Nepal: Melamchi Water Supply Project and Kathmandu Valley Water Services Sector Development Program

Transcription

1 Major Change in Scope and Implementation Arrangements Project Numbers: and Loan Numbers: 1820, 2058, and 2059 January 2008 Nepal: Melamchi Water Supply Project and Kathmandu Valley Water Services Sector Development Program

2 CURRENCY EQUIVALENTS (as of 11 December 2007) Currency Unit Nepalese rupee/s (NRe/NRs) NRe1.00 = $ $1.00 = NRs63.06 ABBREVIATIONS ADB Asian Development Bank BDS bulk distribution system CBP capacity building and public private partnership support DNI distribution network improvement ICB international competitive bidding JBIC Japan Bank for International Cooperation JICA Japan International Cooperation Agency KUKL Kathmandu Upatyaka Khanepani Limited KVWSMB Kathmandu Valley Water Supply Management Board MPPW - Ministry of Physical Planning and Works MWSDB Melamchi Water Supply Development Board MWSP -- Melamchi Water Supply Project NDF Nordic Development Fund NGO -- nongovernment organization NORAD Norwegian Agency for International Cooperation NWSC Nepal Water Supply Corporation OFID Organization of Petroleum Exporting Countries Fund for International Development PBMC performance-based management contract PMU project management unit PMC - project management consultant PSP private sector participation SDP Sector Development Program SDR -- special drawing rights Sida Swedish International Development Cooperation Agency SUP social uplift program WSTFC Water Supply Tariff Fixation Commission NOTES (i) (ii) The fiscal year (FY) of the Government ends on 15 July. FY before a calendar year denotes the year in which the fiscal year ends, e.g., FY2007 ends on 15 July In this report, "$" refers to US dollars. Vice President L. Jin, Operations Group 1 Director General K. Senga, South Asia Department (SARD) Director H. Kim, Urban Development Division, SARD Team leader Team members L. Boenawan Sondjaja, PAU Head, SARD A. Mohammed, Senior Counsel, Office of the General Counsel G. An, Urban Development Specialist, SARD R. Barba, Safeguards Specialist, SARD H. Ikemoto, Urban Economist, SARD

3 CONTENTS Page I. INTRODUCTION 1 II. BACKGROUND 3 A. The Original Project: MWSP 3 B. Implementation Status of the Projects 3 III. THE PROPOSED CHANGE 6 A. MWSP (Loan 1820-NEP) 6 B. SDP (Project Loan 2059-NEP) 8 C. SDP (Program Loan 2058-NEP) 9 D. Impact on the Projects 10 IV. ASSESSMENT 11 A. Revised Cost Estimates and Financing Plan 11 B. Revised Implementation Arrangements 13 C. Economic and Financial Analyses 14 D. Social and Environmental Safeguards 15 E. Project Risk 15 V. ASSURANCES 16 VI. THE PRESIDENT S RECOMMENDATION 18 APPENDIXES 1. Original Project Framework Original Cost Estimates and Financing Plan Latest Project Performance Reports Proposed Management Changes Revised Implementation Arrangements and Organizational Structure Revised Design and Monitoring Framework Revised Cost Estimates and Financing Plan Revised Implementation Plan Revised Procurement Plan Outline Terms of Reference for Capacity Building and Public Private Partnership Support Team Revised Terms of Reference for Project Management Consultant Revised Terms of Reference for Social Development Support Consultant Revised Economic Analysis Revised Financial Analysis 96 SUPPLEMENTARY APPENDIX A. Findings in Social and Environmental Safeguards Review Missions

4 81 o 00'E 85 o 00'E 85 o 35 E 29 o 00'N 27 o 00'N MAHAKALI SETI BHERI KARNALI RAPTI INDIA DHAWALAGIRI LUMBINI GANDAKI NEPAL PEOPLE'S REPUBLIC OF CHINA NARAYANI Project Area BAGMATI Kathmandu JANAKPUR SAGARMATHA 29 o 00'N MECHI KOSHI 27 o 00'N Melamchi River Yangri River LANGTANG NATIONAL PARK Larke River 81 o 00'E 85 o 00'E 85 o 20 E 28 o 00 N NEPAL KATHMANDU VALLEY WATER SERVICES SECTOR DEVELOPMENT PROGRAM Intake Extension Ambathan Ribarma Timbu Gohare River 28 o 00 N NUWAKOT DISTRICT Gyalthum River Talamarang River Sindhu River Melamchi Pul Bazaar SHIVAPURI WATER SHED AND WILD LIFE RESERVE KATHMANDU DISTRICT SINDHUPALCHOK DISTRICT Indrawati River Sundarijal Mahankal Water Treatment Plant Kathmandu 27 o 40 N Kirtipur Lalitpur Thimi BHAKTAPUR DISTRICT Bhaktapur Lamidanda KABHRE PALANCHOK DISTRICT 27 o 40 N River Bagmati LALITPUR DISTRICT N Kilometers National Park National Capital City/Town Intake Water Treatment Plant Highway Main Access Road Under Construction Bulk Distribution Tunnel Alignment Tunnel Extension River District Boundary International Boundary Boundaries are not necessarily authoritative. 85 o 20 E 85 o 35 E HR

5 I. INTRODUCTION 1. Loan 1820-NEP (SF): Melamchi Water Supply Project (MWSP) 1 was approved on 21 December 2000 and became effective on 28 November The MWSP is a comprehensive water supply project that aims to improve the health and well-being of the people in Kathmandu Valley by diverting water from the Melamchi River to the Kathmandu Valley and alleviating the shortage of potable water. The MWSP comprises four parts: (i) infrastructure development, (ii) social and environmental support, (iii) institutional reforms, and (iv) project implementation support. Loans 2058/2059-NEP(SF): Kathmandu Valley Water Services Sector Development Program (SDP) were approved on 18 December 2003 and became effective on 7 December The SDP, complementing the MWSP, is a follow-on sector development program loan to support reforms and institutional development in the water services sector, engaging private sector participation (PSP). The MWSP (SDR million) 2 and SDP (SDR3.473 million for the program loan and SDR6.945 million for the project loan) 3 are integrally related (together they are heretofore referred to as the projects in this report). The Ministry of Physical Planning and Works (MPPW) is the Executing Agency for both projects. The Melamchi Water Supply Development Board (MWSDB) is the implementing agency of the MWSP. The loan closing date of the project loan of the SDP is 30 June 2011, while those of the MWSP and the program loan of the SDP have been extended to 31 March 2008 from the original estimate of 31 March 2007 and 31 December 2005, respectively. 2. Over the past 6 years of MWSP implementation and the past 3 years of SDP implementation, major events and changing circumstances in Nepal have hampered implementation of both projects. For one, efforts of the Government of Nepal (Government) to secure a private partner to manage water services have failed. During the initial years of the MWSP, successive Government efforts to ensure PSP in water services delivery, by way of a lease contract supported by the World Bank, failed because of a lack of interest from potential bidders. This delayed start-up significantly and caused the World Bank to cancel its prospective funding. A subsequent Asian Development Bank (ADB)-supported performance-based management contract (PBMC) also failed to materialize despite several years of focused efforts. These failures to attract PSP have proven that even a PBMC, as an alternative to the original lease contract, is too difficult and costly to process in the fluid political environment of Nepal. In the meantime, the biggest civil works package (a 26-kilometer-long water diversion tunnel) under the MWSP has been put on hold because the loan covenants require completion of the PSP contract award as a condition precedent for awarding this civil works package. Furthermore, two additional development partners have left the projects amid extreme political fluctuations. 4 This has resulted in a substantial funding gap of $133 million equivalent. 3. Despite all the adversity, the Government has consistently maintained its commitment to the projects and managed to complete the challenging process of conducting institutional reforms and preparatory works for infrastructure development under the projects. While the development needs for relieving serious water crises in the Kathmandu Valley are growing, and the expectation on development impact and prescribed outcomes of the projects have become more pressing, the changing circumstances surrounding the projects have necessitated 1 The total project cost was estimated at $464 million in 2000 prices, which was to be funded by the Government of Nepal and a consortium of development partners: ADB ($120 million), the World Bank ($80 million), the Japan Bank for International Cooperation (JBIC, $52 million), the Japan International Cooperation Agency (JICA, $18 million), the Norwegian Agency for International Cooperation (NORAD, $28 million), the Swedish International Development Cooperation Agency (SIDA, $25 million), the Nordic Development Fund (NDF, $9 million), and the Organization of Petroleum Exporting Countries Fund for International Development (OFID, $14 million). 2 Equivalent to $120 million at the time of approval. 3 Equivalent to $5 million and $10 million respectively, at the time of approval. 4 World Bank in 2002, NORAD in 2005, Sida in 2006.

