Provincial communication departments need to adapt to the change in their institutional role while providing more cost-effective construction and operation services to infrastructure users. Institutional Reforms The capacity of provincial and local road agencies must be strengthened to enable them to expand the network and meet the challenge of maintaining the quality standards of existing roads. Therefore, maintenance works undertaken previously by those agencies through force account are being contracted out progressively. The Bank has supported new ways of carrying out maintenance under various projects, mainly with a view to introducing competition, encouraging the use of better equipment, and improving the efficiency of manpower and the overall quality of work. The transition to contract work entails far-ranging institutional reforms with social impacts. In addition, the transition has to be fostered by strengtheningroad agencies' 20  capacity and by developing contractual relationships between the employer and contractors that focus on the.provision of services. Road Maintenance Lessons learned in developing countries about the detrimental impact of neglecting road maintenance and the costs of restoring infrastructure are fully relevant to China. Countries undergoing rapid economic development traditionally underinvest in road maintenance. In Forward with One Spirit, a Bank study carried on in China in 1998, experts recommended allocating 1percent of GDP to maintenanceexpenditures, a theoretic total of $12 billion in2002, but this objective was frustrated both by the shortage of funds and by political intervention. Only $6 billion were actually spent on road maintenance. Management of Toll Roads The introduction of toll roads in China ($7 billion of toll revenues in 2002) has been characterized by a proliferationof highway companies, each managing a relatively short section of road. This situation i s inefficient in a number of ways, and studies carried out under institutional components of Bank-financed projects have suggested setting up commercialized corporations for the construction, operation, and maintenance of toll roads. Economies of scale would result from consolidating management and maintenance facilities at the provincial level and possibly on a wider scale. Furthermore, the question remains-how to regulate toll road companies? A broader question is whether the current tolling policy is relevant. The average toll in China (U.S, cents 4.53 per car-km) i s about the same as in developed countries, but the affordability rate (2.06 percent on average) is very high in comparison to rates in developed and other developing countries (see the following table). (The affordability rate i s the cost for a private car to travel 1,600 km on toll roads, expressed as a percentage of the average annual income per person.) Toll levels therefore deter potential users and reduce overall economic returns of toll roads. Toll Leveland Toll Affordability Comparisons Develooed DeveloDina countries us countkg China SME Toll (US cents/ km) 11.14 4.45 3.11 4.53 6.02 Toll affordabilityrate 0.69% 0.02% 0.65% 2.06% 2.34% Sources:World Bank Research. November 2003 Improving Road Traffic Safety The combination of the expansion, uneven road construction quality, increasing traffic, and a lack of coordinated safety efforts in China led in 2002 to 773,000 accidents, 562,000 injuries, and 109,000 traffic fatalities, a direct economic loss conservatively estimated at more than $3 billion2.An Asian Development Bank estimate puts the total economic loss from road crashes at $12 billion per year. Road accidents are the leading cause of death for Chinese people under 45 Productivitylossesfrom injury inChina, Y. Zhou, T.D. Baker, G.Li,2003 21  years of age. These alarming figures probably understate the reality. Still, the official data make China's annual number of road accident fatalities the world's highest-at least three times the U.S. figure, with a fraction of the number of vehicles. World Bank global projections indicate that if present road safety policies and practices continue, traffic fatalities will rise from about 10 per 100,000 people (2000) to more than 16per 100,000people in 20203. Road safety management practices in China are characterized by their lack of overall goal orientation and performance evaluation, absence of strong leadership and inter-agency coordination, and fragmented safety interventions. Interms of a best-practice safety management system (targets, interventions and implementation arrangements), current practices in China can be considerably improved: China has no official safety targets, monitoring and analysis are limited, and there is no long-term national vision for success. With the possible exception of emergency medical services, basic safety interventions are evident in China, but they lack integration and purposeful direction. There i s also considerable room for improvement in the delivery of road safety enforcement interventions using modern general deterrence techniques. Dialogue with traffic police on strategic directions for the future would be highly beneficial, and roadsafety education initiatives would be a necessarytopic insuch a dialogue. MOC and provincial communication departments, working in partnership with the Bank, have elaborated a road safety strategy for China that has embraced a philosophy of gradualism and safety promotion by pilot demonstration projects. Experience gained in a series of provinces have demonstratedthe effectiveness o f focusing efforts on blackspots analysis and treatment; building institutional capacity early on in the process by creating a focused and well- supported team of roadsafety professionals; reaching out to the wider community; and using local technical expertise to develop safety audit procedures. MOC sees the safety projects as having enriched the experience of its staff, brought agencies closer together, improved safety-engineering practices, createdaccess to high-quality advice, and raised community awareness. The key question to consider is how to sustain and build on the momentum and innovation achieved over the past decade? Institutional Reforms and Efficiency of Road Management in Hubei Previous Bank projects in Hubei (ThirdNational Highway, Fourth National Highway and Hubei Xiaogan-Xiangfan Highway) have begun to address key institutional and policy issues for the road sector by initiating the preparation of a multi-year institutional development plan; strengtheningthe role and capacity of HPCD; establishing roadtraffic safety, quality control and quality management units; improving the management of the road network; and developing expertise, tools, andprocesses to address roadtraffic safety issues. HPCD i s responsible for maintaining national, provincial and county roads. Efforts under previous projects have been aimed at strengthening HPCD's institutional capacity to improve Traffic fatalities and economic growth; Kopits E, Cropper M;World BankPolicyResearchWorking Paper 3035, April 2003 22  maintenance effectiveness and increase funding. The implementation of a road management system was initiated and a maintenance study was completed. A maintenance quality control system was started, and projects focused on the commercialization and use of market contracts for maintenance. While much progress has been made on the institutional side, the key constraint is funding allocation: there is a major shortage of funds for maintenance in Hubei Province. In 2003 only RMB 235 million was spent on periodic maintenance, compared with RMB 778 million on routine maintenance and an estimated RMB 1,103 million on rehabilitation. Although since 2001 HPCD has increased its maintenance expenditures by approximately 3.5 percent per year (faster than the 2.5 percent annually that the road network has expanded), the recent Highway Maintenance Study in Hubei Province4 estimated that periodic maintenance funding is only about 25 percent of the level needed to maintain the network adequately. A significant portion of the HPCD network needs to be improved, which places additional demands on the limitedfunds. A large number of Hubei's bridges are substandard and in need of maintenance or renewal. The Highway Maintenance Study found that in 2000 only 43 percent of pavement had adequate design, so it i s critical that maintenancebe performed when required. With the bulk of the HPCD budget spent on new roadconstruction (see Annex 9, Appendix D), the road maintenancefee too low, and budget constraints HPCD has adopted the rational approach of emphasizing maintenance on the more heavily traveled Class Iand Class I1 roads, which constitute approximately 14 percent of the road network. However, because of inadequate periodic maintenance funding, there more expensive and heavier maintenance i s needed, and HPCD spends five to six times as much on rehabilitation than on periodic maintenance. The net result i s a decrease in the condition of the Hubeinetwork over time. In terms of road safety, Hubei Province reflects the overall situation in China and follows the national trend. HPCD has developed and implemented processes for road safety under World Bank-financedprojects. These projects have been supportedby other agencies, mainly provincial traffic police departments, for specific activities such as accident information systems and blackspot treatment programs. However, HPCD and other government agencies must strengthen their coordination on road and traffic safety enforcement issues and develop public awareness and education campaigns. FinalReport -Highway Maintenance Study inHubei, Third National Highway Project. 23  Annex 2: Major Related Projects Financed by the Bank and/or other Agencies CHINA: Hubei Shiman Highway Project Latest SupervisI(PSR) Ratings Sector Issue OngoingProjects [mplementation Development Progress (IP) Objective (DO) 1. Removehighway capacity Anhui Provincial Highway ~~ S bottlenecks (ongoing)(sector issues 1-5) 2. Institutional Strengthening SecondHenanProvincial Highway S S andtraining (ongoing)(sector issues 1-6) 3. Rural roads andpoverty SecondNationalHighway S S alleviation (ongoing)(sector issues 1,2,4-6) 4. Highway safety Third NationalHighway S S (ongoing)(sector issues 1,2,4-6) 5. Operationand maintenance Third HenanProvincial Highway S S of high-gradehighways (ongoing)(sector issues 1-6) 6. Cost recovery Tri-Provincial Highway S S (ongoing)(sector issues 1-6) FourthNational Highway S S (ongoing)(sector issues 1-5) SecondFujian Highway S S (ongoing)(sector issues 1,2,4-6) Guangxi Highway S S (ongoing)(sector issues 1-6) SecondJiangxi Highway S S (ongoing)(sector issues 1-6) Inner Mongolia Highway S S (ongoing)(sector issues 1-6) Xinjiang I11Highway S S (ongoing)(sector issues 1-6) HubeiXiaogan-Xiangfan Highway S S (ongoing)(sector issues 1-6) SouthernSichuanRoadsDev. Guangxi RoadsDevelopment ShaanxiRoads Development Chongqing-GuizhouRoadsDev. (Leichong Expressway) SouthernYunnan RoadDev. ShanxiRoadsDevelopment Changchun-HarbinExpressway: ChangyuExpressway Changchun-HarbinExpressway: HashuangExpressway Chengdu-NanchongExpressway 24  Latest Supervision(PSR) Ratings Sector Issue OngoingProjects Implementation Development Progress(IP) Objective(DO) Japan Bank for International Hangzhou-QuzhouExpressway Cooperation Wanxian-LiangpingExpressway Liangping-ChangshouExpressway HainanEast Expressway Xinxiang-ZhengxhouHighway HeilongjiangHeife-Beian Road 25  Annex 3: ResultsFramework and Monitoring CHINA: HubeiShiman Highway Project ResultsFramework PDO Support socio-economic SME 'eeds into MOC program development of Hubei province by: Traffic levels on SME and the parallel .ofurther inter-provincial enhancing its access to other highways. ntegration through the provincesparticularly the western Percentageof long distancetraffic on SME :onstruction of the arterial regionof China, (total traffic andbreakdown between :xpressway. carshuses and trucks). improving local mobility within poor, remote westernparts of Average daily traffic, transportation costs, 'eeds into Hubeipolicy province, and daily bus services on improved localroads, mdprogramsfor and number of days theseroads are closed .mprovingroad strengtheninggovernanceof the iccessibility inpoor areas. provincial road sector. to traffic. GDP per capita inserved areas. 0 Employment rate. Population underpoverty threshold (daily income<US$ 1). Feeds into Hubeihighway School enrollment and access to medical managementpolicy and care inserved areas. program. Institutional Increasedskills of HPCD staff through skills assessment. Adoption of asset management principles ensuringbetter management of Hubei expresswaynetwork. Sustainablemodel for financing the HPCD road network. Adopting new technologiesimproving efficiency and effectiveness of highway management and operations. Improved managementof new highway projects through institutional changes. Percentage of Class 1andClass 2 roads systematically treatedinaccordancewith the HPCD Safety ManagementPlan. Percentageof road freight and passenger transportenterprisessystematically screened in accordance with the Safety Review Process. 