Document of The World Bank Report No: 21868 CO PROJECT APPRAISAL DOCUMENT ON A PROPOSED LOAN IN THE AMOUNT OF US$40 MILLION TO THE REPUBLIC OF COLOMBIA FOR A WATER SECTOR REFORM ASSISTANCE PROJECT September 27, 2001 Finance, Private Sector and Infrastructure Department Mexico, Colombia and Venezuela Country Management Unit Latin America and the Caribbean Region CURRENCY EQUIVALENTS (Exchange Rate Effective September 20, 2001) Currency Unit = Peso ($) $2342 = US$1.00 $1 million = US$427 FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS ACUACAR Aguas de Cartagena (The Water and Sewerage Company of Cartagena) AAA Acueducto, Alcantarillado, Aseo (The Water, Sewerage and Solid Waste Company of Barranquilla) BOD Biochemical Oxygen Demand CAR Corporacion Autonoma Regional (Local Environmental Authority) CARDIQUE Corporaci6n Autonoma del Canal del Dique (The Regional Environmental Authority in Cartagena) CAS Country Assistance Strategy CDF Country Development Framework CONPES Comisi6n Nacional de Poiftica Econ6mica y Social (National Comission for Economic and Social Policy) CRA Comisi6n Reguladora de Agua (Water Regulating Committee) DAPS Direcci6n de Agua Potable y Saneamiento (Water and Sanitation Directorate) DNP Departamento Nacional de Planeaci6n (National Planning Department) DDUPRE Direccion de Desarrollo Urbano y Proyectos Especiales DTF Deposito Termino Fijo (interest rate of a fixed term deposit) EIE Environmental Impact Evaluation EIRR Economic Rate of Return EMP Environmental Management Plan FINDETER Financiera de Desarrollo Territorial (a second tier financial intermediary for regional and local infrastructure investment established in 1990) FMS Financial Management Specialist Vice President: David De Ferranti Country Management Unit Director: Olivier Lafourcade Sector Management Unit Director: Danny Leipziger Task Manager: Menahem Libhaber FNG Fondo Nacional de Garantias (National Guarantees Fund) ICN Ingresos Corrientes de la Nacion (Nation's Current Income) ICV Indice de Calidad de Vida (Quality of Life Index) INDEMUN Indice de Desarrollo Municipal (Municipal Development Index) IRR Internal Rate of Return Km Kilometer LACI Loan Administration Change Initiative LGU Local Government Unit M Meter MCM Million Cubic Meters Mm Millimeter MOE Ministry of the Environment M3/d Cubic meters per day M3/s Cubic meters per second MED Ministerio de Desarrollo Economico (Ministry of Economic Development) NBI Necesidades Basicas Insatisfechas (Unsatisfied Basic Needs) NGO Non Governmental Organization NPV Net Present Value PAOI Programa Anual de Obras e Inversion (Ainual Program of Works and Investments) PIU Project Implementation Unit PMR Project Management Report POI Programa de Obras e Inversion (Program of Works and Investments) POM Project Operation Manual PSP Private Sector Participation RPA Regional Procurement Adviser SEA Sectoral Environmental Assessment SEE Strategic Environmental Evaluation SIAS Sistema de Informacion Agua y Saneamiento (Sector Information System) SME Small and Medium Entrepreneur SOE Statement of Expenditures SS Suspended Solids SSPD Superintendencia de Servicios Publicos Domiciliarios (Superintendency of Domestic Public Services) TA Technical Assistance UFW Unaccounted For Water WSS Water and Sewerage Sector WSR Water Sector Reform WTP Willingness To Pay Colombia Water Sector Reform Assistance Project CONTENTS Page A. Project Development Objective .........................................................1 1. Project development objective ..........................................................1 2. Key performance indicators ..........................................................1 B. Strategic Context ..........................................................1 1. Sector-related CAS goal supported by the project ....................................................1 2. Main sector issues and Government strategy ..........................................................2 3. Sector issues to be addressed by the project and strategic choices .............................6 C. Project Description Summary ..........................................................7 1. Project components ..........................................................7 2. Key policy and institutional reforms supported by the project ................................ 14 3. Benefits and target population ......................................................... 14 4. Institutional and implementation arrangements ...................................................... 14 D. Project Rationale ......................................................... 20 1. Project alternatives considered and reasons for rejection ........................................ 20 2. Major related projects financed by the Bank and/or other development agencies .... 21 3. Lessons learned and reflected in proposed project design ....................................... 21 4. Indications of borrower commitment and ownership .............................................. 23 5. Value added of Bank support in this project ......................................................... 24 E. Summary Project Analyses ......................................................... 24 1. Economic ......................................................... 24 2. Financial ......................................................... 25 3. Technical ......................................................... 26 4. Institutional ......................................................... 27 5. Environmental assessment ......................................................... 28 6. Social ......................................................... 30 7. Safeguard Policies ......................................................... 32 F. Sustainability and Risks ......................................................... 33 1. Sustainability ......................................................... 33 2. Critical risks ......................................................... 33 3. Possible controversial aspects ......................................................... 35 G. Main Loan Conditions ......................................................... 36 1. Effectiveness conditions ......................................................... 36 continued Page 2. Other ...................................................... 36 H. Readiness for Implementation ...................................................... 37 I. Compliance with Bank Policies ...................................................... 37 Annexes Annex 1. Project Design Summary ...................................................... 38 Annex IA.Key Performance Indicators ........................................... 41 Annex 2. Detailed Project Description ........................................... 43 Annex 3. Estimated Project Costs ...................................................... 56 Annex 4. Cost-Benefit Analysis Summary ....................................... 57 Annex 5. Financial Assessment of Revenue-Earning Project Entities . . 68 Annex 6. Procurement and Disbursement Arrangements . .......................................... 89 Table A. Project Costs by Procurement Arrangements . ............................................ 94 Table Al. Consultant Selection Arrangements ..................................... 95 Table B. Thresholds for Procurement Methods and Prior Review . . 96 Table C. Allocation of Loan Proceeds ......................................... 101 Annex 7. Project Processing Budget and Schedule . ............................... 102 Annex 8. Documents in Project File ........................................... 103 Annex 9. Statement of Loans and Credits ....................................... 106 Annex 10. Country at a Glance ................................................ 108 Annex 11. Eligibility Criteria for Participating Municipalities . ........................ 110 Annex 12. Sectoral Environmental Assessment Summary . ........................... 112 Annex 13. Social Assessment Summary ......................................... 120 Annex 14. Potential Participating Municipalities ...................................................... 131 Annex 15. Model of Private Sector Participation in Water Companies . ................. 135 in Colombia's Medium Size Cities Annex 16.The Constructor-Operator Model for Private Sector Participation ............. 144 in the Operation of Water Supply and Sanitation Systems in Small Municipalities Annex 17.Private Sector Participation in the Water Sector in Colombia . ................ 153 Annex I8.Private Sector Participation Experience in the Water Sector . ................. 164 in Latin America Annex 19.Comparison of the Performance of Private and Public Water . ................ 167 Utilities with Respect to Service Expansion to Low-Income Areas MAP IBRD 31321 COLOMBIA WATER SECTOR REFORM ASSISTANCE PROJECT Project Appraisal Document Latin America and Caribbean Region LCSFW Date: September 20, 2001 Team Leader: Menahem Libhaber Country Manager/Director: Olivier Lafourcade Sector Manager/Director: Danny M. Leipziger Project ID: P065937 Sector(s): WW - Water Supply & Sanitation Adjustment Lending Instrument: Specific Investment Loan (SIL) Theme(s): Poverty Targeted Intervention: N Program Financing Data [X] Loan [ I Credit [ ] Grant [ ] Guarantee [ ] Other: For Loans/Credits/Others: Amount (US$m): 40.00 Proposed Terms (IBRD): Fixed-Spread Loan (FSL) Grace period (years): 7 Years to maturity: 15 Commitment fee: 0.85% for the first 4 years, 0.75% thereafter. Financing Plan (US$m): Source Local Foreign Total BORROWER 15.00 0.00 15.00 IBRD 24.00 16.00 40.00 PRIVATE SECTOR AND MUNICIPALITIES 15.00 0.00 15.00 Total: 54.00 16.00 70.00 Borrower: REPUBLIC OF COLOMBIA Responsible agency: THE MINISTRY OF ECONOMIC DEVELOPMENT The Ministry of Economic Development, Directorate of Potable Water and Basic Sanitation Address: Calle 28, No. 13A-15, Piso 17, Edificio Bancafe, Bogota, Colombia Contact Person: Carmina Moreno, Director of Potable Water and Basic Sanitation Tel: 57-1-2826352 Fax: 57-1-2822329 Email: Cmoreno@sias.gov.co Estimated disbursements ( Bank FY/US$m): FY 2002 2003 2004 2005 2006 Annual 5.00 11.00 15.00 6.00 3.00 Cumulative 5.00 J 16.00 31.00 37.00 40.00 Project implementation period: November 30, 2001 to December 31, 2006 Expected effectiveness date: 11/30/2001 Expected closing date: 06/30/2007 OM8 PADI Ful Rl US) 2 Page 1 A: Project Development Objective 1. Project development objective: (see Annex 1) 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 ensuring the financial viability of these utilities. Project activities will focus mainly on the Caribbean coastal region of Colombia,which consists of the Departments of Atlantico, Bolivar, Cesar, Cordoba, La Guajira, Sucre, Magdalena and San Andres, Providencia y Santa Catalina. The focus will be in this region because it suffers from the lowest coverage rates of water and sewerage in the country, as well as the lowest level of service, and the Govemment' s policy is to reduce these regional disparities. However, about 15% of project activities will be implemented in other parts of the country. The project might also provide technical and financial support to cities which have undertaken earlier reform processes involving private sector participation in the management of their utilities. The reform principles proposed by the project reflect the policy of the government and will be applied throughout the entire country, even while using other financing sources. 2. Key performance indicators: (see Annex 1) The main indicator for measuring the success of the program is the progress made in attracting PSP, both in the medium size cities and in the small municipalities. For those utilities which are successful in attracting a private operator, eight monitoring indicators will be used to track progress related to the objectives of the water supply and wastewater sector, which aim to improve efficiency, sustainability and service-to-all. The selected indicators are those agreed under the CDF, and form a "utility-based" set of indicators used to measure the operational and financial efficiency of water utilities (which will basically be the target indicators stipulated in the PSP contracts, i.e., coverage of services, reduction in rationing, productivity, financial performance etc.). Details on the performance indicators are provided in Annex IA. B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1) Document number: 17107 CO Date of latest CAS discussion: 11/6/97 CAS Progress Report Report Number: 19805 Date of CAS Progress Report discussion: 11/18/99 The proposed project will support the CAS objective of Achieving Sustainable Growth, by Improving Infrastructure Services. Colombia's poor and deteriorating infrastructure has long been identified as a critical constraint to faster economic growth. The govemment's strategy to improve the quantity and quality of water supply, sewerage and sewage treatment infrastructure emphasizes increased private sector participation. The project is consistent with the CAS's emphasis that "The Bank intends to support rural and small cities water supply at the national level, with a special focus on private sector participation." Page 2 2. Main sector issues and Government strategy: Sectoral Context. In 1986 the Decentralization Law transferred the responsibility for operating and managing the water and sewerage systems to the municipalities. Decentralization has been a major force in shaping the water and sanitation sector's structure. Colombia now consists of 1,091 municipalities and about 1,500 registered water and sanitation service providers, including municipal departments, utilities (public, private and mixed) and other authorized organizations. In 1991 a new constitution was installed in Colombia, in which the right of municipalities to provide water and sanitation services was confirmed, including the power to grant concessions or other forms of private sector participation in the provision of the water and sewerage services. The constitution provided the legal framework to introduce more aggressive reforms in the water sector by clearly separating service provision and policy making, and by allowing private sector participation (PSP) in the infrastructure sector. Law 142, enacted in 1994, established a legislative and regulatory framework for the sector that emphasizes efficiency of service provision through the introduction of competition and the promotion of PSP in the sector. The Ministry of Economic Development is responsible for the water sector. The responsibilities for the sector have been assigned to different institutions within the Ministry. The Potable Water and Sanitation Directorate (DAPS) oversees the water and sanitation sector, formulates sector policies and plans sector development. The Water Regulatory Commission (CRA) promotes competition among service providers, controls monopolies, defines tariff setting methodologies based on standard formulas and on investment plans submitted by the operating companies, and sets service quality and technical standards to be followed by utilities. In addition, the Superintendency of Domestic Public Services (SSPD) is responsible for monitoring and supervising the adequacy and efficiency of the operations, for establishing uniform accounting systems, supervising the administration of subsidies, and monitoring the general administration of public services companies. Environmental regulation is handled by Autonomous Regional Corporations (CARs). Colombia, with a population of about 40 million inhabitants, has made impressive progress in expansion of water and sanitation services in urban areas over the past decade. Approximately 84% of the urban population of about 28 million were connected to water supplies in 1997, as compared to 79%, the average for the LAC region. About 75% were either connected to public sewerage or had individual septic tanks in 1997. Rural coverage was lower with about 44% of the 11 million rural population connected to public water supply and only about 25% connected to sewerage systems. However, the increase in coverage rates masks shortcomings in the quality of service. Water rationing and intermittent supplies are common in most water supply systems. Only slightly less than 50 percent of all drinking water is treated and, as a result, the drinking water quality in many systems is sub-standard. Sufficient pressure in the water supply systems is lacking, adding to the risk of bacterial contamination. Sewage collection systems do not have sufficient hydraulic capacity to handle wastewater flows, especially in poor neighborhoods, resulting in overflow problems. The share of generated wastewater receiving any kind of treatment is about 5%, which is low for a middle income country such as Colombia. Private sector involvement in the water sector began in 1995 in Cartagena, with support from the Bank. Since then, some 15 large and medium size water companies, as well as about 35 smaller ones have managed to incorporate the private sector through various types of models, mainly mixed capital, concession and management contracts. The most important examples of PSP processes in the water sector are in Cartagena, Barranquilla, Santa Marta, Tunja, Monteria, Palmira, Girardot, Riohacha and in some smaller municipalities. The performance of all these utilities has improved. Some of them, especially the ones which were first to incorporate the private sector like Cartagena, Barranquilla and Tunja, are now well run utilities and enjoy a high degree of customer satisfaction. In spite of a favorable government policy, private sector participation in the water sector is still not widespread and is far lower than has been expected. The reasons for the slower than expected spread Page 3 of PSP are twofold: first security problems of the country deter foreign operators and investors; second, carrying out PSP processes is complex and difficult, and needs government technical assistance and financial support in order to be successful. Main Sector Issues and Government Strategy: 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 I 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 Page 4 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 and supervising agencies (CRA and SSPD) have regulatory monitoring 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 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. During May-June, 2001 several legislative initiatives to reform Law 142/1994 have been presented in the Congress. The purposes of those initiatives are diverse and range from proposing to instate caps on tariffs to the elimination of the SSPD. Changes in the regulatory and legal framework do not provide comfort to potential private investors and constitute an obstacle to the efforts of consolidating the reform started in 1994. The government, established a high level commission to address the concerns of the legislature. Limited Coordination Among Central GovernmentAgencies. There are many institutions in the sector, some with overlapping functions in certain areas. Under such circumstances, coordination effort are 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 in the water sector. 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 do 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, are 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, Riohacha 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. Page 5 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. Strengtltening 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 govemments, 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 thte 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. Page 6 3. Sector issues to be addressed by the project and strategic choices: Sector issues to be addressed by the project: The proposed project would be the first Bank-financed project to directly support implementation of the government's sector reform agenda. It would support several key PSP operations, targeting improvement of efficiency and expansion of water and sanitation services in two types of utilities: (i) medium-size cities or regional associations of municipalities (with populations of up to about 300,000 inhabitants); and (ii) small municipalities (with populations of up to about 12,000 inhabitants). In doing this, the project will address the following sector issues: * Poor utility performance * Disparity in service coverage between large cities and between medium and small cities * High investment needs * Low private capital investments and credit to the sector * Subsidies to the poor Sector strategic choices: (i) Publicly v. privately managed utilities: The program reflects the strategic choice already made by the government of Colombia, supported by the Bank, to move from public ownership and management of water and sanitation services to a model in which management and operation are led by the private sector. Continued support to public utilities, aimed at improving their performance, was not accepted and PSP was selected as the preferred institutional strategy because of performance improvement that has been achieved in utilities which have incorporated the private sector in their management, such as in Cartagena, Barranquilla and Tunja. (ii) Focus on small and medium-size utilities: Large utilities have historically received the greatest share of support from the central government and financial support from the Bank. Through the proposed project, the Bank will be providing technical assistance and financing investments in small and medium size utilities that choose to incorporate the private sector in their management. It will focus on a segment of the sector which suffers from the greatest backlog in investments and which has not received significant Bank support in the past. (iii) Promote PSP in small municipalities : Conventional wisdom suggests that it is not feasible to privatize small enterprises, because the private sector has no interest in utilities which serve less than 300,000 inhabitants. However, experience shows that in Paraguay, and to a smaller extent in Colombia and in other countries, there are some successful examples of small-size private operators in the water and sanitation sector, managing utilities without any government support. There is enough evidence to indicate that in Colombia it would be possible to find small private entrepreneurs interested in operating water and sanitation services in small municipalities. (iv) Promote the development of a market of small entrepreneurs to serve as operators of utilities in small municipalities: The number of small municipalities targeted by the project amounts to about 25, while the supply of operators which can currently handle these utilities is far smaller than the number required. The project aims to promote the development of small entrepreneurs in the water and sanitation industry, targeting small and medium construction companies or associations of such construction companies with small consulting firms, to become water operators in small municipalities. The idea is that, through competitive bidding, small and medium size construction companies will compete for the construction and/or rehabilitation of the systems in small municipalities and the winning bidder would commit to operate the system for a period of ten years from the date of signing the contract. This type of contract has been denominated "Constructor- Operator" contract. The MED will provide technical assistance to these small entrepreneurs for the management of water utilities. Page 7 (v) Focus on the Atlantic Coast Region (the Caribbean Region): Because of an investment backlog in the Caribbean region, this region suffers from the lowest coverage of water and sanitation services, as well as the lowest quality of its utility management. The government has now decided to give investment priority to the Caribbean region through an infrastructure program, Plan Caribe. The project will support Plan Caribe in an attempt to reduce the regional disparity in water and sanitation services. C. Project Description Summary 1. Project components (see Annex 2 for a detailed description and Annex 3 for a detailed cost breakdown): Basic Project Concept Introduction: The project seeks to support water sector reforms both in medium size cities or regional utilities ( serving populations of up to about 300,000 inhabitants) and in small municipalities (populations of up to about 12,000 inhabitants) by facilitating the incorporation of the private sector in the management and operation of the water and sanitation services in the utilities of participating cities and municipalities and by providing financial support to these utilities, while ensuring provision of services to the poor. Based on experience in Colombia, as well as elsewhere in the LAC region (Annexes 17 and 18) it is assumed that once the private sector gets involved in managing the utilities, the level of the water and sanitation services will improve, the services will become more efficient and more reliable, their coverage will expand and the access of poor consumers to these services will increase. The project reflects the Government's policy to provide targeted assistance to utilities which choose to incorporate the private sector in management and operation of the water and sewerage services, since the PSP approach is believed to be the best way to improve the performance of the water utilities and the level of service which they provide to the customers. Consequently, the project is demand driven and will assist municipalities which choose to participate and: (i) agree to private sector participation in their water utilities; and (ii) reach an agreement with MED regarding a tariff increase which will elevate the tariffs to a level which, as a minimum, will cover operation, maintenance and depreciation costs, and as higher than that as socially and politically possible. For the purposes of the project, PSP is defined as transferring full management and operational responsibility to the private sector and provision of investments by the private sector in an amount compatible with the agreed level of tariffs. For the purpose of helping to diminish disparities, the project will focus on supporting: (i) medium size cities and small municipalities, which suffer from investment backlog and low level of services; and (ii) municipalities in the Caribbean region, in which the water and sanitation services are less developed than in other parts of the country. The aforementioned priorities would result in providing support to population of scarce resources, since most of the population in the medium size cities and small municipalities of the Caribbean region is of low income. Lists of the medium size cities and small municipalities in the Caribbean region, which are potential candidates to participate in the project, are presented in Annex 14. The preferred option in PSP in the water sector is to reach an agreement on a full concession, under which the concessionaire commits to provide all the investments required during the contract period. However, under the conditions in medium size cities and small municipalities in Colombia, it would be difficult to reach full concession agreements. Most of these cities suffer from significant infrastructure backlogs and need high investments, while the current tariffs are quite low. It is estimated that in most medium size cities and certainly in all small municipalities, even with tariffs increased to a socially acceptable maximum level, it would not be possible to finance all the works required in the next 10-30 years (the contracts period range) just from tariffs. Consequently, the private sector, which will be hired to manage a utility, will invest up to a level that can be recovered Page 8 from tariffs, whereas the rest of the investments would need to be provided by the public sector (national and/or local government) in the form of subsidies or loans to service users. Two different mechanisms were developed during project preparation to facilitate the incorporation of the private sector in: (i) medium size cities or regional associations of municipalities with populations of up to about 300,000 inhabitants; and (ii) small municipalities with populations of up to about 12,000 inhabitants. The differentiation result from the fact that, from the private sector's standpoint, the business is different in the two size ranges of municipalities, and the required type of operator is different in both, i.e., for medium size cities only an experienced operator with proven credentials in operating utilities of comparable size can be hired, while for small municipalities proven experience in operating comparable systems is not required, but rather the capacity to operate them. The cut off number of 12,000 was selected because it defines reasonably well the limit between the two types of municipalities and because it coincides with an administrative division in Colombia. For both types of municipalities, model bidding documents have been developed, which include the terms of reference, specifications and draft contract. For each municipality, engineering and financial consultants will be hired to prepare the required investment program (Plan de Obras e Inversion - POI) and the financial projections of the new privately managed utility, respectively. The PIU at the Ministry of Economic Development, in cooperation with the municipal authorities, would then incorporate the investment and financial data in the model bidding document and will produce a specific set of bidding documents for each participating municipality. Private operators hired under the project will be required to provide water of a quality which complies with the national drinking water quality standards. Medium size cities: The operators for medium size cities must be private companies or joint ventures which have proven experience in operating similar size water and sewerage systems and are financially solid enterprises which can mobilize the required funds for investment. The contract for the medium size cities, which defines the proposed model, is denominated "operation contract". The investment commitment of the private operator of each city will depend on the level of tariffs agreed upon with municipal authorities. In one extreme, where the tariff level can support only operation, maintenance and depreciation, it would be a management contract (operation without investment); in the other extreme under which the tariffs can support all the investments, it would be a full concession (operation plus commitment to provide all the required investment). In most cases, however, it is expected to be an operation contract under which the operator would commit to provide part of the required investment while the rest will have to come from the public sector, either the municipality or the government or both. If the maximum tariff level acceptable to the municipal authorities does not cover the operation and maintenance cost of the utility, the participation of the city in the project will be rejected, since the utility is financially nonviable and the private sector cannot operate under such conditions. The basic principle of the operation contract is that it only commits the operator to provide an investment compatible with the level permitted by the authorized tariff. The financing of any additional investment is the responsibility of the public sector, and, under the project, it will be attempted to provide to participating utilities the amount of support requested in each case by the private operator. However, funding restrictions might limit the availability of funds for each city, in which case the public sector would commit to provide an investment at a level which will at least ensure that the rate of return to the private operator of the entire transaction will be attractive enough'. This will be done by defining in the bidding documents a cap on the amount which the public sector would provide. The cap value will be derived from a financial model which will be prepared for each participating utility prior to initiation of the bidding process for selecting the private operator, so as to ensure the achievement of an adequate rate of return for the private 1 The value of the rate of return for each case will take into account the specific risks of the municipality in question and may vary in the range of 12% to 25%. Page 9 enterprise. The operation contract stipulates the investment program over time (the POI) required to bring the system to optimal conditions, as proposed by the winning bidder, and including a commitment of the operator to finance and construct the part of it which corresponds to him according to his proposal. When public funding is required, its use and allocation will be derived from the POI. MED and the municipal authorities will reach an agreement with the operator regarding the works and/or goods of the POI, which be financed by the government subsidy. The criterion for selection of the winning bidder is simple and transparent: the contract would be awarded to the bidder who requests from the public sector the lowest capital investment subsidy in order to complete the works of the POI and bring the system to the optimal state, as well as operate and maintain the water and sanitation system. No operation subsidies are involved and the maximum amount that the government is ready to pay (the subsidy cap) will be stipulated in the bidding documents. The performance indicators targets (metas del contrato) will be stipulated in the draft contract which forms part of the bidding documents, will be compatible with the subsidy cap, and will also ensure an adequate service to the poor. Each bidder will submit his own POI, which may be different from the POI proposed by the engineering consultant, since the POI is essentially a technical proposal and it is advisable to let the private sector introduce its own ideas and innovations. Each bidder will provide in his proposal a detailed annual scope of works and related dollar amount which he commits to carry out each year. The winning bidder will agree that, once he has received from the government an agreed set of works whose value is equivalent to the amount of subsidy which he requested, he will reach the target indicators value over time, as stipulated in the contract, i.e., the operator will commit to attain the target indicators corresponding to the total level of investments provided (private plus public investments). The yearly work program can be changed in mutual agreement with the mayor but the operator would have to comply with the total amount of the annual investment program. The amount which the public sector has committed to provide will not be made available to the operator, for his discretional use, but will be rather used to finance part of the infrastructure works stipulated in the POI, which will be proposed by the operator (i.e., works considered by him as high priority works) and approved by the municipal authorities and the MED. In this way, the private operator will not receive a financial contribution from the government, but rather the right to operate additional infrastructure which is provided by the government as a grant and is owned by the municipality, and whose value is equivalent, or close, to the amount of the subsidy which he requested in his proposal. In this manner, the government, in effect, finances additional infrastructure for the city residents and not the provision of funds to the operators, a concept more acceptable to the public. 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 privatized water utility of the city. This arrangement will ensure that the infrastructure provided by the government will be totally satisfactory to the private operator and will meet his requirements. The works and goods financed with Bank proceeds will be procured through public bidding processes in accordance with the Bank procurement guidelines. The supervision and control of the PSP contract will be the responsibility of the contracting agency, i.e., the municipality, which may hire an individual consultant or a consulting firm, on a full or part time assignment, to carry out that task and determine if the performance targets are achieved by the operator. The duration of the operation contracts would be in the range of 20-30 years, which is the time required to recover investments in these type of contracts. If the authorized tariff level is sufficient to cover all the investment program (with no need for financing support from the public sector), the contract would then be awarded to the bidder who offers the highest reduction in the authorized tariff (i.e., the lowest tariff). Additional details regarding the proposed model for medium size cities are presented in Annexes 2 and 15. Page 10 Recently, the water utilities of several medium size cities in the Caribbean region have been privatized under various PSP models, utilizing technical assistance provided by the government. The government has also offered financial support to the privatized utilities but has encountered difficulties in providing it. It requested, therefore, that these utilities be eligible to access financing under the proposed project. Such utilities could become eligible to project financing under the following conditions: (i) the private operator has been elected through a competitive bidding process acceptable to the Bank; (ii) the agreed tariff levels are adequate and coincide with the principles of the proposed project, or, in case they are inadequate, the operator and the municipal authorities agree to bring them to adequate levels; (iii) the municipal authorities are ready to contribute matching financial resources from government transfers or other sources; and (iv) when necessary, the private operator and the municipal authorities agree to modify the performance indicators stipulated in the operation contract, add to it indicators for low income areas and incorporate in it other amendments, as required by MED and the Bank. During project preparation, PSP processes based on the described model were prepared for several cities (Cucuta, Maicao, Sincelejo, Corozal, Quibdo, Flandes, Espinal, Duitama, Popayan and others) as well as for several regional schemes (Acuavalle, composed of 33 municipalities, ERAS composed of Cerete, Sahagun, Cienaga de Oro, San Carlos and San Pelayo, and ARATT composed of Arjona Turbaco and Turbana). Three bidding process were initiated, like those in Cucuta, ERAS and Maicao. One process, in the city of Maicao, was completed successfully and has been awarded to a private operator. Unfortunately, in the other two, no proposals were submitted. The reasons for that are: (i) the bidding processes coincided with the end of the term of mayors in Colombia in late 2000, which hindered the processes by allowing only a short time of about three weeks for submission of proposals; (ii) security problems in the regions of the two cities; and (iii) the impact of the water pollution taxes "tasas retributivas" and other environmental contingent liabilities (financial impact of possible future more stringent environmental norms), which were mentioned by potential private operators as a reason for finally deciding not to submit a proposal. Small municipalities: The contract with private operators in small municipalities is denominated "Constructor-Operator" contract. The concept of incorporating the private sector in the management of utilities of small municipalities, with populations of up to 12,000 inhabitants, is perhaps the most significant innovation of the project. Common perception suggests that it is impossible to privatize small utilities, because the private sector does not have interest in utilities which serve less than 300,000 inhabitants. However, experience has shown that in Colombia (see Annex 17), as well as in other countries, there are successful small-size private operators in the water and sanitation sector, managing utilities without any government support. The basic assumption of the "constructor-operator" concept is that big operators have an interest in managing utilities of large and medium size cities, while small utilities attract small operators. The concept was developed during project preparation and was adopted by the government It is the first time that any government in Latin America supports PSP in a large number of small municipalities with a population of less than 12,000 inhabitants each. The concept of the "constructor-operator" model in small municipalities is that through competitive bidding small and medium size construction companies, possibly in association with small consulting firms, will compete for the construction and/or rehabilitation of the water supply and sewerage systems in a small municipality and the winning bidder will have to commit to operate the systems for a period of 10-15 years from the date of signing the contract. No prior experience in operation of water systems is required from the bidders. It is assumed that construction companies that have the capacity to construct the systems, also have the technical and management capacity to operate them after minimal training, since the systems are quite small and simple. The winning bidder will receive training in management of water utilities as well as written material and management software, from the PIU. Although it might appear that the bidding process for selecting the Constructor-Operator is similar to that for selecting a constructor for small works, it is in fact a process for selecting a private operator, Page 1 1 in which the selection criterion of the winning bidder is the lowest subsidy that is required to construct, operate and maintain the specified water and sewerage infrastructure in the municipality. Bidders will estimate the present value of surplus operating revenue and determine how much they can contribute from future income to finance the works, and how much they request as public sector (government and municipality) subsidy. The winning bidder will be required to establish a special purpose company with, separate accounts, to construct and operate the water and sewerage systems of the municipality. The Constructor-Operator model is basically a concession tailored for small municipalities, in which the government finances, in the form of a subsidy, most of the required water and sewerage infrastructure investment in the participating small municipalities. The requirement for a high level of government subsidy results from the fact that small municipalities suffer a significant backlog in infrastructure while the population does not have the capacity to finance this backlog through tariff increases. The Constructor-Operator model is, in fact, similar to that of the operation model in medium size cities, with three differences: (i) in small municipalities the operator is also the constructor, and this was required for the creation of the operators market; (ii) the level of government subsidy will most probably be greater (in terms of percent of total investment) in small municipalities; and (iii) the duration of the contracts in small municipalities is 10-15 years while the duration of the contracts in medium-size cities is 20-30 years. Although initially constructors may not find such an operation attractive, they might agree to be responsible for system operation and management because of their interest in the construction portion of the contract. After operating the system he himself constructed for ten years, the Constructor-Operator will most probably recognize the benefits of performing as a system operator, i.e., benefiting from a stable, reliable and continuous source of income, while performing a relatively simple task. It is expected that this will convince the entrepreneur to remain an operator on a permanent basis. In that manner, through the concept of constructor-operator, it is expected that the market of private operators for small municipalities will be created. Additional details regarding the proposed "Constructor-Operator" model for small municipalities are presented in Annexes 2 and 16. During project preparation, a pilot PSP processes based on the "Constructor-Operator" model were prepared in eight small municipalities (Puerto Escondido, Los C6rdobas, Mofiitos, San Bernardo del Viento, Cumaral, Nataga, Palermo, and Tello). Because of government budget restrictions to finance the related investments, the bidding processes were carried out for only five municipalities; of these, two processes have been successfully completed for the municipalities of Cumaral and Nataga and the respective contracts have been awarded and signed. The others were negatively impacted from the fact that the bidding processes coincided with the end of the term of mayors in Colombia, in late 2000, which is the reason that no proposals were submitted for the other municipalities. Destination of Bank Proceeds: The Bank funds will be lent to the government of Colombia, which will use them mostly as subsidies to finance public investments in water and sanitation infrastructure in medium size cities and small municipalities. In addition, part of the Bank funds will be used to finance the technical assistance activities which will be provided to each participating municipality for incorporating the private sector in the management and operation of the services, as well as for other technical assistance activities included in the project. Ensuring the Provision of Services to the Poor: In medium size cities: in order to ensure services in poor neighborhoods of medium size cities, two sets of pre-established performance targets, varying over the years, will be stipulated in the operation contracts, one for the entire city and one for the low income neighborhoods. The operators will commit to achieve both sets of targets, thus ensuring the provision of services to the poor in the medium size cities. In small Municipalities: the eligibility criteria will provide a screening mechanism which will ensure that only municipalities with a high portion of low income population will be able to participate in the project. This will be done through Page 12 use of the social indicator INDEMUN2 (Indice de Desarrollo Municipal - Municipal Development Index) which is determined annually by DNP for each municipality. Only municipalities with an index value of up to 5, which reflects low income municipalities, will be eligible to participate in the project. This value will ensure that most of the population in the participating small municipalities is of low income. Subsidy Policy: The tariffs for each stratum will be structured in such a manner that high income consumers in strata 4, 5 and 6 will pay their share in the investment program through the tariff and will not receive any subsidies. As a result, all the investment subsidies financed by the Bank will benefit only consumers in strata 1,2 and 3, i.e., population residing in low income areas. This approach is a requirement of Law 142 and also a project objective of supporting the poor. Eligibility Criteria: Although there are some differences between the eligibility criteria of small municipalities and medium size cities for participating in the project, the criteria in both cases are quite similar. The main eligibility criteria are: (i) the water coverage rate in the municipality is lower than a pre-established value; (ii) the mayor and the municipal council agree to PSP and accept the proposed PSP model; (iii) the mayor and the municipal council agree to new tariffs at a level which will ensure coverage of, at least, the operation, maintenance and depreciation costs, and as high as socially and politically possible; (iv) the mayor and municipal council agree to contribute to the investment program a certain percent (between 8 to 20%, to be established specifically for each case) of the Law 60 municipal transfers or other municipal resources; (v) the mayor commits to carry out a campaign aimed at informing the community about the reform, the PSP model and the tariff adjustment involved (vi) the investment per capita is capped and cannot exceed a pre-determined value; and (vii) the proposed works will not include resettlement. Additional details regarding the eligibility criteria of small municipalities and medium size cities are presented in Annex 11. Project Components The proposed project will help to incorporate the private sector in the management and operation of about 3 water utilities in medium size cities and in about 25 water utilities in small municipalities. It will also provide financial support for infrastructure investments in the utilities which have been successful in incorporating the private sector. The main project components are: (i) the provision of financial support for investments in water utilities of medium size cities and small municipalities; and (ii) technical assistance for PSP and project management. Additional project components include sector environmental capacity strengthening and rural water and sanitation policy development. The project components are summarized in the following table, which includes the estimated cost of each component and sub-component. 2INDEMUN is a territorial development indicator which reflects in each municipality a set of social indicators (coverage of education, coverage of public services, health, unsatisfied basic necessities) as well as financial indicators (tributary and non-tributary income per capita and expenses per capita). The INDEMUN indicator has 8 categories. Category I reflects the least developed municipal level and category 8 the most developed. Category 5 was selected as the cut off category of the indicator in order to be inclusive enough, while on the other hand not to include in the project municipalities with too high a level of development and too low a level of poverty. Page 13 Project Components and Estimated Cost Indicative Bank- % of Component Sector Costs % of financing Bank- ______(US$M) Total (US$M) financing A. Investments in Subprojects in 61.8 88.3 31.8 79.5 Medium Size Cities and Small Municipalities Al. Loan investments in W&S Urban Water 15.0 21.4 15.0 37.5 works in medium size cities in Supply the Caribbean region A2. Loan investments in W&S Urban Water 16.8 24.0 16.8 42.0 works in small municipalities in Supply the Caribbean region A3. Government counterpart Urban Water 15.0 21.4 0.0 0.0 funds for investments in Supply medium and small municipalities in the rest of the country A4. Private Sector and Law 60 Urban Water 12.5 17.9 0.0 0.0 investments in medium size Supply cities A5. Private Sector and Law 60 Urban Water 2.5 3.6 0.0 0.0 investments in small Supply municipalities B. Sector Environmental Environment 0.8 1.1 0.8 2.0 Management Capacity Adjustment Strengthening C. Rural Water and Sanitation Rural Water 0.9 1.3 0.9 2.2 Policy Development Supply & Sanitation D. Project Management and 6.5 9.3 6.5 16.3 Training, PSP Technical Assistance, Studies and Supervision of Works Dl. Project Management and Urban Water 2.5 3.6 2.5 6.3 Training Supply D2. TA for PSP in medium Urban Water 1.0 1.4 1.0 2.5 size cities and supervision of Supply works D3. TA for PSP in small Urban Water 3.0 4.3 3.0 7.5 municipalities and supervision Supply of works Total Project Costs 70.0 100.0 40.0 100.0 Total Financing Required 70.0 100.0 40.0 100.0 (Note: The Borrower shall pay the Bank a front-end fee equal to US$400,000 no later than 60 days after effectiveness date of the Loan). Page 14 2. Key policy and institutional reforms supported by the project: The proposed project will support the following reforms: * Promotion of private sector participation in the management and operation of medium-size water utilities. * Promotion of private sector participation in the management and operation of water utilities in small municipalities. * Incorporation of a poverty strategy in PSP contracts. * Promotion of reform of environmental regulations, especially in regard to effluent discharge regulations. * Development of a policy for increasing water and sanitation coverage in the rural sector. 3. Benefits and target population: Project benefits are related to the reform of the water and sanitation sector in Colombia. They include efficiency gains expected from private sector management of sector operations; increased and more efficient investments to rehabilitate and expand infrastructure--within the incentives of private sector decision making--to meet clearly defined operational and service targets; and fiscal gains from increased tax revenues. Improved operational and investment efficiency translates into: (i) More reliable water and sanitation services; (ii) The elimination of water rationing and intermittent water supply during the summer months; (iii) Reduction of wastage of water by establishing a metered- based tariff regime; (iv) Improved water quality for human consumption to meet international standards; (v) Reduction of water pollution, within a defined framework of environmental regulations; (vi) Better services to the poor by the establishment of service and coverage targets in poor areas within PSP arrangements; and (vii) Better sizing, timing and technology choice of sector investments through the incentives of private sector rationale. Furthermore, the project's benefits are expected to extend beyond the direct beneficiaries and the 5-year implementation period. In the medium term, the project is expected to improve the sector's access to the private capital markets by establishing a track record for well designed privately operated contracts. The project will also provide credible and acceptable PSP models which will be tested during the implementation period and which could be adopted by utilities in other countries. Finally, the project would provide assistance to the impoverished Caribbean region, which has the lowest service coverage and lowest quality of service, as well as an average income below the national average, so as to attempt to reduce regional disparities. Targeted population: an estimated population of about 700,000, a large portion of which is of low income (when measured in terms of unsatisfied basic needs-NBI, about 40% of the Caribbean population is living in poverty and about half of that population is living in misery, see Annex 13), residing in small municipalities, is expected to benefit from improved water and sanitation services as a result of the project. Of the eight departments included in the project area (Atlantico, Bolivar, Cesar, Cordoba, La Guajira, Magdalena, Sucre and San Andres, Providencia y Santa Catalina), all except one (Atlantico) have a higher incidence of poverty and lower water and sewerage coverage rates than the national averages, as shown in Annex 13. It is noteworthy that, of all departments in the country, the highest misery levels are found in Cordoba and Sucre, when measured in terms of unsatisfied basic needs (NBI). When using the quality of life index (ICV) to measure poverty, again Bolivar, Cordoba, Magdalena and Sucre are, after Choco (which is a department not located in the Caribbean region), among the poorest departments in the country. 4. Institutional and implementation arrangements: Implementation period: FY 02-FY07 (5 years) 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 Page 15 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 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, the executing agencies will comply with the Bank's guidelines. Project management and coordination: Overall project management and coordination 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 Director will be assisted by the PIU in MED, which will be the implementation and coordination agency of the project. The PIU will supervise the implementation of subprojects and manage all the technical assistance activities through a team of consultants financed under the Loan. This team has already 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 in structuring PSP processes, in social aspects related to PSP and in Bank procedures. One of the most important tasks to be carried out by the PIU during project implementation is the "socialization" of the PSP process in each municipality. First of all, this would entail convincing the mayor to participate in the project. Secondly, the PIU would assist the Mayor to secure support from other important actors such as the municipal council, community organizations, the business community and NGOs. Then it would assist the mayor to carry out public information campaigns and community consultation. A detailed description of the PIU functions and responsibilities in implementing the project is included in the Project Operational Manual (POM), which is being prepared with Bank assistance. Oversight of project management will be provided by an inter-institutional committee created specifically for this project. This committee, called "Comite Coordinador Interinstitucional DNP- MDE", is made up of representatives of MED and of two units of the National Department of Planning (DNP), namely DDUPRE (Direcci6n de Desarrollo Urbano y Programas Regionales Especiales), which is a unit in charge of the water sector; and the Caribbean Plan Program. Learning and Feedback Arrangements: The PIU in MED will also serve as a focal point for exchanging experiences (best practices and lessons learned), training, and an information data- base for sector reform. To that end, the PIU will do three things. It will organize periodical workshops with the participating municipalities to exchange experiences. It will also prepare training programs for small operators and decision makers as well as for community representative groups, and it will maintain the sector information system which would be available to the public, including potential investors and lenders. Legal Agreement: The Loan Agreement will be signed between the Bank and the Government. In addition, the government will sign contracts with two Assistance Entitities which will assist it in administrating the Loan funds. One Assistance Entitity will administer the investment funds and the other wil administer the TA funds. For each subproject, an agreement of financial support, Convenio de Apoyo Financiero, will be signed by the government, through the MED, and the respective municipality. This agreement would: (i) describe the works to be financed by the government; (ii) stipulate the commitment of the municipality to use the Bank procurement guidelines for executing the works and to employ the selected private operator as the executing agency of the works; (iii) establish the funding obligations of the municipality (contribution of Law 60 transfers or other sources); and (v) specify any additional conditions and issues associated with the contribution of investment funds by the government. Page 16 Decision flow and processing steps: The project will be demand driven. MED will inform medium size and small municipalities located in the project area about the project, and interested municipalities will initiate the contact with MED. The main eligibility criterion for participating in the project is the agreement of the municipal authorities to PSP. Additional eligibility criteria are presented in Annex 11 and are included in the POM. Mediun size municipalities in the project area, which have previously carried out PSP processes in their water utilities (not in the framework of the project) may be eligible to participate in the project, subject to two conditions. The first condition is that the hiring process for the private operator and the subsequent contract are found satisfactory to the Bank. The second condition is that procurement of any goods or works by the municipality should follow Bank guidelines. In each municipality the process starts with signing a technical assistance agreement (Convenio de Asistencia Tecnica) between the municipal government and MED. In this agreement, the municipality expresses interest in participating in the project, it agrees to PSP, and also agrees to adjust tariffs as well as provide partial financing for investments from Law 60 resources. The TA activities are somewhat different in medium size and small municipalities, being simplified in small municipalities. However, in both cases, the TA includes the preparation of a works and investment plan (Plan de Obras e Inversiones-POI) with service/quality targets, a tariff regime and bidding documents, including a draft PSP contract. All these are prepared by qualified consultants hired by the PIU. Before the bidding process for selecting the private operator is initiated, the PIU conducts a detailed review of the material prepared by the consultants, especially of the proposed tariffs and subsidy, as well as of the bidding documents, in order to assess the technical/financial/economic viability of the proposed subproject. The most important aspects of this review are the proposed tariffs, investment subsidy and financial projections. This will be done using a financial model agreed upon with the Bank. Once the PIU has decided on the proposed tariffs and subsidy cap, which will be proposed to the mayor, it will send the information to the Bank for no objection. After obtaining the Bank's comments and no objection, negotiations with the municipal authorities will then take place and the resulting agreement on tariffs and subsidy cap will be sent again to the Bank for no objection. Before initiating the bidding process, an agreement of financial support (Convenio de Apoyo Financiero) will be signed between MED and the municipality, as described above. Once a PSP contract is awarded, the utility becomes eligible for receiving financial support from the national government in the form of a subsidy, the amount of which will be a result of the bidding process but would not exceed the agreed cap. During the construction period, the PIU will supervise each subproject, with the assistance of technical/financial consultants and external auditors, to ensure that the agreed rules and regulations are complied with. The supervision and control of each PSP contract is the responsibility of the corresponding municipality, which might hire consultants to provide it with assistance in evaluating the operator's compliance with the target indicators of the PSP contract. Procurement: When implementing works financed wholly or partly by Bank funds, the subprojects' implementation agencies, namely private operators, will adhere to the Bank procurement guidelines. This means that works and goods will be procured in accordance with the Bank's "Guidelines for Procurement under IBRD Loans and IDA Credits" (published in January 1995; revised in September 1997 and January 1999). When using their own funds for financing investments which they have committed to provide, other procurement procedures may be used. For the technical assistance components, consulting services, either wholly or partly financed by IBRD, will be procured in accordance with the Bank's "Guidelines for Selection and Employment of Consultants by World BankBorrowers" (published in January 1997, revised in September 1997 and January 1999). Goods will be procured in accordance with the Bank's Guidelines for Procurement under IBRD Loans and IDA Credits mentioned above. For works implemented in medium size cities, the executing agency of each investment subproject (i.e., the utility of each municipality, managed by a private operator) will use Standard Bidding Documents published by the Bank, for works and goods to be procured under International Competitive Bidding (ICB). Works implemented in small Page 17 municipalities under the Constructor-Operator model, will be procured using model bidding documents which have been specially prepared and authorized to be used for that purpose, and are the same bidding documents used for selection of the operator. Standard documents for Requests for Proposals and consulting services contracts will be used under the technical assistance components of the project. Detailed project procurement arrangements are given in Annex 6. A procurement capacity assessment of the PIU has been carried out and the overall procurement risk was assessed as average. An action plan for strengthening the skills of the PIU has been agreed upon, including hiring a high level procurement specialist and sending additional procurement staff to Bank procurement training seminars. The PIU will provide procurement training for each of the individual subproject executing agencies and will monitor their performance to ensure that they comply with Bank procurement guidelines. Flow of funds: Financial management will be the responsibility of the PIU. All Loan funds will be deposited by the Bank, upon request of the PIU, in a special account in Banco de la Republica. Investment funds for works and goods in medium size cities and small municipalities under component A will be withdrawn by the PIU from the special account and deposited in an Administrator Account. The Administrator, which will be in charge of handling these funds, will be an Assistance Entity (Entity 1), which is an entity established by an international organization of countries, of which Colombia is a member, and which has the expertise, facilities and personnel required to carry out on behalf of the PIU certain activities under the project, such as administrating funds, contracting services and entering into respective agreements. Advances from the special account to the Administrator account will be documented within 30 days from the date the special account is debited. Bank funds will be used only to finance investments in the Caribbean region. When used to finance works in subprojects of medium size cities, Bank funds will be transferred from the Administrator account to subsidiary trust accounts managed by local fiduciary agencies. The funds of each subproject will be handled by one local fiduciary agency which will be hired to manage the funds of the respective subproject, and which will receive, in addition to the Bank funds also the input from the corresponding municipality (mainly Law 60 funds). Each local fiduciary agency will realize payments to constructors and service providers, upon authorization from the PIU. For payments of taxes and duties, the local fiduciary agencies will use the funds contributed by the municipalities. The local fiduciary agencies will sign the contracts with constructors and service providers on behalf of the respective municipalities. When used to finance works in subprojects of small municipalities, Bank funds will be transferred from the Administrator account of the Assistance Entity directly to the bank accounts of the respective Constructors-Operators. In such cases, a local fiduciary agency is not necessary since each subproject has only one works contract. Technical Assistance funds, which will be used to finance all activities under components B, C and D and will be fully financed by the Bank, will be transferred by the PIU from the special account to a designated account for financing technical assistance activities, which will be administered by another Assistance Entity (Entity 2), which is the same type of entity which will manage the investment funds. From the designated account managed by Entity 2, payment will be made to consultants and service providers, according to instructions of the PIU. Entity 2 will sign the consulting contracts on behalf of the government. MED is reviewing the performance of the Assistance Entities available in Colombia, and will sign, before the effectiveness date, agreements with the two which will be selected for the project. MED might decide to sign both agreements with a single Assistance Entity, which will be in charge of both tasks and open the two accounts (the Administrator account for investments funds under component A and the Designated account for TA funds under components B, C and D). The costs associated with the agreements of hiring these entities are not eligible for Bank financing. Nevertheless, the Entities need to be acceptable to the Bank. Government counterpart funds will be used to finance investments in all parts of the country, mostly out of the Caribbean region, but they can be used also for investments within that region. The counterpart funds will be managed directly by MED and will be deposited by the treasury in the Page 1 8 project account, which is an account in a commercial Bank which will be opened by MED for this purpose. From this account the funds will flow in an identical fashion to that of the Bank funds, i.e., when used to finance works in subprojects of medium size cities, they will be transferred from the project account to the subsidiary trust accounts in the local fiduciary agencies, and when used to finance works in subprojects of small municipalities, counterpart funds will be transferred from the project account directly to the bank accounts of the respective Constructors-Operators. If, for some reason, the described flow of funds route from the special account to the accounts managed by the Assistance Entities is interrupted, other routes acceptable to the Bank, such as reimbursement of the Borrower for eligible payments made for the project and direct payment by the Bank to service providers, may be used. Direct deposits from the Bank into the Administrator account and Designated account managed by the Assistance Entities may also be done. A diagram detailing the flow of funds scheme is presented in Annex 6. The PIU will be responsible for sending withdrawal applications to the Bank and for reporting on the use of funds. The PIU will also be responsible for management of the counterpart funds contributed by the government, and for timely replenishment of the counterpart funds' project 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 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, project account, 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. Project's Operational Manual: The POM is an essential tool for project implementation. It has been designed to maintain the institutional memory of the project throughout its implementation life. Therefore it includes all relevant information regarding the project and procedures to guide the PIU (detailed information on subproject evaluation, reviews and approval, instructions for document flows, standards for progress reports, procurement and disbursement procedures, operational agreements between the participating agencies, and a detailed description of the PIU functions). The POM is currently under preparation and its completion is a condition of Loan Effectiveness. Page 19 Counterpart funds: The proposed loan has already received Congressional approval (aprobacion Comisi6n Interparlamentaria) and Executive Branch approval through a CONPES document (CONPES 3001 de abril 1998, "Autorizaci6n de la Naci6n para contratar creditos externos hasta por US$ 296.5 millones con destino a completar la financiaci6n de las estrategias para la gente Caribe- Es Caribe). 