Report No. PID9655 Project Name Colombia-Water Sector Reform Assistance (@) Project Region Latin America and Caribbean Region Sector Water Supply & Sanitation Project ID COPE65937 Borrower(s) GOVERNMENT OF COLOMBIA Implementing Agency THE MINISTRY OF ECONOMIC DEVELOPMENT The Ministry of Economic Development, Directorate of Potable Water and Basic Sanitation Calle 28, No. 13A-15, Piso 17, Edificio Bancafe, Bogota, Colombia Contact Person: Carmina Moreno, Director of Potable Water and Basic Sanitation Tel: 57-1-2826352 Fax: 57-1-2822329 Email: Cmoreno@sias.gov.co Environment Category B (Partial Assessment) Date PID Updated March 19, 2000 Projected Appraisal Date April 2001 Projected Board Date June 2001 1. Country and Sector Background Main Sector Issues: Poor Utility Performance. The main reason for poor utility performance is inadequate management capacity, which is a result of political intervention in management, political nomination of managers and their frequent replacement for reasons not related to their performance. Poor utility performance is reflected in the low quality of service provided and in inadequate commercial systems, low billing and collection, as well as inadequate maintenance. As noted in B2, coverage rate values do not reflect the real quality of service. A better performance indicator is the effective water service coverage, which takes into account continuity of service and water quality, in addition to physical coverage. The effective water service coverage in Colombia, which reflects coverage of 24 hours per day with water quality that complies with drinking water standars, is shown below: The Effective Water Coverage in Colombia as Indicator of Level of Service (Data for 1997) Major Cities Medium Cities Small Municipalities National Average 82% 46% 27% < 50% ?? Source: ACODAL, Estado del Sector de Agua y Saneamiento en Colombia, Julio 24 de 1998 These data indicate that (i) utility performance in the country, on average, is less than satisfactory; (ii) utility performance in medium and small municipalities is deficient; and (iii) there are great disparities between major cities and the rest of the country. Large Regional and Urban - Rural Disparities in Service Coverage. It is estimated that 10 million Colombians (of a total of 40 million) do not have access to piped water and about 15 million lack access to adequate sanitation systems. The Atlantic Coast (Caribbean region), Orinoquia and Amazonia regions present the lowest coverage rates for both services. Larger cities tend to have better coverage indicators (both in quantity and quality) than small cities and rural areas. The rural population, which accounts for about 30 % of the national total, has the lowest coverage rates, at 44% for piped water and 25% for sewerage. High Investment Needs. Total investment required for implementing the four year water and sanitation plan (1998-2002) is US$ 1.9 billion or approximately US$ 475 million per year. These figures do not provide for any investment in wastewater treatment. In the past, funding of almost 60% of the sector investments has come from Government resources, but given the current economic situation the Government can no longer continue to provide such a level of support. Consequently, there is a need for increasing cash generation from utilities and for attracting private sector investment. Low private Capital Investments and Credit to the Sector. In spite of expectations, little private investment has been channeled to the water and sanitation sector (3.4% of total private investments in recent years). Most lending for the sector is made through FINDETER with little private participation. Limited Subsidies to the Poor. Cross subsidies are part of the design of the tariff structure in Colombia and have proven to be an effective mechanism for income redistribution in large urban areas. However, as the number of municipalities in which the entire population classified in the lower income strata has grown, the cross subsidy mechanism became less effective. A specific mechanism, the Solidarity Funds,was proposed to allow a better service to low-income groups while helping utilities achieve financial sustainability, by providing an additional direct subsidy to the service provider. However, these funds are supposed to be financed with municipal resources. Because of budget shortfalls, the municipalities do not have resources and the Solidarity Funds concept has not been put to practice. Low Wastewater Treatment Coverage. Only about 5% of the wastewater generated in the country undergoes any kind of treatment, while the rest is discharged without any treatment, thereby contaminating a significant part of the natural water resources. Contributions from the central government for water quality control are normally assigned as a result of difficult negotiations between regional and central authorities and there is no clear mechanism for financing municipal wastewater treatment plants. Weaknesses in the Regulatory System. The regulatory agencies (CRA and SSPD) have regulatory oversight responsibility for over 1500 service providers in the country. This situation makes the regulatory activity costly and inefficient. Large utilities serving over 6 million inhabitants like Bogota - 2 - are regulated in the same way as those serving 2,000 inhabitants. Current regulation is based on tariff setting formulas that were designed to provide incentives for efficient services, but have not been fully successful in promoting efficiency. Tariff levels are in most cases still too low due to political considerations that override sector incentives. Limited Coordination Among Central Government Agencies. There are many institutions in the sector, some with overlapping functions in certain areas, most notably MED, responsible for setting sector policies and strategy, and DNP, which is responsible for overall economic planning. Both institutions participate in the CRA, both design and implement programs and projects and both participate in the allocation of funds for the sector. With similar functions culture, coordination effort is a must. Utilities frequently complain about the large amount of information requested by the government, and about the costs associated with generating it. On the Positive Side the following can be mentioned: Adequate Sector Policy Framework. The Government of Colombia has always been a pioneer in adopting correct sector policies. The decentralization policy was enacted long ago, and promotion of PSP is a key sector policy. These are advanced policies which provide opportunities for improvements in sector performance. The government has also steadily provided financing to the sector