Turkey - Istanbul Sewerage Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-3307-TU REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO ISTANBUL SU VE KANALIZASYON IDARESI GENEL MUDURLUi WITH THE GUARANTEE OF THE REPUBLIC OF TURKEY FOR AN ISTANBUL SEWERAGE PROJECT May 3, 1982 This document has * restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  TURKEY CURRENCY EQUIVALENTS Currency Unit Jan.1980 /1 Oct. 1980 June 30, 1981 Dec. 1, 1981 US Dollar = TL70.0 /2 TL83.50 /2 TLIOO.00 /2 TL130.00 Turkish Lira = US$0.014 US$0.012 US$0.01 US$0.008 /1 Since January 1980, the rate is being adjusted for the differential irflation between Turkey and its major trading partners. TL130/$1.00 was used for this report. /2 'xcept for imports of fertilizers and insecticides/pesticides, as well as raw materials and inputs for their manufacture, for which the rate was TL55/$1.00 in January 1980, TL70.0/$1.00 from October 1980, and TL85.34/$1.00 from April 15, 1981. The special rate for fertilizers has now been eliminated. ABBREVIATIONS DSI - State Hydraulic Works IB - The Bank of the Provinces (Iller Bankasi) ISI - Istanbul Water Authority ISKI - Istanbul Water Supply and Sewerage General Directorate (Istanbul Su ve Kanalizasyon Idaresi) YSE - Rural Infrastructure General Directorate of the Ministry of Village Affairs and Cooperatives FISCAL YEAR Republic of Turkey - March 1 to February 28 /3 ISKI - January 1 to December 31 /3 Turkey is in the process of changing its fiscal year from January 1 to December 31, commencing in 1983.  FOR OFFICIAL USE ONLY TURKEY ISTANBUL SEWERAGE PROJECT Loan and Project Summary Borrower: Istanbul Water Supply and Sewerage General Directorate (ISKI) Guarantor: Republic of Turkey Amount: US$88.1 million equivalent, including $1.3 million capitalization of the front-end fee, in various currencies. Terms: 17 years including 4 years grace with interest at 11.6 percent per annum. Project Description: The project is aimed at (i) expanding and improving the sewerage services in Istanbul; (ii) improving the city environmental conditions; and (iii) strengthening the institutional framework for planning, financing and implementation of water supply and sewerage facilities in Istanbul. It would cover about 60 percent of ISKI's proposed investment program during 1982-87. To achieve these objectives, the project would include the following major components: (i) laterals and collectors, 285 km; (ii) interceptors, 26 km, and tunnel, 2.4 km; (iii) pretreatment works with inlet and outlet pumping stations; (iv) submarine outfall main, 2.0 km; (v) operating and maintenance equipment; (vi) consultant services; and (vii) technical assistance and training. Project Benefits and The project is expected to (i) increase the population Risks served by sewer connections from 52 percent to about 60 percent and that of the lower income group from 50 percent to about 70 percent; (ii) through the reduction of water pollution reduce the This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  - ii - health hazard at public beaches, commence the restoration of Golden Horn and generally improve environmental conditions; and (iii) strengthen ISKI and its cost recovery procedures with improvements expected in project implementation, works operation and accounting systems. The institutional development could provide a pattern for other urban areas. Major project risks would include the possibilities for delays in project implementation and for cost overruns which are normally associated with large and complex civil works and the difficulties inherent in the merging of former sector entities. With actions already taken to complete project design elements, and the provision of technical assistance to ISKI in project implementation and improvement in its internal organization, these risks have been reduced to acceptable levels. Estimated Cost: Local Foreign Total -------- US$ Million -------- Sewerage System 24.5 1.3 25.8 Interceptors and Tunnel 20.9 13.7 34.6 Pretreatment Works, Pumping Stations and Pumping Mains 21.0 23.9 44.9 Submarine Outfall Main 16.8 11.2 28.0 Operating and Maintenance Equipment 3.0 4.5 7.5 Land Acquisition 1.1 - 1.1 Sub-Total 87.3 54.6 141.9 Project Management and Construction Supervision 1.9 2.3 4.2 Physical Contingencies 14.1 8.9 23.0 Price Contingencies 29.6 18.6 48.2 Consultant and Technical Assistance and Training 1.1 1.9 3.0 Total Project Costs 134.0 86.3 220.3 Project Preparation Facility - 0.5 0.5 Front-End Fee - 1.3 1.3 Total Financing Required 134.0 88.1 222.1  - iii - Financing Plan: Local Foreign Local ------- US$ Million ---- Proposed Bank Loan - 88.1 88.1 Portion of Municipal Fund 48.5 - 48.5 Central Government Contributions 82.7 - 82.7 Internal Cash Generation and Customers' Contribution 2.8 - 2.8 Total 134.0 88.1 222.1 Disbursements Bank FY 1983 1984 1985 1986 1987 1988 1989 Annual 5.2 11.4 18.1 18.8 15.6 10.7 8.3 Cumulative 5.2 16.6 34.7 53.5 69.1 79.8 88.1 Rate of Return: Since the benefits accruing from a sewerage and sewage disposal project cannot be meaningfully quantified, no rate of return has been calculated. Staff Appraisal Report: No. 3836-TU of May 3, 1982.  * 4 4~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO ISTANBUL SU VE KANALIZASYON IDARESI GENEL MUDURLUGU WITH THE GUARANTEE OF THE REPUBLIC OF TURKEY FOR AN ISTANBUL SEWERAGE PROJECT 1. I submit the following report and recommendation on a proposed loan to Istanbul Su ve Kanalizasyon Idaresi Genel Mudurlugu (ISKI) with the guarantee of the Republic of Turkey, for the equivalent of US$88.1 million (including $1.3 million for the capitalization of the front-end fee) to help finance the expansion and improvement of the sewerage services in Istanbul. The loan would have a term of 17 years, including 4 years of grace, with interest at 11.6 percent per annum. PART I - THE ECONOMY I/ 2. The last economic report entitled "Turkey: Policies and Prospects for Growth" (No. 2657a-TU) and the Postscript thereto, were distributed to the Executive Directors in December 1979 and March 1980 respectively. Updating of economic prospects as well as indepth economic analysis and dialogue has since been undertaken through the continuing work on structural adjustment loans (SALs) to Turkey, and two special economic missions. The report of the special economic mission in November/December 1980 to evaluate the investment program and entitled "Turkey: Public Sector Investment Review" (No. 3472-TU) was distributed to the Executive Directors in December 1981. The report entitled "Turkey: Industrialization and Trade Strategy" (No.3641-TU) was distributed to the Executive Directors on February 18, 1982. Its analysis is also reflected in this Part. Annexes I-A and I-B contain the Basic Country Data and relevant details about recent economic developments. Characteristics and Development Constraints 3. Turkey is a country about as big as France and Germany combined, with an estimated GNP per capita of $1,450 in 1980. With a population of around 45 million, the density is low (78 per square kilometer of agricultural land), although the rate of urbanization is high (about 45 percent). Educational enrollments have expanded greatly, but the rate of adult literacy remains relatively low (60 percent). Although population growth is not high by middle-income country standards (2.2 percent per annum), the employment situation has deteriorated steadily, with an unemployment rate of about 16 percent, despite rapid economic growth, substantial emigration of workers to Western Europe in the early 1970s and the more recent flow of workers to the Middle East. There is little or no absolute poverty, but income distribution is still relatively skewed. Data for more recent periods is incomplete, but indicates a worsening especially of the position of wage and salary earners over the last few years with a sharp real decline in the minimum wage. There are also considerable regional differences, and large rural-urban disparities. 