China - Hebei Urban Environment Project

Document of The World Bank Report No: 20062-CHA PROJECT APPRAISAL DOCUMENT ON A PROPOSED LOAN IN THE AMOUNT OF US$150 MILLION TO THE PEOPLE'S REPUBLIC OF CHINA FORA HEBEI URBAN ENVIRONMENT PROJECT May 10, 2000 Urban Development Sector Unit China Country Management Unit East Asia and Pacific Regional Office  CURRENCY EQUIVALENTS (Exchange Rate Effective January 31, 2000) Currency Unit = Yuan Y 1.00 = US$ 8.3 US$0.12 = Y1.00 FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS AIC - Average Incremental Cost IPCAP - Industrial Pollution Control BOT - Build, Operate, Transfer Action Plan CAS - Country Assistance Strategy MIS - Management Information CNAO - China National Audit Office System EA - Environmental Assessment MOC - Ministry of Construction FMS - Financial Management System NCB - National Competitive Bidding GDP - Gross Domestic Product OED - Operations Evaluation GIS - Geographic Information System Department HEPB - Hebei Environrnental Protection PMO - Project Management Office Bureau HFB - Hebei Finance Bureau RAP - Resettlement Action Plan HP - Hebei Province SDPC - State Development and HPG - Hebei Provincial Government Planning Commission HUEP - Hebei Urban Environment SWWC - Shijiazhuang Wastewater Project Company HWSC - Handan Water Supply TVE - Town and Village Enterprise Company TWSC - Tangshan Water Supply HWWC - Handan Wastewater Company Company IA - Implementation Agency TWWC - Tangshan Wastewater IAP - Institutional Action Plan Company ICB - International Competitive WTP - Water Treatment Plant Bidding WWTP - Wastewater Treatment Plan NBGF - Not Bank Group Financed Vice President: Jemal-ud-din Kassum Country Manager/Director: Yukon Huang, EACCF Sector Manager/Director: Keshav Varma, EASUR Task Team Leader/Task Manager: Wiebe Moes, EASUR  CHINA HEBEI URBAN ENVIRONMENT PROJECT CONTENTS A. Project Development Objective Page 1. Project development objective 2 2. Key performance indicators 2 B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project 2 2. Main sector issues and Government strategy 2 3. Sector issues to be addressed by the project and strategic choices 4 C. Project Description Summary 1. Project components 5 2. Key policy and institutional reforms supported by the project 7 3. Benefits and target population 7 4. Institutional and implementation arrangements 8 D. Project Rationale 1. Project alternatives considered and reasons for rejection 10 2. Major related projects financed by the Bank and other development agencies 11 3. Lessons learned and reflected in proposed project design 12 4. Indications of borrower commitment and ownership 13 5. Value added of Bank support in this project 14 E. Summary Project Analysis 1. Economic 14 2. Financial 15 3. Technical 17 4. Institutional 18 5. Social 19 6. Environment 20 7. Participatory Approach 20 F. Sustainability and Risks 1. Sustainability 21 2. Critical risks 21 3. Possible controversial aspects 22  G. Main Conditions 1. Effectiveness Condition 22 2. Other 22 H. Readiness for Implementation 24 I. Compliance with Bank Policies 24 Annexes Annex 1: Project Design Summary 25 Annex 2: Project Description 27 Annex 3: Estimated Project Costs 35 Annex 4: Cost Benefit Analysis Summary 36 Annex 5: Financial Summary 45 Annex 6: Procurement and Disbursement Arrangements 64 Annex 7: Project Processing Schedule 73 Annex 8: Documents in the Project File 74 Annex 9: Statement of Loans and Credits 76 Annex 10: Country at a Glance 81 Annex 11: Environmental Assessment 83 Annex 12: Resettlement 92 Annex 13: Institutional Strengthening 94 Annex 14: Financial Management System 98 MAP(S) IBRD Nos. 30926, 30928, 30929  CHINA HEBEI URBAN ENVIRONMENT PROJECT Project Appraisal Document East Asia and Pacific Region EASUR Date: May 10, 2000 Team Leader: Wiebe Moes Country Manager/Director: Yukon Huang Sector Manager/Director: Keshav Vanrma Project ID: P0459 10 Sector(s): WS - Sewerage, WU - Urban Water Supply Lending Instrument: Specific Investment Loan (SIL) Theme(s): Environment; Water Poverty Targeted Intervention: N Project Financing Data Z Loan L] Credit I-I Grant 0 Guarantee Z Other (Specify) For LoanslCreditslOthers: Amount (US$m): 150 Proposed Terms: Variable Spread & Rate Single Currency Loan (VSCL) Grace period (years): 5 Years to maturity: 20 Commitment fee: 0.75 Front end fee on Bank loan: 1.00% FlPinancIn Plan: SourceLol regTta GOVERNMENT 122.00 21.00 143.00 IBRD 54.00 96.00 150.00 Total: 176.00 117.00 293.00 Borrower: PEOPLESt REPUBLIC OF CHINA Responsible agency: HEBEI PROVINCE, BEBEI PROJECT MGMT OFFICE Hebei Finance Bureau and the municipalities of Shijiazhuang, Tangshan and Handan. Address: 14 Huaan Street, Shijiazhuang, Hebei, People's Republic of China 050051 Contact Person: Mr. Li Lusi, Vice Director, Hebei Project Management Office Tel: 311 701.1834 Fax: 311 703.1129 Email: hbpmo@public.sj.he.cn iEstimated disbursements ( Bank FYIUS$M): 2002 20Q3 , 204205 262907-1 Annualf 12.0 20.0 J 25.0 I 003. 4.0 9. Cumulative 12.0 32.0 1 57.0 87.0 117.0 141.0 150.0 Project implementation period: July 2000-June 2006 ,Expected effectiveness date: 11/01/2000 Expected closing date: 06/30/2007 OCA PAD F-n R~ vh 2MaA  A. Project Development Objective 1. Project development objective: (see Annex 1) The development objective of the proposed Hebei Urban Environment Project (HUEP) is to provide a safe environment and to sustain the long-term economic growth of urban areas in Hebei Province (HP). The project would support Hebei Province in implementing a long-term urban environmental services improvement program to recover from environmental degradation of its water and land resources, provide an adequate supply of safe water to its growing urban population and economy, and ensure sustainability of delivery through institutional and financial reforms of the service utilities. Progress towards the development objective of the proposed project would be measured in terms of: (a) reduction of pollution load from the urban sector through selective high-impact wastewater collection and disposal improvements; (b) expansion of supply capacity for safe water in urban areas; and (c) strengthened financial viability and institutional autonomy of municipal service companies. 2. Key performance indicators: (see Annex 1) Key performance indicators would include quantified targets for reduced water pollution for the urban sector into rivers, reduced water pollution from the industrial sector, expanded supply of safe water to meet urban demand, improved efficiency of service delivery and asset management, and reduced level of subsidies for investments in urban environmental infrastructure. B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1) Documentnumber: 16321-CHA Date of latest CAS discussion: 03/18/97; 5/28/98 Progress Report The project supports two of the five priorities of the most recent CAS: (1) safeguarding the environment; and (2) reducing infrastructure bottlenecks. Specifically, it would expand the capacity of urban environmental services and improve the strengthening of water quality monitoring capability. The project also supports the strategy to increasingly use tariffs to finance environment related public services. 2. Main sector issues and Government strategy: There are three major issues facing Hebei with regard to the urban environment: (i) environmental degradation; (ii) infrastructure constraints; and (iii) financial weakness of the municipal service providers. In order to address growing demand for water and environment cleanup, the Hebei Provincial Government (HPG) plans to expand and improve municipal wastewater management and water supply systems. The major concerns of HP are the quantity and quality of water it supplies to households and industries, as well as its impact on economic development, and the continuing environmental deterioration of the aquatic environment and subsequent impact of water pollution on public -2 -  health. The quality of drinking water typically complies with national standards, but the quality of raw water at the water intake frequently does not meet the standard for E.coli and other bacteria and constitutes a significant risk to the water supply in case of operational problems of the water treatment. Pressure to augment capacity for wastewater management and water supply is increasing with sustained economic growth and migration to the cities. Currently, the capacity for wastewater treatment is limited. Except for some industries which undertake their own treatment, facilities for domestic wastewater treatment are limited in Hebei. In Shijiazhuang, the capital city, only 16% of the wastewater is being treated in a centralized facility. The predominant means of treatment is through the use of septic tanks, which are often not operated efficiently and correctly. With regard to water supply, deficits have been projected for several project cities, with the exception of Shijiazhuang which has recently commissioned a new water treatment plant for 300,000 m3/day. Water services in China have historically been provided by wholly government owned companies, some of which have been in existence for over 70 years. Urban environmental services are the responsibility of municipal governments and are provided either at the municipal or at the district level. Wastewater services are usually run by municipal government department, normally as part of an engineering services department which also has responsibilities for roads, bridges and street lights. Water supply and wastewater services report to different bureaus, although both are the ultimate responsibility of the municipal construction commissions. Municipally-owned service companies maintain segregated accounts, which since July, 1993 use accounting system similar to those of international practices, however, this has not been the case for services run by municipal departments. The water industry has registered a marginal profit (0.1%) in 1996, but 35% of the companies were at a loss. In the case of wastewater, the picture is less clear but certainly the sector survives by virtue of government subsidies. In a context of serious water pollution and water scarcity, limited coverage (particularly for wastewater treatment) and increasing costs, there is now mounting pressure for the industries to achieve full cost recovery and introduce cost control measures. While several pricing reforms, to inspire tariff increases and introduce more scientific methods of charging for the service received, have been enacted by central government agencies, these can only be successful in the long term only if institutional and organizational reforms for the sector providers are also implemented. Water and wastewater entities find themselves in a transitional phase where the traditional government subsidies have been reduced, but tariffs for municipal services do not yet cover the full cost of operation and investment. Hebei is no different in the challenges it faces in the sector and has embarked on a series of reforms both aimed at improving cost recovery and improve efficiency of service delivery by the companies. Government Strategy: To finance the expansion of urban environmental infrastructure, the Government intends to rely increasingly on user charges, given shrinking public investment budgets and subsidies. As for management, the Government encourages the creation of financially autonomous municipal companies. While this policy has been implemented for some time in the - 3 -  water supply sector, the wastewater subsector remains largely within the government realms and relies on subsidies. However, the recent State Circular No.1192 of October 1999 stipulates the need for institutional and financial reforms with regard to wastewater collection, treatment and disposal services, similar to the regulations implemented earlier in 1998 for water supply. In addition, as part of the policies devised to facilitate the project, the Hebei Government has recently decided to delegate authority for setting water and wastewater tariffs in the three project cities directly to the municipal governments and their price bureaus. This would not only simplify the approval process for tariff revisions but also enhance the financial sustainability of utility companies. It is hoped that similar regulations will be soon issued for the other cities in HP. The HPG plans to curb pollution from urban and industrial sources and to expand the supply of water. With regard to pollution, ambitious targets have been set for the year 2000 for major rivers in the province. The target for wastewater collection and centralized treatment by the year 2005 is to increase the coverage in Shijiazhuang to 65%, in Tangshan to 85% and Handan to 60%. It is also planned that 75% of industrial wastewater should comply with discharge standards. For the year 2010, the target is to have 75% of all urban wastewater treated and the water quality of all rivers, canals and lakes comply with the standards. To achieve these targets, HPG also wants to expand the capacity of wastewater collection and treatment and improve the enforcement of existing standards, in particular for industrial pollution control. 3. Sector issues to be addressed by the project and strategic choices: Wastewater Management: The Project will support HPG in implementing its water quality strategy in the three project cities, through expansion of wastewater collection and treatment facilities. Water Supply: The project will support the upgrading and expansion of water supply in Tangshan and Handan, as well as demand side management, in particular through tariff increases. Current water consumption figures in all cities are high compared to other countries. Taking into consideration the overall water deficit in the province (and North China in general) and the large investment requirements for both water and wastewater infrastructure, it is of the utmost importance that water demand be controlled, and possibly reduced. This will be achieved through a combination of monetary incentives (higher tariffs) and public information campaigns. Tariff Reform and Financial Viability of Utilities: The financial situation of the water utilities is poor and deteriorating. Estimated return on assets of water supply companies is negative which is not surprising, given the fact that water supply tariffs have slightly decreased in real terms over the last 10 years, despite substantial increases in nominal terms. Wastewater charges were very low (only 5 - 15% of the water tariff). As part of project preparation, all the cities have substantially increased their water and wastewater tariff. The project would also provide TA support for government departments and utility companies' staff to continue institutional and financial reforms, as well as to enhance operational management. Industrial Pollution Control: There is also substantial pollution from industry, particularly in the Hai and Fuyang river basins. Without a significant effort to control industrial wastewater pollution, expected environmental benefits from municipal investments would be marginal. HPG -4 -  has agreed to address this issue through the implementation of a policy focussed on Industrial Pollution Control Action Plan (IPCAP). The IPCAP would reduce pollution loads discharged from key polluting sectors. C. Project Description Summary 1. Project components (see Annex 2 for a detailed description and Annex 3 for a detailed cost breakdown): - 5-  The project includes the following components: ;1!|!idct'ive,t' Bak '%* of (a) Water Supply. Urban Water 43.50 14.8 24.30 16.2 Supply Tangshan: Water Treatment Plant, capacity 150,000 m3/day, including intake pumping station, 19 km raw water transmission main and 9.5 km distribution trunk mains Handan: Water treatment plant, Urban Water 42.70 14.6 22.90 15.3 capacity 100,000 m3/day, 57 km raw Supply water transmission main and some 50 km of water distribution network 0.0 0.0 (b) Wastewater Management Shijiazhuang: Wastewater treatment Sewerage 109.30 37.3 59.70 39.8 plant, capacity 500,000 m3/day, including some 40 km of sewer rehabilitation and expansion; Tangshan: Wastewater treatment plant Sewerage 30.90 10.5 15.30 10.2 at Xijiao, capacity 120,000 m3/day and 20 km of sewer infrastructure; Handan: Wastewater treatment plant, Sewerage 39.00 13.3 20.90 13.9 capacity 100,000 m3/day with 40 km of trunk sewer infrastructure and sludge treatment expansion at existing plant (c) Environmental Pollution Control Other 0.90 0.3 0.90 0.6 Environment (d) Institutional Strengthening & Institutional 4.50 1.5 4.50 3.0 Training Development Total Project Costs 270.80 92.3 148.50 99.0 Interest during construction 21.00 7.2 0.00 0.0 Front-end fee 1.50 0.5 1.50 1.0 Total Financing Required 293.30 100.0 150.00 100.0 -6 -  2. Key policy and institutional reforms supported by the project: The development objectives of the project would be achieved through enacting a blend of policy and investment initiatives. Financial and policy reform would concentrate on: (a) establishment and capacity building of wastewater companies; (b) enhancement of the utilities' operational efficiency; and (c) resource mobilization and cost recovery measures. The institutional strengthening and training component would enhance policies and operational activities in environmental protection and water supply and wastewater management. Industrial pollution control would be implemented through a time-bound action plan and non-Bank financed investments with respect to pollution mitigation, principally from paper, chemical and pharmaceutical industries. Support for these initiatives has been grouped into a number of packages for the various executing agencies, covering institutional development, financial management improvement, industrial pollution control, and construction supervision and training. As part of the process of reforms, the newly established companies should be given more freedom to properly manage the activities for which they have been made responsible. While reforms are being implemented at the company level, there is a need to also change procedures and responsibilities of the municipal departments in charge of supervising and regulating the sector. All water supply and wastewater companies are natural monopolies that operate in imperfect markets. This means that continuing regulation of the companies either by government directly, or on behalf of government is required. This regulation is necessary to protect the interests of customers (in terms of service provision and charges) and to avoid the companies generating excessive profits. The project will assist in this regard, as part of the technical assistance component. Advice will be provided to the municipal governments to give some additional certainty and application of scientific method to price setting, particularly in how local affordability and willingness to pay are measured and presented to decision-makers. 3. Benefits and target population: Target Population: Considering the importance of the three cities in terms of overall economic growth in Hebei province, the expected demands for urban environmental infrastructure are significant. The target population of the project is living in the urban core of the three project cities and is estimated at 2.9 million, which will grow to some 5.0 million by the year 2010. The direct beneficiaries of the physical investments number 950,000 for water supply and 1.6 million for wastewater collection and disposal. In addition, substantial part of the works, up to 75%, will benefit industrial and commercial development. Benefits: The project would help Hebei to put in place policies, institutions, and infrastructure to sustain environmental quality and improve urban services in a period of strong growth. The proposed project would generate benefits in terms of improvements in environmental quality, health, municipal services and institutional capacity: * Environmental Benefits: improved ambient water quality through reduced pollution loads from urban wastewater and waste and more effective, GIS based, water quality monitoring. -7 -  * Improved Municipal Services: expanded coverage of water distribution and wastewater collection, treatment, and disposal for the urban population of the three largest cities in the province: i.e., Shijiazhuang, Tangshan, and Handan; * Institutional Reforms: strengthened financial and management autonomy will enable the utilities to sustain and expand the provision of essential services for the growing population. Support for institutional development would ensure the long-term sustainability of the organizations and of the physical investments. 