Documentof The WorldBank FOR OFFICIALUSE ONLY ReportNo: 27759-HR FOROFFICIALUSE ONLY ' PROJECTAPPRAISALDOCUMENT ONA PROPOSEDADAPTABLE PROGRAMLOAN INTHEAMOUNT OFEURO40 MILLION TO THE REPUBLICOF CROATIA FORA COASTAL CITIES POLLUTIONCONTROLPROJECT INSUPPORTOFTHEFIRSTPHASEOFTHE COASTAL CITIES POLLUTIONCONTROLPROGRAM May 4,2004 InfrastructureandEnergySector Unit SouthCentralEuropeCountryUnit EuropeandCentralAsia Region This document has a restricteddistributionandmay beusedby recipients only inthe performanceoftheir official duties. Its contents mavnot otherwise be disclosedwithout World Bankauthorization. CURRENCY EQUIVALENTS (Exchange Rate Effective April 30,2004) Currency Unit = Croatian Kuna (HRK) HRKl = US$0.1584 US$1 = HRK6.3143 FISCAL YEAR January 1 -- December 31 ABBREVIATIONS AND ACRONYMS APL Adaptable ProgramLoan CAMP Coastal Areas Management Programme CAS Country Assistance Strategy CPAR Country Procurement Assessment Review EBIT Earnings Before Interest and Taxes EBRD EuropeanBank for Reconstruction and Development EA Environmental Impact Assessment EIB European Investment Bank EIFF Environmental Infrastructure Financing Facility EIRR Economic Intemal Rates o f Retum EMP Environmental Management Plan EU EuropeanUnion FMR Financial Management Report FMS Financial Management System GORE% Government Office for the Rights o f Property HBOR Croatian Bank for Reconstruction and Development HV Hrvatske Vode (Croatian Waters) IBRD International Bank for Reconstruction andDevelopment I P H Institute o f Public Health KfW Kreditanstalt fix Wiederaufbau (Germany) MAP Mediterranean Action Plan MEIP Municipal Environmental Infrastructure Project MoE Ministryo fEnvironmental ProtectionandPhysicalPlanning andConstruction MW Minor Works MWSC Municipal Water and Sewerage Company NEAP National Environmental Action Plan N P V Net Present Value O&M Operation and Maintenance P M U Project Monitoring Unit PPL Public Procurement Law S A Special Account SAs Social Assessments SEA Strategic Environmental Assessment SFI Specialized FinancialIntermediary SPSC Special Puqose Subsidiary Company SOEs Statements o f Expenditures FOROFFICIAL USEONLY TA Technical Assistance UNCITRAL UnitedNations Commission on International Trade Law Vice President: Shigeo Katsu, ECAVP Country Director: Anand Seth, ECCUS Country Manager: IndiraKonjhodzic, ECCHR Sector Director: Hossein Razavi, ECSIE Sector Manager: Sumter Lee Travers, ECSIE Task Team Leader/Task Manager: Manuel Mariiio, ECSIE This document has a restricted distribution andmay be used by recipients only in the performance of their official duties. I t s contents may not be otherwise disclosed without World Bank authorization. CROATIA COASTALCITIES POLLUTION CONTROLPROJECT CONTENTS A. Program Purpose and Project Development Objective Page 1. Programpurpose andprogramphasing 3 2. Project development objective 3 3. Key performance indicators 4 B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported bythe project 2. Main sector issues and Government strategy 3. Sector issues to be addressedby the project and strategic choices 4. Program description and performance triggers for subsequentloans C. Program andProject Description Summary 1. Project components 10 2. Key policy andinstitutional reforms supportedby the project 12 3. Benefits and target population 13 4. Institutional and implementationarrangements 13 D.Project Rationale 1. Project altematives considered and reasons for rejection 15 2. Major related projects financed by the Bank andor other development agencies 17 3. Lessons learned andreflectedinthe project design 17 4. Indications o fborrower commitment and ownership 18 5. Value added o f Bank support inthis project 18 E. Summary Project Analysis 1. Economic 18 2. Financial 19 3. Technical 19 4. Institutional 20 5. Environmental 21 6. Social 23 7. Safeguard Policies 25 F. Sustainability andRisks 1. Sustainability 27 2. Critical risks 27 3. Possible controversial aspects 29 G. MainLoanConditions 1. Effectiveness Condition 29 2. OtherNegotiations Conditions 29 H. Readiness for Implementation 31 I.CompliancewithBankPolicies 31 Annexes Annex 1: Project Design Summary 32 Annex 2: DetailedProject Description 34 Annex 3: Estimated Project Costs 36 Annex 4: Cost Benefit Analysis Summary, or Cost-EffectivenessAnalysis Summary 37 Annex 5: Financial Summary for Revenue-Eaming Project Entities, or Financial Summary 39 Annex 6: (A) ProcurementArrangements 46 (B)Financial ManagementandDisbursementArrangements 52 Annex 7: Project ProcessingSchedule 55 Annex 8: Documents inthe Project File 56 Annex 9: Statementof Loans and Credits 57 Annex 10: Country at a Glance 59 Annex 11: Flow ofFunds 61 Annex 12: Monitoring System 63 Annex 13: Policy Framework 65 MWS) IBRDNo. 32862 CROATIA COASTAL CITIES POLLUTIONCONTROL PROJECT ProjectAppraisalDocument Europe and Central Asia Region ECSIE ~ D T e :May 4,2004 Team Leader: Manuel G. Marino Sector Manager: Sumter Lee Travers Sector@): Sewerage (70%), Generalwater, sanitationand Country Director: Anand K. Seth flood protection sector (30%) Project ID: PO65416 Theme@): Pollutionmanagement and environmentalhealth LendingInstrument: Adaptable ProgramLoan (APL) (PI, Other e n v h " t and natural resources management (PI For LoanslCreditslOthers: Loan Currency:Euro Amount (US$m): 47.54 millionUS$equivalent Euro 40 million - Borrower Rationalefor Choice of LoanTerms Available on File:[XI Yes ProposedTerms (IBRD): Fixed-SpreadLoan (FSL) Grace period(years):5 Years to maturity: 15 Front end fee (FEF) on Bank loan: 1.00% Paymentfor FEF: Borrower to Pay from OwnResources Initialchoice of Interest-rate basis: Maintain as Variable Type of repaymentschedule: [XI Fixed at Commitment,with the following repayment method(choose one): level [ ] Linkedto Disbursement Borrower: GOVERNMENTOF CROATIA Responsibleagency: HRVATSKEVODE (HV) Address: Ulica GradaVukovara220, 10000Zagreb, Croatia Contact Person: GeneralManager Tel: +385 16155 820 Fax: +385 16155 910 Email: @voda.hr Other Agency(ies): Ministryof EnvironmentalProtection, PhysicalPlanningandConstruction Address: Zagreb, Croatia Contact Person: RokoAndricevic, Assistant Minister Tel: +385 161 06 578 Fax: +385 16112073 Email: roko.andricevic@mzopu.hr Estimated Disbursements( Bank FY/US$m): Projectimplementationperiod: four (4 years) Expectedeffectivenessdate: 09/01/2004 Expectedclosingdate: 11/30/2008 - 2 - A. Program Purposeand Project DevelopmentObjective 1. Programpurpose andprogram phasing: The proposed Adaptable Program Loan (APL) supports the Government o f Croatia's comprehensive program to improve the provisiono f efficient and sustainable sanitation services inCroatia's Coastal Cities and, thus, improve coastal water quality along the Adriatic Coast. The overall objective o f the APL-supported Program is the improvement o f ambient coastal water quality to meet European Union (EU) standards. The key elements o fthe Program's first phase (the proposedProject) are: (i) expansion o f sewerage networks, adequate treatment and appropriate disposal o f municipal wastewaters; (ii) enhanced operation and management o f Municipal Water and Sewerage Companies (MWSCs);(iii)expanded and improvedmonitoring of coastal water quality and wastewater discharges; (iv) reform o f Croatia's financing and control instruments for wastewater management infrastructure at the regional level; and (v) sector reform for EU accession. In subsequent phases, the proposed APL Program aims at expanding and consolidating the results o f the first phase through: (vi) improvement o f sector management through the establishment o f financially viable water and sewerage companies with significant participation o f the private sector; and (vii) krther development o f sewerage coverage and treatment levels, including the reuse o f wastewater. The adaptive nature o f the Program will support a learning environment for the application o f an efficient financing policy for sector investments, whereby municipal governments decide whether or not to participate in the Program based on a clear understanding o f the rules o f engagement. This will include a willingness by local governments to require users to meet their financial obligations and assume responsibility for sustaining and making effective use o f their improved services. The programmatic approach allows for the gradual application o f the new policies throughout the country by providing investment incentives to municipalities that are willing to reform, and by coupling the transition with adequate institutionbuildingat all levels. 2. Project development objective: (see Annex 1) The overall Project Development Objective is to improve the quality o f Croatia's Adriatic coastal waters to meet EU ambient quality standards in the participating municipalities, in a financially and operationally sustainable manner, through (i) support for the strengthening o f the institutional arrangements for financing and management o f wastewater management in Croatia and (ii)financing o f wastewater collection, treatment and disposal infrastructure in selected coastal municipalities. The Project will also provide technical assistance and financing for engineering services, improvements inthe environmental monitoring system for the assessmentso f Project results and support o f Project implementation. The Government has selected the APL approach for the sector, rather than addressing investment needs city-by-city and project-by-project. The sector policy issues, under the overall objective o f complying with the environmental "ucquis communuutuire", are basically identical throughout Croatia's urban areas and the model for addressing them was established with the Municipal Environmental Infrastructure Project (MEIP). The work carried out during Project preparation has resulted in a comprehensive "Coastal Cities Pollution Control Program" (the Program) approved by the Government on May 29, 2003 and on the adoption o f the Program's Operational Manual. This Manual covers all aspects o f Program implementation, from appraisal methodology to the procedures to mainstream social and environmental safeguard policies. The Government's strategy i s to initiate the Program in larger urban areas not yet served with adequate wastewater management infrastructure, and to expand horizontally, and if necessary vertically, in a programmatic manner. Additionally, the Government has established an environmental - 3 - regional onlending mechanism for this Program and i s in the process o f creating a Special Purpose Subsidiary Company (SPSC) of Hrvatske Vode (HV), which will be in charge o f and responsible for the implementation o fthe Program. An APL approach will provide a framework for planning and implementing the medium-term investment programneededto comply with requirements for EUaccession by helping HV, through the SPSC, to take a phased approach to planning and identifying fbnding sources, while building the necessary regulatory, monitoring, and control capacity. Individual investment subprojects ineach MWSC, as has been the case until now, would have made such planning more difficult to conceptualize and implement, and a "projectized" approach would have been less efficient from a management perspective. Thus, an APL, with triggers designed to deepen the sector's financial, regulatory and management policies and practices, was the logical choice for the next intervention. In order to acknowledge the speed with which the Government and urban utilities can implement the envisaged measures and adapt and refine the implementation procedures and safeguards, the APL is designed inthree Phases. Phase Ieligibility criteria concentrate on developing the financing framework and achieving operational autonomy and financial stability in participating MWSCs through the adoption o f adequate tariff structures and levels and appropriate investment scope, while proceeding to Phase I1 requires that (i) adequate monitoring and control capacity i s inplace; (ii) Phase Iinvestments have been efficiently implemented; (iii) reforms policy inlinewiththe objective ofcomplyingwiththe relevant environmental "acquis communautaire havebeen " adopted; and (iv) relevant sector institutions have demonstrated their ability to implement the Program and extend its coverage to the rest o f the coastal areas. 3. Key performance indicators: (see Annex 1) The key Project performance indicators are (i) percentage o f wastewater produced in the coastal area municipalities participating in the Project that i s collected, treated, and disposed o f according to EU requirements; (ii)percentage of population in participating municipalities with adequate wastewater collection and disposal systems; (iii) percentage o f samples from monitoring bathing and shellfish areas in participating municipalities complying with EUwater quality standards; and (iv) the technical and financial situation o f MWSCs in the participating municipalities, as indicated respectively by their level o f unaccounted for water (where applicable) and sewerage network coverage rates and by their operating and debt service ratios. B. Strategic Context 1.Sector-related Country Assistance Strategy (CAS) goal supportedbythe project: (see Annex 1) Documentnumber: R2001-0167 [IFC/R2001-0174;/1] Date of latest CAS discussion: Sept. 18,2001 The Country Assistance Strategy (CAS) for Croatia addresses the need to establish conditions for sustainable growth and specifically addresses (a) fostering growth and creating conditions for competitiveness through maintaining existing infrastructure and protecting the environment, especially in the coastal area; and (b) reducing the size o f the public sector and involving the private sector in the provision o f state fimctions. The CAS Progress Report o f September 28,2001 reviewedthe Bank assistance strategy to Croatia and the developments since its formulation (the last CAS discussion in the Board o f Directors took place in June 1999), and redefined the main goals o f Bank support. Job creation, structural reforms aimed at reducing - 4 - public expenditures and the developmentof the private sector inutilities and infrastructure, and improving Croatia's environmental sustainability, particularly in the Adriatic coastal region, figure prominently among these goals. This Project directly supports these goals by contributing to reducing coastal water pollution, a critical threat to the tourism industry and to the economic growth associatedwith it, and to the fisheries and aquaculture sector (direct and indirect revenues from tourism represented in2003 22 percent o f Croatia's GDP. Source: World Travel and Tourism Council, March 2003). The proposed operation will also improve govemance and financial management of localutilities, by financing performance-baseddirect investments, promotingtheir sustainability, andby developing an improvedbusiness environment favorable to potential private sector participation. As the CAS notes, the tourism sector represents a key source o f potential economic growth and foreign exchange for Croatia, and improvingthe quality of Croatia'scoastal bathingwaters will be critical to growth inthe sector. 2. Main sector issues and Government strategy: Incontrastto water supply, wastewater managementis deficient andwater pollution constitutesa problem ina numberof Croatia's coastalmunicipalities. Coverage and quality ofwater supply services inCroatia ranks highcompared to other countries inthe region. However, coverage for sewerage is only around 40 percent in households and 40 percent from industry and less than 12 percent of all collected wastewater i s beingtreated. A total of 82 treatmentplants are currently inoperation, though most of these plants suffer from operation and maintenance(O&M) problems and will needto be upgradedto meet EUenvironmental standards as part o f Croatia's anticipated accessionto the EU. The degradation o f seawater quality in some parts of Croatia due to inadequate discharges of raw sewage has already resulted in visible problems, includinglocalized eutrophication and phytoplankton blooms, as well as less-visible contamination ofthe marine life by organic and nonorganic micro-polluting substances. (source: Nasci et al. 1998). Obviously, water pollution has a negative effect on ecology, public health, tourism and fishing industries. Water pollution affects some of the main population centers of Rijeka, Sibenik and Zadar, and importantly, many small and medium municipalities along the coast and on the islands. Although some efforts are already under way to address the problem (particularly in Dubrovnik, Split / Kastela Bay and Pula), the cost of no action could be disastrous for the potential of further growth in the tourist industry, on which Croatia's development depends to a great extent, and for other related industries such as aquaculture. Basic background for the Program was developed in the comprehensive integrated study on SpWKastela Bay, which was undertaken between 1988 and 1992 as part of the Coastal Areas Management Programme (CAMP) within the framework of the Mediterranean Action Plan (MAP). This study, prepared with the financial support of the World Bank, produced data and information on major pollution problems and ecosystem hnctioning, allowing formulation of policies and definition of technical solutions, as well as a feasibility study for the integrated wastewater collection, treatment and disposal system. In addition, the National Environmental Action Plan (NEAP), which was recently completed by the Government with extensive public participation, concludes that protection o f Croatia's 1,780 km-long Adriatic Sea coastline and 1,185 offshore islands must be a priority for both ecological and economic reasons. Although much has already been accomplished, the NEAP recognizesthat needs are still great - especially inthe area of water pollution