FOR OFFICIAL USE ONLY

Transcription

1 Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY Report No: AZ Public Disclosure Authorized PROJECT APPRAISAL DOCUMENT ON A PROPOSED LOAN Public Disclosure Authorized IN THE AMOUNT OF US$200 MILLION TO THE REPUBLIC OF AZERBAIJAN FOR A HIGHWAY 2 PROJECT Public Disclosure Authorized Infrastructure and Energy Department Europe and Central Asia Region December 20,2005 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

2 CURRENCY EQUIVALENTS (Exchange Rate Effective November 2005) Currency Unit = Manat 1 Manat = US$ US$l = 4,600 Manat = 0.92 New Manat FISCAL YEAR January 1 - December 31 ABBREVIATIONS AND ACRONYMS ADB AZM CAS CPAR CPS CQS EA EBRD ECA EIA EIF2R EMF EMP ESS EU FB S FMRs FSL GDP GIS GNI HDM IBA IBRD IC ICB IDA IFC IFIs IMF ISDS ITQ LAD LCS MoF Asian Development Bank Azerbaijan Manat Country Assistance Strategy Country Procurement Assessment Report Country Partnership Strategy Consultant s Qualifications Selection Environmental Assessment European Bank for Reconstruction and Development Europe and Central Asia Environmental Impact Assessment Economic Internal Rate of Return Environmental Management Framework Environmental Management Plan Ecology and Safety Sector in RTSD European Union Fixed Budget Selection Financial Monitoring Reports Fixed-Spread Loan Gross Domestic Product Geographical Information System Gross National Income Highway Design Model Important Bird Area International Bank for Reconstruction and Development Individual Consultant International Competitive Bidding International Development Association International Finance Corporation International Financial Institutions International Monetary Fund Integrated Safeguard Data Sheet Invitation To Quote Land Acquisition Department Least Cost Selection Ministry of Finance MOT MW NCB NPV OED OPEC PAD PAP PCN PDO PIC PID PIU PMS PRSC RAP RDB RER ROW RPF RTSD RVP QCBS SA SBD SIL S SoE SPA SPPRED TA TOR TRACECA VAT voc VPD Ministry of Transport Minor Works National Competitive Bidding Net Present Value Operations Evaluation Department Organization of Petroleum Exporting Countries Project Appraisal Document Project Affected People Project Concept Note Project Development Objective Public Information Center Project Information Document Project Implementation Unit Pavement Management System Poverty Reduction Support Credit Resettlement Action Plans Road Data Bank Regional Environmental Review Right Of Way Resettlement Policy Framework Road Transport Service Department Regional Vice President Quality and Cost Based Selection Special Account Standards Bidding Documents Specific Investment Loan Shopping Statements of Expenditure State Procurement Agency State Program on Poverty Reduction and Economic Development Technical Assistance Terms of Reference Transport Corridor Europe-Caucasus-Asia Value Added Tax Vehicle Operating Costs Vehicle Per Day Vice President: Country Director: Sector Manager: Task Team Leader: Shigeo Katsu, ECAVP D-M Dowsett-Coirolo, ECCU3 Motoo Konishi, ECSIE Olivier Le Ber, ECSIE

3 AZERBAIJAN Highway 2 CONTENTS Page A. STRATEGIC CONTEXT AND RATIONALE Country and sector issues... 1 Rationale for Bank involvement... 4 Higher level objectives to which the project contributes... 5 B. PROJECT DESCRIPTION Lending instrument Program objective and phases... 6 Project development objective and key indicators... 7 Project components Lessons learned and reflected in the project design Alternatives considered and reasons for rejection 10 C. IMPLEMENTATION Partnership arrangements Institutional and implementation arrangements Monitoring and evaluation of outcomes/results., Sustainablllty Critical risks and possible controversial aspects Loadcredit conditions and covenants D. APPRAISAL SUMMARY Economic and financial analyses Technical Fiduciary Social Environment Safeguard policies Policy Exceptions and Readiness This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

4 FOR OFFIcI[AE USE ONLY

5 Annex 1: Country and Sector or Program Background Annex 2: Major Related Projects Financed by the Bank and/or other Agencies Annex 3: Results Framework and Monitoring Annex 4: Detailed Project Description Annex 5: Project Costs Annex 6: Implementation Arrangements Annex 7: Financial Management and Disbursement Arrangements Annex 8: Procurement Arrangements Annex 9: Economic and Financial Analysis Annex 10: Safeguard Policy Issues Annex 11: Project Preparation and Supervision Annex 12: Documents in the Project File Annex 13: Statement of Loans and Credits Annex 14: Country at a Glance Annex 15: Maps... 69

6 Date: December 20,2005 Country Director: D-M Dowsett-Coirolo Sector ManagedDirector: Motoo Konishi Project ID: PO94488 Lending Instrument: Specific Investment Loan AZERBAIJAN HIGHWAY 2 PROJECT APPRAISAL DOCUMENT EUROPE AND CENTRAL ASIA ECSIE Pro-ject Financing Data [XI Loan [ ] Credit [ ] Grant [ ] Guarantee [ ] Other: Team Leader: Olivier P. Le Ber Sectors: Roads and highways (1 00%) Themes: Infrastructure services for private sector development (P);Administrative and civil service reform (S);Trade facilitation and market access (S) Environmental screening category: Full Assessment Safeguard screening category: Requires framework Source BORROWER INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT Total: Local Foreign Total Borrower: Republic of Azerbaijan Azerbaijan Responsible Agency: Road Transport Service Department (RTSD) 72/4, U. Hachibeyov St Baku, Azerbaijan Tel: ( ) Fax: ( ) nn-ynsd@azeronhe.com

