WATER USERS ASSOCIATION DEVELOPMENT SUPPORT PROJECT IDA FINANCING AGREEMENT 4913-AZ AND IBRD LOAN AGREEMENT 8039-AZ Special-Purpose Financial Statements and Independent Auditors' Report For the period from January 1, 2017 to July 20, 2018 WATER USERS ASSOCIATION DEVELOPMENT SUPPORT PROJECT TABLE OF CONTENTS Page INDEPENDENT AUDITORS' REPORT 1-2 SPECIAL-PURPOSE FINANCIAL STATEMENTS FOR THE PERIOD FROM JANUARY 1, 2017 TO JULY 20,2018: Special-purpose balance sheet 3 Statement of summary of sources and uses of funds 4-5 Statement of designated account 6-7 Statement of expenditure and summary sheet withdrawal schedule 8-10 Notes to the special-purpose financial statements 11-16 BAKERTILLY AZERBAlJAN Audit, Tax and Consulting Demirchi Tower, 16th floor Khojaly Avenue, 37 AZ1025, Baku Azerbaijan T:+ 994(12)404 7 666 F:+ 994 (12) 404 7 667 office@bakertilly.az www.bakertilly.az INDEPENDENT AUDITORS' REPORT To the Project's Implementation Unit of the Water Users Association Development Support Project: Opinion We have audited Special-Purpose Financial Statements of the Water Users Association Development Support Project (the "Project"), which comprise the Special-Purpose Balance Sheet as at July 20, 2018, and the Statement of Summary of Sources and Uses of Funds, the Statement of Designated Account and the Statement of Expenditure and Summary Sheet Withdrawal Schedule ("SOE and SSWS") for the period from January 1, 2017 to July 20, 2018 and a summary of significant accounting policies and other explanatory notes (hereafter collectively referred to as the "Special-Purpose Financial Statements") financed under the International Development Association (the "IDA") through credit number 4913-AZ and International Bank for Reconstruction and Development (the "IBRD") through loan number 8039-AZ (hereafter collectively referred to as the "Loan Agreement"). In our opinion, the accompanying Special-Purpose Financial Statements present fairly, in all material respects, the financial position of the Project as at July 20, 2018, the cash receipts and disbursements on behalf of the Project and transactions passed through the Project's Designated Accounts for the period from January 1, 2017 to July 20, 2018 in accordance with IPSAS "Financial Reporting under the Accrual Basis of Accounting" and relevant provisions of the Loan Agreement as described in Note 2 of the Special-Purpose Financial Statements. Basis for Opinion We conducted our audit in accordance with International Standards on Auditing (ISAs). Our responsibilities under those standards are further described in the Auditors' Responsibilities for the Audit of the Special- Purpose Financial Statements section of our report. We are independent of the Project in accordance with the International Ethics Standards Board for Accountants' Code of Ethics for Professional Accountants (IESBA Code), and we have fulfilled our other ethical responsibilities in accordance with these requirements and the IESBA Code. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our opinion. Responsibilities of Management for the Special-Purpose Financial Statements Management is responsible for the preparation and fair presentation of the Special-Purpose Financial Statements in accordance with IPSAS and relevant provisions of the Loan Agreements as described in Note 2 to the Special-Purpose Financial Statements, and for such internal control as management determines is necessary to enable the preparation of Special-Purpose Financial Statements that are free form material misstatement, whether due to fraud or error. An independent member of Baker Tilly international BAKERTILLY AZERBAIJAN Emphasis of Matter Basis ofAccounting and Restriction on Distribution and Use We draw attention to Note 2 to the Special-Purpose Financial Statements, which describes the basis of accounting. The Special-Purpose Financial Statements are prepared to assist the Project's Implementation Unit in complying with the financial reporting provisions of the Loan Agreement referred to above. As a result, the Special-Purpose Financial Statements may not be suitable for any other purpose. Our report is intended solely for the Project Implementation Unit, the Government of the Republic of Azerbaijan, the IDA and the IBRD and should not be distributed to or used by parties other than Project's Implementation