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 was agreeable to initiate project preparation on condition that it would be a national project, and an APL, and accepted that the first phase would 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 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, mainly works under Constructor-Operator schemes, and to a smaller extent, works in medium size cities. Taxes and duties associated with project activities will be financed for each subproject from the contributions of the municipalities, mainly Law 60 transfers. When necessary, taxes could be financed also from counterpart funds. 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 November 2001. An estimated US$150,000 will be required to maintain the services of the PIU from January 1, 2001, until the proposed loan becomes effective. These services have been financed by the proceeds of Loan 3336-CO until December 31, 2000, when the loan was closed. The total amount of retroactive financing would not exceed 10% of the loan amount, i. e., US$ 4 million and it would be used to finance works and services which have been executed within a period not exceeding 12 months prior to loan signing, and whose contracting has been carried out in accordance with the Bank procurement guidelines. Page 20 D. Project Rationale 1. Project alternatives considered and reasons for rejection: * A conventional investment lending project with institutional strengthening. This approach was rejected for medium size utilities because experience from the Colombia Water and Sewerage Sector Project (Loan 2961-CO) demonstrated that this approach was not successful in terms of institutional development. For small-size utilities, a conventional strengthening of public utilities was considered, by providing technical assistance aimed at improving performance. However, this approach has not yielded satisfactory results in larger municipalities and it is doubtful that it will work better for smaller utilities. On the other hand, there is evidence that small private operators entering the sector have been successful in some Colombian regions as well as in other countries, such as Paraguay. * A technical assistance project. Limit Bank activity to providing intellectual leadership and financing consultants to prepare PSP transactions. This alternative was discarded since the government recognized that even in concessions for major urban areas, non-recourse financing was not feasible (even in the case of Buenos Aires, Argentina). It is also not realistic to expect that, in medium size and small utilities, all the required investments can be financed simply through tariffs. Consequently public investment would still be needed. * A sector reform project. With the requirement of incorporating the private sector in the management and operation of the water and sewerage utilities, a sector reform project has been selected as the preferable approach. In the past, the government invested large amounts in strengthening public utilities without achieving positive results. In contrast, the performance of several water utilities which have recently incorporated the private sector in their management, has significantly improved. The govemment therefore considers the PSP alternative, combined with financing part of the investments through public sector funding, as the best alternative given the current condition of the sector in Colombia. The participation of the Bank is perceived by the private sector as a key stabilizing factor. * An APL program. At first there was an attempt to reach an agreement with the government on an adaptable lending program as an instrument for the sector reform. This alternative was discarded because a condition for APL was that a medium and long term strategy, acceptable to the Bank, which can be implemented under one umbrella, needed to be agreed upon with the government. An agreement on such strategy could not be reached. Moreover, with the support of another financing agency, the government has initiated the preparation of programs similar to the one supported by the project (the government strategy is to diversify financing sources so it did not favor long term agreements with one lender). Also, uncertainties regarding regulatory and legal framework reforms, as well as the unstable security conditions in the country are not compatible with the APL concept. Page 21 2. Major related projects financed by the Bank and/or other development agencies (completed, ongoing and planned). Latest Supervision Sector Issue Project (PSR) Ratings (Bank-financed projects only) Implementation Development Bank-financed Progress (IP) Objective (DO) Water Supply & Sanitation 2470-CO: Cucuta Water Supply & S U Sewerage Project-(completed in 1995) Water Supply & Sanitation 2637-CO: Barranquilla Water Supply HU HU Project-(cancelled in 1991) Water Supply & Sanitation 2512-CO: Fourth BogotA Water Supply S S Project-(completed in 1993) Water Supply & Sanitation 2961-CO: Water Supply and Sewerage S S Sector Project-(completed in 1996) Water Supply & Sanitation 3952-CO/3953-CO: Santa Fe I Water S S Supply and Sewerage Rehabilitation Project (ongoing) Water Supply & Sanitation 4345-CO: Urban Infrastructure Services S S Development Project (ongoing) Water Supply & Sanitation 3336-CO: Municipal Development S S Project, Component E, Water Utilities Modernization Water Supply & Sanitation 4507-CO: Cartagena Water Supply, S S Sewerage and Environmental Management Project (ongoing) Urban Environment 3973-CO: Urban Environment Technical S S Assistance Project (ongoing) Technical Assistance 16260-CO, Regulatory Reform Technical S S Assistance Project Other development agencies IDB Financed, Water Supply & Sanitation Cartagena Sewerage Project IDB Financed, Private Sector Devdopment Privatization and Concessions in Infrastructure IDB Financed, Technical Assistance Technical Assistance - PSP Water and Sanitation in Bucaramanga IDB Financed, Technical Assistance Technical Assistance - Support to Regulation in the Water and Sanitation Sector IDB Financed, Water Supply & Sanitation National Water Plan, US$ 60 million, under preparation, aimed at supporting all the regions of the country and expected to be effective in 2002 IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory) 3. Lessons learned and reflected in the project design: 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. Page 22 Successfulperformance 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 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. Needfor 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. Needfor 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 the Philippines 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. Community consultation would be carried out in participating municipalities, but this would be done 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. Page 23 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 to attract bidders. Using a single consultantfor 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 dividing 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 standardfinancial 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. 4. Indications of borrower commitment and ownership: The Central government is fully committed to the sector strategy supported by the project as indicated in the document "Cambio para Construir la Paz". This document has been approved by Congress, and outlines the key principles for reform of the water and sanitation sector in Colombia. Commitment to the project is also reflected by the following: * The government amended the Municipal Development Project Loan Agreement (Loan 3336-CO) and created a new component for water utilities' modemization, reallocating US$ 5 million, which have been used for the sector policy reform program; * The govemment fully adopted the sector reform program which now forms the basis of a national water sector policy; * The government has established a Project Implementation Unit staffed by a high quality multi- disciplinary team; Page 24 * The government has disseminated extensively information regarding its policy, which resulted in generating an impressive demand by mayors for participating in the project; * PSP processes in about 15 medium size cities are underway as part of project preparation. One of them, in a city located in the Caribbean region, has been awarded and is expected to be signed shortly. * PSP processes in a pilot of 8 small municipalities has been carried out during project preparation and the government will finance from its own resources, in the form of subsidies, the main part of the investment programs in two municipalities which have managed to sign PSP contracts. 5. Value added of Bank support in this project: * 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. E. Summary Project Analysis (Detailed assessments are in the project file, see Annex 8) 1. Economic (see Annex 4): [X] Cost-Benefit Analysis: NPV= US$ 11.74 million; ERR= 28.12% (see Annex 4) []Cost Effectiveness Analysis [ ] Other A cost-benefit analysis which was carried out to determine the economic and financial viability of the project demonstrates that it is beneficial to the economy as a whole, as well as to each of the stakeholders, as detailed in Annex 4. A sample of the following 10 municipalities from all around the country was initially considered to be representative for the economic analysis: the medium size cities of Maicao, Cucuta, Sincelejo, Corozal, Quibd6, Flandes and Espinal, the regional system of ERAS, and the constructor-operator schemes of Cumaral and Nataga. At a later stage, the proposed loan was downsized to its current level and the project focus shifted to the Caribbean region. However, since a previous analysis on an extended sample had already been carried out, its results are presented in this PAD even though part of the medium size municipalities included in it are located out of the Caribbean region. The results of the cost-benefit analysis of the projects included in the extended sample analyzed show that 90% of the projects were economically feasible and their expected net impact on the economy is substantially positive. Only one project, in the municipality of Corozal, had a negative economic return. In this particular case, works could be redesigned to ensure that the investment financed and the incorporated efficiency gains would result in a desirable economic impact. The sample considered representative for the project includes 5 municipalities: Maicao and Sincelejo (medium size cities in the Caribbean region-CR), the regional system of ERAS (CR), and the municipalities of Cumaral and Nataga, located outside the Caribbean region, but still eligible to participate in the project because they are small municipalities. The results of the economic analyses of the utilities of the sample municipalities show that all the respective projects are viable, with EIRR values in the range 15 to 47%. Page 25 Once the overall viability of the proposed reform in the sample utilities was verified, a distributive analysis was carried out to assess the impact of the reform on each of the stakeholders, which include the government (fiscal impact) and service users. The impact analysis on direct beneficiaries focussed on assessing the net impact on the poor. Finally, risk and sensitivity analyses were conducted to assess the impact of changes in critical assumptions on the economic viability of the reform in the sample utilities. Detailed results of these analyses are presented in Annex 4. 2. Financial (see Annex 4 and Annex 5): NPV=US$ 5.06 million; FRR= 16.0% (see Annex 5) A financial assessment of a sample of 5 utilities, which would potentially participate in the project, was carried under assumed conditions of future private operation. The main objective of carrying out the financial analysis was to develop a methodology which could be used during project implementation to ensure that only financially feasible transactions will be included in the project and to train the PIU staff in using that methodology. The specific objectives of the financial assessment of each municipal utility were to: (i) assess the financial feasibility of each of the proposed PSP contracts included in the sample municipalities, which have been prepared with the help of privatization consultants; (ii) assess the debt service capacity of the potential operators and their eligibility for obtaining commercial loans; and (iii) determine the main risk factors and the sensitivity of the overall feasibility of the operation contracts to these factors. The cost-benefit analysis described above determined the viability of the project on an incremental basis (net benefits from reform, i.e., the difference between "with" and "without" reform scenarios). The financial assessment then determined the viability of the operation contracts structures from the point of view of the investors and lenders. A privately operated company is financially viable, when: (i) NPVs of the utility operations (cash flow) and the returns to the shareholders are positive; and (ii) the main financial indicators (debt service coverage, debt equity ratio, and liquidity ratio) of the utilities are expected to remain sound throughout the lifetime of the operation contract. Financial assessment and projections were prepared for a sample of five municipal utilities under assumed conditions of future private operation. Three of the utilities correspond to the medium size municipalities of Maicao, Sincelejo and ERAS with populations of between 100,000 and 250,000 inhabitants; while the other two correspond to the small municipalities, Cumaral and Nataga, with less than 12,000 inhabitants each. The sample of municipalities on which the financial analysis was carried out is smaller than the sample used for the economic analysis and it includes only five municipalities out of the 10 included in economic analysis sample. The reason for the difference in the samples size is that the preparation of the financial analysis only began after reducing the loan amount and modifying the project focus to include medium size cities only from the Caribbean region while maintaining the all-country focus for small municipalities. At that stage, there was no reason to carry out a financial analysis of the medium size utilities located out of the Caribbean region, so only the utilities of Maicao, Sincelejo, Corozal and ERAS were maintained in the sample, as well as the small utilities of Cumaral and Nataga. It was decided to discard the utility of Corozal from the sample since it did not pass the economic analysis threshold, so the sample was finally established as including the five aforementioned municipalities. This is a reasonable sample size for the current project magnitude. The utilities included in the sample were found to be financially viable only when a government investment subsidy was included in each transaction. Using the tariffs proposed in the draft bidding documents, the average IRR of the sample, in real terms, was found to be 16% for the enterprise and 17% for investors. The net benefit is US$ 4.7 million for investors and US$ 5 million for the enterprise. The total government subsidy required was US$ 15 million. It was also found that when some adjustment were made in tariffs and in service targets in relation to the values used by the privatization consultants, the results improved: total profit for investors reaches US 9.3 million with an internal rate of return of 21% in real terms, while the results for the enterprise increased to US$ 9 million, achieving an IRR of 18% in real terms. The required subsidy decreased to US$ 10 Page 26 million. In the case of Sincelejo, the utility became financially viable even without requiring a government subsidy. For small municipalities the required government subsidy is estimated at about 70% of investment cost which corresponds to a subsidy of about US$ 300 per connection, or about US$ 60 per person served. For medium size cities the required government subsidy is estimated at about 15% of investment cost which corresponds to a subsidy of about US$ 100 per connection, or about US$ 20 per person served. The sensitivity and risk analyses show that the viability of the operation contracts is largely dependent on: (i) tariff level; (ii) rate of return expected by the investors; (iii) government and municipal subsidies; (iv) investment costs; and (v) bill collection rates. According to the results of the financial risk analysis, the variables who have the highest impact on the project's financial results are: (i) government subsidy; and (ii) investment cost overrun. The risk associated with the availability of subsidy funds will be mitigated by obtaining, before signing each operation contract, a clear government commitment to provide the required subsidy, using for that purpose the Bank loan funds. The risk associated with investment cost overruns should be mitigated by good management control of the private operator. Fiscal Impact: The net fiscal impact of the project is yet unknown since it depends on the municipalities participating in the project, which are unknown up front in a demand driven project. It is estimated that in the poorer municipalities, which require higher subsidies, the fiscal impact would probably be negative, while in the better off municipalities it may be positive. The Government gains from: (i) increased income from income tax paid by private operators; and (ii) increased VAT income due to increase in investment and materials purchases. However, under the proposed project the government provides capital investment subsidies to the consumers and it is estimated that in poor municipalities, the value of the collected taxes is unlikely to be high enough to compensate for the subsidies provided. The net fiscal impact on the government from the utility reform in the sample of 5 municipalities which were used for the financial analysis (Maicao, ERAS, Sincelejo, Cumaral and Nataga) is estimated to have a positive value of about US$3.5 million. However, this positive value is driven by the high positive fiscal impact of Sincelejo, which is the largest city in the group and the only one with a positive impact (of US$ 7.39 million). 3. Technical: It is expected that by the end of the project, about a third of the water utilities in medium size cities in the Caribbean region, (about 20 cities), will have completed PSP transactions. This includes some cities which have already signed PSP contracts without project support. Likewise, it is expected that about 15 out of the I 10 small municipalities in the Caribbean region, as well as about 10 small municipalities in other parts of the country, will have incorporated small private entrepreneurs in the management and operation of their water systems. As a result of the project, the management of the water services for a significant part of the population in the Caribbean region will be better shielded from political interference in their operation, and the way will be paved to improving the level of service for this population through the management expertise of the private sector. It is expected that such a widespread level of PSP will change the sector characteristics and mode of performance, not only in the Caribbean region but in the entire country, by encouraging continuation of similar reform activities. The main portion of the project funds will be used to finance civil works and equipment for improvement of water supply and sanitation services in about 3 medium size cities and in about 25 small municipalities. These investments are expected to comprise generally routine upgrades and rehabilitation to the existing systems. In the medium size cities, the scope of works will be determined by the private operators, as part of the POIs (programs of works and investments) which they will submit. The detailed designs will also be prepared by them. The works and goods will be procured by the private operators, in accordance with Bank guidelines. The supervision of works will be carried out by consulting firms which will be hired for that purpose, while the adherence to the Bank procurement guidelines will be the responsibility of the Page 27 PIU. In the small municipalities, the works will be designed by consultants hired by the PIU, and will be carried out by the private operators, "constructors-operators". The supervision of works in small municipalities will be carried out by consulting firms hired for that purpose. 4. Institutional: 4.1 Executing agencies: The executing agency of the TA component of the project is the Project Implementation Unit (PIU) in the Directorate of Water and Basic Sanitation (Direccion de Agua Potable y Saneamiento Basico) in the Ministry of Economic Development. The executing agency of each investment subproject will be the utility of the municipality, managed by a private operator. It is assumed that these private operators will have the capacity to manage and execute their investment programs. The PIU will control and monitor the performance of the executing agency of each subproject and will ensure that when using Bank funds, they comply with the Bank's guidelines. The PIU will also provide appropriate training to the executing agencies. 4.2 Project management: Overall project management will be carried out under the guidance of the Director of Water and Basic Saanitation in MED, who will also be responsible for policy issues and overall coordination of municipal and departmental governments. The PIU in MED will be the 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 already been working on the implementation of component E of Loan 3336-CO. Component E supported the preparation of the proposed project, and the team has gained valuable experience 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 manage the project successfully. A detailed description of the PIU functions will be included in the Project Operational Manual. Being a unit in a government ministry, the PIU suffers from limitations typical to such units, exacerbated by frequent changes in the Minister of Economic Development. Changes in its staffing are therefore likely. In order to minimize the risk of disruption in project management, the Bank will organize periodic training sessions for the PIU on various aspects of project management, in conjunction with supervision missions. Oversight of project management will be provided by an inter-institutional committee, "Comite Coordinador Interinstitutional DNP-MDE", formed specifically for this project. This committee comprises representatives from MED and two units of the National Department of Planning (DNP): (i) DDUPRE; and (ii) the Caribbean Plan Program. 4.3 Procurement issues: When implementing works financed with Bank funds, the subproject implementation agencies, the private operators, will adhere to the Bank procurement guidelines. When using financing investments which they have committed to provide, or while using municipal resources, other procurement procedures may be used. 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. For 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 for purchasing goods. Page 28 4.4 Financial management issues: Financial management will be the responsibility of the PIU. Administration of funds will be carried out through a fiduciary agency, which will open two accounts: one 9the special account) for depositing the loan funds from the Bank and the other (the project account) for depositing the govemment 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 service providers of the executing agencies. Each executing agency will report to the PIU on the use of funds at the subproject level. 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 which will be managed directly by the PIU. The PIU will be responsible for reporting to the Bank as well as sending withdrawal applications to the Bank. 5. Environmental: Environmental Category: B (Partial Assessment) 5.1 Summarize the steps undertaken for environmental assessment and EMP preparation (including consultation and disclosure) and the significant issues and their treatment emerging from this analysis. Since most investments financed by the project will be used for rehabilitation of existing water systems, the project will not have any significant negative environmental impacts. Moreover, positive environmental and social impacts are envisioned as water service level, coverage and quality improvements in participating municipalities. The project, however, will ensure proper environmental screening and enforcement measures to guarantee that all investments pay appropriate attention to environmental issues and comply with existing environmental norms and procedures in the country. Water and sewerage rehabilitation projects will not entail any resettlement of population, and specific eligibility criteria for municipalities will establish that projects entailing resettlement will not be accepted. An environmental assessment of the water and sanitation sector (SEA) carried out during project preparation, identified key legal and 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, 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 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 regulation of the water and sanitation sector in Colombia is the responsibility of weak institutions of the national and local governments. The responsibilities of different sectoral ministries and local entities are often overlapping. Wastewater treatment levels and effluent discharge standards 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. Page 29 5.2 What are the main features of the EMP and are they adequate? The 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 and taking into account economic and financial analysis of environmental regulations; (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 operators and determine environmental liabilities; (v) prepare an environmental annex for bidding documents for use in the selection of private operators; and (vi) monitor compliance, ensure enforcement and proper reporting of environmental issues in the sector. Specific outputs of the SEA are already available, including: (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) draft 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; (ii) harmonizing the inconsistencies within the current legislation (mainly between Decrees 1594 and 901); (iii) improving procedures (including institutional responsibilities) for issuing environmental licenses for water projects; (iv) evaluation of environmental risk and identification of mitigation mechanisms which would be included in operation contracts; and (v) involving the CRA in effort to establish mechanisms that would enable the inclusion the tasas retributivas in the water tariffs. An inter-institutional task force (the environmental task force), which will include representatives of the Ministry of Economic Development and the Ministry of the Environment, will be constituted before project effectiveness to work on all the mentioned issues, build consensus on environmental aspects, mitigate the risk to the project resulting from the current legislation and resolve during project implementation ad-hoc problems related to specific subprojects, in cooperation with the respective regional environmental authority. 5.3 For Category A and B projects, timeline and status of EA: Date of receipt of final draft: December 31, 2000 The SEA report has been finalized and reviewed by the Bank. After consultation with relevant stakeholders, a final draft has been sent to the Bank before appraisal. 5.4 How have stakeholders been consulted at the stage of (a) environmental screening and (b) draft EA report on the environmental impacts and proposed environment management plan? Describe mechanisms of consultation that were used and which groups were consulted? The SEA has been 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. Page 30 5.5 What mechanisms have been established to monitor and evaluate the impact of the project on the environment? Do the indicators reflect the objectives and results of the EMP? For the PSP processes, environmental requirements, guidelines and targets are being written into the operation contracts. As part of the long-term strategy for improved environmental management in the water and sanitation sector in Colombia, the project will support the EMP for the water and sanitation sector described above. Environmental management capacity will be strengthened in key sectoral agencies, especially the Water and Sanitation Division of the Ministry of Economic Development, so as to improve its capacity to supervise subprojects. 6. Social: 6.1 Summarize key social issues relevant to the project objectives, and specify the project's social development outcomes. A Social Assessment study was carried out to analyze the key social issues of the project and guide the design of mitigation measures of negative impacts. The key social issues relevant to project objectives include: (i) socio-economic burden of water cost before and after project; (ii) consensus building and community participation strategy; and (iii) labor force reduction and measures for mitigation of its impact. The expected social development outcome of the project is to achieve at least 80% of household water connections in low income areas (defined as connections for strata 1, 2 and 3) in each participating municipality. The social assessments study was carried out on a sample of six municipalities: the five used in the financial analysis plus the municipality of Quibdo, which was considered to be of interest because it is one of the poorest in the country. A summary of the social assessment study is presented in Annex 13. The project targets the Caribbean region where about 40% of the population is below the poverty line and about half of this poor population lives in conditions of misery. The level of water and sanitation services in medium size cities and small municipalities, which are potential participants in the project is currently quite low. Nominal average water coverage in the project area is estimated at about 75% for water and about 50% for sewerage. However, the effective water coverage, taking into account continuity of supply and water quality, is only about 45% in medium cities and less than 30% in small municipalities. Also, service delivery is focused on providing water to high income areas. The poor and unreliable water and sanitation services, especially in low income areas, have significant negative social implications. The project will have a positive impact on improving the living conditions of the population in the participating municipalities, and especially of those residing in low income areas, by expanding the coverage of water and sewerage services, improving water quality and incrementing service continuity. Considering the project targets with respect to improving the coverage and the level of services, as well as the subsidy policy applied under the project, it is expected that its impact on household expenses on water will vary, depending on the pre-project level of services as follows: (i) if the current service is extremely poor and forces households to buy water from alternative suppliers, it is expected that the social impact of the project will be remarkably positive for all the socio-economic strata; water consumption will increase and the expenses on purchase of water will decrease (by as much as 13% in stratum I in Maicao); (ii) if the current service already reaches a reasonable coverage rate and quality, the project's social impacts are also expected to be positive. However, it would provide different benefits to different socio-economic strata: the poor, who in general receive services of lower quality, will benefit from improved services, while the wealthier will continue to receive good services. Under this scenario, the consumers in all socio-economic strata will spend more on the purchase of water, however, the Page 31 increase in the expenses on water purchase will not be higher than 5.1% (stratum 2 ERAS) and smaller in the other municipalities. This level of increase in expenses will not have a significant effect on the households socio-economic conditions. (iii) For consumers in all the socio-economic strata, in both scenarios the monthly expenses on purchase of water after the project (i.e., the monthly water bills) will not exceed, on average, 8% of monthly household income and in most cases it will be lower than that (in the range of 4 to 8%). The project aims at supporting 2-3 medium size water utilities and about 25 small municipalities. The estimated total number of employees in the medium size utilities would be between 300 to 500, while the total number of employees in the small municipalities is estimated at 100-150. In the worst case scenario, the number of employees in the medium size utilities would be reduced by half under private operation, whereas in the small municipalities it is not expected to be reduced. The labor issues associated with the project are spread over a large area. Through the project, significant funds will be invested in each municipality, of which about 35% will be directed to creation of new jobs. Most of the remaining 65% will be applied to material, mainly of local origin, which contributes to the local economy. Several mitigation measures will be incorporated into the project to ease these labor problems. These measures include voluntary separation programs and retrenchment training and activities. 6.2 Participatory Approach: How are key stakeholders participating in the project? Activities to promote community participation will be undertaken by a multidisciplinary team (engineers, PSP and social specialists), which forms part of the PIU. This team will be responsible for participation, taking advantage of the lessons learned from the pilot project implemented during preparation, as well as of the experience of private operators in Colombia. The form of stakeholder participation is different in small municipalities and in medium size cities. It also depends on the project phase and is different in the first phase of PSP preparation and in the second phase in which the services are operated by the private sector. In medium size cities stakeholder participation will involve representatives from the public and private sector, including municipal authorities, municipal council, commerce and industry associations, engineers associations, environmental authorities and licensing entities, NGOs, community organizations, press and media, etc. The local community as a whole will be informed about the reform through a media campaign (press, radio, TV). In small municipalities, stakeholder participation will directly involve the residents, through their community organizations, neighborhood representatives, user entities, local leaders, religious leaders, etc., on top of all other relevant public or civil society organization existing at the municipal level. To promote participation of small municipalities in the project, as well as community acceptance, it was considered advisable for the PIU to associate with a strategic partner which would support the "socialization" process. The Regional Autonomous Corporations (CRAs), which are the regional environmental authorities, could serve as strategic partners, since they share the common goal of improving sanitation services and safe wastewater disposal. During the first phase of the sector reform, the duration of which might be 6 to 12 months, the participatory process will be intensive. This phase will successfully conclude when the proposed reform obtains a favorable public opinion. Without such support, mayors will be reluctant to proceed with the reform. During the second phase, namely the phase of operation and management of the systems by the private sector, public participation will take the form of creation and operation of the "veedurias populares". These "veedurias populares" are public committees whose task is to act as independent public reviewers of the performance of the private operators, and to provide information to the public, as a means of ensuring utility accountability to consumers. Page 32 Finally, after a detailed analysis it was decided not to seek an up front formal commitrnent from a significant portion of the community in each municipality regarding the acceptance of the increased tariffs. Achievement of such a commitment in medium size cities is practically impossible, because of the large number of consumers. It might be possible in small municipalities. However, since the improvement in service will come gradually, and since the willingness to pay is related to the service improvement, the up front community approval approach was not considered advisable. 6.3 How does the project involve consultations or collaboration with NGOs or other civil society organizations? The participatory and consultation program will involve NGOs and civil society organizations as part of the strategy of strengthening community adherence to the project. 6.4 What institutional arrangements have been provided to ensure the project achieves its social development outcomes? Provision of services to the poor will form part of the contracts with the private sector. The use of Bank funds to subsidize the poor will form part of the Loan Agreement. 6.5 How will the project monitor performance in terms of social development outcomes? The percentage of households in low-income areas connected to the water network, which is the performance indicator for social development outcome, will be stipulated in the PSP contract of each participating municipality and will be monitored by the municipal authorities as part of the PSP contract control, and also by the PIU. 7. Safeguard Policies: 7.1 Do any of the following safeguard policies apply to the project? Policy Applicability Environmental Assessment (OP 4.01, BP 4.01, GP YES 4.01) Natural habitats (OP 4.04, BP 4.04, GP 4.04) No Forestry (OP 4.36, GP 4.36) No Pest Management (OP 4.09) No Cultural Property (OPN 11.03) No Indigenous Peoples (OD 4.20) No Involuntary Resettlement (OD 4.30) No Safety of Dams (OP 4.37, BP 4.37) No Projects in International Waters (OP 7.50, BP 7.50, No GP 7.50) Projects in Disputed Areas (OP 7.60, BP 7.60, GP No 7.60) 7.2 Describe provisions made by the project to ensure compliance with applicable safeguard policies. Local screening studies undertaken for the environmental analysis certify that the nature of required investments for water and sanitation services improvement, which include existing infrastructure rehabilitation and extension, should not entail population displacement. Eligibility criteria for subproject financing include the screening for population displacement. In case a specific subproject requires population displacement, it would not be eligible for participating in the project. Page 33 F. Sustainability and Risks 1. 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 PSP process. i A proactive strategy and a credible mechanism to address the issue of expanding services to the poor will be implemented. 2. Critical Risks (reflecting the failure of critical assumptions found in the fourth column of Annex 1): Risk Risk Rating Risk Mitigation Measure From Objective to Goal Interest from local and international operators in S Flexible design of the program to adjust to the pace the W&S sector in Colombia declines. of private operators interest, allocating time and funds for rebidding. Government has no capacity to ensure sector M Through sector dialogue, Bank management will policies are maintained during an extended period. try to convince the government to maintain the right policies. Continuity of policies depends also on local governments and their multiplicity provides The newly proposed regulatory framework (which S safegard against complete change of policies. is planned to be innovative and based on Hiring of local private operators, which is a target deregulation of all system components except supported by the project, contributes to continuity. water supply and sewage networks) does not Successful performance of the private operators is provide credibility and deters private operators. the most significant factor in ensuring continuity in policy. The Bank is working with the CRA and provides TA, under another project (Regulatory Reform Technical Assistance Project, 1 6260-CO). in an effort to help the CRA come up with a credible regulatory framework. A Bank supported workshop was held to review the implications of the new framework and support the CRA in taking responsible decisions. Utilization of independent public disclosure of service performance will be practiced as a means of ensuring CRA's and utility accountability to consumers. From Outputs to Objective Page 34 Risk Risk Ratinq Risk Mitigation Measure Support to PSP from future local governments and S Carrying out adequate promotion of the reform community is not provided. prior to PSP, and an information campaign, social and community participation and consultation activities. Applying realistic initial assumptions and moderate expectations. Inconsistency in environmental legislation and M It is expected that the activities under project weakness of environmental institutions have component B (Strengthening Sector Environmental negative impact on activities and financial Management Capacity) will assist in resolving the situation of participating utilities. legislation inconsistency issue and contribute to relaxation of too stringent environmental requirements. An inter-institutional environmental Task Force which will be established under the project will also work with the respective CARs to resolve issues of specific PSP processes, establishing appropriate levels of treatment based on the uses of the specific receiving body and considering a waiver of contamination tax or modification of schedule of payment as warranted. Utilization of independent public disclosure of the performance of the environmental authorities will be practiced as a means of ensuring responsible performance and accountability. The legal and regulatory framework established M The government established a commission by Law 142 is changed by Congress. composed by the Ministers of Economic Development, Mines and Energy and Communications, the Directors of the three Regulatory Commissions (energy, communications and water), the "Superintendente de Servicios Puiblicos" and two Congress members, whose purpose is to analyze the current situation of the public services sector and to provide an adequate response to existing problems which triggered the legislative initiatives for change, but without modifying Law 142. From Components to Outputs Insufficient political support to PSP from local S Matching contribution of central government grants government. to construct infrastructure would provide incentives for local governments to participate in the project and provide the necessary support to it. Initial tariffs authorized by local governments are S Tariff negotiations will be based on financial too low. projections and adequate tariffs will be an eligibility criterion Insufficient interest from private operators in H Flexible design of the project to adjust to the pace project supported utility privatizations. of private operators interest. Creating the interest of small operators through the Constructor- Operator approach. Allocating adequate time for rebidding. Delays and corruption in the procurement of PSP S Transparency in PSP procurement processes and Page 35 Risk Risk Ratinp Risk Mitigation Measure contracts. contracts awards, which would be based on one clear, easily defined economic criterion, close supervision of procurement processes and timely Bank support. Frequent management changes in related S The project is consistent with government strategy, govemment agencies. is expected to enjoy continuity, and be relatively immune from management changes. Currency devaluation and interest rates exceed the S Macroeconomic stability will have to be maintained forecasted values and cause cost overruns. by the government. In case of cost overruns, the government will need to provide the additional required funds to complete the public sector support obligations. Otherwise, less works financed by the public sector will be implemented. Delays in availability of financial resources of the S Only financially viable private operators will be private operators and in provision of counterpart eligible for contract award. Agreements with funds by municipalities. government agencies regarding counterpart funds and with municipalities regarding Law 60 transfer contributions will be reached up front and will form part of the Loan Agreement. Delays in provision of funds by the private sector and municipalities will trigger a halt in provision of Bank funds. Works in the Caribbean region, totally financed by Government will delay the provision of funds for H the Bank, would be financed in tranches. The works in parts of the country out of the Caribbean trigger for financing each tranche will be the region, which need to be totally financed by corresponding financing of a tranche of works out government resources. of the Caribbean region, financed by the government. Risk mitigation out of reach General security status in the country and in H project areas continues to deteriorate, resulting in deterrence of private operators. Overall Risk Rating H Risk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N(Negligible or Low Risk) 3. Possible Controversial Aspects: The three main following potential controversial aspects were identified: (i) planned increases in tariffs; (ii) labor force reduction; and (iii) environmental legislation related to the water sector. Tariff increases: One of the basic concepts of the project is to reach agreements with the mayors of participating municipalities regarding tariff increases, so as to improve the attractiveness of municipal utilities to PSP. Tariff increases are always controversial and unpopular. Mitigating measures will be implemented through public information campaigns, community participation and consultation events, contact with community representatives, NGOs, municipal councils and politicians to explain and promote the project concepts and justify the tariff increases. Page 36 Labor force reduction: One source of inefficiencies in ailing public utilities is a higher than required number of employees. Private operators will certainly tackle this issue and reduction in the number of employees of the utilities in the participating municipalities is expected and will be a controversial issue. This issue, and the related mitigation measures, are discussed in the Social section of the Summary Project Analysis. Current environmental legislation related to the water sector: The current environmental legislation (mainly Decrees 1594 and 901), which sets water quality standards and tasas retributivas for water contaminant discharges, reflect priorities that need to be harmonized with the water sector policies and priorities which the project aims to support. The existing inconsistencies in legislation coupled with the institutional weakness of regional environmental authorities (CARs) who are in charge of law enforcement, and rigidities in the water sector legislation with respect to the transfer through water tariffs of pollution costs to consumers, send mixed messages to the water utilities and generate confusion and resistance to comply with the current legislation. The existing situation thus constitutes an unstable regulatory environment regarding the environmental legislation and obligations, posing a potential risk to the proposed privatization program supported by the Water Sector Reform Project. G. Main Loan Conditions 1. Effectiveness Conditions e The Project's Operation Manual, satisfactory to the Bank, has been completed. e PIU maintained fully operational, with an adequate team of experienced professionals, including a new procurement specialist and two new financial management specialists (a financial coordinator and a public accountant). * The Model of Technical Assistance Agreement (between the government and a municipality), satisfactory to the Bank, has been prepared. * The Model of Subproject Agreement (between the government and a municipality), satisfactory to the Bank, has been prepared. * The Environmental Task Force, comprising representatives of the Ministry of Environment and the Ministry of Economic Development, has been established. * A Project Agreement (Project Agreement 1), acceptable to the Bank, in respect of the subprojects components of the project, has been signed with an Assistance Entity. • A Project Agreement (Project Agreement 2), acceptable to the Bank, in respect of the Technical Assistance components the project, has been signed with an Assistance Entity. * A contract for supply of the software for the accounting and financial system and for the development of the necessary modules for monitoring project investments and the contracts signed under the project, has been awarded. 2. Other [classify according to covenant types used in the Legal Agreements.] * Operational and financial indicators agreed upon with the Bank will be used for monitoring and evaluation of the performance of the privatized utilities. * Monitoring and evaluation reports to be furnished to the Bank twice a year in a format agreed upon with the Bank. * A mid-term review will be carried out no later than July 31, 2004. * Maintain the level of liquidity in the special fiduciary account (government counterpart funds) as required for the execution of every subproject. * Upgrade and maintain a financial management system compatible with LACI, one year after effectiveness. Page 37 H. Readiness for Implementation The engineering design documents for the first year's activities are complete and ready for the start of project implementation. 1. b) Not applicable. The procurement documents for the first year's activities are complete and ready for the start of project implementation. 3. The Project Implementation Plan has been appraised and found to be realistic and of satisfactory quality. The following items are lacking and are discussed under loan conditions (Section G): 1. Compliance with Bank Policies 1. This project complies with all applicable Bank policies. The following exceptions to Bank policies are recommended for approval. The project complies with all other applicable Bank policies. _-T-t ' X5S I Menahem Libhaber Danny M. pg Olivier L rcade Team Leader Sector Man er/Director Country Manager/Director Page 38 Annex 1: Project Design Summary COLOMBIA: WATER SECTOR REFORM ASSISTANCE PROJECT Hierarchy of Objectives Key Performance Indicators Monitoring & Evaluation Critical Assumptions Sector-related CAS Goal: Sector Indicators: Sector/ country reports: (from Goal to Bank Mission) 1. Creation of mechanisms to facilitate 1. No. of utilities with PSP SIAS (sector information Macroeconomic PSP in the provision of urban public system) stability services (including water and sewerage) 2. Increase in quality and coverage of water supply and sanitation services 2. No. of Customers served by water and sanitation services 3. Achieve sustainable economic growth by improving infrastructure 3a.- Taxes paid by utilities services (US$fyear) 3b.- Revenues generated (US$/year) 3c.- Investment level (US$/year) Project Development Objective: Outcome / Impact Indicators: Project reports: (from Objective to Goal) 1. Support the water sector reform by: (in participating utilities) * Reports produced by the * Continued interest (a) facilitating the incorporation of the privatized utilities and the of local and private sector into the management - coverage rates for water and PIU international and operation of the water utilities sewerage operators in the participating in the project for the - coverage rates for water and * SIAS (sector information W&S sector in purpose of creating an enabling sewerage in poor system) Colombia environment for improving the neighborhoods efficiency and sustainability of these - continuity of service and water * Government utilities; and quality demonstrates (b) providing the privatized utilities - Number of employees per capacity to with financial support to ensure their thousand water consumers maintain sector viability - Working ratio policies during an extended period 2. Expand the coverage of water and (See Efficiency, Access, sewerage services in participating Sustainability and Service to * The newly municipalities Poor indicators and their target proposed values in Annex IA) regulatory framework (which is planned to be innovative and 3. Facilitate the access of the based on population in low income areas of deregulation of all participating municipalities to water system and sewerage services. components except water supply and sewage networks) provides credibility and does not deter private operators Output from each Component: Output Indicators: Project reports: (from Outputs to Objective) 1. PSP incorporated in medium size 1. At least I medium city with * Project management Reports * Continued support Page 39 Hierarchy of Objectives Key Performance Indicators Monitoring & Evaluation Critical Assumptions cities PSP by mid term and at least 2 (PMRs) to PSP from future by closing date local governments Supervision missions and the community 2. PSP incorporated in small 2. At least 5 small municipalities municipalities with PSP by mid term and at * General security least 15 by closing date status in the country and in project areas will 3a. Water supply infrastructure 3. Access to water and sewerage not deteriorate and expanded in at least 2 medium size services provided to at least will not have a cities 140,000 additional inhabitants of negative impact on medium size cities and reliable the participation of 3b. Sewerage infrastructure expanded service provided to at least the private sector in at least 2 medium size cities 350,000 inhabitants of medium size cities * Inconsistency in environmental 4a. Water supply infrastructure 4. Access to water and sewerage legislation and expanded in at least 15 small services provided to at least weakness of municipalities 60,000 additional inhabitants of environmental small municipalities and reliable institutions do not 4b. Sewerage infrastructure expanded services provided to at least affect participating in at least 15 small municipalities 150,000 inhabitants of small utilities municipalities The legal and 5. Water and sewerage infrastructure 5a. Water and sewerage services regulatory provided in low income areas provided to at least 100,000 framework inhabitants of low income established by Law neighborhoods in medium size 142 is not changed cities by Congress 5b. Water and sewerage services provided to at least 40,000 inhabitants of low income neighborhoods in small municipalities 6. Environmental studies under TA 6. Set of environmental studies component carried out and the reports completed environmental committee fully active 7. Rural water and sanitation policy 7. Policy document ready and defined, adequate methods for approved by the government increasing water and sewerage coverage in the rural sector developed Project Components / Sub- Inputs: (budget for each Project reports: (from Components to components: component) Outputs) A. Investments in Subprojects in US$ 61.8 million * PMRs * Strong political Medium Size Cities and Small support provided to Municipalities * Supervision missions PSP by local * Al. Loan Investments in W&S government works in the participating medium * Semestral project progress * Adequate initial size cities in the Caribbean region reports tariffs authorized * A2. Loan Investments in W&S I by local Page 40 Hierarchy of Objectives Key Performance Indicators Monitoring & Evaluation Critical Assumptions works in the participating small governments municipalities in the Caribbean region * Sufficient interest * A3. Government counterpart of private operators funds for investments in medium in project and small municipalities in therest supported utility of the country privatizations * A4. Private Sector and Law 60 investments in medium size cities * Minimum delays * A5. Private Sector and Law 60 and corruption in investments in small the procurement of municipalities PSP contracts B. Sector Environmental Management US$ 0.80 million * Minimum Capacity Strengthening management changes in related C. Rural Water and Sanitation Policy US$ 0.9 million government Development agencies * TA for identifying methods for increasing water and sewerage * Currency coverage in the rural water sector devaluation and interest rates not D. Proiect Management and Training, US$ 6.5 million exceed the PSP Technical Assistance. Studies and forecasted values Supervision of Works and do not result in cost overruns * DI. Project Management and training * Timely availability * D2. TA for PSP in medium size of financial cities resources and * D3. TA for PSP in small counterpart funds municipalities from municipalities and the private operators * Government will provide counterpart funds also for works in other parts of the country out of the Caribbean, which need to be totally financed by government resources * General security status in the country and in project areas will not deteriorate See Values of monitoring indicators in Annex 1A Page 41 Annex 1A: Key Performance Indicators COLOMBIA: WATER SECTOR REFORM ASSISTANCE PROJECT Performance Monitoring Indicators for Medium Size Cities Indicators Baseline Minimum Targeted Value Expected for Each Project Value Participating Utility End of End of - End of Full Impact Year 2 Year 4 Year 5 Number of At least 2 At least 2 PSP Contracts Signed - Service to All Percentage of <60 >65 >75 >80 >90 households connected to piped water Percentage of <40 >50 -.>60 - >65 >80 households connected to public sewerage Percentage of <50 >65 >75 >80 >90 household with continuous supply%4 Percentage of <50 >65 >75 >80 - >90 households with disinfected supply Service to the Percentage of <40 >50 >70 >80 >90 Poor households in strata 1,2,3 connected to .......piped water % -> 8 Percentage of <40 >50 >70>7>8 households in strata 1,2,3 connected to public sewerage O/ Efficiency of Number of employees >8 <6 <4 <4 <4 Service per thousand water .supply customers Sustainability Working ratio \6>1.0 <0.7 <0.7 <0.6 <0.5 of Service I/ Cunting from the time the PSP contract was signed. The results of year 4 and on will be measured after closing date. Specific targets for each utility will be specified in PSP contracts 2/ Number of households served with piped water / total number of households in the concession/service area 3/ Number of households served with sewerage service / total number of households in the concession/service area 4/ Number of households served with continuous water supply / total number of households in the concession area 5/ Number of households served with Disinfected water / total number of households in the concession/service area 6/ (Cash operating expenditure/Cash operating revenue) Page 42 Performance Monitoring Indicators for Small Municipalities Indicators IBaseline Minimum Targeted Value Expected for Each Value Project Participatfing Utility End of i End of iEnd of Full Year 2i Year 4 Year 5 Impact - ---p. - -~~~~~~~~~~~~~~~~~~.. .. ....... .- - .- - 4..... ...... ........ Number of At least 15 .