6 2 revisions of the projects scope and implementation arrangements. This paper seeks Board approval for the following major changes to the projects scope and implementation arrangements: 4. With respect to the MWSP (Loan 1820-NEP): (i) (ii) (iii) (iv) (v) Reallocation of funds among the project components subsequent to the reduction of total project cost from the original $464 million to $318 million 5 (a reduction of more than 15%). This reduction is largely due to the financial gap caused by withdrawal of the World Bank, the Norwegian Agency for International Cooperation (NORAD), and the Swedish International Development Cooperation Agency (Sida). The reduced funds have been carefully reallocated to the MWSP components to reduce front-end preparation costs and deliver water to beneficiaries in a phased manner. 6 Changing the implementation arrangements by splitting the Project into two distinct subprojects, the Melamchi River water diversion subproject (subproject 1) and the Kathmandu Valley water supply and sanitation subproject (subproject 2). The existing Implementing Agency will continue to implement subproject 1; three new entities established in the Kathmandu Valley will take over the roles and responsibilities of the existing Nepal Water Supply Corporation to implement subproject 2. Removing the loan covenant requiring PSP contract award as a condition precedent for awarding Melamchi diversion tunnel civil works contract, to enable the restructured projects to move forward without further delay. Extension of loan closing date to 31 December 2013 in accordance with revised implementation schedule. Administration of the Nordic Development Fund (NDF) loan by ADB subject to and conditional upon detailed terms of agreement for such administration being agreed between NDF and ADB. 5. With respect to the SDP Project Loan 2059-NEP: (i) Capacity building and public private partnership support team (CBP team) as an alternative to the failed PBMC model. A new management support scheme, focusing on long-term capacity building and strengthening of the operational and management skills of new water utility operator, is proposed in place of the failed PBMC model. This is based on the assessment of the volatile political environment, and lessons learned from the failures of the PSP modality. (ii) Reallocation of funds following replacement of the PBMC model with the CBP team model. (iii) Change in Implementing Agency for the computerized billing and accounting system component from the existing water utility operator to a new operator. (iv) Extension of the loan closing date from 30 June 2011 to 31 December The World Bank's withdrawal of funding created an $80 million gap in Kathmandu side institutional reform and distribution network improvement. In an effort to fill that gap and complement the original project scope, ADB processed the SDP (Loans 2058 and 2059) and put another loan in the pipeline planned for 2010 mainly for distribution system improvement. The total project cost will be $352 million if additional funding of $15 million (provided by SDP) and $20 million (loan in the pipeline for 2010) all of which are meant to cover components of the original scope of the MWSP are included. 6 Adopting a zonal approach for augmenting distribution networks, it is proposed that the scope is reduced to focus on priority zones in Kathmandu and Lalitpur municipalities, where water demand is concentrated. The Government seeks additional funding resources, including the loan from ADB-$20 million loan is in the pipeline planned for 2010-to carry out distribution networks in the remaining zones.

7 3 6. With respect to the SDP Program Loan 2058-NEP: (i) (ii) Waiver of conditions (items 5 and 6) for the second tranche release, reflecting the change under the SDP project loan (replacing the PBMC model with CBP team model). Waiver of Conditions (items 7 and 8) for second tranche release, reflecting the change in implementing agency for voluntary retirement scheme from Kathmandu Upatyaka Khanepani Limited (KUKL) to Kathmandu Valley Water Supply Management Board (KVWSMB); therefore, there is no need for KUKL to enter into an assumption agreement and subsidiary loan agreement. II. BACKGROUND A. The Original Project: MWSP 7 7. The main outcome of the MWSP is projected to be alleviation of the chronic shortage of potable water in Kathmandu Valley, with an expected impact of improving the health and wellbeing of its inhabitants, particularly the poor. To achieve this impact and outcome, the MWSP seeks to effect comprehensive institutional reforms as well as infrastructure development. The original design and monitoring framework for the MWSP, depicting long- and short-term outcomes and outputs, as approved by the Board, is attached as Appendix The MWSP was designed to finance four major components: (i) infrastructure development, comprising a 26 km diversion tunnel, access roads, water treatment plant and bulk distribution system, distribution network improvement, wastewater system improvement, and water source improvement in Kathmandu Valley; (ii) social and environmental support to mitigate potential negative project impacts and improve the living conditions of the beneficiaries; (iii) institutional reforms comprising a PSP scheme for water services delivery in the Kathmandu Valley, the modality of which was later revised in the SDP; and (iv) project implementation support. MPPW is the Executing Agency and MWSDB is the Implementing Agency. 9. The MWSP was projected to cost $464 million in 2000 prices. According to the original financing plan, ADB shouldered the largest financing share ($120 million equivalent) followed by the World Bank ($80 million), the Japan Bank for International Cooperation (JBIC, $52 million equivalent), NORAD ($28 million equivalent), Sida ($25 million equivalent), the Japan International Cooperation Agency (JICA, $18 million equivalent), the Organization of Petroleum Exporting Countries Fund for International Development (OFID, $14 million equivalent), and NDF ($9 million equivalent). The Government s original financing share in the MWSP was $118 million equivalent. A breakdown of the original cost estimates and the financing plan of the MWSP are in Appendix 2. B. Implementation Status of the Projects 10. Part of the rationale for the MWSP was that the chronic water shortages affecting Kathmandu are caused not only by a lack of supply infrastructure and bulk water sources, but also by the poor performance of the existing water utility, the Nepal Water Supply Corporation. Therefore, the MWSP combined investments in physical infrastructure with major institutional reforms, including engagement of the private sector in water services delivery in Kathmandu Valley under a PSP scheme. To ensure that necessary institutional reforms would be in place before implementation of the larger investment, the award of PSP contract was set as a 7 The original project of MWSP covered the scope of the SDP which was processed later to complement MWSP in filling the gap of institutional reforms component after the World Bank left MWSP.

8 4 condition precedent for awarding the tunnel civil works in the MWSP s loan covenants. The Melamchi River water diversion tunnel, diverting water from the Melamchi River to the Kathmandu Valley through a 26 km tunnel, is the largest infrastructure development component under the MWSP. 11. The original design of the project called for the World Bank to undertake institutional reforms with its lease contract model as a PSP modality. However, the international competitive bidding (ICB) process for private lease failed to attract interest from potential bidders, who assessed the investment as too risky. After failing twice in its tendering efforts, the World Bank decided in June 2002 to cancel its prospective financing of $80 million. In addition to resulting in a funding gap of $80 million, this also significantly delayed project implementation. Subsequently, at the request of the Government, ADB processed the SDP in 2003 to support institutional reforms. Under the SDP, institutional reforms in Kathmandu Valley were redesigned and the PSP modality was changed from the originally planned lease contract model to the PBMC model. 12. So far the Government has demonstrated its commitment to all of the institutional reform requirements. However, the extreme political instability, frequent changes of government, 8 and countrywide armed conflict of recent years have significantly delayed the reform process. The ICB process for the PBMC model took a particularly long time as long as 3.5 years until the Government s cancellation of the tendering process in August Three out of the four shortlisted firms and joint ventures withdrew from the tendering after prequalification. In the end, after several extensions of the bid submission deadline, only one firm submitted a bid. As the award of a PSP contract is a precondition for undertaking major civil works under the MWSP, the Government had to call a special cabinet meeting to allow a single management contractor bid. 13. In Nepal s political context, the general public has strongly opposed the single bidder approach, despite the fact that this approach was in compliance with ADB guidelines. The Government's decision to allow the single bid was politicized by some stakeholders and was a subject of intense and widespread media attention. The nongovernment organization (NGO) community also criticized the Government's accepting the single bid and negotiating with the single bidder. However, given the utmost importance of completing the agreed reform process, the previous cabinet of the Government reviewed and endorsed the draft PBMC negotiated with the single bidder. 14. After the sweeping political changes of early 2007, the single bidder issue was further politicized. Despite ADB s strong recommendation to conclude the duly processed and negotiated recruitment process, and award the contract to the selected bidder, the Government decided to discontinue the current recruitment process amid the controversy. As a result, the awarding of the tunnel civil works has been significantly delayed. 15. In recent years, the MWSP has experienced other challenges. The Office of the Special Project Facilitator, and later the Compliance Review Panel, opened investigations following an NGO s complaint in May In June 2005, the integrity division of the Office of the Auditor General investigated allegations of corruption in the procurement process of the re-tendered civil works contract for the access road 9. Neither of these investigations uncovered any irregularities, according to Compliance Review Panel report (December 2004) and the briefing 8 The governments were turned over six times since Contract code-named AAR/02. The Royal Commission for Corruption Control (RCCC), formed after the royal takeover of 1 February 2005, led the investigation. As a result of the RCCC investigation, several high-level government officials both politicians and bureaucrats, including the executive director of the MWSP Implementing Agency were imprisoned. This was followed by substantial changes in the Implementing Agency s top management. After the abolishment of RCCC following the end of the royal regime, all charges were dropped.