Unit, the IDA and the IBRD. Our opinion is not modified in respect of this matter. Termination of Project Without qualifying our opinion, we also draw attention to Note 1, which describes that the Project's completion date is June 30, 2018 and the Project will have additional four months grace period for making disbursement. Auditor's Responsibilities for the Audit of the Special-Purpose Financial Statements Our objectives are to obtain reasonable assurance about whether the Special-Purpose Financial Statements as a whole are free from material misstatement, whether due to fraud or error, and to issue an auditors' report that includes our opinion. Reasonable assurance is a high level of assurance, but is not a guarantee that an audit conducted in accordance with ISAs will always detect a material misstatement when it exists. Misstatements can arise from fraud or error and are considered material if, individually or in the aggregate, they could reasonably be expected to influence the economic decisions of users taken on the basis of these Special-Purpose Financial Statements. As part of an audit in accordance with ISAs, we exercise professional judgment and maintain professional skepticism throughout the audit. We also: * Identify and assess the risks of material misstatement of the Special-Purpose Financial Statements, whether due to fraud or error, design and perform audit procedures responsive to those risks, and obtain audit evidence that is sufficient and appropriate to provide a basis for our opinion. The risk of not detecting a material misstatement resulting from fraud is higher than for one resulting from error, as fraud may involve collusion, forgery, intentional omissions, misrepresentations, or the override of internal control; * Obtain an understanding of internal control relevant to the audit in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Project's internal control; * Evaluate the appropriateness of accounting policies used and the reasonableness of accounting estimates and related disclosures made by management. We communicate with those charged with governance regarding, among other matters, the planned scope and timing of the audit and significant audit findings, including any significant deficiencies in internal control that we identify during our audit. August 3, 2018 Baku, the Republic of Azerbaijan WATER USERS ASSOCIATION DEVELOPMENT SUPPORT PROJECT SPECIAL-PURPOSE BALANCE SHEET AS AT JULY 20, 2018 (Amounts expressed in the United States Dollars unless otherwise indicated) Note July 20, December 31, 2018 2016 ASSETS AND CUMULATIVE USES OF FUNDS Cash at bank 3 18,141 1,451,495 Cumulative uses of funds 4 107,649,375 100,844,672 Advances to region support units - 16,265 Accumulated exchange rate differences 120,397 123,344 TOTAL ASSETS AND CUMULATIVE USES OF FUNDS 107,787,913 102,435,776 SOURCES OF FUNDS Cumulative IDA Funds 72,680,716 69,365,850 Cumulative IBRD Funds 3,200,000 3,200,000 Cumulative Project Account 31,907,197 29,869,926 TOTAL SOURCES OF FUNDS 107,787,913 102,435,776 Approved and sjgiied on h eh%fo,4lev roVY> ' mlmetto Unit: ayev Gulbahar MamLadloa Project Direct r Chief Accountant August 3, 2018 August 3, 2018 Baku, the Republic of Azerbaijan Baku, the Republic of Azerbaijan The notes on pages 11-16 form an integral part of these Special-Purpose Financial Statements. 3 WATER USERS ASSOCIATION DEVELOPMENT SUPPORT PROJECT STATEMENT OF SUMMARY OF SOURCES AND USES OF FUNDS FOR THE PERIOD FROM JANUARY 1, 2017 TO JULY 20, 2018 (Amounts expressed in the United States Dollars unless otherwise indicated) For the period from December 31, Cumulative January 1, 2017 to 2016 to date July 20, 2018 July 20, 2018 OPENING BALANCE IDA Designated Account 4913-AZ 1,214,579 411,123 IBRD Designated Account 224,494 308,658 Project Account 12,422 74,870 TOTAL OPENING BALANCE 1,451,495 794,651 ADD: FUNDS RECEIVED IDA Credit Number 4913-AZ Designated Account advances - - 3,000,000 SOE and SSWS replenishment 3,314,866 6,717,560 66,110,657 Direct payments - - 3,570,059 Total IDA Credit funds 3,314,866 6,717,560 72,680,716 IBRD Loan Number 8039-AZ Designated Account advances - 500,000 SOE and SSWS replenishment - 1,309,322 2,692,000 Front-end fee - 8,000 Total IBRD Loan funds - 1,309,322 3,200,000 Government of Azerbaijan Project Account 2,037,271 2,992,247 31,907,197 Total