Armenia - Irrigation Rehabilitation Project

Documit of The World Bank FOR OFFICAL USE ONLY Report No. P-6279-AM MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT OF SDR 29.4 MILLION TO THE REPUBLIC OF ARMENIA FOR AN IRRIGATION REHABILITATION PROJECT NOVEMBER 2, 1994 This document has a restricted distribution and mav be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EOUIVALENT Currency Unit - Ruble Exchange Rate Rubles per $ March 1993 684 June 1993 1,100 October 1993 2,600 Currency Unit - Drum Exchange Rate Drum per $ November 22, 1993 14.0 (introduction) December 18, 1993 80.0 September 28, 1994 385.0 FISCAL YEAR January 1 - December 31 WEIGHTS AND MEASURES Metric System ABBREVIATIONS EBRD European Bank for Reconstruction and Development EU European Union DWSI Department of Water Supply and Irrigation FAO/CP Food and Agriculture Organization Cooperative Programn FSU Former Soviet Union GDP Gross Domestic Product GOA Government of Armenia ICB International Competitive Bidding IDA International Development Association IFAD International Fund for Agricultural Development IMF International Monetary Fund LCB Local Competitive Bidding MOA Ministry of Agriculture NMP Net Material Product OME Operation and Maintenance Enterprise of the DWSI O&M Operation and Maintenance PHU Project Implementation Unit UNDP United Nations Development Programme USAID United States Agency for International Development USDA United States Department of Agriculture WUA Water Users Association  FOR OFFICIAL USE ONLY ARMENIA IRRIGATION REHABILITATION PROJECT PROJECT SUMMARY Borrower: Government of the Republic of Armenia Executing Agencv: Ministry of Agriculture Beneficiarv: About 300,000 private farmers Amount: SDR 29.4 million (about US $43.0 riiillion equivalent) Terms: Standard IDA terms, with 35 years' maturity and 10-year grace period Financg Plan: Item Local Foreign Total Million of US$ l 1. IDA 4.65 38.35 43.00 2. IFAD 1.80 6.20 8.00 3. The Government 4.15 4.15 4. End Users, Farmers 2.00 2.00 Total Project Cost 12.60 .55 _ 57.15 Estimated Disbursements (US$ million): Bank FY: 96 97 98 99 Annual 4.0 11.0 16.0 12.0 Cumulative 4.0 15.0 31.0 43.0 Economic Rate of Return: 53% Poverty Category: N.A. Environmental Category: "B" Closing Date: June 30, 1999 Staff Appraisal Report: 12811-AM Mav: IBRD 25388 This document has a resticted distribution and may be used by recipients only in the pezformance of ther official duies. Its contents may not otherwise be disclosed without World Bank authorization.  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF''l-E INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE3 DIRECTORS ON A PROPOSED CREDIT TO THE REPUBLIC OF ARMENIA FOR AN IRRIGATION REHABILITATION PROJECT 1. I submit for your approval the following memorandum and recommendation on a proposed credit to Armenia for SDR 29.4 million (US$ 43.0 million equivalent) on standard IDA terms with 35 years' maturity, including a 10-year grace period, to help finance an irrigation rehabilitation project. The International Fund for Agricultural Development (IFAD) will co-finance the project for an amount of US$8.0 million. A Staff Appraisal Report (Report No. 12811-AM) is being circulated to the executive directors separately. PART I: COUNTRY POLICIES AND BANK GROUP STRATEGY A. Background and Recent Economic Developments 2. Challenges and opportunities. Armenia is a small, mountainous, landlocked country with a rich cultural and literary tradition dating back to several centuries B.C. The land area is 29,800 square kilometers, and its ethnically homogeneous population numbers 3.5 million. With few resources in a rocky mountainous land, Armenians have learned to survive through skill, ingenuity, and trade with those around them. The level of education is high, and the Armenia has a strong tradition of successful entrepreneurship which should work to the country's advantage in the difficult times ahead. The country's position at the intersection of regional trading routes is another potential strength. 3. Adversity and Economic Contraction. Along with developments in the rest of the FSU, Armenia's real gross domestic product 'GDP) started falling in 1987. In December 1988, Armenia experienced a severe earthquake, which caused at least 25,000 deaths and widespread destruction of fuel pipelines and industrial plant, and left 500,000 homeless. Many people are still living in metal containers and unused fuel tanks. Apart from a rebound in real GDP in 1989 caused by the short-lived post- earthquake construction boom, each year after 1986 has shown an accelerating decline. Privatization of agricultural land, which began in 1991, produced a 15% surge in output in that sector in 1991. But the recovery in agriculture could not outweigh the decline in other sectors caused by the disruption of the former Soviet economy and the lack of foreign exchange. Compounding all these problems is the blockade stemming from the conflict over Nagorno-Karabakh, and the disruption caused by the civil war in Georgia, which have cut key imports, particularly of food, fuel, and medical supplies. 