control. - 5 - The recently prepared water sector note identifies three main sector issues that should also be addressed whentackling the problems ofwater pollution inthe Adriatic coastal areas: Although MWSCs operate reasonably well, there is ample room for efficiency gains in terms o f better management, improving financial performance, reducing water consumption, malung water systems operate more efficiently, and reducing leakage. Reforms and improvements in this area are essential to allow MWSCs to undertake the large investments required in wastewater management and guarantee their sustainability. The lack o f physical infrastructure is matched by an inadequate institutional framework, both to create incentives for investing inwastewater treatment infrastructure and to provide overall policy direction. A sound institutional arrangement i s neededto provide strategic guidance and fulfill the role o f a national regulator for the sector. Existinginstitutional and policy arrangements are not conducive to ensure that scarce resources for wastewater treatment can be employed most economically, as the current investmentselection approach is driven by outdated effluent standards rather than an impact approach that allows prioritization o f investments to obtain maximum benefit interms of receiving water use and quality. Corollary to this assessment is the realization that a municipally-focused institutional set up is not always conducive to regional solutions that are needed to combat pollution and manage wastewater treatment infrastructure, particularly in the islands and coastal areas. An improved financing framework and additional resources for wastewater treatment investments are needed to improve water quality, particularly on the Adriatic Coast, despite the expected resources that might become available with an eventual EU accession. Financing constraints on local municipalities and the lack of institutional clarity have resulted in the absence of a reliable and comprehensive model for financing wastewater treatment infrastructure in Croatia. Because wastewater treatment facilities are in some respect "public" goods, with financial and economic costs bome in upstream municipalities and benefits accruing elsewhere, the key to the sustainable management o f Croatia's wastewater sector is to develop coordinated mechanisms at the national and sub-regional level for financing the construction and management o f wastewater treatment facilities. Govemment Strateav The Government has embarked upon a program to address the challenges facing the sector. The core o fthe strategy includes: Redesign o f the institutional arrangements for wastewater management. The Government has initiated an overarching reform of the institutions involved in the management, financing, and oversight o f the water supply andwastewater treatment sector inCroatia. The critical effort has been the consolidation of the role o f HV as the entity responsible for planning and policy setting inthe area o f wastewater treatment and for assisting in the financing of wastewater treatment infrastructure to municipalities responsible for local water distribution and sewerage networks. For this purpose, seeking to secure the sustainability o f the system, the Government's approach includes the strengthening o f HV and the municipaYregiona1 water utilities and institutions incharge of the operation and maintenance of wastewater management facilities. It also includes the harmonization o f national standards and those defined inrelevant EUDirectives. Investment in wastewater treatment and sewerage exuansion in coastal areas. The Government has developed a comprehensive Program for the provision o f wastewater treatment facilities to improve the quality o f the waters off Croatia's Adriatic coast. The Program foresees the assistance from the Bank and from other donors @e., the European Investment Bank (EIB) has financed a Master Plan for the Adriatic as - 6 - part o f the Stability Pact for South Eastern Europe; KfW has recently approved a loan for investments in the southem Dalmatia area). Along with investments in physical infrastructure, the Government has also engaged in the strengthening of the technical and financial capacity of municipalities and local utilities, throughtechnical assistance andthe promotion ofprivate sector participation. Addressing the need for a sustainable financing solution for wastewater treatment. Given the difficulties inherent in financing wastewater treatment infrastructure, the Government seeks to ensure the affordability and sustainability o f investment through a combination of up-front capital grants (from Government budgetary transfers and other sources), credit, local contributions, and user supported fees and surcharges. HV,as the entity responsiblefor the technical and financial managementofthe sector investmentprogram, will usean Environmental Infrastructure Financing Facility (E1FF)-approach to be implementedthrough its subsidiary SPSC, which will be given lead responsibility for coordinating subproject design and ensuring the technical and financial feasibility of the investment. Of critical importance is the fact that, while up-front capital grants are being provided through the Program, eligibility criteria for subprojects include explicit sustainability of investment and full cost recovery of operation and maintenanceexpenses. 3. Sector issuesto be addressed bythe project and strategic choices: The Project addresses the near-term needs and priorities of the Government strategy by (a) improving and expanding existing infrastructure in priority hot-spots along the Adriatic coast; (b) addressing strategic institutionalreforms inthe Project area and at the sector level; and (c) supporting the strengthening of the capacity of MWSCs through technical assistance, training, and specific investments. The key strategic choices made during Project preparation were (i) to focus on Croatia's coastalarea; (ii) include technical to assistance for the strengtheningof MWSCs; and (iii) to adopt a phasedapproach, linkedto the institutional reformprocess. The priority areas for action are the Istria littoral and the Dalmatian coast, where pollution is more evident, and where Croatia's tourism industryi s concentrated. By focusing on this region, the Project aims to have an important impact on preserving the environmental resources on which tourism growth and its capacity for employment generation i s based. Major investment in infrastructure in priority areas and "hotspots" would help to both improve water quality in key areas and to develop replicable models for sector development. Government and the sector authorities have decided to implement a nation-wide program to improve the productivity and efficiency of MWSCs. Efforts for improving efficiency and productivity will benefit from the introduction of a "benchmarking program" which would allow Croatian utilities to compare their performance with other utilities in Croatia and other countries. Utilities are beginning to implement administrative and operational performance enhancement programs with time-bound targets for efficiency improvements in utility management and operations. Most Croatian MWSCs have ample opportunity to improve their productivity andthereby reduce the cost o f management and operations. For example, per capita water consumption ranges between 200 to 300 Vd and unaccounted for water averages 35 percent. Both of these efficiency indicators are poor compared to performance of Westem European utilities. Utilities tend to be over-staffed, averaging eight employees per 1,000 connections (compared to 1-2 employees per thousand connections in generally recognized efficient companies in Westem Europe). Technical assistance provided under the Project will help improve the productivity of MSWCs and strengthen managementandadministrative systems. - 7 - Finally, the phasedapproach, applying simpler least-cost solutions, and the use of the EIFFand an escrow managementof Project funds, represents a major advance inthe water sector. Such an approach (a) makes more explicit and public the capital subsidy provided by the Government in support to local water companies; (b) reduces the moral hazard inherent in passing resources from the Central Govemment to locally-owned water enterprises; (c) supports the development of a market for sub-national finance by introducing the commercial banking sector, in a limitedway, to Croatian municipalities; and (d) provides a replicable model for financing municipal infrastructure, in general, within the context of Croatia's decentralizedsystem ofpublic administration. The Government's approach for the financing of these investments and its subsidy policy, on which the Project builds, are based on the water pollution fees collected by HV from each consumer (all Croatia's MWSCs collect this "HV water pollution fee" as a tariff surcharge, currently at 0.9 W m 3 , and transfer it to HV) that, coupled with the adoption o f a phased approach and least-cost solutions, guarantee that the necessary project surcharges to be addedto the current tariffdo not exceedthe levelsthat are affordable for the population(see social analysisbelow for further details). 4. Programdescriptionandperformancetriggersfor subsequentloans: The APL will be implementedinthree Phases over 10 years: Phase Ifor four years (2004-2008); Phase I1 for three years (2008-2011) and Phase I11for three years (2011-2014). The overall Program costs are estimatedat approximately Euro 750 million, of which the Bank would most likely finance a total of Euro 140 million for the entire APL. Parallel financing by other donors is possible, particularly from EIB and the EU(inlater phases), but is still to be identified. At the end of the Program, it is expected that the APL would have delivered (i) policy reform hlly a consolidated and in compliance with EU"acquis communautaire"; (ii) improved efficiency and complete O&M and investment cost recovery in all participating MWSC; and (iii) 1.13 million additional people (2.90 million if summer population i s considered) in coastal municipalities served by newhehabilitated sanitation infrastructure (Phase I+ Phase I1+ Phase 111). Phase Iof the APL Program i s estimatedat Euro 80.0 million with the Bank financing Euro 40.0 million. As prior conditions for the first operation, HV has identifiedthe first year subprojects, in municipalities which have agreed to revise tariffs to ensure sustainability and include Project surcharges sufficient to guarantee the local contribution to investments, and will have established the SPSC. The first year's investment program has been satisfactorily appraised, as have the Operational Manual and relevant policy reforms. Additionally, HV has providedthe Bank with a ResettlemenfiandAcquisition Policy Framework and the Government has communicated to the other Adriatic Sea ripariancountries the scope and approach of the proposed Project. Works proposed are typical for the sector: sewer network rehabilitation and expansion (primarily main collectors and pumping stations); rehabilitatiodexpansion o f existing wastewater treatment facilities and submarine outfalls; technical assistance (TA) to support sector reform, Program managementandthe strengtheningof participating MWSCs; and equipment andstaff training for upgrading the monitoringand control networks. There are five expected outcomes for Phase I. m,there should be a significant increase in sewerage services quality and coverage in the participating municipalities It is estimated that about 146,000 additional people will be served by newhehabilitated sanitation infrastructure, 225,000 if summer population is considered, in the four subprojects for the first year that were analyzed in detail and respectively about 300,000 and 850,000 on the basis of 12 potential subprojects used for determining the - 8 - scope o f the Phase Io f the APL. Second, coastal waters pollution in participating municipalities will be reduced through the adequatetreatment o fwastewaters andtheir discharge through submarine outfalls with the appropriate length and depth of discharge. Third a more reliable and comprehensive monitoring network will be established to control discharges and quality o f the receiving marine environment. Fourth, the municipalities participating inAPL Phase Iand the SPSC should have achieved financial viability and accountability, improved implementation capacity and be eligible for further on-lending arrangements in subsequent Phases o f the Program. Finallv, the sector legislation regarding discharge standards and treatment requirementswould have been adapted to ensure better harmonization with the corresponding EU Directives. MWSCs would be eligible to participate inAPL Phase Iprovided that they meet the following criteria: Completion o f an Environmental Impact Assessment (EA) acceptable to the Bank for proposed subprojects The existence o fa billingand collection systemacceptable to the Bank Fullcoverage o fO&M expensesona cash basis Tariffs and project surcharges are approved by the regionalllocal corporation that are sufficient to cover the subproject local counterpart and sub-loan repayment The investment and financing planhas been endorsedby the SPSC and appraised by the Bank. APL PhaseI1isestimated at Euro 130millionwithBankfinancing ofEuro60million. Investmentstobe financed would be similar to those outlined for APL Phase Iinadditional municipalities o fthe coast and further sewerage andtreatment expansioninthe municipalities o fPhase I.The overall objective o f Phase I1would be to make a significant increase inthe numbero fpeople reachedbywastewater treatment services, continue the process o f controlling coastal waters pollutionby expanding it geographically, strengthen the sector's finances, and further improve the capacity o f the monitoringnetworks. Triggers for Phase 11. During the Mid-Term Review o f Phase I,a comprehensive evaluation would be made to determine the degree to which Phase Iobjectives will be met. Lessons leaned from experience will be incorporated into Phase I1 design. Triggers for going ahead with Phase 11, in addition to 70% commitment and40% disbursement o f Component I, be: would The performance indicators for Phase Iefficiency show that improvements targets have been met, including sewerage and wastewater treatment coverage (see Annex 1). The upgraded monitoring system i s inplace and functional. The Government has adapted legislation concerning the treatment and discharge o f municipal wastewaters incoastal areas to the relevant EUDirectives and issuedthe declaration o f "sensitive" and "less sensitive" areas. A Strategic Environmental Assessment (SEA) that deals withregional cumulative effects has been completed. Each MWSC seeking investment under the first year o f Phase 11, complies with similar eligibility conditions as of Phase I. Exit Strategy. The exit strategy for the Bank in the case o f poor Program performance would be built around (i)an evaluation o f progress on key indicators at the Mid-Term Review o f each individual subproject; and (ii)the failure to meet Phase Iand Phase I1triggers for disbursements, improvements in efficiency performance and physical investment. The key indicators at Mid-Term Review would likely include the increase in sewerage coverage (measured by civil works disbursements and sewerage network coverage rate), and improvement in the overall sector's financial viability (measured by the number o f - 9 - MWSCs likely to actually participate in Phase I1 that cover O&M cost and will be able to cover full sub-loan repayment through tariffs andProject surcharges). C. Programand Project DescriptionSummary 1. Project components (see Annex 2 for a detaileddescriptionandAnnex 3 for a detailedcost breakdown): To support the Govemment's Program, the first phase o f the APL will comprise a sector investment loan usingthe Government's EIFF, to be implementedthrough HV's SPSC, to finance wastewater treatment and discharge infrastructure, sewerage expansion and technical assistance, with SPSC acting as technical implementing agency. HV will facilitate subproject preparationand implementation and coordinate funding requests to the Bank and other sources. The SPSC would have overall technical responsibility for Project implementation (including procurement) and specific financial responsibilities for investments in infrastructure for wastewater treatment and discharge, while MWSCs would have financial responsibility for investments in sewerage expansion. The attached maps identify the municipalities that have been identified as candidates to participate inthe Project and in the overall Program. These maps also present subproject engineering and technical designs for the systems o f the municipalities o f Biograd, Krk, Opatija and Zadar. These have been identified as candidates for the first year o f Project implementation and appraised as part o f Project preparation. Overall investments for Phase Ihave been estimated on the basis o f the investment proposed for these municipalities' wastewater management systems for those in the municipalities o f Korcula, Makarska, Novigrad, Orebic, Rijeka, Ston, Trpanj and Vela Luka. Consistent with the scope and objectives identified above, the Project (Phase Io f the APL) would have three components: 1. Coastal Environmental Infrastructure Component (Euro 61.65 million -US$73.25 million equivalent-), to finance investments inthe constructiodexpansion o f sewerage networks, main collectors, pumping stations, wastewater treatment plants and submarine outfalls. Investments would be financed by HVthrough the SPSC, usinga combination o fcredit, resources from the HV Water Pollutionfees, specific Project surcharges, andtargeted subsidies from Government budgetary transfers. As discussedabove, the operation is beingprepared