Peru - Rural Road Rehabilitation and Maintenance Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. P-6687-PE MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$90 MILLION TO THE REPUBLIC OF PERU FOR A RURAL ROAD REHABILITATION AND MAINTENANCE PROJECT NOVEMBER 6, 1995 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.  CURRENCY EQUIVALENTS (as of October 23, 1995) Current Unit = Nuevo Sol (S/.) US$1 = S2.26 FISCAL YEAR OF GOVERNMENT OF PERU January I - December 31 ACRONYMS and ABBREVIATIONS DGC General Directorate of Roads (Direcci6n General de Caminos) FONCODES Social Development and Compensation Fund (Fondo Nacional de Compensacion y Desarrollo Social) FCM Fondo Compensaci6n Municipal GDP Gross Domestic Product ICB International Competitive Bidding IDB Inter-American Development Bank IERR Internal Economic Rate of Return INADE National Institute of Development (Instituto Nacional de Desarrollo) NCB National Competitive Bidding MIEF Ministry of Economy and Finance (Ministerio de Economiay Finanzas) MTC Ministry of Transport, Communications, Housing and Construction (Ministerio de Transportes, Comrunicaciones, Vivienda y Construcci6n) NGO Non-Governmental Organization NMT Non-Motorized Transport PERT-PCR Project Implementation Unit (Proyecto Especial - Programa de Caminos Rurales) PERT Project Coordination Unit for Ln.3717-PE Proyecto Especial de Rehabilitacion de Infraestructura de Transporte SOE Statement of Expenditures  FOR OFFICIAL USE ONLY PERU RURAL ROAD REHABILITATION AND MAINTENANCE PROJECT Loan and Project Summary Borrower: Republic of Peru Implementing Agency: Ministry of Transport, Communications, Housing and Construction Beneficiary: Not applicable. Poverty Category: Program of Targeted Interventions. The project intends to: (a) improve access of rural areas to markets and services, encompassing about 2.7 million people living in six departments, and about 4.5 million or 20 percent of the population of Peru once the project is expanded to 12 departments, (b) form and strengthen small and medium enterprises and community groups that will be involved in the execution of works financed by the project, and spur the creation of more than 250 micro-enterprises that would participate in routine maintenance contracts; and (c) bring benefits to about 100 provincial municipalities as a consequence of the investment and institutional strengthening components included in the project. About 35,000 one-year equivalent of non-skilled seasonal jobs would be generated by road rehabilitation works and more than 4,000 of non-skilled permanent jobs would be generated by road maintenance works contracted out to micro-enterprises. Loan Amount: US$90 million including up to US$9 million in retroactive financing. Terms: Payable in 17 years, including five years of grace at the standard interest rate for LIBOR-based US dollars single currency loan. The loan will be amortized in level payments of principal. Commitment Fee: 0.75 percent on undisbursed loan balances, beginning 60 days after signing, less any waiver. Net Present Value: All sub-projects will meet eligibility criteria that assess institutional, environmental and technical factors (including the sustainability of the investments) as well as social and economic benefits. The social criteria based solely on prevailing poverty levels would be applied to sub-projects with costs below a certain threshold. The economic criterion establishes a benchmark minimum rate of return of 10 percent, based on a net increase in 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 wiLhout World Bank authorization.  - 11 - agricultural and livestock output. The economic analyses of 76 percent of the rehabilitation investments under the pilot program, in terms of kilometers (and 70 percent, in terms of cost), yielded a net present value of almost US$25 million and a prorated internal economic rate of return of 44 percent. If this economic worth is proportionally extrapolated to the total physical targets planned for the road rehabilitation component under the project, the corresponding NPV would amount to US$210 million, yielding a B/C ratio of about 3.0. Financing Plan: See Schedule A Environmental Classification: B Staff Appraisal Report: 14939-PE Map: IBRD No. 27276  MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE IBRD TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE REPUBLIC OF PERU FOR A RURAL ROAD REHABILITATION AND MAINTENANCE PROJECT 1. I submit for your approval the following memorandum and recommendation on a proposed loan to the Republic of Peru in an amount equal to US$90 million to help finance a project for the rehabilitation and maintenance of rural roads. The loan would be on LIBOR-based terms for Single Currency Loan in US Dollars, to be repaid in 17 years, including a grace period of five years. This would be the first single currency loan to Peru and would amount to 25.4 percent of the Bank's planned FY96 lending to Peru of US$355 million equivalent. The Republic of Peru is eligible for single currency loan terms, since they have authorized conversion of all VLR82 loans. The Government of Peru elected this option because: i) the US Dollar is the currency used in about 80 percent of Peruvian international trade transactions; ii) Peru6's liability portfolio is diversified by currency, reflecting the Bank's currency pool loans and Yen and Deutsche-Mark liabilities from other sources. Selecting a loan in US Dollars will allow Peru to better align the composition of its liabilities with that of its net trade position; and iii) Peru6's strategy in the management of its portfolio is to have an adequate balance in the interest rate bases of its liabilities. The portfolio currently is composed of fixed-rate loans from various sources, stable-variable rate loans from the World Bank and the IDB currency pools, and some LIBOR- based liabilities. Thus Peru has capacity to incur additional LIBOR-based liabilities. 