7 Does the project depart from the CAS in content or other significant respects? [ ]Yes [XINO Re$ PAD A.3 Does the project require any exceptions from Bank policies? Re$ PAD D. 7 [ ]Yes [XINO Have these been approved by Bank management? [ ]Yes [ IN0 Is approval for any policy exception sought from the Board? [ ]Yes [ ]No Does the project include any critical risks rated substantial or high? [XIYes [ ]No Re$ PAD C.5 Does the project meet the Regional criteria for readiness for implementation? [XIYes [ ]No Re$ PAD D. 7 Project development objective Re$ PAD B.2, Technical Annex 3 The main project development objective is to reduce road transport costs and improve access, transit and road safety within Azerbaijan s East-West and North-South corridors, through upgrading some sections of the Alat-Masalli road of the Baku-Iran highway (M3) and rehabilitating the Baku-Shamakhi road (M4). Project description [one-sentence summary of each component] Re$ PAD B.3.a, Technical Annex 4 Component 1 : Upgrade of some sections of the M3 highway between Alat and Masalli and Rehabilitation of the existing M4 road Baku-Shamakhi as well as some access roads. Component 2: Provision of technical assistance, training and goods to support MOT S and RTSD s strengthening, RTSD road maintenance capacity and project implementation. Which safeguard policies are triggered, if any? Re$ PAD D. 6, Technical Annex 10 Environmental Assessment (OP/BP/GP 4.0 1) Natural Habitats (OP/BP 4.04) Cultural Property (OPN , being revised as OP 4.1 1) Involuntary Resettlement (OP/BP 4.12) Significant, non-standard conditions, if any, for: Re$ PAD C. 7 Board presentation: None Loan effectiveness: (i) Approval by RTSD of the operational manual, satisfactory to the Bank; and, (ii) The Borrower has opened a Project Account for the Project, in a bank on terms and conditions acceptable to the Bank, with an initial deposit of 1.5 million New Manat.

8 Covenants applicable to project implementation: (i) The Environmental Management Framework (EMF) and the Environmental Management Plan (EMP) for the 22 km section south of Alat of the first year program as well as other EMPs prepared later in accordance to the EMF are implemented by RTSD during the project; (ii) The Resettlement Policy Framework (RPF) and the Land Acquisition Plans and Resettlement Action Plans prepared later in accordance to the RPF are implemented by RTSD during the project; (iii) The selection of connecting roads will meet the following economic criteria depending of annual average daily traffic: (a) above 250 vehicles, have an economic rate of return of at least 12%; (b) between 150 and 250 vehicles, have an economic rate of return of at least 10%; and (c) below 150 vehicles, have an economic rate of return of at least 8%, all to be calculated in accordance with a methodology acceptable to the Bank; and, (iv) The use of standards recommended by the European Committee for Standardization on design and construction of roads and highways (in addition to the national standards) will be permitted in the design and construction of road works under the Project.

9

10 A. STRATEGIC CONTEXT AND RATIONALE 1. Country and sector issues Azerbaijan stands on the verge of a major oil boom and an important economic transition. Over the past few years Azerbaijan has put into place both the infrastructure needed to realize rapid growth in oil and gas exports as well as a credible framework to effectively manage the increase in resource flows. With the oil boom expected to last maybe 15 years only, the challenge ahead is for Azerbaijan to ensure growth in the non-oil economy and a sustainable reduction in poverty. In the coming years it will be essential for Azerbaijan to maintain its fiscal discipline to avoid inflation and Dutch disease, while at the same time investing in the non-oil economy and broadening participation in economic growth by rebuilding crucial infrastructure and removing barriers for doing business. With the location of Baku as the only major city at the Caspian Sea, Azerbaijan has a unique opportunity to become a prosperous transit hub for energy and goods flowing along the East-West and North-South corridors at the crossroads between Europe and Asia. The non-oil economy is developing rapidly, with average growth of 13 percent during the last five years, which is faster than the oil sector. At present, 70 percent of GDP and 99 percent of employment comes from the non-oil economy, which has tripled since Although still a low-income country, Azerbaijan will grow rapidly in the years ahead because of the oil and gas resources it is currently developing. Overall GDP is estimated to increase from US$8.5 billion in 2004 to US$22.2 billion in 2008l. This includes revenues from the ACG oil field and the Baku-Tbilisi-Ceyhan (BTC) pipeline, where oil has already started to flow from Azerbaijan in late With the support of the International Monetary Fund (IMF) and the Bank, Azerbaijan has put in place a strong governance framework for managing these oil revenues. In particular, the State Oil Fund (SOFAZ) was established in 1999 as the mechanism to separate commercially oriented resource extraction decisions from prudent public expenditure policies2. The Government has repeatedly demonstrated its commitment to transparent oversight and control over SOFAZ resources and was an early participant in the Extractive Industries Transparency Initiative (EITI). While Azerbaijan s oil and gas resources are considerable, they are also finite, peaking in about six years and then declining rapidly. The most difficult challenge Azerbaijan faces, which is well understood by the Government, is to avoid the path followed by many natural resource rich countries, wherein their citizens derive little benefit from the influx of oil revenues. This requires implementing a policy agenda that leads to poverty reduction and improves incomes as well as equity for current and future generations, while maintaining macroeconomic and financial stability. Continued growth in the non-oil sector will be critical to achieving the objectives of the State Program on Poverty Reduction and Economic Development (SPPRED). While the oil sector will contribute to the majority of GDP growth in the next few years, the magnitude of poverty World Bank, Program Document for a Proposed Poverty Reduction Support Credit to the Republic of Azerbaijan, Annex 111, April The Fund s main objective is to ensure intergenerational equality of benefit with regard to the country s oil wealth, whilst improving the economic well-being of the population today and safeguarding economic security for future generations. The Fund also provides a sterilization mechanism for foreign exchange inflows in order to avoid the Dutch Disease. Audited reports on the Fund s activities are published annually, see 1