Government of Azerbaijan funds 2,037,271 2,992,247 31,907,197 TOTAL FUNDS RECEIVED 5,352,137 11,019,129 107,787,913 LESS: EXPENDITURE Expenditures paid through IDA Credit Number 4913-AZ Works (2,654,876) (4,010,969) (54,524,825) Goods (294,490) (86,564) (4,931,910) Consulting services (897,093) (1,126,587) (10,103,364) Training (476,903) (500,624) (1,487,726) Operating costs (203,195) (189,360) (1,616,503) Total expenditures paid through IDA Credit Number 4913-AZ (4,526,557) (5,914,104) (72,664,328) Expenditures paid through IBRD Loan Number 8039-AZ Works (217,588) (1,372,637) (3,150,542) Consulting services and audit (1,877) - (1,877) Operating costs (5,029) (20,849) (39,581) Total expenditures paid through IBRD Loan Number 8039-AZ (224,494) (1,393,486) (3,192,000) 4 WATER USERS ASSOCIATION DEVELOPMENT SUPPORT PROJECT STATEMENT OF SUMMARY OF SOURCES AND USES OF FUNDS FOR THE PERIOD FROM JANUARY 1, 2017 TO JULY 20, 2018 (Continued) (Amounts expressed in the United States Dollars unless otherwise indicated) For the period from December 31, Cumulative January 1, 2017 to 2016 to date July 20, 2018 July 20, 2018 Front-end fee 8039-AZ - - (8,000) Government of Azerbaijan Works (1,250,601) (2,221,428) (24,296,286) Goods (119,418) (42,192) (2,060,692) Consulting services (318,118) (434.936) (3,813,688) Training (194,845) (198,338) (526,998) Operating costs (170,670) (138,756) (1,087,383) Total Government of Azerbaijan expenditure (2,053,652) (3,035,650) (31,785,047) TOTAL EXPENDITURE (6,804,703) (10,343,240) (107,649,375) FOREIGN EXCHANGE RATE Project Account 2,947 (19,045) (120,397) TOTAL FOREIGN EXCHANGE RATE DIFFERENCES 2,947 (19,045) (120,397) Advances to Regional Support Units from IDA Designated Account 4913-AZ 13,500 Advances to Regional Support Units from Project Account 2,765 - - ADVANCES TO REGIONAL SUPPORT UNITS 16,265 - - CLOSING BALANCE IDA Designated Account 4913-AZ 16,388 1,214,579 IBRD Designated Account 8039-AZ - 224,494 Project Account 1,753 12,422 TOTAL CLOSING BALANCE 18,141 1,451,495 Approved and signed ",behalf oft Project's ImpleniMntation Unit: Akif M `nt4f ' vGulbahar Mammadova Project Director ,Chief Accountant August 3, 2018 , August 3, 2018 Baku, the Republic of Azerbaijan Baku, the Republic of Azerbaijan The notes on pages 11-16 form an integral part of these Special-Purpose Financial Statements. 5 WATER USERS ASSOCIATION DEVELOPMENT SUPPORT PROJECT STATEMENT OF DESIGNATED ACCOUNT FOR THE PERIOD FROM JANUARY 1, 2017 TO JULY 20, 2018 (Amounts expressed in the United States Dollars unless otherwise indicated) IDA Credit Number 4913-AZ Account held at: International Bank of Azerbaijan OJSC Account no: 38190028409330119120USD Opening IDA Designated Account 4913-AZ balance as at January 1, 2017 1,214,579 Add: IDA replenishments during the period from January 1, 2017 to July 20, 2018 3,314,866 Advances to Regional Support Units from IDA Designated Account 4913-AZ 13,500 Total outstanding amount advanced to IDA Designated Account 4913-AZ 4,542,945 Less: Closing Designated Account balance as at July 20, 2018 16,388 Amount of eligible expenditures paid through designated account during the period from January 1, 2017 to July 20, 2018 4,526,557 Total advanced amount during the period from January 1, 2017 to July 20, 2018 4,542,945 Discrepancy - Opening IDA Designated Account 4913-AZ balance as at January 1, 2016 411,123 Add: IDA replenislunents during the period from January 1, 2016 to December 31, 2016 6,717,560 Total outstanding amount advanced to IDA Designated Account 4913-AZ 7,128,683 Less: Closing Designated Account balance as at December 31, 2016 carried forward to the next period 1,214,579 Amount of eligible expenditures paid through designated account during the year 5,914,104 Total advanced amount during 2016 7,128,683 Discrepancy - 6 WATER USERS ASSOCIATION DEVELOPMENT SUPPORT PROJECT STATEMENT OF DESIGNATED ACCOUNT FOR THE PERIOD FROM JANUARY 1, 2017 TO JULY 20, 2018 (Continued) (Amounts expressed in the United States Dollars unless otherwise indicated) IBRD Loan Number 8039-AZ Account held at: International Bank of Azerbaijan OJSC Account no: 38190038409330119120USD Opening IBRD Designated Account 8039-AZ balance as at January 1, 2017 224,494 Add: IBRD advances during the period from January 1, 2017 to July 20, 2018 IBRD replenishments during the period from January 1, 2017 to July 20, 2018 - Total outstanding amount advanced to IBRD Designated Account 8039-AZ 224,494 Less: Closing IBRD Designated Account 8039-AZ balance as at July 20, 2018 - Amount of eligible expenditures paid through designated account during the period from January 1. 