-A t le a'st'1"5' PSP Contracts Signed --- Service to Al Percent age of - <60 >80 ->90 >90 >90 households connected to pipd water " Percentage of <30 >60 >70 - >75 >90 households connected to public sewerage iPercentage of < <0 >80 >90 >90 >90 household with continuous supply Percentage of - ~ <50 1 >80 >90 >90 >90 households with disinfected supply iEfficiency of 1Number of >8 <6 <5 <5 <5 Service iemployees per Ithousand water supplycustomers Sustainability Working ratio ~ > 1.0 <1. - 0.8 <0.7 -<0.6 ~ofService I/ Co&un`ti,n-g, 'f'ro',m th'e ti-m,"e t,he P S P- "co n- t ra-ct- w a-s signed. The results of year 4 and on will be measured after closing date. Specific targets for each utility will be specified in PSP contracts 2/ Number of households served with piped water I total number of households in the concession/service area 3/ Number of households served with sewerage service / total number of households in the concession/service area 4/ Number of households served with continuous water supply / total number of households in the concession area 5/ Number of households served with Disinfected water / total number of households in the concession/service area 6/ (Cash operating expenditure/Cash operating revenue) Page 43 Annex 2: Detailed Project Description COLOMBIA: WATER SECTOR REFORM ASSISTANCE PROJECT Basic Project concepts: Introduction: The project seeks to support the water sector reforms in medium size cities or regional associations of municipalities (populations of up to about 300,000 inhabitants) and in small municipalities (populations of up to bout 12,000 inhabitants) by facilitating the incorporation of the private sector in the management and operation of the water and sanitation services in the utilities of participating cities and municipalities and by providing financial support to these utilities, while ensuring provision of services to the poor. Based on experience in the LAC region and in Colombia (see Annexes 17, 18 and 19) it is assumed that once the private sector gets involved in managing the utilities, the level of the water and sanitation services will improve, the services will become more efficient and more reliable, the coverage of the services will expand and the access of poor consumers to the services will increase. The project reflects the Government policy to provide assistance only to utilities which choose to incorporate the private sector in management and operation of the water and sewerage services, since the PSP approach is believed to be the best way to improve the performance of the water utilities and the level of service which they provide to the customers. Consequently, the project is demand driven and will assist municipalities which choose to participate and: (i) agree to private sector participation in their water utilities; and (ii) reach an agreement with MED regarding a tariff increase which will elevate the tariffs to a level which will cover at least operation, maintenance and depreciation cost, and as higher than that as socially and politically possible. For the purposes of the project, PSP is defined as transferring full management and operation responsibility to the private sector and provision of investments by the private sector in an amount which is compatible with the agreed level of tariffs. For the purpose of helping to diminish disparities, the project will focus on supporting: (i) medium size cities and small municipalities, which suffer from investment backlog and low level of services; and (ii) municipalities in the Caribbean region, in which the water and sanitation services are less developed than in other parts of the country. The mentioned priorities would result in providing support to population of scarce resources, since most of the population in the medium size cities and small municipalities of the Caribbean region is of low income. Lists of the medium size cities and small municipalities in the Caribbean region, which are potential candidates to participate in the project, are presented in Annex 14. Usually the tendency in PSP in the water sector is to reach an agreement on a full concession, under which the concessionaire commits to provide all the investments required during the contract period. However, under the conditions in medium size cities and small municipalities in Colombia, it would be difficult to reach full concession agreements. Most of these cities suffer from significant infrastructure backlogs and need high investments, while the current tariffs which the service users in these cities pay are quite low (see typical values of current average monthly bill per stratum in the following table). As mentioned, the first step is to reach an agreement with the municipal authorities of cities which choose to participate in the program in regard to the maximum acceptable tariffs increase. Estimated values of average monthly bill per stratum after PSP are presented in the following tables. However, it is estimated that in most medium size cities and certainly in all small municipalities, even with tariffs increased to the maximum socially acceptable level, it would not be possible to finance all the works required in the next 10-30 years (the contracts period range) just from tariffs. So the private sector which will be hired to manage a utility will invest up to a level that can be recovered from tariffs, whereas the rest of the investments needs to be provided by the public sector (national and/or local government) in the form of subsidies or loans to service users. Page 44 Typical Current Average Monthly Water and Sewerage Bill in Small and Medium Size Municipalities Stratum Average Monthly bill In Small Average Monthly bill In Medium Size Municipalities Before PSP Cities Before PSP (US$) (US$) I 1-3 1-4 2 2-4 3-7 3 3-5 4-8 4 4-6 5-9 5 6-12 6 12-20 Commercial 5-15 10-25 Expected Average Monthly Water and Sewerage Bill in Small and Medium SizeMunicipalities After PSP Stratum Average Monthly bill In Small Average Monthly bill In Medium Size Municipalities After PSP Cities After PSP (US$) (US$) 1 3-6 3-7 2 4-7 6-10 3 5-8 7-15 4 6-9 8-16 5 10-25 6 18-35 Commercial 10-30 30-40 The assistance which will be provided by the project would include: (i) technical assistance to utilities to prepare and carry out the processes of incorporating the private sector in the management of the water and sanitation services; (ii) support to mayors in convincing the main actors (mainly municipal councils, Governors and state governments, business community, community representatives community organizations and NGOs) to accept PSP in the utilities; and (iii) financial support to cover a portion of the required infrastructure investments, which the private sector cannot provide. The concepts and the methodology of the project were developed in the framework of component E, the water utilities modernization component, of the Municipal Development Project (Loan 3336- CO). Two different mechanisms were developed to support: (i) medium size cities with populations of up to about 300,000 inhabitants; and (ii) small municipalities with populations of up to about 12,000 inhabitants. The differentiation resulted from the fact that from the private sector's standpoint, the business is different in the two size ranges of municipalities, and the required type of operator is different in both, i.e., for medium size cities only an experienced operator with proven credentials in operating utilities of comparable size can be hired, while for small municipalities proven experience in operating comparable systems is not required, but rather the capacity to operate them. The cut off number of 12,000 was selected because it defines reasonably well the limit between the two types of municipalities and because it coincides with an administrative division in Colombia. For both types of municipalities, model bidding documents have been developed, which include the terms of reference (bases de la licitaci6n), specifications and draft contract. For each municipality, engineering and financial consultants will be hired to prepare the required investment program (Plan de Obras e Inversion - POI) and the financial projections of the new privately managed utility, respectively. The PIU at the Ministry of Economic Development, in cooperation with the municipal authorities, would then incorporate the investment and financial data in the model bidding document and will produce a specific set of bidding documents for each participating municipality. Page 45 Medium size cities: The operators for medium size cities must be private companies or joint ventures which have proven experience in operating similar size water and sewerage systems and are financially solid institutions which can mobilize the required funds for investment. The contract for the medium size cities, which defines the proposed model, is denominated "operation contract". The investment commitment of the private operator of each city will depend on the level of tariffs agreed upon with each mayor. In one extreme, under which the tariffs can support only operation, maintenance and depreciation, it would be a management contract (operation without investment), in the other extreme under which the tariffs can support all the investments, it would be a full concession (operation plus commitment to provide all the required investment), while in most cases it is expected to be an operation contract under which the operator would commit to provide part of the required investment while the rest will have to come from the public sector, either the government or the municipality or both. In practical terms, in medium size and small municipalities in Colombia, the government would have to provide such funds because the financial conditions of the municipalities prohibit them from providing meaningful contributions. If the maximum tariff level acceptable to the mayor does not cover the operation and maintenance cost of the utility, the participation of the city in the project will be rejected, since the utility is financially nonviable and the private sector cannot operate under such conditions. The basic principle of the operation contract is that it only commits the operator to provide an investment compatible with the level permitted by the authorized tariff. The rest of the investment is the responsibility of the public sector and it will be attempted to provide, under the project, the amount of support requested by the private operator. However, funding restrictions might limit the availability of funds for each city, in which case the public sector would commit to provide an investment at a level which will at least ensure that the rate of return to the private operator of the entire transaction will be attractive enough3. This will be done by defining in the bidding documents a cap on the amount which the public sector will provide. The cap value will be derived from the financial model ensure the achievement of the adequate rate of return. The operation contract stipulates the investment program over time (the POI) required to bring the system to optimal conditions, as proposed by the winning bidder, and includes the commitrnent of the operator to finance and construct the part of it which corresponds to him according to his proposal. When public funding is required, its use and allocation will be derived from the POI. MED and the municipal authorities will reach an agreement with the operator regarding the works and/or goods of the POI, which be financed by the government subsidy. The criterion for selection of the winning bidder is simple and transparent; the contract would be awarded to the bidder who requests from the public sector the lowest capital investment subsidy in order to complete the works of the POI and bring the system to the optimal state, as well a operate and maintain the water and sanitation system. No operation subsidies are involved and the maximum amount that the government is ready to pay (the subsidy cap) will be stipulated in the bidding documents. The performance indicators targets (metas del contrato) will be stipulated in the draft contract which forms part of the bidding documents, will be compatible with the subsidy cap and will also ensure an adequate service to the poor. Each proponent will submit his own POI, which may be different than the POI proposed by the engineering consultant, since the POI reflects the technical proposal and it is advisable to let the private sector introduce its own ideas and innovations. Each bidder will provide in his proposal a detailed annual scope of works and related dollar amount which he commits to carry out each year. The winning bidder will commit that after receiving from the government an agreed set of works whose value is equivalent to the amount of subsidy which he requested, he will attain the target indicators value along time, as stipulated in the 3 The value of the rate of return for each case will take into account the specific risks of the municipality in question and may vary in the range of 15% to 25%. Page 46 contract, i.e., the operator will commit to attain the target indicators corresponding to the total level of investments provided (private plus public investments). The yearly work program can be changed in mutual agreement with the mayor but the operator would have to comply with the total amount of the annual investment program. The amount which the public sector has committed to provide will not be made available to the operator, for his discretional use, but will be rather used to finance part of the infrastructure works stipulated in the POI, which will be proposed by the operator (i.e., works considered by him as high priority works) and approved by the municipal authorities and the PIU. In this form, the private operator will not receive a financial contribution from the government, but mther 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 privatized water utility of the city. In this manner it will be assured that the infrastructure provided by the government will be totally satisfactory to the private operator and will meet his requirements. The works and goods financed with Bank loan proceeds will be procured under public bids in accordance with the Bank procurement guidelines. If the total amount required for financing the works and goods as a result of the bidding processes will be higher than the amount committed by the government, the private operator will provide the balance. If the required amount will be lower than the that committed by the government, the remaining government committed fund will be used to finance additional works. The supervision and control of the PSP contract will be the responsibility of the contracting agency, i.e., the municipality, which may hire an individual consultant or a consulting firm, on a full or partial time assignment, to carry out that task and determine if the performance targets are achieved by the operator. The duration of the operation contracts would be in the range of 20-30 years, which is the time required to recover investments in this type of contracts. A clause of tariff revision once every five years will be included in the draft operation contract. If the authorized tariff level would be sufficient to cover all the investment program (with no need for receiving support from the public sector), the contract would then be awarded to the bidder who offers the highest reduction in the authorized tariff (i.e., the lowest tariff). Additional detailed regarding the proposed model for medium size cities are presented in Annex 15. Other PSP models do not require a technical proposal and some experts consider that a technical proposal should not be requested since the operator is only requested to provide performance and it is irrelevant how he achieves it, as long as he delivers. This approach might be reasonable for the cases in which no capital investment subsidy is requested from a third party, usually the government, i.e., when the operator is required and agrees to provide all the investments during the contract period (which is defined as a full concession). However, when a third party is providing partial financing, especially when this financing is provided in the form of a subsidy, it is reasonable to expect that that this party will receive all the technical and financial information regarding the program it is going to finance and have a say on the works it is financing, especially when the third party is the government, which has social objectives and has auditing commitments, i.e., needs to be able to provide detailed report regarding the use of its funds. Submission of the technical proposal does not deprive the private operator from the ability to be innovative. First of all, it is the operator that prepares the technical proposal and he can incorporate in it the innovations he finds fit. In addition the operator does not lose the option to incorporate new innovations in the future, since he may propose alternative PAOIs, in the future, prior to the period of implementation of the works. If the alternatives achieve the same result at a lower cost, they may be approved by the contracting authority and the operator will benefit from the savings. This will provide an incentive to the operator to propose innovations. Page 47 The financial analysis of the proposed privately managed utility is an essential tool for preparing the PSP process. The financial model which will be used in the future by the consultants, for preparation of the concession documents and by the MED staff to conduct the quality control of the consultants' work, will be agreed upon with the Bank. Whatever the model chosen, arrangements will be made to have the PIU team trained in the use of the model. Recently, the water utilities of several medium size cities in the Caribbean region have been privatized under various PSP models, utilizing technical assistance provided by the government. The government has also offered financial support to the privatized utilities but has encountered difficulties in providing it. It requested, therefore, that these utilities be eligible to access financing under the proposed project. Such utilities could become eligible to project financing under the following conditions: (i) the private operator has been elected through a competitive bidding process acceptable to the Bank; (ii) the agreed tariff levels are adequate and coincide with the principles of the proposed project, or, in case they are inadequate, the operator and the municipal authorities agree to bring them to adequate levels; (iii) the municipal authorities are ready to contribute matching financial resources from government transfers or other sources; and (iv) if necessary, the private operator and the municipal authorities agree to modify the performance indicators stipulated in the operation contract, add to it indicators for low income areas and incorporate in it other amendments, as required by MED and the Bank. During project preparation, PSP processes based on the described model were prepared for several cities (Cucuta, Maicao, Sincelejo, Corozal, Quibdo, Flandes, Espinal, Duitama, Popayan and others) as well as for several regional schemes (Acuavalle, composed of 33 municipalities, ERAS composed of Cerete, Sahagun, Cienaga de Oro, San Carlos and San Pelayo, and ARATT composed of Arjona Turbaco and Turbana). Three bidding process were initiated, like those in Cucuta, ERAS and Maicao. One process, in the city of Maicao, was completed successfully and has been awarded to a private operator. Unfortunately, in the other two, no proposals were submitted. The reasons for that are: (i) the bidding processes coincided with the end of the term of mayors in Colombia in late 2000, which hindered the processes by allowing only a short time of about three weeks for submission of proposals; (ii) security problems in the regions of the two cities; and (iii) the impact of the water pollution taxes "tasas retributivas" and other environmental contingent liabilities (financial impact of possible future more stringent environmental norms), which were mentioned by potential private operators as a reason for finally deciding not to submit a proposal. Small municipalities: The contract with private operators in small municipalities is denominated "Constructor-Operator" contract. The concept of incorporating the private sector in the management of utilities of small municipalities with populations of up to 12,000 inhabitants is perhaps the most significant innovation of the project. Common perception suggests that it is impossible to privatize small utilities, because the private sector does not have interest in utilities which serve less than 300,000 inhabitants. However, experience shows that in Colombia (see Annex 17) and in other countries there are successful small-size private operators in the water and sanitation sector, managing utilities without any government support. The basic assumption of the "constructor- operator" concept is that big operators have interest in managing utilities of large and medium size cities, while small utilities attract small operators. The concept was developed during project preparation and was adopted by the government.. It is the first time that any government in Latin America supports PSP in a large number of small municipalities with a population of less than 12,000 inhabitants each. The concept of the "constructor-operator" model in small municipalities is that through competitive bidding small and medium size construction companies, possibly in association with small consulting firms, will compete for the construction and/or rehabilitation of the water supply and sewerage systems in a small municipality and the winning bidder will have to commit to operate the systems for a period of 10-15 years from the date of signing the contract. No experience in operation of water systems is required from the bidders. It is assumed that construction companies that have the capacity to construct the systems, also have the technical and Page 48 management capacity to operate them after minimal training, since the involved systems are quite small and simple. The winning bidder will receive from the PIU training in management of water utilities as well as written material and management software. Certification of small operators will also be undertaken by the MED two years after the initiation of the activity of each operator. In this manner, the project will help to convert the constructors to operators. The required qualifications of bidders will be: (i) technical -experience in construction of works of similar size and complexity and availability of an operation and management team; (ii) financial - submission of audited income statements of the last three years, as well as proof of availability of working capital; and (iii) legal - submission of documents of registration as a legal entity. It is expected that this type of contract will be attractive for both the municipal governments and the construction companies. Municipal governments will find it attractive because of the significant amount of central government subsidy involved, as detailed below, while construction companies will be interested in the construction contracts, especially during the crisis period which the country is currently experiencing. The Constructor-Operator must first calculate the construction cost of the works he is required to construct, and then the ten-years operating cost, bearing in mind the income to be generated by user tariffs and the portion of that income which he can contribute to construction, while still maintaining reasonable profits during the operation period. The residual construction cost, i.e., the difference between the value of the works and the contribution to construction cost from future income, will be contributed by the government as a "construction cost contribution" in a form of a n investment subsidy to the population of the small municipality. The municipality will also be requested to contribute a portion of the subsidy from Law 60 resources. As in all concession contracts, the commercial risk will be borne by the operator. Since the majority of the population in small municipalities, especially in the Caribbean region, is of low income, the subsidy will mainly benefit the poor. Also, since the small municipalities suffer a significant backlog in infrastructure and the population does not have the capacity to finance this backlog through tariffs, the government subsidy needs to be high enough so as to finance most of the works, while only a small portion can be financed from tariffs and Law 60 funds. Although it might appear from the description presented above that the bidding process for selection the Constructor-Operator is a process for small works, it is in fact a process of selecting a private operator, in which the selection criterion of the winning bidder is the lowest subsidy that is required to construct, operate an maintain the specified water and sewerage infrastructure in the municipality. The Constructor-Operator model is basically a concession tailored for small municipalities, in which the government finances, in the form of a subsidy, most of the required water and sewerage infrastructure investment in the participating small municipalities. The model is in fact similar to that of the operation model in medium size cities, with three differences: (i) in small municipalities the operator is also the constructor, and this was required for the creation of the operators market; (ii) the level of government subsidy will most probably be grater (in terms of percent of total investment) in small municipalities; and (iii) the duration of the contracts in small municipalities is 10-15 years while the duration of the contracts in medium-size cities is 20-30 years. Although initially constructors may not find such an operation attractive, they might agree to be responsible for system operation and management because of their interest in the construction portion of the contract. After operating the system he himself constructed for ten years, the Constructor-Operator will most probably recognize the benefits of performing as a system operator, i.e., benefiting from a stable, reliable and continuos source of income, while performing a relatively simple task. It is expected that this will convince the entrepreneur to remain an operator on a permanent basis. In that manner, through the concept of constructor-operator, it is expected that the market of private operators for small municipalities will be created. The proposed process for incorporating the private sector into the utilities of small municipalities is a simplified process, which reflects the conditions in municipalities of that size. The procedures followed traditionally for incorporating the private sector in the management of the services, in addition to being lengthy and cumbersome, are inappropriate for small operators with limited resources. The process begins with a study which defines how much can the population pay for the Page 49 water and sanitation services. The capacity to pay must be taken into account, because if operating costs exceed what users can afford, the project will not be viable. If the capacity to pay exceeds the operating costs, leaving a suitable profit for the operator, the project can be considered viable. The average tariff users will pay will be constant during the operations phase and must be agreed upon with the municipal authorities and approved by them. A fixed formula for revising the tariff, to be applied automatically for inflation adjustment, will be established. A tariff review mechanism to compensate for unforeseen events will also be included. After the govemment reaches an agreement on tariffs with the municipal authorities, the detailed design of the required works will be prepared by a consulting firm, including specifications. Model bidding documents have been developed for the Constructor-Operator model. They are based on standard documents for procurement of small works, in which appropriate modifications have been introduced and to which the operation contract has been attached, so that altogether they provide the documents for a concession model. The contract (construction plus operation) will be awarded to the bidder which requests the lowest amount for constructing the water and sanitation infrastructure works and commits to manage and operate the utility in accordance with the terms of the contract, for a period of ten years from the date of signing it, while charging the tariffs stipulated in the contracts. This is equivalent to the lowest subsidy that is required to construct, operate and maintain the specified water and sewerage infrastructure in the municipality. The bidding process for selecting the operator will begin when the design has been completed and the specific information has been introduced in the set of bidding documents. Bidders will estimate the present value of surplus operating revenue and determine how much they can contribute from the future income to finance the works, and how much they request as public sector (government and municipality) subsidy. Bidders may also provide alternative designs which might reduce costs. The winning bidder will be required to establish a special purpose company with separate accounts to construct and operate the water and sewerage systems of the municipality. Additional detailed regarding the proposed "Constructor-Operator" for small municipalities are presented in Annex 16. 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, which may hire an individual consultant or a consulting firm, most probably on a partial time assignment, to carry out the that task and determine if the performance targets are achieved by the operator. The "constructors-operators" will be small entrepreneurs who may have limited 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 Fondo Nacional de Garantias (FNG), a government agency whose purpose is to promote the activity of small firms and entrepreneurs by providing them with credit guarantees which will enable them to obtain loans from local banks. The PIU is working with FNG to ensure the provision of guarantees to "constructors-operators" participating in the project. During project implementation, the MED will provide technical assistance to small operators to assist them in obtaining the knowledge and experience required for managing a water utility. The PIU has already prepared a package of technical assistance for the small entrepreneurs which provides information, training and software for financial and commercial (billing and collection) management, operational performance in aspects such as unaccounted for water reduction, metering, service coverage, labor efficiency etc. During project preparation, the PIU has been promoting the idea of small private water operators by conducting various workshops and seminars with potential operators. It has also financed some training courses on management of small water utilities which were offered by several universities and were in great demand. All these activities will continue and are expected to assist in the developing the market of small entrepreneurs which would serve as operators of the utilities in small municipalities. The financial analysis of the proposed privately managed utility is an essential tool for preparing the PSP process. The financial model which will be used in the future by the consultants, for preparation Page 50 of the "Constructor-Operator" documents and by the MED staff to conduct the quality control of the consultants' work, will be agreed upon with the Bank. Whatever the model chosen, an arrangement will be made to have the PIU team trained in the use of the model. During project preparation, a pilot PSP processes based on the "Constructor-Operator" model were prepared in eight small municipalities (Puerto Escondido, Los C6rdobas, Mofnitos, San Bernardo del Viento, Cumaral, Nataga, Palermo, and Tello). Because of government budget restrictions to finance the related investments, the bidding processes were carried out for only five municipalities, and of these, two processes have been successfully completed for the municipalities of Cumaral and Nataga and the contracts have been awarded and signed. The others suffered from the fact that the bidding processes coincided with the end of the term of mayors in Colombia, on late 2000, which had a negative impact on those processes. Details regarding the processes of Cumaral and Nataga are presented at the end of Annex 16. Destination of Bank proceeds: Under the conditions in Colombia, in most of the medium size cities and practically in all the small municipalities, the private sector would not be able to finance all the required investments because the tariff levels, even after the increase induced by the project, will not be sufficient for that, and the public sector will have to provide financing to close the gap. The Bank funds will be lent to the government of Colombia, which will use them mostly as subsidies to finance public investments in water and sanitation infrastructure in medium size cities and small municipalities, which cannot be financed by the private sector and need to provided by the public sector. Since the program is demand driven and the loan amount has been set in an agreement between the government and the Bank, a mechanism needs to be set to determine how much funding will be allocated to each medium size city. A cap will be included in the bidding documents of each city regarding the amount of subsidy which the government will provide. The cap will be decided upon so as to ensure the financial viability required achieve the established set of performance targets and by the availability of funds allocated to the medium size cities component, so as to ensure targeting the planned number of these type of cities. The allocation problem does not exist in the case of small municipalities since in those, the amount allocated for each municipality will be the amount required to complete the investments. In addition, part of the Bank funds will be used to finance the technical assistance activities which will be provided to each participating municipality for incorporating the private sector in the management and operation of the services, i.e., to finance the involved studies (engineering, financial, legal), assistance in bid evaluation, contract signing, etc. Bank funds will also be used to finance studies regarding strengthening the sector's environmental management capacity and developing the policy for the rural and sanitation sector, as well as for financing the activities of the PIU. Ensuring Provision of Services to the Poor: In medium size cities: in order to ensure services in poor neighborhoods of medium size cities, two sets of pre-established performance targets, varying along the years, will be stipulated in the operation contracts, one for the entire city and one for the poor neighborhoods (defined as neighborhoods of strata 1,2 and 3). The operators will commit to achieve both sets of targets, thus ensuring the provision of services to the poor in the medium size cities. In small Municipalities: the eligibility criteria for participating small municipalities will provide a screening mechanism which will ensure that only poor municipalities will be able to participate in the project. This will be done by the use of the social indicator INDEMUN4 (Indice de 4INDEMUN is a territorial development indicator which reflects in each municipality a set of social indicators (coverage of education, coverage of public services, health, unsatisfied basic necessities) as well as financial indicators (tributary and non-tributary income per capita and expenses per capita). The INDEMUN indicator has 8 categories. Category 1 reflects the least developed municipal level and category 8 the most developed. Category 5 was selected as the cut off category of the indicator in order to be inclusive enough, while on the other hand not to include in the project municipalities with too high a level of development and too low a level of poverty. Page 51 Desarrollo Municipal - Municipal Development Index) which is determined annually by DNP for each municipality. Only municipalities with an index value of up to 5, which reflects low income municipalities, will be eligible to participate in the project. That will ensure that most of the population in the participating small municipalities is of low income, and so the small municipalities component of the project would provide services to the poor and assist in poverty alleviation. Experience in Colombia shows that, contrary to the common perception, which holds that the private sector serves better the rich and neglects the poor, utilities managed by private operators serve the low income areas better than the best public utilities in the country, as demonstrated in Annex 19. Policy of Subsidies: The tariffs for each stratum will be structured in such a manner that consumers in strata 4, 5 and 6 will pay through the tariff their share in the investment program and will not receive any subsidies. As a result, all the investment subsidies financed by the Bank will benefit only consumers in strata 1,2 and 3, i.e., population residing in low income areas. This approach is a requirement of Law 142 and also a project objective of supporting the poor. Eligibility Criteria: There are some differences in the eligibility criteria of small municipalities and medium size cities to participate in the project, however, the criteria in both cases are quite similar. The main eligibility criteria are: (i) the water coverage rate in the municipality is lower than a pre- established value; (ii) the mayor and the municipal council agree to PSP and accept the proposed PSP model; (iii) the mayor and the municipal council agree to new tariffs at a level which will ensure coverage of at least the operation, maintenance and depreciation costs, and as higher as that as socially and politically possible; (iv) the mayor and municipal council agree to contribute to investments a certain percent (between 8 to 20%, to be established specifically for each case) of the Law 60 municipal transfers or other municipal resources; (v) the mayor commits to carry out a campaign aimed at informing the community about the reform, the PSP model and the tariff adjustment involved (vi) the investment per capita is capped and cannot exceed a pre-determined value; and (vii) the proposed works will not include resettlement. Additional details regarding the eligibility criteria of small municipalities and medium size cities are presented in Annex 11. Possible Impact of Potential Regulatory Reform: The regulatory framework is supposed to be revised by July 2001, but no major modification are expected to be undertaken by that date. However, the CRA is considering a major modification of the framework, expected to be completed before July 2002. The main reforms contemplated for that date include: (a) redefining the scope of regulation to focus on the larger utilities while providing technical assistance and support to smaller municipalities, and giving consumers some responsibility regarding service quality; and (b) promoting competition for and in the market, to provide incentives for cost reduction and efficient management. Since the project is being prepared under the current regulatory framework, there might be a need adjustments after the new framework becomes effective. This, in turn, could introduce a degree of uncertainty, which might deter the private sector from participating in the project. However, two things are currently known about the new regulatory framework: (i) it is not expected to become effective before July 2002; and (ii) it will target only about 200 of the largest utilities. With this in mind, the new regulatory framework does not constitute a substantial concern for the project because: (i) most of the operation contracts in medium size cities are expected to be signed before July 2002, so the new framework will not apply to them; and (ii) the new framework is not meant to apply to small municipalities. The project team consulted with DNP and MED on the impact of the new framework on project preparation and was advised to continue preparation activities according to schedule. Page 52 By Component: Project Component A - Investments in Subprojects in Medium Size Cities and Small Municipalities - US$ 61.8 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 in medium size cities within the Caribbean region 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. It is expected that 2-3 medium size cities will participated and be financed under this sub-component. 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 for each city loan funds in the amount requested by the winning bidder. 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 using loan funds will be designed by the privately managed utilities and the executing agency of each subproject will be the privatized water utility of the city. This would ensure 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 execution of works and will ensure that Bank procurement guidelines are followed when Bank funds are used. The detailed supervision of works will be carried out by consulting firms which will be hired under the Technical Assistance activities of the project. 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 assignment, to carry out the control of the PSP contract and determine if the performance targets are achieved by the operator. A2. Providing financial support to partially finance the public sector funding requirements of the water and sanitation infrastructure in about 15 participating small municipalities, and execution of the respective works (US$ 16.8 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 in small municipalities within the Caribbean region 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. It is expected that about 15 small municipalities will participated and be financed under this sub-component. 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 execution Page 53 of the works. The detailed supervision of works will be carried out by consulting firms which will be hired under the Technical Assistance activities of the project. 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 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 Fondo Nacional de Garantias (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 the small municipalities component of the project, will be made out of the counterpart funds and will be returned to the government in due course. A3. Government counterpart funds for investments in medium size cities and small municipalities located outside the Caribbean region (US$ 15 million). Under this sub-component, civil works and equipment for water supply and sanitation in medium size cities and small municipalities located outside the Caribbean region will be financed by counterpart funds as contribution of the public sector to the investments in water and sanitation infrastructure which cannot be financed by the private sector. The works and activities financed by the government will be handled under the same procedures of those financed by the loan funds within the Caribbean region and will be an integral part of the project. It is expected that 1-2 medium size cities and about 10 small municipalities located outside the Caribbean region will participated and be financed under this sub-component. A4. Execution of works financed by the private sector and by Law 60 resources in medium size cities (US$ 12.5 million). According to the operation contract, the private operators commit to finance a portion of the required works in each participating medium size city (in all the regions of the country). The investments provided by the private operators will be recovered from tariff incomes. The execution of the works financed by the private operators forms part of the project. Contemplated activities 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 do not involve any Bank financing, the private operators will use their own procurement procedures to implement these works. In addition, as part of the PSP transaction, participating municipalities will be requested by the government to commit to provide each year to the water utilities 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. A5. Execution of works financed by Law 60 resources and by the private sector in small municipalities (US$ 2.5 million). As part of the PSP transaction, small municipalities (in all the regions of the country) 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 in small municipalities financed by Law 60 and the private sector resources are expected to form a small portion of the total investments required in these municipalities and they will be implemented under the same procurement procedures as the works financed by the government. Page 54 Project Component B - Sector Environmental Management Capacity Strengthening - US$ 0.8 million Strengthening sector environmental management capacity will be achieved mainly by carrying out the following activities: (i) providing advice on 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) providing advice on 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 public participation and community consultation criteria and procedures for water and sanitation projects. Project Component C - Rural Water and Sanitation Policy Development - US$ 0.9 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 D - Project Management and Training, PSP Technical Assistance, Studies and Supervision of Works - US$ 6.5 million Dl. Project Management and Training (US$ 2.5 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. D2. 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 medium size cities (US$1.0 million). This sub-component represents an important project activity and would entail provision of technical assistance for the completion of incorporating the private sector in the management and operation of the participating water utilities in medium size cities, which has started during project preparation, or if necessary, initiation of processes in new cities and canying them out to successful completion. The PIU staff will assist the municipalities in hiring the consulting services needed to carry out the PSP processes, Page 55 which will be financed by the project. The PIU staff will also accompany the municipal authorities of each city all along the process up to the point of signing the operation contract by the Mayor and the successful bidder, and will provide all the assistance needed along the way. This assistance will include review of the work of the consultants hired for preparing and structuring the PSP processes, especially the program of works and investments (POI) and the financial projections, assistance in preparing the bidding documents, assistance in carrying out the bidding processes for selecting the private operator and in evaluating the proposals submitted. After the award of the operation contract and initiation of the execution of the works financed by the government, the TA will include the hiring of consulting firms to supervise the works. D3. Providing technical assistance to carry out the processes of incorporating the private sector in the management and operation of the water and sanitation utilities in about 25 small municipalities (US$ 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 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 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. Page 56 Annex 3: Estimated Project Costs COLOMBIA: WATER SECTOR REFORM ASSISTANCE PROJECT Local Foreign Total Project Cost By Component US $million US $million US $million A. Investments in Subprojects in Medium Size 43.51 13.49 57.00 Cities and Small Municipalities B. Sector Environmental Management Capacity 0.64 0.16 0.80 Strengthening C. Rural Water and Sanitation Policy 0.90 0.00 0.90 Development D. Project Management and Training, PSP 5.75 0.75 6.50 Technical Assistance, Studies and Supervision of Works Total Baseline Cost 50.80 14.40 65.20 Physical Contingencies 2.00 1.00 3.00 Price Contingencies 1.20 0.60 1.80 Total Project Costs 54.00 16.00 70.00 Total Financing Required 54.00 16.00 70.00 Local Foreign Total Project Cost By Category US $million US $million US $million Goods 7.46 7.46 14.92 Works 39.57 7.69 47.26 Services 6.77 0.85 7.62 Training 0.20 0.00 0.20 Total Project Costs 54.00 16.00 70.00 Total Financing Required 54.00 16.00 70.00 Page 57 Annex 4: Cost Benefit Analysis Summary COLOMBIA: WATER SECTOR REFORM ASSISTANCE PROJECT 1. Methodology A cost benefit analysis was used to determine the economic and financial viability of the Water Sector Reform Assistance project. The analysis presented in this Annex demonstrates that the sector reform project is highly beneficial to the economy as a whole, as well as to the major stakeholders. The main objective of the cost-benefit analysis was to determine the financial and economic viability of: (i) the investment projects that will be partly financed by the Bank; (ii) the sector reform projects which will be implemented in each municipality; and (iii) the financial and operational target indicators proposed in the draft operation contracts. To assess the viability of the investment projects which will be partly financed by the Bank, a cost-benefit analysis was conducted. The cost-benefit analysis was conducted on a sample of potential municipal/regional utilities for which the PSP processes were prepared during project preparation. The investment programs (POIs) used were conservative estimates based on the operational and service targets proposed in the draft operation contracts. It is estimated that the winning bidders will adjust the investment programs by modifying timing of investments or by adopting different technologies, after obtaining proper authorization from the contracting authority, as long as they can meet the performance targets. The cost-benefit analysis includes costs and benefits associated with the reform project, and not only ones related to the proposed works. It not only includes a possible set of rehabilitation and expansion investments to enable the private operator to achieve the proposed targets, but also the transaction costs of privatization. Once the overall viability of the proposed utilities reform was verified, a distributive analysis was carried out to assess the impact of the reform on overall service users, on the poor and on the government (fiscal impact). Finally, risk and sensitivity analysis were conducted to assess the impact of changes in critical assumptions on the economic viability of the reform. To determine the net incremental costs and benefits, "with" and "without" project scenarios were constructed in which the for the "with" project scenario it was assumed that all targets in the operation contracts would be met. For the "without" project scenarios it was assumed that the performance of the companies under public management would continue unchanged; coverage rates would be maintained at current levels and no additional expansion and rehabilitation investments are foreseen. On the basis of these scenarios, the net incremental financial benefits and costs of the proposed investment programs were assessed, and those were then adjusted for the impact of taxes, subsidies, and externalities to arrive at the economic flow of costs and benefits. The cash flows were discounted using a discount rate of 12 percent, which is estimated to be a proxy of Colombia's opportunity cost of capital. The same methodology will be applied on municipalities interested in participating in the project, to establish their eligibility from the economic feasibility standpoint. Only economically viable municipal project will be eligible to participate in the project. A detail explanation of the methodology will be part of the project's Operational Manual. Sample Selection: 10 subprojects for which PSP processes were undertaken during project preparation were subjected to a cost-benefit analysis and the viability of their proposed operational and financial targets was assessed. At a later stage, after the project area was redefined to focus on the Caribbean region, a sub-sample of five subprojects, representing each type of the proposed PSP (medium size cities, regional systems and small municipalities) was selected for conducting a distributive, sensitivity and risk analyses, the results of which are presented in the following paragraphs. The sub-sample selected includes Page 58 the medium size municipalities of Maicao and Sincelejo, the regional system of ERAS and the small municipalities Nataga and Cumaral, and is identical to the sample used in the financial analysis. 2. Economic Benefits The main benefits of the reform programs considered include: (i) increases in water and sewerage service coverage; (ii) the reduction or elimination of rationing and intermittent water supplies; (iii) reduction of water pollution levels; (iv) reduction of financial transfers from local governments to water utilities. Economic benefits are assumed equal to the WTP for water supply and sewage disposal services. The WTP was estimated using revealed preferences method through the estimation of a water services demand function. Although the improved hygienic and environmental conditions that result from increased water supply and sewerage coverage and the from improved quality and reliability of these services, are clearly important benefits, these benefits are not quantified in this analysis. 2.1. Estimation of a Water Demand Function A demand function was estimated using the "Quality of Life Survey" Encuesta de Calidad de Vida that was done by the government's statistic department, (DANE) in 1997 (ECV). This sample was establish in 58 municipalities of the country and includes 2.469 households; the size of the sample allowed to introduce different markets and with them different price structures, a considerable group of socioeconomic characteristics of the households and other technical, regional and environmental variables. Given that the survey did not directly reported the volume consumed and its associated tariff, but the monthly bill that the household had to pay, consumption was estimated based on 1997 tariffs. In the modeling process it was found that not only the mean but the variances of income were significantly different in municipalities above 1,000 meters above sea level. As a result, two demand functions were specified at a national level, one for municipalities located at an altitude of up to a 1,000 meters above sea level and one for municipalities located above that altitude. That way a temperature variable was incorporated into the model. Different dummy variables were introduced to correct the heterogeneity of the observations, obtaining homogeneity in consumption for each of the observational units (Atlantic, Central, Orinoquia, Pacific, and Oriental regions and Antioquia and Bogota). As a result the model presents significant coefficients for the dummies: Oriental region and Antioquia for the model for cities above 1000 meters. Both functions were specified with constant elasticity. The details of this work are available in the project files. For municipalities bellow 1,000 meters altitude: (1) C = e3,58817 NO,26732 e,05896 e,25742 (14.8024) (7.0985) (3.5479) (-6.8895) Where: C:. Metered water consumption, in m3 per month N: Household size Y: Disposable Income, calculated as the residual income after subtracting the fixed costs for water and sewerage. P: Instrumental variable that represents the marginal price of the services, calculated as the arithmetic mean of the complementary and luxurious tariffs. This specification was made through a sample of 989 households and the coefficients of all explanatory variables were significant at a 99% level of confidence (the values of the t statistic of the coefficients are presented in parenthesis), and no statistically significant collineality was present. For all other municipalities the following specification was obtained: Page 59 (2) C e3'9851601 .yO 33198 14,s0536 r- 334792 eReg 40,20502 eeg2-01176323 (21.602) (IQ.$45) (4.428) (-11.966) (-2.737) (-4.982) Where: C: Metered water consumption, in m3 per month N: Household size Y: Disposable Income, calculated as the residual income after subtracting the fixed costs for water and sewerage P: Instrumental variable that represents the marginal price of the services, calculated as the arithmetic mean of the complementary and luxurious tariffs eR,gl Dummy for the Oriental region, being (1) if the municipality is from this region and (0) when its of any other region eRe,2: Dummy for the Antioquia department being (1) if the municipality is from this department and zero (0) otherwise This function was specified based on a sample size of 1,480 households and again all explanatory variables were significant at a 99% level of confidence (the values of the t statistic of the coefficients are presented in parenthesis), and no statistically significant collineality was present. 2.2. Estimation of Economic Benefits Economic benefits for water and water and sanitation services, that is the potential beneficiaries willingness to pay, were estimated applying the revealed preferences methodology, which is the best methodology to use when there is a market, for the good or service. Using a representative sample of households at the national level, a demand function for water supply services was specified. It explains the relation between water consumption and a series of social and economic variables of the household, and some characteristics of the service supplied. Additional information about the "without" project situation in each municipality provided a characterization of the service supplied (type, level, quality, quantity) and its price. Then, using the tariff levels expected in the case the project is not implemented (without project scenario) the consumption level was estimated and projected for that scenario. Using the information from surveys applied in the project area-characteristics of the household, of the services supplied and its associated prices, and willingness to pay-the consumption levels from alternative sources are estimated for the households that will not have access to piped services if the project is not implemented. Using the proposed tariffs under the project, the consumption levels for this group of consumers was estimated for the with project scenario. The economic benefits of the project for each household are represented by the area under the demand curve defined for the range between the consumption level with and without the project, and the resource savings if as a result of the project the consumers will substitute the use of more expensive sources. In that sense it is possible to define three main beneficiary groups: connected households and households that will have access to the service even if the project is not implemented; households that without project will not have access to a good quality service, and finally households that will not be connected, even if the project is implemented. The first group, those that will be connected in both scenarios, will have economic benefits only if in the with project situation tariffs are expected to decrease (as a consequence of increased efficiency, for example), an will consume more at a lower price, or if without the project rationing is expected, so their consumption will be reduced in that scenario. The second, group will be the main beneficiary as it will be able to substitute alternative (more expensive) sources for reliable piped water and they will also be able to increase consumption. For the third group there will be no economic benefits nor costs to the project in either scenario. The size of the groups was determined using the coverage targets in the PSP contract, and the household and population projection that was done for each Page 60 city. The addition of the incremental benefits from each consumer group determines the gross benefits of the project. The estimation of economic benefits is considered conservative as (i) the quality of service in the with and without project scenarios was assumed similar, although it is expected that service quality will improve and as a consequence consumption could increase; (ii) for the consumers not connected to the system in the without project scenario, incremental benefits are explained by the reduction on the cost of the water, and not to the service quality, and (iii) although some estimation on impact on health were investigated using information available in the Ministry of Health, these were very difficult to quantify, thus conservatively were not included in the analysis. Other benefits like possible impact to the local economy via increased industrial/tourism opportunities were also not included in the analysis. 3. Estimation of Economic Costs The main costs considered include: (i) the incremental operation and maintenance costs and investment costs required to achieve the proposed targets; (ii) the cost of connection for water and sewerage services as additional costs to the customers (this is normally borne by customers, and does not appear on utility balance sheets); and (iii) transaction costs related to sector reform. For the estimation of economic costs, shadow prices were used to capture the effects to the economy of the use of goods and resources such as labor by the project. To convert market prices into shadow prices conversion factors were calculated for the main inputs of the project: Skilled and unskilled labor, national and main imported inputs (pipes, equipment and pumps) which are subject to different duties. Accordingly, both investment and operating costs were also classified in these categories. The results of these calculations are presented in Table 1. The details of these calculations are available in the project files. Table 1: Conversion Factors Category of costs Conversionfactor* Skilled labor 0.68 Unskilled labor 0.61 Imported materials/equipment 0.76 National goods 0.87 Electricity 1.00 * Conversions factors were calculated specifically for this study. Calculations are available in project files. Once all financial costs were converted into economic costs, incremental costs were calculated based in the comparison of the "with" and "without" project scenarios. Given the nature of the reforms that are being considered, the cost saving s to the economy expected from the incorporation of a private operator are expected to be substantial. 4. Main Assumptions The primary source of data are reports prepared by privatization consultants, under the supervision of the project preparation unit, and the Bank. Investnent costs include the costs of project preparation, environmental compensatory actions, physical contingencies, and supervision. The connection and secondary network costs are paid by the customers, and does not appear on utilities' balance sheets. These costs are thus not included in the financial costs, but are included in the economic costs. These are costs that the users need to pay for, in order to enjoy the additional benefits of a piped water supply and sewerage systems. Page 61 Operation and maintenance costs (0&M) include the cost of labor, chemicals, power, and all administrative costs. O&M costs for the "without" reform scenario are based on current unit costs. O&M costs for the "with" reform scenario assumes efficiency gains. Labor costs are calculated as the number of employees per 1,000 water and sewerage connections (labor productivity) times the number of connections times the average cost per employee. In the "without" reform scenario, labor productivity and number of connections remain constant. In the "with" reform scenario, labor productivity and the number of connection increases in accordance with each utility's efficiency targets specified by the contract. Chemicals and energy costs are calculated based on projected water production volumes and unit costs. Other costs are calculated as percentage of direct O&M costs. The implementation period of investment programs ranges from 20 to 30 years for medium size cities, depending on the proposed contract terms. For small municipalities, it is 10 to 15 years. The rest (terminal) value of investments has been assumed to be zero. Current andprojectedpopulation in the project areas is based on the 1951, 1964, 1973, 1985 and 1993 population census and the populations projections for 2005 made by the National Department for Statistics (DANE). Usually the number of households per connection is assumed to be one. The annual targets for the installation of new service connections are based on the projected coverage levels as specified in the draft operation contracts. Per capita water consumption is calculated as the weighted average of the current per capita consumption of metered and non-metered households. Per capita water consumption of non-metered households is assumed equal to that of metered customers, after adjustments for the impact of price elasticity, which is assumed -0.26 based on results of demand analysis in municipalities bellow 1,000 meters of altitude. The discharge factor to collectors and interceptors is assumed as 0.70 and the infiltration factor 0.20. Water billed. Non-metered customers are charged a flat fee, and metered customers are charged by volume consumed. The metering rate is projected to increase gradually. Unaccounted-for water, defined as water not billed over water supplied, is estimated to gradually decrease. The physical losses are assumed to decline to 15 percent of water production, while administrative losses will decline to about 10 % percent. The division between commercial and physical losses varies by company, but assumed to be 30 and 70 percent, respectively, of total UFW. The tariff structures and levels are assumed to remain unchanged for both the "with" and "without" project scenarios. The collection efficiency rate is assumed to remain unchanged in the "without" project scenario and gradually increase in the "with" project scenario. 5. Results of the Cost Benefit Analysis for the Sample of Utilities Analyzed The results of the economic cost-benefit analysis for the medium size cities of Cuicuta, Sincelejo, Corozal, Quibd6, Chiquinquira, Espinal, Maicao and Flandes; for the ERAS regional system and for the constructor-operator schemes of Cumaral and Nataga are presented in the following table. This analysis was carried out at an early stage of project preparation, when the project had a national focus. At a later stage, the focus was shifted to address issues of the Caribbean region, so that only medium size cities from that region are eligible to participate in the project, while for small municipalities, the national focus was maintained and municipalities from all the regions of the country are eligible to participate. Two types of average results were calculated: (i) project sample average which is an average of the results of the sample of the five municipalities eligible to participate in the project, i.e., Maicao, Sincelejo, Eras, Cumaral and Nataga; (ii) extended sample average which includes the 10 municipalities on which the economic analysis was carried out. All the utilities were analyzed for a period of 20 years except those of Page 62 Maicao and Sincelejo which were analyzed for a period of 30, in accordance with the terms of the operation contracts prepared for these utilities. Table 2: Economic Indicators Subproject NPV' (US$ 000) EIRR Benefit Cost Ratio Maicao 28,273 46.8% 2.30 Cucuta 25,342 20.5% 1.61 Sincelejo 18,883 32.7% 1.83 Corozal - 0.117 6.8% 0.83 Quibd6 4,139 29.1% 1.65 Flandes 0.133 14.3% 1.09 Espinal 2,143 31.0% 1.71 ERAS2 11,185 27.6% 1.92 Cumaral3 240 14.8% 1.18 Nataga3 129 18.7% 1.61 Project Sample 11,742 28.12% 1.77 Average 4 Extended Sample 10,037 23.1% 1.66 Average5 =__ _ Using a discount rate of 12%. 2 Regional system. 3 Small municipality: Constructor-operator scheme. 4 Average for the following municipalities: Maicao, Sincelejo, ERAS, Cumaral and Nataga. 5 Average of all municipalities included in the tale, excluding Corozal. The results of the cost-benefit analysis for the projects included in the extended sample show that as designed by the privatization consultants, 90% of the projects were economically feasible and their expected net impact on the economy will be substantially positive. In cases like Corozal, with negative economic returns, works could be redesigned to ensure that the investments financed and efficiency gains incorporated will have a desirable economic impact. The results for the project sample average are slightly better than those of the extended sample average because the systems in the Caribbean Region are more deteriorated and the population in this region is in many cases in desperate need for improved water services. In the case of Maicao, because of the highly deteriorated state of the system, the expected returns on investments are expected to be higher than in the others. 