Page 1 PROJECT INFORMATION DOCUMENT (PID) APPRAISAL STAGE Report No.: AB555 Project Name Second National Water Development Project (NWDP II) – Supplemental Credit Region AFRICA Sector Water supply (100%) Project ID P083263 Borrower(s) GOVERNMENT OF MOZAMBIQUE Implementing Agency Ministry of Public Works and Housing Environment Category [ ] A [X] B [ ] C [ ] FI [ ] TBD (to be determined) Safeguard Classification [ ] S 1 [X ] S 2 [ ] S 3 [ ] S F [ ] TBD (to be determined) Date PID Prepared January 6, 2004 Date of Appraisal Authorization September 1, 2003 Date of Board Approval February 26, 2004 1. Country and Sector Background Mozambique’s growth rate has been 9% from 1997 to 2002, well above the African average and among the highest in the world, and is projected at between 7% and 12% annually until 2005. Growth has been driven mainly by megaprojects, foreign investment, and strong agricultural performance. Poverty, however, remains deep and may not have been reduced in the rural areas, where 70% of Mozambicans live. Improved quality of and increased access to safe water in urban and rural areas is among the six priority areas of the Government’s poverty reduction strategy, known as PARPA, endorsed by the Board of Directors of the World Bank and the International Monetary Fund in August 2001. In April 2003, the Government completed a first Progress Report and in June and July 2003, the Fund and Bank Boards found that Mozambique commitment to poverty reduction and that the PARPA continues to provide a sound basis for concessional assistance. The recent Country Assistance Strategy (CAS) was discussed at the Board November 20, 2003. The CAS supports the PARPA and stresses the provision of sustainable access to water, a key Millenium Development Goal (MDG). 2. Objectives: The Second National Water Development Project (NWDPII), the parent project of the Supplemental Project, was approved on June 17, 1999 and became effective on March 8, 2000 in the amount of about of US$75 million equivalent. The total cost of the project was US$115 million and included a US$10 million grant from the Government of the Netherlands and US$30 million credit from the African Development Bank (AfDB). The main objective of the project is to improve the quality, reliability and sustainability of water services for the cities of Maputo, Beira, Quelimane, Nampula and Pemba. The project had two major components. The first component made up the majority of the credit (US$110 m) and included support to private sector management and financing for major capital works for five cities. The second component included TA support for urban water supply policy and support to the Water Sector Regulator (CRA -Conselho de Regulação do Abastecimento de Água). Page 2 The proposed supplemental credit is consistent with the main development objective of the parent project which is to improve the quality, reliability and sustainability of water services for five major cities through promoting greater private sector participation in the provision of these services. 3. Rational for Bank Involvement The benefits of the NWDP II and the proposed Supplemental Credit would be to support the full achievement of the project development objectives (PDOs). The project will continue to improve water supply coverage and service to communities of the five major cities of Mozambique or over 75% of the urban population in a sustainable way through private sector management and investments in water supply infrastructure. Successful implementation of the Project is expected to lead to safer and more reliable water supply services for about 1.3 million people living in urban and peri-urban areas as well as increased supply to service industrial, institutional and commercial users. 4. Description The Government of Mozambique decided to improve the management and efficiency of water supply in the five cities by contracting out operations to a private operator. Oversight and control of the urban water sector and private operator were to be assured by the autonomous public body, Fundo de Investimento e Patrimonio do Abastecimento de Agua (FIPAG), and the Independent Regulator (CRA). Both these institutions were created in 1998 under legislative arrangements and passed into law. Early in 1999 bids were submitted for undertaking a 15-year lease contract in Maputo and 5 year management contracts in the cities of Beira, Quelimane, Nampula and Pemba. In April 1999 Aguas de Mozambique (AdeM) (a consortium of SAUR International, IPE Aguas de Portugal and a group of five local investors) was declared the successful bidder, and in late September, 1999, the lease contract for Maputo and the management contracts for the four cities were signed. In February 2001, 15 months after take over, AdeM submitted a request for an interim review of the operator tariff and the tariff indexing formula for the lease contract for Maputo. During this operating period financial problems of AdeM were exacerbated due to the extensive flooding of February 2000. Negotiations over a revised operating tariff and requests for other cost increases under the lease continued but were ultimately unsuccessful. As of December 14, 2001, Saur International, which was previously the majority shareholder in AdeM, terminated its involvement in the lease and management contracts. On December 15, 2001, FIPAG, together with AdeM, AdeP, and AdeM’s other shareholders, signed a Memorandum of Understanding (“MoU”) that sets out the basis on which AdeM would continue to operate under the lease and management contracts while FIPAG and AdeM continued to negotiate long-term financial and contractual arrangements. The MOU was initially to last 15 months but in fact continued until the end of October, 2003 for the lease and until mid November, 2003 for the management contract. Early in this process, and subsequent to the withdrawal of Saur International from AdeM, the possibility of rebidding the contracts was discussed. It was concluded, however, that the launching of a new competitive bidding process was unlikely to attract enough competition mainly because of the lack of qualified companies Page 3 willing to take part in Mozambique. Under