9 paper from integrity division of the Office of the Auditor General (July 2005). However, these two cases delayed project implementation and further paralyzed the decision making process of the Government and the Implementing Agency by fostering an environment of fear. The resultant excessive caution and timidity exhibited by the top cadres of the Implementing Agency has hampered timely decision-making during project implementation. 16. NORAD and Sida withdrew from the MWSP amid political turmoil in the wake of the royal takeover of 1 February Their withdrawals created another large funding gap ($53 million equivalent) in financing the Melamchi diversion tunnel. The funding gap may be reduced by the probable savings from untied ICB of a single civil works package as opposed to the original combination of one ICB civil works package and one Norwegian-Swedish tied bidding civil works package. However, such savings alone will not be sufficient to make up the funding gap. 17. Despite the hindrances described above, and despite considerable security risks in the field, the MWSP has managed to progress to the point where preparatory works for the primary infrastructure development component (i.e., the tunneling civil works) are nearing completion. These preparatory works include construction and upgrading of the access roads, design and tender document preparation of the water treatment plant, acquisition of required land, associated resettlement and compensation payments, and delivery of a range of social and environmental support activities throughout the Melamchi Valley. Development of a shallow well field at Manohara has already been completed, with funding from JICA, and additional water is now being supplied to Kathmandu Valley residents. 18. The projects have also achieved substantial progress in bringing about institutional reforms, albeit slowly. These reforms include the separation of asset ownership from management, the establishment of an independent regulatory commission for regulating water tariffs, and the establishment of an autonomous water operator company under the Companies Act (1996). Three key entities namely, (i) the Kathmandu Valley Water Supply Management Board (KVWSMB), 10 asset owner of water and wastewater systems within the Kathmandu Valley; (ii) the Water Supply Tariff Fixation Commission, 11 responsible for the economic regulation of the sector; and (iii) the Kathmandu Upatyaka Khanepani Limited (KUKL), 12 in charge of operating the assets under lease and license from KVWSMB; have been established. Relevant laws 13 have been amended or enacted to allow the implementation of these institutional reforms and the PSP scheme. This level of institutional reform has no precedence in the South Asian region. Despite its failure to engage in a PBMC, the Government has strenuously pursued the remaining reform requirements and is nearing completion of most institutional reforms under the projects. 19. The latest project performance reports are in Appendix 3. Despite the aforementioned extenuating circumstances (i.e., the extremely fluid sociopolitical environment in Nepal over the last several years, withdrawals of funding by some development partners, and the loan condition requiring PSP), which have constrained the projects progress thus far, the projects have still achieved extensive institutional reforms, and the Government has shown strong commitment to sustaining the reforms and to speeding up implementation of the projects. Therefore, the proposed major changes in the projects' scope and implementation arrangements are both necessary and timely KVWSMB was previously known as the Kathmandu Valley Water Authority. 11 The Water Supply Tariff Fixation Commission was previously known as National Water Supply Regulatory Board. 12 KUKL was previously known as the Water Utility Operator. 13 The Water Supply Management Board Act (Act No. 21,2063 [2006]). The Water Supply Tariff Fixation Commission Act (Act No. 29, 2063). The Nepal Water Supply Corporation (Third Amendment) Act (2063).

10 6 III. THE PROPOSED CHANGE A. MWSP (Loan 1820-NEP) 1. Reallocation of Funds by Prioritizing and Phasing the Project Components 20. Given the current total financial gap of $133 million equivalent caused by the withdrawal of three cofinancing development partners for the Project the World Bank ($80 million), NORAD ($28 million equivalent), and Sida ($25 million equivalent) 14 representing 28.7% of the original total project cost of $464 million, the remaining available funds need to be reallocated by phasing and prioritizing the project components. 21. The 26 km Melamchi diversion tunnel, which was originally financed partially by NORAD and Sida, is the largest single infrastructure component of the project; therefore, it should be prioritized over the other components. Based on a thorough revision of the cost estimates and studies conducted over the past years, some savings 15 are expected to arise by combining the original two packages one (Norwegian Swedish) tied bidding civil works package and the other ICB package into a single untied ICB civil works package. The total base cost for the tunnel, which was originally estimated at $74.3 million, is now reestimated at $65.2 million. 22. It is proposed that the bulk distribution system (BDS) and distribution network improvement (DNI) components are implemented in a phased manner under available funding amount. The JBIC-financed "Special Assistance for Project Implementation" study 16 recommended that both BDS and DNI be implemented in phases. 17 This would correspond to the actual urbanization trend in the Kathmandu Valley, and would be realistic given the capacity of the newly formed water utility operator, KUKL. The JBIC study estimated that the phased BDS and DNI components would cost about $136.3 million over 9 years. Taking into account of available funds at this stage, it is proposed that the project focuses on "priority zones" (i.e., zones where demand for water is high and where water shortages are most serious) by allocating $34.4 million 18 for the first phase of the implementation. As it is crucial to have as much BDS and DNI completed as possible by the time of the completion of the Melamchi diversion tunnel and to maximize the project benefits, the Government seeks further funding, including an additional loan from ADB by 2010, to carry out complete coverage of BDS and DNI in a timely manner. 2. Changes in Implementation Arrangements 23. After the establishment of KVWSMB and KUKL under the agreed institutional reform 14 World Bank in 2002, NORAD in 2005, SIDA in The engineer s estimate by Norplan in 2000, based on two different packages, was $74.3 million, broken down as follows: an upstream 20.5km tunnel, including headworks, under a tied bidding arrangement open only to Norwegina or Swedish joint ventures and consortiums, estimated at $61.5 million; and a 6 km tunnel from Sundarijal adit, funded by ADB and the Government of Nepal, estimated at $13.8 million. Following the pullout of NORAD and Sida, these costs were reassessed and revised by the project management consultant based on (i) a panel of expert s review of the Norplan estimate, taking into account the excavation cost of Middle Marsyangdi Hydropower Project and Chilime Hydropower Project in Nepal; (ii) Nippon Koei s review of the Norplan estimate; (iii) visit to the tunneling site of Mansi Wakal Water Supply Project in India in 2005, and (iv) peer reviews by two independent tunnel experts in The reassessment estimated that costs would be about $9 million less than the original estimate. 16 Kingdom of Nepal Special Assistance for Project Implementation (SAPI Phase 2) for the Melamchi Water Supply Project. Kathmandu: SAPI Team for JBIC (final report, February). 17 For the BDS component, two service reservoirs and transmission mains of 170 million liter per day capacity could be the first phase; the DNI component, which the World Bank was originally expected to finance, could be limited to rehabilitation and improvement works in priority zones in Kathmandu and Lalitpur municipalities. 18 The original allocation was $114.5 million for BDS and DNI.

11 program, many roles and responsibilities of the existing Implementing Agency, MWSDB, will be transferred to KVWSMB and KUKL. Therefore, it is proposed that the MWSP be split into two separate subprojects: (i) the Melamchi River water diversion subproject (subproject 1), and (ii) Kathmandu Valley water supply and sanitation subproject (subproject 2). MPPW will remain the Executing Agency for both subprojects. 24. For subproject 1, MWSDB will remain the Implementing Agency. However, given that the MWSP has experienced serious implementation delays in the past at least partly because of MWSDB s inefficiency significant changes are proposed to streamline MWSDB's management and organizational structure. Changes will include reorganization of MWSDB and revision of its internal processes (including its formation order). The project management unit (PMU) established under the Implementing Agency is headed by a fulltime executive director who will be designated as a signatory for withdrawing the loan funds, and will continue to be responsible for the overall management of subproject 1. The PMU will maintain the subproject imprest account and will be supported by a consultant team in preparing progress reports and other relevant documents for ADB, with respect to subproject 1. The PMU will be restructured based on functional divisions; each unit will consist of qualified technical staff. Units handling the main infrastructure civil works and social programs for the Melamchi Valley (such as engineering and safeguard units) will be located in the Melamchi Valley and headed by a qualified deputy executive director, while the main PMU office (which will handle administration, procurement, financial, communication, and planning) will be located in Kathmandu and managed by another qualified deputy executive director. To ensure professional and efficient decision making in procurement of civil works, an executive committee will be formed within MWSDB. The voting members of the executive committee will be the PMU executive director and two independent professionals a geotechnical expert and a contract management expert. The team leader of the subproject management consultants will be on the executive committee as a non-voting secretary. The role and scope of the existing consultancy packages will be revised in line with the changed implementation arrangements and management processes. The existing consultancy packages supporting the project components of social uplift program 19, environmental management, and public relations will be consolidated into a single package to deliver technical advisory and capacity-building services for the implementation of social development program and the safeguard unit in Melamchi Valley. Appendix 4 sets out the principles of management changes, including proposed revised roles for various consultants. 25. For subproject 2, the implementation responsibilities will be transferred from MWSDB to KUKL, which will operate the water services system within the Kathmandu Valley as per the operating license to be issued by KVWSMB. KUKL will be assisted by an interim management support team for the initial operating period of 1.5 years, and after that will be assisted by the CBP team. During the period of recruitment of the CBP team and during the initial operating period for KUKL, the interim management support team will be engaged through an advisory technical assistance (TA) project, and will assist KUKL in (i) starting up and managing its operations, and (ii) establishing a suitable corporate structure and operational system for the company. Under this advisory TA project, ADB will engage three qualified professionals as interim management advisors for KUKL a general management advisor, an operational and technical management advisor, and a financial management advisor in accordance with ADB's Guidelines on the Use of Consultants (2007, as amended from time to time). Details of the TA and the scope of work of the interim management support team are in the separately processed 7 19 Social uplift program (SUP) is a program under MWSP s social and environmental support component to mitigate direct and indirect project impacts and improve the living conditions of the local population, through buffer zone development, rural electrification, health, education, income generation and community development in Project affected 14 village development committees.