and continues to so. Satisfactory Service in the Large Cities. The water and sewerage services in the five large cities (Bogota, Medellin, Cartagena, Barranquilla, Bucaramanga), which serve a population of about 12 million inhabitants, is good, although not always the most efficient. The exception is Cali, which is currently undergoing a crisis in the water and sewerage services. Successful Performance of Utilities with PSP. The experience with the privatized utilities (Cartagena, Barranquilla, Santa Marta, Tunja, Monteria, Palmira, Girardot, Rio Hacha and more) is encouraging. The performance of all of them has greatly improved, customer satisfaction is high and they provide good examples for resolving the water sector problems. Consequently PSP is emerging as a methodology which tends to be adopted by mayors who are interested in improving the water sector performance. Government Strategy In recent years, the government of Colombia has embarked on a water sector reform program aimed at incorporating the private sector into the management and operation of public water utilities. About 50 Colombian municipalities of various sizes have already adopted the private sector participation (PSP) concept and are managed by private operators. The performance of these utilities has significantly improved after transferring their management to the private sector (see Annex 17 for details regarding performance before and after PSP in some of the utilities). Experience in Colombia also shows that, contrary to the common perception which holds that the private sector serves better the rich and neglects the poor, if PSP processes are adequately structured, utilities managed by private operators serve low income areas better than the best public utilities in the country, as demonstrated in Annex 19. The government's strategy is based on four key policy objectives aimed at improving the sector performance: (i) strengthening the regulatory framework; (ii) implementing technical assistance programs; (iii) providing financial support to promote modernization and efficient management as well as to subsidize the poor; and (iv) rationalizing the institutional framework at the national level to improve coordination in the sector. - 3 - Strengthening the Regulatory Framework. This policy aims at achieving a stable and transparent regulatory framework that: (i) takes into account differences in local markets; (ii) makes economic regulation (CRA's responsibility) and its monitoring and enforcement (SSPD's responsibility) compatible; (iii) harmonizes efficiency and social objectives; (iv) promotes efficient operation and investment; (v) encourages investment by private sector; and (vi) allows cost recovery. Implementing Technical Assistance Programs. This policy objective aims to assist in sector improvement through technical assistance which will be provided by MED in three main areas: (i) utility modernization to improve efficiency and service quality, both to public and private utilities of different sizes, (ii) sector planning, at the sub-national level, to Departmental governments, and (iii) improving the sector information system. Providing Financial Support. This policy objective aime at achieving sector self sustainability by promoting the concept that financing of sector utilities would be mainly based on income generated by collection of bills. When required, municipalities could subsidize the tariff of low income customers or subsidize part of the investments using the revenue transfers of Law 60. When warranted and when the previous resources are not sufficient, the government will make available to individual utilities, under strict conditions, additional resources from the national budget to solve structural problems, generally through PSP. Rationalizing the Institutional Framework. This process would allow to: (i) Strengthening the coordination capacity of MED. Coordination at the national level would be fostered through the strengthening of the MED. (ii) Coordination of environmental policies. To achieve a balance between environmental and public services legislation, the MED and the Ministry of the Environment (MOE) would regulate the retributive charges in the water sector and fix these charges to cover the costs of improving the quality of water resources. They would also stipulate the priorities for applying these charges to different user groups. (iii) Coordination of actions in rural areas. With the objective of integrating rural policy with water sector policy, the MED would coordinate actions with other national entities, Departments and municipalities. 2. Project Objectives The development objectives of the project are: (i) to support water sector reform by facilitating the incorporation of the private sector into the management and operation of water utilities participating in the project for the purpose of creating an enabling environment for improving the efficiency and sustainability of these utilities, and by providing them with financial support to ensure their viability; (ii) expand the coverage of water and sewerage services in participating municipalities; and (iii) facilitate the access of populations in low income areas of participating municipalities to water and sewerage services. These objectives are expected to be achieved by providing: (i) technical assistance for incorporating private sector participation in the management and operation of the water and sewerage services in the utilities of about 3 medium size cities or regional associations of municipalities, with populations of up to about 300,000 inhabitants, as well as in the utilities of about 25 small municipalities with populations of up to about 12,000 inhabitants; and (ii) financial support to the utilities which have successfully incorporated the private sector; and which will be directed at benefiting the poor, as well as - 4 - ensuring the financial viability of these utilities. 3. Rationale for Bank's Involvement Brings Bank experience and intellectual leadership with private participation in the water, sanitation and other sectors, gained in the region and elsewhere in the world. Introduces transparency to the privatization process. Brings techniques and experiences in extending water and sanitation services to the poor on a large scale. Brings management discipline to the project. Bank financing will act as catalyst for private sector financing. Brings credibility to the project, thereby promoting participation of private operators. 