Philippines - Second Local Government Unit (LGU) Urban Water and Sanitation Project (APL)

Document of The World Bank Report No: 21431-PH PROJECT APPRAISAL DOCUMENT ON A PROPOSED LOAN IN THE AMOUNT OF JPY3, 717, 900,000 (USS30 million equivalent) TO THE DEVELOPMENT BANK OF THE PFHLIPPINES (DBP) FOR A LGU URBAN WATER AND SANITATION PROJECT APL2 September 14, 2001 Urban Development Sector Unit East Asia and Pacific Region  CURRENCY EQUIVALENTS (Exchange Rate Effective) Currency Unit = Philippine Peso PhP I = US$0.02 US$1 = 51 FISCAL YEAR January I - to December 31 ABBREVIATIONS AND ACRONYMS ADB - Asian Development Bank AMO - Area Management Office (DBP) APL - Adaptable Program Loan BAP - Barangay Action Plan CAS - Country Assistance Strategy CAU - Contract Administration Unit COA - Commission on Audit DBL - Design-Build-Lease Contracts DBP - Development Bank of the Philippines DENR - Department of Envirornent and Natural Resources DILG - Department of Interior and Local Government DOF - Department of Finance DPWH - Department of Public Works and Highways EA - Environmental Assessment E[A - Environmental Impact Assessment EMP - Environmental Management Plan GFI- Government Financing Institution GOP - Government of Philippines IDA - International Development Agency IEE - Initial Environmental Examination IFC - Intemational Finance Corporation IP - Indigenous People IRA - Internal Revenue Allotmnent iPY - Japanese Yen LBP - Land Bank of the Philippines LGU - Local Government Unit LWUA - Local Water Utilities Admninistration MOA - Memorandum of Agreement MWSS - Metropolitan Waterworks and Sewerage System NEDA - National Economic Development Authority NDF - Nordic Development Fund NGO - Non-governmental Organizations OM - Operations Manual PHRD - Population and Human Resources Development PMU - Project Management Unit PMO - Project Management Office PSP - Private Sector Participation SB - Sangguniang Bayan (Municipal Council) SBMA - Subic Bay Metropolitan Authority SOE - Statement of Expenditures SA - Social Assessment TWC - Technical Working Committee WBI - World Bank Institute WBOM- World Bank Office in Manila WD - Water Districts WTC - Willingness to Connect Vice President: Jemal-ud-din Kassum Country Manager/Director: Robert V. Pulley Sector Manager/Director: Keshav Varma Task Team Leader/Task Manager: N.Vijay Jagannathan  PHILIPPINES LGU URBAN WATER AND SANITATION PROJECT APL2 CONTENTS A. Program Purpose and Project Development Objective Page 1. Program purpose and program phasing 3 2. Project development objective 4 3. Key performance indicators 5 B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project 5 2. Main sector issues and Government strategy 5 3. Sector issues to be addressed by the project and strategic choices 6 4. Program description and performance triggers for subsequent loans 7 C. Program and Project Description Summary 1. Project components 13 2. Key policy and institutional reforms supported by the project 14 3. Benefits and target population 15 4. Institutional and implementation arrangements 15 D. Project Rationale 1. Project alternatives considered and reasons for rejection 15 2. Major related projects financed by the Bank and other development agencies 16 3. Lessons learned and reflected in the project design 17 4. Indications of borrower comnmitment and ownership 20 5. Value added of Bank support in this project 20 E. Summary Project Analysis 1. Economic 20 2. Financial 21 3. Technical 2 1 4. Institutional 22 5. Environmental 23 6. Social 24 7. Safeguard Policies 27 F. Sustainability and Risks  1. Sustainability 27 2. Critical risks 28 3. Possible controversial aspects 29 G. Main Conditions 1. Effectiveness Condition 30 2. Other 30 H. Readiness for Implementation 30 I. Compliance with Bank Policies 30 Annexes Annex 1: Project Design Summary 32 Annex 2: Detailed Project Description 35 Annex 3: Estimated Project Costs 40 Annex 4: Cost Benefit Analysis Summary 41 Annex 5: Financial Summary 51 Annex 6: Procurement and Disbursement Arrangements 59 Annex 7: Project Processing Schedule 69 Annex 8: Documents in the Project File 70 Annex 9: Statement of Loans and Credits 71 Annex 10: Country at a Glance 73 Annex 11: Environmental and Social Safeguards Guidelines - Summary 75 MAP(S)  PHILIPPINES LGU Urban Water and Sanitation Project APL2 Project Appraisal Document East Asia and Pacific Region EASUR Date: August 24, 2001 Team Leader: Narasimham Vijay Jagannathan Country Director: Robert V. Pulley Sector Manager/Director: Keshav Varma Project ID: P069491 Sector(s): WU - Urban Water Supply Lending Instrument: Adaptable Program Loan (APL) Theme(s): Water Poverty Targeted Intervention: N Program Financing Data Estimated APL Indicative Financing Plan Implementation Period Borrower (Bank FY) IBRD Others Total Commitment Closing US$ m % US$ m US$ m Date Date APL 1 23.30 73.0 8.60 31.90 05/01/1999 09/30/2002 Development Bank of the Loan/ Philippines, with the Republic Credit of the Philippines as guarantor APL 2 30.00 85.1 5.26 35.26 11/30/2001 11/30/2006 Development Bank of the Loan/ Philippines, with the Republic Credit of the Philippines as guarantor APL 3 100.00 75.2 33.00 133.00 06/30/2004 06/30/2008 Development Bank of the Loan/ Philippines and Land Bank of Credit the Philippines, with the Republic of the Philippines as guarantor APL 4 130.00 56.5 100.00 230.00 07/01/2006 08/01/2010 Development Bank of the Loan/ Philippines and Land Bank of Credit the Philippines, with the Republic of the Philippines as guarantor Total 283.30 146.86 430.16 _ [X] Loan [ Credit [ ] Grant [I Guarantee [1 O ther: For Loans/Credits/Others: Amount (US$m): $30.00 equivalent Proposed Terms (IBRD): Fixed-Spread Loan (FSL) Front end fee on Bank loan: 1.00%  Financing Plan (US$m): Source Local Foreign Total BORROWER 0.00 0.00 0.00 IBRD 0.00 30.00 30.00 LOCAL GOVTS. (PROV., DISTRICT, CITY) OF BORROWING 5.26 0.00 5.26 COUNTRY Total: 5.26 30.00 35.26 Borrower: DEVELOPMENT BANK OF THE PHILIPPINES Responsible agency: DEVELOPMENT BANK OF THE PHILIPPINES Address: DBP Building, P.O.Box 1996, Makati Central Post Office 1200, Philippines, Contact Person: Marietto Enecio, Vice President DBP, Tel: DBP:(632) 818-9511, Fax: DBP: (632) 817-1639 Email: MAEnecio@epic.net, PDLazaro@devbankphil.com.ph Other Agency(ies): Department of Interior and Local Government: WSS-PMO Unit Address: Francisco Gold Condomninium, Edsa Cor. Mapagmahal Street, Quezon City Contact Person: Ellen Pascua Tel: (632) 925-0362 Fax: (632) 929-9406 Email: ElPascua@epic.net Estimated disbursements ( Bank FY/USSm): FY 2002 2003 2004 2005 2006 2007 Annual 1.50 5.00 6.50 7.00 7.00 3.00 CumulaUve 1.50 6.50 13.00 20.00 27.00 30.00 Project implementation period: Five Years Expected effectiveness date: 11/30/2001 Expected closing date: 11/30/2006 SAPLPADF R. P- M.. Z -2-  A. Program Purpose and Project Development Objective 1. Program purpose and program phasing: The Bank's assistance strategy for the Philippines is to strengthen infrastructure, facilitate private sector participation, and upgrade basic urban services in its towns. For water supply specifically, the Bank is assisting the Government in implementing policies that ensure access to safe and reliable water supply within a reasonable period of time for at least 90 per cent of the urban populations. Such an expansion in coverage (from 60 per cent at present) is possible only if substantial inflow of private financing supplements existing public and overseas donor financing support for the sector. The program, of which this project is the second loan, aims to assist LGU-managed and privately-managed water utilities operate on commercial principles, and thereby providing consumers with safe, reliable, sustainable water and sanitation services in about 250 secondary towns and cities. Once a sufficiently robust track record is built in the water sector, the prospects of attracting private financing will imnprove. If the program achieves its impact (stated as the Development Objectives indicators), it will contribute toward improving the living standards of the urban population, while simultaneously increasing private financing flows and private operational expertise into the sector. The development objective of the LGU Urban Water and Sanitation Program is to ensure that by year 2010, approximately a quarter of LGU-managed water utilities is able to provide residents with water and sanitation services on the basis of consumer demand, as enunciated in NEDA Board Resolutions Nos. 4 and 5 of 1994, and NEDA Board Resolution No. 6 of 1996. In order to achieve this objective the program is generating incentives for the private sector to participate in utility management, lower production costs and increase responsiveness to consumers. The development objective of this program will be achieved when through a series of four Bank-supported investments, the Government of the Philippines implements its forward-looking water and sanitation sector policies. In APLI the basic rules and administrative processes of project implementation are being tested and validated in approximately 20 municipalities. In APL2 the program is being scaled-up by widening the market for private operators of water supply systems. In APL3 the program continues the expansion of support to more LGUs, while simultaneously testing out new approaches aimed at leveraging private financing into Philippine water utilities. APL4 loan funds will support a national program aimed at facilitating substantial private financing into Philippine water utilities. Project implementation rules and processes are being validated with regard to: a) Clarifying the role of local government units (LGUs), other governmental agencies and private utilities in the provision of water supply services, and determining the types of assistance made available to them by national government agencies concemed; b) Providing guidance to the LGUs in the development and implementation of viable and sustainable water supply and sanitation projects, supporting the principles of managing water as an economic good, promoting a demand-oriented approach in the provision of services, utility management at the lowest appropriate level, greater private sector participation in service delivery, and c) Fulfilling institutional strengthening needs of LGUs that would develop their capacity to adequately perform financing, planning and project monitoring functions. -3-  2. Project development objective: (see Annex 1) The experience implementing APLI indicates that the design assumptions of the program are robust, and that prospects for private sector participation are good. This project is building upon the experiences gathered during the implementation of APLI, particularly with regard to project implementation processes and incentives to attract private sector participation through lease ("affermage") contracts. These implementation experiences have been evaluated and utilized to update the APL 1 Project Operational Manual. The project development objective of APL2 is to extend the outreach of the project to approximately 40 more LGU-managed water utilities. The project development objective is one of confirming in more LGUs that the project design concept in APLI (i.e. with appropriate technical andfinancial designs, pricing rules and institutional incentives, water supply systems, irrespective of size, can be made both viable and sustainable), is robust enough to be mainstreamed into the water supply sector of the Philippines. Annex I describes the project development objectives and key indicators. 3. Program Objectives APL1 and APL2 projects aim at attracting private sector management expertise in order to help LGUs operate water supply systems in a sustainable manner. Once the track record of cashflow generation from consumers is sufficiently robust, the program (through APL3 and beyond) is expected to induce private financing to the sector. The program objectives have therefore both a medium-tenn and a long-term aspect. In the medium-term (APL1 and APL2), the objective is to finance investments in water supply infrastructure, attract sufficient numbers of private sector operators to operate and maintain LGU-managed water supply systems efficiently, while being responsive to their customers. In the long term (APL3 and beyond), the objective is to generate a sufficiently large market for LGU-based water utilities, so that private financing institutions supplement the meager public financing available at present. The program objective will be accomplished if safe, reliable and sustainable water supply and sanitation services to at least 90 per cent of all urban residents in the Philippines is provided in participating towns by 2010, compared to the current estimate of 55 to 60 per cent. The four APLs proposed in this revised program are a part of a long-term program of sector assistance aimed at changing the structure and incentives of water utilities in the Philippines. The three elements in this program are to: a) Assist water utilities improve operational efficiency and accountability to consumers: This has formed the basis of the Operational Manual Procedures, which guide how services according to what consumers want and are willing to pay for can be provided. b) Facilitate private sector participation (PSP) in the sector: Most policy work in this area has been completed, and the only major remaining work is reorganizing the regulatory framework for water utilities. Currently technical assistance is being provided to the govenmnent through the Public-Private Infrastructure Assistance Facility (PPIAF), so that legislation for streamlining the economic regulation of water utilities is effected in the Philippine Congress. c) Leverage private financial flows into the water and sanitation sector: At present water sector financing is limited to what is available either from the public sector or through donor-assisted programs. With competing claims on limited budgetary resources, the government's ability to meet population growth requirements of water supply services is obviously constrained. Private financing could be attracted only when an adequate track record of sustained cash flow generation is established. For this to happen, tariffs - 4 -  need to be maintained at financially viable levels, and LGU admninistrations build a tradition of honoring their commitments to private operators and investors. The program expects to complete through APLs 1 and 2 about 60 PSP contracts (mainly lease arrangements) in participating LGUs. With this track record the transition to leveraging private financial flows in APL3 and APL4 is expected to take place. 3. Key performance indicators: (see Annex 1) These indicators have been developed and modified as a part of project implementation. Annex 1 describes the APL2 indicators of performance B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1) Document number: R99-55 [IFC/R99-46] Date of latest CAS discussion: 05/04/99 A significant element of the Country Assistance Strategy is the offer of World Bank assistance to the Government to support the decentralization initiatives, so that LGUs decide on infrastructural investments based on local priorities, full cost recovery and enhanced private sector participation. In the water sector Bank lending will continue to support the rationalization of management of urban water utilities, promote private sector participation, and help increase coverage of urban populations to safe and reliable water supply. The proposed project will advance these objectives in about forty additional water utilities. 2. Main sector issues and Government strategy: i. General issues affecting the sector: (a) Lack of adequate coverage: A substantial population in Metro Manila as well as in other urban areas of the town is without access to safe water and sanitation. In the 1000 small towns, in which municipal agencies are responsible for water supply and sanitation, approximately 40 per cent of the population do not have access to safe water and sanitation. These residents end up paying unit rates for water supply at ten to fifteen times higher than what residents with access to public sector services pay. The estimated financing requirements to meet existing deficits in services run into billions of dollars. (b) Unreliable services: Even among those with piped water, services are often restricted to less than one hour a day. Residents often have to privately invest in wells, arrange for contracts with water vendors and even purchase costly bottled water in order to mitigate the risks of unreliable supply. (c) Inefficient management of water utilities: The general standards of efficiency have been low throughout the country in LGU-managed water utilities. Tariff-setting is usually based on political considerations, rather than on the basis of operational efficiency. Further, as LGUs are unwilling to share water resources with neighboring towns and urban centers, formation of regional water utilities that could lower costs to consumers through economies of scale in service provision have been difficult to promote. ii. Specific issues to be addressed by the project: (d) Unsustainable service provisioning, especially in small towns: Water supply services have been unable to meet demand because past sectoral practice was one of undertaking investments based on generic designs, rather than responding to what consumers wanted and were willing to pay for. APL1 experience confirmns that the key to commercial viability and sustainability is to ensure consumer agreement of proposed services levels and tariffs. -5 -  (e) Low institutional and technical capacity in LGUs and LGU-managed water utilities: LGUs do not have the financial resources to subsidize inefficient water utilities, let alone the political will to manage them as commercial enterprises. iii. Government Strategy Since 1994 the Government of Philippines, with Bank support, has instituted a series of measures to develop a policy and financing framework aimed at (a) rationalizing the Philippine water sector, (b) promoting private sector participation, and (c) improving water and sanitation service delivery to low income communities in urban areas. The highest policy making body in the country, the NEDA Board, through its Resolution Nos. 4 and 5, series of 1994, laid out the national policies for extending sustainable service provisions throughout the country. A Water Management Cluster or Cabinet Cluster G was established with the mandate of implementing the policy recommendations. In June 1995 the National Water Crisis Act (RA 8041) was enacted, vesting the Executive with special powers in order to improve management of water resources in general, and addressing the specific water crisis faced by the Metro Manila area. In April 1996, the Joint Executive-Legislative Water Crisis Commission, set up under the National Water Crisis Act completed its recommendations to the President on strategies and approaches that could be adopted to rationalize and streamline the water sector in the Philippines. Further, NEDA Board Resolution No 6 in May 1996 devolved planning and implementation of water and sanitation services to LGUs, with the Department of Interior and Local Government (DILG) being made the national agency responsible for building capacity in LGUs. In order to facilitate private sector participation in the water sector the Bank provided technical assistance to the national government to develop a water sector PSP framework and a set of operational guidelines for accessing national government guarantees. Both these activities were concluded in 1999. The Government is currently preparing for another Water Summit to be convened at the end of 2001, with the objective of accelerating reforms In terms of follow-up actions, the Government successfully privatized MWSS in August 1997 by awarding two concession contracts for the Metro Manila area. Since then two additional models have been successfully tried out in the Philippines. Subic Water, a joint venture involving a private operator, the Subic Bay Metropolitan Authority (SBMA) and the Olangapo Water District became a regional water utility created to service the fast-growing export processing zone of Subic Bay and neighboring Olangapo City. Through the APLI project public-private partnerships involving lease contracts have been facilitated. The municipalities of Magdalena, Kitatao, Talisayan, Initao, Manolo Fortich, Kalilangan and Lantapan have signed lease agreements with local private sector operators. The municipalities of Luna, San Mateo, Mallig, Quezon, Aurora and Cabatuan are currently finalizing PSP arrangements to operate constructed systems. 3. Sector issues to be addressed by the project and strategic choices: The sectoral challenge is to build into the design and operation of urban water supply systems practices that reflect the forward-looking principles of the NEDA Board Resolutions summarized in Section 2 above. Chief among these are that water will be managed as an economic good, that the projects must be demand-oriented, and that systems should be managed at the lowest appropriate level. In the context of the small LGU-managed water utilities, which have been traditionally considered "non-viable" water supply systems, changing the practices required a period of "doing and learning" before widespread acceptance of the concepts. So far over 300 LGUs have signaled their interest in participating in the program, despite its stringent conditionalities with regard to pricing of services, cost recovery and institutional re-organization. - 6 -  This project therefore continues the work of APL I of validating the policy concepts before the government launches a nation-wide sectoral program for expanding water supply and sanitation services based on the following three themes: a. From Principles to Practice: Technically Feasible Options and User Choice. The management of water as an economic good and demand-orientation require that consumers of water supply and sanitation services are given the opportunity to make informed choices among technically feasible options for service delivery. As technically feasible options for the delivery of service have significantly different capital and operating costs and provide somewhat different levels of service, the final choice has to be exercised by users. The key element in the procedure to select supply options, is the value which users attach to the improvement in service offered by the technical option. This information regarding user valuation is most accurately provided by the willingness of users to pay for the service. Consequently, project procedures have included not only the preparation of technically feasible options, but also user indications of the value (willingness to pay) that they attach to the feasible options. Selection of the preferred option was agreed between LGU administrations and the users, with mutually shared information about the expected costs and the expected user payments for service improvement. All subprojects require full cost recovery, with users from the household to the barangay and town council levels exercising choice, and paying for the services. A consultant team, funded under a Japan Government PHRD grant worked closely with LGU administrations to operationalize the above process in about 20 LGUs as a part of project preparation. b. From Principles to Practice: Lowest Appropriate Management Level. In determnining the lowest appropriate level for the management of water supply systems, the project design takes into account the fact that the cost of a technical option is strongly influenced by the management mode and the scope of the service area. Economies of scale often result in lower costs for services to larger service areas. In practice, therefore, it is useful to investigate examples in which the establishment of a regional service delivery organization would result in lower costs and lower user payments for the same service level, compared to single LGU management. c. From Principles to Practice: Identifying Feasible Financing Levels and Repayment Options. In the case of participating LGUs, the costs of agreed improvements are large relative to the initial revenue base of the LGU. Moreover, the expected benefits from the improvement for current and future users will be long lasting, if managed effectively. Financing the improvements from up-front revenues will not generally be possible for LGUs, as most have no experience in financial management beyond the range of current budgets. As a part of preparation, a long-range financial management model was developed and utilized to estimate LGU borrowing capacity. This estimate was discussed with each LGU during field visits, and has formed the basis of estimating the size of the IBRD loan. So far LGU borrowing capacity estimates have been limited to IRA income levels, but there is now confidence on the part of the borrower (DBP) of LGUs supplementing these with borrowings based on the anticipated cashflows from water supply investments. As far as sanitation is concerned the project provides financing to households to improve domestic sanitation facilities on the basis of full cost recovery. 