11 reduction will be dependent on achieving the projected growth in the non-oil sectors. Azerbaijan has already put into place a number of critical structural reforms to achieve this. In particular, privatization of small businesses and land has largely been completed and the basic legal framework for a market economy has been established including strengthening the policies and institutions for expenditure management and improved service delivery and financial discipline. Well-focused rapid infrastructure improvements, after years of neglect due to fiscal restraint, are crucial for continued non-oil sector growth. The development of infrastructure (in particular utilities, telecom, and transport) is one of the six major strategic pillars of the SPPRED and is critical to further expansion of the non-oil sector and for improving the living standards of the low-income population. Generating jobs and sustainable economic non oil growth is also a priority strategic goal of the CAS and an inadequate transport infrastructure is a major obstacle. Approximately 56 percent of the main road network is in a poor state3 and in need of urgent repair, and about 1,000 kilometers (30 percent) of rail track requires reconstruction. The upgrading of the East-West road corridor (Baku-Ganja-Kazakh-Georgian border through Alat and a more direct route through Shamakhi) and of the North-South road corridor (Russian border-baku-alat-astara-iranian border), and better connections to rural areas are among the most important infrastructure requiring attention. As such, investment in road infrastructure is the main priority outlined in the draft Public Investment Program of Azerbaijan. All sections of the East-West corridor to Georgia are scheduled for upgrade by 2007, with secured funding; while the North-South corridor is to be completed by 2008 (see Map in Annex 15). These investments are part of the government strategy to upgrade its international connections and bring the main network to a maintainable condition, while gradually introducing policies to focus on the sustainability and the quality of road services. Achieving Azerbaijan s potential as a transit economy is essential for non-oil economic development. Azerbaijan s geographical position makes it an important link between the Black and Caspian Seas and between Russia and Iran. There are a number of reasons to expect that the long anticipated regional transit corridor will take off over the next few years. First, the large oil and gas pipeline projects now in place will likely result in increased oil products and equipment trade, as well as build confidence in cooperation between South Caucasus countries. Second, there is the likelihood of two of Azerbaijan s biggest and fastest growing neighbors - Russia and Kazakhstan -joining WTO in Azerbaijan itself has set a target of joining WTO by Third, the recent start of EU accession negotiations with Turkey and the inclusion of the three South Caucasus countries as European Neighborhood Policy (ENP) countries are likely to bring closer trade links within the region and with Europe. Fast paced growth, not just in Azerbaijan, but in neighboring countries is generating strong demand for goods and services. Fourth, Baku, as the only capital city on the Caspian Sea, is well situated to become a competitive logistical trade hub. At present, several companies based in Baku service regional markets by storing and packaging transit goods. In fact, Azerbaijan s non-oil exports are consistently growing at more The Azeri road network (excluding Nakhchivan and Nagomo-Karabakh) comprises 18,437 km of road, which divides into 958 km of major arterial ( magistral ) roads, 1,216 km of minor arterial ( republican ) roads, and 4,312 km of collector roads. The remaining part of RTSD network consists of local roads. Half of the total network is paved, and much is in a poor state of disrepair with three-quarters in need of rehabilitation. Only 19 1 km are four-lane highways. 2

12 than 25 percent p.a., and transport infrastructure needs urgently to keep up with these developments. Given the small size of domestic markets, and enhanced trade potential with its neighbors, trade infrastructure is therefore an important and growing feature of the Azeri economy. Bank studies project a dramatic rise in transit cargo volumes, in line with oil and non-oil related investments. With much of the non-oil trade being small sized shipments transported by road to neighboring countries, access to international markets requires the provision of suitable road transport infrastructure on corridors ready to meet mid-term strong traffic increase rather than the presently narrow, low quality roads. The proposed project would focus on upgrading key sections of the Baku-Alat-Astara road of the Baku-Iran highway (M3) and rehabilitating the 2nd category road (M4) linking Baku to Shamakhi (see Map in Annex 15). The former, with a length of 230 km, would be widened to four lanes in line with modern standards, mostly along a new alignment which will shorten it by about 30 km and bypass the main cities, as well as improve overall traffic safety. The Bank project will finance works on the first 136 km of the Alat-Astara road section, while the Asian Development Bank (ADB) will finance the upgrading of the 60 km between Masalli and Astara. The latter is a section of the shortest way from Baku to Georgia and to western Azerbaijan. This road, which winds in the mountains for 124 km, needs to be repaired urgently, both for the economic revitalization of the region and for safety reasons. The proposed project also offers an opportunity to further modernize the sector, through enhanced design of roads and improved maintenance planning. In 2004, the total vehicle fleet was 517,0004 and is currently rising: 22,000 vehicles were imported in 2003 and 37,000 in This trend should gain further momentum following the strong growth of the GDP, as the middle class should widen and get broad access to car property. Traffic on the Baku to Astara road is currently about 10,000 vehicles per day (vpd) between Baku and Alat, falling to around 6,000 vpd after Alat and then ranging between 3,000 to 5,000 vpd near the Iranian border. Considering the expected tremendous growth of the economy (and thereafter of the road traffic) and the current low ratio of vehicle per inhabitant, it is necessary to start now the modernization of the road network as traffic is expected to grow fast and to reach much higher values by the time the road modernization program is completed. Another set of important sector issues are related to the institutional development needed to accompany the modernization of the road network. The Government, with the support of the International Financing Institutions (IFIs) involved in sector financing, is addressing three key sector issues: (i) the legal and institutional organization of the transport sector; (ii) the technical and economic quality of expenditures on roads, and (iii) the medium and long-term financial sustainability of the investments in the network. The Ministry of Transport (MOT), organized following the recommendations of an EU funded study, was created only two years ago and its authority on the sector's legal, policy and financing decisions is still evolving. The division of responsibilities between the Ministry, as a normative institution, and the executing agencies in each mode, remains to be clearly defined and adopted. Under the ongoing IDA-financed 49 passenger private car per 1,000 inhabitants, which is very low by comparison with European norms. It was 35 in 1995, 39 in 1999 and 43 in