2017 to July 20, 2018 224,494 Total advanced amount during the period from January 1, 2017 to July 20, 2018 224,494 Discrepancy Opening IBRD Designated Account 8039-AZ balance as at January 1, 2016 308,658 Add: IBRD advances during the period from January 1, 2016 to December 31, 2016 - IBRD replenishments during the period from January 1, 2016 to December 31, 2016 1,309,322 Total outstanding amount advanced to IBRD Designated Account 8039-AZ 1,617,980 Less: Closing IBRD Designated Account 8039-AZ balance as at December 31, 2016 carried forward to next period 224.494 Amount of eligible expenditures paid through designated account during the year 1,393,486 Total advanced amount during 2016 1,617,980 Discrepancy Approved and"tgned on'behalf lr Proeatsigplonenhtion Unit: Akif Mustafact 7 7 Gulbahar Mammadova Project Director Chief Accountant August 3, 2018 August 3, 2018 Baku, the Republic of Azerbaijan - Baku, the Republic of Azerbaijan The notes on pages 11-16 form an integral part of these Special-Purpose Financial Statements. 7 WATER USERS ASSOCIATION DEVELOPMENT SUPPORT PROJECT STATEMENT OF EXPENDITURE AND SUMMARY SHEET WITHDRAWAL SCHEDULE FOR THE PERIOD FROM JANUARY 1, 2017 TO JULY 20, 2018 (Amounts expressed in the United States Dollars unless otherwise indicated) IDA Credit Number 4913-AZ Advance Works, goods, Total Advance payment consulting payment/ services, Replenished/ training and Direct payment operating costs 0001 - 888,524 888,524 0002 1,000,000 - 1,000,000 0003 - 79,219 79,219 0004 - 499,976 499,976 0005 - 622,712 622,712 0006 - 648,290 648,290 0007 - 569,712 569,712 0008 1,000,000 - 1,000,000 0009 - 997,708 997,708 0010 - 924,453 924,453 0011 - 1,057,217 1,057,217 0012 - 910,047 910,047 0013 1,000,000 - 1,000,000 Total applications reimbursed during the year ended December 31, 2012 3,000,000 7,197,858 10,197,858 0014 - 2,021,412 2,021,412 0015 - 2,733,601 2,733,601 0016 - 2,200,131 2,200,131 0017 - 1,706,316 1,706,316 0018 - 2,553,043 2,553,043 0019 - 2,340,941 2,340,941 0020 - 655,899 655,899 0021 - 2,969,131 2,969,131 0022 - 1,908,555 1,908,555 0023 - 782,607 782,607 Total applications reimbursed during the year ended December 31, 2013 - 19,871,636 19,871,636 0024 - 939,129 939,129 0025 - 2,282,521 2,282,521 0026 - 2,289,465 2,289,465 0027 - 2,353,614 2,353,614 0028 - 1,620,979 1,620,979 0029 - 2,286,625 2,286,625 0030 - 1,930,793 1,930,793 0031 - 1,744,738 1,744,738 0032 - 2,821,820 2,821,820 0033 - 2,184,517 2,184,517 0034 - 2,462,799 2,462,799 0035 - 1,498,732 1,498,732 Total applications reimbursed during the year ended December 31, 2014 - 24,415,732 24,415,732 8 WATER USERS ASSOCIATION DEVELOPMENT SUPPORT PROJECT STATEMENT OF EXPENDITURE AND SUMMARY SHEET WITHDRAWAL SCHEDULE FOR THE PERIOD FROM JANUARY 1, 2017 TO JULY 20, 2018 (Continued) (Amounts expressed in the United States Dollars unless otherwise indicated) Advance Works, goods, Total Advance payment consulting payment/Replenished/ services, Direct payment training and operating costs 0036 - 1,504,694 1,504,694 0037 - 933,127 933,127 0038 - 2,418,089 2,418,089 0039 - 2,177,772 2,177,772 0040 - 1,129,382 1,129,382 Total applications reimbursed during the year ended December 31, 2015 - 8,163,064 8,163,064 0041 - 1,840,299 1,840,299 0042 - 335,078 335,078 0043 - 1,243,042 1,243,042 0044 - 1,114,163 1,114,163 0045 - 1,029,128 1,029,128 0046 - 1,155,850 1,155,850 Total applications reimbursed during the year ended December 31, 2016 - 6,717,560 6,717,560 Total applications reimbursed as at December 31, 2016 3,000,000 66,365,850 69,365,850 0047 - 1,371,921 1,371,921 0048 - 551,472 551,472 0049 - 1,081,030 1,081,030 0050 - 310,059 310,059 0051 - 384 384 0052 - - 0053 - 0054 - - - Total applications reimbursed during the period from January 1, 2017 to July 20, 2018 - 3,314,866 3,314,866 Total applications reimbursed as at July 20, 2018 3,000,000 69,680,716 72,680,716 IBRD Loan number 8039-AZ 0001A 500,000 - 500,000 0002 - 291,635 291,635 0003 - 496,852 496,852 0004 - 289,177 289,177 0005 - 305,014 305,014 Total applications reimbursed during