1/ Parts I and II are substantially the same as Parts I and II of the President's Report on the Export-Oriented Industries Project (P-3199 TU) dated January 29, 1982.  - 2 - 4. Agriculture is the most important sector in th- i-onr-, Tt contributes 23 percent of GDP (1980), employs about 55 percen- of the labor force, and provides about half of merchandise exports. Turke'- 's One of the very few developing countries which is self-sufficient in food. Yet, agriculture has been given a secondary role compared to industry in the development strategy. The main sector objectives have been to: (a) expand food supply for a growing population; and (b) provide exports to finance industrial development. Turkish agriculture is dualistic; a modern irrigated commercial sector using modern inputs in coastal areas, produces cash crops and most exports; traditional rainfed agriculture emphasizing grains and livestock, is practised on the Anatolian plateau where only a small part of the irrigation potential has been developed, despite massive investments through slowly implemented and long-gestating projects. 5. With its natural and human resources, Turkey has considerable potential for expanding agricultural production and exports. The major constraints on growth and productivity are: (a) limited development of irrigation/ drainage facilities and poor utilization of what has been developed; (b) small and fragmented farm holdings; (c) inadequately funded and poorly coordinated research and extension services; (d) insufficient availability of credit; and (e) inadequate marketing arrangements, especially for exports. Increased productivity could be realized with a somewhat larger and more efficient allocation of investments, backed by more coherent credit and price policies and support services. 6. Reflecting the heavy emphasis of the development strategy on rapid industrialization, industry has absorbed up to 30 percent of total investment. Consequently, it today accounts for 19 percent of GDP, 48 percent of exports (mainly textiles, processed foods and leather products), but only 14 percent of employment. The private sector is overwhelmingly dominant in exports, and accounts for some 60 percent of value-added and an even higher share of employment. Industrial policy has sought to achieve self-sufficiency through import substitution, use of advanced technology and greater depth of integration in productive processes, with consequent priority for capital intensive investments in basic and intermediate products. Exports have generally been given a secondary role, and accounted for only about 4 percent of sector output in 1979. The principal policy instruments used have been large public investments in inefficient State Economic Enterprises (SEEs), and generous incentives combined with high levels of protection for private investments. These policies yielded high growth rates, domestic production of some key basic and intermediate goods based on domestic resources, adoption of modern technology, a skilled labor force, as well as some dispersal of industries to less developed regions. But they also resulted in the establishment of a number of uncompetitive industries, wasteful of scarce capital and too dependent on imported inputs, with low employment and limited export possibilities. 7. The major sector constraints which the Government is now attempting to overcome, are: (a) low levels of capacity utilization; (b) limited export capability in some subsectors; (c) inefficiency of the manufacturing SEEs; (d) lack of sufficient long-term financing for industry; and (e) excessive dependence on imported inputs and low productivity. Apart from import protection, several factors have adversely affected productivity, of which a marginal research and development effort and inadequate labor training are of particular importance. Export efforts have also been hampered by the limitations of marketing facilities.  - 3 - 8. Turkey has large underdeveloped energy resources (hydropower and lignite), but little petroleum. Energy consumption has grown in line with GDP, but remains below the per capita average for middle-income developing countries. However, imported oil accounts for over 85 percent of oil consumption and about 45 percent of total energy consumption. As a result, the oil bill was $3.3 billion in 1980, equivalent to 113 percent of exports, probably the highest figure in the world. 9. Hence, the energy situation has become a major preoccupation of the Government, and the sector has been accorded the highest economic priority. Prices for most products - especially petroleum products - have since 1980 been brought into line with prices in Europe and other indices of real costs to the economy. Investments in energy now have the largest share in the public investment program. The principal sector constraints are: (a) organization and management of institutions in the sector; (b) the lack of comprehensive demand-management and conservation programs; (c) insufficient resources for exploration; and (d) poor project implementation capacity, especially in the power and coal/lignite sub-sectors. Government Policies Until 1980 10. Economic policies until the mid 1970s were responsible for the achievement of rapid economic growth, with substantial growth in industrial capacity. However, both the pattern of growth and the excessive recourse to external finance, especially in the seventies, resulted in the substantial problems which Turkey is confronting today. At the same time, income distribution remained relatively unequal; employment creation inadequate; savings performance poor; and the industrial sector mostly inefficient, despite sizeable investments, and not contributing sufficently to either exports or employment. 11. In the past decade, economic management suffered further due to political instability, which thwarted effective decision-making. At the same time, economic problems were aggravated by serious economic shocks emanating from abroad: international inflation, leading to a sharp rise in Turkey's import prices (including oil) and a significant deterioration in her terms of trade; high interest rates resulting in an increased debt servicing burden; and recession in Europe leading to reduced export prospects and emigration possibilities. Inappropriate expansionary policies in response to these factors delayed Turkey's adjustment to the changed international environment, so that by 1977 the country was set on a course of rapidly growing inflation and an inexorable foreign exchange crisis. By 1977, the inflation rate had * escalated to 25 percent against 15 percent in 1976, and was rising: the budget deficit as a percentage of GDP increased to over 6 percent; with a tripling of imports between 1973-77 to $5.8 billion and merchandise exports and workers' remittances equalling only $1.8 billion and $1 billion in 1977, the balance of payments deficit soared to $3.6 billion, or over 6 percent of GDP. The Government's response to the crisis emerging since 1973 was to increase external borrowing, mainly short-term. Consequently by end-1977, total external indebtedness surged to $11 billion, of which short-term debt alone was $6.2 billion. A crisis of confidence developed, the inflow of external capital nearly ceased and Turkey faced a host of severe interlocking domestic and external problems. Since January 1980, to achieve its goal of reestablishing viable growth and increased efficiency of resource allocation, through greater reliance on market forces and the introduction of an outward orientation in economic policy, the Government has adopted a series of  measures in the areas of exchange rates, export promotion, protection policy, interest rates, SEE prices, taxes, investment criteria and incentives, and institutional reforms. A number of additional medium-term policies continue to be initiated, and it is clear that the Government is determined to follow through with its newly adopted development strategy. Government's New Policy Priorities and Actions 12. The new regime, which took over following the military intervention on September 12, 1980, has vigorously pursued these new policies, pari passu with efforts to restore political order following a period of rampant terrorism, paralysis of the constitutional process, and widespread labor unrest. It has also emphasized, like previous military regimes in 1960-61 and 1971-73, that it will transfer power to civilian authorities once order is restored and a new viable democratic system suited to Turkish circumstances has been constitutionally established. 