within a dynamic institutional setting. The Government is revising the role o f HV, consolidating it as the agency responsible for wastewater treatment facilities throughout Croatia. The financing mechanism for the Project would reflect the success o f the ongoing Bank-financed operations (namely the MEIP inSplit and the Eastem Slavonia ReconstructionProject), and at the same time the aims to advance on the policy agenda for developing sustainable sub-national credit facilities in Croatia. As inthe Slavonia Project, the Ministryo f Finance would be the Project's borrower. Project funds will be on-lent to establish the EIFFwithin the SPSC, which will on-lend part o f these funds to municipal (or regional) water and sewerage companies (see Annex 11presenting a schematic diagram o f the proposed flow o ffunds). - 10- Under the proposed Project, the approach would build upon HV's experience to handle the financial management o f the on-lending activities with the support o f the Bank, which will appraise all subprojects on an annual basis. All procedures for subproject preparation and the criteria for subproject appraisal have been defined ex-ante and includedinthe Program's Operational Manual, which the Bank has reviewed and found to be satisfactory. Detailed engineering and technical designs for the first year o f the Project, including environmental and social assessments, financial models, and tariff schedules agreed-upon with municipal officials, have been completed prior to loan appraisal. Inaddition to an annual appraisal o fthe work program during Project supervision, the guidingprinciples for subproject evaluation and eligibility include: Afinancial analysis, taking into account all sources o f financing (project and HV surcharges, direct Government subsidies, and tariff revenues) demonstrating that funds will be sufficient to cover O&M costs, loanrepayment, and depreciation. Locationpermits. Locationpermits are required by Law inCroatia before any public work can be executed. Inorder to obtain a location permit the developer has to produce an EA approved by the MoE. Compliance with this requirement is a condition o f eligibility for all subprojects in subsequent years. A least-cost analysis for each subproject, reviewing all options considered for achieving EU quality standards inbathing and shellfish growing waters inthe vicinity o fthe affected areas. Priority in terms of receiving water quality. Region-wide criteria developed during Project preparation define clear investment objectives and, based on these objectives, the Government has adopted a prioritized plan that ranks wastewater treatment investments in terms o f their cost effectiveness and sensitivity ofreceiving waters. Utilitypreparedness interms ofits abilityto contribute to capital cost, management andoperation capacity and financial viability. In this context, an assessment o f water supply and sewerage operations is also includedto ensure that they meet reasonable efficiency standards. 2. Institutional Strengthening and Program Management Component (Euro 4.67 million -US$5.55 million equivalent-),to finance equipment, technical assistance, training and studies to: Devise and implement an institutional framework for water pollution control Complete engineering designs and environmental and social assessments for investments after the first year o fthe Program and supervise Project investments Ensure the capacity o f the SPSC for Project implementation, evaluation and monitoring, including financial management Strengthen and bring utilities to reasonable levels o f management, operational efficiency and financial viability and potentially facilitate private sector participation. Technical assistance for the strengthening o f municipal water utilities would be provided on a grant basis by HV through the SPSC. 3. Strengthening of the Coastal Waters Monitoring Network (Euro 7.68 million -US$9.12 million equivalent-) to finance equipment, civil works and technical assistance (see Annex 12 for details on the existingcapacity andprograms and onthe proposed approach) to: -11 - Improve the capacity of the MoE network of laboratories for environmental monitoring to assess the impact ofthe Program on coastalwaters quality Improvethe capacity of HV's laboratories to assess the individual dischargesof municipalities and industries, determine the overall pollutants load contributed by Croatia to the Adriatic sea and evaluateand control the efficiency o fthe financed infrastructure. The first part o f this Component, to be implemented by MoE, would be financed on a grant basis from Government funds and loan proceeds, through direct budgetary transfers from the Ministry o f Finance. The secondpart ofthe Componentwould be implementedbythe SPSC on behalfofHV. Main Project costs, in US$ equivalent, for the APL Phase Iare summarized in the attached table below. Detailedcosts per component and subcomponentare included inEuro inAnnex 2. Indicative Bank- % of Component costs YOof financing Bank- (US$M) Total (US$M) financing 1. Coastal EnvironmentalInfrastructure 73.25 77.1 36.63 77.1 2. InstitutionalStrengtheningand ProgramManagement 5.55 5.8 2.78 5.8 3. Strengtheningo fthe CoastalWaters Monitoring Network 9.12 9.6 4.56 9.6 Unallocated 7.13 7.5 3.57 7.5 Total ProjectCosts 95.05 100.0 47.54 100.0 Front-end fee 0.00 0.0 0.00 0.0 , TotalFinancingReauired I 95.05 1 100.0 I 47.54 I 100.0 I 2. Key policy and institutionalreformssupportedby the project: The Project supportsthe reformo fthe sectorrecently initiatedbythe Governmentwiththe explicit goals o f developing mechanisms for the expansionand sustainable financing of wastewater treatment infrastructure. Specifically, the Project: Supports roles of both HV and MoE. The operation supports the consolidation o f HV as the key institutional player in the provision and management of wastewater services in Croatia. At the same time, it supports the Government's efforts to put in place an independent environmental monitoring and evaluation capacity in the MoE. Such an approach is both consistent with international experience and in line with the shared vision of a well-functioning system for managingthe coastal ecosystem. Supports capacity buildingfor MWSCs through TA. The Program has been designed to support technical and managerial capacity buildingat the local levelthrough HV. It also has been designed to support the institutional reform needed to create a favorable environment for private sector participation, as a mechanism for enhanced management and for the mobilization o f additional financial resources. -12- 3. Benefitsandtarget population: The Project will have substantial environmental benefits with a direct impact on the populations o f the Project area, which counts approximately 300,000 permanent residents in the coastal region (in the participating municipalities) as well as seasonal tourists which increases population to 850,000 in the summer months. Investing in wastewater treatment i s expected to have a direct and positive impact on improving and maintaining the quality o fbathing and fishingwaters. The associated economic benefits are expected to be significant, and meeting the EU water quality requirements for accession is an articulated policy goal of the Government. In addition, Program investments are expected to have positive effects on the viability o f the fisheries and aquaculture sectors, and detailed investment design will take into account the impact on local fisheries and areas o f shellfish cultivation. The rehabilitation o f the environmental infrastructure in the coastal area will ensure that Project benefits reach beyond the participating municipalities, as improvedenvironmental conditions will enhance prospects for the growth o f tourist and fishing activities and improve prospects for the multiplier-effect growth and private sector investment which are expected to accompany the recovery inthe tourism sector. As the CAS for Croatia explicitly recommends, the Project addresses the need for investments in infrastructure to support the development o f the tourism sector, which is seen as a key to national growth in the medium term. Further, the operation is expected to have important environmental and sector-wide benefits as the Project will assist Government authorities to consolidate their long-term vision for the rehabilitation and efficient provision o f water services by sustainable local utilities. The Project will clearly enhance the capacity o f local authorities to finance and manage water sector infrastructure during Project implementation and inthe future. The Project i s expected to have a direct impact on the viability o f local utilities inthe water sector. Furthermore, the constructiodexpansion o f sewerage networks in participating municipalities, along with the general environmental conditions' improvement inthe coastal area, will have significant benefits on the municipalities themselves, since the opportunity to connect new areas to the sewerage network will facilitate municipahban expansion, increase the land value o f connectable areas and reinforce the potential for economic development o fthe municipality. 4. Institutionalandimplementationarrangements: The Project has been designed to be implemented based on the evolving structure o f the institutions involved in sector administration. HV, through the SPSC, with the support o f the Ministries o f Public Works and Environment, and local utilities will be responsible for the management and implementation o f the Program. Similar to the successful approach used in the MEIP in Split and Eastem Slavonia Reconstruction Project, it is proposed that SPSC will receive Project funds (on-lent by the Ministry o f Finance through HV) and on-lend part o f these funds to participating municipalities in the Program. The SPSC, as the key technical implementing agency, would manage and supervise Project implementation, reporting, procurement, and disbursements, controlled by H V ' s Department for Wastewater Management, incooperation withthe respective water utilities. For investments in the expansion and rehabilitation o f sewerage networks, wastewater treatment and disposal infrastructure, the SPSC will on-lend Project`EIFF funds to participating MWSCs, which would be the final beneficiaries o f the Project. Municipal utilities, within the context o f the institutional restructuring spearheaded under the Project, will remain responsible for investing in and managing local sewerage systems. As such, they will ultimately be responsible for all aspects o f local utility management, - 13- including tariff setting, billing and collection. As indicated above, the SPSC will ensure that (a) subprojects are economically and financially sound based on an agreed-upon methodology for financial and economic assessment; (b) the MWSCs are technically, financially, and institutionally capable o f managing subproject implementation and repayment; (c) that financial arrangements, including any tariff changes which might be applicable, are agreed-upon prior to subproject appraisal; and (d) that all safeguard approaches are followed as defined in the Operational Manual. In addition, the SPSC will contract an escrow agent (a commercial bank) for all aspects o f fiduciary management, including the establishment o f sub-loan accounts for Project repayment. The escrow account fee' will be capitalized inProject subloans. For investments in the H V ' s monitoring; infrastructure, and for the Institutional Strendhening; and Proiect Management component, the SPSC will directly manage these investments as a commissioned agent o f HV. Loan proceeds would be made available by the SPSC to MWSCs for sewerage expansion and rehabilitation, wastewater treatment and final disposal infrastructure investments under Subloan Agreements. For each subproject, an Escrow Project Account would be set up. The Bank would enter into a Loan Agreement with the Ministryo f Finance inrepresentation o f the Republic o f Croatia and a Project Agreement with HV. As the Project ImplementationAgency, the SPSC will be responsible for overseeing the implementation o f the Project, including procurement, approval o f invoices for payment to suppliers and contractors, and progress reporting for the benefit o f the MWSCs. MWSCs will be responsible for implementing their Performance Enhancement Programs and the provisions o f the Environmental Management Plans for their respective investments. HV has builtup substantial experience and capacity in regard to the Bank's withdrawal application and disbursement requirements under the projects it currently implements. H V ' s capacity would be transferred to SPSC, which will submit withdrawal applications to the Bank and request withdrawals for the SpecialAccount (SA). HV role in the project derives from its condition as the primary agency established to carry out water management activities under the Water Act. It manages activities related to guarantee water quantities, water pollution control, flood and erosion control and activities o f public interest in water management. Approximately 70 percent o f HV expenditures are covered by the water use and user fees. The remaining 30 percent comes from the central budget. Although it receives hnds from the central budget, HV uses the same accrual accounting system employed by independently managed state utilities. Annual financial statements are audited by a private independent auditing firm. The accounting system is fully computerized and the staff has extensive experience in accounting methods. For subprojects which have been reviewed and approved by HV, half o f H V ' s consumption charge i s allocated back to the utilities from which it originates. The remaining 50 percent i s used for economically depressed areas or for investments that are o f a highnational priority. Of pollution charges, 93 percent are returned for investment and 7 percent are usedfor administration. HV has regulatory control over all water activities, including water withdrawals, construction o f domestic water supply and wastewater systems, pollution discharges, and sand and gravel excavation. The Project supports the Government's infrastructure financing approach which utilizes the EIFF for targeted investments in key infrastructure for environmental protection and economic growth. For Project implementation, the SPSC would be responsible for managing the EIFF, the accounts o f which would be held within a commercial bank as an escrowitrust. The SPSC would be staffed by personnel seconded from HV and line ministries and would have a Supervisory Board representing HV, the Central Government, and Project municipalities. The SPSC/escrow combination would achieve three critical objectives indesigning the Project institutional arrangements: first, it would help to reduce the moral hazard inherent in intra-governmental lending through a more robust governance structure; second, the use of a -14 - commercial bank as an escrow agent would bringa highlevel o ftransparency and accountability, providing comfort to the Bank, Ministryo f Finance, and local governments, alike; and third, inthe context o f shallow capital markets for sub-national lending, the arrangement brings replicability to Croatia's infrastructure financing supply needs, which will likely expandas the country proceeds towards integration with the EU. Accounting, Financial Reporting and AuditingArrangements: The SPSC will be responsible, on behalf o f HV, for maintaining financial records and will prepare separate Project and subproject reports, satisfactory to the Bank. The SPSC will be responsible for preparing the consolidated Project accounts, including reports for the Bank and, in conjunction with the commercial bank managing the escrow accounts, will keep records o f loan proceed receipts and disbursements, including these from the Special Account. HV, the SPSC and the participating MWSCs would be required to have their financial statements audited, according to international standards, by auditors satisfactory to the Bank. Audits will be made available to the Bank by May 31 each year for the preceding year. The audits will include separate opinions on the use o f the SA and o f Statements o f Expenditures (SOEs). H V ' s annual financial statements will be auditedby auditors satisfactory to the Bank. Monitoring and Evaluation Arrangements: The Sub-loan and ImplementationAgreement between SPSC and MWSCs defines their mutual obligations for the duration o f the Project. These Agreements will include monitorable annual or semi-annual targets for institutional performance, bill collection performance, and operational efficiency improvements. These performance targets, which are included in the Project Implementation Plan, will be usedto track and evaluate progress made towards these objectives. The Bank's Project Agreement with HV and the sub-loan and implementation agreement between SPSC and the MWSCs defines their mutual obligations in pursuing their respective responsibilities in Project implementation, including engagement o f technical assistance, and timely and satisfactory progress reporting. The Bank's Loan Agreement with the Republic o f Croatia defines the Borrower's obligations. Annual reviews would be jointly undertaken with the Project agencies during a supervision mission. A Mid-Term Review will be conductedinthe third quarter o fthe year 2005. An Implementation Completion Report would be submitted to the Bank promptly after the completion o f the Project, no later than six months after the Loan Closing Date. 