4. Project Description The project would consist of the following components: Project Component A - Investments in Medium Size Cities - US$ 27.5 million Al. Providing financial support to partially finance the public sector funding requirements of the water and sanitation infrastructure in the medium size cities participating in the project, and execution of the respective works (US$ 15 million). This sub-component is the second largest of the project and represents an important project activity. Under this sub-component, civil works and equipment for water supply and sanitation will be financed by the loan funds as contribution of the public sector to the investments in water and sanitation infrastructure which cannot be financed by the private sector since the tariff level is not sufficient to recover the cost of these investments. The loan funds allocated for each city will be determined on the basis of the financial model utilized during the preparation of the respective PSP processes and the availability of loan funds. It will be attempted to provide loan funds in the amount requested by the winning bidder, and if this would not be possible, than to provide at least an amount which would ensure the sustainability of the transaction. The funds allocated for each city will not be transferred to the private operator but rather used to finance infrastructure works considered of high priority by the operator and which have been approved by the municipal authorities and by the PIU. In this form, the private operator will not receive a financial contribution from the government, but rather the right to operate additional infrastructure which is owned by the municipality, and whose value is equivalent or close to the amount of the subsidy which he requested in his proposal. Under the project, the government in effect finances additional infrastructure for the city. In each city, the works financed by the government will be designed by the private sector managed utilities and the executing agency of each subproject will be the water utility of the city. In this manner it will be assured that the infrastructure provided by the government will be totally satisfactory and will meet the requirements of the private operator. The PIU at the Ministry of Economic Development will oversee, in cooperation with the municipal authorities, the implementation activities and will ensure that Bank procurement guidelines are followed when Bank funds are used. The supervision and control of the PSP contract after the completion of works will be the responsibility of the contracting agency, i.e., the municipality. The PIU will provide respective guidance and the municipality may hire an individual consultant or a consulting firm, on a full or partial time - 5- assignment, to carry out the control of the PSP contract and determine if the performance targets are achieved by the operator. A2. Execution of works financed by the private sector and by Law 60 resources (US$ 12.5 million). According to the operation contract, the private operators commit to finance a portion of the required works in each city. The investments provided by the private operators will be recovered from tariff incomes. The execution of the works financed by the private operators form part of the project and they will include water supply and sanitation works, as well as supply and installation of equipment. Since these works are totally financed by the private sector and not involve any Bank financing, the private operators will use their own procurement procedure to implement these works, which will certainly not be the procedures prescribed by the Bank procurement guidelines. In addition, as part of the PSP transaction, participating municipalities will be requested by the government to commit to provide to the water utilities each year a portion of their annual Law 60 income. These proceeds will also be used to finance water supply and sanitation works, the execution of which forms part of the project. The execution of the works financed by the private sector and by Law 60 will be the responsibility of the privatized utilities and will be managed by them, with no intervention of the PIU. The control of the implementation of these works will be undertaken as part of the control of the private operator's contract and will be the responsibility of the contracting agency, i.e., the municipality. Project Component B - Investments in Small Municipalities - US$ 32.3 million Bi. Providing financial support to partially finance the public sector funding requirements of the water and sanitation infrastructure in the 25 participating small municipalities, and execution of the respective works (US$ 29.7 million). This sub-component is the largest in terms of project funds allocated for it and represent the main effort of the project. Under this sub-component, civil works and equipment for water supply and sanitation will be financed by the loan funds as contribution of the public sector to the investments in water and sanitation infrastructure which cannot be financed by the private sector since the tariff level is not sufficient to recover the cost of these investments. Taking into account that most of the population in small municipalities is of low income, it is expected that most of the investments in this type of municipalities will need to be provided from public resources, mainly through the loan funding. The works will be designed by consultants which will be hired by the PIU and will be constructed by the private operator of each municipality, under the "constructor-operator" principle. The constructors-operators will be selected using model bidding documents which have been especially prepared for this project. The winning bidder may submit an alternative design, which might be approved by the contacting authority if found to be advantageous. The PIU at the Ministry of Economic Development will oversee, in cooperation with the municipal authorities, the implementation activities of the works. The supervision and control of the PSP contract after the completion of works will be the responsibility of the contracting agency, i.e., the municipality. The PIU will provide respective guidance and the municipality may hire an individual consultant or a consulting firm, most probably on a partial time assignment, to carry out the control of the PSP contract and determine if the performance targets are achieved by the operator. The "constructors- operators" will, most probably, be small entrepreneurs who may have limited - 6 - access to credit. Since they will need such access in order to be eligible to participate in the bidding processes and to finance a portion of the works, the project will help them obtain a credit guarantee through the Fondos Nacional de Guarantias (FNG), a government agency whose purpose is to promote the activity of small firms and entrepreneurs by providing