4. Early Reforms. Within the former Soviet Union, Armenia was a pioneer in reform. In 1991 a new liberal-minded Government started to put in place a substantial program of reforms. Agricultural land was privatized, and the Government moved ahead with tax, pricing, and legislative refo. n. However, the consequences of the blockade resulting from the conflict over Nagorno Karabakh and general political instability in the region required the Government to deal with short term problems diverting attention from the implementation of a longer term strategy of reforms. Until the Spring of 1994, the initial reform momentum was lost in the daily management of a siege economy. 5. Progress towards Peace. Recently, there have been several positive developments in  2 Armenia's relations with its neighbors. Of greatest importance is the progress towards peace in the 6- year-old Karabakh conflict: on July 27, 1994, Azerbaijan, Karabakh, and Armenia signed an agreement in Moscow formalizing the ceasefire, and providing for the immediate commencement of negotiations on a comprehensive peace agreement. This development offers a real prospect of a lifting of the blockade in the near future. In addition, rapidly-growing trade with Iran, which is now second in importance only to that with Russia, and increasing stability in Georgia, have significantly eased Armenia's isolation. 6. Beginnings of Macroecononic Stabilization. In parallel with these developments, the authorities began to tighten financial policies. Beginning in the second quarter of 1994, public expenditures were lirnited to priority items in conjunction with a drastic reduction in net lending and subsidies to enterprises, and revenue collection was enhanced; this allowed a sharp decline in deficit financing through the central bank, enabling monetary growth to be cut back. The central bank refinance rate becanme highly positive in real terms. Inflation declined from an average of more than 50 percent per month in January-May to 9 percent in June and less than 4 percent in August. Monetary tightness has also been reflected in the stability of the nk.minal exchange rate since May and the sharp appreciation of the dram in real terms over the same period. 7. A Fledging Output Recovery. In the first half of 1994, real GDP is estimated to have grown by 2-3 percent (compared to the same period in 1993). Armenia is alone in the CIS to have recorded positive GDP growth so far in 1994; the increase probably reflects the development of alternative trade routes in the face of the blockade and possibly the effects of the previous net lending to enterprises. Only the firm pursuit of the launched stabilization and reform will ensure the sustainability of this increase. B. The Government's Reform Agenda and Development Objectives 8. The Government realizes that Armenia faces a permanent adverse terms of trade shock and is burdened by serious structural rigidities, compounded by recent extreme macroeconomic instability and severe financial constraints. It is committed to a comprehensive program of stabilization and structural reforms, which it sees as the only alternative to continued stagnation and dire poverty. Armenia's medium term reform agenda is designed to exploit the country's potential as a regional trading center, and as an attractive base for foreign investment aimed at using it as a bridgehead for exports into the region. An ancillary objective of the Government's policies will be to enhance Armenia's energy security. In order to preserve Armenia's valuable human resource base, the Government plans to undertake a strong effort aimed at maintaining health and education standards and at direct poverty alleviation. 9. Stabilization and Structural Reform. The Government's program contains a number of interdependent elements. First, the Government recognizes that a stable macroeconomic and political environment is required so that producers and consumers can make sound business decisions. Stabilization will rest primarily upon tight fiscal and monetary policies. Second, the Goverunent is convinced that competitive markets are essential to an efficient allocation of resources. It will promote open markets through a variety of policies: the liberalization of prices as well as of the foreign exchange and trade regime; dismantling of the state order system and the consolidation of private agriculture through land reform and land registration; and elimination of undue restrictions on the emerging private sector. Third, the Government intends to harden the enterprise budget constraints in order to encourage enterprises to respond to market forces. This shift in behavior will be induced through privatization, the  3 enforcement of bankruptcy and liquidation laws, and reform of corporate governance mechanisms. Strict financial policy, particularly the elimination of subsidies to enterprises, and reform of the banking sector will serve to support the changes at the enterprise level that are envisaged under the program. Fourth, the Government will aim to improve the targeting of the social safety net in order to protect effectively and in a fiscally sustainable manner the living standards of the most vulnerable population and the human resource base of the country. 