4. Program description and performance triggers for subsequent loans: The program development objectives will be achieved with steady progress over a further period of nine years. The size and duration of the program has been changed since APL 1 was approved by the Board in December 1998, following a request from the borrower and the Government of Philippines. These changes to the original program have been confirmed at negotiations, and incorporated the lessons learned from implementing APL 1 (discussed in Section D below). - 7 -  Project I (APL I): Testing and operationalizing the demand-based framework, as supported by GOP stated policy, in approximately 20 LGUs. In the first APL water supply services are being extended at an investment cost of $28 million. Most towns have opted to outsource operations and maintenance of the constructed facilities through "affernage" (i.e. lease) contracts between the municipal governments and private sector operators. Sanitation investments by households are being organized through specific credit arrangements between DBP, the LGU, the operator, local credit institutions and the households. Project II (APL2): Validating the APLI experience by extending the design to approximately 40 more LGUs, incorporating the lessons learned in APLI, institutionalizing program oversight, monitoring and evaluation through the Technical Working Committee, and constituting a Contract Administration Unit (CAU) at the national level until appropriate water regulatory legislation is enacted. The extension of APL1 to another loan is discussed below. Proposed Project III (APL3): A new APL3 has been included as a 'transitory' APL because project implementation experience so far indicates that mitigating political risks is likely to take a longer period of time than what was anticipated at APLI project approval in 1998 (discussed in Section F - Sustainability and Risks). APL3 will include Land Bank of Philippines (LBP) in the program. It will consist of one part that will continue retailing loans from DBP and LBP to LGUs, while another part will fund wholesale/credit enhancing arrangements through private financing institutions. The allocation between the two parts will be developed on the basis of monitoring the program's experience with private sector participation in APLI and APL2. Proposed Project IV (APL4): APL3 of the original program approved by the Board has been relabeled APL4. This loan will finance water supply and sanitation services in approximately 130 Philippine water utilities, with IBRD financing being utilized by DBP and LBP to leverage private financing into the sector. The role of the two Banks will change from being retail lending institutions to being (i) wholesalers to private financing institutions, (ii) underwriters, facilitators of syndication, securitization and insurance for private providers of water supply and sanitation in secondary cities and towns of the Philippines. Justification for changes in Program and proposed modifications in triggers for subsequent loans: The Second LGU Urban Water and Sanitation Project (APL2; $30 million equivalent) is being presented to the Board, with significant modifications since the program was approved in December 1998. The triggers, as approved in December 1998 by the Board were: a) Fully operational project-funded water supply system improvements in 10 LGUs. This trigger requires 10 LGU water supply systems to be fully operational. The accomplishment of this trigger has been defined to mean that constructed water supply systems are (i) providing beneficiaries with water supply, and (ii) further, been handed over to LGUs by the contractors for start-up or commercial operations. The following is the current status: * 3 systems have been constructed and handed over to LGUs for commercial operations; * 4 systems in Isabela province have been constructed, but not handed over to the concemed LGUs by the contractor; * 2 systems in Isabela province still have not been completed, in the sense that a few minor works remain to be accomplished by the contractor; * I system in Sapang Dalaga was not started because of political force majeure problems. -8-  Therefore, this APL2 trigger has not been accomplished in six LGUs of Isabela province because of a contractual dispute with the contractor, and in one LGU, Sapang Dalaga for the reason mentioned above. The borrower requested the Bank team at negotiations for the Bank to waive this trigger in view of the underlying issues. b) Devolution of operation, management, and revenue collection responsibilities under long-term commercial arrangements in 12 LGUs This trigger is an indicator of private sector interest in the project concept, and is accomplished when the operator signs with LGUs to undertake specific responsibilities as specified in the lease contract. For the first set of nine subprojects lease and management contracts were developed by the borrower with assistance from the Bank. For succeeding batches, in order to expedite the procurement process, design-build-lease contracts were developed. Bidding was effectively completed for the engagement of 23 operators for both lease and design-build-lease contracts under APL1. Of these, 9 LGUs have received the Bank's No Objection Letters (NOLs) to the contract awards. Based on the information received from the borrower these 9 contracts have been entered into with the respective bidders. The remaining 14 LGUs (in the provinces of Isabela and Quirino) were not submitted by DBP to the Bank for NOLs because of DBP's decision to cancel the procurement process because in their opinion there were perceived irregularities. These included a bid for lease contracts in six Isabela towns for which construction progress has been summarized in the preceding paragraph. As an altemative strategy for the latter LGUs, DBP is finalizing, in consultation with 3 of the Isabela LGUs where water supply systems are physically completed, management contracts to operate the systems. The main reason why the 3 management contracts have still not been signed is because the contractor has not handed over any Isabela water supply systems to the LGUs for reasons explained in the preceding paragraph. In the remaining 3 Isabela LGUs where construction will be completed by the end of October, 2001, bids will be invited for similar management contracts. As mentioned above, based on the information received from the borrower, only 9 lease and design-build-lease contracts have been entered into with the respective bidders. The trigger is therefore partially accomplished. However, the objective of the trigger, which is to encourage private sector participation in management and operation of LGU water supply systems has been accomplished, with as many as 29 bidders prequalifying for APL2 subprojects that have been processed so far. As the objective of the trigger has been met, the Borrower requested the Bank team at negotiations to move forward with the APL2 project. APLI project's strength has been in its ability to change the way elected officials plan and implement basic service provisioning (on the demand side), and attract sustained interest from bidders for constructing and operating completed water supply systems (on the supply side). As mentioned in the earlier paragraph, successful bids were received in all 23 LGUs for which procurement actions were initiated. What the project had to "learn by doing" was to figure out how best to mitigate risks of political interference by local executives in procurement matters. The borrower, DBP chose to send a message to potential bidders by canceling loans in those LGUs that appeared unwilling to follow the Bank (or even Philippine Govemment) Procurement Guidelines. These actions are important in improving govemance at the subnational level: and had the desired effect in terms of confidence building with private sector bidders, as evidenced by the continued participation in bids for new batches of subprojects. However, this action drastically reduced APL 1 loan disbursements. -9-  In the revised APL2 program, the twin issues of (i) significantly higher than anticipated LGU and private sector interest in the project design and (ii) the poor disbursement rates in APLI, have been factored in the suggested revisions to the APL program design. The APL2 project is being presented to the Board at this stage of APLl project implementation because the program design has attracted a lot of interest among the mayors, and currently the number of applicants for program funding runs over 300. Project preparation activities are either under way or about to commence in about 100 LGUs, which is clearly more than what the revised APL2 loan can finance. The Philippine Government decided to approve a smaller loan than what was appraised in order to give the borrower, DBP a chance to improve disbursement rates before accessing larger loans in APLs 3 and 4. The new APL4 loan size was fixed at $130 million on the premise that if the triggers to move from APL3 to APL4 loan are accomplished (described in the table below), the demand for investments from the APL4 loan would increase substantially from private financing institutions. The revised program, which was negotiated from August 20 to 22, led to the following changes from the program approved by the Board in December 1998: Reduce APL2 loan size, so that DBP not only meets the pressing demand from LGUs for projects, but demonstrates its ability to streamline project financial management and speed up disbursements to justify further APLs. Introduce one more APL loan (i.e. a new APL3), which substitutes for the APL2 originally approved by the Board, with modifications to reflect the interest shown by private operators. Include Land Bank of Philippines participation in APL3, which will be a 'transitory' APL by changing of the borrower's role from a retailer to a wholesaler of IBRD loans. Assist DBP/LBP change their roles from retail Bankers to wholesale Bankers only in APL4, with APL3 being a transitory APL. Include new triggers reflecting concerns on governance and policy reforms. Include disbursement triggers for the sanitation component. The Table below presents the proposed triggers for the APL3 and APL4, compared to the original triggers approved in December 1998 by the Board for moving from APL2 to APL3. Explanations of why some triggers were dropped are in italics. - 10 -  Triggers Approved by Board in December Triggers proposed in revised APL2 Project 1998 Likely conditions to proceedfrom APL2 to Likely conditions to proceedfrom APL2 to APL3 APL3 a. Devolution of operation, management and a. Devolution of operation, management and revenue collection responsibilities under revenue collection responsibilities under long-term management contracts and leasing long-term commercial arrangements (i.e. arrangements in 40 LGUs management and leasing contracts) in a The reduction reflects a smaller loan size cumulative total (APLl and APL2) of 20 water (from $60 million to $30 million) utilities; b. Achieving a working ratio less than 0.50 in at b. Confirnation from project reports that least 80 LGU water utilities receiving financing sanitation loans were offered to users of all from APLs 1 and 2 participating LGUs; This trigger was dropped because it was c. All APLI-financed water supply systems included primarily to monitor efficiency of completed and fully operational; publicly managed water utilities. In APLI, d. In APL2, 10 water supply systems constructed private sector participation interest is much and fully operational, and at least $12 million of greater than what was anticipated in 1998 APL2 disbursed by APL3 Investment c. Achievement of at least 16 hours of water per Coordination Committee (ICC) presentation day to connected households in participating urban areas with completed systems through APLs 1 and 2 investments This trigger has been moved to APL4 because systems have to be functioning longer in order to demonstrate sustainability d. Average of 80% consumers satisfied with service performance in participating LGUs This trigger has been moved to APL4 because systems have to befunctioning longer in order to validate consumer satisfaction e. At least 60% of households in a barangay connected to the water supply system The 60% "willingness to connect" rule became institutionalized as a project rule. Trigger d above serves as an appropriate substitute Likely conditions to proceedfrom APL3 to Likely conditions to proceedfrom APL3 to APL4 APL4 a) Devolution of operation, management and Not applicable because the original program revenue collection responsibilities under ended with APL3 long-term commercial arrangements (i.e. management and leasing contracts) in a cumulative total (APLI, APL2 and APL3) of 70 water utilities; b) A cumulative total (in APLI, APL2 and APL3) of $4 million invested in sanitation component; -11-  c) All APL1 and APL2-financed water supply systems completed and fully operational; d) In APL3, 40 water supply systems constructed and fully operational, and at least S50 million of APL2 disbursed by APL3 Investment Coordination Committee (ICC) presentation; e) Surveys by independent consultants indicate that average of 70 per cent customers in water utilities financed under APLs 1 and 2 satisfied with service performance in subprojects financed by those loans; f) DBP/LBP utilize a part of aggregate APL3 loan amount to finance water utilities with primary collateral recourse through the utility's cash stream, rather than the LGU's Intemal Revenue Allocation; g) Water Regulatory Commission fully operational in terms of regulating water utilities in the Philippines. With these changes factored in, the new Third LGU Urban Water and Sanitation Project (APL3; indicative amount of $100 million) would be considered when there is: a) Devolution of operation, management and revenue collection responsibilities under long-term management contracts and leasing arrangements in a cumulative total (APL1 and APL2) of 20 water utilities; b) Sanitation loans offered to users of all participating LGUs; c) All APLI -financed water supply systems completed and fully operational, and d) 10 water supply systems in APL2 constructed and fully operational, and at least $12 million of APL2 disbursed by Investment Coordination Committee (ICC) of the Philippine Govemment presentation of APL 3. The Fourth LGU Urban Water and Sanitation Project (APL 4; indicative amount of $130 million) would be considered when there is: a) Devolution of operation, management and revenue collection responsibilities under long-term management contracts and leasing arrangements in a cumulative total of 70 water utilities (i.e. in APL1, APL2 and APL3); b) A cumulative total (in APL 1, APL2 and APL3) of $4 million invested in the sanitation component; c) All APLI and APL2 financed water supply systems completed and fully operational; d) In APL3 40 water supply systems constructed and fully operational and $50 million of APL3 disbursed by Board presentation of APL4; e) Surveys by independent consultants indicate that average of 70 per cent customers in water utilities financed under APLs 1 and 2 satisfied with service performance in subprojects financed in APLI and APL2; f) DBP/LBP utilize a part of the aggregate APL3 loan amount to finance water utilities with primary collateral recourse through the utility's cash stream, rather than the LGU's Internal Revenue Allocation; and - 12-  g) Water Regulatory Commission fully operational in terms of regulating water utilities in the Philippines. C. Program and Project Description Summary 1. Project components (see Annex 2 for a detailed description and Annex 3 for a detailed cost breakdown): Water Supplv: The major component of the project is to finance civil works and equipment (i) in water supply infrastructure in participating municipalities, and (ii) in water utilities where private operators were selected under procedures acceptable to the Bank. For the former, preliminary feasibility studies and financial affordability analysis were concluded for a total of about 40 municipalities between March 2000 and March 2001. The findings were then discussed with mayors, members of town councils and communities in order to select a technical option that matched the LGU and community willingness to pay. 14 of the LGUs have approved preliminary designs and bidding documents. These contracts are currently being bid out. These municipalities, representing the Phase I of the project, will be ready for construction through design-build-lease contracts immediately after Board approval (i.e. in September 2001). The sanitation and drainage components (derived after consultations with households and through environmental assessments) will, as in APL1, continue to finance investments in household/communal toilets, on-site sanitation systems, and micro-drainage infrastructure respectively. For the latter, the expectation is that some of the private operators are likely to apply for financing from DBP for system expansion within their respective franchise areas. An additional 20 LGUs will be readied for project implementation by December 2002 and another forty by December 2003, with cofinancing from the Nordic Development Fund (Annex 2). The institutional components (for which cofinancing arrangements were made available by the NDF for a five-year period spanning APLI and APL2) supports technical assistance to facilitate the formation of regional and subregional water utilities, training LGU and utility staff to plan and manage the water utilities and local environmental concems in a sustainable manner. This component will also assist the Technical Working Committee monitor and evaluate program performance, in order to distill sector policy lessons, and develop APL3 and APL4 project designs. Sanitation: This component will finance physical imnprovements at the household level, including the collection, treatment and disposal of wastewater flows because of augmented water supply. Investments in sanitation will be based on full cost recovery on the basis of user demand. The first batch of towns has completed construction, and the borrower has been requested to engage commnunities in finalizing loan conduit mechanisms by loan effectiveness. As these loans will be taken by households and paid out of the water bill, the financing and admninistration of the sanitation component is being developed in consultation with the lease operators, utilizing the first nine constructed systems as the pilots to test out different approaches to answer the following questions: * On who will be the conduit for the Loan. The loans to households will be coursed through the water operator and local banks zusing DBP's standard criteria for credit applications. * On what should be the role of the PMU. The municipal engineer will certify the plans of loan applicants. * On what should be the ceiling for each household level loan. The LGUs with constructed systems will be used as the pilots to determine the ceilingfor household level loans. DBP is planning to initiate the program with loans in the range of 10,000 to 20,000 pesos per household connected to the water supply system. - 13-  * On what should be the repayment terms. The repayment terms should not exceed the lease expiry date, so that households had the maximum incentive to avail of the loan. * On enforcement mechanisms. The operator will recover the loan from the water bill of customers. Drainage: These investments will be financed on the basis of either demand from participating LGUs or identified by the environmental assessment process. Institutional Capacity Building: Financing available through the Nordic Development Fund and the Bank-financed LGU Finance and Development Project will be utilized to build LGU capacity in financial management and its capacity to manage and regulate the water utilities in a sustainable manner. The national government will continue to monitor the project through the Technical Working Committee, to (i) ensure that implementation is conducted in accordance with the Operational Manual, (ii) oversee translating APL program lessons to other sectoral projects, and (iii) finalize the composition of the Contract Administration Unit (CAU), which is responsible for handling contractual disputes between the lease operators and LGUs until appropriate national water regulatory legislation is enacted. The PMO in DBP will continue to be assisted by the Construction Supervision Consultant to supervise engineering supervision of subprojects. Indicative Bank- % of Component Sector Costs % of financing Bank- (US$M) Total (US$M) financing Water Supply Urban Water 19.84 56.3 17.85 59.5 supply Consultancy 1.65 4.7 1.65 5.5 Sanitation 1.67 4.7 1.50 5.0 Drainage 1.11 3.1 1.00 3.3 On-Lending to Private Operators 4.00 11.3 3.60 12.0 Land Acquisition 2.60 7.4 0.00 0.0 Total Project Costs 30.87 87.5 25.60 85.3 Interest during construction 4.10 11.6 4.10 13.7 Front-end fee 0.30 0.9 0.30 1.0 Total Financing Required 35.27 100.0 30.00 100.0 2. Key policy and institutional reforms supported by the project: APL2 is geographically scaling up the program to cover another 40 LGUs with financing. In addition, it will also assist the national governnent finalize the procedures by which regional water utilities are able to access water resources, and serve communities across LGU boundaries in situations where substantial economies of scale could be obtained. The expectation is that by completing procurement actions for the design-build-lease contracts in approximately 60 LGUs by June 2004, the program would have adequately validated the project design concepts. These actions will enable DBP and LBP prepare for key innovations in the water sector financing arrangements proposed in APL3 and APL4. - 14 -  3. Benefits and target population: An estimated 800,000 residents, (many with low income levels, and mostly in the relatively small municipalities) are expected to benefit from improved access to safe water and sanitation facilities fiom this project. The total beneficiaries from the program is estimated to be about 6 million persons. 4. Institutional and implementation arrangements: The loan will channeled through the Development Bank of the Philippines (DBP), a Government Financing Institution (GFI). Operational management of the project will be undertaken by Project Management Offices in DBP (DBP-PMO). The PMO is required to have a Financial Management Unit (FMU), and Procurement Unit. Area Management Offices and branches of DBP will be used as conduits and actively involved in loan administration and marketing. Disbursements shall initially be SOE-based but eventually PMR-based with Special Accounts set up in DBP. Actual investments (first three components of the project) will be implemented by Project Management Units (PMUs) established by the participating LGUs. Cofmancing of SDRs 5 million from the Nordic Development Fund continues to be available for the institutional capacity building component (of APL2 and APL3), and is being coursed through the DBP. The Water Supply and Sanitation Project Management Office in DILG, (WSS-PMO) will continue to exercise supervision over the project preparation phase, and for institutional capacity building. DBP will be required under the loan covenants to maintain certain liquidity, past due and capital ratios as well as submitting audit reports on the GFI and on the project to the Bank. The policy oversight role will be exercised by the Technical Working Committee comprising the Department of Interior and Local Government and DBP, with the Department of Finance, National Economic Development Agency being involved whenever policy issues arise. This Committee will continue to be responsible for overall coordination among the various components, with its working arrangements as defined in the Memorandum of Agreement approved at the time APLI was being processed, and confirmed at negotiations. D. Project Rationale 1. Project alternatives considered and reasons for rejection: Developing appropriate rules for loan financing for water supply projects: The Philippine water sector has traditionally classified water utilities as being either viable or non-viable. Public loan financing has been largely directed towards viable water systems serving large cities and towns, where the full economies of scale could be realized. Non-viable systems, as in many of the smaller municipalities, by contrast, have relied on sporadic grant financing (from bilateral donors or Congressional Development Fund grants with Congressmen and Congresswomen). The alternative project design could have continued with the 'business as usual' practice of financing investments in larger, proven viable water districts in the country. This altemative was rejected because the project team questioned the wisdom of distinguishing between viable and non-viable water utilities - viability ultimately depends on whether consumers are willing to accept a tariff rate that reflects the economic costs of a proposed improvement program. Once communities and LGU administrations accepted the idea that paying cost-recovery tariffs is the only way to assure the desired quality of services, all water supply systems not only become viable, but even attractive for private sector participation. The experience in APLI subprojects has validated this point, as exemplified by bids received from the private sector in 23 municipalities so far. The project design, therefore, will continue the APL I practice of assessing the budget envelope' of LGUs, presenting feasible options with corresponding tariff rates to users, and letting users decide whether or not they would like to avail of the opportunity for an improvement program under the project. The design will - 15 -  however, take specific measures to mitigate the problems experienced in the initial APL1 subprojects (such as, relatively high drop-out rates, suspicions of political interference, delays in procurement/disbursement processes etc.), which are discussed in section 3 below in the lessons learned section. Enlarging the role of the private sector: Private sector participation in Philippines water utilities has been limited to service contracts outside Metro Manila and the Subic Bay Region. Other options such as concessions, leases and joint ventures are not widely practiced because investors and operators perceive risks in dealing with the highly political LGU administrations. Investors and operators have been justifiably apprehensive of dealing with subnational governments that are driven by the compulsions of three-year election cycles. In order to enhance the PSP role in LGU-managed water utilities, APLI and APL2 projects attempt to develop a robust track record of successfully concluded deals between LGUs and PSP operators in the water sector. Once such contracting processes become commonplace in the Philippines, it would be possible to attract private financing to water utilities into secondary cities and towns. In APL3 pilot programs aimed at attracting private financing into the water sector will be financed, while APL4 will support programs in which water utilities successfully conclude deals with PSP operators that involve private financing. 