13 Highway Project, the Government developed a comprehensive business plan including the establishment of a client-supplier relationship between MOT and the also newly created Road Transport Service Department (RTSD). This relationship will be formalized through Service Agreements supported under a recently approved European Bank for Reconstruction and Development (EBRD) project, which also intends to enhance sector governance through the creation of a Road Advisory Board. The institutional aspects of the proposed project will mainly focus on (i) ensuring RTSD s capacity to gradually improve its road manager role, developing construction and maintenance design standards, road data gathering, and planning and programming road investments and maintenance on the basis of sound economic and technical criteria; and (ii) developing MOT S monitoring capacity through the provision of data sharing mechanisms to monitor the road network performance. In addition, the project will contribute to the modernization of the sector legal framework through the drafting and adoption of a new Road Transport Law which, interalia, clearly incorporates the rights and obligations of the users, establishes the responsibilities of the different government entities involved in the sector, revises and modernizes the classification of the network and allows for the option of toll charges. 2. Rationale for Bank involvement Transport has been a sector in which the World Bank has been heavily involved in Azerbaijan to date through both investments in the road infrastructure and assistance on transport policy. The current Highway Project (started in 2001 and due to close in 2007) has enabled Azerbaijan to rehabilitate parts of the main East-West highway and started strengthening and reorganizing roads maintenance. The involvement of the Bank was able to help the Government achieve both high quality and considerable savings in the design and contracting of works. Just as importantly, the Bank has helped to establish MOT, strengthen RTSD and to enable MOT to complete a prioritized five-year rolling budget. This loan will build upon the Bank s past involvement and address some of the remaining policy and investment gaps in the road sector. The Government has decided to implement an investment program of approximately US$1,500 million to rehabilitate and reinforce major transit highways and secondary roads over the next 10 years. It has requested the Bank to take a leading role and a very significant share of this program5 to meet the urgent need to upgrade the network as instructed by a Presidential Decree under very tight deadlines. Accordingly, the Bank will concentrate in this phase of our involvement on the highways M3, part of the North-South corridor linking Russia, Azerbaijan and Iran and M4, part of the East-West corridor linking Georgia and Azerbaijan. The Government s key rationale for the Bank s involvement goes beyond financing and rests with our ability to provide the necessary project management capacity, best practice safeguard measures in order to mitigate social and environmental impact, critical design issues, transparent procurement procedures, as well as policy and institutional support. As a best practice, the project preparation included the development of a Regional Environmental Review (RER), an Environmental Management Framework (EMF) and a Resettlement Policy Framework (RPF) covering the entire scope of the project. The project will The Government also has indications of financial support (EBRD, ADB, Islamic Development Bank, some bilaterals and private banks) for about US$ million. 4

14 also provide a mechanism to support the Government s development of a sound Road Transport Law, a Road Data Bank, and the preparation of improved targets for road maintenance. This involvement is particularly important to help Azerbaijan avoid wasting its increasing wealth, and setting the framework for sustainable non-oil economic growth. 3. Higher level objectives to which the project contributes Improvement of transportation infrastructure has been a central element of the latest Country Assistance Strategy (CAS) for Azerbaijan and of the country s PRSP (SPPRED), and it will also feature prominently in the new Country Partnership Strategy (CPS) which is currently under preparation. The FY03-05 CAS, approved by the Board on April 29, 2003 (Report No AZ) identifies improving the quality and capacity of Azerbaijan s transportation infrastructure as a critical component of two of the CAS four strategic goals: Generating Jobs and Sustainable Non-oil Growth and Improving Social Services and Infrastructure. The CAS emphasized Azerbaijan s need for much improved infrastructure to cope with the fast growing economy and recommended a balanced combination of policy based assistance, investment projects (including transport infrastructure following on the ongoing Highway Project), institution building and technical assistance, as well as Economic and Sector Work through a South Caucasus Trade and Transport Facilitation Study. The CAS also authorized the transition to the status of blend country, eligible to receive IBRD loans; Azerbaijan s first IBRD loan was made in FY05, for a Power Transmission Project. While the proposed project was not specifically foreseen in the CAS, it is fully in keeping with the CAS objectives. The Second Progress Report of the SPPRED in 2005 also underlines the importance of investments in the transport sector and the Bank and IMF in their Joint Staff Advisory Note (JSAN) emphasized the importance that such investments are made in a transparent, prioritized manner. Finally, the PRSC-I in support of the SPPRED, approved in May 2005, also supported the development of a modern well managed transport sector. The importance of infrastructure development, including the proposed Highway 2 Project, will be highlighted as well in the new CPS for FY06-09, which is under development and expected to be discussed by the Board in the current fiscal year. The Highway 2 Project is being brought in advance of the new CPS in order to take fill advantage of this year s construction season and the readiness of the Government to move forward. Improving infrastructure services remains an essential component of Azerbaijan s strategy to promote sustainable non-oil growth and to develop its potential as a transit economy. Project design also addresses good safeguard, technical and institutional foundations. The new Highway 2 Project will generate additional employment and economic benefits by serving as a transit corridor for trade to Central Asia and other neighboring countries. It will also enhance the effectiveness of other key Bank activities. The Bank and the IFC have a series of projects aimed at improving rural development and business development. The highway corridor will be a central element in linking rural areas and businesses to markets. Other activities such as irrigation, water supply and power transmission will also provide critical inputs to increase the earnings capacity at farms and businesses which again will increase demand for an improved highway sector. Finally, the Bank will continue to engage the Government of Azerbaijan on a wide range of macro-economic, structural, social and governance issues. The Bank s engagement is seen as critical to establishing and implementing the broad framework that will build a sustainable non-oil economy, 5

15 B. PROJECT DESCRIPTION 1. Lending instrument The lending instrument proposed for this project is a Specific Investment Loan (SIL). The Loan type is a dollar denominated fixed-spread loan (FSL) with repayments linked to commitment and with a 20 year maturity, including an 8 year grace period. 2. Program objective and phases The Government asked the Bank to concentrate on the modernization of the highways M3 Alat- Masalli (about 136 km), and M 4 Baku-Shamakhi, (124 km) which are part of the country s arterial road network. The project, following an integrated network approach, will also include the upgrading of about 120 km of access roads to the Alat-Masalli and Baku-Shamakhi roads. The estimated total cost of the modernization of these two roads and their accesses is about US$ 400 million, for which a phased approach is envisioned. The operation is divided into two projects, with the second loan being expected to be approved as a repeater or through Additional Financing for Investment Lending (as reflected in the revised OP/BP 13.20) if the Bank is satisfied with the performance of the first project and when funds under the first project are fully committed. This phasing would allow a seamless implementation while definitely being financially more advantageous for the Government as it would limit the commitment fee paid by the Government on the undisbursed amount. The whole program is conceived as follows: 0 Upgrade the M3 highway between Alat and Masalli (about 136 km), including expansion of the existing 2 lane roadway to a 4 lane roadway under a mostly new alignment; and the construction of bypasses around key towns. Estimated cost: US$ 280 million (US$l50 million included in the first project)6. 0 Rehabilitation of the M4 road Baku-Shamakhi, a 124 km section of the much traveled road to the good farming areas West of Baku. Estimated cost: US$80 million (filly financed under the first project). 0 Improvement of about 120 km of access roads. Estimated cost: US$ 5 million (fully financed under the first project). 0 Provision of technical assistance (TA) and goods to support development of the sector s legal framework, strengthening of MOT and RTSD and project design, implementation and supervision of which US$13 million are included in the first project. 0 Land acquisition (about 800 hectares) and resettlement for the M3 highway between Alat and Masalli. Estimated cost: US$ 15 million (fully financed by the Government). Regarding the Alat-Masalli road, a first section of 22 km about 5 km south of Alat between PK 80 and PK 102 has been identified for immediate upgrading. A four-lane carriageway would be constructed in that section within the existing right of way, which is free of encroachment (i.e. no land acquisition or resettlement) and without major environmental issues. Detailed design and This motonvay upgrade is expected to be divided in several sections of about 25 km each corresponding to contracts of up to US$50 million each. The first tranche would finance the first 3-4 contracts and the second tranche the remaining contracts. 6