them with credit guarantees. The PIU is working with FNG to ensure the provision of guarantees to "constructors-operators" participating in the project. It is estimated that a deposit of about US$ 500,000 will need to be made in favor of FNG to ensure issuing the required guarantees. This deposit, which forms part of small municipalities component of the project, will be made out of the counterpart funds and will be returned to the government in due course. B2. Execution of works financed by Law 60 resources and by the private sector (US$ 2.5 million). As part of the PSP transaction, municipalities will be required to commit to provide to the water utilities each year a portion of their annual Law 60 income. These proceeds will be used to finance water supply and sanitation works, the execution of which forms part of the project. In certain cases the Constructors-Operators may commit to finance a portion of the required works which can be recovered from tariff incomes. The execution of such works also comprises part of the project. The works financed by Law 60 and the private sector resources are expected to form a small portion of the total investments and they will be implemented under the same procurement procedures as the works financed by the government. Project Component C - Sector Environmental Management Capacity Strengthening - US$ 0.7 million Strengthening sector environmental management capacity will be achieved mainly through: (i) modifying and strengthening key environmental regulations, especially the existing water quality and effluent discharge regulations; (ii) establishing sector wide criteria for the environmental management of water and sanitation projects (siting, design, construction and operation), completing the existing sector technical specifications; (iii) defining environmental requirements to be included in bidding documents and private sector operation contracts; (iv) defining methodologies and programs for environmental audits of water and sanitation facilities; (v) strengthening the environmental management capabilities of the sector as a whole, especially the Directorate of water and Sanitation in the Ministry of Economic Development; (vi) streamlining the environmental licensing procedures for water and sanitation projects in regional environmental agencies; (vii) sponsoring training programs on environment for water and sanitation system operators; and (viii) defining of public participation and community consultation criteria and procedures for water and sanitation projects. Project Component D - Rural Water and Sanitation Policy Development - US$ 1.0 million This component consists of Providing technical assistance to support the development of the rural water and sanitation sector policy, strategy and methods for incrementing water and sanitation coverage in the rural sector. The strategy development might include an implementation of a pilot program for testing alternative strategies, focusing on the Caribbean region. Project Component E - Project Management and Training, PSP Technical -7 - Assistance, Studies and Supervision of Works - US$ 8.2 million El. Project Management and Training (US$ 3.5 million). Financing the activity of the Project Implementation Unit (PIU) in the Ministry of Economic Development. This PIU will be the implementing agency of the project on behalf of the government. It will consist of about 17 consultants who would be in charge of implementing all the technical assistance activities of the project and of overseeing the implementation of works which would be carried out under the responsibility of the participating privately operated water utilities. One of the main tasks of the PIU is to carry out the "socialization" program involved in the project, which for each potential participating municipality includes providing all the information to interested mayors and convincing them to participate, convincing the municipal councils to approve the participation of their municipality in the project, carrying out the public information and consultation campaigns, convincing community representatives, business community representatives NGOs and other important stakeholders to support PSP etc. The PIU will also be responsible for the financial management of the project, for ensuring that Bank procurement guidelines are used as required, for disbursements, auditing and reporting. All the training activities of the project form part of this sub-component. This include training of the PIU staff and training of the individual implementation units of each subproject, i.e., training of medium size utilities staff in Bank procurement procedures and training of Constructors-Operators in water utilities management procedures. E2. Providing technical assistance to carry out the processes of incorporating the private sector in the management and operation of the water and sanitation utilities in about 3 medium size cities (US$1.7 million). This sub-component represents an important project activity and would entail provision of technical assistance for the completion of incorporating the private sector in the management and operation of the participating water utilities in medium size cities, which has started during project preparation, or if necessary, initiation of processes in new cities and carrying them out to successful completion. The PIU staff will assist the municipalities in hiring the consulting services needed to carry out the PSP processes, which will be financed by the project. The PIU staff will also accompany the municipal authorities of each city all along the process up to the point of signing the operation contract by the Mayor and the successful bidder, and will provide all the assistance needed along the way. This assistance will include review of the work of the consultants hired for preparing and structuring the PSP processes, especially the program of works and investments (POI) and the financial projections, assistance in preparing the bidding documents, assistance in carrying out the bidding processes for selecting the private operator and in evaluating the proposals submitted. After the award of the operation contract and initiation of the execution of the works financed by the government, the TA will include the hiring of consulting firms to supervise the works. E3. Providing technical assistance to carry out the processes of incorporating the private sector in the management and operation of the water and sanitation utilities in about 25 small municipalities (US$ 3 million). This sub-component represent the main effort of the project. The PIU staff will get in touch with mayors of potential small municipalities and will carry out the