2. Major related projects financed by the Bank and/or other development agencies (completed, ongoing and planned). Latest Supervision Sector Issue Project (PSR) Ratings (Bank-financed projects only) Implementation Development Bank-financed Progress (IP) Objective (DO) Manila sewerage and sanitation Manila Second Sewerage S S development Project (Effective March 1998) Sewerage, sanitation and water supply Water Districts Development S S development in secondary cities, and Project (Effective September introduction of public performance 1999) audit in metro Manila Water Supply and Sanitation LGU Urban Water and S S development in LGU-managed water Sanitation Project APLI utilities (Effective April 1999) Other development agencies Asian Development Bank Rural WSS Project I (DPWH/DILG/DOH) $18.50 million Rural WSS Project II (DPWH/DILG/DOH) $17.40 million Municipal Water Supply (LWUA) $43.20 million Small Towns WS Project (LWUA) $50.00 million Angat WS Optimization Project (MWSS) $130.00 million Manila South Water Distribution Project (MWSS) - 16 -  $31.40 million Umiray Angat Transbasin Project (MWSS) $92.00 million France Rizal WS Project (MWSS) $9.30 million Germany Provincial Towns WS Project I/II (LWUA) $16.90 million Japan/OECF Angat Water Optimization Project (MWSS) $83.15 million Provincial Cities WS Project III (LWUA) $48.91 million Provincial Cities WS Project IV (LWUA) $48.28 million Provincial Cities WS project V (LWUA) $56.91 million Ongoing Grant-funded projects (as of Advisory Services for Rural June 1999) WSS in Selected Regions/ GTZ LGUs DM 2.85 million Baguio WS Upgrading & AusAid Rehab Project (LWUA) A$7.00 million DANIDA Negros WSS Project (LWUA) DK 64.00 million P/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory) 3. Lessons learned and reflected in the project design: The inclusion of the three elements of the project mentioned above - assessment of feasible borrowing capacity of LGUs, preparation of feasible technical options and their costs; agreement between service organizations and users regarding user valuation and user payment for services --formed the basis of APL 1. To date construction work is close to completion in nine towns, bids have been received for lease contracts in all nine municipalities and design-build-lease contracts concluded in 6 more municipalities. Additionally, another hundred towns are at different stages of project preparation. In keeping with the project's "doing and learning approach" some key lessons have been learned, and already incorporated in the project design. This process will continue in APL2. An independent evaluation of APL I experience was conducted in June and July 2000. The lessons are summarized below under seven major headings as follows: (a) selection criteria, (b) estimation of LGU budget envelope, (c) system management options, (d) streamlining the process of concluding PSP transactions, (e) improving the management of project implementation, (f) resolving boundary problems in transferring water rights, and (f) maintaining a pipeline for potential PSP deals. (a) Selection Criteria: The initial list of LGUs identified for project participation was drawn on a "first come-first serve" basis, and an initial preliminary assessment of technical and financial viability. The argument was that the submission of application and the required financial and technical information by an LGU was a sufficient manifestation of its willingness to participate in the project, and therefore justified priority in funding. By using this criteria, the first batch of towns selected ended up being located in - 17 -  different parts of the archipelago. There were two consequences of this "first-come-first -serve" rule. First, drop-out rates were quite high (about 50 per cent in participating towns so far). Second, project preparation costs were relatively high because of travel and logistical costs. The selection criteria resulted in a highly dispersed set of towns selected in the first batch. This led to relatively higher project preparation costs, and operational difficulties in project supervision. Of the initial list of 21 towns, eight were located in Isabela province, four in Laguna province, four in Bicol province, all scattered in Luzon island and five in Mindanao island. In the final list of ten towns in Phase 1, six were located in Isabela province, while the remaining four were in Laguna, Bukidnon and Misamis Occidental provinces. The Isabela subprojects turned out to be naturally a regional cluster because the towns are within a few kilometers of each other, while the others are isolated systems catering to between 900 and 3000 connections each. Involving the provincial level had its advantages and disadvantages. On the positive side, the provincial LGU played a key mediatory role in bringing together the Mayors and Municipal Councils of the participating towns. The role of the latter often turned out to be critical in defusing inter-jurisdictional disputes and resolving political conflicts between the towns (it may be mentioned that each town signs a separate subloan with DBP). In addition, when six systems were offered under a lease contract, the combined number of connections was around 15,000, making the system potentially far more attractive to the private sector than each town by itself. On the negative side, involving one more layer of the political structure has exposed subprojects to problems of interference (discussed in Section 6 on Sustainability and Risks). From phase 2 of APL I onwards, and LGUs that had the potential of forming subregional clusters were given priority by the project, while minimizing the role of the provincial LGU. The only exception made so far is the inclusion of Iligan city (Population of 300,000 and the largest LGU-managed water utility in the country), so that before embarking on APL3 the program also tests the relevance of the design to large urban centers. In APL2 projects LGUs are required to confirn their intention to participate by paying an initiation fee of P50,000, apart from obtaining an endorsement of the Mayor and their respective Municipal Councils. The endorsement must explicitly indicate LGU agreement with the project rules of pursuing (full) cost recovery, considering private sector management of the water utility, and borrowing at the terms set by the DBP. To sum up, the lessons learned were several. A major factor for the relatively high drop-out rate was the community's unwillingness to accept the suggested tariff. This arose because the proposed tariff rates was unacceptable by Council members and beneficiaries (mostly because cheaper options, such as groundwater extraction was easily available). In addition, many Mayors and Municipal Councils deferred decision-making because project preparation involved no cost to them (as these were financed from grants). The third reason was because the LGU had other financing options (e.g. Congressional grants, unsolicited Build-Operate-Transfer or BOT proposals from the private sector), which offered, in their view, better terms than the project. (b) Estimation of budget envelope: The initial estimates of the budget envelope were undertaken using the long term financial planning model developed for this purpose. These initial estimates were extremely useful in limiting the size of investments to what was affordable to the LGU. (c) System management options: During project consultations in the first phase, LGU officials expressed a preference for outsourcing management of constructed systems to private operators. They recognized the risk of water tariffs becoming a campaign issue in the three-year LGU election cycle. There was widespread agreement - among elected and career officials - that a solution required the management of the water supply systems separated from the municipal administration, so that the issue of tariffs did not get - 18 -  entangled into election politics. Two management options identified and evaluated. The first option, which was the preferred one, was for the LGU to undertake a fifteen-year lease contract with a private sector water utility operator, who would be fully responsible for demand risks. A lease contract was accordingly drafted incorporating global best practices, and bids were invited for all participating towns. So far 15 lease contracts are at various stages of finalization for APL 1 subprojects. The second or fall-back option (in case there are no bidders for a long-term lease arrangement), is the establishment of a Securities Exchange Commission (SEC)-registered water utility. The company will be provided technical assistance to outsource its principal operational functions through management and service contracts. The SEC-registered water utility's rules have been finalized with technical assistance provided by the Water and Sanitation Program. (d) Streamlining the process of concluding PSP transactions: The experience with implementation of the first phase LGUs indicated that the lead time caused by separate bidding processes for feasibility studies, detailed design, selection of an operator, and actual construction was almost 20 months. In the second phase of APL I, the transaction process has been streamlined by reducing preparation activities to two stages. The first is the feasibility study stage, in which the basic project concept, preliminary design, tariffs and financing arrangements are developed, and the second is the "design-build-lease" stage, in which the entire responsibility for detailed design, construction and management of the system through a fifteen year lease contract is awarded to the private sector. The estimated time saved is about eight months, which could bring water supply to the community substantially earlier than what has taken the project in the first phase towns. As a result, 14 APL2 subprojects will be fully ready for implementation by Board presentation in September 2001. (e) Improving the management of project implementation: Experience with implementing the project in nine towns has been extremely useful in highlighting project management problems. These have been occurring at three stages. First, the flow of documentation and communications between DBP and PMUs has been inadequate. In most of the LGUs visited by Bank supervision missions PMU staff did not have adequate knowledge of basic documentation such as the contracts, subsidiary loan agreements and even official receipts for payments made by DBP to the contractor. Second, within DBP the flow of information between the Technical Assistance Group, Loan Administration and Disbursement Departments needs to be improved. Applications for disbursements, for example have been lagging because of coordination problems between the three offices. Third, between DBP and the Bank the flow of paperwork has been slow and halting. These concerns have been addressed by DBP since appraisal in March 2001. (f) Resolving boundary problems in transferring water rights: During preparation of APLI subprojects in at least two provinces the project team had difficulty convincing neighboring LGUs to agree to regional water utilities, so that cost savings of constructing larger regional systems could be passed onto consumers. The difficulty arises because under existing Philippine regulations the transactions costs of concluding deals that transfer water rights from one LGU jurisdiction to another are high. In the case of the regional water utility Subicwater, for example, access to water rights from aquifers in two neighboring municipalities have been held up by endless negotiations - in which these transfers are viewed as exchanges of political favors rather than as a market exchange for water rights - for over four years. Technical assistance from the Global Water Partnership is being utilized to explore the feasibility of creating tradable water rights in the Philippines. (g) Maintaining a pipeline for potential PSP deals: Apart from streamlining the procurement process, implementation experience has signaled the need to maintain an adequate pipeline of subprojects for the design-build-lease deals. Traditionally in the Philippines, project preparation activities are undertaken through grant assistance (such as PHRD grants, Consultant Trust Funds etc.), and by convention LGUs do not borrow for this purpose. As the number of towns keeps expanding, it is becoming increasingly difficult to secure adequate grant assistance. In order to prepare APL2 and APL3 projects, the borrower will be - 19-  accessing concessional credit available under the NDF cofinancing. If the flow of PSP deals is maintained, the costs of project preparation will be recovered from the selected PSP operator. 4. Indications of borrower commitment and ownership: Two of the primary platforms of government policy are to (i) provide basic urban services to all city and town residents in the Philippines, and (ii) build capacity in LGU administrations, so that decisions concerning services in a town are taken locally by the Mayor and Municipal Councils. The project development objectives, therefore, are fully consistent with the national government's strategy of promoting planning and management of local civic services through local institutions. What makes the project attractive to the national government is the fact that it does not require any subventions from the national level either in the form of counterpart financing or subsidies. For the Development Bank of the Philippines (and Land Bank of the Philippines), the project is opening up a potentially huge market for investment financing and deposit mobilization. For participating LGUs the project enables its citizens access to safe and reliable water supply. It is not surprising to find therefore, that the recent political crisis at the national level has had minimal impact on project preparation. 5. Value added of Bank support in this project: The World Bank is assisting the Government implement one other demand-driven project in addition to this program, the Water Districts Development Project. The value added by the Bank involvement in these operations is the global experience and multi-disciplinary support it brings at both the project design and implementation phases. There is also value added to the Bank's own learning experience of implementing this first APL in the water sector - the program has afforded the Bank a laboratory of new practices and ideas. APLI project concepts were exhibited at the World Bank Pavilion at EXPO 2000 in Hannover, and elements of the program design are being replicated by sectoral task teams working in other regions of the Bank. E. Summary Project Analysis (Detailed assessments are in the project file, see Annex 8) 1. Economic (see Annex 4): O Cost benefit NPV=USS million; ERR = % (see Annex 4) O Cost effectiveness O Other (specify) The major benefits of this project are improved water services to beneficiaries of LGU systems. These benefits are direct user benefits from water consumed and consumer surplus for users, who now use less effective and more costly alternatives (such as buying water from vendors, relying on dugwells, rivers etc.). The project offers improvements to LGUs who have expressed a willingness to participate and the improvements scaled to a level of service and a tariff which have been agreed with the beneficiaries. Thus, it is highly probable that user benefits calculated on the basis of expected revenues will be realized. In the APL 1 project towns, the average economnic internal rate of return based on conservative assumptions was about 17 per cent. The potential consumer surplus including cost savings are nonetheless substantial and would raise the econormic rate of return even higher. The results are robust because they link agreed user willingness to pay and cost of chosen technical solutions, as shown by sensitivity tests of possible reductions in revenue and increases in costs. Further information is provided in Annex 4. - 20 -  2. Financial (see Annex 4 and Annex 5): NPV=US$ million; FRR = % (see Annex 4) Financial (see Annex 5): NPV=US$ million; FRR = % In the area of finance the project aims to: (i) ensure financially viable systems through full recovery of capital, and operating and maintenance costs; and (ii) strengthen prospects for commercial operations by broadening private sector participation in the financing and management of the water utilities. A methodology, utilizing a fully integrated long-term financial planning model, was developed for evaluating the borrowing capacities of the APL1 and APL2 sub-projects. The procedures estimate the total 5-year investment envelope available with the LGU, for which a portion would be earmarked for water projects. Thereafter, a project budget ceiling is determined by the LGUs after discussions with the Mayor and SB members. Finally, tariff levels are derived, based on a uniform formula, which ensured full recovery of all capital and operating cost plus allow for a nominal return on the capital invested. The tariff levels proposed are adequate to assure an adequate rate of return for a private operator interested in bidding for a long term affermage or lease contract. By the end of APL2, the project experience is expected to provide a critical mass of about 60 lease and management contracts in water supply production and distribution. This should enable, by the end of APL2, to set the stage for the more ambitious policy objectives of APL3 and APL4. The financing strategy recognizes the fact that at present many obstacles exist before private banks can actively engage in extending credit to LGUs. Domestic financing in long-term maturities are extremely scarce. Long term maturities in the private sector range between four to five years, with a maximum of only seven years. Recent developments for bridging the gap that currently exists in this market between the LGUs and private banks are promising, as the banling community has begun to recognize the potential market in LGU lending, although the question of political risks of working with LGU officials continues to be a serious concem. A private LGU credit guarantee facility (in which the DBP is the largest minority shareholder) has already been established to enable private banks to begin tapping this market. In order to complement this facility, an LGU credit rating system has also been developed in the Philippines. Efforts are also under way to reform the accounting standards and reporting systems, so that the entire financial conmmunity can understand LGU financial management systems better. The project will support these initiatives in APL4, at which time the DBP's and LBP's financing facility will be converted to a wholesale operation involving private banks in lending to LGUs for the water infrastructure projects. Such an operation is essential for achieving significant increases in coverage by 2010. Fiscal Impact: The counterpart funding will be provided by LGUs from their intemally generated revenues and Internal Revenue Allocations (IRAs). Hence there will be no fiscal impact at the national level. All participating LGUs have signaled their interest in encouraging the constructed facilities to be leased out to the private sector. In subprojects where the facilities are successfully bidded out, the affermage fees are expected to fully amortize the loans. 3. Technical: The project will finance civil works and equipment for improved water supplies for about sixty towns. It will also finance the construction of on-site sanitation and micro-drainage system in participating towns to mitigate some minimum negative environment impacts that might result from the increase of wastewater. Based on the APLI experience, the technical memorandum has been revised, so that the technical design - 21 -  standards are based not only on proven international experience, but also project-specific experiences. Feasibility studies for the subprojects and bidding documents of design-build-lease contracts will be completed for about 20 towns by Board presentation. During implementation, engineering consultants will assist the local government in the supervision of construction. For the towns that have made the option for possible private operation, the prospective private operator will be in charge of the quality control during the construction phase through the design-build-lease contracts. 4. Institutional: The loan will be coursed through the Development Bank of the Philippines (DBP). National agencies, such as DOF, NEDA will participate in an oversight role. The Water Supply and Sanitation Project Management Office in DILG (WS S-PMO) will continue playing an advocacy, brokering and capacity building role with the LGUs. 4.1 Executing agencies: The borrower for the investment components of the project will be the Development Bank of the Philippines, which will on-lend the loan proceeds to participating LGUs. For the technical assistance components of the project, cofinanced by the Nordic Development Facility (NDF) the borrower will be the Development Bank of the Philippines. The Development Bank of the Philippines will on-lend the technical assistance funds as either soft loans or for a fee to participating LGUs under the overall supervision of the Technical Working Committee. A credit agreement already signed between the DBP and NDF in this regard will remain valid in APL2. 4.2 Project management: -Pr*ect management will be the responsibility of the Development Bank of the Philippines, which-will continue managing the project through its Project Management Office, DBP-PMO. The Water Supply and Sanitation Project Management Office of DILG (WSS-PMO) will continue functioning in its role of "advocacy, brokering and capacity building", by facilitating and managing the process of preparing new batches of subprojects according the project rules. Consultants will provide technical assistance, as and when required. For overall coordination among the components, the Technical Working Committee comprising DOF, NEDA, DBP-PMO, and DILG-WSSPMO, established under APLI will continue functioning. 4.3 Procurement issues: A Procurement Assessment was conducted for DBP. The conclusions are summarized in Annex 6. 4.4 Financial management issues: Financial Management Units (FMUs) have been established as part of the PMOs in DBP. The FMU will be the focal point of all financial management concems for the project and will be staffed by an FMU Head and an accountant. It will handle all coordination with the field units, the LGUs, the contractors, the Bank and other units of the GFI concerned. Project Management Reports (PMRs) will be submitted using the GFIs modified or developed computer system. Separate books of accounts will be maintained for the project and a good internal control system shall be established and documented in a project financial management manual. The finance units of the Area Management Offices and Branches will actively be involved in the financial management of the project especially in the screening of sub loans. Disbursements will initially be SOE-based, but eventually PMR- based. Special Accounts will be established for each of the GFIs. Capital, liquidity and past due ratios will be required to be maintained. Audit reports shall be - 22 -  required to be submitted both for DBP, and for the project. Internal Audit coverage of the projects shall also be required. The Bank will conduct Orientation Workshops for the Financial Management staff involved in the project prior to effectiveness. 5. Environmental: Environmental Category: B (Partial Assessment) 5.1 Summarize the steps undertaken for environmental assessment and EMP preparation (including consultation and disclosure) and the significant issues and their treatmnent emerging from this analysis. The project is expected to have mainly positive environmental and public health impacts through the provision of affordable clean and more reliable individual water supply connections to residents of small towns in the project LGUs. There is potential for some negative impacts, mainly resulting from the wastewater which needs to be disposed off in a sustainable manner. Environmental assessment procedures for APL-1 was guided by an Operations Manual (OM) for preparing and assessing sub-projects. Based on the lessons learned, the OM has been updated. The potential negative impacts of sub-projects will be mitigated and managed through individual Environmental Management Plans (EMPs). The emphasis of the EA process for this project is less on the assessment of the obvious, generic impacts, and more on their ongoing management, including the protection of the watershed which sustains the raw water sources (including groundwater). The OM is responsive to Philippines regulations for sanitation and environmental protection, which are consistent with the Bank's OP 4.01 (Environmental Assessment). The nature of sub-projects will require, at the minimum, the preparation of Initial Environmental Examinations (IEEs). If an IEE indicates any significant issues, then an EIA will be prepared for that sub-project. For APL-1, IEEs and EMPs were prepared by a team of consultants for LGUs under the supervision of DILG. Mitigative actions will be supported through capacity building, in particular training of local health officers and sanitation inspectors. The national government will provide adequate funds for local capacity building, the project envisages that LGUs may on-lend a portion of their subloans to individual households for on-site sanitation imnprovements, based on full cost recovery. NDF cofinancing will build municipal capacity for sound environmental management. A part of the cofinancing could also prepare future batches of sewerage projects in LGUs facing problems of municipal pollution. The project will not have any significant effect on natural habitats, nevertheless the OM clearly provides for the review of any potential natural habitats impacts in future sub-projects. 