6. Sensitivity and Risk Analysis of the Project Sub-Sample 6.1 Sensitivity Analysis The sensitivity analysis shows that the results of the economic analyses are robust for the five cases analyzed (Maicao, Sincelejo, ERAS, Cumaral and Nataga). The variables identified as representing major risk to the subprojects are: changes in consumption (price elasticity of demand), resource savings (substitution of altemative water sources by piped water provided by the project), investment cost overruns and operating cost overruns. The impacts of these four variables were analyzed in the sensitivity and risk analysis. The following table shows the possible impact and risk significance of the identified risk factors. Page 63 Table 3: Risk Variables, their Significance and Impact Risk Variable Impact and Risk Significance Resource savings Direct impact on economic benefits of the project if consumers will (substitution of sources) not replace alternative sources for piped water. Beyond management control this variable could convey a moderate risk to the project. Price Elasticity of Direct impact on revenues and profitability. Beyond management Demand control; this variable could convey a risk to the project. Investment Cost Overrun Direct impact on investment costs. Largely under management control, conveys a moderate risk to the project Operating Cost Overrun Direct impact on operating costs. Largely under management control conveys a moderate risk to the project. The sensitivity analysis calculates the impact of single variable changes in a static world. The four variables identified in Table 3 above, were switched until the subproject analyzed presented no positive impact. In most cases the exclusion of benefits from resource savings will not be sufficient for the subprojects to yield a NPV = 0. The large percentage of operating cost overruns required for a negative result shows that the miscalculation of that variable alone will not be sufficient to make the subprojects fail. Only in the case of Cumaral, it is possible that an investment cost overrun could jeopardize the economic result of the subproject. In the constructor-operator schemes, where investments will be subsidized, investment costs will be closely monitored to avoid any overruns not covered in the estimated contingencies. In view of the relatively high switch values for the different variables, subproject results turn out to be robust for all cases. Table 4: Results of the Economic Sensitivity Analysis - Switching Values for Net Benefit Economic Benefits Economic Costs Reduction in Reduction in Investment Operating Cost Locality consumption source Cost Overrun Overrun (NVP=O) savings (NPV=0) (NPV=0) (NP V=0) Maicao -75% -229% 154% 845% Sincelejo -54% -298% 90% 500% ERAS -50% -992 98% 1,036% Nataga -42% -408% 70% 428% Cumaral -20% -69% 22% 90% 6.2 Economic Risk Assessment To enhance the accuracy of the economic analysis by incorporating the uncertainty of the real world, Crystal Ball software was used. This software allows to measure the extent of various risks and their effect on the project, modeling a probability distribution for each risk variable and the resulting outcome. Based on a Monte Carlo simulation of 1,000 trials, the model recalculated the results of the economic analysis by changing the major risk variables all at the same time. The results of the sensitivity analysis show that the variables that will have the highest impact are the price elasticity of demand and the investment costs in the initial years. Table 5: Assum tions on Probability Distribution and Standard Deviation Risk Factors Distribution Price elasticity of demand Normal distribution. Mean = -0.26, standard deviation = 0.037 (from demand function for less than 1,000 meters). Investment cost increase Triangular distribution. Mean: cost overrun of 1.1. Minimum = no cost overrun; Maximum = 1.20. Page 64 Changes in the price elasticity of demand will have a direct impact on consumption and its associated benefits. When the demand is more price elastic, price increases will be neutralized by decreases in the demand for services. According to results from the demand analysis, price elasticity has been assumed normally distributed, with mean = -0.26 and standard deviation = 0.037, with values ranging from -0.15 to -0.38. Investments cost overruns have a direct impact on the costs of the project. For this variable, a triangular distribution was used. Conservatively, assuming that the engineers accurately estimated the investment costs, the most likely value for overruns is 10 percent. The minimum value is no costs overruns (engineers' estimates) and the maximum value is 20 percent. The results of the economic risk analysis are presented in Table 6. Although the probabilities of a positive net present value are between 55 and 75%, the mean expected net present value from the simulations were positive in all cases, and considerably higher than the estimated NPV of the subprojects. Given that the main condition of the proposed project is the incorporation of a private operator in each of the participating utilities, the risks related to cost overruns are expected to be mitigated by the incentives established in the contracts to reduce costs. On the other hand, demand related risk could be substantial and the PIU at the Ministry of Economic Development will have to monitor them closely during project execution, specially tariff design and its effect on consumption. The social work included as part of project design will contribute to the mitigation of this risk. Table 6: Economic Risk Assessment of Subprojects Subproject Net Benefits Locality Probability NPV>0 Mean Expected NPV(US$ 000) Maicao 75% 181,955 Sincelejo 55% 410,819 ERAS 65% 89,320 Nataga 65% 854 Cumaral 55% 64,084 7. Distributive Analysis - Poverty Impact The difference between the economic and financial cash flows (defined from the equity point of view), was analyzed to determine who benefits from and who pays for the project. The impact on the direct beneficiaries of the project, especially of the lower strata, was analyzed in detail to estimate the probable poverty impact ofthe proposed subprojects. The calculation of the net impact to consumers includes the benefits form the consumer 'surplus' and the benefits from substituting alternative sources and the costs that the consumers have to pay. When the management of water utilities is transferred to private operators, in most cases connected customers will have to the pay more for the service, since the service will be metered (and hence will reflect the actual water consumption and wastewater production), billing and collection will improve, and illegal consumption will be curtailed. The consumer surplus for some existing customers will be significantly negative, specially for those of higher socioeconomic stratum who currently benefit from lower tariffs and a better service when compared to poor customers who currently are usually not connected to the system and pay more. With an adequate tariff structure, new customers, mainly poor, will be the major beneficiaries from private sector participation in the sector. Table 7 shows the results of this analysis. Page 65 Table 7: Net Impa t on Users values in US$ 000 Total Net Impact Stratum 1 Stratum 2 Stratum 3 Sstratum 4-6 on Direct Subproject Beneficiaries Beneficiaries Beneficiaries Beneficiaries Beneficiaries MAICAO Net present value 28,273 33,649 10,042 of benefits % of subproject 100% 119% 36% 52% 31% benefits__ _ _ _ _ ___ _ _ _ _ _ % of benefits to 100% 30% 44% 26% direct users SINCELEJO* Net present value 18,883 3,637 -501 1,495 3,590 -946 of benefits % of subproject 100% 19% -3 8% 19% -5% benefits % of benefits to 100% -14% 41% 99% -34% direct users ERAS Net present value 11,185 1,444 330 835 -721 1,000 of benefits __ ___ % of subproject 100% 13% 3% 7% -6% 9% benefits % of benefits to 100% 23% 58% -50% 69% direct users NATAGA Net present value 129 120 46 35 40 of benefits % of subproject 100% 93% 36% 27% 31% benefits % of benefits to 100% 38% 29% 33% direct users CUMARAL Net present value 623 330 196 168 -34 of benefits % of subproject 100% 53% 32% 27% -5% benefits % of benefits to 100% 59% 51% -10% direct users Maicao. In this case, most households are connected to the system but there is high rationing. The project will provide access to a more reliable water source, but even in the with project scenario water consumption it is expected that some rationing will continue. The economic cost of water is therefore very high. During project the preparation tariff design did not consider the distributive analysis, since it was not available at that time, and tariffs were set too low when compared to the Willingness To PaS (WTP). As a result, direct beneficiaries are receiving more than the net impact of the project, which means that the government subsidies are set higher than needed. Without project, consumers are paying about 16% of their monthly income to buy water from trucks and othedr sources, while the with project scenario considers that only 4.3% of the consumers income will be spend on purchase of water. In this case charging a higher tariff will be more efficient and the impact on government would be more Page 66 reasonable. When considering Bank financing for this specific project, the proposed tariff structure should be revised to avoid unnecessary subsidies. Sincelejo. The results for Sincelejo show that only 19% of the net impact of the project goes to the direct beneficiaries. The tariff structure selected was not the best alternative, as it has a major negative impact on the poorest, stratum 1, since the proposed structure charges the same tariff to the first three strata and goes against the equity spirit of cross subsidies in Colombia. An alternative structure that charges more to stratum 3 could compensate the losses in welfare to stratum 1. ERAS. The results for ERAS show that only 13% of the net impact of the project will go to the direct beneficiaries. Users in stratums 4 to 6 will be the winners and stratum 3 users will have a negative impact. A higher tariff for the richer stratums, could mitigate the loss in welfare to the poorer strata. Nataga. The results for Nataga could be an example for other small municipalities. Not only that 93% of the benefits will have a positive impact on the welfare of direct users, but the project will also have a clear positive impact on the poor, as most net benefits will go to strata I and 2. Cumaral. The results for Cumaral show that 53% of the net impact will benefit the direct users, specially the poor. The proposed tariff structure, however, will generate a negative impact on stratum 3 users, probably because of the existing tariff lag that prevails in the without project situation. Overall the proposed projects are economically viable and are expected to be beneficial to the economy and to the direct beneficiaries. However, the projects are mainly sensitive to demand so an adequate tariff design should be the main tool for the PIU team to ensure successful projects, not only in terms of managing consumption but also analyzing closely the proposed structures to avoid negative impacts to the most vulnerable (stratum I and 2). Unnecessary subsidies should be avoided, although the results show that subsidies might be needed, especially in smaller municipalities like Cumaral and Nataga. 8. Fiscal Impact The net fiscal impact of the project is unknown yet since depends on the municipalities which will participate in the project, which are not known up front in a demand based project. It is estimated that in the poorer municipalities, which require higher subsidies, the fiscal impact would probably be negative, while in the better off municipalities it may be positive. The Government gains from: (i) increased income from income tax paid by private operators; (ii) increased VAT income due to increase in investment and materials purchases as a result of the project; however, under the proposed project the government provides capital investments subsidies to the consumers and it is estimated that in poor municipalities, the value of the collected taxes might not be high enough to compensate for the subsidies provided. The government also has to 'invest' in transaction costs to facilitate the transfer from public to private management. The net fiscal impact on the government from the utility reform in the sample of 5 municipalities which were used for the financial analysis (Maicao, ERAS, Sincelejo, Cmaral and Nataga) is estimated to have a positive value of about US$3.5 million, however, this result is driven by the high positive fiscal impact of Sinselejo, which is the largest city in the group and the only one which has a positive impact (of US$ 7.39 million). Details on the fiscal impact of the sample group are presented in Table 8. Page 67 Table 8: Fiscal impact of a Sam le of Five Municipalities Maicao ERAS Sincelejo Cumaral Nataga Total uS $(000) US $(ooo) uS $(°°°) US $(OOO) us $(OOO) us $(000) Municipalities Subsidies (Ley 60) 3,745 3,103 0 2793 44 7,170 Net impact -3,74G -3,103 0 -279 -44 -7,170 Departments Income (tax) 0 0 0 0 0 0 Subsidies (Investment) 0 0 67 0 67 Net impact 0 0 -67 0 -67 Departmental Government National Govemment Income (Taxes) 3,610 3,517 8,626 148 15 15,915 IVA 153 372 247 27 3 802 Regulation Tax 491 473 938 0 4 1.906 Total Taxes 4,254 4,362 9,811 175 21 18,623 Subsidies (investment)s 3,028 1,714 2,421 518 142 7,823 Net impact 1,226 2,648 7,390 -343 -120 10,800 National Government Total Fiscal Impact -2,519 -455 7,390 -689 -120 3,564 Page 68 Annex 5: Financial Summary for Revenue-Earning Project Entities COLOMBIA: WATER SECTOR REFORM ASSISTANCE PROJECT Introduction The proposed reform program will be successful only if it is structured to attract potential investors and lenders. In order to ensure success, the proposed PSP structures must allow sufficiently attractive rates of return to potential investors and provide adequate financial comfort to lenders. Detailed financial analyses and financial projections were prepared for a sample of five utilities (Maicao, ERAS and Sincelejo, which are medium size utilities, and Cumaral and Nataga which are small utilities). Draft PSP contracts which were available for the five utilities were used to build the financial scenarios for the privately managed utilities , and analyze their financial viability. The operation contract of Maicao and the constructor-operator contracts of Cumaral and Nataga have already been awarded during project preparation, while the bidding processes for Sincelejo and ERAS have not yet started. Some important lessons were learned from the results of the financial analyses carried out and those helped to build a financing policy for the utilities which will participate in the project. Based on that, some changes were included in the draft PSP contracts which were not yet awarded, i.e., those of ERAS and Sincelejo. Overall, the financial analysis was an important tool in the learning experience for the PIU staff, by training them how to evaluate the financial projections of interested utilities, establish the adequate tariffs and select the utilities which will be included in the project. The methodology, assumptions and results of the financial analysis of the sample utilities are presented in this Annex. The presented material reflects the adjustments made in the iterative process of analysis. Objectives The main objective of carrying out the financial analysis during project preparation was to develop a methodology which would ensure that only financially feasible transactions will be included in the project and to train the PIU staff in using that methodology. The specific objectives of the financial assessment of each municipal utility were to: (i) assess the financial feasibility of each of the Proposed PSP contracts included in the sample municipalities, which have been prepared with the help of privatization consultants; (ii) assess the debt service capacity of the potential operators and their eligibility for obtaining commercial loans; and (iii) determine the main risk factors and the sensitivity of the overall feasibility of the operation contracts to these factors. Methodology Samples. Financial projection and evaluation models were prepared for a sample of five privately operated municipal utilities, three of which correspond to the medium size municipalities Maicao, Sincelejo and ERAS with populations of between 100,000 and 250,000 inhabitants; while the other two correspond to the small municipalities Cumaral and Nataga with less than 12,000 inhabitants each. The sample of municipalities on which the financial analysis was carried out is smaller that that on which the economic analysis was carried out and it includes only five municipalities out of the 10 municipalities of the economic analysis sample. The reason for the difference in the samples size is that the preparation of the financial analysis initiated after the downsizing of the loan amount and modifying the project focus in a manner that participating medium size cities will be only from the Caribbean region while small municipalities maintained the all-country focus. At that stage, there was no reason to carry out a financial analysis of the medium size utilities located out of the Caribbean region, so only the utilities of Maicao, Sincelejo, Corozal and ERAS were maintained in the sample, as well as the small utilities of Cumaral and Nataga. It was decided to discard the utility of Corozal from the sample since it did not pass the Page 69 economic analysis threshold, so the sample was finally established as including the five mentioned municipalities. This is a reasonable sample size for the current project size. Moreover, the main purpose of the financial analysis is to develop the methodology which would be used during project implementation, and this can be well achieved with the sample selected. The PIU with the help of some local firms of privatization consultants prepared financial projections and assessments for each of the five municipal privately operated utilities, which represent a potential group of project beneficiaries. Sensitivity and risk analyses were then added to the financial assessments. Construction of a Spreadsheet Model for financial projections Based on the reports prepared by the privatization consultants, the PIU, with the help of the Bank, constructed a comprehensive spreadsheet model for financial projections of the utilities. The model consisted of information regarding performance indicators targets, demand forecasts, production and treatment capacity, investment programs and operating costs data, which were all fed into the cost-benefit analysis, financial projections, and risk and sensitivity analysis modules of the model. The same model will be used by the PIU for quality assurance of financial projections of other potential participating utilities which will be prepared by privatization consultants under the project, so as to ensure the financial viability of participating utilities. Measuring the Financial Viabilitv of the Privately Operated Utilities The financial viability of the privately operated utilities was determined by analyzing the following indicators: (a) Net present value of cash flow from operations, to find out whether the operating contract structure as proposed in the bidding document is financially viable or not (overall value of business). (b) Net present value of the operating contract to shareholders, to find out if the concession structure is attractive to foreign and domestic investors (value to investors). (c) Debt equity ratio, to find out if the operating contract structure allows the utilities to stay financially healthy. (d) Debt service coverage, to find out if the utilities would have the financial capacity to service loans that it needs to contract. (e) Current ratio, to find out if the utilities remain sufficiently liquid to stay financially healthy. Unlike the cost-benefit analysis presented in Annex 4, which determines the benefits on an incremental basis (NPV of benefits with reform minus NPV of benefits without reform), the net present values in the financial analysis was determined on the basis of the "with reform" scenario only. Sensitivity and Risk Analysis Finally, a sensitivity and risk analysis was conducted to determine how different assumptions and risks affect the viability of the operation contracts. The risk analysis was carried out using.the Crystal Ball risk analysis software. Assumptions The main assumptions utilized in the analysis refer to: (i) operational performance, customer base, physical capacity of the existing public utilities; (ii) the expected efficiency gains from a private operation contract; (iii) operational and physical targets of performance indicators as specified in the draft contract and the most likely investment programs which is expected to achieve these targets; and (iv) minimum capital, minimum subsidy, and other financial requirements set forth in the draft operation contracts. Although many of the assumptions were based on the privatization consultants' reports, some assumptions were adjusted to reflect more conservative scenarios. Page 70 Operation Contract Award Criteria The operation contract will be awarded to the bidder that requests the lowest capital investments subsidy in order to comply with the requested performance indicators targets under the specified tariff regime. Starting Assets and Liability Under the proposed PSP scheme, each winning bidder will create a special purpose operation company with a minimum level of capital. It was assumed that non of the assets and liabilities of the former public utilities would be transferred to the newly created privately operated utility. However, the new utility will have the right to operate the assets of the former public utility. In addition, the government will finance the construction of new installations, which will be agreed upon by the operator, the municipality and the PIU, in an amount equivalent to the subsidy requested by the operator. These new assets will neither be transferred to the new utility, but it will have the right to operate them as well. Basic Assumptions All the assumptions are identical to those used for the "with reform" scenario of cost-benefit analysis presented in Annex 4. Most assumptions are based on various efficiency and physical targets set forth in the draft operation contracts. All the public utilities analyzed presented the following problems before their take over by the private sector: (i) low operating efficiency; (ii) low metering; (iii) high level of unaccounted-for water; (iv) low tariffs; and (v) low collection efficiency rates. One of the key assumptions taken is that the values of these operational efficiency indicators will improve substantially after take over of operation by the private sector. The following assumptions are related to the utilities' financing activities that are not presented in Annex 4. Table 1: Financial Assumptions Factors Assumptions |Exchange Rate It is assumed that the Colombian peso will be devaluated against US$ l ~~~~~~dollar at a rate of 5% per year. Inflation 2001: 9% 2002: 8% 2003: 7% 2004: 6% 2005 and on: 5% per year Discount Rate 12% real discount rate for the calculation of net present values under the base scenarios Account Receivables Based on bill collection rates, and expected gradual increase in bill collection rates. Account Payables Two months of operating expenses Cash One month of operating expenses Long Term Debt Debt financing is assumed when the sum of cash from operations, capital and subsidies do not cover investment. For the base case scenario we assumed a real interest rate of 8.5%, amortization period of 15 years for the Bank loan; and interest rate of 14%, amortization period of 4 years for the rest. Short Term Debt Short term debt is taken to finance working capital needs. Interest rate 24%. Equity Financing Equity financing occurs when it is required, but is limited to guarantee an adequate rate of return to investors Dividend Payout Policy Any cash in excess of minimum cash Page 71 Water and Sewerage Tariffs The current legal framework for water and sewerage tariffs in Colombia was established in 1994 by Law 142. Current regulation is based on tariff setting formulas, and specific rules on the percentage of subsidy and overcharge that can be applied to the tariffs. The CRA, as the regulatory agency, has issued some resolutions to explain the methodology which should be followed by the water utilities. The basic principles that rule water and sewerage tariff policy in Colombia are the following: * Tariffs have to be based on the economic cost, including operating costs as well as investment cost. The CRA establishes that the economic cost for investmnent corresponds to long run average cost (LRAC), which is defined as the sum of the current assets appraised at their new brand value plus the present value of future investments divided by the present value of total demand. * The subsidies will benefit only the three lower income categories of residential customers (strata 1,2 and 3). * The subsidies will be applied only to the monthly fixed charge term of the tariff formula and to the basic consumption block, i.e., the first block in the tariff formula (but not to the consequtive consumption blocks). - The maximum subsidy level which can be applied is: 50% for the category of the lowest income customers (stratum 1); 40% for the category of second lowest income customers (stratum 2); and 15% for the category of third lowest income group of customers (stratum 3). The subsidy could be higher when the utilities receives additional funds to finance investments, such as government transfers, private donations or customers contributions. * The maximum overcharge which can be applied to residential customers of high income levels (strata 4, 5 y 6) and to non-residential customers is 20%. The same overcharge will be applied to poor customers (strata 1,2 and 3) in the second and third blocks of consumption. * The deadline to comply with all those regulation has been set to be December 2005. Currently there are only a few utilities which have complied with all the regulations established by the CRA. Most of the medium and small municipalities have applied tariffs without taking into account the cost of providing the service, and in most cases they have not even provided the CRA information regarding the level of their tariffs. The result has been the majority of the water utilities charge too low tariffs. Some of the reasons that can explain low tariff levels applied by these utilities are: political interference, inefficiently run utilities and lack of technical capacity at management level. Consequently most of the utilities have been financially dependent on government subsidies to cover investments and sometimes even operating costs. The utilities included in the sample on which the financial analysis was carried out are in the same situation as most of the water utilities in Colombia. Tariff structures do not follow the guidelines issued by the CRA, and current tariff levels are lagging far behind the targets set by the current regulations. In ERAS and Cumaral current water and sewerage tariffs are just 21% and 30%, respectively, of their economic cost; in Nataga is 36%; and in Maicao and Sincelejo 60% and 53%, respectively (Table 2). For these estimations it was assumed that for economic cost of medium size cities, the long run average incremental cost (LRAIC) is an approximation of the LRAC since no information was available on current assets appraised as its new brand value, which need to be supplied in the tariff formula of CRA. For small municipalities, the long run average cost (LRAC) was calculated according to the reference values given by the CRA for utilities with less than 8,000 households connected to the service, which Page 72 applies to Nataga and Cumaral5. Operating costs were added based on the information used for the financial and economic evaluations. The tariffs used for the financial and economic analyses were those agreed upon by the Ministry of Economic Development and the municipal authorities during project preparation. These tariffs are in all cases higher than the current tariffs except for Sincelejo. The increase is more than double in ERAS and Cumaral, 32% in Maicao, and 21% in Nataga (Table 2). In Sincelejo, average the tariff remains the same, in spite of changes in some of the tariff levels in different strata categories. It was assumed that a transition period of 5 years will be applied to reach these tariffs gradually6, so that by December 2005 the agreed tariffs will be fully implemented, in accordance with the deadline set by the CRA. The ratio of the agreed tariffs and their corresponding economic cost is about 50% in ERAS, Sincelejo, and Nataga; 82% in Maicao, and 69% in Cumaral. Table 2: Economic Cost and Tariffs for Water and Sewerag Water and Sewerage Cumaral Nataga Maicao Sincelejo ERAS Economic cost' (US$/m3) 0.51 0.51 0.88 0.74 1.02 Current tariff (US$/m3 ) 0.15 0.19 0.53 0.39 0.22 Current tariff as % of Economic Cost 30% 36% 60% 53% 21% Tariff in Draft Bidding Contract (US$/m3) 0.37 0.23 0.72 0.39 0.50 Tariff in Draft Contract as % Economic Cost 72% 45% 82% 52% 49% The economic cost assumed is the LRAIC for medium cities, and the LRAC for small cities. Based on the economic cost, the subsidies' and the overcharges which result from the tariffs presented in the draft bidding documents were calculated. The results were then compared with the guidelines given by the CRA. This procedure was repeated for each of the components of the tariff structure (i.e., for each of the terms of the tariff formula) and the results are presented in tables 3 and 4. 5 To facilitate the application of the methodology of the tariff formulas, the CRA estimated values of the long run average cost (LRAC) for water investment in municipalities serving less than 8,000 customers. The values depend on the monthly consumption per connection and the annual growth rate of demand, and are presented in prices of December 1995. For consumption between 20 and 25 m3 per month and annual growth rate between 1% to 2% the investment LRAC for water is Col$ 291.96/m3, and from 2% to 3% growth, the LRAC is Col $ 269.24/m3. The first value was used for Nataga and the second one for Cumaral. For sewage CRA authorizes a 40% increase as an approximation cost. These equivalent water and sewage LRAC of investment at December 2000 prices are Col$ 81 I/m3 and Col $ 748/rn3 respectively. For more detail see Resolution CRA No 15 de 1996. 6 With the excepcion of Sincelejo and Nataga, where tariffs do not change much. 7 The subsidy and overcharge reflect the amount recovered through tariffs in relation to the investment cost. To estimate subsidy or overcharge, first the portion of the tariff related to investment (i.e., free of operating costs) is calculated, and then it is compared to the investment cost. Page 73 Table 3: Tariffs in the Draft Bidding Document of the Sample Utilities Cumaral Nataga Maicao Sinceleo ERAS Stratum I Monthly fixed charge (US$hh/month) 1.6 0.4 2.9 1.6 4.2 First Block of Consumption (1-20 m 3) (US$/m3) 0.2 0.2 0.3 0.2 0.2 Second block of consumption (20-40m 3(US$/m3) 0.3 0.2 0.8 0.7 0.5 Third Block of consumption (>40 m3 (US$/m3) 0.3 0.3 0.8 0.7 0.5 Stratum 2 Monthly fixed charge (US$hh/month) 1.9 0.7 3.3 1.6 4.2 First Block of Consumption (1-20 m 3) (US$/m3) 0.2 0.2 0.4 0.2 0.3 Second block of consumption (2040m 3(US$/m3) 0.3 0.2 0.9 0.7 0.5 Third Block of consumption (>40 m3 (US$/m') 0.3 0.3 0.9 0.7 0.5 Stratum 3 Monthly fixed charge (US$ hh/month) 2.3 1.0 4.5 1.6 4.2 First Block of Consumption (1-20 m 3) (US$/m3) 0.2 0.2 0.5 0.2 0.4 Second block of consumption (2040m 3(US$/m) 0.4 0.2 1.0 0.7 0.5 Third Block of consumption (>40 m3 (US$/m3) 0.4 0.3 1.0 0.7 0.5 Stratum 4 Monthly fixed charge (US$hh/month) 3.2 1.2 5.5 5.8 4.2 First Block of Consumption (1-20 m 3) (US$/m3) 0.3 0.2 0.6 0.5 0.5 Second block of consumption (20-40m 3(US$/m3) 0.4 0.2 1.3 0.9 0.5 Third Block of consumption (>40 m3 (US$/m3) 0.4 0.3 1.3 0.9 0.5 Stratum 5 Monthly fixed charge (US$hh/month) 4.8 1.2 5.5 5.8 4.2 First Block of Consumption (1-20 m 3) (USS/m3) 0.3 0.2 0.6 0.5 0.5 Second block of consumption (20-40m 3(US$/m3) 0.5 0.2 1.3 0.9 0.5 Third Block of consumption (>40 m3 (US$/m') 0.5 0.3 1.3 0.9 0.5 Stratum 6 Monthly fixed charge (US$ hh/month) 5.8 1.2 5.5 5.8 4.2 First Block of Consumption (1-20 m 3) (US$/m3) 0.3 0.2 0.6 0.5 0.5 Second block of consumption (2040m 3(US$/m3) 0.5 0.2 1.3 0.9 0.5 Third Block of consumption (>40 m3 (US$/m3) 0.5 0.3 1.3 0.9 0.5 The tariff structures agreed upon by MED and the respective municipal authorities for the sample utilities do not fully comply with the current regulation guidelines in respect of: (i) the requirements that no subsidies be included in the tariffs of strata 4,5 and 6, nor in the second and third blocks of consumption of strata 1,2 and 3 (subsidies have been assigned to high income residential customers of categories 4-6 with monthly consumption smaller than 20 m3 and to consumption blocks greater than 20 m3 per month); and (ii) overcharges, when existing, are higher than 20% (Table 4). However, the deviation from the regulation requirements does not have much impact because the municipalities under consideration include only a small number of households in strata 4-6 (and only in two of them). Also, consumption usually does not reach the second block (over 20 m3/month). These issues were discussed with the PIU, lessons were learned from the procedures used during preparation and conclusions were drawn. These procedures will not be repeated during project implementation, but rather improved ones which will ensure that all the tariffs which will be agreed upon with participating utilities will comply with the current tariff structure legislation. As part of the learning and training process of the PIU during project preparation, some adjustments were proposed to the tariffs agreed upon with the municipal authorities included in the sample. The new proposed tariffs are shown in one of the following sections of this Annex. Page 74 Table 4: Subsidies and Overcharges Embedded in the Tariffs Agreed upon with the Municipal Authorities (the Draft Bidding Documents Tariffs) Cumaral Nataga Maicao Sincelejo ERAS Stratum I First block (include fixed charge) 66% 85% 51% 60% 65% Second Block (20 - 40 m 56% 72% 15% 10% 59% Third block (>40 m) 56% 67% 15% 10% 59% Siratum 2 First block (include fixed charge) 58% 78% 58% 72% 79% Second Block (20 - 40 m ') 56% 72% 0% 10% 590/o Third block (>40 m ) 56% 67% 0% 10% 590/o Stratum 3 First block (include fixed charge) 48% 70% 42% 72% 67% Second Block (20 -40 m 3) 37% 72% -17% 10% 59% Third block (>40 m ) 37% 67% -17% 10% 59% Stratum 4 First block (include fixed charge) 30% 63% 32% 41% 59% Second Block (20 - 40 m ') 26% 72% -49% -22% 59% Third block (>40 m ) 26% 67% -49% -22% 59% Stratum _ First block (include fixed charge) 12% 63% 32% 41% 590/o Second Block (20 - 40 mi3) 3% 72% -49% -22% 59% Third block (>40 m ) 3% 67% -49% -22% 59% Stratum 6 First block (include fixed charge) I % 63% 32% 41% 59% Second Block (20 - 40 m 3) 3% 72% -49% -22% 59% Third block (>40 m ) 3% 67% -49% -22% 59% Note: The calculations of subsidies and overcharged take into account only the investment costs When the estimated monthly bills (based on a consumption of 15 m3) of the consumers in the sample municipalities were compared to those of some other cities whose tariffs have followed CRA regulation (Medellin, Cartagena and Bogota), it was noted that for low income customers (strata 1,2 and 3) the bills are higher in the sample municipalities, while for higher income customers (strata 4,5 and 6) the bills are lower in the sample municipalities. Table 5: Comparison of Monthly Bills in the Sample Municipalities with Monthly Bills in Medellin, Cartagena and Bogota (Bills in US$/Month) Sample Other Utilities Cumaral Nataga Maicao Sincelejo ERAS Medellin Cartagena Bogota Stratum I 4.7 2.9 7.6 5.3 7.8 2.4 2.9 6.0 Stratum 2 5.3 3.4 9.2 5.3 8.5 4.8 6.2 7.7 Stratum 3 5.9 4.0 12.3 5.3 10.3 9.0 10.2 10.5 Stratum 4 7.2 4.5 14.7 12.6 11.4 14.7 14.0 12.8 Stratum 5 8.8 4.5 14.7 12.6 11.4 23.2 21.3 20.0 Stratum 6 9.8 4.5 14.7 12.6 11.4 30.8 29.6 25.2 Note: Bills estimated on the basis of a monthly consumption of 15 m' Page 75 IV. Results The results of the financial analysis are presented in table 6. They confirm that none of the sample utilities would be financially viable after PSP without receiving a government investment subsidy. The amount of the subsidy required in each case varies depending mainly on the tariff agreed upon and on the efficiency gains which would be obtained by the private operator. The net present value of total amount of subsidies required for the 5 utilities included in the sample is estimated at US$ 15 million. The results show that the structure of the operation contracts allows the shareholders and the business to generate enough profits to attract investors. The profit for the shareholders is estimated at US$ 5 million, while the benefit from the operation is also estimated at US$ 5 millions (Table 6). Table 6: NPV, IRR and Subsidies for the Sample Utilities Utilizing the Tariffs Agreed Upon with the Municipal Authorities Utility Contract Results for Investors Results for the Business Subsidy Period Required NPV IRR in real NPV IRR in real NPV (000 US$) terms (000 US$) terms (OOOUS$) Cunmaral 10 years 51 17.3% 193 24.1% 864 Nataga 10 year 3 15.7% 35 30.5% 185 Maicao 30 year 314 12.8% 315 12.6% 6,773 ERAS 20 year 1,199 18.0% 1,363 17.2% 4,817 Sincelejo 30 year 3,139 22.2% 3,154 19.5% 2,421 Total 4,706 17.0% 5,060 16.0% 15,060 Subsidies The subsidy corresponds to 23% of investment in medium size municipalities and 70% in small municipalities. Capital injection is about the same in all the municipalities, with an average of 13% of investment. The required long term debt and internal sources is about 64% in medium size municipalities and 17% in small municipalities (Table 7). The resultant percentages of subsidies required to finance investments are reasonable, given that the population of small municipalities has, in general, a lower income than that of medium size cities, and most of households in small municipalities are located in areas of the three lowest income categories. Table 7: Sources of Investment Financing (Present Values, US$ 000) Maicao ERAS Sincelejo Nataga [Cumaral Total Medium Small I______________ ______ I_________ ________ _________ ________ ____ _ cities cities Investments 21,J517 14,873 24,215 244 1,249 62,099 60,606 1,493 Financing Sources Subsidy 6,773 4,817 2,421 185 864 15,059 14,010 1,049 Capital Injection 3,698 1,849 2,694 20 174 8,436 8,242 194 Long Terrn debt 7,535 3,536 5,730 16 175 16,992 16,801 191 Internal sources 3,511 4,671 13,370 23 36 21,611 21,552 59 Total 21,517 14,873 24,215 244 1,249 62,099 60,606 1,493 Financin Sources (%) Subsidy 31% 32% 10% j 76% 69% 24% 23% | 70% Capital Injection 17% 12% 11% 8% 14% 14%0/ 14% 13% Loan 35% 24% 24% 7% 14% 27% 28% 13% Internal sources 16% 31% 55% 9% 3% 35% 36% 4% Total 100% 100% 100% 100% 100% 100% 100% 100% s The resulting IRR are calculated based on the amount of subsidy which can be given and the maximum tariffs that can be charge to the communities. Page 76 When the subsidy is analyzed in terms of number of households connected and number of people served, the conclusions are similarly reasonable (table 8). The subsidy per person served is higher in small municipalities and lower in medium cities. There is no perfect relationship between income and subsidy, but there is a tendency to provide a higher subsidy in cities with lower incomes (table 8). Table 8: Average Household Income and Subsidy per Connection _Maicao ERAS Sinceleio Nataga Cumaral Current Population 117,519 121,599 227,104 2,061 9,931 Income per household (US$/hh-month) 191 161 188 91 150 Subsidy per connection (US$/conn) 275 189 37 361 324 Subsidy per person (US$/pp) 48 36 8 76 65 Financial Indicators From the financial standpoint, the projects are viable and the financial indicators of each utility demonstrate that the companies are stable during the entire period of the operation contracts. On the basis of the assumptions of the financial analysis, the utilities will stay financially firm, will have the financial capacity to serve the loans they need to contract, and will enjoy a sufficiently high liquidity which will ensure that they stay financially healthy. The financial statements of each utility are presented at the end of this Annex and a summary of the main financial indicators is shown in table 9. Table 9. Main Financial Indicators of the Sample Utilities Under Base Case Scenario Conditions Utility Min Debt Maximum Minimum Service Debt Equity Liquidity (current Coverage Ratio) Cumaral 0.9 (2nd year) 0.5 (1st year) 2.3 (I"5 year) Nataga 1.3 (2nd year) 0.3 (lt year) 2.1 (It year) Maicao 1.0 (2nd year) 0.8 (5th year) 1.5 (1" year) ERAS 0.8 (1" year) 0.3 (3nd year) 2.4 (3nd year) Sincelejo 2.5 (I'tyear) 0.5 (3rd year) 1.1 (lryear) Risk and Sensitivity Analysis Sensitivity Analysis The variables identified as conveying major risk to the project are presented in table 10. This analysis estimates the impact of a single variable changes in an static world. The variables identified in table 10 were switched until the subproject analyzed presented no positive impact. Page 77 Table 10. Risk Variables and their Impact and Risk Significance Investment cost overrun Direct impact on investment costs. Largely under management control. Conveys a high risk to the financial results of the project. If they are higher than 15% the NPV of business benefits becomes negative. In Maicao they can not be higher than 2%. A similar situation happens with the NPV of investors. Operating cost overrun Direct impact on operating costs. Largely under management control. They convey a moderate risk for all the projects, but Maicao where they can not be higher than 6%. Subsidy from National and Direct impact on return of business. Based on National or departmental Departmental Governments government's decisions and hence beyond management control. Conveys a high risk to some projects, as Maicao, where it has to be at least 90% of the assumed value, in Nataga 70% and in Cumaral 60% Subsidy from Municipal Government Direct impact on return of business. Based on Municipal authorities' decisions and hence beyond management control. Conveys a high risk to some projects as Maicao, where it has to be at least 93% of its assumed values, and ERAS where it has to be at least 53% of its assumed values. Revenue Collection rate Direct impact on revenue collection. Largely under management control. It I conveys a moderate risk to the project. Besides these variables, a sensitivity analysis was carried out for variations in the discount rate from 12% to 16% and 20%. Results show that when a discount rate of 16% is considered, the project is still viable in all municipalities but Maicao, where subsidies would have to increase from 32% to 40% of investment and equity would have to decrease from 17% to 12% of investment to make the project viable. When a discount rate of 20% is considered, the business is viable only in Sincelejo, however, from the investors point of view, the project is still viable in Cumaral and Nataga. In order to turn the project viable with such an discount ratem, it is necessary to increase the average percentage of subsidies in medium cities from 23% of investment to 31%. That will result in an IRR of 21.7% for both business and investors. It is interesting to note however that the riskiest project, i.e, Maicao, was already awarded to a private operator and that the investors requested a subsidy amount similar to the one calculated in the base case scenario of that project. Risk Analysis To enhance the accuracy of the financial analysis, the dynamic and uncertainties of the real world were approximated through the use of Monte Carlo simulations using the Crystal Ball software. This software measures the extent of various risks and their effect on the project, modeling a probable distribution for each risk variable and the resulting outcome. Based on simulation of 1,000 trials the model recalculates the results of the financial analysis by simultaneously changing each of the selected variables. The assumed distribution of probabilities and their respective specifications for each variable are presented in table 11. Table 11: Risk Variables and their Distribution of Probability Investment cost overrun Triangular distribution. Minimum value: -10%, likeliest: 0%, and Maximum value: 20%. Operating cost overrun Triangular distribution. Minimum value: -10%, likeliest: 0%, and Maximum value: 20%. Revenue Collection rate Normal distribution for assumed values. Mean 0, standard deviation 10% The financial risk analysis shows a very robust project for investors, in Cumaral, Sincelejo, and Eras, where the probability of having a positive return is higher than 90%. In Nataga and Maicao those probabilities are 58% and 42%, respectively, with a very interesting result that when all risks variable are analyzed simultaneously in a dynamic world, the most important variable impacting the project's financial cash flow is investment cost overrun, which is largely under management control. From the business point of view, the probability of having positive return is almost risk free in Nataga, Cumaral, Sincelejo, and Eras. In Maicao this probability is about 40%, however, the most important Page 78 variable impacting the result is the investment cost overrun, which is under the control of management, and makes the project less risky. Table 12: Probability of Positive NPV Benefit Business Investors Mean Expected Probability of Mean Expected Probability of NPV Positive NPV NPV Positive NPV (US$000) for business (USS 000) for investors Nataga 27 96% 2 58% Cumaral 158 97% 54 99% Maicao (383) 41% (126) 42% Sincelejo 2,196 95% 2,495 100% ERAS 703 87% 682 90% V. Conclusion and Recommendations The results of the financial analysis demonstrate that none of the utilities included in the sample would be financially viable after PSP without receiving a government investment subsidy. This confirms the basic assumption of the project, that the water utilities of the target municipalities can become financially viable only if they receive an adequate investment subsidy. It was found that carrying out a financial analysis and generating financial projections for each participating utility is an important an essential step in the evaluation of the operation of each utility by the private sector and in determining its eligibility to participate in the project. During project preparation, some lessons which helped to develop a procedure for the evaluation of interested utilities were learned. These also helped to develop the methodology for determining the target tariffs which will form the basis for negotiation of tariffs with the municipal authorities of each utility. Setting the right target tariff is a key issue in conducting successful negotiation with the municipal authorities. The following considerations need to be taken into account when establishing the right target tariffs: * The government is ready to provide a subsidy with a cap of US$ 500 per connection for small municipalities and US$ 250 per connection for medium size cities. * The tariffs need to cover at least operation and maintenance costs in small municipalities and part of the investments in medium size cities. * The tariffs must comply with the legislation regarding tariff structure and level of subsidies. * The tariff levels need to be socially acceptable, i.e., compatible with the capacity to pay. * Each municipal authority must participate in partial financing of investments by providing to the utility a portion of its Law 60 transfers income. * The privatized utility must be financially viable and attractive to the private sector, i.e., the returns for investors and for the business must be higher than 12% (in real terms). The methodology which will be used during project implementation for determining the target tariffs, is the following: * First the cost of providing the services will be estimated according to methodologies established by the current guidelines of the CRA. The cost will be estimated based on the minimum cost investment plan, projected demand and efficiency gains expected to be achieved during the operation contract period. All the investment plan should be included in the cost estimates. * Based on the economic cost, preliminary tariffs for each category of customers and for each block of consumption will be set. The guidelines on subsidies and overcharges established in Law 142 and the resolutions of the CRA will be applied. Page 79 * Estimation of the monthly bills for the poorest residential customers based on the first consumption block will be carried out. A social assessment will be undertaken to establish the relation between the monthly bills and the capacity to pay. If the bills are too high compared to the capacity to pay, an additional subsidy will be incorporated. The subsidy will only be applied to investment costs and not to operating costs. * Financial model run will be carried out using the preliminary tariffs established earlier, which for poor customers will include the assumed subsidy and for other customers will be free of subsidy. * The subsidy could come from two different sources: (i) cross subsidy, corresponding to a subsidy given to the poor which could be compensated partially or totally through the overcharges paid by the wealthier customers; and (ii) direct subsidy, which corresponds to transfer from the government provided to the utility to pay part of the investments. Under the current regulation requirements the municipalities need to establish a special fund of the transfers resulting from cross subsidy denominated "fondo de solidaridad". When the internal sources and the "fondo de solidaridad" do not generate enough funds to cover investment cost, a direct subsidy or transfers from public resources could be obtained. The first source will be municipal transfers from Law 60 resources, then departmental or national government funds. * If the utility does in fact require a direct subsidy, its amount will be calculated using the financial model which generates financial projections under different scenarios based on variation of subsidies (both government and Law 60) and tariffs. The required government subsidy will be the one which, along with acceptable Law 60 contribution and acceptable tariff levels, would allow an adequate financial return for the business and the investor, and will not be higher than the set cap. This entails the application of an iterative processes based on successive financial model runs which will generate the required set of results. - The iterative analysis will generate for each utility the proposed target tariff and the proposed investment subsidy. The PIU will negotiate with the municipal authorities the tariff which will be included in the operation contract, utilizing as the starting position the target tariffs and the corresponding government subsidy and Law 60 contributions resulting from the iterative process of financial model runs. During the negotiation the financial model will be used to run additional scenarios which may come up. If an agreement acceptable to the PIU (in terms of reasonable tariffs, Law 60 contribution and government subsidy level) will be reached and later approved by the Bank, the utility will be included in the project, however, if the municipal authorities will insist on maintaining the tariffs too low and on requiring an unjustifiably high subsidy, the participation of the utility in the project will be rejected. As previously mentioned, the tariffs agreed upon during project preparation with the municipal authorities of the sample utilities deviate in some aspects from regulation requirements. As part of the training of the PIU in utilizing the methodology developed for setting the right tariffs, the agreed tariffs were adjusted and a new set of tariffs has been calculated for the sample utilities, utilizing the developed methodology. This entailed recalculating the tariff for each category of residential customers, and for each consumption block in all the sample municipalities, as well as the required government subsidy in each case. In order to calculate the tariffs, the values of the economic cost of providing the service were required. According to CRA these correspond to the long run average cost (LRAC), including operating and investment cost. The LRAC for investment is defined by the CRA as the sum of the current assets appraised at their new brand value and the present value of future investments divided by the present value of total demand. For medium size cities, the LRAIC was used as an approximation of the LRAC, while for small municipalities, the LRAC values used were those estimates according to guidelines of the CRA9. Based on the subsidy policy defined in the current regulation, the tariffs were calculated, in such a 9 Resolution CRA No 15 de 1996. Page 80 way, that subsidies were applied only to low income strata and to the first block of consumption, and overcharges, applied only to high income customers and high consumption blocks, do not exceed 20%. The corrected proposed target tariffs for the sample utilities and their corresponding subsidies and overcharges, calculated on the basis of the developed methodology (which will also be used during project implementation) are presented in tables 13 and 14. Table 13. New Proposed Tariffs for the Sample Utilities Stratum I Cumaral Nataga Maicao Sincelejo ERAS Monthly fixed charge (US$hh/month) 0.1 0.1 1.6 0.2 0.3 First Block of Consumption (1-20 m 3) (US$/m3) 0.2 0.1 0.4 0.3 0.3 Second block of consumption (2040m k(US$/m') 0.5 0.5 0.9 0.7 1.0 Third Block of consumption (>40 m3 (US$/m') 0,5 0.6 1.1 0.9 1.2 Stratum 2 Monthly fixed charge (US$hh/month) 0.3 0.1 1.6 0.4 0.4 First Block of Consumption (1-20 m 3) (US$/m3) 0.2 0.2 0.5 0.3 0.4 Second block of consumption (20-40m 3(US$/m3) 0.5 0.5 0.9 0.7 1.0 Third Block of consumption (>40 m3 (US$/m3) 0.5 0.6 1.1 0.9 1.2 Stratum 3 Monthly fixed charge (US$hh/month) 0.5 0.2 2.4 0.7 0.5 First Block of Consumption (1-20 m i) (US$/m') 0.3 0.2 0.8 0.6 0.7 Second block of consumption (2040m '(US$/m3) 0.5 0.5 0.9 0.7 1.0 Third Block of consumption (>40 ml (US$/ml) 0.5 0.6 1.1 0.9 1.2 Stratum 4 Monthly fixed charge (US$hhlmonth) 0.7 0.2 2.7 0.9 0.7 First Block of Consumption (1-20 mi') (US$/m') 0.5 0.5 0.9 0.7 1.0 Second block of consumption (2040m 3(USS/m3i) 0.5 0.5 0.9 0.7 1.0 Third Block of consumption (>40 m' (US$/m') 0.5 0.6 1.1 0.9 1.2 Stratum 5 Monthly fixed charge (US$hh/month) 0.9 0.2 2.7 1.3 0.7 First Block of Consumption (1-20 m ') (US$/mn) 0.5 0.6 1.1 0.9 1.2 Second block of consumption (20-40m 3(USS/m3) 0.5 0.6 1.1 0.9 1.2 Third Block of consumption (>40 m' (US$/m') 0.5 0.6 1.1 0.9 1.2 Stratum 6 Monthly fixed charge (US$hh/month) 0.9 0.2 2.7 1.9 0.7 First Block of Consumption (1-20 m 3) (US$/m3) 0.5 0.6 1.1 0.9 1.2 Second block of consumption (20-40m '(US$1m3) 0.5 0.6 1.1 0.9 1.2 Third Block of consumption (>40 m' (US$/m') 0.5 0.6 1.1 0.9 1.2 Page 81 Table 14: Subsidies and Overcharges in the New Proposed Tariffs Cumaral Nataga Maicao Sincelejo ERAS Stratum I First block (include fixed charge) 83% 99% 50% 69% 74% Second Block (20- 40 m 3) 0% 0% 0% 0% 0% Third block (>40 m ) -9% -17% -20% -20% -20% Stratum 2 First block (include fixed charge) 77% 78% 40% 60% 65% Second Block (20 - 40 m 3) 0% 0% 0% 0% 0% Third block (>40 m) -9%/0 -17% -20% -20% -20% Stratum 3 First block (include fixed charge) 44% 68% 15% 15% 30% Second Block (20 - 40 m 3) 0% 0% 0% 0% 0% Third block (>40 m) -9% -17% -20% -20% -20% Stratum 4 First block (include fixed charge) 0% 0% 0% 0% 0% Second Block (20 - 40 m) 0% 0% 0% 0% 0% Third block (>40 m) -9% -17% -20% -20% -20% Stratum 5 First block (include fixed charge) -20% -20% -20% -20% -20% Second Block (20 - 40 m 3) -9% -17% -20% -20% -20% Third block (>40 m) -9% -17% -20% -20% -20% Stratum 6 First block (include fixed charge) -20% -20% -20% -20% -20% Second Block (20 - 40 m 3) -9% -17% -20% -20% -20% Third block (>40 m) -9% - 17% -20% -20% -20% Comparing these proposed tariffs with the ones in the draft bidding documents (see table 3), the monthly bill for low income strata will be lower for consumption in the first block, while for high income strata the monthly bill will be higher. The financial results calculated on the basis of the newly proposed tariffs show an improvement in comparison to the results of the base case scenario (see table 15 for new results and compare to table 6 for base case scenario results). The project (i.e., the total operation of the five sample utilities) will generate an additional US$ 4 million, and investors will receive an additional return of US$ 5 million in profits. The government will be also benefit from newly proposed set of tariffs and subsidies since the total amount of subsidies it will need to provide will be reduced by US$ 5 million. Table 15: NPV, IRR and Subsidies with the Newly Proposed Tariffs Utility Contrac Results for Investors Results for the Business Subsidy t Required Period NPV IRR in NPV IRR in NPV (OOOUS$) (000 US$) real (000 US$) real terms terms Cumaral 10 years 59 18.2% 203 24.9% 864 Nataga 10 year 21 36.5% 27 20.3% 145 Maicao 30 year 716 13.8% 809 13.5% 6,773 ERAS 20 year 1,362 17.8% 938 14.3% 2,509 Sincelejo 30 year 7,140 37.9% 7,246 26.6% 0 Total 9,297 21.2% 9,224 18.3% 10,291 The subsidies under the new proposal account for 15% of investment in medium size cities and 68% in small municipalities. In Sincelejo a government subsidy is not necessary (compare table 16 to table 7). Page 82 The internal sources increased in medium size cities by 3% (from 36% to 39%), and in small municipalities by 1%, from (4% to 5%). Table 16: Source of Investment Financing Under the New Tariff Proposal (Present Values US$ 000) Maicao ERMS Sincelejo Nataga Cumaral I Total Mediaum Small .__ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ __I cities cities Investment 21,517 14,83 24,215 244 1,249 62,099 60,606 1,493 Financing Sources _ _ Subsidy 6,773 2,509 - 145 864 10,291 T 9,282 1,008 Capital Injection 3,698 1,849 2,694 20 174 8,436 8,242 194 LT debt 7,403 5,455 6,449 39 173 19,518 19,307 211 Internal sources 3,643 5,060 15,072 41 38 23,854 23,775 79 Total 21,517 14,873 24,215 244 1,249 62,099 60,606 1,493 Financing Sources (%) Subsidy 31% 17% 0% 59% 690/o 17% 15% 68% Capital Injection 17% 12% 11% 8% 14% 14% 14% 13% Loan 34% 37% 27% 16% 14% 31% 32% 14% Internal sources 17% 34% 62% 17% 3% 38% 390/o 5% Total 100% 100% 100% 100% 100% 100% 100% 100% The required subsidy for small municipalities is about US$ 300 per connection or about US$ 60 per person served. In medium size cities, excluding Maicao'°, the required subsidy is about US$ 100 per connection or about US$ 20 per person (table 17). Table 17: Income and Subsidv per Connection Under the New Tariff Pr posal Maicao ERAS Sincelelo Nataga Cumaral Current Population 117,519 121,599 227,104 2,061 9,931 Income per household (US$/hh-month) 191 161 188 91 150 Subsidy per connection (US$/conn) 275 98 - 282 324 Subsidy per capita (US$/pp) 48 19 60 65 Based on the analysis presented it can be concluded that the subsidy cap in terms of percentage of investment should be about 70% for small municipalities and about 15% for medium size cities. When defined in tersm of subsidy per connection the subsidy cap should be about US$ 500 per connection for small municipalities and about US$ 250 per connection for medium size cities. Expected Financial Indicators Values Required to Maintain the Financial Health of the Utilities The financial indicators values which will be required to maintain the privately operated utilities financially viable are: (i) debt-equity ratio of less than 1; (ii) liquidity ratio of more than 1; (iii) starting debt-service coverage of more than 0.8, increasing gradually to 1.3 by the end of the fifth year of operation; and (iv) starting working ratio of less than 1, decreasing gradually to 0.6 by the end of the fifth '0 Maicao presents the same amount of required subsidy as in the base case scenario. The reason is that Maicao will have a problem of rationing of water even after the project is implemented, and at the same time there is a program to install domestic meters for most of the customers. Given the insufficient supply, people consume less than thcy require and therefore they are charged for a low consumption. Under this situation, changes in tariff do not have a big impact on billed consumption neither on revenues. Page 83 year of operation. These financial indicators and their proposed values will be included in the operation contracts as target values which the utilities need to achieve under private operation. Financial Summary for Municipal Water Concession of Eras 2001 2002T20 0420 0620 08 0921 01 21 05 22 Forecast Income Statement Items Revenues Water 1,153 1,506 1,909 2,585 2,694 2,762 2,832 2,904 2,977 3,053 3,114 3,176 3,371 3,723 Sewerage 274 388 514 780 852 916 1,011 1,037 1,063 1,090 1,112 1,134 1,204 1,329 Revenues (Total) 1,427 1,894 2,423 3,365 3,545 3,678 3,843 3,940 4,040 4,143 4,226 4,310 4,575 5,052 Operating Income 418 912 1,381 2,243 2,377 2,478 2.599 2,677 2,747 2,818 2,876 2,935 3,120 3,453 Net Income 187 422 547 1,044 1,088 1,079 1,128 1,189 1,183 1,134 930 1,003 1,378 1,858 Funds Statement Items Internal Sources 303 666 1,063 1,647 1,756 1,860 1,953 1,997 2,069 2,166 2,333 2,352 2,332 2,402 Subsidies 1,116 1,463 1,450 657 682 708 735 756 0 0 0 0 0 0 Borrowings 0 732 1,717 0 653 452 0 0 1,319 1,964 698 0 0 0 Equity Investments 1,134 1,080 0 0 0 0 0 0 0 0 0 0 0 0 Total Sources 2,552 3,940 4,229 2.305 3,091 3,020 2,689 2,754 3,388 4,131 3,031 2,352 2,332 2,402 Capital Expenditures 1 5,867 3,524 1,240 2,694 2,641 1,902 1,869 2,731 3,512 1,774 936 314 105 Working Capital Increase (Decrease) 965 -315 640 -15 -14 -110 126 -127 255 -67 159 -31 78 28 Debt Service 357 230 366 572 381 460 543 478 498 655 1,151 1,164 676 218 Dividend 168 8 331 497 22 22 235 527 151 23 98 276 1,378 1,858 Total Applications 1,491 5,789 4.860 2,294 3,083 3,013 2,806 2,747 3,635 4,123 3,182 2,345 2,446 2,209 Change in Cash 1,061 -1,849 -631 11 8 7 -117 6 -248 8 -151 7 -114 193 Balance Sheet Items Current Assets 2,527 279 567 543 518 406 456 331 443 375 441 405 528 1,134 2 Less Current Liabilities 315 76 238 81 83 84 117 86 151 90 131 94 119 116 Net Fixed Assets 57 5,645 8,928 9,836 12,021 14,058 15,350 16,558 18,577 21,258 22,193 22,308 20.849 18,806 t Total Assets 2,268 5,848 9,258 10,298 12,456 14,380 15,690 16,803 18,868 21,542 22,503 22,619 21,259 19,824 Debt 0 732 2,344 2.003 2,341 2,411 1,995 1,614 2,582 4,038 3,990 3,206 1,537 45 Equity 2,268 5,116 6,913 8,296 10,115 11,969 13,695 15.189 16,286 17,504 18,513 19,413 19,722 19,779 Total Liabilities and Equity 2,268 5,848 9,258 10,298 12,456 14,380 15,690 16,803 18.868 21,542 22,503 22,619 21,259 19,824 Financial Ratios Operating Income as a % of Revenue 29.3% 48.2% 57.0% 66.7% 67.1% 67.4% 67.6% 67.9% 68.0% 68.0% 68.1% 68.1% 68,2% 68.3% Net Income as a % of Revenue 13.1% 22.3% 22.6% 31.0% 30.7% 29.3% 29.3% 30.2% 29.3% 27.4% 22.0% 23,3% 30.1% 36.8% Retum on Average Invested Capital 11.4% 9.1% 13.7% 11.8% 9.8% 8.8% 8.2% 7.5% 6.7% 5.2% 5.3% 7.0% 9.4% Debt Service Coverage -1.9 4.3 1.2 2.9 4.6 4.3 3.4 4.4 3.6 3.4 1.9 2.0 3.3 10.9 % of Total Capital Expenditures financed 12.8% 1.6% 88.0% 51.5% 57.2% 67.6% 88.1% 48.2% 44.9% 57.7% 100% 100% 100% by Internal Sources Current Ratio 8.01 3.67 2.38 6.71 6.25 4.85 3.91 3.86 2.92 4.17 3.36 4.33 4.45 9.74 Debt as % of Equiy 0.0 0.1 0.3 0.2 0.2 0.2 0.1 0.1 0.2 0.2 0.2 0.2 0.1 0.0 Main Efficiency Ratios Operating Ratio (incl. Depreciations) 71% 65% 59% 46% 47% 49%/o 48%/ 48% 50% 52% 52% 51% 47% 42% Working Ratio (excd. depreciations) 71% 52% 43% 33% 33% 33% 32% 32% 332% 32% % 32% 32% 32% Personnel Cost/Operating Cost 53% 50%o 50% 51%/ 51%° 52% 53% 53% 53% 53% 53% 53% 53% 53% Financial Summary for Municipal Water Concession of Maicao 2001 | 2002 | 2003 | 2004 2005 2006 2007 2008 2009 | 2010 | 2011 2012 2015 2020 Forecast Income Statement Items Revenues Water 1,247 1,350 1,426 1,479 2,059 2,180 2,282 2,385 2,489 2,595 2,624 2,653 3,314 3.468 Sewerage 595 608 611 606 850 922 985 1,051 1,119 1,189 1,213 1,238 1,585 1,734 Revenues (Total) 1,842 1,959 2,037 2,086 2,910 3,102 3,267 3,435 3.608 3,784 3,837 3,891 4,899 5,202 Operating Income 1,236 1,330 1,407 1,457 2,288 2,457 2,586 2,720 2,849 2,986 3,025 3,060 3,969 4,139 Net Income 569 586 588 495 774 633 674 810 927 1,056 1,134 1,194 1,447 1,502 Funds Statement Items Internal Sources 911 995 1,070 1,169 1,843 2,085 2,190 2,250 2,314 2,380 2,377 2,379 3,141 3,278 Subsidies 452 1,333 1,305 492 496 496 496 496 496 496 3,996 3,996 496 496 Borrowings 718 0 1,695 2,001 4,746 1,630 45 0 141 0 0 0 5,108 0 Equity Investments 2,268 2,160 0 0 0 0 0 0 0 0 0 0 0 0 Total Sources 4,348 4,487 4,071 3,662 7,085 4,211 2,731 2,746 2,951 2.876 6,373 6,375 8,745 3,775 Capital Expenditures 2,533 2,784 3,840 3,033 6,105 2,866 1,424 1,478 1,919 1,591 1,177 1,421 7,713 1,454 Working Capital Increase (Decrease) 1,964 1,117 533 136 317 -26 -126 -181 -209 -217 -152 -81 41 35 Debt Service 727 984 558 509 743 1,304 1,360 1,251 1,142 1,061 965 876 859 1,119 Dividend 512 528 325 117 236 63 67 193 93 435 1,020 1,075 165 1,195 Total Applications 5.736 5,413 5,256 3,795 7,400 4,207 2,726 2,741 2,945 2,870 3,010 3,290 8,779 3,802 Change in Cash -1,388 -926 -1,185 -133 -315 4 5 5 6 6 3,363 3,085 -33 -28 Balance Sheet Items Current Assets 777 1,044 395 392 407 387 350 303 254 205 3,528 6,429 143 159 Less Current Liabilities 514 305 159 60 105 26 28 29 31 33 33 34 48 53 Net Fixed Assets 3,231 6,280 10,007 12.637 18,097 20,095 20,567 21,051 21,935 22,498 22,717 23,239 37,854 38,449 Total Assets 3,495 7,019 10,242 12,969 18,400 20,456 20,889 21,325 22,158 22,669 26,212 29,634 37,948 38.555 ( Debt 718 638 2,260 4,004 8,290 8,968 7.951 6,966 6,196 5.342 4,555 3,830 8,327 3,365 Equity 2,776 6,380 7,983 8,965 10,110 11,488 12,938 14,359 15,962 17,328 21,657 25,804 29,621 35,189 Total Liabilities and Equity 3,495 7,019 10,242 12,969 18,400 20,456 20,889 21,325 22,158 22,669 26,212 29,634 37,948 38,555 Financial Ratios Operating Income as a % of Revenue 67.1% 67.9% 69.1% 69.8% 78.6% 79.2% 79.2% 79.2% 79.0% 78.9% 78.8% 78.7% 81.0% 79.6% Net Income as a % of Revenue 30.9% 29.9% 28.9% 23.7% 26.6% 20.4% 20.6% 23.6% 25.7% 27.9% 29.5% 30.7% 29.5% 28.9% Return on Average Invested Capital 12.8% 8.2% 5.8% 8.1% 5.9% 5.5% 5.9% 6.1% 6.3% 5.8% 5.0% 5.1% 4.3% Debt Service Coverage -1.4 -0. 