'Initial discussions with some commercial banks indicate that this fee would be in the order of 0.2% o f disbursedrepaid funds. D. Project Rationale 1. Projectalternatives considered and reasons for rejection: The team considered a number o f alternative Project designs, including: A coast-wide programmatic loanfor infrastructure investment. Inconsultation with the Government o f Croatia, it was decided that a more focused approach, centered around key areas o f investment and selected "hotspotsl' would better ensure successful Project implementation and develop a replicable model, with a clear demonstration effect, withinthe framework o fa medium-term program supportedby anAPL which couldbe used to scale up sector investments ina phased manner. A line of creditfor local municipalities to invest in wastewater treatment. Inthe initial stages o f Project design, it was envisaged that developing a line o f credit through the existing ,mechanisms for local -15- borrowing would be an appropriate approach to delivering financing to the local level for wastewater treatment infrastructure. The Government's institutional arrangements, namely the strengthening o f HV as the entity responsible for planning and supporting wastewater treatment infrastmcture, has obviated the need for local borrowing for such investments (though they remain responsible for sewerage). Instead, the Project has been designed to support the redesign o f the institutional arrangements and financing which will be provideddirectly to HV for sector investments. Furthermore, such an approach was rejected(a) to focus the Project ina way and allow technical teams from HV and the M o E to work closely with the Bank during the initial stages o f implementationto focus the operation and ensure implementationsuccess; and (b) to limit and focus the overall Program investments so that a demonstration effect could prove replicable, especially given Croatia's prospects for grant financing for environment investments in the near future. A comprehensive environmental improvement program including solid waste. The team discussed the possibility o f financing an overall program for environmental improvement, including wastewater treatment, sewerage, and solid waste management, with Government authorities. As above, it was decided that a focused approach would be more likely to yield demonstrable effects that would allow the Government to more successfully develop its sector strategies inboth water and solid waste. In addition, during Project preparation, a number of options were considered for channeling Bank resources to the investment program inthe participating MWSCs, including usingthe Ministryo f Finance as a financing vehicle for local investment or using the Croatian Bank for Reconstruction and Development (HBOR) as a financial intermediary to assess subproject viability and MWSC creditworthiness. Under the selected approach, for wastewater treatment infrastructure of which HV is the responsible agency, HV will finance its investment program through its overall budget, water fees, government contributions, and World Bank funds (and other credit sources) as described above and in Annex 11. For investment in sewerage at the municipal level, ingeneral terms, the team considered two options in additionto the modality selected: 0 Hrvatske Vode as Implementing Agency and Lender. HV would take on a loan from IBRD (through MoF) and act both as the Project's technical management and as a limited role financial intermediary, on-lending to MWSCs at agreed upon rates. HV would be backed by a guarantee from the Central Government, and would directly bear subproject risk. This approach was rejected because it did not meet a core requirement that a financing mechanism be established which minimizes moral hazard and future bailout risk, which will last for a long time into the future as MWSCs repay sub-loans. 0 HBORas a SpecializedFinancial Intermediaw (SFI). The team considered working withHBORas a risk-bearing financial intermediary, under an approach which would build upon that used in the ongoing MEIP. In the MEIP model, HBOR acts as a financial intermediary and on-lends IBRD funds to MWSCs through its standard lending practices, with subprojects identified ex-ante and fully guaranteed by local governments. Under the risk-bearing SFI model, HBOR would have assessed subprojects on a rolling basis and made lending decisions based on the perceived creditworthiness o f MWSCs and local governments, while HV would have been responsible for technical issues. While such a model would have strengthened HBOR and helped to consolidate it as the Government financial intermediary to help spur the development o f a municipal credit market, the Government's strategy has now evolved towards the private sector, consistent with - 16- intemational experience. Furthermore, in discussions with the Government, the authorities expressed their concern over HBOR's capacity to play such a role in the context o f a complex operation, and while the risk-bearing SFI model was initially the Bank team's first choice, the team agreed to a more streamlined approach in order to avoid potential institutional conflicts during Project implementation. Implementation Development Bank-financed Progress(IP) Objective (DO) Municipal EnvironmentalInfrastructure S S Eastem Slavonia Reconstruction S S Other development agencies DalmatiaMunicipal Infrastructure (KfW and HBOR) Municipal EnvironmentalInfrastructure (EBW MEIP. The MEIP has been used as the primary model for the design o f this Project. Inparticular the design will build on the experience obtained with the financial management arrangements, on-lending procedures and on the difficulties and lack o f management flexibility which have resulted from multi-institutional implementation arrangements. The MEIP experience also demonstrated the need for systematic public consultation and active information dissemination, which are incorporated in the Project. Eastem Slavonia Reconstruction. The Eastem Slavonia Reconstruction Project has served to consolidate the role o f HV as technical Project implementing unit. Inthe implementation o f this Project, HV staff, who will be seconded to the SPSC, have developed excellent capacity for subprojects evaluation, procurement management, financial management and overall Project supervision and reporting. The proposed Project plans to use the same procedures. Further, the Project makes a major advance interms o f governance and transparency over the Eastern Slavonia operation, which, reflecting its design as an emergency response Project, involved direct lending from HV to a local water enterprise. 3. Lessonslearned and reflected inthe project design: Project design reflects the Bank's experience in the preparation and implementation o f environmental management and urban water supply and wastewater treatment projects throughout the world, and specifically borrows on the lessons learned from the design o f operations involving the financing o f local infrastructure and reforms to institutional arrangements for local service provision in the wastewater sector, particularly inCroatia. - 1 7 - Some o fthe critical lessons leamed and applied inthis Project's preparation include: 0 The need for clarity interms o f institutional roles andresponsibilities among the multiple stakeholders at the Central Government andlocal levels 0 The need for a clear and transparent institutional structure when lending resources between levels o f government 0 The needfor enhanced public consultation indesign andpublic informationduring implementation of major infrastructure 0 The importance o f integrating Project activities withina broader context o f sectoral reform, with a focus on regulatory and legal issues 0 The need for effective coordination with other donors working inthe sector. More specifically, the Project has been developed inthe context o fthe successful ongoing Bank operations inSplit (MEIP) and Eastem Slavonia. Bothoperations providedmodels for the arrangements for Project monitoring and supervision, for coordination o f different municipalities and have demonstrated the capacity of HV to play the key role in the technical and financial management o f the operation. The design incorporates these implementation arrangements. 4. Indicationsof borrowercommitmentandownership: The Government has demonstrated its commitment to the Programthrough: a. The ongoing reforms inthe environment sector, includingthe redefinition o f responsibilities for HV andthe MoEandplannedestablishment ofthe SPSC andrelatedescrow agreement b. The allocation o f approximately Euro 1 million from H V ' s budget for the preparation o f the operation during Project preparation c. Its intention to leverage additional government financing for Project investments through the development plan for the islands. 5. Value addedof Banksupportinthis project: The Bank i s uniquely positionedto add value in supporting the Project and the broader aspects o f sectoral reformwhich are ongoing. Specifically, the Bank contributes: 0 Broadintemational experience, both inprivate sector participation inthe water and sanitation sector and inthe design o fdevelopment projects inpost-conflict areas 0 Policy development expertise and experience inthe design o f institutional regimes for water resourcesmanagement 0 The Bank`s extensive experience indevelopment o f sustainable mechanisms for municipal service provision inthe water and wastewater sectors 0 The relationships to mobilize other sources o ffunds for donor cooperation. E. Summary ProjectAnalysis (Detailed assessmentsare inthe project file, see Annex 8) 1. Economic(see Annex 4): 0 Costbenefit NPV=US$ million; ERR = 11-24% (see Annex 4) 0Costeffectiveness 0Other(specify) - 18- The Project i s expected to generate significant economic benefits, including difficult-to-quanti@ environmental benefits. An economic analysis has been undertaken for the first-year program; given the inherent conceptual and logistical difficulties in estimating environmental benefits using standard methodologies, the analysis has focused on the non-environmental benefits o f subproject investment, which include (a) greater productive activities, including tourism, tourism-related business expansion, and shellfish and fisheries production; and (b) enhanced land values which accrue from both improved environmental conditions and development opportunities due to the expansion o f sewerage network coverage. NPVs o f analyzed sub-projects are substantially positive with economic rates o f retumbetween 11% and 24%. The results are reasonably robust to adverse changes in relevant economic conditions, includingvariations intotal tourist expenditures and real estate values. 2. Financial (see Annex 4 and Annex 5): NPV=US$ million; FRR = (see Annex 4) Detailed subproject financial analysis has be completed in cooperation with Hv for the first year subprojects and reviewed by independent consultants during Project preparation. Summaries o f the financial analyses are attached in Annex 5. In addition, a financial analysis o f the SPSC has been undertakento ensure its financial positionis well established. The complete assessmentsare included inthe Project files. Fiscal Impact: The Project would entail a fiscal cost since it involves the provision o f direct transfers and equity contributions from HV to MWSCs. The aggregate fiscal cost i s difficult to assess ex-ante, since sub-projects will be defined during the course o f the operation. For the first four sub-projects analyzed in detail, the Government contribution has been estimated at approximately 14.6 million, o f which 7.5 million would be in the form o f retumed pollution fees. Over the course o f the 4 year operation, it is estimated that the transfers provided for wastewater treatment infrastructure would be valued at approximately 30.5 million, o f which 18.7 million would be in the form o f retumed pollution fees. Nonetheless, because the operation would ensure sustainability o f investments through full cost recovery of O&M expenditures, it is not expected to introduce incremental recurrent fiscal expenditures. Further, taxes related to project investments are estimated to be inthe order of Euro 17 million for the whole Project (9.4 million for the first four subprojects). 3. Technical: HV expertise in this area, the abundant experience in Croatia in the use o f submarine outfalls and the involvement of accredited international experts to peer review the solutions proposed, provide sufficient guarantees on the technical soundness o f the proposed investments to be financed under the Project. Furthermore, as indicated above, a least-cost analysis has been carried out as part o f subproject eligibility o f the options available to achieve the Project objectives (reaching ambient water quality EU standards in the subproject area). During Project preparation two main activities were carried out to confirm the technical viability and appropriateness o f proposed solutions. First, a peer review technical team composed by three international experts with experience inthe MAP andinLatinAmerica was convenedto review three pilot subprojects in Porec, Krk and Dubrovnik (Zupa Dubrovacka), Croatian legislationand procedures for Project preparation and evaluation and criteria for wastewater treatment and discharge into coastal areas. Their recommendations were used to refine the overall Program objectives, scope and approach, as well as the specific environmental, social, health and financial criteria used in subprojects design. Second, feasibility -19- analysis and alternatives evaluation studies were performed on thirty (30) potential subprojects, which were evaluated from a technical, financial and environmental point o f view. The reports for these two activities are available inthe Project files. On the basis o f these studies and following recommendations from the experts team, the Project has been designed using least-cost altematives (based mostly on mechanical treatment and disposal of treated wastewaters through deep submarine outfalls in less-sensitive areas with high dilution capacity) that comply with EUstandards. Inparallel, the current monitoring network would be strengthened to assess the impact o f the proposed investments and the degree o f achievement o f the EU environmental water quality standards. On the basis o f this assessment, individual solutions would be re-evaluated and the need for more advanced levels o ftreatment decided and implemented insubsequentphases o fthe Program. 4. Institutional: 4.1 Executing agencies: There are no major issues expected from HV, or its subsidiary SPSC, the Project executing agency. The experience gained during the implementation o f the on-going MEIP and Eastem Slavonia Reconstruction Project support this assessment. The Project includes a sub-component to provide assistance to SPSC in carrying out its functions in Project management so that their capacity i s sufficient to meet the large challenges presented by a Program like the one envisaged. An analysis o f the financial viability of the SPSC was undertaken during Project preparation and it was shown that the SPSC would be financially robust based on the projected Program flow of funds. MoE's capacity to implement the small sub-component under its responsibility, as well as to provide adequate monitoring and control of the Project's results, is also guaranteed on the basis o f its experience in the implementation of other Bank projects and onthe provencapacity inenvironmental controlresponsibilities. 4.2 Project management: H V ' s performance in the management o f the ongoing projects in the Croatia water sector, including the MEIP and Eastern Slavonia Reconstruction Project, has been highly satisfactory. MoE's performance in other similar projects it is implementing has also been highly satisfactory. A recent review by staff from ECSSD o f the monitoring o f environmental and social impacts, including the protection o f cultural property, under the execution o f the MEIP and Eastem Slavonia Reconstruction Project, determined Croatia's and HV's performance to be "best practice." 4.3 Procurement issues: There are no issues requiring special attention. A full assessment o f HV's capacity to manage the procurement o f goods, works, and services under the Project has been completed during Project preparation. HV procurement practices under the Easter Slavonia ReconstructionProject has been rated as "best practice'' for the region. M o E capacity has also been satisfactorily rated since it i s participating in the Eastem Slavonia Reconstruction Project's implementation (under the Kopacki Rit environmental management and rehabilitationcomponent). 4.4 Financial management issues: A financial management (FM) assessment has been undertaken for the Project. Similar to the successful approachused inthe MEIP in Split, it i s proposedthat SPSC will receive Project funds, through HV, and - 20 - act as a financial intermediary for the Program. The SPSC, as the key technical implementing agency, would manage and supervise Project implementation, reporting, procurement, and disbursements, in cooperation with the respective water utilities. Although the SPSC has not yet been legally established, the Bank has had the opportunity to review the draft incorporation documentation and has determined that the corporate governance arrangements are satisfactory. Core members o fthe SPSC have been identified from withinHV. They willremain on the payroll o fHV butwill be secondedto the SPSC for the duration ofthe Project. The SPSC will maintain accounts o f the Project and will ensure appropriate accounting o f the hnds provided. The SPSC will be responsible for preparing Financial Management Reports (FMR) on a quarterly basis. The formats o f the FMRs have been agreed upon. The SPSC i s expected to use H V ' s FMS and FM practices. Establishment o f an appropriate FMS in SPSC i s a condition o f effectiveness. It i s anticipated that the SPSC will utilize the systems o f HV and it i s upon this understanding that the FM assessmenthas beenundertaken. 