16 bidding documents have already been prepared. For the rest of the road, only the preliminary design is available, the alternative analysis is ongoing and processing guidelines regarding environmental and social issues have been developed7. On this basis, the project will be divided in sections and for each section the best alternative will be selected and detailed design (financed by this project) will be prepared. This will include appropriate specific Environmental Assessments, Environmental Management Plans and Land Acquisition PlardResettlement Action Plans with adequate disclosure. Regarding the rehabilitation of the Baku-Shamakhi road, the preliminary design is available and the detailed design is ongoing. It is expected that the first package of bidding documents would be ready by the second half of The Project, in coordination with other donors (EBRD and ADB) will also support a comprehensive program aiming at strengthening RTSD road maintenance and institutional capacity. The institutional assessment carried out by the Finnish consultants under the ongoing Highway Project identified the need to: (i) improve the organizational structure of the Maintenance Department in RTSD; (ii) streamline work procedures; (iii) gradually change the Department s culture to empower middle level ranks to make decisions; and (iv) develop the planning and programming capacity to create long term work programs for the road network based on actual needs. The proposed project will support the government s efforts to gradually move RTSD towards a more commercial vision for road management, while acknowledging the difficulties of replacing long established traditions. As a first step, the project will finance the mainstreaming of basic planning and programming tools leading in order to build RSTD s capacity to prepare multi-year road maintenance programs based on actual needs and sound technical and economic foundations. A dated Action Plan was agreed with the government and is detailed in Annex Project development objective and key indicators The main project development objective is to reduce road transport costs and improve access, transit and road safety within Azerbaijan s East-West and North-South corridors, through upgrading some sections of the Alat-Masalli road of the Baku-Iran highway (M3) and rehabilitating the Baku-Shamakhi road (M4). For road users, the project would lead to better road quality and level of serviceability, avoiding or deferring costly congestions expected on the basis of mid-term traffic projections, better road safety through new alignments and city bypasses, avoiding hazardous crossing of urban areas by heavy transit traffic, and savings derived from shorter travel times. A RER has been prepared covering the entire scope of the project. The RER describes the existing environment, discusses and compares project alternatives and identifies risks and issues to be addressed during project implementation. An EMF has also been developed that outlines the procedures for the screening and management of environmental issues related to Category A and B sub-projects. Similarly, a RPF outlines the procedures to prepare the Resettlement Action Plans (RAP) developed once exact road alignments are determined and civil works are identified. * The rehabilitation is done within the existing right of way which is free of encroachment (Le. no land acquisition or resettlement) and without major environmental issues. 7

17 In view of the massive road investment and maintenance program, it is expected that the strengthening of the road administration will allow a more efficient use of the resources allocated to the sector. In particular, the project institutional component i s based on the premise that sector agencies should get ready for the gradual shift of emphasis from modernization to maintenance of the network and focuses on setting the basis for sound maintenance budgeting, planning, programming and implementation. Key Indicators. Project performance would be assessed through a number of qualitative assessments and quantitative indicators. The specified indicators would be regularly monitored and evaluated by MoF, MOT, RTSD and the PIU. The proposed indicators to be used to assess project performance are detailed in Annex 3 and include: Project Outcome Indicators 0 Reduction in transit timehehicle operating cost from Alat to Masalli 0 Reduction in transit timehehicle operating cost from Baku to Shamakhi 0 Reduction in number of road accidents in the project roads Intermediate Outcome Indicators 0 Number of km upgraded for Alat-Masalli 0 Number of km rehabilitated for Baku-Shamakhi 0 Preparation of the revised Road Transport Law 0 Number of km of road data introduced in the Road Data Bank (RDB) 0 Preparation of new geometric and structural design standards 0 Preparation of the new norms (for maintenance by technical road classes) 4. Project components Component 1: Upgrade of some sections of the M3 highway between Alat and Masalli and Rehabilitation of the existing M4 road Baku-Shamakhi as well as key access roads (US$259 million): This component comprises the civil works for these two roads and key access roads as well as the consultancy services for the alternative analysis of Alat-Astara, engineering design, environmental and social studies of Alat-Masalli and the supervision of the works. Land acquisition and resettlement costs required for the 136 km alignment of the Alat- Masalli road (about 800 hectares) would be solely financed by the Government. 0 M3 highway between Alat and Masalli: the project will finance the upgrade of about km of the M3 highway between Alat and Masalli, including expansion of the existing two-lane roadway to a four-lane roadway under a mostly new alignment; and the construction of bypasses around selected towns. 0 M4 highway between Baku and Shamakhi: the project will finance the rehabilitation within the existing right of way of the Baku-Shamakhi road, a 124 km section of the much traveled road to the good farming areas West of Baku. Improvement of about 120 km of access roads: the project will finance the upgrade of about 120 km of access roads connecting to the M3 highway between Alat and Masalli, and connecting to the Baku-Shamakhi road to enhance accessibility from villages nearby. 8