the year ended December 31, 2015 500,000 1,382,678 1,882,678 0006 - 121,342 121,342 0007 - 308,670 308,670 0008 - 174,223 174,223 0009 - 260,147 260,147 0010 - 182,535 182,535 0011 - 262,405 262,405 Total applications reimbursed during the year ended December 31, 2016 - 1,309,322 1,309,322 Total applications reimbursed as at December 31, 2016 500,000 2,692,000 3,192,000 9 WATER USERS ASSOCIATION DEVELOPMENT SUPPORT PROJECT STATEMENT OF EXPENDITURE AND SUMMARY SHEET WITHDRAWAL SCHEDULE FOR THE PERIOD FROM JANUARY 1, 2017 TO JULY 20, 2018 (Continued) (Amounts expressed in the United States Dollars unless otherwise indicated) Advance Works, goods, Total Advance payment consulting payment/Replenished/ services, Direct payment training and operating costs Total applications reimbursed during the period from January 1, 2017 to July 20, 2018 Total applications reimbursed as at July 20, 2018 500,000 2,692,000 3,192,000 Approved and signefr"n behalf of the Poject's,Ji01plnwtAiton Unit: Aki Mst4fay ev ' \Gulbahar Mammadoia Project Directo Chief Accountant August 3, 2018 August 3, 2018 Baku, the Republic of Azerbaijan Baku, the Republic of Azerbaijan The notes on pages 11-16 form an integral part of these Special-Purpose Financial Statements. 10 WATER USERS ASSOCIATION DEVELOPMENT SUPPORT PROJECT NOTES TO THE SPECIAL-PURPOSE FINANCIAL STATEMENTS FOR THE PERIOD FROM JANUARY 1, 2017 TO JULY 20, 2018 (Amounts expressed in the United States Dollars unless otherwise indicated) 1. DESCRIPTION OF THE PROJECT Water Users Association Development Support Project (the "Project") of the Republic of Azerbaijan (the "Recipient") was formed between the Recipient, the International Development Association ("IDA") and the International Bank for Reconstruction and Development ("LBRD") under a Financing Agreement Number 4913-AZ and Loan Agreement Number 8039-AZ dated October 25, 2011 in the amount of SDR 48,900,000 and USD 3,200,000, respectively. The Project's original completion date of June 30, 2016 has been extended to June 30, 2018. The Project has four months grace period for disbursement beyond the completion date. The overall project objective is to improve the effectiveness and financial viability of on-farm irrigation water distribution and management in the Project area. The Project consists of the following components: Component A: Institutional Strengthening and Capacity Building Institutional strengthening and capacity building of the Project Implementing Entity, the central support unit, the raion water users associations support units and the regional support centers, through the provision of goods, consultants' services and training; as well as rehabilitation and construction of the offices of the said regional support centres through the carrying out of works. Capacity building of eligible Water User Associations (the "WUAs") through the provision of goods, consultants' services and training. Provision of operations and maintenance equipment and management and management facilities to eligible WUAs through the carrying of works, and the provision of goods and consultants' services. Strengthening the capacity of the Project hnplementing Entity to exercise the responsibility of state supervision of the WUA's activities pursuant to the Law on "Amelioration and Irrigation" through the provision of goods, consultants' services and training. Preparation of selected studies, research and demonstration pilots in irrigation and drainage, integrated water resource management; and related institutional areas through the carrying out of works, provision of goods and consultant services. Component B: On-farm Irrigation and Drainage Rehabilitation Rehabilitation of on-farm irrigation and drainage systems for eligible WUAs in selected raions through the carrying out of works and the provision of consultants' services. Component C: Project Management, Monitoring and Evaluation Support for project management and implementation activities including monitoring and evaluation through the provision of goods, consultants' services and training. 