13. Especially since September 1980, there has been substantial action on economic policies,, although the severity of the economic crisis has forced the new government to continue to focus much more on short-term than on medium-term concerns. In view of the severity of the crisis, and the urgent need to bring down inflation and stabilize the balance of payments as quickly as possible, it has accepted the need for a temporary sacrifice of growth and social objectives. However, while financial aspects of economic management, especially availability of foreign exchange and balancing the budget, have come to dominate policy concerns, fairly drastic structural changes have been made or initiated in the operation of the exchange rate regime, the tax system, interest rate policy, export strategy, the SEE sector and public investment policy. 14. On development issues, a welcome change is beginning to be apparent in the scope as well as in the sectoral emphasis to favor the development of energy, infrastructure and agriculture, at the expense of manufacturing, especially as far as the allocation of public sector resources is concerned. There is acceptance of the division of labor between the public and the private sectors, with the former now expected to concentrate on the provision of infrastructure while the latter provides the main impetus to industrial growth and exports. The administrative arrangements in the agriculture sector are being drastically recast to provide better service support to the farmers. The development strategy has also changed, to give much greater weight to exports, relative to import-substitution. Finally, and most significantly, reliance on the market mechanism is being emphasized as against more centralized planning, including in the inefficient SEE sector. Given the long period of inward orientation, detailed planning and administered prices prevalent until January 1980, the impact of these changes will take some time to manifest. They also need to be complemented by further actions, which the Government proposes to pursue, to fully implement the new development strategy. 15. The retrenchment following the financial crisis resulted in both public and private investment declining in real terms since 1977. The overall level of investment in 1980 was around that in 1975, with private investment being barely larger than in 1974. The extreme shortage of domestic resources resulting from the Government's restrictive policies on credit and high interest rates aimed at bringing down inflation, has necessitated rationing of investible funds. The high oil import bill also forced a drastic reduction in capital goods and raw materials imports needed for public and private sector  investments. The private sector, which to some extent has also continued to adopt a wait-and-see attitude before investing, has been particularly affected by the shortfall in resources, high cost of credit, and the lack of a developed capital market. 16. Despite the Government's attempts to reduce the investment-savings gap and improve on the poor savings performance of the past years, the results in 1979-80 continued to be poor as the Government had to bear the large financial losses of the SEEs. However, as a result of major tax reforms in late 1980/early 1981 and improved expenditure discipline, there was a significant improvement in public accounts in FY81. The budget deficit is expected to be about 1 percent of GDP vis-a-vis 4 percent in FY80; the SEE financing requirements are estimated to have been reduced to 8 percent of GDP in 1980, compared to 11 percent in 1979. 17. The new Government's policies to reduce the size of public investments, stimulate the private sector to take the slack, and overall, to further reduce the gap between savings and investments, will need to be vigorously pursued. In the last three to four years, the strategy has been to meet the gap by tapping external financing on a prudent basis, which practice is expected to continue. Turkey obtained increased support and debt rescheduling from OECD countries and diversified its aid relationships with OPEC countries, especially Saudi Arabia and Libya. Loan commitments, which totalled $2.5 billion during 1972-75, increased over threefold to $8 billion during 1976-79, and the gross public M&LT disbursements in 1980 reached about *1.5 billion. Effects of the 1980-81 Policy Measures 18. These new policy directions are beginning to show results. The recent results are provided in Annex I-B. Briefly, the average annual rate of inflation has been successfully brought down from 107 percent between January-December 1980 to around 35 percent for the same period in 1981. The flexible exchange rate policy under which the TL has been adjusted daily since May 1981, together with the new export oriented policies, has led to an unprecedented export growth in 1981; exports are estimated to be over $4.5 billion, or over 55 percent higher in dollar terms than the 1980 level. Increases were concentrated in manufactured goods, which experienced a rise of nearly 120 percent; product groups with the largest increases included textiles, clothing, cement, iron/steel, and non-electrical equipment, with the Middle East becomming an increasingly important market. A new and rapidly growing source of foreign exchange is income earned from construction contracts (with a gross value of nearly $7 billion in 1981) in the Middle East and North African countries. These activities are also expected to add to the normal flow of worker remittances, which remained strong throughout 1981. Although import growth continued to be strong in 1981 (around 14 percent of GDP), import volumes had declined sharply in 1978-79, and as a proportion of GDP, will remain well below the 1974-77 average. Given these developments, the current account deficit in 1981 is expected to be about $2.6 billion (4.1 percent of GNP) compared to $3.2 billion in 1980 (5.5 percent of GNP). 