4. Institutional and implementation arrangements: Project Management: HPG has established a high level Leading Group to oversee project preparation and has set up the Hebei Project Management Office (HEPMO) to prepare and execute the project. The HFB is the lead agency for the project, with support from the Construction Commission, the Planning Commission, and the Environmental Protection Bureau. The HEPMO's responsibilities include: (a) overall project coordination, macro-level project management and monitoring; (b) annual budget preparation; (c) project-wide quality assurance; (d) progress reporting to HPG and the Bank, including cost management, project impact and environmental improvement assessment; (e) interagency coordination and procurement support; and (f) sectional training facilitation. The personnel mix of HEPMO and municipal project offices would need to be adjusted from time-to-time to reflect the needs of the various phases of the project, including completion of preparation, tendering phase and project implementation. The project cities have established Project Management Offices to facilitate and monitor implementation of the respective project components on behalf of the municipal government. Implementing Agencies: The effective implementation of the physical works will be the responsibility of the following municipal utility companies: newly created and existing Wastewater Companies (WWCs) would be responsible for implementing the sewerage component, as well as operating all facilities in the cities. These services traditionally have been provided by municipal utilities management bureaus, but given the magnitude of the project, the city governments have recognized the need for establishing autonomous and self-accounting enterprises in the wastewater sector. Wastewater companies have been established in all three project cities and all assets have been transferred to them from the municipal drainage offices. The Water Supply Companies (WSC) in each of the cities would be responsible for implementing the water supply component. They would be responsible for construction management, production, operation and maintenance, consumer service and administration of the water supply systems in their respective jurisdictions. The water supply companies will bill and collect wastewater charges on behalf of the wastewater companies. The revenues, minus a fee, will be transfered directly to the wastewater companies. The industrial pollution control action plan (IPCAP) would be managed by the Hebei Environmental Protection Bureau (HEPB) and implemented by the municipal EPBs and wastewater companies. The International Tendering Company CMC will be retained as the procurement agency for all aspects of the civil, electrical and mechanical works requiring bidding through international competitive bidding (ICB) procedures. Design review and advisory and construction management - 8 -  services would be carried out by an international firm using joint international/national teams. Construction supervision will be carried out by local supervision companies retained by the Implementing Agencies. Onlending Arrangements: The proposed loan of $150 million would be made to the People's Republic of China. The loan would be for 20 years, including five years of grace, at the Bank's standard interest rate for LIBOR-based US dollar single currency loans. The Ministry of Finance, would make the proceeds of the loan available to Hebei Province on the same terms and conditions as the Bank loan to China. The Province would onlend to the Municipalities on the same terms and conditions as the Bank loan to China. The onlending from the Municipalities to the water supply and wastewater companies would have a total maturity of 15 years, including 5 years grace. The foreign exchange risk will be passed on to the utility companies. Financial Management: Hebei Province has the required systems and staff to carry out the financial management of the project. HP already has ongoing Bank Group-financed projects in other sectors and the HFB is familiar with the Bank Group's disbursement procedures. Hebei prepared a Financial Management Systems (FMS) Manual, which was found satisfactory to the Bank. This would be the basis for financial management during project implementation. To facilitate disbursements, a Special Account would be opened with an authorized allocation of $10.0 million, equivalent to the estimated average expenditures to be financed by the Bank Group over a four-month period. The account would be opened in US dollars in a bank acceptable to the Bank Group and would be managed by HFB. Utility Performance Monitoring: In the Project Implementation Plan (PIP) a variety of monitoring indicators and target dates have been identified for institutional, financial, operational and technical aspects of the project and utility management. Furthermore, the technical assistance program with the utility companies include the mainstreaming of benchmarking processes. Auditing Arrangements: As with other Bank Group-financed projects in China, the Foreign Investment Audit Bureau of the China National Audit Office (CNAO), established in 1983 under the name of State Audit Administration, would have overall responsibility for auditing the accounts of the project. The actual auditing work would be conducted by the Hebei Provincial Audit Department under CNAO's supervision. The Bank Group currently accepts audits performed under the responsibility of CNAO. Audits of the financial statements of implementing agencies, and audit of the Special Account would be submitted to the Bank group within six months after the end of the financial year. The audit reports of the implementing agencies would include opinions on whether the agencies were in compliance with their respective financial covenants, and whether these agencies had taken out adequate insurance on goods and works financed from the loan proceeds. Monitoring, Reporting, and Evaluation Arrangements: HEPMO has primary responsibility for monitoring and reporting through quarterly project preparation and implementation progress reports, based on information compiled from the implementing agencies. Bank supervision of project implementation will be conducted twice a year by both headquarters and resident mission staff. During implementation, project performance, including the achievements of project outputs -9-  and attainment of development objectives, would be monitored through the use of quarterly reports prepared by HEPMO. The first such monitoring report would be submitted by October 31, 2000 and the last one by July 31, 2007. Also a mid-term review will be undertaken jointly with the Government to evaluate the project achievements and identify the need for corrective measures. In addition, an implementation completion report, reviewing the planned objectives and project achievements, including costs and benefits derived, and performance and contribution of all parties associated with project execution, would be prepared by HEPMO and submitted to the Bank Group within six months of the closing date. D. Project Rationale 1. Project alternatives considered and reasons for rejection: Project Focus: The Government has determined that the focus of this project should be urban environmental management, and that investments would concentrate on improved wastewater collection, treatment and disposal, and expansion of water supply services. To reduce pollution from industrial wastewater discharges, and strengthen environmental management, the project would support the implementation of a time-bound action program addressing the largest polluters in and around the project cities. Investments in clean technology, end-of-pipe treatment, pre-treatment before discharge to the sewers and industrial rationalization would be financed by Government and industry in parallel with the proposed project. Project Site Selection: The Government had originally submitted proposals for investments in six cities, but Bank management expressed concerns about the size and complexity of the proposed project and the need to reduce the number of project cities. At project formulation, priority investments in urban environmental services in four cities were identified: Shijiazhuang, Tangshan, Handan and Qinghuangdao. Subsequently, project proposals were prepared by HPG and the Municipalities, assisted by international consultants, with regard to their technical, institutional and economical viability. At a late stage in project preparation, Qinghuangdao city was withdrawn from the project, reportedly due to counterpart funding problems. Wastewater and Water Supply Options: The proposed project calls for the construction of water supply and wastewater disposal facilities. The balance between water supply and wastewater disposal services levels was examined in considerable detail. It was ensured that the project cities that had proposed water supply projects for Bank funding were adequately addressing wastewater treatment and that any Bank-funded water supply project was not aggravating the wastewater situation in the city. Consequently, it was concluded that several complementary wastewater projects must be undertaken, either independently or with Bank support, in two of the cities where water supply projects had been proposed. The project supports sewage treatment with a capacity of 750,00 m3/day which is triple the capacity of water supply financed in the three cities. The extent of sewage treatment has been reviewed in the light of the limited assimilative capacity of the adjacent streams and rivers and secondary treatment has been justified. Alternative wastewater treatment processes were considered and cost comparisons were undertaken as part of project preparation to determine the optimal solution and the adequate level of treatment to meet the health standards and water quality targets. - 10-  Non-Government Sources of Funding: Alternatives to public financing of the proposed investments were considered, in particular the scope for private sector financing of urban infrastructure. However, private sector participation, e.g. in form of a build-operate-transfer (BOT) schemes, is currently limited to pilot programs. HPG wants to await the outcome of this pilot before entering in any private sector deals. Hence, the option for private sector financing is not available for the proposed investments, however should be considered for future investments. 2. Major related projects financed by the Bank and/or other development agencies (completed, ongoing and planned). LatesLt Supervision Sector Issue Project (PSR) Ratings I I W ~~~~~~~~~~~~~~~~~(Bank-financed projecfs onhfly Implementation Development Bank-financed Progress (IP) Objective (DO) Urban Environment: Water, China: Yunnan Urban S S wastewater, sanitation, solid waste, Environment Project industrial pollution (Ln.4055/Cr.2892) Urban Environment: Water, China: Guangxi Urban S S wastewater, sanitation, solid waste, Environment Project industrial pollution (Ln.4348/Cr.3097) Wastewater & tariff reform policy China: Second Shanghai HS S Sewerage Project (Ln.3987) Urban Development: Water, urban China: Zhejiang Multicities S S upgrading, land development, cultural Development Project (Cr.2457) heritage Delivery, management and operations China: Shanghai Environment S S of large water supply and wastewater Project(Ln.371 1) systems, industrial pollution control Pollution Control through improved China: Hubei Urban U U urban wastewater management and Environment Project pollution control at major industries. (Ln.3966/Cr.2799) Other development agencies The Asian Development Bank has Reported to have been generally financed several investment programs in successful investment program the urban sector of China, mainly supporting urban environmental services, in cities that do not overlap with World Bank supported programs - 11 -  Bilateral support from a number of These investments have sources including KfW and the generally been successfully Govermnents of Austria, Australia, implemented, though attention Finland and Denmark, has financed has not been paid to equipment for urban water supply, institutional and financial wastewater and industrial waste matters. Finance has been treatment plants available mainly to support equipment sourced (restrictively) from the lending country The Department for Intemational Performance has been reported Development-DFID (United Kingdom) to be satisfactory has provided support on institutional and financial development needs of urban utilities, and on broad aspects of environmental management The Govemment of Japan has financed Perfonnance is reported to be equipment for urban water supply, satisfactory. However, wastewater and industrial waste financial policies are not treatment plants. developed IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory) 3. Lessons learned and reflected in the project design: Greater Reliance on User Charges: A major finding from the OED review of Bank water and sanitation projects has been a generally good achievement of physical targets, but less success in sustaining the financial viability of municipal services. This is in line with the findings from a recent sector work on China ("Urban Environmental Service Management," Report #13073-CHA). This report notes the need for greater reliance on user charges and concludes that such charges would be affordable and would encourage resource conservation and create a more dependable income stream. Tariff reforms and improvement of operational efficiency have been a centerpiece of the policy dialogue with the Hebei Government. Adjustments of tariff levels, prior and during implementation, are an integral part of the project design. Timing of Tariff Increases: Previous urban environment projects in China have frequently encountered difficulties in implementing agreed tariff increases in a timely manner, sometimes delaying loan or credit effectiveness. Tariff increases often represent politically difficult decisions for local governments, but are critical for the sustainability of the project. This project has required that substantial tariff adjustments be implemented during the preparation stage (four of the five cities have already approved and implemented tariff increases). Two further increases are expected prior to negotiations. Written assurances were obtained from the municipal governments that they will further increase tariffs during project implementation as per schedule agreed with the Bank. - 12 -  Support for institutional reform: The establishment of financially autonomous utility enterprises to develop and manage urban services is a long-standing Chinese practice, and avoids many of the management difficulties of publicly owned utilities in other countries. However, wastewater companies have only recently been given the same autonomy generally by absorbing the existing drainage bureaus and construction management units already active in the sector into separate enterprises. The prior experience of these bureaus will certainly benefit the transition, but substantial levels of technical assistance will be needed to strengthen the new companies' managerial, financial and operational capacities. Industrial Pollution Control: Experience with funding for industrial pollution control (IPC) has been geiierally disapppointing, such as in the Zhejiang Multicities project and Hubei Urban Environment project. Therefore, no Bank funding for industrial pollution control has been included in the project design. However, the impact of industrial discharges on the local environment is considerable. Without any action on IPC may undo the environmental benefits of the municipal treatment works and endanger the water resources for the cities' water supply. So far, the IPCAP approach has proven to be reasonably successful in dealing with the pollution from major industries. This also keeps the Bank involved in IPC during project implementation. Extent of technical assistance: Full utilization of TA funds by borrowers at the local level remains problematic in the China urban portfolio. The costs of the identified TA packages are modest in terms of percentage of total project costs. Since the technical assistance is essential for achieving the project objectives, the main TA packages will be procured under retroactive financing arrangements and are part of the conditions of disbursement. Sufficient Preparation Time and Budget: Experience in China has shown that first-time projects demand significantly greater time and monetary investments in the preparatory and initial implementation phases than those managed by experienced project offices. As this would be the Bank Group's first involvement in the urban environmental services sector in HP, a longer lead time was needed to develop clear understandings of institutional and services delivery arrangements. Adequate time and resources have been allocated for preparation of the project, with 30% of the contracts fully designed and tender documents prepared. Five contracts will be implemented under retroactive financing as well as technical assistance would be available at an early stage for construction supervision and quality control and strengthening of institutional and financial management. 4. Indications of borrower commitment and ownership: HP has demonstrated excellent commitment to the proposed project as evidenced by: (i) regular involvement by the high level Leading Group, headed by the Vice Governor, to support institutional reformn and tariff increases; (ii) excellent performance by the provincial and municipal project management offices during the preparation of the proposed project; (iii) major upfront actions on institutional reform in the wastewater subsector and substantial tariff increases for both water supply and wastewater; (iv) investment of considerable provincial and municipal resources in the preparation of comprehensive feasibility studies for an extended period; and (v) hiring of top class local design institutes for technical studies as well as safeguard policies. - 13 -  5. Value added of Bank support in this project: The Bank Group brings considerable international experience to assist in policy formulation and investment program design, in particular with respect to economic, financial and institutional analyses and systematic consideration of alternatives. Bank Group assistance will also draw on our growing experience in addressing institutional and financial reform within water supply and wastewater utilities. Bank Group assistance in the design phase enabled the Province and project entities to widen the scope of possible options, find more cost-effective solutions than the ones originally considered, maximize environmental impact of treatment facilities and introduce energy saving opportunities with significant financial benefits. The Bank Group involvement will enhance the construction quality control of the physical investments, accelerate institutional strengthening and training, and contribute its considerable experience in bringing about meaningful utility reform in the sector. E. Summary Project Analysis (Detailed assessments are in the project file, see Annex 8) 1. Economic (see Annex 4): * Cost benefit NPV=US$ million; ERR= % (see Annex 4) o Cost effectiveness O Other (specify) Project Benefits. The physical infrastructure components will strengthen the reliability of water supplies to the three largest urban centers cities in Hebei and will mitigate the effects of over-abstraction from ground water sources. By treating wastewater and removing it from the city centers, the project components will improve the quality of available surface water resources and improve the environmental conditions in the cities. Investments in wastewater are first steps towards long term clean up of the rivers. Approximately 400,000 people will directly benefit from the completion of the Handan wastewater and water supply components; approximately 640,000 people will benefit from the completion of the Shijiazhuang wastewater component; and approximately 570,000 people will benefit from the completion of the Tangshan wastewater and water supply components. An important benefit of the project is that it will promote institutional and financial reforms for the water and wastewater utilities, and for the relevant municipal offices. The project will also contribute to financial and operational management capacity building. This will not only contribute to the long term sustainability of the project, but put in place permanent mechanisms for the local governments and utilities to improve water supply and wastewater service delivery. Economic Viability. Although an attempt has been made to quantify the project benefits, the choice for priority interventions for the project has been guided by cost effectiveness considerations. A least cost analysis was undertaken for all the project components and least cost solutions were selected among the alternative technologies available, with the exclusion of the Handan wastewater for which a marginally more costly option was selected, because of easiness of operation and maintenance of the facilities. - 14 -  Economic Internal Rates of Returns (EIRRs) were estimated for the two water supply components. In the case of the wastewater components, benefits are difficult to quantify, hence the calculation of the EIRRs has not been attempted. Average incremiental economic costs (AIEC) were calculated for all components. Water problems in the project cities is caused by over-extraction of groundwater, insufficient projected water quantities to meet growing demand, and in some cases, unreliable supply. The water supply components will benefit customers by improving the quantity and reliability of water supplies, and quality of the water supplied. Both water projects are economically viable. EIRR are 14.4% in Tangshan and 12.9% in Handan. Additional non-quantifiable benefits, particularly arising form a reduction of over-extraction of groundwater, would lead to higher EIRRs. The EIRRs for the two water components are most sensitive to a reduction in the project benefits, while the AICs are most sensitive in variations in the capital costs. The main benefit of the wastewater components will be an increase in the amount of sewage treated, and hence an improvement in ambient water quality in the receiving water bodies and in the future quality of underground water. There will be improved drainage of sewage and storm water from the built-up area, which will improve the sanitary conditions within the cities. 