11 WATER USERS ASSOCIATION DEVELOPMENT SUPPORT PROJECT NOTES TO THE SPECIAL-PURPOSE FINANCIAL STATEMENTS FOR THE PERIOD FROM JANUARY 1, 2017 TO JULY 20, 2018 (Continued) (Amounts expressed in the United States Dollars unless otherwise indicated) 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Statement of compliance The Special-Purpose Financial Statements have been prepared on the cash basis of accounting in confornity with International Public Sector Accounting Standards ("IPSAS") "Financial Reporting under the Cash Basis of Accounting" issued by the International Public Sector Accounting Standards Board of the International Federation of Accountants and incorporate the principal accounting policies from the "Guidelines: Annual Financial Reporting and Auditing for World Bank Financed Activities". Other basis of preparation criteria The Special-Purpose Financial Statements are prepared under the historical cost basis of accounting. Source funding and government contributions are recognized when the related cash is received or paid out on the Project's behalf. Expenditures are accounted for on the basis of actual disbursement of funds from the Project's accounts. Foreign currency transactions and translation The Project uses the United States Dollar ("USD") as its functional currency for following reasons: a) ADB's funding is received in the USD; b) Budgets and financial reports for the Project are prepared in the USD. Balance sheet monetary items denominated in currencies other than USD have been translated into the USD using the exchange rate of the Central Bank of Republic of Azerbaijan ("CBRA") effective as at appropriate date. All income and expense transactions denominated in currencies other than USD are converted into USD using the exchange rate of the CBRA prevailing on the date of transaction. 3. CASH AT BANK As at July 20, 2018 and 2016 the Project had cash at bank balances with "International Bank of Azerbaijan" CJSC ("IBA") as follows: As at July 20, December 31, 2018 2016 IDA Designated Account in USD 4913-AZ 16,388 1,214,579 IBRD Designated Account in USD 8039-AZ - 224,494 Project Account 1,753 12,422 Total cash at bank 18,141 1,451,495 12 WATER USERS ASSOCIATION DEVELOPMENT SUPPORT PROJECT NOTES TO THE SPECIAL-PURPOSE FINANCIAL STATEMENTS FOR THE PERIOD FROM JANUARY 1, 2017 TO JULY 20, 2018 (Continued) (Amounts expressed in the United States Dollars unless otherwise indicated) 4. CUMULATIVE USES OF FUNDS Cumulative uses of funds comprise the following: As at July 20, December 31, 2018 2016 IDA 4913-AZ share 72,664,328 68,137,771 IBRD 8039-AZ share 3,200,000 2,975,506 Government of Azerbaijan share 31,785,047 29,731,395 Total cumulative uses of funds 107,649,375 100,844,672 5. BASIS OF FUNDING AND ELIGIBLE EXPENDITURE The following table specifies the categories of eligible expenditures that may be financed out of the proceeds of the Financing, the allocations of the amounts of the Financing to the category, and the percentage of expenditures to be financed for eligible expenditures in the category: Category IDA Financing Agreement 4913-AZ Amount of the Percentage of expenditure Financing allocated to be financed (Net of VAT) (expressed in SDR) (1) Works, goods, consultants' including audit, training and operating costs 48,900,000 83% Total eligible expenditure 48,900,000 The following table specifies the categories of eligible expenditures that may be financed out of the proceeds of the Loan, the allocations of the amounts of the Loan to each Category, and the percentage of expenditures to be financed for eligible expenditures in each category: Category IRRD Loan Agreement 8039-AZ Amount of the Loan allocated Percentage of expenditure (expressed in USD) to be financed (Net of VAT) (1) Works, goods, consultants' including audit, training and operating costs 3,192,000 83% (2) Front-end Fee 8,000 (3) Premia for interest rate caps and interest rate collars - Total eligible expenditure 3,200,000 6. DESIGNATED ACCOUNT The Recipient has established a Designated Account at a commercial bank acceptable to the IDA and BRD in accordance with the Loan Agreement. Designated Account is established, managed, replenished and liquidated in accordance with the IDA and 11BRD's "Project's Operations Manual" and detailed arrangements agreed upon between the Recipient, the IDA and the 1BRD. 13 WATER USERS ASSOCIATION DEVELOPMENT SUPPORT PROJECT NOTES TO THE SPECIAL-PURPOSE FINANCIAL STATEMENTS FOR THE PERIOD FROM JANUARY 1, 2017 TO JULY 20, 2018 (Continued) (Amounts expressed in the United States Dollars unless otherwise indicated) The Designated Account of the