26  IntermediateResults Oneper Component Component One (SME): Component One: component One: Zonstruction of SME. ?rogressrate of works. Llonitoring of mplementation progress mdaction planto address 3ossible delays. Component Two (LRIP): Component Two : Component Two: Rehabilitation of local road sections Progress rateof works. Monitoringof includedinthe LRIP. implementationprogress mdaction planto address possibledelays. Component Three: Institutional Component Three: Component Three: Development and road Safety HPCD staff trained. Number of staff trained Monitoring of Skill assessments. implementation progress andactionplanto address Pilot study to implement an asset Annual 10year management planfor the pilot possibledelays. managementsystemonthe :xpressway. expressway network. Finalreport on the systemapplicability to HPCD network. Study on group managementof Studyreport completed and adoptedby expressway projects. HPCD. Strategy for mobilizing capital to Study report completed and adoptedby highway management. HPCD. Study on new technologiesfor road Study report completed. maintenance. Adoption of new technologiesor techniques for maintenanceby HPCD. Acquisition of monitoringand Procurementexpenditurerate. maintenanceequipment. Road map for implementing a HPCD Safety ManagementPlanfinalized, comprehensivehighway safety specifying safety goals, objectives, policies; management plan. priorities for Class 1and Class 2 roads set and organizational processes and measuresto achievethem. Action plan to improve the safety of Safety Review Processfor road freight and commercial transportcompanies. passenger transport enterprisesfinalized, specifying mandatory safety requirements, proceduresand monitoring arrangementsfor the granting, continuation andremoval of operating licenses 27  IP IW o w $ ! "W P P 0 0 0 0 - 3 Iln W  I T # # - 9 b m Q Q I x  X X X X 0 M X X X 4 X X X I rcl 0 .-0 C Y0 8 Q e, I e, C 3> m a Px $5 > .Y r A > 2 9 0 0  * v) Ba 2 z c d d  sp 8 3 0 0 2 2 sp 8 3 2 8 8 sp 8 3 3 3 8 8 C  8 8 8 =2 0 vi m 8 8 8 =3 zm 1 g g 2 2 .9 M .e E 0 0 6   Annex 4: Detailed Project Description CHINA: HubeiShiman Highway Project I. HighwayCapacityInvestment($414.88million) The project will finance the construction of the 105.1 km Hubei section of the Shiyan Manchuangan Expressway (SME), a 106.8 km highway linking Shiyan City in northwestern Hubei province to Manchuangan in Shaanxi province. At the Shaanxi border S M E connects to the planned Manchuangan- Shangluo expressway, that will complete the Hubei - Xi'an corridor. InHubei, the project will be the final section of the Wuhan-Shaanxi border expresswaycorridor that includes two other sections: the Xianshi Expressway, which opened for traffic in December 2003 and the Bank-financed Xiaoxian Expressway further east, which i s under construction (the Hubei Xioagan-Xiangfan Highway project). At its eastern end, SME will serve Shiyan city, which is at the edge of a mountainous, low- income area. The urban agglomeration of Shiyan has a population of 3.4 million. It i s an industrial center with a strong automobile industry, mineral resources, and tourism attractions. Shiyan's economic development depends on good transport connections-on one side, to Wuhan, the provincial capital and the portal to the north-south arterial highway corridor, and on the other side to western provinces through Shaanxi. From Shiyan, S M E runs northwest, to Yunchian city (population 500,000), following essentially the alignment of NH209 along a valley crossing low mountains. In Yunchian, S M E turns west and crosses the Hanjiang River at the lowest point of the alignment (140 m). From there, S M E enters a mountainous area and climbs a narrow valley along Yunman provincial road (Class 11or 111) until it reaches Erdoya mountain, with gradients reaching 4 percent. This section includes a series of bridges and tunnels and high slopes and retaining walls; the 3,100 mtunnel crossing Erdoya mountaini s 14 kmfrom the end of S M E and is the highest point of the road alignment (at an altitude of 700 m). From that point, the highway descends similarly steep slopes to the border with Shaanxi, which it reaches in the middle of a 2,200 m tunnel, to link to the Manchuangan - Shangluo expressway. HPCD will managethe construction of the entire tunnel, including a 1.7 km section inShaanxi. The project is designed as a four-lane expressway (two lanes in each direction) with an 80km per hour speed. The long, steep, curvy slopes in the mountainous sections pose special traffic safety risks. These risks will be addressed through the construction of emergency facilities such as parking bays and emergency deceleration gravel beds and the placement of reinforced markings and road signs. Fire risks in long tunnels will be mitigatedthrough design features and equipment as well as operating proceduresestablished after consultation with firefighters. The project also includes a 6 km connecting road in the Shiyan city area, six interchanges, one monitoring center, one monitoring sub-center one service area, two rest areas, two maintenance areas, and electrical and mechanical equipment (E&M) for maintenance operations and management. E&M equipment includes toll, telecommunications, and traffic monitoring systems, and safety and fire emergency facilities in tunnels. Because of the mountainous terrain, earthworks and stoneworks are estimated at 17.22 million m3 of cuts and 16 million m3 of fill. The total lengthof the 89 bridges i s estimated at 28.32 kmand that of the 30 tunnels at 13.69km. S M E construction should last 48 months; the opening to traffic i s planned for March 2008. A joint foreign-local team will carry out the supervision of SME civil works and E&Mworks. Contracts with domestic firms will be funded from domestic sources, and the contract with the 35  international supervising firm will be financed by the Bank loan. The supervision office will be staffed by domestic firms (56 at the general office and 129 in local offices along the alignment). International experts will assist the chief supervision officer and support domestic firms in managing and supervising project contracts, subgrade works, pavement works, bridge building, tunnel works, and E&M works. They should be in place before civil works start. The tasks of domestic supervision firms are estimated to require 6,192 persons per month and the tasks of the international supervision firm are estimated at 95 personsper month. The Hubei Provincial Shiman Expressway Company (HPSEC), under HPCD, will operate and maintain the infrastructure after it opens to traffic. Highway users will pay tolls. HPCD will carry out a toll rate study before the end of construction to determine toll levels and structure. HPSEC will prepare an operations risk managementplanbefore the road opens to traffic, paying special attention to safety and fire hazards. Truck weight will be checked at tollgates, and overloaded trucks will not be allowed on the expressway. Drivers will receive information about the risks of driving on the steep slopes of the expressway. Finally, the dialogue established by HPCD with firefighters will continue during construction to ensure that fire equipment and operational procedures are appropriate. The project will involve land acquisition andresettlement, which will be financed from domestic sources. 11. Local Road ImprovementProgram($50.70 million) The Local RoadImprovement Program (LRIP)addresses the lack of accessibility inremote, low- income areas of Hubei province. Under this program, the project will rehabilitate and upgrade a series of low-class local roads in Shiyan City. The LRIP will be completed in two phases. The first phase consists of upgrading a bridge (355 m) with a 700 m long connecting road and a road (82 km). In 2002, Class IV and nonclassified roads account for 75 percent of total road mileage inHubei (85,757 km). The high proportion of low-class roads and the fact that most are not all-weather roads highlight the need to increase investment in this sector. Most counties and cities classified as poor (24 of 25) are in the western mountainous areas. The economic disparity between these western mountainous areas and other areas has increased despite the impressive growth in GDP inwestern areas (15-fold duringthe past20 years). Shiyan City and Enshi Prefecture in the western mountainous part of Hubei include 14 counties classified as poor on the national poverty scale. The lack of transport infrastructure i s one of the main constraints to economic and social development in these areas. HPCD proposed Shiyan City for the LRIP because Enshi Prefecture has enjoyed the benefits of the national Go West policy in the past three years and of a rural road improvement program under the ongoing Hubei Xiaogan-Xiangfan Highway project. In Shiyan City, the LRIP road sections will be selected according to the following criteria: 0 Current roadconditions; 0 Lack of alternative transport infrastructure; Current minimumdaily traffic volumes of 400 medium truck equivalent (MTE) for Class IVroads, 500MTEfor Class I11roads, and600 MTEfor Class I1roads; 0 Potential impact of the project on population's access to education, health, and other social activities, and on economic development, including facilitation of production and commercialization of local products; 36  0 Contribution to Hubei province's plan to improve the functional responsiveness of the highway network; 0 Strong support by local government andresidents; and 0 Expected EIRR higher than 12 percent. HPCD used these criteria to identify 11 road sections and two bridges as candidates for improvement under the LRIP. A first phase of two of these projects was fully identified before project appraisal: Baoxia-Zhushan road (85 km) and Jiangjunhe bridge (355 m), both in Shiyan city and includedinthe provincialThree-Year Highway Program (2003-2005). The first phasei s estimated to cost US$24.87million, of which US$21.29 million in civil works will be financed by the Bank. Baozhu road passes through Yunxian, Zhushan, and Yunxi counties, and Jiangjunhe bridge i s in Shiyan City. All three counties are poor counties according to the national poverty scale; their GDP per capita was about RMB 2,000 in 2001, approximately 25 percent of the Hubei province average. Baozhu road i s in very poor condition, below even Class IV standards, and has become a transport bottleneck between NH316 and Zhushan County, impeding local people's access to the provincial road network. Upgrading Baozhu road to Class 111i s expected to promote local economic and social development significantly. In general, the proposed upgrading will retain the existing alignment, with some improvement on sharp curves (both horizontal and vertical). Two tunnels will be built (total length of 230 m). The total rehabilitation cost i s estimated at RMB 168.46 million (US$20.30 million), and civil works financed by the Bank (excluding one tunnel) amount to RMB 146.89million (US$17.7 million). The estimated EIRR is 14percent. Jiangjunhe bridge crosses the Han River in the corridor connecting Yunxi County to NH316 and Yunxian County. The existing bridge i s only 5.6 m wide, and the structure i s no longer safe. Only single trucks and cars at a limited speed and with a limited load can pass. Consequently, a new bridge i s critical for keeping traffic flowing smoothly in this important provincial transport corridor. The construction cost of a new Class I1bridge i s estimated at RMB 39.97 million (US$4.57 million). Civil works are estimated at RMB 29.76 million (US$3.59 million). The EIRR is estimated at 16.64 percent. The construction of the Jiangjunhe bridge will be completed on December, 2006. The characteristics of subprojects in phase 1of the LRIP are shown inthe following table. County Pop. in County HighwayCharacteristics Cost (US$ million) directly GDP influenced per Project Length Class Construc Total Civil Bank areas capita (km) -tion works loan (RMB, period 2001) Yunxian 131,000 2,238 Baoxia- 85 km Ill 2004- 20.30 17.70 3.54 Zhushan Zhushan 2006 Yunxi, 78,000 2,163 Jiangjunhe 355 m II 2004- 4.57 3.59 0.72 Yunxian Bridge 2006 The Environmental Impact Assessments and EnvironmentalMonitoring Plans for the first phase projects follow Bank guidelines. A social assessment was also preparedin accordance with Bank requirements. No resettlement i s expected; however, HPCD has prepared a resettlement policy framework that will be applied if detailed design studies identify locations where resettlement is 37  needed. No ethnic community is affected by the project; therefore, the Bank has confirmed that no Ethnic Minorities Development Plan (EMDP)needs to be prepared. Duringproject implementationHPCD will select additional road sections for the secondphase of LRP according to the same criteria as for the first phase, and the Bank will review them. For each subproject, HPCD will prepare an EIA and EMP as well as a resettlement action plan (RAP) consistent with the resettlement policy framework if works entail involuntary resettlement, in compliance with Bank safeguard policies. A social assessment will be prepared for eachproject, and if ethnic minorities will be affected, an EMDPwill be prepared. 111. Institutional Strengthening, Policy Development and Road Safety ($6.36 million) As shown in the following figure, the Bank has undertaken a range of institutional strengthening activities under the NH3,NH4, and Xiaoxiang projects. The activities under this project buildon this work and focus on assisting HPCD in developing more proactive management of the highway network and therefore in meeting its objective of transitioning towards more efficient roadmanagementpractices. 38  _ ._ ._ ._ . -1 NH3-1998 Training Expresswy I i , . ! ! Development Plan ! 1 I t ._ I ` I I ition i Maintenance l l '~ n Tall Rate hudy I ! I I ! j ............... I L t t.-._.[I --! I I I I - !!!!!!! ReadTraining !!!!!!!!!!!! ? !!!!! !!!!!!!! 39  The project will introduce a total asset management approach through a pilot study, investigate improvements in highway financing and maintenance processes, streamline operations by implementing group project management, enhance safety planning and the safety of the road transport industry, and support training activities and equipment procurement. Training Program ($550,000) A major training program will be undertaken with the support of Hubei Communications Technical College (HCTC), which i s the principal trainer under the Hubei Xiaogan-Xiangfan Highway project. The HPCD undertook a training-needs assessment review for the project. The review considered a range of factors, including (a) who needs training; (b) the levels of training required; (c) availability of training resources; (d) training methods and locations; and (e) training budget requirements. The training needs data were collected through a comprehensive survey conducted throughout HPCD and reflect the feedback from 438 questionnaires. The review also identified a need to enhance the professionalism of highway technicians and managers and improve specialized construction, maintenance, and management skills. The training program will strengthenstaffers' skills andintroduce new concepts. The proposed training program calls for domestic training ($200,000) in topics such as environmental protection, supervision and quality control, resettlement, procurement, and project management. Overseas study tours and training ($327,500) in more specialized skills such as road management, road finance, and expressway operations are also recommended. The following table summarizes the training program; it will be updated periodically during project implementation. 