2. Financial (see Annex 5): NPV=US$ million; FRR = % (see Annex 4) In order to determine the financial viability of the water supply project components in Handan and Tangshan, the financial rate of return (FRR) was calculated. An analysis of the cost effectiveness and subsidy requirements of both the water supply and wastewater project components has also been undertaken. The average incremental financial cost (AIFC), which is an approximation of the long run marginal cost, was calculated. The present value is calculated by discounting all cash flows at the weighted average cost of capital (WACC). In order to identify those factors posing the greatest risk to the financial viability of the Project, an analysis of the sensitivity of FRR and AIFC to adverse changes in selected key variables was also undertaken. Financial Viability. The FRRs for the Handan and Tangshan water supply components are 8.8 percent and 9.8 percent respectively, both above the WACC. Therefore, the water supply project components are considered to be financially viable. The AIFCs for the Handan and Tangshan water supply components are Yl.66/m3 and Y1.34/m3 compared to average 2014 tariff levels YO.93/m3 and YO.95/m3 respectively. The difference between the AIFC and the average tariff represents a financial subsidy. Most of this subsidy is provided in the form of the equity contributions by each municipality toward the capital cost of the project. The AIFCs for the three wastewater components also exceed the average tariff in 2014. However, while the AIFC is calculated on the basis of the volume of wastewater treated, the average tariff is based on the total volume of wastewater generated. Since all piped and self-supplied water consumers pay the wastewater tariff, regardless of whether they are actually discharging into the sewer system, the -15 -  required tariff is lower than the AIFC. In the case of the two water supply components, the sensitivity analysis indicates that the FRR is most sensitive to a reduction in incremental revenues. This highlights the importance that tariffs be increased in accordance with the required implementation schedule. In the case of the Handan and Tangshan wastewater components, the AIFC is most sensitive to a one year delay in project completion. The AIFC for the Shijiazhuang wastewater component is most sensitive to an increase in capital cost. Public Utility Financial Reforms. A major component of the project is the development and implementation of a comprehensive financial reform program by each project company. Each has implemented enterprise accounting systems in order to enable more effective financial management, particularly over receivables. Under these new systems, affiliated non-core business activities have been clearly separated from those of the core water supply and wastewater functions. Previous exemptions from the payment of user charges provided by some of the companies to specific customer groups have been terminated. Tariff increases have been implemented in advance of project implementation and the largest proportion of the additional increases required are concentrated in the first two years of project implementation. These up-front tariff increases not only ensure the longer-term financial sustainability of the companies more effectively, but they will also enable them to contribute toward the counterpart funding requirements of the project. The water supply companies will contribute about 25 percent of the cost of the project while the wastewater companies will contribute between 10 percent and 15 percent of the project cost from internally generated funds. Recent reforms at both the state and provincial government levels have significantly enhanced the ability of the water and wastewater companies to implement their financial reform programs. The HPG, through the Hebei Provincial Price Bureau (HPB), has been working toward establishing policies and regulations to set wastewater tariffs consistent with State Circular No. 1192 concerning financial reforms in the wastewater sector. Consistent with these reforms, in January 2000, the HPB delegated authority to set water and wastewater tariffs in the three project cities directly to each respective municipal government and their price bureaus. Furthermore, these up-front tariff increases, combined with further increases over the project implementation period, will significantly reduce existing pricing distortions and thereby promote more efficient water consumption pattems. Public Utility Financial Projections. Consistent with the financial reforms, the objectives set by the municipalities for their water supply and wastewater utility companies are to achieve full cost recovery on their operations, maintain debt service coverage of at least 1.3 times, and, in the case of the water supply companies, to generate funds sufficient to cover at least 20 percent of their capital investment programs. In order to achieve these objectives for 2000, the companies began implementing tariff increases in 1999. Financial projections have been prepared for each company indicating the levels of tariffs required to meet these objectives. Due to the lower levels of cost recovery presently achieved by the wastewater companies, required increases in wastewater tariffs are higher than that for water supply. Based on agreed upon tariffs to be implemented in 2000, the increases in wastewater tariffs to 2006 in Shijiazhuang, Tangshan and Handan are 90 percent, - 16 -  and 100 percent and 135 percent respectively. The required increases in water tariffs over this same period are 60 percent in Tangshan and 65 percent in Handan. An analysis of the impact of these increases on low income domestic groups indicates that the tariffs are affordable in that the combined cost of water and sanitation does not exceed 5 percent of household income. In all three cities, the proportion of income allocated to water and sanitation by a low income household is projected to peak in 2004 at 3.1 percent in Handan, 3.4 percent in Shijiazhuang and 4.4 percent in Tangshan before declining gradually thereafter. Fiscal Impact: Municipal Finances. In order to assess the ability of the project cities to provide counterpart funds, total municipal revenues and the portion of revenues that is specifically available for capital investments have been compared to required project contributions. The analysis indicates that the project components are affordable in all cities, though more onerous in the case of Handan. As a proportion of total municipal revenues, the requirement for project counterpart funds varies between 2.5 percent in Handan (3.5 percent in the peak year), 1.8 percent in Tangshan (3.0 percent in the peak year), and 1.1 percent in Shijiazhuang (1.9 percent in the peak year). When considering only revenues that can be earmarked for the purpose of capital expenditure, which is an approximation of the city's financial capacity to contribute to the project, the incidence of the project counterpart funds varies between 12.8 percent on average in Handan (17.8 percent in the peak year, 2003), 7.4 percent in Tangshan (12.1 percent in the peak year, 2000), and 4.4 percent in Shijiazhuang (7.2 percent in the peak year, 2000). The counterpart contributions required from all three cities are well within generally accepted limits of affordability. 3. Technical: Project Design. HEPMO has retained the services of A-class Chinese design institutes which, assisted by international consultants and municipal design institutes, will prepare the engineering designs, cost estimates and bid documents. International consultants have verified all basic data and assumptions for accuracy and practicality. Where possible, wastewater flow data and the like were supported by measurements in the field. Selection of technology and materials have been based on operational experience, taking into account the specific conditions in the project cities and cost efficiency (both capital and recurrent costs). The technologies involved are proven and within the capability of Chinese contractors and manufacturers if successful in winning bids. Cost Estimates. Base cost estimates of the project reflect preliminary and detailed designs and price levels prevailing in January 2000. The unit prices were derived from: (a) quotations obtained from manufacturers and suppliers; (b) prices of goods and works from recent contracts; and (c) construction costs according to prices published by the Central and Hebei governments, all adjusted for inflation. Survey cost have been taken at 1 percent of civil works, design preparation at 3 percent of cost of civil works and equipment, and construction supervision at 3 percent of the works and goods. Project management and engineering overhead costs of 3 percent have also been included. Physical contingencies of 10 percent have been applied to base costs for all components. Price contingencies have been applied to expenditures at projected global foreign and local inflation rates, as follows: local: 2.0 percent in 2000; 5.0 percent in 2001 - 17 -  and thereafter; foreign: 1.6 percent in 2000; 2.5 percent in 2001, 2.6 percent in 2002, and 2.5 percent thereafter. 4. Institutional: a. Executing agencies: The project will be implemented by five municipally owned utilities. The water supply companies of Handan and Tangshan have been in operation for years and will be fully responsible for the implementation of both the construction and operational phases of the schemes. The wastewater components in Tangshan, Handan and Shijiazhuang will also be implemented by three recently incorporated enterprises, established based on the 1995 Company Law. These companies, with the exclusion of Tangshan, were established during project preparation. Financial and institutional reforms are essential to promote the long term sustainability of the project, as well as to improve efficiency and service delivery. A description of recent organizational changes implemented by the project companies is summarized in Annex 5. As wastewater and drainage services have traditionally been provided by government departments, the reform process in this sector is bound to be slower and more cumbersome than in the water sector, but several steps have been taken in the project cities over the last year, to accelerate the pace of these reforms. In particular: (i) wastewater functions are now separated from that of municipal departments and sewage collection and treatment have been reorganized under the responsibility of newly formed, or strengthened, companies established under the 1995 Company Law; (ii) for the wastewater companies, all senior management officials have been appointed and the Board of Directors and of Supervisors has been established; (iii) the required revaluation and transfers of assets have been completed for all companies; (iv) all companies have implemented enterprise accounting, although not yet fully on an accrual basis; (v) joint billing for water and wastewater has been implemented in all cities; and (vi) all incomes collected by the water supply or the water saving offices are now transferred directly to the wastewater companies rather than being channeled through the municipal finance bureaus. The project assumes that all companies will be responsible for repaying the Bank's loan. In the case of wastewater companies it is expected that they will be able to recover operating and maintenance costs, depreciation and contribute to part of the capital requirements (for an amount varying between 10 percent to 15 percent). In the case of the water company, a contribution of 25 percent to capital investment has been assumed. This is a major departure from the past, in particular in the case of wastewater, where full subsidies of capital and operating costs by municipal governments have been the predominant practice. Tariff increases for all consumer categories have been approved and implemented for all the Companies. Further tariff increases are also planned for Shijiazhuang. All exemptions have been eliminated and all consumers are requested to pay for the service received. - 18 -  The project companies are at different stages of development and there are obvious differences in their management capability, experience and use of technology. In each case, however, there is significant scope for further institutional development and performance improvement. During project preparation, Institutional Action Plans (IAP) were developed for each company and agreed with Municipal Governments. The implementation of these action plans has been covenanted. Annex 13 include a sample of a draft IAP. While reforms are being implemented at the company level, there is a need to also change the procedures and responsibilities of the municipal departments in charge of supervising and regulating the sector. The IAPs and the technical assistance component under the project, will also support the municipal government departments on matters related to the companies' supervision and methods for price setting. b. Project management: Project Management: The organization for the management of the project and staffing for the Hebei PMO, city PMOs and Implementing Agencies (lAs) are outlined in detail in the Project Implementation Report. Assurances have been obtained concerning further strengthening to ensure adequate capacity and budgets during implementation. Institutional strengthening and training program forms an integral part of the proposed project as it ensures the long-term sustainability of the project entities and adequate operation and maintenance of the existing facilities as well as the assets created under the project. Both HEPMO and some of the utilities have implemented internationally funded projects in the water and sanitation sector in the past and, therefore, are equipped with the knowledge, skills and equipment necessary to carry out their mandate. Institutions which are likely to take part in the program include the HEPMO, city PMOs, EPBs, water supply companies, wastewater companies, supervision companies and monitoring institutions for EAs and RAPs. 5. Social: Land acquisition and resettlement. About 90 hectares of land would need to be acquired for the project components and some 130 households will require resettlement. No minority issues have been identified. The total cost of the program is about $18 million. Resettlement impacts have been identified and resettlement action plans (RAPs) have been prepared, addressing issues related to entitlements of affected people (see Annex 12). The resettlement requirements of the project are relatively small, and considering the good experiences in other urban projects and the strong commitment of the local authorities to the safeguard policies, it is unlikely that any significant problems will be encountered. - 19 -  6. Environmental assessment: Environment Category: B (Partial Assessment) An environmental assessment (EA) has been carried out for HUEP. During preparation and evaluation, national procedures including those set out in China's Circular on "Strengthening Impact Assessment Management for Construction Projects Financed by International Organizations (1993)," as well as those required by the Bank Group, were diligently followed. The EA documents such as Environmental Assessment Report and Executive Summary have been prepared, incorporating Bank group comments, and found to be satisfactory. A detailed annex covering environmental assessment and impact has been prepared (Annex 11), which summarizes the finding of the Chinese EAs on the various project components and reflects the appraisal mission findings. Potential Impacts: The environmental impact of the project is, on balance, substantially positive and the benefits greatly outweigh the negative impacts. The project would reduce pollution loads in the Fuyang, Xiao and Quilonghe rivers, allow for the replacement of poor-quality water supply sources as well as eliminate groundwater mining practices (Handan). Major potential impacts during the construction phase include excavation, dust, noise, spoil disposal and disruption of urban services. Impacts during the operational phase include sludge disposal, noise, and odors. Mitigation Measures: The EA specified the appropriate mitigation measures, environmental monitoring plans, institutional arrangements and training and equipment requirements, and the cost estimate of implementing the mitigation measures. Major mitigation measures include controls on construction practice, careful siting of facilities with appropriate buffer zones and controls on noise. The EMPs have been mainstreamed into the Project Implementation Plan. Public Consultation and Feedback: During the EA work, local people were consulted. The following approaches were used for public consultation: (a) consultation meetings with local government representatives; and (b) questionnaire analysis of public opinion, supplemented by interviews. Major concerns from the public were resettlement-related issues and noise and air pollution during the construction phase. Details of the public consultation process are presented in Annex 11. Information Disclosure: The Environmental Assessment Report (EA) and Executive Summary were submitted to the Bank Group on January 25, 2000; the Resettlement Action Plan was submitted on January 28, 2000. Both reports were reviewed and found satisfactory. The detailed EA reports and EA summary report were sent to the Bank's Public Information Center on February 4, 2000 and copies are in the project files. These documents also have been available to the public in Hebei. The details of the information disclosure during EA and RAP preparation are provided in Annex 11. 