2. The project would be co-financed jointly with the Inter-American Development Bank, which would contribute with another loan of US$90 rnillion, at the IDB standard variable interest rate, with a maturity of 25 years and repayments starting six months after the expected closing date of the project. The IDB loan also carries a commitment fee of 0.75 percent on undisbursed loan balances, beginning 60 days after signing. 3. Country Background. While Peru has a generous supply of minerals, fish and hydrocarbons, the country has seen vast fluctuations in its economy in the last 40 years and poverty has been a long-standing problem. The inauguration of the Fujimori administration in July 1990 saw the implementation of the most comprehensive program of economic reform in the history of the country. The reforms aimed at reducing inflation, stabilizing the economy and radically changing the state-dominated economy into a market-orientated one. The economy has recovered strongly and overall progress has been impressive. Inflation was reduced from 7,600 percent in 1990 to 15 percent in 1994 and the economy grew by 10 percent in 1994. 4. In the shorter term, despite the reform and economic progress, the benefits have not reached the poor to a sufficient degree. As a result priorities have shifted towards enhancing the access of poor communities to mainstream economic activities by reversing the deterioration of basic infrastructure after years of neglect. The Government is rehabilitating basic infrastructure, concentrating on areas with the highest prevalence of extreme poverty, the rural sierra and the urban pueblos j6venes. The proposed project would contribute to this effort in the rural sierra. 5. Sector Background. The Peruvian road network comprises about 70,000 km of roads, of which about 11 percent are paved roads, organized into three tiers consisting of (1) about 16,000 km of national roads, (2) about 14,000 km of secondary or departmental roads, and (3) about  - 2 - 40,000 km of rural roads. The road system deteriorated badly in the 80s due to mismanagement, severe financial constraints and deferred maintenance practices. While the condition of the national network has improved since 1990 as a result of on-going rehabilitation and maintenance programs supported by IDB, the Bank and other donors, conditions on the secondary and rural networks remain critical. The lack of all-weather roads coupled with poor maintenance practices and adverse topographical and climatic conditions, render large segments of the rural road network impassable or very costly to users. This has impeded development and contributed to the isolation of poor rural communities, particularly in the mountainous sierra, where 66 percent of the population is poor and about 1.6 million inhabitants live in extreme poverty. 6. Administration of roads in Peru6 has gone through shifting changes in the last decade, in part due to a protracted decentralization process which is still far from being settled. Historically, MTC's General Directorate of Highways (DGC) had overall responsibility for the planning, design, construction, and maintenance of the entire road system. The Regionalization Law (1984) transferred all roads to the newly established regional governments. This mandate was partially reversed in 1991, when MTC was reassigned the responsibility for managing the national road network, while departmental and rural roads remained under the control of regional and local governments. A weak institutional base, ill-defined responsibilities, and strong dependence on central government budgetary allocations have prevented regional governments from delivering more responsive services and coordinating development programs. Presently, the future of regional governments is uncertain under the government's decentralization agenda. Though municipalities, together with regional governments, are responsible for rural road planning, construction and maintenance, such responsibilities are not commensurate with their institutional and financial capacity. 7. Since January 1995, Government has embarked on a long-term effort to restructure road sector management, in a process that involves consultations with representatives of the private sector, as well as IDB, the Bank and German Technical Assistance (GTZ). The Government's strategy is designed to arrest the deterioration of the road network by (a) defining a decentralization agenda that would clarify responsibilities over the three-tier road network and resources to attend those responsibilities; (b) strengthening road administration, promoting private sector participation, and building up capacity at the local level; (c) increasing budgetary allocations for road rehabilitation and maintenance; and (d) focusing investments on areas with high levels of poverty and emphasizing labor-based construction methods as a means to generate employment in those areas. At an operational level, Government is taking steps to (1) refocus MTC's mission on policy-making, investment planning, and coordination among transport modes, (2) establish an autonomous road agency to manage the national road network (and temporarily the departmental road network until the role of regional governments --if any-- is addressed under the decentralization policy), and (3) channel technical and financial support to local governments for the rehabilitation and maintenance of the rural road network. 