5. Environmental: Environmental Category: F (Financial Intermediary Assessment) 5.1 Summarize the steps undertaken for environmental assessmentand EMPpreparation (including consultation and disclosure) andthe significant issues and their treatment emerging from this analysis. For the purposes o f O.P. 4.01 on Environmental Analysis the Project has been classified as Category FinancialIntermediary (F). The Bank has reviewedboth: (i) EAs for the first year subprojects; and(ii) EA guidelines to be implemented under the Project insubsequent years. EAs for the first year suburoiects: DuringProject preparation each o f the first year subprojects (Opatija, Krk, Zadar, and Biograd) has obtained a location permit that is required by Law in Croatia before any public work can be executed. As part o f this process, as required by the MoE, an EA has been prepared using standards that are acceptable to the Bank. The process to obtain a location permit also includes consultation consistent with the World Bank's requirements. This involved communities and local stakeholders on the selected solution and setting o f the proposed infrastructure. By design, no subproject sites will be located inthe proximity o f any protected areas or sites of critical natural habitats, as has been confirmed during the EA, at which time the possible existence o f culturally or socially sensitivity areas have been assessed. Previous (2001) World Bank analysis o f Croatia's environmental impact assessment system has shown it to be consistent with EU EA standards, and highly compatible with World Bank's O.P. 4.01. Therefore, during Project preparation one o f the pilot subproject EAs (Zupa Dubrovacka) was translated into English and found satisfactory by the ECA safeguards team. On the basis o f this assessment, it was agreed that only the executive summaries o f the other first year EAs would be required for review by the World Bank before appraisal. These EAs Executive Summaries have been submitted to the Bank together with evidence o ftheir public disclosure. EA guidelines: To be eligible for financing under the Project, subprojects insubsequent years will needto - have approved location permits, thus ensuring that an EA is prepared and approved by the MoE. To ensure that O.P. 4.01 requirements are met, the Project's Operational Manual contains a separate volume (Volume 111) on "Guidelines for Environmental Assessment o f subprojects.'' The Guidelines lay out the procedures o f the EA in a format satisfactory to the World Bank and address the range o f applicable safeguard policies. During Phase Iof the Project, in conjunction with Component 3 - Strengthening o f the Coastal Waters - 21 - Monitoring Network a SEA will be prepared to analyze the cumulative impacts o f the Program on coastal - water quality. As part o f the monitoring system component, the SEA is included inthe triggers for Phase 11. The Project is expected to have positive environmental impacts which relate to: (i)improvements inpublic health through better water quality o f bathing and shellfish growing areas; (ii) enhanced environmental conditions as a result o fmore reliable wastewater treatment; and (iii) increased viability o fthe fisheries and aquaculture sectors. 5.2 What are the main features of the EMP and are they adequate? Each EA includes an Environmental Management Plan (EMP) to address specific local conditions. The Guidelines include details on the preparation o f the EMP which describes the mitigation measures for each potential negative environmental impact as well as the responsible party for ensuring the measures are taken. Potential negative impacts generally associated with wastewater projects, which the EMPs will address, are: 0 Impacts due to constructionpractices, e.g., noise, dust 0 Degradation o f sensitive aquatic environment due to discharge o fwastewater 0 Degradationo f neighborhoods or receiving water quality from sewer overflows, treatment works bypasses, or treatment process failures 0 Public health hazards inthe vicinity o f discharges 0 Odors, noise and emission o f volatile organics from treatment processes 0 Sludge disposal issues 0 Accidental destruction o f cultural heritage sites. Due to the nature o f the Project, the EMPs will give special attention to the impact on receiving waters o f the proposed discharge infrastructure and to the arrangements for the proper disposal o f sludge and solid waste residues that might be produced in the treatment process. Potential negative impacts o f the Project will be addressed by prevention or mitigation measures. Additionally, the EMPs will detail the environmental monitoring program requirements. Project Component 111, Strengthening o f Environmental MonitoringNetworks, will support HV and the MoE in improving the coverage, reliability andaccuracy o f the monitoring networks currently operating. 5.3 For Category A and B projects, timeline and status o f EA: Date o freceipt o f final draft: 5.4 How have stakeholders been consultedat the stage o f (a) environmental screening and (b) draft EA report on the environmental impacts and proposed environment management plan? Describe mechanisms o f consultation that were used and which groups were consulted? Local authorities, including elected officials and community representatives, have and will continue to be involved in all aspects o f Project design, including subproject environmental and social screening and review ofthe EAs for each subproject (to avoid relatedproblems that have affected the MEIP). As part o f the normal procedures for the issuance o f location permits, full consultation activities have and will be undertaken, under procedures that have been found to be satisfactory to the Bank. The consultation process is part o f the required EA and form an integral element o f the requirements for obtaining the - 22 - locationpermits. The guidelines for Environmental Assessment o f subprojects that are part o fthe Project's Operational Manual include detailed recommendation on how this consultation process and Social Assessments (SAs) will be carried out. These procedures have been developed during project preparation on the basis onpractical experiences on six potential subprojects. 5.5 What mechanisms have beenestablished to monitor and evaluate the impact o fthe project on the environment? D o the indicators reflect the objectives and results o f the EMP? Integral to the Project's design is a dedicated component to monitor environmental impact. 6. Social: 6.1 Summarize key social issues relevant to the project objectives, and specify the project's social development outcomes. The principal social development outcomes o f the Project are improved health and sanitary conditions for residents and tourists and increased incomes from tourism by protecting water quality and improving the wastewater management infrastructure for expanded tourism development. By all accounts, this i s a very highpriority throughout the target area. Tourism is vital for the current economy o fthe Istria littoral, the Dalmatian Coast and Adriatic Islands and future development requires action now to maintain the quality o f the environment that attracts visitors and to ensure that the expansion o f tourism does not despoil that environment. Proper wastewater management is key to current and future growth in all o f the coastal areas. Some o f the major population centers have wastewater management systems, most o f which are being upgraded or need upgrading and expansion. Many o f the poorer, less densely populated municipalities, which generally have more fragile environments, have been unable to invest in the infrastructure necessary to manage wastewater properly, however. Moreover, systems need to deal with huge seasonal fluctuations in use, meaning that a small resident population essentially needs to invest in infrastructure that serves their own needs as well as those o f tourists, who outnumber them many times over. Consequently, smaller and poorer municipalities are caught ina vicious cycle: they cannot afford the immediate investment needed to meet their own needs, let alone systems that are designed to serve short-term summertime populations, and the lack o f systems constrains their ability to increase tourist revenues that would help pay for the systems. This Project will enable municipalities to break out o f that cycle, providing financial support to build or complete systems quickly, rather than forcing them to rely on piecemeal funding that never allows them to complete the task at hand. The Project will help municipalities find cost-effective solutions to their wastewater management needs either individuallyor jointly. Inall municipalities, the issue has long been a subject o f concem and prolonged discussions between citizens, local administrations, MWSCs and HY, some o f which have continued for two decades or more. Water utility tariffs are expected to be increased as the result o f the Project, but no subprojects will be includedwithout confirming that least-cost solutions are adopted and that a financing mechanism i s used to avoid that the anticipated increases impose a significant burden onthe population. The subproject specific SA assesses the willingness and ability to pay o fthe local population. Inall instances, one objective o f cost recovery will be to ensure that as much o f the investment and operations and maintenance costs as feasible and practical are recovered through direct and indirect levies on tourists. The cost o f connecting to the new system also needs to be assessed and addressed, ifit poses a noticeable burden on people. For people who currently use septic tanks, new water and wastewater tariffs are expected to be lower than their existing costs o f maintainingand emptying septic tanks. Subprojects may trigger either OPN 11.03, Cultural Property, or OP 4.12, Involuntary Resettlement. In - 23 - the first case, the principal issue i s chance finds; in the second case, the acquisition o f land or rights-of-way. Croatia has standard procedures to deal with both land acquisition and cultural assets issues that are satisfactory to the Bank, detailed in the Project Operational Manual and, inthe case o f OP 4.12, clarified inthe LandAcquisitionResettlement Policy Framework agreed by the Bank (see Annex 13). The four projects includedinthe first phase will involve land acquisition, but no resettlement, and will not affect any cultural assets. In each case, a detailed land acquisition plan will be prepared duringthe final design stage, at which time it will be made available for review by the Bank accordingto the Policy Framework. In addition to provisions dealing with safeguards issues, the Project Operational Manual also includes instructions for conducting and making productive use o f SAs in each subproject. A SA is and will be included in each subproject as good practice, based on the experience o f the MEIP, which illustrated the problems that can arise in infrastructure development from inadequate consultation and poor public information. The SAs provisions in the Operational Manual are simple and straightforward, offering a standardformat to be modified according to local characteristics. As indicated above, these provisions are based on the experience o f local consultants who carried SAs in six municipalities that were identified as likely prospects for inclusion inthe first year o f the Project: Biograd, Krk, Markaska, Novigrad, Opatija and Zadar. These SAs focused on a range o f issues common to water and wastewater projects, as well as specific issues suggested by the experience in MEIP. The results o f the SAs have been presented to local stakeholder workshops prior to appraisal, followed by a the incorporation o f SA provisions for the Operational Manual. Results o fthese SAs strongly support the Project concept and indicate that some o fthe issuesthat emerged during the implementation o f MEIP may not be common in other areas. In each site, wastewater management (water quality) was uniformly recognized as a paramount issue for residents, the reputation o f the area and for hture development o f tourism. Without question, it i s a priority concern. In all cases, there is a high level of.interest in the Project and high levels o f expectations. The amount o f land acquisition that will be required varies considerably, affordability and willingness to pay for improvements i s also a variable, and the level and quality o f information about alternatives and current plans also varies from one site to another, but i s generally acceptable. Based on the sample o f these six municipalities, it i s hard to predict the extent to which investments will be subject to the "not in my back yard" response that appeared in MEIP, but this i s not expected to represent a problem for implementation if the agreed consultation anddissemination procedures are followed. The SAs also highlightedthe need for the Project to help HV, MWSCs and local administrations improve their communications and public information skills. In this respect, the Project design will take into account that the subject o f communications and public information varies from one site to another, from simple information about plans and implications for cost and repayment to more complicated information about technologies and technological choices, particularly in municipalities where residents and officials are convinced that they need treatment levels and equipment that may not be needed and cannot be afforded. 6.2 Participatory Approach: How are key stakeholders participating inthe project? The key stakeholders in the Project are HV, MWSCs, local administrations, citizens, civil society organizations, such as environmental groups, tourist enterprises, the media and contractors. Investments will be demand driven, thus municipalities and MWSCs will play key roles, in collaboration with HV. Relationships between the three groups are already well established. Although different parties may have differing views on topics such as costs, technologies, and other technical questions, they all have well-defined common interests that the Project will enable them to realize. Citizens have varying degrees o f - 24 - awareness regarding the progress o f planning investments and, use both private and public means to raise questions and make their opinions known to decision makers. For the most part, however, there i s little systematic public consultation, and public information is erratic, thus there i s considerable scope for improving the official/public interface. Public consultation i s required as part o f the EA process, and public notification is required for construction plans and system alignments, and both requirements will be honored in the preparation and implementation o f subprojects. SAs will also offer another opportunity to improve public information and identify fruithl communications strategies for each subproject. To assist municipalities and MWSCs in carrying out these requirements, and improving their standard practices, the SPSC will either include an experienced communications specialist on its staff or retain the services o f an experienced public relations firm to help the SPSC and other stakeholders improve their communications and public informationskills and practices. 6.3 How does the project involve consultations or collaborationwith NGOs or other civil society organizations? Environmental NGOs are strong and visible in Croatia, although their presence and influence varies from one location to another. Preliminary results o f the SAs suggest that if local groups exist, they take an active part in discussions regarding wastewater management requirements and plans. The preparation o f EAs and SAs in each subproject will actively engage the participation o f NGOs and other civil society organizations. They are also expected to play an active part in public consultations and be invited to collaborate indesigning and carrying out communications and public information efforts. 6.4 What institutional arrangements have beenprovidedto ensure the project achieves its social development outcomes? SAs, institutionalized inthe Project, will identify anticipated site-specific social development outcomes and, as appropriate, recommend steps that need to be taken to ensure that they are achieved. The SA will identify social development issues ineach subproject and create a series o f benchmarks: current water and wastewater costs (including both sewage tariffs andor septic tank management costs); current wastewater management practices; willingness and ability to pay for improvements; expectations regarding costs, levels of service and technologies; information levels; and potential "not in my back yard" issues. In addition, each SA will recommend ways to mitigate anticipated problems and to monitor specific issues that need special attention. 6.5 How will the project monitor performance interms o f social development outcomes? Except for specific issues that may be highlighted in specific SAs, most anticipated social development outcomes will be captured by the Project monitoring program which, in addition to other technical indicators, will focus on changes in coverage, real costs, tariff payments and the efficiency and effectiveness o f public information efforts. 