10. Public Expenditures. In addition to the reform agenda, the Government's immediate prioritv is to initiate a limited number of urgent investments that will restore vital infrastructure before it deteriorates beyond the point of no repair. Investments in power maintenance and rehabilitation of irrigation infrastructure and roads will preserve the physical infrastructure necessary to restore growth. In order to preserve the human resource base as well, the Government is planning to restructure the health and education sectors and to set up a Social Investment Fund which would support the most vulnerable groups among the population, through the creation of employment opportunities and improvement of quality of basic social services. To establish investment priorities for the medium term, the (;overnment has started preparing a Public Investment Plan (PIP). C. Bank Group Assistance 11. Assistance to date. The first Country Economic Memorandum on Armenia was distributed to the Board in March 1993. An Energy Sector Review was distributed to the Board in June 1993, while an Agriculture and Food Sector Review has recently been completed. These reports have provided the basis for an active dialogue with the Government on economic policies and investment priorities. In March 1993, the Bank's first operation for Armenia, a US $12 million Institution Building Loanl (Loan 3585 AM), was approved. Under this loan, technical assistance is being provided to the Govern1nent to strengthen the institutional basis for economic reform through institutional building programs in four functional areas: (a) economic management, including social safety net and employment issues; (b) resource mobilization; (c) enterprise reform; and (d) financial sector reform. The loan became effective on June 15, 1993. After significant start-up delays, implementation of the loan is now progressing quite well, as implementing agencies have familiarized themselves with World Bank procedures. On January 27, 1994, the Earthquake Reconstruction Credit was approved (Credit 25620) in the amount of US $28 million. The objectives of this loan are to provide improved housing and living conditions to victims of the 1988 earthquake; to reconstruct basic infrastructure, which will support employment creation; and to develop a longer-term sustainable program for rehabilitation in the earthquake zone. 12. Future assistance. In response to the Government's immediate priority, the Bank is moving forward with the proposed Irrigation Rehabilitation Credit and the proposed Ur,ent Power Maintenance Credit, in order to be able to commence works in the construction season of the summer of 1995. Further delay of these projects would put essential infrastructure at risk. At the same time, a Rehabilitation Credit is being prepared in parallel with an IMF STF, the Credit would support the Government's program of structural reform in the areas outlined in para 8 above. With the preparation of that credit, a Bank/IDA Assistance Strategy is being developed with the Government and a limited CAS will be presented to the Board with the Rehabilitation Credit.  4 13. Other Bank Activities. Armenia is in the process of joining IFC and expe!ts to be a member before the end of 1994. Membership of MIGA is under consideration. Given the severely constrained possibilities for investments under the blockade, substantive discussions on possible IFC or MIGA interventions have not yet taken place. The potential of such interventions to unlock support from the Armenian diaspora, however, should be significant. 14. Coordination of External Assistance. A pre-Consultative Group meeting to coordinate technical assistance to Armenia was held in May 1993. A full Consultative Group is being held on November 22,1994 to mobilize balance of payments financing to complement a possible Rehabilitation Credit and STF from the IMF. Extensive consultation with the IMF is taking place on the design of a Rehabilitation Credit and on implementation of the Institution Building Loan. In addition, the EU and USAID are providing parallel financing for the Institution Building Loan. The Government of Japan contributed to the preparation of the Earthquake Reconstruction project, while USAID and the EU contributed to the preparation of the Urgent Power Maintenance project. The Bank's work in the power sector is also being closely coordinated with EBRD. While these efforts point in the direction of relatively good donor coordination, this function in the Armenian Goverrnent still needs significant strengthening. To support this, the Bank intends to organize annual Consultative Group meetings.  