8. For this network, the Government's strategy has translated into a road rehabilitation program whose long term goal is to rehabilitate the whole of the 40,000 km of the rural network. To start with, the Government has designed a Six-year Rural Roads Program (1995-2000)-- estimated to cost US$478 million--that targets about 30 percent of the rural network with priorities established on the basis of: (1) the percentage of rural population served; (2) poverty  indicators; (3) the existence of parallel programs of social stabilization, and (4) the commitment of the local population. The Project would finance the first phase (1995-1998) of the Six-year investment program. 9. Project Objectives: The overall purpose of the proposed project is to provide a well- integrated and reliable rural road system through rehabilitation and maintenance of rural roads and secondary and primary roads connecting to the primary road network. This will help alleviate rural poverty and raise living standards of rural communities through increased access to basic social and economic and income-generating activities. The specific objectives are to: (a) reduce transport costs and raise the reliability of vehicular access to expand markets for agricultural and non-farm products; (b) integrate poorly accessible zones with regional economic centers; (c) improve transport conditions in rural villages; (d) generate employment through the rehabilitation and maintenance of rural roads to mitigate rural poverty; and (e) build up institutional capacity at local government level and develop small- and medium-size enterprises to manage and execute, on a sustainable basis, the maintenance and upgrading of rural roads. The achievement of these objectives would be monitored during project implementation using the key indicators given in Schedule B. This schedule also shows the logical framework of the Six-year Rural Roads Program, which links the purpose and main components of the project with measurable performance indicators, the means of verification and the factors outside the control of the project that are critical to successful achievement of the project objectives. 10. The project emphasizes the connection of benefited rural communities with a well- integrated and reliable road system through rehabilitation and maintenance of a "core" road network composed of rural roads and connecting primary and secondary roads. Several advantages are foreseen from this strategy. First, it will remove the bottlenecks constraining transport services in rural areas, maximize the population benefited, and overall, have a greater social and economic impact than in the case of isolated road improvements. Second, through improved road access the project would permit easier coordination among other rural development programs. Third, it introduces local governments to the principle of systemic management of their entire road networks (including the informal network of non-motorized tracks), which is key to improving transport services. However, it will take time and substantial efforts in technical assistance for this principle to take root among local governments, since this is a major change from the current practice where municipalities' operations are mostly limited to piecemeal actions and occasional emergency works on individual road links. Thus, while building an intense road investment program, the project also supports a strong institutional development component. The program will support MTC's policy to emphasize rehabilitation and maintenance over construction. 11. Project Description: The project will cover the first phase of the Six-year Rural Roads Program from 1995 (Pilot) to 1998. The project cost is estimated at US$250.3 million, with a foreign exchange component of about US$83 million (33 percent). In accordance with the financial plan, the proposed Bank loan of US$90 million would finance about 36 percent of the total cost, including up to US$9 million for retroactive financing of expenditures incurred under the Pilot, and IDB would provide joint cofinancing through a loan of US$90 million. Government requested this joint financing as opposed to parallel cofinancing to simplify project administration. This is feasible in view that (1) both banks are financing the same components under the same  implementation arrangements, and (2) no international procurement is envisaged as the small size of the contracts is unlikely to attract contractors from outside the region. It is expected that the second phase of the Six-year Program would be financed by follow-on loans by IDB and the Bank to cover expenditures from 1999 on, and that depending on the performance achieved in implementing the project, the appraisal of the second project would be undertaken at the project's third-year review. The phased approach will facilitate accommodating investments to changes in the sector environment --i.e., progress in the decentralization agenda--, reduce project risks, and establish incentives for better implementation performance. A summary of the project costs and financial plan is given in Schedule A, altogether with the costs estimated for the second phase of the program (1999-2000) and the totals for the entire Six-year Rural Roads Program (1995- 2000). Schedule C summarizes the procurement arrangements, allocation of loan proceeds and estimated disbursements by Bank fiscal year. 12. The project initially concentrates on the six departments which rank highest in rural poverty and, starting in 1997, progressively expand to about 12 (of Peni's 24) departments. This staged-approaches will give an opportunity to immediately apply lessons learned from the Pilot and during the first year of implementation to the additional departments incorporated into the project. The 12 departments selected account for about 61 percent of the rural road network in Peri. They cover most of the Sierra region and departments where road improvements can support alternative development programs in coca producing areas. To enhance coordination with other agencies involved in rural development programs, it was agreed at negotiations to a series of mechanisms to coordinate with investment programs within common targeted areas of FONCODES as well as other agencies involved in rural development and poverty alleviation programs. To strengthen this coordination, the Project will provide technical assistance to staff of MTC's Planning Office. 