1 1.0 2.0 2.1 1.6 1.7 1.9 2.2 2.4 2.6 2.8 3.6 2.9 % of Total Capital Expenditures financed 0% 0% 0% 17.3% 12.8% 28.2% 67.1% 79.8% 72.0% 96.5% 100% 100% 100% 100% by Internal Sources Current Ratio 1.51 3.42 2.48 6.53 3.89 14.67 12.54 1032 8.15 6.13 105.82 186.69 2.95 3.01 Debt as % of Equity 0.3 0.1 0.3 04 0.8 0.8 0.6 0.5 0.4 0.3 0.2 0.1 0.3 0 1 Main Efficiency Ratos Operating Ratio (incl. Depreciations) 39% 43% 49% 53% 46% 46% 45% 44% 44% 43% 42% 42% 47% 44% Working Ratio (excl. depreciations) 33% 32% 31% 30% 21% 21% 21% 21% 21% 21% 21% 21% 19% 20% Personnel CostUOperating Cost 71% 69% 69% 68% 66% 66% 66% 66% 66% 65% 66% 66% 65% 65% Financial Summary for Municipal Water Concession of Sincele'o 2001 2002 | 2003 | 2004 2005 2006 | 2007 2008 | 2009 | 2010 | 2011 2012 2015 | 2020 Forecast Income Statement Items Revenues Water 3,067 3,267 3,447 3,604 3,732 3,864 4,002 4,144 4,292 4,445 4,603 4,767 5,294 6,306 Sewerage 1,283 1,361 1,430 1,489 1,536 1,601 1,670 1,740 1,814 1,890 1,969 2,052 2,318 2,831 Revenues (Total) 4,350 4,628 4,877 5,093 5,268 5,466 5,672 5,885 6,106 6,335 6,572 6,818 7,612 9,137 Operating Income 3,002 3,234 3,448 3,639 3,803 3,952 4,109 4,272 4,442 4,614 4,800 4,987 5,590 6,719 Net Income 1,705 1,834 1,845 1,807 1,808 1,859 1,948 2,047 2,135 2,176 1,878 1,466 2,045 3,167 Funds Statement items Internal Sources 2,041 2,200 2,405 2,615 2,777 2,897 3,003 3,111 3,232 3,379 3,723 4,130 4,413 4,922 Subsidies 0 0 0 0 0 0 0 0 0 0 4,176 5,303 0 0 Borrowings 0 1,738 1,770 1,175 408 309 0 8 238 1,180 3,863 2,540 0 0 Equity Investments 2,268 864 0 0 0 0 0 0 0 0 0 0 0 0 Total Sources 4,308 4,802 4,175 3,791 3,184 3,206 3,003 3,119 3,469 4,559 11,763 11,973 4,413 4,922 Capital Expenditures 1,420 3,771 3,479 3,303 2,696 2,622 2,233 2.546 2,957 4,007 10.897 10,321 1,836 2,680 Working Capital Increase (Decrease) 2,227 982 127 -176 -297 -208 -151 -135 -133 -76 -43 -24 -4 0 Debt Service 824 894 587 620 743 745 728 657 592 573 860 1,635 1,350 645 Dividend 1,534 528 101 36 36 37 183 41 43 44 38 29 1,218 1,581 Total Applications 6,005 6,175 4,294 3,783 3,178 3,196 2,993 3,108 3,459 4,548 11,752 11,961 4,400 4,906 Change in Cash -1,696 -1,373 -119 8 7 10 10 10 10 11 11 12 13 16 Balance Sheet Items X Current Assets 777 450 452 404 334 288 256 229 204 193 188 188 201 240 Less Current Liabilities 679 372 161 132 133 137 140 144 148 152 156 161 174 208 Net Fixed Assets 2,339 6,255 9,418 12,056 13,817 15,506 16,819 18.405 20,332 23,233 32,605 41,031 40,427 44,221 Total Assets 2,438 6,333 9,708 12,328 14,018 15,658 16,934 18,489 20,388 23,273 32,637 41,059 40,454 44,253 Debt 0 1,738 3,260 3,954 3,750 3,440 2,826 2,271 1,992 2,665 5,897 7,307 3,998 593 Equity 2,438 4,595 6,449 8,374 10,267 12,218 14,108 16,219 18,396 20,608 26,740 33,751 36,456 43,660 Total Liabilities and Equity 2,438 6,333 9,708 12,328 14,018 15,658 16,934 18,489 20,388 23,273 32,637 41,059 40,454 44,253 Financial Ratios Operating Income as a % of Revenue 69.0% 69.9% 70.7% 71.5% 72.2% 72.3% 72.4% 72.6% 72.8% 72.8% 73.0% 73.1% 73.4% 73.5% Net Income as a % of Revenue 39.2% . 39.6% 37.8% 35.5% 34.3% 34.0% 34.3% 34.8% 35.0% 34.3% 28.6% 21.5% 26.9% 34.7% Return on Average Invested Capital 52.2% 33.4% 24.4% 19.4% 16.5% 14.8% 13.5% 12.3% 11.2% 7.9% 4.8% 5.7% 7.4% Debt Service Coverage -0.2 1.4 3.9 4.5 4.1 4.2 4.3 4.9 5.7 6.0 4.4 2.5 3.3 7.6 % of Total Capital Expenditures financed 0% 8.6% 48.6% 65.7% 86.5% 90,0% 100% 100% 94% 72% 26.7% 24.4% 100% 100% by Internal Sources Current Ratio 1.15 1.21 2.80 3.07 2.51 2.11 1.82 1.59 1.38 1.27 1.20 1.17 1.15 1.15 Debt as % of Equity 0.0 0.4 0.5 0.5 0.4 0.3 0.2 0.1 0.1 0.1 0.2 0.2 0.1 0.0 Main Efficiency Ratios Operating Ratio (incl. Depreciations) 33% 35% 38% 39% 40% 41% 41% 42% 42% 44% 50% 54% 49% 44% Working Ratio (excl. depreciations) 31% 30% 29% 29%0 2 28% 8 28% 28% 27% 27% 27% 27% 27% 27% 26% Personnel Cost/Operating Cost 39%, 39% 9 39 38% 39 9 3% 3% 0 0% 4% 41 1 Financial Summary for Munici Water Concession of Cumaral 2001 2002 2003 1 2004 2005 2006 2007 2008 2009 2010 Forecast Incorne Statement Items Revenues Water 101 118 135 152 207 212 218 224 229 235 Sewerage 43 50 56 64 87 89 91 94 96 99 Revenues (Total) 144 168 191 216 294 301 309 317 326 334 Operating Income 41 60 81 105 184 191 200 207 216 223 Net Income -3 -24 1 20 72 82 93 100 108 114 Funds Statement Items Intemal Sources 39 58 79 92 142 144 146 150 154 158 Subsidies 454 592 0 0 0 0 0 0 0 Borrowings 258 3 0 0 0 0 0 0 0 0 Equity Investments 45 173 0 0 0 0 0 0 0 0 Total Soutces 796 825 79 92 142 144 146 150 154 158 Capital Expenditures 692 814 0 0 0 0 0 0 0 0 Working Capital Increase (Decrease) 110 0 -5 0 15 12 11 10 10 10 Debt Service 41 63 35 32 35 35 31 28 26 24 Dividend 0 0 1 18 65 74 84 90 97 103 Total Applications 843 877 30 50 115 121 125 128 132 136 Change in Cash -46 -52 48 43 27 23 21 22 22 22 Balance Sheet Items Current Assets 76 21 67 106 145 174 199 222 244 265 Less Current Liabilities 33 6 6 6 10 9 9 9 9 9 t Net Fixed Assets 712 1,481 1,444 1,400 1,351 1,307 1,269 1,231 1,196 1,162 % Total Assets 754 1,496 1,504 1,500 1,486 1.472 1,459 1,445 1,431 1,418 X Debt 258 232 205 180 158 136 117 99 83 67 Equity 496 1,264 1,299 1,320 1,329 1,336 1,342 1,346 1,349 1,350 Total Liabilities and Equity 754 1,496 1,504 1,500 1,486 1,472 1,459 1,445 1,431 1,418 Financial Ratios Operating Income as a % of Revenue 28.3% 35.7% 42.6% 48.8% 62.5% 63.5% 64.5% 65.3% 66.2% 66.7% Net Income as a % of Revenue -1.9% -14.3% 0.7% 9.3% 24.6% 27.3% 30.0% 31.6% 33.1% 34.2% Return on Average Invested Capital -2.7% 0.1% 1.5% 5.5% 6.2% 6.9% 7.5% 8.0% 8.5% Debt Service Coverage -1.7 0.9 2.4 2.9 3.6 3.8 4.4 5.0 5.6 6.2 % of Total Capital Expenditures financed 0% 0% 100% 100% 100% 100% 100% 100% 100% 100% by Intemal Sources Current Ratio 2.28 3.45 10.95 17.21 14.39 18.67 22.21 25.28 27.94 30.27 Debt as % of Equity 0.5 0.2 0.2 01 0.1 0.1 0.1 0.1 0.1 0.0 Main Efficiency Ratios Operating Ratio (incl. Depreciations) 92% 101% 88% 77% 56% 52% 49% 47% 45% 44% Working Ratio (excl. depreciations) 72% 64% 57% 51 % 38% 37% 35% 35°h 340/o 33% Personnel CostUOperating Cost 67%° 67% 67% 661% 66% 66% 66%° r 66% 65%/ 66% Financial Summar for Municipal Water Concession of Nataga _ _ . ~ 2001 | 2002 1 2003_1 -2004 1 2005 2006 2007 2008 2009 1 2010 Forecast Incorne Statement Items Revenues Water 21 22 23 24 24 25 25 25 26 26 Sewerage 9 9 9 10 10 10 10 10 10 10 Revenues (Total) 30 31 32 33 34 34 35 35 36 37 Operating Income 16 18 19 19 20 20 21 22 22 23 Net Income 2 1 3 4 5 6 7 8 9 9 Funds Statement Items Internal Sources 1S 17 17 17 17 17 17 17 17 17 Subsidies 181 30 0 0 0 0 0 0 0 0 Borrowings 51 0 0 0 0 0 0 0 0 0 Equity Investments 18 4 0 0 0 0 0 0 0 0 Total Sources 265 51 17 17 17 17 17 17 17 17 Capital Expenditures 243 36 0 0 0 0 0 0 0 0 Working Capial Increase (Decrease) 23 0 -2 -1 0 0 0 1 1 1 Debt Service 9 13 7 6 6 5 5 5 4 4 Dividend 2 1 2 3 4 6 6 7 8 8 Total Applications 277 49 8 9 10 11 12 12 13 13 Change in Cash -11 2 9 8 8 6 5 5 4 4 Balance Sheet Items Current Assets 14 16 24 31 37 41 45 48 51 53 X Less Current Liabilities 7 1 1 1 1 1 1 1 1 1 Net Fixed Assets 243 273 266 257 247 239 232 224 218 211 ID Total Assets 250 288 289 287 283 279 275 271 267 263 Debt 51 45 40 35 31 26 23 19 16 13 Equity 200 243 249 252 253 253 252 252 251 250 Total Liabilities and Equity 250 288 289 287 283 279 275 271 267 263 Financial Ratios Operating Income as a % of Revenue 54.9% 56.2% 57.5% 58.2% 58.9% 59.5% 60.2% 60.8% 61.4% 62.0% Net Income as a % of Revenue 7.0% 4.3% 8.2% 11.2% 13.7% 18.2% 20.5% 22.3% 24.1% 25.7% Retum on Average Invested Capital 0.6% 1.1% 1.5% 1.8% 2.5% 2.8% 3.1% 3.4% 3.7% Debt Service Coverage -1.0 1.3 2.7 2.9 3.1 3.2 3.4 3.6 3.9 4.2 % of Total Capital Expenditures financed -0% 12% 100% 100% 100% 100% 100% 100% 100% 100% by Intemal Sources Current Ratio 2.1 16.2 25.1 32.0 38.1 41.4 41.7 42.7 43.9 45.3 Debt as % of Equity 0.3 0.2 0.2 0.1 0.1 0.1 0.1 0.1 0.1 0.1 Main Efficiency Ratios Operating Ratio (incl. Depreciations) 79% 79% 75% 72% 70% 64% 61% 59% 57% 56% Working Ratio (excl. depreciations) 45% 44% 43% 42% 41% 40% 40% 39% 39% 38% Personnel Cost/Operating Cost 53% 54% 54% 54% 53% 53% 53% 53% 52% 52% Page 89 Annex 6: Procurement and Disbursement Arrangements COLOMBIA: WATER SECTOR REFORM ASSISTANCE PROJECT Procurement Introduction: The selection of all operators in the municipalities participating in the project, both for medium size cities and for small municipalities, will be carried out through a competitive bidding process, regardless of the financing source of investments in water and sanitation infrastructure. A prior review would be required for the award of each Constructor/Operator contract in small municipalities and for each Operator contract in medium size cities. The principles of the bidding process and selection criterion for a Constructor/Operator of a utility in a small municipality are presented in Annex 16. Model bidding documents and construction/operation contract for this type of utilities were submitted to the Bank for review and have been cleared. The selection of a Constructor/Operator for a certain municipality means inter alia that the procurement of goods and works for this municipality have been completed. The principles of the bidding process and selection criterion for an Operator of a utility in a medium size city are presented in Annex 15. Model bidding documents and operation contract for this type of utilities were submitted to the Bank for review. The procurement of goods and works described in this Annex refer to goods and works for medium size municipalities and to goods under the technical assistance components. According to the project financing plan, the project is based on three financing sources: (i) private sector and municipalities (US$ 15 million); (ii) government (US$ 15 million); and (iii) Bank loan funds (US$ 40 million). Although the activities financed by each source form together one project, they do not overlap. i.e., each activity is financed by only one source and none of the project's activities is financed by two or more sources. Consequently, each of the financing sources can use the procurement procedures it finds fit, without interfering with the procedures of the other sources. While carrying out the investments it committed to, the private sector will use its own procurement procedures in accordance with the regulations authorized in Colombia for the that sector. Procurement of goods and works financed under counterpart funds provided by the government may either follow Law 80 guidelines (the Colombian procurement law) or Bank procurement guidelines. The PTU expressed its intention to apply the Bank guidelines for procurement activities financed by counterpart funds and the project team will help the PIU in doing that. Procurement of activities financed by the Bank loan funds would be carried out in accordance with World Bank "Guidelines: Procurement Under IBRD Loans and IDA Credits", published in January 1995 (revised January/August 1996, September 1997 and January 1999); and "Guidelines: Selection and Employment of Consultants by World Bank Borrowers" published in January 1997 (revised in September 1999 and January 1999), and the provisions stipulated in the Loan Agreement. Works, Goods and Services financed under the project: The project is demand driven, so it is not known at present which municipalities will participate in it, what specific works will be carried out and what will be the procurement packages. However, it is known what type of works, goods and services will be financed under the project. For project description refer to Annex 2. Under component A (investments in medium size cities) the private sector and municipalities will finance water and sewerage works in medium size cities which would include installation of water and sewerage networks, pumping stations, water storage tanks, water meters, water and sewerage treatment plants etc. Page 90 Under sub-component Al the Bank will finance in medium size cities the same type of works financed by the private sector and described above. The works financed by the Bank and the private sector will be complementary and will constitute the infrastructure necessary to ensure the provision of water and sewerage services in the participating medium size cities. Out of the government counterpart contribution of US$15 million, about US$ 5 million will be used to finance payment of taxes related to project execution. An amount of US$ 0.5 million will be deposited in the Fondo Nacional de Garantias, to ensure credit guarantees for small entrepreneurs awarded with operation contracts in small municipalities, and an amount of up to US$ 1 million may be used to finance voluntary separation of utility employees. The remaining amount of about US$ 9.5 million will be used under Aub-component A3 to finance Constructor-Operator schemes in about 10 small municipalities in regions other than the Caribbean coast. Under sub-component A5, the private sector and municipalities will finance a small portion of the municipal water and sewerage infrastructure in participating small municipalities. The Bank will finance the major part of the mentioned infrastructure in about 15 small municipalities, which will include small scale water and sewerage networks, pumping stations, water storage tanks, water and sewerage treatment plants etc. As mentioned, the government will finance similar type of works in about 10 additional small municipalities. Consulting services will be financed under components B, C and D. These will include carrying out environmental and rural sector studies, structuring of the PSP processes for the participating municipalities, consulting services for supervision of project works, financing the PIU staff, all of whom are consultants, and financing training activities to the PIU staff and to the implementation units at each participating municipal utility. Procurement methods: The methods to be used for the procurement of the goods, works and services mentioned above are described below. The estimated amounts for each method, are summarized in Table A. The threshold contract values for the use of each method are fixed in Table B. Procurement of Works Works contracts in medium size cities (sub-component Al) financed by Bank proceeds estimated to cost more than US$ 4 million equivalent per contract would be procured following International Competitive Bidding (ICB) procedures, using Bank-issued Standard Bidding Documents (SBDs). Contracts estimated to cost less than US$ 4 million equivalent per contract and US$ 350,000 or more, up to an aggregate of US$ 15 million, would be procured using National Competitive Bidding (NCB) procedures using standard bidding documents agreed in advance with the Bank. Small works estimated to cost less than US$ 350,000 equivalent per contract, up to an aggregate of US$ 2 million, may be procured locally, on the basis of price quotations from at least three qualified contractors, received in response to a written invitation, which will include a detailed description of the works, including basic specifications, the required completion date, a basic form of agreement acceptable to the Bank, and relevant drawings, where applicable. Works contracts in small municipalities (sun-component A2) financed by Bank proceeds and government counterpart funds, each estimated to cost about US$ I million on the average, would be procured using specific model bidding documents which have been developed for the Constructor- Operator concept. These bidding documents are based on the Bank's standard bidding documents of small works and the procedures and commitments of the execution of works are practically identical to the ones defined in the SBDs for small works (in addition to which the documents contain the requirements regarding the operation of the utility). It is estimated that about 15 contracts of this type would be financed by the Bank and about 10 by government counterpart funds. Page 91 Procurement of Goods Goods under components A and D may include pipes, pumping equipment, process control equipment, water and wastewater treatment equipment, water meters, computer equipment and software, and office equipment. To the extent possible, contracts for these goods will be grouped into bidding packages of more than $250,000 equivalent and procured following ICB procedures, using Bank-issued SBDs. Contracts with estimated values below this threshold per contract and of US$ 50,000 or more, up to an aggregate amount of US$3.0 million equivalent may be procured using NCB procedures and standard bidding documents agreed in advance with the Bank. Contracts for goods which cannot be grouped into larger bidding packages and estimated to cost less than US$50,000 equivalent per contract, up to an aggregate amount of US$500,000, may be procured using shopping (National /International) procedures based on a model request for quotations satisfactory to the Bank. Selection of Consultants Consulting services will be hired to carry out environmental and rural sector studies, preparation of PSP processes, supervision of works and project management activities by the PIU staff. Consultingfirms: All studies by consulting firms estimated to cost more than US$ 200,000 equivalent per contract would be procured utilizing QCBS procedures. Studies by consulting firms estimated to cost less than US$ 200,000 would be procured utilizing Fixed Budget Selection. The short list of consulting firms for services estimated to cost less than US$ 200,000 equivalent may comprise entirely national firms, in accordance with the provision of paragraph 2.7 of the consultant guidelines. Studies by consulting firms estimated to cost less than US$ 50,000 would be procured utilizing Consultants qualification (CQ) procedures. Individual Consultants: Some consulting services, including those of the PIU staff and of specialized advisory services, would be provided by individual consultants selected by comparison of qualifications of three candidates and hired in accordance with the provisions of the procedures for selection of individual consultants per section V, paragraphs 5.1 through 5.3 of the Consultants Guidelines, up to an aggregate amount of US$ 4.5 million equivalent. Prior Review thresholds: The proposed thresholds for prior review are based on the procurement capacity assessment of the project implementing unit and are summarized in Table B. In addition to this prior review of individual procurement actions, the procurement plan of the PIU will be reviewed and approved by the Bank annually. Procurement Capacity Assessment: A procurement capacity assessment was carried out during preparation. The PIU includes a group of staff trained to handle procurement processes following the Bank procurement guidelines, as it managed a previous Bank project (Loan 3336-CO). However, they handled mostly hiring of consulting services. It was agreed that an expert in Bank procurement procedures be hired for the PIU before first disbursement. In addition, PIU staff as well as staff of subprojects implementation units of component A need to update their skills to be able to follow Bank procurement guidelines. The project management component includes financing for such activities. An independent annual procurement audit will be carried out to review procuremet activities. Procurement Plan: Since the subprojects are demand driven, it is impossible to provide an exact procurement plan and implemantation plan for this project. However typical procurement plans for the two types of the main activities under the project (small municipalities and medium size cities) can serve as a useful planning tool and are provided in the following diagrams. Page 92 Typical Procurement Plan for a Small Municipality 0 . 2002 1 2003 !2004 ID i Task Name Duration Qtr 1 LQtr 24 Qtr_|Qtr4tQtrilQtr2jQtr3 ltr4i Qtr i; 1 Selection Consulting Firn to Prepare PSP 41 days \ 2 | Prepare request for expression of interests 6 days 3 Publication and submission of letters of interf 30 days 4 Evaluation and preparation of short list 5 days 5 Hiring Consulting Firm to Prepare PSP 109 days T 6 'i Prepare TOR and LOI 7 days No Objection request 5 days 8 Publication of RFP 10 days | 9 Submission of proposals 30 days 10 Evaluation of proposals 15 days 11 No Objection request 5 days 12 Negotiations 7 days 13 No Objection request 5 days 1 4 Finalizing legal procedures 15 days 15 Signing contract 10 days 16 Structuring of PSP Processes 222 days _ 17 Phase I - POI, design and capacity to pay stL 75 days i8 Phase il - Financial modeiing 20 days 1 9 I Phase Ilii - Prepare bidding documents and c 7 days 20 No Objection request 5 days 21 Publication of announcement 10 days 22 I Submission of proposals 60 days 23 . Evaluation of proposals 20 days 24 i No Objection request 5 days 25 1 Signing of PSP contract 20 days 26 l Execution of Works of a Small Municipality 247 days _ 27 Payment of advance and initiation of works 7 days t 28 t1 Execution of works 240 days I _ . Page 93 Typical Procurement Plan for a Medium Size City 1 i | 2002 T12003 ! 2004 ID Task Name I Duration Qtr 1Qtr air Qt ilr i i Qtr' - tr 3' Qtr 4, Qtr i . tr 2. 1 Short Listing Consulting Firms 41 days 2 i, Prepare expression of interest 6 daysh 3 Publication and submission of letters o 30 days 4 Evaluation and Preparation of Short Li. 5 days j 5 Hiring Consulting Firm to prepare PSP 125 days _ : 6 Prepare TOR and LOI 7 days 7 . No Objection request 5 days 8 | Publication of RFP 10 days 9~ | Submission of Proposals 30 day,, 10 1 Evalaution of proposals 15 day 11 No Objection request 5 days Negotiations 7 daysi 13 i No Objection request 5 days I 14 t Finanlizing legal procedures 15 daysK 15 ' Signing contract 10 dayE 16 Structuring of PSP Process 190 days| _ 17 i Phase I - POI and Capacity to pay stud 45 daygi 18j Phase II - Financial Modeling 20 day-, 19 I Phase IlIl - Pepare bidding documents; 7 days 20 No Objection request 3 days; 21 Publication of Annoncement 10 daysE 22 l Submission of prposals 60 dayst i 23 X Evaluation of proposals 20 days 24 No Objection request 5 daysh 25 t Signing of PSP contract 20 dayEj _ 26 'Execution of typical project financed wo 268 days, 27 Design 30 days 28 Prepare bidding documents 7 days 29 No Objection request 5 days| 3 0 j Publicaction 10 dayEs 31 X Submission of proposals 30 dayEs 32 Evaluation of proposals 10 daysj 33 . No Objection request 5 daysi 34 Signing contract 20 daysE 35 Execution of work 150 days1 Page 94 Procurement methods (Table A) Table A: Project Costs by Procurement Arrangements (US$ million equivalent) Expenditure Category Procurement Method1 Total Cost ICB NCB Other2 N.B.F3 1. Works 7.63 21.12 2.15 16.00 46.90 (7.10) (19.80) (2.00) (0.0 (28.90) 2. Goods 0.90 2.00 0.00 12.00 14.90 (0.90) (2.00) (0.00) (0.00) (2.90) 3. Services and Training 8.20 8.20 (8.20) _ (8.20) Total 8.53 23.12 10.35 28.00 70.00 ________________________ (8.00) (19.70) (10.20) (0.00 (40.00) I/ Figures in parenthesis are the amounts to be financed by the Bank Loan. All costs include contingencies 2/ Includes civil works and goods to be procured through international and national shopping, consulting services, services of contracted staff of the project implementation unit, training and technical assistance services 3/ Woks and goods financed by government counterpart funds, municipalities and private sector Page 95 Table Al: Consultant Selection Arrangements (optional) (US$ million equivalent) Consultant Services Selection Method Expenditure Category QCBS QBS SFB LCS CQ Other N.B.F. Total Costl A. Firms 4.00 0.00 0.30 0.00 0.20 0.00 0.00 4.50 (4.00) (0.00) (0.30) (0.00) (0.20) (0.00) (0.00) (4.50) B. Individuals 0.00 0.00 0.00 0.00 0.00 3.50 0.00 3.50 (0.00) (0.00) (0.00) (0.00) (0.00) (3.50) (0.00) (3.50) Total 4.00 0.00 0.30 0.00 0.20 3.50 0.00 8.00 (4.00) (0.00) (0.30) (0.00) (0.20) (3.50) (0.00) (8.00) 1\ Including contingencies Note: QCBS = Quality- and Cost-Based Selection QBS = Quality-based Selection SFB = Selection under a Fixed Budget LCS = Least-Cost Selection CQ = Selection Based on Consultants' Qualifications Other = Selection of individual consultants (per Section V of Consultants Guidelines), Commercial Practices, etc. N.B.F. = Not Bank-financed Figures in parenthesis are the amounts to be financed by the Bank Loan. Page 96 Prior review thresholds (Table B) Table B: Thresholds for Procurement Methods and Prior Review Expenditure Contract Value Procurement Contracts Subject to Category Threshold Method Prior Review .(US $ thousands) (US $ millions) 1. Works >4,000 ICB All/8.0 350-4,000 NCB All Constuctor- Operator/23.0 <350 Quotations (at least 3) None/0 2. Goods >250 ICB All/1 .0 50-250 NCB All/2.0 <50 International and None/0 ____________________ __ National Shopping, 3. Services (a) Consulting Firms >200 QCBS All/4.0 <200 Fixed Budget Selection All/0.3 <50 Consultant Review of TORs Qualification only/0.2 (b) Individual Consultants >50 According to Section V All/0.5 of Consultants' Guidelines <50 According to Section V Review of TORs of Consultants' only/3.0 Guidelines Total value of contracts subject to prior review: 38.8 Overall Procurement Risk Assessment Average Frequency of procurement supervision missions proposed: One every 6 months (includes special procurement supervision for post-review/audits) Page 97 Disbursement Disbursement: During the first year disbursements will be based on submission of SOEs. After that the loan will be disbursed based on quarterly project management reports (PMRs) up until closing date. Effectiveness is expected to be reached on November 2001 and closing date would be June 30, 2007. The allocation of loan proceeds is provided in Table C. The loan will be disbursed against (i) implementation of works; (ii) purchase of goods; and (iii) consulting services and training, all at a rate of 100% free of taxes and duties. Financial management, reporting and auditing: Accounting and financial management of the project will be under the responsibility of the PITJ. A project financial management assessment 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, which will allow to integrate the register of accounting operations and the physical-financial planning of the project, will be purchased. Project accounting and management will start with the submission of SOEs. A year after project initiation and after installing an integrated project financial system acceptable to the Bank, 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, which would be consistent with requirements of the PSP contracts and the regulatory framework. Twice a year, (March 31 and September 30) summary progress reports on the 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, project account and of the SOE's. Use of statements of expenditures (SOEs): During the period in which disbursements will be based on submission of SOEs, standard Bank procedures for disbursements of this type will be followed. Full documentation for expenditures under contracts requiring the Bank's prior review will be submitted with the corresponding applications. Disbursement for work contracts below US$ 350,000, good contracts below US$ 50,000, consulting firms contracts below US$ 50,000 and individual consultants contracts below US$ 50,000 would be made on the basis of SOEs. Documentation to support these expenditures would be maintained by the PIU and made available for review by the Bank supervision missions and project auditors. Documentation related to SOEs would be maintained for up to one year after the final withdrawal of loan proceeds. Disbursement by SOEs will be phased out as soon as the project is converted to a PMR-based disbursement project. Flow of funds: Financial management will be the responsibility of the PIU. All Loan funds will be deposited by the Bank, upon request of the PIU, in a special account in Banco de la Republica. Investment funds for works and goods in medium size cities and small municipalities under component A will be withdrawn by the PIU from the special account and deposited in an Administrator Account. The Administrator, which will be in charge of handling these funds, will be an Assistant Entity (Entity 1), which is an entity established by an international organization of countries, of which Colombia is a member, and which has the expertise, facilities and personnel required to carry out on behalf of the PIU certain activities under the project, such as administrating funds, contracting services and entering into respective agreements. Advances from the special account to the Administrator account will be documented within 30 days from the date the special Page 98 account is debited. Bank funds will be used only to finance investments in the Caribbean region. When used to finance works in subprojects of medium size cities, Bank funds will be transferred from the Administrator account to subsidiary trust accounts managed by local fiduciary agencies. The funds of each subproject will be handled by one local fiduciary agency which will be hired to manage the funds of the respective subproject, and which will receive, in addition to the Bank funds also the input from the corresponding municipality (mainly Law 60 funds). Each local fiduciary agency will realize payments to constructors and service providers, upon authorization from the PIU. For payments of taxes and duties, the local fiduciary agencies will use the funds contributed by the municipalities. The local fiduciary agencies will sign the contracts with constructors and service providers on behalf of the respective municipalities. When used to finance works in subprojects of small municipalities, Bank funds will be transferred from the Administrator account of the Assistance Entity directly to the bank accounts of the respective Constructors-Operators. In such cases, a local fiduciary agency is not necessary since each subproject has only one works contract. Technical Assistance funds, which will be used to finance all activities under components B, C and D and will be fully financed by the Bank, will be transferred by the PIU from the special account to a designated account for financing technical assistance activities, which will be administered by another Assistance Entity (Entity 2), which is the same type of entity which will manage the investment funds. From the designated account managed by Entity 2, payment will be made to consultants and service providers, according to instructions of the PIU. Entity 2 will sign the consulting contracts on behalf of the government. MED is reviewing the performance of the Assistance Entities available in Colombia, and will sign, before the effectiveness date, agreements with the two which will be selected for the project. MED might decide to sign both agreements with a single Assistance Entity, which will be in charge of both tasks and open the two accounts (the Administrator account for investments funds under component A and the Designated account for TA funds under components B, C and D). Since the selection process of the Assistance Entity is not competitive, the costs associated with the agreements of hiring these entities are not eligible for Bank financing. Nevertheless, the Entities need to be acceptable to the Bank. Government counterpart funds will be used to finance investments in all parts of the country, mostly out of the Caribbean region, but they can be used also for investments within that region. The counterpart funds will be managed directly by MED and will be deposited by the treasury in the project account, which is an account in a commercial Bank which will be opened by MED for this purpose. From this account the funds will flow in an identical fashion to that of the Bank funds, i.e., when used to finance works in subprojects of medium size cities, they will be transferred from the project account to the subsidiary trust accounts in the local fiduciary agencies, and when used to finance works in subprojects of small municipalities, counterpart funds will be transferred from the project account directly to the bank accounts of the respective Constructors-Operators. If, for some reason, the described flow of funds route from the special account to the accounts managed by the Assistance Entities is interrupted, other routes acceptable to the Bank, such as reimbursement of the Borrower for eligible payments made for the project and direct payment by the Bank to service providers, may be used. Direct deposits from the Bank into the Administrator account and Designated account managed by the Assistance Entities may also be done. A diagram detailing the flow of funds scheme is attached below. The PIU will be responsible for sending withdrawal applications to the Bank and for reporting on the use of funds. The PIU will also be responsible for management of the counterpart funds contributed by the government, in conjunction with the use of the Bank funds, as prescribed in the Loan Agreement and for timely replenishment of the counterpart funds' project account by issuing requests to the government for replenishing that account, according to project needs and agreed procedures. Page 99 Retroactive financing: Project preparation activities were carried out by the implementation unit of component E of the Municipal Development Project, Loan 3336-CO. This unit was financed from the proceeds of Loan 3336-CO, whose closing date was December 31, 2000. The personnel of this unit has gained valuable experience in carrying out PSP processes. The proposed project is expected to become effective in October 2001. It is imperative that the same PIU will continue to be active in the forthcoming months because of the following reasons: (i) it needs to continue to carry out the project preparation activities; and (ii) because of the valuable experience it has gained, it is important that in continue to perform the project management activities after effectiveness. However, since all the PIU personnel are consultants financed by the proceeds of Loan 3336-CO, the funding source of this unit has been discontinued on December 31, 2000. Given the importance of maintaining the PIU active, the project team reached an agreement with the government that from January 1, 2001 until the effectiveness date, the PIU will be finance by DNP (Plan Caribe) funds (at an estimated amount of US$ 150,000), which will be retroactively financed after effectiveness. In addition, several medium and small municipalities have recently signed contracts with the private sector, which was incorporated in the provision of their water and sewerage services under various modalities. Municipalities that can be mentioned in this respect include: Monteria, Riohacha, Sur de la Guajira, Soledad and Malambo. The government has committed to provide financial support to these municipalities. If the utilities under private sector management in these and other municipalities will be eligible to participate in the project, retroactive financing of all or part of the subsidies provided by the government might be approved. The total amount of retroactive financing will not exceed 10% of the loan amount and they will be used to finance works and services which have been executed within a period not exceeding 12 months prior to loan signing, and whose contracting has been carried out in accordance with the Bank procurement guidelines. Page 1 00 FLOW OF FUNDS DIAGRAM Counterpart Funds .............................Bank in Washington fromGovernment .............................US$40 m Budget ............................ _ _ _ _ _~~~~No Special Account in Ministry of Economic Assistance Entity I Banco de la Development Administrating Administrating Loan Repuiblica Counterpart Investment Funds Investments A1,A2) US$40 m US$3 1.8m_ = _ _ _ _ s ,~~~~~~~~~~~~~~~~I Assistance Entity 2 Project Account to Administartor Account Administrating Finance Subprojects in (World Bank funds) to .lDesignated Account to the Entire Country Finance Subprojects in Finance Tecnical Assistance the Caribbean Region (Components B,C,D) |~~~~~~~~~~~~~~~~~~~U $ . m::t + 11 ~~~~~~~~~Payments to l i 11 ~~~~~~~~~~~~~Consultants | aw 60ML Transfers l l Direct Payments to LOCAL FIDUCIARY | 1 Law 60 l Constructors-Operators [ lAGENCIES | |l ransfers l |3of Small Municipalities for Medium Size Cities 1 _ | |mmE (Pop. 2,000-12,000 res.) | |(Pop. 12,000 - 300,000 res.) | | _ ll Other lll Other l Municipal | -|| Municipal l Sources, Payments to _Sources, l Royalties, etc. | 1 Constructors and |1 Royalties, etc.| Suppliers of Utilitiesl l l|of Medium size Cities| Page 101 Allocation of loan proceeds (Table C) Table C: Allocation of Loan Proceeds Expenditure Category Amount in Financing Percentage US$million 1. Works Under Subprojects 26.5 93% 2. Goods for Subprojects 3.0 100% of foreign 84% of local 3. Goods for TA 0.2 100% of foreign 84% of local 4. Consulting Services and Training 7.3 100% 5. Unallocated 3.0 Total 40.0 (Note: The Borrower shall pay the Bank a front-end fee equal to US$400,000 no later than 60 days after effectiveness date of the Loan). Page 102 Annex 7: Project Processing Schedule COLOMBIA: WATER SECTOR REFORM ASSISTANCE PROJECT Project Schedule Planned Actual Time taken to prepare the project (months) 19 28 First Bank mission (identification) 08/17/99 08/17/99 Appraisal mission departure 11/11/00 06/11/01 Negotiations 02/03/01 07/25/01 Planned Date of Effectiveness 04/01/01 11/30/01 Prepared by: Project Implementation Unit, Water and Sanitation Directorate, Ministry of Economic Development Preparation assistance: Loan 3336-CO, Municipal Development Project, Component E, Modernization of the Water Sector Bank staff who worked on the project included: Name Speciallty Menahem Libhaber Task Team Leader, Sr. Water and Sanitation specialist Fernando Troyano Consultant, Private Sector Development Specialist Maria Angelica Sotomayor Economist Sophie Sirtaine Financial Analyst Sumeet Thakur Sr. Financial Analyst Luz Maria Gonzalez Consultant, Financial Expert Juan David Quintero Sr. Environmental Specialist Paula Pini Social and Community Specialist Philip Gray Private Sector and Regulation Specialist Luis Schwarz Financial Management Specialist Luis Carlos Guerrero Financial Management Specialist Luiz Gazoni Sr. Procurement Specialist Jaime Roman Lead Procurement Specialist Roberto Cucullu Consultant, Counsel Juan Carlos Alvarez Counsel Krishna Challa Sector Leader Abel Mejia Sector Manager Martha Gonzalez Team Assistant Silvia Delgado Team Assistant Klas Ringskog Peer Reviewer Vijay Jagannathan Peer Reviewer Robert Taylor Peer Reviewer Page 103 Annex 8: Documents in the Project File* COLOMBIA: WATER SECTOR REFORM ASSISTANCE PROJECT A. Project Implementation Plan Manual Operativo del Proyecto B. Bank Staff Assessments I. Elaboraci6n de los estudios para el establecimiento de los planes de obras e inversiones de acueducto y alcantarillado requeridos en ciudades intermedias del pais (Armenia, Calarca, Corozal, Cuicuta, Villa del Rosario, Los Patios, El Zulia, San Cayetano, Dosquebradas, Florencia, Ipiales, Maicao, Quibd6, Sincelejo y Duitama), Ingetec S.A. 2. Elaboraci6n de los planes de obra e inversiones requeridos en los sistemas de acueducto y alcantarillado requeridos en esquemas regionales del pais [ARATT (Arjona, Turbaco, Turbana); ERAS (Cerete, Cienaga de Oro, San Carlos, Sahagin, San Pelayo); ATLANTICO ORIENTE (Baranoa, Palmar de Vatela, Polo Nuevo, Ponedera); ACUAVALLE (33 municipios); Sabanagrande, Santo Tomas y Cumaral), Hidrotec S.A. 3. Formulaci6n, Promoci6n y Venta de Esquemas de Vinculaci6n de Operadores Especializados a la Prestaci6n de los Servicios de Acueducto y Alcantarillado entre Seis y Diez Ciudades Intermedias del Pais (Duitama, Manizales, Florencia, Maicao, Cucuta, Quibdo, Dosquebradas, Corozal, Sincelejo), Capital Corp-Hytsa. 4. Formulaci6n, promoci6n y venta de esquemas de vinculaci6n de operadores especializados a la prestaci6n de los servicios de acueducto y alcantarillado entre tres y cinco empresas regionales del pais [ARATT (Arjona, Turbaco, Turbana); ERAS (Ceret6, Cienaga de Oro, San Carlos, Sahagun, San Pelayo); ACUAVALLE (33 municipios)], Flemings-Corficolombiana. 5. Formulaci6n, Promoci6n y Venta del Esquema de Vinculaci6n de Operadores Especializados a la Prestaci6n de los Servicios de Acueducto y Alcantarillado en la ciudad de Popayan, Selfinver- Chemonics 6. Elaboraci6n de los estudios conducentes a la Formulaci6n y puesta en marcha de los esquemas de participaci6n de pequeflos y medianos empresarios de servicios de acueducto y alcantarillado - PYMES - en tres grupos objetivos [ATLANTICO ORIENTE (Baranoa, Polo Nuevo, Palmar de Valera, Ponedera); ERCA (Chima, Lorica, Momil, Purisima, San Antero, Sotavento); ASMUARIGUANI (Astrea, Bosconia, Ariguani, El Copey, El Paso, La Gloria, San Alberto); Sabanagrande, Santo Tomas], Sedic S.A. 7. Elaboracion de los estudios conducentes a la Formulaci6n y puesta en marcha de los esquemas de participaci6n de pequefios y medianos empresarios de servicios de acueducto y alcantarillado - PYMES - en seis capitales de departamentos y municipios intermedios del pais [ATLANTICO ORIENTE (Baranoa, Polo Nuevo, Palmar de Valera, Ponedera); ERCA (Chima, Lorica, Momil, Purisima, San Antero, Sotavento); ASMUARIGUANi (Astrea, Bosconia, Ariguani, El Copey, El Paso, La Gloria, San Alberto); Sabanagrande, Santo Tomas, Chichinquiri, Malaga, Espinal, Flandes, Puerto Carrefno, Mocoa], Silva Carreflo y Asociados. 8. Elaboraci6n de los estudios conducentes a la Formulaci6n y puesta en marcha de los esquemas de participaci6n de pequeflos y medianos empresarios de servicios de acueducto y alcantarillado - Page 104 PYMES - en cuatro municipios intermedios de 30.000 a 70.000 habitantes del pais (Sabanalarga, El Carmen de Bolivar, Magangue, San Juan Nepomuceno), REN - Jose Mora. 9. Consultoria para la estructuraci6n de esquemas Constructor - Operador para la7participaci6n de pequefnos y medianos empresarios de servicios de acueducto y alcantarillado - PYMES en el departamento de C6rdoba (Puerto Escondido, Los C6rdobas, Moffitos, San Bernardo del Viento), Ingetec S.A. 10. Consultoria para la estructuraci6n de esquemas Constructor - Operador para la participaci6n de pequefios y medianos empresarios de servicios de acueducto y alcantarillado - PYMES en el departamento de Tolima (Cumaral, Nataga, Palermo, Palermo-Rural, Tello), Hidrotec S.A. 11. Estudio del consumo y estimacion de una funcion de demanda de agua potable, Econometria S.A. 12. Evaluacion socio-economica de proyectos de acueducto y alcantarillado: analisis costo-beneficio (Socio-economic analysis of the a sample of water utilities, a cost-benefit analysis), Econometria S.A. 13. Evaluacion del impacto social del proyecto (Social impact assessment of the project), Econometria S.A. 14. Evaluaci6n Ambiental del sector de agua potable y saneamiento basico en Colombia (Environmental assessment of the water and sanitation sector in Colombia), Ernesto Sanchez. 15. Financial Analysis of a sample of water utilities, Luz Maria Gonzalez. 16. Pliegos modelo de licitacion, Contratacion de obras y operacion de los sistemas de acueducto y alcantarillado del Municipio pequeno (Nombre del municipio) [Model Bidding Documents for works and operation of the water and sewerage systems in small municipalities). 17. Modelo de Documentos de licitacion para un contrato de operacion de los sistemas de acueducto y alcantarillado en la ciudad intermedia (Nombre de la ciudad) [Model Bidding Documents for operation of the water and sewerage systems in a medium size city]. 18. Modelo de PSP en empresas de acueducto y alcantarillado en ciudades intermedias en Colombia, Fernando Troyano 19. Modelo Constructor-Operador para participacion privada en municipios pequenos, Fernando Troyano. 20. Modelo Financiero Estamdard para Analisis de procesos de Participaci6n Privada en Empresas de Acueducto, Economica Consultores. C. Other I. Plan de accion y estrategia regulatoria para el sector de acueducto y alcantarillado en Colombia, Fernando Troyano. 2. Comportamiento de empresas de agua y alcantarillado frente a la expansion de los servicios a areas de bajos recursos: el caso de Cartagena, Barranquilla, Tunja, Bogota, Medellin y Manizales, Econometria S.A. 3. Disefno de una formula de asignaci6n de subsidios a los proyectos de acueducto, Econ6mica Consultores. Page 105 4. El Resago de la Costa Caribe Colombiana, Haraldo Calvo, Adolfo Meisel, Banco de la Republica, Fundesarrollo, 1999. 5. Buletin SISD No. 20 and No. 26, National Planning Department (DNP), Colombia. *Including electronic files Page 106 Annex 9: Statement of Loans and Credits COLOMBIA: WATER SECTOR REFORM ASSISTANCE PROJECT Feb-2001 Difference between expected and actual Original Amnount in USS Millions disbursementsa Project ID FY Purpose IBRD IDA Cancel. Undisb. Orig Frm Rev'd P044140 2000 CARTAGENAWATERSUPPLY&SEWERAGE 85.00 0.00 0.00 75.75 12.05 000 P050578 2000 ENVIRO 20.00 0 00 0.00 19.80 1t95 0 00 P057326 2000 CO- RURAL EDUCATION 5.00 0.00 0.00 4.77 -0.23 0.00 P063643 2000 SIERRA NEVADA SUSTAINABLE 506.00 0.00 0.00 212.99 0 00 000 P065263 2000 DEVELOPMENT 225.00 0.00 0.00 103.66 -281 0.00 P068762 2000 CO-FSAL 100.00 000 0.00 10000 1167 000 P039082 1999 EARTHQUAKE RECOVERY 137.00 0.00 0.00 100.00 100.00 0.00 P050576 1999 CO- COMMUNITY WORKS(MANOSALA 5.00 0.00 0.00 3.18 2.35 000 P053243 1998 OBRA) 5.00 0.00 0.00 3.46 1.63 0.00 P046112 1998 TOLLROADCONCESSION 7.20 000 0.00 4.28 2.62 0.00 P006891 1998 CO- YOUTH DEVELOPMENT 40.00 0.00 0.00 31.71 16.56 000 P006861 1998 PEASANTENTERPRISEZ 75.00 0.00 0.00 57.32 1449 000 P040102 1997 CO- PASTO EDUCATION 12.50 0.00 0.00 6.77 4 27 0.00 P006884 1997 CO- ANTIOQUIA EDUCATION 15.00 0.00 0.00 10.52 9.62 0.00 P039291 1996 URBAN INFRASTRUCTURE 20.00 0.00 0.00 3.39 3 39 -1.20 P006687 1996 REG.REF.TA 249.30 0.00 0.00 19.00 14 83 154 P006S72 1996 FINANCIAL MARKETS DEVELOPMENT 65.00 0.00 0.00 4.16 3.00 0.16 P006S94 1996 URBAN ENVIRONMENT TA 145.00 0.00 0.00 64.87 62.70 0.00 P006880 1995 POWER MARKET DEVELOPMENT & ENERGY 36.00 0.00 0.00 15.95 13.35 -4 75 P006893 1995 (TA) 11.00 0.00 0.00 0.47 047 0.00 P006866 1994 URBAN TRNSPRT 90.00 0.00 0.12 0.06 0.18 -3.76 P006854 1993 SANTAFE I (Waler/Supply) 50.00 0.00 2.12 009 1 39 2.22 AGRICULTURE TECHNOLO ENERGY TECHNICAL ASSISTANCE CO- SECONDARY EDUCATION CO- MUNICIPAL HEALTH SERVICES Total: 1904.00 0.00 2.24 842.41 273.48 -5.80 Page 107 COLOMBIA STATEMENT OF IFC's Held and Disbursed Portfolio Feb-2001 In Millions US Dollars Committed Disbursed IFC IFC FY Approval Company Loan Equity Quasi Partic Loan Equity Quasi Partic 1969/85/88/93J95 CF del Valle 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1963/90 Coltejer 6.02 0.00 0.00 0.00 6.02 0.00 0.00 0.00 1995/99 Corfinsura 25.00 0.00 25.00 0.00 0.00 0.00 25.00 0.00 1999 Harken 30.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1987 PRODESAL 0.00 0.59 0.00 0.00 0.00 0.59 0.00 0.00 1977/89/92/94/96 Promigas 6.88 0.00 0.00 14.58 6.88 0.00 0.00 14.58 1994/95 Promisan 0.00 0.23 0.00 0.00 0.00 0.23 0.00 0.00 1996 Proyectos 0.00 5.00 0.00 0.00 0.00 5.00 0.00 0.00 1997 Suleasing 24.82 0.00 0.00 0.00 2.25 0.00 0.00 0.00 1999 Surenting 0.00 5.10 0.00 0.00 0.00 2.50 0.00 0.00 Total Portfolio: 92.72 10.92 25.00 14.58 15.15 8.32 25.00 14.58 Approvals Pending Commitment FY Approval Company Loan Equity Quasi Partic 2001 Tolcemento 3333.33 0.00 0.00 10666.67 2001 CHMC 0.00 10000.00 30000.00 0.00 2001 Cementos Caribe 4047.62 0.00 10000.00 12952.38 Total Pending Commitment: 7380.95 10000.00 40000.00 23619.05 Page 108 Annex 10: Country at a Glance COLOMBIA: WATER SECTOR REFORM ASSISTANCE PROJECT Latin Lower- POVERTY and SOCIAL America middle- r- Colombia & Carib. income Development diamond' 1999 Population, mid-year (millions) 41.5 509 2,094 Life expectancy GNP per capita (Atfas method, US$) 2170 3,840 1,200 GNP (Atlas method, /JS$ billions) 90.0 1,955 2.513 Average annual growth, 1993-99 Population (%) 1.9 1.6 1.1 GNP Go Labor force (%) 2.7 2 5 1.2 per p Gross Most recent estimate (latest year available, 1993-99) capita enrollment Poverty (% of population beleu national poverty line) 21 Urban population (% oftotalpopulation) 73 75 43 Life expectancy at birth (years) 70 70 69 L Infant mortality (per 1,000 ive births) 23 31 33 Child malnutribon (% of children under 5) 8 8 15 Access to safe water Access to improved water source (% of population) 78 75 86 Illiteracy (% of population age 150) 9 12 16 Gross primary enrollment (% of school-age population) 113 113 114 Colmbia Male 113 114 Lower-middie-income group Female 112 116 KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1979 1989 1998 1999 1 vEconomic ratios' GDP (US$ billions) 27.9 39.5 99.1 86.6 Gross domestic investmentGDP 18.2 18.5 19.5 13.0 Exports of goods and services/GDP 15.2 18.0 15.0 17.8 Gross domestic savings/GOP 19.9 22.7 13.6 11.0 Gross national savings/GDP 19.2 19.8 12 3 9.0 Current account balance/GDP 1.4 -0.5 S53 -1.1 Domesbc InJe.t.en Interest payments/GDP 0.9 4.0 1.6 2.1 Investment Total debt/GDP 21.0 42.7 33.6 39.9 Savings Total debt service/exports 14.3 48.4 30.5 43.2 Present value of debt/GDP 32.7 45.1 Present value of debVexports 216.5 255.6 | Indebtedness 1979-89 1989-99 1998 1999 1999-03 (average annual growth) GOP 3.4 3 4 0.5 -4.3 2.6 Colombia GNP per capita 0.8 1.6 -0.9 -71 1.0 Lower-middfe-income gmoup Exports of goods and services 5.8 5.8 5.9 4 7 3.6 STRUCTURE of the ECONOMY 1979 1989 1998 1999 'Growth of Investment and GDP (%) (% of GDP) so Agriculture 22.0 16.6 13.3 12.2 Industry 30.3 38.2 25.7 24.8 30 Manufacturing 23.0 21.6 14.2 12.9 Services 47.7 451 61.0 62.9 - ° 9 Private consumption 70.7 68.1 67.5 67.9 [30 General government consumption 9.3 9.2 18.9 21.1 r Imports of goods and services 13.5 13.8 20.9 19.5 GOI GOP 1979.89 1989-99 1998 1999 Growth of exports and imports (%t (average annual growth) Agriculture 2 5 -2.1 0.6 -0.2 40 Industry 4.7 1.9 -1.8 -11.0 Manufacturing 2.8 -1 7 -0.3 -12.4 20 Services 3.0 5 3 -.5 -0.7 Private consumption 2.6 3.5 0.8 -5.1 0 94 95 96 9 7 General government consumption 4.3 8.4 0.9 4.3 Gross domestic investment 2.3 5 7 -5.7 -30.1 -20 _ C Imports of goods and services 0.8 13.2 -2.8 -13.5 Expots ImponS Gross national product 2.9 3.6 1.0 -5.5 Note: 1999 data are preliminary estimates The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond will be incomDlete Page 109 Colombia PRICES and GOVERNMENT FINANCE 1979 1989 1998 1999 Inflation (%) Domestic prices 3 (% change) Consumer prices 24.7 26.1 16.7 9.2 20 Implicit GDP deflator 24.1 24.7 15.5 12.5 Government finance 10 (% of GDP, includes current grants) 01 Currentrevenue .. 10.2 11.9 12.6 94 95 96 97 9B 99 Current budget balance .. 1.2 -3.1 4.7 GDP deflator 0CP Overall surplus/deficit .. -0.5 -5.3 -6.5 TRADE (US$ millions) ~ ~~~~1979 1989 1998 1999 Export and import levels (US$ mill.) (USS millions) Totalexports(fob) 3,441 6,031 11,494 12,044 20000 Coffee 2,005 1,476 1,896 1,325 Petroleum 146 1,400 2,333 3,761 15,000 Manufactures 1,224 2,145 6,588 3,922 Total imports (cif) 2,978 4,558 14,836 10,311 10000 Food 254 219 1,655 1,415 5iii 11199 Fuel and energy 322 316 158 270 Capital goods 1,077 1,595 5,522 3,651 0 93 95 s 1 97 985 9 Exoort odne index (1995=100) 5 36 112 117 1 ImDort Doce index (1995=1001 4 43 116 116 *Exports *Imports Terms of trade (1995=100) 123 82 96 101 BALANCE of PAYMENTS (USS millions) 1979 1989 1998 1999 Current account balance to GDP (%) Exports of goods and services 4,532 7,330 13,560 13,959 0 Imports of goods and services 3,919 6,411 17,542 13,595 Resource balance 613 919 -3,982 363 Net income -277 -2,019 -1,735 -2,123 Net current transfers 66 898 444 796 Cunrent account balance 402 -201 -5,273 -964 Financing items (net) -487 350 6,663 1,387 Changes in net reserves 85 -149 -1,390 -423 -6 .Jemo., Reserves includina oold (USS millions) . .. 8.741 8.103 Conversion rate (DEC. localWUSS) 42.5 382.6 1.426.5 1.757.0 EXTERNAL DEBT and RESOURCE FLOWS 1979 1989 1998 1999 (USS millions) Composition of 1998 debt (USS mill.) Total debt outstanding and disbursed 5,869 16,886 33,263 34,519 IBRD 838 3,808 1,740 1,958 A 1,740 B: 9 IDA 22 15 9 8 G: 6,232 D 2,801 Total debt service 703 3,905 4,565 6,596 E:1,397 IBRD 124 640 347 391 IDA 0 1 1 1 Composition of net resource flows Official grants 10 37 61 Official creditors 137 102 107 923 Private creditors 542 -10 566 995 Foreign direct investment 127 576 3,038 1,008 Portfolio equity 0 0 26 663 F. 21, 084 World Bank program Commitments 331 330 227 591 A - IBRD E- Bilateral Disbursements 139 361 184 499 B- IA D- Other m.tilateral F- Private Principal repayments 52 333 233 271 C- IMF G - Short-term Net flows 87 28 48 228 Interest payments 73 308 115 123 Net transfers 14 -280 -164 105 Development Economics 8/29/00 Page 110 Annex 11: Eligibility Criteria for Participating Municipalities COLOMBIA: WATER SECTOR REFORM ASSISTANCE PROJECT A. Eligibility criteria for small municipalities Because of the large number of small municipalities, the competition for participating in the project is expected to be strong and the eligibility criteria are expected to provide a screening. Participation is demand driven and is based on the principle of first come first served. The eligibility criteria for small municipalities are: (i) the population in the municipality (in urban area) is in the range of 2,000 to 12,000 inhabitants, although when warranted and on an exceptional basis, somewhat larger municipalities will be allowed to participate; (ii) the level of low income population in the municipality exceeds an established level (only municipalities with an INDEMUN index value of 5 or lower will be eligible); (iii) the nominal water coverage rate in the municipality is lower than 80%; (iv) the mayor agrees to PSP and accept the proposed PSP model, by signing an initial agreement (Convenio de Asistencia Tecnica) with the MED which will commit them to repay 80% of the PSP preparation costs if they change their mind on the way and drop from the project before completing the PSP process; (v) the mayor agrees to new tariffs at a level which will ensure coverage of at least the operation, maintenance and administration costs. This commitment will be part of the initial agreement document; (vi) the mayor and municipal council agree to provide annually a certain percent (between 8 to 20%, to be established specifically for each case) of the government transfers (Ingresos Corrientes de la Nacion-ICN, under Law 60) or other municipal resources; (vii) the mayor commits to carry out a campaign aimed at informing the community about the reform, the PSP model and the tariff adjustment involved; (viii) design of works, especially sewerage, is based on the condominial approach and appropriate technology or on the ASAS (Alcantarillado Sin Arrastre de Solidos) system; (ix) the proposed works do not include resettlement; (x) the susbsidy per connection is capped and cannot exceed the value of US$ 500; (xi) works will be carried out in accordance with the guidelines in the environmental urban manual; and (xii) the operator will prepare the Environmental Assessment of the works and carry out an environmental mitigation plan, while the municipality will be responsible for obtaining the environmental license, when needed. Page 111 B. Eligibility criteria for medium size cities The potential number of medium size cities is not large, so the eligibility criteria for this type of cities are more relaxed. Participation is demand driven and is based on the principle of first come first served. The eligibility criteria for medium size cities are: (i) the population of the municipality (in urban area) is in the range of 12,000 to 300,000 inhabitants; (ii) the mayor agrees to PSP and confirm their commitment by signing an initial agreement with the MED (Convenio de Asistencia Tecnica) which will commit them to repay 80% of the PSP preparation costs if they change their mind on the way and drop from the project before completing the PSP process; (iii) the mayor agrees to instate the tariffs to a level which will cover at least operation, maintenance and administration costs and will reach the maximum socially acceptable level and contribute to the systems expansion costs. This commitment will be part of the initial agreement document; (iv) the mayor and municipal council agree to provide annually a certain percent (between 8 to 20%, to be established specifically for each case) of the government transfers (Ingresos Corrientes de la Nacion-ICN, under Law 60) or other municipal resources; (v) the mayor commits to carry out a campaign aimed at informing the community about the reform, the PSP model and the tariff adjustment involved; (vi) the mayor and the existing public utility agree to the subsidy principles of the project, i.e., that subsidies benefit only strata 1,2 and 3; (vii) the proposed works do not include resettlement; (viii) the subsidy per connection is capped and cannot exceed the value of US$ 250; (ix) works will be carried out in accordance with the guidelines in the environmental urban manual. (x) the operator will prepare the Environmental Assessment of the works and carry out an environmental mitigation plan, while the municipality will be responsible for obtaining the environmental license, when needed. (xi) Water utilities of medium size cities which have awarded PSP contracts prior to the loan effectiveness date may be eligible to project financing if: (a) the private operator has been elected through a competitive bidding process acceptable to the Bank; (b) the agreed tariff levels are adequate and coincide with the principles of the proposed project, or, in case they are inadequate, the operator and the municipal authorities agree to bring them to adequate levels; (c) the municipal authorities are ready to contribute matching financial resources from government transfers or other sources; and (d) when necessary, the private operator and the municipal authorities agree to modify the performance indicators stipulated in the operation contract, add to it indicators for low income areas and incorporate in it other amendments, as required by MED and the Bank. Page 112 Annex 12: Sectoral Environmental Assessment Summary of the Water and Sewerage Sector in Colombia COLOMBIA: WATER SECTOR REFORM ASSISTANCE PROJECT Introduction To assist the government of Colombia in addressing the problems related to water and sewerage services in medium size and small municipalities, the project will support the government's modernization program of the water supply and sewerage sector, whose purpose is to increase sewerage coverage and improve the level of services and quality of drinking water in the national territory. The Ministry of Economic Development (MED) intends to reach the proposed goal by promoting participation of the private sector as an operator of the water and sewerage systems and by providing financial support to ensure that the necessary investments be undertaken. In order to partially finance the investments required and to guarantee participation of private sector in the water and sanitation sectors, the government has resorted to multilateral financing agencies, particularly to the World Bank. When completed, the proposed project would have: (i) improved water supply by rehabilitation, expansion and optimization of the operation of water supply systems in about 25 small municipalities and 3 medium size cities; (ii) improved sewerage services in participating municipalities by expanding the coverage of the sewerage network specially in poor marginal areas; (iii) supported the consolidation of new institutional arrangements with private sector participation and (iv) contributed to the goal of achieving sustainable economic development by ensuring reliable water and sewerage services. This Annex summarizes the findings of the Environmental Assessment of the Water and Sewerage Sector (Sectoral Environmental Assessment- SEA) in Colombia prepared by the MED through a group of local consultantsI', as part of project preparation. The "Strategic Environmental Evaluation - (SEE)" is a more recent tool than the "Environmental Impact Evaluation- (EIE)"'2, that goes beyond individual projects. It is intended to anticipate and analyze the environmental consequences of sectoral or regional policies proposed at the governmental level. The purpose of the environmental analysis is to examine the implications of the reform plan designed by the Ministry of Economic Development. Results from the SEA identify restrictions for improving environmental management capacity in the sector and also recommend a series of institutional strengthening actions aimed at overcoming identified bottlenecks. The SEA was subjected to intensive institutional and public consultation with the participation of the Ministry of Environment, National Department of Planning, Regional Environmental Agencies, Regulatory agencies, NGOs and public defense groups. Formal Bank review of the final reports was carried out before appraisal and found that they conform filly to Bank policy guidelines regarding environmental and social issues. The mentioned report was made available to the public in the Public Information Center of the World Bank in Washington and in the office of the PIU in MED in Bogota. " Evaluacion Ambiental del Sector de Agua Potable y Saneamiento, E. Sanchez and others, January 2001. 12 During the 80s and 90s, the tool used to cope with environmental problems of development projects was the so-called "Environmental Impact Study" This tool is used to present prevention, mitigation and compensation plans against the environmental impact caused by each project. Environmental Impact Studies have been one of the main tools used by the water and sewerage sector and licenses granted by the Ministry of Environment and autonomous regional corporations depend on their approval. Page 113 Environmental Impacts Associated to the Water and Sewerage Sector Three key environmental issues were identified regarding the water sector: (i) public health, particularly, water pollution and related morbidity and mortality; (ii) the inefficient use of water and degradation of water resources; and (iii) environmental problems associated with the construction, operation and maintenance of water and sewer projects. Public Health. The main environmental impacts associated with the water and sewer sector are related to public health issues. Water-related diseases mostly affect children. For example, diarrhea-associated diseases are directly related to the bacteriological contamination of water. It has been estimated that more than 50 types of infection can be transmitted by contaminated water. On the other hand, supply of high quality drinking water improves hygiene in consumers residents as well as safe preparation and preservation of food. Diseases such as cholera, typhoid fever, diarrhea, shigellosis, and hepatitis are associated to the lack of access to potable water, fecal contamination and inadequate hygienic habits. Although statistical reliability is not fully confirmed, information supplied by Sivigila and the Ministry of Health indicates that morbidity associated with water borne diseases is very high in Colombia. For example in 1991, reported cholera cases reachedl6.800 incidents, including 291 mortalities. The lack of access to drinking water and sewerage services is more significant in areas where other factors such as low income, and lack of education and of good hygiene combine to form a situation of high risk to public health. The lack of access to drinking water is also related to skin diseases such as scabies and other parasites. The public health related costs to the Colombian society resulting from the limited coverage of drinking water, water contamination and poor hygiene are very high."3 Diarrheic related diseases not only have a high economic cost, but are also associated with physical pain, particularly among children. Persistent high rates of diarrhea among children are still prevalent in the country (see Graph 1). GRAPH 1: INCIDENCE OF DIARRHEA AND ENTERITIS AMONG CHILDREN UNDER 5 YEARS OF AGE, COLOMBIA 1990 - 1997 In ci d e n 120 ce 100 113,5 114,1 112,2 111,4 1104,1 16,0 110 1. 80 87,8 00 60 0 40 H 20 a 01 b. 1990 1991 1992 1993 1994 1995 1996 1997 Consolidated mortality data on diarrheic diseases, mortality rate, and presence of cholera show that high risk areas are prevalent throughout the country.'4 Sewerage coverage and water quality are determinant 13 Between 1991 and 1997, 4.400.000 and 3.500.000 cases of diarrheic diseases respectively were diagnosed. The cost of treatment per sick person is estimated as US$30.00 and the cost of absence from work is estimated as US$60.00 per person. Therefore, the annual cost associated with the diarrhea-associated morbidity is estimated at US$315 to 400 million. At an annual discount rate of 10%, the present net value of the associated cost is estimated at more than US$3000 million. 