7. Participatory Approach (key stakeholders, how involved, and what they have influenced or may influence; if participatory approach not used, describe why not applicable): a. Primary beneficiaries and other affected groups: - 20 -  The major beneficiaries would be the majority of the population, institutions and industries of Shijiazhuang, Tangshan and Handan, who would enjoy enhanced water supply, and a cleaner environment through wastewater collection, treatment and proper disposal. The implementing agencies would also benefit through the institutional and financial reform incorporated into the project as well as from the associated technical assistance. The cities would benefit, overall, through improved city management from implementing cost-effective tariffs and charges for these services. b. Other key stakeholders: During EA preparation, local communities were consulted through meetings with local government representatives, and public opinion questionnaires supplemented by interviews. The project has been designed to yield social benefits to all income groups. Project focus on environmental service provision to meet basic needs would provide a sustainable and equitable basis for underpinning economic development of lower income and underserved groups. F. Sustainability and Risks 1. Sustainability: The project is expected to be sustainable in three respects: (i) financially; (ii) institutionally; and (iii) technically. The tariff reforms, now strongly supported by the Government, will enhance the viability of municipal service providers, particularly the newly created wastewater companies. The establishment of automous utility companies is also supported by the state and provincial Governments. Finally, the project addresses an issue of high priority to both the local and the national government, i.e., vital self-interest in achieving affordable basic urban services within conducive environmental conditions necessary for sustained economic growth whereby water resources become an increasing scarce commodity. 2. Critical Risks (reflecting assumptions in the fourth column of Annex 1): Risk Risk Ratina Risk Minimization Measure From Outputs to Objective Complementary pollution reduction M Implementation of the IPCAP will ensure that efforts in industry are not implemented major sources of pollution will be dealt with and outlined water quality objectives achieved Utility companies may not be able to bear S Governments are committed to the financial the foreign exchange risk performance targets of the utilities and adjust the tariffs annually. From Components to Outputs Autonomous wastewater organizations M Companies created prior to appraisal, including assets transfers - 21 -  Financial sustainability of water and M Upfront tariffs increases, further increases wastewater companies not maintained covenanted and written commitment from municipal leaders. Comprehensive institutional strengthening assistance. Institutional and financial perfornance to be core activity of project supervision Improvement in user charge collection M Combined billing of water and sewer charges as collection efficiency may progress slower well as more pronounced government policies on than projected cost recovery for basic utility services Overall Risk Rating M Risk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N(Negligible or Low Risk) 3. Possible Controversial Aspects: While at State and Provincial level the need for corporatization of utilities is fully understood and supported, the special interests at municipal level as well as the direct personal implications of enterprise reform may encounter resistance with the danger of "reform on paper" only. Sustained efforts by both the Government and the Bank during project implemenitation are needed to overcome these hurdles. G. Main Loan Conditions 1. Effectiveness Condition * Execution of subsidiary loan agreements between the project cities and their water supply and wastewater companies, satisfactory to the Bank. 2. Other [classify according to covenant types used in the Legal Agreements.] Disbursement Condition * The signing of contracts with consultant firms for (i) institutional and financial technical assistance; and (ii) design review advisory and construction management and quality control technical assistance, is a condition of disbursement of the civil works category. Implementation Covenants At negotiations, assurances would be sought from HPG that it would: * implement the Institutional Strengthening component in accordance with a schedule acceptable to the Bank Group, and discuss and agree upon any revisions with the Bank Group; * carry out or cause to be carried out the resettlement of persons affected by the project in a manner and according to the Resettlement Action Plan satisfactory to the Bank Group; - 22 -  * cause the project agencies to carry out, in a manner satisfactory to the Bank Group, the mitigation plans specified in the Environmental Assessment; * maintain the Project Management Office and municipal project offices throughout implementation, with functions and responsibilities satisfactory to the Bank Group, and with competent staff in adequate numbers for the duration of the project; * carry out, or cause to be carried out, a time-bound Industrial Pollution Control Action Plan satisfactory to the Bank Group; and Financial Covenants At negotiations, assurances would be sought from HPG that it would: * cause the municipalities to onlend part of the loan proceeds to their respective water supply and wastewater agencies, on terms and conditions satisfactory to the Bank Group; * arrange for the following annual audits to be submitted to the Bank Group within six months after the end of the financial year: (a) audit of the project accounts maintained by PMO; (b) audit of the Special Account; (c) audits of the financial statements of the water supply companies of Tangshan and Handan; and (d) audits of the wastewater companies of Shijiazhuang, Tangshan and Handan; * cause the water supply companies of Tangshan and Handan to: (a) produce revenues from their water supply operations sufficient to cover operations and maintenance costs (before depreciation), increases in working capital, debt service, and a minimum 20 percent of the average capital expenditures made in a three-year period (the year preceding the reference year, the reference year itself, and the year after the reference year), taking actions to meet requirements; (b) incur no additional debt without the Bank Group's agreement, unless a reasonable forecast shows that it would have a debt service coverage of at least 1.3 times; and (c) apply tariff increases, when implemented, to all categories of consumers; * cause the wastewater companies of Shijiazhuang, Tangshan and Handan to: (a) produce revenues from their wastewater operations sufficient to cover operations and maintenance costs (including depreciation), and the amount by which debt service requirements exceed the provision for depreciation; (b) incur no additional debt without the Bank Group's agreement, unless a reasonable forecast shows that it would have a debt service coverage of at least 1.3 times; and (c) to take necesssary steps to ensure tariff increases apply to all categories; * cause the water supply and wastewater companies to prepare, before September 30, 2001, and in each of the following fiscal years, forecasts satisfactory to the Bank Group; and (a) review whether they would meet the covenanted requirements set fourth above in each such year and the following fiscal year; and (b) furnish the results of such reviews to the Bank Group, and if any such reviews would show that the entity would not meet the requirements set out above, the entity would take all necessary measures, including adjustments to the - 23 -  structure of its tariffs and charges to meet the requirements. Reporting and Monitoring At negotiations, assurances would be sought from HPG that it would: * cause each implementing agency to prepare quarterly project progress reports; the Project Management Office would then send a consolidated report to the Bank Group by the thirtieth of the following month, commencing December 31, 2000; * carry out with the Bank Group a mid-term review of the project by June 30, 2003, and implement, or cause to be implemented, agreed recommendations. H. Readiness for Implementation N 1. a) The engineering design documents for the first year's activities are complete and ready for the start of project implementation. O 1. b) Not applicable. N 2. The procurement documents for the first year's activities are complete and ready for the start of project implementation. X 3. The Project Implementation Plan has been appraised and found to be realistic and of satisfactory quality. K 4. The following items are lacking and are discussed under loan conditions (Section G): The project is well prepared, whereby all stakeholders, provincial and municipal governments as well as the implementing utility companies have been extensively involved. Detailed designs and tender documents have been prepared for 12 contract packages, of which 5 will be implemented under retroactive financing arrangements (US$5 million). A detailed Project Implementation Plan has been prepared, outlining all aspects of procurement, implementation schedules, project management, and financial management. Most implementing agencies have experience with internationally funded projects (bilateral or multilateral) and have allocated well qualified and experienced staff for the implementation of the project. 1. Compliance with Bank Policies N 1. This project complies with all applicable Bank policies. C 2. The following exceptions to Bank policies are recommended for approval. The project complies with all other applicable Bank policies. oOR40es ___NKs~~Arma Yukon Huang Team Leader Sector Manager/Director Country Manager/Director - 24 -  Annex 1: Project Design Summary CHINA: HEBEI URBAN ENVIRONMENT PROJECT Sector-related CAS Goal: Sector Indicators: Sector/ country reports: (from Goal to Bank Mission) Safeguard environment and Ambient environment EPB statistics for water and River pollution from public health through conditions in Hebei improved land environmental quality non-project related sources alleviation of urban does not increase. Migration environmental infrastructure to urban centers is within constraints controllable trends Environment related health Bureau of Public Health problems reduced. Urban environmental Statistics of the Construction infrastructure supply meets Commission demand. Project Development Outcome / Impact Project reports: (from Objective to Goal) Objective: Indicators: Protect quality of Hebei's Reduction of pollution load Statistics of Hebei EPB Parallel efforts to manage rivers and provide safe water from urban sources industrial pollution and land to project cities. Provide use are implemented adequate wastewater disposal arrangements on a sustainable basis to growing population Expansion of supply of safe Statistics of Water Supply water to meet demand from Companies domestic and industrial sectors Improvement of financial Audited financial statements, Timely tariff adjustments to viability of municipal service annual financial projections maintain viability are providers. implemented - 25 -  - Output from each Output Indicators: Project reports: (from Outputs to Objective) component: Market oriented pricing and Ratio of actual tariff to cost Companies' financial Government maintains tariffs financial management are recovery tariff is increased statements. Project at cost recovery levels for all introduced supervision missions utilities Infrastructure capacity for Volume increase for: Hebei statistics and company Upstream industrial pollution wastewater and water supply wastewater collected, safe reports and periodic reports is contained is increased water supplied, number of small and medium industries adopting cleaner technology Cost-effective wastewater Long-term water resource Statistics of Hebei EPB Pilot experience disseminated pollution abatement measures strategy developed and and adopted throughout are undertaken in industry number of staff trained in Hebei's industry sector water quality monitoring Water Quality Monitoring and Long-term water resource Hebei EPB Long-term strategy is being Management strengthened strategy developed and EPB implemented municipal staff trained in water quality monitoring Project Components I Inputs: (budget for each Project reports: (from Components to Sub-components: component) Outputs) Achievement of planned activities Wastewater management Percentage of sewage collected Project Progress Reports, Wastewater companies are and treated. supervision missions, data of established and sustained Percentage nutrient removal companies and HiEPB Water Supply management Supplies increased to meet Tariffs timely and adequately demand; water quality adjusted to maintain financial improved viability Industrial Pollution Control Reduction in pollution load Progress reports, data from Action Plan from key industries industries, EPB monitoring reports Technical Assistance for tariff Improvements in accounting Government's commitment to reform, utilities, and EPB and MIS, numbers of TA fund utilization management and staff trained -26 -  Annex 2: Project Description CHINA: HEBEI URBAN ENVIRONMENT PROJECT 1. Hebei Province is located in the north east of China, covering an area of 188,000 kmi, and has a population of approximately 66 million. The province is bound by Shanxi Province to the west, Inner Mongolia to the north, Henan and Shandong Provinces to the south, Tianjin and the Bohai Sea to the east and Liaoning Province to the north east. Hebei effectively surrounds the administrative areas of Beijing and Tianjin, and they are therefore economically and socially interdependent. The province has a semi-arid continental climate, characterized by low annual rainfall, cold winters and warm summers. 2. Hebei lies within the basin of the Hai River and is severely deficient in water resources. The rivers, reservoirs and groundwater resources have difficulty in meeting growing demands from agriculture and for domestic and industrial consumption. Groundwater levels are falling as demands exceed sustainable replenishment rates, and water frequently has to be extracted from polluted rivers or piped from distant sources. Failure to improve the efficiency of water use will require more costly water transmission from even more distant sources. Economic and industrial growth in Hebei has resulted in degradation of the limited water resources. The generally low assimilative capacity of watercourses in Hebei, coupled with inadequate wastewater treatment, has resulted in a severe decline in surface water quality. By Component: Project Component 1 - US$109.30 million Shijiazhuang Wastewater 3. Existing Situation. Shijiazhuang is both the provincial capital and the largest city in the province, and is one of China's most water resource-deficient cities. The two principal watercourses in the urban area of Shijiazhuang are the Futuo and Xiao rivers. 4. The Xiao river flows eastwards to meet the Fuyang river downstream of Handan and receives discharges of municipal and industrial wastewater from the cities and counties through which it flows. The most significant discharges are those from Shijiazhuang, amounting to approximately 900,000 mn/day. Part of the wastewater from Shijiazhuang is treated to secondary standard but the majority receives no treatment. The Xiao river has become a de facto wastewater discharge channel, and the water quality is considerably worse than even the least stringent Class V standard. At present, only 160,000 cubic meters per day (m /day) or 16 percent of the wastewater produced in Shijiazhuang, is treated in the existing Xiao treatment works. 5. There are four drainage systems serving the urban area, the West Bridge sewerage system, East Bridge sewerage system, Changan sewerage system, and the North drainage system of Shijin channel, none of which is a completely separate system. The total length of open channels amounts to 37.4 km, and flood-proof dikes amount to 32 km. There are 20 sewage pump stations. - 27 -  6. Proposed Wastewater Subcomponent (Y976.8 million; $109.3 million). The proposed subcomponent will comprise the following works: * Sewer interceptors with a total length of 27.9 km, connecting to the proposed wastewater treatment plant at the southwestern edge of the city; * Conventional activated sludge sewage treatment plant with a capacity of 500,000 m'/day, including sludge digesters and energy recovery; and * Secondary sewer program, including link sewers, with a total length of 12.3 km. Project Component 2 - US$43.50 million Tangshan Water Supply 7. Existing Situation. The major water resource for Tangshan is the Douhe Reservoir on the Douhe river about 22 km from the city. The reservoir is filled mainly by water transfers from the Panjiakou and Daheiting multi-purpose reservoirs. Water quality in the reservoir is good, generally meeting Class II water quality standard, but is showing signs of eutrophication. 8. The current water supply system consists of the Bejaio Water Treatment Plant with a capacity of 220,000 m'/day, fed from the Douhe Reservoir, 180,000 m3/day of groundwater and surface from six different plants in the city, and a distribution network of 516 km. 9. Proposed Water Supply Subcomponent (Y390.2 million, $43.5 million). The proposed subcomponent will comprise the following works: * Raw water intake pumping station, with capacity of 160,000 mnIday, at Douhe reservoir some 15 km north of the city - Raw water transmission main of pre-stressed concrete with diameter DN 1400 mm and total length of 19 km; * Water treatment plant, with capacity of 150,000 m3/day; and * Distribution network strengthening with a total length of 9.5 km pipes, varying in diameter from DN 600-1200 mm. Project Component 3 - US$ 30.90 million Tangshan Wastewater 10. Existing Situation. The wastewater drainage of Tangshan central is divided into the East separate sewerage system that serves the East part of central Tangshan; and the West separate sewerage system that serves the western sections. The newly constructed secondary treatment plant with a capacity of 150,000 m`/day (East Suburb WWTP) serves the East collection system. Also, the secondary treatment plant under construction with a capacity of 150,000 m'/day (North Suburb WWTP) will serve the East sewerage system. Both raw wastewater and treated - 28 -  wastewater in the East system are discharged into the Douhe River. The West Suburb WWTP with capacity of 36,000 mr/day is serving the West part of central Tangshan. Wastewater volume in the West drainage system is about 90,000 m3/day and is expected to reach 155,200 m`/day by the year 2005. The wastewater is all discharged into the Qinglonghe Stream, which is seasonal with no base flow. Only about one-third of the wastewater discharged to the stream is currently treated, and the water quality is 'therefore considerably worse than Class V. 11. Proposed Wastewater Subcomponent (Y262.1 million; $30.9 million). The proposed subcomponent will comprise the following works: * Sewer interceptors with diameters varying from DN 1000-1800 mm, and a total length of 6.1 km, connecting to the proposed wastewater treatment plant at the southeastern edge of the city; * Conventional activated sludge sewage treatment plant with a capacity of 120,000 m3/day, including sludge treatment and composting facilities; and * Secondary sewer program, including link sewers, with diameters varying from DN 300-800 mm, and a total length of 13.5 km. Project Component 4 - US$42.70 million Handan Water Supply 12. Existing Situation. Handan is the smallest of the three project cities, with an urban population of about 0.8 million. Supplies to Handan are from groundwater; the multi-purpose Yuecheng reservoir on the Zhang river at the Hebei/Henan border; the Dongwushi reservoir on the Fuyang river upstream of Handan; and from direct abstractions from the Fuyang, which flows through the Handan urban area. 13. Dongwushi reservoir is located up the Fuyang River with storage of 152 million m and is used as a water supply for Handan industry and irrigation. The average annual inflow of the reservoir is about 366 million m . Yuecheng reservoir is located at the midstream of the Zhang River, on the border of Hebei Province and Henan Province. It provides water to Handan city and Anyang city, and irrigates a crop area of 1.56 million Mu. The water quality of Yuecheng reservoir is quite good, meeting Class II standards. 