13. The project would include the following components: (a) Rehabilitating about 7,500 km (including the 1,500 km of the 1995 Pilot) or about 20 percent of the classified rural road network to improve accessibility and help reduce the overall deterioration of that network. The proposed works would concentrate on eliminating critical sections and spot improvements to ensure adequate transitability and a level of access tailored to the specific transport needs of the local communities. To obtain long-term benefits, spot improvements would be followed by a community-based road maintenance program. (b) Rehabilitating primary and secondary roads that are directly connected and give access to the rural road network under rehabilitation. About 2,200 km of primary and mostly secondary roads will be rehabilitated under the Project. The works envisaged for the main roads aim at restoring year-round trafficability and will include regraveling, grading, bridge replacing, slope protection and drainage system repairs. Paving, widening or realignment are not envisaged, to avoid unnecessary high standards that affect both cost and program output over time. This component will be coordinated with works being undertaken by DGC on an annual basis.  - 5 - (c) Setting up a routine maintenance system. Innovative cost-effective schemes based on contracting out labor-intensive works to micro-enterprises or local cooperatives, and equipment-intensive works to small- and medium-size contractors, would be introduced. Routine road maintenance would consist of simple works regularly performed throughout the year to maintain the drainage systems and the running surface. The project would finance maintenance of those roads already rehabilitated under the project, but other roads could be included if local governments commit themselves to supporting these activities. Roads built or rehabilitated by other rural development programs (e.g., FONCODES, INADE) could also be maintained with project support, provided they are linked or in the vicinities of road sub-projects being implemented under the Project. Overall, the Project will finance a maintenance program of a length of roads that would increase from about 1,500 km at project's beginning to about 7,500 km at its end. (d) Improving streets in small rural communities to enhance environmental conditions and raise living standards by upgrading or paving the section of the rural road crossing a village, including sidewalks, drainage systems and safety measures. It is anticipated that about 140 km of village streets will be improved with the potential to benefit about 200 villages. The works will remain simple and appropriate for labor-based construction methods, including laying new stone pavements and/or resetting existing stone pavements, paving with adoquines of interlocking concrete blocks, and paving with concrete slabs. The initial investment cost of the two latter options are higher than asphalt surface treatments, but more cost-effective if maintenance costs are brought into a life cycle cost analysis, and much less costly in terms of foreign exchange. (e) Providing local governments and communities with a tool to help them formulate coherent programs for managing village level infrastructure and improving non- motorized rural transport techniques. To this end, the project will finance technical assistance for village-level infrastructure management, and physical works aimed at removing unsafe spots and other bottlenecks constraining the use of the intermediate means of transport. The project would finance 80 percent of the total cost estimated by the Project Implementation Unit for the proposed works, based on standard designs and unit costs. This would fully cover the cost of materials, equipment and skilled labor, while most of the unskilled labor would be contributed by the community. (f) Providing technical assistance to: (i) improve planning and management of rural roads at the national and local levels, including the support of two policy and institutional studies on local road administration practices and rural road financing and technical assistance to MTC's Planning Office; (ii) develop micro-enterprises for execution of routine maintenance using work methods tailored to the institutional and financial capacity of rural municipalities; (iii) strengthen the local road construction industry, to be offered on a voluntary basis to local contractors and micro-enterprises who will be awarded contracts under the road rehabilitation components; and (iv) train, on-the-job, local engineering firms and beneficiaries on  - 6 - the preparation of feasibility studies and technical project proposals. A plan of action to implement the recommendations of the studies on local road administration practices and rural road financing would be agreed upon between Government, IDB and the Bank at the project third-year review. 