5 PART II: THE PROJECT 15. Project Background. About three quarters of the total agricultural production in Armenia is from irrigated lands. Only a limited potential exists for increasing rainfed production in the more mountainous areas. With a growing need for food self-sufficiency in the disrupted FSU environment, the irrigation subsector has become more critical to the Armenian economy than at any time in the past. 16. Half of the 530,000 ha of arable land has some irrigation facilities. Approximately 80% is irrigated by surface methods (borders, furrows, flood irrigation, etc.) and th.e balance by various types of sprinkler equipment. Some of the gravity systems require pump lifts from the deep river gorges to the conveyance networks along the sides of the valleys. 17. Because of financial and material shortages since the start of the blockade, maintenance of irrigation infrastructure was reduced and lately has stopped almost completely. Without a concerted effort to rehabilitate the worst-affected structures and an immediate resumption of routine maintenance in the rest of the irrigation network, the entire irrigation infrastructure is in danger of collapse. 18. Lack of maintenance, the growing electricity shortage, and the limited agricultural experience of the newly established smallholders has caused a decline in irrigated areas. This trend seems likely to continue. The proposed rehabilitation project, which focuses on areas that are supplied by gravity, or which require only a small pumping lift, would be a first step in reversing this destructive trend. 19. Most of the water distribution system is in urgent need of rehabilitation and in many areas canals and pipelines have to be completely reconstructed. Pumping equipment in some of the main pumping stations is over 30 years old, well beyond its useful life. The absence of monitoring equipment for pump and electric motors makes it practically impossible to establish their operating efficiency, but estimates range as low as 50%. Tubewolls need to be reconstructed and their equipment modemized to reduce pump failures. Maintenance and repair of pumping equipment are severely constrained by a lack of modem workshop machinery and essential spare parts. 20. Against this background, the Government of Armenia (GOA) has requested assistance from the Bank to help finance the rehabilitation of the irrigation infrastructure, and to streamnline the water management system. This system is confronted with the exceptionally difficult task of distributing water to about 300,000 new farmers who received land under land reform enacted at the beginning of 1991. The project was identified in September 1992 and March 1993 by the FAO/CP. A Bank preparation mission was in Armenia in June 1993, and an appraisal mission in October 1993. Separate missions to carry out dam safety checks were carried out in October and December 1993, and in May 1994. 21. Rationale for IDA Involvement. The Government considers the proposed project to be a priority investment in the agricultural sector. It supports the development objectives of the agriculture sector in Armenia identified in the Bank's Agriculture Sector Report (June 1994). The key elements in this regard are to: expedite completion of the transition to a market-based system, including privatization of food production, processing, and marketing; change the role of Government towards the provision of research, education, extension, and market information; improve efficiency of production, processing, and distribution of food and agriculture products; and improve competitiveness of Armenian agricultural  6 products in international markets. Following these identified priorities, the sector review proposed an assistance strategy that include: provision of critical inputs for agriculture production; support to the Ministry of Agriculture to implement a consistent transition program in food and agriculture; development of institutions and support facilities needed for a market-based privatized agriculture; and capital investments for the development of competitive production, processing and marketing, and related infrastructure (espezially the irrigation system). Hence, investments proposed under the project are intended to enable the agriculture sector to maintain and increase production capacity which has been eroded due to severe deterioration of the irrigation infrastructure. The project would also support increasing the role of irrigation beneficiaries in determining their water needs and their financing of the operation and maintenance of the irrigation infrastructure. Under the proposed project, the beneficiaries would gradually take over water distribution and maintenance of the conveyance networks. The Bank strategy also emphasizes the rehabilitation and protection of the enviromnent, which has been severely damaged by the deterioration of the water conveyance systems. The environment is now threatened by a possible collapse of several storage dams. 22. Project Objectives. The main objectives of this project are to assist Armenia in maintaining the level of irrigated agriculture production for food security and to improve the country's water resource management. 