socialization of the processes, the first step of which is to convince the mayors to participate in the project. The PIU staff will then - 8 - assist the municipalities in hiring the consulting services needed to carry out the PSP processes, which will be financed by the project. The PIU staff will also accompany the municipal authorities of each city all along the process up to the point of signing the operation contract by the mayor and the successful bidder, and will provide all the assistance needed along the way. This assistance will include review of the work of the consultants hired for preparing and structuring the PSP processes, especially the program of works and investments (POI) and the financial projections, assistance in preparing the bidding documents, assistance in carrying out the bidding processes for selecting Constructor-Operator and in evaluating the proposals submitted. After the award of the operation contract and initiation of the execution of the works financed by the government, the TA will include the hiring of consulting firms to supervise the works executed by the Constructor-Operator. A pilot of incorporating the private sector in the management of five small municipalities has been carried out during project preparation, two of which have been successfully completed by awarding and signing PSP contracts. The experience gained from this pilot has been incorporated in the design of the project and will be incorporated in implementing the activities for structuring the PSP processes in the small municipalities which will participate in the project. 5. Financing Total ( US$m) GOVERNMENT 15 IBRD 40 PRIVATE SECTOR AND MUNICIPALITIES 15 Total Project Cost 70 6. Implementation Implementation period: The project implementation period is 5 years, starting on October 2001 and closing on December 2006. Borrower and Executing Agencies: The Borrower is the Government of Colombia. The ministry in charge is the Ministry of Economic Development (MED). The executing agency of the TA component of the project is the Project Implementation Unit (PIU) in the Directorate of Water Supply and Basic Sanitation (Direccion de Agua Potable y Saneamiento Basico) in the Ministry of Economic Development. The executing agency of each investment subproject which corresponds to each participating municipality, will be the utility of the municipality, managed by a private operator. The PIU will control and monitor the performance of the executing agency of each subproject and will ensure that when using Bank funds, they will comply with all the Bank's procurement guidelines. The PIU will also provide appropriate training to the executing agencies. Project Management: Overall project management will be carried out under the guidance of the Director of Water and Basic Sanitation in MED, who will also be responsible for policy issues and overall coordination with municipal and departmental governments. The PIU in MED will be the financial and implementation agency of the project. It will supervise the implementation of subprojects and manage all the technical assistance activities through a team of about 17 consultants financed under the Loan. This team has been working in the implementation of component E of Loan 3336-CO, which supported the preparation of the proposed project, and has gained valuable experience -9- in structuring PSP processes, in social aspects related to PSP and in Bank procedures related to procurement, disbursement, reporting and auditing, all of which will help it to manage the project successfully. Detailed description of the PIU functions will be included in the Project Operational Manual. Oversight of project management will be provided by an inter-institutional committee formed specifically for this project "Comite Coordinador Interinstitucional DNP-MDE" formed by representatives of MED and of two units of the National Department of Planning (DNP): (i) DDUPRE; and (ii) the Caribbean Plan Program. Procurement: When implementing works financed by Bank funds, the subprojects implementation agencies, i.e., the private operators, will adhere to the Bank procurement guidelines, whereas when using their own funds for financing the investment portion which they have committed to provide, they might use other procurement procedures. The PIU will provide procurement training to the executing agencies and will control and monitor their performance and ensure that they comply with the Bank procurement guidelines. In the technical assistance components which will be implemented under the responsibility of the PIU and financed by the Bank, Bank procurement guidelines will be used for hiring of consultants and purchasing goods. Flow of funds: Financial management will be the responsibility of the PIU. Funds will be administered through a fiduciary agency, which will open two special accounts, one for depositing the loan funds originating from the Bank and the other for depositing government counterpart funds. The PIU will receive withdrawal requests from the participating executing agencies and will authorize them as warranted, instructing the fiduciary agency to transfer corresponding amounts to the individual executing agencies. The PIU will also instruct the fiduciary agency to execute payments to consultants, goods and service providers, in conjunction with activities under the TA components. The PIU will be responsible for reporting and for sending withdrawal applications to the Bank. The PIU will also be responsible for management of the counterpart funds contributed by the government, including replenishing the counterpart funds' special account. Financial management, reporting and auditing: Both the accounting and financial management of the project will be the responsibility of the PIU. A financial management assessment of the project was carried out by a LAC Financial Management Specialist (FMS). The FMS concluded that the PIU needs to be strengthened. An action plan was drawn up and it was agreed to hire two financial management experts for the PIU. The PIU will be responsible for consolidating project accounts and information, budgeting, preparing financial reports, establishing internal controls and contracting independent audits for the project. A new accounting, planning, monitoring and supervision software, compatible with LACI, will be purchased. A year after project initiation and after installing an integrated project financial system , the PIU shall prepare and submit to the Bank quarterly project management reports (PMRs) linking project expenditures to key monitoring indicators of activities carried out during each quarter. The formats and basis to produce those reports would be in accordance