14. Project Implementation: MTC will have overall responsibility for project coordination and implementation. Actual implementation will be delegated to a specialized unit, the Proyecto Especial de Caminos Rurales (PERT-PCR), which has been created by presidential decree. This unit, with staff and budget separated from the rest of the Ministry, will enjoy broad technical, administrative and financial autonomy. The central unit will be complemented with decentralized executing units in each of the departments where works will be underway. These units will be largely responsible for the execution of the project; their staff will be contracted out or drawn from qualified PERT-PCR personnel and will enjoy the same technical, administrative and financial autonomy endowed to the central unit. Nevertheless, the central unit will keep its oversight and monitoring functions and will be fully responsible for the ultimate implementation of the project. Semi-annual performance audits will ensure that the project is undertaken according to the tenets and institutional framework established under the project. 15. Municipalities will also play an active role. PERT-PCR will enter into "participation agreements" with the municipalities with jurisdiction over the project areas, which will most notably spell out future obligations and undertakings assumed by both parties with regard to the execution and sustainability of the project. As part of these agreements, municipalities and PERT-PCR will draw up together action programs to develop the municipality's capacity to assume within a reasonable time, full responsibility for managing the maintenance of the respective rural road network. Though the project funds will not be channeled to the municipalities, they would participate in (1) identifying sub-projects and coordinating with PERT- PCR's decentralized units the execution of the investment programs, (2) contributing to the cost of the works for community-managed components and directly executing small works through convenios, (3) undertaking the institutional action programs, and (4) overseeing through Road Committees the delivery of programs and reporting any difficulties in the implementation of the project. The project would avoid further investments in those municipalities where compliance with the participation agreements and the institutional action programs has not been satisfactory. 16. Rehabilitation works requiring medium-sized equipment, such as re-grading and compaction, would be carried out by small construction firms contracted by the PERT-PCR field offices. All other works would be implemented through labor-based means, managed partly by small firms and partly by community-based groups. Local consultants will be engaged to prepare engineering designs and supervise work execution for roads grouped by geographical area. In order to ensure consistency in the implementation of the project's various components across departments, MTC assisted by consultants has developed a Project Operational Manual that will define the responsibilities of PERT-PCR and its deconcentrated units in project implementation and monitoring, including the use of a project information and monitoring system throughout project implementation, and the guidelines and procedures to: (a) select and approve sub-projects, (b) conduct pre-investment studies, (c) design and apply environmental mitigation measures, (d) undertake appropriate procurement and accounting, and (e) monitor project implementation. The manual also provides model documents for items such as participation agreements with  municipalities, road rehabilitation and maintenance standards, bidding documents, and terms of reference for performance audits. 17. In view of the large size of the project and the history of inactivity in the rural road sub- sector, MTC is currently carrying out a Pilot, which would be partially financed retroactively by the loan, to establish basic technical, administrative, socio-economic and cost information necessary to design the project. The Pilot encompasses about 1,500 km of road rehabilitation and 21 km of village streets improvement (with a total cost of about US$18 million), located in 19 provinces ranking highest in terms of poverty within six of Perui's poorest departments. Though implementation of the Pilot is still underway, the experience gained so far has confirmed the validity of the assumptions and data used for project design. 18. Project Sustainability. As shown in Schedule B, annual maintenance of the project investments is estimated to cost almost US$17 million at project end. Though this represents less than 12 percent of the central government funding to the road sector in 1994, local government sharing of these costs will further enhance financial sustainability. More precise figures about local government contribution and the most suitable mechanisms for implementing the cost- sharing arrangements will become available upon completion of the study on Rural Road Financing funded under the project. Hence, the project would provide the venue for continuous dialogue with government regarding the mobilization of local resources and revenue-sharing mechanisms for road maintenance. This will constitute a preamble to the ultimate definition of the Government's decentralization agenda. At project third annual review, agreement will be reached on a road funding mechanism consistent with the progress made by Government in the decentralization process, prior to considering the possible financing of Phase II of the Six-year Rural Road Program. The project would also address its sustainability by engaging local communities in the design and execution of the project's components. At the local level, involving communities and developing small contractors would increase capacity and build pressure over local governments for continuous road maintenance. The project adopts technology appropriate for the capacity of the benefited communities, further enhancing the prospects for the sustainability of road maintenance. 