14 The areas at higher risk (from highest to least) are: Guainia, Vichada, Cauca, Quindio, Magdalena Santander, Caldas, Guavire, Sucre, Caqueta, Guajira, Putumayo, San Andres y Providencia, Valle, Cundinamarca, Amazons, Choco and Narifio Page 114 factors: of the 1070 municipalities, only 574 have water distribution networks and water treatment plants, but of those only 236 are working properly. According to the Ministry of Health, residential water connections amount to 69% of households in urban areas and 26% in rural areas. Degradation of water resources. The second environmental priority identified for the sector is the waste of water and the degradation of water basins. CRA (1999) estimated that technical and commercial water losses reach a level of 50% on a national, i, e, around 750 million cubic meters of water per year are not accounted for representing a costly waste of resources (see tables I and 2). Table 1: Unaccounted-For Wate r: Large Water Companies Year AVERAGE MAXIMUM MINIMUM MEDIAN 1995 40% 60% 24% 41% 1996 41% 55% 33% 38% 1997 40% 51% 30% 41% Source: Spiller, Pablo. Action Plan and Regulatory Strategy. Final Report, 2000. Table 2: Values of Unaccounted-For Water (1997) CITY UAFW IN CUBIC VALUE OF UAFW METERS ($OF 1996) Medellin 99.411.303 49.606.242.538 Barranquilla 109.283.255 57.037.695.651 Bogota 159.337.525 149.878.289.201 Cali 63.138.339 24.434.537.193 Total of these 4 Companies 431.170.426 280.956.764.583 Total of 16 Companies 626.735.579 353.050.807.250 Source: Spiller, Pablo. Action Plan and Regulatory Strategy. Final Report, 2000. In addition to the waste of treated water, wastewater discharges constitute a major source of environmental pollution in Colombia. Wastewater treatment is low (see Table 3). Severe pollution problem in rivers and wetlands are persistent around most of the country's major cities (well known cases are those of Bogota, Cali, Medellin and Cartagena). In addition, deforestation and land use patterns have caused severe damage to watersheds used for water supply. Table 3: Wastewater Treatment Levels in Colombia Urban Population Water use m3/ day Wastewater Treated O/otreated Production Wastewater wastewater m3/day m3/day 29.386.109 6.788.191 5.407.044 11.680 0.21 Source: MED and DANE (National Department of Statistics) Impact of the Construction and Operation of the Sector's Infrastructure. Inadequate environmental considerations in the siting, design, construction and operation of sector infrastructure often leads to degradation of natural habitats, social conflicts and economic impacts in urban areas. Although MED has prepared technical standards for the design and operation of sector projects"5, these specifications do not include environmental considerations, because the responsibility for such considerations is within the jurisdiction of the Ministry of the Environment. Legal and Institutional Framework The SEA analyzed in great detail the environmental legal framework of the water and sewerage sector including a large number of constitutional, legal and regulations provisions. The most relevant environmental legislation for the sector include: Decree 1594 of 1983 (related to the Sanitation Code of 1979), which regulates wastewater discharges; Law 99 of 1993 and its decrees, which established the "Sistema Nacional Ambiental" (SINA), National Environmental System, sets pollution charges and an 15 RAS: Reglamento del Sector de Agua Potable y Saneamiento Page 115 environmental license system. The SEA concludes that Decrees 1594 of 1984 and 1753 of 1994, as well as Decree 901 of 1997, which sets environmental taxes (tasas retributivas) for contamination discharged to the environment, are inefficient because they require actions which are more expensive than the expected benefits. In addition, the SEA considers that Decrees 1594 and 901 ineffective because they are inconsistent in relation the level of wastewater treatment that they prescribe and because they consider only parameters such as organic matter and suspended solid, leaving out others more related to health. Decree 1753 of 1994 establishes an environmental licensing system that gives administrative authority to local environmental officials in weak regional agencies and causes an uncertain legal environment to potential private investors in the water sector. Decree 1594 of 1984 establishes standards to reduce water pollution, mainly as removal of 80% of organic material, measured as biochemical oxygen demand (BOD) and removal of 80% of suspended solids. Compliance with these parameters means that municipalities would all have to invest in secondary treatment plants. Present net costs of those wastewater treatment plants indicate that water tariffs would have to increase over 100% above the rates in effect in August 200016. Compliance with Decree 1594 would also mean the exclusion of the use ocean outfalls for disposal of wastewater in coastal cities. The Standards required by Decree 1594 preclude taking advantage of the waste assimilation capacity of receiving bodies. Decree 901 of 1997, that regulates Law 99 of 1983, sets forth pollution charges for discharges of organic matter and suspended solids into water bodies. Concentration of organic matter and suspended solids affect aesthetics of superficial water bodies. This Decree promotes the improvement of the aesthetics of water bodies by increasing tariffs several times above inflation rates. Environmental pollution indexes for substances affecting human health are not related to organic matter and suspended solids. The intolerable economic burden on water utilities prescribed by Decree 901, caused more than 99% of Colombian utilities to refuse paying the charges associated with that Decree 901 and generated a great controversy. Enforcement of Decree 901 on water and sewerage service providers will deter private operators from participation in the water sector and limit the incorporation of private sector operators into the water sector. Law 99 of 1993 and Decree 1753 of 1994 provide the legal framework of the Environmental Licensing System. Deficiencies in the environmental regulation concerning critical aspects such as pollution control, hazardous waste management and treatment, solid waste management and fauna and flora preservation are compensated with the drafting of environmental impact studies and environmental management plans. The absence of an administrative procedure for environmental evaluation and the lack of criteria for the approval of Environmental Impact Analyses and Environmental Management Plans, assign to the regional environmental authorities discretionary jurisdiction to rule on environmental aspects. Such administrative discretionality generates legal instability. Private investors would be reluctant to enter into business adventures associated with legal uncertainties as those produced by the environmental licensing provisions of Law 99 of 1993 and Decree 1753 of 1994. The provision of water and sewerage services are, according to the constitution, a responsibility and an obligation of municipalities. Formulation of sector policies at the national level is the responsibility of the Ministry of Economic Development, the Ministry of Finance and Public Credit, the Ministry of Health, the Ministry of the Environment and the National Department of Planning. The Water and Sanitation Regulatory Commission is in charge of economic regulation of water tariffs. At the regional and departmental levels, regional corporations and departmental governments formulate and adapt respective sector policies. The Ministries of Development, Health, Environment, the National Planning Department and the Superintendency of Public Utilities supervise, control and enforce the sector regulations. Enforcement of environmental regulations in the water and sanitation sector is weak. Generic language of 16 Internal Report, Direccion de Agua Potable MDE, 2000 - Directorate of Water, Ministry of Economic Development, 2000 Page 116 sectoral regulation concerning competitiveness and the market, the prevailing institutional dispersion of responsibilities and sector dynamics cause a large number of public operators not to improve traditionally low coverage, poor quality and inefficient use of its resources. In summary, The legislation package currently in effect (mainly Decree 1594 which requires that all wastewater must already be treated for removal of at least 80% of Biochemical Oxygen Demand -BOD- and at least 80% of Suspended solids -SS, and Decree 901 which sets the environmental tax - tasa retributiva - for contamination of natural water bodies) is inconsistent and sets priorities which are inconsistent with the water sector priorities. These inconsistencies coupled with institutionally weak regional environmental authorities (CARs) who are in charge of law enforcement, generate confusion for the water utilities and resistance to comply with the current legislation. The existing situation also constitutes an unstable regulatory environment regarding the environmental legislation and obligations. Mitigation of Environmental Impacts in the Sector In order to guarantee prevention of morbidity and mortality problems associated with water borne diseases, the Ministry of Economic Development is currently proposing sector policies aimed at increasing coverage and improving the quality of the awter and sewerage services. Coverage increase and quality improvement demand on one hand,participation of private investment and on the other, modification of public sector investment allocations. In order to promote participation of private capital in the water sector it is indispensable to guarantee a stable environmental legislation environment and promote clear environmental "rules" and procedures. Therefore, it is of utmost importance to amend Decrees 1594 of 1984; 1753 of 1994, and 901 of 1997 and ensure consistency among the distinct Decrees. To guarantee legal certainty and thus private investment in the sector, it is recommended to amend Law 99 of 1993, putting an end to administrative discretionality of officials working in environmental agencies and clearly define duties and procedures for environmental control to be exercised by such agencies. Concerning tariffs, application of solidarity criteria to protect low income groups can sometimes lead, specially when insufficient information prevails, to defer and even impair rate definition processes and their approximation to actual investment and operational costs. Under these circumstances it is possible that even with rates exceeding the current ones, the comparatively lower cost required to cover the present supply to poorest communities through tank trucks, water suppliers and other modalities would turn to be more expensive due to transportation costs, untimely supply and poor water quality. It is recommended to review water tariff setting policies making a clear analysis of these type of situations in order to get the necessary acceptance from benefited communities by considering the cost-benefit ratio represented by these solutions. Concerning modification of public investment allocations, investment in potable water and sewer is considered as an environmental investment under Decree Ill of 1995. Operation of the National Environmental System (SINA) concerning coordination of the system, jurisdiction of CARs and determination of priorities for public investment, is aimed at investment in basins reforestation programs, forest conservation and wastewater treatment systems, neglecting basic needs for provision of water. Similarly, distribution of royalties set forth in Law 141 of 1994 gives priority to investment in the conservation of wilderness areas, reforestation or the promotion of mining activities, over basic investment in the water and sewerage sector. In order to channel funds from royalties to the water and sewerage sector, one of the following alternatives should be taken into consideration: (i) to temporarily modify the royalties law so as to the modify the generic and specific destination of royalty funds in order to allocate them totally to investments in water supply and sewerage systems; or (ii) taking into consideration the large accumulated financial deficits in the water sector, financing total or partial investment needs in this sector could be considered. Due to the lack of public funds and the existing deficits, it is necessary to establish strict investment priorities in the sector, particularly concerning allocation of direct and indirect royalties to investment in Page 117 water networks until coverage exceeds 98%. The second priority would be investments in sewerage collection systems, and its minimum goal would be a 90% coverage. Last (but not least) would be to allocate funds to basic sanitation, management and final disposal of garbage. Supplementary environmental works such as water basin reforestation, forest conservation, water bodies dredging, primary, secondary and tertiary wastewater treatment plants could be financed once water coverage exceeds 98%, sewerage coverage exceeds 90% and urban wastes disposal coverage exceeds 90%. Since government contributions to investments in medium size cities and small municipalities under the project would be limited, it would be advisable to lever up funds already existing under law 60 of 1993, direct and indirect royalties and other existing government funding programs. If all indirect royalty funds would be allocated to the water sector, it would receive a minimum annual amount of US$250 million, which would meet, in the short term, the water and sewerage investment needs for medium size cities and small municipalities. This would lead reacing a full coverage of water and sewerage services in a very short term. Ninety four per cent of Colombian cities have populations under 100.000 inhabitants. Until 1991, Colombia had high coverage levels in rural areas. This achievement resulted from the participation of national entities such as INAS, that promoted self construction of water networks in rural areas. During the past 10 years, due to organizational deficiencies, small municipalities and rural areas have lagged behind as to their administrative, financial and organizational conditions to develop and manage properly their water and sewerage systems. It is necessary to create the conditions to promote and support this significant group of municipalities and to launch, at the national and regional levels, the timely development of efficient water supply and sewerage systems. It is recommended to establish a program to increase water supply and sewerage coverage in rural areas. Environmental Management Plan The SEA report recommends the implementation of an sector-wide Environmental Management Plan (EMP). The EMP proposes a number of measures to mitigate environmental impacts during the construction and implementation phases and establishes an organizational structure, set of procedures and a budget to implement activities under the EMP. The EMP has also identified a set of priority environmental activities that will strengthen environmental management capabilities in the sector and will assure achievement of the project's environmental objectives.. Priority activities include (i) modification and strengthening of 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 sectoral technical specifications; (iii) definition of environmental requirements to be included in bidding documents and private 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 at the Ministry of Economic Development; (vi) streamlining the environmental licensing procedures for water and sanitation projects in regional environmental agencies; (vii) training programs on environment for water and sanitation system operators; and (viii) definition of public participation and community consultation criteria and procedures for water and sanitation projects. Environmental safeguards for PSP. In order to mitigate environmental effects associated with the inefficient use of water and the degradation of water sources, as a result of this analysis, it is recommended to improve the PSP process to include environmental considerations within all technical, economic and financial stages of operation contracts in the water sector. A complete set of environmental specifications to be included in the operation contracts are proposed in the SEA which include: (i) environmental language in the definition of the contract purpose; (ii) specific references to the duties arising from the Environmental Licenses and Environmental Management Plans; (iii) the definition of environmental requisites for contract execution; (iv) the definition of the environmental obligations of the Page 118 private operators; (v) the evaluation of environmental liabilities; (vi) environmental monitoring and reporting requirements; and (vii) environmental considerations in tariff related aspects. Environmental criteria and procedures for sectoral projects. In addition to the inclusion of environmental considerations in the execution of sectoral investment projects, sectoral criteria and procedures for EA in the sector are proposed by the SEA. Final EIE's would be divided into three groups or categories: Group I corresponds to investment projects not needing Environmental Impact Analysis studies, but would only need of Technical Environmental Specifications. This group would include for example, replacement and/or maintenance of specific works of existing water supply and sewerage systems. Group II would include investment projects needing Simplified Environmental Evaluation, as for example, construction and/or expansion of specific civil works of water and sewerage systems located in rural or sub-urban areas, which do not imply relocation of persons and/or economic activities and/or occupation of sensitive natural areas. Group III would include projects in this sector requiring full Environmental Impact Evaluations as such, for example in cases of dams, implying relocation of persons and/or economic activities. These criteria and procedures are being consulted with the Ministry of Environment and the Regional Corporations. Strengthening Environmental Management Capacity in the Sector. In order to cope with the identified weak institutional capacity in the sector to manage environmental issues it is recommended to assign responsibility to the Ministry of Economic Development, as to the management and determination of technical environmental criteria, and as to decision-making and coordination with Ministry of Environment in the establishment and enforcement of the environmental requirements for water supply and sewerage projects. In addition, it is necessary to strengthen necessary mechanisms (physical, human, technical and financial) to assure that the Ministry of Economic Development will comply with its duties. It is also necessary to ensure that economic and financial analysis be taken into account in the framework of of environmental regulations. Monitoring. During implementation, each private operators that will take over the responsibility for providing the water and sewerage services in a participating municipality will need to prepare an EA for the works he proposes to construct and, if warranted, prepare an EPM to be cleared by the Regional Environmental Agency. The PIU in the MED will ensure that this is done and the Government financial support to each participating municipality will be conditioned on proper handling of local environmental impacts. In addition, environmental specifications to be included in all bidding documents and contracts will be prepared as part of the SEA. Cooperation Between Government 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 between Decrees 1594 and 901; (iii) defining procedures and assigning responsibilities for 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 the environmental taxes (tasas retributivas ) and definition of mechanisms that would enable the inclusion of these taxes in the water tariffs. An inter-institutional task force (the environmental task force) which will include representatives of the Ministry of Economic Development and of the Ministry of the Environment will be constituted during project implementation to work on all the mentioned issues, build consensus on environmental aspects, mitigate the risk to the project resulting from the current legislation and to resolve ad-hok problems related to specific subprojects, in cooperation with the respective regional authority. Page 119 The following tables define the activities of the EMP that will be included in the project: Studies/Technical Assistance: Studies Cost Priority Responsibility Duration, US dollars months Design, edition and $ 50.000.00 l MDE (UA) 8 dissemination of Technical Environmental Specifications Sectoral Environmental $ 50.000.00 2 MDE (UA) e IDEAM 5 information systems Water efficient technologies $ 50.000.00 1 MDE 7 Guidelines for Wastewater $ 200.000.oo 2 MDE 18 treatment plant technology selection Priorities for Institutional Strengthening Project Cost, USD dollars Priority Responsibility Duration, months Environmental $ 150.000.00 1 MDE 40 Management Capacity in MDE Training to $ 75.000.00 1 MDE 21 municipalities on technical environmental specifications Environmental $ 50.000.00 2 MDE 48 management capacity of private operators Technical assistance $ 50.000.00 l MDE 21 to municipalities on environmental clauses in concession contracts Priorities for Support to Reform of Regulatory Framework Cost, US dollars Priority Responsibility Duration, months Support to reform of $ 50.000.00 l MMA-MDE 5 wastewater discharge standards Support to $ 50.000.00 1 MMA-MDE 7 consultation processes on pollution charges Strengthening of $ 25.000.00 l MMA-MDE 3 ElAs in water and sanitation sector Page 120 Annex 13: Social Assessment Summary COLOMBIA: WATER SECTOR REFORM ASSISTANCE PROJECT 1. Introduction As part of its effort to improve the living conditions of a large number of poor inhabitants, the government of Colombia is planning to launch the Water Sector Reform Project, whose purpose is to extend water supply and sewerage networks to medium and small size municipalities, as well as to ensure quality and continuity of water supply services in order to reduce public health risks, especially for children. To accomplish this objective, the government proposes to involve financially sound specialized private operators in the management and operation of the water and sewerage services, so as to guarantee efficient systems operation and to develop new investment programs. The project's social benefits are focused on increasing coverage of water and sanitation services in impoverished areas. Statistics show that in Colombia, about 10 million people lack access to piped water supply and about 15 million lack connection to sewerage systems. The effective 7 water supply coverage in the country is 38% for main cities and 27% for minor municipalities. Only 30% of municipal water supply systems include water treatment plants and only a small portion of about 5% of the wastewater generated in the country is treated. The project targets the Caribbean region where about 40% of the population is below the poverty line and about half of this poor population lives in conditions of misery. The Caribbean GNP is 61% lower than the national average and for many decades the region has suffered from structural social problems, such as land ownership concentrated in the hands a few landowners, limited access to agriculture credit lines, political violence and population displacement. The main issues on which the Social Assessment study undertaken during project preparation has focussed include: (1) socio-economic condition in project area; (2) current level of water and sewerage services; (3) expected project impact; (4) socio-economic burden of water cost before and after project; (5) experience regarding the performance of private water operators with respect to services in low income neighborhoods; (6) consensus building and community participation strategy; and (7) mitigation measures for labor force reduction and tariff increase. 2. Socio-Economic Conditions in the Project Area In Colombia, residential areas are classified into 6 socio-economic strata, stratum 6 being the highest income area and stratum I the lowest. The classification is updated annually by DNP and is used for calculation of tariffs for public services, for calculations of government transfers to municipalities and for additional purposes. Residents of areas classified as 1,2 and 3 are considered low income population. Population in strata 1,2 and 3 is a commonly used and easy to measure indicator of low income population in Colombia. More accurate indicators of poverty are the unsatisfied basic needs (NBI) indicator and the quality of life index (ICV). The project focus area, i.e., the Caribbean region, is composed of eight departments: Atlantico, Bolivar, Cesar, Cordoba, La Guajira, Magdalena, Sucre and San Andres y Providencia. Data on poverty and coverage of water and sewerage services in the Caribbean region are provided in table 1. When measured in terms of NBI, about 400/o of the Caribbean population is living in poverty and about half of that population is living in misery. Of the seven departments included in the project area, all except one (Atlantico) have a higher incidence of poverty and lower water and sewerage coverage rates than the national averages. It is noteworthy that of all departments in the country the highest misery levels are found in Cordoba and Sucre, when measured in terms of NBI. When using the quality of life index (ICV) to measure poverty, again Bolivar, Cordoba, Magdalena and Sucre are, after Choco (which is a department not located in the Caribbean region), among the poorest departments in the country. 17 Measured by the percentage of hours/year with service. Page 121 Table 1: Percentage of Poor Population and Access to Water and Sewerage Services in the Caribbean Region % of Population % of Population % of Access to % of Access to Department Living in poverty* Living in Misery* Water Sewerage (1999) (1999) (1997) (1997) Atlantico 19.5 5.2 97.0 68.1 Bolivar 36.7 15.5 69.7 36.2 Cesar 33.8 11.2 75.9 60.3 Cordoba 49.4 23.3 57.0 24.5 La Guajira 37.6 16.1 85.5 49.4 Magdalena 40.3 15.8 69.8 40.1 Sucre 44.6 19.8 75.8 44.5 Nation Total 25.4 7.7 83.3 70.0 * Poverty and misery measured using unsatisfied basic needs (Necesidades Basicas Insatisfechas, NBI) Source: Boletin SISD, No.26 and No.20. National Planning Departtnent (DNP), Colombia. Specific surveys and field studies were carried out for the purpose of generating data for the social assessments of the project. These data were also used for the financial and economic analysis of the project. The social assessments presented in this Annex refers to a sample of six municipalities. This sample includes the five municipalities used for the financial analysis (Maicao, ERAS, Sincelejo, Cumaral and Nataga) and one additional medium size municipality, Quibdo, which although being located out of the project focus area, was studied (along with additional ones) before the loan amount was decreased, and it was considered worthwhile to present also the information of this municipality because it is of the poorest in the country and the information about it is very relevant to the project. The region targeted by the project is composed of a large concentration of population in the lower socio-economic strata. Based on the information provided by the surveys carried out on the sample of municipalities, over 70% of the population in the sample is of strata I and 2, which implies that for this large portion of the population the monthly household income ranges from US$106 to US$ 160. Most of the municipalities lack population of strata 4,5 and 6, and in municipalities in which those exist, their portion is small. Tables 2 and 3 provide data on the distribution of the population among strata and on the average monthly household income per strata. Table 2: Distribution of the Population per Strata in the Sample Munici palities Strata Total Munici- 1 2 3 4 to 6 House- pality House- % House- % House- % House- % holds holds holds holds holds Nataga 70 18% 190 49% 127 32% 0 0% 387 Cumaral 119 6% 1,334 67% 551 27% 0 0% 2,004 Quibdo 6,664 38% 7,698 44% 2,798 16% 0 0% 17,159 Eras 8,206 36% 10,280 44% 3,530 15% 1,015 4% 23,031 Maicao 5,270 25% 11,037 54% 4,122 20% 0 0% 20,429 Sinceleio 14,323 27% 16,512 31% 14,822 28% 6,575 12% 52,232 Sample 34,652 30% 47,051 41% 25,950 23% 7,590 7% 11,5243 Page 122 Table 3: Monthly Household Income per Strata in the Sample Municipalities Strata Munici- 1 2 3 4 to 6 pality Income Fraction Income Fraction Income Fraction Income Fraction US$/ of Min. US$/ of Min. US$/ of Min. US$/ of Min. month* Sal.** month* Sal.** month* Sal.** month* Sal.** Nataga 78 0.6 99 0.8 101 0.8 Cumaral 123 1.0 144 1.7 170 1.4 Quibdo 119 1.0 273 2.2 474 3.8 - - ERAS 109 0.8 147 1.2 292 2.3 296 2.4 Maicao 156 1.2 183 1.5 263 2.1 - - Sincelejo 92 0.7 157 1.3 270 2.2 241 1.9 * US$ (I US$ = CoP$2,229, Dec, 2000) ** I Minimum Salary is approximately US$130 (December, 2000) 3. Current Level of Water and Sewerage Services in Project Focus Area: Coverage and Continuity The level of water and sanitation services in medium size cities and small municipalities which are potential participants in the project is currently quite low. Nominal average water coverage in the project area is estimated at about 75% for water and about 50% for sewerage (see table 1), however, the effective water coverage, taking into account continuity of supply and water quality, is only about 45% in medium cities and less than 30% in small municipalities. Also, service delivery is focused on providing water to high income areas. The poor and unreliable water and sanitation services, especially in low income areas, have significant negative social implications, which are demonstrated through the case study of Quibd6, a medium size city with a population of about 100,000 inhabitants. The water distribution network covers less than 30% of the city's population. Hospital, health posts and schools are located outside the service area. Service continuity within the served area reaches only 6 hours/day. Most of the households in the city collect rain water for washing and even cooking. Water, where and when available, is drawn by households who can afford to built a storage tank or install a pump which draws directly from the supply line. A pump owner deprives ten surrounding households from receiving water. Purchase of bottled water is widespread and the associated costs form part of the daily household expenses. Small private providers fetch water from contaminated water courses and distribute it to consumers using donkeys for transportation. A significant amount of the household budget is spend on buying water from alternative providers and it is usually the low income segments of the population that depends most on alternatives water supply sources. As usual, women and children suffer most from the burden of the lack of a reliable public water supply system. Households do not consider the water to which they have access as safe for drinking. As a general practice, water is boiled before use, thereby increasing its costs. Water supply is considered to be the most unreliable services, trailing far behind the electricity and telecommunication services, which receive a high rating in terms of service reliability. Table I provides data on average coverage rates of water and sewerage in each department in the Caribbean zone. Of the seven departments included in the project area, all except one (Atlantico) have a lower water and sewerage coverage rates than the national averages. Table 4 provides data coverage rates and continuity of the water service in the sample municipalities. The coverage of water in the sample of municipalities studied does not exceed, on the average, 71% of the total population. The data demonstrate that the higher the socio-conomic strata, the higher is the coverage of water and sewerage services. Data on service continuity show that in most of the sample municipalities, especially in the ones located in the Caribbean region, the service is not continuous and is provided only during a fraction of the time (between 12% to 53% of the time). That is an indication of the poor level of the water service provided. No data were collected regarding the quality of the water supplied, but it is estimated that treatment level does not always correspond to the standards, so the general conclusion is that the level of water supply service in the sample municipalities is rather low. Page 123 Table 4: Water Coverage and Continuity of Supply per Strata in the Sample Munic palities Strata Total Municipality 1 2 3 4 a 6 Cove- Cover- Conti- Cover- Conti- Cover- Conti- Cov- Conti- rage age nuity age nuity age nuity erage nuity (%) (%) (Hrs/ (%) (Hrs/ (%) (Hrs/ (°) (Hrsl Week) Week) Week) Week) Nataga 65% 99 80% 93 100% 100 99% Cumaral 22% 92 95% 24 100% 30 - 92% Quibdo 2% 23 26% 6 66% 6 23% ERAS 87% 21 95% 21 96% 20 80% 12 92% Maicao 30% 36 41% n.a 63% na - - 36% Sincelejo 68% 16 94% 21 95% 26 95% 26 89% Sample 31% 71% 87% 93% 12 71% Data on sewerage coverage per strata in the sample municipalities are presented in Table 5. The Sewerage coverage rates are low in ERAS, Maicao and Quibdo and are higher in the other municipalities of the sample. Table 5: Sewerage Coverage per Strata in the Sample Municipalities Strata Cove- Municipality 1 3 4 a 6 rage Conne % Connec % Connec % Conne % ctions tions tions ctions Nataga 65 65% 80 80% 100 100% 0 0 81% Cumaral 26 22% 1,000 90% 496 90% 0 0 67% Quibdo 107 1% 1,478 19% 2,364 65% 0 0 23% ERAS 2,484 30% 6,371 65% 3,196 90% 787 77% 57% Maicao 817 15% 3,962 35% 2,749 63% 0 0 36% Sincelejo 10,719 74% 16,281 94% 13,621 95% 6,276 95 89% 4. Expected Project Impact on the Water and Sewerage Services and on Their Provision to Inhabitants of Low Income Areas All the water supply related problems are expected to be relieved in the municipalities which will participate in the project. Expected direct project benefits include improvement of the water and sanitation services in terms of coverage, continuity, water quality, water loss reduction, treatment of wastewater and more. Indirect project benefits include improved public health and reduction in water borne diseases, improvement in living conditions, urban development and a new and efficient allocation of the municipal budget (currently, municipalities are financing the inefficiencies of the water utilities such as high expenses for overstaffing, high water losses and more). Nonetheless, the project might also generate negative social effects like increase in tariffs and possible lay-offs of utility employees. As an example, in ERAS, a regional water supply system that covers 5 municipalities with a total of about 1 00,000 inhabitants, the nominal water coverage is 91% but in a significant part of the city water is available only 12 hours per week. The sewage coverage is 57%. Over a horizon of 5 years, the project goal is to increase the coverage up to 98% in water and 80% in sewage. In Cumaral, a small municipality with about 9,000 inhabitants and a high coverage of services, 90% for both water and sewerage, the problem is the quality of the service, its continuity and the lack of capacity of the utility to provide service to new consumers. These problems will be resolved by project implementation. The project's strategy and design establish specific mechanisms to ensure that low income neighborhoods will benefit from the project investments and that the level of water and sanitation services in these neighborhoods will improve. This would be achieved by including in the operation contracts targets for water and sewerage coverage in low income neighborhoods and by identifying the specific locations of the low income areas to which the services will be extended. Page 124 5. Socio-Economic Burden of the Water Cost 5.1 Before project On average, 8.1% of the household income in the sample of municipalities studied is currently spent on purchase of water. The expenses on purchase of water may be as high as 10.5% for the lower socio- economic strata and 6.8% for the higher strata. The cost of water depends significantly on to the water supply source available. In general, the cost of the water distributed by the existing public supply network is significantly lower than the cost of water provided by alternative suppliers (bottled water, water trucks). In Maicao, a medium size municipality in the Caribbean region, the existing water supply service is provided only to 36% of the population. In the poorer neighborhoods of the city this coverage is only 30% while in the wealthiest areas it reaches 63%. The socio-economic impact of this low coverage is tremendous. Currently, the spending on water, a basic human necessity, consumes up to 19% of the income of the poorer households and up to 16% of the income of wealthier households. consumers from all socio-economic strata in this municipality have to buy bottled water and water delivered by trucks, the cost of which averages US$ 2.90 per m3 compared to a cost of less than US$ 0.30 per m3 delivered through the existing public supply network. The average household water consumption from the existing water supply network does not exceed 1 Om3 per month because of insufficient supply, and a similar volume has to be bought from alternative suppliers to obtain 20m3 per month, considered an adequate average household monthly consumption. Sincelejo is another municipality where the cost of water is extremely high. In this case, the coverage of the existing water network is quite high: 89% of the households are connected to the network. However, continuity of service is low and water is available only 16 hours per week in the poor neighborhoods, and 26 hours in the wealthier areas (out of 168 hours the week). In Sincelejo, expenses on purchase of water consumes up to 17% of the income of the poor households and up to 1 1% of the income of and wealthier households. In other municipalities, where the level of water services is higher, the cost of water is significantly lower. This is the case in the municipalities of ERAS, Nataga and Cumaral, where the current cost of water does not exceed 5% of the household income on the average, and consumption ranges from 15 m3 to 24 m3 per months. 5.2 After project Considering the project targets with respect to improving the coverage and the level of services, as well as the subsidy policy applied under the project, it is expected that its impact on the household expenses on water will vary, depending on the pre-project level of services as follows: (iv) if the current service is extremely poor and forces households to buy water from alternative suppliers, it is expected that the social impact of the project will be remarkably positive for all the socio-economic strata: water consumption will increase and the expenses on purchase of water will decrease (by up to 13% in stratum I in Maicao); (v) if the current service already reaches a reasonable coverage rate and quality, the project's social impacts are also expected to be positive, however, it would provide different benefits to different socio-economic strata: the poor, who in general receive currently services of lower quality, will benefit from improved services while the wealthier will continue to receive good services. Under this scenario, the consumers in all socio-economic strata will spend more on the purchase of water, however, the increase in the expenses on water purchase will not be higher than 5. 1% (stratum 2 ERAS) and smaller in the other municipalities. This level of increase in expenses will not have a significant effect on the households socio-economic conditions. (vi) For consumers in all the socio-economic strata, in both scenarios the monthly expenses on purchase of water after the project (i.e., the monthly water bills) will not exceed, on average, 8% of monthly household income and in most cases it will be lower than that (in the range of 4 to 8%). Page 125 5.3 Percentage of Expenses on Water Purchase in Respect to Household Income Before and After Project Implementation Tables 6,7 and 8 provide data on the percentage of the monthly expenses on water in respect to household income for the different socio-economic strata before and after project implementation. The monthly expenses on water before project include expenses on all water sources (water supplied by the public utility, trucked water, bottled water etc.), while the expenses after project are practically those paid to the private operator, i.e., the monthly water bill. The bills after project implementation were estimated on the basis of the tariffs agreed upon with the mayors of the municipalities of the sample during preparation. In Maicao and Sincelejo, the water bills are expected to significantly decrease because the current level of service in these cities is very low and the expenses on water purchased from alternative suppliers is high, however after project implementation water will not be purchased from alternative suppliers. In the other municipalities of the sample, the water bills are expected to moderately increase. Table 6: Percentage of Expenses on Water Purchase in Respect to Household Income Before Proiect Municipality Percentage of Ex enses on Water Purchase in Respect to Household Income 1 2 __ _4 to 5 Average Nataga 3.3% 3.0%/o 4.4% 3.6% Cumaral 3.3% 3.8% 6.7% 4.6% Quibdo 8.1% 6.6% 3.9% - 6.1% ERAS 6.2% 2.7% 3.8% 4.6% 4.8% Maicao 19.1% 16.8% 14.8% - 16.7% Sincelejo 17.6% 15.0% 8.8% 4.7% 12.2% Note: Based on current water consumption Table 7: Percentage of Water Bill in Respect to Household Income After Project Municipality Pe centage of Water Bill in Respect to Household Income 1 2 3 4 to 5 Average Nataga 5.5% 5.0% 5.9% 5.9% Cumaral 6.0% 6.0% 5.0% 5.5% Quibdo 4.4% 2.7% 1.7% - 2.7% ERAS 9.7% 7.8% 4.9% 5.4% 8.0% Maicao 6.5% 6.5% 5.6% - 6.4% Sincelejo 6.9% 3.8% 2.2% 4.9% 4.0% Note: Based on a consumption of 20 m3 per month in all strata Table 8: Project Impact: Increase of Expenses on Purchase of Water as a Result of Project Implementation Municipality Percentage Increase in Expenses 1 2 3 4to 5 Average Nataga 2.2% 2.0% 1.5% 2.3% Cumaral 2.7% -1.5% -2.3% = -5.5% Quibdo -3.7% -3.9% -2.2% - -7.3% ERAS 3.5% 5.1% 1.1% 1.1% -3.2% Maicao -13.0% -10.3% -9.2% -10.3% Sincelejo -10.7% -11.2% -6.6% -0.2% -8.2% Worth noting is the fact that the increase of tariffs and monthly bills charged by the utilities is higher than the increase in the real expenses for purchase of water since the real expenses include payments to all providers, including alternative providers. Page 126 5.4 Level of Water Tariffs Required to Obtain the Same Service Targets if the Project Subsidy Policy Would not be Applied If the policy subsidy proposed under the project would not be applied, an additional tariff increase would be required in order to achieve the same service targets proposed by the project. The additional tariff increase required in this case, on top of the tariff increase already included in the project would be: | Municipality | Nataga | Cumaral ERAS Maicao | Sincelejo Additional Tariff Increase 130% 90% 30% 60% 5% The average monthly bill per strata in the "with project" case for the two scenarios: (i) project subsidy policy applied; and (ii) project subsidy policy not applied, is presented in Table 9. The additional tariff increase vary for each municipality and can be moderate or significantly high, according to the additional investments required. Table 9: Monthly Water Bill per Strata With and Without Project Subsidy Policy, for the "With Project" Scenario ______________ Monthly Water Bill per strata (USS/Month) l Municip- 1 2 3 4 to 5 Average ality With No With No With No With No With No Subsidy Subsidy Subsidy Subsidy Subsidy Subsidy Subsidy Subsidy Subsidy Subsidy Nataga 2.9 6.7 3.4 7.8 4.0 9.2 4.3 9.8 Cumaral 4.7 8.9 5.3 10.0 5.9 11.2 - - 5.3 10.1 ERAS 7.8 10.0 8.5 11.0 10.3 13.4 11.4 14.8 9.5 12.4 Maicao 7.6 12,1 9.2 14.8 12.3 19.7 - - 9.7 15.5 Sincelejo 5.3 5.5 5.3 5.5 5.3 5.5 12.6 13.2 7.3 7.6 Note: Based on a consumption of 20 m3 per month in all strata It can be noted that without the project subsidy policy, the monthly bills, especially for the low income strata will increase to levels which will present a meaningful economic burden. 6. Experience Regarding the Performance of Private Water Operators with Respect to Services in Low Income Neighborhoods The performance of the public water utilities in Colombia is unsatisfactory, as reflected in low coverage rates of water and sewerage and low quality of services, particularly in the poor areas. Critical financial constraints, excessive labor force and administrative failures of the public service providers contribute to this problem. Participation of private operators may offer a remedy. The first private operation in a large city began in Cartagena in 1995. Barranquilla followed soon the route of PSP. Today, the private sector is operating water supply and sanitation services in 47 municipalities in Colombia (14 large to medium size and 33 small municipalities). During the next three years, additional municipalities are expected incorporate the private sector in the management and operation of their water services. The common perception of the population is that the private sector's only interest is profits and therefore it provides a better service to wealthy areas and neglects low income poor neighborhoods. However, during the last five years, the municipalities operated by the private sector have experienced significant increase in the coverage of the water and sewage services, including in low income areas. Total water coverage in Cartagena went from 68% to 86%, in Barranquilla from 89% to 94% and in Tunja from 89% to 98%. Increases in coverage rates occurred also in low income areas (defned as strata I and 2 neighborhoods). With respect to provision of services to the poor, the private operators performed as well as the utility of Medellin (EPM), which is the most efficient public utility in Colombia, and better than utilities of Bogota and Manizales, which are of the best public utilities in the country (see Annex 19). Page 127 The main reason for the satisfactory performance of private operators is the need to expand the number of consumers, in order to reduce the impact of fixed costs. This leads to three behavioral patterns of the private sector that benefit the poor: (i) Generally, at the beginning of the project, services coverage for the poorest strata households is lower than that of the rest of the population. Necessarily the lowest strata must be served in order to increase the size of the water market. (ii) Private operators are better able than public operator to provide short-term investment in new connections supported by marketing and commercial strategies focused on capturing new clients. (iii) Public operators often postpone investment in new connections in lower strata population, particularly in those subnormal or illegal neighborhoods, whereas, private operators design strategies like common connections, incentives for long-term payments for connection, etc. Indeed, experience in Colombia shows that private operators provided alternative water supply solutions to irregular settlements. They are also providing free water to localities which in the short term have not yet received a legal status and do not receive regular service. Publicly owned water utilities do not provide water to irregular settlement, justifying that approach by legislation which prohibits such action before the settlement is legalized. 7. Consensus Building and Community Participation Strategy Community participation is considered a key element in the strategy to ensure the sustainability of the Project. It can contribute to the project success, although by itself it does not guarantee the success. Lack of community participation may constitute a threat to the project in terms of timing and transaction costs. Because of the diversity of the communities involved, the mechanisms of participation must be tailored for each case to fit local conditions. Community participation fulfills three purposes: (1) Achieving community consensus regarding the lack of coverage and the poor quality of water and sanitation services; (2) Promoting the project and the advantages of private participation, providing information about positive effects and mitigation measures aiming at avoiding negative effects, thereby providing a process through which the community can resolve questions and doubts about the project; (3) Promoting and strengthening community oversight of private sector participation in order to ensure the sustainability of the process. Community participation strategy has been designed in six steps in accordance with the project execution process: (1) PSP Promotion. The Ministry of Economic Development presents information about the project to the municipality's mayor and staff, to representatives of the municipal council and to the public water company staff.; (2) Institutional agreement. In those municipalities in which an agreement between the Ministry and local authorities is reached, consulting services are hired for preparing engineering studies (investment programs for medium size cities and detailed designs for small municipalities). Through the media, the community is informed about the agreement, the studies and the consultation process designed to involve all the key stakeholders; (3) The third step is subdivided into two stages: 3.1 Diagnosis and alternatives for the development of the project. A diagnosis of the water and sanitation services at the municipal level is prepared involving the community and local leaders in several events, which creates concrete opportunities to carry out a consultation process with respect to the community needs and the impact of the project. This allows the community to become familiar with the project. During this process the municipal authorities Page 128 are the main sponsor of the participation process, while the Ministry of Economic Development acts as an advisor and coordinator; 3.2 Selection of the operational alternative and definition of the terms of the contract. Once the possible technical and financial alternatives to undertake the services reform are identified, an agreement with local authorities and community representatives regarding project's conditions, such as investment requirements, financing sources, tariffs, and mitigation plans for utility employees lay-offs is established. The community has the opportunity to express its perceptions about the process and resolve any doubts in order to promote their support of the project and its approval by the municipal authorities. This phase will successfully conclude when the proposed reform obtains a favorable public opinion. Without such support, mayors will be reluctant to proceed with the reform. In medium size cities, the project does not seek a formal support from the communities, because of the large number of consumers. However, in small municipalities, the discussion of the community needs and the project proposals and impacts benefits from a much closer contact with the community members and local leaders. Nevertheless, even in small municipalities, a formal approval from communities has not been conceived as a target for the participatory strategy, since the willingness to pay is related to the service improvement, which in turn, will come gradually, so it is considered that support to the project will increase with time, after the take over by the private operator of responsibility for the provision of the services, and the approach of obtaining a formal up-front community approval as a condition of eligibility is not considered advisable. (4) Public bidding. At this step, the community, represented by municipal authorities from the executive and legislative bodies, oversees the public bidding process in order to accomplish clearness, responsibility and sound economic principles. Suitable information mechanisms are designed for community oversight; (5) Transition from public to private operator. The objective is to achieve the community support for the new operator. Open forums, work meetings and periodical bulletins can be effective tools. Also, promotion of Development and Social Control Committees inside the private utility must be accomplished as a mechanism required by national law in order to guarantee community participation in the water and sewage services operation; (6) Private operation. During the phase of operation and management of the systems by the private sector, public participation will take the form of creation and operation of the "veedurias populares", public committees whose task is to act as independent public reviewers of the performance of the private operators, and will provide information to the public, as means of ensuring utility accountability to consumers. These committees act in accordance with Law 134 of 1994 (Mechanisms of Participation, article 100). The project will ensure financial and technical support to promote the creation and enforcement of these committees. 8. Mitigation Measures for Labor Force Reduction and Tariff Increases Impacts on labor and tariffs may imply risk for the PSP processes. The number of employees of the water utilities will most probably decrease in order to reduce labor redundancy, thereby resolving one of the main causes of utility inefficiency. Tariffs will rise to cover costs of improved water and sanitation services. Both issues require mitigation mechanisms, focused on offsetting adverse consequences of unemployment and consumers dissatisfaction with higher tariffs. 8.1 Labor Issues PSP reform in water utilities usually involves reduction in labor force aimed at improving efficiency. In Cartagena the ratio of employees per 1000 connections descended from 15 to 2.4 as a result of the PSP Page 129 reform; in Barranquilla from 5.4 to 3.4 and in Tunja from 5 to 3.718. The project aims to support the reform of 2-3 medium size water utilities and about 25 small municipalities. The estimated total number of employees in medium-size utilities is between 300 to 500 while 100-150 workers are employed in the small municipalities target by the project. In the worst case scenario, the number of employees in the medium-size utilities might be reduced by half under private operation, whereas it is not expected to be reduced in small municipalities. The labor problem associated with the project is not concentrated in one city but spread over a large area. Also, the reduction in the number of employees will not take place in the same time in all the effected utilities, but will rather spread over a period of 3-4 years. Several mitigation measures will be incorporated in the project in order to ease the labor problem. First, voluntary separation programs will be offered to all participating municipalities (medium and small). Secondly, two other strategies will be implemented: (i) Labor Adaptation Program (Programa de Adaptaci6n Laboral PAL) is suitable for all size municipalities. It focuses on the treatment of individual employees needs. It is part of the municipal administration and the public operator responsibilities to insure that mitigation measures be incorporated. The PAL program is based on individual counseling aimed at identifying employment alternatives, psychological support, retraining and providing information on other alternatives such as the establishment of workers association enterprises or cooperatives. PAL requires participation of specialized private operator human resources as social workers, psychologists, training experts; it can be developed with the assistance Colombian NGO's which have relevant expertise (nearly 50 of them are available in the country). The estimated cost of such support attain US$162 per employee involved in the PAL. (ii) Associative work cooperatives (Cooperativas asociativas de Trabajo CAT)'9. This strategy is suitable for medium and large utilities with enough employees for the constitution of a cooperative (with more than 25 members). The project will encourage the constitution of CAT which can carry out some activities of water supply and sanitation such as construction, maintenance and operation. 8.2 Tariff Increase Mitigation Private operation implies higher tariffs when water and sewage services need to be improved. 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 ( "Gasto Social y Desigualdad: Logros y Extravios", C. Velez, DNP, 1996). However, since there are so many municipalities in which the entire population is classified as residing in low income areas, the cross subsidy mechanism loses it's effect. To overcome this problem, Law 142 created a specific mechanism, the Solidarity Funds, to allow better service to low-income groups while helping utilities maintain their financial resources, by providing an additional direct subsidy to the service provider. However, Solidarity Funds management is the responsibility of the municipalities and these funds are supposed to be financed from municipal public resources. Due to budget shortfalls, the municipalities do not have available resources and the solidarity funds concept has not been put to practice, i.e., in most cases these funds have not yet been constituted. Although the project will induce tariff increases, those will take into account the willingness and capacity to pay. The existing cross subsidy tariff systems effective in Colombia will apply in the municipalities participating in the project and will ease the burden on the poor. In addition, the project has been designed in such a manner that residents of low income areas (strata 1,2 and 3) will receive as a subsidy 18 International standard indicates 2 employees per 1000 connections. In small municipalities this standard is not appropriate. ,9 Associative work cooperatives are one of the two alternatives of Organized associative work (the other are associative work enterprises), recognized by the Colombian law as a mechanism to create flexible work market and as an alternative to unemployment. CAT do not imply a direct labor contract with the private operator and are suitable for outsourcing activities. Page 130 the benefits generated by the project investments. This subsidy policy would be very significant for small municipalities, in which the government will be financing a major portion of the investments. In regard to house connection costs, private operators will be encouraged and will have their own incentives to provide soft term financing to consumers in low income areas. In certain cases, when warranted, financing for house connections might be provided by the project. The above mechanism can be supported with an educational program for the community, focused on demonstrating that service improvement justifies higher tariffs. An emphasis should be made on the creation of a collective conscience that there is no better option, and that alternative water sources are even more expensive than the cost resulting from the new tariffs. The educational program must be developed by the private operator through a multidisciplinary group interacting closely with community leaders and organizations previously identified. The private operator of Barranquilla, has a very positive experience on this matter. Page 131 Annex 14: Potential Participating Municipalities COLOMBIA: WATER SECTOR REFORM ASSISTANCE PROJECT The Potential Market of Medium Size Cities in the Caribbean Region with Populations Greater than 12,000 Inhabitants SEWAGE COVERAGE RATES Water Treatment Plant TREAT. PLANT No. MUNICIPALITY DPART. ~POPULATION EXISTS FUNCTIONS EXISTS No. MUNICIPALITY DPART u1997 WATER (97) SEWAGE 197) (YES-NO) (YES-NO) (YES-NO) 1 SANTA LUCIA ATLANTICO 12,681 90.00% 0.00% YES YES NO 2 CHIRIGUANA CESAR 12,983 95.00% 50.00% NO NO YES 3 CHIMICHAGUA CESAR 13,397 70.00% 50.00°/ NO NO YES 4 EL RETEN MAGDALENA 13,545 16.10% 0.00% YES NO NO 5 LA JAGUA IBIRICO CESAR 14,500 90.00% 70.00% YES NO YES 6 REPELON ATLANTICO 15.564 60.00% 0.00% YES YES NO 7 SAMPUES SUCRE 15,834 78.00° 47.00% YES YES NO 8 SAN BENITO ABAD SUCRE 16,410 58.00% 0.00% YES YES NO 9 GALAPA ATLANTICO 16,753 80.00% 1.00% YES YES NO 10 EL COPEY CESAR 17,249 90.00% 40.00% YES YES NO 11 MARIA LA BAJA BOLIVAR 17,473 80.00% 0.00% YES YES NO 12 CHINU CORDOBA 17.535 95.00% 84.00% YES YES YES 13 CIENAGADEORO CORDOBA 17,914 93.00% 48.00% YES YES NO 14 SABANAGRANDE ATLANTICO 18,099 90.00% 60.00% YES YES YES 15 SAN JACINTO BOLIVAR 18.640 80.00% 0.00% YES YES NO 16 CURUMANI CESAR 18,882 83,00% 40.00% YES YES YES 17 AYAPEL CORDOBA 18,995 97.00% 21.00% YES YES NO 18 SANTO TOMAS ATLANTICO 20,878 90.00% 60.00% YES YES YES 19 SUCRE SUCRE 21,423 100.00% 84.00%1 YES NO NO 20 ARIGUANI MAGDALENA 21,439 80.00% 0.00% YES NO NO 21 CAMPO DE LA CRUZ ATLANTICO 21 862 60.00% 0.00% YES YES NO 22 TOLU SUCRE 22,419 74.00% 30.00% YES NO YES 23 PALMAR DE VARELA ATLANTIGO 22,671 90.00% 0.00% YES YES NO 24 BOSCONIA CESAR 23,381 80.00% 74.00% NO NO YES 25 MOMPOS BOLIVAR 23.555 86.00% 30.00% YES YES NO 26 ARACATACA MAGDALENA 24.252 77.00% 30.00% YES NO YES 27 SAN JUAN NEPOMUCENO BOLIVAR 24.348 73.00% 0.00% YES YES NO 28 SINCE SUCRE 25,446 88.00% 50.00% YES NO NO 29 SAN JUAN DEL CESAR GUAJIRA 25,770 56.80% 29.50% YES NO YES 30 TIERRALTA CORDOBA 25,949 97.00% 12.00% YES YES NO 31 PIVIJAY MAGDALENA 28,313 75.00% 55.00% YES YES YES 32 MONTELIBANO CORDOBA 29.834 93.00% 60.00% YES YES YES 33 SAN MARCOS SUCRE 30.509 53.00% 10.00% YES NO NO 34 SAN ONOFRE SUCRE 30.996 85.00% 2.00% YES NO NO 35 LORICA CORDOBA 33.944 92.00% 70.00% YES YES YES 36 PLANETA RICA CORDOBA 34.786 71.00% 12.00% YES NO NO 37 COROZAL SUCRE 37,198 90.00% 76.00% YES YES NO 38 BARANOA ATLANTICO 37,710 70.00% 20.00% YES YES NO 39 AGUSTIN CODAZZI CESAR 42.655 90.00% 90.00% YES YES YES 40 ARJONA BOLIVAR 42.950 80.00%° 0.00% YES YES NO 41 EL CARMEN DE BOLIVAR BOLIVAR 43,900 55.00% 0.00% YES YES NO 42 SAN ANDRES SAN ANDRES 46,256 39.00% 56.00% YES YES NO 43 CERETE CORDOBA 46,425 81.00% 41.00% YES YES NO 44 TURBACO BOLIVAR 46,486 80.00% 0.00% YES YES NO 45 EL BANCO MAGDALENA 46.898 57.00% 0.00% YES YES NO 46 SAHAGUN CORDOBA 46,953 95.00% 31.00% YES YES YES 47 SABANALARGA ATLANTICO 53,354 60.00% 60 00% YES NO NO 48 AGUACHICA CESAR 59,807 71.10% 48.80% YES YES NO 49 MAGANGUE BOLIVAR 77,343 80.00% 50.00% YES YES NO 50 MAICAO GUAJIRA 101.381 25.42% 41.00% YES NO YES 51 SINCELEJO SUCRE 208.091 82.00% 70.00% YES YES NO 52 VALLEDUPAR CESAR _249559 93.00% 88.00% YES YES YES 53 SOLEDAD ATLANTICO 280.500 80.00%° 50.00% YES YES YES Page 132 The Potential Market of Small Municipalities in the Caribbean Region With Populations Below 12,000 Inhabitants SEWAGE COVERAGE RATES WATER TREAT. PLANT TREAT. PLANT POPULATION EXISTS FUNCTIONS EXISTS No. MUNICIPALITY DPT. 1997 WATER (97) SEWAGE (97) (YES-NO) (YES-NO) (YES-NO) 1 SAN CRISTOBAL BOLIVAR 0 100.00/% 0.00% YES YES NO 2 SAN FERNANDO BOLIVAR 1,646 90.000/0 0.00% YES YES NO 3 MARGARITA BOLIVAR 1,782 80.00%° 0.00% YES NO NO 4 PROVIDENCiA SAN ANDRES 1,829 _ 5 LOS CORDOBAS CORDOBA 1,854 82.00°/ 46.00% YES YES NO 6 CANALETE CORDOBA 2,257 75.000/ 45.00% YES YES NO 7 SAN JACINTO DEL CAUCA BOLIVAR 2,356 8 REGIDOR BOLIVAR 2,439 100.00% o.oo% YES YES NO 9 CHIMA CORDOBA _ 2510 74.00% 49.00% YES YES NO 10 CAIMITO SUCRE 2,537 100.00% 0.00°/ YES YES NO 11 CHALAN SUCRE 2, 5986 12 HATILLO DE LOBA BOLIVAR 2,813 95.00% 0.00% YES YES NO 13 PUERTO ESCONDIDO CORDOBA 2.854 100.00% 0.00% YES NO NO 14 PIOJO ATLANTICO 2,895 40.00% 0.00°/ NO NO NO 15 TIQUISIO BOLIVAR 2,918 90.00% 70.00% YES NO NO 16 PEDRAZA MAGDALENA 2,921 47.00% 0.000/ YES NO NO 17 SAN CARLOS CORDOBA 3.092 82.00% 63.00% YES YES NO 18 PALMITO SUCRE 3,304 74.00% 74.00% YES YES NO 19 EL PENON BOLIVAR 3,339 95.00% 000A% YES YES NO 20 PINILLOS BOLIVAR 3,463 95.00% 80.00% YES YES NO 21 COTORRA CORDOBA 3,578 35.00% 0.00% YES NO NO 22 DIBULLA GUAJIRA 3,650 68.500A 0.00% YES NO NO 23 COLOSO SUCRE 3,761 24 CANTAGALLO BOL VAR 3,803 100.00% 30.00% YES YES NO 25 LA UNION SUCRE 3,848 92.00% 19.00% YES NO YES 26 ALTOS DEL ROSARIO BOLIVAR 3,863 75.00% 0.00% YES YES NO 27 MORALES BOLIVVAR 3,871 80.00% 90.000/0 YES NO YES 28 SAN ZENON MAGDALENA 3,893 80.00% 60.00% YES NO YES 29 MONITOS CORDOBA 4,054 66.00% 0.00% YES YES NO 30 GONZALEZ CESAR 4,101 80.00% 40.00% NO NO NO 31 MORROA SUCRE 4.229 63.00% 45.00% YES NO NO 32 EL GUAMO BOL VAR 4,249 33 PIJINO DEL CARMEN MAGDALENA 4,326 74.10% 0.00% YES NO NO 34 ARENAL BOLIVAR 4,348 95.00% 0.00% NO NO NO 35 MONTECRISTO BOL VAR 4,378 90.00% 0.00% YES YES NO 36 TAMALAMEQUE CESAR 4,402 83.20% 0.00% YES NO NO 37 BARRANCO DE LOBA BOLIVAR 4,480 90.00% 50.00% YES YES YES 38 IURIB A GUAJIRA 4,593 49.50% 20.00% YES YES YES 39 SANTA CATALINA BOLIVAR 4,706 85.00% 0.00% YES YES NO 40 GUARANDA SUCRE 4,707 78.00% 0.00% YES NO NO 41 BUENAVISTA CORDOBA 4,712 93.00% 60.00% NO NO NO 42 ELPASO CESAR 4,840 95.000/n 40.000/ NO NO YES 43 SIMITI BOLIVAR 4,879 100.00% 0.000/ YES YES NO 44 LA GLORIA CESAR 4,995 70.00% 70.00% YES YES NO 45 TALA GUA NUEVO BOL VAR 5,053 90.00% 40.00% YES YES NO 46 SAN PELAYO CORDOBA 5,126 98.00% 30.00°/ YES YES NO 47 SAN SEBASTIAN DE BUENAV MAGDALENA 5.1561 76.50% 0.000/ YES NO NO 48 RIO VIEJO BOLIVAR 5,184 92.000/ 80.000/ YES YES YES 49 SALAMINA MAGDALENA 5.311 61.04% 0.00% YES NO NO 50 SANANDRESSOTAVENTO CORDOBA 5,357 85.00% 90.00% YES YES YES 51 CORDOBA BOLIVAR 5,462 90.00% 0.00% YES YES NO 52 RIO DE ORO CESAR 5,518 77.50% 77.40°/ YES NO NO 53 EL PINON MAGDALENA 5,711 82.90% 0.00% YES NO NO 54 MANAURE GUAJIRA 5,741 67. 00° 47 00 YES NO YES 55 CERRO SAN ANTONIO MAGDALENA 5,899 76.30%° 0.00%° YES YES NO Page 133 The Potential Market of Small Municipalities in the Caribbean Region With Populations Below 12,000 Inhabitants-Cont. SEWAGE COVERAGE RATES WATER TREAT. PLANT TREAT. PLANT No. MUNICIPALITY DPT. 1997 WATER (97) SEWAGE (97) (YEXSTS FUNCIONS (YESS-OS 56 TUBARA ATLANTICO 5,915 70.00% 0.00% YES NO NO 57 PURISIMA CORDOBA 5,936 95.00% 70.00% YES YES YES 58 SAN MARTIN CESAR 6,022 90.90% 42.40% YES NO NO 59 MANAURE BALCON DEL CES CESAR 6,077 97.00% 38.500/o YES NO YES 60 BUENAVISTA SUCRE 6,143 95.00% 20.00% YES YES YES 61 TOLUVIEJO SUCRE 6,328 96.00% 77,00% YES NO YES 62 CICUCO5 BOLIVAR 6,350 80.00% 0.00% YES YES NO 63 SANTA ROSA DEL SUR BOLIVAR 6,496 90.00% 90.00°/ YES YES NO 64 MOMIL CORDOBA 6,619 76.00% 17.00% YES YES NO 65 TENERIFE MAGDALENA 6,637 72.40% 000% YES NO NO 66 ACHI BOLIVAR 6,667 70.00% 0.00% YES YES NO 67 CLEMENCIA BOLIVAR 6,841 70.00% 0.00% YES YES NO 68 GAMARRA CESAR 6,982 92.00% 0.00°/ YES NO NO 69 SAN MARTIN DE LOBA BOLIVAR 7,049 90.00% 60.00% YES YES YES 70 REMOLINO MAGDALENA 7,055 80.00% 0.00% YES NO NO 71 SAN DIEGO CESAR 7,055 91.30% 80.00% YES NO NO 72 JUAN DE ACOSTA ATLANTICO 7,129 70.00% 0.00% NO NO NO 73 PUEBLO NUEVO CORDOBA 7,222 82.00% 30.00% NO NO NO 74 SAN JUAN DE BETULIA SUCRE 7,351._ 75 SOPLAVIENTO BOLIVAR 7,534 80.00% 0.00% YES YES NO 76 SAN BERNARDO VIENTO CORDOBA 7.636 81.00% 30.00% YES YES NO , 77 USIACURI ATLANTICO 7,737 60,00% 0.00% NO NO NO 78 GUAMAL MAGDALENA 7,899 62.20% 0.00% YES NO NO 79 MAHATES BOLIVAR 7.940 70.00% 50.00% YES NO NO 80 ASTREA CESAR 8,200 63.00% 50.00°/ NO NO YES 81 URUMITA GUAJIRA 8,268 62.40% 62.40% YES NO YES 82 MAJAGUAL SUCRE 8,484 100.00% 0.00%° YES NO NO 83 GALERAS SUCRE 8,503 99.00% 34.00°A YES YES No Inform 84 LA APARTA0A CORDOBA 8,558 47.00% 0.00% NO NO NO 85 BECERRIL CESAR 8,574 96.00% 80.00% YES NO YES 86 PUERTO LIBERTADOR CORDOBA 8,945 92.00% 35.00% YES YES NO 87 CANDELARIA ATLANTICO 9,022 40.00% 0 00% YES YES NO 88 ZAMBRANO BOLIVAR 9.123 8000% 000% YES YES NO 89 TURBANA BOL VAR 9,443 80.00% 0.00% YES YES NO 90 PELAYA CESAR 9,501 95.000/ 000°A YES NO NO 91 CHIVOLO MAGDALENA 9.525 92 PONEDERA ATLANTICO 9533 95.00% 0.000% YES YES NO 93 CALAMAR BOLIVAR 9,534 75.000/ 0.00% YES YES NO 94 VALENCIA CORDOBA 9,597 98 00°/ 0.00% YES YES NO 95 SAN ALBERTO CESAR 9,756 95.500/ 76.14% YES NO YES 96 PAILITAS CESAR 9,782 97.80% 80.00% YES NO YES 97 SANTA ROSA BOLIVAR 9,857 60 00% 0.00% YES YES NO 98 SUAN ATLANTICO 9,993 40.00% 0.00% YES YES NO 99 POLO NUEVO ATLANTICO 10,404 60.00% 0.00% YES YES NO 100 SAN ANTERO CORDOBA 10,679 44.00% 23.00% YES YES NO 101 LURUACO ATLANTICO 10,699 90.00% 0.00% YES YES NO 102 SAN PEDRO SUCRE 10,968 97.000/ 68.00% YES YES YES 103 SITIONUEVO MAGDALENA 11.049 40.00% 0.00% YES NO NO 104 LOS PALMITOS SUCRE 11,090 88 00% 88.00% YES YES YES 105 CVEJAS SUCRE 11,339 88.00% 75.00% YES YES NO 106 PUEBLOVIEJO MAGDALENA 11,452 20.00% 0.00% YES YES NO 107 SAN ESTANISLAO BOLIVAR 11,532 80.00% 0.00% YES YES NO 108 SAN PABLO BOLIVAR 11,698 85.00°/ 60.00% YES YES NO 109 VILLANUEVA BOLIVAR 11!821 50.000/ 0,000 YES YES NO 110 SANTA ANA MAGDALENA 11.841 89.00% 40.00% YES NO YES 111 ROELESILA PAZ) CESAR 11 88 90.000/ 7730/ YES NO YES 112 ___MANATj__ ATLANTICO 11 ,915 40.00°A 0.00% YES YES NO Page 134 Water and Sewerage Utilities with Private Sector Participation in the Caribbean Region M7MTFTEATNENT SE_ AGE TRAT PMST TREAT. F'L4N _ POaJ-.TY A11O'J VATM : AB E) EG5TS R1_US5 NCK SBO MIVATVZAlcN MRATM 1997 ___ (EW YPO ME 1 B(IWCAS (LJJIRA 11861 77.40%! 