18 Component 2: Provision of technical assistance, training and goods to support MOT S and RTSD s strengthening, RTSD road maintenance capacity and project implementation (US$5.375 million): This component comprises specialized consultancy studies, technical assistance, training, services, and equipment as needed to support MOT and RTSD strengthening and project implementation. The loan will also finance basic equipment (and spare parts) to support the agreed increased level of routine maintenance since the existing equipment is mostly obsolete and/or in a state of disrepair that results in low levels of availability. The estimated total cost of the equipment is US$1 million. Regarding the TA, the component would build on the comprehensive TA program of the ongoing Bank-financed Highway Project, respond to new issues, and be coordinated with the institution and capacity building programs of the ADB and EBRD loans and would include: Updating and modernization of the Road Law. Improving and expanding the computer systems in MOT, RTSD, and (during the second tranche) RTSD s Regional Offices. Completing the Road Data Bank. Establishing technical road classes superimposed on the functional road classification. Including: a. Review and update geometric and structural design standards to replace the existing Soviet era standards. These standards would be specific to technical and functional road classes. b. Development of road condition norms for each technical class. Developing a model for the Service Agreement between RTSD and its Regional Offices. Developing the capacity of the Ecology and Safety Sector (ESS) and the Land Acquisition Department (LAD) in RTSD for environmental and resettlement issues, including possible use of a Geographical Information System (GIS) to manage environmental and social impacts. The training component will include: (i) consultant services to train RTSD staff in the use of the HDM model for the preparation of multi-year road investment and maintenance programs; and (ii) study tours to familiarize officials of MOT and RTSD on current best practices in the area of road management. In addition, the component will include resources to fund a Workshop to be hosted by the Ministry of Finance (MoF) to exchange ideas with officials from developed and developing countries on current thinking and experiences for the financing of road investments and maintenance. Project implementation: the component will fund consultant services for the PIU and will comprise the following equipment and TA to support implementation of the project: office computers, software, office equipment/furniture, training and seminars, financial management TA, and project financial audits. 5. Lessons learned and reflected in the project design The Bank s experience with its highway portfolio in general, and that of the Caucasus and Central Asian countries in particular, highlights a high level of client satisfaction with investment 9

19 components that have contributed to the fulfillment of many of the sector and macroeconomic objectives of the Bank s assistance strategy. Nevertheless, institutional initiatives contained in those projects have sometimes resulted in outcomes below original expectations. The Bank Operation Evaluation Department (OED) has found in many of its reports that limited institutional capacity and the sometimes hastened pace to introduce new approaches to the existing institutional culture have been detrimental to the policy agenda. The following lessons from similar projects in the sector and in the region are reflected in the design of the current project. Ensure client ownership of the institutional components. RTSD has built on its experience under the ongoing Highway Project to determine the priorities of the institutional strengthening components. As a result, the project will build on the ongoing project and continue the efforts to advance road management techniques through the improvement of data collection and the upgrading of design standards, an area in which the government has started work and has shown strong commitment. Keep the level of project difficulty in line with the local institutional capacity. The project comprises very few and well-defined project components, including the strengthening of the PIU to ensure smooth project management and the continuation of efforts in road maintenance and design that are being successfully undertaken in the ongoing Highway Project. The scope and size of the component replicates the ongoing experience, which has a proven record of fitting the local absorptive capacity. Avoid giving sole priority to the construction of major thoroughfares. While the completion and upgrading of the main highway network is an undeniable priority of the country s strategic development, a budget heavily skewed towards major construction projects affects the attention of the existing roads and the capacity to improve road accessibility to the poorer segments of the economy. The proposed project balances the need to upgrade one of the main arterial roads of the country (M3) with the improvement of the existing secondary network (M4 road Baku- Shamakhi), the upgrading of access roads to incorporate an integrated network intervention, and the development of the capacity to plan and implement multiyear road maintenance programs to ensure long term sustainability of the primary, secondary and rural roads. Avoid design changes and variations during construction. Because the technical complexity of highway construction is many times underestimated, many projects of this type experience substantial cost overruns and construction delays. To address these risks, RTSD is implementing a phased approach to road construction, with each phase to be supported by an interactive process in designing alignment alternatives, assessing technical, environmental and social impacts, and cross-validating design results with engineering firms and other experts. 6. Alternatives considered and reasons for rejection Various alternatives, technical and financial have been considered for this project. Various alignments have been analyzed by the consultants and a multi criteria analysis incorporating cost, environmental impact, land availability, access to local villages, and travel 10

20 time has been carried out to determine the best alignment and phasing of the works. In particular, it has been concluded that because of the numerous settlements along the southern part of the existing highway, it was not possible to retain and modernize the existing alignment. Also in view of the rapid traffic growth, it was decided to build a four-lane motonvay immediately as usually a time phased approach (building two lanes and expanding later to four lanes) is economically sound only if the expansion to four lanes is done ten years or more after the completion of the first phase. A toll motonvay (with or without private financing) has also been considered but has been rejected because of lack of adequate legislation. Moreover the Government felt that with the lack of experience and precedent in the country, such approach was unnecessarily risky and could have delayed the process. However the road is designed in such a way (limited number of interchanges) that it could be possible later on to introduce a tolling system. As already mentioned, only the detailed design of the first section of 22 km about 5 km south of Alat is available, while the detailed design of the rest of the road will be financed by the project and will take 12 to 18 months to complete. A possibility would have been to wait for the completion of this design before appraising the project but this would have postponed by more than a year the start of the works on the first section. A more client oriented approach has been selected, appraising the whole project in principle and establishing adequate guidelines for the finalization of the alignment, particularly in terms of environmental and social requirements as prescribed in the RER, the Environmental EMF and the RPF. C. IMPLEMENTATION 1. Partnership arrangements There is a coordinated approach of donors in the transport sector in Azerbaijan, and the process of informal consultation will continue under the proposed project. In particular, key elements of the institutional strengthening program will be implemented under an EBRD loan (mostly topdown initiatives), and will be complemented by the bottom-up measures envisaged under the proposed loan. Also, because ADB will finance a section of the M3 road contiguous to the project-financed Alat-Masalli section, coordination will be needed in terms of unifying the alignment selection and ensuring consistent environmental management approaches, To that end, it was agreed that the Government would carry out under Bank financing the feasibility study of the whole M3 road, while each institution will participate in the preparation of the final designs of the road sections it finances. ADB is also preparing, with input from the World Bank and others, a Transport Sector Review that is expected to provide a basis for continued investment, policy, and institutional planning in a coordinated manner. 2. Institutional and implementation arrangements The Loan Agreement will be established between the Bank and the Republic of Azerbaijan. The project will be implemented by RTSD with the assistance of a PIU. The PIU has already been established to implement the Highway Project (Credit AZ-3517) and will also assist RTSD in the implementation of this project. The PIU is administratively under RTSD within MOT. The 11

