Document of The World Bank ON A PROPOSED LOAN CREDIT IN THE AMOUNT OF SDR 15.9 MILLION (US$20.0 MILLION EQUIVALENT) TO THE REPUBLIC OF UZBEKISTAN

Transcription

1 Public Disclosure Authorized Document of The World Bank Report No: UZ Public Disclosure Authorized Public Disclosure Authorized PROJECT APPRAISAL DOCUMENT ON A PROPOSED LOAN IN THE AMOUNT OF US$20.0 MILLION AND A PROPOSED CREDIT IN THE AMOUNT OF SDR 15.9 MILLION (US$20.0 MILLION EQUIVALENT) TO THE REPUBLIC OF UZBEKISTAN FOR A BUKHARA AND SAMARKAND WATER SUPPLY PROJECT Public Disclosure Authorized Infrastructure and Energy Services Department Central Asia Country Unit Europe and Central Asia Region February 19, 2002

2 CURRENCY EQUIVALENTS (Exchange Rate Effective January 31, 2002) Currency Unit = Uzbekistan Sum (UZS) UZS = US$1 US$ = 1 UZS FISCAL YEAR January I -- December 31 ABBREVIATIONS AND ACRONYMS ACS Agency of Communal Services NS National Shopping BVK Bukhara Water and Wastewater Utility) O&M Operation & Maintenance CAS Country Assistance Strategy PAD Project Appraisal Document CPI Consumer Price Index PAS Procurement Accredited Staff CIS Commonwealth of Independent States PCU Project Coordination Unit EMP Environmental Management and Monitoring PCO Procurement & Contract Coordination Plan Officers FMS Financial Management Specialist PICA Performance Incentive Compensation Appenddix GoU Government of Uzbekistan PIU Project Implementation Unit IAS International Accounting Standards PMR Project Management Report IBTA Institutional Building Technical Assistance POM Project Operational Manual Loan ICB International Competitive Bidding PSA Performance Standard Appendix ICR Implementation Completion Report QCBS Quality & Cost Based Selection IF Investment Fund SA Special Account IFI International Financial Institute SC Service Contract IS International Shopping SLA Subsidiary Loan Agreement LCS Least Cost Selection SOE Statement of Expenditures MMS Ministry of Macroeconomics and Statistics SVK Samarkand Water and Wastewater utility) MOF Ministry of Finance VAT Value-Added Tax NCB National Competitive Bidding Vice President: Acting Country Director: Sector Director/Sector Manager: Task Team Leader: Johannes F. Linn, ECAVP Dennis de Tray, ECCO8 Hossein Razavi/Motoo Konishi, ECSIE Ede Jorge Ijjasz-Vasquez, ECSIE

3 UZBEKISTAN BUKHARA AND SAMARKAND WATER SUPPLY PROJECT CONTENTS A. Project Development Objective Page 1. Project development objective 3 2. Key performance indicators 3 B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project 3 2. Main sector issues and Government strategy 4 3. Sector issues to be addressed by the project and strategic choices 6 C. Project Description Summary 1. Project components 8 2. Key policy and institutional reforms supported by the project 9 3. Benefits and target population 9 4. Institutional and implementation arrangements 11 D. Project Rationale 1. Project altematives considered and reasons for rejection Major related projects financed by the Bank and other development agencies Lessons learned and reflected in the project design Indications of borrower commitment and ownership Value added of Bank support in this project 19 E. Summary Project Analysis 1. Economic Financial Technical Institutional Environmental Social Safeguard Policies 32

4 F. Sustainability and Risks 1. Sustainability Critical risks Possible controversial aspects 35 G. Main Loan/Credit Conditions 1. Effectiveness Condition Other 36 H. Readiness for Implementation 37 I. Compliance with Bank Policies 38 Annexes Annex 1: Project Design Summary 39 Annex 2: Detailed Project Description 61 Annex 3: Estimated Project Costs 64 Annex 4: Cost Benefit Analysis Summary 65 Annex 5: Financial Summary 68 Annex 6: Procurement and Disbursement Arrangements 76 Annex 6B: Financial Management Assessment Report 86 Annex 7: Project Processing Schedule 94 Annex 8: Documents in the Project File 96 Annex 9: Statement of Loans and Credits 97 Annex 10: Country at a Glance 99 Annex I 1: BVK and SVK Benchmarking Core Indicator Values 101 Annex 12: Project Implementation Program 106 Annex 13: Summary of Social Assessment 107 MAP(S) IBRD 30863

5 Date: February 19, 2002 Country Director: Dennis de Tray Project ID: P Lending Instrument: Specific Investment Loan (SIL) UZBEKISTAN Bukhara and Samarkand Water Supply Project Project Appraisal Document Europe and Central Asia Region ECSIE Program Financing Data [ ] Loan [ ] Credit [ ] Grant [] Guarantee [ ] Other: Team Leader: Ede Jorge Ijjasz-Vasquez Sector Manager/Director: Motoo Konishi, Hossein Razavi Sector(s): MP - PSI, WU - Urban Water Supply Theme(s): Private Sector; Water Poverty Targeted Intervention: N For Loans/Credits/Others: Amount (US$m): IBRD Loan - US$ 20.0 million; IDA Credit - SDR 15.9 million (US$20.0 million equivalent) Financing Plan (US$m): Source Local Foreign.Total BORROWER IBRD IDA SWITZERLAND, GOV. OF (EXCEPT FOR FOFEA) Total: Borrower: REPUBLIC OF UZBEKISTAN Responsible agency: BUKHARA AND SAMARKAND WATER UTILITIES (BVK AND SVK) Project Coordination Unit Address: 45a, Uzbekistanskaya Av., Tashkent, Uzbekistan Contact Person: Vyacheslav Bulychev, PCU Director Tel: (998-71) Fax: (998-71) BK@pcu.pv.uz Other Agency(ies): Ministry of Macroeconomics and Statistics Address: 45a, Uzbekistanskaya Av., Tashkent, Uzbekistan Contact Person: Mr. Bakhodir Khodjaev, Deputy Minister Tel: (998-71) ; Fax: (998-71) Bukhara Water Utility/Samarkand Water Utility Address: PCU Coordination Offices - Bukhara and Samarkand Contact Person: Rasul Ostanov, Director BVK; Shukhrat Rakhmonov; Director SVK; Olim Vokhidov, Project Coordinator in Bukhara City; and Abdualim Azimov, Project Coordinator in Samarkand City Tel: ( ) /( ) Fax: ( ) /( ) Estimated disbursements ( Bank FY/US$m): FY Annual Cumulative Project implementation period: 5 years Expected effectiveness date: 05/15/2002 Expected closing date: 06/30/2007

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7 A. Project Deveiopment Objective 1. Project development objective: (see Annex 1) The Development Objective of the project is to improve the safety, quality, reliability, efficiency, financial viability and sustainability of the water supply services in Bukhara and Samarkand. The Development Objective would be achieved through: (a) strategic rehabilitation and efficiency improvement of existing facilities in critical condition; (b) institutional strengthening of the Bukhara and Samarkand Water Utilities (Bukhara City Vodokanal - BVK and Samarkand City Vodokanal - SVK) through a perfornance-based management contract (SC) with an internationally experienced water utility operator (the Operator); and (c) strengthening of BVK's and SVK's financial capacity through improved financial management and commercial practices. 2. Key performance indicators: (see Annex 1) The Performance Standard Appendix (PSA), the Performance Incentive Compensation Appendix (PICA), and other related provisions of the management contract establish a set of annual performance targets to be met during project implementation. The extent of progress towards achieving those performance improvement targets by the Operator will be directly related to the amount of annual performance incentive compensation paid. Annex 1 presents the key performance indicators and the detailed PSA and PICA of the draft management contract. The key indicators for the project through which progress towards the development objectives will be assessed include: * Safety and Oualitv: Percentage of water quality samples meeting target values of key parameters; * Reliability: Continuity of service; * Efficiency: Reduction in energy use per cubic meter of water; Reduction in water losses; and Increase in accounted-for water; * Financial Viability: Annual ratio of collected revenues over the sum of operation and maintenance costs and project-related expenses; and * Sustainability: Satisfaction of population with water services, and agreement on effective institutional arrangement for sustainability of project achievements after completion, possibly with expanded participation of the private sector. The indicators in the PSA and in the PICA have a specific annual performance target presented in Annex 1. The installation of monitoring systems and data collection for the performance improvement indicators and for a better understanding of BVK's and SVK's physical and commercial operations will be part of the Operator's responsibility. Independent technical and financial auditors will verify the results as they are directly linked to the incentive fee to the Operator. B. Strategic Context 1. Sector-related Country Assistance Strategy (CAS) goal supported by the project: (see Annex 1) Document number: UZ Date of latest CAS discussion: 03/10/98 The project is fully consistent with the latest CAS and supports two of the four focus areas agreed in the CAS discussion, namely, the need to remove the inefficiencies in resource utilization in municipal services, infrastructure and social services, and the need to address environmental problems. Progress on these fronts would have a substantial impact on softening the constraints that bind Uzbekistan's low-income families, and on moving towards cost recovery, institutional strengthening and privatization of municipal services. Performance benchmarks agreed include: (i) increase in level of cost recovery; (ii) increase in - 3 -

8 institutional capacity; and (iii) increase in competition among service providers and expansion of privatization of services. A new CAS for FY02-04 will be presented to the Board of Directors at the same time as this project. The proposed Bukhara and Samarkand Water Supply Project is included in the new CAS and is consistent with its objectives. 2. Main sector issues and Government strategy: The water and sanitation services in Uzbekistan are rapidly deteriorating and the reliability and safety of drinking water are continuously decreasing in a downward spiral. The water supply and sanitation sector in Uzbekistan and in particular in Bukhara and Samarkand faces several constraints: Inefficient operations: Potable water and wastewater treatment plants are poorly maintained and operated resulting in poor performance in terms of quality of output and efficiency. With respect to energy efficiency, improper design of pumping stations, old equipment and low level of automation lead to high levels of energy consumption. For example, the two main pumping stations of wastewater system of Samarkand have been in service for at least 35 years with little maintenance, and pump efficiency is reported to be in the range of 45% leading to very high waste of energy. In Bukhara, the main and the network pumping stations of the wastewater system are in a dramatic poor state of maintenance. As a result of this situation and rapidly rising energy prices, energy costs in 2000 are as high as 66% of operational and maintenance expenses in Samarkand and 42% in Bukhara. Other components of the water and sewage systems are similarly inefficient. For example, water networks suffer from excessive leakage (measured loss rates are about 39% for Bukhara and 48% for Samarkand respectively). Other measures of leakage performance show that the systems in Bukhara and Samarkand are times worse than well-maintained systems. For example, losses in Bukhara and Samarkand are 5.6 and 17.6 m3/km of main/day/meter of pressure, compared to 0.25 for systems in Westem Europe. Losses inside apartment blocks is equally high. Measured consumption by apartment dwellers is about 112 liters per capita per day (lpcd), but leakage in apartment blocks is as high as an additional 100 lpcd. Consumers, households, industry and public agencies not accustomed to water conservation and not faced with appropriate water tariffs waste significant amounts of water. All the losses in the system result in a total production of water of about 700 lpcd in Samarkand and 750 Ipcd in Bukhara. These levels are several times higher than in Western Europe, and consequently the operating costs is significantly higher than international practice. Poor service levels: The excessive water losses and waste result in poor service levels to the population and industries. The water supply services in the two cities are poor in different dimensions. In Samarkand, 30 percent of the network receives a supply for just two periods of two hours every day, and the rest of the network suffers from very low pressure. In Bukhara, the quality of potable water is deficient with very high content of solids. Poor state of repair of facilities: Although the percentage of urban households connected to pipe water supply is greater than 80%, the water treatment and distribution facilities, as well as the wastewater collection and treatment installations are rapidly deteriorating. In both cities a good part of the secondary network of the wastewater system is hydraulically overloaded. The lack of appropriate maintenance, poor planning, the use of low quality materials and equipment, and poor construction quality, combined with the recent shortages of resources, are responsible for the poor state of repair of water supply and wastewater assets. This trend brings the water and sanitation systems towards lower and lower service levels that will bring parts, and eventually the totality of the system, to a halt. -4 -

9 Unviable financial shortfalls: The water and wastewater utilities in Uzbekistan are facing reduced government transfers due to fiscal constraints and decentralization policies aimed at increasing self-reliance of local utilities, very low tariffs authorized by the local Governments (the household water tariff in Samarkand in 1999 was about US$0.014/m3 and in Bukhara US$0.005/m3), high cross-subsidies (in Bukhara and Samarkand the level of tariffs for non-domestic consumers is about 8-10 times higher than for domestic consumers), and poor collections. Not only revenues are insufficient to cover basic operational costs (much less maintenance costs), the BVK and SVK are only able to receive about 18% and 27% of their billings in cash respectively. The rest is either paid through a cumbersome system of invoice clearing and compensation with other utilities and customers' own invoices and payments, or simply not recovered at all leading to a total collection level of 56% and 79% of billing in Bukhara and Samarkand respectively. In both cities the utilities' accounts receivable represent about 7 months of billing leaving them in a financially untenable situation. The utilities continue their operations by cutting maintenance expenses and not paying vodokanal staff and their suppliers, most notably electricity providers. Weak human resource and institutional capacity: Despite many of skilled technical professionals working in the water sector in Uzbekistan, there is an urgent need for updating and improving skills in modem utility management systems (including management and operations of water supply and sanitation systems), planning strategies, financial and commercial management, and investment selection. The capacity of Municipalities and anti-monopoly commissions to monitor and regulate the vodokanals without undue interference also needs substantial strengthening. Lack of adequate information: The financial and technical information available to the utility management is insufficient and does not provide the information base needed to manage the operations or plan the development of the water and sanitation systems efficiently. The accounting, financial and operational data collection and management systems are inadequate and do not provide a clear picture of the problems faced by the utilities. In fact, financial reports severely overstate the financial performance of vodokanals. Water resources scarcity: Many water supply enterprises in Uzbekistan are located in basins with limited water resources. Although urban water supply is not the largest user of water resources, the competition with other sectors, mainly agriculture becomes particularly important during drought periods. The problem of water resources is compounded by poor management of regional water systems, poor allocation of water, pollution caused by agriculture and industry in some areas, and wastage in the drinking water systems, both from leakage and lack of water conservation practices. Additionally, operational costs of some of the utilities, such as BVK, are increased by their dependence on water resources located at a long distance from the population they serve and transported through channels or large mains over hundreds of kilometers. The Government strategy for the proposed Bukhara and Samarkand project is twofold. First, to define a new relationship between the central and local governments based on a full decentralization of responsibilities to the local level for the provision of services and full cost-recovery of operational, maintenance and debt service expenses through water and wastewater tariffs. Second, to test for the first time in Uzbekistan, a new strategy to improve water supply services by involving the private sector in the provision of these services. This operation is designed as a first step in the implementation of this strategy, focusing on the two key areas that need the most improvement in the vodokanals, namely the operational efficiency of the water supply systems and the financial and commercial strategies. As part of the Government strategy in the water supply sector, and more generally in the communal services, the Ministry of Communal Services was restructured in December 2000 as an Agency of Communal Services (ACS) with the main goal of commercializing the activities of city and district - 5 -

10 communal service providers. Some of the key goals of this restructuring and the responsibilities of the new ACS include: (i) to coordinate the reforms in the communal services sector; (ii) to act as regulator and to monitor the compliance of local authorities and commercial entities with the sectoral legislation; and (iii) to attract foreign investments into the sector, including the establishment of joint ventures. As part of the reform, the local governments received the responsibility for the provision of water supply and sanitation services. The new policy calls for the promotion of altemative contractors for such provision so as to create a competitive environment. Additionally, the policy gives a clear mandate to the local governments and service providers to improve efficiency and focus on water demand management. 3. Sector issues to be addressed by the project and strategic choices: Restoring basic levels for water supply service in Bukhara and Samarkand (both ancient cities of significant cultural and historical importance and important tourism potential) is estimated to require investments of about US$125 million. This estimate does not include the resources needed for the rehabilitation and expansion of the sewage collection system and the upgrading of the wastewater treatment system. These additional resources are expected to be larger than those needed for water supply. For the time being, addressing all of these investment needs is clearly beyond the present financial capacities of BVK and SVK because of the enormous short-term tariff increases it would entail for the both Bukhara and Samarkand population. It is also beyond the availability of external resources that can reasonably be expected to be mustered for such an operation in Uzbekistan. Furthermore, the very weak institutional and implementation capacities of BVK and SVK would prevent them from implementing such an ambitious program. The approach proposed for the project would be to design this operation in the simplest possible way with a view to address, in an emergency basis, only the technically and financially most critical issues and to use it to build up a basis for future, gradually expanding support to BVK and SVK from the World Bank, other International Financial Institutions (IFIs) or bilateral donors. The sector issues to be addressed by the project and the strategic choices made during project design are: Progress towards financial viability of BVK and SVK at the core of sector issues addressed by the proiect: Aside from considerable technical problems, the main obstacle that must be overcome to re-establish satisfactory water supply conditions is to set up the financial and institutional framework that will eventually allow BVK and SVK, over a long-term horizon, to operate as both technically and financially sound local utilities. Increasing BVK's and SVK's water tariffs and revenue collection are the most critical issues. The project's strategic choice has been to jointly prepare and agree with the municipal governments a feasible financial recovery plan aimed at reducing costs associated with system inefficiencies, increasing tariffs and collections, reducing accounts payable to BVK and SVK from Government-owned entities, reducing non-cash forms of payment, and improving financial and accounting information and planning. It is important to note that under the prevailing circumstances it is unrealistic to expect an immediate improvement of BVK's and SVK's financial situation leading to full cost-recovery. Close supervision of progress and effectiveness of the financial recovery plan, and flexibility to adapt to changing conditions within the framework of the management contract are required. Turning over key management and operation responsibilities of the vodokanals in the water supply and financial/commercial areas to a private operator under a management contract: At present BVK's and SVK's very weak managerial and technical capacity prevents the companies from addressing even the most urgent operational problems and would not allow them to implement the project. Effective international assistance will be an important factor in reaching project objectives. The strategic choice is to bring in a foreign qualified operator under a performance-based management contract with a highly focused scope of responsibilities that would be limited to the management of the water supply, financial and commercial - 6 -

11 areas, and more specifically to: (i) the rehabilitation and operations improvement of the water treatment and distribution system; (ii) the implementation of a program of demand management and customer service; (iii) the implementation of an energy efficiency program; and (iv) the implementation and operation of commercial and financial management systems, as part of a financial recovery plan. In these areas the operator will have full responsibility, including the management and training of BVK and SVK staff, determination of strategic approaches, and selection and implementation of investments. Involvement of an experienced and qualified intemational utility operator under a management contract type arrangement as opposed through a traditional technical assistance program will provide a faster and more cost-effective way to improve services and efficiency, management and operation of BVK and SVK, and to invest scarce resources in the most cost effective capacity with direct and long lasting benefits to the utilities. A performance-based management contract is considered the most adequate approach to involve the private sector at this time as it has attractive features that would increase the likelihood of success and is in line with the Government's policy of gradual transformation of the economy. BVK and SVK as proiect executing agencies: In line with the decentralization policies of the GoU, the decisions and ownership of the project will be focused on the lowest level of government involved in the provision of water and wastewater services. All aspects of project administration and coordination will be managed by the vodokanals, as the lowest and most direct level of government organization dealing with water and sanitation services. The vodokanals will be supported by a small Project Coordinating Unit (PCU) supported by an experienced international technical and financial auditing firm. BVK and SVK will coordinate certain aspects of project implementation with the Ministry of Macroeconomics and Statistics (MMS), the ACS, the Ministry of Finance (MOF) and the local and regional governments of Bukhara and Samarkand, but these higher-level government organizations will not have a direct day-to-day involvement in project implementation. -7 -

12 C. Project Description Summary 1. Project components (see Annex 2 for a detailed description and Annex 3 for a detailed cost breakdown): Component Sector Indicative Costs % of Bankfinancing % of Bank-...(US$M) Total (US$M) financing 1. Investment Fund (IF) Urban Water Supply Bukhara IF Urban Water Supply Samarkand IF Urban Water Supply Service Contract (SC) - Base Fee Urban Water Supply SC - Incentive Fee Urban Water Supply Consulting services and Project Urban Water Supply Coordination Unit 4. Swiss-financed component Urban Water Supply Swiss-financed Investment Fund Urban Water Supply 4.2 Swiss-financed technical and Urban Water Supply financial audits and consulting services Total Project Costs Front-end fee Total Financing Required (1) The costs for components 2-4 correspond to the combined estimates for Bukhara and Samarkand. (2) Percentages are rounded. Project Component 1: Investment Fund. This component would finance essential short-term expenditures (such as materials, equipment, vehicles) and a least-cost capital investment program (including associated engineering and construction supervision services) aimed at improving the operations of the water supply system and the services to the population by achieving the performance improvement targets in the service contract. The Operator, together with BVK and SVK staff, will propose the investments that are required to optimally re-structure and rehabilitate key components of the systems (such as sections of the water distribution networks and block distribution systems, specific components of the treatment plants, pumping stations), implement a demand management program, and set up financial management, accounting and commercial systems. Project Component 2: Service Contract. This component would finance the costs related to the service contract. These costs include a base fee and a performance-based fee to be paid to the private Operator based on achievement of targets defined in the contract. The Operator would be given full responsibility for managing the investment program, operating the water supply system, and developing and implementing the demand management program and the commercial (billing and collection) and financial management departments. Project Component 3: Consulting Services and Project Coordination Unit. This component would support - 8 -

13 the PCU including salaries, training, and incremental operating costs; and various consulting services of technical, legal and financial nature. Proiect Component 4: Swiss-financed component. The Government of Switzerland is processing a US$9.0 million grant to provide parallel financing to the World Bank-financed project. This grant will provide supplemental resources for two activities. First, it will finance an investment fund (goods and services of Swiss origin) with uses to be determined in parallel to those of the IF under Project Component 1. It will also finance independent technical and financial auditors that would monitor the Operator's performance and prepare the financial project and water utility audits, as well as complementary consulting services to support the PCU. The front-end fee will be financed from the proceeds of the IBRD Loan. 2. Key policy and institutional reforms supported by the project: The key policy and institutional reforms in the provision of water services in Bukhara and Samarkand sought by the project are to: * Change the Government's role in infrastructure development and public service provision in these two cities, accompanied by greater autonomy and decentralization of the management of services; * Support the first steps of an institutional reform under which BVK and SVK would truly be able to carry out their responsibilities, in accordance with their original charters as autonomous municipal enterprises, following commercial principles, and with greater technical and financial efficiency and improved customer-orientation; * Use of a private operator to manage key parts of the BVK and SVK operation through a service contract with the aim of initiating the reform of the operating practices and the managerial and technical capacity of BVK and SVK; * Implement a financial recovery plan with a view to have BVK and SVK collect sufficient revenues to cover their operational costs, ensure a basic level of maintenance of their assets at the end of the project and service their debt; and * Change in the criteria and approach to select investments in the water and sanitation sector, from a view that focuses only on capacity expansions to one that supports adequate maintenance, improvements in operational efficiency, and reduction of wastage. 3. Benefits and target population: The final beneficiaries of the project are the populations of Bukhara and Samarkand connected to the water supply systems of BVK and SVK (about 260,000 and 390,000 people respectively) who are now facing a rapid deterioration of quality and reliability of their services. The main direct benefit is expected to be an improvement in the service by halting the deterioration of the water supply infrastructure, reducing inefficiencies in the systems, and addressing some of the most urgent priorities. Given the limited resources that would be available through the project, the rehabilitation of the system would not be completed to a fully acceptable level, but noticeable improvements in the quality, reliability, efficiency and sustainability are expected. Because of the high level of connection to the water supply network, the system improvements would benefit the great majority of the populations of Bukhara and Samarkand including their poorer segments. The intermediate beneficiaries are the water and wastewater utilities in Samarkand and Bukhara. The involvement of an experienced private sector operator would bring better management to specific operations of the vodokanals such as water supply services and the financial and commercial operations, as -9-