Project is maintained in USD with TEA. 7. METHOD OF DISBURSEMENT The methods of disbursements were as follows: Advance - IDA and IBRD may advance proceeds in accordance with Loan Agreement into a Designated Account of the Recipient to finance eligible expenditure as they are incurred and for which supporting documents will be provided at a later date. Direct funding - IDA and B1RD may make payments, at the Recipient's request, directly to a third party for eligible expenditure. Reimbursement procedure - IDA and IBRD may reimburse the Recipient for expenditure eligible for financing pursuant to the Loan Agreement that the Recipient has pre-financed from its own resources. Commitment procedure - IDA and lBRD may pay amounts to a third party for eligible expenditure under special commitments entered into, in writing, at the Recipient's request and on terms and conditions agreed between the IDA, the IBRD and the Recipient. 8. METHOD OF WITHDRAWAL IDA and IBRD Designated Accounts Designated Account is designated disbursement account of the Project to effect the payment of eligible expenditure, within defined limits, which do not require individual authorization from the IDA and IBRD. Available amounts were drawn down within the limits determined by the relevant Loan Agreement for the payment of eligible expenditure for sub-contractors from the Designated Account. Direct payments front the IDA and IBRD Designated Accounts Under this method, the Project management prepares applications based on supporting documents which are submitted to the IDA and IBRD. Payments are made from the Loan Account directly to the contractors. Project Account The Project maintains a separate account in the State Treasury Agency where the Government funds are accumulated. The funds are further disbursed to sub-contractors based on the shares of expenditure to be incurred by each funding source. Statement of expenditure ("SOE'9 Under the SOE method, the Project forwards to the IDA and IBRD an application for reimbursement of payments already made using an application for withdrawal with SOE forms as the only documentation. 14 WATER USERS ASSOCIATION DEVELOPMENT SUPPORT PROJECT NOTES TO THE SPECIAL-PURPOSE FINANCIAL STATEMENTS FOR THE PERIOD FROM JANUARY 1, 2017 TO JULY 20, 2018 (Continued) (Amounts expressed in the United States Dollars unless otherwise indicated) 9. OPERATING ENVIRONMENT The Project's operations are conducted in the Republic of Azerbaijan. As an emerging market, at the present time the Republic of Azerbaijan is developing business and regulatory infrastructure that would generally exist in a more mature market economy. The Azerbaijani economy contracted by 1.3% growth (year-on-year) in the first half of 2017, driven by a decline in oil GDP (7.2%) as oil revenues were decreased due to production volumes and oil prices. On the upside, and despite continued banking sector distress, the non-oil economy expanded by 17% for the first time in over a year, supported by the strong performance of the agriculture and manufacturing sectors. Annual inflation remained high at 13-14% during 2017, driven mainly by an increase in governnent-controlled tariffs for electricity, water, and gas, and in domestic food prices. Citing inflationary pressures, the Central Bank of the Republic of Azerbaijan continued to tighten the monetary policy stance during 2017 by scaling up liquidity absorption operations. The manat has appreciated by 4.4% against the U.S. dollar since end-2016, reflecting its stronger external position and increased liquidity absorption operations. The troubled financial sector continues to exert a negative impact on the economy. Credit contracted by 15.6% in the first half of 2017, and the quality of assets continued to deteriorate. Per official statistics, the nonperforming loan ratio reached 13% in June 2017 compared to 9% at end-2016. Although manal deposits grew in the second quarter of 2017, the client deposits (corporate and household) shrank by 4.4% during the first seven months of 2017. Starting from February, 2016 the Central Bank of the Republic of Azerbaijan has gradually increased refinancing rate from 5 to 15% during 2017 and the minimum capital adequacy ratio was lowered from 12% to 10%. In February 2018, Standard & Poor's, international credit agency, affirmed long and short-term