12 8 TA paper. 20 The interim management advisors will also assist KUKL in setting up a PMU within KUKL to manage and oversee all activities related to the subproject A new imprest account will be established for subproject 2. One of the directors on the KUKL board or the general manager of KUKL will be authorized as signatory to withdraw loan funds, as endorsed by KVWSMB and the Government. The PMU set up within KUKL and headed by the general manager will be responsible for preparing procurement of the various consultancy, equipment purchase, and civil works packages relevant to subproject 2, supported by CBP team, and for obtaining approval from KVWSMB if the procurement relates to consultants, goods, and/or works funded by KVWSMB. To ensure that KVWSMB exhibits professional and efficient decision making in procurement, a three-member executive committee will be formed under the KVWSMB board, with fully delegated authority by the KVWSMB board on procurement and contract management. KUKL will appoint a fulltime project coordinator within the PMU who will administer the implementation of subproject 2 and coordinate with KVWSMB and ADB as necessary. The PMU will maintain the subproject account and prepare progress reports and other relevant documents for ADB with respect to subproject KVWSMB will be in charge of planning, financing the capital works, and monitoring the performance of the water supply and sanitation services in Kathmandu Valley as an asset owner, and the Water Supply Tariff Fixation Commission will be responsible for monitoring and approving the tariff adjustments in accordance with the principles of cost recovery. The proposed implementation arrangements and organizational structure are detailed in Appendix Removing the Loan Covenant Requiring PSP Contract Award as a Condition Precedent for Awarding Melamchi Diversion Tunnel Civil Works Contract 28. The preparatory work for the MWSP has been going on since 1992, when the Melamchi River diversion scheme was adopted as a comprehensive, long-term solution to the chronic water supply shortages in Kathmandu Valley. The MWSP was accordingly approved in 2000, and to this day there has been no change in the view that bringing water through such a diversion tunnel is the only realistic way to obtain a sustainable, long-term supply of drinking water for the Kathmandu Valley. Building the tunnel is essential to relieving the worsening water shortage in the Kathmandu Valley, but the tunneling civil works did not commence because of the loan covenant stipulating PSP contract award as a condition precedent for awarding the tunnel civil works contract. 29. Given that the grace period of Loan 1820 under MWSP is due to expire in 2008, subsequent to which the Government will start repaying the loan in accordance with the amortization schedule 21 under the Loan Agreement for the MWSP, further delays will not be affordable. Meanwhile, recruitment of the CBP team the proposed replacement of the PBMC model is expected to take at least 1 year, if not longer. Given this, it is proposed that the current loan covenant permitting tunnel construction only after PSP contract award be lifted. B. SDP (Project Loan 2059-NEP) 1. CBP Team as an Alternative to PBMC 30. The MWSP and the SDP have both failed to engage a private operator through PSP schemes. The attempted PSP modalities included lease contract model which the World Bank 20 The TA was approved by the Board on 10 December 2007: TA 7007-NEP: Supporting Capacity Development for Water Services Operations and Public-Private Partnership in Kathmandu Valley. 21 The current amortization schedule requires the Government to repay the fixed amount (irrespective of the actual disbursed amount) on a semi-annual straight-line method for 24 years.

13 twice attempted to employ, and the recently terminated PBMC model. As mentioned earlier, these successive failures have proven that a PBMC may be too difficult and costly to process in Nepal's fluid political environment. Retrying the same PSP modality might fail to attract interest from competent international players. Therefore, it is proposed that the alternative management support modality be introduced to replace PBMC. Instead of management contractor under PBMC model, a team of consultants, namely capacity building and public private partnership support team (CBP team) will be engaged during KUKL s initial operation, with a new focus on long-term capacity building and strengthening of management and operational skills of the newly formed utility operator. 31. Based on current conditions in Nepal, lessons learned from past failures resulting from over-ambitious PSP schemes, and the need to strengthen management capacity of KUKL to ensure efficient long-term management and operation of water services in the Kathmandu Valley, the CBP team would be a suitable mechanism for supporting KUKL. The CBP team will not only manage KUKL s initial operations, but they will also prepare KUKL s system and staffs to take over operation and management of the Kathmandu Valley water supply and wastewater services. Given these responsibilities, the CBP team should have experience in operating and managing water services utilities. The experienced consultant will be recruited in accordance with ADB s Guidelines on the Use of Consultants (2007, as amended from time to time) using the quality-cost-based selection (QCBS) method Cost Reallocation 32. The original estimated cost of the SDP Loan 2059-NEP was $15 million equivalent, of which (i) $10 million equivalent was to be funded by ADB mainly for financing the base fee of PBMC, and (ii) $5 million equivalent was to be contributed by the Government, primarily to cover the performance-based bonus payments due to the management contractor under PBMC. The replacement of PBMC model with the CBP team model, and the revised implementation arrangements for both the MWSP and SDP, have resulted in reallocation of the costs Change in Implementation Arrangement 33. Computerization of the billing and accounting systems under SDP Loan 2059-NEP for all branches of water utility operation in the Kathmandu Valley will be implemented by KUKL, not by the existing water utility, the Nepal Water Supply Corporation. This component includes geographic information system installation and other information technology services. C. SDP (Program Loan 2058-NEP) 34. Waiver of Conditions Relating to PBMC for the Second Tranche Release. Following the failure of the PBMC model and the subsequent proposal to change to the CBP team model, it is proposed that the conditions relating to PBMC (conditions 5 and 6) be waived. In continuing ADB assistance to the projects through the proposed change in scope and implementation arrangements, the funds under the SDP (Program Loan 2058) are essential to complete institutional reforms. In the absence of these funds, the reforms could not be completed and implementation of the projects could not move forward. While the policy conditions for release of the first tranche of the loan are still being complied with (the first tranche was released in December 2005), the remaining conditions for release of the second tranche are expected to be met by middle of February The progress report on release of the second tranche is being prepared separately and is scheduled to be circulated to the Board shortly after this paper is approved by the Board The outline terms of reference for the CBP team is described in Appendix The details of revised cost estimates are in Table 3 in section IV.

14 Waiver of Conditions of KUKL Assumption Agreement and Subsidiary Loan Agreement for the Second Tranche Release. The SDP pursued institutional reforms in water services sector in Kathmandu Valley. Right-sizing of the Kathmandu Valley water utility operation by utilizing a voluntary retirement scheme (VRS) is one of the reform agenda and the funds under the SDP program loan (Loan 2058) are earmarked to finance VRS. The original program loan designed that KUKL would implement VRS using loan funds onlent to it by way of a subsidiary loan agreement (subsidiary loan agreement is the condition 8 for the second tranche release). Now that KVWSMB is legally authorized and liable to carry out VRS implementation 24, it is not necessary for KUKL to enter into a subsidiary loan agreement. Similarly, KUKL is not required to enter into an assumption agreement 25 (condition 7) either. Therefore, it is proposed that these two conditions be waived. D. Impact on the Projects 36. In principle, the proposed changes to the projects scope and implementation arrangements described above restructure the projects' design, by optimizing the available funding resources and changed institutional environment. The changes in scope will not alter the projects' development benefits or impact improving the health and well-being of the inhabitants of Kathmandu Valley by alleviating the chronic shortage of potable water. The proposed changes aim to achieving such benefits and impact by delivering increased water supply to the people of the Kathmandu Valley without further delay. The proposed removal of loan covenant requiring PSP contract award as a condition precedent to the tunnel civil works contract award will allow the tunnel construction works, which have been on hold for 6 years, to start immediately so that Kathmandu Valley inhabitants will have increased water supply as soon as possible. Dividing the MWSP into two subprojects, with two distinct implementing agencies, will augment the outputs of the projects by increasing implementation efficiency. 37. The outputs envisaged under the SDP have already been substantially achieved, with the exception of the PBMC model, which has proven to be overly ambitious in Nepal's current political environment. Despite the failure of the PBMC model, the remaining institutional reforms separation of utility operation from asset ownership and establishment of independent regulatory entity are still more extensive and intensive than similar reforms carried out by developing countries in the South Asian region. The introduction of the CBP team model, combined with TA support 26 should adequately replace the failed PMBC model, in terms of management support for KUKL. Having a sharper focus on capacity building and more extensive engagement of local resources, the new management arrangements will mitigate the effects of potential political disturbances and enhance the realistic achievement of the objectives of the projects. A revised design and monitoring framework, based on the proposed changes is attached in Appendix The staff currently working within Kathmandu Valley operations of the Nepal Water Supply Corporation will be transferred to KVWSMB together with the assets and liabilities belonging to Kathmandu Valley operations at the transfer date that is tentatively scheduled on 13 February The transferred staff will then deputed to KUKL for the 1st year from the transfer date before they are finally transferred to KUKL. Two rounds of VRS will be implemented while KVWSMB remains as an employer of the staff. 25 The original program loan conditioned an Assumption Agreement between ADB and KUKL whereby KUKL assumes the rights and obligations from MWSDB with respect to the implementation of the program loan. The Program Agreement was signed between ADB and MWSDB before KVWSMB and KUKL were established. Now that the Implementing Agency of the VRS will be KVWSMB instead of KUKL, KUKL is no longer required to enter into this agreement. 26 See para 25.