14 well as operational and technical know-how. Furthermore, the policy and institutional reforms sought by the project would help BVK and SVK take the first few steps in a gradual path towards self-sustainability, technical efficiency and financial viability. Additionally, the success of this project will have an important demonstration effect for the necessary reforms in the urban water sector in Uzbekistan

15 The reduction of water and energy wastage would bring environmental benefits. Improvements in the quality of drinking water and in the operation of the water supply system are expected to bring health benefits and respond to an expressed preference by the population. 4. Institutional and implementation arrangements: Implementation period: FY FY2007. Executing agencies: Bukhara Water and Wastewater Utility (BVK) and Samarkand Water and Wastewater Utility (SVK). Project administration and coordination: * The PCU has been established under the authority of the provinces of Bukhara and Samarkand as the government level responsible for the provision of water supply services. The PCU will also have a coordination role with the MMS, as this organization has taken a leading role in the reform of the water supply sector. The PCU will report to a Coordination Committee that will have representatives from the local governments and key agencies of the central government (MOF, ACS, State Committee on Property and MMS). The Coordination Committee, headed by the MMS, will meet at least quarterly to review the progress of the project and to approve the annual procurement plans prepared by the operator, BVK and SVK. The Coordination Committee will also provide the forum to discuss policy issues of the water sector related to project implementation, particularly on financial matters. The PCU would be responsible for: overseeing day-to-day project activities and the implementation of the service contract; coordinating with BVK, SVK, the Operator, the Municipalities of Bukhara and Samarkand, and the auditing consultants; monitoring performance indicators during implementation of the service contract; and carrying out all coordination and supervisory functions related to project implementation. The PCU is fully staffed and operational and has received training during project preparation, particularly on the Service Contract documents. Under the proposed administration and coordination structure the PCU is in no way subordinate to the Operator and no payments to the PCU staff will be channeled through the Operator. * BVK and SVK will operate as legally separate, government owned enterprises (a Regional Production Enterprise and a Municipal Production Enterprise, respectively). The relationship between municipal governments and utilities will be at arm's length. Municipal governments will provide an enabling environment that will give their utilities the freedom and obligation to reform and strengthen their institutional and financial capacity. The Coordination Committee will deal with policy and strategic issues and project oversight. * BVK and SVK will sign a single service contract with the Operator with specific items in the service agreements to reflect the differences in the city systems. The Operator will be responsible for managing the water supply services in Bukhara and Samarkand under a four-year performance-based contract. Ownership of the underlying assets and authority for setting tariffs will remain with the Municipalities of Bukhara and Samarkand. The Operator will have responsibility to carry out, on behalf of the vodokanals and in coordination with them, the procurement goods, works and services in accordance with the World Bank Procurement Guidelines, including contract signature. The PCU will approve and submit to the World Bank for review the annual implementation plan for the use of IF resources as proposed by the Operator.

16 Financial Management: To maintain project accounts and produce reports in accordance with standards acceptable to the Bank, an interim FMS was established at the PCU. This system will be integrated into the overall financial management system that will be installed by the Operator in BVK and SVK to ensure consistency and adequate reports using the format agreed for Project Management Reports (PMRs). In accordance with OP/BP 10.02, a Bank-accredited financial management specialist reviewed the proposed financial management system in March Based on this assessment, it was found that the PCU satisfies the Bank's minimum financial management requirements. However, the PCU has agreed to take a series of actions to improve its financial management processes as described in Appendix 6. The PCU will ensure the preparation and distribution of consolidated periodic progress reports to the BVK and SVK and relevant government institutions, including the World Bank, to reflect: (i) sources and uses of funds, by component and activity; (ii) project progress; and (iii) procurement activities. In this context, the PCU will prepare quarterly Project Monitoring Reports (PMRs), which would be submitted to the Bank within 45 days of the end of each quarter. The first quarterly PMRs will be submitted at the end of the third quarter of Audit Arrangements: The PCU, with the support of the Operator, would be responsible for ensuring that the Project financial statement, Special Accounts (SA), and Statement of Expenditures (SOEs) are audited by an independent auditor, acceptable to the Bank, in accordance with International Auditing Standards (IAS). The PCU will maintain responsibility for the management of project funds and the Special Accounts. They will monitor and keep track of the use of funds. The audit will cover all funds related to the project, including counterpart funds, for all project components. The annual audit will be carried out in accordance with the Guidelines for Financial Reporting and Auditing of Projects Financed by the World Bank. The audited financial statements, the Special Accounts, and SOEs of the preceding fiscal year will be sent to the Bank within six months of the end of the fiscal year. Selection of an independent Auditor will be a loan and credit condition of effectiveness. In addition, the financial statements of both BVK and SVK will be audited and sent to the Bank along with the project audit. Disbursements: Disbursements from the Loan and Credit will be made based on traditional disbursement methods (i.e., from the Special Account with reimbursements made based on Statements of Expenditures (SOEs) and full documentation, and direct payments from the Loan Account). The proceeds of the World Bank Loan and Credit will be allocated in accordance with Table C, Annex 6. To facilitate timely project implementation, the PCU will establish, maintain and operate, four special accounts (two each for BVK and SVK, corresponding to the IBRD funds and the IDA funds, respectively) under terms and conditions acceptable to the Bank. On-lending Arrangements: Loan proceeds will reach BVK and SVK via a Loan Agreement and a Developmental Credit Agreement (DCA) with the Ministry of Finance (MOF) on behalf of the GoU and two Subsidiary Loan Agreements (SLAs) between MOF and BVK and SVK. The on-lending terms to BVK and SVK for both Loan and Credit funds will be on IBRD terms (including a five year grace period and a repayment period of 20 years). During project preparation, the central Government indicated that, in line with national policies for foreign loans to sub-national entities, the foreign exchange risk would be passed on to BVK and SVK (i.e., sub-loan repayments would be made using the official UZS/USD exchange rate on the day of payment). As the Government continues to implement the program of unification of the various exchange rates and a liberalization of the foreign exchange rate regime, the UZS/USD exchange rate is expected to increase significantly. The Government will provide an annual zero-net budget subsidy to compensate for this risk. The methodology to determine this subsidy is incorporated in the Credit and Sub-Loan Agreements

17 Monitoring and evaluation arrangements: The PCU, with the support of international independent technical and financial auditors acceptable to the Bank, will monitor progress against agreed performance indicators specified in the service contract. One of the tasks given to the Operator under the service contract will be the implementation of monitoring mechanisms to gather the necessary technical data to better manage the water supply system. This data will also serve as basis to determine performance improvements in a way that can be independently verified by auditors. The Operator will furnish the PCU with quarterly and annual reports summarizing the service contract operations and the utilization of project funds. The PCU will prepare and provide to the Bank, on a quarterly basis, consolidated reports on project implementation progress covering: (i) projections for project financing and implementation; (ii) status of project finances, procurement of goods and works; (iii) status of implementation of the Investment Fund; (iv) statement of income and expenditure for the current and previous quarter; and (v) monthly cash flow projections for the next six months. Reporting formats were discussed at appraisal. All project financial information presented would be in compliance with International Accounting Standards (IAS). These reports would be submitted to the World Bank within one month of the end of the relevant quarter, and would provide the basis for monitoring the progress of the project. Draft annual action programs for the upcoming year will be included with the corresponding quarterly report for the Bank's review and comment. The Government of Uzbekistan and the World Bank will conduct joint reviews annually during supervision missions. The PCU would prepare a detailed mid-term report to serve as the basis for a Project Mid-Term Review, to be undertaken no later than two years after project effectiveness. The Government will prepare and discuss with the World Bank, no later than three years after project effectiveness, a report on the future institutional and managerial arrangement for the provision of water and wastewater services in Bukhara and Samarkand with the consideration of the various options for private and public sector participation. The PCU, with guidance from the World Bank, would also prepare and submit an Implementation Completion Report (ICR) to the World Bank within six months of the closing date of the IBRD Loan and IDA Credit. Included in the ICR would be an assessment of the execution of the project, its costs and benefits, the performance of the Borrower, BVK, SVK, the Operator, the PCU, the Bank, and Government agencies involved in the project regarding their respective obligations and accomplishments, and lessons learned. D. Project Rationale 1. Project alternatives considered and reasons for rejection: Conceptually, the project would follow a two-pronged approach to improvement of utility operations: on one hand, the rehabilitation of existing key elements of operational infrastructure for water supply services, and, on the other hand, the implementation in parallel of a few well-defined and critical changes in BVK's and SVK's financial management structures and institutional framework, that will provide the basis for strengthened operations and the preparation of future investment projects. The alternatives for project design considered and rejected included: Institutional approach: Traditional Technical Assistance: The Bank experience in the municipal water supply sector worldwide has demonstrated that a Technical Assistance approach is limited in achieving rapid and successful implementation of the cost-effective investments and institutional reforms necessary to bring water utilities in a path of financial self-sustainability and technical efficiency, particularly when the initial capacity of the utility is very weak. As a consultant contracted to provide technical assistance services does not have

18 managerial responsibilities nor a financial incentive tied to improvements in technical and commercial performance, his ability and commitment to support and bring about effective and positive changes in water companies are limited unless the utility is able to absorb and effectively implement the advice. Both the Government and the Bank believe that, if done right, a service contract would have more direct and long lasting benefits to the utilities. It was also agreed that there is a need to introduce new and innovative forms of service provision in Uzbekistan as demonstration cases for utilizing private sector oriented management techniques to be used more widely in other areas of the country. This is consistent with the recent policy changes in the sector. * Long-term Lease or Concession: There are numerous uncertainties surrounding the water supply systems of Bukhara and Samarkand, including lack of knowledge of the facilities and the capacity of the customer base to generate sufficient revenues to operate and rehabilitate the system, lack of private sector in the utilities sector in the country, slow reforms in the macro-economic framework and uncertainty in the dynamics of the foreign exchange rates, and lack of familiarity with private operators in the water supply sector. These conditions would make it unattractive for a foreign operator to make a long-term commitment in the form of a lease or concession contract unless a very high-risk premium would be charged. A performance-based service contract is considered at this point the most adequate approach to involve the private sector as it has attractive features that would increase the likelihood of success including: (i) lower risk for the operator as there is a fixed operating fee; (ii) relatively short-term commitment by the Government to have an opportunity to learn more about the benefits of private sector participation in the sector; (iii) incentives in the service contract for the operator to achieve key improvement targets; and (iv) full delegated management responsibility to the operator and control over an investment fund to cover priority operation and maintenance needs that would facilitate the achievement of the improvement targets. The Government evaluated various options to involve the private sector in the provision of water supply services and rejected the alternative of a long-term lease or concession. Scope of project: * Include Sanitation Component: The limited funds under this Bank operation, directly linked to the small borrowing capacity of the vodokanals and municipalities, require a focused operation in the most critical part of the systems. An evaluation of the sector indicated that water supply has several components close to collapse with potentially major negative consequences for the population. Extending the project into the area of sewerage collection and wastewater treatment would lead to an ineffective dilution of resources and not bring sufficient and sustainable benefits in neither sector. Furthermore, the expected benefits are expected to be greater by focusing first on water supply and the expressed preference of the population is for initial improvement in water supply services as indicated by the Social Assessment results (improving water quality is the first priority in Bukhara and improving reliability of water supply services is the first priority in Samarkand). * Include Cultural Heritaze: The initial concept of the project included a component in cultural heritage to restore historical monuments with support by donors in order to develop the tourism industry. As project preparation progressed, it became clear that the water supply problems were very urgent and this area was selected to focus the project objectives in order to have greater benefits with the limited funding available. Separate donor programs for the cultural heritage activities were initiated. Additionally, the organizations and skills needed for a cultural heritage component are totally different from those of a water supply component. Including both components would make the project extremely difficult to implement thereby reducing the likelihood of success

19 Technical approach: * Traditional Master Plan and Focus on Major System Facilities: The traditional approach of selecting a long-term investment plan during project preparation through a master plan and detailed feasibility work was rejected because these conventional supply-driven investment projects are often not conducive to an efficient use of resources both in cost and size due to uncertain information and general focus on over-the-ground facilities. The water supply systems of Bukhara and Samarkand face very large needs in investments, most of them in parts of the underground system or linked to operational constraints, and the decision on the most appropriate sequence of projects requires a data collection and analysis effort that would be impossible to undertake during project preparation given the existing time and cost constraints. Additionally, the urgency of the deteriorating situation does not lend itself to lengthy multi-year studies without prompt initial action in the most urgent investments. A traditional technical assistance project would be limited in its ability to implement substantial institutional reforms the vodokanals and to support the Government's reform policies in the water supply sector. 2. Major related projects financed by the Bank and/or other development agencies (completed, ongoing and planned). Two projects closely related to the proposed operation, financed by the French Government in Samarkand (recently completed) and by the Spanish Government in Bukhara Region (including both the city of Bukhara and secondary towns are currently under preparation), respectively. Both projects are complementary to the activities implemented in the Bank-financed project. The activities financed by these two projects focus on well-defined equipment replacement (pumping stations, operational equipment) that can be identified and designed quickly and related engineering services. The Bank-financed activities will concentrate on the distribution network and the financial management of the vodokanals. The Government of Switzerland is processing a US$9.0 million grant to provide parallel financing to the proposed World Bank-financed project. The Grant will provide supplemental resources parallel to the Bank-financed Investment Fund (Component 1) for goods and services of Swiss origin. It will also finance independent technical and financial auditors that would monitor the Operator's performance and prepare the financial project and water utility audits. - : - Latest Supervision Sector Issue Project (PSR) Ratings L. j (Bank-financed projects only) Implementation Development Bank-financed Progress (IP) Objective (DO) Uzbekistan Supply of water to rural and urban Water Supply, Sanitation and S S areas Health US$75,000,000 ID: 9121 Signed: 08/97; closing: 12/05 Improvement of solid waste services in Tashkent Solid Waste S S Tashkent Management US$24,000,000 ID: Signed: 11/98; closing: 12/03 Other ECA countries - 15-

20 Private Sector Participation in the Armenia: Municipal S S provision of water and wastewater Development Project services in Yerevan US$30,000,000 ID: Signed: 06/98; closing: 12/03 PSP in the provision of water and Georgia: Tbilisi Water Supply wastewater services in Tbilisi and Sanitation Project US$TBD Under preparation PSP in the provision of water supply in Tajikistan: Dushanbe Water Dushanbe Supply Project US$15 million (est.) Under preparation PSP in the provision of water supply in Kazakhstan: Northeast Karaganda, Kokshetau and Temirtau Vodokanal Water Supply Project US$TBD Under preparation Other development agencies Asian Development Bank - financed Urban Water Supply Project Uzbekistan US$36 million Rehabilitation of urban water supply in Djizzak, Gulistan and Karshi Asian Development Bank - fnanced Uzbekistan Rehabilitation of rural water supply in selected rural areas of Karakalapakstan and Khorezm oblast Rural Water Supply project US$30 million (est.) Under preparation EBRD - financed with grant Andijan City District Heating contributions from Reconstruction project the Japanese Government and US$15 million (E17.5 million the Swiss Government EBRD loan) Uzbekistan US$1.5 million (Japan) Reconstruction of district heating in US$4.0 million (Swiss) Andijan IP/DO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisfactory) - 16-

21 3. Lessons learned and reflected in the project design: The proposed operation in Bukhara and Samarkand is the second Bank-financed project in the water supply sector in Uzbekistan. The first project, the Water Supply, Sanitation and Health Project, suffered numerous implementation difficulties and was in unsatisfactory status for more than two years. It was designed to assist communities most severely affected by the Aral Sea environmental disaster, is now in satisfactory status and the lessons learned during the restructuring process have been very useful in the preparation of the proposed operation. The key lessons learned during the implementation of the project include: (i) overly complex designs tackling several sectors (urban water supply, rural water supply, rural sanitation, health promotion and hygiene education) in several regions (cities of Nukus and Urgench and rural areas of Karakalpakstan) with several counterparts (six water agencies), and several co-financing international agencies are very difficult to implement; (ii) the activities of international consultants must be discussed in advance with the Government and their selection and contracting should be done as early as possible and at least before launching project implementation; (iii) project implementation arrangements must be well defined and the roles between project coordinators named by the Government and international consultants should be clearly identified so that adequate supervision can take place; (iv) officials from the central and local government and vodokanal staff should be fully involved in project preparation from the very early stages; (v) project development objectives should be modest, well-defined, achievable in line with the Government reform policies in the sector; and (vi) all agencies in charge of providing counterpart financing should understand the expected profile so that adequate planning can be made in advance. The Bank's involvement in the water and wastewater sector in the transition countries is still at its beginning and no operations have been completed in the Commonwealth of Independent States (CIS) countries. Some of the water supply projects in the region have suffered from a lack of focus in project design, inadequate or unclear implementation arrangements that cause significant delays, no up-front conditions to demonstrate commitment, and inadequate understanding by the Govemment of project objectives. One of the main lessons in Bank's water sector operations worldwide and in the region is that poor quality at entry may result in unrealistic expectations and large disbursement delays, and projects may fall short of meeting institutional and financial development targets. Among the water supply projects, only a few operations recently prepared have supported the involvement of the private sector in the provision of water and wastewater services. The important lessons that can be learned from the Bank's general experience in the water supply sector, and in transition economy countries in particular, and that have been integrated in the design of this operation are: * The sustainability of the project depends on a realistic assessment and projection of the minimum financial capabilities of the water utilities and the commitment of the participating municipalities to support the financial viability of the utilities through higher collection of water fees and commensurate tariff increases. * The involvement of an international private operator with adequate delegation of managerial, operational, and investment selection responsibilities, combined with clear financial incentives to achieve the performance improvement targets can provide significant benefits. * Innovative projects like the proposed one requires intensive technical, procurement and managerial Bank supervision during project preparation and implementation. Implementation arrangements must be clearly defined and understood. Successful project preparation and implementation require a strong PCU supported by an experienced international consulting team with engineering and financial expertise

22 * The project should support the Government's efforts to implement institutional and financial reforms in water supply and sanitation sector. The experiences of this project are expected to be used in other cities and other utilities sectors. * The institutional and policy reforms required for the success of the project need the involvement, commitment and support of the authorities with clear demonstrations of commitment during project preparation. This commitment should be demonstrated through the implementation of the first steps of the reforms needed for achievement of the project's development objective. Three Bank-financed projects similar to this operation are currently under preparation in Georgia, Tajikistan, and Kazakhstan, and one is currently under implementation in Armenia. In all these projects, an operator will be contracted to manage and operate the water supply services (and in some cases wastewater) of urban centers. Although it is too early to evaluate improvements in these projects, similar management contracts (with incentive fees directly linked to performance improvements) in other regions have resulted in rapid improvements in the quality of service and efficiency of the system. For example, the management operator in the Gaza Water Supply and Sewerage Service Improvement Project with an investment fund of about US$12 million was able to achieve basically all performance improvement targets. The experience in the Ammnan Water and Sewerage Management Project initiated in 1999 has been so far equally positive. The proposed project in Uzbekistan faces similar difficulties to the above projects, particularly those in CIS countries, such as lack of understanding on the side of local government and the utility of the key reforms needed; a possible waning of commitment and interest with the implementation of politically sensitive issues, for example institutional reform and cost recovery; and initial unrealistic and over-ambitious expectations at the local level, particularly in terms of the financial capacity of vodokanals and the required capacity of facilities. 4. Indications of borrower commitment and ownership: Launched since 1993 Government's strategy of economic reforms in public utilities sector has been followed and deepened during previous three year period, and includes: (i) decentralization of responsibilities to the local authorities; (ii) instituting new pricing and cost-recovery mechanisms; (iii) encouraging private sector participation in developing the country's infrastructure; and (iv) phased elimination of subsidies, partially compensated by means-tested allocations. Number of programs within this concept are implemented, including ongoing improvement in metering of water supply, natural gas and district heating consumption. As a part of the strategy, in December 2000 the Ministry of Public Utilities was restructured into an Agency of Public Utilities with the main goal of commercializing the activities of municipal and rural service providers and key functions of the Agency being: (i) coordination of the reforms in the public utilities sector; (ii) acting as regulator and monitoring compliance of the local authorities and commercial entities with the sectoral legislation; and (iii) attracting foreign investments into the sector, including establishment ofjoint ventures. The national government and the regional and local governments of Bukhara and Samarkand have indicated their strong commitment to the necessary reforms associated with the project. All levels of government are convinced that the involvement of a private operator in the provision of water supply services in Bukhara and Samarkand is the preferred option to improve these services quickly and cost-effectively. This decision was agreed after a long process of discussion and review of options by the various government agencies involved, including study tours to countries with similar experiences involving the private sector in the provision of water supply services and several workshops with key stakeholders in Tashkent, Bukhara and Samarkand