7. Safeguard Policies: 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 0No I - 25 - Indigenous Peoples(OD 4.20) 0Yes 0 No Involuntary Resettlement (OPIBP 4.12) 0 Yes 0No Safety of Dams (OP 4.37, BP4.37) 0Yes 0No Projectsin International Waters (OP 7.50, BP 7.50, GP 7.50) 0Yes 0No 7.2 Describe provisions made by the project to ensure compliance with applicable safeguard policies. Full environmental impact assessmentsfor all subprojects inthe first year o f Project implementation were completed prior to Project appraisal. Full EA o f each investment, including consultation and disclosure requirements acceptable to the Bank, will be completed before requesting a location permit as required by Croatian legislation. Summaries o f EAs and SAs will be submittedto the Bank for review. According to OP 7.50, the Government (Ministry o f Foreign Affairs) has sent a notification to the other Adriatic riparian countries (Albania, Serbia and Montenegro, Bosnia and Herzegovina, Slovenia and Italy) regarding the Project's content and proposed investments to be financed, even though the project activities will not produce any adverse impact on quality or quantity o f international waters. N o objections have been received from the riparian states to date. Conceming OPN 11.03, it has been confirmed that, for each o f the four first-year subprojects, no cultural assets above ground would be affected by the investments. For the following subprojects, yet to be appraised, the issue will be addressed systematically. Preliminary drawings o f alignments are submitted to the local Institute associated with the Ministry o f Cultureto determine ifthe construction would affect any cultural assets. If so, the alignment is changed. This occurs long before the project proposal i s submitted to the Special Purpose Subsidiary Company for fbnding. Consequently, the only likelihood o f triggering OPN 11.03 i s for chance finds that are discovered during construction, during which time they will be subject to the Croatian Government's very strict procedures for dealing with cultural assets. These procedures, which are fully consistent with OPN 11-03, are described indetail inthe Operational Manual. Consequently, during Project preparation, full compliance with OPN 11.03 has been ensured. As sub-projects may trigger OP 4.12, Involuntary Resettlement, a Resettlemenaand Acquisition Policy Framework was prepared for the Project, based on existingrequirements and standardpractices inCroatia, which were also demonstrated in the MEIP and reflected in the Policy Framework and field experience o f the Rijeka Gateway Project. The Policy Framework, which has been reviewed and accepted by the Bank, requires a simple land acquisition plan for each subproject to be submitted to the Bank for review. In compliance with Croatian laws and procedures and as part o f the land acquisition plan, the amount o f land acquisition will be evaluated in broad scale in preliminary designs and refined during the preparation o f detailed designs o f each subproject prior to obtaining construction permits. Inthe project, land acquisition i s expected for right of way and, in some cases, for siting o f treatment plants and outfalls. The amount of total land acquired will thus be small, generally a narrow strip at the edge o f a holding, in addition to a treatment plant site. Each acquisition i s subject to a negotiation and appeals process that protects the interests o f the landowner. The Procedures for both land acquisition and resettlement are described in the Policy Framework and inthe Operational Manual, which includes more public consultation than is strictly required. Compliance will be monitored during each supervision mission. The four first-phase projects involve land acquisition, but no resettlement. The Project Operational Manual has provisions to screen for safeguards-EA, Involuntary Resettlement and Cultural Property-and provide detailed guidance for compliance with the safeguards, as appropriate. These portions o f the Operational Manual have been reviewed and found acceptable to the Bank. As the - 26 - provisions ineach case are consistent with Croatian laws and practices, they require no additional measures beyond presenting summary reports (EA, Land Acquisition, Cultural Asset Management) to the Bank for review. Compliance will be monitoredclosely during supervision. F. Sustainability and Risks 1. Sustainability: The Project is expected to be fully sustainable. It has full support o f the Government and o f the involved municipalities, which see these investments as critical in their future development and inthe growth o f the tourism industry, on which they depend. Except for the construction period, duringwhich, by its nature, the Program will require budgetary support from the Central Government, through channels already available, the Project financed infrastructure will be self-financing usingthe mechanisms and tariffs already inuse andwill not require extemal financial support duringits operation. The Project will require budgetary support during the construction phase, but will be a net fiscal contributor during the operations phase. Typically, in view o f the significant extemalities they provide through health and environmental improvement benefits, wastewater investments require substantial extemal financing other than from the direct beneficiaries. In the case o f the Project, significant extemalities are expected to accrue for the Croatian economy as a whole through its impact on tourism. Additionally, the Project will generate taxes during construction that are larger than the net Government contribution (after deducting the returnedpollution fees from HV). 2. CriticalRisks (reflecting the failure o f critical assumptions found inthe fourth column o f Annex 1): Risk Ratina I Risk Mitiaation Measure Municipalitiesunable to support Project S The state o f fiscal affairs o fthe many smaller objectives and neededtariffs changes municipalities on Croatia's coast i s tenuous. Many require improvements intheir financial management andtechnical capacity, and some are at the limits o ftheir debt capacity. To mitigate these risks, the operation has been designed incoordinationwith ongoing programs to improve municipal financial management capacity and to restructure the debt o f local governments. Inaddition, technical oversight will be handledbyHV. Future development and other sources o f M Although most and more important sources o f pollutionmight diminishthe impact o f pollution inthe Adriatic coast are associated to proposed investments inthe control o f urbanareas andmunicipaldischarges, the coastal waters pollution development o fthe coast inresponse to a rapid growth might create additional discharges that mightreduce the impact o fthe infrastructure proposedunder the Project. Inorder to avoid this riskthe Project will require that the solutions to be financed are decided from a regional perspective, including all existing and - 27 - potential future discharges inthe area andthat its impact be assessedusing the strengthened monitoring network. NwilllackGovernmentsupportfor M DuringProjectpreparationthe Government has heirroleinsector reformandthe codified HV's roles inthe sector through legal inancingof municipal infrastructure instrumentsdevelopedinthe overall sector regulatory framework and HV's responsibilities. %omComponents to Outputs ~ idividual project designs are not M ippropriate or over designed Local resistanceto proposedtechnical S solutions, locationoftreatment plants and ise of submarineoutfalls for the discharge 3f treated wastewaters approachwill be usedinall Project subprojects SPSC, despite N support, will not be N Duringpreparation, athorough analysis of able to implementandmanage sucha H v ' s capacityto manage the Program has been complex Project undertaken;basedinno small part ontheir managementofthe ongoing Bank operationsin Split and EasternSlavonia. Eventhough it has been already seen that HV's capacity i s more than adequate to handlethe technical management and implementationofthe operation, the Project includes financingto provide for the strengtheningo fthis implementingagency inProject monitoring, evaluation andreporting. Overall Risk Rating M Although the Project attempts a comprehensive sector reform and involvesnumerous municipalities, both aspectsthat mightincrease . the risks, most ofthe institutionaldevelopments have beenreachedduringProject preparation andthe experienceandprovencapacity ofHV and MoE inmanaging and implementingsimila operationsconfirmedthat the overall risk o fthi Project canbe consideredas moderate. Risk Rating- H (High Risk), S (SubstantialRi - 28 - 3. Possible Controversial Aspects: The operation includes a number o f aspects that might become controversial. These and the actions taken to mitigate the potential risk they represent for Project implementation are described below: m,the Project will require needed tariff changes and tariff surcharges to make investments sustainable and feasible. As indicated above, the state o f fiscal affairs o f the many smaller municipalities on Croatia's coast i s tenuous and no support can be expected to reduce this need. To prevent the controversy that the necessary tariff increases could cause, HV has initiated a public information campaign in coastal areas that, coupled with the specific SA activities in each subproject area, would inform the population o f the need for tariff reviews. Initial reactions, as measured by the SAs carried out for the first year subprojects, and confirmed by the local authorities willingness to introduce the Project surcharges and tariff reviews, indicate that population understanding and support for these measures i s ample. Second, there is a risk, as in any environmental investment program, that individual subproject designs might be considered and questioned as not appropriate or providing insufficient protection for the environment. Inparticular, one possible controversial aspect would be that subproject designs often include the constructionhehabilitation o f submarine outfalls for final discharge o f treated wastewaters into the sea. This risk is mitigated through (a) requirements that all subproject designs are subject to an EA that is publicly disclosed and subjected to a SA specifically designed to address this potential issue in the Program's Operational Manual; (b) experience gained during the implementation o f the MEIP, reflected in the communication and consultation activities carried out as part as Project, and abundant experience in Croatia in the use o f submarine outfall preparation; (c) a review o f the first year investment program by outside, international specialists that supported and endorsed the adopted approach; and (d) assurance o f compliance with EUDirectives on wastewater discharges and receiving water quality, inparticular through the implementation o fthe monitoring network component. G. Main Loan Conditions 1. Effectiveness Condition The following will be conditions o fEffectiveness: (i) The Subsidiary Loan Agreement has been executed on behalfo fthe Borrower and HV. (ii) Establishment o f SPSC under applicable commercial law (iii) Adoption o f the Accounting Manual o f Procedures and establishment o f a FinancialManagement system inSPSC satisfactory to the Bank 2. Other [classify according to covenant types used in the Legal Agreements.] As condition o f Boardpresentation, the Government will confirm to the Bank that the agreed Statute for the establishment o fthe SPSC have been approved by HV's Governing Board The following are legal covenants includedinthe LoanandProject Agreements: (a) The Borrower shall make the proceeds o fthe Loan available to Hrvatske vode 0under a Subsidiary LoanAgreement to be entered into between the Borrower and HV under terms and conditions which shall have beenapproved bythe Bank. - 29 - (b) HV,through its Special Purpose Subsidiary Company (SPSC) will be responsible for the management and implementation o f the Project. HV will sign an ImplementationAgreement with SPSC definingSPSC's responsibilitieswithrespect to implementationo fthe Project. (c) The Borrower shall appoint auditors for the Project accounts and financial statements for HV and the SPSC. (d) The Borrower shall ensure that HV maintains, duringthe term o f the Project, the SPSC with staff and other resources required for Project implementationand satisfactory to the Bank. (e) The Borrower shall ensure that the SPSC and HV implement the Project inaccordance with the terms and conditions o fthe Subsidiary-Loan Agreement, and the Operational Manual, includingthe Safeguard Policies. (f) The Borrower and HV shall maintain a financial management system, includingrecords and accounts, and prepare financial statements inaccordance with consistently applied accounting standards, acceptable to the Bank, adequate to reflect the operations, resources and expenditures relatedto the Project. (g) The Borrower will prepare and furnish to the Bankthe first Financial Monitoring Report (FMR) no later than forty-five (45) days after the end o f the first calendar quarter after the Effective Date; thereafter, each FMRshall be furnished to the Bank not later than 45 days after each subsequent calendar quarter, and shall cover such calendar quarter. (h) SPSC will provide sub-loans to MWSCs under Sub-loan and Implementation Agreements acceptable to the Bank. Under these agreements, MWSCs will be required to comply with the Safeguard Policies o f the Operational Manual, including submissiono f Environmental and Social Assessment, and Land Acquisition and/or Resettlement Plans, when applicable. MWSCs will also be required to met and maintain, through the life o fthe Project, basic financial ratio as conditions for inclusion inthe project: (i) operating ratio should be greater than 1.1; (ii) ratio should be greater than 1.2; (iii) interest current the coverage ratio should be greater than 1.5. (i) HVshallcauseSPSCtoobtaintheBank'spriorapprovalforthefirstfourSub-projects, andfor each Sub-loan and ImplementationAgreements which involves acquisition o f land and/or resettlement o f residents, and thereafter shall cause SPSC to submit for prior approval to the Bank the annual investment plan. G) The Borrower, HV, SPSC andthe Bankwill conduct a mid-term review o f the project on January 1,2006. The Borrower and HV will submit a mid-term report to the Bank by September 1,2005. Operatingratio is equal to total operating revenue divided by total operating expenses Currentratio is equal to current assets plus paid future expenses and deferred income divided by current liabilities and deferred payments and future period income. The interest coverage ratio is measured as earnings before interest and taxes (EBIT) divided by interest expenses. - 30 - H. Readiness for Implementation 1. a) The engineering designdocuments for the firstyear's activities are complete andready for the start o fproject implementation. 0 1.b)Notapplicable. 2. The procurement documents for the first year's activities are completeandready for the start o f project implementation. 3. The Project Implementation Planhas been appraisedand found to be realistic ando f satisfactory quality. 174. The followingitemsarelacking andare discussedunderloanconditions (SectionG): I. Compliance with Bank Policies 1. This project complies with all applicable Bankpolicies. 02. ThefollowingexceptionstoBankpoliciesarerecommendedfor approval. Theprojectcomplieswith all other applicable Bankpolicies. .- umter Lee Travers Team Leader Sector Manager Country Director - 31 - Annex 1: Project Design Summary CROATIA: COASTAL CITIES POLLUTION CONTROL PROJECT Key Performance Indicators sector Indicators: Fostering growth and creating 3rowth inthe country and in conditions for competitiveness he tourism industry oastal water quality will not through improving existing dversely affect tourism and infrastructure andprotecting Iurismwill continue to be a the environment, especially at riving force for growth in the coastal areas :roatia Reducing the size o f the Zfficiency inwater and .nnual reports 'he proposed reform will public sector iewerageutilities icreasethe efficiency o f nanagement and financing later and sewerageutilities Program Purpose: Ind-of-Program indicators: rogram reports: from Purposeto Goal) The overall objective ofthe Satisfactory compliance with ,Ureporting procedures :oastal water quality will not APL supported Program ipplicable EUstandards for ffect tourism and other would be to improve ambient he Adriatic coastal water lroductive activities along the coastal water quality to meet imbient quality oast EUstandards I Project Development 3utcome I Impact 'roject reports: from Objective to Purpose) Objective: Indicators: Improve the quality o f Percentage o f samples from innual MoE reports :uture development and other Croatia's Adriatic coastal monitoring bathingand ources o fpollutiondo not waters to meet EUambient shellfish areas water quality liminish the impact o f quality standards inthe :omplying with EUstandards roposedinvestments inthe participating municipalities, inparticipating :ontrol o f coastal waters ina financially and municipalities. )ollution. operationally sustainable I'echnical and Financial innual reports for each vlunicipalities canmeasure situation o f MWSC inthe iarticipating municipal water itilities eficiency and suppor participating municipalities, .ndsewerage utility 'roject objectives and needed (as indicatedrespectively by ariffs changes. their level o f unaccounted for water and sewerage network coverage rate and by their operating and debt service ratios. I - 32 - htputfrom each 3utput indicators: Projectreports: from Outputs to Objective) :omponent: trengthenedinstitutional The SPSC and the EIFF are 4nnual Project reports I V will continue to have rrangements for financing :stablished and capitalized jovernment support for its ndmanagement of mdparticipating MWSC .ole insector reform and Jastewatertreatment in :ontribute to Project inancing o f municipal :roatia investments as planned. nfrastructure. mproved and expanded Percentage o f wastewater Annual HV reports rhereis local support to tastewater treatment ?rodwedinthe coastal area xoposed technical solutions ifrastructure inselected municipalities participating in )rlocation oftreatment plants oastal municipalities the Project that i s collected, mddischarge infrastructure. treated, and