19. In response to the freeing of interest rates, total deposits in July 1980-June 1981 increased by 97 percent and time deposits (including certificates of deposit) by an astonishing 265 percent over the corresponding period in 1979-80. Since July 1981, private companies have been free to set their own bond rates in competition with banks, and can use flexible rates, if  they so choose. The Capital Market Law was passed in July 1981 and steps are being taken to establish a capizal market. Follo-L ing to improve SEE financial performance - by freeing most SEE prices and gradually exposing SEEs to market forces - the SEE losses are projected to be only TL 5 billion in 1981, compared to TL 72 billion in 1979. This gain was partly offset by the increases in SEE investment expenditures which in 198i sLoo- a. TL j4 billion, compared to TL 460 billion in 1980. The major tax reform initiated in late 1980/early 1981, is now beginning to show effect. The overall deficit on public account in 1981 is estimated to be about 1.5 percent of GDP, compared to 4.5 percent in 1980. Medium Term Prospects 20. Making a reasonable assumption that the Government's new economic policies will continue and be followed-up by further necessary measures, one can tentatively project that the investment rate over the next 5 years could average 23 percent of GDP and gross domestic savings 19 percent of GDP, with the current account deficit remaining on average close to the 1980 level of about $3 billion. This could allow the economy to grow at an annual average of between 4-5 percent during 1981-85. The gross capital inflow required to meet the financing needs would reach $6 billion in 1985, as against slightly over $3 billion in 1981. The past and prospective movements of macroeconomic indicators are summarized in the Table below. Le-els Average _ l Actual Rrojected Xeal Growth Rates /1 1975 1980 1985 1975-80 1980-85 (Units) A. GDP 1980 TLbn 3,818 4,325 5,287 2.5 4.1 - Consumption 3,342 3,660 4,244 1.8 3.0 - investment " 997 994 1,216 0.0 4.1 B. Exports of Goods Current 1,402 2,910 9,086 6.4 18.8 ibn Imports of Goods " 4,739 7,667 13,842 -3.7 4.8 - Oil: value 808 3,552 6,585 - - Current Account Balance Current $bn -1,892 -3,196 -3,164 Gross Capital Inflows Current $bn 2,067 4,057 6,010 C. Investment/GDP z 23.7 23.0 23.0 Savings/GDP 15.3 15.4 19.0 D. Exports of Goods/GDP X 3.2 5.2 10.0 Oil imports/Exports of Goods 57.6 122.1 72.5 E. Debt Service Ratio /2 8 11.5 33.2 /1 This does not reflect the latest (January 1982) estimates of GDP growth (4.4 percent) and exports of goods (S'.5 billion) in 1981 /2 Total dabt service as percent exports of goods + NFS + workers' r_ittancee.  21. The balance of payments picture in the 1980s could however be less severe if: (a) worker remittances increase by 2-3 percent in real terms, instead of remaining constant as assumed in tl-he above table; (b) remittances from overseas construction activities annually average about $300 million during the 5-year period (instead of $15-20 million assumed earlier); and (c) average import elasticity is between 1.0-1.1 (instead of an assumed 1.1- 1.2). The current account deficit in 1985 could then be below $2 billion, necessitating gross capital inflow of $5 billion in 1985. 22. The viability of prospects in the table is briefly discussed below. Continuation of economic and fiscal policies give room to expect that the inflation rate can be progressively brought down further between 1982-85. Policies, including continuation of the present exchange rate policy, and the excellent 1981 export performance, should also make it possible for Turkey to achieve a real growth of exports of about 19 percent per annum during 1980-85. The export growth rate appears attainable, taking into account the low export base and market prospects, especially in the Middle East and North African countries, and the present underutilization of industrial capacity. However, as the economy returns to a normal growth path, non-oil imports as well as the demand for energy should pick up significantly. Although Government policy is to substitute domestic energy resources, especially lignite, for imported oil to the extent possible in all major consuming sectors, Turkey will have to continue to rely heavily on imported oil. The oil import bill is estimated to increase from $3.6 billion in 1980 to $6.6 billion in 1985; but as a percentage of exports of goods, it is likely to decline to 73 percent in 1985 from 113 percent in 1980. The pressure of oil imports on the balance of payments position will thus continue. 23. A significant determinant of future prospects, in addition to increased aid flows, will be the negotiation of substantive improvements in trade policies towards Turkey. Revised agreements between the EEC and Turkey in 1977 and 1980 have partly compensated for the erosion caused by EEC restrictions on labor movement and textile exports, and offer hope for a better future relationship. The EEC could provide a large and growing market for Turkey's engineering products, as well as textiles and clothing - if their quality and product composition is upgraded. Moreover, Turkey has recently succeeded in diversifying its trade to include larger shares for the Middle East and North African countries, from 14 percent in 1978 to 44 percent in the first ten months of 1981. While these markets are becoming increasingly important to Turkish firms, exports from Turkey represent only a small proportion of the manufactured imports of these countries. Hence, while one should cautiously interpret the recent upsurge in sales to Iran and Iraq, Turkey has excellent possibilities to increase exports of relatively simple engineering goods, cement, and various chemicals, in addition to processed food, to these markets, in view of its geographical proximity and cultural ties. Creditworthiness 24. At the end of 1978, Turkey faced an overwhelming debt burden of $7.5 billion in short-term debt and $6.8 billion in M&LT debt. Turkey was faced with service payment obligations (mostly on short-term debt) of $5.1 billion (including arrears), or nearly three times the value of merchandise exports in 1977. Prolonged discussions with over 200 creditor banks resulted in an agreement in July 1979 to reschedule a total of $3.0 billion in short-term  - 8 - liabilities, including some $2.4 billion in convertible Turkish Lira deposits and $400 million banker's credits (both at 1.75 percent above the London Inter-Bank Offer Rate (LIBOR), with 7 years maturity including 3 years grace) and $300 million in third party reimbursement credits (also at 1.75 percent above LIBOR, but with an accelerated repayment schedule). Some $300 million in oil loans were also rescheduled in 1979. At the end of 1980, arrears on unguaranteed trade credits were consolidated in an amount of around $1 billion. As a result of these exercises, short-term debt outstanding at end-1980 was reduced to $2.8 billion, the balance having been converted to M&LT debt. Finally, in January 1981, leading commercial banks agreed in principle to extend the terms of the 1979 commercial debt rescheduling. A series of large-scale rescheduling operations relating to M&LT official debt also took place. In 1978, 1979 and 1980, OECD member creditors rescheduled $1.0, $1.1 and $2.5 billion respectively of debt service obligations and accumulated arrears (the last exercise including some re-rescheduling). The terms of the 1980 rescheduling were 8 to 10 years including 4 to 5 years of grace, and provided debt relief estimated at $1.1 billion in 1980 and another $0.8 billion in 1981, with smaller amounts thereafter. Without these reschedulings, the debt service ratio would have been around 29 percent instead of 12 percent at the end of 1980, on short-term debt of $2.8 billion and M&LT debt of $14.3 billion. Nevertheless, debt service obligations are likely to remain high over the coming years. The ratio is likely to rise to about 33 percent in 1985, and still be around 30 percent if the favorable assumptions spelled out in para. 21 are realized. The high ratios in the mid to late 1980's, are partly the result of repayment, which would amount to about $1.0 billion in 1985 alone of rescheduled debt carrying a very high interest rate, and partly due to the need to borrow additionally in the coming years to enable the economy to achieve a modest level of growth and revived vitality. However, despite the rapid increase, the debt burden should remain manageable, provided current policies are successfully implemented, the export drive is sustained, and Turkey continues to receive further international support from private and official donors. 