23 The regional and local governments of Bukhara and Samarkand support the need for full cost-recovery through increased but affordable tariffs and collections from users. The MMS and the ACS fully support this approach as the only option for sustainability of the sector. The first set of tariff increases took place in the first semester of 2000 (30% in Samarkand and close to 90% in Bukhara where domestic tariffs were smaller). Since then, the regional govermnents have continued the implementation of measures to support the financial recovery of BVK and SVK, both in termns of increases of tariffs and collections, as described in Section E.2. The oblasts and the national govermment have divided the regional vodokanals of Bukhara and Samarkand in two organizations, one in charge of the urban areas of the regional capitals, and the other in charge of the remainder of the oblasts. This was a condition to proceed with project preparation, as the achievement of independent financial sustainability of the borrowing entity was needed, plus it allowed to focus the institutional strengthening activities on a manageable core set of services. 5. Value added of Bank support in this project: The Bank's specific advantage is its comprehensive approach to economic and institutional development issues in Uzbekistan. The Bank has been involved in the reform of public sector enterprises, in particular under the Institutional Building Technical Assistance Loan (IBTA), and has accumulated a good knowledge of the respective key institutional and financial issues in the public sector of the country. Through its water supply operations (either ongoing or under preparation) and sector work in other Central Asian countries (Kazakhstan, Kyrgyzstan, Tajikistan) the Bank has also acquired a strong understanding of sectoral issues in the region and is therefore in a good position to provide Uzbekistan access to comparative and relevant experiences. Additional value added of Bank support in this project lies in: (a) insisting on a comprehensive reform rather than "band-aid" approaches; (b) requiring the introduction of commercial and cost-recovery practices in water and sanitation services in transition economies; (c) facilitating the selection and contracting of a private utility operator for the project implementation; (d) acting as catalyst for various policy and sector reform decisions; (e) assuring transparency in the selection of the most attractive offer from intemational operators through the use of Bank's procurement procedures; (f) ensuring that the Operator is not subject to political interference or is prevented from doing its work; (g) supporting the project management and implementation arrangements; (h) providing support to mobilize trust funds for the preparation of the project; (i) ensuring a continued commitment at various levels to carry out the agreed project activities and reforms in a timely manner; (j) knowledge transfer to local staff on similar experiences worldwide and (k) coordination of capacity building strengthening activities to vodokanals. Without the Bank's support, the reform program in the water and wastewater sector of Uzbekistan would progress much more slowly, and the condition of water and sanitation services and related public health and environmental issues in Bukhara and Samarkand would continue to deteriorate. The funds provided by the Bank will allow the financing of investmnents and services to support the project objectives. E. Summary Project Analysis (Detailed assessments are in the project file, see Annex 8) 1. Economic (see Annex 4): * Cost benefit NPV-US$2.28 million; ERR = 18 % (see Annex 4) 0 Cost effectiveness O Other (specify) - 19-

24 The BVK and SVK have very deficient technical and operational data. This lack of information makes an optimal up-front identification of all investments before project effectiveness impossible. To ensure the most effective allocation of resources and their highest economic return the specific identification of the use of resources available under the proposed IF will be used to achieve the performance improvement targets (which have been chosen along dimensions such as better water quality, improved levels of water supply services, lower operational costs particularly in energy, and improved financial viability). The Operator will have the incentives to select the optimal investments to achieve these targets based on the operational and technical information it collects during project implementation. Although reliable data for the system's operation is not available, the field measurements and projections made by international consultants as part of a Consumption, Demand and Water System Network Analysis provide a basis for defining reasonable performance improvement targets that could be expected from the Operator with the funds available. The estimated economic return of the improvements associated with the project investments and, more importantly, the management improvements have a larger confidence interval than would be common for better documented utilities. Nevertheless, a cost-benefit framework was used to assess the financial and economic viability, based on with and without project scenarios. A sensitivity analysis was used to assess the influence of key variables on the economic viability of the project. The analyses evaluates the net present value at a discount rate of 10% and the economic rate of return for the service contract and the IF. The discount rate used is 10%, which is the World Bank's generally accepted and used hurdle rate for water supply projects. The key assumptions for the Base Case model include the improvement performance targets of the service contract, particularly in lower energy costs and increased operational efficiency that would result in reduction of water losses and wastage. A major contribution to the economic benefits would come from the respective programs for reduction of unaccounted for water and wastage. Current production levels of Ipcd are clearly unacceptable and unsustainable, leading to very high costs per unit of water sold, and penalizing non-domestic customers through higher levels of tariffs than warranted under more efficient operating conditions. If nothing is done to remedy the situation, water production would have to increase from the current production of 71mm3/year and 1 00mm3/year in Bukhara and Samarkand, respectively, to 87mrn3/day and 12 1mm3/day in 2010 to simply maintain the existing poor level of service. The base case scenario (see assumptions in Annex 4) indicates economic rates of returns of 17.1% and 18.6% for Bukhara and Samarkand, and 15.5% and 14.9% financial rates of returns. The difference between the present value of financial and economic flows is a result of: (i) controls in electricity tariffs (determined by the central Govermment); and (ii) incremental revenues due to tariff and collection rate increases that are not accounted for in the economic analysis. With this background, a full discussion of the project's economic analysis is given in Annex 4. The base case scenario analysis does not include other benefits of great importance for the population but difficult to quantify given the limited data available. Some of these benefits include: (i) avoided coping expenditures (fetching water and purchasing water tanks or booster pumps in Samarkand, and filtering, boiling and purchasing bottled water in Bukhara), increase in living standards and reduced hardships through the provision of continuous water supply services (including timesaving to household keepers); (ii) avoided cost of expanding or rehabilitating redundant water production and treatment facilities; and (iii) reduction of the incidence of water-related diseases. Because these economic flows have not been factored in the analysis, the rates of return obtained are expected to underestimate the total benefits. 2. Financial (see Annex 4 and Annex 5): NPV=US$ million; FRR = 15 % (see Annex 4) The evaluation of the vodokanals' financial evaluation at present is speculative given the inadequacy of the financial management and reporting practices of the companies. The lack of computerized information and

25 inaccurate financial information result in substantial uncertainties in the analysis. The local accounting standards show the vodokanals as profitable enterprises, despite their current financial crisis. The main problems facing BVK and SVK in the area of finance include: (i) tariffs that are below operating and maintenance costs (and no adequate provision for asset renewal); (ii) low collection of service charges that result in ever increasing accounts payable and receivables; (iii) minimal cash collections particularly from the budget organizations and industrial consumers that cancel their service fees through a complex and cumbersome clearing system that leaves the vodokanals stranded for cash; (iv) a highly distorted tariff structure with commercial tariffs about 8-10 times higher than those for domestic consumers; (v) inadequate short and medium-term operating and capital planning; and (vi) insufficient and outdated information about customers that directly affects billing. The sub-loans for each city were determined through an iterative review process with the central government, the municipalities and vodokanals. A financial model was set up to evaluate a politically acceptable combination of tariff, collection, and reduction of tariff differentials among customers that would allow BVK and SVK to move towards basic levels of financial viability. A key variable in the decision-making process was the estimated monthly water and wastewater bill for a family of average size in comparison with the average income. This comparison demonstrated to decision-makers that there is room for tariff increases in the domestic sector without significant impacts on the population. The main financial goal of the project is to allow BVK and SVK to collect sufficient revenues to cover: (i) operational and basic technical maintenance costs according to operational standards (the latter to be refined as better information on the system's actual situation is collected during project implementation); (ii) interest and other charges on debt service; (iii) counterpart financial contribution as established in the Sub-Loan agreement; and (iv) taxes (profit and VAT). The model was also used to evaluate with all stakeholders the consequences of various scenarios and policy measures on tariffs and water fees (particularly to domestic customers), specifically: (i) the effect of lower government contribution to the project that would imply higher counterpart contribution to be generated by the vodokanals from their own revenues; (ii) the effect of transferring the foreign exchange risk to the vodokanals; and (iii) various scenarios to reduce the tariff differential between domestic and non-domestic customers. The municipalities and vodokanals selected conservative levels of sub-loans (an intermediate level for Bukhara and a low level for Samarkand). The municipalities and vodokanals selected the financial and commercial areas as one of the key services to be transferred for management to the Operator. The urgent need to improve the billing, commercial, accounting and financial management systems and practices was recognized as a key area for improvement. The specific actions to move BVK and SVK towards an improved financial situation include: 1. Aggressive reduction of system inefficiencies (water losses, energy inefficiency, low revenue collection, and water wastage) to reduce costs of operations; 2. Implementation of a commercial strategy aimed at eliminating unregistered connections and users, and building trust in the community through better water supply and customer service; 3. A strategic and cost-effective metering policy linked with a customer relations plan aimed at increasing revenues and reducing wastage; 4. Set up of financial management, accounting, and commercial systems and procedures that will provide indispensable information about costs, revenues, and customers, and allow BVK and SVK to make better policy and tariff recommendations to the Government and implement effective commercial actions; and 5. Collection of better information on the fixed assets and current operational situation of the water

26 supply system as a first step to have a clear assessment of the maintenance and rehabilitation needs, and to make informed recommendations in the tariff reviews during project implementation. The above areas will be linked to the performance targets of the service with the intemational utility Operator to ensure adequate attention to the urgency of BVK's and SVK's financial improvement needs. These activities managed by the Operator in the financial and commercial areas will require sustained support from the Govemment, particularly in the following issues: 1. Periodic review and approval of tariffs based on improved financial and technical information; 2. Gradual reduction of cross-subsidies combined with enforcement of the disconnection policy to reduce fiscal pressure, increase revenue collection from Govemment organizations and industry, and free up resources to design and implement a targeted subsidy policy to the truly poor once better information on the customer base is available; 3. Gradual reduction of non-cash forms of payment (barter and off-sets); 4. Support in the implementation of existing tools to improve revenue collection such as disconnection to non-paying customers; and 5. Continuous support in the resolution of potential difficulties and slow processing with the banking sector institutions. Bank's supervision should pay special attention to the areas above to ensure continued Govermnent support. Even with the implementation of this strategy, the current situation of BVK and SVK is so poor that it is unrealistic to expect an immediate improvement leading to full cost-recovery. Close supervision of progress and effectiveness of the financial recovery plan, and flexibility to adapt to changing conditions within the framework of the service contract are required. During project preparation, the central Govemment indicated that, in line with national policies for foreign loans to sub-national entities, the foreign exchange risk would be passed on to BVK and SVK (i.e., sub-loan repayments would be made using the official UZS/USD exchange rate on the day of payment). This policy results in a substantial financial risk for BVK and SVK as the UZS/USD exchange rate is expected to increase very rapidly once the Goveimnent completes its process to liberalize the foreign exchange rate regime. There are no financial instruments in Uzbekistan that BVK and SVK can use to hedge against this risk. As both the funds from the Credit and the Loan are on-lent to BVK and SVK at IBRD rates, the tariff increases that will be required to absorbs the potentially very high foreign exchange rate increase will probably not be affordable to the domestic consumers of Bukhara and Samarkand. As a way to protect the water consumers from unaffordable tariff increases, the Govemment will provide a transparent budget grant to BVK and SVK equivalent to the difference between the amortization payments made to IDA for the Credit, and the amortization payments due to MOF by BVK and SVK, respectively. The financial sensitivity analyses carried out to evaluate the combined effect of the foreign exchange risk and the up-front defined budget grant indicate that the tariff increases needed to achieve the basic financial objective of the project are affordable. Annex 5 present the results of this evaluation. BVK and SVK, with the support of the Municipalities of Bukhara and Samarkand, have started before project initiation the implementation of some of the measures in the financial recovery plan agreed during project preparation. The main areas of improvement include: * Domestic tariffs have increased 4 times in Bukhara and 5 times in Samarkand between 1999 and * The tariff differential between non-domestic and domestic tariffs has been gradually reduced from 8.7 to 4.8 in Bukhara between 1999 and 2000 and from 10 to 4 in Samarkand over the same period. * Collection of billed revenues increased from 79% to 95% in Bukhara between 1999 and 2000, and

27 from 65% to 83% in Samarkand. * Cash collection showed modest increases from 20% to 33% in Bukhara but remained stable at 33% in Samarkand. These low levels are linked to macroeconomic conditions in the country. The above measures are positive steps forward, although BVK and SVK still face significant challenges to achieve financial sustainability, including lack of adequate provisions for bad debts in the accounting legislation for utilities, important untargeted subsidies to the population, and insufficient budget allocation for water fees of institutional customers. Fiscal Impact: The project is estimated to cost US$62.33 million, to be financed by an IBRD loan of US$20.00 million, an IDA credit of US$20.00 million equivalent, a proposed Grant from the Government of Switzerland for US$9.00 million equivalent, and US$13.33 million equivalent from local sources (US$8.0 million from the Government and US$5.3 million from BVK and SVK). All taxes and duties for the goods, works and services required for the project would be financed or exempted by the Government. The IBRD loan will be repaid in 20 years with a five-year grace period. The IDA credit will be repaid in 35 years with a ten-year grace period. The reduction of central government expenses related to emergency responses when parts of the water supply system collapse (an expense that is expected to become more frequent in the future in the no-project option) will reduce the fiscal impact in coming years. The increased ability of BVK and SVK to pay profit taxes and VAT as they progressively improve their financial capacity will partially off-set the fiscal impact of the Government's contribution to the project. The defined annual zero-net budget grant from the Government to BVK and SVK equivalent to the difference between the amortization payments made to IDA for the Credit, and the amortization payments due to MOF by BVK and SVK, respectively, will be neutral to the Government budget. The Government choose a Single Currency LIBOR-based Loan denominated in United States Dollars. The rationale for the choice of currency is that the majority of foreign currency earning of the country is in United States Dollars. With regards to the choice of financial product, the Government chose a Variable Spread Loan because in order to take advantage of the Fixed Spread Loan (FSL) features and to compensate for the additional expenses associated with this product, further calculations, reviews and analyses of the applicability of the FSL are needed as part of the comprehensive debt management of the country. 3. Technical: The most critical technical issue BVK and SVK face is the enormous amount of losses and wastage of water in the system. This translates into poor water quality for Bukhara and deficient and unreliable water supply service for Samarkand. There is not sufficient technical and operational information on the systems. Therefore, as part of project preparation, a short-term monitoring program of flow and pressure within the distribution network, water sources, and consumer premises; an assessment of projections of quality of water service, demand, consumption; analysis of network state of repair, efficiency losses, definition of improvement strategy and identification of immediate investments has been undertaken for the water supply service to attain a basic understanding of the current situation. Additionally, a separate analysis of the groundwater sources and the surface water treatment plants was undertaken. The results of both studies clearly demonstrate the alarming state of vodokanal's water supply infrastructure and its enormous inefficiencies. The annual volume of water produced was found to be about 100 million m3 per year in Samarkand and

28 70.8 million m3 per year in Bukhara (or about 850 and 660 liters per person served per day respectively). Water networks suffer from excessive leakage. The annual volume of total water loss was found to be about 48 million m3 per year or 48% (37% of network losses and 11% of apartment plumbing losses) in Samarkand and 28 million m3 per year or about 39% (26% of network losses and 13% of apartment plumbing losses) in Bukhara, not counting additional water savings that could be achieved through an effective water demand management program especially in the large number of detached houses with gardens. None of the two water systems have bulk meters, though Samarkand vodokanal recently installed bulk meter within the scope of the French loan. Consumers, households, industry and public agencies not accustomed to water conservation, are not faced with appropriate water tariffs, and waste significant amounts of water. Very few meters are used for metering consumption of industrial, commercial and institutional customers, while households remain unmetered at all (only 2% of total number of customers in Samarkand and 4% in Bukhara are metered). The state of maintenance and repair of the existing meters is deficient. The preliminary review and assessment of the water systems in Bukhara and Samarkand indicates that parts of these systems are in very poor condition and require urgent rehabilitation. Mechanical and electrical equipment in the pumping stations are in need of repair. Pumps in the systems are old and very inefficient. The treatment plants, though operational, are also in poor state of repair. The pumping mains and pumps require urgent rehabilitation. Full details on the technical evaluation of the water distribution and treatment systems, including the estimated improvement targets based on the investment funds available, can be found in the Project Files. The technical challenge of the project is to identify least-cost yet effective solutions to the problems of network leakage and rehabilitation of water treatment plants, in combination with a demand management program that reduces the enormous losses and wastage in apartment blocks. The minimum technical information available prevents a full definition a-priori of the investments needed. The IF will provide the resources to the Operator to improve the knowledge of the system conditions and operations and to propose and implement targeted interventions to achieve the targets in the service appendix of the service contract. Annex 2 presents more details about the expected uses of the Investment Fund. Equipment, materials and construction work to be financed under this project will be required to meet appropriate standards of intemational quality and best practice. Supervision of construction to international standards will be required. 4. Institutional: 4.1 Executing agencies: The executing agencies of this project are the Bukhara city and Samarkand city Water and Wastewater Utilities (BVK and SVK). The assets of BVK and SVK are owned by the respective Municipalities of Bukhara and Samarkand and although the vodokanals are legally independent and supposedly self-sufficient enterprises according to their statutes, decisions are heavily centralized. The executing capacity of BVK and SVK is very limited and they do not have previous experience with World Bank projects or other IFIs. Pervasive lack of institutional capacity will be a serious issue for the implementation of the project and will need to be addressed through, on one hand, the simplicity of project design, and, on the other hand, the preparation of an appropriately designed program of training. Technical operations management and staff are, in general, resourceful in operating and maintaining the systems in an

29 environment of increasing resource constraints and constant emergencies, but have had limited exposure to modem developments and advances in the field and have basically no experience in essential functions for the operation of utilities such as commercial billing and collection, financial planning, accounting, optimization of network operations, and water demand management programs. The strengthening of BVK and SVK will take place not only through the training program to be implemented by the Operator, but also through the on-the-job training and transfer of know-how that will take place as the Operator manages the water supply system and the commercial and financial systems. The Operator will manage the existing staff of the water supply and financial departments of BVK and SVK during project execution to fulfill its contractual obligations and achieve the performance improvement targets required to obtain the incentive fee. 4.2 Project management: The Municipalities of Bukhara and Samarkand will have oversight responsibility for project coordination through the Project Coordination Committee that has representation from other Government agencies including the MMS, the ACS, State Property Agency (SPA) and the MOF. This Committee will provide strategic direction, ensure policy and facilitate coordination among Government agencies. The Committee has set up an independent PCU for daily coordination activities and supervision of the Operator, these responsibilities being delegated by BVK and SVK to this unit. The PCU is independent from BVK and SVK and will have no subordinate contractual relationship with the Operator as the unit will supervise the implementation of the SC and the Operator's performance. The project management organization is designed to avoid any conflict of interest situations in the decision-making process during project implementation. The PCU is staffed with coordinators in Tashkent, Bukhara and Samarkand, an accountant and support staff. The PCU will receive substantial support from an intemational team of technical and financial advisors (independent from the Operator) to be financed by the parallel Swiss Grant. These auditors will perform periodic performance improvement reviews of the Operator's activities and will assist the PCU to monitor the service contract. In addition, the PCU will receive training in various aspects of regulation of contracts with utility operators, and other government officials will initiate their training in regulatory activities. The long-term objective is to train the PCU staff in regulation of utility operations as the country evaluates options to involve further the private sector in the operation and management of utility services. The regulatory capacity in the country is very limited but its development is expected to be initiated through this project and the regulation of utility services through a SC as a first step. Under the performance-based service contract, the Operator will have responsibility for management, operation and maintenance of the water supply system in the service area and the commercial operations and financial management of BVK and SVK, as specified in the service and incentive appendices of the contract. During implementation of the SC, the Operator will have managerial responsibilities over the BVK and SVK staff that works in the water supply and financial areas and it will have the authority to recommend hiring and firing of employees. 4.3 Procurement issues: A preliminary evaluation of the BVK and SVK capacity to carry out procurement in accordance with Bank guidelines showed that they are currently not capable and will require substantial support. A procurement capacity assessment of BVK and SVK has been carried out by the project team and an action plan has been prepared. The most important procurement action that will take place during project preparation is the selection of the Operator for the service contract. The PCU, the Selection Committee in charge of this procurement, and the Coordinating Committee will receive substantial support during this activity in terms

30 of continuous on-call assistance and at least two training sessions prior to the receipt of qualifications and bids, respectively. During project implementation, the Operator will procure, on behalf of BVK and SVK and with their involvement, goods, works and services in accordance with Bank's Procurement Guidelines and support the client in contract signature. The Operator will prepare and submit to the BVK, SVK and the respective municipalities an annual procurement plan (indicating specific procurement methods as per Annex 6) to procure goods, works and services. The Bank will also review this annual procurement plan. Once this procurement plan is approved, the Operator will implement it and will sign the contracts on behalf of the client. The Operator will use funds from the IF only for those activities listed in the IF Appendix of the service contract. No procurement activity related to investments financed by the project will take place prior to the Operator's arrival. The Operator and any entity affiliated with it are precluded from providing goods, works and services procured through the IF. The Operator's independence and incentives to improve performance will reduce the risks of undue pressure to deviate from the Bank's Procurement Guidelines. Specific provisions to avoid potential conflict of interest situations will be incorporated in the service contract with the Operator. The Operator is specifically precluded from developing or reviewing bidding documents to retain any subsequent operator after the completion of the SC. Bank's support and supervision during implementation will be key to reduce these risks. 4.4 Financial management issues: To maintain project accounts and produce reports in accordance with standards acceptable to the Bank, an interim FMS was established at the PCU. This system will be integrated into the overall financial management system that will be installed by the Operator in BVK and SVK to ensure consistency and adequate reports using the format agreed for Project Management Reports (PMRs). In accordance with OP/BP 10.02, a Bank-accredited financial management specialist reviewed the proposed financial management system in March Based on this assessment, it was found that the PCU satisfies the Bank's minimum financial management requirements. However, the PCU has agreed a set of actions to improve its financial management processes, as described in Appendix 6. A Country Financial Accountability Assessment for Uzbekistan is expected to be launched in FY03. As a result, and in order to mitigate any negative impact on the project due to corruption or fraud, special attention was focused on financial management issues during appraisal. An assessment of the PCU was carried out and an action plan for the development of a good financial management system and building up of the financial management capacity at the PCU was carried out. The Assessment can be found in project files. A service contract will be signed by BVK and SVK to hire an operator. A key task of the Operator will be the installation of a computerized financial, accounting and information systems for BVK and SVK, the development of adequate accounting procedures, and the introduction of financial planning in the utilities. The goal of this activity is to improve the financial management and planning capacity of the utilities and to provide adequate accounting and financial management information about BVK and SVK activities. The utilities' financial statements including the project accounts maintained by the PCU will be audited annually according to IAS and the audits will be submitted to the Bank. The audit of the on-going Water Supply, Sanitation and Health Project has been satisfactory, as have been the banking arrangements for the special account. Although the audits were submitted with delays for the Water Supply, Sanitation and Health Project, the Government has committed to earlier planning for contracting of auditors and completion of audits. 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