15 11 IV. ASSESSMENT A. Revised Cost Estimates and Financing Plan 38. The revised cost estimates and financing plans are summarized in Tables 1 through 4 below, while the details of the projects components and their revised cost estimates are in Appendix 7. Table 1: Revised Summary Cost Estimates MWSP ($ million equivalent) Category Total Cost A. Melamchi Valley Subproject 1. Base Costs a. Infrastructure Development i. Tunnel and Headworks ii. Access Roads iii. Water Treatment Plant b. Social and Environment Support 8.31 c. Project Implementation Support i. PMU ii. DSC iii. Incremental Administration iv. Training 0.67 Subtotal (A1) Contingencies a. Physical Contingencies b. Price Contingencies 3.40 Subtotal (A2) Tax and Duties Subtotal (A) B. Kathmandu Valley Subproject 1. Base Costs a. Infrastructure Development i. DNI, BDS and Wastewater System Improvement ii. Kathmandu Valley Water Source b. Social and Environment Support 1.75 c. Project Implementation Support 7.85 i. DSC 6.35 ii. Incremental Administration 1.50 Subtotal (B1) Contingencies a. Physical Contingencies 1.14 b. Price Contingencies 1.14 Subtotal (B2) Tax and Duties 3.73 Subtotal (B) C. Financial Charges Total BDS = bulk distribution system, DNI = distribution network improvement, DSC = design and supervision consultant, PMU = project management unit. a Base costs are as of August b Physical contingencies are estimated at 10%. Price contingencies are estimated at 2.4%. d VAT of 13% on all goods, and custom duties on imported goods. Source: Asian Development Bank estimates.

16 12 Table 2: Revised Financing Plan MWSP ($ million equivalent) Source Total Percent ADB JBIC JICA NDF OFID Government Total ADB = Asian Development Bank, JBIC = Japan Bank for International Cooperation, JICA = Japan International Cooperation Agency, NDF = Nordic Development Fund, OFID = Organization of Petroleum Exporting Countries fund for International Development. Source: Asian Development Bank estimates. Table 3: Revised Cost Estimates SDP (Loan 2059-NEP) ($ million equivalent) Category Total ADB Loan (%) Government (%) A. Base Costs Capacity Building and Public-Private Partnership Support Team 2. Implementation Assistance Computerization of Billing and Accounting Systems of KUKL 4. Incremental Administration B. Contingencies 1. Physical Price C. Taxes and Duties D. Interest During Construction Total KUKL = Kathmandu Upatyaka Khanepani Limited. a. Base costs are as of August b. Physical contingencies are estimated at 10%. c. Price contingencies are estimated at 2.4% d. Value-added tax (VAT) of 13% on all goods, and custom duties on imported goods. Sources: Asian Development Bank estimates. Table 4: Revised Financing Plan SDP (Loan 2059-NEP) ($ million equivalent) Source Total Percent ADB Government Total ADB = Asian Development Bank. Source: Asian Development Bank estimates. 39. MWSP. The total cost of the project is now estimated at $317.3 million, after adjustments made for price escalations resulting from implementation delays and currency exchange rate changes. This represents reduction of $146.7 million or 32%, from the original total cost estimate of $464 million. The ADB loan (Loan 1820-NEP) provides $137 million equivalent, which is the current value of the SDR amount under the original project. Similarly, JBIC, JICA, OFID, and NDF provide $47.5 million, $18 million, $13.7 million, and $10.5 million equivalent, respectively. The Government will fund $90.6 million equivalent for the project under the revised financing plan. The revised cost estimates are prepared based on the available funds already committed and projected funding needs, reflecting prioritized and phased project components. 40. At the request of OFID, ADB has administered the OFID funds, which were earmarked for the access road component of the MWSP. NDF, which committed its financing for the tunnel

17 supervision consultancy under subproject 1, is now winding up its operations and has requested that ADB administer its loan. The NDF loan has remained intact since its commitment in 2000 because of the delay in the tunnel component. NDF will extend its loan in line with ADB's loan from the original closing date of 31 March 2007 to 31 December 2013 the currently estimated completion date of the MWSP. Therefore, it is proposed that ADB take over administration of the NDF funds pursuant to the terms agreed between the parties. 41. SDP. The total cost of Program Loan 2058-NEP remains unchanged. But the total project cost of Project Loan-2059, originally estimated at $15 million, has been reduced to $14 million. B. Revised Implementation Arrangements 1. Revised Implementation Schedule 42. Originally scheduled to be commissioned by September 2006, the Melamchi diversion tunnel, the most costly and time consuming infrastructure development component, is now scheduled to be completed in June The water treatment plant construction has been rescheduled for completion at the same time as the diversion tunnel. All other components of the projects have also been rescheduled to deliver the intended benefits to the inhabitants of Kathmandu Valley at the projects' end in The revised project implementation schedule is in Appendix 8. In accordance with the revised implementation schedule, it is recommended that the loan closing date for the MWSP be extended from 31 March 2008 to 31 December 2013 as per the Government s request. It is recommended that the closing date for the SDP project loan be extended to 31 December 2014, with a 1-year buffer to allow for probable continuation of management support services to KUKL after bulk water supply is augmented in Kathmandu Valley upon completion of the Melamchi diversion tunnel. 2. Procurement and Consulting Services 43. Procurement of all remaining goods, works, and services to be financed out of proceeds of the Loans will be in accordance with ADB s Procurement Guidelines (2007, as amended from time to time). A revised procurement plan showing the details of procurement works and prospective contracts is attached in Appendix 9. For subproject 1, preparation works for procurement of goods, works, and services will be supported by the PMU of subproject 1 (PMU MWSDB), while an executive committee under MWSDB will be in charge of decision making regarding procurement and contract awards. For subproject 2, the PMU established within KUKL for subproject 2 (PMU KUKL) will be responsible for preparing procurement of goods, works, and services, and overseeing and monitoring all procurement and contract awards, with the support of the CBP team. As implementation arrangements for subproject 2 have changed, where KUKL is to directly manage without a management contractor, it would be reasonable to consider outsourcing some of its operations to private contractors for rehabilitation, construction, and maintenance of existing and new assets. The CBP team will assist KUKL in exploring and designing combined contract packages for design, construction, operation, and maintenance, as well as securing management expertise, as appropriate. 44. The proposed CBP team under subproject 2 will be recruited in accordance with ADB s Guidelines on the Use of Consultants (2007, as amended from time to time) using the QCBS method, which are explained in Appendix