25. On all aspects of economic analysis, the IMF and the Bank have coordinated closely with each other, and Turkey continues to be in good standing with the IMF. A three-year standby arrangement in an amount equivalent to SDR 1,250 million was approved by the IMF's Board and became effective on June 18, 1980. Under the arrangement, Turkey has thus far made six purchases totalling SDR 760 million, including the tranche for SDR 100 million released in January 1982. PART II - BANK GROUP OPERATIONS IN TURKEY 26. The Bank/IDA have to date lent about $3,476 million, through 68 projects. Agriculture accounts for 20 percent of funds lent, industry and DFCs (including structural adjustment) for 41 percent, power for 12 percent, and urban development, transportation, education and tourism for the rest. Annex II contains a summary statement of Bank loans, IDA credits and IFC investments as of March 31, 1982, with notes on the execution of ongoing projects.  - 9 - 27. The implementation of private sector projects has been satisfactory. Political instability, limited coordination amongst ministries, staffing problems and the serious external and domestic financial crisis since 1977 have seriously affected project implementation in the public sector. A system of joint project reviews between Turkey and the Bank was instituted in June 1975. This has resulted in distinct, but modest, improvements. The broad reform of the public sector launched in January 1980, and pursued with new measures since then, allows cautious optimism that performance can be gradually improved further, provided it is not eroded by new factors, including shortages of resources. As of December 31, 1981 overall disbursements amounted to 68 percent of appraisal estimates, which compares favorably with other countries in the Region. This figure includes structural adjustment lending which tends to disburse more rapidly than other project funds, and also reflects good disbursement performance in the power, industry/DFC and water supply sectors. Disbursements have been fair in the agricultural sector and rather poor in the urban, energy and railways sectors, due mostly to project-specific problems that are being addressed through on-going supervision efforts. 28. Bank lending is aimed at supporting the economic policies initiated in January 1980, especially: (a) the pursuit of an export-oriented development strategy; and (b) domestic economic policies aimed at establishing a macro-economic balance, increasing domestic savings, restraining public investment and reorienting it to reflect the new Government priorities (completion of ongoing projects, emphasis on quick-yielding new investments, and balance of payments impact). The Bank has discussed with the Government how its overall lending can best contribute to the latter's medium-term objectives, and help remove past policy and institutional constraints. A series of structural adjustment loans (SALs) is envisaged, at the Government's request, to support its program of structural adjustments that is being implemented. Agriculture, industry and energy will be the key sectors for project lending. In agriculture, projects emphasize livestock, exports, and rural development; in industry (including DFCs), the emphasis is on promotion of exports and employment, and the gradual strengthening of the SEEs. Energy projects underway are in power generation based on domestic hydro and lignite resources; future projects will emphasize the oil/gas sub-sector and coal/lignite. Projects for urban development and public utilities may supplement these efforts. The close macroeconomic and sector dialogue established with the Government in recent years is expected to be pursued on key issues. The economic and sector work undertaken over the last 15 months includes special studies of the public investment program, of industrialization and foreign trade strategy, and of the energy sector, and completion of sector memoranda on agriculture and industry. In addition, the progress made in fostering structural adjustment will be monitored in the context of each future structural adjustment loan. 29. Besides the proposed project, other projects expected to be ready for consideration by the Executive Directors in this fiscal year are for highway rehabilitation and the third loan for structural adjustment. Other projects being processed include: agricultural credit, irrigation completion, development of gas reserves, rehabilitation of the paper and cement industries, and a supplement to the Elbistan loan. 30. The Bank Group's share of the estimated total external debt was 8 percent in 1980, and is expected to grow to about 11 percent by 1985. Its  - 10 - share of total debt service payments (excluding debt rescheduling) is projected to increase from about 10 percent in 1980 to about 12 percent in 1985. 31. IFC has invested in synthetic yarns, pulp and paper, glass, aluminum, iron and steel products, motor bicycle engines, piston rings and cylinder liners, and tourism. It has also invested in the Turkish Industrial Development Bank (TSKB). As of March 31, 1982, gross IFC commitments totalled about $226 million, of which $87 million were still held by IFC. New investment opportunities are being pursued. PART III - THE WATER SUPPLY AND SEWERAGE SECTOR Water Supply and Sewerage Sector Organization 32. Traditionally, the provision of water supply and sewerage has been the responsibility of municipalities and village councils. However, the local bodies have lacked the financial resources and, except for a few major cities, the technical capabilities for discharging this function. Thus, planning, design and construction of new systems have been gradually absorbed by three government organizations, which were originally established as advisory and financing agencies. These organizations are the State Hydraulic Works (DSI), Iller Bankasi (Bank of the Provinces), and the Directorate for Roads, Water and Electricity (YSE), of the Ministry of Rural Affairs and Cooperatives. 33. For the Istanbul Municipality, a semi-autonomous Water Supply Authority (ISI) has been responsible for works operation and maintenance, while DSI has undertaken project preparation and implementation. ISI also was bulk supplier for a score of smaller municipalities. In other urban and rural areas, municipal departments and village councils operate their own water supply and sewerage facilities, except for major rural water supply systems which are operated by YSE. 34. Alternative institutional arrangements had been considered, in particular at the 1978 Conference on Planning and Development of Community Water Supply and Sanitation in Turkey. Major changes, however, were not to be made until the Government created greater municipal areas by executive order of February 1981 sanctioned by law of December 1981. This is expected to improve planning and implementation of municipal services. 35. With the creation of greater municipal areas in 1981, the water supply and sewerage services of the small municipalities were merged with those of the nearest large urban centers. At the establishment of the Greater Istanbul Municipality, the water supply services of 24 surrounding municipalities were merged with those of ISI, while all sewerage services were vested in a Municipal Sewerage Department. 36. The most important institutional reform, however, and one which may set the pattern for other urban areas, was initiated by Law 2560 of November 20, 1981. It created the Istanbul Water Supply and Sewerage General Directorate (ISKI) as an autonomous entity responsible for the planning, design, construction, operation and maintenance of all water supply and sewerage facilities in the Greater Istanbul Municipality. Of particular significance, the new law gives ISKI's General Council the freedom to set water tariffs and sewerage charges without, as in the past, having to seek  - Il - prior approval of the Municipality or the Central Government. The new arrangements should enable ISKI to meet its financial obligations and to finance a gradually increasing share of its investments with internally generated funds. 