5.2 What are the main features of the EMP and are they adequate? The EMP is divided into a two parts, namely 1) the Environmental Mitigation Plan and 2) the Environmental Monitoring Plan. The Environmental Mitigation Plan consists of the set of measures to be taken during implementation and operation, while the Environmental Monitoring Plan will be carried out during the construction and operational phase. The decision of when to invest in drainage, sewerage or on-site disposal is an integral part of the Environmental Assessment and EMP process. As all LGUs selected so far are relatively small urban centers (population below 40,000) the EMP recommendations have been restricted to on-site disposal or drainage improvements. The adequacy of the EMP depends on the extent to which environmental impacts are monitored during project implementation. Funding from the NDF is being made available to LGUs for strengthening environrnental monitoring. The Technical Working Committee will also decide whether additional assistance can be made from the Bank-financed Local Government Finance and Development Project (also under implementation). - 23 -  5.3 For Category A and B projects, timeline and status of EA: Date of receipt of final draft: July 2000 Environmental Category: B 5.4 How have stakeholders been consulted at the stage of (a) environmental screening and (b) draft EA report on the environmental impacts and proposed environment management plan? Describe mechanisms of consultation that were used and which groups were consulted? A) Discussions were made with the LGU officials on the various environmental aspects and possible requirements. Visits and assessment of the different field sites were also made. Discussions were conducted with the LGU officials, the Regional Environment Agency and the communities. B) Small group meetings and technical presentations were conducted with the concemed stakeholders. 5.5 What mechanisms have been established to monitor and evaluate the impact of the project on the environment? Do the indicators reflect the objectives and results of the EMP? The Environmental Mitigation Plan is intrinsically linked with the Environmental Monitoring Plan which outlines a framework for a comprehensive monitoring and evaluation of the impacts of the project on the environment. An example of an Environmental Monitoring Plan is available, which identifies specific environmental parameters to be monitored during the construction and the operational phases. The monitoring indicators chosen provide a realistic picture of the environmental conditions in the project sites. The GFIs will prepare an Annual Statement of Compliance for all sub-projects. On the Bank's side, environmental and social safeguard specialists will regularly participate in project supervision, including the review of the Annual Report on Compliance with the Environmental and Social Safeguard Guidelines. An Action Plan for NDF financing will be prepared by the GFIs to improve the environmental management capacities of the LGUs. 6. Social: 6.1 Summarize key social issues relevant to the project objectives, and specify the project's social development outcomes. The project will bring net benefits, both social and economic, to the residents of participating LGUs. No negative social impacts are anticipated. Public consultations have generally been well attended, with good participation from local residents. No major social issue has either been identified in the surveys conducted during project preparation, or raised during the consultation meetings with the LGU administrations and the barangays (communities). In nearly 100 sub-projects in which preparatory work has been undertaken so far, there have been no cases of resettlement in the nearly 100 sub-projects. In any event that land acquisition and other matters arise that may have a negative social impact in future batches of projects., the OM contains a comprehensive "Policy Framework on Involuntary Resettlement and Compensation of Land and Other Assets". In addition, Guidelines on Resettlement and Compensation of Land and Other Assets consistent with Bank policies are included in the OM to complement the given framework. The Guidelines provide principles and instructions on: (i) minimnizing land acquisition and subsequent displacement; (ii) compensation to all project affected persons including non-title holders; (iii) replacement of productive assets and amenities; and (iv) provision of rehabilitation measures and transitional allowances. Based on the lessons learned in preparing the first phase projects, the Guidelines simplify the - 24 -  process of consultation and the roles and responsibilities of the LGUs, so that while the project design principles are adhered to, all owners of assets and occupants of land likely to be affected by the proposed investments are properly consulted before final decisions are taken. DBP is committed to protecting the interests of Indigenous People (IP), who may be identified by the characteristics described below. To that end, DBP shall not approve a sub-project with activities that impact IPs until LGU or Private Operator proposing the sub-project:(a) has carried out the program described in paragraph (i) below and the sub-project design satisfies the criteria set out in paragraph (i); or (b) developed an IP plan described in paragraph (ii) below. (i) The LGU or Private Operator proposing the sub-project shall carry out a program of consultation with and informed participation of IPs to ensure that the design and implementation of said sub-project adequately addresses the needs and cultural preferences of the IPs and that such IPs receive culturally compatible social and economic benefits under the sub-project. The program of IP consultation and informed participation shall be carried out in accordance with guidelines satisfactory to the Bank and to the achieve the objectives of the World Bank's policy on IPs as set forth in the World Bank's Operations Directive 4.20 dated September 1991. (ii) Where activities under a proposed sub-project would adversely affect the livelihood of IPs, the LGU or Private operator shall develop an IP plan in accordance with policy, principles and general procedures set forth in the World Bank's said Operations Directive 4.20 and submit the IP plan to DBP for approval. After DBP's approval of such sub-project, DBP shall ensure that the sub-project is implemented in accordance with the approved IP plan. (iii) IPs can be identified in particular geographical areas by the presence in varying degrees of the following characteristics: (a) a close attachment to ancestral territories and to the natural resources in these areas; (b) self-identification and identification by others as members of a distinct cultural group, (c) an indigenous language, often different from the national language, (d) presence of customary social and political institutions, and (e) primarily subsistence oriented production 6.2 Participatory Approach: How are key stakeholders participating in the project? a. Primary beneficiaries and other affected groups: During the project preparation stage, five significant activities ensured beneficiary involvement in the project. These are: A letter of intent signed by the Municipal Mayor and in some municipalities, a Sangguniang Bayan (Municipal Council) Resolution were submitted to the Department of Interior and Local Government (DILG) signifying the interest of the municipal LGU in participating in the proposed project; Results of the feasibility study and socio-economic surveys i.e. technical options, management options, financial assessment and cost recovery options were presented to the Municipal Mayors and Sangguniang Bayan for assessment of LGU capacity and decision-making in assuming the responsibilities required by the Project. The agreements and decisions made among the members of the Municipal Council was embodied in a SB Resolution. The SB Resolution confirms the willingness of the LGU to: (i) delegate the day-to-day management of the water utilities through supervision contracts to professional water management organizations; (ii) adopt - 25 -  water tariff rates to levels that will ensure system sustainability; (iii) undertake specific investments to ensure that there are no adverse environmental impacts from augmented water supply; (iv) borrow from a recommended government financing institution (GFI) on terms and conditions specified by the national government; and (v) confirm that 10% of the total project cost will be provided by the local government unit as its counterpart contribution. The provisions of the SB Resolution were presented and discussed in a series of meetings with the barangays (village) that will be served by the project. The result of the barangay meetings is the signing of the Willingness-to-Connect (WTC) form by individual households. The WTC is a clear measure of demand at the household/community level. At least 60% of the target households to be served by the water supply project should sign and submit this document so that the project will proceed to implementation. If a number below 60% is reached, the project will not be implemented even if there is a demand at the LGU level. The Project believes that demand should be demonstrated at both LGUs and communities levels since the responsibilities of making the Project work also belong to both LGUs and communities. In the approximately 40 LGUs in which this process has been successfully concluded an average between 65-70% WTC has been generated. The results of the barangay meetings, WTC and the detailed engineering design were presented to the Mayor and the Sangguniang Bayan. This led to the adoption of the final SB resolution designating authority to the Municipal Mayor to sign a subsidiary loan agreement in behalf of the municipality with the DBP after the loan is approved by the World Bank. All of the five activities mentioned above underwent an iterative process of (i) informnation dissemination; (ii) discussions; (iii) decision-making; and (iv) commitment and responsibility, summarizes the participatory process adopted by the project team. Indigenous People: In situations where indigenous people live in participating towns, the Operational Manual requires that decisions of service levels and tariffs are taken after adequate consultation and participation of households at the barangay level. A strategy for the inforned participation of and consultation with indigenous peoples is included in the Operations Manual. 6.3 How does the project involve consultations or collaboration with NGOs or other civil society organizations? The project design involves elected officials of LGUs and beneficiaries directly in decision making. As the construction cycle requires engaging contractors and consultants with appropriate technical knowledge, participation by beneficiaries is mainly in the form of receiving information on construction progress, and with regard to the accessing sanitation loans. Municipal Council members in the APL I towns have been following work progress closely. Collaboration with NGOs and civil society is an option in LGUs where local elites appear to be dominating the consultation process. 6.4 What institutional arrangements have been provided to ensure the project achieves its social development outcomes? A consultative and participatory design has been followed in order to ensure that water supply and sanitation services are provided to the entire community in each participating LGU. In order to ensure that low income residents have the same opportunity to secure connections as affluent residents, the house connection charges are being financed by the LGUs. 6.5 How will the project monitor performance in terms of social development outcomes? In APL I a team of consultants were engaged to evaluate the extent of community involvement during the - 26 -  construction phase. Baseline data on socio-economic characteristics have also been collected for each LGU. The social development outcomes will be monitored a year after system commissioning by assessing the impact of the project on low income residents. The Technical Working Committee will be requested to include monitoring project performance as a key activity. 7. Safeguard Policies: 7.1 Do any of the following safeguard policies apply to the project? Policy Applicability Environmental Assessment (OP 4.01, BP 4.01, GP 4.01) * Yes 0 No Natural habitats (OP 4.04, BP 4.04, GP 4.04) 0 Yes 0 No Forestry (OP 4.36, GP 4.36) 0 Yes 0 No Pest Management (OP 4.09) 0 Yes 0 No Cultural Property (OPN 11.03) 0 Yes 0 No Indigenous Peoples (OD 4.20) 0 Yes 0 No Involuntary Resettlement (OD 4.30) * Yes 0 No Safety of Dams (OP 4.37, BP 4.37) 0 Yes 0 No Projects in International Waters (OP 7.50, BP 7.50, GP 7.50) 0 Yes * No Projects in Disputed Areas (OP 7.60, BP 7.60, GP 7.60) 0 Yes 0 No 7.2 Describe provisions made by the project to ensure compliance with applicable safeguard policies. The Operational Manual of the project has detailed guidelines on environmental assessments, Compensation and Resettlement Guidelines. The legal documents will require all participating LGUs and governmental agencies to adhere to these Guidelines, and will be confirmed with the guarantor and borrowers at negotiations. F. Sustainability and Risks 1. Sustainability: The sustainability of project benefits depend on five key factors, as specified in the Operational Manual: (i) the full participation and ownership of stakeholders in the design, implementation and operation of the project; (ii) good financial management, clarity in fund channeling rules, particularly with regard to LGU commitments, contributions, and responsibilities of LGUs, communities and households; (iii) flexibility in engineering design in order to meet specific service requirements of communities in a sustainable manner; (iv) outsourcing of operations and maintenance responsibilities to the private sector, as much as possible, and (v) TWG receiving periodic feedback from beneficiaries on the quality and reliability of services from the project investments. - 27 -  2. Critical Risks (reflecting the failure of critical assumptions found in the fourth column of Annex 1): Risk Risk Rating Risk Mitigation Measure From Outputs to Objective Newly elected LGU administrations will S 1. Sign-off from at least 60 per cent of remain committed to agreements between community was required as evidence of the project and communities stakeholder commitment to the project 2. Repeated consultations with stakeholders will be ensured through the project cycle 3. The Subloan Agreements and lease contracts mitigate political risks through specific provisions Political interference by elected officials in H 1. Evidence from APL 1 indicates that this is a bidding process and during the operational substantial risk for the project. Risk mitigation phase strategy includes (a) canceling subloans in LGUs in which political interference problems are evident, (b) elevating political interference discussions from DBP to the national-level Project Steering Committee for resolution, (c) three activities directed to ensure that the ensure that LGUs carny out procurement in an open and efficient manner, they are: - regular one-day introduction to the Bank's procurement requirements delivered by WBOM staff; - all concemed LGU staff attend two week residential procurement and project management course; - hands-on assistance to LGUs in all aspects of procurement by consultants, and - close supervision of procurement aspects by Bank staff based in Manila Lessons leamed from APL process M 1. Successful implementation of APLI projects generate support in national govemment has provided the most powerful platform for and among other donors generating support. 2. Technical Working Committee required to play a key oversight role 3. Dissemination meetings with WBI support need to be continued in APL2, so that there is sharing of the Philippine and global sectoral experiences - 28 -  From Components to Outputs DBP-PMO and the FMUs have the M 1. A condition for appraisal was the organizational capacity to handle a rapid establishment of a PMO that has adequate increase in business in a dynamic political capacity for project management and financial enviromnent management. This has been accomplished. 2. Continued use of intemationally recruited consultant team for supervision of construction contracts in PMOs and participating LGUs World Bank Manila Office has the M Procurement staff in the Manila office has been organizational capacity to guide project provided additional supervision budget. management, financial management and process procurement-related activities Risks of contractual disputes caused by a M Prequalification bid documents will specify the single contractor obtaining contracts in a amount of contracts each contractor can subregional cluster of LGUs undertake on a cluster by cluster basis. Overall Risk Rating S APL1 experience suggests that managing political risks is the most challenging aspects of the project. As the number of constructed systems increase during project implementation DBP will require strong support from the Technical Working Committee. If this is absent, unresolved conflicts between operators and LGU officials could become unmanageable despite the widespread community support for the project. Risk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N(Negligible or Low Risk) 3. Possible Controversial Aspects: Based on the implementation experience for APLI, a possible controversial aspect is the attempts in some provinces at political interference by locally elected officials in the bidding process. DBP conveyed to LGUs that interference in the bidding process would result in cancellation of subloans. In six LGUs of Isabela province and two LGUs of Quirino province DBP actually canceled the subloans for this reason. The experience so far has been only at the project preparation stage, but there is reason to believe, given the three-year election cycle, political interference could rear its head during the operational phase as well, when private operators are managing the utility. This is an issue for the national government to monitor closely through its oversight agencies such as the Commission on Audit. Decentralization in the Philippines has delegated decision-making to locally-elected officials. What the project has sought to promote in APLs I and 2 is the idea that public-private partnerships is an essential way to build trust and goodwill between private operators, local politicians and consumers. In this partnership the investment risk is bome by the LGU, and the demand risk by the operator. Clearly, if consumers are provided the services they want and willing to pay for the risks of political interference would diminish over time. However, there is no question that an impartial arbiter through Water Regulatory Legislation needs to be created immediately, if the program is to graduate to APL3 and APL4. In the interim, the extent of political interference depends on the effectiveness of DBP-PMO in managing political risks, and the support provided by the Technical Working Committee. - 29 -  For the interim, a Contract Administration Unit (CAU), under the oversight of the Technical Working Committee has been established. G. Main Conditions 1. Effectiveness Condition: 10 subloans signed between DBP and LGUs 2. Other [classify according to covenant types used in the Legal Agreements.] Negotiation conditions: a. The Financial Management Unit in DBP for the APLs has been created and staffed with at least a full time FM Head and an Accountant, both having adequate experience in managing foreign funded projects or its equivalent. b. The accounting system of DBP provide for separate books of accounts for the project. c. Project management reporting finalized by DBP. d. A procurement unit will be created in the DBP to handle work related to the APLs and staffed with at least a full time Procurement Specialist by Board Presentation e. The Technical Working Commnittee has adopted the revised Operations Manual, which includes guidelines, acceptable to the World Bank, for the treatment of indigenous peoples impacted by subproject activities f. A training program for key PMO staff involved in procurement has been approved by DBP. g. Amended Letter of Sector Development Objectives from the Republic of the Philippines. H. Readiness for Implementation Z 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. 1 2. The procurement documents for the first year's activities are complete and ready for the start of project implementation. Z 3. The Project Implementation Plan has been appraised and found to be realistic and of satisfactory quality. D2 4. The following items are lacking and are discussed under loan conditions (Section G): 1. Compliance with Bank Policies Z 1. This project complies with all applicable Bank policies. l 2. The following exceptions to Bank policies are recommended for approval. The project complies with all other applicable Bank policies. - 30 -  NJ--f4- " , V " A----1 -,a V. _____ __ Nara rmham Vijay Jagannathan Kes - Roben V. Pulley Team Leader Sector Manager/Director Country Director -31-  Annex 1: Project Design Summary PHILIPPINES: LGU Urban Water and Sanitation Project APL2 Key Performance Hierarchy of Objectives Indicators Monitoring & Evaluation Critical Assumptions Sector-related CAS Goal: Sector Indicators: Sectorl country reports: (from Goal to Bank Mission) Living standards in Philippine Improving trends in public 1. National Policy documents 1. Government adherence to towns and cities improved. health and urban on urban service provisioning its strategy, as stated in the environmental indicators by and living standards. NEDA Board Resolutions, 2020: 2. World Development Report remains committed 1. 70% of LGU residents and other internationally receive reliable water supply, compiled documents on basic at least 16 hours a day. urban service provisioning. 2. 70% of urban population 3. Benchmark Philippines has access to safe drinking water utility performance, and water. compare this to other 3. In the 20 largest cities developing countries. outside Manila 60% of wastewater is collected and treated. Program Purpose: End-of-Program Indicators: Program reports: (from Purpose to Goal) Customers in about 250 LGUs Program implementation Technical Working use safe and reliable water strategy fully integrated into Committee monitors and and sanitation services, which the national policy by 2010: evaluates policy lessons for are managed on commercial the sector through: principles and are environmentally sustainable Phase I (APLI): Proto-typing 1. The program design is 1. Follow-up studies and and testing a demand-based replicated through a number legislation (Water Regulatory framework, that provides of successor projects by the Legislation, tradable water participating LGUs with NG and ODA financing. At rights, public performance sustained water and sanitation least one similar project is audit etc.). services, and provides financed through another incentives for private sector source. participation. Phase 11 (APL2): Based on the 2. Private sector involvement 2. Monitoring LGU lessons learned from APL I, evident in 50% of LGUs by supervision of lease contracts. adjusting and modifying the lease/concession contracts. project design, and applying it 3. Overseeing CAU (until to about 40 LGUs and other 3. Consumers in participating Water Regulatory Legislation governmental agencies in towns receive at least 16 is enacted). order to create a sufficiently hours of water supply a day. large market to attract a PSP-led water operators industry. Phase III (APL3): APL3 tests 4. Consumers in these 4. Building capacity in the transition of the DBP and municipalities are satisfied participating LGUs and LBP from being retail with: communities to manage Bankers to financiers of - water quality contracts effectively. privately financed water - wastewater collection 5. Program Completion - 32 -  utilities. - wastewater disposal. Phase IV (APL4): Based on Report. the lessons leamed from 5. Unit price charged by APL3, adjusting and informal water vendors to modifying the project design, consumers in participating so that OD assistance is towns not more than 10% utilized to leverage private higher than prices charged by financing in the water sector. the water utilities. Project Development Outcome I Impact Project reports: (from Objective to Purpose) Objective: Indicators: 1. Consumers in 1. CAU/Regulatory body Technical Working 1. Successor LGU approximately 30 p resolves conflicts between Committee monitors and administrations will remain articipating LGUs are LGUs/customers and evaluates success in committed to maintaining provided with clean and Operators without resort to implementing subprojects agreements with regard to sustainable water supply and contract cancellations in at with assistance from tariffs and honoring long-termn sanitation services. least 70% of PSP contracts. DBP-PMO and DILG contracts with the private WSS-PMO: sector for operations and 2. Simplified procedures 2. Water production per 1. Biannual Review of maintenance developed for sharing water connection meets the design CAU/Regulatory Body resources across municipal parameters. functioning. boundaries. 