79 50° YES N YES Cawao ir,4 Tctd vdam 2 B&*A1UllA AThOfllWC 1.172651 81.40% 83.140 YES Yes YES MiCab TidleA 3 CART A BCUVAR 758. 72 00! 60.0!°/ YES Yes NO Ae alr 4 B(E' M_B_A 76,624 67.70" 57.FM YES Yes YES Ccm cn Ooadies cd Samdos 5 'SrR'CQCN WAJIRA 4,45 91.39/! 51.44M! YES NO NO Ue t Cawdo Irn Tota v ct 6 ELBaOUND 3j.IRA 51Z 51.20'! 51.20°/ YES NO YES B Ccsoxdo Ira Tct v s 7 FCNGtCRAaji 226r6 61.60°' 84.2)! YES IN:) YES r Cdo IC a Tde v os 8 FRILICN MkGNJA 484, BOW 1r6.00Y YES Yes NO IVa Pr 9 FATA) (2AIIRA 5601 8130! 81. 70'! YES N YES Qr dao Iru Tci v ob 10 ALAlH ATLNI1co 8X,5)6 4Q08'! 40 QN! YES NO NO (ion U.T. O,aad de Sd cid d Nrbte 11 MONTERA (RA 240, 65.00) 26MOO YES YES YES Canesc FCC Priiva 12 RATD MENBA 44.788 88.70! 34RON! YES YES NO Aas v Samdos de FLao 13 L CCODC ATA LANflCO 185W 6 !.00 85W'! YES YES YE TvBI QltE Tnde A 14 ROQ'A (GA3JIRA 87321 75.20' 7200W! YES YES NO Mxbed Caiatl Aasdes LaGeira 15 SNTAMORA M336A42A B 90.C0° 80.00! YES YES NO Mxed Cap M 16 UlMAULEVA SW"RA 1J90 68.33)! 55.30% YES YES YES Caisaao Irn Tcd v cbs Page 135 Annex 15: Model of Private Sector Participation in Water Companies in Colombia's Medium Size Cities COLOMBIA: WATER SECTOR REFORM ASSISTANCE PROJECT This Annex presents an overview of the Model proposed to be used under the project for private sector participation in water companies of medium size cities. Of course, this is not the only model which might be used and it is most probable that others will also be used, however, this is the model which was developed during project preparation and is considered as best responding to the needs of medium size cities. It must be bome in mind that for the purpose of better understanding the model, nothing can replace the thorough reading of the model Bidding documents and draft contract which have been prepared in the framework of project preparation. The relationship between the Contracting Authority and the Operator is governed by an Operating Contract (hereinafter called "the Contract") which may be divided into two principal parts: the Main Body of the Contract (MBC), comprising all the conditions imposed by the Contracting Authority that are to be met by the Operator during the course of its work,20 and a Works and Investment Plan [POI - Plan de Obras e Inversiones] submitted by the Operator in its bid, in which the Operator undertakes to carry out the work in compliance with all the conditions of the MBC. It is immediately realized that it is the MBC that determines the POI. The Consultant preparing the MBC must ensure that it includes all the requirements to be met by the Operator, both those concerning operational aspects of the system, as estimated by the Consultant, and those of a sociopolitical nature that may be imposed by the Contracting Authority. But care must be taken not to allow excessive and unnecessary requirements to pile up, since a POI combined with a very demanding MBC will logically be more expensive than one connected to a more reasonable MBC. The Consultant should therefore study different alternativesfor the MBC/"indicative POI" correlation,2' until a reasonable balance is found Whenever the Contracting Authority seeks to impose excessive demands, which is often the case when rapid results are desired, the Consultant should counter this by prudently emphasizing that goodfinancial equilibrium is essential for the Contract. Among the conditions included in the MBC, a fundamental condition of the Model is the Fixed Average Tariff for services, in terms of monetary units per inhabitant served per year during the entire Contract period (obviously with an appropriate price revision formula geared to input prices, which would adjust tariffs to inflation). It will be necessary to include clauses making it possible to calculate for each year the number of inhabitants receiving the services, as a function of the number of residential connections, using an equivalent rate of consumption (for example, 150 liters per inhabitant per day) for nonresidential connections. A three-way breakdown of services is recommended: (1) water; (2) sewerage; and (3) wastewater treatment.22 The cost of 20 All conditions must be set out clearly and accompanied, as appropriate, by: (1) an indicator for measuring compliance with the condition concemed; and (2) a system of penalties to be applied when the measured compliance is unsatisfactory. It is recommended that all penalties be referred to the annual monetary burden per inhabitant (see below), and that the revision of that parameter be accompanied by a revision of the applicable penalties. No generic penalties are to be established, since any penalties that do not correspond to this indicator/penalty system would in effect be arbitrary. 21 The term "indicative POI" refers to the plan drawn up by the Consultant during its studies prior to the bidding process. Bidders will submit a "Bidder's POI," and the plan submitted by the winning bidder will be called simply "POI" in all matters relating to performance of the Contract. 22 It is always advisable to include wastewater treatment as a generator of additional income and not merely as a source of operating costs, otherwise the Operator will be very reluctant to operate treatment systems. Page 136 the services under (2) and (3) may be correlated to the cost of water for each user, thereby simplifying the pricing process. The Fixed Average Tariff multiplied by the number of inhabitants served in a given year provides the Authorized Annual Billing that the Operator may collect from all users (the Operator niaturally bearing the risk of collection).23 Thus this is a capped-price system, similar to those used in certain other types of services. The Tarif Structure will serve to deduce what each user has to pay in order for that user 's bills to total the amount of the Authorized Annual Billing. Since the Tariff Structure will include a term representing each user 's consumption, the Real Annual Billing will not coincide exactly with the Authorized Annual Billing, and the difference upward or downward will be corrected by deducti71g that difference from, or adding it to, the Authorized Annual Billing for the followv ing year. The financial commitment between the Contracting Authority and the Operator thus consists of operation of the systems at an annual fixed price (revised by a price index and as a function of growth in user numbers).24 This arrangement is the best one from the point of view of urban planning (the planner knows how much this service is costing to all of society at any given moment) and also obliges the Operator to seek the highest economic return by minimizing the costs of the service, an approach that is also in the social interest. In other types of concessions, the Operator makes a greater effort to obtain tariff increases than to reduce his own production costs. The initial Tariff Structure should appear in the MBC, but provision should also be made in the MBC for the Tariff Structure to be amended by mutual agreement between the parties whenever deemed appropriate. Since there is a limit on the Authorized Annual Billing amount regardless of the Tariff Structure, any amendment ofthe Tariff Structure will not influence the Contract's financial equilibrium. This represents an enormous advantage, since the Tariff Structure may be adjusted as needed during the period of operation without any danger that such changes will prove harmful to the entire user population. There is complete facility of supervision, and it is necessary to ensure agreement between the parties simply to prevent an irrational Tariff Structure from resulting in deterioration of the Operator's billing to collection ratio.25 The Average Annual Tariff and the Tariff Structure (the initial one, included in the MBC) are to be put in place following a study of user capacity and willingness to pay. A low Average Anllual Tariff will be easier to implement from the sociopolitical standpoint, but it will produce fewer surpluses that can be used for investment, thereby holding up the improvement of a system in a bad state of deterioration. Once again, the Consultant will need to give prudent counsel to the public authorities on this aspect, and ensure that the Average Annual Tariff is the highest compatible with the users' willingness to pay at the time the Contract is signed. However, as we shall see below, the Model contains very flexible arrangements for increasing the annual burden on the users. so that, if there is increased willingness to pay (usually the consequence of better service), it will be possible to increase the annual user burden as needed and when new 23 Logically, there are three Authorized Annual Billings, for inhabitants served with water, sewerage services and wastewater treatment, respectively. As an alternative, the Authorized Annual Billing for wastewater treatment may be imposed on all users of sewerage services, even though not all wastewater is treated, since the disposal service is of the same quality for all sewerage service users, regardless of the fact that certain wastewater is treated while other wastewater is not. 24 It should be noted that this does not lead to water wastage, since each user pays according to his consumption. It is the total of the bills that remains subject to a limit, but each user has an interest in reducing his consumption to be charged as little as possible when that total is distributed. 25 For example, the Operator could oppose a Tariff Structure that exceeded the willingness to pay of any given segment of the user population. Page 137 investments are required. Consequently, the use of a relatively low Average Annual T'ariff allows for a certain degree of correction in the future, for which reason it should never exceed the users' willingness to pay when the bidding process is under way. Since the Average Annual Tariff is fixed, the POI is generally the only proposal submitted by the Operator. As noted above, the POI is the sequence of investments through which the Operator undertakes to comply with the terms of the MBC. Nevertheless, the Model recognizes that, in reality, it often happens that the conditions of the MBC cannot be met by the Operator exclusively out of surpluses generated by the Average Annual Tariff it is authorized to charge.26 The Model therefore recognizes the possibility of: (1) adding in third-party investments (we shall identify such sources in this way, since they may be from the central or municipal governments, or, alternatively, fully or partially paid for by the users themselves "over and above" the Average Annual Tariff) in order to fully comply with the MBC; or (2) accepting that for part of the Contract period the system will need to operate under conditions resulting from incomplete implementation of the Operator's proposed POI. The ability to make such adjustments without altering the contractual equilibrium between Contracting Authority and Operator is the Model's basic premise. Consequently, the Operator will include in his bid the POI with which he undertakes to comply with all the conditions of the MBC, but will identify those investments he is willing to make at his own expense, using tariff surpluses. For operational reasons, the Operator's investments are required to appear first, i.e. "on the left" of the PO1.27 The remaining investments, for which the Operator does not intend to use surpluses from the Average Annual Tariff, will be shown "oin the right" of the POI. The variable to be considered during bid evaluation is thus the third-party investment requirement of each bidder, represented, in mathematical terms, by the current value of investments shown "on the right" of the POI that the bidder acknowledges it cannot afford to make. This is therefore a single monetary value, immediately comparable, and the winning bidder will be the one for whom that value is the lowest.8 In the particular case of the bidder being able to use operating surpluses to carry out all of its POI investments, he will be required to also offer a reduction in the Average Annual Tariff established in the MBC, and the bidder offering the largest reduction will naturally be the winner.29 The POI submitted by a bidder binds that bidder in terms both of execution of the investments mentioned (which consequently will need to be very clearly described) and of their estimated amounts. It is recommended that those amounts be in dollars and be considered firm, since this will avoid the need for them to be revised at a later date. The Model acknowledges, and this is fundamental to its application, that a long-term POI will definitely be subject to amendments. Maintenance of the commitment in dollars, with the rules we set out below, will make it possible to effect such amendments without affecting the Contract's financial equilibrium. 26 This would simply mean, and it is the case most commonly arising with degraded systems such as those that we are accustomed to finding in Colombia. that user willingness to pay is insufficient to meet the investment needs of the systems and that it is impossible to arrive at a perfect system during the lifetime of a Contract if exclusive reliance is placed on user inputs. 27 This will oblige the Operator to undertake advance financing of his operations, which he will have to recover as the operation progresses. 28 To understand the rationale of the contract award system, it is sufficient to realize that for a bidder to be able to operate the system during the entire Contract period and in compliance with the conditions of the MBC he will receive part of the funds directly from the users and solicit other funding "from third parties." Since the first part (funding from users) is fixed for all bidders, the winner will be the bidder who asks for the lowest amount from third parties. 29 The Consultants will need to ensure that this reduction has a sufficient number of figures behind the decimal point to avoid any possibility of a tie occurring in practice. This is better than including tiresome clauses to cover the event of a tie, which often prove rather absurd, since it is highly unlikely that a tie should occur. Page 138 During the operation, the POI will be broken down each year into an Annual Works and Investment Plan (PAOI) to be proposed by the Operator sufficiently in advance to enable it to be studied, discussed if necessary, and approved by the Contracting Authority. The PAOIs will apply both to the Operator-financing stage ("on the left of the POI") and to the third-party financing stage ("on the right of the POI"). The basic rules for PAOIs are as follows:30 - All PAOI works will be carried out by the Operator, both those financed by the Operator and those financed by third parties, and will be posted to the accounts, in principle, at the price established in the POI, regardless of their real cost at the time of their execution. However, bidding for works budgeted above a given amount (to be established in the Contract) will have to take place in the presence of the Contracting Authority, to ensure transparency of the bidding process, and will be posted at their real cost or at the cost estimated in the POI, whichever is lower. Possible surpluses will be applied to the carrying out of new investnients. The operator may propose alternative PAOIs prior to the period of implementation of the works. If the alternatives achieve the same result at a lower cost, they may be approved by the contracting authority and the operator will benefit from the savings. This will provide an incentive to the operator to propose innovations. - The Operator may propose in a PAOI that works contained in the POI be brought forward or delayed, and these will be transferred at their respective budgetary values. The Operator must, however, respect its annual investment commitment. * The Contracting Authority may finance works of third parties using any of the following procedures: (1) making available to the Operator the necessary funds or the proceeds of loans signed by and repayable by the Contracting Authority; (2) subject to the Operator's agreement,"1 charging the repayment installments to the users in such manner as the PAOI shall determine (in such cases, the Operator will act simply as collection agent, without additional remuneration), or with the Operator acting as financier of the works, in which case the Operator will be remunerated as provided in the PAOI; and (3) a combination of the foregoing methods. The Contracting Authority may, with the Operator's agreement, order that certain levels of users be charged for the corresponding repayment installments while other levels be subsidized. - The Contracting Authority may bring forward the execution of POI works to be financed by third parties. The Operator will be obliged to carry out such works when the Contracting Authority finances them and handles all amortization directly. However, if the Contracting Authority orders that repayments be charged to the users and/or that the Operator finance the works, the Operator's agreement will be required. - By way of exception, the Operator may propose the inclusion in a PAOI of new works not contained in the initial POI, which will replace or displace other POI works. Valuation of the new works will be carried out, when possible, by analogy with the POI works, and, in any case, the values will require the Contracting Authority's approval. 30 The most basic and necessary rules will be included, but the Consultant must propose a logical set of rules that is as complete as possible. 31 Whether third-party works are brought forward or carried out on schedule, any financial operation that increases the monetary burden upon the users shall first be approved by the Operator, since it could unfavorably impact its collection ratio. Page 139 * As may be seen from the foregoing, any decision of a financial nature32 required by the Contract during operation of the systems has to be approved by the Contracting Authority as and when such decision is required. This means that the decision is taken by the political authority in office at the time. It also implies that the political authority originally signing the Contract may not take decisions of a financial nature relating to actions to be taken at a later date.33 This is undoubtedly the greatest advantage, and also the most important requirement, of the Model. The reason why certain PSP arrangements have foundered has generally been that conventional models tend to tie up the future to conform to the will of the political authority that signed the Contract, whose decisions are often completely unacceptable to those individuals who assume that particular office later on. Three types of selection criteria for a private operator in the water sector have been used in PSP processes in Latin America: Type I (Buenos Aires, Tucuman, Monteria) * Pre-established performance targets * Selection Criterion: lowest proposed tariff Type 2 (La Paz) * Pre-established tariff * Selection Criterion: highest proposed performance target Type 3 (the proposed model for this project) * Pre-established tariff * Pre-established performance targets * Selection Criterion: minimum capital investment subsidy (no operating subsidies) requested from a third party to comply with the performance targets during the entire contract period (which is equivalent to a maximum investment commitment) * The operator's proposal includes a technical proposal in the form of a detailed overall and annual investment program for the contract period. He defines in his proposal the portion of the investment out of the total which he commits to invest on the basis of the income from future tariffs, and the year until which he provides the investments. He also commits to achieve the performance targets up until this year. Models type 1 and type 2 do not require a technical proposal and some experts consider that a technical proposal should not be requested since the operator is only requested to provide performance and it is irrelevant how he achieves it, as long as he delivers. This approach might be reasonable for the cases in which no capital investment subsidy is requested from a third party, usually the Government, i.e., when the operator is required and agrees to provide all the investments during the contract period (this is 32 Such decisions are those that refer to any amendments to the Tariff Structure, and, in particular, those that refer to approval of the PAOI, which is the act by which the Authority directs and approves the operation's development, and, more particularly, any increase in or maintenance of the monetary burdens upon the users. 33 For example, and most importantly, a mayor signing the Contract may not prescribe subsequent increases in the Average Annual Tariff that would come about when he is no longer mayor. It is a common practice for mayors who do no not want to deal with a tariff increase at the time when they sign the Contract to be very generous with subsequent increases that will become effective when they are no longer mayor. This is basically contrary to the spirit of the Model, which requires that all financial decisions be taken by the political authority in office at the time, who will determine the right moment for such a decision and defend it before the public through an appropriate information campaign. Page 140 defined as a full concession). However, when a third party is providing partial financing (especially when this financing is provided in the form of a subsidy), it is reasonable to expect that that this party will receive all the technical and financial information regarding the program it is going to finance and have a say on the works it is financing, especially when the third party is the Government, which has social objectives. Submission of the technical proposal does not deprive the private operator from the ability to be innovative. First of all, it is the operator that prepares the technical proposal and he can incorporate in it the innovations he finds fit. In addition the operator does not lose the option to include innovations in the future, since he may propose alternative PAOIs, in the future, prior to the period of implementation of the works. If the alternatives achieve the same result at a lower cost, they may be approved by the contracting authority and the operator will benefit from the savings. This will provide an incentive to the operator to propose innovations. Usually the tendency in PSP in the water sector is to reach an agreement on a full concession. However, under the conditions in medium size cities in Colombia, it would be difficult to reach full concession agreements. Most of these cities suffer from infrastructure backlogs, need high investments, and the current tariffs which the service users in these cities pay are quite low. The first step is to reach an agreement with the municipal authorities of cities which choose to participate in the program in regard to the maximum acceptable tariffs. The assumption is that, in most cities, even with tariffs increased to the maximum acceptable level, it would not be possible to finance all the works required in the next 20-30 years (the contract period) just from tariffs. The winning private operator in a certain city will commit to invest the portion of the investments which can be financed by the agreed tariff, and to achieve the performance targets compatible with his investments. The Government will finance from the loan proceeds part of the rest of the investments, as a subsidy targeted to support the poor. The works financed by the Government in each city will be implemented by the private operator, who will then commit to achieve the performance targets compatible with the additional works. The remaining non-financed works, which will usually be required in the late years of the contract periods, will be financed by one of following sources (i) contribution of users in the future; (ii) additional public sector subsidies in the future (from municipal or government sources); or (iii) a combination of the previous two sources. Since, under the proposed project the Government is providing an investment subsidy to each participating city, type 3 model was found reasonable to be used, since it allows the Government to know exactly how the city's utility will be transformed, to decide what will be financed with the subsidy it provides and to target it as it wishes, as well as have control and ensure that the funds are used according what has been authorized. The basic concepts of the model are the following: defining FAA as Annual Authorized Billing (Factuaracion Annual Autorizada) COA as Annual Operation and Administration Cost of the System (Costo de Operacion y Administracion) If FAA-COA< 0, PSP is not financially viable, the utility should remain public and management should be improved. If FA-COA>0, PSP is financially viable. After the private operator takes over, he will improve efficiency by decreasing operational costs and increasing billing and collection. The following will be maintained: INV=FAA-COA-RAP>0 Page 141 where RAP = Reasonable Annual Profit INV = Annual Surplus for Investment The capacity of the operator to contribute to investments is the present value of the annual series of INV during the operation contract period and is defined as PV(INV). This capacity might not be sufficient to finance all the required investments and in medium size cities in Colombia, will most probably not be sufficient. The Bidding Process The bidding documents stipulate the fixed authorized annual average tariff and the tariff structure (which might be changed later). They also stipulate the transition period and pattern, if tariff increase is not immediate and there is a transition period from the current to the authorized tariff. The biding documents also include the required performance targets in terms of coverage (water, sewerage, in the entire city and in poor neighborhoods) and quality during each year of the contract period. The targets vary along time. Each proponent is required to submit his overall Works and Investments Program (POI) broken down to detailed Annual Works and Investment Programs (PA0Is) during each year of the contract period. The requirement that each proponent submit his own POI promotes private sector innovations and transfers technical and financial responsibility as well as risks to the proponents. Each proponents submits two envelopes: one with the technical proposal and the other with the financial proposal: * Ebvelope I contains the detailed proposed POI during the contract period, detailing annual works and investments (description of each work and cost estimate of each one). e Envelope 2 contains the present value of the resources requested by the operator as a subsidy from a third party which would allow the operator to complete the entire investment program. This also indicates, inter alia, the present value of the investments he commits to undertake and the year until which his investment commitment will cover the requirements. The Selection Criterion The winning bidder is the one which requests the minimum present value of the resources (minimum investment subsidy) from a third party. If a bidder does not request any support from a third party, then he should indicate what is the percentage of reduction in average tariff that would be acceptable to him. The bidder that proposes the highest tariff reduction is the winning bidder. The following figure provides an illustration of the selection criterion: Page 142 PSP Process- Selection Criterion Investment Plan Investments to be Realized by 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Private Operator Selectioni C riterion 1. Minimum Net Present Value (12%) of the investment flow to be realized by a third party 2. If No Investment of Third Party is Requested, then Percentage of Reduction in average Tariff (Average monthly bill for a consumption of 20 m3) The Contract Althouglh the selection criterion is based on investments which the operator cannot finanice from the tariff, this criterion is theoretical in the sense that there is no commitment in the contract that the public sector would finance the shortfall. The contract refers only to the amount that the operator commits to invest and the corresponding performance targets. The operator will provide the financing up until the year he committed to and will achieve the performance targets of this year. After that he will not be obliged to invest and will have to maintain the targets at a level of the year at which he completed his investments obligations. The POI submitted by the winning bidder will form part of the contract. The Mayor will have a right to review the annual investment program and request modifications, on condition that those do not increase the investment commintmnents of the operator. If the public sector will choose to provide additional investments to cover part or all the investment shortfall, these will be invested according to the POI and after completing the additional works, the operator will have to achieve the corresponding performance targets. If the public sector's investments are provided before the operator completed his investments obligations, works can be switched. Page 143 Model Benefits * Establishes contractual performance targets of the operator coupled with financial resources based on an achievable cash flow. * Is adjusted to the fiscal restrictions of the Government and the public sector. * Offers contractual stability and flexibility for adaptation to the conditions and priorities of each municipality. * Ensures consumers tariff efforts without exceeding capacity and willingness to pay. * Promotes local financial efforts without committing uncertain resources. * Ensures a simple, objective and transparent process of selecting a private operator, based on one easy- to-measure criterion. * Allows the municipal authorities to be involved in decision making as and when such decisions are required. Maicao managed to contract a private operator During project preparation, PSP processes based on the described model were prepared for several cities and bidding process were initiated. Unfortunately, because of budget related issues, the bidding processes coincided with the end of the term of mayors in Colombia, which hindered most of the processes. However, one process, in the city of Maicao, a city with a population of about 130,0000 inhabitants in the Department of La Guajira, was completed successfully, an operation contract was awarded to the private sector ( a consortium of Colombian operators and a foreign investor) which took over the responsibility for the provision of the water and sewerage services in the city as of March 15, 2001. Alternative models Although the described model is considered to be the most appropriate for medium size cities in Colombia, the use of other models would also be permitted, in accordance with the specific conditions of each city. For an alternative PSP contracts to be supported by the Project, the lessons learned from the past PSP experiences in the water and sanitation sector in Latin America should be fully taken into account. The main problems can be grouped into several issues: (i) lack of transparency in PSP/competition process; (ii) lack of clarity in regulatory framework and PSP contracts; (iii) weak and expensive regulatory institutions; (iv) inefficient tariff regime; (v) lack of clear strategy and feasible models to expand services to urban poor within the context of PSP; and (vi) unclear environmental responsibilities. Page 144 Annex 16: The Constructor-Operator Model for Private Sector Participation in the Operation of Water Supply and Sanitation Systems in Small Municipalities COLOMBIA: WATER SECTOR REFORM ASSISTANCE PROJECT A. The Need for Private Sector Participation in the Water Sector in Small and Medium-Size Municipalities Experience has shown that in Latin America the private sector tends to get involved in the management of the water services in large cities rather than in small municipalities or rural areas. Privatization occurs more often in large cities as a result of the lobbying efforts of the large private operators. However, analysis of the sector's dynamics indicates that large cities and their large water companies are least in need of private sector participation. The water company of Bogota can serve as an illustrative case. Because of low efficiency, this company has accumulates a deficit on several occasions. The reason for its inefficiency is essentially the instability in its policies which results from frequent turnover of management. Measures that were positive initially are usually interrupted after two or three years and replaced by inferior measures or programs. The company then loses the benefits financial surplus it had gained. When the financial situation deteriorates, the politicians enact a law which in one form or another covers the deficit, because they cannot permit that the national capital will be left without a water service. Large cities and their large water companies can continue to function as public utilities because when they run into financial problems, the Government will, sooner or later, bale them out and cover their deficit by providing them with funds from the national budget. On the other hand, small municipalities continue to pose a real concern in terms of the water service provided to their population. Multilateral Development Banks need to pay more attention and provide more help to small municipalities than to large cities, since the latter have easier access to government support, while small municipalities, mostly inhabited by population of low income, have limited access to the financial and technical support needed to improve their water and sanitation services. In Colombia, most of the past Bank support to the water sector was directed to large cities. The approach of the proposed project constitutes a shift in policy by setting out a new approach aimed at strengthening and supporting the water sector in small and medium size municipalities. The underlying assumption of this policy is that the water utilities in large cities can develop and grow on their own, although they, too, experience crises at times, as is currently happening in Cali. B. Big Versus Small Operators A number of misconceptions regarding big versus small and medium-size private operatoys, generally accepted as representing the truth need to be corrected. The first of these -the so-called "economy of scale effect" - maintains that it is more difficult and expensive to supply water to small municipalities than to large cities. This is completely false. Although circumstances do of course vary from one municipality to another, analysis of the most common water supply systems shows that it is cheaper to provide water service to small and medium-size towns than to large cities. The opposite is assumed to be the case because large regional water companies benefit from pointing out that their inefficiencies may be blamed on the fact that they need to provide unprofitable service to small municipalities, whereas in reality, a different quality of service is acceptable in small towns since the systems required do not have to be highly sophisticated. In small municipalities it is possible to use the services of operators who are familiar only with the basic operational tasks typically Page 145 needed for small systems, such as replacing a pipe -jobs which in the end are always performed by small contractors even when large water companies are also present. However, large firms do not wish to leave the task of serving small municipalities to small operators because they try to hide their own inefficiency. To cite a distant example (not related to Colombia), the city of Campo Grande, the capital of Mato Grosso do Sul in Brazil was faced with a water shortage which, as one would expect, affected mainly the outlying districts of the city. A local entrepreneur appeared on the scene and began drilling small wells in these districts, supplying water to an area which has never had a regular water service. The state-owned water company bought the entrepreneur out, realizing that someone was making very small investments to serve a market it had never tapped before, and for which it proposed constructing works valued at US$100 million in order to provide the water service. Large companies like to take over small operations for political gain, not just in large cities, but in small municipalities as well. The political returns which a large company stands to reap in a small municipality are much greater than in a large city. In large cities, substantial works must be built in order to generate political gains, whereas in a small municipality, building a small system captures the interest of the entire population: the press, TV, the mayor, everyone finds out about it. The large company thus becomes a political instrument, and that explains why politicians have no desire to give up managing public companies. This is the reality. Politicians are therefore not pleased to learn that it is more effective and profitable to leave operations in small municipalities to small operators. And these operators, moreover, are not going to be from Europe, Asia, or Australia; they are from the country itself. They are small entrepreneurs, which contribute far more wealth to the country than the huge multinationals, which prefer to operate only large water systems and, of course, to repatriate a share of their income. The establishment of small and medium-size operators makes so much sense that such programs have arisen spontaneously in a number of countries in Latin America. Returning to the example of Brazil, in spite of ten years of efforts by the govemment and the multilateral agencies, the success in privatizing state-owned and large municipal water utility has been modest. On the other hand, some thirty small municipalities now have small private operators, all the product of local initiatives, with no intervention or support of the state. The example of Paraguay's aguateros, or independent small water suppliers, is relevant in this regard. When we discovered them and analyzed the results of their efforts and activities we were very surprised to note that their situation refuted the so-called "economy of scale effect" mentioned earlier. On the outskirts of Asuncion, which attract emigrants from rural areas (the city's poorest inhabitants), a number of small operators (aguateros) provide water service to these residents, passing on to them all investment and operating costs as well as the cost of the aguateros' profits - and all this at tariffs which even the poorest users can afford. And they accomplish this without the investments or operating subsidies granted to the state-owned public utility which supplies water to the center of the capital. In Ciudad del Este, Paraguay's second largest city, aguateros once served the entire city, except for a small central sector supplied by the State-owned company. This company submitted to the government a water supply scheme for the entire city requiring an investment of US$200 million. The investment would have been used to provide water to areas which already had water service thanks to the aguateros. Moreover, besides wasting US$ 200 million, by ignoring the existence of the aguateros, the scheme would have ruined a host of small enterprises capable of serving small and medium-size towns without the Government's help. Page 146 In Campo Grande, as already observed, the large public utility chose to buy out the small private entrepreneur rather than compete with him. Even more drastic, in Ciudad del Este the large public utility sought to destroy the small private companies by simply ignoring their existence. The first lesson to be learned is that large cities need large operators while small municipalities need small local operators. The second lesson is that existing small operators should be respected. It is also recommended to promote and encourage the establishment of small private operators in places where legislation or custom have posed obstacles to their establishment. In all the cases of exiting small operators in Latin America, they are either ignored or opposed by the authorities. The proposed project is the first one under which the activity of small private operators will be supported and promoted by a Government, and the Government of Colombia is the first one which has incorporated in its policy the use of small private operators as an instrument for improving the water service in small municipalities. C. The Principles of the Constructor-Operator Model Let us now examine the principles of the Constructor-Operator model, which will be applied in Colombia as a measure aimed at providing a response to the need for small operators. The proposed arrangement is applicable to very small localities, i.e., municipalities with populations in the range of 2,000 to 12,000 inhabitants. It is based on a government program to invest in the rehabilitation and expansion of water and sanitation systems in the participating small municipalities, coupled with the institutional concept that the systems must be managed by small private entrepreneurs. How can a market of small operators be created where none exist? we suggest turning small constructors, a market of which does exist anywhere, into operators by including provisions in their construction contracts requiring them to operate the systems they construct for a certain period of time, for example, ten years. The Constructor-Operator must first calculate the construction cost of the works he is required to construct, and then the ten-years operating cost, bearing in mind the income to be generated by user tariffs and the portion of that income which he can contribute to construction, while still maintaining reasonable profits during the operation period. The residual construction cost, i.e., the difference between the value of the works and the contribution to construction cost from future income, will be contributed by the Government as a "construction cost contribution" in a form of a n investment subsidy to the population of the small municipality. Although initially constructors may not find such an operation attractive, they might agree to be responsible for system operation because of their interest in the construction portion of the contract. Then, with time they might grow to get fond of the operation activity, after learning about its benefits and getting used to them. The project begins with a study which defines how much can the population pay for the water and sanitation services. The capacity to pay must be taken into account, because if operating costs exceed what users can afford, the project will not be viable (this should never be the case; users should always be capable of paying at least the operating costs). If the capacity to pay exceeds the operating costs, leaving a suitable profit for the operator, the project can be considered feasible. The average tariff users will pay will be constant during the operations phase and must be agreed upon with the municipal authorities and approved by them (a fixed formula for revising the tariff, to be applied automatically for inflation adjustment, may be established as well). After reaching an agreement on tariffs with the municipal authorities, the detailed design of the required works will be prepared, including specifications. The bidding process for selecting the operator will begin at this point. Bidders will calculate operating surpluses in terms of present value and determine how much can they contribute from the future income to finance the works, and how much they request as Government contribution. Bidders may also provide Page 147 alternative designs which might reduce costs. Standard bidding procedures will be used and the contract will be awarded to the bidder that submitted the lowest responsive bid for construction. After operating for ten years the system he himself constructed, the Constructor-Operator will most probably recognize the benefits of performing as a system operator, i.e., benefiting from a stable, reliable and continuos source of income, while performing a relatively simple task. It is expected that this will convince the entrepreneur to remain an operator on a permanent basis. D. Details of the Constructor-Operator Model for Small Municipalities and Procedures for its Implementation Private operators in small localities should be encouraged to participate in the operation of water supply and sanitation systems in accordance with procedures reflecting the specific circumstances dictated by the size of the municipality. The procedures followed traditionally for incorporating the private sector in the management of the services, in addition to being lengthy and cumbersome, are inappropriate for small operators with limited resources and no source of financing. Unless appropriate procedures are implemented for incorporating the private sector in management and operation of water systems in small municipalities, there is a risk that no operators will be found to serve such municipalities - not because such operations are unprofitable, but rather, because the procedural obstacles and financial requirements discourage small and medium-size entrepreneurs (SMEs) from getting involved. However, it is even more important to encourage SMEs to specialize in such operations in small municipalities than in larger cities because the difficulties of the public authorities in organization and proper operation of water and sanitation systems in small municipalities are much greater than the difficulties in greater municipalities, whereas SMEs have all the required management capacity to operate such small systems. The first thing to bear in mind when preparing a private sector participation (PSP) operation in small municipalities is that the operator does not need to be experienced in the particular field or have the financial capacity to make investments. Rather, the operator should be able to take the place of a public utility (which is subject to political intervention and is always short of funds) by assuming contractual obligations under which the operator acquires responsibilities which he has to comply with and which can be-properly controlled and monitored. However, a small operator cannot accept substantial economic risks in such transactions. Accordingly, the initial conclusion to be drawn is that whereas in large population centers it is possible to require that operators provide significant investments at the beginning of the contract period (since their investments will be recovered during the operation period), such a requirement cannot be imposed in small municipalities. Even if investments are not required, the operation of water systems in small municipalities might seem unattractive, particularly in regions were there is no tradition of this type of operations. Nevertheless, experience in a number of countries has shown that such an assumption is incorrect and that with proper organization and specialization SMEs can obtain meaningful profits from operating water and sanitation systems in small municipalities. However, it is not easy to transfer this experience from one country to another. Where there is no established history of SME involvement in small municipalities, it is necessary to start by promoting their involvement in the water sector and by helping to establish the small and medium-size entrepreneurs in the water sector. Later, once successful operations have been established, SMEs will continue operating in the sector without additional encouragement and will even consider taking on some risk by investing their own resources. SME participation in the water sector can be promoted through groups of small construction firms. Such firms by definition possess the required technical skills to operate water and sanitation systems and the functional capacity to mange commercial enterprises. It should not be forgotten that these firms are generally the ones called upon most often to repair and construct water and sanitation systems, often Page 148 working together with larger construction companies which retain most of the profits from large contracts to which they have access. But the fact remains that the operators who work on such projects are often smaller companies. Furthermore, all small construction firms are familiar with administrative and accounting procedures, which differ little from those needed by SMEs in the water sector. It is therefore sufficient to attract small construction companies to the water sector in small municipalities by offering them the business in a form which will result attractive to them. Such firms are most likely to be attracted by a construction contract suited to their means and conditions. Because most small municipalities suffer from infrastructure investment deficit in their water supply and sanitation systems, programs to improve the water and sanitation services must begin with system rehabilitation and consolidation works. According to the principle of the Constructor-Operator model, the central and/or local Government (municipality), in coordination and with the assistance of the Project Implementation Unit, would start off by inviting bids for the works, including in the bidding documents the requirement that the successful bidder must operate the system from the time construction begins and for several years after it has been completed (an operation period of 10 to 15 years seems reasonable). Small construction firms, initially attracted by the construction component of the contract, will then evolve into private small water system operators. It is very likely that once the agreed operating period has ended, the small construction companies will be interested in continuing such operations in the municipalities they were already involved in and/or in others of a size matching their capabilities. Preparations for a program based on the principles outlined above should begin with a study of the small municipalities that is sufficiently targeted and simple to ensure that the desired small operators will be found. The consulting firm conducting the study should comply with terms of reference (TOR) which encourage simplification and specificity, avoiding the complexities that generally accompany the typical PSP process. Specifically, the TOR should require that the study cover the following items: * Firstly, the capacity and willingness of users to pay should be considered in order to determine the maximum possible tariff they can afford. A tariff structure for the municipality in question should then be established. * Next, the consulting firm should discuss the defined tariff structure with the local authorities and reach a respective agreement after the latter have introduced any changes deems necessary. The approved tariff structure should then be reflected in formal commitment (such as municipal council resolution, or whatever is required by law). * The consulting firm, with the assistance of the local authorities, should conduct a public campaign to convince users and their immediate representatives (existing social organizations) about the need for paying adequate tariffs if they are to benefit from the improvements bein provided with government assistance. Wherever possible, the agreement by users' representatives should be set out in writing, in meeting records or similar documents. The consulting firm should emphasize in particular that in order to be included in the assistance program managed by the proiect, users must make a formal commitment and pay water tariffs in a timely manner. * The consulting firm will calculate the expected income on the basis of the agreed tariff structure, utilizing the collection rate deemed adequate on the basis of its experience with the authorities and users. In parallel, the consulting firm will establish the system operating costs, and will prove that an operating surplus does exists, since otherwise the business will not be profitable and the private sector participation will materialize. In particular, if municipal employees are working on the system before the takeover by the private operator, they must continue to do so even once the private operator got involved, and the consulting firm will include the real costs related to these workers in its calculations. This is imperative in order not to cause any disruptive changes for existing personnel during the transformation of management. Page 149 * If no operating surplus is expected, the consulting firm will conclude its work with a report detailing a description of its activity and its recommendations to the municipality for improving the system under public sector management. No PSP operation could be considered viable without an operating surplus. * If an operating surplus is expected and can be maintained, the consulting firm will request the local authorities to formally authorize the project implementation unit to invite bids on behalf of the municipality for construction and operation of the water and sanitation system. The project implementation unit will keep the municipality informed on the status of the process of incorporation of a private operator. * Once the authorization referred to in the preceding paragraph has been received, the consulting firm will prepare a study defining the Works and Investment Plan (Plan de Obras e Inversiones, POI) which the municipality needs in order to bring its system up to adequate state, within service quality levels compatible with conditions in the municipality. In addition to the POI, the consulting firm will prepare a report for the project implementation unit indicating all measures taken, documents from the authorities and users proving adherence to the program, the willingness of users to pay in accordance with the tariff structure, and the authorization to the project implementation unit to proceed with the bidding process for selecting the constructor- operator. * On the basis of this information the project implementation unit team will establish the amount of financial support which the municipality would receive. Once this figure is known, the consulting firm will determine which works a priority for municipality and can be accommodated within the available budget, after which the firm will prepare the final design and specifications for the works which would be constructed. The project implementation unit, with assistance of the consulting firm will also re-evaluate and prove that, after the proposed works have been put into service, the system can continue to operate with the operating surplus. * Finally, the consulting firm will prepare the following documents: (1) the Bidding documents; and (2) a construction and Operating contract which, together with the final design and specifications, will form the basis for the agreement for construction and operation between the municipality and the successful bidder. As is typical with bidding for works, the selection criterion will be the lowest responsive bid, i.e., the winning bidder will be the one which proposes to construct the required works for the lowest cost. During the operation period, all operating conditions will be fixed and will not change with time. However, the tariff structure will be subject to adjustment in the light of consumer price increases, as stipulated in the contract. * The documents referred to in the preceding paragraph should be drafted as model documents applicable to all municipalities. To each model document, the information specific to each municipality will be incorporated, namely (1) the tariff structure and (2) the final design and specifications. When the consulting firm has completed its work the project implementation unit, with input from the municipality, will initiate the bidding process, endeavoring to ensure the broadest possible competition among local and nonlocal participants, under the following conditions: * The bidding processes for various municipalities will proceed simultaneously if there are not too many participating municipalities. Otherwise, several municipalities will be joint appropriately into a single biding process and so several bidding processes will take place, each including a group of municipalities. The Bidding documents will stipulate if bidders must bid on the entire group, or on Page 1 50 each municipality in the group separately, or only separately in respect of specific municipalities in the group. The project implementation unit, will decide whether all the municipalities in a group should be the responsibility of a single operator or whether each municipality should be covered by a different operator. In the latter case, it is required that several offers are received for each municipality. * No matter which award procedure is followed pursuant to the preceding paragraph, a contract must be signed for each municipality, even if several or all of them will be the responsibility of the same operator. It is important to keep in mind that once the project implementation unit's work is over, each municipality will control its operator in accordance with its own contract. It is not recommended that several municipalities join together to sign the same contract. * The successful bidder must begin construction and operations on the same date (the contract start date). Users will begin to pay from that same date in accordance with the agreed tariff structure. * Pursuant to the contract terms, the operator will have the right to discontinue water service to users who fail to pay. If, during the first six months of operation, or halfway through the construction phase of the works covered by the final design specifications, whichever period is shorter, payment arrears are above a certain percentage (established in the contract), the operator will have the right to halt construction and turn the operation over to the municipality, and the operator will be paid for the portion of the works completed at that date. The project implementation unit will make the payment and will cancel the remaining works. * The project implementation unit will pay for the works according to progress, keeping with the usual practice for construction contracts. The work of the project implementation unit will end once the works have been completed in accordance with the final design specifications. The operator will continue operating the system under the control of the municipality, in compliance with the contract terms. The ideas regarding the constructor-operator presented above obviously need to be refined and expanded before action are taken under the proposed project. During project preparation, a pilot program to incorporate SMEs in 8 small municipalities utilizing the described constructor-operator principles has been prepared under Loan No. 3336-CO. However, this TA loan could not finance works. Because of the economic crisis in Colombia, the government did not have sufficient available funds to finance the required works in all the 8 small municipalities, however, two biding processes have been carried out, in Nataga and Cumaral, and have terminated successfully with award of operation contracts to two operators. Experience gained in the pilot program will be used to design and implement the SME component of the proposed project. However, the successful pilot experience demonstrates that the Constructor-Operator is a viable concept. The main conclusion from the pilot operation is that the most important actor is the project implementation unit team, which plays the main role in: (i) convincing Mayors and municipal councils to undertake the PSP reform; (ii) negotiating the tariffs with the local authorities; (iii) carrying out the campaign to convince the community to accept the reform; (iv) prepare the biding documents, ensure their integrity and carry out the bidding process, providing guidance up to the point of signing the contract. The performance of the consulting firms was somewhat disappointing. They did not take the lead in activities they were expected two and concentrated on preparing the technical aspects, such as the detailed design and specifications, so the project implementation unit had to step in and take care of all the rest. The PSP process in the Municipality of Cumaral: The municipality of Cumaral in the Department of Meta, with a population of 12,000 inhabitants, decided to participat in the pilot project of PSP through the constructor-operator concept. The nominal coverage of services prior to PSP was high (90% for water and 85% for sewerage), however the real coverage of water is much lower and the main problem is continuity of service, which is only available between 4 to 8 hours per day. In addition, the municipal Page 151 authorities had no way to improve the service, other than to join the project. The contract includes the operation of both the water and sewerage services, although investments are required only for water because the municipality has recently invested in optimizing the sewerage system. GTZ helped the PIU in the socialization process which initiated in October 1999. The process consisted of meetings with the mayor, the municipal council, community leaders and the community as a whole. The Department of Meta participated and there was methodology transfer to it, in order to develop a capacity to replicate the process in other municipalities. The consulting firm Hidrotec was hired to prepare the PSP process. It prepared the POI which was presented to the municipal council, but neither the mayor nor the council took a decisive positive position regarding the process, because of the approaching elections. The PSP process continued in spite of the hesitation of the authorities and the mounting objection from various actors (such as the municipal controller and the municipal legal adviser). The bidding documents were based on the constructor-operator model, which was adjusted to Law 80 (the Colombian procurement law) and not to the Bank guidelines, because the government is financing the investment. The bidding process finally started on November 30, 2000, and a period of only 21 days was given for submission of proposals, since the term of the mayor expired on December 30, and it was necessary that he sign the contract before leaving office. This objective was achieved. The water and sewerage tariffs for a consumption of up to 20 m3/month prior to PSP and the agreed tariffs to be effective during PSP are presented in the following table. Stratum Average Monthly bill Before PSP Average Monthly bill During PSP (US$) (US$) 1 2.6 5.5 2 3.1 6.1 3 4.5 6.8 4 4.5 8.2 Commercial 6.9 9.1 The public audience for presentation of information, which was carried out prior to the initiation of the bidding process, attracted 8 interested bidders which included several constructors from the Meta region and from Bogota. The process was announce in all the important newspapers in the country, in the web page of the Ministry of Economic Development and in professional chat rooms (sias-foro). Three proposals were submitted, all of them by groups with experience of construction of water installations. The winning bidder was Aguas del Llano, a local constructor with experience in the type of works required. The financial structure of the transaction is the following: Contributor Amount (US$) Municipality of Cumaral (Law 60) 363,640 Department of Meta 181,820 Government 636,630 Operator 268,180 Total Project Cost 1,450,270 The PSP process in the Municipality of Nitaga: The municipality of Nataga in the Department of Huila, with a population of 2,000 inhabitants, also participated in the pilot project of PSP through the constructor-operator concept. The nominal coverage of services prior to PSP was 70% for water and 70% for sewerage, however, the main problem is continuity of service, which is only available between 10 to 12 hours per day. The municipal authorities had no way to improve the service, other than to join the project. The contract includes investments in a water intake, water treatment, extension of water distribution networks and extension of sewerage networks, as well as the operation of both the water and sewerage services, however, it does not include investments in sewage treatment. The socialization Page 152 process consisted of three stages: (i) presentation to the mayor and to the municipal council of the principles of PSP under the constructor-operator concept, to establish the political willingness to participate; (ii) presentation of the POI and the proposed tariffs to the municipal authorities and to community leaders; and (iii) presentation of the final design and a draft contract to the municipal authorities and to community leaders. The consulting firm Hidrotec was hired to prepare the PSP process. During the third stage, on the basis of the estimated project cost, the council authorization was granted to initiate the bidding process and provide Law 60 funds to finance part of the works. The request for council authorization coincided with the election period and one of the candidates for mayor used the objection to the project as his election campaign main issue. The mayor reacted by calling a town hall meeting, in which he presented the project to the community and obtained its support. After the election, the mayor elect expressed support to the project and continues to support it. The bidding documents were based on the constructor-operator model, which was adjusted to Law 80. The bidding process started on November 24, 2000, and a period of only 24 days was given for submission of proposals, since the term of the mayor expired on December 31, and it was necessary that he sign the contract before leaving office. This objective was achieved. Before PSP the water bill was based on the number of water taps in each house. The payment for the first tap was US$ 0.71 per month and for any additional tap, an additional US$ 0.21 per month. The average monthly water and sewerage tariffs prior to PSP and the and the agreed tariffs for a consumption of up to 20 m3/month to be effective during PSP are presented in the following table. Stratum Average Monthly bill Before PSP Average Monthly bill During PSP (US$) (US$) 1 2.5 3.5 2 3.0 4.1 3 4.3 4.8 Commercial 7.3 7.3 The public audience for presentation of information, which was carried out prior to the initiation of the bidding process, attracted 6 interested bidders which included 5 constructors from the Huila region and one from Bogota. The process was announce in all the important newspapers in the country, in the web page of the Ministry of Economic Development and in professional chat rooms (sias-foro). Two proposals were submitted, one of a consortium of three of the local interested constructor and the other of another interested local constructor. Both proponents have experience of construction of water installations. The winning bidder was the local constructor Almafama, with experience in the type of works required. The financial structure of the transaction is the following: Contributor Amount (US$) Municipality of Nataga (Law 60) 54,550 Government 200,300 Operator 0 Total Project Cost 254,850 The award of these two contracts demonstrate the viability of the constructor-operator concept in Colombia, for municipalities with populations ranging from 2,000 to 12,000. Page 153 Annex 17: Private Sector Participation in the Water Sector in Colombia COLOMBIA: WATER SECTOR REFORM ASSISTANCE PROJECT A. Introduction The first case of private sector participation in a water company in Colombia is that of the city of Cartagena, which was prepared with support of the World Bank and introduced in 1995 the PSP concept into the country and paved the way to the following cases. To date, about 50 water utilities in municipalities of various sizes in Colombia have already adopted the PSP concept and are managed by private operators. About 14 of those are large and medium size utilities and the rest are smaller municipalities with populations in the range of 10,000 to 30,0000 inhabitants. Among the known large and medium size water companies managed by the private sector are those of Cartagena, Barranquilla, Santa Marta, Tunja, Monteria, Palmira, Girardot and others. The experience with the privatized utilities is encouraging. The performance of all of them has greatly improved after transferring their management to the private sector, customer satisfaction is high and they provide good examples to the way for resolving the water sector problems, so PSP is emerging as a methodology which tends to be adopted by mayors who are interested in improving the performance water sector in their nunicipalities. In this Annex information is provided on the following topics related to PSP in the water sector in Colombia: (i) performance of large and medium size privatized companies; (ii) performance of ACUACAR, the Mixed-Capital water company of Cartagena, managed by the private sector; and (iii) private sector participation in the provision of water services in small municipalities in Colombia. A partial list of the utilities with PSP is provided in the Appendix to this Annex. B. Performance of Large and Medium Size Privatized Utilities Nominal coverage34 of water and sewerage services increased substantially in Colombia between the years 1977 and 1997. In the poorest regions of the country35, on the Atlantic coast, water coverage rose from 70 percent to 76 percent and sewerage from 39 percent to 48 percent, while on the Pacific coast6 piped water coverage was 54 percent in 1993 and 70 percent in 1997, with sewerage coverage increasing from 32 percent to 44 percent.37 The strategy pursued by recent governments in the water and sanitation sector has focused on promoting private sector participation as a way of helping to solve the problems of poor quality and low coverage of these services and as a way to reduce the amount of fiscal transfers that the central government has traditionally earmarked for the sector. The sector Modemization Program set up in the Water and Sanitation Directorate of the Ministry for Economic Development was designed to support private sector participation in water and sanitation utilities. Colombia is currently one of the Latin American countries most actively engaged in processes associated with private sector participation in the water sector. Colombia's first PSP process in the water and sanitation sector in a large city began in Cartagena (with a population of about 800,000 inhabitants) in 34 Nominal coverage does not take into account the continuity of water service, i.e., the number of hours per day during which water is available. 