21 preparation and supervision of this project under the proposed schedule is very challenging and will definitely require a strong implementation capacity of RTSD and the PIU. After discussion with RTSD it was proposed to increase the number of staff of the PIU from 5 to 11 staffg. The hiring process is ongoing and some of the positions have already been filled. The PIU has the overall responsibility for project implementation and coordination, including planning, procurement, disbursement of funds, monitoring the use of funds, auditing arrangements, monitoring and evaluation, and reporting on the progress of implementation and use of project funds in close cooperation with RTSD and MOT. The PIU prepared a draft operational manual. The manual inter alia clarifies: (i) the organization of the PIU; (ii) the mandate and powers delegated to the PIU; (iii) the procurement procedures; (iv) the financial management and disbursement procedures; and (v) the guidelines related to the implementation of the project, in particular for the phasing, environmental and social issues. The approval of the operational manual by RTSD is a condition of effectiveness. It is expected that the PIU will also assist RTSD in the implementation of ADB project which is currently being negotiated. 3. Monitoring and evaluation of outcomedresults Project monitoring during the course of project implementation will be carried out by the PIU staff, with the assistance and guidance provided by RTSD, under close supervision' from MOT and MoF. This would entail close supervision of the works and TA to RTSD, auditing of financial statements, and monitoring project performance indicators for the duration of the project (per agreed indicators - Annex 3). Indicators will be important to ensure a timely completion of the project and flag any time delays. In view of the selected indicators, data collection should not be a major problem and therefore no capacity issue is foreseen. Project progress reports will be prepared by the PIU on a quarterly basis and submitted to the Bank's review. The progress reports will focus on results rather than providing process related information. 4. Sustainability Sustainability for Azerbaijan is expected to come from good returns on investments through the strong growth of the traffic on the concerned roads, the decrease in fatal injury thanks to bypasses of cities and better safety standards, and most importantly, on the efforts under the project to ensure sound maintenance practices. Considering that the project addresses the main arterial sections of key international routes, it has assured a high level of priority in any future road rehabilitation and maintenance program, thus guaranteeing the high level of serviceability needed to attain the expected project benefits. The technical assistance component of the project will build on the ongoing Highway Project and continue the efforts to advance road management techniques through the improvement of data 1 director; 3 engineers; 2 procurement specialists; 1 financial specialist; 2 secretariesitranslators; 2 drivers. 12

22 collection and the upgrading of design standards, an area in which the government has started work and has shown strong commitment. The building up of RTSD under the ongoing project with a cadre of young and enthusiastic professionals willing to bring to the road institution new ideas and best practices from similar road agencies in the world, is a trend likely to continue and probably to expand in the near future. 5. Critical risks and possible controversial aspects The following issues have been identified as critical risks. Whenever possible, mitigation measures have been identified and the Bank supervision missions will pay particular attention to them. Weak institutional capacity. The preparation and implementation of this project under the proposed schedule is very challenging and will definitely require strengthening the implementation capacity of RTSD and the current PIU. After discussion with RTSD the risk of insufficient capacities has been addressed through the proposed increase in the number of staff of the PIU to 11 people. Adequate training should be provided to RTSD and PIU in terms of project management and procurement. Land Acquisition. The proposed project will imply the acquisition of about 816 hectares of land along the 136 km alignment. This process, to be efficient, will require the establishment of a proper organization. This is particularly important because, while the existing Azeri laws on land acquisition are sound, RTSD does not have experience in land acquisitions of the size expected under the project. RTSD already established a specialized unit, the Land Acquisition Department (LAD), to deal with the resettlement that will take place during the project, and has gradually increased the number of its staff. During project implementation TA will provide, hands-on support to LAD whose staff is not familiar with international practice of resettlement and Bank safeguard policies. The design consultant will prepare an exhaustive list of all the parcels of land to be acquired, with description, area and name of owners, so as to ease the work of the Land Committee, which comprises representatives of the affected households and local government officials and is in charge of determining the terms of compensation for land acquisition. The Government/RTSD have instructed all the Rayons affected by the project to stop land privatization in the areas affected by the project to avoid having to buy back lands just privatized. Environment. The section of highway between Shorsulu and Masalli routes through a wetlands area that is a potential Ramsar site and Important Bird Areas (IBAs). There is currently limited available information on the ecology of this area and field studies spanning up to a year would be required to more filly understand the potential environmental impact of construction. The selected alternative may imply a significant conversion of critical natural habitats for which compensatory measures would need to be agreed with the Government. Handlinp of safeguards. The Government might move ahead without proper safeguards management due to the slowness of the Bank. This risk has been mitigated by the innovative approach (development of the RER, EMF and RPF) duly in compliance with Bank safeguards policies. 13

23 Overheating of the economy. The tremendous growth that is expected for the coming years, combined with the implementation of important infrastructure projects, could lead to high inflation, especially in the construction sector which might suffer from a shortage of raw materials, This inflation would primarily affect the poorer people and should thus be closely monitored. Planning and securing in advance the supply and increasing the availability of necessary materials should be a priority. Design consultants will make recommendation regarding quarries and bitumen supply. And the other hand, the construction of the pipeline is finishing and this would free some capacity to handle the surge in the road program. Counterpart funding. Crude oil price fluctuations may impact the ability of Azerbaijan to fund its overall investment program and may result in counterpart funding shortages if oil prices drop significantly. The cofinancing percentage for this loan is defined rather conservatively. Nevertheless, this risk is not perceived so high given the increasing volume of oil exports, as well as the accumulation of excess funds in the State Oil Fund. Road sector budget. Road maintenance in the past was seriously neglected and the current and projected sector expenditures involved substantial allocations for road improvements, with modest funding for maintenance. The rationale is that the network has to be brought up to a maintainable condition, and the maintenance budget should be increased gradually as additional kilometers of roads are rehabilitated or reconstructed. The Government has been increasing maintenance allocations at a high rate (a 40% increase in the last year), although the levels would still be insufficient for taking care of the whole network. Continuous increases in funding as well as efforts to improve the efficiency in the uses of funds will be critical to ensure the sustainability of the current investments. There is a risk of a continuous tendency to fund investments at the expense of maintenance. The risk is mitigated by the agreements under EBRD project for increasing annual funding and by the Bank s technical assistance component which also funds equipment and data collection for the road data bank to improve maintenance efficiency. Sharing the wealth. Even though the GDP is projected to grow rapidly, also indicating high traffic growth rate, it is uncertain that this wealth will be shared with a large segment of the population. Should such sharing not occur, the traffic growth will be less and may reduce the economic impact of the new road towards Iran. The emphasis within the project and the larger transport dialogue to ensure access to a wide portion of the populace to transit services will play an important role in making the benefit of the project widespread. Secondary benefits including the growth of small businesses and jobs are also expected to be enhanced. 6. Loadcredit conditions and covenants The following conditions and covenants were agreed with the Government during negotiation. Conditions for Effectiveness: (i) Approval by RTSD of the operational manual, satisfactory to the Bank; and, (ii) The Borrower has opened a Project Account for the Project, in a bank on terms and conditions acceptable to the Bank, with an initial deposit of 1.5 million New Manat. 14