19. Lessons Learned from Past Bank Projects: Rural road components were included in eight Bank loans to Peru which supported overall highway development and maintenance, transport corridor improvements, rural development and reconstruction after a major disaster. Experience exists with free-standing rural road projects elsewhere, especially in Africa and Asia. The principal problems in achieving sustainable results have been: (a) institutional weaknesses and inadequate coordination, leading to delays in implementation and incomplete execution of the works; (b) attention to road upgrading without adequate provision for maintenance; and (c) inadequate monitoring of results. Bank-wide experience has resulted in the following advice for designing a successful rural roads project: (a) there should be a strong government commitment and beneficiary participation to ensure the sustainability of services and infrastructure; (b) a central focal point should be established for formulating and reviewing rural roads policy, for project planning and execution, and for coordination between the ministries of agriculture, interior and transport; (c) a strong and dedicated project management team should be created to assure timely implementation and adequate monitoring of the project; and (d) the capacity for applying labor-based methods and developing intermediate means of transport should be built up.  - 8 - 20. Rationale for Bank Involvement: The Bank has been assisting the Government implement its poverty eradication efforts as outlined in the Country Assistance Strategy presented to the Board on November 22, 1994, which concentrates on (a) infrastructure development, (b) social sector development, (c) institution building, and (d) macro-economic sustainability. The project follows the Government's longer-term strategy and focuses on local government service delivery and maintenance. The project would bolster infrastructure development by supporting a comprehensive road rehabilitation and maintenance program to arrest deterioration of the existing road system in the rural sierra, safeguarding key social and economic links, and providing a framework for further assistance in the rural road subsector. Bank's experience on free-standing feeder road projects elsewhere, especially in Africa and Asia, has been incorporated into the design of the project. Dialogue between the Government and the Bank during preparation resulted in stricter definition of sub-project eligibility criteria, in-depth elaboration of community participatory mechanisms, and stronger emphasis on institutional development. The project will have a positive demonstration effect, and should be considered as a complement to the on-going Transport Rehabilitation Project. It will also help in providing broader Bank assistance in the transport sector, in particular towards facilitating the integration of poor rural communities into the mainstream economy and the expansion of markets for agricultural and other non-farm products. The joint IDB-World Bank collaboration has strengthened IDB's and the Bank's dialogue with the country and the effectiveness of both banks' involvement in the sector. 21. Agreed Actions. The main actions agreed with the Government during negotiations are: (a) the definition of an operational set-up for project execution, including the establishment of (1) PERT-PCR and its deconcentrated executing units, (2) participation agreements with the municipalities involved in the project, and (3) mechanisms to coordinate investment programs within common targeted areas of FONCODES, INADE, as well as other agencies involved in rural development and poverty alleviation programs; (b) the adoption of the Project Operational Manual, which may be modified from time to time to take account of the experience gained during project implementation; (c) annual project reviews to assess project performance and incorporate adjustments, if necessary, to strengthen consistency of the project with the Government's decentralization agenda and the role of municipalities in project activities; and (d) the definition of an action plan for the implementation of suitable mechanisms for financing rural roads maintenance and streamlining local road managements practices at the project third annual review. 22. Poverty Category: This project specifically addresses poverty reduction. The departments of Ancash, Ayacucho, Apurimac, Cajamarca, Cuzco, and Huancavelica have been identified for the initial years of the proposed project. They are six of the country's eight poorest departments and account for about 40 percent of Peru's rural population. The other six departments selected for expansion of the project after its first year form the next group of poorest departments of Perui. 23. Environmental Aspects. The project has been rated "B" as no major environmental issues are foreseen. The project supports rehabilitation and maintenance of existing unpaved roads. Since these are existing roads, the risk of additional indirect negative impact linked with human activities (i.e., colonization, deforestation) is limited and the proposed project activities are unlikely to harm the ecological and social environment. The greatest environmental damages  - 9 - associated with the existing targeted road network is erosion and flooding of farmlands and road surfaces. By its very nature, the spot rehabilitation and maintenance strategy adopted in the project has positive impacts on the environment because of its strong focus on identifying and offsetting drainage and erosion problems. 