with the Bank Financial Management Manual and LACI procedures. Participating water utilities would follow accounting procedures and financial reporting outlined in the POM. Twice a year, (March 31 and September 31) summary progress reports of the - 10 - operational/financial performance of the utility, and the implementation of the subprojects, would be presented by each participating utility to the PIU according to guidelines and formats included in the POM. An independent accounting firm acceptable to the Bank will be hired annually, in accordance with terms of reference approved by the Bank, to carry out the covenanted yearly audits of the special accounts, all project accounts, and of the SOEs. Monitoring and evaluation arrangements: Monitoring and evaluation would be done by the Bank and by qualified consultants hired by the Bank. Participating utilities will submit summary reports to the PIU, following formats included in the POM. The PIU will submit the Bank consolidated progress reports on the performance of the project at the end of each semester ending April 30 and October 30. The Bank would carry out at least two full supervision missions and one partial supervision mission a year. Counterpart funds: The proposed loan has already received Congressional approval (aprobacion Comisi6n Interparlamentaria) and Executive Branch approval through a CONPES document. Nevertheless, both approvals authorize the use of loan proceeds only for works and activities implemented in the Caribbean region. When DNP first requested Bank support, the request referred only to the Caribbean region. Bank management responded that it agrees to initiate project preparation on condition that it would be a national project and an APL, and accepted that the first phase wpold focus on the Caribbean region, but insisted that the project provide assistance also to the rest of the country. Given these constraints, the Bank project team and the government team (i.e., representatives of DNP and MED) reached a compromise which responds to the requirements of both the government and the Bank. The loan proceeds, in the amount of US$ 40 million, will be used only to finance works and activities (technical assistance, consulting services project management activities, etc.) implemented in the Caribbean region. The Government will provide counterpart funds in the amount of US$ 15 million from its budget, which will be used to finance works and activities in other regions of the country and the taxes and duties associated with project activities in all the regions (including the Caribbean). However, the project concept, principles and conditions will be the same for the Caribbean region and for the rest of the country, and the same implementation unit will manage project activities in the entire country. The total amount of project counterpart funds includes, on top of government's contribution from its budget, also private sector contributions, as well as some Law 60 contributions, at an estimated amount of US$ 15 million. This brings the total project counterpart fund to about US$ 30 million. Retroactive financing: The proposed project is expected to become effective in August 2001. An estimated US$150,000 will be required to maintain the services of the PIU from January 1, 2001, until the proposed loan becomes effective. These services have been financed with the proceeds of Loan 3336- CO until December 31, 2000, when the loan was closed. In addition, several medium and small municipalities have recently signed contracts with the private sector, and the government has committed to provide them with financial support. If these utilities under private sector management prove to be eligible to participate in the project, retroactive financing for all or part of the subsidies provided by the government may be required. The total amount of retroactive financing would not exceed 10% of the loan amount, i. e., US$ 4 million and it would be used to finance works and services which have been executed within a period not exceeding 12 months - 11 - prior to loan signing, and whose contracting has been carried out in accordance with the Bank procurement guidelines. 7. Sustainability The main factors that support the sustainability of the project are: Institutional reform supported by the project promotes incorporation of the private sector in the management and operation of the utilities. PSP is considered the key instrument in ensuring project sustainability. Participating municipalities will have to complete the PSP process prior to obtaining access to project financing, so the institutional reform will be implemented up-front. Selection of the private operators will be achieved through transparent competition for the market, on the basis of one clearly defined economic criterion. In medium size municipalities the project will finance utilities with a 20-30 year operating and planning horizon and a well-defined and realistic investment plan which would be formulated by the operators, with designs having also been prepared by them. In small municipalities, the works will be carried out by the operators, who will have the incentives to construct them to the highest quality standard possible, since they themselves will have to operate the installations for the duration of the operation contracts. The tariff level at the time of the award of each operation contract will be agreed upon with the mayor and will be communicated to the community prior to the to the PSP process. A proactive strategy and a credible mechanism to address the issue of expanding services to the poor will be implemented. 8. Lessons learned from past operations in the country/sector Since 1975, the Bank has made 13 loans totaling approximately US$707 million for water supply and sewerage development in Colombia. The Bank's overall experience in Colombia's water and sanitation sector has been mixed, with satisfactory achievement of physical objectives but inadequate progress towards the institutional and financial performance goals set at appraisal. The main lessons that emerge are summarized below. Successful performance of utilities with PSP. Experience with privatized water utilities in Colombia is encouraging (see Annex 17). There is also positive experience with PSP in water utilities in other countries in Latin America such as Chile, Argentina and Bolivia (see Annex 18, and in other parts of the world. On the basis of this experience, a commitment of each participating municipality to sector reform based on incorporating the private sector in the management of its utility is a fundamental aspect of project design. Front-loading institutional reform. The most important lesson is that key