23. Project Description. The project consists of four main components: (a) Rehabilitation of 12 irrigation schemes and the Ararat Valley groundwater network. These cover an area of about 164,700 ha (about 60% of Armenia's irrigated land); (b) establishment of pilot projects for water distribution and new water users' associations; (c) financing incremental operation and maintenance (O&M) costs of the irrigation infrastructure until effective water user's associations are in place, and in the meantime to prevent further deterioration of the irrigation infrastructure; and (d) technical assistance (including the Project Implementation Unit), assistance to update the Water Master Plan, training, preparation of the next irrigation project, and assistance to improve irrigated crop production. 24. Project Costs. The proposed project is estimated to cost (based on 1993 prices), about US $57 million, including physical and price contingencies. The foreign exchange component is estimated at about US $44.5 million or about 78% of the total project cost. The cost of imported equipment and materials reflects current market prices of suppliers in the former Soviet Union (FSU). IFAD will co-finance the project for an amount of US $8 million to cover the cost of tertiary canals, pilot projects to improve water management, and monitoring and evaluation. However, IFAD's board is expected to consider its decision on co-financing the project ir. April 1995. In case the IFAD Loan Agreement shall have failed to become effective by July 30, 1995 or such later date, Section 5.01(a) and 5.01(b) of the Credit Agreement provide that IDA has the right to suspend, terminate or cancel the entire credit or part of it. This condition will not be enforced if the Borrower succeeds to secure adequate fund from other sources on terms and conditions satisfactory to IDA, or if the Borrower can demonstrate to the satisfaction of IDA that it can implement the project regardless of the missing portion of the IFAD loan. Project cost and financing arrangements are summrarized in Schedule A. Procurement and disbursement arrangements are shown in Schedule B. A timetable of key processing events and the status  7 of IDA operations are given in Schedules C and D, respectively. 25. Project Implementation. The management, administration, and coordination of the Irrigation Rehabilitation Project will be the responsibility of a newly established project implementation unit (PIU). The Ministry of Agriculture (MOA) will have overall responsibility for the project. The MOA has already nominated a Project Board of Management, chaired by a Vice Minister .o oversee the operations of the PIU. Members of the board include the Director of the DWSI, the Director of the Operation ani Maintenance Enterprise (OME), which is under the responsibility of DWSI, the Director of the Economic Department in the MOA, a Deputy Minister of MOA, and representative of the Ministry of Economy. In view of the Government inexperience in operating a PIU, the Government will employ an international consulting firm under a single contract to establish the PIU. The PIU will initially be staffed by four qtualified foreign consultants, and a project manager nominated by the Government. The consultants will have the responsibility to establish the DiU procedures, policies, and accounting and, in collaboration with the project manager, to recruit local counterpart staff whom they will train to assume their functions. The term of the expatriate staff is dependent on the transfer of appropriate technology to the recruited local staff and proiect manager. 26. The objectives of the PIU would be as follows: (a) coordination of project implementation, including planning and design of works and direct responsibility for procurement and contracting, and supervision on the building sites; (b) financial management of the project, including the preparation and submission of disbursement claims, and liaison (reporting) with the Bank; and (c) coordinating preparation of a follow up project. 27. Project Sustainability. Two actions will be undertaken to ensure project sustainability. First, the project loan would cover the balance of the cost of operation and maintenance and the cost of energy which presently is completely subsidized. This action will ensure that the irrigation infrastructure is maintained until other actions result in replacing the loan financing with other stable and long-term sources of financing. Second, Curing project implementation the subsidized operations and maintenance will decrease, and under the project beneficiaries of the project would gradually take responsibility for the operation and maintenance of the irrigation infrastructure. Water user's associations (WUAs) will be established, and will gradually assume responsibility for the maintenance of the irrigation infrastructure. The WUAs are also going to be responsible for collection of water charges. When the responsibility for operation and maintenance of the irrigation system is shifted to the WUAs, they will also cover the cost of energy, which is presently subsidized. 