40  Intermediateresults: Numberof peopletrained on the project. Outcome: -- Improvedskills inconstruction, maintenance and management, which will result ingreater efficiency and effectiveness inHPCD operations. Indicators: - HCTC staff trained and offering courses to meet - HPCD's needs. Percentageof trained personnel able to use new skills in -- their work. Annual progress reports. Training effectiveness report basedon post-training evaluations. Pilot Study on Expressway Asset Management ($160,000) Under the NH3, NH4 and Xiaogan-Xiangfan Expressway projects, HPCD has been developing expertise in infrastructure asset management. It has prepared annual condition survey reports and a highway maintenance management study, developed an accident information system, road data bank, and pavement and bridge management systems. The objective of this study is to build on this work andpilot test the application of full infrastructure managementon an expressway. The study will prepare an asset managementplan for an expressway company to be selected by HPCD and will last the duration of the project. An annual life-cycle asset management report will be produced, including: (a) a summary of physical assets; (b) a summary of asset condition; (c) valuation of assets, including depreciation; (d) a routine maintenance plan; (e) a periodic maintenance plan; (f) an improvement plan; and (g) a disposal plan. Annual financial statements showing the projected financial performance of the expressway during the next 10 years will be prepared, including: (a) cash flow forecasts; (b) expenditure breakdown by asset and activity; (c) valuation forecasts; and (d) time trends. The final report will review the effectiveness of the pilot study and make recommendations for how the asset managementapproachcould be applied to the provincial roadnetwork. Intermediateresults: - An asset managementplanfor the expressway network that i s regularly updatedthrough the various - support systems. Report recommending how asset management can be applied to other roads in the province. Outcome: - Successful application of total asset management principles to Hubei and foundation for applying throughout HPCD. Indicators: ----- Implementation of asset managementsystems. Inventory and annual data collection surveys. Annual asset managementreports. Annual financial statements. Recommendations on how to implement throughout Hubei. 41  Capital Mobilization Study ($150,000) Hubei province already suffers from a severe shortfall in road maintenance funding (see Annex 1)that will beexacerbatedas moreroads are constructed. This study will build on the maintenance cost and fund allocation study conducted under NH4. For 5-, 10- and 20-year horizons, total capital demand for road construction, maintenance, and management will be estimated along with likely income. From this the capital deficit will be established. The various mechanisms that can be mobilized to provide capital for road construction, maintenance, and management will be identified along with those that are most suitable for Hubei. The study will be conducted by HPCD and will take 2.5 years. Intermediateresults: - Strategy for mobilizingcapital for meeting 5-, lo-, and 20-year construction, maintenance, and management needs. Outcome: - HPCD will have sufficient capital to ensure that the roadnetwork continues to develop and existingroads are properly maintained. Indicators: - Identificationof total capital demands for construction, maintenance, and management for 5-, - lo-, and20-year horizons. Recommendationon mechanismfor meeting capital - demands. Implementation strategy. New Technologiesfor Road Maintenance ($100,000) The shortage of funds for road maintenance in Hubei has led HPCD to consider innovations in the way it delivers road maintenance. Under the NH4 and Hubei Xiaogan-Xiangfan Highway projects HPCD is testing the delivery of maintenance by contract rather than by force account. Another avenue for innovation is new technologies for road maintenance. These offer the potential of improvedquality and/or efficiencies. The study will review road maintenance performance issues in Hubei. An investigation will be made into domestic and foreign technologies that have the potential to improve the delivery of maintenance. A small number of technologies that hold potential for practical adoption in Hubei will be procured andtestedinpilot studies to be conductedindifferent regions. The results of the pilot studies will be used to determine the economic benefits gained by adopting the different technologies and to prepare a plan for wide-scale implementation. The study will be done by the Hubei Highway AdministrationBureau of HPCD and will take 3.5 years. 42  Intermediateresults: - Report on technologies offering potential to improve - maintenancequality and/or efficiency. Report describing results of pilot testing of selected technologies. Planfor wide-scale implementation. Outcome: -- Improvedquality and/or efficiency of road maintenance. Indicators: - -- Assessment of technologies. Procurement and pilot testingof selectedtechnologies. Progressreports. GroupManagement of Projects ($100,000) HPCD i s facing major institutional challenges in completing all the projects identified in the Tenth Five-year Plan. Given staffing and resource levels, the current practice of assigning one team to each project to carry out the many project preparation tasks (prefeasibility studies, feasibility studies, design, environment and social monitoring, bid documents, etc.) will no longer be viable. This technical study will identify opportunities for adopting group project management principles and new IT solutions to streamline the operations and delivery of projects. Intermediateresults: - Report on group management methods and how they can be appliedto Hubei. Outcome: - Improvedefficiency of expressway construction and management. Indicators: - Consolidation of activities for expressway construction and management. HPCD Safety ManagementPlanfor ClassI and Class II Roads ($100,000) HPCD agreedto develop a comprehensive highway safety managementplan that sets out its road safety goals, objectives, policies, and priorities for Class Iand Class 11 roads and the organizational processes and measures that it i s taking to implement them. It will draw together all past, ongoing, and future road safety components, including a long-term road safety action plancoordinated by the multi-agency HubeiProvincial Safety Council. Specifically, the Highway Safety Management Plan will optimize safety resource allocation by establishing priorities and systematic processes for the medium term, including regular safety performance monitoring, according to an annual timetable. The Bank and Hubei Province agreed that future road safety projects would be in accordance with a clear vision for improved road safety outcomes, well-specified objectives to achieve this vision, and robust arrangements for inter-agency coordination and cooperation, taking into account the progress made under previous projects, the needs revealed by accident data, opportunities for innovation, anticipated impacts of traffic growth and the requirement to maximize quality and safety performance within capital and personnel constraints. It was also agreed that the project focus should be on safety measures that fall clearly within the scope of HPCD responsibilities and spheres of influence. The potential scope of HPCD safety measuresis extensive and includes the design of safe roads, setting of speed limits, safe construction of roads, safe maintenance of roads, undertaking regular safety reviews, adding new safety facilities, removal of roadside safety hazards, identification 43  and treatment of blackspots, safety screening of commercial operators, safety training for staff, and safety research and development. The HPCD Safety ManagementPlan project will: Survey a representative sample of Class Iand I1roads to compile and analyze data on safety-related features (surface quality, shoulders, roadside hazards, signs, markings, blackspots, etc.) and relevant vehicle performance measures (overloading, etc). 0 Collect and analyze data from previous and ongoing road safety project components and other sources on road user and vehicle performance that affects safety outcomes on Class IandI1roads. Review all potential HPCD safety measures (including those developed in previous, ongoing and future road safety project components) to assess the scope of their application. Prepare a highway safety management plan that sets out HPCD safety goals, objectives, policies, and priorities for Class Iand I1 roads and the organizational processes and measuresit is taking to implement them. HPCD will implement the project over three years. It will be assisted by domestic consultants and will use the findings of domestic and international study tours to be completed inJune 2007. Intermediateresults: - HPCD Safety Management Plan finalized, specifying safety goals, objectives, policies and priorities for Class Iand I1roads and organizational processes and measuresto achieve them. Outcome: - Improved safety performance of Class Iand I1roads, resulting inreduceddeaths and injuries. Indicators: - Percentage of Class Iand I1 roads systematically treated in accordance with the goals, objectives, policies and priorities of the Highway Safety Management Plan. Safety Review Processfor Road Freight and Passenger TransportEnterprises ($100,000) The road transport industry i s experiencing rapid development in Hubei Province, reflecting national economic growth trends. However, this escalating activity i s generating a high rate of road crash deaths and injuries. Safety management capacity in the road transport industry is weak, and measures taken by industry to improve the safety performance of vehicles and drivers are poor. Regulatory arrangements in Hubei Province need to be strengthened. HPCD agreed to review the safety performance of the road transport industry in the province and develop better safety criteria for enterprises seeking approval to operate freight and passenger services. This project subcomponentwi11: Review the safety of road freight and passenger transport enterprises in Hubei Province and develop safety performance measures. 0 Conduct three intensive pilot studies with selected enterprises - covering passenger transport, freight transport and the transport of dangerous goods - to further develop and improve proceduresto ensure safe operations and compliance with safety regulations. 44  0 Develop a safety screening and appraisal process for road and passenger transport enterprises in HubeiProvince, specifying mandatory safety requirements, procedures, and monitoring arrangementsfor granting, renewing, andrevoking operating licenses. * Design and conduct training courses for management and operational staff of transport enterprises and HPCD staff to ensure compliance with safety requirements, procedures, and monitoringarrangements. HPCD will implement this activity over three years. It will be assisted by domestic consultants and will use the findings of domestic and international study tours to be completed in October 2007. Intermediate results: - Safety review process for road freight and passenger transport enterprises finalized, specifying mandatory safety requirements, procedures and monitoring arrangements for granting, renewal, and revoking operating licenses. Outcome: - Improved safety performance of road freight and passenger transport enterprises, resulting in fewer deaths and injuries. Indicators: - Percentageof roadfreight and passenger transport enterprises systematically screenedin accordance with the safety requirements, procedures, and monitoringarrangements of the Safety Review Process. Procurement of Equipment ($5.10 million) The equipment procurement program takes into account the equipment procured under the previous Bank-financed highway projects or by HPCD during the past few years for strengthening the road agency's capability and operating new expressways. The new project includes equipment for (a) construction quality control and monitoring, including laboratory equipment and environment control and monitoring equipment; (b) operation and maintenanceof S M E after it opens for traffic; (c) institutional strengthening of HPCD, including office and informationtechnology equipment. Among the equipment to be procuredi s a vehicle for measuring roadconditions at highspeed. This vehicle will be usedprimarily on the expresswaybut also for monitoringat least 7,500 km per year of other HPCD roads. Weigh-in-motionequipment will be procured for installation on SME. This will be usedto gather data on the magnitude and extent of truck overloading. Both of these will enable HPCD to monitor the network ina more detailed manner, thereby improvingits ability to make good investment decisions. 