institutional reforms should be front-loaded. This is reflected in the design of the present project. PSP is a condition for participating in the project and each utility will have to sign an operation contract with a private operator in order to access the loan funds. Safeguards against political interference. Past and present Bank experience in Colombia show a consistent pattern of political interference in the WSS sector. Consequently, there is an overriding need to protect the privately operated utilities in participating municipalities against political - 12 - interference from future local government authorities. To this end, the agreements governing the transfer of government funds to the participating utilities, which will be signed between the MED and each municipality, will include the obligation of the municipal authorities to maintain private sector participation in the provision of the water and sewerage services in accordance with the signed contract. Violation of this condition will result in withdrawal of government financing. The agreement of financial support will be in effect also after the loan closing date. Even if a municipality violates the mentioned condition after the closing date, the government will still have the power and means to protect the operator, if he is mistreated by future mayors. Need for Adequate Tariffs and subsidies. Past experience shows a need to restructure tariff systems and to improve public awareness on the true cost of water and sewerage services, while targeting social subsidies in such a manner that they directly benefit the poor. An important principle in preparing the PSP processes under the proposed project consists, therefore, of reaching an up-front agreement with each mayor regarding the tariff level in his municipality, ensuring that it will cover operational and maintenance costs as well as part of the investment costs. Also, the subsidy policy will directly benefit the poor and only the poor. Need for utilizing appropriate design standards. On a technical level, past Bank projects in the sector have often fallen victim to chronic overestimation of water demand and frequent implementation delays, which, in an inflationary environment, have resulted in cost overruns for most of the projects. The focus on careful design through a strategy of minimum cost that is protective of the environment, and with a private operator in charge of design, will minimize the risk of over-design in the proposed project. Community consultation. Recent experience in the Philippines with a similar project highlights the importance of community acceptance of tariffs during the project preparation process. In this project, it was required that 60- of households agree to the proposed tariff. Community consultation also helps filter out investments for which there is not adequate demand. Notwithstanding these benefits, it is considered that for the proposed project in medium size cities, it would be impractical to seek agreement from such a high percentage of the population. However, community consultation would be carried out in small municipalities, but during project implementation rather than as an eligibility condition, since the willingness to pay is related to service improvement which occurs gradually. Experience gained with structuring PSP processes during project preparation. During project preparation, several PSP processes were completed both for medium size cities and for small municipalities. The lessons learned are summarized below. Providing Flexibility to add and drop municipalities . This is required since political commitment of mayors may change during implementation. Allocating adequate time for rebidding. Each municipality is different with its own peculiarities, so that a high level of flexibility must be maintained to reach a successful conclusion to the bidding process. Because of the high risks involved, flexible design has also to be accompanied by allocating adequate time for re-bidding in order to provide the appropriate incentives - 13 - to attract bidders. Using a single consultant for structuring a PSP process. Experience has shown that it is preferable to award just one consulting contract for preparing a PSP process, which will include the responsibility for all the activities involved, rather than devidimg the preparation activities between two contracts: (i) preparing the program of works and investments; and (ii) preparing all the rest (financial projections, legal aspect, bidding document). Also, because of the complexity of the processes, consulting firms do not have the capacity to prepare more than 2-3 processes for medium size cities simultaneously. Hence, it is important to clearly define the distribution of responsibilities between the PIU and the consulting firms in a manner that would improve efficiency and productivity. The PIU should carry out the "Socialization" processes. The PIU needs to be the main actor in the "socialization" of the PSP process in each municipality; this responsibility cannot be delegated to consultants. The need to use model bidding documents and standard financial models. In order to ensure quality and standardized processes, it is advisable to request all consulting firms to use a standard financial model for the analysis of the new private sector managed utilities and to use model bidding documents and a PSP contract for preparing the transactions. Low capacity in small municipalities to contribute to investments. Contributions to investments in small municipalities are low. In better off municipalities they can be as high as 20%, whereas in municipalities with a high portion of low- income inhabitants it is much less. The government, therefore, needs to continue to be a fundamental stakeholder in financing the water and sanitation sector in small municipalities. Providing continuous support to newly privatized utilities. The signing of a PSP contract is only the start of a complex transaction process that requires several years to consolidate. The government, therefore, needs to provide continuous support to the privatized utilities in technical, financial and political aspects. 