disposed o f according to EUrequirements Percentageo fpopulation in Annual HV reports [ndividualproject designs are participating municipalities ippropriate and not over with adequate wastewater lesigned. collection and disposal systems donitoring systeminplace County laboratories Annual HV and MoE reports Laboratories with adequate rehabilitated andequipped by quality mechanisms and the MoE and HV central and controls inplace will be used regional laboratories for the monitoring o fthe operational and coastal waters quality and intercalibrated wastewater discharges 'roject ComponentsI Inputs: (budgetfor each Project reports: (from Componentsto hb-components: component) Outputs) ?oastalEnvironmental Euro61.65 million HV will be able to implement `nfrastructure Component such a complex Project i) Sewerage extension and Euro 19.28 million SPSC Project supervision ,ehabilitation reports ))Wastewater treatment and Euro 42.37 million SPSC Project supervision lisposal infrastructure reports `nstitutionalStrengthening Euro4.67 million SPSC Project supervision md Program Management reports Tomponent Rrengtheningof the Coastal Euro 7.68 million SPSC Project supervision WatersMonitoring Networks reports Strengthening o fthe Euro 3.73 million Znvironmental Monitoring ietwork Strengthening ofthe Euro 3.95 million Wastewater discharge control ietwork Unallocated Euro 6 million rOTAL Euro80 million - 33 - Annex 2: Detailed Project Description CROATIA: COASTAL CITIES POLLUTION CONTROL PROJECT By Component: -ProjectComponent 1 Coastal EnvironmentalInfrastructure Component. Euro 61.65 million, equivalent to - US$73.35 million Works proposed to be financed under this Component are those typical for the sector: sewer network rehabilitation and expansion (secondary network -diameters up to 250 mm- and main collectors, including tunnels, underwater passages and pumping stations as might be required for hydrological functioning); rehabilitatiodexpansion o f existing wastewater treatment facilities and submarine outfalls. Attached table below presents the planned investments for the four subprojects appraised duringProject preparation. Final investments to be financed by the Project will depend onthe subprojects that are successfully appraised. II Unit Krk 11 Opatija 11 Biograd Zadar ,I-- /Sewerage secondary network meters ~ ~~~ l ain collectors meters l~stewater 11 I~umping station i11 number reatment plant number(type *) 2 (PRI, MHI) number - length Submarine outfall (m) 1depth (m) 1(60C . .i00/25/300) 2 (1,700/25/300; diameter (mm) II 1,600/25/300) ** MHI:mechanical, PRI; primary * Rehabilitationand expansion Project Component2- InstitutionalStrengthening and Program Management Component. Euro 4.67 million, equivalent to US$5.55 million - Under this Component, the Project will finance consultant services and equipment to strengthen the capacity o f SPSC to implement and supervise the Project and provide technical assistance to the participating MWSC. Activities to be financed under this Component include: e Supply andinstallation o f informationtechnology equipment e Development o fwater pollutioncontrol institutional fkamework e Final designs, associated environmental and social assessmentsand supervision o f investments financed under approved subproject - 3 4 - 0 Technical assistance to the SPSC for Project implementation and evaluation, monitoring and financial management 0 Technical assistance for the strengthening o fmunicipalwater utilities. Project Component 3- Strengtheningof the Coastal Waters Monitoring Network. Euro 7.68 million, equivalent to US$ 9.12 million - Under this Component, the Project will provide financing for rehabilitating and equipping the county laboratories used by the M o E for environmental monitoring of coastal waters, and for HV central and regional laboratories. Equipment to be supplied will include special analyticalllaboratory equipment (atomic absorption spectrophotometers, toxicity testing, microbiological, etc), field vehicles (truck, boats) for sampling campaigns, field monitoring equipment and probes and general laboratory material and supplies. This component will also provide technical assistance for training and strengthening the staff capacity, introducing quality assurance procedures, including the execution o f intercalibration exercises, establish sustainable and harmonized data collection and analysis mechanisms incompliance with EUstandards, and carrying out special sampling and control campaigns. It will also include the design and development of a detailed Water Quality Monitoring Plan including specification of station locations, analytical parameters, and sampling/analysis/reportingprotocols. In this regard, liaison will be established with regional programs such as the MAP which provide technical and financial assistance towards the development o f national coastal water quality monitoring programs, to ensure that no duplication o f effort is made. - 35 - Annex 3: Estimated ProjectCosts CROATIA: COASTAL CITIES POLLUTIONCONTROL PROJECT I of the Coastal Waters HV LaboratoriesSubcomponent 3.95 4.9% MonitoringNetwork Total 7.68 9.6OA Unallocated 6.00 7.5% GRANDTOTAL 80.00 100.0% - 36 - Annex 4: Cost Benefit Analysis Summary CROATIA COASTAL CITIES POLLUTION CONTROL PROJECT Summary of Benefits and Costs: The major benefits o f the operation include (a) improvements in the environmental health in the Project area; (b) enhanced prospects for future tourism and growth and associated employment; and (c) improvements inlandvalues. Because the methodology for estimating social benefits as regards investments in sewerage and wastewater treatment is quite controversial and may entail conceptual difficulties (EC, 1997), the applicability o f standard methodologies o f environmental valuation, such as contingent valuation, may be limited. Consequently, the approach applied here focuses on the non-environmental benefits o f the proposed investments in sewerage and wastewater treatment systems. The benefits stem from direct and indirect results o f the proposed investments. The methodology selected is consistent with the guidelines utilized by the European Union (EC, 1997). To determine the net incremental costs and benefits, "with" and "without" Project scenarios were constructed, applying appropriate shadow prices. Input data has been derived from data presented from the feasibility studies, financial analysis, relevant tourism and shellfish productionsector projections, and other publicly available data (e.g., data on real estate values). Economic Internal Rates o f Return (EIRRs) and Net Present Values (NPVs) for individual sub-projects were calculated (utilizing a discount rate o f 10% and a 10-year cash flow stream to be consistent with the financial analysis undertaken). Using a 15-year projection o f benefits and costs, the EIRRs are considerably higher. The results are summarized in Table A4.1 below. Table A4.1: Subproject Economic Internal Rates of Return EIRR@I 10% Novicrad 16.3% Biogradna M o r u24.4% Zadar 23.2% The high EIRRs reflect, in large part, the efforts taken during Project design to limit investments to appropriate technologies and least-cost approaches. -37 - MainAssumptions: The main assumptions, other than those included as legal covenants relatedto the financial performance o f MWSCs andmaintenance o f appropriate financial ratios (see Annex 5), include: (a) collection ratios were assumed to remain relatively constant based on historical data; (b) investment costs were assumed to include a physical contingency o f lo%, an extremely conservative estimate given experience with World Bank financed wastewater treatment investments inCroatia under the ongoing projects; (c) imputed yearly operation and maintenance costs o f approximately 15% o f investment; and (d) population-equivalent growth o f24%. Sensitivity analysis/ Switching values of critical items: Sensitivity analysis was then undertaken to assess the robustness o f the sub-projects by switching the discount rate, values o f key variables (including tourism expenditures and real estate value benefits). Inall four sub-projects, discount rates to yield a null NPV average approximately 18% (with Opatija being the most sensitive at 13.2%). FiscalImpact: The Projectwould entail a fiscal cost since it involves the provision o f direct contributions from the Central Government through Hv to MWSCs. The aggregate fiscal cost i s difficult to assess ex-ante, since sub-projects will be defined during the course of the operation. The estimate which has been made o f the fiscal cost o f the four sub-projects analyzed indetail indicates that Government contribution is expected to be approximately Euro 14.6 million. This figure includes approximately Euro 7.5 million from the pollution charges managed by Hv which are revertedas direct H v ' s contributionto investments. Over the course o f the 4 year operation, it i s estimated that the contribution provided for wastewater treatment infrastructure would be valued at approximately Euro 30.5 million (Euro 18.7 million in the form o f returnedpollution fees). Project generated taxes will amount to approximately Euro 17 million. - 38 - Annex 5: FinancialSummary CROATIA: COASTAL CITIES POLLUTIONCONTROL PROJECT Financial summaries for the appraised municipal utilities i s presented inthe attachedtables. Main aspects ofthe analysisperformedduring Project preparation are describedbelow. Krk Ponikve d.o.0. Krk is a municipal utilitywhose principal shareholdersinclude the municipality of Omisalj, Malinska-Dubasnica, Punat, Baska, Vrbnik, Dobrinj, and Krk. Total company operating expenses attributed 2003 are estimated at HRK 25.5 million (Euro 3.9 million). Even when these operational expenses are combined with depreciation, Ponikve's total business operations generates a profit estimated at HRK 13,644 (Euro 2,100). Ponikve's modest level o f profitability i s a result of its relatively hightariff schedule. Ponikve ranks as one of the top four municipal utilities with respect to its level of tariffs the surveyed group. In 2003, household and business enterprise sewerage tariffs were HRK 1.74 m3 (Euro 0.27 m3) and HRK 3.16 m3 (Euro 0.50 per m3), respectively. Utility and municipal officials intend to raise the tariff again inearly 2004. Ponikve d.o.0. has a medium-to long-term investmentplanincluding collectors, pipelines, and wastewater treatment operations estimated at a total HRK 46.8 million (Euro 7.1 million) for APL Phase I.Under Phase Io f the regional environmental lending facility, Ponikve has a total financing requirement of HRK 46.8 million. Thirty-percent, or HRK 14.4 million (Euro 2.2 million) are projected to be grant or equity financed from Hrvatske Vode. About fifty percent of total capital investment requirements, or HRK 23.4 million(Euro 3.6 million) is projected to be financed from a loan facility. The loan is calculated with a tenor of 15 years, 5 years grace, and the prevailing IBRD interest rate. The utility will need to finance HRK 9.4 million (Euro 1.4 million) from its own internal resources. It is expectedthat the utility will increase their sewerage tariff by a minimumof HRK 3 to 4 m3 (Euro 0.50 to Euro 0.60 m3). Financialprojections indicate that these potential levels of sewerage tariff increaseswould be more than sufficient to cover debt servicing under several stress test variations. Despite having comparatively higher water and sewerage tariffs than the surveyed sample group, average household income at HRK 55,000 (Euro 8,461) i s also the highest in our survey sample. With projected tourist inflows averaging between 45,000 to 50,000 personsper season, Ponikve is a municipal utility that should have sufficient capacity to service a loanobligation of HRK23.4 million. Komunalac d.o.0. Opatija i s a municipal utility whose principal shareholders include the municipality of Opatija, Lovaran, Matulji and Moscenicka Draga. Operating expenses attributed to wastewater treatment for 2003 are estimatedat HRK 3.2 million(Euro 0.51 million). Evenwhen these operational expenses are combined with depreciation, the wastewater side of Komunalac's wastewater operations generates a profit estimated at HRK 587,000 (Euro 93,000). Komunalac's seemingly strong wastewater profitability i s a result of its relatively hightariff schedule. Opatija has one of the highest water and sewerage tariffs o fthe surveyed group. In 2003, household and business enterprise sewerage tariffs were HRK 2.49 m3 (Euro 0.40 per m3) andHRK 3.80 m3 (Euro 0.60 per m3), respectively. Utilityand municipal officials intendto raise the tariff again inearly 2004. The enterprise has a medium- to long-term investment plan for collectors, expanded sewerage coverage, and wastewater treatment/disposal estimated at a total HRK 158.1 million (Euro 24.4 million). In 2003, - 39 - the utility and its municipal owners spent HRK 20 million (Euro 3.2 million) from their own resources for capital improvement projects. Under Phase Iof the Program, Komunalac would receive financing inthe neighborhood of HRK 79.8 million. Thirty-percent, or HRK23.9 million (Euro 3.7 million) are projected to be grant or equity financed from Hrvatske Vode. About fifty percent of total capital investment requirements,or HRK39.9 million (Euro 6.2 million) is projectedto be financed from a loanfacility. The loan is calculated with a tenor of 15 years, 5 years grace, and the prevailing IBRDinterest rate. The utility will need to finance HRK 16.6 million (Euro 2.2 million) from its own internal resources. It is expectedthat the utilitywill increasetheir sewerage tariff by a minimumof HRK 3 to 4 per m3 (Euro 0.50 to Euro 0.60 per m3). Financial projections indicate that these potential levels of sewerage tariff increases would be more than sufficient to cover debt servicing under several stress test variations. Despite having comparatively higher water and sewerage tariffs than the surveyed sample group, average household income at HRK 55,000 (Euro 8,461) i s also the highest in the survey sample. With projected tourist inflows averaging between 45,000 to 50,000 personsper season, Komunalac d.o.0. Opatijia is a municipal utilitythat shouldhave sufficient capacity to service aloanobligationofHRK 16.6 million. Komunalac d.o.0. BiogradN a M o r u Komunalac d.o.0. Biograd na Moru is a limited liability company established in 2000 with an officially registeredcapital stock of HRK 20 million (Euro 3.2 million). Komunalac d.o.0. Biograd is owned by the municipalities of Biograd, Sv. Filip IJakov, Pakostane, and Pasman. Komunalac provides sewerage, water delivery, solid waste, road and park maintenance services for its municipal owners. Total Komunalac d.o.0. revenues equaledHRK 17.6 million (Euro 2.8 million) and HRK 10.6 million (Euro 1.6 million) in 2002 and 2001, respectively. More than HRK 5.2 million (Euro 0.83 million) of the year over year increase inrevenues can be attributed to a grant infusion from national government resources. In2001 and 2002, operating expenditures (excluding depreciation) equaled HRK 10.6 million (Euro 1.6 million) and HRK9.5 million(Euro 1.5 million), respectively. Taking depreciationandamortization into consideration, the net deficit as a function of total expenditures in 2001 was 14.1%. As a result of the grant in 2002, Komunalac d.o.0. found itself ina net positive financial operating position. Komunalac d.o.0. Biograd's tariff decisions are made at the discretion of the local municipal managing authorities. However, tariffs have not been adjusted to accommodate inflation and increased capital improvement expenses for several years. The subproject's inclusion in the initial year of the Program would be contingent on the approval by the utility's municipal directors to of a recently proposed increase inwater andseweragetariffs beginningin2004. The subproject would include financing for main collectors, pumping stations, a wastewater treatment facility and an improved submarine outfall. The total value of the investments i s estimated at HRK 64.8 million (Euro 9.9 million). In order to finance this level of capital investment, about HRK 19.4 million (Euro 3.0 million) are expected to be financed from grant (or additional equity contributions), and HRK 32.3 million (Euro 4.9 million) is projected to be financed from a loan facility. The utility will need to finance HRK 12.9 million (Euro 2.1 million) from its own internal resources. It i s expectedthat the utility will increasetheir sewerage tariffby a minimumo fHRK3 to 4 per m3 (Euro 0.50 to Euro 0.60 per m3) to cover this additional level of debt service. Financial projections indicate that these potential levels of sewerage tariff increase would be more than sufficient to cover debt servicing under several stress test variations. - 40 - Odvodnja d.o.0. Zadar i s a limited liability company established in 1998 whose sole owner i s the municipality of Zadar. The company's sole responsibility is to deal with municipal sewerage issues. Total revenues equal HRK 8.2 million (Euro 1.2 million). O f this HRK 8.2 million in company revenues, approximately 47%, or HRK 3.9 million, comes from municipal grants or subventions. Total expenditures (net of depreciation) equals HRK 5.7 million (Euro 0.9 million). When taking depreciation and amortization into consideration, the total 2002 operational deficit equaledabout 6%. O f the surveyed utilities, Zadar has one of the lowest tariff schedules applied to householdsand businesses (enterprises). Sewerage household and business tariffs have remained fixed at HRK 0.77 per m3 (Euro 0.12) and HRK 1.07 per m3 (Euro 0.16), respectively over the past several years. Average family household income provided by the service providers indicates that Zadar's annual average household income is modestly greater than that of Biograd. In order for Zadar to participate in the Program, the municipality would needto increasehouseholdand business sewerage tariffs to about HRK2.5 per m3 and HRK4.0 per m3, respectively. Tariffs establishedat this level would create an environment of financial stabilityfor the utility. The subproject includes financing for main collectors, two wastewater treatment plants andtwo submarine outfalls. The total value of the investments i s estimated at HRK 112.2 million (Euro 17.7 million). In order to finance this investment, about HRK 33.6 million (Euro 5.2 million) i s expectedto be financed from grant (or additional equity contributions), and HRK 56.1 million (Euro 8.6 million) is projected to be financed from a loan facility. The utility will needto finance HRK22.4 million (Euro 3.5 million) from its own intemal resources. It i s expected that the utility will need to increase their sewerage tariff by an additional minimumHRK 3 to 4 per m3 (Euro 0.50 to Euro 0.60 per m3) to accommodate the additional debt servicing requirements. FinancialReauirements All ofthe utilities participating inthe Program are expectedto meet and maintain throughout the life ofthe Project basic financial ratios as conditions for subproject inclusion: 0 Operating ratio should be greaterthan 1.1. 