31 An initial review of potential environmental impacts and appropriate mitigation measures indicated that the project activities fall within the Category B as per the Bank's OP The project is expected to bring significant environmental and health benefits, such as improvements in public health through better quality and availability of treated water, and improvements in the sustainability of raw water sources through reductions in losses and wastage. Potential negative effects can be minimized through appropriate mitigation measures, which for this project are basically normal construction and utility operation practices. Potential impacts of the project would relate to: (i) inappropriate disposal of water treatment sludge; (ii) safety hazards from chlorination process; (iii) pollution by construction run-offs; (iv) disturbance during construction including dust, noise, vibration, access restriction, closure of roads, and increased traffic; (v) improper disposal of demolition debris; (vi) damage to existing utility services during pipe repairs and installation; (vii) safety hazards from construction activities; (viii) spillage of fuel and oil from construction; (ix) damage to trees and vegetative cover; and (x) chance encounters of cultural resources. The project will not entail any resettlement, expansion of existing facilities or construction of new structures of significant size. Construction works will predominantly involve pipe replacement, which includes pavement demolition, trench excavation, pipe laying, trench filling, and pavement application. Other construction works will be limited to rehabilitation of existing structures such as pumping stations and specific parts of treatment plants. All works under the investment program are planned to be of rehabilitation nature, in properties owned by BVK and SVK or rights-of-way assigned to municipal infrastructure. In order to ensure adequate implementation of the necessary measures to minimize potential negative environmental effects, an Environmental Management and Monitoring Plan (EMP) satisfactory to the Bank will be completed with incorporation of public comments. Requirements for the works to be performed following specific provisions in the EMP and good construction practices will be included in the contracts for rehabilitation and minor works. In both Samarkand and Bukhara, there are important cultural monuments and architecturally significant mahallas. Specific notification requirements and work stop and rescue procedures will be included in the EMP to respond adequately to chance findings of cultural resources during excavations. The likelihood of such findings is limited as the excavations will be done to rehabilitate existing pipes and equipment in already disturbed rights of way. The OP 7.50 applies to the Project as the cities Bukhara and Samarkand are located on intemational waterways as defined by paragraph l(a) of OP 7.50 (both cities are located near the Zerafshan river which originates in the Pamir Mountains of neighboring Tajikistan, and one of the four sources of water for Bukhara receives water from the Amu Daria river). However, considering the nature of the project activities and focus, the exception to the extemal notification requirements of OP 7.50, set forth in paragraph 7(a) of OP 7.50 is fully applicable. The Project involves rehabilitation of ongoing schemes and construction that in the team's judgement: (i) will not adversely change the quality or quantity of water flows to the other riparians; and (ii) will not be adversely affected by the other riparians' water use. 5.2 What are the main features of the EMP and are they adequate? The EMP includes a description of the legal and administrative framework of the environment sector with specific application to the project, a description of the baseline conditions, identification of main impacts, specific mitigation measures with implementation and monitoring responsibilities and estimated budget. The provisions in the EMP are adequate to minimize potential negative environmental impacts associated

32 with project activities. The EMP will be implemented by BVK and SVK, under the management of an international utility Operator. The provisions of the EMP and the applicable local environmental regulations will be incorporated in the service contract to be signed between the Municipalities of Bukhara and Samarkand cities and the international utility Operator. Having an international Operator managing the utility company will ensure compliance with these measures as well as knowledge transfer. 5.3 For Category A and B projects, timeline and status of EA: Date of receipt of final draft: Draft for public consultation: July 30, Final draft August 30, 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? On March 13 (in Bukhara) and March 14-15, 2000 (in Samarkand), the project approach and the technical, financial, institutional, social and environmental aspects were discussed in workshops with key stakeholders, and representatives from responsible ministries and agencies. Multiple environmental and health-related issues and questions were discussed at the workshop. The draft of the EMP was placed for public consultation in public libraries of the cities of Bukhara and Samarkand, the vodokanal offices and other relevant agencies. An announcement was published in a local newspaper informing about the EMP availability and requesting comments from the general public. Public consultation meetings were held on July 5, 2001 in Samarkand and on July 9, 2001 in Bukhara. Comments received from the public and various Government agencies were collected and kept in Project Files. Relevant comments were incorporated in the final version of the EMP. 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? Responsibilities for daily monitoring will be part of construction supervision. Compliance with the EMP and monitoring of the impact during the construction phase will be undertaken by an Environmental Officer in the PCU as part of his/her contract supervisory duties, and by the regional departments of the State Committee for Nature Protection in Bukhara and Samarkand. The key monitoring indicators of project benefits are included in the PSA of the service contract and will be monitored and audited independently by the international technical team. 6. Social: 6.1 Summarize key social issues relevant to the project objectives, and specify the project's social development outcomes. As part of project preparation, a social assessment was carried out by a team of local social scientists under the general direction of a senior social scientist from the Bank. Annex 13 summarizes the main findings of the social assessment. The main objectives of the social assessment were to: (a) identify social issues relevant to the proposed investment; (b) identify key stakeholders; (c) evaluate potential impacts of the proposed investment on individuals and social groups, particularly the poor and other vulnerable groups; (d) determine users' willingness pay for water services; (e) develop a framework for public participation in the project; and (f) identify desirable social development outcomes. The key findings of the social assessment include:

33 1. Among the domestic customers who are not satisfied, the main reasons for their dissatisfaction differed between cities, and between the old and new parts of each city. In the new part of Samarkand, where water quality is considered be relatively good, the main reason was the irregularity of the cold water supply (81%) and the second main reason was inadequate water pressure (64%). In the old part, the main reason was low water pressure. In the new part of Bukhara, respondents were unsatisfied mainly because of insufficient pressure, poor quality, and water supply irregularity. In the old part of Bukhara, dissatisfaction with the water quality was considerably higher. Another finding is that the number of hours water is supplied during the day varies by season. While water is supply 24 hours a day to the large majority (90%) in winter and fall, 60% receive it with this regularity summer. In Samarkand, this problem is particularly acute. 2. According to the survey, the majority (70%) of households are paying for water. On average, the water tariffs are low; 129 soums per month. The fact that about 30% of the respondents did not know how much they were paying for water is another indicator that the amount is not large. When all households costs for water supply and related uses (water tariff, payment for use of public bath, purchase of water, etc.) are added together, the amount (148 soums per month) is one percent of average household income. 3. About three quarters of the residents in both cities would be willing to pay a water tariff of 20 soums/person/month for an improved cold water supply system (defined as good quality water; good water pressure in water-pipes, and regular 24 hour a day water supply). This amount is equivalent to about 2 to 2.5 times more than the current amount of 8 soums/person/month). Based on an average household monthly income of 16,390 soums and an average family size of 5 people, raising the tariff to 20 soums/person/month would mean that the average household would be paying about one percent of their income on their piped water supply. For the poorest segment of the population with average household incomes of 5,100 soums or US$34 (official rate) and US$11 (unofficial), however, households would have to pay a larger percentage of their income (about 2 percent) for water. 4. Overall the majority of households expressed dissatisfaction with the vodokanals. The main reasons accounting for their dissatisfaction are: poor performance and inadequate response to the requests for making repairs. However, there are differences between the reactions of residents from Samarkand and Bukhara. For example, 70% of households in Bukhara mentioned that they are always informed about any changes in water supply schedule (disconnection, change in the quality of water, etc), while less than half of the respondents in Samarkand had a similar response (40% said SVK provides this information only on occasion). In both cities, however, there was a significant amount indicating that they never receive this information. The main implications and recommendations of the social assessment include: 1. Priority improvements to the water supply system should take into account differences between the two cities. In Bukhara, improving water quality is the first priority; in Samarkand, the first priority is improving the reliability of the water supply. Addressing this problem would benefit women and children who are responsible for providing the household with water. Improving the regularity of the water supply would allow them to reduce the amount of time currently spent securing water for the family, and use their time in more productive activity or on leisure activities. 2. Public information campaigns should be carried out early in the implementation process to raise awareness of the need to pay for improving and maintaining the water supply. The campaigns should

34 provide information on the nature and timing of project improvements, what it costs to upgrade and maintain the water supply system, the need for residents to make regular payments to ensure proper maintenance of the system, and the need to conserve water. Informational campaigns should incorporate the participation of the mahalla committees as well as Uzbek television stations. The latter had the highest rating of trust among the public in comparison to other mass media. About 90% of citizens watch local television daily and 71% trust this source of information. 3. It is of great importance to establish a public relations department which would be responsible for designing and implementing a comprehensive information/communications strategy to provide timely information and respond to questions about the water supply and sewerage services and any expected problems and remedies. This department also should provide information to consumers on who to call for information and how to lodge complaints when necessary. 6.2 Participatory Approach: How are key stakeholders participating in the project? The project was prepared in close collaboration with the vodokanals, the concerned ministries, regional and local governments, local experts, and consumers. Different strategies for consultation and participation of these stakeholders were implemented. The interaction with government agencies and vodokanals was continuous throughout project preparation. The social assessment involved a wide range of stakeholders in the following quantitative and qualitative activities: (a) background study of available statistics and documents containing data and information on water supply, sanitation, and related social and economic conditions in both cities during the last 5 years; (b) household survey administered to 800 households (400 per city) administered in June 1999; (c) 50 semi-structured interviews with representative of important stakeholder groups; (d) survey of tourists visiting Samarkand and Bukhara during the months of November and December 1999; and (e) 8 focus group discussions (4 per city) involving: (i) representatives of various government and nongovernmental organizations related to the project; (ii) women residing in the old and new parts of each city; (iii) men from old and new parts of the city; and (iv) ethnic minorities (Roma in Samarkand and the Jews in Bukhara). 6.3 How does the project involve consultations or collaboration with NGOs or other civil society organizations? During project implementation, the responsibilities of the Operator under the service contract will include (a) public awareness raising, (b) consumer information, and (c) the establishment of a customer service office in BVK and SVK and to implement public information campaigns, both of which will be new functions for the vodokanals. These activities will provide ongoing mechanisms for consultation and participation of consumers in the day to day operations of the utilities. These activities will provide ongoing mechanisms for consultation and participation of consumers in the day to day operations of the utilities and the improvement program. Without adequate interaction with its customers, the Operator will not be able to achieve the targets in revenue collection increases and other related improvement targets. 6.4 What institutional arrangements have been provided to ensure the project achieves its social development outcomes? The utility Operator will be responsible for implementing the investments aimed at improving the quality and reliability of drinking water for the population in the two cities, according to specific performance indicators and targets to be included in the contract. The Operator will be required, by contract provisions, to carry out the investment program and to manage the utility in such a way that takes into account consumer preferences and reactions to service improvements. Specific contract provisions will require the Operator to develop and implement ongoing public information and awareness raising campaigns as well as establish a customer relations office

35 6.5 How will the project monitor performance in terms of social development outcomes? The performance of the utility Operator will be monitored on the basis of key performance indicators and their corresponding targets for each of the Operator's tasks, including those related to improvement of water supply services to users. Parameters to be monitored include water quality, reliability of supply, reduction in water losses, time to repair leaking mains and service connections, number of households with plumbing systems serviced, and results of customer surveys relating to user satisfaction with water supply improvements. The PCU will be responsible for supervising the performance of the utility Operator. In addition, independent technical and financial auditors will be hired to verify the data and performance of the Operator, upon which the incentive fee will be paid

36 7. Safeguard Policies: 7.1 Do any of the following safeguard policies apply to the project? Policy Environmental Assessment (OP 4.01, BP 4.01, GP 4.01) Natural Habitats (OP 4.04, BP 4.04, GP 4.04) Forestry (OP 4.36, GP 4.36) Pest Management (OP 4.09) Cultural Property (OPN 11.03) Indigenous Peoples (OD 4.20) Involuntary Resettlement (OP/BP 4.12) Safety of Dams (OP 4.37, BP 4.37) Projects in International Waters (OP 7.50, BP 7.50, GP 7.50) Projects in Disputed Areas (OP 7.60, BP 7.60, GP 7.60)* Applicability * Yes 0 No 0 Yes * No 0 Yes * No 0 Yes * No 0 Yes * No 0 Yes * No 0 Yes * No 0 Yes * No 0 Yes 0 No 0 Yes 0 No 7.2 Describe provisions made by the project to ensure compliance with applicable safeguard policies. The necessary environmental mitigation measures needed to minimize potential negative effects to the environment associated with rehabilitation and operational activities of BVK and SVK in their water supply operations under the management of the Operator will be included in the EMP and be a contractual obligation under the service contract. F. Sustainability and Risks 1. Sustainability: The sustainability of the project during the implementation phase depends on the following factors: * The private Operator is selected through an open and transparent competition to achieve the best price for the scope of services requested; * The private Operator is able to work successfully with the local staff of BVK and SVK and effectively transfer managerial, technical and financial know-how; * The financial resources available to the operator are sufficient to implement the rehabilitation activities necessary to bring noticeable benefits in the quality and reliability of the water services and, furthermore, these benefits are perceived by consumers to be commensurate with the tariff increases; * The operating revenues of BVK and SVK that the Operator is able to collect are sufficient to cover the operating and maintenance costs and make the counterpart contributions to the project; * The populations of Bukhara and Samarkand agree to the increases in tariffs and the vodokanals are able to increase collection efficiency from all user categories; and * The regulatory environment of all aspects related to the management and operations of the systems (e.g., construction permits, procurement, water shut-off) are flexible and agile enough to allow the Operator to carry out its functions. The sustainability of the project after implementation depends on the following main factors: * Improvements in the water supply services and operational efficiency are in line with the increases in tariffs and collection through which the population is expected to support the reform of the sector and contribute to better services; * The capacity of BVK and SVK to increase its revenues to a level required to cover adequate operation

37 and maintenance expenses and continues to grow to allow the water supply companies to cover debt service and principal repayment; * The local governments provide the Operator with the enforcement tools to collect water fees; * The central and local governments continue to provide the necessary resources to institutional customers to pay their water fees; * The Operator not only fulfills its minimum obligations as contracted, but is also able to achieve significant improvements along the target measures, and thereby demonstrates to the Govemment and the populations of Bukhara and Samarkand that the experiment with the private sector was successful and worthwhile and therefore could be continued; * The management and know-how brought by the Operator is effectively transferred to BVK and SVK personnel and leads to fundamental changes in vodokanals' management and operating practices; and * Arrangements are set in place to ensure continued good management of the water supply services after completion of the project. A specific plan will be prepared after careful analysis of the lessons learned during implementation of the project and evaluation of the full spectrum of future options to continue with private management and operations. 2. Critical Risks (reflecting the failure of critical assumptions found in the fourth column of Annex 1): Risk Risk Rating Risk Mitigation Measure From Outputs to Objective The Municipalities of Bukhara and S 1) Up-front increase of tariffs to demonstrate Samarkand do not continue to support the commitment to financial principles of project tariff level increases necessary for VKs' 2) Intensive monitoring of compliance with financial recovery program financial covenants and prompt action in case of noncompliance 3) Adequate collection of financial information to demonstrate to local authorities need and ability for requested tariff increases 4) Physical investments designed to have a visible impact on service to make tariff increases more acceptable to local government and consumers 5) Implementation of an effective tariff policy Population awareness of water M 1) Public education campaign included in conservation does not increase and linkage Operator's obligations under SC between financial resource needs of BVK 2) Customer relations offices in BVK and SVK and SVK, the increase in collection of tasked with increasing awareness water fees and the improvement in service 3) PCU to lead information campaign to the quality is not understood population on benefits of the project prior to initiation Government does not maintain its support S 1) Intensive monitoring of compliance with to the project particularly in regards to the financial covenants and prompt action in case of payment of water fees by institutional noncompliance customers 2) Gradual reduction of tariff differentials 3) Metering program to demonstrate actual volume consumed by larger institutional customers Municipalities of Bukhara and Samarkand S 1) Intensive dialogue and exchange of do not give the Operator the necessary experiences between Bank, Municipalities and

38 tools and enforcement support to increase Operator to support collection efforts collection 2) Monitoring of financial covenant compliance 3) Adequate provision of infornation to focus collection efforts on largest debtors 4) Clear demonstration of the link between low collections and the need for compensation through higher tariffs for all consumers 5) Training to municipality key staff on tariffs and enforcement mechanisms prior to project initiation Improvement in financial situation of S 1) Intensive monitoring of financial situation vodokanals is not sufficient to adequately and support to find alternative strategies to cover O&M increase revenues as proposed by Operator and vodokanals BVK and SVK are not able to acquire S 1) Intensive Bank supervision to support sufficient autonomy to manage its Operator, BVK and SVK in its process of operations on sound commercial autonomous decision making and institutional principles under the guidance of the strengthening Operator An agreement is not reached for adequate S I) Demonstrated success with improved services management of the system after project 2) Exchange of successful experiences in other completion countries with higher involvement of private sector Macroeconomic conditions of the country S 1) Monitoring of economic conditions and Bank deteriorate to a level that significantly support to adapt project objectives and affects project implementation implementation strategy From Components to Outputs Government interferes in the Operator's S 1) Use of PMRs and Bank's commitment to procurement decisions causing delays in provide efficient support to Operator in rapid procurement of goods and services under procurement reviews the Investment Fund 2) Intensive Bank supervision to ensure prompt review of investment plans by PCU and Coordinating Committee Counterpart funds are not sufficient or H I) Intensive monitoring of Credit covenants to timely ensure timely Government's contribution 2) Continuous review of BVK's and SVK's financial situation to find alternatives approaches to increasing revenue to a level sufficient to provide the necessary counterpart funds Project funding is not sufficient to achieve M 1) Continuous monitoring of system data noticeable improvement in service as collected by Operator and support to proposals projected in PSA made to prioritize areas of improvement 2) Bank's coordination of additional financial resources by other IFIs and bilaterals Operator does not bring all necessary M I) Clear criteria in bidding process skills and experienced staff to manage the 2) Continuous Bank supervision to evaluate

39 system skills and experience of Operator's staff in the field and prompt action taken in case of inadequacy Local contractors are not able to achieve M 1) Operator to ensure adequate supervision of acceptable standards in quality of construction and training if necessary construction Operator, PCU, BVK, SVK and S I) Bank to facilitate discussions and provide Coordinating Committee do not agree or impartial support to all parties to reach prompt delay decisions on proposed annual agreement investment plans Government agencies not directly involved M 1) Municipalities and Bank to provide support in the project (such as tax authorities, to Operator, BVK and SVK to reduce such customs, etc.) interfere in project interference implementation or do not provide the 2) Continuous supervision of this issue by Bank necessary construction and operational missions permits Disputes between Operator and PCU or S 1) Intensive Bank supervision to avoid long municipalities are not resolved promptly discussions without resolution and cause significant project implementation delays Overall Risk Rating Risk Rating - H (High Risk), S (Substantial Risk), M (Modest Risk), N(Negligible or Low Risk) S 2) Well prepared contract to minimize risks of misunderstandings and disputes 3) Support to PCU and Municipalities with international consultants for prompt resolution of disputes 3. Possible Controversial Aspects: The main possible controversial aspects of the Project are: (i) Tariff increases necessary for BVK and SVK to move towards financial viability are not approved by the Municipalities or are rejected by the population. The risk is reduced by the up-front demonstration of commitment by the Municipalities to increased tariffs before the arrival of the Operator. Future tariff increases will be accompanied by improvement of services and a public awareness and education campaign. (ii) Measures to improve revenue collection, such as disconnection to nonpaying customers, may be controversial if implemented without supporting public campaigns. (iii) Political opposition to private operator due to its foreign origin or the management contract cost. The risk is reduced by the open discussion and consensus that has been built during project preparation among stakeholders. Some opposition from political leaders not directly involved in the project could be expected but the Govemment and the Bank supervision missions will continue the discussions and exchange of information with various levels of Government to demonstrate the need for such implementation approach and the expected benefits. The improvement of service and an effective customer relations campaign by the Operator should reduce the risk of rejection by the community. Exposure of Government and water utility staff to similar experience in other countries would reduce the risk of rejection

40 (iv) Project focus on water management and reduction of losses and wastage as a mean to improve services, as opposed to the standard approach of further increasing production capacity. This risk is reduced through demonstrated improvements in service and awareness raising and training activities to policy makers and sector specialists. G. Main Loan/Credit Conditions 1. Effectiveness Condition * The Loan and Development Credit Agreements have been executed and delivered and all conditions precedent to its effectiveness have been fulfilled; * The BVK and SVK Subsidiary Loan Agreements, satisfactory to the Bank/IDA, have been executed on behalf of the Government and BVK, and on behalf of the Government and SVK, respectively; * The Service Contract, satisfactory to the Bank/IDA and the Government, has been executed on behalf of BVK, SVK, the Municipalities of Bukhara and Samarkand and the Operator; * The Government has opened the Project Account on terms and conditions satisfactory to the Bank/IDA in Sum and the Bank/IDA has received evidence that an initial amount equivalent to $20,000 has been deposited into said Account; and * The Government has adopted the PIP and the Operational Manual, satisfactory to the Bank/IDA. * An independent Auditor has been selected acceptable to the Bank. 2. Other [classify according to covenant types used in the Legal Agreements.] Miscellaneous During Project Implementation: * BVK, SVK, and the Regions of Bukhara and Samarkand shall ensure that the SC with the Operator, satisfactory to the Bank/IDA, is maintained throughout Project implementation. * BVK and SVK shall establish not later than June 30, 2003, and thereafter maintain, a financial management system, including records and accounts, and prepare financial statements, all in accordance with accounting standards acceptable to the Bank/IDA, consistently applied, adequate to reflect its operations and financial condition and to register separately the operations, resources and expenditures related to the Project. * BVK and SVK shall: (i) by June 30, 2003 have its records, accounts and financial statements (statements of income and expenses); and (ii) by June 30, 2004, have its records, accounts and financial statements (balance sheets, statements of income and expenses and related statements) for each fiscal year audited. * Except as the Bank/IDA shall otherwise agree, BVK and SVK shall not incur any debt unless a reasonable forecast of the revenues and expenditures of BVK and SVK shows that the estimated net revenues of BVK and SVK for each fiscal year during the term of the debt to be incurred shall be at least 1.2 times the estimated debt service requirements of BVK and SVK in any future year on all debt of BVK and SVK including the debt to be incurred. * The Regions of Bukhara and Samarkand shall review, in accordance with the established procedures, the periodic proposals for tariff adjustments submitted by BVK and SVK, at least quarterly; and shall promptly take action to adjust said tariffs so that BVK and SVK can meet its obligations by collecting sufficient revenues to cover operation and maintenance costs and other expenses. The GoU shall take all measures necessary to ensure that the necessary tariff adjustments are implemented. * The Regions of Bukhara and Samarkand, after review of the forecast amount of water consumption prepared by BVK and SVK, respectively, every six months shall: (a) allocate in the relevant operating budgets of budget organizations adequate funds for payment of water fees; and (b) ensure that said funds are paid to BVK and SVK. * The Regions of Bukhara and Samarkand shall: (a) enable BVK and SVK, respectively, to collect water

41 fees from its customers, including but not limited to disconnection of nonpaying customers; and (b) assist the Operator in the implementation of said collection of water fees. * The GoU shall, by June 30, 2002, define and initiate the implementation of adequate measures to enable the accounts payable and receivable of BVK and SVK to be reduced to a level that will allow BVK and SVK to conduct properly their financial and commercial activities and to prevent blocking of their bank accounts. * BVK, SVK and the Regions of Bukhara and Samarkand shall: (a) review with the Bank/IDA, not later than March 31, 2005, proposals for continued management of the water services of Bukhara and Samarkand upon completion of the Service Contract, with due consideration to various options for public and private sector management; and (b) based on the conclusions and recommendations of said review take appropriate measures regarding the management of the water services upon completion of the Service Contract. H. Readiness for Implementation L] 1. a) The engineering design documents for the first year's activities are complete and ready for the start of project implementation b) Not applicable The procurement documents for the first year's activities are complete and ready for the start of project implementation The Project Implementation Plan has been appraised and found to be realistic and of satisfactory quality. Z 4. The following items are lacking and are discussed under loan conditions (Section G): The preparation of engineering design and specification documents for the first year's activities will be coordinated and supervised by the operator under the Service Contract currently under bidding as part of the operator's contractual obligations, once the first annual investment plan is approved by the Bank and the Government