9. Program of Targeted Intervention (PTI) N 10. Environment Aspects (including any public consultation) The project will support private sector participation in the provision of water and sanitation services to small and medium sized municipalities. The investment components of the project will involve mainly rehabilitation and improvement of existing water and sanitation infrastructure and extension of water and sewerage network . As such, no major environmental impacts are envisioned. Most impacts will be associated to construction nuisances in populated areas. The rehabilitation of existing systems will not entail resettlement of population. The PIU will screen each subproject and will ensure that it does not include any resettlement, i.e., if it will identify any intent of resettlement it will work with the corresponding subproject implementation unit to generate an alternative solution which does not include resettlement. An environmental assessment of the water and sanitation sector (SEA) which was carried out during project preparation identified key legal and - 14 - institutional issues related to environmental management in the sector. Colombia has severe environmental pollution problems. These problems have been exacerbated by intense urbanization rates and industrialization, combined with still an inadequate environmental regulatory framework and a long-standing backlog in sanitary and waste treatment infrastructure. Only about 5% of collected sewage receives any kind of treatment, well below the regional levels. Fragmentation of institutional responsibilities and lack of coordination have led to an uneven and often confusing regulatory and institutional framework for environmental management as it pertains to the water and sanitation sector. Regional environmental institutions (Corporaciones Regionales), with which the municipalities benefiting from the project will have to deal, are weak (with a few exceptions). Environmental licensing processes for private operators may become cumbersome and the capacity to monitor environmental conditions at the regional level is almost non-existent. Environmental regulations governing the water and sanitation sector in Colombia are weak and often overlapping among national and local governments and different sectoral ministries. Effluent discharges are based on effluent standards and treatment levels that do not allow for cost effective solutions even if the existing law hints that proper consideration be given to receptor body assimilation capacity. Non-domestic discharges to sewerage networks lack a proper regulatory framework and definition of institutional responsibilities for their management and control. The Sectoral Environmental Assessment proposes an action plan, to be financed by the project, that will: (i) strengthen the legal and institutional frameworks through revision of existing laws and regulations and redistribution of tasks among responsible institutions; (ii) strengthen the capacity of the regulatory and enforcement agencies, clarifying roles, responsibilities and budget requirements; (iii) prepare environmental guidelines for design and construction of civil works, and for environmental auditing procedures of existing works; (iv) clarify environmental requirements for the private sector participant and determining environmental liabilities; (v) prepare an environmental annex for bidding documents for use the selection of private operators; and (iv) monitor compliance, ensure enforcement and proper reporting of environmental issues in the sector. Specific outputs of the SEA are already available: (i) a detailed set of environmental specifications and requirements to be included in all bidding documents and contracts; (ii) a methodology for environmental impact assessment criteria and procedures for water and sanitation projects; (iii) a draft of environmental guidelines for the construction of water and sewerage systems; and (iv) an institutional strengthening program to improve environmental management capabilities in water and sanitation sector agencies. During project preparation, agreements have been reached among the main stakeholders (Ministry of Economic Development, Ministry of the Environment and DNP) in regard to cooperation during project implementation aimed at working towards the resolution of the described problems and supporting the implementation of the proposed project. The cooperation activities will focus on: (i) implementation of the Environmental Management Plan of the project and assigning responsibilities to stakeholders; (ii) harmonizing the inconsistencies within the current legislation (mainly between Decrees 1594 and 901); (iii) defining procedures and assigning responsibilities for - 15 - issuing environmental licenses for water project; (iv) evaluation of environmental risk and definition of mitigation mechanisms which would be included in operation contracts; and (v) involvement of CRA in the regulation of environmental taxes (tasas retributivas) and definition of mechanisms that would enable the inclusion of these taxes in the water tariffs. An inter- institutional committee (the environmental committee) which will include representatives of the Ministry of Economic Development, the Ministry of the Environment and of other stakeholders will be constituted during project implementation to work on all the aforementioned issues, build consensus on environmental aspects, mitigate the risk to the project resulting from the current legislation and resolve ad-hock problems related to specific subprojects, in cooperation with the respective regional authority. The SEA report has been finalized, reviewed by the Bank and subjected to intensive institutional and public consultation with the participation of the Ministry of Environment, Ministry of Development, National Department of Planning, Regional Environmental Agencies, water sector Regulatory agencies, private operators, academics, professional associations, NGOs and public defense groups. A national level workshop took place prior to appraisal. The project will finance an environmental component to support the implementation of the most critical activities identified in the sectoral action plan defined in the SEA. For the PSP processes, environmental requirements, guidelines and targets are being written into the concession documents. As part of the long-term strategy for improved environmental management in the water and sanitation sector in Colombia, the project will support the above-described EMP for the water and sanitation sector. Environmental management capacity will be strengthened in key sectoral agencies, especially the Water and Sanitation Division of the Ministry of Economic Development. 11. Contact Point: Task Manager Menahem Libhaber The World Bank 1818 H Street, NW Washington D.C. 20433 Telephone: (202) 4735327 Fax: (202) 6761821 Email: mlibhaber@worldbank.org 12. For information on other project related documents contact: The InfoShop The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 458-5454 Fax: (202) 522-1500 Web: http:// www.worldbank.org/infoshop Note: This is information on an evolving project. Certain components may not be necessarily included in the final project. - 16 -