45  Annex 5: Project Costs CHINA: HubeiShiman Highway Project Local Foreign Total Project Cost By Componentand/or Activity US $million US $million US $million 1. Shiman Expressway -- Civil works 192.66 163.99 356.65 ---- Land Buildingsand annex areas 7.13 1.78 8.91 E&M equipment works 2.95 11.82 14.77 Connecting roads 1.88 0.47 2.35 Construction supervision 5.88 1.82 7.70 Acquisition 24.50 0.00 24.50 11. Rural Road ImprovementProgram -- Civil works 40.00 10.00 50.00 Constructionsupervision 0.7 0 0.70 111. Institutional Developmentand Road Sector Management --- Institutionalstudies 0.51 0.00 0.51 Road safety studies 0.20 0.00 0.20 - Training program 0.22 0.33 0.55 Equipment 2.31 2.79 5.10 Total BaselineCost 278.94 193.00 471.94 Physical Contingencies 28.43 5.00 33.43 Price Contingencies 21.99 0.00 21.99 Total Project Costs (1) 329.36 198.00 527.36 Front-endfee 2.00 2.00 ' Total Financing Required 329.36 200.00 529.36 Identifiable taxes and duties are US$m13.49, and the total project cost, net of taxes, i s US$m515.86. Therefore, the share of project cost net of taxes i s 38.29%. 46  Annex 6: ImplementationArrangements CHINA: HubeiShimanHighwayProject The project will be implemented by HPCD, the provincial agency responsible for road management in Hubei province. The World Bank-Financed Project Office (WBFFO) in that department has coordinated project preparation and will remain the Bank's main counterpart during implementation. Similar arrangements have been made on the three previous Bank- financed highway projects inHubei and have proved very effective. HPCD has established a dedicated project headquarter, the newly created Hubei Provincial Shiman Expressway Construction Headquarter (HPSECH), to implement the SME, and the Hubei Provincial Shiman Expressway Company Ltd. (HPSEC) to operate and maintain it after it opens to traffic. HPCD has staffed the headquarter by transferring people from the Xiangfan- Shiyan Expressway headquarter after this infrastructure opened to traffic. HPCD has hired the Hubei Provincial Highway Design Institute (HPHDI) and the Second National Survey and Design Institute from MOC to carry out design studies of SME. The HPSECH will manage construction works as the "Client" with the assistance of HPSEC and a supervision organization made of domestic firms and an international consultant. The HPSEC will operate S M E after the infrastructure opens for traffic. With respect to resettlement, the dedicated HubeiExpressway Resettlement Office (HERO) has prepared the RAP. That office will lead resettlement operations under the oversight of the provincial resettlement leading group led by the Vice-Governor, and manage multi-level resettlement units established along the alignment with local governments at City, countyhanner, and township. This organization has been staffed with experienced experts, their responsibilities have been specified in the RAP and training programs will be organized. Other relevant government agencies responsible for planning, financing, communications and land administration will also be involved at different levels. HPCD has prepared and included in the RAP a detailed training program for the capacity building of project offices. Moreover, HPCD will issue a specific regulation for the approval and usage of resettlement funds. The payment process to beneficiaries will be streamlined to avoid possible fund deductions during disbursement, and each affected village will have a specific account with a local Bank. The appointed bank will report daily on the usage of resettlement funds items to the project office for internal monitoring. HPCD will also strengthen the capacity of township-level and county-level to manageresettlementfunds. On environment, HPCD has prepared an EMP on S M E that includes practical and cost effective measures necessary to mitigate the project related impacts by incorporating them in the design and by implementing them during the construction and operation phases. The EMP also specifies the appropriate monitoring plans, training, institutional arrangements, implementation schedule, budget needs, etc. necessaryto implementthe mitigation measures and strengthen the borrowers capacity. Since the project would be the fourth Bank project to be implemented by Hubei province, HPCD has developed ample in-house capacity in its environment unit to implement, supervise and monitor the EMP. With respect to the LRIP, the Hubei Provincial Highway Administration Bureau (HPHAB) has identified and prepared projects as it is in charge within HPCD of managing the provincial highway network. The experienced HPHDI has undertaken the design of road improvement, 47  whereas respective county offices of HPHAB will carry out procurement activities under the oversight of the HPSECH, and manage works with the assistance of domestic firms for supervision. The implementation of the EMPs prepared on each road section will be supervised by the WBFPO. Finally, the WBFPO i s preparing the institutional strengthening and policy development component and will coordinate the implementation of activities. Depending upon activities, other unitsfrom HPCD will contribute. Procurement HPCD will be responsible to carry out the procurement under the project. The HPSECH will handle the day-to-day management of the project including the procurement process with the assistance of the HPSEC. Staff who have been familiarized with Bank-financed procurement in previous highway projects have been transferred to HPSEC. To obtain necessary professional assistance for ICB procurement, HPCD has selected China International Tendering Company (CITC) as procurement agent for the proposedproject. This agent has 16 years of handling Bank- financed ICB procurement. The LRIP will be separately implemented by Project Management organizations (PMO) of Yunxi and Yunxian counties of Shiyan City. The PMOSwill carry out NCB procedures with close oversight by HPSEC, who will conduct prior review of the critical steps of the procurement process. Such arrangement has been adopted in the ongoing Hubei Xiaogan-Xiangfan Highway Project and found to be generally satisfactory. The above implementing agencieshavebeenassessedto have adequate capacity to carry out the procurement under the project. 48  Annex 7: Financial Management and Disbursement Arrangements CHINA: Hubei Shiman Highway Project I. ExecutiveSummaryandConclusion The Financial Management Specialist (FMS) has conducted an assessment of the adequacy of the project financial management system of the Hubei Shiman Highway Project. The assessment, based on guidelines issued by the Financial Management Sector Board on June 30, 2001, has concluded that the project meets minimumBank financial management requirements as stipulated in BP/OP 10.02. In the FMS' opinion, the project will have in place an adequate project financial management system that can provide, with reasonable assurance, accurate and timely information on the status of the project in the reportingformat agreed with the project and as requiredby the Bank. Funding sources for the project include Bank loan and counterpart funds. Bank loan funds will flow from the Bank to the project's special account to be established at and managed by the Hubei Provincial Finance Department (HPFD) to the project implementing agency, the HPCD, and finally to contractors or suppliers. The Bank loan will be signed between the Bank and the People's Republic of China through its Ministry of Finance (MOF), and a on-lending arrangement for the Bank loan will be signed between MOF and the Government of Hubei through HPFD, and between HPFD and HPCD. In accordance with the agreement between the Bank andMOF, the project will use traditional disbursement techniques. Counterpart funds will be loans from local banks (28%) and appropriations from MOC and provincial government (35%). No outstanding audits or audit issues exist with the implementing agency involved in the proposed project. However, the Financial Management team will continue to be attentive to financial managementmatters and audit covenants duringproject supervisions. 11. Summary Project Description The main objective of the project is to support socioeconomic development of Hubei province by enhancing its access to other provinces, particularly the western region of China, improving local mobility within poor, remote western parts of the province, and strengthening governance of the provincial road sector. The project will produce the following outputs: The construction of Shiyan-Manchuangan Expressway (SME), which will increase transportation capacity in a corridor connecting Hubei to western provinces. 0 A program of localroadimprovements (LRIP) inthe poor northwestern part of Hubei. 0 A series of institutional strengthening and policy development activities for road managementand improvements inroad safety inHubei. Total project cost i s estimated at US$529.36 million, of which US$200 million would be from a IBRDloan. Counterpart funds wouldmake upthe remainingUS$329.36 million balance. 111. Country Issues To date, no CFAA (Country Financial Accountability Assessment) has been performed for China, though dialogue with the Government of China inrespect of the CFAA exercise has been initiated and currently underway. The Bank has relied on a similar exercise carried out by the Asian Development Bank in 2000 for reference. 49  However, basedon observations of developments inthe areas of public expenditures, accounting and auditing, and Bank experience with China projects for the past few years, we noted that substantial achievement in the aforementioned areas has been made and further improvement is expected in the next few years. As economic reform program further unfolds, the Government of China has come to realize the importance of establishing and maintaining an efficient and effective market mechanism to ensure transparency and accountability, and minimize potential fraud or corruption. Dueto rather uniquearrangementby the Government of China, funding (inparticular Bank loan) of Bank projects i s controlled and monitored by the MOF and its extension, (i.e. finance bureaus at provincial, municipal/prefecture and county level). However, project activities are usually carried out by implementing agencies of a specific industry or sector due to the level and complexity of expertise involved. The above arrangement then usually requires more coordination on the project, as the multi-level management of the funding and implementation mechanism sometimes works to the detriment of smooth project implementation. IV. RiskAnalysis The following risks with corresponding mitigating measures have been identified during assessment: 50  Risk RiskRating MitigatingMeasures I.InherentProject Risk Moderate Close monitoring by project management, regular supervision mission by Bank task team, and implementing agency has experience with prior Bank project. 11.Control Risk a. Implementing Entity Low The project implementing entity, HPCD, has previous experience with Bank project. They are currently involvedwith 3 other projects. b. FundsFlow Low HPCD andHPFB have worked together on previous Bank projects and are very knowledgeableof the processand Bank requirements. c. Staffing Moderate Periodic verificationon accounting work by the PMO and the task team shouldbe performed. Accounting staff have already been identified and their qualifications are in-line with their expectedresponsibilities. d. Accounting Policies andProcedures Low Accounting policies and proceduresare already inplace. e. Internal Audit Moderate IIAlthough an internal audit department exist a<HPCD, we will not be relying on their work. Supervision visits by the task team along with annual audits by the external auditors will be utilized. f. External Audit Low The external auditors, the Hubei Provincial Audit Office, has extensive experience with previous Bank-financed projects. g. Reporting and Monitoring Low Format and content of financial statements and frequency of submission havebeenclearly defined by the Bank and MOF. h. .InformationSystems Moderate The PMO proposesto use the Golden Butterfly financial managementsoftware for this project. This software is one of the MOF approved software. FMS will evaluatethe effectivenessof this system during implementation. V. Strengthsand Weaknesses Strengths. This will be the fourth Bank project to be implemented by HPCD. Project personnel identifiedto assume financial or accounting positionhave relevant adequate work experience and educational background. HPCD has accumulated extensive experience from prior projects. HPCD has established a construction headquarter, HPSECH, to be the PMO responsible for the overall management of this project with the assistance of the future operator of S M E (HPSEC). HPSECHwill comprise some employees from previous expressway projects managedby HPCD. Additionally, HPCD will also benefit from the experience of HPFD, whom are familiar with Bank requirements. Management structure and funds flow arrangement are similar to those of the previous projects. Prior records indicate that HPFD capacity has been found satisfactory in respect of project financial management and processing of withdrawal applications. 