37. Environmental protection and conservation have also received increased priority through the recent creation of a central organization for environmental activities in the Deputy Prime Minister's Office. Water Supply and Sewerage Service Levels 38. In 1979, 63 percent of Turkey's total population had adequate water supply (63 percent of urban and 63 percent of rural areas); 18 percent had inadequate supply (14 percent of urban and 23 percent of rural areas); and 19 percent had no public supply (23 percent of urban and 14 percent of rural areas). Inadequate supply means insufficiency and intermittence in water availability and distribution. 39. Sewerage systems exist only in the major cities serving about 4.4 million people or 18 percent of total urban population, a large part being in Istanbul. However, none of these systems includes treatment and only a few have adequate disposal facilities. As a result precarious sanitary conditions prevail, particularly in high density, low income, urban areas. 40. The insufficiency of sewerage systems and the indiscriminate disposal of domestic and industrial liquid and solid wastes have caused serious deterioration of rivers and coastal waters increasing considerably the dangers of contaminating drinking water supplies. According to public health statistics, 38 percent of water samples tested (during 1977) were unsatisfactory from a bacteriological viewpoint. Water related diseases are endemic with outbreaks occurring annually. In 1977 the total recorded number of such cases exceeded 15,000 with 143 deaths. In 1970 a cholera epidemic in Istanbul caused 52 deaths, and was attributed to unsatisfactory sanitary conditions. 41. In 1978, the Conference on Planning and Development of Water Supply and Sanitation formulated the following objectives: (i) provision by 1990 of adequate water supplies to the entire urban and rural populations; (ii) provision by 1990 of satisfactory excreta disposal facilities to the total rural population; and (iii) provision by 2000 of satisfactory sewerage and sewerage disposal facilities to the total urban population. 42. These objectives are ambitious and unlikely to be met in the time frame originally envisaged. The National Action Committee set up in connection with the U.N. Water Decade has established a number of priorities. Their realization, however, will depend in large part on available financial and human resources. The progress on these matters would be addressed further in future sector studies, and during the course of project supervision. Sector Investment Program 43. The share of water supply and sewerage in public investments has been decreasing. The sectoral investment program for the fourth Five-Year-Plan, 1978-1982, represents about 3.5 percent of total public investments, divided between urban water supply, rural water supply and urban sewerage in the proportions of 37 percent, 46 percent and 17 percent respectively.  - 12 - 44. A comparison between the 1973-1977 and the 1978-1982 investment plans indicates that rural water supply and sewerage are getting increased priority over urban water supply. While the plan investment allocations are inadequate in relation to the needs of the sector, the amounts actually provided during 1978-80 were about 80 percent of the funds requested, distributed in the ratio of 45 percent, 35 percent and 20 percent between urban water supply, rural water supply and urban sewerage. The actual allocations made for the sector are reasonable in the country's economic circumstances in recent years. The Government plans to concentrate public investment on energy and infrastructure projects. Thus the resources devoted to improving water supply and sewerage services will continue to be limited. This is in line with the approach recommended by the Bank following a review of the Government's medium-term public investment program. As the country's economy recovers, greater attention will be given, inter alia, to improving urban services. 45. The planning and coordination of sectoral investments needs improvement. The sector investments have been planned in five year increments independently by the different sector agencies and are not fully integrated. The utilization of the available funds could be improved by better inter-agency coordination. Capital investments have been financed by Government grants or low interest rate loans, which in the past have seldom been repaid. 46. Water tariffs are set by local bodies with Government's approval. Except in the major cities, water tariffs have been insufficient to cover even operating expenses. Sewer connection charges have been levied but sewage disposal service has so far been free. Thus operational and maintenance costs for sewerage and sewage disposal systems and to a certain extent also for water supply systems, have been covered by municipal budget allocations. 47. It is the Government's intention, through appropriate tariff levels for water supply in urban and rural areas and the introduction of sewerage charges, to enable sector entities to cover operational expenses. Water supply and sewerage entities will also be expected to finance a gradually increasing proportion of their investment requirements through internal cash generation. Previous Bank Involvement 48. The Bank made a $37 million loan in 1972 (Loan 844-TU) for expansion of the Istanbul water supply system. The project implemented by ISI was substantially delayed due to institutional and financial constraints, and ISI's difficulties in attracting and retaining competent staff. The additional water supply provided under the project has helped to maintain a relatively good level of service which is expected to improve considerably as leak detection and other improvements under way start yielding results. More importantly, the project contributed to institutional development in the establishment of ISKI as an autonomous entity. This will facilitate the rational planning, execution and financing of water supply and sewerage services. The experience gained from the implementation of the Water Supply Project has been incorporated in the proposed project to ensure timely execution and financing arrangements. In addition to the Water Supply Project, IDA made a $2.3 million credit in 1972 (Cr. 324-TU) to prepare master plans and studies for urban programs in Istanbul. This credit partly helped to prepare the Camp-Tek-Ser report (para. 50) which included a review of the master plan for sewage disposal in the Istanbul area. The Bank also made a $6.0 million loan in 1979 (Loan S-15-TU) to the Government to develop viable  - 13 - methods of manufacturing smokeless fuel from lignite, and to investigate other possible technologies which may reduce air pollution in Ankara. This project is still in the early implementation stage. PART IV - THE PROJECT Background 49. Istanbul, the capital of the former Byzantine and Ottoman Empires and one of the oldest cities of the world, is the foremost cultural, industrial and economic center of Turkey. Industrial growth started on the European side around the Golden Horn and later spread to the Bakirkoy area along the northern shore of the Sea of Marmara. On the Asian side of Istanbul, industrial growth is concentrated mainly in the Kartal area. The growth has been accompanied by heavy migration and accelerated proliferation of large squatter settlements. The present population of the Greater Istanbul Municipality is about 4.7 million. 50. Two comprehensive sewerage and sewage disposal master plan studies have been carried out for the Greater Istanbul area, i.e., the Damoc report and the Camp-Tek-Ser report completed in 1971 and 1975 respectively. In 1978 it was decided to update the Camp-Tek-Ser study, to further evaluate some alternative technical proposals and to include detailed engineering for three of the four major drainage areas - Yenikapi, Kabatas and Uskudar (see attached maps). The updating of this study was carried out by consultants and completed by end-1980, and financed by a $0.5 million advance from the Project Preparation Facility approved in August 1978. Concurrently, detailed engineering was prepared for the fourth drainage area Kadikoy-Kartal by a local consultant (Tek-Ser) engaged by Iller Bankasi. 