0 Current ratio shouldbe greater than 1.2. 0 The interest coverage ratio should be greater than 1.5. Operatingratio is equal to total operatingrevenue dividedby total operatingexpenses Current ratio is equal to current assets plus paidfuture expenses and deferredincome dividedby current liabilities anddeferredpaymentsandfuture periodincome. The interestcoverageratio i s measured as earnings before interest andtaxes (EBIT) dividedby interest expenses. -41 - - 42 - IOpatijaBaseCaseForecast 2003 2006 2007 4,252,500.00 4,366,813.41 4,585,154.08 4,814,411.79 5,055,132.38 43,000.00 43,464.42 44,333.71 45,220.39 46,124.79 325,044.73 329,052.74 335,633.80 342,346.47 349,193.40 119.15323 119.15323 119.15323 119.15323 119.15323 4,739,697.96 4,858,483.81 5,084,274.82 5321,131.88 5,569,603.80 464,96826 474,267.62 483,752.97 493,428.03 503a.59 1,350,000.00 1,360,269.% 1,387,286.15 4415,03 1.88 1,443,332.51 550,075.70 556,858.49 56795.66 579355.57 590,942.68 225,ooo.00 227,430.13 231,978.73 236,618.30 241350.67 77.611.91 75283.55 zu25.&? 70.834.29 69.510.63 2,667,655.86 2,694,109.75 2,744,038.56 2795,268.08 u 2 848433.08 920.000.00 920.000.00 920,000.00 920.030.00 920.000.00 920,000.00 920,000.00 - 930,295.83 937,650.00 937,650.oO IGR0SPFmFl.r 1,152,042.10 1,244,374.06 L1409940.43 -2 550,000.00 552,974.64 558,504.38 564,089.43 569,73032 I""""""" 6o2.042.10 691399.42 B2kUfiu 1.024.124.37 1213.790.40 BQ2P4210 h91.399.42 851.436.05 1.024.124.37 uu.7qa4L) I I - 43 - - ~~ iograd BaseCaseForecast 2003 2004 2005 2006 2007 2008 KomeStatement HouseholdWater 2,998,065.00 4,207,284.55 4,207,284.55 5,206,639.55 5,206,639.55 6,205,994.55 BusinessWater 3,517,776.00 3,957,498.00 3,957,498.00 3,957,498.00 4,397,220.00 4,397,220.00 Sewerage 297,675.00 396,900.00 396,900.00 496,125.00 4%,125.00 595,350.00 OUKls 7,717,515.13 7,794,690.28 7,872,637.18 7,951,363.55 8,030,877.19 8,111,185.96 MeterMaintenance 1,870,978.02 1,964,526.92 2,062,753.27 2,165,890.93 2,274,185.48 2,387,894.75 ConnectionFees 1326.133.72 1,339,395.06 1.352.789.01 1.366.316.90 1,379.980.07 1.393.779.87 otalRevenue 17,728,142.87 19,660,294.81 19,849,862.0 1 21,143,833.93 21,785,02729 23,091,425.13 xpenditures (wers 2,187,02 1.09 2,187,021.09 2,187,021.09 2,187,021.09 2,187,021.09 2,187,021.09 MaintenanceBuildings 811,123.94 827,233.59 843,778.27 860,653.83 877,866.91 895,424.25 Fuel 525,247.25 535,S32.84 546,243.49 557,168.36 568,311.73 579,677.96 Mate& -Other Expenditures 843,040.01 861,966.91 887,825.92 914,460.70 941,894.52 970,151.35 salariesandEmploymentBenefits 3,613,280.06 3,685,043.07 3,758,743.93 3,833,918.81 3,910,597.19 3,958,689.74 FinandPaymenls 1,622,464.91 1,573,790.97 1,526,577.24 1,480,779.92 1,436,356.52 1,393,265.83 'otalFactorvOverheads(excatDeureciation) 7,415,156.17 7,483,567.38 7,563,168.85 , 7,646,981.62 , 7,735,026.87 7,797,209.14 kpreciationandAmortization Equipment 1,432,000.00 1,432,000.00 1,432,000.00 1,432,000.00 1,426,166.67 1,362,000.00 'otalDepreciationandAmortization - - - - 1,432,000.00 1,442,295.83 1,449,650.00 1,449,650.00 1,443,816.67 1,379,650.00 ;ROSS PROFIT =-= 5,300,518.48 7,112,159.96 7,171,714.01 8,337,523.92 - 8,850,825.64 10,112,157.78 .. L- tiveExpenses 2,155,425.34 2,209,310.97 2,264,543.7s 2,321,157.34 2,379,186.27 2,438,665.93 lPERA'ITNG PROFIT &145.093.14 4.902.848.99 4.907.170.27 6.016.366.58 5471.639.37 7.673.491.Q :BIT 2,au&ui4.902.848.994.907.170.276.916.366.586.471.639.37- - 44 - zoo2 2003 2004 2005 2006 2007 2,372,490.00 2372,490.00 3,523,500.00 3323,500.00 4,698,000.00 4,698,000.00 5,872,500. 1,783,968.00 1,793,616.47 1,81155263 1,829,668.16 1,&47,964.&4 1,866,444.49 1,885,108. 3.941.032.00 3962346.80 4.00197027 4.041.989.98 4.082.409.88 4.123233.97 4.164.466.31 8,0!7,490.00 8,128,453.28 9,337,022.91 9,395,158.14 10,628,374.72 10,687,678.47 11,922,07525 1,476365.19 1,505,89249 1,536,01034 1366,730.55 1,598,065.16 1,630,026.46 1,662,626. 2,810,068.00 2,831,445.25 2,%37,W.32 295,433.92 3,004,342.60 3,064,429.45 3,125,718. 511,000.00 511,000.00 511,000.00 511,000.00 511,000.00 511,000.00 511,000. 897,451.00 907,143.97 !Z5,2&j.85 943,792.59 962,668.44 981$21.81 1,001,56025 62558.10 58.179.03 54.106.50 50319.05 48.101.55 48.07725 48.07725 5,757,442.29 5,813,660.75 5,914,084.01 6,017276.10 6,124,177.75 6,235,454.97 6,348,982.53 2,712,881.00 2,712,881.00 2,712,881.00 2,712,881.00 2,712,881.00 2,712,881.00 2,712,881.00 2,712,881.00 2,723,176.83 2,730,531.00 2,730,531.00 2,730,531.00 P ~ P --=- -372,833.29 -398,088.47 699,762.07 647351.03 1,7?3,665.97 1,721,692.49 488,607.00 498,379.00 50835.00 518,513.00 528,883.00 539,461.00 550,250.00 2 3 a f i u a - m - - - -45- Annex 6(A): Procurement Arrangements CROATIA: COASTAL CITIES POLLUTION CONTROL PROJECT Procurement The components o fthe proposed Project, their estimated cost andprocurement methods are summarized in Table A o fthis annex. The procurement methods are presented inTable B o f this annex. The procurement o f major contracts will be subject to prior review. Table B1 summarizes the capacity o f the Project implementing agency, the SPSC, in procurement and the proposed arrangements for procurement and monitoring. Table B 2 presents a procurement plan for the packaging and estimated schedule o f the major procurement actions for the first year o f APL Phase I.The Project will be financed from the proceeds o f the proposed Euro 40 million (equivalent to US$47.53 million) loan andthe local expenditure contributions from the Government o f Croatia (Euro 40 million). The total cost o f the Project would be Euro 80 million (equivalent to US$95.06 million). Goods and works wholly or partially financed by IBRDwill be procured in accordance with the Guidelines for Procurement under IBRD Loans and IDA Credits published in January 1995 and revised in January and August 1996, September 1997 and January 1999. Consultant's services wholly or partly financed by IBRDwill be procuredinaccordance withthe Guidelines for Selectionand Employmento fConsultants by World Bank Borrowers published inJanuary 1997 and revised in September 1997, January 1999 and May 2002. Standard documents published by the World Bank will be used by SPSC for the preparation o f biddingdocuments andrequest for consultant's proposals. ECARegional Sample BiddingDocuments will be usedfor National Competitive Bidding(NCB) o fWorks. Procurement of Works. Civil works contracts estimated to cost over Euro 1,000,000 equivalent will be procured by International Competitive Bidding (ICB) with post qualification based on the Bank Standard Smaller Civil Works Document. Contracts estimated to cost less than Euro 1,000,000 equivalent per contract may be procured under National Competitive Bidding (NCB) procedures with the specific conditions added to ensure compliance with World Bank Guidelines, as described in Schedule 3, Section I Part C.l (b) o f the Credit Agreement. In addition, contracts to be procured under N C B have to be advertised in the entire Croatia and the NCB Works document would be based on the Region's Sample Biddingdocuments for Works under NCB. Other smaller contracts estimated to cost less than Euro 100,000 equivalent per contract, will be procured underMinor Works (MW) procedures. Procurement of Goods. Goods and equipment estimated to cost less than Euro 500,000 equivalent, will be procured by N C B inaccordance with the Bank Standard Goods Procurement Documents. International Shopping (IS) procedures may be used for readily available goods of standard specifications estimated to cost less than Euro 100,000 equivalent per contract. I S procedure will require quotations from at least three (3) suppliers from two different countries. IS may be used for goods such as information technology equipment. ICB procedures will be used for contracts estimated to cost Euro 500,000 equivalent or more per contract, through the use o fBank Standard BiddingDocuments for Goods. Selection Procedures for Consulting Services. Selection o f Consulting Firms for services including engineering and design, estimated to cost Euro 200,000 equivalent or more per contract, will be done through QCBS. Selection o f Consulting Firmsfor services including technical assistance, estimated to cost less than Euro 250,000 equivalent per contract, may be done through QBS method. Consultant services including technical assistance, estimated to cost less than Euro 100,000 equivalent, may be contracted out - 46 - under CQ procedures. Services o fa standard nature, includingAudits and simple Design, estimatedto cost less than Euro 200,000 equivalent, will be procured through LC procedures. Individual Consultants for the provision of services including Project management support services will be procured in accordance .with the procedures set up in Section V, 5.1 to 5.4., of the Guidelines. Procurementmethods (TableA) I (14.34j (11.77)l (13.88j 0.4 (40.00 1)Figuresmprentksesarethean"@ kamdbytheBank PRD). AU costs incluckmtinpcks. tobe 2)h h x kcivilwnkiandgoodst0bepmucdlhwghMinorWorksp"shqpmg,axLFultingservices,senicesofm&ictedstafFof thehojectmanagementoffice,h g , technicalassistanceservices,andincremenfalopezatingcostsrelatedto(i) iheProject,and(ii) managing re-lendingProjectfirndstolocalgovernmentunitsasthecasemaybe. TableAI: ConsultantSelectionArrangements(optional) MillionEuroequivalent -47- Prior reviewthresholds (Table 6) Contracts wholly or partially financed by IBRD will be prior reviewed according to the following table, taking into account HV's experiencedprocurement staff -from which SPSC staff will be drawn- practical experience inprocurement under the World Bank`s guidelines. The Borrower would use Bank's standard BiddingDocuments for ICB procurement. The NCB Works document would be based on the Region's Sample Bidding documents for Works under NCB. For Consultant's assignments, the Bank's standard forms o f contracts would be used. All the ICB goods and civil works contracts, the first NCB works contract, the first NCB goods contract, the first I S contract, the first MW contract, and all consulting contracts exceeding Euro 100,000 equivalent in case of firms, and Euro 50,000 equivalent in case of individuals, would be subject to the Bank's prior review. All other procurement documents and procedures would be subject to the Bank's ex-post reviewon a randombasis inaratio of one into five. A procurement assessment of the Agency will be undertaken duringthe first supervision mission. Provisional conservative thresholds are proposed at start and may be revised after the assessment. (See Table B1: Capacity Assessment) Table B: Thresholdsfor ProcurementMethodsand Prior Review' ContractValue Contracts Subject to 1 Threshold Procurement Prior Review II.Works ExpenditureCategory (Euro) Method (Euro millions) over 1,000,000 ICB all: 28.69 less than 1,000,000 NCB first contract :0.70 lessthan 100.000 MW first contract: 0.05 2. Goods over 500,000 ICB all: 2.36 up to 500,000 NCB first contract 0.80 I S first contract: 0.09 QCBS all: 5.61 foreign firms) between lO0;OOO and QBS above 100,000: 1.19 250,000 less than 100,000 CQ less than 150,000 LCS above 100,000: 0.00 50.000 IC above 50.000: 0.10 4. Miscellaneous 5. Miscellaneous 6. Miscellaneous Total value of contracts subject to prior review: Euro 39.60 million Overall ProcurementRisk Assessment: Frequency of procurement supervision missionsproposed: One every 12months (includes specialprocurement supervision for post-reviewiaudits) - 48 - Table B1: Capacity of the Project Coordination Unit inProcurement and Assistance RequirementsinProcurementMonitoringSystem (To be reviewed afterjrst mission of Procurement Specialist to Croatia) 'roject: The overall Project Development Objective is to improve the quality of Croatia's Adriatic :oastal waters in a financially and operationally sustainable manner, through (i)strengthening the nstitutional arrangements for financing and management o f municipal wastewater treatment nfrastructure in Croatia and (ii)financing o f wastewater treatment facilities in selected coastal nunicipalities. The Project will also provide technical assistance for engineering services, environmental issessments and support o f Project implementation. The project will be implemented through the APL rogram approach for the sector rather than addressing investment needs city-by-city and )roject-by-project. The APL program will be implemented in three Phases, spread over 10 -years: Phase I(the Project) for 'our years (2004-2008); Phase I1for three years (2007-201 1) and Phase I11for three years (201 1-2014). The overall Program costs are estimated at approximately Euro 750 million, o f which the Bank would nost likely finance a total o f Euro 140 million for the three phases. Parallel financing by other donors is Iossible, particularly from EIB and the EU (in later phases), but is still to be identified. Phase Io f the 4PL Program (the Project) is estimated at Euro 80 million with the Bank financing Euro 40 million and .ncludesthe following components (an unallocated amount o f 6 million is reserved): (I) Coastal Environmental Infrastructure Component. Euro 61.65 million - rehabilitation and :xpansion o f sewer network, existing wastewater treatment facilities and submarine outfalls. (2) Institutional Strengthening and Program Management Component. Euro 4.67 million - :onsultant services and equipment to strengthen the capacity o f SPSC (subsidiary company o f HV) to :any out the project and provide technical assistanceto the participating water companies (MWSC). (3) Strengthening of the Coastal Waters Monitoring Network Euro 7.68 million - special ana1yticalAaboratory equipment)vehicles for sampling campaigns) field monitoring equipment, etc. OrganizationalArrangement: The overall implementation responsibility for the proposed project rests with Hrvatske Vode (HV) and local utilities. HV will use its subsidiary company - Special Purpose Subsidiary Company (SPSC) - for the management and implementation o f the project. The SPSC will be established prior to Effectiveness. HV`s performance inthe project management o f the on-going Eastem Slavonia Reconstruction Project has been highly satisfactory and its procurement practices has been rated as "best practice" for the ECA Region. SPSC will receive 3 procurement specialists from HV who have demonstrated the "best practice" inthe procurement while implementingthe Reconstruction project. The Reconstruction project has similar components to the proposed project, therefore, it is expected that the procurement under the project would be satisfactory. This will be checked during the assessment o f the procurement capacity o fthe Implementing Agency. CPAR: The latest Country Procurement Assessment Review (CPAR) for Croatia was carried out by the Bank inAugust 1999. The Bank's assessment was based on the "Public Procurement Law, December 19, 1997" besides other laws andregulations. According to the CPAR the 1997 Public Procurement Law (PPL) came into force on March 9, 1998. The PPL follows UNCITRAL model law. The PPL replaces the procurement decrees o f 1995, 1996 and 1997. The PPL is not applicable to procurement under international agreements, grant-funded procurement, procurement relating to defense and national security, and for urgent rehabilitation o f damages causedby natural disasters and emergencies. The CPAR indicates that according to the assessments provided by the task team leaders o f the - 49 - 3ank-financed projects thenunder implementation, the overall procurement performance in these projects s generally satisfactory except some cases o f delays in evaluations and contract award, and some ,ebiddings. It also states that there are some problems reported for the portfolio under implementation vhich include: negotiations with bidders after selection, lack o f delegation of authority which resulted in Iecision-making delays, frequent cost overruns in works specially those relating to landmine clearing; nadequate and inappropriate technical specifications, lack o f security for advance payment, and ion-auditing o f some Bank-financedcontracts. aecommendedThresholds for ProcurementMethods The CPAR states that the analysis of the public and private sector environment in Croatia indicates that he country has fair and transparent competitive policies and procedures in place, therefore, from the xocurement point o f view, Croatia is an average risk country. The following threshold o f procurement nethods were recommended by the CPAR. The task team will review the thresholds for procurement nethod duringthe appraisal, since the CPAR review was carried out about 5 years ago. ProcurementMethod Thresholds [CB Works Euro 1,000,000 or more YCB Works Euro 500,000 NCB Goods