51  Weaknesses. The local roadimprovements portion of this project i s to be implemented by PMOS established within the Shiyan City Communications Bureau (SCCB) from the HPHAB, responsible for managing the Hubei highway network. SCCB has no experience with previous Bank projects but will operate underthe oversight of the HPSECH. VI. ImplementingEntity HPCD is the implementing agency responsible for this project. HPSECH i s the PMO responsible for the overall management of this project. Inaddition, HPCD will utilize the World Bank-Financed Project Office (WBFPO), a department established within HPCD, as the entity responsible for coordinating project preparation. WBFPO has been involved with the previous three Bank projects and continues to be the Bank's main contact in coordinating the various projects. The separate implementing entity, SCCB, will be responsible for the local roads improvement portion of this project and will report directly to HPSEC. The organization chart is as follows: HPCD - HubeiProvincialCommunications Department WBFPO - World Bank-FinancedProjectOffice HPSECH- HubeiProvincialShimanExpressway ConstructionHeadquarter SCCB - ShiyanCity Communications Bureau VII. FundsFlow Funding for the project includes Bank loan and counterpart funds. One special account will be - established at the Hubei Provincial Finance Department. Bank loan will be signedbetween the People's Republic of China and the Bank, and on-lending agreements will be signed between MOF andHPFD and between HPFD and HPCD. The funds flow i s as follows: I Th;I;ld .I SAmanaged HPSECH ~ by HPFD I I I 52  VIII. STAFFING Adequate project accounting staff with educational background and work experience commensurate with the work they are expected to perform i s one of the factors critical to successful implementation of project financial management. For the financial/accounting staff already identified for the project, the FMSpecialist notes that, basedon discussions, observation and review of the background and work experience, they are qualified and appropriate for the positions and work they are expectedto perform. To strengthenfinancial managementcapacity andachieve consistent quality of accounting work, the task team has suggested that a project financial management manual (the Manual) be prepared. The Manual will provide detailed guidelines on financial management, internal controls, accounting procedures, fund and asset management and withdrawal application procedures. A draft of the Manual has been prepared by HPSECH and provided to the Bank by WBFPO. The FMS has reviewed it and providedWBFPO with feedback on necessary changes. The FMS anticipates that a Manual would be finalized by the end of January 2004 and distributed to all the financial staff before project effectiveness. As some financial staff maybe new to the Bank's project, a well-designed and focused training program in project financial management should be provided prior to project effectiveness by WBFPO and HPSECH to all financial and accounting staff to ensure a good understanding and knowledge of the following: 0 Bank's financial managementpolicy anddisbursement procedures 0 Fundassetkontractmanagement 0 Format and content of project financial statements 0 Audit requirement IX. Accounting Policiesand Procedures The administration, accounting and reporting of the project will be set up in accordance with the following regulations/circulars issued by MOF: Circular #13 - "Accounting Regulations for World BankFinancedProjects" issued inJanuary 2000 by MOF. HPSECH will manage, monitor and maintain project accounting records. Original supporting documents for project activities will be retained by them. In addition, HPSECH will prepare project financial statements and submit them to the Bank for reviews and comments on a regular basis. Additionally, WBFPO will provide coordination support throughout the project. X. Internal Audit Although HPCD has its own internal audit department, we have not and will not assess the competency of the internal audit department due to the costhenefit of doing such work. As such, reliance will not be placed on work performedby them. XI. ExternalAudit Inline with other Bank financed projects inChina, the project will be audited inaccordancewith both International Auditing Standards and the Government Auditing Standards of the People's Republic of China. The Hubei Provincial Audit Office (HPAO) has been identified as the auditor for this project. Annual audit reports will be issued in the name of HPAO and subject to 53  reviews by the China National Audit Office (CNAO). The Bank currently accepts audit reports issued by CNAO or provincial/regional audit bureadoffices for which CNAO i s ultimately responsible. Audit reports on annual project financial statements will be due to the Bank within 6 months of the endof each calendar year. XII. ReportingandMonitoringandFormatof FinancialStatements The format and content of the following project financial statements represent the standard project reporting package agreed to between the Bank and MOF, and have been discussed and agreed with all parties concerned. In line with the newly issued Financial Monitoring Report (FMR) guidelines, the unaudited project consolidated financial statements will be submitted as part of FMR to the Bank on a semi-annual basis (prior to August 15 and February 15 of the following year), and include the following four statements: 0 Balance Sheet; 0 Summary of Sources and Uses of Fundsby Project Component; 0 Statement of Implementation of Loan Agreement; and 0 Statement of Special Account. XIII. InformationSystems A computerized financial management system will be utilizedby the PMO. "Golden Butterfly", a well-established accounting software package approved by MOF, will be used for this project. The task team will closely monitor accounting work to ensure proper recording and reporting in order to determine the effectiveness of this system. XIV. Impactof ProcurementArrangements Thresholds set for procurement post-review will be consistent with that set for SOE for disbursement purpose. To have maximum effectiveness and efficiency, financial management specialist and procurement staff should jointly participate in supervision missions to ensure the following: 0 Contracts awarded are in line with the Bank's procurement guidelines; and 0 Contract payments made are in accordance with the terms of the contract and well supported. XV. DisbursementArrangements The project will be disbursing on the traditional disbursement techniques and will not be using PMR-based disbursements, inaccordance with the agreement between the Bank and MOF. Bank loan proceeds would be disbursed against eligible expenditures as follows (i) works - 46% of expenditures on S M E civil works, 80% on S M E E&M, 20% on S M E annex areas, buildings and connecting roads and LRIP, (ii) - 100% of foreign expenditures, 100% of local Goods expenditures (ex-factory) and 75% of other items procured locally, (iii)consultant services- 91% of expenditures, and (iv) training - 100%of foreign expenditures. Disbursement methods, such as replenishment, direct payment and special commitment, are available for the project. The SOE limits will be set up in line with procurement post-review threshold, as follows: 54  0 Works under contractscosting less than US$5 million equivalent each; 0 Goodsunder contracts costing less than US$250,000 equivalent each; 0 Consulting services under contracts awarded to consulting firms costing less than US$lOO,OOO equivalent each; 0 Consulting services under contracts awarded to individual consultants costing less than US$50,000 equivalent each; 0 All trainings. One special account (SA) will be established at and maintained by HPFD for this project. The SA for the project will be in US dollar, with an authorized allocation at US$14 million equivalent to about 4 months of eligible expenses reimbursable via special account. The initial authorized allocation from the Bank would be US$11 million until the aggregate withdrawals and outstanding Special Commitments will be equal to or exceed US$60 million equivalent. From the SA, the Bank funds would be disbursed to project implementing entities andor supplier andcontractors. HPFD will be directly responsible for the management, monitoring, maintenance and reconciliation of the SA activities of the project in the province. Supporting documents required for Bank disbursements will be prepared and submitted by the PMO to HPFD for verification andapproval before submission to the Bank for disbursementprocessing. XVI. ActionPlan The following proposed time-bound actions that have no major impact on project preparation or Boardpresentation, but should be adequately addressedby the project: Action Responsibleperson CompletionDate 1. Financial management WBFPO andHPSECH Beforeeffectiveness manual finalized and issued. 2. Adequate financial and HPSECH Beforeeffectiveness accounting staff should be inposition. XVII. FinancialCovenants In addition to the standard financial covenants (e.g. maintaining project accounts in accordance with sound accounting practices, audit requirement and SOE), as described in the legal document, specific financial covenants applicable to project will be detailed in section C of the PAD. XVIII. SupervisionPlan A detailed supervision plan for this project will be includedas part of the China Audit Strategy document which is currently inprocess. This document will take into consideration of the size of the project and the risks identified. 55  Annex 8: Procurement CHINA: HubeiShimanHighwayProject Summaryof the Assessment of Agencies' ProcurementCapacity 1. A procurement capacity assessment of the implementingagencies was carried out during the appraisal of the proposed project. Reportof such assessment was archived inthe project files and the following summarizesthe assessment. 2. HPCD will be responsible for all project related procurement activities. It has accumulated relevant experience inBank-financed projects as the implementingagency for NH3, NH4 and Hubei Xiaogan-Xiangfan Highway Project. HPCD has established a dedicated work unit (HPSECH) to handle the day-to-day management of the project including the procurement process with the project shareholding company (HPSEC) assistance. HPSEC has allocated adequate human and other resources for the same. HPSECH and HPSEC staff are quite familiar with Bank-financed procurement procedures. To avoid excessive cost overruns and improve the procurement economy, HPCD has agreed to take measures to ensure that the procurement is carried out basedon adequate geological investigations and complete detail engineering design. 3. The LRIP will be implemented by PMOSestablished in Yunxi and Yunxian counties of Shiyan City that report to HPHAB. Biddingdocuments are being prepared by the HPCDI and all the contracts under this component will be procured following NCB procedures with close oversight by the HPSECH, who will conduct prior review of the critical steps of the procurement process. Such arrangement has been adopted in the ongoing Hubei Xiaogan-Xiangfan Highway Project andfound to be generally satisfactory. 4. HPCD has selected China International Tendering Company (CITC) as procurement agent for ICB procurement for the proposed project. CITC has 16 years experience in ICB procurement under Bank financed projects. 5. The procurement capacity assessment has assessed the overall risk of the procurement process as average and confirmedthe capacity and capability of HPCD and involved agencies to satisfactorily manage the project procurement activities. 6. Comparing with the Bank Guidelines, the assessment has also identified the major deviations of the Tendering and BiddingLaw (TBL) of China as follows: (a) Advertisement: the TBL requires open biddingto be advertised in state-designatedmedia, which sometimes accept advertising in radio broadcasting, notices displayed at tendering centers, TV andwebsites, etc.; (b) Time for bidpreparation and submission: the TBL sets 20 days as the minimum time for bidpreparationand submission; (c) The TBL does not require provisions to be included in BD that sufficient performance security be providedto protect the purchaser for works contracts; (d) Minimumnumber of bids: the TBL requires mandatory re-bidding incase less than three bids are received. (e) The TBL allows that bids be evaluated by a comprehensive bracketing and scoring method, and a bidoffering price lower than cost be rejected. However, it does not provide provisions for determining the cost. 56  The TBL has been effective since January 1, 2000 and governing all tendering activities of investment projects in China except foreign funded projects. To ensure that the Bank-financed NCB procurement follows the procedures which are acceptable to the Bank and in broad consistency with the Bank Guidelines, clarifications on procedures to be followed have been incorporated into the procurementschedule of the Project Agreement of the proposed project. ProcurementMethods (TableA) 7. Procurement arrangements are outlined in Table A. Procurement of GoodslWorks and services will be carried out in compliance with the Bank Guidelines Procurement under IBRD Loans and IDA Credits(January 1995, revised January and August 1996, September 1997, January 1999, and May 2004) and the Guidelines Selection and Employment of Consultants by World Bank Borrowers(January 1997, revised September 1997, January 1999, May 2002, and May 2004). The Chinese MBDs, as issued by Ministry of Finance in May 1997 with the Bank's agreement will be used with further modifications to reflect the latest changes of the Bank's standard bidding documents. Where no MBD exists, Bank SBDs will be used. Bank standard Request for Proposals will be used for consultant assignments above US$200,000. The General Procurement Notice (GPN) for the project was published in UNDevelopment Business in paper form (Issue 617 dated 31 October 2003). 8. Works (US$487.38 million, including contingencies). Civil works for Shiman Expressway (SME) estimated to cost US$402.71 million (including contingencies) would be divided into 14 contracts, with an average size of about US$28.8 million. There would be essentially two types of contracts: earthworks and bridge construction, and pavement works. The civil works were sliced into contracts in view of the site constraints, the nature of works and efficiency gains achievable by puttingtogether pavement works inonly three contracts. 