42 1. Compliance with Bank Policies 1 1. This project complies with all applicable Bank policies. El 2. The following exceptions to Bank policies are recommended for approval. The project complies with all other applicable Bank policies. Ede Jorg jasz- asquez K4otoo Konishi; Hossein RazaJ Kadir T. Yurukoglu Team Leader Sector Manager/Director Country Director

43 Annex 1: Project Design Summary UZBEKISTAN: Bukhara and Samarkand Water Supply Project Key Performance. Data Collection Strategy.Hierarchy of.objectives Indicators._._. Critical Assumptions Sector-related CAS Goal: Sector Indicators: Sector/ country reports: (from Goal to Bank Mission) Remove inefficiencies in * Increase in level of cost Bank and Country Reports Acceptance by Government resource utilization in the recovery of the concept of private municipal services, * Increase in institutional participation in infrastructure and social capacity infrastructure. services * Increase in competition among service providers Existence of the right legal o Expansion of privatization framework for increased of services competition. Project Development Outcome / Impact Objective: Indicators: Project reports: (from Objective to Goal) To improve the safety, quality, * Safety and quality: Periodic Monitoring Reports * Experience from the project reliability, efficiency and Percentage of microbiological (Quarterly & Annual) will provide confidence and sustainability of the water water quality samples meeting Annual Audit Reports acceptance by the government supply services in Bukhara target values at user points; Bank Supervision Reports to push further with private and Samarkand * Reliability: Percentage of Independent technical and sector operations in the customers receiving 24 hours financial audits of operator municipal services sector in a day of adequate water performance other cities service up to 100% as per Reports by Management * Increasing interest from PSA annual targets; Operator local and international * Efficiency: Operational ICR investors and operators in the costs, reduction of physical Reports from Customer water industry losses and liters per capita per Relations Office * Strong support institutional day consumed, and reduction and financial reform of the of kwh/mm3 of energy water and sanitation sector consumed as per PSA annual targets; * Financial viability: Annual ratio of collected revenues over the sum of operation, adequate maintenance costs and project-related expenses; and * Sustainability: Satisfaction with water services, and agreement on institutional arrangement for sustainability of project achievements, possibly with even greater participation of the private sector

44 P ; ' Hierarchy of Objectives ~~~Key Perforrnance Indicators 't' Data Collection Str'ategy.l _..-- Critical Assumptions - Output from each Output Indicators: Project reports: (from Outputs to Objective) Component: Water distribution network Detailed output indicators are Periodic Monitoring Reports * Improvements in BVK's and treatment facility presented in the PSA of the (Quarterly & Annual) and SVK's financial results operations improved Service Contract following the are sustainable and allow it to logframe. Key indicators in Annual Audit Reports continue to operate under the PSA include: satisfactory conditions and * Network information Bank Supervision Reports maintain an adequate level of system developed by year 2 O & M. for both cities Independent technical and * The Municipalities of *80% of network with discrete financial audits of operator Bukhara and Samarkand supply zones established performance continue to support the tariff * % of detected leaks repaired level necessary to achieve within 2 days as per PSA Reports by Operator BVK's and SVK's financial annual targets viability * % of leaking service * Population awareness of connections repaired within 7 water conservation rises and days as per PSA annual linkage between BVK's and targets SVK's financial resource * Production metering needs, increase in collection installed by year I of water fees, and * Loss reduction savings in improvement in service established network zones of quality is understood 24,000 m3/d in Bukhara and * Government maintains its 45,000 m3/d in Samarkand support to the project * 20% reduction in energy particularly in regards to consumption in Samarkand payment of water fees by and 15% reduction in institutional consumers Bukhara * Municipalities of Bukhara and Samarkand give the Operator the necessary tools and enforcement support to increase collection BVK's and SVK's financial * Computerized financial, BVK and SVK operational * BVK and SVK acquire management improved accounting and commercial data in periodic monitoring sufficient autonomy to systems installed and reports (quarterly & annual). manage its operations on operational by year 1 Reports of technical and sound commercial principles * Accounting procedures for financial independent audits with the guidance of the BVK and SVK developed and Bank supervision reports Operator staff trained by year I Financial statements * An agreement is reached for * IAS financial statements Annual audits adequate management of the prepared by year 2 and Bukhara and Samarkand thereafter water supply systems after * Collection efficiency project completion, including increased as per PSA annual possible increase in the role of targets private sector in the provision of water supply services Customer service improved * Customer database BVK and SVK operational * Macroeconomic conditions completed by year I data in periodic monitoring of the country do not * Unregistered connection reports (quarterly & annual). deteriorate to a level that Reports of technical and

45 regularized by year I significantly affects project * Public education program financial independent audits implementation implemented as per PSA Bank supervision reports annual targets * 100% of apartment blocks and detached houses metered * New contracts with customers established as per PSA annual targets * Resolution of customer service complaints as per PSA annual targets Institutional capacity of BVK * Operations, safety and BVK and SVK operational and SVK strengthened monitoring manuals data in periodic monitoring completed by year I reports (quarterly & annual). * BVK and SVK staff trained Reports of technical and in operational, safety and financial independent audits monitoring manuals as per Bank supervision reports PSA annual targets * BVK and SVK financial staff fully trained in computerized financial, accounting and commercial systems and in IAS by year I and thereafter

46 I Key Performance. Data Collection Strategy Hierarchy of Objectives I Indicators I Critical Assumptions Project Components / Inputs: (budget for each Project reports: (from Components to Sub-components: component) Outputs) 1. Investment Fund BVK and SVK progress * Procurement decisions not 1. I Bukhara IF 1.1 US$21.30 million reports delayed and Operator fully 1.2 Samarkand IF 1.2 US$25.58 million Bank supervision reports able to procure goods and 2. Performance-Based Service 2. Base fee US$3.65 million Disbursement status reports services under the Investment Contract Incentive fee US$1.55 Fund 3. Consulting services and million * Provision of counterpart Project Coordination Unit 3. US$1.05 million funding is adequate and 4. Swiss-financed component timely 4. US$9.00 million * Project funding is sufficient to achieve noticeable improvements in service as projects in PSA * Operator brings all necessary skills and experienced staff to manage the system * Local contractors are able to achieve acceptable standards in quality of construction * Operator, PCU, BVK, SVK and Coordinating Committee agree promptly on the proposed annual investment plans * Government agencies not directly involved in the project (such as tax authorities, customs, etc.) do not interfere in project implementation and provide promptly all necessary construction and operational permits * Disputes between Operator and PCU or municipalities are resolved promptly -42 -

47 Service Standard Appendix - Water Supply Service Contract for Bukhara and Samarkand DEKS CIF 113WU E [E 1 EAR NEARLY TAR 9R'% KE SAD TIARr YEAR I YEAR2 YEAR 3 YEAR4 Bae Year Dla Rexxt * deve Base Year * QmOpyng BseYearDEa Data Report Sandard RepXt &bys aswrtt%* Date * devep 01 (hy l Cg Op -a-d andmamntrme StmKhd MbiAmenePhl PIM -nobldtom90 Dae * plpe a * WQ- Op-gM h Sd mmh *labtes90o r days affdc SXe. dvelp *Qmhy oiawnng Ma-t Mmli S9d Gwdnuim Cdefgs *rio ba dw30 dysaflerdesttig D* * p- a St-w.QWhpyC%- S&cBaE B Bush=Plm 9ard Pbn I.rXWfftdwU24 StFarit Dle Res:pI Paaiund * IePnn~~~~~~~~~~ I nolata 3n 6 r niafbri fff p lan _ 1m -43 -

48 -carry ou a ill * Q( Op-g_ days aftie Fe Stin DysftftS * deip a Staff * cwhomg StffTm ad Tm ig and Suamkd Dadovm Pruw- fnnfsafberde *mulaiu1stf *f tatgeofstaff lo/v 30/. l Tning mar Tming and * vdep a Meri * QmLOpetg ntpat 10CU/ IOU,'/o PuynP al- Swbad Pw rnubmerdn90 ds af r the StM Date. -~ ~~~~ I amds avos StaM afd frlmindayoda it adivin; xa,%,,wd Guk_ 3&arbm ir acodacewl *- *0- 'F--goCI wqian d * S. -oz ud _ with reset Dth Rdiitahm Furd O Rqepama Rdubin Fund pinuzuniant War~l,s(SangdT*igP~am * dcdv ai art * COSr Scmfrid Wat y _ Watard *Oy Sairg and Teig * xxi Wdmr 30 &DsafeiadStar_g -44 -

49 F-MWHahamdSa*~Pmg-a "&&pmi ann.*qcum9g O~Hi SbOd mdsa*pmi midsai*rlypt9 dasafterf Date SrffSg * cry at ta iaing.n wqihy pi(1g ThId Saff IWIW/o IODW% mato eallff Ssxiardk ardmfeiynms *%ofstafftain deyelp an *Q-kmtn -r h-oy SWkd MM* Mu- day*s mp d}t Swing Dae * * hmx. le/o IW Peam *%cfpym kwrantl ra ting OA hrd * pin S9idd iq-w -g StarddOp-g Opg Rcc,&= Stamid PuCeinftrall SwnDote ard NbMbe Sadd uinrte IMmIMI *rrohadla12 M12 nalfaflerde *bainng on *(y Opalg 11I/ 11o% Refiesh for Rei fr erand A ds ndais ffad dstaffand Maiae *%fsaffual an rrw staff alr new sff -45 -

50 *evealfip * 0QuItyOemg EoMmm t Mm fpbn Sbad Pbn *mo*. Sard. Mwunf Plan MmuFnIPbn ondu aflerdu Sftnig Date- *% aduckcn in 20/. roducn N% roductio r 1/ 0 tticn 15 0 /oaklion 20%re'rcion a-eaonnifauo fitn Bas YYar fi ftm Baw Y frn fiurn Ba Year Bas Yeu 0,Spermll -._- cubic ntas) fian Bu Base Year Wahs Prt, Tmant, D :nlk and Pm *ycarry ole *WatmrQualty rarrnt a BVK's Staards esablished water Ueatn plan Wdlr PSA Swum 23 *de'bkp Water * Quiy 1rg War Parg RMgSchell Starlal Sdxxl 15%axheidi r 2/oanb 101/.l8%ierha d2%thandm 15%an fan Base Year frn Bw Yer dn BaB Yr hdan Basr Ye- fdun Bam Ycar daysafer dustag Dat * updatemx ad Q*Op*dg Updla±iWater aw ofa oro rolg oing pule Water Stadad PrannSdu Pr g Sdchle * a dainx by dxu *deelpwaw * mlbty madqg Wam q&urces Surcesrl a Srd PRctim ard and Monitorirg Plan * ate dm90 M Pla daysafle rdswaing *nwrged *-Quakyoxatirg 98% 70% 80%/. 90o/o 98% d&iqnfwion of wauer Stainid water qt -* Mantin msidl of I ppm iri distiim mnis *Pnunag r aeraw~orodln nexticoffailig sarcs fiaz Bam Y-ar

51 * wkeelopa *(tyo g MNni: lanmar= Sdd M Nlars *rdbwd9 Puw Stg Date appgmused Stard od-- *nolvdml8 n1e nxse lrv dv * arry a.n v Q *Opg aridpvea Stud nuiracarve mins auxlxswith Nbulmove Facii Data Base ard ratl C x S&rvey * prepar Facdtis *Qua(y0pirg Faaliis Dla Base Data Base Sd * Erd atiin4 tuid aff te * pree ia *Quhyaseasg h Cni CudS& y *Stmd Sawy nxrfdsarte *rs ltiflng 4 Susgtbl awecksofds Facilitis Swa±rd daysaflictlahieftg Daft -47 -

52 N N :1 I *1 d Iii Ij iii' I. I I dj I C' I II III.ii.h

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54 *. sp etyk *-notdlou1 90_ Ph" Dat *u4da1onss *%ofr IcO'/ 3c;%1w% Pbnomlmtdcm % b nnak Hy&-N-ukMoxHW nawblmnea 0the databas NdkMo&hmg Smxidm d3ysdbwril*g *pmm ofan *rowarlmn12 I_I/ I wivaified fist vesim ofa n"fu mfiw Sa*n ing D 1tI un~c of lte m eiaflt h~kunk SlaDate * caib Qntofy g a 9ig DEIC *aoneion gnn ard tclo/o * no 1w&& 24 0_ leoo- k~~~~~~~~~~~~~5 -

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58 Performance Incentive Compensation Appendix (PICA) of the Service Contract Under the terms of the Service Contract, the Operator's compensation shall include a fixed base fee, based on the price quoted in its proposal, which shall basically cover the Operator's management staff and administrative costs. In addition, the Operator is eligible to be paid a Performance Incentive Compensation up to a maximum of US $1.55 million over the contract period, which is intended to compensate it on the basis of the extent to which it achieves the thresholds for water system performance improvements set out in the Contract. In this regard, various performance criterion relating to the different services to be provided by the Operator, have been explicitly spelt out in the Performance Incentive Compensation Appendix (PICA) of the Service Contract. For each criterion, a weight has been assigned according to the relative importance in that contract year. The actual Performance Incentive Compensation to be paid to the Operator for each contract year is calculated as follows: PIC = Composite Score * 0.2 * Maximum Annual Compensation where: the Composite Score = total of all the weighted scores for the performance criteria; and the weighted score for each performance criterion =Criterion Weight * Criterion Value. Criterion Values are based upon the Operator's actual performance in comparison to performance standards set out in the PICA under the headings, "Excellent", "Very good", "Good", "Fair", and "Minimum", and allocated corresponding values of 5, 4, 3, 2, or 1 respectively. Further details on the mechanics of the incentive compensation to the Operator are presented in the Service Contract. As the incentive compensation is based on performance improvements on a series of key indicators, these indicators are directly linked to the Development Objective of the project and to the improvement of water services to the population in a sustainable way. The following tables reproduce the criteria, indicators, and targets for each of the four years of the Service Contract

59 Chart 1- BUKHARA Performance Incentive Obligations Year 1 Setwvkes Criterion Value Appeodk Perferrance Criterion units Criteri Excedent Very Good Good Fair POr Reference WehW*t SA (1) Development of Plans and Quality and Timeliness 0.30 Completed on Not Not Completed on Not to (27) Programs time with no applicable applicable time but applicable excluding SA need for requires 2.2.1(5) revision to the revision to substance ofthe the substance docurnent of the document SA 5.2.2(i) Chlorine Residual % reduction of fiiling samples from Base Year (measured for the Contract Year) SA Energy Management % reduction ofkilowatt hours of clectricity per m3 of water produced fiom Base Year SA 7.3(3Xe) Rehabilitation ofwater /. completion of rehabilitation projects Treatment Facilities SA Physical Loss Reduction m3/day reduction of physical losses measured from baselines of individual zones SA Water Distribution Main kilometers of Water Distribution Mains Replacement replaced from Starting Date to end of the applicable Contract Year SA Network Zoning % of distribution network divided into ~ rklnfb _ nthydraulically discrete zones SA 7.7 Networkcloftrroaton %of watertrnsmission and distribution System network mapped, verified and object data entered into database SA Computerized Billing and numberofdays aflerthe Starting Date 0.10 l (1)(b) Collecfion System until the computerized billing and collection system is in place SA 8.1.2(f) Conversion of Unregistered number ofdays after the Starting Date Connections until all known unregistered connections have been converted SA Colleteion of new sales to % of new sales to domestic Customers (2Xa) domestic Customers collected SA Collection of new sales to % of new sales to commnercial Customers (2Xa) commercial Customers collected SA 8.2.2(a) Domestic Meter Installation % ofapartennt blocks equipped with Apartment Blocks meters SA 8.2.2(a) Domestic Meter Installation % of detached houses equipped with Detached Houses meters In respect ofthe Plans and Programs each plan or program listed in SA Section 2.2.l(l)except for the Strategic Business Plan and the Subscription Contract shall be given a score of either 5 (Excellent), 2 (Fair) or (0) and the average score for all plans and programs shall be multiplied by the Criteria Weight. The average score shall be rounded to the nearest.5 decimal

60 Chart 2 - BUKHARA Performance Incentive Obligations Year 2 Sersleea -Crtrrion Vane Appendli Performanee Criterion URNS C(rhurla E.celleal Ver Good Good Fair Poor Relerence Weighit j^22 l15j De.ekpn,en i Pl".i dnd QIosIisn.1eIn,e,ne. _ 20 CNor.i a'. _._ N_ Compleld on Noi Prgrams Steategic Business time with no applicable applicable time but applicable Plan need for requires revision to the revision to substance of the substance the documcnt of the document SA Energy Management % reduction of kilowatt hours of to clectricity per m 3 of water produced from Base Year SA (i) Chlorine Residual % of reduction or failing samples from Base Year (measured for the Contract Year) SA 7.3(3)(c) Rehabilitation of Water % completion ofrehabilitation projects Treatment Facilities SA Reduction in Water Supply %reduction from Base Year of water Interruptions supply interruptions SA Physical Loss Reduction m'/day reduction of physical losses measured from baselincs of individual zanes SA Water Distribution Main kilometers of Water Distribution Mains Replacement replaced from SLarting Date to end of the applicable Contract Year SA Network Zoning % of distribution network divided into hydraulically discrete mnes SA 7.7 Nctwork Information System number of months after Starting Date NIS is completed SA Collection of new sales to % of new sales to domestic Cuslomers (2)(a) domestic Customers collected SA Collection ornew sales to % of new sales to commercial (2)(a) commnercial Customcrs Customers collected SA 8.2.2(a) Domestic Meter Installation - number of months to cquip 100/o of Apartment Blocks apartment blocks meters with meten SA 8.2.2(a) Domestic Meter Installation - % of detached houses equipped with Detached Houses meters

61 - LS - P'll'I'll 1111-:e'. 0)l60)l0l *P 1.)(0)1 V Pill I 0t P I d Ot n I OI 0 1W00V solon~~~~~~~~~~~~~v 0l'1;1A0!YL r * wrl!arar tz 0007E oul ooool 0lta.P" J!ozdI!Jl 00 0r1 I Ios p Vs Vs 09 9,. L0E 09 o. z JO -A Ill. -IJ.!ana I.1n. I6.!.o.P a.l.1 S S I 1 01 ss. 0 J.. --P!". I l L S I Vs.. *J..O..1I *5500'....,,.. '505,0. :.. I sza 1wS~~~~~~~~~~- P- D - D * - F! i ^DJ...I 1l' l - suopuea3qo aapua3ui a3ueuwojjsa VIIHX1f - iv JJU4).olloq p.q,l pj _001 d!obo H P9090--a 00000S )01 0i 0!l003)0 9c 5E tc6 0 (0)Z Z0S VS S6 S'06 66 S 66 00) 010 I5! mll ( % 0* ) VS ol3n 0 op 0 0 JO % J.0r VS ) po...id:l o.!4 o alluo I d.)] 0 SS 16 r6 L6 01)0 00)6066)061) )0 0) VP Z'9OL VS A1po)!lnoopAq SC rs 0 ZS 01'0.6.a I.l...S 6-J l0q060 00!)0Z 4--66N 009 L Vs OOO0Z OO06Z OOOLZ OO0 0 Z St )0)94d J.0 00")060 A160h0 I0p00w I...qd 0f I Z J. -00A... a -06J 60!)60P00 X Aldd.S 3-0 Al j J00!)0p0m6 6'9 L VS Z'S L VS 'o!,..![!q.q.i JO LOO I -is d - P 9f St PC f Z )6 *!..J.S qJ.ow fl M/ J ''!I' (!'6)00E )( ) L VS 6000( o0 P ) -0A... i t6 6 P6 c0 0 60j0.)d... S063!)j J0.0)o6p60 6 I-1P-idE 001.Ol1) 6)I0 Z5 VS 06 i^.1 0a.I o6 P k,, d 0334 P..) SI-A l ) *110 b 0 sp.oddy 5l1J@1.._.1 113@ suopi JUea, lqo A1PU33UI a3u tuh oj.1aj VIVHXffl - E )JRq3

62 Chart 5 - SAMARKAND Performance Incentive Obligations Year 1 Sinims Cmiez*m V'alue AppR Eh Pft*"i QAeIN Unl Cn VayGod Good Fak fb. Rfelict Wd& I SA '.21(l)w D nq aoiplm a Qkuh aid Tai Tr 0.U0 C.Ts* C iict a Nc tl Ndn Comlksed. NA (27) Ptcamln ime with no appheable applicable time but applicable exludfing SA need for ires 22.1(5) revision tdthe reviaion t subsance of the subance the dmnsrct ofthe doainiat SA Enss M-ag-a1 % redicun of Ilowat hs of electmity per n? water puced frm Base Year SA 522(i) Nilomine Residual % educion offiling samples fmm Base Year (measurse overt e Caiatd Year) SA 73(3Xm) WeU FieldRehlabilslaon % ocmionofwell-field I 10 rehabilitation poject SA 73(3Xn) Rehiabiltation of Booster %ofbostaerpurningstakris psumping alsisixi rdhabilitated SA PfYSiCal Lss Redaction rnr/day ruction ofphysical kss ioooo naeured frm baseenes ofindividual SA 7.6,2 Water Disinbuion MLin kilaners of Water Distribution Mains R nt ql Mpied finm Sting Date td end of the appliable Conbac Year SA NlWuk Zaing % ofdistilbution netwck divided hydraulkauyi dslcr zeas_ SA 7.7 Ndwixk Inbirntion System % ofwatert isimand n dion nwnekmn,ec veniied an object data entted into dtabase SA Corr,uter-d Biluig and iunitrofdays aflier he Stir Dabe (1Xb) Coectimon Systen urtild Ihe opized biding and collectiom system is in place SA &1.2(f) Coansmon ofunregisthrd nmiberofdays aferthe Sta g Date Cbmmons until all lesown uaristered coecfcns have been omvuted SA Collection ofnew sleas to % of rew msles Dt dm ic Cuctns (2Xa) udmstic Cus(xners colleced SA Cdleciion ofnew sals to % ofnwe sals tomomecial (2Xa) conamaial Cusornes Cutst s collected SA 82.2(a) 1rsnetic Meter Installation - % of aim it blodcs eq ped with ApbnaftBbcs Bees SA 822(a) Domnesic Meter IlstaDatim - % of detached hiks equipped with Deached Houses meters In respect ofthe Plans and Prangrm each plan orprogwamn listed m SA Section 22-1(1) except for the Strategic Business Plan and the Subscription Contact shall be given a scoe ofeitler 5 (ExcellerA), 2 (Fair) or (0) and the average scoe for al plans and pngans shall be multipfied by the Criteria Weight lhe avrage score shall be mrunded to the nearest.5 decimal