sovereign credit rating of Azerbaijan in foreign and local currency at 'BB+/B' upgrading rating outlook from negative to stable. The Azerbaijani economy is vulnerable to market downturns and economic slowdowns elsewhere in the world. While the Government has introduced a range of stabilization measures and plans to expedite reforms and support to banking system in response to current economic challenges. The Management believes it is taking appropriate measures to support the sustainability of the Project's business in the current circumstances, unexpected further deterioration in the areas described above could negatively affect the Project's results and financial position in manner not currently determinable. The fiuture economic growth of the Republic of Azerbaijan is largely dependent upon the effectiveness of economic, financial and monetary measures undertaken by the Government, together with tax, legal, regulatory and political developments. The Management is unable to predict, all developments in the economic environment which would have an impact on the Project's operations and consequently what effect, if any, they could have on the financial position of the Project. Amidst the ongoing crisis, the government of Azerbaijan shifted its oil-oriented economic policy, dominated for two decades, to the diversification of the economy. For that purpose, a "national strategic roadmap" was adopted to formulate a correct development strategy covering II sectors. The implementation of the "national strategic roadmap" was assigned to the newly formed "Center for Analysis of Economic Reforms and Communications," the aim of which is analyzing the effectiveness of conducted reforms and making new proposals. 15 WATER USERS ASSOCIATION DEVELOPMENT SUPPORT PROJECT NOTES TO THE SPECIAL-PURPOSE FINANCIAL STATEMENTS FOR THE PERIOD FROM JANUARY 1, 2017 TO JULY 20, 2018 (Continued) (Amounts expressed in the United States Dollars unless otherwise indicated) Significant measures have been taken in custom services and taxation as well. As of August 1, 2016, new regulations to ensure more operative and transparent custom clearance (a "green corridor" and other access systems) were implemented. The new simplified procedures are intended to stimulate imports and provide favorable conditions for business and external trade. As a continuation of reforms in customs, the reception of e-declarations is introduced minimize the contact of citizens with government officials. In order to amend the existing tax system, the decree approving the "Directions of Reforms in Taxation for 2016" was signed. The presidential decree requires the Ministry of Taxes to ensure that on-site and off-tax audits are perfonned within short periods of time and extend the coverage of electronic tax audits to limit face-to-face contacts with taxpayers. Another important amendment on monopolistic actions was made to the Criminal Code. Besides, the latest changes in December 2016 to Taxes Code "transfer pricing" will be applied against artificially exaggerated expenses and "voluntary tax disclosure" notion included in the Code which is highly practicable in greatest economies. Furthennore, in order to prevent additional exposure to financial sanctions by the tax authority because of tax liability miscalculation, the mechanism of "determination of tax liability in advance" principle will be in force. Along with them, implementation of electronic invoices will play an important role in prevention of tax evasion and will impact positively on tax system optimization. Azerbaijan is also trying to benefit from regional connectivity initiatives to boost transit and trade. In particular, the country is one of the sponsors of the East-West and North-South transport corridors. Construction of the Baku-Tbilisi-Kars railway line, connecting the Caspian region with Turkey, was completed in 2017. The Trans-Anatolian Natural Gas Pipeline (TANAP) and Trans-Adriatic Pipeline (TAP) will deliver natural gas from Azerbaijan's Shah Deniz gas field to Turkey and Europe. The economy is expected to expand from 2018 onward, supported by an acceleration of oil GDP as the Shah Deniz gas field-one of the largest gas fields in the world-begins production. Non-oil output will continue to grow at a slow pace due to limited credit growth and the weak business envirorunent. 16