28. Lessons Learned from Other Irrigation Projects. Investments in water resources have played a major role in the Bank's efforts to help countries to reduce poverty and to upgrade living conditions'. Irrigation systems have expanded food production, improved nutrition and increased rural incomes. Bank assistance has evolved from simple project lending toward country focused support for 1/ See Water Resource Management: A Policy Paper, Int tn tional Bank for Reconstruction and Development,R93- 14/1, may 3, 1993.  8 elaborating and implementing subsectoral strategies. These strategies are developed through sector work and subsectoral reviews in which priorities are articulated and performance is analyzed. The proposed Irrigation Rehabilitation Project incorporates the Bank experience in irrigation projects. Hence, special attention was paid in the project design and concept to reptr cturing of the operation and maintenance of the irrigation system; quality of construction; cost recovery; adequacy of the water management; the need to complete the country's water master plan that will incorporate intersectoral impact of water development investments, and environmental issues. 29. Agreed Actions. During negotiations agreements were reached that include the following: (a) collection of water charges would increase according to stinulated schedule that will cover the cost of operation and maintenance of the irrigation infrastructwo; (b) the Government would appropriate in its budget sufficient funds to cover its share in the cost of the project financing; (c) procurement procedures would be applied in accordance with the Bank and IDA guidelines; (d) prior to every fiscal year in Armenia the Government would agree with IDA on its budgetary allocation for O&M and oni the extent of the IDA disbursement to cover the incremental O&M; (e) the Government would establish a project implementation unit which would operate on a preagreed program; (f) a monitoring and evaluation unit would be established within the project implementation unit; and (g) audit of the project would be carried out by an independent auditor agreed with IDA and audited project accounts would be submitted to the IDA fo. review within four months of the end of each fiscal year. A condition of effectiveness of the proposed Credit will be the establishr.ment of a PIU with an adequate number of suitably qualified staff. 30. Environmental aspects. The project has been placed in category "B" in accordance with Operational Directive 4.01. Basically, the proposed rehabilitation works, including the conveyance structures, the tubewells in the Ararat Valley and on storage dams would have positive environmental consequences. It would reduce waterlogging and erosion near the conveyance structures and protect reclaimed areas in the Ararat Valley and it would eliminate the threat of life and property danage downstream from the dams. Sustaining these improvements in the long term requires adequate maintenance of the rehabilitated structures and careful monitoring of the environmental effects. 31. International Waterways. The investment program under the proposed project would affect rivers that are international waterways in accordance with OD 7.5, para. 2(a)(i) and (ii), i.e., rivers and tributaries that ultimately flow to and/or are shared with other riparian countries. However, the project is exempt from notification requirements, pursuant to OD 7.5, para. 8, because it finances strictly rehabilitation works. The nature of the planned investments-replacing corrosive pipes, repairing lined canals, replacement of tubewells and repairing leaking dams-should not have negative impacts on either the quantity or the quality of present and future flows. 32. Program Objective Categories. The proposed project is likely to avert decreases in food production and in fact improve productivity of irrigated production. It is expected that the improved productivity and water management would contribute to an increase in small farmers' incomes, and in that sense the project would contribute to alleviation of poverty and to the improvement of living conditions of the population, especially in rural areas. 33. Participatory Approach. The Armenian irrigation systems were designed to service large farms which may have irrigated 50 to 400 ha from a single headgate or canal outlet. Presently the same outlet may service 400 or more farmers, because the land reform program turned former collective and state farms into a patchwork of small holdings, generally ranging from 0.5 to 1.2 ha. Altogether  9 under the land reform more than 300,000 farmers became land owners. The proposed project is designed to incorporate the new land owning farmers into the management of the irrigation infrastructure by establishing pilots projects of water users' associations, which would gradually assume responsibility for management of the irrigation system, including collection of water charges to cover the cost of operation and maintenance. 