63 Chart 6 - SAMARKAND Performance Incentive Obligations Year 2 Sm les Cnherton Vale Appendh Performn nee Crilerioa uniat Criteria Eacellenl Very Good Good FAir Poor R _ferene Weight ;A 2:,.3ij De,elopmer.t.ol Plani and Qua)ny anj Tnmel.nes, o.. CComplried On NC-[ Not tc1 MnplrLed.1 NC.1 Programs Strategic Business time with no applicable applicable time but applicable Plan need for requires revision to the revision to substance of the substance the document of the document SA Energy Management % reduction of kilowatt hours of to electricity per m' of water produced from Base Year SA (g) Chlorine Residual % reduction of failing samples from Base Year (measured for the Contract Year) SA 5.2.3(e) Reduction of Water Supply % reduction from Base Year of watcr Interruptions supply interruptions SA 7.3(3)(m) Well Field Rehabilitation % completion of well-field rehabilitation project SA 7.3(3)(n) Rehabilitation of Booster % of booster pumping stations pumping stations rehabilitation SA Physical Loss Reduction m'/day reduction of physical losses measured from baselines of individual zones SA Water Distribution Main kilometers of Water Distribution Replacement Mains replaced from Starting Date to end of applicable Contract Year SA Network Zoning % of distribution network divided into ~~~~~~~hydraulically discrete zones SA 7.7 Network Information System number of months after Starting Date NIS is completed SA Collection of new stots to % of new sales to domestic Customc (2)(a) domestic Customers collected SA Collection of new sales to % of new sales to commercial (2)(a) commercial Customer Customers collected SA (a) Domestic Meter Installation - number of months after Starting Date Apanment Blocks that I 00% of apartment blocks are equipped with meten SA 8.2.2(a) Domestic Meter Installation - % of detached houses equipped with Detached Houses meters

64 Chart 7 - SAMARKAND Performance Incentive Obligations Year 3 servie Oakmin Valie AWpp P ec U(ib Cijiala.xeda Vay God Good Rmee 5Wdg SA I ' EZ kt-e -. rtiuas n fkioouwm haas of (a 0 IfI, I! I elecdiatyperam ofwatrpduced fim Base Yew SA 521() aloine Residual % n offailin g W m 4sfiom Base Year (mnassl for ithechac Year) SA 523(e) Rextcim ofwater sly % ion fm Base Yearofwabr Irterniions bpbo SA73(3Xm) Well Fied Rdilablimali n mnber ofo mater Slatig Date tood CMplte 100/oofwdl-field relatbltilmpon jects SA 73(3Xn) Relabiliation ofboae rmmiba ofn n s afters ug Date Piapig Sta6om for ohnlefdon SA Physical LossRhknim m?/dayeducion ofhscad eats X 495C C n aed fin olas of ividualzesom SA7.62 WaterDistibutimntain kleters ofwaterdistnbnuion Rqtiplasrri n Maiaelnsaen d fiom Stag Date to Ier of athe applicable Cmat Year SA 7.63 Net%kZaring mmberofnsa after S laing Daoe to divide 100% of dis`rulon d hicallydsmete 2ones SAC ectionofnewsalestd %ofrew sales t stic % (2Xa) dmstic Cuscmsers I Cses o1locted SA Collection ofnew alesto % ofnew sales to c ounaca l.l(2Xa) coasmvcial CumeTr Cusfons couecd SA 822(a) Dmns&ic Mder na]allion - iranber ofnmths to equip 10o0 of Daa hd HRe &tadied h m %wfid rnetms Chart 8 - SAMARKAND Performance Incentive Obligations Year 4 App-edla PerforuaceCrtr. Uli, Crlteia :k VY Owd Goed FRr Peor Relemda.... dgh*i ' *4_ SA5.7 EnergyManagement % reduction of kilowatt hours of electricity perm 3 of water produced from Base Year SA (i) Chlorine Residual % reduction of failing samples from Base Year (measured for the Contract Year) SA Reduction in Water Supply % reduction from Base Year of water Interruptions supply intemaptions SA Physical Loss Reduction m'/day reduction of physical losses measured from baselines of individual zones SA Water Distribution Main niunber of months after Sltating Date to Replacemnent complete the replacement of 130 kilometers of Water Distribution Maies SA Collectionofnewsales to % ofnew sales todomestic Customers (2Xa) domestc Customers collected SA Collection of new sales to % ofnew sales to commetcial (2)a) commercial Customer Customers collected

65 By Component: Annex 2: Detailed Project Description UZBEKISTAN: Bukhara and Samarkand Water Supply Project Project Component I - US$46.88 million Investment Fund (IF) 1.1 Bukhara IF - US$21.30 million 1.2 Samarkand IF - US$25.58 million The IF will provide the Operator and both BVK and SVK with the financial resources for investments to improve Operation and Maintenance (O&M) and support rehabilitation of the water supply system. During the course of service contract implementation, changes in the needs and priorities may require adjustment of the categories and amounts available in each category in order to meet the performance improvement targets. The design of the IF provides for this flexibility that is indispensable to meet the project objectives. The Operator and vodokanals will develop an annual plan for the use of the Fund to be approved by the Coordinating Committee (based on the recommendation by the PCU) and the Bank. The first annual plan will be due 60 days after the start date of the contract. Subsequent annual plans will be due 90 days before the end of the first, second, and third contract years. Any amount not expended in any particular year will be carried over to later years. The proposed plan will include: (i) a description of the proposed investments; (ii) estimated costs and expenses; (iii) implementation plan; (iv) procurement schedule; (v) priority analysis; and (vi) any environmental, social, or financial issues of relevance. The Operator's annual plan for use of IF funds will generally comply with the following categories of expenditures for goods and works: * Rehabilitation of the Water Distribution Systems, including piping and other items generally identified with a water distribution systems, including water pipes, valves, fittings, service connection assemblies, air release valves, blow off assemblies, taps, plumbing fittings, water meters, tools and equipment to rehabilitate the piping network, and leak detection equipment and surveys. * Water Production, Treatment and Pumping Equipment and Structural Rehabilitation of Facilities, including various items of equipment generally identified with collecting, treating and distributing water from the source to the consumers. This includes but is not limited to pumping equipment, spare parts, mechanical and electrical parts, controls and control systems, wells and parts of well systems, wellhead protection works, chlorination equipment, and structural rehabilitation relating to the operating equipment or related facilities. * Bulk and Retail Water Measuring Equipment, including purchase and installation bulk meters and water pressure gauges at outlets of production sites and distribution reservoirs, and water level measuring devices. New or repaired retail water meters at domestic service connections (apartment buildings or blocks rather than individual units). * Water Supply Technical and Administrative Support Systems. Technical and administrative equipment necessary to support the operations of the water supply system, including maintenance and construction equipment, computer hardware and software, copy machines, office furniture, communications equipment, other administrative equipment and structural rehabilitation required for the efficient administration of the water supply system

66 * Operations Consumables and Administrative Operations. Items used in the course of effective operation, maintenance, and administration of the water supply system, such as treatment chemicals, consumables for pumping and treatment equipment, maintenance supplies, and temporary labor for emergencies and bonuses. * Engineering and Supervision Services. Engineering design, construction supervision, technical and related assessments to implement the rehabilitation activities under the Investment Fund. Project Component 2 - US$5.20 million Service Contract - Base fee (US$3.65 million) and Incentive fee (US$1.55 million) This component would: (i) pay for salaries and expenses of the Operator's core group of management staff with international experience in the water supply sector who will implement the service contract; and (ii) provide funds for a performance-dependent bonus paid to the Operator for achievement of specific targets defined in the service contract. This bonus will provide the incentives necessary to ensure measurable improvements in reduction of water losses, increase of collection, and increase in water safety among other factors specifically defined in the contract. The actual amount of the incentive fee to be paid to the Operator will be determined by the application of a performance factor to the maximum annual incentive fee. Staff provided by the Operator will include expertise in: (i) general management of water supply utilities; (ii) financial accounting and management, cost accounting and budgeting; (iii) water supply, mechanical, electrical, and environmental engineering; (iv) computer systems administration and database management; (v) customer management, public information and community relations; (vi) maintenance, repair, material and inventory management; and (vii) human resources development and training. As summarized in the Performance Service Appendix (Annex 1), the services to be provided by the Operator include: * operate the facilities to carry out pumping and transport of water from water sources, treatment and disinfection of water, and distribution and supply of potable water to customers; * maintain the facilities to an improved standard of maintenance within the resources available and develop a maintenance management program for the facilities; * carry out rehabilitation and repair of the facilities according to procedures of, and using funds from, the Investment Fund so as to achieve the performance improvement targets of the system; * carry out all billing, collection and customer service functions related to the new and existing customers in the service area, and install and manage a computerized commercial system; * install and manage financial management and accounting systems; * develop and implement programs for: (i) water quality monitoring; (ii) facility safety deficiencies correction; (iii) inventory management; (iv) operating and maintenance procedures; (v) energy management; (vi) staff training and development; and (vii) commercial management; and * prepare quarterly, semi-annual and annual reports as specified in the service contract, and PMRs using formats acceptable to the Bank

67 Project Component 3 - US$ 1.05 million Consulting Services and Project Coordination Unit This component would finance: (i) maintenance of the PCU (including staff salaries, incremental operating expenditures, travel, training, and related expenses) with skilled staff to facilitate project implementation, coordinate project activities between the Operator, the Municipalities of Bukhara and Samarkand cities and other Government agencies, and supervise the Operator's performance; and (ii) carry out related consulting assignments and studies during project implementation. A parallel Swiss Grant will finance the services of independent technical and financial auditors to monitor the Operator's performance in relegation of the service contract obligations and achievement of performance improvement targets, and to provide technical and financial analysis in support of the PCU as needed, and services of financial auditors acceptable to the Bank to carry out annual project and company financial audits. Project Component 4 - US$9.00 million Swiss-financed component The Govemment of Switzerland is processing a US$9.0 million grant to provide parallel financing to the World Bank-financed project. The Grant will provide supplemental resources parallel to Project Component 1 described above for goods and services of Swiss origin. It will also finance independent technical and financial auditors that would monitor the Operator's performance and prepare the financial project and water utility audits, as well as complementary consulting services to support the PCU

68 Annex 3: Estimated Project Costs UZBEKISTAN: Bukhara and Samarkand Water Supply Project - Local Foreign Total Project Cost By Component US $million US $million US $million 1. Investment Fund (IF) - Bukhara and Samarkand Service Contract - Base Fee and Incentive Fee Consulting Services and Project Coordination Unit Swiss - financed component Total Baseline Cost Physical Contingencies Price Contingencies Total Project Costs' Front-end fee Total Financing Required No physical contingencies are applied to Component I (Investment Fund) since all values are budget and do not cover specific predefined contracts. Identifiabic taxes and duties are 0 (US$m) and the total project cost, net of taxes, is (US$m). Thereforc. the project cost sharing ratio is 64.17% of total project cost net of taxes

69 Annex 4: Cost Benefit Analysis Summary UZBEKISTAN: Bukhara and Samarkand Water Supply Project Summary of Benefits and Costs: This Annex reviews the economics of the proposed project. Costs and benefits are assessed from both qualitative and quantitative standpoints. However, it is important to note that much of the operational, technical and financial data required for the economic analysis is very limited or contradictory when different sources are compared. This lack of data makes the economic analysis speculative to a great degree. The data collection systems to be installed by the Operator will provide the necessary information to allow better assessments of the economic benefits of the project and better design of future operations. The incentives built in the service contract will lead the Operator to optimize the use of the limited resources available to achieve the performance improvement targets in a cost-effective way. For the economic analysis presented in this annex, a cost-benefit framework is used to assess the viability of the project and its sensitivity to some of the key variables. Given the expected life of civil works under the capital investment component, the analysis is modeled over 25 years (period ). The cash flows are discounted using a discount rate of 10% which is the Bank's typical hurdle rate for water and sanitation projects. The analysis does not examine the project's components as separate exercises as the full benefits of the IF would not be achieved without the direction of the Operator under the SC. However, it does look at the benefits and costs for each city separately. Table A4-l shows the estimated net present values and internal rates of return of the project. The most important quantitative benefits under the project are due to: * Efficiency improvement in the operations of the water supply system, specifically in two areas where noticeable benefits are expected. First, the reduction in water losses and wastage (which is a key performance target in the SC and is specific of the network conditions in each city - in Bukhara the savings at the end of the four-year contract are expected to be 35,000 m3/d and in Samarkand 70,000 m3/d based on the field monitoring program conducted during preparation of the proposed project). Second, improvement in energv efficiency (another important performance improvement target selected by the vodokanals and the Government as it is the most important cost factor for SVK and the second in importance for BVK after purchase of raw water) which is expected to reach 25% of current energy use by the end of the SC. Although some of the electricity in Uzbekistan is generated domestically, the country also imports energy from neighbor countries such as Tajikistan in summer, and sells it to Kyrgyz Republic, Tajikistan and Kazakhstan in winter. * Improvements in quality of service, particularly in Samarkand where 30 percent of the population receives water for just two periods of two hours every day, and the rest of the city suffers from very low pressure and frequent service cuts. The Social Assessment results provided an approximate range of the value assigned by the population of Samarkand to the improvement of quality of service. The perceived value appears to be low when compared to anecdotal evidence of the cost of coping strategies that the population must implement as a response to the poor level of service (reservoirs, water purchase, time fetching water, etc.). * The current minimum level of maintenance and sub-optimal management of the water supply system will continue in the no-project situation leading to a downward spiral of service that eventually will

70 bring the system (or parts of it) to a collapse. The health emergency associated with such situation will imply significant response costs that would be avoided through the strategic project investments and the change of mentality to a least-cost optimal maintenance strategy. The costs avoided could be characterized as sporadic (no less than three years in frequency) and of significant value (associated with catastrophic damages of the water supply system). In addition, there are qualitative benefits which are difficult to quantify with the available information. These qualitative benefits include: * Public health: In Samarkand the lack of continuity in service increases significantly the risk of contaminating the water supply network through infiltration from nearby sewage network lines due to negative pressure. In Bukhara, the water quality is the main problem perceived by the community, particularly in terms of solids and salinity. The effectiveness of the water treatment in these conditions is not certain. The population respond to the water quality problem with coping strategies such as filtering and purchasing bottled water. * Energy costs associated with water boiling: The Social Assessment results indicate that large segments of the population boil water as a coping strategy against perceived water quality problems. The cost of energy can be substantial. * Environmental benefits associated with less water use: The water resources around Bukhara and Samarkand are not particularly abundant. Furthermore, one of the main water sources of Bukhara is located several hundred kilometers from the city. The reduction in water losses and wastage will bring environmental benefits that are difficult to quantify. * Social benefits associated with improved water supply: In areas of Samarkand with very limited water supply service, the citizens have to delay activities such as bathing and washing. The low pressure in large parts of both cities causes nuisance to the population. Table A4-1: Summary of Cost-Benefit Analysis - Base Case - Present Value of Flows (million UZS) I Bukhara Samarkand Benefits 4,923 5,789 Costs 3,619 4,343 Net Benefits (NPV) 1,127 1,160 IRR 17.1% 18.6% The financial evaluation takes into consideration other benefits that are not accounted for in the economic analysis, such as the increased financial revenues for BVK and SVK associated with the tariff adjustments and the collection rate increases. Further details of the financial analysis are presented in Annex 5. The estimated NPV of the financial value is US$7.72 million for Bukhara and US$8.35 million for Samarkand, with financial rates of return of 15.5% and 14.9% respectively. Main Assumptions: The main assumptions imbedded in the economic and financial analysis are directly related to the performance improvement targets in the SC, specifically in the areas of: (i) reduction targets for water losses and wastage; (ii) reduction of energy consumption; (iii) increase in collection of vodokanal revenues; and (iv) improvement in the quality of service in terms of continuity of service, defmed as the percentage of hours per month that all consumers can draw water from the system. For the specific values used for each

71 city in the above parameters, the reader is referred to the PSA in Annex 1. Additional information on willingness to pay for improved services were taken from the Social Assessment. Further information is presented in Annex 13. Sensitivity analysis / Switching values of critical items: The sensitivity analysis is presented in Annex

72 Annex 5: Financial Summary UZBEKISTAN: Bukhara and Samarkand Water Supply Project Introduction A financial evaluation of BVK and SVK was carried out to analyze the key challenges the companies are facing, their financial structure, operational efficiency, and long-term viability, with particular attention to their ability to assume the proposed loan and to contribute financially to the project-related expenses. The financial evaluation also analyzed the main financial risk factors that could affect the capacity of BVK and SVK to continue operations and implement the project. This Annex is divided in six sections. Section II presents a brief description of the key financial challenges of the vodokanals; Section III describes the strategic choices made in the financial improvement plan defined in the financial projections of the analysis, as well as in the PSA for the SC operator; Section IV summarizes the operational and financial assumptions of the base-case financial evaluation; Section V presents the results of the financial evaluation and the results of a sensitivity evaluation on the main risk factors that will need close attention during project supervision. It is important to note that the financial analysis is speculative in that much of the required data either are nonexistent or in conflict when different sources are compared; the manual accounting systems are inconsistent and prone with errors; and the transition of vodokanals in Uzbekistan to international accounting standards has not been complete. The financial and accounting procedures of the companies will require major improvements through the Operator's directed efforts and the installation of new financial management and accounting systems and procedures. The present financial assessment is based on the limited information available as prepared by BVK and SVK accounting staff with the support of international consultants. The detailed financial evaluation can be found in the Project Files. Main Financial Challenges of BVK and SVK BVK and SVK face substantial financial challenges associated with the following factors: Low tariffs and verv high tariff differentials: In 1998 water tariffs non-domestic customers (budget organizations and commercial consumers) in Bukhara and Samarkand were, respectively, 8.2 and 9.6 times higher than those for domestic customers, resulting in a non-targeted subsidy to the population that actually receives services. Table A5-1 shows the water and wastewater tariffs for As illustrated by the results of the Social Assessment (see Annex 13), the water fees are a very small proportion of the average income. The typical monthly water bill for a family of five in an apartment with hot water and adequate sanitary facilities in early 1999 was about 139 and 189 soums per month in Bukhara and Samarkand, respectively. This amount is less than one percent of the average income, indicating that there is room for rapid increases in tariffs

73 Table A5-1 BVK and SVK Tariffs (net of VAT) Bukhara Samarkand Tariffs Water Sums/m3 Sums/m3 Sums/m3 Domestic Budget organizations Commercial and Self sufficient Industrial Wastewater Domestic Budget organizations Commercial and Self sufficient Industrial Low collection of water fees and minimal cash collection: As illustrated in Table A5-2, in 1999 BVK and SVK collected 18% and 27% of its total billings in cash. The rest is either paid through a cumbersome system of invoice clearing and compensation with other utilities and customers' own invoices and payments, or simply not recovered at all leading to a total collection level of 56% and 79% of billings for BVK and SVK, respectively. In both cases, the utilities' accounts receivable represent about 7 months of billings. Table A5-2 BVK and SVK Collection in 1999 Bukhara Total ICollection as Cash Cash Collection as Category of Customers Revenues Collected % of Billing Collection % of billing Domestic 55,774 24,537 44% 24,537 44% Budget 161, ,644 86% 63,743 39% Self-sufficient organizations, bathhouses, industry, etc. 276, ,202 82%1 9,158 3% Total 494, ,383 79% % Samarkand Total Collection as Cash Cash Collection as Category of Customers Revenues Collected % of Billing Collection % of billing Domestic 110,520 67,022 61% 36, / Budget 219, ,551 58% 45,529 21% Self-sufficient organizations, bathhouses, industry, etc. 283, ,692 71%1 113, / Total 613, ,265 65%1 196, / Low metering, very high water leakage and wastage. and high operating costs: Reliable metering and billing based on metered consumption is currently rare in both Bukhara and Samarkand (less than 2 and 4 percent of customers are metered and quality of metering system is doubtful due to lack of maintenance). Most public institutions, industrial firms, and commercial customers are supposed to have meters, but they are largely inoperative. Domestic consumption is billed using standard consumption norms that go as high as 300 Ipcd. Lack of metering and payment enforcement results in very high consumption and wastage (as observed in the field monitoring program - see Section E.3) and therefore water production has to be

74 increased, driving up operating costs and safety risks. Largely unpaid water bills also result in very high, and so far unaccounted for, bad debt expenses. Although current legislation allows tariffs to be determined taking into consideration the actual costs and expenditures related to the production and sale of water and sewerage services from the previous year, the tariff approval process is subject to political approval and tariffs proposed by BVK and SVK are approved after long delays. The apparently low tariffs that have been approved are claim to be related to the very low input costs for BVK's and SVK's operating expenses (particularly energy and salaries), but they are also a result of an ever smaller provision for maintenance and repairs and inadequate accounting records. Strategic Choices in Financial Recovery Plan A gradual financial recovery plan for BVK and SVK will be implemented as part of the proposed project. The recovery plan has two main objectives: (i) to achieve at the end of the project a basic level of financial sustainability where BVK and SVK can collect sufficient revenues to cover its operations, basic maintenance of the water supply system, and debt service; and (ii) to make counterpart contributions to the project and use this revenue collection capacity at the end of the project to continue the enhanced maintenance and repairs of the system. Even if these targets are met, BVK and SVK will not have achieved at the end of the project full financial viability, as it will not be able to collect sufficient revenues for adequate maintenance of the wastewater system nor adequate provisions for major repairs of the system. After project implementation, both vodokanals will be in a position to continue its financial improvement with the support of the Bank, other IFIs or bilateral donors. The financial recovery strategy is based on the following strategic actions: * Aggressive reduction of system inefficiencies (water losses, energy inefficiency, low cash collection, and water wastage) to reduce costs of operations; * Implementation of a commercial strategy aimed at eliminating unregistered connections and users, and building trust in the community through better water supply and customer service; * A strategic and cost-effective metering policy linked with an effective customer relations platn aimed at increasing revenues and/or reducing wastage; * Set up of financial management, accounting, and commercial systems and procedures that will provide better information about costs, revenues, and customers, and allow BVK and SVK to make better policy and tariff recommendations to the municipal governments and implement effective commercial actions; * Gradual reduction of cross-subsidies combined with enforcement of the disconnection policy to reduce fiscal pressure, increase revenue collection from Government organizations and industry, and free up resources to design and implement a targeted subsidy policy to the truly poor once better information on the customer base is available; * Gradual reduction of non-cash forms of payment. As BVK and SVK are just one link in the existing chain of clearance payments, it will be impossible to do an immediate shift to payments exclusively in cash. The cash collection increase will focus first on the domestic and commercial sector, and gradually move to the industrial and government sector; * Collection of better information on the fixed assets and current operational situation of the water supply system as a first step to have a clear assessment of the maintenance and rehabilitation needs and to make informed recommendations in the tariff reviews during project implementation; and * Linkage of the financial recovery strategy with the service appendix in the management contract with the intemational utility operator to ensure adequate attention to the urgency of BVK's and SVK's financial improvement needs