3. At lest 50% of households 2. Evaluation of service without sanitation improve performance in project towns sanitation facilities. compared to sample of nonparticipating towns. 4. Average of 80% of consumers satisfied with 3. Assessments of Consumer service performance in LGUs Satisfaction in participating with constructed systems. towns through household surveys, public performance 5. Low income consumers audits. living within service area receive house connections. 4. Program mid-term Reviews. - 33 -  Key Performance Hierarchy of Objetves Indicators Monitoring & Evaluation Critical Assumptions Output from each Output Indicators: Project reports: (from Outputs to Objective) Component: 1. Water supply systems are At least 30 additional towns DBP-PMO and WSS-PMO 1. Newly elected LGU successfully constructed in with lease and management through: administrations will remain project towns. contracts by the end of APL2 committed to agreements 1. Monitoring disputes in between the project and lease and management communities; contract implementation. 2. Monthly report of Construction Supervision Consultant. 3. Environmental indicator monitoring. 2. The DBP-PMO is able to Capacity to process proiectsl . 1. Review of FM system, 2. IRA allocations to LGUs effectively manage project PMO fully operational in the disbursement lags, & audit will continue through APL2 implementation DBP . reports. 2. Project FM System fully operational in the DBP . 2. Report on TA 3. NDF disbursements Implementation Progress. commence 3. Project Supervision Aide Memoires 3. Minimum negative impacts Negative environmental Environmental audit sampling 3. WSS-PMO commitment to from the increase in impacts due to untreated of completed subprojects 24 play facilitative role in terms wastewater are mitigated wastewater and sanitation months after system start-up of training LGU staff for the through on-site sanitation and absent in project towns. dates. environmental management drainage investments role remains Project Steering Committee monitors environmental and social safeguards Project Components I Inputs: (budget for each Project reports: (from Components to Sub-components: component) Outputs) Target DBP-PMO and DILG 1. DBP-PMO structures fully Investments in water supply Actual through: operational by appraisal. Sanitation $2.9 million $1.2 -Monthly progress reports Drainage million (committed) -Supervision mission reports 2. DBP-PMO works Technical assistance for water Project Implementation Plan effectively in preparing supply, sanitation and Project Management Reports second and third batches for drainage (PMRs). implementation in 2002 and 2003 respectively. 3. Co-financing of technical assistance from Nordic Development Fund is accessed by loan effectiveness by DBP-PMO - 34 -  Annex 2: Detailed Project Description PHILIPPINES: LGU Urban Water and Sanitation Project APL2 The negotiated loan is in Japanese Yen, but all figures below are expressed in US$ equivalents By Component: Project Component I - US$19.84 million Water Supply This component will finance civil works, equipment and supervision for improved water supply systems in LGUs, water utilities where private operators were selected under procedures acceptable to the Bank, and regional water utilities. Selection of project towns and technical options to be used in them have been demand driven, using consultations at household, community (Barangay), and local government levels, based on the project team's assessment of borrowing capacity using the GOP guidelines and a long-term financial planning model developed for this purpose. This component will finance the construction of new systems, source works, as well as the rehabilitation and expansion of existing systems. The constructed systems will be operated and managed, as far as practicable through leasing (affermage) and management contracts with private sector operators. if no bids are received, the LGU will be required to create an independent water utility duly registered under Philippine law, in which DBP will exercise rights to appoint key members of the Board of Directors. Project Component 2 - US$1.67 million Sanitation Program This component will finance physical improvements in household toilets, on-site sanitation facilities, including soakaway pits for septic tank effluents or the disposal of wastewater flows arising from augmented water supplies hygiene education. Funds will be on-lent to the households and would be administered by the water supply operators and recovered from the water bills on an installment basis. Selection of beneficiaries will be demand driven and on the basis of first come first served. Project Component 3 - US$ 1.11 million Urban Drainage Program This component will finance investments and consultant services in micro-drainage infrastructure. Selection of towns for this component will be demand-driven, except where it is necessary in order to mitigate adverse impacts of the augmented water supplies. Project Component 4 - US$1.65 million Consultancy Construction Supervision Consultant (US$1.50 million): The DBP-PMO has limited experience of managing contracts and therefore consultants will be hired to assist the DBP-PMO with construction management. Consulting Engineers were hired in August 1999, using $1.035 million from the APL 1, to supervise the construction of around 20 towns financed under APL 1. A similar contract will be awarded for the assisting DBP-PMO to supervise the construction of around 60 towns to be included in APL 2, after the project becomes effective. It is estimated that 52 person-months of intemational staff and 750 person-months of national staff will be needed for perforning these tasks. Individual Consultants (US$0.15 million): Specialized consultants will be hired to support the LGUs and Government Agencies in implementing their Water Supply, Sanitation and Drainage Components. - 35 -  Third LGU Urban Water and Sanitation Project (APL3): Likely conditions to proceed for APL3: To be met before commitment of APL3: a) Devolution of operation, management and revenue collection responsibilities under long-term commercial arrangements (i.e. management and leasing contracts) in a cumulative total (APLI and APL2) of 20 water utilities; ) Confirmation from project reports that sanitation loans were offered to users of all participating LGUs; ) All APL1-financed water supply systems completed and fully operational, and ) In APL2, 10 water supply systems constructed and fully operational and at least $12 million of APL2 isbursed by APL3 ICC presentation APL3 Development Objective: Support a 'transitory' APL, in which a part of the funding will continue funding retail loans from DBP and Land Bank of Philippines to LGUs, while another part will fund wholesale/credit enhancing anrangements for Philippine water utilities, with the objective of continued demonstration of improvements in service quality and financial sustainability in participating water utilities. The IBRD-Funded Project (US$100 million) would likely finance: construction of water supply and sanitation in about 80 water utilities, focusing on facilitation of subregional systems, wider involvement of different forms of private sector participation in those water utilities, and improved institutional capacity in participating LGUs. Other donors would likely finance technical assistance under cofinancing arrangements (US$ 3 million): Completion of feasibility studies using program design principles, institutional capacity building in LGUs, particularly with regard to local environmental management, financial management and staff training. Private Financial Institutions (US$20 million) would likely cofmance: construction of water supply and sanitation facilities in subregional systems, "repeater" subprojects by private operators and other water utilities. Financing by LGUs participating in the project (US$10 million): This would provide LGU equity in the project in the form of land acquisition and equity finance from intemal resources. Project Financing Data (Indicative) Processing Time Table I I (Tentative) IBRD Loan: $100 million Appraisal: 12/15/2003 Bilateral Cofinancing: $3 million Negotiations: 1/15/2004 LGU Equity: $10 million RVP Approval: 03/30/2004 Private Financing: $20 million Effectiveness: 06/30/2004 Total: $133 million Estimated Year 1 Year 2 Year 3 Year 4 Year 5 Disbursement (US$ million) Annual 10 30 30 20 10 Cumulative - 36 -  Fourth LGU Urban Water and Sanitation Project (APL4) Likely conditions to proceed for APL4: To be met before commitment of APL4: a) Devolution of operation, management and revenue collection responsibilities under long-term commercial arrangements (i.e. management, concession and leasing contracts) in a cumulative total (APLI, APL2 and APL3) of 70 water utilities; ) A cumulative total (in APL I, APL2 and APL3) of $4 million invested in the sanitation component; ) All APLl and APL2 financed water supply systems completed and fully operational; d) In APL3 40 water supply systems constructed and fully operational and $50 million of APL3 disbursed by Board presentation of APL4; ) Surveys by independent consultants indicate that average of 70 per cent customers in water utilities inanced under APLs I and 2 satisfied with service performance in subprojects financed in APLI and APL2; f DBP/LBP utilize a part of the aggregate APL3 loan to finance water utilities with primary collateral recourse through the utility's cash stream, rather than the LGU's Internal Revenue Allocation, and g) Water Regulatory Commission fully operational in terms of regulating water utilities in the Philippines. APL4 Development Objective: This loan will finance water supply and sanitation services in approximately 130 Philippine water utilities, with IBRD financing being utilized by DBP and LBP to leverage private financing into the sector. The role of the two Banks will change from being retail lending institutions (as in APL 1 and APL2) to being (i) wholesalers to private financing institutions, (ii) underwriters, facilitators of syndication, securitization and insurance for private providers of water supply and sanitation in participating water utilities in the LGUs. The IBRD-Funded Project (US$130 million) would likely finance: construction of water supply and sanitation in about 80 water utilities, focusing on facilitation of subregional systems, wider involvement of different forms of private sector participation in those water utilities, and improved institutional capacity in participating LGUs. Other donors would likely finance technical assistance under cofinancing arrangements (US$ 3 million): Completion of feasibility studies using program design principles, institutional capacity building in LGUs, particularly with regard to local environmental management, financial management and staff training. Private Financial Institutions (US$60 million) would likely cofinance: construction of water supply and sanitation facilities in subregional systems, "repeater" subprojects by private operators and other water utilities. Financing by LGUs participating in the project (US$10 million): This would provide LGU equity in the project in the form of land acquisition and equity finance from intemal resources. - 37 -  I Project Financing Data (Indicative) Processing Time Table (Tentative) IBRD Loan: $130 million Appraisal: 06/15/2006 Bilateral Cofinancing: $3 million Negotiations: 08/01/2006 LGU Equity: $10 million RVP Approval: 10/08/2006 Private Financing: $60 million Effectiveness: 07/01/2006 Total: $203 million Estimated Year 1 Year 2 Year 3 Year 4 Disbursement (US$ million) Annual 10 40 40 40 Cumulative List of LGU sub-projects for which contracts will be ready for award by Board Presentation: PROVINCE/ TOTAL PROJECT COST Status of Procurement MUNICIPALITY (Philippine Pesos) Bohol Province (1) Alicia Bid Documents issued 17,335,000.00 Misamis Occidental Province (5) Calamba 21,268,000.00 Bid Documents issued Lopez Jaena 15,823,000.00 Bid Documents issued Oroquieta 120,896,000.00 Bid Documents issued Panaon 17,188,000.00 Bid Documents issued Sinacaban 21,466,000.00 Bid Documents issued Nueva Vizcaya Province (3) Bayombong-Solano 119,521,000.00 Bid Documents issued Santa Fe 25,400,000.00 Bid Documents issued Villaverde 18,944,000.00 Bid Documents issued Oriental Mindoro Province (4) Baco 21,427,000.00 Published for bidding Bansud 21,849,000.00 Published for bidding Gloria 28,094,000.00 Published for bidding San Teodoro 19,910,000.00 Published for bidding Quezon Province (2) Buenavista 18,504,000.00 Bid Documents issued Padre Burgos 20,020,000.00 Awarded to Rodman Const. TOTAL - 1st Year 486,218.00 APL 2 US$ 9.53 million - 38 -  APL 2 - DISTRIBUTION OF TOWNS BY AREA MANAGEMENT OFFICE OF DBP (AMO) TO BE FINANCED BY NORDIC DEVELOPMENT FUND (2001-2003) AMO 1, AMO 11, AMO III AMO IV AMO V AMO VII AMO VIII AMO X Northeastern LuzonNorthwestern LuzonCentral LuzonSouthern BicolEastern Visavas Tagalog PanavNorthwestern Mindanao Lallo, Cagayan; Buguias, BennettMoons, Nueva Ecija; Clinton, Pilar, Sorsogon Biliran, BiliranSan Oriental Mindoro Miguel, Iloilo; Ipil, Zamboanga del Sur San Iced, Isabela; Burgos, Pangasinan; Rizal, Nueva Ecija; San Jose, Oriental Mindoro Burgos, Isabela; Calasiao, Pangasinan; Nampicuan, Nueva Ecija; Juban, Sorsogon Borongan, Eas. Rizal, Oriental Mindoro Samar Balasan, Iloilo; Titay, Zamboanga del Sur Jones, Isabela; Sison, Pangasinan; Talugtug, Nueve Ecija; Sorsogon, Sorsogon Dulag, Sablayan, Oriental Mindoro LeyteBatad, Iloilo; Roselier Lim, Zamboanga del Sur Cabagan, Isabela; Rosario, La Union; Angat, Bulacan; Sta. Bacon, Sorsogon Sta. Fe, Cruz, Oriental Mindoro LeyteBanate, Iloilo; Tungawan, Zamboanga del Sur Ilagan, Isabela; Laoag, Ilocos Norte; Boac, Marinduque Castilla, Sorsogon Kananga, Leyte; Miag-ao, Iloilo; Bayog, Zamboanga del Sur Ambaguio, Nueva Vizcaya; Basistal, Pangasinan; Polillo, Tapaz, CapizSiay, Zamboanga del Quezon Sur Kasibu, Nueva Vizcaya; Mauban, Quezon Diplahan, Zamboanga del Sur Real, Tayabas, Quezon; Roxas, Oriental Mindoro Malangas, Zamboanga del Sur Siayan, Zamboanga del Norte AMO Xl, AMO XII, AMO XIll, AMO XIV Northern MindanaoNortheastern MindanaoSoutheastern MindanaoSouthern Mindanao Claveria, Misamis Or.Tubod, Surigao del NorteKapalong, Davao del NorteMagpet, North Cotabato Balingasag, Misamis Or.Alegria, Surigao del Norte El Salvador, Misamis Or.Bacuag, Surigao del Norte Lugait, Misamis Or.Dapa, Surigao del Norte Tagoloan, Misamis Or.Tago, Surigao del Sur Opol, Misamis Or. Talacugon, Agusan del Sur Malaybalay City Trento, Agusan del Sur - 39 -  Annex 3: Estimated Project Costs PHILIPPINES: LGU Urban Water and Sanitation Project APL2 Local Foreign Total Project Cost By Component US $million US $million US $million Works - Water Supply 13.24 6.60 19.84 Services -Consultancy 0.15 1.50 1.65 Works - Sanitation 1.67 0.00 1.67 Works - Drainage 1.11 0.00 1.11 On-Lending to Private Operators 2.00 2.00 4.00 Land acquisition 2.60 0.00 2.60 Total Baseline Cost 20.77 10.10 30.87 Physical Contingencies 0.00 0.00 0.00 Price Contingencies 0.00 0.00 0.00 Total Project Costs 20.77 10.10 30.87 Interest during construction 4.10 4.10 Front-end fee 0.30 0.30 Total Financing Required 1 20.77 14.50 35.27 Local Foreign Total Project Cost By Category US $million US $million US $million Goods 0.00 0.00 0.00 Works 15.08 7.54 22.62 Services 0.15 1.50 1.65 On-Lending to Private Operators 2.00 2.00 4.00 Land Acquisition 2.60 0.00 2.60 Total Project Costs 19.83 11.04 30.87 Interest during construction 4.10 4.10 Front-end fee 0.30 0.30 Total Financing Required 19.83 15.44 35.27 Identifiable taxes and duties are 0 (US$m) and the total project cost, net of taxes, is 35.26 (USSm). Therefore, the project cost sharing ratio is 85.08% of total project cost net of taxes. -40 -  Annex 4: Cost Benefit Analysis Summary PHILIPPINES: LGU Urban Water and Sanitation Project APL2 [For projects with benefits that are measured in monetary terms] Present Value of Flows Fiscal Impact Economic Financial Analysis1 Analysis Taxes Subsidies Benefits: Costs: Net Benefits: IRR: L If the difference between the present value of financial and economic flows is large and cannot be explained by taxes and subsidies, a brief explanation of the difference is warranted, e.g. "The value of financial benefits is less than that of economic benefits because of controls on electricity tariffs." Summary of Benefits and Costs: The Project aims to test a demand-based framework in the provision of water services in about 250 towns nationwide which are deemed non-viable systems under existing sector rules. The first phase funded under APLI, in the amount of US$ 23.3 million, targets to cover about 40 towns. Of this number, nine (9) towns are undergoing construction, 11 towns have completed project preparation and about 12 towns are in different stages of project implementation in September 2001. Cost benefit analyses are conducted for each cluster of subprojects as and when they become ready for appraisal. An example from the second cluster of APLl is presented below for illustrative purposes. The subject of this analysis is the 11 towns in Isabela, Kalinga and Quirino provinces which have completed project preparation and represents Batch 2 towns under APLI. Of these towns, two (Pinukpuk and Rizal in Kalinga provinces) have dropped out prior to the bidding of a private operator in April 2000. These towns shall be used as the sample for the APL2 appraisal. These systems involve a total of 23,230 connections by design year 2011. Without Pinukpuk and Rizal towns, total number of connection sis 21,082 connections. The overall objective of the Project is to demonstrate that economically and financially viable systems can be built and operated in these towns by designing technical solutions whose costs can be recovered through tariffs that have been agreed upon with the beneficiaries prior to construction. The progress using the demand-based approach in APL 1, including lessons leamed so far, have been used in refining project design. APL2, which may involve a loan amount of about US$ 60 million is targeting to cover an additional 60 towns and APL3, another 130 towns. Under APL 3, it is also envisioned that government financial institutions (GFIs) would be in a position to wholesale loans and induce private sector banks to invest in LGU systems, and for these systems to be increasingly managed and operated by the private -41 -  sector primarily through lease and concession contracts. The assumption for proceeding to APL3 is that economic and financial viability is demonstrated in the earlier APLs. In this type of a program loan, it is not possible to have a prior estimation of the net present value or the economic internal rate of return for the whole Project. This is because specific investments in the towns which would choose to participate are subject to negotiations between prospective beneficiaries and their respective LGU officials and their acceptance of the project rules regarding loan financing and cost recovery through user payments. However, the Project design provides adequate assurance that technical solutions would be both economically and financially viable. In particular, the Project rules require that tariffs should at least cover for the operation and maintenance costs and that users of the improved systems agree to the proposed tariff levels. Nonetheless, since this is a Project that involves learning-by-doing, economic performance shall be continually monitored. The framework provides that the Project may be modified as necessary in order to achieve its economic worth. The LGU systems, which will be largely replaced in this Project, perform poorly and usually for a very limited number of hours a day. The economnic consequences are (1) that the current systems generate very low levels of direct-user benefits, and (2) people, even for those already connected to the existing system, are forced to seek alternative sources of water which are often expensive, time consuming and unsafe from a health perspective. With the improved/new system, many would be able to switch to more or exclusive use of the better and much more reliable services. They will therefore be able to avoid some of these costs, that is, money, time and health costs, while generating increased direct-user benefits. With the exception of health costs which are often difficult to quantify but are nonetheless real costs, direct-user benefits, consumer surplus and cost savings have been estimated for the individual subprojects. In general, it has been shown that direct-user benefits have been sufficient to justify the projects from the econornic sense. Considering further consumer surplus and cost savings benefits have substantially increased the economic return of the sub-projects. However, from the perspective of society, the latter may only be a transfer if users opt to shift their spending from water to some other commodity or if the improved/new system results in a loss for the existing LGU-managed water utility or water vendors. In such a case, there would be no real savings to society, although a real gain from cost savings would have accrued to the consumers. On the basis of the 11 towns covered by this analysis, the required tariffs to fully cover the investment and operating costs are considerably lower than the costs that users at present incur to get water. This being the case, it is expected that the consumer surplus and cost savings would be significant for those who will be served by the improved/new systems and are able to use more water at a lower price. While it is difficult to estimate the exact consumer surplus without more information on the shape and elasticity of demand, it is expected that this is positive and may be substantial. - 42 -  A. Economic Rate of Return of Subprojects For the 11 subprojects, certain assumptions were used for the base case scenario. These assumptions were meant to approximate the most likely situation in these towns upon the operation of the improved systems. First, it was assumed that per capita consumption levels would increase gradually towards the projected consumption of 120 liters per capita per day (Ipcd) used in the design of the subprojects, the reason being that it is possible for users to maintain their current water sources at least in the initial years of operation of the improved system. The assumptions on water consumption levels under the base case scenario are as follows: 60 Ipcd for the first two years of operation; 90 lpcd for the next three years of operation; and 120 lpcd for the sixth year of operation and onwards. Second, the projections of served population (again used in the design of the subprojects) reflect a gradual increase starting with 60 percent of households in the service area (used as a condition for participation in the Project) on the first year of operation to 90 percent at the end of the design year. With these assumptions (including the basic assumptions discussed in the latter part of this Annex) and considering direct-use benefits only, the average EIRR for the 11 subprojects under the base case scenario is 19.2 percent (using a discount rate of 15 percent). The consumption of institutional and commercial/industrial users were not included. On the average, this is estimated to be an additional 15 percent in direct-use benefits. Considering consumer surplus and cost savings, the EIRRs of the subprojects are expected to increase substantially. Using partial data to estimate consumer surplus, the average EIRR considering both direct-use benefits and consumer surplus is 29 percent. (Data to estimate consumer surplus and cost savings are not available for about 15 out 57 barangays proposed to be covered by the service areas in the project towns.) Adopting more optimistic assumptions of full capacity in terms of water consumption levels and target served population would provide much higher EIRRs. Table 1 presents a summary of the EIRR estimates for each town. -43 -  Table I Summary of Economic Viability Indicators Batch 2IAPL11LGU-UWSP With Direct-Use Benefits (DUB) With DUB & Consumer Surplus Municipality NPV EIRR BCR NPV EIRR BCR (P '000) (%) (P '000) (%) _ Isabela Province Derfin Albano I/ 6.519 19.28 1.68 12,178 22.24 2.00 Gamu 21 3,006 18.19 1.58 11.200 25.03 2.27 San Mariano 946 16.25 1.41 30,030 37.07 4.07 San Pablo 3/ 6,188 19.24 1.68 33,339 32.40 3.23 Santa Maria 4.334 19.07 1.63 77,800 51.66 6.88 Santo Tomas 2,200 16.58 1.44 42.639 34.30 3.63 Kalinga Province Pinukpuk 1,622 17.37 1.51 3,485 19.80 1.72 Rizal 4/ 8,696 23.50 2.08 14.271 27.05 2.56 Tabuk 5/7/ 15.152 20.21 1.73 28,959 23.29 2.09 Quinno Province Agllpay 6/ 9,081 21.28 1.93 11,223 22.40 2.07 Nagtipunan 7/ 4,527 19.83 1.78 8.898 23.42 2.22 Average 19.16 28.97 Notes: 1/ Consumer surplus is underestimated; no data available for 2 out of 12 barangays proposed to be covered by the service area. 2/ Consumer surplus is underestimated; no