11of the 14 civil works contracts, each estimated to cost more than US$15 million, will be procured by one tender call under ICB procedures. Contracts for pavement works will be procuredby another tender call under ICB procedures, regardless of the estimated cost of each contract, in order to attract qualified bidders for multiple awards. Bidders for the ICB civil works will be prequalified. Electro-mechanical works on S M E (E&M) would be handled as a single contract for supply and installation of about US$15.5 million equivalent. This contract will be awarded under ICB procedures. The Specific Procurement Notice (SPN) for the civil works and M&E works will be published in the UNDevelopment Business online version. Each contract for works estimated to cost US$15 million or more but less than US$50 million will provide for a disputereview expert set forth in the standard bidding documents; for each contract estimated to cost US$50 million or more a dispute review board will be adopted. Domestic contractors are no longer eligible for domestic preference underICB works procurement, 9. Other works for an amount of about US$69.17 million financed by the Bank include (i) S M E buildings, annex and maintenance areas, and connecting roads estimated at $12.71 million, and (ii)rural roadimprovements under the LRIPestimated at $56.46 million. As all contracts are estimated to cost less than US$15 millioneach, they will be awarded following NCB procedures acceptable to the Bank. Since such amounts will be relatively small in the Chinese context, and scatteredthroughout the province and implementedover four years, ICB will not bejustifiable or practical. However, foreign firms will not be precluded from participation. NCB procurementof works will be publishedin arelevant newspaper of national circulation, except the contracts each estimated to cost less than US$2 million, which may be advertised in a provincial newspaper. 57  10. Goods (US$5.35 million). Contracts for road maintenance equipment, each estimated to cost US$250,000 or more and up to a total amount of US$2.79 million, will be awarded under ICB. Domestically manufactured goods under ICB will be eligible for domestic preference in accordance with Appendix 2 of the Bank Guidelines. Although the current procurement plan does not include contracts awarded under NCB and shopping procedures, these two methods would be provided in the Loan Agreement, i.e. NCB for contracts each estimated to cost between US$lOO,OOO and US$250,000, and shopping for contracts each estimated to cost less than US$lOO,OOO. 11. Consultants' services and training (US$10.13 million). This component includes both consultant services and training financed by the Bank for an amount estimated at $2.33 million and consultant services and training financed from domestic sources only for an amount estimated at $7.80 million and procured through domestic procedures. The Bank-financed contracts for construction supervision (international firm), staff training, technical assistance and studies will be awarded following Quality-and Cost-Based Selection(QCBS) and Selection Based on Consultants' Qualifications(CQ) procedures. Contracts with firms estimated to cost US$lOO,OOO or more, up to a total value of US$2 million will be procured through QCBS; contracts estimated to cost less than US$lOO,OOO, up to a total value of US$0.33 million will be procured through CQ. All contracts financed by the Bank shall be advertised in a national newspaper, and the contracts above US$200,000 shall be advertised in the UN Development Business. Shortlist of consultants for services, estimated to cost less than $300,000 equivalent per contract may comprise entirely of national consultants in accordance with the provisions of paragraph 2.7 of the consultant Guidelines. Prior Review Thresholds (Table B) 12. Prior review procedures will be followed for: (a) works contracts each estimated to cost US$5 million or more; (b) goods contracts each estimated to cost US$250,000 or more; and (c) consultant service contracts each estimated to cost US$lOO,OOO ore more for firms and US$50,000 or more for individuals. This will apply to respectively 86 percent and 100 percent of the total contract values of works and goods financed by the Bank. For contracts below these thresholds, post-review procedures will be followed (sample ratio at 1/4).Terms of reference for consultant assignments, regardless of the value of the contract, will be subject to Bank's prior review. Procurement Plan 13. A detail procurement plan has been agreed with HPCD. The plan has covered more than 80% of the Bank-financed procurement under the project. Since most of the contracts inthe plan will be awarded in the first one year of the project implementation, the plan may not be updated annually. However, any changes to the plan during the project implementation shall be subject to the Bank's prior approval. Since only the Phase Iof the LRIP component has been included in the plan, and a procurement plan for the subsequent phases of the component shall be prepared and submittedby HPCD for the Bank's prior approval. Retroactive Financing 14. Retroactive financing of up to US$10.40 million may be applied to expenditures incurred after March 15,2004 for the procurement of works, goods and services. (a) consultants for construction supervision of SME. This would allow for the training of local staff, setting up of the supervision offices, and start-up of construction supervision by the time contracts are signed with contractors. Expenses to be incurred by the 58  implementing agency are estimated at US$439,560, and loan withdrawals on account of such payments estimated at US$400,000; (b) construction of SME. Early start of construction of S M E would help meet the planned schedule for opening the expressway to traffic. The expenses to be incurred by the implementing agency are estimated at US$22.2 million, and the amount subject to retroactive financing at US$ 10 million. Table A: Project Costs by Procurement Arrangements (US$ million equivalent) ProcurementMethod' Expenditure Category ICB NCB Other2 N.B.F. Total Cost 1.Works 418.21 69.17 0 0 487.38 (180.46) (12.60) (0.00) (0.00) (193.06) 2. Goods 2.79 0.00 0.00 2.56 5.35 (2.79) (0.00) (0.00) (0.00) (2.79) 3. Consultants' 0 0 2.33 7.80 10.13 services and training (0.00) (0.00) (2.15) (0.00) (2.15) 4. Miscellaneous 0 0 0 24.50 24.50 (0.00) (0.00) (0.00) (0.00) (0.00) 5. Front-endfee 0 0 2 0 2 (0.00) (0.00) (2.00) (0.00) (2.00) Total 421.OO 69.17 4.33 34.86 529.36 (183.25) (12.60) (4.15) (0.00) (200.OO) 'Figures inparenthesesare the amountsto be financedby the {LoadCrediflrust Fund}. All costs include contingencies. 'Includes civil works and goods to be procuredthrough national shopping, consulting services, servicesof contractedstaff of the project management office, training, technical assistanceservices, and incremental operating costs relatedto (i) managingthe project, and (ii)re-lending project funds to local government units. 59  Table A1: Consultant Selection Arrangements (optional) (US$ million equivalent) SelectionMethod Consultant Services Expenditure Total Category QCBS QBS SFB LCS CQ Other N.B.F. Cost' A. Firms 2.00 0 0 0 0.33 0.00 7.80 10.13 (1.82) (0.00) (0.00) (0.00) (0.33) (0.00) (0.00) (2.15) B. Individuals 0 0 0 0 0 0 0 0 (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) Total 2.00 0.00 0.00 0.00 0.33 0.00 7.80 10.13 (1.82) (0.00) (0.00) (0.00) (0.33) (0.00) (0.00) (2.15) Table B: Thresholdsfor ProcurementMethods andPrior Review Contract Value Contracts Subject to Threshold Prior Review ExpenditureCategory (us$thousands) ProcurementMethod (us$millions) 1.Works >15,000 ICB, prior review 418.21 5,000- 15,000 NCB, prior review 0 4,000 NCB, post review 69.17 2. Goods >250 ICB, prior review 2.79 100-250 NCB, post review 0.00 <loo Shopping, post review 0.00 3. Consultant's >lo0 firms QCBS, prior review 2.00 services andtraining <loo CQ, postreview 0.33 Total value of contracts subject to prior review: $423.00 million Overall ProcurementRiskAssessment: Average Frequencyof procurement supervisionmissions proposed: One every six months (includes specialprocurement supervision for post-review/audits) 60  rable C: Allocation of LoanProceeds Amount inUS$ million Financing Percentage -SME civil works 163.99 46% -SME buildings and annex 1.78 20% areas - SME E&M 11.82 80% - S M E Connecting roads 0.47 20% - LRIP 10.00 20% Goods 2.79 100%of foreign expenditures, 100%of local expenditures(ex- factory costs) and 75% of local expendituresfor other items procured locally Consultant's Services 1.82 91% of foreignexpenditures Training 0.33 100%of foreign expenditures Unallocated 5.OO I Front-end Fee 2.00 100% I Tota 200.00 61  - J N t 3, c en E R 8 -f - 0 Ef 0 0 0 0  Annex 9: Economic and Financial Analysis CHINA: Hubei Shiman Highway Project I. EconomicAnalysis Preface 1. The economic evaluationof the project covers the following two project components: a) construction of the 105.1kmSME; and b) upgrading of one rural road (85.8km) and construction of one bridge (355 m) under the first phaseof the LRIP. 2. The analysis is based on the actual traffic volume and forecasts, vehicle operating costs (VOC), cost and time savings for users, reduction in accident costs and economic project costs. The main inputsfor the evaluation are: a) capital investment andmaintenancecosts, reflectingMarch 2004 prices; b) the benefit stream, also reflecting March 2004 prices, that comprises savings inVOC, travel time savings, andreductionin accident costs; c) implementation of investments during 2005-2008 and an evaluation of benefits over a 20 years longperiod; and d) benefits accruing as from 2009 for SME, and 2007 for the LRIP. 3. This Annex is comprised of three parts: the economic evaluation of SME; the economic evaluation of the LRIP; and the overall economic evaluation of the project, including a probabilistic risk analysis. SHIYAN MANCHUANGUANEXPRESSWAY (SME) - 4. For the purpose of the evaluation, S M E has been divided into three sections: Lengthof the Lengthof the new existingroads (km) expressway(km) Section2: Yunxia- Yunxi Section1: Shiyan- Yunxian 42.6 24.1 Section 3: Yunxi -Manchuanguang 89.2 45.0 80.0 36.0 TOTAL 211.8 105.1 Highway ExpansionPlan -Justification for the Investment Overview 5. Hubeiprovince is a large inlandbasin (185,900 sq. km) located inthe South central region of China. The Yangtze River flows from West to East across Hubei and the confluence with the Hanshui River (the largest tributary of the Yangtze River) is at Wuhan- the provincial capital - in the eastern part of the province. That central inland location and the Yangtze River make the Hubei province a major transport hub for both the East - West and North - South bound transport 63  influxes in South Central China. All major long distance transport modes (highways, railways, inland waterways and air transport) in South central China converge at Wuhan. Hubei's major economic activities are located in an East-Northwest corridor, that starts from Wuhan (East), crosses the province and reaches Shiyan (the major metropolitan city in the Northwest region of the province Northwest). The proposed S M E i s the last section of the entire Wuhan- Shaanxi border expressway corridor in Hubei province. Given the important role of the S M E corridor in the economy and the role of this expresswayin Hubei roadnetwork, the proposedproject has the highest priority inHubei's regional highway development plan. 6. S M E will link Shiyan with two smaller cities further West (Yunxian and Yunxi) and the border with Shaanxi province, and be the only high grade highway crossing cross one of the poorest areas in the province. Thus, S M E will improve the accessibility for remote areas well and help balance the economic development within the province. Current traffic i s this mountainous area is essentially long distance (90% in2001). Level andTiming of Investment 7. There are seven major local roads in the highway corridor, but only three roads (G209, G316 and Yunman road) would be significantly affected by the proposed SME. The pavement condition of the existing Yunman road is very poor, resulting in a low speeds and high safety risks. Motorized traffic on that highway was at about 5,600 - 9,600 motorized vehicles per day in 2003, and has increased on average 5.1 percent per year between 1995 and 2005. Non motorized traffic add about 300-500 vehicles per day. Even with a modest projected 5 percent future annual growth, motorizedtraffic would reach between 7,200 - 12,500 vehicles per day by 2009, the planned opening year of the SME. As the total capacity for the existing roads i s 10,000 to 12,000 vehicles each day, it is relevant to plan the construction of S M E right now. Situation onExistingHighways Section 1 Shiyan- Section2 Yunxian - Section3 Yunxi - Yunxian Yunxi Manchuanguan RoadClass (oldroadsI newroad) I1I Exp. 111I Exp. I11Rxp. RoadCondition(oldroadsI new road) FairI Good PoorI Good PoorI Good Terrain (oldroadsI new road) Mountains Mountains Mountains Capacity(AADTIday) (oldroadsI new road) MotorizedTraffic -2003 (AADT I day) 12,000125,000 10,000125,000 10,000/ 25,000 9,600 5,800 5,600 ProjectedTraffic -2009 (AADTI day) 12,489 7,480 7,180 ProposedOpeningYear 2009 2010 2010 Sources: HPCDand the Bank staff. Highway Corridor Traffic 8. HPCD has estimated future traffic on S M E from results of routine traffic counts and a comprehensiveorigin and destination (OD)survey that took place on November 2001 (updatedon April 2003). Its forecasts were further assessed and confirmed by an independent transport institute hired by the Bank to review regional transport demand and traffic on highways in the wider Shiyan - Wuhan - Hefei corridor. The traffic growth rate in the project corridor has been estimated at 5.0 percent per year between 2001 - 2009, 3.5 percent between 2009-2019, and 2.7 percent between 2019-2029, given the historical trend of economic growth during 1995-2001 in Shiyan area (6.1 percent per year ) and in other areas of the province served by expressways (9.9 percent per year), the estimated elasticity of passenger and freight traffic to economic growth, and 64  forecasts for the economic growth inChina incoming years. Traffic growth rates are summarized as follows: Annual Traffic Growth Rate inS M E Corridor --- Bus&Truck Car A v e r a L Actual: 1995-2001 13.6% 2.2% 5.1% Projection: 2001-2009 5.7% 4.7% 5.0% 2009-2019 4.4% 3.0% 3.5% 2019-2029 3.8% 2.0% 2.7% Traffic on S M E 9. The S M E should open for traffic in late 2008. Diversionratios were calculated by using financial the VOC for the road users and taking into account estimated impacts of the level of proposed toll rates on SME, reduction in travel distances, and the experience from other recently Bank financed highways in China. That analysis indicates that between 51 - 54 percent of motorized vehicles in 2009, depending on the road section, may be diverted to the new highway. Traffic diversion is expected to increase linearly inthe first ten years of operations to reach 56 - 62 percent by the year 2019 andstabilize thereafter. 