14. The existing well fields are generally extracting groundwater and the supply capacity will be reduced once the new water supply facilities are in operation. There are three municipal water plants (No. 1, No. 2 and No. 4 water plants) pumping groundwater with a total capacity of 24,500 m3/day, and one plant intake for water from the Fuyang River (No. 3 water plant) with a capacity of 120,000 m 3/day. Recently, the No. 1 water plant was taken off-line. 15. Proposed Water Supply Subcomponent (Y380.9 million; $42.7 million). The proposed subcomponent will comprise the following works: - 29 -  * Raw water intake works, with a capacity of 120,000 m3/day, at Yuecheng reservoir some 60 km south of Handan city; * Gravity raw water transmission main of pre-stressed concrete pipe, with a diameter varying from DN 1200-1400 mm and a total length of 56.6 km; * Phase II of Tiexi water treatment plant, with a capacity of 100,000 m3/day; and * Strengthening of distribution network, with a total length of 50.8 km with pipe diameters varying from DN 300-1000 mm. Project Component 5 - US$39.00 million Handan Wastewater 16. Existing Situation. There are two separate drainage systems in the Handan urban areas. One is Tiedong drainage system, serving the area bordering the Jingguang railway, Remin road and Fuyang River, including industrial wastewater and sanitary sewage. The existing East WWTP, with a capacity of 100,000 m3/day with the triple-oxidation ditch process, serves this system (currently operating at two-thirds of capacity because of sludge treatment capacity limitations). The presently untreated wastewater from the west-north sewerage system discharges to the Shuyuan river, a tributary of the Fuyang. Water quality in all rivers and streams in the urban area is significantly worse than Class V, reflecting very limited dilution. 17. Proposed Water Supply Subcomponent (Y338.3 million; $39.0 million). The proposed subcomponent will comprise the following works: * Sewer interceptors with a diameter varying from DN 1000-1800 mm, and a total length of 8.1 km, connecting to the proposed wastewater treatment plant at the northwestern edge of the city; * Rehabilitation and expansion of the North Sewage Pumping Station, with a capacity of 60,000 m /day; * Oxidation ditch sewage treatment plant with a capacity of 100,000 m3/day, including sludge treatment facilities; * Secondary sewer program, including link sewers, with a diameter varying from DN 300-800 mm, and a total length of 30.2 kin; and * Expansion of sludge treatmnent capacity with 33,000 m3/day at existing East Wastewater Treatment Plant to optimize plant operational capacity. Project Component 6 - US$4.50 million Institutional Development, Strengthening and Training 18. The objective of the technical assistance is to give support and advice so that appropriate institutional, managerial, financial and operational arrangements are put in place to ensure operational effectiveness, efficiency of management and the financial sustainability of the water supply and wastewater companies in the project. - 30 -  19. Institutional/managerial component. This includes: (a) development of a company strategy, business plans and management information systems (MIS); (b) establishing service standards and monitoring performance targets under a more autonomous arrangement; and (c) company reorganization and development of human resources planning and training programs. 20. Financial strengthening. This includes: (a) operationalizing computerized accounting and financial reporting systems; (b) developing a financial MIS system; (c) reviewing and revising current billing practices to optimize collection efficiency; and (d) developing training programs. 21. Operation enhancement. This includes: (a) identification and implementation of cost savings initiatives; (b) preparation and implementation of sludge disposal plans; and (c) introduction of modem, cost effective, operations and maintenance equipment, including training. 22. Management and Geographic Information. This includes: (a) assess current methods and systems for collection and maintenance of spatial and non-spatial data; (b) develop action plans for implementation of improved information technologies such as MIS and GIS; (c) identify and implement linkages required at local, provincial and national level for data sour_ing; and (d) implement training programs to support the introduction and maintenance of the above information systems. Project Component 7 - US$0.70 million Industrial Pollution Control 23. The Hebei Provincial and Municipal Environmental Protection Bureaus have longer term programs lasting until 2010 to achieve the desired industrial pollution load reductions through a combination of: (a) industrial restructuring in favor of inherently less polluting industry; (b) adoption of cleaner production techniques in existing industry; (c) greater degrees of wastewater treatment by industry; (d) centralized wastewater treatment wherever appropriate; and (e) strengthened regulatory control including imposition of much large fines for non-compliance. The technical assistance program includes local and international expertise, limited pollution monitoring equipment and computer hardware and software. 24. The proposed Industrial Pollution Control Action Plan (IPCAP) consists of an overall time-bound action plan for each city outlining preliminary actions for: (a) quantitative analysis of pollution loads from industry based on compliance with national standards at present rates of wastewater discharge; (b) highlighting remaining non-complying discharges for inmmediate term control/closure; (c) set up of a pollution load database for each receiving watercourse; (d) developing future water quality objectives for all watercourses; (e) determining pollution load reductions required for all watercourses to meet 2005 and 2010 water quality objectives; (f) stating priority receiving watercourses requiring load reductions to meet desired water quality objectives; and (g) stating priority industry sectors and enterprises for control and load reduction requirements. - 31 -  25. The IPCAP prioritizes industrial sectors and enterprises that will implement enhanced pollution control in order to meet pollution load reduction requirements in order to achieve the water quality objectives for the target dates of 2005 and 2010. The priority list identifies: (a) industrial enterprise and sector; (b) location of discharge and receiving water; (c) pollution load in 2000 and target for 2005/2010; (d) pollution control approach - cleaner production; process change; wastewater treatment, etc.; (e) outlines costs, finding source (self finance; local bank; pollution fund) and implementation schedule. Component Description Location Capacity/size Function-] Shijiazhuang Wastewater Trunk Sewer Lines Extension of main trunk lines along Sewer lines at the following DN 2000, 2078 m To convey Second Ring Road and to WWTP. roads: DN 1800, 1743 m wastewater Network strengthening and expansion Zhonghuadajie Road, Nanxiao DN 1500, 6051 m generated in the in eastern part of the city. Road, DN 1200, 9869 m city to the Pingan Road DN 1000, 8202 m WWTPs Second Ring Road- East, and DN 800, 1692 m others. DN 700, 4061 m DN 600, 1385 m DN 500, 5124 m Wastewater Construction of a conventional At the south-eastem outskirts of 500,OOOm'/day, To treat the Treatment Plant activated sludge treatment plant with Shijiazhuang 8 pumps of 1250 Ils, wastewater from sludge digestion and energy recovery, fixed speed the eastem part of inlet pump station, grit removal tank, Shijiazhuang aeration basin, primary and secondary City sedimentation tank, sludge pumping station, blower house, digester, digester gas recovery. Tangshan Water Supply Intake Pump Construction of works and supply & Intake at Douhe Reservoir 3 pump of 975 Vs of To abstract Station installation of equipment at intake which 2 variable additional water pumping house speed from the Douhe Reservoir Raw Water Laying of 19km long pre-stressed From Douhe Reservoir to the DN 1400, 19000 m To convey water Transmission pipeline. new WTP along Xueyuan and from the Douhe Pipeline Yongqing Roads Reservoir to the WTP Water Treatment Construction of works and supply & New WTP located in the 150,000m'/day To augment the Plant installation of equipment for the WTP northwest of the central district water supply to incl. static mixer, mechanical of Tangshan City the Tangshan City flocculator, sedimentation tank, clean water tank, sludge thickening and de-watering, clean water pumping house, laboratory and accessories -32 -  Tangshan Wastewater Wastewater Construction of conventional No.2 WWTP, located in the 120,OOOm'/day, 4 To enhance the Treatment Plant activated sludge wastewater works southwest of the Tangshan City pumps of 600 l/s, existing WWTP incl. Coarse grid and intake pump, fixed speed capacity in the fine grid & grit-removal, primary & southem part of secondary sedimentation tanks, the city aeration basin & sludge return pump, blower house, sludge thickening tank, and sludge treatment. .. Sewer Network Extension of sewer network in the Laying of trunk sewers at DN 1800, 400 m To convey Tangshan City Nanxin Road & Xinhus Road. DN 1500, 180m wastewater DN 1200, 870m generated in the DN 1000, 4690 m Tangshan city to DN 800, 2230m DN the WWTP 600, 3280 m DN 500, 3860 m DN 400,530 m DN 300, 3600 m Handan Water Supply Inlet Works & Raw 56.6 km long pre-stressed concrete From Yuecheng Reservoir to DN 1200, 36.6 km To abstract and Water Conveyance raw water transmission main, incl. 8 the Tiexi WTP in the city. DN 1400, 20 km convey raw water Pipeline river crossings, 3 railway crossings & Capacity 110 ,000 from Yuecheng 2 highway crossings. Raw water m3/day reservoir to gravity intake works in the Yuecheng Handan Tiexi Reservoir. WTP Water Treatment Construction of works and supply & Located in the Tiexi District of 1 00,OOOm'Iday To augment water Plant installation of equipment at the Tiexi Handan City as the second supplies to WTP incl. Sedimentation tank, filter, phase of Tiexi WTP Handan City clear water tank, sludge conditioning tank, sludge thickening basin, sludge de-watering house, static mixer, clean water return chamber, planting, and control, laboratory & transportation Equipment Strengthening Laying of 54.3 km distribution main Pipe laying at the following DN 1000, 5608 m To strengthen the Distribution roads: Lianfang Road, DN 800, 1926 m water distribution Network Guanghua Road, and others DN 700, 4509 m network of DN 600, 8083 m Handan City. DN 500, 7241 m DN 400, 5420 m DN 300, 18024 m Handan Wastewater Trunk Sewer & Laying of main trunk lines & Trunks mains to the new DN 1800, 460 m To convey Secondary Drainage secondary trunk lines WWTP in Tiexi and Guoyuan DN 1350, 786 m wastewater Network Roads and network DN 1200, 6200 m generated in the strengthening in western and DN 1000, 608 m city to the existing eastem part of the city. DN 800, 1200 m and new treatment DN 600, 4400 m plants DN 500, 1040 m DN 400, 6600 m DN 300, 17000 m - 33 -  North Sewage Construction of civil works & supply North Sewage Pumping Station. 60,000 mr/day, 4 Rehabilitation Pumping Station & and installation of equipment at the pumps of 300 I/s Pumping Station Sludge Thickening North Pumping Station. at the Existing Expansion of the sludge treatment Maximizing WWTP capacity at the existing WWTP East WWTP 33,000m 3/day treatment plant _________________ ~~~~~~~~~~~~~~~~~~~~~capacity Wastewater Construction of works & supply and Northwestern edge of Handan. I 00,000m /day, 5 To treat Treatment Plant installation of equipment at WWTP pumps of 375 I/s waste-water of the incl. coarse grid & intake pumping westem and house, grit-removal tank, oxidation northern parts of ditch, sedimentation tank and sludge Handan City treatment facilities - 34 -  Annex 3: Estimated Project Costs CHINA: HEBEI URBAN ENVIRONMENT PROJECT . ., $ i Es , S ~~~kOct or Project Component 1: Shijiazhuang - Wastewater 48.40 39.90 88.30 Project Component 2: Tangshan - Water Supply 26.20 9.60 35.80 Project Component 3: Tangshan - Wastewater 17.80 6.00 23.80 Project Component 4: Handan - Water Supply 26.10 7.40 33.50 Project Component 5: Handan - Wastewater 19.80 11.70 31.50 Project Component 6 - Institutional Strengthening, Training and 2.70 5.00 7.70 Construction Supervision Project Component 7 - Environmental Protection and Pollution 0.40 0.30 0.70 Control Total Baseline Cost 141.40 79.90 221.30 Physical Contingencies 14.10 8.00 22.10 Price Contingencies 19.50 7.90 27.40 Total Project Costs 175.00 95.80 270.80 Interest during construction 21.00 21.00 Front-end fee 1.50 1.50 Total Financing Required 175.00 _ 118.30 293.30 Goods 37.30 43.10 80.40 Works 99.30 43.70 143.00 Services 1.60 4.00 5.60 Land Acquisition and Resettlement 17.70 0.00 17.70 Construction Supervision Services 1.80 5.00 6.80 Engineering and Management 17.30 0.00 17.30 Total Project Costs 175.00 95.80 270.80 Interest during construction 21.00 21.00 Front-end fee 1.50 1.50 Total Financing Required 175.00 118.30 293.30 - 35 -  Annex 4: Cost Benefit Analysis Summary CHINA: HEBEI URBAN ENVIRONMENT PROJECT A. Economic Analysis 1. Economy. Hebei Province has a population of approximately 66 million. There are 11 municipalities, each centered around a major city. The three project cities, Shijiazhuang, the capital, Handan and Tangshan, are the three largest urban centers in the province. Like in many other Chinese Provinces there is a growing migration of the population from the rural to the urban areas. The project cities have registered population increases between 12% (Handan) to 17% (Tangshan) in 1998. Areas around Beijing are being affected by overspill development and this particularly affects Tangshan municipality which is located to the east of Beijing. This migration is placing increased stress on urban utility services such as water supply and sewerage, and raising the importance of urban sewage treatment as an essential environmental protection measure. 2. The wealth of the Province varies significantly with the more sparsely populated northern municipalities generally being poorer than the rest of the provincial area. The Province as a whole is significantly poorer than its more wealthy neighbors, Beijing and Tianjin municipalities who have more than double the per capita Gross Domestic Product (GDP). The provincial GDP in 1997 was Y395.4 billion, a 39% increase from the 1995 GDP of Y285.0 billion. This growth trend continued in 1998, which registered a GDP increase of 12.5%. Per capita disposable income in 1998 was Y5,592 ($674). The province also registered an increase in income disparity. Survey data indicate that per capita disposable income of the highest 10% income family group was Y10,464, while the lowest 10% had a disposable income per capita of only Y2,385. GDP per capita in the province is about 25% above the national average (Y4,8 10). 3. Like many other provinces in China, Hebei Province has been undergoing remarkable growth and transformation since the early 1980s, reflecting trends in the economy at large. After two decades of stagnation, urban population and incomes have been increasing substantially. However, growing urban population and industrialization are causing widespread pollution, and environmental problems have become a central issue in the province. The benefits of the recent economic expansion have been accompanied by serious environmental degradation. Urban redevelopment, funded by increased wealth and industrialization, has increased water demand substantially, with many rivers and streams now only having seasonal flow as a result of increased surface and ground water abstraction. Almost all urban homes now possess an indoor water supply, and traditional night-soil collection has been replaced through the growth of sewerage systems with a consequent discharge of largely untreated domestic and industrial wastewater into water courses. 4. Environment. China is poor in water resources, relative to its population, and the Hai River Basin, in which the proposed project is located, suffers from acute water shortages. The per capita availability of water in the northern part of China is estimated to be just 750 cubic meters - a tenth of the world average. The seasonal pattern of rainfall in the Hai River Basin, where 70-80% of the rain falls in the summer months, means that extensive water storage and careful water management are required. Also, groundwater in the Hai River Basin is over-extracted, relative to replenishment, by more than 30%. This lack of water resources is compounded by the - 36 -  poor quality of much of the available surface water. The low level of water resources results in a greater polluting impact per cubic meter of wastewater discharged. In 1995, wastewater accounted for 11 per cent of surface water runoff in the Hai River Basin. 5. Hebei Province lies within the Hai River Basin which is one of three large river basins identified by the Chinese Government for urgent environmental improvement (the others are the Huai and Liao river basins). The Province is severely short of water with the rivers, reservoirs and ground water resources having difficulty in meeting the demand from irrigation and for domestic and industrial consumption. 6. The natural droughts occurring during the winter season have been exacerbated by pollution of surface water sources and overuse of ground-water resources. Some of the water resources have become increasingly polluted over the last twenty years and in many places ground-water levels are falling yearly as consumption regularly exceeds replenishment amounts. In the whole Hair river basin, over 50% of the length of water courses do not comply with the Class V national standard, and are therefore unsuitable for use as a raw drinking water supply. Many river reaches are so polluted that the water is unsuitable even for agricultural uses. 7. Water has often to be extracted from polluted rivers, rain-fed reservoirs, or piped from distant water sources. The usable water resources are now estimated at 260-400 cubic meters per year per person, which rank the 25th of all 28 provinces and regions in the country. Unless water is better managed, in the near future, some cities will have to rely on costly water transmission from the Yellow River and, perhaps in the long-term, from the South-to-North water transfer project. 8. Added to the problems of an adequate safe water supply are the impacts downstream of the pollution discharged from the Hai River and adjacent river basins to the Bohai Sea. These discharges, both of high-levels of nutrients and toxic compounds from anthropogenic activities within the upstream river basins, are leading to dramatic and potentially irreversible effects on aquatic life. 9. The Hebei Provincial Government (HPG) has outlined an ambitious environment protection plan for the province up to the year 2010, to be implemented in three phases. Investments in fixed assets for municipal infrastructure amounted to Y5.6 billion in 1998 with a jurnp of 80% over the previous year. These plans are consistent with national envirom-nental plans including the Trans-century Green Plan and the Hai River Pollution Control and Prevention Plan, both of which have been approved by the State Council. The objectives for the year 2000 are that the drinking water sources should meet national standards. Wastewater treatment coverage in urban areas should reach 35%, and 75% of industrial wastewater discharges should meet standards. By the year 2010 the water quality of all rivers, lakes and reservoirs should meet the standard and 75% of all sewage from urban areas should be treated. 