3 A study is currently being conducted of water and sewage services coverage by socioeconomic stratum and income decile between 1993 and 1997 in order to determine how the poorest segments of the population have fared. 36 Excluding the department of Valle del Cauca. 37 According to estimates by Econometria S.A. based on DANE, DNP, and Household Surveys conducted in 1993 and 1997. Page 154 1995. The following year, Barranquilla (with a population of about 2 million inhabitants) also decided to incorporate the private sector in the provision of its water and sanitation services. Tunja, with a population of about 300,000 soon followed and signed a concession contract with a private operator. Today, private enterprises are providing piped water and sewerage services in 14 large and medium-sized municipalities in Colombia, as well as in approximately 33 smaller ones. Under the proposed project, approximately 35 additional municipalities are expected to incorporate the private sector over the next five years. Cartagena, Barranquilla and Tunja have already several tears of experience of operation under the responsibility of the private sector. During a period of five years the performance indicators of the water and sewerage services in these cities improved substantially, as demostrated in the following Table. The information in the table shows that under private management of the services not only the genaral population has benefitted from improved services but also the low income population: 98% of the service connections in Cartagena were for strata I and 2, in Barranquilla 86%, in Tunja 79%, and in another privately operated utility in Santa Marta over 50%. Table 1: Performance Indicators in Some Large and Medium Size Utilities Opertaed by the Private Sector Cart gena Barra quilla Tunja Indicators Before After Before After Before After International Indicators PSP PSP PSP PSP PSP PSP Standard 1994 2000 1995 2000 1995 2000 Number of employees 1,300 272 929 813 117 86 Number ofemployeesper 15 2.4 5.47 3.36 5.01 3.71 2 1000 connections I____ I______ Water coverage 68% 86% 89% 94% 89% 98% 100% Sewerage coverage 56% 70% 74% 78% 87% 92% 100% % of domestic metering 30% 98.7% 25% 60% 90% 99% 100% Number of connections 84,143 113,035 180,717 241,902 23,308 26,139 Unaccounted for water 60% 38% 46% 42% 53% 43% 25% Production capacity (m3/sec) 1.6 3.1 7.5 8.2 0.3 0.3 Continuity of service (hr/day) 7 24 18 24 12 18 24 Response to complaints (days) 6 1.3 2 1.7 1.5 1.5 0.5 Connections in poor areas (strata land 2) as percentage 82% 58% 79% of new connections installed in 1995-99 Source: Ministry of Economic Development C. Performance of ACUACAR, the Mixed-Capital Water Company of Cartagena, Managed by the Private Sector Private Sector Participation in the Management of the Water and Sewerage Services in Cartagena Since ACUACAR is the first privately operated utility in Colombia, and is already operating during a period of 6 years, it was considered valuable to reviewe in further detail the performance of this company and the strategy it had used to improve the level of the provision of the water and sewerage services in Cartgana. Usually, the main problem associated with financing water utility projects in developing countries is ensuring sustainability in view of institutional weakness. In the case of the Cartagena water and sewerage utility, institutional problems have been dealt with by incorporation of the private sector in the management of the servicest. This was done in the framework of a previous Bank loan for the Water and Sewerage Sector Project in Colombia (Loan 2961-CO). In October 1993, following many years of chronic inefficiency, political interference and poor quality of service, the Mayor of Cartagena decided to liquidate EPD, the public municipal water and sewerage utility of Cartagena, and at the advice of the Page 155 Bank, involve the private sector in the management of the water and sewerage services in the city. Activities to prepare the privatization process initiated in February 1994, with strong support, guidance and technical assistance of the Bank, which were essential for the successful completion of the process in the tight timeframe in which it was actually accomplished (which was restricted by the remaining term of the Mayor in office, which expired on December 31, 1994). The PSP model selected was a mixed-capital company model, under which the municipality associates with a qualified experienced water operator to create a joint venture company in charge of the operation and maintenance of the water and sewerage systems, while the assets remain under the ownership of the municipality, which is also in charge of all new investments for expansion of the system. After a public bidding process, Aguas de Barcelona (AGBAR, the privately owned water company of Barcelona), an experienced European private operator, was selected as the partner of the municipality. In December 1994, as the first stage in the privatization of the city's water and wastewater services, Aguas de Cartagena (ACUACAR), the new joint-stock company, was legally established with an initial share capital of US$ 4 million. Following six months of negotiations with the District of Cartagena, which were facilitated by the Bank, the responsibility for providing the water and sewerage services was transferred to ACUACAR on June 25, 1995. The share capital of ACUACAR is distributed as follows: 50% to the District of Cartagena, 46% to AGBAR and the remaining 4% to local private shareholders. ACUACAR's Board of Directors is composed by five members: two nominated by the District, two nominated by AGBAR and one nominated by the private shareholders. Decisions in the Board have to be reached on the basis of a majority of 80%, i.e. by a supporting vote of at least four members, which requires a common agreement between the District and AGBAR. The General Manager of ACUACAR is nominated by AGBAR and needs to be approved by the Board. ACUACAR has an operations and maintenance contract to provide water and wastewater services to the District of Cartagena for a period of 26 years. Under the contract, the District is responsible for future capital investments to expand the existing water and wastewater system; while ACUACAR is responsible for capital expenditures to improve the existing system and has the right to use existing and future assets at no cost during the contract life. The contract included various performance targets which require the company to improve the quality of service and maintenance, reduce unaccounted-for-water (UFW) and improve the collection rate. It stipulates that 50% of net income will be declared as dividend to shareholders, which is the mechanism for income generation to the District of Cartagena. AGBAR receives in addition to the dividend also a management fee, calculated as a percentage of revenues, which is declining along the years. The District has also some regulatory responsibility as a share holder in ACUACAR and as the supervisor of compliance under the contract. In spite of the implicit conflict of interest (representing the public interest and trying to maximize returns), an advantage and a potential weakness of this model is that it is self regulating; both the District and AGBAR have effective veto power and must reach decisions by consensus. The contract assigns some regulatory and policy functions to the District, including the approval of the tariff level. However, final decisions and approval of tariff levels rest with the water regulation committee (CRA). There is external control and monitoring through financial auditors and a "Revisor Fiscal" appointed by the Company. The former provides traditional company auditing and the latter a light touch regulatory impact. There is provision for appointment of an "Interventor" by the District of Cartagena to provide a degree of control over the operations and investments in the business. An appointment has not been made however. The tariff structure is controlled by the resolutions of the Water Regulation Committee (CRA). Tariff effects are set out in three Corporate "Acuerdos" as are numerical values, projected to December 2001 and worked up in a study "Estudio de Costos y Tarifas de los Servicios de Acueducto y Alcantarillado" prepared for ACUACAR in June 1996. The study was prepared in accordance with Law 142 of 1994 using the prescribed formulae. The structure provides for recovery of operational costs associated with volumetric demand and facility costs related to existing and projected capital values. Allocations to six different domestic economic groups and official, industrial, commercial, multi- and common users are Page 156 built into charges formulae. The Acuerdos provide for convergence over time between existing (lower) charges and approved (higher) charges. ACUACAR's Performance and Achievements The Cartagena mixed capital company is an interesting model that has survived its first five years of operation in a market environment that few intemational sector utility operators would approach with equanimity. Corporate operation has developed along ultra-modem partnering lines, defying contract structure critics. The model brings together a private operator and a public authority in a service company under transparent corporate governance rules, providing an opportunity for disciplined activity and accountability before customers and shareholders. During its first five years of operation, ACUACAR has achieved significant improvements in operational performance. It is considered the most successful privatization case in Colombia and has served as a catalyst for similar privatization processes in other Colombian cities. The privatization has already resulted in improved management and higher efficiency within the system. These efficiency gains have resulted in cash generation which the company has re-invested to further improve the system. Achievements include putting the business on a sound commercial footing, increasing efficiency and staff commitment, creating a credit-worthy public/private company, providing customer satisfaction and dialogue, and increasingly auditable information. ACUACAR is unique as a South American water sector utility in being the first one in the continent to achieve the ISO 9002 accreditation for its quality of operations and laboratory. Management and staff that are well-qualified and trained and demonstrate a high degree of competence, motivation and commitment. Networks are efficiently managed under extremely difficult operating constraints which include the legacy of a network in extremely poor condition that it inherited on takeover of operations and a very significant number of unauthorized connections and tampering with customer meters From field visit, scrutiny of reports, discussions with ACUACAR staff and ad hoc enquiry of third parties it becomes clear that ACUACAR has, in the period since the take-over in 1995, significantly improved the water supply and sanitation services to the District of Cartagena, in comparison to the situation which prevailed before the take over. The ultimate indicator for success is customer satisfaction. Casual limited questioning of the public by Bank staff and consultants, as well as surveys by ACUACAR suggest that it is impressing its customers, none of which is willing to reverse the situation and go back to the state of service prevailing before the take over by ACUACAR. Improvements made by ACUACAR include: (i) increasing water supply, in production, treatment and coverage; (ii) increasing sewerage coverage; (iii) improving water quality; (iv) introducing modern commercial and recognizable management information systems; (v) installing water meters on practically all its customers connections; (vi) improving continuity of service; (vii) rationalizing labor force; (viii) putting in place a staff training program and creating an enabling and encouraging working environment; (ix) investing heavily in Information Technology/Information Systems; (x) introducing an environment of maintenance of assets; (xi) introducing automated control of processes and operation; (xii) improving efficiency and financial performance; (xiii) undertaking significant investments for expansion of services by borrowing from local banks and multilateral donors, although such investments are not mandatory under the ACUACAR contract, (xiv) improving relations with customers; and (xv) creating relations of trust with suppliers. Increasing water supply, in production, treatment and coverage: Since take over, production capacity increased from 165,000 m3/d to 256,000 m3/d, treatment capacity increased from 165,000 m3/d to 320,000 m3/d, 120 km of water networks were installed and water coverage increased from 75% to 80%. Page 157 Increasing sewerage coverage: since take over sewerage coverage increased from 58% to 70%. Improving water quality: The quality of water supplied to customers, which before the take over did not meet the required quality standards, is now strictly monitored and its quality is better than the standard at all times. The water treatment plant at El Bosque has been rehabilitated and is now most modern and efficient. A new modem quality control laboratory has been built, equipped with most modern instruments. It obtained the ISO 9002/94 accreditation on March 18, 1998. Introducing modern commercial and recognizable management information systems: The commercial and management information systems introduced are the most modern systems used by the AGBAR group. A wealth of information is generated in the company and decisions are taken on the basis of that information. ACUACAR installed a secure billing system with access control, service linkages and classification of customer contact and has improved billing performance and collection. According to ACUACAR's reports, it has met the recovery to billing ratio targets set out in Annex VIII to the contract (85%) demonstrating a spectacular improvement over the previous public service. While that performance is on target, 85% debt recovery combined with high non-revenue water still present a difficult business environment when it comes to generating sufficient funds for improvement and expansion of services within reasonable tariff limits. Installing water meters on practically all its customers connections: by May 1998 there were a reported 96,297 customer connections, of which 91,406 were metered, indicating a metering level of 95%. All the meters were installed after the take over. This may be close to effective saturation metering and should permit a high degree of system control. It is doubtful that effective 100% metered supply is practically achievable. Meter reading is realize at a one month frequency (i.e., 12 times a year), which is a very high reading frequency. The Company's computerized system can download meter reading frequency data. The company has reportedly been reducing illegal connections by around 2,000 per year over the period 1996, 1997 and to May 1998. That is suggestive of an active program of legalization of customers. The Company has an apparently aggressive disconnection and lively reconnection policy. The outcome from the figures for 1996, 1997 and 1998 seems to indicate that a growing number of customers is denied access to water supply services. Improving continuity of service: During the first five years of private sector operation of the water distribution system it has succeeded in improving the continuity of supply and raise system pressures. Approximately 100% of those currently served in the city receive a continuous supply of water throughout 24 hours of the day, whereas this was only available to about 65% of the customers in 1995, before the take over by ACUACAR. Rationalizing labor force: The organization has been reduced dramatically from the pre company size of about 1300 employees to around 250 directly employed staff and 110 indirectly employed staff. The reported target is 300 overall but that may not be achievable nor desirable, should expansion move forward rapidly. In terms of Staff number per customer the ratio is less than 4 per 1000 connections and is reasonable for the Company's dynamic growth situation. There is relative stability within departments and a very small tumover of personnel. The classic problem of an organization in decline has been overcome in that staff have been enabled with appropriate tools to carry out allotted tasks. Management centers follow a recognizable structure and the spread of personnel seem reasonable. At May 1998 the composition was as follows; general management (23); human resources (20); finance (15); information systems (18); commercial (107); technical (124); master planning (25); projects (4); and quality control (29). Putting in place a staff training program and creating an enabling and encouraging working environment: The company has developed and implemented a training program (Plan de Formaci6n). Subjects are clearly orientated towards the need of the business and the Human Resources department seeks to give some training to all staff. From the May 1998 Company report, some 237 participants Page 158 attended 21 courses ranging from one to one intensive training in quality systems and English to sector service principles attended by 30 people over twelve hours. 128 Thousand hours of staff training (of the order of 20% of available time) were provided in 1997, representing a major investment in enhancing capacity and capability. Internally led training packages cover such subjects as the use of EXCEL spreadsheet, ACCESS and GIS computer programs; communications systems; safety in dealing with electricity at work; health and safety; chlorine handling; and working in confined spaces. Externally led courses are provided in such as environmental matters, computer management (IBM) and quality assurance procedures (ICONTEC). Several staff have also been sent to training in Spain, for periods of up to one year, to acquire high level management skills. Investing heavily in Information Technology/lInformation Systems: A systems directorate has been created such that the Company operates on its own intranet with internet connection. It has a web site. This latter facility is a light years step in exposure of the utility to local, national and international enquiry and scrutiny. Widespread desk top access is available through Windows applications and the Company has around 200 linked PC stations. Treatment plant operations are computer controlled using remote monitoring and operation via telemetry connections. Introducing an environment of maintenance of assets: One of the most depressing aspects of the pre-ACUACAR era was the lack of systems maintenance, which resulted in corrosion, erosion and deterioration of installations, in many cases up to an inoperable level. One of the important improvements introduced by ACUACAR was the application of strict maintenance procedures, which are not usually practices in Colombia. A visit to El Bosque treatment plant and review of pre and post rehabilitation photographs in promotional literature and reports indicates that routine operations were being carried out in a workmanlike way and that works had been rehabilitated. The plant is now tidy and well maintained. It has been automated and is operated from a computerized control center. Pumping stations have been rehabilitated as well and are well maintained. Those who know the systems from the pre-ACUACAR era would be surprised from the amazing progress achieved by ACUACAR. Introducing automated control ofprocesses and operation: The El Bosque treatment plant has been automated and is operated from a computerized control center. Schematics, animated plant and equipment status and performance information is stored and manipulated within the electronic system. The combination of electronic information handling and hard copies indicate the high technical level of ACUACAR. The pumping stations are controlled as well from the El Bosque control center. With the expansion of the systems, the remote control systems also need to be expanded and improved. Improving efficiency andfinancial performance: The PSP in the water sector in Cartagena has already resulted in improved management and higher efficiency within the system. These efficiency gains have resulted in cash generation which enabled the company to attract local and foreign loans and execute works for systems expansion. These scope of works is obviously restricted by the capacity of cost recovery dictated by the regulated level of tariffs, and does not include the entire scope of works required to satisfy the needs of the Cartagena water and especially sanitation sectors. However, on June 1999, a World Bank Loan to the District has been approved for a project of expansion of the water and sewerage systems and or completing the wastewater disposal system of the city. The project is currently under implementation. Undertaking significant investments not mandatory under the service contract: Although not obligated to do it under its service contact, ACUACAR has undertaken major loans that enable it to make investments for expansion of the water and sewerage systems. ACUACAR is currently operating as if it was under a concession arrangement. Improving relations with customers: The Company operates three offices with easy access for customers and has established relations with 12 banks and three supermarket chains for payment of bills. Addresses are shown on service invoices as are methods of payment, notes on opening times, billing information, Page 159 metering information and billing observations. The customer relations and billing department is a modern set up and completely computerized. Protected access to key staff is available to interrogate customer history. Program design allows searching on a wide range of parameters and filtering data for dealing with customers and management information. Creating relations of trust with suppliers: Relations with suppliers have reportedly been established such that the Company is trusted and holds favored status as a responsible client. That should have been a considerable boost to the local economy and have added credibility to the district as a place to do business. It should reap the benefit of market discount. Arrangements have been set up such that work and supplies are ordered through traceable systems and come under a regularized payment regime. Payments are made via an authorization procedure whereby the Company sends instructions to its bank to pay against approved batches of invoices twice per month. Suppliers are made aware of the system and collect a certified cheque from the bank should their payment be due. The system is self disciplining in that suppliers can revert immediately to the Company should their cheque not be in the appropriate batch. The important conclusion from the information presented is that at present, in contrast to the pre- ACUACAR period, there is a responsible manager that takes care of the water and sanitation services. He is highly knowledgeable and experienced, uses the most modern commercial, financial and technical instruments and practices, generates a wealth of operational, commercial and financial information and takes decisions on the basis of this information. The ultimate indicator of adequate performance is customer satisfaction. In the case of Cartagena, customer satisfaction is high and nobody will accept reverting the service to the pre-PSP conditions, although the current tariffs are much higher. D. Private Sector Participation in the Provision of Water Services in Small Municipalities: The Colombian Experience Introduction This chapter refers to the experience with private sector participation in small water utilities in Colombia. The word "small" as used in this chapter refers to municipalities with population in the range of 10,000 to 30,000 inhabitants, which are the smallest utilities with PSP in Colombia to date. In comparison to the large and medium size utilities which have been privatized in Colombia (with populations in the range 300,000 to 2,000,000 in Barranquilla) the municipalities with 10,000 to 30,000 inhabitants are really small. However, according to the definition of small municipalities under the proposed project, the municipalities referred to in this chapter are medium size. The private operators of the utilities referred to in this chapter can act under the proposed project as both local operators of medium size utilities and operators of small utilities. Although Colombia transferred the esponsibility for water supply and sanitation (WS&S) services to municipalities in 1987, the regional public agency of ACUANTIOQUIA continued to operate the system in 40 municipalities in the department of Antioquia. The inefficiencies identified by the departmental government in that agency made it undertake a drastic change of the institutional scheme: transferring management from one public utility to multiple private operators, each of which will be responsible for the provision of services in groups of 6 to 8 municipalities. A partial list of the small private water operators in Antioquia and of the municipalities operated by each of them, which resulted from the mentioned institutional reform, is presented in the Appendix. In 1997, ACUANTIOQUIA awarded a management contract to CONHYDRA, a domestic private company, to manage services in Marinilla and six other municipalities. The Ministry of Economic Development has documented the case of Marinilla, a municipality with a population of 26,000 inhabitants. Following are the results and lessons learned from this experience. Page 160 Main Results of Private Management of the Water Utility of Marinilla The provision of WS&S services in Marinilla has improved since CONHYDRA took over operation. In March 1997, 21,600 people were connected to piped water and 19,500 to sewerage in this municipality. By January 2000, an additional 3,500 of the city's inhabitants had been connected to the water system (a 15% increase). Sewerage coverage has increased by 5%, an increase of 700 connections, or 3,000 people. The water quality has also been upgraded. Water pressures have been optimized and physical leakage has diminished. The unaccounted-for water index has decreased from 46% to 41% in the last two years, and is expected to be further reduced to below 35% by 2001. Service is provided 24 hours per day. According to the last surveys, user satisfaction is at 93%. CONHYDRA has been working in maintaining appropriate performance indicators in different areas. As a result of this effort, CONHYDRA was awarded the international certification of quality assurance, ISO- 9001, in February 2000. Relevant performance indicators of CONHYDRA are presented in Tables 2, 3 and 4. Table 2. CONHYDRA Technical Performance MARINILLA March 1997 1999 2000* Population n.a. 25,280 26,070 Number of water connections 5,880 6,754 7,106 Water supply coverage (°/O) 94% 98% 99% Sewerage coverage (%) 85% 88% 90% Metering (%) 84% 93% 100% Water produced (million m3/year) 2.0 2.06 2.12 Unaccounted-for water (%) 46% 41% 35% Continuity of service (%) 83% 100% 100% Consumption per connection (m31month) n.a. 15 15 : Projected Source: CONPHYDRA Table 3. CONHYDRA Financial Viability MARINILLA 1999 Annual billing (US$) 448,000 Collection rate (%) 84% Total annual revenues (US$) 375,000 Operating cost recovered (%) 100% Source CONHYDRA Table 4. CONHYDRA Commercial Data MARINILLA 1999 Number of billed connections 5,673 Consumer complaints 697 Consumer complaints resolved 697 Source: CONHYDRA Marinilla provides an excellent example of the potential for private sector participation in the provision of the water and sewerage services in small municipalities. Marinilla represents a valuable example of increasing community participation in government decision-making. Despite practical and political problems associated with decentralization in Colombia, strong evidence exists that local communities are capable of organizing accountable institutions, reducing political interference, and promoting good government practices for the benefit of their citizens. Page 161 Prospects of Long-term Sustainability and Replicability Three basic factors have encouraged an increasing number of municipalities in Latin America to look for innovative alternatives to improve their coverage and quality of WS&S services: * Accumulated deterioration of existing infrastructure * Eroded financial condition of most municipalities and public utilities * Increasing demands of the population for more and better services Experience demonstrated that the managerial model developed in Marinilla is a practical, realistic option for increasing coverage and improving the quality of water services. The sustainability of this model is not guaranteed, however. The municipality must direct efforts to consolidate the strengths of the management model and overcome the following remaining obstacles and weaknesses: > Institutional and legal barriers. To secure complete autonomy of the municipality and positive results in the long run, it will be necessary to clarify the roles of the municipality and departmental governments in the context of the decentralization process. ACUANTIOQUIA must also complete the transfer of ownership of assets to the municipality of Marinilla. > Financial restrictions. The backlog of investment in the WS&S sector is enormous, and annual maintenance requirements are considerable especially in small municipalities. Tariff increases are necessary, although in practice they are limited by the users' capacity to pay. Private sector involvement can contribute to reducing, but will not eliminating, the need for government financing and the government's obligation to develop innovative financial mechanisms and provide guarantees and subsidies when necessary. > Political risk. Although technical criteria have dominated the decision-making process in Marinilla, political interference is an underlying risk. Mayors are elected every three years, and they have a decisive influence on the Executive Board. There is a moderate risk of reversing the reform process under the weight of a populist backlash before the real benefits can become consolidated. Clear, stable rules and balanced contracts will be key factors in minimizing this type of risk. Prospects for Replicability of the Model Colombia has about 1,090 municipalities, 500 of them with populations ranging between 12,000 and 50,000 inhabitants. A great majority of these small municipalities have shown interest in transforming public water utilities and modernizing managerial practices. The municipalities' increasing interest in improving the provision of water and sanitation services may be channeled and strengthened through the implementation of systematic technical assistance and financial programs designed by the federal government with the support of international agencies. The following five main stages are necessary to promote the replicability of the Marinilla management model in other mid-sized and small municipalities and facilitate a successful transition from inefficient public water utilities to autonomous and accountable companies: * Federal and municipal govemments must ensure strong and sustained commitment at the highest political level. * Careful preparation of PSP projects is required. Govemments should finance and facilitate the sound structuring of technical, financial, and legal aspects of sustainable PSP schemes. Developing simple guidelines, model contracts, and standard bidding documents will help to reduce transaction costs. Contracts must be clear and flexible and include incentives and penalties according to the operator's performance. Page 162 * Tariff levels should be consistently evaluated in relation to the population's payment capacity and realistic investment programs. Governments need to improve the provision of subsidies for the poor and facilitate wider access to the benefits of private sector involvement. • Governments may have to maintain a financing role in the WS&S sector. The major challenge is to find the right balance between public and private financing and risk sharing. Crucial challenges for national governments and external financial institutions include the development of risk-reduction mechanisms, local capital markets, guarantees that encourage long-term private lending, and alternative financial instruments to provide accessible credit to investors and private operators for at least the first five years of the PSP contracts. * Governments must work to effectively manage consumer expectations. Experience suggests that long-term benefits from private sector involvement take time to become firmly established. To facilitate the public acceptance of the reform process, governments should foster community involvement, promote the dissemination of transparent and reliable information, and implement adequate supervision and control mechanisms. Page 163 Appendix Partial List of Private Participation in Water Utilities in Colombia, 1995-2000 Contracts and Schemes in Execution Municipality Department Scheme Operator Initial year Large and Medium Size Utilities I Cartagena Bolivar Mix AGBAR 1995 2 Manizales Caldas Mix Aguas de Manizales 1996 3 Girardot Cundinamarca Mix LYSA-Lyonnaisse 1997 4 Barranquilla Atlantico Mix AGBAR 1997 5 Bogota -Tibitoc Cundinamarca Concession BOT CGE-CFV-Fanalca 1997 6 Tunja Boyaca Concession AQA-SERAGUA 1997 7 Palmira Valle del Cauca Mix LYSA S.A E.S.P. 1997 8 Cajica Cundinamarca Mix Aguas de Manizales 1998 9 Santa Marta Magdalena Mix AGBAR 1998 10 Monteria C6rdoba Concession FCC 2000 11 Malambo Atlantico Operation Contract Uni6n Temporal 2000 Operadora de Servicios del Norte. Utilities in Municipalities of 10,000-30,000 Inhabitants in the Department of Antioquia 12 Santa Barbara, Fredonia, Antioquia Operation Contract Operadores de Servicios 1997 Valparaiso, Caramanta. s.a. 13 Turbo Antioquia Operation Contract Conhydra s.a. 1996 14 Marinilla, Sons6n, Santa Fe Antioquia Operation Contract Conhydra s.a 1997 de A., Chigorodo, Mutata. 15 Caucasia, Taraza, Nechi, Antioquia Operation Contract Consorcio Aguascol 1997 CAceres. Arbelaez. 16 Amalfi, Anori, Yali, Antioquia Operation Contract Acueductos y 1997 P.Triunfo, Armenia, Alcantarillados Bolomb6, Ituango, San Jose Sostenibles s.a.E.S.P. de la Montafha. 17 San Pedro de los Milagros, Antioquia Operation Contract Acueductos y 1997 Santa Rosa de Osos, Titiribi, Alcantarillados Venecia. Sostenibles s.a.E.S.P. 18 Apartado. Antioquia Operation Contract Presea E.S.P. 1996 19 Necocli, San Pedro de UrabA. Antioquia Operation Contract Sistemas Puiblicos s.a. 1997 20 Andes, Ciudad Bolivar, Antioquia Operation Contract Ingenieria Total 1997 Jardin, Salgar. Servicios Puiblicos. Source: Superintendencia de Servicios Publicos Domiciliarios, Superintendencia Delegada para Acueducto, Alcantarillado y Aseo. June, 2000. Page 164 Annex 18: Private Sector Participation Experience in the Water Sector in Latin America (The cases of the PSP in the Utilities of Buenos Aires, La Plata, Santiago and la Paz- El Alto) COLOMBIA: WATER SECTOR REFORM ASSISTANCE PROJECT Introduction Latin America has been a pioneer in PSP in the water and sanitation services in comparison to other parts of the developing world, and is the region in which the greatest number of transaction have taken place. The first PSP case was the concession of the water and sewerage services in Buenos Aires, Argentina, in 1993. Since then, PSP transactions were carried out in most of the countries in Latin America, with Argentina, Colombia and Chile being the leaders of reforms, as a result of specific PSP promotion policies adopted by the governments of these countries. Information regarding the experience of PSP in the water sector in Colombia has been provided in other sections of the PAD document. In this Annex, information is presented regarding the PSP experience in the water utilities of Buenos Aires and La Plata, Argentina, Sntiago, Chile and La Paz-El Alto, Bolivia. Argentina The City of Buenos Aires. The concession of the water and sanitation services of the city of Buenos Aires to Aguas Argentinas (AA) in 1993, serving a population of over 10 million inhabitants, has been a successful experience. The main results can be summarized as follows: (i) a ten-fold increase in annual WSS investments (from about US$20 million before 1993 to an average of US$200 million over the past 7 years), using a tariff that is still 12.5% below the level charged by the former public utility OSN; (ii) an increase in coverage levels for water (from 70% to 83%) and sewage (from 58% to 69%); (iii) substantial improvements in water quality (average turbidity decreased from more than 7 NTU to less than I NTU); and (iv) a reduction in the time required to attend to pipe breaks from more than 5 days to less than I day on average. The Province of Buenos Aires. Azurix holds the WSS concession for the provincial capital of La Plata and 3 of 4 other service areas within the province of Buenos Aires. [AGBA (Aguas de Grande Buenos Aires, led by Aguas de Bilbao) has the concession for the remaining service area]. One and a half years into the concession, Azurix is clearly struggling with the demands imposed by its regulator (ORAB), whom it accuses of trying to impose the means to achieve contractual outcomes. Chile General information on PSP: Chile has 13 regional water companies (one each for the 12 "geographical" regions plus one for the Santiago metropolitan area) of which 5 (serving 73% of all customers nationwide) have been privatized since December, 1998. In addition to the regional companies there are a number of municipal WSS companies. In each of the 5 privatizations completed to date, a block of shares was sold to a private concessionaire concurrently with an increase in the company's equity (financed 100% by the private concessionaire). After the transaction, the private operator typically holds 55% of all shares, while the State retains 35% and company employees receive 10% to ensure appropriate buy-in. The remaining public assets are managed by a state holding company, the "Sistema Administrador de Empresas - Corporaci6n de Fomento (SAE-CORFO), which also conducts the privatization processes. Unlike PSP in Argentina, Chilean WSS privatizations were preceded by profound sector reform: before 1990, Chile had 13 non-autonomous regional water authorities controlled by the Ministry of Public Works. In 1990, these WSS authorities were converted into 13 autonomous public companies regulated by the Superintendencia de Servicios Sanitarios (SISS). Only after this separation of regulatory and operational responsibilities was well established, did significant PSP begin in 1998. In the five major PSP transactions conducted to date, private operators paid share prices equivalent to between 7.7 and 16.2 times annual revenues and between US$1,348 and US$2,030 per water connection. Page 165 Santiago. Empresa Municipal de Obras Sanitarias de Santiago (EMOS) is responsible for the water and sanitation services in the Chilean capital. In Santiago, where the public operator was already very efficient (about 1.5 employees per 1000 water connections before PSP) and where water and sewage collection coverage were already high (100% and 97% respectively) PSP was sought primarily to finance 3 large sewage treatment plants (STP's). So far the new private operator has initiated one of the three STP's (Trebal) and further cut back EMOS' workforce to about 1.2 employees per 1 000 water connections. Bolivia La Paz - El Alto. La Paz- El Alto concession is an example of a case that has been designed to expand service to the poorer households through private sector participation. This twenty-five year concession for the neighboring cities of La Paz and El Alto in Bolivia was signed in August 1997. The primary objective of the concession was to expand services to low income households while holding down costs by increasing efficiency. The criteria used to select a private concessionaire was to have the bidders identify the number of water connections they would make in exchange for a pre-specified tariff (unlike the traditional approach of asking the bidders to specify the tariff they would require to meet pre-specified investment and service obligations). The winning bidder, the Suez Lyonnaise des Eaux consortium Aguas del Illimani committed to achieve I 00 percent water coverage in La Paz and to install 71,752 new water connections in the El Alto subsystem (the poorest in the metropolitan area) by December 2001 (from 87 percent coverage in 1997). The concessionaire also committed to 90 percent sewer coverage in El Alto and 95 percent coverage in La Paz by 2021 (from 48 percent coverage in 1997). The following were the key factors for preparing this concession: (i) An independent national body to grant and regulate concessions for municipal water and sanitation services was created. The regulator monitors and enforces compliance with the expansion and quality obligations but not the specific investments made by the concessionaire. (ii) The contract specified requirements for service quality (including water quality, continuity of service, water pressure and flow, and customer service). Such specifications have given the operator the incentives to choose the most efficient way to provide the desired outputs. (iii) The concession contract gives an exclusive right to provide services in a defined area and specifies that all new water and sewer connections must be in-house connections. This has encouraged the operator to expand services to customers which he might otherwise be unwilling to serve. (iv) Innovative technological and institutional solutions for service in low income households were identified, tested, and adopted. (v) An increasing block tariff structure and an average 38.5 percent tariff increase were introduced just before the concession began, so as to ensure cost recovery. The regulator approves all tariff revisions over the life of the contract. The first tariff review is scheduled to take place five years into the contract; in the interim, tariffs are indexed to the US dollar. (vi) The contract sets maximum connection fees of US$155 for a water connection and US$180 for a sewerage connection for both in-fill connections on existing lines and for connections in areas with no existing network, however, to avoid the operator's preference in focusing on in-fill connections, the contract mandates that in-fill connections can account for no more than half of all new connections. Page 166 Lessons Learned The operators and regulators from the cases reviewed above have made the following recommendations to improve future concession transactions in the water and sanitation sector in Latin America: * Clearly define targets, not means for achieving them; * Reduce the performance guarantee posted by the concessionaire over time. AA pointed out that its current US$150 million performance guarantee limits its ability to contract debt capital, since banks factor in the value of such guarantees when calculating overall indebtedness. The value of unamortized investments in the ground is a far better guarantee that the concessionaire will not withdraw from the concession. * Contracts should contain provisions that allow the concessionaire to recover his non-amortized investment costs in case the concession contract is cancelled prematurely. * Instead of front-loading civil works during the first 2 years of the contract, allow the concessionaire a I year period to take stock of existing assets and prepare tenders for the first batch of works. Especially where the documentation is incomplete or out of date (e.g. after a long drawn out tender process), there may be immediate investments needs not considered in the tender documents. * Investment plans will not be honored by the concessionaire simply because they form part of the concession contract. Concessionaires will seek to circumvent investments that are not financially viable by any means necessary. Use subsidies from public funds (or reinvest proceeds from canon payments) to make socially (or environmentally) desired investments financially viable for the concessionaire. * Concession contracts should be clear about what civil works, goods and services need to be procured publicly by the concessionaire. Otherwise concessionaires that are linked to industrial groups are likely to purchase internally at non-competitive prices that are then passed through to consumers. In Santiago de Chile, for example, the new private concessionaire is required to tender any contract above US$150,000 publicly. * Concession contracts usually require the concessionaire to reach minimum service pressures (e.g. I bar) in water supply systems by deadlines that may be several years in the future. Intermediate targets are recommended to allow the regulator to monitor progress. * Local particularities should be considered when fixing the time frame for reaching desired water quality targets. Uniform timeframes for service areas with a great variety of raw water sources may impose unnecessary costs on consumers. Where raw water salinity or turbidity is relatively high but treated water is bacteriologically safe, for example, it may be preferable to allow more time for concessionaires to comply with water quality standards that impact only the water's appearance and taste but not sacrifices public health. Page 167 Annex 19: Comparison of the Performance of Private and Public Water Utilities with Respect to of Services Expansion to Low-Income Areas COLOMBIA: WATER SECTOR REFORM ASSISTANCE PROJECT Background Colombia is currently one of the Latin American countries most actively engaged in processes associated with incorportaing private sector participation in the management of water utilities. One of the community's main concerns regarding PSP in the water utilities is that attempts to reform the sector by treating water and sanitation services as an economic asset rather than as a social good and allowing providers to apply commercial (profit-oriented) criteria, may harbor a tendency to restrict access to the services for low-income users because they are not perceived as an attractive "business" for private entrepreneurs. Since the government is embarking on a water sector modernization program whose strategy is to promote PSP in water utilities, and one of its objectives is to expand and improve the provision of services to the poor, it was considered necessary to find out if the common perception of the population and the concerns of the community that the private sector focuses on providing good services to the wealthy and neglects the poor, is anchored in reality and can be proved on the basis of the performance of privatized utilities in Colombia. For that purpose, a study was carried out during project preparation, aimed at testing the mentioned perception. The Objective of the Study The objective of the study described in this Annex was to compare the performance of private and public service providers with regard to expansion of services in low-income areas, defined as areas socially classified as strata Ito 3 areas, in which water and sewerage tariffs are subsidized. Cartagena, Barranquilla, and Tunja were selected as the private providers since they were the first large water and sewerage companies managed by private operators in Colombia and their performance can therefore be examined over time.38 The performance of the privatized utilities was compared with that of the most efficient public utilities in the country. The selected efficient public utilities were those of Bogota (which provided information regarding water and sewerage), Medellin39 and Manizales (both of which provided information only on water). Results The study reviewed the performance of the utilities focusing on service expansion to the poor in the six mentioned cities. Given that in Colombia, for utility rates purposes, the population in each municipality is divided into six strata, it may be assumed that the poorest users are classified in strata 1, 2, and 3, whereby stratum I refers to the lowest income groups and stratum 6 to those with the highest income.40 This study analyzes the increase in the number of connections per stratum made by each company in the 1995-1999 period. The findings show that both the publicly and the private utilities focused in their expansion efforts on low income groups (strata I to 3), which, under Colombian law, are eligible for subsidies. In terms of water expansion to low income areas, the private utilities performance was similar to that of Medellin, which is 38 The ACUACAR Company began operating in Cartagena in 1995. The AAA started operating in Barranquilla in 1996, and in Tunja private sector involvement began in 1997. Thus the periods under review are 1995-1999 for Cartagena, 1996-1999 for Barranquilla, and 1997-1999 for Tunja. 39 Excluding the metropolitan area. 40 Based on the 1997 nation-wide Quality of Living Survey, the inter-stratum relationship is being studied. Page 168 one of the most efficient public providers in the country. A detailed breakdown of the distribution of new connections by stratum in each city4' showed that privately run utilities focused their expansion of water and sewage connections on users in stratum 1, Medellin and Manizales focused on stratum 2, and Bogota on users in stratum 3. Chart I shows the distribution of new water connections by stratum over the past four years. It demonstrates quite clearly that in the case of the private providers, over 45% of new water connections were for stratum 1, a similar performance to that of the most efficient public provider, Medellin. The figure for the other two public providers was 11% in Bogota and 8% in Manizales. For strata I and 2 combined, in Cartagena 80% of new connections were for users in those two lowest strata; in Barranquilla 60%; in Tunja 79%, a proportion similar to that of Medellin's; while in Manizales the equivalent number is 57%; and in Bogota only 40%. Most of the new connections in Bogota (55%) were for stratum 3 users, who, although they receive lower subsidies, could not really be defined as poor. In Manizales the percentage of connections in stratum 3 was 22%. Stratum 3 received 16% of new connections in Medellin, 22% in Barranquilla, 12% in Cartagena, and 7% in Tunja. For sewerage services42 the figures also indicate that the poorest users have benefited from new connections to this service. As in the case of water, the three privately operated utilities studied have made the bulk of the new connections benefiting users in strata 1, 2, and 3. Chart 2 shows the distribution of new sewerage connections by stratum in the 1995-1999 period.43 New sewerage connections by tlhe private companies focused significantly on stratum I users: 31% in Cartagena, 27% in Barranquilla, and 22% Tunja, compared to 7% in BogotA. Most of the new sewerage connections in Tunja were for stratum 2 users (53%), while in Cartagena the equivalent figure was 50%, in BogotA 30%, and in Barranquilla 13%. As with water, stratum 3 was the most privileged segment in Bogota with respect to sewerage connections, receiving 66% of the total. In Barranquilla stratum 3 received 30% of new connections; in Cartagena 21% and in Tunja 8%. " The "new connections per stratum" criterion was considered appropriate for this analysis. Another criterion - changes in coverage in each stratum by city - was also explored. There are problems with the data needed for this calculation, particularly because the utility companies sometimes use a stratification that differs from the official one for each city, as part of a commercial strategy geared to restratifying in order to lower rates and collect a higher volume of payments for water and sewage disposal services. 42 The study compares Cartagena, Barranquilla, and Tunja, all of which have private sector operators, with Bogota (3public). 4In the case of AAA, the water utility of Barranquilla, the data on new sewage disposal connections cover the period from 1996 to March 2000. Page 169 Who benefited from the incremental water connections? (1995-99) 70% 60% 0 450% - S C 4 20% - 1 30% C20% - u10% 0% L~JJL * Stratum 1 Stratum 2 atum 3 Stratum 4 Stratum 5 Stratum 6 -10% -20% O Bogota - EAAB M Medellin-EPM(ESP) E Manizales * Cartagena - ACUACAR M Barranquilla - AAA OTunja-Sera.q.a Who benefited from the incrmental sewerage connections? (1 995-99) 70% 60% 50% - _ e 40% 30% - - - 20% .- IC 0 0% Stratum 1 Stratum 2 Stratu3 MStratum 6 -20% E ..... _. .... . .... ... __._ . O Bogota -EAAB * Cartagena -ACUACAR " BarranquiElia-AAA E]Tunja-Sera.q.a Page 170 The study also reviewed the findings regarding overall expansion of coverage by stratum in the same period (1995-1999). In the case of water, the total number of connections increased 38% in Barranquilla, 31% in Cartagena, and 12% in Tunja, while the increase in cities with publicly-run utilities were 25% in Medellin, 25% in Manizales, and 23% in Bogota. A breakdown by strata shows how the private utilities have greatly improved access for stratum I users to both piped water and sewerage services. Comparing, specifically, the number of currently existing connections with those that existed at the start of the PSP process, the data show that stratum I water connections in Cartagena increased 104%, and those in Barranquilla 89%, following a trend set by Medellin (187%), while in Tunja they increased by almost 50%, compared with 16% in Manizales and 70% in Bogota. (See Chart No. 3). Comparing Cartagena, Barranquilla, and Bogota in terms of the increases in sewerage connections by stratum during this period, it emerged that access to this service increased considerably. Chart No. 4 shows that the total number of connections rose 38% in Barranquilla, 23% in Cartagena, and 2% in Bogota. For stratum I in the same period the increase in Cartagena was 235% (over four years) and in Barranquilla 146% (over three years). These figures are not strictly speaking comparable with the lower findings for Bogota, given that Barranquilla and Cartagena started the period with far lower coverage levels than Bogota. However, as an order of magnitude, in that same period Bogota increased sewerage connections by 46% for stratum I and by 56% for stratum 6, whereas in Cartagena and Barranquilla the increases in total connections for stratum 6 were only 2% and 6%, respectively. Page 171 Coverage increment per stratum, residential and total - Water (1995-99) 200% 150% . . E 100% 0 16 50% 0% Stratum 1 Stratum 2 mtrn 3 Stratum 4 Stratum 5 Stratum 6 RESIDENTIAL TOTAL -50% Fl Bogota - EAAB UMedellin-EPM(ESP) Manizales Cartagena - ACUACAR Barranquil AAla - AAA E Tunja-Sera.q.a Coverage increment per stratum, residential and total - Sewerage (1 995-99) 250% 200 10% 0 CC100% 50 0% Stratum I Stratum 2 Stratum 3 Srtm 4 Stratum 5 Stratum 6 RESIDENTIAL TOTAL -50% E Bogota -EAAB ECartagena -ACUACAR IMBarranquilla -AAA E]Tunja-Sera.q .ai Page 172 Conclusions The findings of this study show that private utilities are responding to users' service needs irrespective of their income level. As shown above, the majority of new connections by privately run utilities benefited users in stratum I. Thus it is possible to assert that privately operated utilities have not impaired the interests of low-income users, and specifically those in strata I and 2. In the five years of experience with private participation in the water and sanitation sector in Colombia, the municipalities with private operators have improved their coverage and continuity of service indicators substantially, streamlined their work force and had a major positive impact on poor households. Since the date a private operator was introduced in Cartagena, 98% of new connections were made in strata 1 and 2. In Barranquilla the corresponding figure was 86%, in Tunja 79%, and in another private utility, Santa Marta, over 50%. It should be explained that in when the private operators took over the utilities in Cartagena and Barranquilla, the coverage was lowest among low-income inhabitants, as in most cities in Latin America. As greater coverage was sought under the contracts of the private operators, the way to achieve it was necessarily to increase the number of new connections in the poorest areas. In fact, in Cartagena, coverage of strata I and 2 rose from 65% to 85%. Analysis of new connections shows clearly that, even without contractual obligations expressly requiring operators to serve inhabitants in strata I and 2 (as in the Cartagena and Barranquilla contracts), users in these strata are receiving connections at a pace similar to that of Medellin, and even higher than that of areas covered by other public utilities, such as those in Bogota and Manizales. It should also be noted that in the period under review all utilities received national and or local government support for connecting new low-income users. Even if all the new connections in strata I and 2 carried out by the Cartagena and Barranquilla utilities had been funded by municipal or national subsidies, it remains true that these privately utilities substantially raised the number of connections for stratum I in a relatively short period of time, which is not achieved in most of the public utilities in the country. Another conclusion is that users in strata I and 2 are better off with respect to these services thani they were prior to the arrival of the private-sector operators, because their publicly-run predecessors had excluded them for years. In many cases, the dearth of public sector incentives and inefficiency of public utilities impeded execution even of subsidies and government transfers, whereas private operators have greater incentives to invest in low-income areas, since they increase market volume. Private utilities are generally more efficient than public utilities because of a number of reasons: * Public utilities turn into political fortresses of the government. They are subject to political interference in decision-making, especially with respect to the appointment and withdrawal of managers. They tend to be overstaffed and to siphon off funds from the budget to cover administrative costs, thereby preventing funds from being directed to new investment. * The rates charged for services do not cover operating and investment costs. Municipal authorities prefers not to raise rates rather than face the political costs of a hike. * At best rates suffice only to cover operating and maintenance costs and the municipality is supposed to provide to the public utility funds for investment and for covering deficits. Usually these barely cover very short-term investments or contingencies. * At the same time, public operators put off investing in new connections either due to lack of funds or because users have problems complying with current regulations. Would-be Page 173 users have to have title deeds for the properties to be connected, as well as a building registration certificate." It has been shown that PSP processes rapidly achieve improvements in the coverage rates and quality of services, especially in municipalities which used to be particularly deficient in this respect. Compared with public utilities, private operators can more easily tap short-term funds to invest in new connections, apart from the fact that one ingredient in their commercial strategy is to raise the number of users in all strata. The low-income population is thus benefiting rapidly because it constitutes a new clientele. At the same time, public utilities generally have less investment capacity and are more inefficient in allocating resources, causing delays in expansion of coverage, thereby negatively affecting the low-income population, which is the segment least likely to have access to the services under publicly-run utilities. 4 In the specific case of Bogota, the last administration regularized the status of 300 irregular districts, paving the way for water distribution and sewage disposal connections for almost 500,000 people. Barranquilla and Cartagena each have a large number of "informal" districts. Nevertheless, private operators have taken steps to mitigate the effects of this and do not condition access to service on legalization of properties. Some of those steps include shared connections or outlets, often for a whole block, from which water is then distributed to neighbors. An average rate is charged for water consumption. 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