10. Traffic generated by the new highway has been estimated at 10 percent of the normal traffic. This assumption i s consistent with the Bank experience on recent expressway projects in China. Although Shiyan is linkedby rail to Xi'an, with a single track in Hubei province, no rail traffic i s expected to be diverted to the new highway. Actually, the rail corridor does not run parallel to S M E alignment and railways essentially carry low value bulk freight over long distances (the average transport distance for the railway in 2001 in Hubei was 1,116 km compared with 47.5 km for road transport). In addition, transport costs on highway tariff are significantly higher than railway tariffs (about RMB 0.40 per ton-km compared with RMB 0.10 per ton-km for railway). Traffic forecasts on existing highways and SME, in scenarios without and with the project are as follows: Normal Traffic, by Sections (AADT) Section 1 Shiyan - Section2 Yunxian - Section3 Yunxi - Yunxian Yunxi Manchuanguan Traffic on the existing roads 1995 8,892 2,390 2,345 2000 6,435 4,223 3,992 2001 8,360 5,099 4,887 2002 8,965 5,446 5,225 2003 9,623 5,823 5,592 Traffic without the project 2009 12,489 7,480 7,180 2019 17,961 10,467 9,905 2029 24,178 13,566 12,421 Traffic with the project a. Traffic on the existingroads 2009 6,160 3,448 3,506 2019 7,340 3,938 4,329 2029 9,892 5,112 5,420 b. Traffic on SME 2009 6.329 II 4.032 I1 3.674 2019 10,621 6;529 5;576 I 2029 14,286 II 8,454 II 7,001 c. Traffic diversion (in %) . , 2009 50.7 53.9 51.2% 2019 59.1 62.4 56.3% 2029 59.1 62.3 56.4% 65  Economic Costs 11. Investment costs have been converted into economic costs by eliminating price contingencies, taxes, custom duties on imported materials and applying shadow price factors. The resulting overall economic cost i s about 1.5 percent higher than the financial cost, since eliminating price contingencies more than compensatesfor the other factors. Economic Benefits 12. Project benefits were estimated from the VOC by using the Highway Design and Maintenance Model (HDM-111). The economic analysis takes into consideration benefits derived from: (a) VOC savings on the new highway for normal and generated traffic, (b) time savings from reduced congestion on existing roads, and(c) lower accident costs. Benefits resulting from the lower level of congestion were quantified. The value of passenger time savings was estimated at RMB 1.50 per passenger-hour, by using updated figures from a report on feasibility study methodology for highways in China (Rust PPK. Australia Feasibility Study Methodology Report, May 1996). The same sources were used for vehicle accident rates on different classes of roads. Major assumptionsand formulas usedinthis analysis are summarized as follows: ECONOMIC VEHICLE OPERATING COSTS (RMB per km) TheExistingRoads The New Expressway Section 1 Section2 & 3 Car 0.915 0.842 1.074 Mediumbus 2.078 2.139 2.646 Largebus 3.454 3.919 4.502 Smalltruck 1.618 1.714 1.988 Mediumtruck 2.106 2.172 2.518 Largetruck 3.234 3.373 3.858 Tractorhailer 5.393 5.676 6.343 Accident Rates and CostsinChina Roadclass Accidents per 100million vehicle km Damage (RMBI accident) Expressway -40 0.005 AADT + 12,000 Motorway Class I 37 +0.003 AADT 9,000 Motorway Class I1 83+ 0.0065 AADT 7,000 Highway Class I1 133+ 0.007 AADT 6,000 Highway Class I11 140+ 0.03 AADT 4,000 Source: Table E4.1, pageE21, RustPPK. AustraliaFeasibilityStudy MethodologyReport,May 1996 Economic Evaluation 13. The overall EIRR of S M E is estimated at 16.4percent, with the following results for each road section: Economic Evaluation of SME EIRR(in %) NPV (12%, RMB million) Shiyan- Yunxian 14.4 211.3 Yunxian - Yunxi Yunxi -Manchuanguan 16.5 767.2 17.5 755.9 WHOLE ROUTE 16.5 1,795.7 66  14. The distribution of the estimatedbenefits shows that (a) roadusers on this highway corridor are the main beneficiaries; (b) trucks will receive 52.3 percent of the project benefits, while cars will receive 38.1 percent, and buses passengers 8.6 percent (these proportions are proximately the same as the proportion of traffic). Those latter benefits are more likely to accrue to lower income people; and (c) about 90 percent of total benefits will accrue to the long distance traffic (par. 8). The breakdown of benefits is as follows: Distribution of the Net Benefits (RMB million) Roaduser Roadagency Society Total benefits 5,452.7 (3,657.0) i-1 1,795.7 By vehicles: Truck- - Buses cars Trucks Trailers Total 2,075.9 470.7 2351.9 54.2 5,452.7 38.1% 8.6% 52.3% 1.O% 100.0% i-1: Road agency is negativebecauseit bear the investment cost. Sensitivity and Switching Values Analysis 15. The basic evaluation of the project, whole infrastructure andfor eachsection, showsthat the investment is economically viable. Sensitivity tests with respect to a two-year delay in project completion, zero value of time, no generated traffic and lower traffic projections on the new highway confirmthat result. Sensitivity Tests on the Economic Evaluation of SME EIRR(%) NPV (12%, RMBmillion) Delay incompletion by two years 14.2 926.1 Zero value of time 16.0 1,594.5 Zero generatedtraffic 15.7 1,472.3 Lower traffic projection (20%) 14.9 1,096.5 Switching values % increase Cost increase to reduce EIRR to 12% 149 % Benefit reduction to reduce EIRR to 12% 67 % 16. The results of sensitivity tests (EIRR in %) to cost and benefit variations are summarized below: SENSITIVITY OFEVALUATION RESULTS (EIRR IN %) TO COST AND BENEFITVARIATION Variation in Variation inbenefits ' cost -50% -40% -30% -20% -10% 0% 10% -20% -40% 14.3% 16.5% 18.4% 20.1% 21.8% 23.3% 24.8% 26.2% -10% 10.1% 11.9% 13.6% 15.1% 16.5% 17.8% 19.0% 20.1% 0% 9.1% 10.9% 12.4% 13.9% 15.2% 16.5% 17.6% 18.7% 20% 7.5% 9.1% 10.6% 11.9% 13.2% 14.3% 15.4% 16.5% 30% 6.8% 8.4% 9.8% 11.1% 12.3% 13.5% 14.5% 15.5% 67  LOCALROADSIMPROVEMENTPROGRAM (LRIP) MainFeaturesof the LRIPandTraffic 17. Only the first phase of the LRIP (upgrading of Baozhu road and reconstruction of Jiangjunhe bridge) has been identified during preparation and is evaluated in this annex. Further phases of the LRIP, that will bring total investment to $50 million) will be finalized during the project implementation. That first phase involves three counties (Yunxian, Yunxi and Zhushan) of Shiyan City, that are mountainous areas among the poorest inHubeiprovince. Baozhuroad is invery poor condition with rough surfaces and steep slopes. Inaddition, the existing Jiangjunhe bridge as a maximum useful life of less than three years, i s classified as dangerous and can only accommodate one way traffic with limited vehicle load. The road and the bridge are often inaccessible duringrainy days or the snow season, which affects travel distance and time for road users. The main design characteristics are listedbelow: LocalRoadsImprovementProgram(LRIP) Length Traffic Roadclass Speed (km/hr.) Maxi. Slope (km) (AADT 2000) (Oldhew) (Oldnew) (Oldnew) 1 Baozhuroad 85.8 500 IV 1111 15I30 12%I 8% 2 Jiangjunhebridge 0.355 170 I11I I1 10I40 8% 16% Sources: HPCD andthe Bank staff. 18. Current traffic level i s in the range of 170 500 AADT. Since the road and the bridge - are located in the same district, the local economic development and traffic patterns are quite similar. Based on the actual traffic levels and local economic growth rates, traffic growth rates have been conservatively estimated to be 4.0 percent during 2000-2005, reduced by 1percent for each of the 5 years from 2005-2025. No attempt has been made to quantify generatedtraffic. EconomicCostsand Benefits 19. Financial costs have been converted to economic costs by using the same method and factors as for SME, with the following results: FINANCIAL ECONOMIC AND COSTFORLRIP( R mMILLION) Financial Economic Construction period 1 Baozhuroad 177.40 180.08 2004-2006 2004-2006 2 Jiangjunhebridge 39.97 40.57 Total 217.37 220.65 20. Like on SME, the HDM I11model were used to quantify economic costs and analyze benefits on the road and the bridge. Mainbenefits would accrue from reduced VOCs, because of a better road pavement, and the associated class upgrading and all-weather conditions would 68  allow higher traffic speed, improve the road roughness index and shorten the average transport distance. Economic Evaluation and Sensitivity Analysis 21. Best estimates of the road and bridge EIRRs range from 14.3 percent to 26.2 percent. The overall EIRR and NPV (with a 12 percent discount rate) for the whole first phase of the LRIPare at 24.3 percent andRMB 244.2 million respectively. EIRRAND NPVSUMMARY FORLRIP EIRR(in %) NPV (12%, RMB million) ~~1 Baozhuroad 26.2 237.0 2 Jiangjunhebridge 14.3 7.2 Total 24.3 244.2 22. Risks considered for economic evaluation are: (a) a slower than projected growth of traffic; (b) higher than project cost of civil works; and (c) lower than expected VOC savings. All those risks were analyzed through sensitivity tests and the evaluation results were found to be robust for all of them. For the project component to be non-acceptable (Le. an EIRR lower than 12 percent or a nil NPV at 12 discount rate), the benefits would have to fall to less than 53.4 percent of those inthe base case with no change incosts, or costs would have to increaseto more than 1.88 times the base costs, or costs would have to increase by 30.5 percent and the benefits fall to 69.5 percent at the same time. 23. Additional benefits, not included in the EIRR calculation, are expected from the project, as follows: a) increased income of local farmers who live along the road and the bridge because of better access to town markets andjobs; b) increased accessibility to schools. It is estimated that about 13,800 extra children would attend school (about 5.2% percent of total 266,496 children inthe served areas); and c) increasedaccessibility to hospitals. It i s estimated that 21,500 extra people would benefit from health services (1percent of 2,147,000 people living in served areas). Based on normal observations derived from previous research, benefits can be summarized as below: THEEXTRA BENEFITSFORLRIP Extra children Extra peopleattending attending school/ year healthservicedyear 1 Baozhuroad 6,600 10,500 2 Jiangjunhebridge 7,200 11,000 Total 13,800 21,500 69  THE OVERALLECONOMICEVALUATIONOF THE PROJECT OverallEconomicInternalRateof Return(EIRR) 24. The overall ERR of the project (including S M E and the LRIP) i s at 16.8 percent and the NPV (12 percent discount rate) at RMB 1,821.8 million. ProjectRisks 25. All sections of the SME and LRIP show acceptable economic returns. HPCD has extensive experience in the construction and operation of expressways and rural road projects, which minimizes technical risks associated with the implementation of the project. The main tangible risk of prolonged delays affecting the construction schedule has been tested in the probabilistic risk analysis. ProbabilisticRiskAnalysisfor EconomicEvaluationof SME 26. To determine the degree of uncertainty on the project, a probabilistic risk analysis using Monte Carlo techniques was carried out. In a Monte Carlo analysis, each uncertainty factor i s 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, one can assess risks associated with making various decisions (or probabilistic risk analysis). The outcome of the analysis i s a judgment on the possible range of the decision variable, and on the likelihood of each value within that range. 27. As the total cost of LRIP constitutes only about 9 percent of total capital investment and the respective EIRR is higher than that of SME, the probabilistic risk analysis for the project is focused on the construction of SME. The following highest uncertainty factors associated with the economic evaluation of S M E have been identified: (a) traffic growth rate, (b) traffic diversion ratio to SME, (c) value of vehicle operating costs, and (d) changes in capital investment. The results of probabilistic risk analysis show that the EIRR i s at 16.5 percent for the most likely scenario, 9.1 percent in the low scenario and 24.4 percent in the high scenario. The standard error of the mean is 0.4 percent. The detailed results of the Monte Carlo test and probabilistic risk analyses are shown inTable 1and summarized as follows: SUMMARY OF SME PROBABILISTICRISK ANALYSES Most likelv Standard error Section 1: Shiyan- Yunxian Range of EIRR EIRR of the mean 10.4% 24.1% - 16.9% 0.4% Section 2: Yuixian -Yunxi 9.5%-24.1% 16.5% 0.4% Section 3: Yunxi - Manchuanguan 10.3% 25.4% 17.5% 0.4% Total SME 9.1% 24.4% -- 16.5% 0.4% 70  HUBEIPROVINCE: SHIYAN MANCHUANGUANEXPRESSWAY - EIRRSIMULATIONAND PROBABILISTICRISK ANALYSIS Summary: Display Rangeis from -10.0% to 60.0% (in%) Entire Rangeis from -3.3% to 73.0% (in%) After 1,200 Trials, the Std. Error of the Meanis 0.4% Statistics: Value Percentiles: - Trials 1200 Mean 18.2% Percentile Median 16.5% 0% -3.3% Mode _ _ _ 10% 1.4% Standard Deviation 13.7% Low Scenario 20% 5.6% Variance 1.9% 30% 9.1% Skewness 0.73 Most Likely 40% 13.1% Kurtosis 3.21 50% 16.5% Coeff. of Variability 0.75 High Scenario 60% 19.8% RangeMinimum -3.3% 70% 24.4% RangeMaximum 73.0% 80% 29.5% RangeWidth 76.3% 90% 37.3% Mean Std. Error 0.39% 100% 73.0% Forecast:SME EIRRTotal 1,200Trials FregwncyChart 5 Outliers 029 - t........ -35 .- - 022 -.............................. ............"..~ ......... ...... ~ 26 25 .- a I III II.111 a 015 -100% 7 5% 25 0% 42 5% (!"%) Assumotions Traffic Growth Rate Traffic Diversion Normaldistribution with parameters: Normal distribution with parameters: Mean 100.0% Mean 100.0% StandardDev. 10.0% StandardDev. 