34. Project Benefits. The proposed irrigation rehabilitation investment project would prevent a collapse of the irrigation infrastructure in Armenia. A secure water supply would promote agricultutal production, increase the food supply and create employment in the rural areas. Without the project, Armenia would need to substantially increase its food imports or decrease its food consumption. Construction work under the project would generate employment opportunities for unemployed, skilled, and unskilled labor. The project would also establish tht foundation of improved and rationalized water management by creating water user associations and increase of water charges. 35. The economic rate of return for the project has been estimated at 53 %. The assumption used was that without the project, production of irrigated agriculture would fall by about 5% per year up to the seventeenth year when it will stabilize at 20% of the preproject level; and with the project, the irrigated agricultural production would be rescored to 60% of pre-project level in year 4, and 100% in year 5. Due to the rehabilitation works under the project larger quantity of water would be available for irrigation. Technical assistance provision under the project would also result in improved irrigation practices. The result of more water availabilities and improved irrigation practices would cause yields and agricultural production to increase gradually up to year 12. The result of one sensitivity analysis showed that if the project would also improve the water efficiency from 35%, the present estimate, to 50%, the project would yield an economic rate of return of 61%. With benefits down by 50% and project cost up by 20% simultaneously, the project would still yield a 33% rate of return. A delay in project implementation of one year would cause the rate of return to fall to 48%; a delay of three years would cause the rate of return to fall to 35%. The main reason for such a drop in the rate of return is that delay has an opportunity cost that is equal to the net value of production that is foregone in the delayed period. In addition the irrigation infrastructure is progressively deteriorating and delay in implementation would be significantly more expensive to rehabilitate the irrigation system. 36. Risks. First, the principal project risk is political. If there is a resumption of hostilities between Armenia and any of its neighbors, a reimposition of a blockade would affect the project implementation adversely because of expected difficulties in importing fuel, spare parts, construction machinery, steel pipes, and reinforced steel, without which large-diameter pipes cannot be laid and precast concrete sections cannot be manufactured. In addition resources needed for operation and maintenance of the irrigation infrastructure would be drained and the physical structures would be put in jeopardy as well. The Bank approval of the proposed project is therefore based on the assumption that the current framework for negotiating the international conflict in which Armenia is involved will lead to a peaceful resolution of the conflict, and that the threat of increased hostilities is no longer imminent. The second important risk is associated with implementation of reforms leading to a market economy. Such reforms require the imposition and collection of water charges that would recover the full cost of energy. It is also critical for the project that water subsidies would gradually be reduced and that beneficiaries will eventually assume full responsibility for operation and maintenance. The risk is that if the Government is not strong enough to resist pressure to resume past policies of water subsidies and lax collection of water charges, the irrigation infrastructure in the country will again deteriorate. To safeguard against such risk, any additional assistance by the Bank in the agriculture sector, as well as in other sectors, should consider the Government's progress in reducing subsidies for water in agriculture  10 as planned under this project. A third important risk is that, based on existing modes, the quality of con- struction will not meet internationally accepted standards, and the project lifetime would be less than estimated. This has been the case with most of the existing irrigation infrastructure. A properly staffed and trained project implementation unit would mnitigate that risk. Thefourth type of risk relates to impact of utilization of energy for irrigation on deterioration of the environment. Presently most of the generated energy comes from water originated from Lake Sevan. Overpumping of water from the lake has caused the water level to fall, which has resulted in adverse impacts on the micro climate around the lake. Imposition of water charges that cover the full cost of operations and maintenance and energy costs is imperative to mitigate this risk. Thefifth type of risk relate to potential danger to the project investments from earthquakes. Armenia is in a seismically active zone. Conservative designs for the rehabilitation of dams were adopted to keep this risk to a minimum. 