data available for 1 out of 3 barangays proposed to be covered by the service area. 3/ Consumer surplus is underestimated; no data available for 5 out of 11 barangays proposed to be covered by the service area. 4/ Consumer surplus is underestimated; no data available for 2 out of 6 barangays proposed to be covered by the service area. 5/ Consumer surplus is underestimated; no data available for 1 out of 8 barangays proposed to be covered by the service area. 6/ Consumer surplus is underestimated; no data available for 3 out of 7 barangays proposed to be covered by the service area. 7/ Adopted 10% LGU subsidy on the tariff. With the exception of the worst case scenario which combines the conditions of the three scenarios (described in the latter section of this Annex), the results of the sensitivity analyses which considered direct-use benefits only show that the EIRRs and the NPVs of the subprojects in five (5) towns - Delfin Albano, Gamu, San Pablo, Pinukpuk Aglipay and Nagtipunan - are most sensitive to an increase in the investment cost by 20 percent and two (2) towns -Santa Maria and Tabuk - to lower projections of served population. These towns, however, are still within the 15 percent hurdle rate set by Government for public infrastructure projects. There are three (3) towns - San Mariano, San Tomas and Pinukpuk - which are - 44 -  highly sensitive to any of the scenarios and have negative NPVs and EIRRs less than 15 percent. However, with the further consideration of consumer surplus, the EIRRs in these three towns would still be within the 15 percent hurdle rate set by Government. Table 2 presents a summary of the sensitivity analyses for each subproject. Table 2 Summary of the Sensitivity Analyses Batch 21 APLI LGU-UWSP Considers Direct-Use Benefits only Scenario 1 Scenario 2 Scenario 3 Scenario 4 Municipality NPV EIRR NPV EIRR NPV EIRR NPV EIRR (P '000) (%) (P '000) (00) (%) (P '000) (%) Isabela Province Delfin Albano 2.581 16.82 2.427 16.61 2.585 16.50 (1.118) 14.20 Gamu 613 15.70 480 15.52 500 15.47 (1,674) 13.07 San Mariano (990) 13.59 (1.185) 13.42 (1,172) 13.63 (2,927) 10.80 San Pablo 2.392 16.76 2.261 16.57 2,428 16.48 (1.155) 14.14 Santa Maria 1,374 16.39 1,269 16.21 1,586 16.32 (1.395) 13.57 Santo Tomas (1.199) 14.07 (1.446) 13.95 (1.621) 13.97 (4.505) 11.49 Kalinga Province Pinukpuk (98) 14.85 (156) 14.77 (178) 14.77 (1,704) 12.28 Rizal 5,513 20.84 5.575 20.54 6,333 20.50 2.710 17.91 Tabuk 6.673 17.48 6.547 17.29 7,899 17.41 (1,084) 14.59 Quirno Province Aglipay 5,164 18.85 5.380 18.79 5,635 18.47 1.854 16.41 Nagipunan 2,194 17.50 2,232 17.42 2,200 17.09 132 15.15 Averaae 16.6 - 16.46 16.42 139 B. Distributive Analysis Table 3 shows the net benefits of the subprojects for each major stakeholder - the project, the national Government, the community and the society as a whole. For the project, the benefits are in the forn of financial (project) revenues and costs are in terms of financial costs (both for investment and O&M). This approximates the net benefits to the LGU if it were to run the system following commercial principles. If it were a privately-run water utility, the benefits would be in the form of project revenues and the costs, O&M costs including lease fees and other transaction (contractual) costs. For Government, the benefits come in the form of taxes and duties less the premium on foreign exchange. For the community, the benefits are in terms of consumer surplus and the subsidy for unskilled labor. The net benefits for the society as a whole is a summation of the benefits and costs accruing to the different major stakeholders. The distributive analysis shows that among the stakeholders, the beneficiary communities would gain substantially from the new or improved systems. The benefits to the communities would be mainly - 45 -  non-cash savings (e.g., less queuing time, certainty of water availability) and to some extent cash savings from tankered supply, operation and maintenance costs of household pumps and investment for stand-by wells. The analysis also shows a net gain for the LGU or the water utility as well as for the Government from even a narrow perspective of the subprojects. The long term and broader gains from the subprojects are their contribution to the improvement of the quality of life of the beneficiary communities as well as contribution to the economnic development of the project towns. Table 3 Distributive Analysis Batch 21 APLi1 LGU-UWSP (P '000) Net Benefits Municipality Project Government Community Society Isabela Province Delfin Albano 1/ 18,739 3,919 39,567 62,225 Gamu 1/ 10.450 2,454 36.617 48,521 San Mariano 6.943 2.252 173.657 182.403 San Pablo 1/ 18,167 3,657 83,450 105,274 Santa Maria 13.376 2.945 287,764 304.08 Santo Tomas 11,920 3,902 209,078 224,901 Kalinga Province Pinukpuk 6.782 1.824 8,236 16,842 Rizal 1/ 19,751 2,379 46.214 68.344 Tabuk 1/2/ 41,545 7,860 187,948 237,353 Quirino Province Aglipay 11 22.502 3,112 18,434 44,047 Nagipunan 21 12.225 2.057 28.010 42.293 Notes: 11 Consumer surplus and cost savings are underestimated because of unavailable data in about 15 out of 57 barangays covered by the proposed service areas. 2/ Adopted 10% LGU subsidy on the tariff. C. Net Fiscal Impact From the perspective of the national Government, the fiscal impact of the subprojects is positive with possible income from taxes and duties more than offsetting the premium provided for foreign exchange. From the perspective of the local governments, the Project design ensures a positive net fiscal impact being a net revenue-earning activity even though a portion of their IRA would be used to guarantee their respective loans. The subprojects have been designed to be technically and commercially viable and that the institutional arrangements are such that they would ensure sustainability in the long-run with the participation of a private operator. For the two towns (Tabuk and Nagtipunan) which have opted for 10 - 46 -  percent LGU subsidy in the water tariff, the real fiscal impact to these LGUs is equivalent to the 10 percent LGU equity to their projects that would not be recovered through the tariffs. Table 4 provides a summary of the net fiscal impact for each town Table 4 Net Fiscal Impact of Proposed Investments Batch 2t APLI/ LGU-UWSP (P '000) Isabela Province Total Delfin Albano Gamu San Mariano San Pablo Santa Maria Santo Tomas Taxes Investment 8,599 763 622 577 921 633 885 O&M 7,959 760 505 545 731 734 843 Total 16,558 1,523 1,127 1,122 1,652 1,367 1,728 Duties Investment 32,841 4,109 2,206 1,706 3,340 2,570 3,548 O&M 4.291 384 281 412 418 389 528 Total 37,132 4,493 2,487 2,118 3,758 2,959 4,076 Forex Premium Investment 15,325 1,917 1,030 796 1,559 1,199 1.656 O&M 2,002 179 131 192 195 182 246 Total 17,327 2,096 1,161 988 1,754 1,381 1,902 Net Fiscal Impact 36.363 3.920 2,453 2.252 3.656 2.945 3.902 -47 -  Kalinga Province Quirino Province Pinukpuk Rizal Tabuk Aglipay Nagtipunan Taxes Investment 466 625 1.666 856 585 O&M 396 530 2,117 485 313 Total 862 1.155 3.783 1,341 8981 Duties Investment 1.536 1,961 6.768 3.048 2,049 O&M 268 336 877 273 125 Total 1.804 2.297 7,645 3.321 2,174 Forex Premium Investment 717 915 3.158 1.422 95 O&M 125 157 409 128 5 Total 842 1.072 3,567 1,550 1.01 Net Fiscal Impact 1,824 2.380 7.861 3,112 2,058 LGUs are able to participate in this Project if they are willing to borrow as opposed to receiving government grants. This has been done very little by LGUs in the past. It has only become a serious consideration for LGUs since the decentralization of tasks and revenues mandated under the 1991 Local Government Code. Consequently, they have incentives to pay attention to costs and the means of repayment. Since user fees are a means of repaymnent, they have an incentive to leam more about the willingness-to-pay of users. The users, in turn, have incentives to make sure that a proposed improvement has value to them equal to or higher than what they are willing to pay. Sector technicians, on the other hand, need to learn how to operate in an environment of relatively hard budget constraints, bounded by the LGUs' willingness to borrow and the users' willingness to pay. Nonetheless, there are risks in this demand-oriented approach, even though it should lead to substantial economic and service benefits. Leaming is necessary for all parties and it is unrealistic to expect that it will occur at the same pace for everyone or with uniform depth everywhere. The phased approach to the Project is desirable to mitigate the risks because it offers a means to capture on-going lessons and apply the lessons learned. In the end, collaborative assessment of benefits and costs by LGUs, city councils, and users will determine economically viable investments and improvements when given a voluntary opportunity to participate. Main Assumptions: Economic Costs. Project investment and recurrent costs are based on 1999 prices. The financial price of the investment and operation and maintenance costs were converted to their economic prices using the following assumptions which are based on the NEDA-ICC project evaluation guidelines: * Tariff rate on imported inputs - 30%; Tax on local inputs - 10%; * Premium on foreign exchange - 20%; and Shadow rate for unskilled labor - 0.60. - 48 -  Cost of physical contingency was assumed to be 10 percent of basic construction cost and land, cost of construction supervision, at 4 percent of basic construction cost and physical contingency, and cost of detailed design, at 5 percent of basic construction cost and physical contingency. For the operation and maintenance costs, it was assumed that 30 percent of the costs of energy, chemicals and maintenance would be imported inputs. The asset life of the components for a new/improved system was assumed to be as follows: Civil works: * 30 years for source facilities; and * 50 years for the pumping station, transmission, storage, treatment and distribution facilities and generator sets. Equipment: 15 years for source facilities, transmission facilities and generator sets; and * 50 years for the pumping station, storage, treatment and distribution facilities. Economic Benefits. Project economic benefits consist of (a) direct-use benefits, (b) consumer surplus, and (c) cost savings. For a privately-managed system, collection efficiency of 97 percent was assumed and for a publicly-managed system, 90 percent. Calculations were not made though for publicly-managed systems. The estimates did not include possible consumption of institutional and commercial/industrial users. On the average, this is estimated to be an additional 15 percent of direct-use benefits. In the estimation of consumer surplus and cost savings, for those consumers who go to nearby rivers and springs to do their laundry and other needs, the cost attributed to time spent was assumed to be 30 percent of the estimated per capita income foregone. This translates into the income of about 1.5 to 2 persons in a household, who are usually the economically active members of the household. Primary data on average household size and official data on minimum daily wage for each town were also used in the estimation of consumer surplus and cost savings. Discount Rate. The rate used in discounting flows to their present value is 15 percent. Sensitivity Analyses. Sensitivity of the net present value and economic internal rate of return were checked against the following scenarios: Scenario 1: Lower consumption levels at 60, 80 and I 00 liters per capita per day for periods covering 2002 to 2003, 2004 to 2006, and 2007 onwards, respectively; Scenario 2: Lower served population at 65 and 90 percent for periods covering 2002 to 2003, and 2004 onwards, respectively, applied on the projected served population starting with 60 percent of target served population in the first year of operation and 90 percent in the design year. This translates to about 40 percent and 80 percent of target households connected to the improved system, respectively; Scenario 3: Increase in investment cost by 20 percent; and Scenario 4: Combination of Scenarios 1, 2 and 3 above. - 49 -  Cost-effectiveness indicators: The average per capita investment cost for the 11 towns is about US$ 64.31 (using a P/US$ exchange rate of P 42.50/US$). The highest per capita investment cost was calculated for Nagtipunan, Quirino, about US$ 95.55 and the lowest calculated was for Tabuk, Kalinga, about US$41.41. Sensitivity analysis / Switching values of critical items: - 50 -  Annex 5: Financial Summary PHILIPPINES: LGU Urban Water and Sanitation Project APL2 Affordability Analysis for Participating LGUs The financing rationale for the Water Supply Project suggests a two-phased development wherein, the LGUs carry the load of financing by assuming the project loans. The affordability analysis has verified whether the LGUs have adequate internally available funds in the loan amortization period to fully repay the loans. Thereafter, wherever possible, the water systems are contracted out through affermage/lease arrangements to prequalified PSP operators. In situations where PSP operators are available, the latter will assure the remittances of project revenues sufficient to reimburse the LGUs of their debt servicing needs arising from the project loans. This also includes the reimbursement of the LGUs' equity contributions.Recurrent costs will be the responsibility of the operators. The cost-sharing nature of the financing scheme required an analytical approach which could assess the borrowing capacity of the LGUs and the financial feasibility of the water supply systems. This is accomplished by applying an innovative methodology through the use of the LGU Long-term Financial Planning Model, developed under an earlier project - the Water Districts Development Project This methodology has involved a three-step process. First, a preliminary financial assessment was undertaken for each of the participating LGUs to determine their 5-year investment envelope (potential) for which a portion of which would be earmarked for water projects. Second, a total project budget ceiling was derived that would fit the borrowing capacity of the LGU. Finally, tariff levels were derived based on a uniform formula that ensures full recovery of capital and recurrent cost plus provision for a nominal return on the capital invested. A revision in the analytical approach was, however, instituted after the first batch of LGUs under APL1. The revision involves the first step of the three-step process such that the use of the LGU Long-term Financial Planning Model was discontinued following DBP's stand to stick to its Loan Committee evaluation procedure. Under this procedure, the borrowing capacity of an LGU is limited only to the amount of the Internal Revenue Allotment it receives. The reason for this is DBP's low confidence on collection of revenues other than revenue allotments. This is true particularly in the case of municipalities belonging to 3rd through 6th class municipalities that are the predominant targets of the project. DBP is however open to adapting the Bank's recommended assessment procedure in the future when it gains more confidence on the bankability of small municipalities. Details of current financial operations and the overall condition of the 39 LGUs are available in project files. It suggests that there are potentials to leverage infrastructure investments, although the current financial performances leave room for considerable improvements. Based on these data, LGU projected borrowing capacity was computed for each of the participating LGUs before the engineering feasibility studies. The projected performance, however, took into account only the ratio of debt servicing requirements for the project and existing loan obligations to the internal revenue allotments as discussed above. The LGU's ability to put up its equity contribution is likewise ascertained during project construction. These have formed the basis of estimating the budget envelopes available with each participating LGU. Discussions with Mayors, Municipal Councils and communities on affordability and tariffs were based on these estimates of affordability. - 51 -  Financing Plan for LGUs Participating In Phase II: lligan City 2001 2002 2003 Total Investment Program 174 .8 172.7 16 8.2 515.7 Capitalized Interest 1 8.0 53.3 97.2 166. 5 Total 190.7 226.0 26 5.5 682 2 gop-ret. af F,und* Developm ent Bank of the Philippines 171 .7 203.4 238.9 614.0 Internal Sources 1 9.1 22.6 26.5 68.2 Total 190 .7 226.0 265.5 682.2 0 roquieta City 2001 2002 2003 Total Eia-i R e qui * ite n-ts Investment Program 51 .7 88.3 140.0 Capitalized Interest 11 .3 19.4 22.9 53.6 Total 63.0 107.7 22.9 193.6 qo-rcs nf E-und' Developm ent Bank of the Philippines 43.6 107. 7 22.9 174. 2 Internal Sources 6.3 10.8 2.3 19.4 Total 49.9 118.4 25.2 193.6 Calamba, M isam is Occidental 2001 2002 2003 Total Investment Program 5.4 9.3 - 14.7 Capitalized Interest 1 .2 2.0 2.4 5.6 Total 6.6 1. 3 2.4 20. 3 Developm ent Bank of the Philippines 4.6 11. 3 2.4 18.3 Internal Sources 2 .0 - - 2.0 Total 6.6 11.3 2.4 20. 3 Lopez Jaena, M Isam Is Occidental 2001 2002 2003 Total iar on. Ina R eq ;r I-snts Investment Program 4.5 7.7 12. 3 Capitalized Interest 1 0 1 .7 2.0 4.7 Total 5.5 9.4 2.0 17.0 5 nlrrae of Funrd. Development Bank of the Philippines 3.8 9.4 2.0 1 5.3 Internal Sources 1 .7 - 1 .7 Total 5.5 9.4 2. 0 17.0 Panaon, M lsam Is Occidental 2001 2002 2003 Total F innnr,ngI Ua uir.m.nt. Investment Program 4.2 7. 1 - 11. 3 Capitalized Inlerest 0 .9 1 .6 1 .9 4.3 Total 5.1 8.7 1 .9 1S. 7 sg-, Of F-rd. Developm ent Bank of the Philippines 3.5 8.7 1.9 14. 1 Internal Sources 1 6 - - 1 .6 Total 5 .1 8.7 1.9 1S. 7 S inacaban, M Isam Is Occidental 2001 2002 2003 Total Finanring n .r, ,ir m - n.t Investment Program 5 .1 8.7 - 13.7 Capitalized Interest 1 .1 1 .9 2.2 5 .3 Total 6 .2 10. 6 2.2 19. 0 sn. ,,.. n*f F.. nd. Developm ent Bank of the Philippines 4.3 10.6 2.2 17. 1 Internal Sources 1 .9 - - 1 .9 Total 6.2 10.6 2.2 19.0 - 52 -  Balilihan, Bohol 2001 2002 2003 Total Einancing Requiremennts Investment Program 5.4 9.3 - 14.7 Capitalized Interest 1.2 2.0 2.4 5.6 Total 6.6 11.3 2.4 20.3 Sol-Fees of FuAnds Development Bank of the Philippines 4.6 11.3 2.4 18.3 Internal Sources 2.0 - - 2.0 Total 6.6 11.3 2.4 20.3 Carm en, Bohol 2001 2002 2003 Total Finanrinp Raguireme nt5 Investment Program 9.6 16.4 - 26.0 Capitalized Interest 2.1 3.6 4.3 10.0 Total 11.7 20.0 4.3 35.9 qw-,rcs of Funds Development Bank of the Philippines 8.1 20.0 4.3 32.4 Internal Sources 3.6 - - 3.6 Total 11.7 20.0 4.3 35.9 Duero, Bohol 2001 2002 2003 Total FinrnCing Rqs,.irqmant-s Investment Program 5.1 8.7 - 13.9 Capitalized Interest 1.1 1.9 2.3 5.3 Total 6.2 10.7 2.3 19.2 .o-.na-r o^f El-nds Development Bank of the Philippines 4.3 10.7 2.3 17.3 Internal Sources 1.9 - - 1.9 Total 6.2 10.7 2.3 19.2 Mabini, Bohol 2001 2002 2003 Total Finanring R&qagirGmGant_ Investment Program 6.3 10.8 - 17.1 Capitalized Interest 1.4 2.4 2.8 6.5 Total 7.7 13.1 2.8 23.6 S nurBea of Funds Development Bank of the Philippines 5.3 13.1 2.8 21.2 Internal Sources 2.4 - - 2.4 Total 7.7 13.1 2.8 23.6 San Isidro, Bohol 2001 2002 2003 Total Eina-ning .aquire D.erLs Investment Program 3.9 6.6 - 10.5 Capitalized Interest 0.9 1.5 1.7 4.0 Total 4.7 8.1 1.7 14.6 S u --r e of Fu.nds, Development Bank of the Philippines 3.3 8.1 1.7 13.1 Internal Sources 1.5 - - 1.5 Total 4.7 8.1 1.7 14.6 - 53 -  Trinidad, Bohol 2001 2002 2003 Total Financing Requ.irements Investment Program 6.9 11.8 - 18.7 Capitalized Interest 1.5 2.6 3.1 7.1 Total 8.4 14.4 3.1 25.8 Cni,rrcg nf F,,nd. Development Bank of the Philippines 5.8 14.4 3.1 23.2 Internal Sources 2.6 - - 2.6 Total 8.4 14.4 3.1 25.8 Tubigon, Bohol 2001 2002 2003 Total Financing Requirements Investment Program 7.7 13.1 - 20.8 Capitalized Interest 1.7 2.9 3.4 8.0 Total 9.4 16.0 3.4 28.8 S.-rerAc nf Fiands Development Bank of the Philippines 6.5 16.0 3.4 25.9 Internal Sources 2.9 - - 2.9 Total 9.4 16.0 3.4 28.8 Ubay, Bohol 2001 2002 2003 Total Financing Requirements Investment Program 7.7 13.2 - 20.9 Capitalized Interest 1.7 2.9 3.4 8.0 Total 9.4 16.1 3.4 28.9 SQnhrrec nf F,.nds Development Bank of the Philippines 6.5 16.1 3.4 26.0 Internal Sources 2.9 - - 2.9 Total 9.4 16.1 3.4 28.9 Malabuyoc, Cebu 2001 2002 2003 Total F-Anancing R iquiraements Investment Program 5.3 9.0 - 14.3 Capitalized Interest 1.2 2.0 2.3 5.5 Total 6.4 11.0 2.3 19.7 qn ,ri - nf F ,ndl Development Bank of the Philippines 4.4 11.0 2.3 17.8 Internal Sources 2.0 - - 2.0 Total 6.4 11.0 2.3 19.7 Ronda, Cebu 2001 2002 2003 Total Finanring RqgIiramants Investment Program 5.0 8.6 - 13.6 Capitalized Interest 1.1 1.9 2.2 5.2 Total 6.1 10.5 2.2 18.8 Sn,,rerq nf Famnd. Development Bank of the Philippines 4.2 10.5 2.2 16.9 Internal Sources 1.9 - - 1.9 Total 6.1 10.5 2.2 18.8 - 54 -  Baco, Oriental M indoro 2001 2002 2003 Total Fmnann.ng Re,quiremeant Investment Program 8.0 13.6 - 21.6 Capitalized Interest 1.7 3.0 3.5 8.3 Total 9.7 16.6 3.5 29.9 qn.rces of Fu,nd Development Bank of the Philippines 6.7 16.6 3.5 26.9 Internal Sources 3.0 - - 3.0 Total 9.7 16.6 3.5 29.9 Bansud, Oriental M indoro 2001 2002 2003 Total Finonring Re. iremneats Investment Program 7.4 12.6 - 20.0 Capitalized Interest 1.6 2.8 3.3 7.7 Total 9.0 15.4 3.3 27.7 Sou.rces of EFunds. Development Bank of the Philippines 6.2 15.4 3.3 24.9 Internal Sources 2.8 - - 2.8 Total 9.0 15.4 3.3 27.7 Calapan City 2001 2002 2003 Total Finanring ReqgMiremante Investment Program 65.4 111.8 - 177.3 Capitalized Interest 14.4 24.6 29.0 67.9 Total 79.8 136.4 29.0 245.2 -Sorces of E.,rIg Development Bank of the Philippines 55.3 136.4 29.0 220.7 Internal Sources 24.5 - - 24.5 Total 79.8 136.4 29.0 245.2 Gloria, Oriental M indoro 2001 2002 2003 Total ni an ning R P,nir_nmanteS Investment Program 9.5 16.2 - 25.7 Capitalized Interest 2.1 3.6 4.2 9.9 Total 11.6 19.8 4.2 35.6 so-ces of EUgndS Development Bank of the Philippines 8.0 19.8 4.2 32.0 Internal Sources 3.6 - - 3.6 Total 11.6 19.8 4.2 35.6 - 55 -  Polo, Oriental Mlndoro 2001 2002 2003 Total Financing 0equiprgo ant. Investment Program 7.6 12.9 - 20.5 Capitalized Interest 1 .7 2.8 3.4 7.9 Total 9.2 15.8 3.4 28.4 So eces of F;.nds Development Bank of the Philippines 6.4 15.8 3.4 25.6 Internal Sources 2.8 - - 2.8 Total 9.2 15.8 3.4 28.4 San Teodoro, Oriental Mindoro 2001 2002 2003 Total Fwnanfing RPeiiram ante Investment Program 7.4 12.6 - 20.0 Capitalized Interest 1 6 2.8 3.3 7.7 Total 9.0 15.4 3.3 27.7 -Cotgr.ce of EnnrHs Development Bank of the Philippines 6.2 15.4 3.3 24.9 Internal Sources 2.8 - - 2.8 Total 9.0 15.4 3.3 27.7 Victoria, Oriental Mindoro 2001 2002 2003 Total Finnncinp R.g.irom.ntS Investment Program 9.8 16.8 - 26.7 Capitalized Interest 2.2 3.7 4.4 10.2 Total 12.0 20.5 4.4 36.9 An,yrrae nf Find. Development Bank of the Philippines 8.3 20.5 4.4 33.2 Internal Sources 3.7 - - 3.7 Total 12.0 20.5 4.4 36.9 Buenavista, Quezon 2001 2002 2003 Total Einancing Reqfironmnts Investment Program 6.7 11.4 - 18.1 Capitalized Interest 1 .5 2.5 3.0 6.9 Total 8.2 13.9 3.0 25.1 ns,rr.e of Fg,anda Development Bank of the Philippines 5.7 13.9 3.0 22.6 Internal Sources 2.5 - - 2.5 Total 8.2 13.9 3.0 25.1 Lopez, Quezon 2001 2002 2003 Total Financing Rnia-rements Investment Program 6.7 11.4 - 18.1 Capitalized Interest 1 5 2.5 3.0 6.9 Total 8.2 13.9 3.0 25.1 - 56 -  Sio ree. of Eunds Development Bank of the Philippines 5.6 13.9 3.0 22.6 Internal Sources 2.5 - - 2.5 Total 8.2 13.9 3.0 25.1 Padre Burgos, Quezon 2001 2002 2003 Total Finanring Raeuirment. Investment Program 5.9 10.1 - 16.0 Capitalized Interest 1.3 2.2 2.6 6.1 Total 7.2 12.3 2.6 22.1 So urces of Fuond. Development Bank of the Philippines 5.0 12.3 2.6 1 9.9 Internal Sources 2.2 - - 2.2 Total 7.2 12.3 2.6 22.1 Sampaloc, Quezon 2001 2002 2003 Total Finanr ing Requirem ents. Investment Program 8.0 13.7 - 21.7 Capitalized Interest 1.8 3.0 3.6 8.3 Total 9.8 16.7 3.6 30.0 SQ,rr.es on Fa nuas. Development Bank of the Philippines 6.8 16.7 3.6 27.0 Internal Sources 3.0 - - 3.0 Total 9.8 16.7 3.6 30.0 San Francisco, Quezon 2001 2002 2003 Total rinane np Rea ljrement. Investment Program 10.8 18.5 - 29.3 Capitalized Interest 2.4 4.1 4.8 11.2 Total 13.2 22.6 4.8 40.6 S ,,re- . of FUlnd. Development Bank of the Philippines 9.1 22.6 4.8 36.5 Internal Sources 4.1 - - 4.1 Total 13.2 22.6 4.8 40.6 Sariaya, Quezon 2001 2002 2003 Total Financing Rrngu irem ent. Investm ent Program 17.5 29.9 - 47.5 Capitalized Interest 3.8 6.6 7.8 18.2 Total 21.4 36.5 7.8 65.6 Sou,rre. of Faan,t. Development Bank of the Philippines 14.8 36.5 7.8 59.1 Internal Sources 6.6 - - 6.6 Total 21.4 36.5 7.8 65.6 - 57 -  Bambang, Nueva Vizcaya 2001 2002 2003 Total Fin an ina Rrql,,aIramantq Investment Program 10.8 18.5 - 29.3 Capitalized Interest 2.4 4.1 4.8 11.2 Total 13.2 22.6 4.8 40.6 -,prrap nf Fn.nd. Development Bank of the Philippines 9.1 22.6 4.8 36.5 Internal Sources 4.1 - - 4.1 Total 13.2 22.6 4.8 40.6 Bayombong & Solano, Nueva Vizcaya 2001 2002 2003 Total Finanring Rarqmairaman*A Investment Program 85.6 146.3 - 231.9 Capitalized Interest 18.8 32.2 37.9 88.9 Total 104.4 178.5 37.9 320.8 Ro,rrceq of Funds" Development Bank of the Philippines 72.3 178.5 37.9 288.7 Internal Sources 32.1 - - 32.1 Total 104.4 178.5 37.9 320.8 Dupax del Sur, Nueva Vlzcaya 2001 2002 2003 Total Fin:nr.jng Reqiiramaent-t Investment Program 10.0 17.2 - 27.2 Capitalized Interest 2.2 3.8 4.4 10.4 Total 12.2 20.9 4.4 37.6 8O-ces of E,-ad5 Development Bank of the Philippines 8.5 20.9 4.4 33.8 Internal Sources 3.8 - - 3.8 Total 12.2 20.9 4.4 37.6 Santa Fe, Nueva Vizcaya 2001 2002 2003 Total Fin_itagng. Rl & reampen-ts- Investment Program 7.9 13.5 - 21.3 Capitalized Interest 1.7 3.0 3.5 8.2 Total 9.6 16.4 3.5 29.5 Satlrce, of F-"ds Development Bank of the Philippines 6.7 16.4 3.5 26.5 