18 14 3. Disbursement 45. Disbursement of the remaining loan proceeds under the SDP will be in accordance with existing arrangements. The PMU KUKL will be responsible for preparing disbursement projections for the SDP project loan and requesting budgetary allocations for counterpart funds. An imprest account has already been established by the Government s Nepal Rastra Bank for the SDP Project Loan 2059-NEP. The imprest ceiling shall be equivalent to 6 months estimated expenditures or 10% of the total project loan amount, whichever is less. The imprest account will be managed and liquidated in accordance with ADB s Loan Disbursement Handbook (2007, as amended from time to time) and with detailed arrangements agreed by the Government and ADB. The ADB statement of expenditure procedures will be used to liquidate and replenish the imprest account for individual payments not exceeding $100, Under the revised implementation arrangements of the MWSP, each subproject PMU will be responsible for preparing its disbursement projections, preparing withdrawal applications to ADB and other cofinanciers, and requesting budgetary allocations for counterpart funds. Accordingly, for subproject 1 it will be PMU MWSDB and for subproject 2 it will be PMU KUKL. The existing imprest account will be exclusively for subproject 1, and another first-generation imprest account will be established for subproject 2 by the Government at Nepal Rastra Bank. The imprest accounts will be managed, administered, replenished, and liquidated in accordance with ADB s Loan Disbursement Handbook (2007, as amended from time to time). The advance, initial or outstanding, to each imprest account will be 6 months of estimated expenditure, to be financed by the ADB loan, or 10% of the subproject loan amount, which ever is lower. The ADB s statement of expenditure procedures will be used to liquidate and reimburse the imprest account for individual payments not exceeding $100,000. The delegation of authority to withdraw by PMU KUKL should be effected only after the subsidiary loan agreement between the Government and KVWSMB is put in place. 4. Accounting, Auditing, and Reporting 47. The PMU MWSDB (for subproject 1) and PMU KUKL (for subproject 2 as well as for the SDP project loan account) will maintain separate records and accounts to receive financing resources and cover expenditures. The project accounts and related financial statements will be audited annually in accordance with international auditing standards by independent auditors licensed by the Institute of Chartered Accounts of Nepal and satisfactory to ADB. The PMU MWSDB and PMU KUKL will submit annual audited reports and related financial statements to ADB within 9 months of the end of each fiscal year. The PMU MWSDB and PMU KUKL will also prepare and submit to ADB, within 1 month of the end of each relevant period, quarterly progress reports and semi-annual environmental and social monitoring reports. Within 3 months of physical completion of the projects, the PMU MWSDB and PMU KUKL will prepare project completion reports, including details on costs and compliance with the loan covenants. C. Economic and Financial Analyses 48. Given that the original scope of the MWSP covers all components of the SDP, revised economic and financial analysis has been conducted based on the economic and financial analysis of the original MWSP, taking into account proposed changes in the projects. Because the World Bank, NORAD, and Sida left the MWSP with a total financial gap of $133 million equivalent, the scope had to be reduced. However, cost reallocation was carefully carried to maximize the benefits of the projects. Priority was placed on supplying more water to existing beneficiaries, so that the beneficiaries will realize substantial savings after switching from the alternative sources of water to piped water. The economic internal rate of return with revised cost allocation is estimated at 25.7% in the base case scenario, demonstrating the robust

19 economic viability of the projects. This reflects the results of supplementary surveys and studies carried out during implementation of the projects, which revealed that the economic costs associated with obtaining non-piped water is high; consequently, households in the Kathmandu Valley showed a strong willingness to pay for piped water. 49. The projects will bring the water utility increased revenues from water sales as existing customers purchase more water. A gradual reduction of physical and non-physical losses of water through the projects, and improved capacity of water utility management, will make water supply operations financially efficient and sustainable. The water utility is expected to increase its tariffs in FY2007 and FY2008. Each tariff revision assumed 15% tariff increase in real terms. After two consecutive tariff revisions, it is assumed that the tariff level will be revised merely to keep up with inflation. Given the proposed tariff revision schedule, the financial internal rate of return of the projects is estimated at 4.1%, less than the weighted average cost of capital of 5.5%. The immediate result indicates that the projects do not generate sufficient returns to recover full capital and operational costs, and therefore are financially unfavorable. However, considering the enormous social and political risks of the "do-nothing-option" in Nepal, and the lack of alternative least-cost approaches to the water supply problems, there is little equivalent alternative investment possibilities for the capital. Although the financial internal rate of return of the projects indicates that the projects may not recover full capital and operational costs, the financial projection of the water utility showed that its operational costs will be fully recovered. Therefore, the projects are financially operable. The full economic and financial analysis is in Appendix 13 and 14. D. Social and Environmental Safeguards 50. Safeguard review missions were undertaken in November 2006 (environmental safeguard review) and September 2007 (social safeguard review). These confirmed that the MWSP complies with environmental and social safeguards assurances, loan covenants, and mitigation measures. Findings from the review missions are in Supplementary Appendix A. The review missions pointed out that the implementation arrangements should be strengthened to enhance local ownership and facilitate the decision making process for the social and environment component. 27 Updated resettlement plans 28 and environmental management plans will be finalized in March 2008 and disclosed according to ADB's Public Communications Policy 29 (2005). The recommendations of the review missions are consistent with the recommendations from the panel of experts and the changes in implementation arrangements identified in this paper. 51. The proposed changes in the projects scope and implementation arrangements do not in itself involve additional scope or civil works and will not have any incremental impacts on the environment, persons affected by involuntary resettlement, and/or indigenous peoples. This major change in scope and implementation arrangements was classified as category C for environment, involuntary resettlement, and indigenous peoples in March E. Project Risk 52. The risks associated with the proposed changes to the projects scope and implementation arrangements were all inherent in the original design of the projects. The one exception is the risk of land acquisition, which has decreased because significant progress has Including the levy to be paid to the Melamchi Valley for the water channeled to the Kathmandu Valley. 28 The updated resettlement plans will include a strategy to address the issue of already-acquired land that will no longer be required because of the change in scope. These resettlement plans will be consistent with Government and ADB safeguards policies. The plans will also include specific actions for vulnerable affected persons. 29 MWSP will continue to disclose quarterly progress reports on safeguards implementation.

20 16 already been made in land acquisition and compensation through the resettlement action plan. Other previously identified risks (such as lack of community support, possible political interference over the operation of KUKL, quality of project management, and delays or cost overruns of the tunnel civil works caused by difficult geological conditions) remain the main risks. The proposed changes to the implementation arrangements have addressed these risks to a large extent. Commitment to effecting the proposed changes will remain an important factor in determining future success. 53. Political instability, which was not originally identified as a significant risk but has ended up having the biggest negative impact on the projects (see paras. 12 through 16), remains a major risk. Nepal s political situation is expected to remain unstable in the near future. The Government s strong commitment is therefore required to implementing each activity of the projects. V. ASSURANCES 54. Further to the original assurances where technical amendments are to be made reflecting factual changes, the Government has given the following additional assurances with respect to the proposed changes to the projects scope and implementation arrangements: (i) (ii) (iii) (iv) (v) (vi) The Government shall have entered into the subsidiary loan agreement with KVWSMB by 29 February 2007 for subproject 2, upon terms and conditions satisfactory to ADB. The Government will ensure that, (a) by 31 March 2008, it shall have taken all necessary actions, including amending orders and processes, as required to ensure that; (1) MWSDB s revised management and organizational structure is finalized and endorsed, and (2) standard operating procedures, including the delegation of authorities, are detailed and put in place, all of which shall be satisfactory to ADB, and (b) MWSDB shall have implemented all such changes as described in (a) by 31 May The Government will ensure that all project facilities under MWSP are transferred to KVWSMB upon completion of such project facility (unless such transfer has already taken place). The Government will ensure that the average tariff per cubic meter of water sales be increased to meet the cost recovery levels agreed with ADB in FY2008 for the third time. This is in accordance with agreed cost recovery principle that by June 2013, when the water is expected to begin flowing through Melamchi tunnel, the average tariff charged by KUKL is not less than the level required to cover (a) KUKL s operating costs, (b) payments by KUKL to the Water Supply Tariff Fixation Commission (WSTFC) and KVWSMB, (c) debt service, and (d) a margin sufficient to finance some investments in the distribution network from its own resources, before full cost recovery principles apply. The Government will ensure that WSTFC makes timely approval and publication of water tariff increases on the basis of the indicative water tariffs set out in lease and license agreement between KVWSMB and KUKL. The Government will ensure that KVWSMB receives funds from counterpart funds as well as under Loan 1820-NEP for all capital works for subproject 2 on a