the circumstances, in order to avoid further delays in achieving the desired outcomes under the Project, it was concluded that the best available option was to renegotiate the contract with the reconstituted consortium led by AdeP. During the implementation of the MoU, certain cost increases were negotiated between the FIPAG and AdeM. These included the increases in the operators tariff, increases in the unit rates for the delegated works, and subsequent oversight costs for the PO including program management, procurement, and site supervision, and management fees for the four cities contracts. Further the increased operators tariff had the effect of reducing the variable rental fee for FIPAG thus squeezing its operating budget and therefore limited FIPAG’s ability to support the 4 cities with necessary operating costs. The Supplemental Credit will finance the increased cost of the delegated works program and support operational costs for the FIPAG as a result of the revised contracts. Given the revised contract rates and fees, the extra funds necessary to undertake the work originally envisioned amounted to an increase of US$ 9.35 million. Market based comparisons have been used to establish the creditability of the revised negotiated rates. The credit will also support operational costs for FIPAG and the four cities. These mainly include unfunded costs of electrical power, which make up to 50% of total operational costs, chemical costs and system reinstatement costs. The deficit on operating costs as a result of this is estimated at US$ 7.15 million over the next 4 years. IDA will fund US$ 15 million of the shortfall for delegated works and operating costs. During the Mid Term Review (MTR) in September 2003, it was concluded that an extension of the project closing date would be necessary to achieved the project’s development objectives. The successful implementation of the private sector contracts – the 12 year lease and the 3 year management contract – remain the most important activity in order to achieve these goals. It is expected that some of the works contracts will not be completed until end 2006. The Government requested and IDA agreed that the project will be extended by 18 months until March 31, 2007. Further amendments, as part of the agreed recommendations in MTR, include streamlining of the performance indicators, adjustment to the on-lending rate to be based in the borrower’s currency, creation of a second special account, and reallocation of the credit proceeds. 5. Financing Source: ($m.) BORROWER/RECEPIENT 1.5 INTERNATIONAL DEVELOPMENT ASSOCIATION 15.0 Total 16.5 6. Implementation The proposed Supplemental Credit does not require additional implementation capacity beyond what is already in place. The NWDP II project framework is executed by the Ministry of Public Works and Housing has performed satisfactorily and will oversee the execution of the Supplemental Credit. The Supplemental Credit will be subject to the same monitoring and reporting requirements of the project. Page 4 7. Sustainability Great effort has been made to assess the financial sustainability of the project. FIPAG has developed a 20 year financial model, which projects operating revenues and expenses for the 4 cities, revenues from the Maputo Lease contract, office expenses and capital expenditures and investment financing for all assets under FIPAG’s responsibility 5 cities. Overall results are discussed here. Key results are shown in the tables below and major assumptions used in making projections for each operation are summarized in the attached tables. 8. Lessons Learned from Past Operations in the Country/Sector • Across the sector, a critical lesson learned is that a good water and sanitation policy must strive for cost recovery and sustainability; proper pricing and a good tariff policy are most important in demand management. • A realistic approach to using private sector participation in the urban water sector is critical; private sector needs to be compatible and compliment the Government’s objectives in the sector. Experience shows that there needs to be an effective and firm Government commitment for PSP that will build consensus. Stakeholder consultation is essential along with the full understanding of the different roles of the key players in the sector for: policy, regulation, and implementation. • It is very important to conduct financial analyses at different stages in a project. These need to include affordability assessment and pricing and tariff assessments. These studies should lead to an evaluation of a realistic level of service given the utility’s and community’s financial and technical constraints. 9. Safeguard Policies (including public consultation): The supplementary credit will not finance any new activities that have potential adverse environmental or social impacts, consequently the management measures put in place for the original project and still in effect do not need to be amended or augmented. The proposed Supplemental Credit is rated “B” as the parent project, however no safeguard polices are triggered under the Supplemental Credit. Safeguard Policies Triggered by the Project Yes No Environmental Assessment ( OP / BP / GP 4.01) [ ] [X ] Natural Habitats ( OP / BP 4.04) [ ] [X] Pest Management ( OP 4.09 ) [ ] [X] Cultural Property ( OPN 11.03 , being revised as OP 4.11) [ ] [X ] Involuntary Resettlement ( OP / BP 4.12) [ ] [X ] Indigenous Peoples ( OD 4.20 , being revised as OP 4.10) [ ] [X ] Forests ( OP / BP 4.36) [ ] [X ] Safety of Dams ( OP / BP 4.37) [ ] [X ] Projects in Disputed Areas ( OP / BP / GP 7.60) * [ ] [X ] Projects on International Waterways ( OP / BP / GP 7.50) [ ] [X ] Page 5 10. List of Factual Technical Documents: Five Cities Private Sector Participation (PSP) Contracts – Review of Adjusted Unit Rates and Fees for Delegated Works and Capital Investment Rates 11. Contact point N. Jane Walker Title: Lead Water and Sanitation Specialist Tel: (202) 458-2703 Fax: (202) 473-8301 Email: Nwalker@worldbank.org 12. For more information contact: The InfoShop The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 458-5454 Fax: (202) 522-1500 Web: http://www.worldbank.org/infoshop