Internal Sources 3.0 - - 3.0 Total 9.6 16.4 3.5 29.5 Villa Verde, Nueva Vizcaya 2001 2002 2003 Total Fin2ncing R-q-airameuts Investment Program 5.1 8.7 - 13.7 Capitalized Interest 1.1 1.9 2.2 5.3 Total 6.2 10.6 2.2 19.0 e^rces of Fuinds Development Bank of the Philippines 4.3 10.6 2.2 17.1 Internal Sources 1.9 - - 1.9 Total 6.2 10.6 2.2 19.0 - 58 -  Annex 6: Procurement and Disbursement Arrangements PHILIPPINES: LGU Urban Water and Sanitation Project APL2 Procurement Procurement arrangements described below are for the Bank-funded parts of the project. Separate arrangements for cofinanced parts have been developed by the Government of Philippines and the Development Bank of the Philippines (DBP) with the NDF, and will be confirmed at negotiations. Procurement of works and consultant services funded wholly or partly by Bank Loan will be carried out in accordance with Bank procurement guidelines (i) Guidelines for Procurement under IBRD Loans and IDA Credits of January 1995 revised in January and August 1996 and September 1997 and January 1999, and (ii) Guidelines for Selection and Employment of Consultants by World Bank Borrowers of January 1997 revised in September 1997 and January 1999. For Intemational Competitive Bidding (ICB) procurement, the current version of the Bank's Standard Bidding Documents will be used and consultant requirements will conform with the Bank's Standard Request for Proposals. Civil works procurement under design, build and lease (DBL) schemes will adopt the Bank-approved DBL Bidding Documents used successfully in APL 1. Project cost by procurement arrangement is presented in Table A. Summary of the Assessment of the Agencies' Procurement Capacities. An assessment of the capacities of DBP and Local Government Units (LGUs) to do project procurement was carried out for this project in accordance with the OCSPR Office Memorandum of August 11, 1998. The Bank's Country Procurement Assessment Report (CPAR) for the Philippines, completed in March 1997, was very much used in the Assessment. The general findings of the Assessment conformed to those of the CPAR. The DBP is the borrower for the investment components of the project which will on-lend the loan proceed to the LGUs. DBP will supervise the implementation of the project through its Project Management Offices (PMO). Further, it is currently implementing investment projects assisted by the Bank: the LGUUWSSP-APL1. The agency's capacity is rated satisfactory. The LGUs will create their Project Implementation Units (PIU) prior to the start of sub-project preparation. LGUs are capable of handling government-funded procurement but most of them have not implemented Bank-assisted projects. In this regard, the capacity of LGUs is rated as fair. In general, the laws, rules and regulations relating to procurement being implemented by DBP and LGUs adhere to the principle of competition and are intended to promote faimess, economy, efficiency and transparency. However, there are certain rules and regulations, and procedures, which may not fully support these principles in procurement transactions. In recent years, the conflicts between the Bank's Procurement Guidelines for works and goods and the Consultants' Guidelines have been eliminated through the amendments made to national bidding laws, rules and regulations. The amendments invariably mandate that "for contracts financed partly or wholly with funds from intemational financing institutions, the corresponding loan/grant/credit agreement between the govemment and the concemed IFI shall prevail." These waiver provisions are found in the August 2000 amendment to the Implementing Rules and Regulations(IRR) of Presidential Decree No. 1594, for works; the IRR of Executive Order 262 for goods; and the Guidelines for the procurement of Consultant Services under Administrative Order 164. In a Department of Justice Opinion, the Philippines further confirms that Section 11 of Republic Act No. 8182 of June 1996 which (a) provides preferential treatment for Filipino consultants, suppliers and manufacturers; and (b) prohibits feasibility and design consultants from participating in any subsequent phase of project implementation, does not modify the applicability of Section 4 of Republic Act No. 4860 which allows the President of the Philippines to agree to waive or modify the application of any law - 59 -  granting preferences in connection with the procurement of goods or services financed by foreign loans. There is nothing therefore in national bidding laws that are inconsistent with and would prevent the application of the Bank's Procurement and Consultants' Guidelines. Subsequent amendments to national bidding laws, which are considered procedural, had not seriously impacted on the March 1997 CPAR findings. The changes are: (a) substituting the word 'prequalification' to 'eligibility screening'; (b) mandating the inclusion of government auditors as observers in the bid committee; (c) enumeration of steps to undertake rigid postqualification; (d) the winning bidder is now described as the 'lowest calculated responsive bidder'; and (e) imposition of administrative sanctions against colluding and erring bidders. However, for clarity in processing NCB procurement, unacceptable provisions of national laws are enumerated below: (1) mandatory screening of bidder's eligibility for works and goods; (2) automatic disqualification of bids that are higher than the approved budget for the contract; (3) only licensed contractors are allowed to bid; (4) use of two-envelope system in works and goods bidding; and (5) big contractors are prohibited from participating in small procurement. It is worth noting that a Procurement Reform Law consolidating all piecemeal procurement related laws have been submitted to the Philippine Congress for enactment. The proposed Law incorporated most of Bank's procurement guidelines. The main risks for project procurement concem: (a) lack of effective capacity building for the LGUs on procurement management in terms of staff training; (b) insufficient capacity for the PMOs of DBP; and (c) political interference in procurement decisions in some cluster LGUs. To mitigate these risks, series of actions will be undertaken under the project. Procurement training for the concerned staff of DBP and LGUs will be provided through three main channels. They are: (a) Bank procurement staff located in the WBOM will provide, several times a year, one or two day procurement training seminars for the municipal engineers and COA staff from the LGUs while those from DBP will be present at each of these events; (b) all municipal engineers, head of the PIUs and other concemed project staff of LGUs will be required to attend a two week intensive procurement course at the Asian Institute of Management. The two-week course includes project management for four days; and (c) the consultants who will be undertaking the feasibility studies will be required to provide expertise in procurement so that 'hands on' assistance can be provided to LGU project staff. As regards insufficient capacity for the PMOs: a) DBP will assign three more account officers and hire a lawyer who will be assigned to handle procurement cases affecting the project. Area management centers in the provinces will assign at least one account officers to handle the needs of LGUs on the ground. Lastly, to prevent political interference on the Cluster LGUs, procurement decisions should be the responsibility of all local PBACs instead of the Special PBACs of the Province. Preferably, bid opening, bid evaluation and award should be decided upon within one day, unless a bid clarification is found necessary. Procurement methods (Table A) Civil works contracts of about $26.61 million, on the aggregate, would include construction and rehabilitation of water supply systems, sanitation and drainage infrastructure involving sub-projects of LGUs, private operators selected according to procedures acceptable to the Bank, and Government Agencies. Civil works contracts of about $26.61 million include $22.61 million that will be channeled through DBP to the LGUs, and $4.00 million channeled through DBP to the private operators. Adjacent LGUs are clustered, where practicable, to make the contract attractive to interested operators under a design, build and lease contractual arrangement. To ensure that operators are qualified, prequalification of interested operators will be made, following the prequalification procedures and documents used in APL 1. Prequalification of DBL operators will be required for procurement of works contract for a cluster of towns estimated to cost at least $1 million equivalent. Works for the construction of the water supply systems, - 60 -  which will include providing and installing equipment will be procured as follows: a) design, build and lease (DBL) contracts will, as much as possible, be grouped together to form a cluster of towns and will be procured as follows: (i) cluster of towns or individual town procurement, estimated to cost at least US$2 million equivalent, up to an aggregate amount not exceeding US$11.9 million equivalent will be procured under Intemational Competitive Bidding (ICB) following procedures acceptable to the Bank. The Project Operation Manual will include sample bidding documents and procedures (standard ICB procedures customized for the project in advertising, preparing tender documents, opening bids, evaluating bids and preparing evaluation report, and awarding contract) in compliance with Bank procurement guidelines and specifically designed for this type of infrastructure contract. DBP must include this procedures and the obligation of using the standard bidding documents as a conditionality in the sub-loans to be signed with the LGUs and Government Agencies; b) individual civil works contracts estimated to cost between US $50,000 to US $2.0 million equivalent, up to an aggregate amount not exceeding US$7.94 million equivalent will be procured under National Competitive Bidding (NCB) procedures acceptable to the Bank. A procurement side letter will be issued by the Government detailing the procedures under local rules which are not acceptable to the Bank. The Project Operation Manual will include sample bidding documents and procedures (standard NCB procedures customized for the project in advertising, preparing tender documents, opening bids, evaluating bids and preparing evaluation report, and awarding contract) in compliance with Bank procurement guidelines and specifically designed for this type of infrastructure contract. DBP must include these procedures and the obligation of using the sample bidding documents as a conditionality in the sub-loan to be signed with the LGUs and Government Agencies; c) individual civil works contracts estimated to cost less than US $1.0 million equivalent, up to an aggregate amount not exceeding US $ 4.0 million equivalent will be procured by private operators selected under procedures acceptable to the Bank, using the private operator own procedures, according to Article 3.12 of the Bank procurement guidelines. The private operator should procure the works according to the local commercial practices, acceptable to the Bank, after receiving the sub-loan from DBP. The Project Operation Manual will include procedures in compliance with Bank procurement guidelines and specifically designed for this type of infrastructure contract. DBP must include these procedures as a conditionality in the sub-loan to be signed with the private operator; and d) individual civil works contracts estimated to cost less than US$50,000 equivalent, up to an aggregate amount of US $2.77 million equivalent will be procured through Procurement of Small Works. Contracts will be awarded on the basis of quotations obtained from three qualified bidders, with the contract awarded to the lowest evaluated responsive bidder. Participation of non-governmental organizations (NGOs) would be acceptable, if they are qualified. The Project Operation Manual will include sample shopping documents in compliance with Bank procurement guidelines and specifically designed for this type of procurement. Consultancy Services (US$1.65m, all of which will be IBRD financed) Contracts for consultant services will be procured as follows: (i) US$ 1.50 for consultant services to support DBP-PMO staff in supervising their water supply component where the consultant of APLl selected under QCBS procedures will be contracted under Single Source Selection method for APL2 as provided for in downstream assignment section of the Request for Proposal package; and (ii) $ 0.15 million for individual specialists, with each contract not exceeding $50,000 equivalent, to support the LGUs and Government Agencies' staff in implement their Water Supply, Sanitation and Drainage components will be selected based on Section V, - 61 -  Selection of Individual Consultants. Procurement Management: All civil works procurement for the implementation of subprojects, financed by the loan/equity mix, will be undertaken by participating LGUs and private operators selected under procedures acceptable to the Bank, through the creation of Project Implementation Units (PIUs). The head of the PlUs should be a LGU official appointed by the LGU representatives. The creation of a PIU in each LGU will be a condition prior to approval of each sub-loan application with DBP. For award decisions, each LGU or a group of LGUs shall establish a bidding committee with, at least the third highest ranking official of the municipality as a Chairman. The project will involve the selection of private operators to design, build, operate, and maintain the water supply systems. This selection will be handled by the LGUs and supervised by DBP-PMO and LBP-PMO, guided by PSP advisors. The procurement documents for this type of selection have been developed in the APL I with technical assistance from the Bank as a part of project preparation. This process is being overseen by committee consisting of DBP, DOF and DILG. Procurement Implementation Schedule: The project will involve civil works in almost sixty LGUs with a wide geographical spread through the Philippine islands. For these towns, 25% of feasibility studies are expected to be completed by negotiations, and 20% of the Loan amount will be procured and no objection to award of contracts given the Bank by Board presentation. Implementation of construction activities will immediately commence upon Loan effectiveness. To expedite project implementation activities, DBP will strengthen its project management office, with the addition of a Procurement Specialist by Board Presentation. The DBP-PMO will be guided by the Project Implementation Plans on how to do the technical, financial, economic and an institutional appraisal of sub-projects. The General Procurement Notice was issued on April 2, 2001. The procurement lead time as specified in Administrative Order No. 129 shall be observed. The Commission on Audit shall include in its Annual Audit Program a project performance review specifically focused on the LGUs' compliance with Administrative Order No. 129. All procurement for the implementation of sub-projects, financed by the loan/equity mix as well as procurement of PSP operators to design, build, operate and maintain constructed water supply systems would be undertaken by participating LGUs and private operators selected according to procedures acceptable to the Bank. Consultants to supervise project preparation and implementation will be procured by the DBP before negotiation of the Loan. Table A: Project Costs by Procurement Arrangements (US$ million equivalent) Procurement Method Expenditure Category ICB NCB Other' N.B.F. Total Cost 1. Works 11.90 7.94 2.77 0.00 22.61 (10.70) (7.15) (2.50) (0.00) (20.35) 2. Goods 0.00 0.00 0.00 0.00 0.00 (0.00) (0.00) (0.00) (0.00) (0.00) 3. Services 0.00 0.00 1.65 0.00 1.65 (0.00) (0.00) (1.65) (0.00) (1.65) 4. On-lending to Private 0.00 0.00 4.00 2.60 6.60 Operators and Land - 62 -  Acquisition (0.00) (0.00) (3.60) (0.00) (3.60) 5. Interest during 2.70 1.10 0.30 0.00 4.10 construction (2.70) (1.10) (0.30) (0.00) (4.10) 6. Front-end fee 0.00 0.00 0.30 0.00 0.30 (0.00) (0.00) (0.30) (0.00) (0.30) Total 14.60 9.04 9.02 2.60 35.26 (13.40) (8.25) (8.35) (0.00) (30.00) "Figures in parenthesis are the amounts to be financed by the Bank Loan. All costs include contingencies. 2/Includes civil works and goods to be procured through national shopping, consulting services, services of contracted staff of the project management office, training, technical assistance services, and incremental operating costs related to (i) managing the project, and (ii) re-lending project funds to local government units. Interest during construction (IDC) will finance interest, commitment fees, and any other applicable charges on the total Bank loan that are payable to the Bank during the project's construction period by DBP. The Bank will only finance IDC if DBP finances IDC on its subloans. - 63 -  Table Al: Consultant Selection Arrangements (optional) (US$ million equivalent) Selection Method Consultant Services Expenditure Category QCBS QBS SFB LCS CQ Other N.B.F. Total Cost' A. Firms 0.00 0.00 0.00 0.00 0.00 1.50 0.00 1.50 (0.00) (0.00) (0.00) (0.00) (0.00) (1.50) (0.00) (1.50) B. Individuals 0.00 0.00 0.00 0.00 0.00 0.15 0.00 0.15 (0.00) (0.00) (0.00) (0.00) (0.00) (0.15) (0.00) (0.15) Total 0.00 0.00 0.00 0.00 0.00 1.65 0.00 1.65 (0.00) (0.00) (0.00) (0.00) (0.00) (1.65) (0.00) (1.65) 1\ Including contingencies Note: QCBS = Quality- and Cost-Based Selection QBS = Quality-based Selection SFB = Selection under a Fixed Budget LCS = Least-Cost Selection CQ = Selection Based on Consultants' Qualifications Other = Single Source Selection, Selection of individual consultants (per Section V of Consultants Guidelines), Commercial Practices, etc. N.B.F. = Not Bank-financed Figures in parenthesis are the amounts to be financed by the Bank Loan. - 64 -  Prior review thresholds (Table B) All design, build and lease contracts, and works contracts procured according to ICB regardless of amount will be subject to the Bank's prior review. All civil works contracts with a value of US$50,000 equivalent or more each will be subject to the Bank's prior review. The first three civil works contract, each year, estimated to cost less than US$50,000 equivalent procured through Procurement of Small Works. Prior review of civil works contract include bidding documents, evaluation reports and draft contracts. Prior Bank review would also be required for contracts of individual consultants estimated to cost at least US$ 50,000 equivalent and contracts of firms estimated to cost at least US$100,000. Prior review procedures will apply regardless of the value of consultants' contracts with respect to draft letters of invitation and contracts, terms of reference, sole source selection, qualification criteria, evaluation reports, award proposals and final contracts when substantial differences to original draft are made. Table B: Thresholds for Procurement Methods and Prior Review1 Contract Value Contracts Subject to Threshold Procurement Prior Review Expenditure Category (US$ thousands) Method (US$ millions) 1. Works less than $50,000 Procurement of Small First three contracts each Works year $0.15 million $50,000 to $2 rnillion NCB $7.94 million $2 million and above ICB $ 11.9 million 2. Goods 3. Services Firms>100 Single-Source Selection $1.5 million Individual Consultants Individual Selection $0.1 million >50,000 4. Miscellaneous 5. Miscellaneous 6. Miscellaneous Total value of contracts subject to prior review: $22.00million Overall Procurement Risk Assessment Average Frequency of procurement supervision missions proposed: One every 3 months (includes special procurement supervision for post-review/audits) Thresholds generally differ by country and project. Consult OD 11.04 "Review of Procurement Documentation" and contact the Regional Procurement Adviser for guidance. - 65 -  Disbursement Allocation of loan proceeds (Table C) Disbursement of the proceeds of the loan would be made over 5 years against expenditure categories as shown in Table C. Table C: Allocation of Loan Proceeds Expenditure Category Amount In US$million Financing Percentage DBP Component Works - Water Supply 17.85 90 Services - Consultancy 1.65 100 Works - Sanitation 1.50 90 Works - Drainage 1.00 90 On-Lending to Private Operators 3.60 90 Land Acquisition 0.00 0.00 Total Project Costs 25.60 Interest during construction 4.10 100 Front-end fee 0.30 100 Total 30.00 Use of statements of expenditures (SOEs): For Civil Works contracts below US$50,000 equivalent, consulting firms contracts below US$ 100,000 equivalent, individual consultant contracts below US$ 50,000 equivalent, sub-loans and grants and all administrative, operational and training expenditures, withdrawal applications will be supported by Statement of Expenditures (SOEs). For civil works contracts over US$200,000 equivalent, consulting firms contracts over US$100,000 equivalent and individual contracts over US$50,000 equivalent, withdrawal applications would be supported by full documentation and signed contracts. Special account: Special account: To facilitate loan disbursement, the Development Bank of the Philippines will open and maintain a separate Special Accounts (SAs), in a commercial bank specifically authorized for this purpose by the Bangko Sentral ng Pilipinas, on terms and conditions satisfactory to the Bank, including appropriate protection against set-off, seizure and attachment, acceptable to the Bank. The SA which is a deposit account serving as a revolving accounts funded by an advance from the Bank loan to cover the Bank's share of actual eligible expenditures incurred. The SA shall have an authorized allocation of US$ 2.50 million deposited in the Special Accounts. The balance shall be withdrawn when the amounts disbursed and committed total US$ 15.00 million. Applications to replenish the Special Account, supported by appropriate documentation, would be submitted preferably monthly (not less than quarterly) or when the amounts withdrawn equal 20 per cent of the initial deposit, whichever comes first. The borrower shall likewise open an account for its counterpart funds requirements in pesos. The Special Accounts shall be audited annually by the auditors acceptable to the Bank and the auditor's report submitted to the Bank. - 66 -  Project Management Reports (PMRs): The project shall initially be SOE (Statement of Expenditures) based but ultimately after 6 months from effectiveness, it shall be PMR (Project Management Report) based. The former is based on a reimbursement application whereas the latter is based on periodic financial reports which contain forecast of funds needed for the next 6 months. The Project Management Reports (PMRs) consists of financial, progress and procurement reports which provides significant help for DBP or the PMO to manage the project. The PMRs applicable for this project shall be the following (the format of which shall be agreed with the Bank): 1. Financial Reports a. Project Balance Sheet b. Project Sources and Uses of Funds c. Project Cash Withdrawals (Disbursements) d. Special Accounts Statement e. Project Cash Forecast 2. Monthly Project Progress Report Output Monitoring Report (Unit of Output by Project Activity) 3. Procurement Management Report a. Procurement Process Monitoring (Goods and Works) b. Procurement Process Monitoring (Consultants' Services) c. Contract Expenditure Report (Goods and Works) d. Contract Expenditures Report (Consultants' Services). Financial Management: 1. FM Units in DBP/PMO - Shall be created with professional and experienced staff of at least an FMU Head and an Accountant. It will be the focal point of all FM for the project including the project's records management by negotiations. 2. A project FM reporting system - Shall be set up that covers its financials, progress and procurement. The format of these reports, referred to as the PMRs shall be agreed with the Bank at negotiation. The financial and physical accomplishment reports must be linked. Likewise, a project financial plan must be prepared based on a project implementation and procurement plans by negotiations. 3. Accounting system - The accounting system shall be modified to be able to provide for the generation of the necessary financial management reports for the project by negotiations. 4. Area Management Offices (AMOs) and branches - Shall actively participate in the screening and management of sub loans to LGUs. 5. Orientation - The DBP/PMO and other units concerned shall be properly oriented on the project and its requirements including orientation on the World Bank's financial management (including disbursements and audit requirements) and procurement requirements. 