10.0% Selected range is from -Infinity to +Infinity Selectedrangeis from -Infinity to +Infinity Meanvalue insimulation was 100.4% Meanvalue insimulationwas 99.9% VOC Value Capital Cost Triangular distribution with parameters: Triangulardistribution with parameters: Minimum 90.0% Minimum 100.0% Likeliest 100.0% Likeliest 105.0% Maximum 110.0% Maximum 110.0% Selectedrange is from 90.0% to 110.0% Selectedrangeis from 100.0%to 110.0% Mean value insimulation was 100.0% Meanvalue insimulationwas 104.9% 71  11. FinancialAnalysis Preface 28. The financial evaluation of the project is comprised of three sections: an assessment of the revenue earning entity (SME), focusing on consolidated financial statements; an assessment of the non-revenue earning entity (LRIP), focusing on financial risks regarding the construction, and operation and maintenancephases; and an assessment of the financial capacity of HPCD to sustain its highway activities, focusing on the adequacy of funding allocations with the provincial roaddevelopment plan. The financial cost of capital for the project is assumed to be 4.8 percent (25 percent of financing from local banks at 5.89 percent, 40 percent from the Bank at 4 percent and 35 percent from MOC/Hubei province grants at a normative 5 percent cost). THE FINANCIAL EVALUATION OF SME 29. S M E will be operated from its opening for traffic by a financially independent entity (HPSEC), responsible for the day-to-day management, operations and maintenance of the expressway. The main income of Sh4E will be derived from tolls charged to road users; Hubei government will set toll rates. Financial Objective 30. HPCD has clearly indicated that the financial purpose of the toll collection on S M E is to repay the project's Bank's and domestic loans, cover operating and non-operating expenses and cover routine maintenance, andnot to maximize the financial rate of return on the entire investment. Financial Forecasts 31. Tolls. The toll will be charged on the basis of vehicle size (small passenger cars, large buses, small trucks, medium trucks, large trucks and trailers) and distance traveled. Toll exempted vehicles (police, ambulance and military) are expected to account for 10 percent of total traffic. Becauseof the higheraverageConstructioncost for this mountainous terrain and large debt amount in the financing plan (about 65 percent of the total cost), the toll on Sh4E has to be set on the high side compared with other Chinese expressways (par. 41), to meet the above minimum financial requirements. For example, toll charges will be about 42 percent higher than those applied on the Xiaogan- Xiangfan Expressway, another expressway financed in Hubei by the Bank in 2002. Toll charges are assumedto increaseonce every five years (15 percentor an average of 2.8 percent peryear). Toll Charges (RMB / vehicle-km) Small Medium Large Heavy Overall vehicle vehicle vehiile vehicie average SME- 2009 (a) 0.50 1.oo 1.50 1.90 0.95 XXE- 2006 (b) 0.40 0.80 1.00 1.20 0.67 Increase (a)/(b) 25.0% 25.0% 50.0% 58.3% 41.8% 72  32. Operations. The operating costs of S M E can be broken down between working costs (a. wages and benefits, b. maintenance, c. operating materials and supplies, d. administration, e. others) anddepreciation. 33. Profitability. All operation and other expenses, including interest payments on the loans, are taken into account in the calculation of the S M E profitability. It i s estimated that the expressway will generate enough revenue over the loan period to achieve the above mentioned financial objective. However, deficits will take place in the early years of operation (2009- 2013). The total interest payments alone in 2009 (RMB 127.31 million), for example, are 2.34 times higher than the total working costs (RMB 54.35 million), or equal 44.8 percent of the total revenue (RMB 283.93 million ) in that year. Because of the low toll growth assumptions, the profitability of SME for the first fives years is low. (Income statement, page 1of 3, Appendix A). 34. Cashflow. Despite the low profitability, SME's cash flow should be sufficient to meet all project needs, including the repayment of the Bank loan as from 2010, because of the large sumof depreciation reserves and the flexible principal payment terms agreedby domestic banks on their loans which allow SME to reduce cash outflows in the early years of operations. In 2009, for example, the total annual depreciation reserve (RMB 110.52 million) will represent about 2 times the total annual working cost, thereby generating strong internal cash flow and providing sufficient funds for the SME's operations, maintenance expenses and loan repayments. It i s estimated that S M E will not require any external cash injection andbe able to maintain cash available above RMB 12 million over the life of the project (Sources and applications of funds, page 2 of 3, Appendix A). 35. Leverage and Liquidity. The low profitability and highproportion of debt in the financing plan will dilute the equity of S M E and cause the debt/ equity ratio and debt/ capital ratio (the financial leverage of the company) to exceed 50 percent until 2021. But that will not affect the liquidity of SME, as it is ensuredby strong cashflows. The current ratio will be ina sounder range of 1.1or higher, whereas it should be at least 1.0 to avoid short-term solvency problems (Balance sheet, page 3 of 3, Appendix A). In addition, HPCD has reiterated its full commitment to the expressway, in an official document to the Bank that confirms its full financial support, which guarantees the project financial viability. Major assumptions for and results of the financial evaluation are shown inAppendix B. Financial Internal Rate of Return (FIRR) 36. The low profit margin will impact the FIRR on the capital investment. The financial evaluation concludes that the FIRR i s expected to be at 1.1 percent. This return would be reducedby 50 percent if the opening of the S M E i s delayed by one year (0.7 percent). Financial Probabilistic Risk Analysis 37. To determine the degree of financial uncertainty on the project, a probabilistic risk analysis using Monte Carlo techniques was carried out. The six most uncertain factors which may affect the financial evaluation have been identified: (a) traffic growth rate, (b) the basic toll level, (c) toll charges growth rate (d) total working costs, (e) capital investment, and (f) one year delay in opening the expressway. The risk analysis reveals that the most likely FIRR would be 0.7 percent, while the worst and the best FIRR would respectively be 0.6 percent and 0.8 percent. Details are inAppendix C and summarized as follows. 73  SUMMARY OF FINANCIAL SENSITIVITYAND PROBABILISTICRISKANALYSIS FinancialSensitivityTests FinancialSimulationandRisk Analysis OpeninJan. OpeninJan Range of Most Likely Std. Error of 2009 2010 FIRR / NPV FIRR/ NPV The Mean FIRR (in %) 1.1 0.7 06 -0.8 0.7 0.0 NPV (4.8%, RMB million) - 1,264 - 1,390 - 1,619 -1,483 - 1,557 3.5 Toll Level and Toll Affordability 38. On a toll expressway, the level of tolls need to satisfy two criteria (a) generate enough revenue to ensure an acceptable financial rate of return on the investment, and (b) not deter potential users and compromise the project economic objectives. Those criteria can be contradictory, since the former requires a higher toll while the latter requires a lower one. To help address the conflict and assess the affordability of tolls to road users, the Bank has developed an "affordability rate" indicator (for private cars). The higher the rate, the less affordable the toll. That research is based on data from a series of tolled expressways in a selection of developed and developing countries and uses the purchase power income for each country to quantify a users "toll affordability rate". The toll affordability rate for the proposed S M E has been estimated at 2.34% and can been compared with values in China and other countries as follows: Toll Level and Toll Affordabilitv ComDarisons Developed Developing Hubei Car countries us countries China SME Average toll (US cents/ km) 11.14 4.45 3.11 4.53 6.02 Toll affordability rate 0.69% 0.02% 0.65% 2.06% 2.34% Sources:The theoreticalandpracticalbases for setting roadtolls (Draft), November2003, the World Bank; HPCD 39. Results indicate that: (a) the toll affordability rate for China i s higher than in most developed and developing counties, and (b) the toll and toll affordability rate for S M E are higher than the China's national averages - only next to Shaanxi and Anhui provinces. High tolls especially affect local traffic, when parallel free itineraries are available, but rates considered so far have less impact on the long distance traffic given the high time and cost savings ensuredby the project. Based on the O/D pattern in the served highway corridor, the majority of vehicles (about 90 percent of the total traffic, par. 8) are long distance travelers who are less sensitive to the toll, because they are less likely to detour particular sections of the roadjust to avoid paying the toll. Impact of the Toll Charge 40. Thus the proposed toll for S M E is comparatively high. Raising further tolls would be mostly detrimental mostly to the local short-distance users along the project corridor and not be acceptableto Hubei government. 41. The impact of toll levels on ERR andFIRR has beentested as follows: On the one hand, increasing the toll above RMB 1.0per vehicle km would cause the EIRR to drop; a RMB 2.0 per vehicle km (or about 24 US cents/ km) charge- the highesttoll rate inChina- would reduce the EIRR by about 2 percent (16.5 percent vs. 14.2 percent). The EIRR starts to fall sharply once the toll exceeds RMB 2.0 per 74  vehicle km, because travelers will be motivated to seek alternative routes to S M E even if it means a longer traveling distance. 0 On the other hand, the FIRR would slightly increase with toll increases and reach a maximum (1.9 per cent) when the rate i s at RMB 3.0 per vehicle km (or about 36 US cents/ km). Beyond this rate, the FIRR declines as the loss of traffic will have a greater impact than the increaseof revenueper user. 0 It is estimated that both the ERR and the FER will be close to zero when the toll is at RMB 5.0 per vehicle km (or about 60 US cent/ km). Impact of Toll Levels on the ERR andFIRR Variation of economicandfinancial returnwith levelof toll 20.0 15.0 10.0 5.O Levelof toll (RMB/ vehicle-km) averagetoll +ERR +FIRR THEFINANCIAL EVALUATIONOFTHELRIP 42. The financial evaluation of the LRIP focuses on HPCD's capacity to minimize financial risks, i.e. mobilize sufficient counterpart funds for the construction and ensure the maintenance of project roads. 43. HPCD budget forecasts show that the investment and maintenance costs of the LIRP component constitute only a small fraction of HPCD's road expenses. Based on HPCD's plan, financing the LRP will require less than 1.1 percent of the projected annual total HPCD revenue. In addition, the maintenance costs of LRP i s less than 0.2 percent of the total maintenanceexpenditure of HPCD. These low ratios indicate that the project presents a modest financial risk as regards the availability of counterpart funds. Details are shown in Appendix D to this Annex and summarized as follows: 75  HPCD: Investments, Revenue andMaintenanceExpenditures (Yuanmillion) 2004 2005 2006 2007 2008 2009 2010 InvestmentsandRevenue: LRIP Investments(a) 65.21 108.69 68.26 24.79 24.79 8.26 _ _ Total HPCD Revenue@) 9,630.39 9,502.54 11,282.77 10,999.76 11,233.10 11,377.29 11,279.15 Ratios(a)/@) 0.7% 1.1% 0.6% 0.2% 0.2% 0.1% _- MaintenanceExDenditures: LRIP (c) 3.06 3.14 3.28 3.39 Total HPCDMaintenanceExpenditure(d) 1,840.27 1,933.22 2,028.83 2,184.46 2,321.23 Ratios(c)/(d) -- 0.2% 0.2% 0.2% 0.1% Sources:HPCDand Bank staff. FINANCIALEVALUATIONOFHPCD 44. expenditures during the Tenth Five Year Plan (lothFYP, 2001 -2005) and Eleventh Five Year HPCD has provided its financing plan, including forecasts on total revenues and Plan (1lthFYP, 2006 -2010). Based on available information, the financing plan entails an emphasis on new construction, and an increase in maintenance expenditures which are largely dependent on the grants from the government. 45. Over the IOth FYP, it i s estimatedthat new construction will consume about 63 percent of total revenue while maintenance expenditures will be budgeted at only about 10 percent of total revenue. The low emphasis on maintenancewill accelerate the deterioration of the existingroad network and cause higher rehabilitation expenditures (about 11percent of total revenue). The funds' allocation is expected to improve duringthe 11" FYP. The new construction budget will be reduced to 47 percent while the maintenanceone will increaseto about 18 percent of the total revenue. Increasing maintenance expenditures will reduce the need for road rehabilitation works to about 8 percent of total revenue. 46. Road maintenance expenditures are calculated on the basis of standards issued by the MOC, that are expected to be revised during the llth Facing the possibility of a sharp FYP. increase in maintenance expenditures, HPCD has budgeted a large increase in grants from the MOC. Without these grants, HPCD would have to seek other external resources to fund its operations. A moderate self- financing ratio (total internal cash generation against the total revenue, 52.3 percent for the 11" FYP) will ensure the implementation of the development plan. This is an improvement, compared to the 38.7 percent for the lothFYP. The detailed sources of highway revenue and expenditures for 2001 - 2010 are shown inAppendix Dof this Annex. 47. With regards the long term sustainability of road maintenance with allocated resources, the average yearly increase in maintenance expenditures during the loth FYP (3.0 percent) exceededthe growth of the road network (2.3 percent), which means HPCD budget has provided for anet increasein average maintenanceexpenditures per kilometer. The trend should continue during the 1lth FYPwith percentagesat respectively 3.9 percent and2.0 percent. HPCD: AVERAGEINCREASEINTHE ROADNETWORK AND RoadMaintenance Expenditures (in %) 10"FYP 11