21 timely basis, and applies all such funds received on capital works for KUKL on a timely basis. 17 (vii) (viii) (ix) The Government will ensure that KVWSMB expeditiously discharges its duties and obligations under lease and license agreement. The Government will ensure that, prior to the disbursement of any funds in relation to the social uplift program (SUP) under subproject 1, guidelines are agreed with MWSDB and ADB, with respect to the use of SUP funds, which shall include detailed criteria for subproject selection to ensure consistency and compliance with ADB safeguard requirements, and that any proposed changes in SUP guidelines thereafter are subject to ADB s prior concurrence. Further, the Government will ensure that the Executing Agency will, each year, provide an annual budget which identifies SUP programs to be undertaken, for the following year of implementation, to ADB for review and concurrence. The annual budget should not exceed one-sixth of the current SUP budget. The Government will ensure that the MWSP and SDP shall continue to comply with ADB s Environment Policy (2002), Involuntary Resettlement Policy (1995), and Policy on Indigenous Peoples (1998); and that the Government shall take all necessary mitigation actions as may be required in any updated environmental management plan, updated resettlement plan, or indigenous peoples development plan. (x) The Government shall comply with ADB s Public Communications Policy (2005) in respect of any documentation required for public disclosure under the MWSP and SDP. 55. The Government has also given the following additional assurances with a view to achieving the intended outcome of the institutional reform under the projects: (i) (ii) (iii) (iv) The Government will strictly continue the policy of freezing new recruitments, transfers, and promotions for both permanent and contractual staff positions within NWSC s Kathmandu Valley operations until KUKL actually takes over the operation and staff responsibilities. During the implementation period of the projects, the Government and KUKL will ensure that KUKL strictly adheres to the terms under Shareholders Agreement and Articles of Association and that all proposed changes in the Shareholder s Agreement and Articles of Association of KUKL are subject to ADB s prior approval. Similarly, during the implementation period of the projects, any proposed changes to the negotiated license and lease agreements between KUKL and KVWSMB are subject to ADB s prior approval. The Government will ensure that the second tariff raise agreed with ADB at the time of processing of the SDP will be completed and become effective no later than 31 January The Government will ensure that the voluntary retirement scheme in relation to staffs to be transferred to KVWSMB from NWSC is implemented in two phases, as agreed with ADB, and that there are adequate funding resources to compensate staff willing to take the second round of voluntary retirement scheme after 9 months of KUKL s operations.

22 18 (v) The Government will ensure that any staff liabilities or contractor liabilities remaining with NWSC are settled before the transfer of staff to KVWSMB, and that no outstanding staff or other liabilities are transferred to KUKL. VI. THE PRESIDENT S RECOMMENDATION 56. The President recommends that the Board approves with respect to the MWSP (Loan 1820-NEP), on a no-objection basis, (i) reallocation of funds among the project components subsequent to the reduction of total project cost from $464 million to $317 million; (ii) change in implementation arrangements by splitting the project into two distinct subprojects, the Melamchi River water diversion subproject (subproject 1) and the Kathmandu Valley water supply and sanitation subproject (subproject 2); (iii) removing the loan covenant requiring PSP contract award as a condition precedent for awarding Melamchi diversion tunnel civil works contract; (iv) extension of the loan closing date from 31 March 2008 to 31 December 2013; and (v) administration of the NDF loan by ADB, subject to and conditional upon detailed terms of agreement for such administration being agreed between NDF and ADB. 57. With respect to the SDP project loan (Loan 2059-NEP), the President recommends that the Board approves, on a no-objection basis, (i) capacity building and public private partnership support team (CBP team) as an alternative to PBMC; (ii) reallocation of funds following the replacement of the PBMC model with the CBP team model; (iii) change in implementing agency for the computerized billing and accounting system component, from the existing utility operator to the new operator; and (iv) extension of the loan closing date from 30 June 2011 to 31 December With respect to the SDP program loan (Loan 2058-NEP), the President recommends that the Board approves, on a no-objection basis, (i) waiver of conditions (items 5 and 6) for the second tranche release, reflecting the change under the SDP project loan (replacing PBMC with CBP team); and (ii) waiver of conditions (items 7 and 8) for the second tranche release, reflecting the change in implementing agent for voluntary retirement scheme (VRS) from KUKL to KVWSMB. 59. If the recommended changes are approved, Office of the General Counsel (OGC) will be requested to amend the relevant loan agreements and project administered documents to reflect the changes.

23 Design Summary A. Sectoral/Area Goals 1. Improve health and well-being of the people of Kathmandu Valley. B. Purpose/Objectives 1. Alleviate shortage of potable water in Kathmandu Valley. C. Components/Outputs 1. Melamchi Diversion Scheme ORIGINAL PROJECT FRAMEWORK Table A1.1: MWSP Monitoring Project Targets Mechanisms Reduced incidence of water-borne diseases of the population Potable piped water available to Kathmandu Valley urban inhabitants increased from 65 MLD in 2000 to 170 MLD by 2006 Bring 170 MLD of raw water through a 26 km tunnel from Melamchi Valley to Kathmandu Valley by September Adit and access roads Construction of 25 km adit access roads and upgrading 29 km of existing access roads 3. Water treatment plant 170 MLD capacity 4. Bulk distribution system of pipelines and reservoirs 5. Distribution a. Distribution network improvements b. Private operator/urgent rehabilitation 6. Kathmandu Valley water source improvements 7. Wastewater improvement completed in MLD capacity completed in 2006 Ministry of Health statistics Regulatory body benchmarking MWSDB and NRM MWSDB and NRM MWSDB and NRM MWSDB and NRM Appendix 1 19 Assumptions and Risks Conjunctive use of surface and groundwater can provide adequate water, and private sector involvement will provide efficient operations. 26 km tunnel design and construction is not delayed. Affected persons accept compensation without delay to the Project. Regulatory body will be established on time. NORAD and Sida funding. Access roads available Private sector lease contract awarded Rock conditions favorable. Consensus building succeeds. OPEC funding JBIC funding No land problems No major resettlement or compensation delays 24-hour water supply by 2006 Regulatory body World Bank funding depending on performance of private operator Private sector lease PSPC and World Bank funding contract awarded by 30 MWSDB September MLD by 2005 MWSDB JICA funding Rehabilitate existing sewage treatment plants, sewers, and on-site sanitation. 8. Social uplift program Mitigate direct and indirect project impacts, and channel benefits to the Melamchi Valley on a long-term basis to improve the living conditions of the people in the area. This will include buffer zone development, rural electrification, health, education, and income generation. 9. Project management PMU established within MWSDB with government counterpart staff D. Activities 1. By Government a. Implement institutional reforms on regulatory body, private sector participation, Commence in 2001 Regulatory body Social and environmental monitoring by third party. Progress reports from MWSDB to external funders NRM MWSDB MPPW Good communication between the Government and the local authorities and communities in the Melamchi Valley Sufficient capable government counterpart staff are available Political will plus loan covenants

24 20 Appendix 1 Design Summary Project Targets Monitoring Mechanisms Kathmandu Valley Water Authority groundwater, urban development and resettlement. b. Provide autonomy to NRM Risk of delays MWSDB to implement Project. c. Acquire project land MWSDB and Risk of delays PMU 2. By Nongovernment Organizations (NGOs) a. Assist in implementing resettlement action plan. b. Implement hygiene education program. c. Monitor environmental impacts. d. Include social mobilization in social uplift program. 3. By Consultants a. Public relations/awareness MWSDB and PMU MWSDB and PMU MWSDB and PMU MWSDB and PMU 12 person-months international, 160 domestic b. Project management 234 person-months international, 846 domestic c. Bulk distribution system 113 person-months international, 750 domestic d. Wastewater improvements 35 person-months international, 188 domestic e. Panel of experts 60 person-months international, f. Implement social uplift 12 person-months program international, 396 domestic g. Hygiene education 132 person-months domestic h. Social and environment 80 person-months monitoring by third party domestic i. Training 8 person-months international 4. By Contractors a. Melamchi diversion scheme b. Kathmandu Valley water source improvements MWSDB and NRM MWSDB and NRM MWSDB and PMU MWSDB and PMU MWSDB and PMU MWSDB and PMU MWSDB and PMU MWSDB and PMU MWSDB and PMU $122 million Supervision consultant and PMU $23 million Supervision consultant and PMU c. Water treatment plant $64 million Supervision consultant and PMU d. Bulk distribution system $77 million Supervision consultant and PMU e. Distribution network $100 million Supervision consultant and PMU f. Social uplift program $6 million MWSDB and NRM Assumptions and Risks Good working relationship between NGOs, CBOs, and MWSDB Effective communication Strong, capable, efficient personnel Efficient design and good supervision Political support loan covenant Quality and synergy Good public relations and effective communication Good public awareness Effective communication Retention of trained staff Good progress MPPW decisions Competitive bidding No land problems Good awareness g. Adits and access roads $28 million MWSDB No resettlement problems

25 Appendix 1 21 Design Summary Project Targets Monitoring Mechanisms Assumptions and Risks h. Wastewater system $18 million MWSDB Private sector participation improvement i. Project management $18 million MWSDB and PMU Availability of capable counterpart staff CBO = community-based organizations, JBIC = Japan Bank for International Cooperation, JICA = Japan International Cooperation Agency, km = kilometer, MLD = million liters per day, MPPW = Ministry of Physical Planning and Works, MWSDB = Melamchi Water Supply Development Board, NORAD = Norwegian Agency for International Cooperation, NRM = Nepal Resident Mission, OPEC = Organization of Petroleum Exporting Countries, PMU = Project management unit, PSPC = private sector participation committee, Sida = Swedish International Development Cooperation Agency.