51. The implementation of proposed works in the four drainage areas is estimated to cost about $500 million. Because of financial constraints, the works have been phased taking into account priority considerations such as the need to reduce the pollution in the Sea of Marmara, which is extensively used for recreational purposes and to commence the restoration of the Golden Horn, which in its inner portion shows anaerobic conditions. For these reasons the Yenikapi drainage area was selected to be covered under the proposed project, which should be executed during the period 1982-1987. 52. The physical component of the project is located mainly in the area of the medieval walled city, the most densely populated in Istanbul. This area is bounded by the old city wall to the West, the Golden Horn to the North, the Bosphorus to the East, and the Sea of Marmara to the South. 53. The project was appraised in November/December 1981. The Staff Appraisal Report No. 3836-TU, dated February 23, 1982 is being distributed separately. The key features of the project are described in the Loan and Project Summary, and in Section III of Annex III. Negotiations were held in Washington from April 15-22, 1982 with a Turkish delegation led by Mr. T. Altinok, Chief Counselor at the Turkish Embassy in Washington and including representatives of ISKI and the Government. Project Objectives and Description 54. The major project objectives are: (i) to extend and improve the coverage of sewerage services, by rehabilitation and extension of the  - 14 - secondary sewage systems, thereby serving about 60 t- >al population in the Greater Istanbul Municipality covering about 70 percent of the low income group; (ii) to reduce the amount of sewage be-l-g discharged along the shorelines of the Golden Horn and the Sea of Marmara by the construction of sewage interception systems, and to provide s2tisfactory sewage disposal by the construction of pretreatment works and a deep submarine outfall main, thereby improving environmental conditions; (iii) to improve ISKI's institutional and managerial capacity; and (iv) to promote ISKI's financial viability by the introduction of adequate water supply and sewerage charges. 55. The project further aims at developing procedures for pollution control for the Greater Istanbul area and also for the country as a whole, to be achieved through industrial wastewater and oceanographic surveys. 56. The project would include the following major components: (i) laterals and collectors (secondary sewage systems), about 285 km; (ii) interceptors, 26 km; (iii) tunnel, 2.4 km; (iv) pretreatment works with inlet and outlet pumping stations; (v) pumping mains, 2.3 km; and (vi) submarine outfall main 2.0 km. The sewage disposal works are designed for a capacity of 12 m3/sec. The project also includes equipment for water supply and sewage system operation, consultant services, technical assistance and training, including the establishment of a regional training center and engineering design for next stage water supply and sewerage disposal development. 57. The project would cover about 60 percent of projected water supply and sewerage sector investments in the Greater Istanbul Municipality during the project implementation period, 1982-87. The Borrower: ISKI 58. The Istanbul Water Supply and Sewerage General Directorate, ISKI, upon its creation in November 1981, acquired the relevant personnel, assets and liabilities of the former ISI (para. 33), as well as those of the Istanbul Municipal Sewerage Department. Consolidation under ISKI was substantially and successfully completed in December 1981. ISKI's authority is vested in its General Council, its Board of Directors and its General Director. The General Director is assisted by three Assistant General Directors who are responsible respectively for (i) planning, design and construction; (ii) operation and maintenance; and (iii) administration and finance. ISKI's enabling legislation is general and there is a need for defining operational procedures as well as for operating and maintenance manuals. These should be completed by June 1, 1984 which ISKI agreed to at negotiations (Loan Agreement Section 4.04). 59. Upon its formation, ISKI took over the activities carried out by the former sector entities. An opening balance sheet was established as at the end of 1981. However, it has not been possible to prepare consolidated income and cash flow statements of past operations because the 24 municipalities which joined the Istanbul Municipality to form Greater Istanbul did not keep separate accounts for their water and sewerage operations. 60. ISKI's opening balance sheet includes all sector fixed assets and appropriate depreciation reserves. There are no arrears in the servicing of the existing long-term debt, the Central Government having for the most part provided funds for this purpose. However, the bulk of the receivables and  - 15 - other payables, which are claims on and from municipalities and Government entities, is over one year old. As of the end of 1981, the receivables and payables amounted to $36.0 million and $38.0 million respectively. To ensure that this does not adversely affect its finances, ISKI would carry out a plan, acceptable to the Bank, to segregate from its current account the payables and receivables outstanding on December 31, 1981. They would then be liquidated in a manner that would ensure that ISKI has no negative cash flow in any fiscal year (Loan Agreement Section 4.06). Further, ISKI would establish, by January 1, 1983, a program satisfactory to the Bank to reduce unaccounted for water through leak detection, to improve billing procedures and to institute an effective collection system (Loan Agreement Section 4.08). This would enable ISKI to ensure that its receivables are kept within prudent limits. 61. ISKI, which is run by a competent and forceful General Manager, faces a shortage of qualified and experienced staff particularly in the financial and accounting areas. Thus, to improve its financial and accounting systems, ISKI agreed at negotiations to employ a financial advisor by October 1, 1982 (Loan Agreement Section 3.02). 62. ISKI will develop a training unit and will also be responsible for the establishment of a regional training center. This should cover related training activities in the water supply and sewerage sector on a regional basis. This is according to recommendations made in a training study prepared by the French Cooperation Agency "La Caisse Centrale de Cooperation Economique". At negotiations ISKI agreed to hire a training specialist by October 1, 1982 (Loan Agreement Section 3.02) to advise ISKI on the development of the training unit and on manpower development. 63. ISKI's law gives it broad autonomy including the right to set its own tariffs, and thus enable it to be financially viable. Its immediate financial objectives are to fully recover operating and maintenance costs of its water supply and sewerage services, including depreciation, and in the longer term to make a modest and gradually increasing contribution towards capital investments, after meeting its debt service. ISKI has increased its average tariffs for water supply effective January 1, 1982. Further, during the project period, as part of its annual budget review, ISKI would take appropriate measures, including improvement of operational efficiency and adjustment of its tariffs, in consultation with the Bank, to ensure that in each year its revenues are sufficient to cover O&M costs, and debt service, in excess of the provision for depreciation (Loan Agreement Section 5.04 and 5.05). 