10. Shijiazhuang City. Situated 250 kilometers South of Beijing, Shijiazhuang is the capital of Hebei Province. Shijiazhuang is an important industrial base in North China, being one of the centers of textile, chemical, pharmaceutical and electronic industry. It is also an institutional and educational center of Hebei Province and benefits from good communications (railway stations, express roads, modern airport) with many other large cities in the country. With all these facilities, Shijiazhuang plays a key role in the economic development of the Province. It is also the largest - 37 -  city, with a total population of 8.57 million in its administrative area and an urban population of approximately 1.5 million. The per capita disposable income in 1998 was Y5,592 and registered an increase of 8.3% over the previous year. 11. Handan City. Handan is located in the extreme South of the Hebei Province. The main river flowing through Handan is the Fuyang river. With its 180 km length in the urban area, the Fuyang River is an important water resource for the city of Handan. An ancient city with more than 2,500 years history, Handan is nowadays an industrial city with a significant industrial output value which ranks it the third most important city in Hebei Province. The main industries developed in the city are metallurgy, textiles and construction materials. The south-western part of the urban area is a heavy industrial zone with the headquarters of a major Steel Company which accounts for about half of the urban industrial water use and output value. The urban area has a population of about 730,000 inhabitants. The per capita disposable income in 1998 was Y4,914 and registered an increase of 3.2% over the previous year. 12. Tangshan City. Tangshan is located in the Eastern portion of the North China plain. The Tangshan Central Urban District was formed and developed on the basis of the mining industry (Kailuan Coal Mine). At present, it is an important base of energy resources and raw materials as well as an industrial city. It is also a granary for the East of Hebei and a base for farming and sideline products for North and Northeast China. The per capita disposable income in 1998 was Y5,748 and registered an increase of 7.5% over the previous year. In 1976, the city suffered a strong earthquake which destroyed the middle and southern part of the urban area. After twenty years rehabilitation and construction, a new city has been built, consisting of six district parts. The central district covers a population in 1998, of about 680,000. B. Project Benefits and Beneficiaries 13. The physical infrastructure components of the project include water supply rehabilitation and expansion in the two cities of Tangshan and Handan; and improvements in wastewater collection and disposal systems in the cities of Shijiazhuang, Tangshan and Handan. 14. The project will strengthen the reliability of water supplies to the three largest urban centers cities in Hebei and will mitigate the effects of over-abstraction from ground water sources. By treating wastewater, the project components will improve the quality of available surface water resources. 15. The investments in wastewater are mainly expansion of existing schemes, providing expansion of sewer network, in some cases to new catchment areas, and additional treatment of sewer discharged to the rivers. These investments are first steps towards long term clean up of the rivers. The project cities will be spending a considerable amount of their capital investment budget in these projects, which demonstrates their interest to improve the environment and meet national targets. - 38 -  16. A crucial benefit of the project is that it will promote institutional and financial reforms, as well as development and training, and financial and operational management capacity building of the utilities. These project components will not only contribute to the long term sustainability of the project but put in place permanent mechanisms for the local governments and utilities to improve water supply and wastewater services. 17. Handan City. Industrial and domestic water demand in the city of Handan is approximately 350,000 mr/day and is estimated to reach 469,000 m3/day by 2010. (It should be noted that water demand values used in the financial projections for all components, are more conservative that those used in the engineering design). 18. Water supply for Handan had initially been by groundwater abstraction, which is now in excess of the sustainable aquifer yield. Capacity of the water distribution system is insufficient as a result of lower water supply pressure in some of the customer's areas. The proposed water supply project has a design capacity of 100,000 m3/day and would mitigate the water supply for industry and domestic needs and progressively reduce water abstraction to a sustainable level in the city of Handan. One of the existing treatment plant, extracting water from the polluted Fuyang River, will be closed down when the plant proposed under the project starts operations. 19. There are currently two sewer systems in Handan and total effluent in the urban area are about 300,000 m/day. The Western sewer system is not well-developed and is in poor condition. Wastewater in this area is discharged directly into the Fuyang River without any treatment. The Eastern system is separated and equipped with a 100,000 m`/day WWTP, in operation since 1991. Presently, the WWTP is running under its nominal capacity because of inadequate sludge treatment. The treatment plant proposed under the project for a capacity of 100,000 m`/day. The project will also rehabilitate and expand the current system, so as to increase treatment capacity by an additional 135,000 m/day. Treatment ratio will increase from 25% to 55% at the end of the project. 20. Shijiazhuang is one of China's most water resource deficient cities. Water consumption in industry, daily life, and public utilities have been increasing along with urban development. As a result, discharges of industrial and domestic sewage have been increasing steadily. Total wastewater produced is around 900,000 m3/day. 21. The current treatment capacity is 130,000 m`/day (against a design capacity of 160,000 m' /day). The current treatment rate of the city is therefore only 16%. In most of the sewer catchments, the primary network is made of open channels operating as combined storm water and sewage systems without treatment utilities downstream or with insufficient capacity. Today, some 40 channels are used to discharge sewage without any treatment. Most of these channels are in the urban area and are detrimental to living standards. In the year 2020, sewage discharge will reach 1,100,000 m3/day. The target set in the Environmental Plan by the Shijiazhuang Municipal Government is that by the year 2010 secondary treatment should reach a rate of 70%. The project will add a treatment plant with a capacity of 500,000 mn/day. Treatment ratio in the city will increase to about 65% by the end of the project. 22. Tangshan. Water demand in the city of Tangshan is approximately 450,000 m3/day, estimated to reach 600,000 m3/day by 2010. Good water supply in Tangshan has been scarce, a - 39 -  phenomenon that is due to worsen because of the rapid growing urban population and industry, as well as continuously lowering of groundwater level. Furthermore, urban underground water abstraction is overexploited. 23. The proposed Tangshan water supply component, with design capacity of 150,000 m/day would mitigate water needs in the city and progressively reduce ground water abstraction to sustainable levels. 24. The city has two separate sewerage systems. In the eastern part of the city, a newly constructed plant for 150,000 m3/day is due to be supplemented soon by another plant with similar capacity. Sewage generated in the urban central and western areas (90,000 m/day) is discharged into the Qinglong stream, which is seasonal with no base flow. Only about one third of this flow is treated. Wastewater volume in this area is expected to reach 155,000 m3/day by 2005. 25. The proposed project component includes the construction of a new treatment plant with a design capacity of 120,000 n/day and improvements to the sewer network. It is expected that by the end of the project total wastewater treatment rate in the city of Tangshan would reach approximately 85%. 26. In summary, the project entails an increase in water supply capacity of some 250,000 n3 /day and sewage treatment capacity of approximately 720,000 m/day, improving levels of service to some 2.9 million people. Approximately 400,000 people will directly benefit from the completion of the Handan's wastewater and water supply components; 640,000 people will benefit from the completion of the Shijiazhuang wastewater component; and 570,000 people will benefit from the completion of the Tangshan wastewater and water supply components. C. Project Viability 27. Methodology. A calculation of the Economic Internal Rates of Returns (EIRR) has been undertaken for the water supply components. In the case of the wastewater components, benefits are difficult to quantify and the calculation of the EIRRs has not been attempted. Average incremental costs (AIC), in both economic and financial terms have been calculated and compared to the level of tariffs, in constant terms, to evaluate the subsidy element of the project components. Incremental costs and output are calculated from the difference between a "with project" scenario and the "without project" scenario. The economic capital costs for the components are determined by making adjustments to the component's financial capital costs. All taxes and duties were excluded from the calculation. Price contingencies, interest during construction and net working capital increases are also excluded. A Standard Conversion Factor of 1.0 is used in calculating economic capital costs. The financial viability of the project is discussed in detail at the end of this Annex. 28. The Average Incremental Economic Cost (AIEC) per cubic meter of water supplied or wastewater treated is calculated as the present value of the sum of capital and operational and maintenance costs (evaluated at economic prices) divided by the present value of the quantity of output. For each component, the AIEC was calculated on the basis of a 30-year economic life of the project. -40 -  29. Least-Cost Solutions. Although an attempt has been made to quantify the project benefits, the choice for priority interventions for the project has been guided by cost effectiveness considerations. A least cost analysis was undertaken for all the project components and least cost solutions were selected arnong the alternative technologies available, with the exclusion of the Handan wastewater for which a marginally more costly option was selected because of easiness of operation and maintenance of the facilities. The project also focuses on improving the efficiency of the existing systems, for example in the case of the wastewater components, by focusing on the construction of sewage lines and fully utilizing existing treatment plants. 30. Water components. As indicated in the background description, the major problems with water in the project cities is caused by over-extraction of groundwater, insufficient projected water quantities to meet growing demand, and in some cases, unreliable supply. 31. The water supply components will benefit customers by improving the quantity and reliability of water supplies, and quality of the water supplied. For the water supply components, the correct measure of output is water consumed (rather than water paid for, as in the financial analysis), as water customers benefit from the project whether or not they actually pay their water bills. 32. To assess the economic viability of the project for the water supply components, project benefits should be assessed in terms of customer's willingness to pay for project outputs (rather than in terms of the required tariffs). In China, especially in the case of domestic consumers, the current price paid for water is very low, to the point that a typical household in unaware of the amount it pays for water every month. In Shijiazhuang, for example, the water bill represents only 0.6% of household disposable income, while the electricity bill is 2.3%, telephone is 3.1% and gas 2.1%. All customers are currently connected to a centralized system or are supplied from groundwater wells, either private or public, and although reliability and quality of water is poor in some cases, urban residents have no alternative but to use water provided from these systems. Hence, with very low prices and in the absence of alternative markets for water, it is difficult to assess WTP for water unless sophisticated contingent valuation surveys are undertaken. It is widely recognized, however, that current price charged, which until recently has been heavily controlled and kept artificially low, does not represent consumer willingness to pay for the service and willingness to pay survey, where they have been attempted in China have all shown awareness of the importance of paying for water and willingness to accept higher prices. 33. In the absence of a specific WTP analysis for the project, we have looked at water prices currently being applied in urban cities and have approximated the WTP in the project cities with the average price charged in Dalian city, i.e. Y2.2/cum. Dalian is a city of 2.6 million inhabitants, with domestic consumption comparable to that of the two project cities, and where recent expansion in capacity has prompted significant increases in water prices in recent years. 34. The results of the above analysis shows that both water projects are economically viable, the EIRR for Tangshan is 14.4% and for Handan is 12.9. These values are close to the suggested approximation of the EOCC which is 10-12% (Handbook on Economic Analysis for Investment Operations). There are, however, other benefits of the water supply improvements, due to a reduction of over-extraction of groundwater, and cost savings which would accrue from closing down existing water treatment plant that are currently extracting water from the polluted branches - 41 -  of the Fuyiang river (in Handan). If these were to be fully captured EIRRs would be higher. 35. Wastewater Components. The background presented above indicate the seriousness of the situation in the three project cities. If no action would be taken to treat wastewater, environmental damages would continue. Pollution load would also increase in parallel with increased water consumption. Benefits from the wastewater schemes are mainly environmental and of a public nature, hence it is difficult to translate them into monetary values, especially because of the lack and difficulty of collecting local data. 36. The wastewater project components will increase the proportion of sewage treated in Handan, Shijiazhuang and Tangshan by 30%, 56% and 27%, respectively. The main benefit of the wastewater components will be an increase in the amount of sewage treated, and hence an improvement in ambient water quality in the receiving water bodies and in the future, quality of underground water. Improvements in water quality will also lead to an improvement in agricultural yields, since the receiving rivers' waters are used for irrigation. Finally, there will be improved drainage of sewage and storm water from the built-up area, which will improve aesthetics of the city and indirectly increase land values. 37. Sensitivity Analysis. An analysis was conducted for project items that have an impact on the project's economic viability and for which there is considerable uncertainty. Table 1 summarizes the results of the sensitivity analysis on the economic parameters. The EIRRs for the two water components are most sensitive to a reduction in the project benefits, while the AICs are most sensitive in variations in the capital costs. Table 1: ERR and AIEC Sensitivity Analysis Key Variable Change Water Supplv Wastewater Handan Tangshan Handan Shijiazhuang Tangshan ERR AIEC ERR AIEC AIEC AIEC AIEC Base Case 12.9 14.4 1.58 1.62 1.07 0.97 1 Capital Cost +10% 11.8 2.24 13.5 1.66 1.75 1.15 1.04 2 O&M Costs +10% 12.7 2.10 14.2 1.54 1.65 1.08 0.98 3 Benefits -10% 11.4 - 13.1 - - - - Combination 10.1 2.27 11.9 1.69 1.78 1.17 1.06 of (1+2+3)' a/Combination of (1+2) in the case of the wastewater project components. -42 -  D. Financial Analysis 38. Methodology. In order to determine the financial viability of the water supply project components in Handan and Tangshan, the financial rate of return (FRR) is calculated. The FRR is defined as the discount rate, or rate of return, which equalizes the present value (PV) of incremental project costs to the present value of incremental revenues. The Project component is considered to be financially viable if the FRR is equal to, or greater than, the actual cost of project funding which is referred to as the weighted average cost of capital (WACC). The three project cities employ a polluter-pay approach to the application of wastewater charges in that all wastewater generators pay the charge regardless of whether they are connected to the public sewer. Consequently, while the wastewater system expansions provided under the project will significantly increase the proportion of the population receiving service, the proportion of the population paying the charge will remain unchanged. As a result, increases in revenues will be limited to that resulting from tariff increases and population growth. For this reason, the concept of incremental revenues underlying FRR is not fully applicable and, therefore, FRR is not calculated for the wastewater project components. 39. An analysis of the cost effectiveness and subsidy requirements of both the water supply and wastewater project components has been undertaken. The average incremental financial cost (AIFC), which is an approximation of the long run marginal cost, is calculated. The AIFC is defined as the present value of capital and operation costs at financial prices divided by the present value of the quantity of wastewater treated and paid for in each year over the life of the system. The present value is calculated by discounting all cash flows at the WACC. In order to identify those factors posing the greatest risk to the financial viability of the Project, an analysis of the sensitivity of FRR and AIFC to adverse changes in selected key variables is also undertaken. 40. Major Assumptions. The FRR and AIFC are calculated over the economic life of each project component, which is assumed to be the 30 year period from 2000 to 2029. The FIRR is calculated on a pre-tax basis. All revenues and costs are expressed on an incremental basis in constant 2000 prices. Capital costs are baseline costs plus physical contingencies. In addition, an allowance for the replacement of mechanical and electrical components over the economic life of the project is made. Incremental revenues over the 2000 - 2014 are projected on the basis of the average tariff requirements determined for each project company. Beyond 2014, user fees are assumed to remain at 2014 levels. The WACC is calculated separately for each project component and varies between 6.7 percent (Shijiazhuang wastewater) and 7.0 percent (Handan wastewater) depending on the financial structure of each component. 41. The FIRRs for the Handan and Tangshan water supply components are 8.8 percent and 9.8 percent respectively, both above the WACC. Therefore, the water supply project components are considered to be financially viable. 42. The AIFCs for the Handan and Tangshan water supply components are Yl.66/mn and Yl.34/mi compared to average 2014 tariff levels YO.93/m3 and YO.95/m3, respectively. The difference between the ArFC and the average tariff represents a financial subsidy. Most of this subsidy is provided in the form of the equity contributions by each municipality toward the capital cost of the project. The AIFCs for the three wastewater components also exceed the average -43 -  tariff in 2014. However, while the AIFC is calculated on the basis of the volume of wastewater treated, the average tariff is based on the total volume of wastewater generated. Since all piped and self-supplied water consumers pay the wastewater tariff, regardless of whether they are actually discharging into the sewer system, the required tariff is lower than the AIFC. 43. Sensitivity Analysis. An analysis has been undertaken to test the sensitivity of FRR and AIFC to adverse changes in selected key variables. The variables tested were increases in capital costs, increases in operating and maintenance costs, reductions in revenues and a one year delay in project completion. The results of the analysis are presented in Table 2. In the case of the two water supply components, the sensitivity analysis indicates that the FRR is most sensitive to a reduction in incremental revenues. This highlights the importance that tariffs be increased in accordance with the required implementation schedule. In the case of the Handan and Tangshan wastewater components, the AIFC is most sensitive to a one year delay in project completion. The AIFC for the Shijiazhuang wastewater component is most sensitive to an increase in capital cost. Table 2: FRR and AIFC Sensitivity Analysis Key Variable Change Water Supply Wastewater Handan WS Tangshan WS Handan Shijiazhuang Tangshan FRR AIFC FRR AIFC AIFC AIFC AIFC Base Case 8.8 1.66 9.8 1.34 1.25 0.76 0.73 Capital Cost +10% 7.1 1.80 8.5 1.43 1.34 0.82 0.79 O&M Costs +10% 8.5 1.69 9.4 1.38 1.29 0.78 0.75 Revenues -10% 6.5 1.66 7.9 1.34 - - - One Year 8.2 1.66 9.4 1.37 1.36 0.78 0.80 Delay Combination 4.1 1.82 6.0 1.51 1.49 0.86 0.88 of (1+2+3+4)a/ al Combination of (1+2+4) in the case of the wastewater project components. Summary of Benefits and Costs: Main Assumptions: Sensitivity analysis / Switching values of critical items: -44 -  Annex 5: Financial Summary CHINA: HEBEI URBAN ENVIRONMENT PROJECT A. Municipal Finances 1. An analysis on the availability of counterpart funds was undertaken by reviewing revenues and expenditures in each project city, as well as trends in provincial finances. Table 1 presents a summary of this analysis. Detailed tables for revenues and expenditures are available in the project file. The data analyzed refer to what is called in the Chinese system on-budget and extra-budget funds. Off-budget funds were discussed but are not included in the evaluation, because of the difficulty of verifying the accuracy of the data. 