26 22 Appendix 1 Table A1.2: SDP Design Summary Goals Improve health and wellbeing of Kathmandu Valley urban residents, in particular the poor Purpose Equitable distribution of program benefits, in particular targeting poor customers Implement water sector institutional reforms to ensure a professional and commercially driven operational environment on a sustainable basis Project Targets Reduced incidence of water-borne diseases of the population by the commissioning date of the MWSP currently expected in 2009 Adequate quantity of water supplied (total and for the poor) to make secondary sources no longer needed Number of additional water supply connections (total and for the poor) for expanded service coverage Monitoring Mechanisms Government health statistics to be reviewed on an annual basis NWSRB benchmarking key performance indicators to be monitored throughout the program period Assumptions and Risks Potable water quality (WHO standards) Adequate supply pressure Outputs Establishing appropriate institutional framework Establishing NWSRB Adequate and convenient service hours Act/Ordinance approved by 15 July 2004 (TC1) Program Loan TC monitoring Institutional reforms under the Local Self- Governance Act work and the introduction of PSP is not delayed Establishing water authority for Kathmandu Valley Forming and incorporating WUO company Water authority awards operating license to WUO Government allocates appropriate proportion of existing debts of NWSC to water authority WUO and MC sign a performance-based management contract Act/Ordinance approved by 15 July 2004 (TC1) Registration completed by 1 October 2004 (TC2) License awarded by 1 November 2004 (TC2) Transaction completed by 1 November 2004 (TC2) Contract signed by 1 December 2004 (TC2) MOF MPPW MWSDB KVWSMSC Water authority WUO NWSRB MC NWSC ADB TA consultant team General political instability Temporary absence of Parliament and elected municipal government officials A performance-based management contract will establish incentives for efficient operations Recruitment of MC is successfully completed with sufficient interest among potential operators (consultants) Computerizing billing and accounting system Activities Designing of modalities to be used for pro-poor water supply service delivery and incorporating them as conditions in the prospective RFP and in the subsequent contract with MC Work completed by 31 December 2004 Ongoing till February 2004 Trimesterly progress reports of KVWSMSC and, subsequently, WUO/MC Monthly progress reports of TA consultant team Strong political will for institutional reforms for Kathmandu Valley All necessary legislative arrangements are in place

27 Appendix 1 23 Design Summary Water levy arrangements Engineering design consultant for the proposed demonstration scheme to be engaged. His terms of reference to be incorporated in the prospective RFP for information purposes Restructuring of NWSC Project Targets Ongoing till December 2004 MC signing From June 2004 for about 6 months November 2004 Monitoring Mechanisms MOF MPPW MWSDB KVWSMSC Water authority WUO NWSRB MC NWSC ADB TA consultant team Assumptions and Risks Full cooperation of all parties Good working relationship between nongovernment organizations, community-based organizations, overall civil society, and KVWSMSC and MWSDB Participatory approach is successful NWSRB starts regulation Water authority for Kathmandu Valley starts operation From November 2004 and ongoing From November 2004 and ongoing Capital investment funding by ADB and other cofinancier(s) are available WUO for Kathmandu Valley starts operation From November 2004 and ongoing Handover from NWSC to Water authority and WUO From November to end- December 2004 Initiation of PSP scheme by performance-based management contract From January 2005 and ongoing Distribution network improvement/expansion and service improvement From April 2005 and continuing throughout the Program WUO rightsizing by using voluntary retirement scheme and nonmonetary assistance From January 2005 for about 2 years Management efficiency and staff capacity strengthening by MC Inputs Program loan total Project loan total Performance-based management contract consulting services From January 2005 and continuing throughout the Program $5 million $10 million $9 million (base fees) 10 person-months international; 43 personmonths domestic Quarterly progress reports of KVWSMSC and, subsequently, WUO/MC Monthly progress reports of TA consultant team MPPW MWSDB KVWSMSC Water authority WUO MC NWSC TA consultant team Political support with counterpart funds and counterpart staff engagement ADB = Asian Development Bank, KVWSMSC = Kathmandu Valley Water Supply Management Support Committee, MC = management contractor, MOF = Ministry of Finance, MPPW = Ministry of Physical Planning and Works, MWSDB = Melamchi Water Supply Development Board, MWSP = Melamchi Water Supply Project, NWSC = Nepal Water Supply Corporation, NWSRB = National Water Supply Regulatory Board, PSP = private sector participation, RFP = request for proposals, TA = technical assistance, TC = tranche condition, WHO = World Health Organization, WUO = water utility operator.

28 24 Appendix 2 ORIGINAL COST ESTIMATES AND FINANCING PLAN Table A2.1: Detailed Cost Estimates ($ million) Foreign Local Total Item Exchange Currency Cost A. Base 1. Infrastructure Improvements a. Melamchi Diversion Scheme Civil Works Equipment and Supplies Land Acquisition Subtotal (A1a) b. Access Roads Civil Works Equipment and Supplies Land Acquisition Subtotal (A1b) c. Water Treatment Plant Civil Works Equipment and Supplies Land Acquisition Subtotal (A1c) d. Bulk Distribution System Civil Works Equipment and Supplies Land Acquisition Subtotal (A1d) e. Distribution Network Improvement Civil Works Equipment and Supplies Land Acquisition Subtotal (A1e) f. Kathmandu Valley Water Source Civil Works Equipment and Supplies Land Acquisition Subtotal (A1f) g. Wastewater System Improvements Civil Works Equipment and Supplies Land Acquisition Subtotal (A1g) Subtotal (A1)

29 Appendix 2 25 Foreign Local Total Item Exchange Currency Cost 2. Social and Environmental Support a. Social Uplift Program b. Resettlement Action Plan c. Environmental Management Plan d. Hygiene Education e. Public Awareness/Relations f. Social & Environmental Monitoring Subtotal (A2) Institutional Reforms Project Implementation Support a. Project Management Unit b. Design and Contract Supervision c. Panel of Experts d. Incremental Administration e. Training Subtotal (A4) Subtotal (A) B. Contingencies 1. Physical Contingencies Price Contingencies Subtotal (B) C. Interest During Construction and Fees D. Taxes and Duties Total Percent a b 10% of base cost. 2.4% per annum on foreign and local costs. IDC 8% interest on 50% of project costs including taxes and duties and price contingencies. Taxes and duties 10% on all expenditures plus 1% project duty on foreign costs. Source: Asian Development Bank.

30 26 Table A2.2: Original Financing Plan RRP 2000 Estimates ($ million) Financing Plan, RRP 2000 ($ million) Components FC LC Total Total GON Ext ADB WB JBIC JICA NOR Sida NDF OPEC A. Infrastructure Improvement 1. Melamchi Diversion Scheme Access Roads Water Treatment Plant Bulk Distribution System Distribution Network Improvement Private Operator Dist Improve Kath Valley Water Source Improvement Waste Water System Improvement B. Social and Environment C. Institutional Reforms D. Project Implementation Support Subtotal E. Other 1. Contingencies Interest during Construction and Fees Taxes and Duties Total Project Cost % 41% 100% ADB = Asian Development Bank, GON = Government of Nepal, JBIC = Japan Bank for International Cooperation, JICA = Japan International Cooperation Agency, NDF = Nordic Development Fund, NORAD = Norwegian Agency for Development Cooperation, OPEC Fund = Fund for International Development, Sida = Swedish International Development Cooperation Agency, WB = World Bank. Note: All amounts are based on "commitments in principle" as of October $1 = NRs a Loan terms are 32 years with 8 years grace period and 1% per annum interest during the grace period and 1.5% per annum thereafter. b Loan terms are 40 years with 10 years grace period, 0.75% service charge and 0.5% commitment fee. First credit of $15 is scheduled for approval in September 2001 and the second credit of $65 will depend on satisfactory performance of management contract after 2 years. c Loan terms are 30 years with 10 years grace period and 1% interest per annum. Agreements are expected to be signed after ADB approval of the loan. d The Government has requested Japan to finance this component as a grant. e December 2000 approval is anticipated from the grant. f A mixed credit has been indicated: half as grant and the other half as loan. Loan terms are 10 years, no grace period and 10% per annum interest rate. December 2000 approval is anticipated. g Loan terms are 40 years with 10 years grace period, 0.75% service charge, and 0.5% commitment fee. h Loan terms are 20 years, 5 years grace period, 1% per annum interest, and 1% per annum service charge. Source: Asian Development Bank 26 Appendix 2

31 Appendix 3 27 LATEST PROJECT PERFORMANCE REPORTS FOR THE FOLLOWING PROJECTS 1. Loan 1820-NEP (SF): Melamchi Water Supply Project 2. Loan 2058-NEP (SF): Kathmandu Valley Water Services Sector Development Program 3. Loan 2059-NEP (SF): Kathmandu Valley Water Services Sector Development Program

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