6. Audit Reports - Throughout the implementation of the project, timely annual audit reports, issued by an independent auditor, on the financial statements of DBP and the Project and on the Project's SA and SOEs/PMRs together with the auditor's detailed comments on DBP's and the project's financial - 67 -  management system shall be required to be submitted to the World Bank not later than 6 months after the end of DBP's fiscal year. - 68 -  Annex 7: Project Processing Schedule PHILIPPINES: LGU Urban Water and Sanitation Project APL2 Project Schedule Planned Actual Time taken to prepare the project (months) 16 19 First Bank mission (identification) 02/14/2000 02/14/2000 Appraisal mission departure 02/01/2001 03/12/2001 Negotiations 03/12/2001 08/20/2001 Planned Date of Effectiveness 08/17/2001 Prepared by: Vijay Jagannathan Preparation assistance: Minerva Espinosa-Apurada, Luisa Sambeli Espanola Bank staff who worked on the project included: Name Speciality Vijay Jagannathan Task Team leader, Economic and Institutional Aspects Luiz Claudio Tavares Engineering Aspects Cecilia Vales Procurement Aspects Joseph G. Reyes Financial Management Aspects Maya Villaluz Environmental Aspects Lanfranco Blanchetti-Revelli Resettlement Aspects Karen Jacob Community Participation Aspects Mariles Navarro Economic Analysis and Policy Aspects George Calderon Financial Analysis Jose League LGU Liaison Margaret Png Legal Counsel Angelina Ibus Community Participation Aspects Aldo Baietti Financial Analysis - 69 -  Annex 8: Documents in the Project File* PHILIPPINES: LGU Urban Water and Sanitation Project APL2 A. Project Implementation Plan Including Operational Guidelines for: 1. Preparing technical design 2. Financial Projections of LGU borrowing capacity using long-term financial planning model 3. Economic Appraisal of subprojects 4. Resettlement and Compensation Guidelines 5. Environmental Assessment Guidelines B. Bank Staff Assessments 1. Financial management Assessments of LBP and DBP 2. Procurement Assessment of LBP and DBP 3. Back-to-office reports in March 2000, August 2000, December 2000, April 2001. 4. Project Concept Review Minutes 5. Project Decision Meeting Minutes C. Other 1. Bidding documents for design-build-lease contracts 2. Philippines Water Regulatory Bill draft 3. Feasibility Studies and Preliminary Designs for APL2 LGUs (by SKM) *Including electronic files - 70 -  Annex 9: Statement of Loans and Credits PHILIPPINES: LGU Urban Water and Sanitation Project APL2 May-2001 Difference between expected Original Amount in US$ Millions and actual disbursements Project ID FY Purpose IBRD IDA GEF Cancel. Undisb. Orig Frm Rev'd P057731 2001 METRO MANILA URBANTRANSPORT 60.00 0.00 0.00 0.00 60.00 0.00 0.00 P066069 2001 INTEGRATION 4.79 0.00 0.00 0.00 4.30 0.21 0.00 P058842 2000 LAND ADMIN & MANAGEMENT 27.50 0.00 0.00 0.00 24.57 5.57 0.00 P059933 2000 MINDANAO RURAL DEV 0.00 0.00 1.25 0.00 1.17 0.90 0.00 P065113 2000 COASTAL MARINE 100.00 0.00 0.00 0.00 75.30 48.29 0.00 P039019 2000 PH-SOCIAL EXPENDITLRE MGMT 150.00 0.00 0.00 0.00 134.02 14.35 0.00 P039022 1999 FIRST NATL ROADS IMPROV/MGNT. PROJECT 23.30 0.00 0.00 0.00 18.57 10.17 o.o0 P057598 1999 PHIL-LGU URBAN WATER&SANITATION PROJ 150.00 0.00 0.00 0.00 114.13 69.13 0.00 P048588 1999 RURAL FINANCE III 100.00 0.00 0.00 40.00 56.31 12.68 0.00 P004566 1998 PHIL-LGUl FINANCE AND DEVELOPMENT 19.00 0.00 0.00 0.00 15.37 8.71 0.00 P004576 1998 PROJECT 56.80 0.00 0.00 0.00 34.04 47.11 8.00 P004595 1998 PH-EARLY CHILD DEV. 50.00 0.00 0.00 10.00 34.93 22.87 0.00 P051386 1998 PHIL-WArER DISTRICTS DEVELOPMENT 10.00 0.00 0.00 0.00 0.72 0.72 0.00 P040981 1997 PROJECT 60.00 0.00 0.00 23.85 24.69 48.54 11.31 P004602 1997 COMMUNITY BASED RESO 113.40 0.00 0.00 20.10 80.07 77.86 0.00 P037079 1997 SZOPAD SOCIAL FUND 50.00 0.00 0.00 0.00 13.75 -0.78 0.00 P004613 1997 SECOND SUBIC BAY 58.00 0.00 0.00 7.27 31.89 33.83 -0.15 P004571 1996 PH-THIRD ELEMENTARY EI3JCATION 250.00 0.00 0.00 45.52 90.63 112.41 46.74 P004614 1996 AGRARIANREFCRMCOMM 150.00 0.00 0.00 0.00 8.11 8.11 0.00 P004611 1996 WATER RESOURCES DEVE 57.00 0.00 0.00 9.00 43.70 52.04 8.48 P004567 1995 TRANS GRID REINFORCE 18.00 0.00 0.00 4.30 4.66 8.96 4.08 P004403 1994 RURAL FNANCE II 0.00 0.00 0.00 2.00 5.61 9.48 0.00 PHIL-MANILA SEWERAGE PROJECT 11 PH-WOMENS HEALTH & SAFE MOTHERHOOD CONS. OF PRIORrTY PR Total: 1507.79 0.00 1.25 162.03 876.54 591.15 78.47 - 71 -  PHILIPPINES STATEMENT OF IFC's Held and Disbursed Portfolio May-2001 In Millions US Dollars Committed Disbursed IFC IFC FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic 1980/82/89/90/94/95 AACT 0.00 1.70 0.00 0.00 0.00 1.70 0.00 0.00 1996 All Asia Growth 0.00 4.00 0.00 0.00 0.00 4.00 0.00 0.00 1996 All Asia Manager 0.00 0.04 0.00 0.00 0.00 0.04 0.00 0.00 1996 All Asia Venture 0.00 0.01 0.00 0.00 0.00 0.01 0.00 0.00 2000 Asian Hospital 14.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 BPI Philippines 22.64 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0/97/98 Bataan P/E 30.00 0.00 10.00 138.00 30.00 0.00 10.00 117.25 1997 Drysdale Food 15.00 0.00 0.00 10.00 9.60 0.00 0.00 6.40 1998 General Milling 0.00 0.65 0.00 0.00 0.00 0.65 0.00 0.00 1979/90 H&Q PV III 0.00 7.50 0.00 0.00 0.00 3.74 0.00 0.00 1998 H&QPV-I 0.00 0.61 0.00 0.00 0.00 0.61 0.00 0.00 1989 H&QPV-II 0.00 1.43 0.00 0.00 0.00 1.43 0.00 0.00 1993 MERALCO 1.76 0.00 0.00 0.00 1.76 0.00 0.00 0.00 1967/88 Mariwasa 11.04 0.00 3.00 0.00 11.04 0.00 3.00 0.00 1970/72/00 Mindanao Power 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1993/94 Pagbilao 39.00 10.00 0.00 5.40 39.00 10.00 0.00 5.40 1993 Pilipinas Shell 0.00 1.56 0.00 0.00 0.00 1.56 0.00 0.00 1992 PlantersBank 15.00 0.00 8.71 0.00 15.00 0.00 8.71 0.00 2000 Pryce Gases 10.00 0.00 3.00 5.00 10.00 0.00 3.00 5.00 1998 STRADCOM 12.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 2000 Sual Power 29.35 17.50 0.00 182.06 29.35 17.50 0.00 182.06 1995 TRP 0.00 0.05 0.00 0.00 0.00 0.05 0.00 0.00 1999 UPPC 30.00 0.00 0.00 0.00 30.00 0.00 0.00 0.00 1999 Union Cement 1.40 5.63 0.00 1.00 1.40 5.63 0.00 1.00 1992 Walden Mgmt 0.00 0.05 0.00 0.00 0.00 0.05 0.00 0.00 1994 Walden Ventures 0.00 3.75 0.00 0.00 0.00 3.75 0.00 0.00 1994 ePlanters 0.00 0.21 0.00 0.00 0.00 0.12 0.00 0.00 2000 Total Portfolio: 231.19 54.69 24.71 341.46 177.15 50.84 24.71 317.11 Approvals Pending Commitment FY Approval Company Loan Equity Quasi Partic 2000 Asian Hospital 0.00 0.00 0.00 5.00 1999 Cepalco 16.00 6.00 0.00 0.00 1998 FarEast Bank 11 0.00 0.00 0.00 15.00 2000 LTO Project 0.00 8.00 0.00 20.00 2000 MFI MEP 0.00 0.00 0.00 0.00 2001 Manila Tollways 46.00 0.00 0.00 0.00 1997 PT&T 30.00 0.00 5.00 30.00 Total Pending Commitment: 92.00 14.00 5.00 70.00 - 72 -  Annex 10: Country at a Glance PHILIPPINES: LGU Urban Water and Sanitation Project APL2 East Lower- POVERTY and SOCIAL Asia & middle- Philippines Pacific Income Development diamond* 1999 Population, mid-year (millions) 76.8 1,B37 2,094 Life expectancy GNP Per capita (Atlas method, US$) 1,020 1,000 1,200 GNP (Atlas method, USS billions) 78.0 1,833 2,513 Average annual growth, 1993-99 Population (%) 2.2 12 1.1 Labor force 1%) 2.7 1.3 1.2 GNP Gross per primary Most recent estimate (latest year available, 1993-99) capita enrollment Povertv (% of population below national poverty line) 37 Urban Dopulation (% of total population) 58 34 43 l Life expectancy at birth (vears) 69 69 69 Infant mortality (per 1,000 live births) 32 35 33 Child malnutrition (% of children under 5) 30 22 15 Access to safe water Access to improved water source (% of population) 83 84 86 Illiteracy (% of population aqe 15+) 5 15 16 Gross Drimary enrollment (%of school-age population) 117 119 114 -Philippines Male 121 114 Lower-middle-income group Female 121 116 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1979 1989 1998 1999 Economic ratios' GDP (US$ billions) 27.4 42 6 65.5 76.6 Gross domestic investment/GDP 33.2 21.6 20.2 18.6 Exports of qoods and services/GDP 21.6 28.5 51.9 51.2 Trade Gross domestic savinqs/GDP 28.1 19.8 13.6 19.6 Gross national savinqs/GDP 29.7 21.1 18.6 25.1 Current account balance/GDP -55 5 -34 7.7 14.7 omestic Interest Davments/GDP 1.8 3.9 3.0 2.5 sInvestment Total debt/GDP 48.4 67.2 73.0 68.2 Savings Total debt service/exports 24.6 25.9 10.3 10.8 Present value of debt/GDP 69.2 Present value of debt/exDorts 90.5 Indebtedness 1979-89 1989-99 1998 1999 1999-03 (average annual growth) GDP 0.8 3.0 -0. 8 3.2 4.3 - Ph/ilppines GNP per capita -2.0 1.3 -2.0 1.3 2.3 Lower-middle-income group Exports of qoods and services 4.1 7.8 -21.0 3.6 9.3 STRUCTURE of the ECONOMY 1979 1989 1998 1999 Growth of Investment and GDP (%) (% of GDP) 20 Aqriculture 27.4 22.7 17.4 17.7 T Industrv 37.0 34.9 31.3 30.3 _ Manufacturing 25.1 24.9 21.8 21.5 Services 35.6 42.4 51.3 52.0 0 97 \ N 9 Private consumDtion 62.5 70.6 73.1 67.4 -20 General qovernment consumption 9.4 9.5 13.2 12.9 -Go - -DP Imports of goods and services 26.6 30.3 58.5 50.2 1979-89 1989-99 1998 1999 Growth of exports and Imports (%) (average annual growth) Agriculture 0.9 1.4 -7.3 6.2 20 Industry -1.2 3.0 -2.1 0.3 1 Manufacturing -0.3 2.7 -1.1 1.6 Services 2.6 3.8 3.5 4.1 Private consumption 1.9 3.9 6.9 0.4 -1i General government consumption -0.2 3.5 -1.9 5.3 Gross domestic investment -4.1 3.5 -16.3 -2.9 -20 Imports of goods and services 2.0 8.9 -14.7 -2.8 -Exports 0 Imports Gross national Droduct 0.6 3.7 0.2 3.5 Note: 1999 data are preliminary estimates. The diamonds show four kev indicators in the countrv (in bold) compared with its income-qroup average. If data are missinqg the diamond will be incomplete. - 73 -  Philippines PRICES and GOVERNMENT FINANCE 1979 1989 1998 1999 Inflation (%) Domestic prices (% change) Consumer prices 12.2 9.8 6.6 __ Implicit GDP deflator 14.8 9.0 11.3 8.2 Govemment finance (% of GDP, includes currentgrants) o Current revenue 16.5 26.9 25.6 94 95 96 97 98 9 Current budget balance 1.0 4.5 2.7 -GDP deflator 2 CPI Overall surplus/deficit -2.1 -0.9 -2.7 TRADE (USS millions) 1979 1989 1998 1999 Export and Import levels (USS mill.) Total exports (fob) 7,821 29,496 35,081 40,0 Coconut oil 377 Sugar 89 D 3A00* Manufactures 5,192 25,866 31,097 WC Total imports (cifl 10,419 31,848 36,276 20.000 Food .. 521 1,774 1,982 10.000 Fuel and energy 1,397 2148 3,395 Capital goods 2,424 12,818 14,555 o lfI' 93 94 95 96 97 98 99 Export price index (1995=100) .. 88 Import price index (1995=100) .. 86 * Exports * Imports Terms of trade (1995=100) .. 103 BALANCE of PAYMENTS (USS millions) 1979 1989 1998 1999 Current account balance to GDP (%) Exports of goods and services 5,678 10,674 43,413 47,886 15 Imports of goods and services 7,305 11,845 42,302 41,179 Resource balance -1,627 -1,171 1,111 6,707 10 Net income -223 -1,332 3,530 4,104 s Net current transfers 355 1,045 435 481 Current account balance -1,495 -1,458 5,076 11,292 97 98 99 Financing items (net) 1,811 1,758 -3,717 -7,351 Changes in net reserves -316 -300 -1,359 -3,941 o Memo: Reserves including gold (US$ millions} 10,684 14,988 Conversion rate (DEC, locallUS$) 7.4 21.7 40.9 39.1 EXTERNAL DEBT and RESOURCE FLOWS 1979 1989 1998 1999 (US$ millions) Composition of 1998 debt (USS mill.) Total debt outstanding and disbursed 13,282 28.653 47,817 52,212 IBRD 731 3,492 4,311 4040 A: 4,311 IDA 32 102 205 206 G:7.1BS B:205 Total debt service 1,584 3,244 5,166 6,026 IBRD 86 536 654 642 0_3,456 IDA 0 2 4 4 Composition of net resource flows Official grants 58 380 184 Official creditors 427 874 -6 -38 Private creditors 703 -275 419 3,991 _ : 12,237 Foreign direct investment 7 563 1,713 F: 18.855 Portfolio equity 0 253 454 World Bank program Commitments 273 801 679 128 A - IBRD E - Bilateral Disbursements 213 465 301 163 B-IDA D - Other multilateral F - Prvate Principal repayments 25 269 389 387 C - IMF G - Short-term Netflows 188 196 -88 -224 Interest payments 61 269 268 259 Net transfers 127 -73 -356 -483 Development Economics 9/5/2000 - 74 -  Additional Annex 11 Environmental and Social Safeguards Guidelines - Summary PHILIPPINES: LGU Urban Water and Sanitation Project APL2 Introduction The project aims to assist LGU-managed and privately-managed water utilities operate on commercial principles and provide consumers with safe, reliable, sustainable water and sanitation services in about 250 secondary towns and cities. The substantive environmental impact assessment (EIA) requirements for World Bank projects (i.e. OP 4.01: Environmental Assessment) are consistent with the Philippine Environmental Impact Assessment (EIA) Law (Presidential Decree 1586) requirements. The Department of Environment and Natural Resources (DENR) administers the process and issues Environmental Compliance Certificates (ECCs) to projects meeting the prescribed minimum requirements. In this regard, the World Bank has expressed its no objection if the Philippines Government environmental laws and regulations are followed in the application of procedures for environmental assessment, clearance, management and monitoring during project implementation. Projects that are not considered as environmentally critical, but located in Environmentally Critical Areas are required to prepare an LEE. If a decision cannot be made on the basis of the information obtained in the IEE, the DENR may require to expand the IEE to a full-blown Environmental Impact Statement (EIS). The IEE describes the potential environmental impacts of the projects, and maps out an Environmental Management Plan (EMP), which includes mitigation and monitoring programs. Upon the satisfactory compliance with all the requirements of the law including the incorporation of the components of the EMP in the project design, the regional DENR offices issue the required ECC. Further monitoring of the actions and agreements in the ECC will be required during the construction and operational phase. Given the nature, scope and scale of the subject individual projects, an Initial Environmental Examination (IEE), will be required for each of the project in the separate towns. In the case of social assessment requirements for World Bank projects, the relevant social safeguard policies (i.e. OD 4.20: Indigenous People) of the Bank have been used and specific guidelines have been developed in the Operations Manual (OM) for the preparation of the sub-projects. The OM addresses the following issues: Environmental Issues Environmental Assessment: In compliance with OP 4.01, environmental assessment and EMP preparation which is described in the OM will be an integral part of the project design, appraisal and implementation. Natural habitats: Under OP 4.04, although it is not anticipated, a screening process will determine if the project will likely affect any critical natural habitat or result in significant conversion or degradation of natural habitats. The environmental assessment process laid down in the OM will determine the effects on critical and natural habitats and design mitigation strategies. Proposed sub-projects that do not comply - 75 -  with or for which Bank support is prohibited under OP 4.04 are not eligible to participate in the Project and, therefore, will not be approved for financing under the Bank loan. Social Issues Although the sub-projects are expected to have only marginal social effects or may affect vulnerable groups such as indigenous peoples, the sub-project proponents are required to conduct a preliminary social / land acquisition assessment to determine the degree and scale of impacts and to determine the level of field surveys and investigations necessary and documentation requirements. The social assessment will also help to identify the level of risks and to decide whether or not to proceed further with sub-project preparation. The OM includes the objectives and principles of social assessment and provides an outline of possible mitigation measures such as compensation and other assistance including economic rehabilitation assistance measures. The OM contains guidelines related to compensation, resettlement and rehabilitation of affected persons and vulnerable groups and serve as the overall framework for preparation of appropriate documents for sub-projects. LGUs not complying with OP 4.04 will not be eligible to participate in the project, and therefore will not be approved for financing from the Bank loan. The OM gives emphasis on public participation and consultation in all aspects of sub-project identification, planning and implementation and is supported by a comprehensive framework for public participation and consultation in the project cycle. Applied process The Operations Manual describes the methodology and process to minimize adverse environmental impacts and manage the impact areas, providing appropriate mitigation and enhancement measures. The manual is a toolkit for the borrower (i.e. the Project Management Unit (PMU) of the LGU) and/or consultants to prepare the Initial Environmental Examination (IEE) reports and serve as a guide in obtaining the required ECCs for the projects. The manual does not intend to provide full IEE "blueprints"; the analysis of the local environmental conditions and the prediction of the potential environmental impacts will always be required during each of the IEE preparation. The key to ensuring safeguards is intensive project supervision by Bank staff familiar with the dialects of the archipelago. Supervision budgets have been allocated for environmental and social safeguard specialists based in Manila in order to adequately monitor compliance through periodic visits to the LGUs. In addition, DBP's Project Operations Manual requires an Annual Compliance Report on Environmental and Social concems. SUPERVISION PLAN Project Cycle Stages Responsibilities Project Preparation Consultants, LGU-PMU, DILG staff and World Bank Construction Construction Supervision Consultant and DBP-PMO staff/ World Bank Operations DILG, LGU-PMU, DENR staff and World Bank The proposed methodology is mainly based on, and combines the following guidelines and documents: - 76 -  * DENR Administrative order No. 96-37: Revising DENR administrative order No.2 1, series of 1992, to further strengthen the implementation of the Environmental Impact Statement (EIS) system; * DENR DAO 96-37 Procedural Manual (electronic copy; January 1997); * World Bank OP, BP, and GP 4.01: Environmental Assessment (1999); * World Bank Operational Directive 4.30: Involuntary Resettlement (1990); * NEDA Board resolutions 5 on the national policy and strategy on urban sewerage and sanitation (1994) and 12 on the common definitions and termns in water supply, sewerage and sanitation (1995). * Implementing rules and regulations of Chapters II "Water Supply" and XVII "Sewage collection and disposal, excreta disposal and drainage" of the Code of Sanitation of the Philippines (P.D. 856) * Water Code of the Philippines and the implementing rules and regulations, P.D. 1067 (National Water Resources Board, 1979). The process of compliance monitoring is discussed between the DENR and the LGU before the ECC is issued. A Multipartite Monitoring Team (MMT) is required to be set up co-chaired by the LGU and DENR to ensure that the project is regularly monitored during its life span. The DENR is also a member of the multi sectoral Municipal Development Council (MDC) which oversees the development and implementation of all projects in a municipality and is composed of government and non-government organizations and interest groups (e.g. farmers, business men, population, indigenous people, DENR representatives, NWRB, etc.). The Mayor is the chairman of the MDC; the Municipal Planning and Development Officer (MPDO) is its Technical secretary. World Bank environmental clearances shall be secured based on the results of the monitoring and evaluation of each phase of the project implementation. Accordingly, no bank clearance of the individual IEEs are required before implementation can start, under the condition that the ECC is obtained from DENR according to the procedures described in the Operations Manual, prior to the signing of the Subsidiary Loan Agreement (SLA). Principal activities The preparation of the IEEs is being implemented parallel to the feasibility study and the preliminary design. As such the Environmental Assessment process contributes to incorporating major environmental concerns into the formulation and evaluation of technical altematives, and prepares input for the community consultations. To reduce costs of the preparation, the actual write-up of the IEEs are only started when sufficient confidence is obtained (through a 60% sign-off by barangay households to the willingness to connect forms the project preparation team is required to obtain). The willingness to connect requirement is taken as an indication of social acceptability and commnitment from the municipality to pursue the project. This phase also ensures that indigenous people living in the project area fully participate in the decision making process. The Operations Manual for the project requires the borrower to ensure that there is informed participation and consultation with all stakeholders including indigenous people. The Operations Manual specifies the circumstances under which Resettlement Action Plans have to be applied. There have been no reseKtlements so far in over 100 towns where preparation work has been on-going since water sources presently identified for development are located in open lands and based on preliminary assessment, only a small confined space is needed for the source works and pumping stations. Other attendant works involve digging up existing infrastructure such as public sidewalks to install the service pipes. - 77 -  Under the overall coordination of the Depeartment of Interior and Local Government (DILG) staff, and with support of national environmental consultants, approximately 95 municipalities have been visited and initial discussions on environmental management conducted. For those municipalities who have pursued with the project, a total of 30 ECCs have been obtained. An additional 9 IEEs are still being reviewed by the DENR regional offices. Copies of all the IEEs, ECCs and the OM Update are available publicly in-country at Development Bank of the Philippines (DBP, ie. the borrower), DILG, DENR and the World Bank Office in Manila Public Information Center. The Operations Manual specify how the EA and SA will be incorporated into the sub-project cycle including the institutional responsibilities. The project proponent will ensure that the EMP is incorporated into the contracts used to implement the project. The LGU-PMU staff will provide supervision for projects with major environmental and social issues and or for those projects where unanticipated issues arise. DBP will prepare an Annual Report on Compliance of all sub-projects. Lessons from APL - 1 The DILG staff, with the help of national environmental consultants, developed sufficient capacity to discuss, conduct and process proper environmental assessments for the individual projects. No critical delays have been experienced during the preparation phases, although the different interpretation and application of the DENR regulations have resulted in different processing and approval arrangements between the DENR regional offices. T'he environmental assessment process has helped identify and address a number of challenges faced by the municipalities on water supply and sanitation. These include - Careful selection of the water source in areas where there is inadequate protection of the source and its surrounding areas - 3 for sites in public lands, its management should be clearly defined 3 for sites in private lands, assurance should be given to fence the source and would not require land acquisition 3 Provision under the sanitary component of financing household investments for sanitary facilities such as indoor plumbing and sanitation. This is to prevent improper wastewater disposal and inadequate sanitary facilities at the household level. * Successful implementation in municipalities are largely governed by the availability of adequate land area for the on-site sanitation facilities. * Strengthening the capacity of municipal staff to prepare the environmental assessment reports, and undertake environmental compliance monitoring through training and greater stakeholder participation in the environmental management process. Compliance monitoring during the construction phase is being carried out through the DBP-PMO, in close consultation with the PMU. However, limited experience has been obtained with the compliance monitoring during the operational phase. There is a concern that the current capacity and resources with the LGU administration in environmental regulation and monitoring may be insufficient to guarantee the proper implementation of the ECC conditions. Responsible for the operational management of the project, the DBP-PMO's capacity to provide guidance on environmental matters to the PMUs should also be strengthened. Likewise, the WSS-PMO of DILG which is responsible for the institutional capacity building of the PMUs should also strengthen their capacity to provide advise on environmental concerns. - 78 -  There continues to remain major challenges on how to sustain community-level monitoring of environmental management after the project's construction cycle is completed. Conclusions on how to streamline the process will be possible only after the first phase APL1 water supply systems are in operation for some time. Further training of LGU staff has been discussed to be followed by final implementation arrangements. Funding under the Nordic Development Fund (NDF), which is expected to be available to LGUs by January 2002 will be utilized to finalize the programs. The NDF financing is clearly only a short-term solution, and the Government intends to address these issues on a more long-term basis through technical assistance financed by the Bank-financed Local Government Finance and Development Project. There are covenants in the negotiated loan agreement that require compliance with certain specific aspects of the Operations Manual. In addition, there are two general covenants requiring the Borrower to abide by the provisions in the Operations Manual in carrying out Subprojects and not to amend the Operational Manual without the Bank's agreement. See Schedule 5 at para. 2 and Section 3.03(b). Breach of those covenants would allow the Bank to exercise remedies against the Borrower, including suspension of loan disbursement. - 79 -  0  MAP SECTION   Z 0 g, F : t:: :S::/: - f f 0 0X +' z .i 0 /X '> f (aME f $ \ r f f A S 00; lDDX X tS? ^ ' H~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~2oi J~ 0t 00 00:00000tbo}0;;0 0::0 ut;S;- | I 0