'Normal' or on-budget and extra-budgetary funds, include revenues from statutory taxes and levies. Their allocations are subject to approval by higher levels of government. Off-budget funds are non-tax revenues such as net income remitted from municipally controlled enterprises, and some types of user charges collected by administrative departments. There is little control by higher levels of government on these revenues sources. In all the three municipalities some of the off-budget funds (about 10 percent of the total) are actually transferred to the on-budget revenues (usually included in the ' key project fund' category of revenues) and are generally allocated for the purpose of capital investment expansions. 2. The analysis of historical trends indicates large increases in revenues and expenditures in recent years in all the project cities, as well as in Hebei Province. This is an indication of recent economic growth and the relatively strong financial condition of the Province. Revenues and expenditures have increased in the project cities between 8 percent and 16 percent per year on average over the last 5 years. The amount of expenditures allocated to the capital expenditure budget is substantial (about 10 percent to 15 percent of total on-budget revenues) in all three cities. For the purpose of projections, a different rate of growth in municipal revenues (between 3 to 10 percent per year, in nominal terms) has been assumed depending on past trends of each municipality. 3. The analysis reveals that the project components are affordable in all cities. The project will be relatively more onerous in the case of Handan, though still well within the limits of affordability. Requirements for project counterpart funds (calculated as the difference between the financing required for the project in each year after taking into account the companies' capital contributions and the Bank's loan) over total revenues varies between 2.5 percent in Handan (3.5 percent in the peak year), 1.8 percent in Tangshan (3 percent in the peak year), and 1.1 percent in Shijiazhuang (1.9 percent in the peak year). When considering only revenues that can be earmarked for the purpose of capital expenditure (which is an approximation of the city financial capacity to contribute to the project), the project counterpart fund requirements varies between 13 percent on average in Handan (18 percent in the peak year, 2003), 7 percent in Tangshan (12 percent in the peak year, 2000), and 5 percent in Shijiazhuang (7 percent in the peak year, 2000). -45 -  Table 1: Municipal Finances (Y million, current tenns) 2000 2001 2002 2003 2004 2005 2006 Total Handan Municipal Revenue 1.364 1.483 1,609 1,746 1,933 2.126 2.338 10,260 Capital Investment Capacity 319 321 333 347 331 357 386 2,008 Project Contributions 47 40 51 62 48 10 - 258 Project as % of Revenues 3.4% 2.7% 3.2% 3.5% 2.5% 0.4% 0.0% 3% Project as % of Capital Budget 14.7% 12.6% 15.2% 17.8% 14.7% 2.7% 0.0% 13% Shijiazhuang Municipal Revenue 3,371 3.701 4,051 4,440 4,868 5,344 5.866 31,640 Capital Investment Capacity 907 970 1,039 1,113 1,194 1,281 1,374 7,877 Project Contributions 65 51 44 50 56 74 10 350 Project as % of Revenues 1.9% 1.4% 1.1% 1.1% 1.2% 1.4% 0.2% 1% Project as % of Capital Budget 7.2% 5.2% 4.2% 4.5% 4.7% 5.8% 0.8% 4% Tangshan Municipal Revenue 1,876 1,932 1,995 2,049 2,205 2,174 2,233 12,230 Capital Investment Capacity 465 479 493 508 523 539 555 3.008 Project Contributions 56 42 39 47 30 9 - 223 Project as % of Revenues 3.0% 2.2% 1.9% 2.3% 1.4% 0.4% 0.0% 2% Project as % of Capital Budget 12.1% 8.7% 7.9% 9.3% 5.7% 1.7% 0.0% 7% 4. The two project components in Handan will absorb a major portion of the city capital investments (close to one fourth of the projected investment budget that the city intends to use for capital infrastructure). This will limit Handan's flexibility to invest in additional urban infrastructure improvements over the next five years, while Tangshan and especially Shijiazhuang can afford other major capital investments (the project represents 14 percent and 6 percent respectively of the projected annual capital investment in these cities). This was to be expected considering that GDP per-capita in Handan is approximately half that of Tangshan and 70 percent of Shijiazhuang, hence ability to generate revenues is reduced in relative terms. The two project components are indeed the most important investments included in the city's urban investment plan. 5. To evaluate the sensitivity of the project to the risk of counterpart funds shortages, a worst case scenario for the project was also projected. In the case of Handan, which is potentially the most vulnerable city, it was assumed that: (i) there would be a reduction of projected total revenues to an annual nominal increase of 5 percent; (ii) some of the revenues that are eannarked for the city's capital investment budget would not be available; and (iii) both the water and wastewater companies will be unable to contribute to project investments. Under this scenario, the counterpart fund requirements climbs to an average of 22 percent of the capital investment capacity over the project period (34 percent in the peak year), but is still only 7 percent of total revenues in the peak year. Hence, even under the worst case scenario there is only a limited risk of a counterpart fund shortage during project implementation. - 46 -  B. Public Utility Financial Projections and Institutional Arrangements 6. Financial projections have been prepared for each of the companies on an annual basis over the 2000- 2014 period. These projections are based on the requirement of each company to comply with the agreed upon financial covenants regarding cost recovery, debt service coverage, and internally generated contributions toward capital investments. Details of the assumptions used for these projections are described at the end of this Annex. Summary financial projections for each company are given in Tables 9 - 13. Detailed financial projections are included in the project file. 7. Average tariff requirements have been estimated based on the findings of these projections and are shown in Table 2. Due to the lower levels of cost recovery presently achieved by the wastewater companies, required increases in wastewater tariffs are higher than that for water supply. Wastewater tariffs need to be increased between 90 percent and 135 percent to 2006, while required increases for the two water supply companies over this same period are in the 60 percent to 65 percent range. Table 2: Existing and Projected Tariffs (Y/m3, current terms)a/ Actual Planned Projected Jan 2000 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Handan WS Average Tariff 0.88 1.23 1.23 1.29 1.36 1.43 1.43 1.43 1.43 1.50 1.50 1.57 % Increase 40% 0% 5% 5% 5% 0% 0% 0% 5% 0% 5% Handan WW Average Tariff 0.37 0.37 0.45 0.54 0.65 0.77 0.87 0.87 0.87 0.87 0.87 0.87 % Increase 0% 20% 20% 20% 20% 12% 0% 0% 0% 0% 0% Shijiazhuang WW Average Tariff 0.30 0.38 0.42 0.50 0.60 0.66 0.71 0.71 0.71 0.71 0.71 0.71 % Increase 26% 10% 20% 20% 10% 7% 0% 0% 0% 0% 0% Tangshan WS Average Tariff 0.85 0.85 1.00 1.08 1.16 1.26 1.36 1.36 1.43 1.43 1.51 1.51 % Increase 0% 17% 8% 8% 8% 8% 0% 5% 0% 6% 0% Tangshan WW Average Tariff 0.28 0.42 0.53 0.61 0.67 0.74 0.85 0.85 0.88 0.88 0.93 0.92 % Increase 49% 26% 15% 10% 10% 15% 0% 4% 0% 5% 0% a/ Average tariff for all customer groups expressed on an accural basis. -47 -  WATER SUPPLY COMPANIES Handan Water Supply Company 8. Past Performance. Over the past five years, the financial performance of the Handan Water Supply Company (HWSC) has been adversely affected by declining water sales and deteriorating collection efficiency, both of which are at least in part due to the restructuring of local state owned enterprises. In 1997, the HWSC incurred a small net loss while it just covered its recurrent expenses, including depreciation, in 1998 and 1999. Between 1994 and 1998, water sales declined by 16 percent although they then increased by 9 percent in 1999. Collection efficiency is reported to have declined from almost 99 percent in early 1990s to 86 percent in 1998. In order to reverse this trend and return to more satisfactory collection efficiency levels, the company has reorganized its billing and collection systems and has introduced enterprise accounting. 9. Tariff Requirements. In December 1999, the average water tariff was increased from Y0.64/m3 to Y0.88/m'. The details of the existing tariff structure are shown in Table 3. The HWSC has applied for a further increase in the average tariff to Y1 .23/rnm and anticipates that this increase will be implemented by the end of 2000. Once this increase is implemented, and combined with improvements in collection efficiency, the requirement for further increases should be limited to that needed to recover normal inflationary increases in operating expenses to at least 2006. Table 3: Handan Water SUDDIV ComPanv - Existinv Tariffs (Ylm3) Customer Group Gross Local 6% VAT Net Tariff Surcharge Tariff Domestic 0.73 0.07 0.04 0.63 Industrial 1.25 0.11 0.06 1.07 Commercial 1.52 0.14 0.08 1.30 Institutional 1.15 0.10 0.06 0.98 Special Uses 7.38 0.67 0.38 6.33 Average Tariff 0.88 10. Projected Performance. Given the significant increase in depreciation resulting from the transfer of the new Tiexi No. 1 treatment plant to the HWSC, net income will be negative in 2000 in the absence of any increase in tariffs. This loss can be avoided if the planned tariff increase to Yl.23/mi is implemented no later than the middle of 2000. With the implementation of this increase, and with modest additional increases in subsequent years, the HWSC is projected to generate increasing net income levels to 2004. A portion of the cash generated by the company over this period will be contributed toward the cost of the HUEP. Over the 2000 - 2005 project implementation period, internally generated revenues are estimated to be able to fund 25 percent of the cost of the Handan water supply component. With the full operations of the project assets and debt service commencing in 2006, net income is projected to decline but remain well within acceptable levels. -48 -  11. Institutional Set-up. HWSC, under the supervision of the Urban Construction Bureau (UCB), has been an independent state-owned company since 1958. It is a traditional Chinese water supply company and does not have a Board of Directors or Supervision. HWSC manages water transmission from the Yuegheng reservoir, several ground water wells, water treatment plants and distribution network, and supplies water to consumers including a large number of bulk connections. It has about 875 employees. Registered assets were re-valued in 1998 and amounted to Y 82.3 million. 12. Reform Framework. HWSC did not manage the large implementation of recent construction investments, although it provided part of the counterpart funds from its own revenues. Under the project, it intends to have full responsibility for the proposed investment. The company reports practicing cost control measures and having substantially reduced operating costs in recent years, but it is not clear whether this was more a necessary reaction to the inability to obtain an increase of the water price (the tariffs were not increased in the last three years and are among the lowest in urban centers in Hebei) or an outcome of more efficient business practices. Management is generally keen to receive advice and training to further imnprove its efficiency and modernize. Tangshan Water Supply Company 13. Past Performance. The financial performance of the Tangshan Water Supply Company (TWSC) has been generally satisfactory in that it has generated operating surpluses in nine of the last 10 years. Tariffs have been increased six times in the last nine years and have been largely consistent with inflation. Collection efficiency is reported by the company to be over 95 percent although the recording of invoices when paid, rather than when billed, results in an overestimate of actual efficiency levels. In 1998, the company just recovered its recurrent expenses, including depreciation. With a 10 percent increase in the average tariff in June 1999, net income is estimated to have improved from about YO.6 million in 1998 to Y4.8 million in 1999. 14. Tariff Requirements. The existing tariff structure and levels are given in Table 4. Annual average increases of 8 percent, for a total increase of 60 percent, are estimated to be required over the 2001-2006 period bringing the average tariff to Y1 .36/m3. Beyond 2006, periodic increases will be required only to recover inflationary increases in recurrent expenses. -49 -  Table 4: Tangshan Water Supply Company - Existing Tariffs (Ym 3) Customer Group Gross Local 6% VAT Local Net Tariff Tariff Charge Taxes Domestic 0.70 0.03 0.04 0.01 0.63 Industrial 1.03 0.05 0.06 0.01 0.92 Commercial 1.65 0.05 0.09 0.01 1.50 Institutional 0.70 0.03 0.04 0.01 0.63 Raw Water for Steel Plant 0.97 0.05 0.05 0.01 0.86 Special Uses 3.50 0.05 0.20 0.02 3.23 Average Tariff 0.85 15. Projected Performance. Based on the implementation of the required tariffs, net income is projected to improve from about Y5 million in 2000 to Y31 million in 2004. Over the 2000 - 2005 HUEP implementation period, the company's internally generated revenues are estimated to be able to fund at least 25 percent of the cost of the Tangshan water supply component. With the full operation of the project assets and debt service commencing in 2005, net income is projected to decline by 50 percent, to Y16 million. Beyond 2005, annual net income is projected to range between Y8 million and Y12 million, sufficient to fully comply with the financial covenants. 16. Institutional Set-up. Tangshan Water Supply Company has been an independent state-owned company since 1951. TWSC works under the supervision of the Urban Construction Bureau, but as is the case for long established well run companies, it has sufficient managerial autonomy from Tangshan Municipal Government to make major managerial decisions. The company manages both water transmission, treatment and supply to consumers and has 1,240 staff. Assets had been revalued in 1994 and are included in the company financial statements. The company prepares annual business plans and has been practicing cost reduction and energy savings measures regularly. The company is not a Limited company, hence it does not have a Board of Director and Supervisors. It has, however, undertaken several reforms in line with local institutional reforms and plans to incorporate under the Company law in the future, as well as to merge with two other smaller treatment companies in Tangshan area (in Xinqu and Guye districts). 17. Reform Framework. Senior management is keen to run the company in an efficient, business-like manner. However, possibly the single most serious problem is that the company does not have control over the number of staff it must employ. The key issues identified during project preparation which TWSC needs to address are: overstaffing within the core water supply business; cross-subsidization of commercial business units and a need to review the justification for each of these within the overall business strategy of TWSC; and simplification of bill format and tariff structure. - 50 -  WASTEWATER COMPANIES Handan Wastewater Company 18. Past Performance. The Handan Wastewater Company (HWWC) was registered as a legal entity in March 1999. Prior to this, all sewerage and drainage operations were undertaken by the Municipal Engineering Management Division (MEMD) of the Urban Construction Bureau (UCB). As of January 2000, collections are being directly remitted to the company, rather than through the Handan Finance Bureau, as was previously the case. Under this revised arrangement, the wastewater charge is now included as a line item in the water bill. These changes are intended to address the problem of low collection efficiency, which in 1999 was only 60 percent. This problem, which is largely concentrated within the industrial customer group, is also being addressed through the disconnection of water supply service to delinquent customers and through legal processes. 19. Tariff Requirements. Existing tariffs, which became effective in January 2000, are shown in Table 5. With this most recent revision, the average tariff increased by 16 percent, from YO.32/m3 to Y0.37/m3. Over the period to 2005, additional tariff increases of 135 percent will be required, the largest tariff increase of the five project companies. This increase is based on the assumption that collection efficiency can be progressively increased to 95 percent by 2005. The preferred approach to implementing this increase is through regular annual tariff adjustments. The required average tariff of Y0.87/mn in 2005 can be achieved by implementing 20 percent increases every year from 2001 to 2004 and a 12 percent increase in 2005. Beyond 2005, the requirement for further tariff increases is expected to be very li mited provided that inflationary increases in the cost of operating and maintenance inputs remain at moderate levels. Table 5: Handan Water Supply Company - Existing Tariffs (YIm3) Customer Group Drainage Fee Treatnent Fee Net Tariff Domestic - 0.20 0.20 Industrial 0.10 0.30 0.40 Commercial 0.10 0.50 0.60 Institutional 0.10 0.30 0.40 Average Tariff 0.37 20. Projected Performance. Through the implementation of the required tariff increases, together with significantly improved collection efficiency, the HWWC is projected to generate progressively larger annual net income levels to 2004. The cash generated over this period is conservatively estimated to be sufficient to enable the company to contribute 10 percent of the capital cost of the Handan wastewater component of HUEP. With the full operation of the project assets commencing in 2005, increases in operating expenses, depreciation, and debt service will combine to reduce net income. However, the company will continue to be able to comply with the financial covenants and meet the costs of regular capital replacements from internally generated sources. - 51 -  21. Institutional set-up. Until recently, all sewerage and drainage operations were undertaken by the Municipal Engineering Management Division (MEMD) under the Handan Urban Construction Bureau. This Bureau was also in charge of road and bridge station and road light station. Wastewater treatment tariffs were first introduced in 1997 collected on behalf of MEMD by the Handan Water Supply Company and the Water Savings Office and transferred to the Hebei Finance Bureau (HFB). MEMD's fee collection office collected directly from industries that are not connected to the water supply network but discharge in the sewers. The revenues so collected were also transferred to the HFB. Collection efficiency was low and MEMD did not have a clear picture of how much money and when it would be allocated each year. 22. Reform Framework. The Handan Wastewater Company Ltd. was established and registered in March, 1999. This Company is wholly owned by HMG and reports to the Urban Construction Bureau and has absorbed the division of MEMD in charge of sewerage and storm water. The business scope of the company is to maintain and manage all urban drainage and wastewater treatment facilities in Handan urban area. The two divisions from MEMD which were in charge of roads remained within the MEMD. The company has just been formed, but it has appointed all senior managers and Board of Directors and Supervisors. Company assets, including both treatment plant and network, were revalued in March 1999 with total assets of Y65 million. The transfer of the assets to the company's financial account has been completed. Shijiazhuang Wastewater Company 23. Past Performance. The Shijiazhuang Wastewater Company was registered in 1997, but the wastewater system assets held by the Shijiazhuang Wastewater Drainage Division were not legally transferred to the SWWC until October 1999. Wastewater tariffs, which were introduced in 1996, are collected by the Shijiazhuang Water Supply Company (SWSC) and Water Savings Office (WSO) and, until December 1999, were transferred to the Municipal Finance Bureau (MFB). The SWWC then received allocations from the MFB to fund its operations. However, as of January 2000, the SWSC and WSO directly remit tariff collections to the SWWC. In 1999, collection efficiency was estimated to be only 67 percent with the most significant incidences of non-payment reported to be amongst industrial customers. Although direct remittance of collections by the SWSC and WSO will provide SWWC with greater control over its revenue stream, this alone is not expected to be sufficient to improve collection efficiency levels to more acceptable levels. Inprovements in the receivables management capacity of the SWWC, more active enforcement measures against delinquent accounts, and, possibly, increased commissions to the SWWC and WSO for the provision of billing and collection services will also be required. 