24. Program Objective Categories. The project falls under the poverty alleviation POC, with investments targeted specifically to the poorest rural communities of Perfi. All the physical components would directly benefit, with their participation, villages and communities in the rural sierra, and the institutional development component would largely benefit the municipalities and micro-enterprises in that area. 25. Participatory Approach. To achieve the intended objectives of alleviating poverty and building up local institutional capacity for sustainable maintenance, the project makes the beneficiaries participate in the various phases of subproject generation, design, implementation and maintenance. While the whole project design is built on this participatory approach, it relies on the systematic use of participatory workshops especially designed to ensure that community participation is undertaken in a systematic and organized manner. Specific objectives of these workshops are to: i) assess transport needs at the community level, ensuring that the needs of the rural poor are taken into account; ii) confirm with the beneficiaries the priority of the proposed road rehabilitation subprojects and the commitment of the community to their maintenance; iii) validate the design of the selected subprojects to include local solutions; iv) mobilize support for road maintenance through increasing ownership of the project and promoting micro-enterprises formation; and v) provide local communities with necessary information about the project and their role in the project. Several exercises were undertaken during project preparation to develop the participatory mechanisms that would be applied throughout project implementation to achieve these objectives. Operational Guidelines were developed in the field in conjunction with PERT- PCR for application of the participatory process and organization of workshops with beneficiary communities and municipalities, and now are part of the Project Operational Manual. These Guidelines are intended for use by local consultants, municipalities and PERT-PCR staff in applying participatory mechanisms during project development and implementation. Their use throughout project implementation will also expose municipalities to participatory approaches and provide on-the-job training. The experience of these exercises, as well as that of FONCODES, confirms the potential benefits and viability of the participatory approach proposed under the project. 26. Project Benefits: The project's intended beneficiaries are: (a) the rural population at large--up to about 4.5 million people at project end--benefiting from better access, particularly the poorest communities in the sierra; (b) the small enterprises and community groups that will be formed or strengthened as a result of their involvement in the execution of works financed by the project and the micro-enterprises--up to over 250--that will be created to undertake road maintenance activities; and (c) about 100 municipalities that will benefit from investment and institutional strengthening from the project. All sub-projects will meet eligibility criteria that assess institutional, environmental and technical factors as well as social and economic benefits. The institutional criteria refer to the level of identification the communities in the area of influence of a particular sub-project would have with the road sub-project, including the degree of commitment to the future maintenance of those roads. The environmental criteria refer to the  - 10- compliance of proposed sub-projects with the environmental guidelines established in the Project Operational Manual. The technical criteria refer to the construction characteristics of the proposed sub-projects and their functionality within the road network in the pertinent province or department. The social criteria are based on prevailing poverty levels and are applied for sub- projects that cost less than US$200,000 and less than US$8,500 per km, and benefit more than 100 people per km. The economic criterion establishes a benchmark minimum economic rate of return of 10 percent, based on a net increase in agricultural and livestock output--for the main agricultural and livestock products. The 10 percent benchmark has been selected on the basis that, first, the sub-projects have a strong social focus and, second, that not all the benefits would be quantified due to the lack of readily-available quantitative methodologies (for instance, regarding the benefits that accrue from improved access to services such as health and education). 27. The economic analysis methodology incorporates specific assumptions in relation to future increases in agricultural and livestock production as a consequence of the rehabilitation of rural roads. The application of the methodology to 25 of the pilot sub-projects (76 percent in terms of km) yields a combined net present value (NPV) of almost US$25 million and economic internal rate of return (EIRR) of 44 percent. If this economic worth is proportionally extrapolated to the total physical targets planned for the road rehabilitation component under the project, the corresponding NPV would amount to US$210 million (vis-a-vis a cost of US$104 million for that component. The combined NPV for the pilot sub-project would remain positive even if production increases by 3.9 percent--instead of the assumed 5 percent--and no improvements take place in agricultural yields--instead of the assumed 10 percent--and no reductions in production costs--instead of the assumed 5 percent--or even if there are no increases in production and no reduction in production costs and agricultural yields increase by 6.2 percent. In the event of a 20 percent increase in the costs of road rehabilitation, the NPV and the EIRR would be reduced to US$23 million and 38 percent, respectively. In sum, the sensitivity analyses demonstrate the robustness of the economic worth of the pilot sub-projects, which are considered a representative sample of those to be undertaken under the project. 