37. Recommendation. I am satisfied that the proposed credit would comply with the Articles of Agreement of the Association and recommend that it be approved by the executive directors. Lewis T. Preston President Attachments Washington, D.C. November 2, 1994  11 Schedule A Arnenia Irrigation Rehabilitation Project Summary Cost Estimate (net of taxes and duties) Item Local Foreign |Total % Foreign % Base Millions of US$ Exchange Cost 1. Rehabilitation of 8 Conveyance 5.54 12.93 18.47 70 40.0 Schemes 2. Rehabilitation of 4 Pumping 0.89 8.57 9.46 91 20.0 Schemes 3. Rehabilitation of Tubewells 0.69 6.25 6.94 90 15.0 4. Rehabilitation of Four Dams 0.56 0.75 1.31 57 3.0 5. Pilot Projects to Improve Water 0.14 2.33 2.47 94 5.0 Management 6. Incremental Operation and 2.30 2.70 5.00 54 11.0 Maintenance Cost 7. Technical Assistance - 1.10 1.10 100 2.0 8. Project Implementation Unit .21 1.25 1.46 86 3.0 Base Cost 10.33 35.88 46.21 |77 100.0 10. Physical Contingencies 1.61 6.45 8.06 80 17.0 11. Price Contingencies 0.66 2.22 2.88 77 6.0 Grand Total 12.60 44.55 57.15 78 123.0 Financing Plan (Net of Taxes and Duties) Item Local Foreign Total Millions of US$ 1. IDA 4.65 38.35 43.00 2. IFAD 1.80 6.20 8.00 3. The Government (DWSI) 4.15 - 4.15 4. End Users, Famiers 2.00 - 2.00 Total Project Cost | 12.60 4455 57.15 ]  12 Schedule B Summary of Proposed Procurement Arrangements (000' US$)2 ITEM ICB LCB OTHER TOTAL 1. Works 1.1 Canals, Syphons, Pipes and Hydraulics 4.630 130' 5,040 (3,700) (100) (3,800) 1.2 Installation of Pump sets 1,200 1.200 (970) (970) 1.3 Drilling and Consuuction of New and Existing Wells 5,480 5,480 (4.380) (4,380) 1.4 Rehabilitation of 850 790 1,640 Dams (680) (630) (1.310) 2. Goods 2.1 Precast Concrete Sections 8,380 8,380 (6,700) (6,700) 2.2 Steel Pipes, Valves, etc. for Pumping Schemes 6,200 700 6,900 (5,740) (560) (6,300) 2.3 Concrete Pipes 1,900 1,580 3,480 (1,520) t,'',O (2.780) 2.4 Steel Pipes, Valves, etc. for Conveyance Schemes 10,920 900' 11,820 (9,820) (720) (10,540) 2.5 Submersible Pumps 1,200 1,200 (1,200) (1,200) 2.6 Spare Parts for Submersible Pumps 280 200 480 (280) (200) (480) 2.1 Equipment for Pilot Projects (Syphons, Valves, etc.) 1.490 500 1,990 (1.490) (300) (1.790) 2.8 Equipment for Techrical Assistance and PIU 420 420 (420) (420) 3. Consultaacies 3.1 Consultantcies to Establish a PIU (under a PPF) 1,30W- 1,300 (1.300) (1,300) 3.2 Technical Assistance and Pilot Projects 2,300- 2,300 (2,300) (2,300) 4. Other 4.1 Incremental Expenses 5,800 5,800 (5,000) (5,000) Total 22,560 22,840 11,750 57.150 (20,450) (18,220) (10,600) (49,270) * Local Shopping = US$1.8 million ** Direct Contracting = US$200,000 *** According to IDA Guidelines **** According to Procedures approved by IDA 2/ Figures in parentheses are the respective amounts financed by the IDA and IFAD loan.  13 Schedule B Disbursements Disbursement Category Allocation Disbursement Basis US$ mil. SDR mil. (1) Goods: Equipment and 23.5 16.00 100% of foreign expenditures, Material 100% of local expenditure (ex factory cost) and 85% of local expenditures for other items procured locally (2) Civil Works 9.5 6.47 100% of foreign expenditures, 85 % of local expenditure (3) Technical Assistance 1.0 0.68 100% (4) Operational and Maintenance 5.0 3.40 100% Costs (5) Refund of Project Preparation 1.5 1.03 Advance (5) Unallocated 2.5 1.82 Total 43.0 29.40 Estimated Disbursements (US$ million): Bank FY: 96 97 98 99 Annual 4.0 11.0 16.0 12.0 Cumulative 4.0 15.0 31.0 43.0  14 Schedule C Timetable of Key Proiect Processing Events (a) Time Taken to Prepare: 6 months (b) Prepared by: Government with FAO/CP assistance, and ISK/TKB Consulting Group (c) Appraisal Mission Departure October 1993 (d) Negotiations October 17, 1994 to October 21, 1994 (f) Planned Date of Effectiveness February 28, 1995 Bank Staff Responsible for Project Preparation Ezriel M. Brook, Task Manager Oscar Honisch, Agriculturalist Stan Peabody, Sociologist Camilla Brown, Operations Analyst Eli Gazit, Irrigation engineer (Consultant) Richard Van Klaveren, Water Management Engineer (Consultant) Irina Kichigina, Counsel Department Director: Basil Kavalsky Division Chief: Geoffrey Fox Peer Reviewers: Ulrich Kuffner, Irrigation Engineer Joma Mohamadi, Irrigation Enginee Willem Van Tuiji, Irrigation Engineer Jeremy W. Berkoff, Economist  15 Schedule D Status of Bank Group Operations in Armenia A. Status of IBRD/IDA Loans/Credits (US$ million) Loan # Year Borrower Purpose Bank IDA Undisbursed 3585-AM 1993 Armenia Institution Building 12.0 10.5 2562-AM 1994 Armnenia Earthquake Recons. 28.0 24.7 B. As of June 1994, there were no IFC operations in Armenia. M :\Brook\Armenia\Sar\Mopsarl .Wp5  IBRD 25388 GEORGIA T .s 46'- 47- 48 ToE gdoooXlo 9GEORGIA > ~~~~~~~~~~IrgoncFhoy B,v Noyebrou,/ ' >Toshir ~~~~~~~~Alaed- r,10 \ ,Topokiot Aohotsk -; *Tsi Alcoeri ( ,ToiTo:okh 41 1