64. In addition to the need for tariff adjustments, there is a need to introduce block tariffs both to promote water conservation and to ensure equity among different classes of consumers. ISKI is collecting necessary data for this purpose. At negotiations ISKI agreed to complete a tariff study not later than December 31, 1983, in accordance with terms of reference satisfactory to the Bank, to consult with the Bank on its findings, and, thereafter, to implement its recommendations in accordance with a timetable agreed with the Bank (Loan Agreement Section 4.07). 65. The volume of water sold is expected to increase by about 42 percent in the project implementation period. This, coupled with the forecast tariff increases, would produce revenues which would grow about three-fold. In the same period, operating expenses, including depreciation, would also increase  - 16 - about three times, leaving a combined gross income sufficient to enable ISKI to meet its obligations. On this basis ISKI would realize a rate of return of about 4 percent on its average net fixed assets in operation in the years from 1982 through 1984, 8 percent in 1985, 17 percent in 1986 and 9 percent in 1987. Its overall operating ratio would decrease from about 94 percent in 1982 to about 86 percent in 1987. Project Cost and Financing 66. The estimated project cost is $220.3 million equivalent, including $86.3 million foreign exchange (about 40 percent). It does not include any taxes, as ISKI is exempt from taxes and duties. The costs of the principal components are given in the Loan and Project Summary. Physical contingencies average about 13 percent of base costs. Price contingencies for both civil works and mechanical and electrical equipment have been estimated assuming price increases in dollar terms of 8.5 percent for 1982, 7.5 percent for 1983-85 and 6 percent for 1986-87. These estimates include about $7.1 million for about 1100 man-months of consultant services, based on an average cost per man-month of $2,000 equivalent for local and $10,000 equivalent for foreign consultants (1981 price level), including international travel and subsistance. 67. The proposed Bank Loan of $88.1 million equivalent would cover the entire estimated foreign exchange expenditures, including $0.5 million advance under the Project Preparation Facility and approximately $1.3 million front end fee. The estimated local costs of $134 million would be met by internal cash generation and customers' contributions amounting to $2.8 million, (I percent of total), Government equity contributions of $82.7 million, (37 percent of total), and the portion of the municipal fund allocated to ISKI amounting to $48.5 million (22 percent of total). The proposed Bank loan would be made to ISKI for 17 years including 4 years grace, at an interest rate of 11.6 percent, with the Government guarantee. Project Implementation 68. ISKI will be responsible for project implementation and for operation and maintenance of the water supply and sewage systems for the Greater Istanbul Municipality. By July 1982 detailed engineering including adequate soil surveys and preparation of tender documents would mainly be completed except for the secondary sewage systems, which will be prepared on an annual basis. Final drawings for secondary sewage systems are at present prepared by the contractors executing the works. This is not satisfactory and ISKI agreed to at negotiations that for contracts to be entered into after June 1, 1983, final drawings should be prepared by ISKI (Loan Document Section 3.06). 69. For the implementation of a project of this magnitude ISKI will be assisted by engineering consultants for project management, tender evaluation and preparation of contract documents, review of contractors' drawings, supervision of construction works, material and equipment supply and installation. These consultant services will be provided by a foreign consultant in association with a local one. Consultant proposals have been invited according to terms of reference acceptable to the Bank and at negotiations ISKI agreed to finalize selection and terms and conditions of employment of consultants as a condition of loan effectiveness and to maintain competent supervision teams during the implementation of the project (Loan Agreement Sections 3.01(b)(i) and 7.01). ISKI also agreed at negotiations to  -17 - retain a Project Manager (an ISKI staff member) with terms of reference and qualifications satisfactory to the Bank (Loan Agreement Section 3.01(b)(ii)). 70. Due to the country's economic difficulties, several projects have, in recent years, been delayed for want of adequate and timely resources. In order to ensure that the proposed project receives adequate and timely funds, ISKI agreed at negotiations to determine, in consultation with the Bank, as part of its annual budget review, the annual contributions required from the Government towards its investment program, in time to enable the Government to include such requests in its budget for the next fiscal year (Loan Agreement Section 5.05). The Government would thereafter, as agreed to at negotiations, ensure the provision of such funds in the form of equity (Guarantee Agreement Section 2.02). It is anticipated that during the project implementation period ISKI's debt-equity ratio would be below 60:40, and its current ratio above 3.5. 71. Regulations should be formulated for the control and the pretreatment requirements of industrial affluents before being discharged into the sewage systems, and pollution monitoring programs should be established for the Golden Horn, Sea of Marmara and the Bosphorus. This would provide data on the impact of the proposed project and also a basis for future actions to be taken for further improvements of environmental conditions. At negotiations ISKI agreed to commence, by no later than June 30, 1983, the implementation of a program on the above matters (Loan Agreement Section 4.05). Procurement and Disbursement 72. Procurement of civil works for submarine outfall main, pretreatment works and pumping stations, tunnel and interceptors with pumping mains and of mechanical and electrical equipment for pretreatment and pumping plants should be on the basis of international competitive bidding (ICB) in accordance with Bank guidelines and subject to prequalification procedures. Procurement of equipment for maintenance and operation of the water supply and sewage systems should be according to ICB, except for contracts valued below $150,000 each and not exceeding $800,000 in the aggregate for which local bidding or international shopping on the basis of three price quotations would be acceptable. For goods procured through ICB, domestic suppliers of equipment and materials would be given a 15 percent preference or the import duty, whichever is lower. Consultant services would be procured in accordance with Bank guidelines. 73. The contracts for the secondary sewerage system, estimated at $36 million, would be carried out in accordance with local competitive bidding procedures. These works are technically simple, small, and would be spread over the project period and not attract foreign bidders. Though they are part of the project, Bank disbursements will not be made against these contracts. 74. The proceeds of the proposed loan would be disbursed as follows: (i) 100 percent of foreign expenditures and 100 percent of local expenditures ex-factory for mechanical, electrical and other equipment; (ii) 100 percent of foreign expenditures, and 30 percent of local expenditures, for civil works (other than for the tunnel), consultancy services, technical assistance and training; (iii) 75 percent of total expenditures of the tunnel; (iv) refunding of project preparation advance; and (v) payment of the front end fee.  Project Benefits and Risks 75. For the Yenikapi drainage area, where the maj;or part o