24. Tariff Requirements. As of January 2000, increases of Y0.10/m3 in industrial and commercial tariffs were implemented, bringing the sewage treatment fees for these customer groups to YO.30/m3. Existing tariffs are shown in Table 6. By the end of 2000, a YO.10/mr increase in domestic and institutional tariffs will be implemented. A further Y0.10/mi increase in the industrial tariff, or increases in the tariffs applied to the other customer groups needed to - 52 -  generate equivalent revenues, will also be implemented. Over the period to 2006, additional tariff increases of almost 90 percent will be required, bringing the average tariff to YO.71/mn. Table 6: Shijiazhuang Wastewater Company - Existing Tariffs (Ylm 3)_ Customer Group Drainage Fee Treatment Fee Net Tariff Domestic - 0.20 0.20 Industrial 0.08 0.30 0.38 Commercial - 0.30 0.30 Institutional - 0.20 0.20 Average Tariff 0.30 25. Projected Performance. By implementing annual increases in tariffs beginning in 2000 together with improvements in collection efficiency, the SWWC will generate cash surpluses, a portion of which can be contributed toward the capital cost of HIUEP. Over the 2000 - 2006 project implementation period, internally generated revenues are estimated to be able to fund 15 percent of the cost of the Shijiazhuang component. With debt service and full operations of the project assets commencing in 2005 and 2006 respectively, net income is projected to decline but remain well within acceptable levels. 26. Institutional Set-up. Until 1998, the responsibility for the sewer and drainage networks in Shijiazhuang were under the responsibility of the Municipal Management Division, reporting to the Public Utility Administration Bureau. This division was also in charge of roads, street lighting and greening. The Qiaoxi wastewater treatment plant was managed by a separate division, directly under the Municipal Engineering and Public Utility Administration Bureau. In October 1998 the Wastewater Drainage Division (WDD) was established, to combine the Qiaoxi wastewater treatment plant and the drainage and sewer network, excluding responsibility for road maintenance. The total number of staff in the WDD was 867. A Wastewater Company Ltd. (SWWC) was also established in 1997, with original registered assets of Y100 million, following the new Company Law. This company is wholly owned by Shijiazhuang Municipal Government (SMG) and reports directly to the Shijiazhuang Urban Construction Commission (rather than to the Municipal Engineering). 27. Reform Framework. Although the SWWC was given the responsibility, on paper, for construction, operation and maintenance of the wastewater treatment plant, sewerage network and pumping station, initially it was given no operational responsibilities. This company was mainly conceived and organized as a project implementation unit to manage the construction of the proposed Bank project. However, it soon became evident that a much more concerted reform effort was required to face the challenge of efficiently managing the current and future assets and providing adequate wastewater services. Within this context several actions were taken by the municipal government and the company. SWWC has now appointed all senior management, a Board of Director and a Board of Supervisors. It has set up a bank account, started its own financial account, following the enterprise method of accounting, completed the legal transfer of the assets and included these in its books. The company has also hired a certified public accountant to strengthen its financial management. Assets for both wastewater treatment plant - 53 -  and network were revalued in January 1999 and reflected in the company's accounts. Total assets are Y422 million. Tangshan Wastewater Company 28. Past Performance. The Tangshan Wastewater Company (TWWC) was established in December 1997, the same year in which wastewater tariffs were introduced. Although the company has generated revenues sufficient to recover all recurrent expenses, including depreciation, net income has declined significantly from Y9.3 million in 1998 to an estimated YO.3 million in 1999. Collection efficiency is presently 85 percent, the highest of the three project wastewater companies. This is due in large part to the fact that collections have been combined with those of water supply since 1997 with direct remittance to the company rather than through the MFB. 29. Tariff Requirements. Existing tariffs are shown in Table 7. Unlike the two other project wastewater companies, the TWWC does not fund the recurrent costs of the drainage system through its tariffs. Instead, it provides maintenance functions on a contractual basis to the city and is paid directly by the city for these services. It is anticipated that an increase in the average tariff to at least YO.42/mn3 will be implemented by mid 2000. The need for this increase is being driven primarily by the transfer and commencement of operations of the first and second phases of the Dongjiao WWTP. Although the city is bearing the capital cost of this facility, increased operating, maintenance and depreciation expenses have created an immediate requirement for a significant increase in tariffs. Beyond this requirement, additional increases totaling 60 percent need to be phased in over the next five years bringing the average tariff to Y0.85/m3 by 2005. Beyond 2005, tariff increases should be limited to those needed to offset the impact of general inflation on operating and maintenance expenses. Table 7: Tangshan Wastewater Company - Existing Tariffs (Y/m 3) Customer Group Gross Tariff 6% VAT + Net Tariff Local Taxes Domestic 0.20 0.01 0.19 Industrial 0.40 0.02 0.37 Commercial 0.40 0.02 0.37 Institutional 0.20 0.01 0.19 Treated Effluent Supply 0.20 0.01 0.19 Average Tariff 0.28 30. Projected Performance. The implementation of an increase in the average tariff to at least YO.42/m3 no later than mid 2000 should be sufficient to avoid a net loss in this year. With the implementation of annual tariff increases between 2001 and 2005, net income is projected to increase from Y4 million in 2000 to Y19 million in 2004. The cash surpluses generated over this period are estimated to be sufficient to enable the TWWC to contribute at least 10 percent of the capital cost of the Tangshan wastewater component of HUEP. Like the other project companies, net income levels will then decline beginning in 2005 as the HUEP project assets enter service and debt service begins. However, the company is - 54 -  expected to continue to fully comply with the financial covenants over the entire forecast period. 31. Institutional Set-up. Until 1997, all sewage and drainage works in Tangshan were carried out by the Tangshan Sewage and Drainage Division, under the responsibility of the Municipal Engineering and Sanitary Management Division and reporting to the Tangshan Urban Construction Bureau (TUCB). A separate Tangshan Wastewater Company (TWWC) was established in December 1997, with a registered capital of Y72.5 million. In 1997 wastewater treatment charges were introduced. TWWC is wholly owned by Tangshan Municipal Government and reports to the TUCB. The company has responsibility for construction and management of urban wastewater treatment plants, sludge treatment and reuse of wastewater. It owns and operates three wastewater treatment plants (Xinqu, Xijiao and Dongjiao). The total number of staff is 520, with 54 high level professional. The Company has its own Board of Director and Board of Supervisors, consisting of seven persons each. Total assets value, including the cost for the sewage network, has been revalued and is Y215 million. 32. Reform Framework. The responsibility for the sewer and drainage network has now been transferred from district department to the company, which performs this task under an annual performance contract with the Tangshan Finance Bureau. TWWC also receives a budget contribution from TMG for the management and maintenance of the storn water sewers. C. Affordability Analysis 33. An affordability analysis has been undertaken in order to ensure that domestic customers, particularly those in the lower income group, can afford the new tariffs in conjunction with the project. Based on generally accepted affordability guidelines, the cost of water supply and sanitation should not exceed approximately 5 percent of household income. Two representative household groups are considered in the affordability analysis: (i) the median household income group, and (ii) the low income group which is defined as the average of the group earning the lowest 10 percent of income distribution. The results of this analysis are shown in Table 8 and indicate that the tariffs are anticipated to be affordable over the entire 2000-2010 period. - 55 -  Table 8: Affordability Analysis City Water & Wastewater Bill as a % of Household Income 2000 2002 2004 2006 2010 Handan Low hicome 3.0% 3.0% 3.1% 2.9% 2.4% Median Income 2.5% 2.4% 2.5% 2.3% 1.8% Shijiazhuang Low Income 2.6% 2.9% 3.4% 3.1% 2.4% Median Income 2.1% 2.4% 2.6% 2.5% 1.9% Tangshan Low Income 3.7% 4.2% 4.4% 4.2% 3.5% Median Income 3.0% 3.4% 3.5% 3.4% 2.8% D. Assumptions to Utility Financial Projections 34. Inflation and Exchange Rates. Annual domestic inflation rates used in the projections are 2 percent in 2000 and 5 percent thereafter. Foreign price increases are estimated at 1.6 percent in 2000, 2.5 percent in 2001, 2.6 percent in 2002 and 2.5 percent thereafter. The exchange rate used to convert foreign costs to local currency, where applicable, is Y8.311 per $1.00. It is assumed that exchange rate adjustments will maintain purchasing power parity over the forecast period. Income Statement 35. Operating Revenue. Operating revenue is calculated as the volume of water sold multiplied by the average tariff. In the case of the wastewater companies, water sales include metered water consumption, as recorded by the water supply companies, as well as consumption from self-supplied sources as recorded by the Water Savings Office. The volume of water sold is derived from projected water demand subject to any constraints imposed by the maximum productive capacity of each system. In the case of Tangshan and Shijiazhuang, water consumption per capita is projected to decline by 15 percent over the 15 year forecast period to reflect the impact of tariff increases and the introduction of more efficient industrial processes of system productive capacity. Water consumption per capita in Handan, which is presently only about half that in Tangshan and Shijiazhuang, is assumed to remain constant. Water tariffs are expressed on a weighted average basis in yuan per m3 of water supplied. Wastewater tariffs are expressed on a weighted average basis in yuan per m3 of wastewater. 36. Operating Expenses. The unit cost of personnel is assumed to increase at the general inflation rate plus 2 percent per year. The unit costs of electricity, materials, other supplies and administration are assumed to increase at the general inflation rate. Maintenance expense is set as a function of the original cost of gross fixed assets and is adjusted in each year to reflect the actual requirements of each company as well as inflationary increases in the cost of materials and services. Selling expenses, which represent the commission paid by the - 56 -  wastewater companies for billing and collection services provided by the water supply companies and water savings offices are based on current agreements that range between 1 percent and 3 percent of gross collections. 37. Other Expenses and Charges. Depreciation expense is calculated separately for each company on the basis of the estimated useful economic life of assets. Financial charges are interest expense attributable to the proceeds of the IBRD loan and any other debt less interest earned on the cash balances held by each company. Non-operating expense is the net of non-operating revenue and expense. The income tax rate is 33 percent. Sources and Applications of Funds Statement 38. Internal Cash. Net income plus depreciation and interest expense. 39. Long Term Borrowing. Includes the proceeds of the IBRD loan and any other debt taken by the company having a maturity of more than one year. The proceeds of the EBRD loan are assumed to be onlent by the Handan, Shijiazhuang and Tangshan Municipal Governments to HWSC, HWWC, SWWC, TWSC and TWWC at 7.35 percent a year for 15 years, including a grace period of five years. The companies bear the foreign exchange risk. 40. Equity Injection. Equity contributions by the municipalities to the companies, which consist almost entirely of the share of HUEP counterpart funding requirements met by the parent municipalities. 41. Fixed Asset Investment. Expenditures on fixed assets provided under HUEP as well as other capital works undertaken by the companies over the forecast period. 42. Working Capital Increase. The change in working capital over the year, which is defined as current assets, excluding cash, less current liabilities. 43. Interest and Debt Repayment. Interest includes interest during construction, commitment charges on the IBRD loan and operating interest expense less interest income earned on cash balances held by the companies. Debt repayment consists of the return of the principal amount of the proceeds of the IBRD loan plus any other debt assumed by the companies. 44. Other Applications. Other applications of funds include deferred income charged to non-operating income and contributions to the employee housing fund. - 57 -  Balance Sheet 45. Current Assets. Current assets include cash, accounts receivable from the water and wastewater tariffs less an allowance for doubtful accounts, receivables from other services, inventory and other miscellaneous current assets. Cash is the ending cash balance from the sources and applications of funds statements. Accounts receivable from water and wastewater tariffs, expressed in terms of the number of days worth of annual billings, are assumed to be as follows: (i) HWSC - 51 days reducing to 37 days; (ii) HWWC - 110 days reducing to 47 days; (iii) SWWC - 110 days reducing to 47 days; (iv) TWSC - 29 days; and, (v) TWWC - 51 days reducing to 30 days. Inventory, expressed in terms of the number of days worth of expenditures on materials and maintenance, is as follows: (i) HWSC - 73 days; (ii) HWWC - 102 days reducing to 55 days; (iii) SWWC - 55 days; (iv) TWSC - 90 days; and, (v) TWWC - 55 days. Other receivables, which relate to amounts owed to the company by affiliated units and receivables arising from other services, such as construction and maintenance works, are estimated on the basis of 1998 actual levels. 46. Net Fixed Assets and Work in Progress. Net fixed assets are gross fixed assets in service, valued at historic cost, less accumulated depreciation. Work in progress is fixed assets that are under construction and have not yet entered service. 47. Current Liabilities and Long Term Debt. Current liabilities include accounts payable, short term debt, the current portion of long term debt, and other miscellaneous liabilities. Long term debt is the non-current portion of debt having a maturity of more than one year. - 58 -  48. Equity. The sum of retained earnings and government contributions. Tables 9-13 Table 9: Handan Water Supply Company - Summary Financial Projections (Y million, current termms) Actual Estimate Projected 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Income Statements OperatmgRevenue 45.8 53.3 79.4 114.4 120.4 126.4 132.7 148.6 152.8 157.1 169.6 174.4 188.3 193.7 208.9 208.9 223.5 OperatingExpenses 43.1 43.5 51.8 55.3 58.3 62.1 65.5 75.1 80.7 85.9 92.4 99.4 107.0 115.3 123.3 131.5 140.4 Depreciation 8.5 8.1 27.3 27.8 28.2 30.2 30.8 54.9 56.0 57.2 58.6 60.1 61.7 63.5 65.5 67.7 70.1 OperatingIncome (5.7) 1.7 0.3 31.3 33.9 34.1 36.5 18.5 16.0 13.9 18.7 15.0 19.6 14.8 20.1 9.7 13.0 Fiancial Charges (0.3) 0.4 0.5 (0.5) (0.6) (0.7) (0.8) 6.2 12.1 10.3 8.6 6.9 5.1 3.4 1.6 (0.1) (1.7) Non-Operating Expenses (5.7) 0.5 0.6 0.6 0.6 0.7 0.7 0.7 0.8 0.8 0.8 0.9 0.9 1.0 1.0 1.1 1.1 IncomeTax 0.1 0.2 - 10.3 11.2 11.3 12.1 3.8 1.1 0.9 3.1 2.4 4.5 3.5 5.8 2.9 4.5 NetIncome 0.1 0.5 (0.7) 20.9 22.7 22.9 24.5 7.8 2.1 1.9 6.2 4.8 9.1 7.0 11.7 5.8 9.1 Sources & Applications of Funds Sources Intemal Cash 8.2 9.0 27.0 48.2 50.2 52.4 54.5 68.9 70.2 69.5 73.4 71.8 75.9 73.9 78.8 73.5 77.5 LongTemmBorrowing - - 2.8 8.8 41.1 80.2 67.5 11.3 - - - - - - - - - Equity Injection 16.3 - 260.2 8.8 18.4 57.5 29.1 4.3 - - - - - - Total 24.5 9.0 290.0 65.7 109.7 190.1 151.0 84.4 70.2 69.5 73.4 71.8 75.9 73.9 78.8 73.5 77.5 Applications Fixed Asset Investment 14.6 7.4 271.6 30.7 83.3 177.4 126.4 30.0 19.6 21.6 23.9 26.3 29.0 32.0 35.2 38.9 42.8 WorkingCapital Increase 5.1 (10.1) 22.5 6.7 8.2 (0.2) 0.4 1.7 0.3 (0.6) 0.8 0.4 0.9 0.4 1.1 0.4 1.3 Interest - 0.4 0.5 0.1 1.9 6.4 11.7 13.4 12.1 10.3 8.6 6.9 5.1 3.4 1.6 (0.1) (1.7) DebttRepayment - - - - - - - 21.2 21.2 21.2 21.2 21.2 21.2 21.2 21.2 21 2 21.2 Other 6.8 - 0 3 0.3 0.3 0.3 0.3 - - - - - - - - - - Total 26.5 (2.3) 295.0 37.9 93.8 184.0 138.8 66.3 53.1 52.6 54.4 54.7 56.1 57.0 59.2 60.4 63.6 Cash Changes (1.9) 11.3 (5.0) 27.9 15.9 6.2 12.3 18.1 17.1 16.9 19.0 17.1 19.8 17.0 19.7 13.1 13.9 EndingCash Balance 12.2 23.4 18.4 46.3 62.2 68.4 80.6 98.8 115.8 132.7 151.7 168.9 188.6 205.6 225.3 2384 252.3 Balance Sheets Assets CurrentAssets 48.9 67.6 61.2 92.3 109.6 115.8 128.7 147.8 165.6 182.4 202.6 220.6 241.8 259.8 281.0 295.0 310.7 Net Fixed Assets 141.9 146.1 379.5 361.1 339.5 345.4 324.8 696.4 660.0 624.4 589.7 555.9 523.2 491.6 461.3 432.5 405.2 Work in Progress 4.9 - 11.0 32.9 112.1 260.6 389.3 - - - - - - - - - - OtherAssets 0.8 0.8 5.8 10.8 15.8 20.8 25.8 25.8 25.8 25.8 25.8 25.8 25.8 25.8 25.8 25.8 25.8 Total 196.4 214.5 457.5 497.1 577.0 742.6 868.6 870.1 851.4 832.6 818.1 802.3 790.7 777.2 768.2 753.2 7-1.6 Liabilities and Equity CurrentLiabilities 24.7 42.6 18.7 15.2 8.3 8.6 29.7 29.0 29.5 29.9 30.3 30.8 31.4 31.9 32.4 32.8 12.1 LongTerm Debt 1.7 1.3 3.8 12.2 53.0 132.9 179.2 169.3 148.1 127.0 105.8 84.6 63.5 42.3 21.2 (0.0) (0.0) Equity 170.1 170.6 435.0 469.6 515.7 601.1 659.7 671.7 673.9 675.7 681.9 686.8 695.9 702.9 714.6 720.4 729.5 Total 196.4 214.5 457.5 497.1 577.0 742.6 868.6 870.1 851.4 832.6 818.1 802.3 790.7 777.2 768.2 753.2 741 6 Financial Covenants CostRecoverya, 0.9 1.0 1.0 1.4 1.4 1.4 1.4 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.1 1.0 1.1 SelfFinancingRatio 26% 19