28. Risks: The risks and the corresponding safeguards are: (a) uncertainty in the development of the decentralization agenda, particularly regarding those elements related to responsibilities and funding for road maintenance. The project supports a study to develop a road-funding strategy and introduces maintenance schemes well adapted to the institutional capacity of local governments; (b) weak institutional base at the local level that could hinder the effectiveness of the institutional strengthening component of the project. Local governments' support to the technical assistance component will be a prerequisite for financing further investments in a project area; (c) inexperienced project management, which could delay the selection and execution of sub-projects. The project executing agency will enjoy technical, administrative and financial autonomy, and it will be conveniently supported by consultants; (d) insufficient absorptive capacity of the domestic construction industry. The project targets small and medium enterprises who may adapt more easily to the working environment of municipalities, and provides technical assistance to further strengthen their managerial and technical skills; (e) inadequate provision of counterpart funds for project implementation. The project realigns its investment program to be in phase with the Government's budget; in addition, it would require advanced deposit of counterpart funds into the project account, similar to the procedures successfully being employed in the on-going IDB- and Bank-supported highway projects; and (f) resurgence of guerrilla  activity could hamper execution of the project. In the event that this happens, the works in the affected areas would be postponed until safe execution and supervision is possible; also, it is expected that the very nature of the project and its reliance on communities and local contractors for its implementation will minimize the possibility of becoming the target of guerrilla activity. 29. Recommendation. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve it. James D. Wolfensohn President Washington, D.C. November 6, 1995 Attachments  -12 - SCHEDULE A PERU RURAL ROAD REHABILITATION AND MAINTENANCE PROJECT ESTIMATED COSTS AND FINANCING PLAN Summary of Costs (US$'000) PROJECT (PHASE )t PHASE II TOTAL PROGRAM PROJECT COMPONENTS Coot IUS$'000) Coot US$000) Cost (US$000) Local FrIn So. Total Local Foreign Eo Total Local or-ign Eo Tota CML WORKS 90.448 80.148 150.596 71.370 38.330 109,700 161,818 98.478 260.296 Rahablitation of Rral Roads 45,o00 30,C0 75,000 30.,00 20,00 50,000 75.0W0 50.900 125,000 Rehablitatioo of Conncting Primary and Sacondary Roads 19,400 i1,400 38AG.o 9.0W0 9.0W 18.000 28.400 28,400 56.800 Rootine Moiotanaim n of Roads 11,500 2,390 13,600 22.500 4,5W0 27.000 34,900 6.890 40.800 ImorocemeotofVillaW Straate 12,298 8,188 20.496 6.720 4.480 11.200 19,018 12.678 31.696 Improvameot of Villaga Uncclassiied NatworkS 2,250 250 2.600 3.150 350 3,600 5,490 600 6.000 CONSULTANT SERVICES 11,270 7,514 18.784 5.145 3.430 8,676 16.416 10.944 27,359 Pre-ln-estmaot Stodias 6.206 4.138 10,344 1,434 956 2.391 7,841 5.094 12.735 Supevisionof CinilWorks 4,51B 3,012 7.630 3.291 2.194 5.485 7.809 5.20e 13.015 Pertormeoca Audots ITechnical. Eniroomental. Procuremant 54e 364 910 420 280 700 986 644 1.6 10 and Management Audit) INSTITUTIONAL DEVELOPMENT 2.760 6.140 7.800 1.440 2,760 4.200 4,200 7,900 12.100 Technical Asistance for Rral Road Planning and Managma :1 ,290 2.80O 4.000 720 1,860 2.400 1,920 4.480 6,400 Tech. Assist. tor Deneloping Maintenance Microenterpri-as . 40 960 1,600 360 540 900 1.090 1,5W0 2.500 Tech. Astist. for O-eloping the Local Construction Industry 240 360 600 160 240 400 400 800 1.W00 Tech. Assist. for Non-Molt.ied Rural Transport Component. 280 420 700 120 180 300 400 600 1,000 Studies on flral Road Financing and Local Adnninsitration 280 420 700 00 00 00 280 420 700 Training in Penu and Abrad 120 180 300 80 120 200 200 300 500 TOTAL8ASELNEJCOST 104.478 72.802 177,280 77.955 44,520 122.476 182,433 117.322 299.765 Physical Contingencies 9,045 6,015 16.060 7,137 3.833 10.970 16,182 9,848 26.030 Price Contingencies 5,872 4,077 9,948 10,831 8,155 16.985 18,420 10.514 28.934 Project Managment Costa 9,800 00 9,800 7,500 00 7.500 17,300 00 17,300 TOTAL PROJECT NET COST 128.194 82.893 212.088 103,423 54.508 157,931 232.335 137.684 370,019 T.eos and Outies 38.176 DO 3B.176 28,428 00 28.42B 66,603 00 o6.603 GRAND TOTAL 187.370 62,893 250264 131.851 54.508 188.3568 298,938 137.684 436,622 Financing Plan (US$'000) Local Foreign Ex. Project Taxes Total Cost As % of As % of Cost Cost Cost (IGV) inc. Taxes Project Cost Total Cost PROPOSED PROJECT (PHASE 1, 1995-1998) IBRD 48,553 41,447 90,000 0 90,000 42.4% 36.0% IDB 48,553 41,447 90,000 0 90,000 42.4% 36.0% * GOP 32,088 0 32,088 38,176 70,264 15.1% 28.1% TOTAL PROJECT 129,194 82,893 212,088 38,176 250,264 100.0% 100.0% PHASE 11(1999-2000) * IBRD 32,772 27,254 60,026 60,026 38.0% 32.2% IDB 32,772 27,254 60,026 60,026 38.0% 32.2% GOP 37,880 0 37,880 28,428 66,307 24.0% 35.6% TOTAL PHASE II 103,423 54,508 157,931 28,428 186,358 100.0% 100.0%