75 The Municipalities of Bukhara and Samarkand, in support of the financial principles of the project, approved earlier this year a tariff increase of close to 90% in Bukhara and 30% in Samarkand. Results of the Financial Evaluation and Sensitivity Analysis Table A5-3 and A5-4 present a summary of the financial projections for the basic financial evaluation for Bukhara and Samarkand. Based on the assumptions used in the base-case projections, the tariff increases required to achieve the basic goals of the financial recovery are significant but considered feasible by the municipal governments of Bukhara and Samarkand. The basic financial evaluation scenario shows that the financial recovery plan will require drastic efforts by the Operator with the support of the Municipalities to increase tariffs, collection and cash collection, and to reduce operational costs and wastage. During project preparation, several modeling scenarios were discussed as possible future altematives to achieve the financial improvement goals. Based on these scenarios, the municipal governments and the vodokanals selected a sub-loan size based on a level of tariff increase that was considered politically acceptable. The choice in both cities was conservative. The impact of various key assumptions was analyzed to evaluate their influence on the tariff increases needed. The key factors analyzed are: (i) lower collection rates; (ii) reduction in volume sold particularly to commercial and industrial customers; (iii) faster reduction of cross-subsidy from non-domestic to domestic customers; and (iv) different levels of counterpart contribution required from the vodokanal and the Government. The poor quality of the financial data available does not allow for a meaningful risk analysis to determine the most likely financial outcome of the project or the contribution of different factors to the various outcome indicators. Slower improvements in revenue collection rates: If the collection rates are lower than projected, the incentive fee to the operator would be smaller. Also, the minimum required tariffs to achieve the basic goal of the financial recovery plan will have to be higher, as illustrated in the following table, to comply with the financial covenants in the Loan Agreement aimed at improving the financial situation of the vodokanals. Achievement of target collection rates by end Percentage increase in domestic tariffs required in 2006 of project over base case to achieve financial recovery goal Bukhara Samarkand No increase in collection achieved 30% 42% Half the collection increase target achieved 14% 18% Annual decrease in sales to commercial and industrial customers: A large proportion of BVK's and SVK's revenues are generated by its non-domestic customers due to the much higher tariffs than those for domestic customers. Although this tariff differential is planned to be eliminated gradually, it is possible that the introduction of effective meter-based billings and further economic deterioration of some of the larger industries will result in lower non-domestic sales. On the other hand, if the number of small and medium enterprises and commercial establishments in both cities continues to grow, particularly those associated with the tourism industry, the non-domestic sales may increase. The following table analyzes the effects of these changes on the minimum required changes in the domestic tariffs to achieve the financial recovery goal

76 Decrease of sales to non-domestic customers Percentage increase in domestic tariffs required in 2006 over project implementation period over base case to achieve financial recovery goal Bukhara Samarkand -20% 9% 5% -10% 4% 3% 10% 4% -3% Faster reduction of cross-subsidies: Although the Municipalities have indicated their preference for a gradual elimination of tariff differentials, there is uncertainty about the speed at which this elimination will take place. In Tashkent, for example, the cross-subsidy was eliminated in a single step. If this were to take place in Bukhara and Samarkand, the domestic tariffs would have to be increased 69% and 134% immediately to achieve the financial viability of BVK and SVK, respectively. A decision to eliminate the cross-subsidies faster would require a careful consideration of a more targeted mechanism to the truly poor, once better information is collected through project implementation. Different levels of contribution from the vodokanals and the Government: The level of counterpart financing from the Government has a direct influence on the minimum required domestic tariffs if all the other assumptions in the base case are kept constant. The following table illustrates the effects of lower and higher counterpart contribution on the required tariff increases. Vodokanal Counterpart Contribution to the Project Percentage increase in domestic tariffs required in (Government to contribute difference to achieve 2005 over base case to achieve financial recovery 25% local counterpart contribution) goal Bukhara Samarkand 1% -% -29% 15% 22% 24% 25% 65% 71% Update post-appraisal: BVK and SVK, with the support of the Municipalities of Bukhara and Samarkand, have started before project initiation the implementation of some of the measures in the financial recovery plan agreed during project preparation. The main areas of improvement include: * Domestic tariffs have increased 4 times in Bukhara and 5 times in Samarkand between 1999 and 2000 (see table below) * The tariff differential between non-domestic and domestic tariffs has been gradually reduced from 8.7 to 4.8 in Bukhara between 1999 and 2000 and from 10 to 4 in Samarkand over the same period. * Collection of billed revenues increased from 79% to 95% in Bukhara between 1999 and 2000, and from 65% to 83% in Samarkand. * Cash collection showed modest increases from 20% to 33% in Bukhara but remained stable at 33% in Samarkand. These low levels are linked to macroeconomic conditions in the country. The above measures are positive steps forward, although BVK and SVK still face significant challenges to achieve financial sustainability, including lack of adequate provisions for bad debts in the accounting legislation for utilities, important untargeted subsidies to the population, and insufficient budget allocation for water fees of institutional customers

77 Bukhara 1999 Bukhara 2000 Samarkand 1999 Samarkand 2000 Domestic tariff (sums/m3) Non-domestic tariff (sums/m3) Tariff differential Collections as % of billings 79% 95% 65% 83% Cash collection as % of 20% 33% 32% 33% billings I_I Foreign Exchange Risk Allocation and On-lending Terms In line with national policies for foreign loans to sub-national entities, the central Government will pass the foreign exchange risk to BVK and SVK (i.e., sub-loan repayments would be made using the official UZS/USD exchange rate on the day of payment) and will on-lend both the IDA Credit and IBRD Loan to BVK and SVK on IBRD conditions (five years of grace and twenty-year repayment period). The UZS/USD foreign exchange rate is expected to increase significantly once the Government completes the process to liberalize the foreign exchange rate regime. As there are no financial instruments available at the current time to BVK and SVK to hedge against foreign exchange rate fluctuations, the associated risk that has to be absorbed by the utilities will most probably translate into unaffordable tariff increases. In order to support BVK and SVK in its reform process aimed at improving water services to the population, the Government will provide a transparent budget grant to BVK and SVK. The Government would provide an annual zero-net budget subsidy equal to the difference between: (i) payments made by the Government to the Association for all charges and principal repayment of the IDA Credit; and (ii) all charges and principal repayment of the Sub-Loan to be made by BVK and SVK to the Government on terms equivalent to those of the IBRD. This arrangement is considered international best practice to provide transparency of the subsidy and to ensure better accounting and management of the Government's budget. There will be no such budget subsidy for the on-lending of the IBRD Loan. If during the IDA Credit repayment period, the installments schedule from the Borrower to the Association is modified, then the annual budget subsidy will be modified accordingly to continue on a zero-net basis

78 Table A5-3 -Base Case Financial Evaluation Bukhara Vodokanal (post-appraisal update) Millions of Soums Project Implementaidon Period Revenues from Services Water&wastewater billed revenues 853,992 1,132,588 1,319,417 1,779,400 1,970,294 1,977,783 1,982,575 1,858,430 Revenue Collecdon Collected revenue (soums millions) 810,308 1,079,695 1,263,445 1,712,267 1,906,217 1,925,030 1,942,923 1,821,261 Collection ratio (% of revenue billed) 95% 95% 96% 96% 97% 97% 98% 98% Collected cash (soums millions) 283, , , ,732 1,232,467 1,430,830 1,774,651 1,803,049 Cash collection (% ofrevenue billed) 35% 31% 48% 55% 65% 74% 91% 99O/8 Costs and Expenses StaffCosts 37,536 37,536 37,536 37,536 37,536 37,536 37,536 37,536 Electricity 188, , , , , , , ,664 Fuel 5,400 5,400 5,400 5,400 5,400 5,400 5,400 5,400 Materials 137, , , , , , , ,931 General operating costs 165, , , , , , , ,888 Allocations forsocial security 15,013 15,013 15,013 15,013 15,013 15,013 15,013 15,013 Non-operating costs 105, , , , , , , ,703 Another direct costs (refund IEK expenses) Depreciation on pre-2000 assets 6,444 6,444 6,444 6,444 6,444 6,444 6,444 6,444 Depreciation on post 2000 assets - 68, , , , , ,579 rotal Costs and Expenses 719, ,837 1,057,611 1,457,767 1,636,973 1,663,443 1,693,098 1,621,287 Total Minimum Collected Revenue Required Operations and Maintenance Costs 747, , , , , , , ,549 Profit tax 34,511 57,926 63,809 78,895 83,466 81,092 77,446 50,861 VAT on W&WW sales 107,939 94, , , , , , ,339 Debt service (including fees) 43,678 57, , , ,275 1,017, ,512 BVK project contribution (68,114) 272, , , ,496 Total ,352 1,263,445 1,712,267 1,906,217 1,925,030 1,942, Revenues Domestic Tariff(1999UZS) Revenue billed 206, , , , , , , ,248 Collection ratio 87% 87% 89% 92% 94% 96%/ 98% 98% Revenuecollected 180, , , , , , , ,743 Bill of Family of Five (unmetered)-uzs/month ,398 1,670 1,820 2,148 2,380 Budget Tariff(1999UZS) Revenue billed 205, , , , , , , ,784 Collection ratio 97'/. 97% 97% 97% 98% 98% 98% 98% Revenue collected 199, , , , , , , ,088 Self-Sufficient Entity Tariff(1999UZS) Revenue billed 266, , , , , , , ,739 Collection mtio 97% 97% 97% 97% 98% 98% 98% 98% Revenue collected 258, , , , , , , ,204 Industries Tariff(1999UZS) Revenue billed 175, , , , , , , ,659 Collection ratio 98% 98% 98% 98% 98% 98% 98% 98% Revenuc collected 172, , , , , , , ,225 Total Revenue billed 853,992 1,132,588 1,319,417 1,779,400 1,970,294 1,977,783 1,982,575 1,858,430 Revenue collected 810,308 1,079,695 1,263,445 1,712,267 1,906,217 1,925,030 1,942,923 1,821,261 Collection ratio 95%1 95% 96% 96% 97% 97%1 98% 98%

79 Table A54. B3ase Case Flnancial Evaluation Samarkand Vodokanal (post-appraisal Update) Millions of Souns Peealneetao Period Revenues from Services Waterf&astewaterbilledrevenues 857, ,500 1, ,981,772 2,200,061 2, ,012 2,319,215 Collected revenue (UZS millions) 738, ,000 1,342,743 1,851,246 2,106, ,391, ,831 Collection ratio (% of revenue billed) 86% 899/. 91% 93% 96% 98% 98% 98% Collected cash (UZS millions) 410, , ,250 1,367,998 1,654,489 2,266,642 2,323,402 2,272,831 Minimum cash collcction (% of revenuc billed) 36%/ 44% 53% 65% 78% 93% 97% 1000/ StaffCosts 69,686 69,686 69,686 69,686 69, ,686 69,686 Electricity 327, , , , , , , ,289 Fuel Materials 52, ,738 52,738 52, , , ,661 Repairs fund ,000 70,000 70,000 70, , , ,500 Genenal operating costs 43,650 43,650 43,650 43,650 43, ,650 Allocations for social security 27, ,874 27,874 27, ,874 27,874 Tao and mandatory paymcnts (excluding pmfit tax) 11,508 11,508 11,508 11,508 11, ,508 11,508 Non,operatingcosts 194, , , , , , , ,032 Another direct costs (refund JEK expenses) 77, ,116 77,116 77,116 77,116 77, Diepreiation on pre-2000 assets 7,059 7,059 7,059 7,059 7,059 7, ,059 Depreciation on post 2000 assets. 81, , , ,769 1,049,687 1,049, ,687 Total Costa and Expenses 869,444 1, ,180,797 1,642, ,378 1, ,702 2,073,513 Operations and Maintenance Costs 796, , , , ,777 1,042, , ,200 Profittax ,889 50,203 64, ,768 61,788 VAT on W&WW sales 131,109 88, , , ,021 Debt servicc (including fees) - 52, , , ,650 1,221,011 1,134,822 SVKprojectcontribution , , ,837 Total , , , , , , Revenues Domestic Tariff(2000UZS) Revenue billed 187, , , , , ,256 1,058,404 Collection Mtio 909' 92% 93% 95% 96% 98% 98% 98% Revenuecollected , , , ,431 1,037,236 Bill of Family of Five (unmcttered)uzs/month ,365 1,645 1,774 2,326 2,483 Budget Self-Sufficient Entity ndustries Bathhouse Total Tariff(2000UZS) Revenue billed 245, , , , , , ,847 Collection ratio 87% 89%/. 91% 94% 96% 98%/ 98% 98% Revene collected 213, , , , , , ,110 Tariff(2000UZS) Revenue billed 94, , , , , , ,200 Collection ratio 60%h 68% 75% 83% 909/, 98% 98% 98% Revenue collected 56,755 88, , , , , , ,256 Tariff(200OUZS) Revenue billed 249, , , , , , ,242 Collection ratio 91% 92% 94% 95% 97% 98% 98% 98% Revenue collected 225, , , , , , , ,897 Tariff(200OUZS) Revenuebilled 80,077 80,333 98, , , , ,Q Collection ratio 91% 92% 94% 95% 97% 98% 98% 98% Revenuacollected 72,489 73,922 91, , , , , ,332 Revenaebilled 857,084 1,293,500 1,475,092 1,981,772 2,200,061 2,167,500 2,440,012 2,319,215 Revenue collected 738,249 1,146,000 1,342,743 1,851,246 2,106,407 2,124,150 2,391,212 2,272,831 Collection rtio 86% 89 h 91% 93% 96% 98% 98% 98%

80 Annex 6: Procurement and Disbursement Arrangements UZBEKISTAN: Bukhara and Samarkand Water Supply Project Procurement The components of the proposed project, their estimated cost and procurement methods are summarized in Table A of this annex. The procurement methods and prior review thresholds are presented in Table B of this annex. Table B 1 summarizes the capacity of the PCU in procurement at the time of preparation of this PAD and the proposed arrangements for procurement and monitoring. Table B2 presents a procurement plan detailing the packaging and estimated schedule of the major procurement actions. The project will be financed from the proceeds of the proposed US$20.00 million loan, the US$20.00 million equivalent credit, the local expenditure contributions from the Government and vodokanals, and a $9.00 million equivalent parallel Swiss Grant. The total cost of the project would be US$62.33 million, with a total Bank financing of US$40.00 million equivalent. A general procurement notice has been published on the Development Business of the UN on October 16, The Operator, as part of the Services to be provided under the SC, shall have the responsibility to carry out, on behalf of the Borrower, the procurement activities and contract signature, of all goods, works and services financed under the IF, in accordance with the World Bank Guidelines: Procurement under the IBRD Loans and IDA Credits (issued in January 1995, revised January and August 1996, September 1997, and January 1999). Consulting Services, technical assistance and training would be procured in accordance with the Guidelines - Selection and Employment of consultants by World Bank Borrowers, January 1997, revised September 1997 and January The Bank's Standard Bidding Documents, Request for Proposals and Forms of Consultants' Contract will be used. In order to ensure adequate procurement capacity, the Operator will be required in the Staff Appendix of the Management Contract to provide international staff with adequate procurement qualifications. The establishment of the PCU was initiated by the Municipalities of Bukhara, Samarkand and the Ministry of Macroeconomics and Statistics in November The responsibilities of the PCU will be: (i) the overall coordination of the project; and (ii) the supervision of the Operator's performance. The PCU will be assisted by intemational technical and financial auditors. The PCU will have two full time Procurement and Contract Coordination Officers (PCO), one in each city. Competitive selection of this position has been completed. Although all procurement activities for goods and works financed by the Loan (including the Immediate Investment Program) will be the responsibility of the Operator, the PCU will be responsible for the International Competitive Bidding process (ICB) for the selection of the Operator using Bank guidelines. The PCU will also be responsible for the selection of the international technical and financial auditors financed by the parallel Swiss Grant using specific procurement procedures and requirements established in the Swiss Grant Agreement. In anticipation of the weak capacity of the PCOs to carry out procurement independently or to supervise effectively the procurement activities of the Operator, a foreign individual consultant with adequate procurement experience will be brought to support and train the local PCOs. Additional grant funding has been secured to provide two training sessions in Uzbekistan to the PCU before the Pre-Qualification stage and the Bid Evaluation stage for the selection of the Operator. This training will be conducted by a senior international procurement specialist

81 Procurement methods (Table A) Component 1 - Investment Fund As described in Annex 2, the specific works, goods, and services to be financed during each year of project implementation through the IF will be determined by the operator working jointly with the BVK and SVK. An annual procurement plan will be prepared for review by the Government and the Bank. This plan will include a description of the proposed investments, estimated costs and expenses, implementation plan, procurement schedule, priority analysis, and any environmental, social or financial issues of relevance. The procurement plan will be based on the hands-on knowledge gained by the operator during the implementation of the SC. The activities to be financed by the IF will be designed to allow the operational improvement targets that will translate into service improvements to the population and that will serve as basis to determine the incentive fee to the operator. As the specific works, goods, and services to be financed by the IF will be determined only during implementation, it is impossible to determine ex-ante the specific procurement activities. Therefore, aggregate ceiling amounts for each procurement method is not predetermined under the projects, but types of procurement are specifically to be used are specifically described below. The Bank Procurement Assessment indicates that the Operator and the PCU will operate in a high-risk environment. It is recommended that for the proposed project the following thresholds for each contract be used: * Procurement of Works. Civil works contracts estimated to cost more than US$200,000 will be financed under ICB. Civil works contracts estimated to cost less than US$200,000 may be procured using National Competitive Bidding procedures (NCB). Minor works contracts for urgent repair works associated with unexpected operational emergencies estimated to cost each less than US$25,000 may be procured using three quotations. Given the state of repair of the water supply distribution system, it is expected that a limited number of emergencies may occur each year that cannot be handled with the vodokanal equipment. The provision for Minor Works contracts is designed to facilitate the response of the Operator to these emergencies so as to be able to restore services to the population. * Procurement of Goods. Contracts for the supply of goods valued at more than US$100,000 will be procured under ICB. Intemational Shopping (IS) may be used for goods valued at US$100,000 or less per contract up. National Shopping (NS) may be used for goods valued at US$50,000 or less per contract. The provision for Shopping is designed to allow the Operator to purchase equipment for rapid response to emergency breakdowns in the system and other activities that require rapid response. The Operator will have annual procurement plans for strategic purchase of much needed equipment in a continuous program. * Procurement of Consulting Services. Recruitment of consulting firms to assist in construction supervision, feasibility evaluations and other consulting services estimated to cost more than US$50,000 will be carried out under the Quality and Cost Based Selection method (QCBS) in accordance with the Bank Guidelines. For engineering designs of less than US$200,000 per contract the Least Cost Selection (LCS) method will apply. Individual Services for surveys and studies related to public awareness, community relations, or similar activities may be procured based on qualifications of consultants (CQ) each of contract value less than US$100,

82 Component 2 - Service Contract The selection of the international utility operator will be carried out under ICB with pre-qualification. The issuance of the RFP is a condition of negotiations and the opening of the financial proposals after completion of the technical evaluation is a condition for Board presentation. Completion of contract negotiations and initialing of the SC is a condition of loan/credit effectiveness. Component 3 - Consulting Services and Project Coordination Unit Individual Consultants for assistance to the PCU staff and for short-term advisory and legal services will be selected based on qualifications in accordance with the Guidelines of the Bank (Section V-IC). Component 4 - Swiss-financed component All goods and services to be financed by the parallel Swiss Grant under Project Component 4 will be procured in accordance with the specific procurement requirements in the Swiss Grant agreement. These investments will also be included in the annual procurement plan to be prepared by the operator, BVK and SVK and will be jointly reviewed to ensure technical consistency. The procurement of goods and services will be perfonned separately. Table A - Procurement Methods Expenditure Category Procurement Method Total ICB NCB Olher N.B.F. Cost 1. Investment fund (33.74) (0.00) (33.74) 2. Service Contract (5.20) (0.00) (0.00) (0.00) (5.20) 3. Incremental Operating Costs (0.00) (0.00) (0.56) (0.00) (0.56) 4. Consulting services (0.00) _. (0.00) (0.30) (0.00) (0.00) S. Front-end fee (0.00) (0.00) (0.20) (0.00) (0.00) 6. Parallel Swiss Grant (0.00) (0.00) (0.00) (0.00) (0.00) Total (40.00) (0.00) (40.00) 1/ Figures in parenthesis are the amounts to be financed by the Bank Loan/Credit. All costs include contingencies 2/ Includes civil works and goods to be procured through national and international shopping, consulting services, services of contracted staff of the PCU, training, technical assistance services, and incremental operating costs related to managing the project. 3/ Includes works, goods and services to be financed by the Investment Fund under annual procurement plans prepared by the Operator, approved by the Bank and in accordance with the Bank's Procurement Guidelines. 4/ The total Service Contract fixed fee (est. $3.65 million) is subject to competitive bidding, while the Performance Incentive Compensation is not subject to competitive bidding (est. $1.55 million) 5/ The Consulting Services do not include the services to be financed by the parallel Swiss Grant. This grant will finance the Technical and Financial Audits of the operator's performance, the project and water utility audits, and related consulting services. 6/ Civil works to be funded by local sources as part of the Investment Fund

83 Prior review thresholds (Table B) All contracts awarded through ICB will be subject to prior review by the Bank. For works, the first two NCB and the first three minor works packages will be subject to prior review. For goods, the first two IS packages will be subject to prior review. With respect to services, prior Bank review will be required of all terms of reference, irrespective of the contract value. The SC operator will be selected through a prequalification and bidding process with prior review by the Bank. For each contract with a consulting firm estimated to cost US$100,000 or more, the technical evaluation report will be submitted to the Bank for its review prior to the opening of the priced proposals. For contracts with individual consultants costing US$50,000 or more the qualifications, experience, terms of reference and terms of employment shall be furnished to the Bank for review prior to contract signature. All other contracts will be subject to ex-post review by the Bank. Table B. Thresholds for Procurement Methods and Prior Review Category ICB NCB is NS Other Methods Contracts Subject to Prior Review (US$ millions) 1. Civil Works 1.1 >$200,000 <$200,000 N/A N/A <$25,000 Procurement l Thresholds 1.2 Prior All contracts First two N/A N/A First three 1.44 Review Z. Goods 2.1 Procurement >$ 100,000 N/A <$ 100,000 <$50,000 N/A Thresholds 2.2 Prior All contracts N/A First two First two N/A 7.42 Review 3. 1 contract of Management US$3.65m - Contract base fee and US$1.55m - incentive fee 3.1 Prior Prequalification N/A N/A N/A N/A 4.00 Review and bidding 4. QCBS CQ Individuals LCS Consultants Prior Review >$100,000 TOR >$50,000 >$ 100,000, otherwise TOR otherwise TOR otherwise TOR Ex-post Review will be conducted on I in 5 contracts during supervision mission

84 Table Bl: Capacity of the Project Coordination Unit in Procurement and Assistance Requirements in Procurement Monitoring System A Capacity Assessment of the Borrower was carried out during the appraisal mission in June 2001 and the following action lan has been prepared taking into account the experience gained in similar projects financed by the Bank. The procurement srangement under the project is that the PCU will procure an international utility operator under a Service Contract before project effectiveness. During project implementation, the Operator will procure, on behalf of BVK and SVK and with thei nvolvement, goods, works and services in accordance with Bank's Procurement Guidelines and support the client in contract ignature. No procurement activity of goods, works or services financed by the Investment Fund component will take place efore the Operator is mobilized. rhe establishment of the PCU was initiated by the Municipalities of Bukhara, Samarkand and the Ministry of Macroeconomics md Statistics in November The PCU will be assisted by international technical and financial auditors. The PCU has two ill time Procurement and Contract Coordination Officers (PCO), one in each city. Competitive selection of this position has een completed. All procurement activities for goods and works financed by the Loan and Credit under the Investment Fund vill be the responsibility of the Operator. The PCU will be responsible for the International Competitive Bidding process ICB) for the selection of the Operator using Bank guidelines. In anticipation of the weak capacity of the PCOs to carry out this rocurement of the Operator, a foreign individual consultant with adequate procurement experience will be brought to support d train the local PCOs. Additional grant funding has been secured to provide two training sessions in Uzbekistan to the PCU fore the Pre-Qualification stage and the Bid Evaluation stage for the selection of the Operator. This training will be onducted by a senior international procurement specialist. The overall risk assessment is rated as "high risk" because the PCU as no experience in Bank procurement. Accordingly, the prior review thresholds were conservatively established as indicated n Table B. rhe Operator will prepare and submit to the Project Coordination Committee an annual procurement plan (indicating specific Rrocurement methods in a format acceptable to the Bank) to procure goods, works and services. The Bank will also closely review this annual procurement plan. Once this procurement plan is approved, the Operator will implement it and will sign the ontracts on behalf of the client. The Operator will use funds from the Investment Funs (IF) only for those activities listed in he IF Appendix of the service contract. The Operator's independence and incentives to improve performance will reduce the isks of undue pressure to deviate from the Bank's Procurement Guidelines. Specific provisions to avoid potential conflict o nterest situations will be incorporated in the service contract with the Operator. Bank's support and supervision during mplementation will be key to reduce these risks. In addition, the Bank will review at the beginning of the project mplementation the capacity of the Operator's management team to conduct procurement in accordance with Bank guidelines. Country Procurement Assessment Report status: Are the bidding documentsfor the procurement actionsfor thefirstyear ready by negotiations: Procurement actions related to the Investment Fund will be the responsibility of the Operator and will only be initiated after mobilization. TRAINING INFORMATION AND DEVELOPMENT ON PROCUREMENT A Country Procurement Assessment Report has not been conducted for Uzbekistan Estimated Date of Date of publication of Indicate if there is Domestic Preference Domestic Preference Project Launch General Procurement procurement subject to for Goods: for Works, if Workshop: Notice: mandatory SPN in applicable: Development Business: Yes 04/02 October 16, 2000 Yes Yes Retroactive Financing: No Project Preparation Facility: No Advance Procurement: No Explain briefly the Procurement Monitoring System: Fhe Operator, under the obligations of the Service Contract, will have the responsibility, on behalf and with full involvement o he BVK and SVK staff and members of the PCU, for all procurement activities and contract signatures, and for installation ad management of the procurement monitoring system. The PCU, that report to the Project Coordination Committee, will have a supervisory role and will be supported by technical and financial auditors that will monitor the Operator's performance n its obligations under the Service Contract. All project documentation which requires prior review will be cleared by a PAS ad the relevant technical staff. Procurement information will be collected and recorded by the Operator, transmitted to the PCU that will submit to the Bank in the quarterly progress reports. This information would include: (a) revised cost estimates 'or individual contracts; and (b) revised timing of procurement actions including advertising, bidding, contract award and completion time for individual contracts. Cofinancing: Explain briefly the Procurement arrangements under co-financing: A US$9 million equivalent Grant is being processed by the Government of Switzerland for parallel financing of goods and ervices of Swiss origin. Independent bidding process will be used to procure goods and services to be financed by the Swiss Grant. The donor's procurement requirements and guidelines will be followed for this component

85 SECTION 4: PROCUREMENT STAFFING lndicate name of Procurement Staff or Bank's staffpart of Task Team responsiblefor the procurement in the Project: Name: Takao Ikegami (PAS), Sr. Sanitary Engineer, (202) ; Explain briefly the expected role of the Field Office in Procurement: No procurement service support is currently envisioned from the Resident Mission

86 Table 82: Procurement Plan Estimated Number of Estimated Procurement Invitation Submission Contract Contract Component Type Contracts Cost USSMM Methods to Bid of Bids Signing Completion A. Investment Fund Investment Fund activities with Bank financing and To be procured under different schedules between corresponding local CW/Goods June 2002 and June 2006 based on yearly counterpart funds /Services Multiple Total: ICB/NCB/Other procurement plan Procurement Plan Year Procurement plan for the remaining nine months 1 for Bank-financed CW/Goods (06/02-04/03) of Year 1 of SC submitted for review to portion /Services Multiple ICB/NCB/Other the Bank within three months of Operator mobilization Annual Procurement Annual procurement plan submitted by the Operator Plan Year 2 for Bank- CW/Goods and B&SVK to the Bank for review by end of Year I of financed portion (Services Multiple ICB/NCB/Other SC for implementation during Year 2 Annual Procurement Annual procurement plan submitted by the Operator Plan Year 3 for Bank- CW/Goods and B&SVK to the Bank for review by end of Year 2 of financed portion /Services Multiple ICB/NCB/Other SC for implementation during Year 3 Annual Procurement Annual procurement plan submitted by the Operator Plan Year 4 for Bank- CW/Goods and B&SVK to the Bank for review by end of Year 3 of financed portion /Services Multple ICB/NCB/Other SC for implementation dunng Year 4 B. Service Contract SC 1 contract Total: 5.20 ICB Sep-01 Dec-01 Feb-02 May-06 PQ was issued on Apr-01 Incremental C. Incremental Operating Operating Costs Costs Multiple Total: 0.75 Other D. Consulting To be procured on an as-needed basis for PCU Services Services Multiple Total: 0.30 QCBS, CQ, IC assistance outside the Investment Fund Notes: IF: Investment Fund CW = Civil Works; SC = Management Contract ICB = Intemational Competitive Bidding; IS = Intemational Shopping; NS = National Shopping; NBF = Not Bank Financed QCBS = Quality and Cost-Based Selection; CQ: Consultant Qualificabons; IC = Individual Consultants The annual investment plans will also include the proposed procurement and investment activities for the parallel Swiss Grant and will be reviewed jointly for technical consistency. The procurement of the goods and services financed by the parallel Swiss Grant will be done separately under the donor's procurement guidelines

87 Disbursement Allocation of loan proceeds (Table C) Table C: Allocation of Loan and Credit Proceeds Expenditure IDA Credit IBRD Loan Financing Percentage Category Amount in Amount in US$ SDR million million BVK Works 1,950,000 2,420,000 85% Goods 3,060,000 3,840, % of foreign expenditures and 100% of local expenditures (ex - factory cost) and 50% of local expenditures for other items procured locally Management 950,000 1,180, % Services Consulting Services 450, , % Incremental 110, ,000 75% Operating Costs SVK Works 2,330,000 2,910,000 85% Goods 3,700,000 4,620, % of foreign expenditures and 100% of local expenditures (ex - factory cost) and 50% of local expenditures for other items procured locally Management 1,140,000 1,410, % Services Consulting Services 515, , % Incremental 120, ,000 75% Operating Costs Fee l l 200,000 l 100% Unallocated 1,575,000 1,960,000 Total 15,900,000 20,000,000 Use of statements of expenditures (SOEs): Project funds will be initially disbursed under the Bank's established procedures, including SOEs. Disbursements made on the basis of SOEs will be as follows for each expenditure category: (a) goods under contracts costing less than US$100,000 each; (b) works under contracts costing less than US$ 200,000 each; (c) services under contracts less than US$100,000 each for consulting firms, and less than US$50,000 each for individual consultants; and (d) recurrent costs, under such terms and conditions as the Bank shall specify. Supporting documentation for SOEs will be retained by the Borrower, be made available to the Bank during project supervision, and be audited annually by independent auditors

88 acceptable to the Bank. Disbursements for expenditures above these thresholds will be made against presentation of full documentation relating to those expenditures. The Operator, as part of the Services to be provided under the SC, will consolidate project information for all components and prepare quarterly PMRs including financial report, project progress report and procurement management report, for project monitoring and reporting for submission to the Bank through the PCU. The reporting system would support the application of the PMR-based disbursements, to be made at the mutual agreement of the Government and the Bank. Special account: To facilitate disbursements against eligible expenditures, four Special Accounts (SAs), including two BVK special accounts (one for IBRD loan proceeds and the other for IDA credit proceeds, respectively), and two SVK special accounts (one for IBRD loan proceeds and the other for IDA credit proceeds, respectively), will be established in commercial banks to be maintained and operated by the PCU under terms and conditions satisfactory to the Bank. The IBRD/IDA would, upon request, make authorized allocations of US$0.5 million into each of the SAs. For the IDA Credit, initially the allocation for the BVK IDA Special Account and the SVK IDA Special Account would be limited to US$0.25 million until disbursements have reached SDR 2 million, at which time the full authorized allocations could be claimed. Applications for the replenishment of the SA would be submitted on a monthly basis, or when about 20 percent of the initial deposit has been used, whichever comes first. The replenishment applications will be supported by the necessary documentation, in accordance with Bank guidelines, including the SA bank statements and a reconciliation of the bank statements to the project's accounting records. The PCU, with the support of the Operator, will be responsible for the appropriate accounting of project funds provided under the Credit, for reporting on the use of these funds, and for ensuring that audits of the financial statements are submitted to the Bank. Accounting for Special Account transactions and for all other project-related accounts will be maintained in accordance with the World Bank Financial Accounting Reporting and Auditing Handbook, January The SA would be audited annually by independent auditors acceptable to the Bank. Financial Management: To maintain project accounts and produce reports in accordance with standards acceptable to the Bank, an interim FMS was established at the PCU. This system will be integrated into the overall financial management system that will be installed by the Operator in BVK and SVK to ensure consistency and adequate reports using the format agreed for Project Management Reports (PMR). In accordance with OP/BP 10.02, a Bank-accredited financial management specialist reviewed the proposed financial management system in March Based on this assessment, it was found that the PCU satisfies the Bank's minimum financial management requirements. However, the PCU has agreed to take the following actions to improve its financial management processes. * Prior to Effectiveness, the selection of the auditor for the Project shall be completed, acceptable to the Bank, for the audit of the project financial statements. * Prior to Effectiveness, the Bank will approve the operational manual. * PCU will be able to prepare the following reports by Effectiveness on the interim system. (i) sources and uses of funds; (ii) Use of funds by project activity; and (iii) the reconciliation of the Special Account. Once the new system is installed by the Operator and the interim system is integrated into the new system, the PCU will produce full PMR by June 30,

89 * Nine months after the start date of the Operator, to have in place a financial management system for both BVK and SVK, which would also integrate the interim financial management system that has been established at the PCU

90 Annex 6B: Financial Management Assessment Report - December 2001 UZBEKISTAN: Bukhara & Samarkand Water Supply Project 1. Executive Summary and Conclusion A review of the Financial Management arrangements for the project was undertaken in March 2001 to determine whether the financial management arrangements within the PCU are acceptable to the Bank. It is concluded that the PCU currently satisfies the Bank's minimum financial management requirements. The financial management arrangements at the PCU are considered capable of satisfactorily recording all transactions and balances, supporting the preparation of regular and reliable financial statements, safeguarding the entities' assets, and are subject to auditing arrangements acceptable to the Bank. A summary of financial management assessment and conclusions are as follows: Financial Management Assessment Rating Comments 1. Implementing Entity Satisfactory PCU. Is staffed with experienced people. 2. Funds Flow Satisfactory Operation of the SA in related projects have been good. Local project accounts will be opened for counterpart funding, and such funding will be provided as a condition of Effectiveness 3. Staffing Satisfactory Experienced accountant. 4. Accounting Policies and Procedures Satisfactory Appropriate financial manual and policies have been formulated. These will be further enhanced by the Utility Operator. 5. External Audit Satisfactory The project will be audited by auditors acceptable to the Bank. On-going Water and Sanitation project has been audited and given a clean opinion. 6. Reporting and Monitoring Satisfactory PCU prepares reliable PMRs (on a test basis on the interim system) 7. Information Systems Satisfactory Interim system in place. This system will be integrated into the main system to be implemented by the Utility Operator Overall Financial Management Satisfactory Rating 2. Project Description Summary The project would consist of four components: Component 1: Investment Fund. This component would finance essential short-term expenditures (such as materials, equipment, vehicles) and a least-cost capital investment program (including associated engineering and construction supervision services) aimed at improving the operations of the water supply system and the services to the population by achieving the performance improvement targets in the service

91 contract. The Operator, together with BVK and SVK staff, will propose the investments that are required to optimally re-structure and rehabilitate key components of the systems (such as sections of the water distribution networks and block distribution systems, specific components of the treatment plants, pumping stations), implement a demand management program, and set up financial management, accounting and commercial systems. Component 2: Service Contract. This component would finance the costs related to the service contract. These costs include a base fee and a performance-based fee to be paid to the private Operator based on achievement of targets defined in the contract. The Operator would be given full responsibility for managing the investment program, operating the water supply system, and developing and implementing the demand management program and the commercial (billing and collection) and financial management departments. Component 3: Consulting Services and Project Coordination Unit. This component would support the PCU including salaries, training, and incremental operating costs; and various consulting services of technical, legal and financial nature. Component 4: Swiss-financed component. The Government of Switzerland is processing a US$9.0 million grant to provide parallel financing to the World Bank-financed project. The Grant will provide supplemental resources parallel to Project Component I described above for goods and services of Swiss origin. It will also finance independent technical and financial auditors that would monitor the Operator's performance and prepare the financial project and water utility audits, as well as complementary consulting services to support the PCU. 3. Country Financial Management Issues A CFAA for Uzbekistan is expected to be launched in FY03. From a financial management perspective, the project is considered high risk due to the following reasons: * Financial risk associated with both BVK and SVK * Weak financial management systems and lack of qualified staff at both BVK and SVK * Public perception of corruption in the country These risks are considered manageable, based on the experience of other Bank financed projects, where proper procedures have been established. As a result, and in order to mitigate any negative impact on the project due to corruption, lack of proper systems and training, special attention was focused on financial management issues during appraisal. An assessment of the PCU was carried out and an action plan for the development of a good financial management system and building up of the financial management capacity at the PCU was planned and is being carried out. A service contract will be signed by BVK and SVK to hire a consulting firm (Service Operator). A key task of the Operator will be the installation of a computerized financial, accounting and information systems for BVK and SVK, the development of adequate accounting procedures, provide training for the staff and the introduction of financial planning in the utilities. The goal of this activity is to improve the financial management and planning capacity of the utilities and to provide adequate accounting and financial management information about BVK and SVK activities. The utilities' financial statements including the project accounts maintained by the PCU will be audited annually according to IAS and the audits will be submitted to the Bank. The audit of the on-going Water Sanitation and Health Project has been timely and satisfactory, as have been the banking arrangements for the special account

92 4. Financial Management System Assessment 4.1 Project Management and Coordination The PCU has been established under the authority of the provinces of Bukhara and Samarkand as the government level responsible for the provision of water supply services. The PCU will report to a Coordination Committee that will have representatives from the local governments and key agencies of the central government (MOF, ACS, State Committee on Property and MMS). The Coordination Committee, headed by the MMS, will meet at least quarterly to review the progress of the project and to approve the annual procurement plans prepared by the operator, BVK and SVK. The Coordination Committee will also provide the forum to discuss policy issues of the water sector related to project implementation, particularly on financial matters. The PCU would be responsible for: overseeing day-to-day project activities and the implementation of the service contract; coordinating with BVK, SVK, the Operator, the Municipalities of Bukhara and Samarkand, project financial management; monitoring performance indicators during implementation of the service contract; and carrying out all coordination and supervisory functions related to project implementation. 4.2 Staffing of the Accounting/Finance Function The PCU is fully staffed and operational and has received training during project preparation, particularly on the Service Contract documents. The accountant has visited other Bank financed project PIUs, with established systems to gain hands-on experience on Bank requirements. Under the proposed administration and coordination structure the PCU is in no way subordinate to the Operator and no payments to the PCU staff will be channeled through the Operator 4.3 Accounting and Internal Controls Operational procedures and guidelines for project financial management will be documented in an Operational Manual, encompassing all levels of project management and administration. A draft has being prepared by the PCU. The Bank has reviewed the manual and given its comments. The PCU will incorporate these comments, and the Bank will approve the manual prior to Effectiveness. The Manual includes financial management procedures and staffing, identification of accounting and auditing standards and procedures used for the project, project reporting and monitoring, procurement procedures, procedures for cash management and the format of project management reports. This manual is project specific. The operator will prepare separate manuals for both BVK and SVK for their operational procedures, including all accounting and control functions, and up-date the project manual if required

93 4.4 Computerized Accounting Systems A project specific interim financial management system has been established at the PCU. This system is capable of providing accurate and timely information regarding project resources and expenditures, including planning, internal controls, accounting and financial reporting and audit arrangements relating to the project. Once the Service Contractor is selected and has started work, the SC will introduce new financial management systems for both BVK and SVK. The interim system at the PCU will be integrated into the newly established systems at the vodokanls. If the interim system has to be up-graded to be integrated into the new system, the Operator will also do this. A Bank FMS will inspect the systems once installed, to ensure that they meet Bank requirements. Till such time, the project accounts will be kept on the interim system and is based on a Chart of Accounts drawn-up by the appraisal mission with the assistance of the PCU. The Chart of Accounts will accommodate the proposed project to capture sources and uses of funds, assets and liabilities in sufficient detail to satisfy PMR-based reporting requirements. Cash basis accounting will be applied. The proposed system will, in addition to producing periodic and cumulative budgeted and actual expenditures, link the financial data to measures of output and procurement activities of the project. The Project Monitoring Reporting (PMRs) formats were discussed and agreed with the PCU 4.5 Conclusion It is concluded that the PCU has a financial management system which will meet the Bank's minimum financial management requirements because: * The PCU has implemented an acceptable interim computerized accounting system * The PCU has drafted an operations manual describing the accounting policies and procedures, internal controls, delegation of responsibilities and authorities, transaction flows, which will be approved by the Bank as an Effectiveness condition * The PCU has an accountant acceptable to the Bank. 5. Project Management Reports The PCU will maintain accounts of the Project and will ensure appropriate accounting of the funds provided. It has been agreed that the PCU will be responsible for designing appropriate Project monitoring reports (PMRs) and preparing PMRs on a quarterly basis. The PMRs include: * Project Sources and Uses of Funds * Uses of Funds by Project Activity * Project Balance Sheet (where appropriate) * Special Account Statement Plus Local Bank Account Statement By September 30, 2002, PCU will prepare PMRs incorporating all components, categories and performance indicators, which are acceptable to the Bank

94 6. Financial Risk Analysis From a financial management perspective, the proposed Project is considered a high-risk project. summary of the consolidated risk assessment for the project is as follows: A Risk Rating Comments Inherent Risk 1. Country Financial Management High As no CFAA has been conducted, the Risk comments are based on experience gained from on going projects. There is generally low financial management capacity and accountability in the public sector. 2. Project Financial Management Substantial Timely counterpart funding could be a major Issues issue. 3. Banking sector High Is considered weak. The sector is receiving technical assistance under a Bank financed project to enhance its capacities and competence. 4. Perceived corruption High Corruption is prevalent OVERALL INHERENT RISK High Control Risk 1. Implementing Entity Moderate PCU staff experienced in Bank financed projects 2. Funds Flow High Operations of the SA is not expected to be a problem. Counterpart funds will be deposited in the Project Account to be opened as condition of effectiveness. 3. Staffing Moderate Experienced staff 4. Accounting Policies and Procedures Moderate A manual has been prepared. Will be enhanced once the Operator has assumed its management role. 5. Intemal Audit N/A 6. Extemal Audit Moderate Based on on-going project, not expected to be a problem. 7. Reporting and Monitoring Moderate Formats and systems are in place. To be further enhanced once the Operator has taken over the running of the utility. 8. Information Systems Moderate Interim system is in place. The Operator will install FM systems for both vodokanals. Overall Control Risk Moderate

95 The following financial management risks could adversely affect project implementation: * Funds Flow: Local contributions could be a problem. In order to mitigate this problem, the Borrower will advance a portion of the local contribution to the two local accounts. This is a condition of Effectiveness. 7. Financial Performance A financial evaluation of BVK and SVK was carried out to analyze the key challenges the companies are facing, their financial structure, operational efficiency, and long-term viability, with particular attention to their ability to assume the proposed loan and to contribute financially to the project-related expenses. The financial evaluation also analyzed the main financial risk factors that could affect the capacity of BVK and SVK to continue operations and implement the project. The summary is contained in Annex 5 of the PAD and details are in the project files. The poor financial perfornance are related to several factors, among them: (i) Low tariffs and very high tariff differentials, (ii) low collection of water fees and minimal cash collection; and (iii) low metering, very high water leakage and wastage and high operating costs. It is important to note that the financial analysis is speculative in that much of the required data either are nonexistent or in conflict when different sources are compared; the manual accounting systems are inconsistent and prone with errors; and the transition of vodokanals in Uzbekistan to international accounting standards has not been complete, which will be in effect from January 1, this is expected to be completed by the Operator. The financial and accounting procedures of the companies will require major improvements through the Operator's directed efforts and the installation of new financial management and accounting systems and procedures. The present financial assessment was based on the limited information available as prepared by BVK and SVK accounting staff with the support of international consultants. 8. Auditing Arrangements Audit Arrangaements. The PCU, with the support of the Operator, would be responsible for ensuring that the Project financial statement, Special Accounts (SA), and Statement of Expenditures (SOEs) are audited by an independent auditor, acceptable to the Bank, in accordance with International Auditing Standards (IAS). The PCU will maintain responsibility for the management of project funds and the Special Account. They will monitor and keep track of the use of funds. The audit will cover all funds related to the project, including counterpart funds, for all project components. The annual audit will be carried out in accordance with the Guidelines for Financial Reporting and Auditing of Projects Financed by the World Bank. The audited financial statements, the special accounts, and SOEs of the preceding fiscal year will be sent to the Bank within six months of the end of the fiscal year. Appointment of the independent auditors will be a condition of effectiveness. In addition, the financial statements of both BVK and SVK will be audited and sent to the Bank along with the project audit. 9. Disbursements Disbursements. Disbursements from the Loan will be made based on traditional disbursement methods (i.e., from the Special Account with reimbursements made based on Statements of Expenditures (SOEs) and full documentation, and direct payments from the Loan Account). The proceeds of the World Bank loan will be allocated in accordance with Table C of Annex