24 Financial Covenants: (0 Not later than September 1, 2006, the Borrower, through the PIU, shall have appointed an independent auditor under terms of reference acceptable to the Bank. (ii) The Borrower, through the PIU, shall maintain a financial management system, including records and accounts, and prepare financial statements in accordance with consistently applied accounting standards acceptable to the Bank, adequate to reflect the operating resources and expenditures related to the Project. (iii) The Borrower through the PIU, shall prepare and furnish to the Bank quarterly Financial Monitoring Reports (FMRs), in form and substance satisfactory to the Bank. The first FMR shall be furnished to the Bank no later than 45 days after the end of the first calendar quarter after the Effective Date, and shall cover the period from the incurrence of the first expenditure under the Project through the end of such first calendar quarter. Thereafter, each FMR shall be furnished to the Bank no later than 45 days after each subsequent calendar quarter. The Government will replenish on a quarterly basis the Project Account up to the original amount and up to 3 Million New Manat when the authorized allocation will reach US$ 16 million. The Borrower, through the PIU, shall have the project financial statements, SoEs and Special Account audited, by independent auditors acceptable to the Bank, under terms of reference acceptable to the Bank, and have the audit report submitted to the Bank within six months of the end of each calendar year audited. Acceptable auditing standards are International Standards on Auditing (ISA). Project Covenants: The following covenants have been agreed with the Government and RTSD to ensure that the project meets its objective: The Environmental Management Framework (EMF) and the Environmental Management Plan (EMP) for the 22 km section south of Alat of the first year program as well as other EMPs prepared later in accordance to the EMF are implemented by RTSD during the project. The Resettlement Policy Framework (RPF) and the Resettlement Action Plans prepared later in accordance to the RPF are implemented by RTSD during the project. The selection of connecting roads will meet the following economic criteria depending on annual average daily traffic: (a) above 250 vehicles, have an economic rate of return of at least 12%; (b) between 150 and 250 vehicles, have an economic rate of return of at least 10%; and (c) below 150 vehicles, have an economic rate of return of at least 8%, all to be calculated in accordance with a methodology acceptable to the Bank. The use of standards recommended by the European Committee for Standardization on design and construction of roads and highways (in addition to the national standards) will be permitted in the design and construction of road works under the Project. 15

25 D. APPRAISAL SUMMARY 1. Economic and financial analyses Economic (Cost-Benefit) analysis: ERR= 25.7%; NPV= US$308.8 million The economic evaluation covered two project components: the upgrading of the 136 km highway between Alat and Masalli" and the rehabilitation of the 124 km Baku-Shamakhi road. The principal benefits of the project are savings in vehicle operating costs (VOC), time savings for vehicle occupants, and enhanced road safety. The estimated economic internal rate of return (EIRR) for the project is 25.7%. The estimated EIRR for the proposed works on the Alat- Masalli road is 26.6 percent, while the estimated EIRR for the rehabilitation of the Baku- Shamakhi road is 21.3 percent. The overall economic net present value (NPV), based on a 12 percent discount rate, is estimated at US$308.8 million, of which the Alat-Masalli road is contributing US$277.5 million and the Baku-Shamakhi road is expected to contribute US$3 1.3 million. Driven by the surge in oil exports, the Azeri Growth Domestic Product (GDP) should increase tremendously during the next five years: it is expected to double in real terms between 2004 and 2009". Besides, the current level of car ownership in Azerbaijan, at only about 49 cars per 1000 inhabitants is very low compared to similar countries in Eastern Europe. Following the forecast increase in the non-oil Growth National Income per capita'*, the level of car ownership is expected to increase by 75% between 2004 and Given the expected very high rates of economic growth in Azerbaijan, the estimated traffic growth in both roads is substantial, with traffic levels quadrupling over the period. The evaluation results confirm the economic merits of the project. The sensitivity analysis to cost and traffic variations (plus or minus 20%) corroborates the soundness of the proposed investment^'^. A detailed assessment and a description of the method used are provided in Annex Technical The main focus under this project is on modernizing the road network through road improvements. There are no technical issues with the proposed investments. However, the Kura- Talysh area is known for seismic activity with earthquakes registering magnitudes of between 6 and 7 on the Richter scale; the design shall take this constraint in consideration. Design standards for all the investments are well established by reputable consultants and there are plenty of quality contractors to carry out the works. No trial or experimentation is involved and there are no risks related to technology, design or installation, and future maintenance of the roads. lo This section is part of the complete upgrading of the Alat-Astara road (about 200 km), whose cost is estimated at 400 millions. A preliminary economic evaluation of the investments for the entire road Alat-Astara shows an economic internal rate of return of 25.4% for a net present value of US$ million. I' International Development Association, Project Appraisal Document for a Proposed Poverty Reduction Support Credit to the Republic of Azerbaijan, April 19,2005. The non-oil GNI per capita at market price, in real terms, should increase in average by 9.7% per year between 2004 and 2009 (IDA, Project Appraisal Document for a Proposed Poverty Reduction Support Credit to the Republic of Azerbaijan, April 19, 2005). l3 Cj: Annex 9 for detailed computation. l4 The sensitivity analysis determined that the estimated EIRR for the whole project ranges from 16.5% in the worst case scenario (cost +20% and traffic - 20%) to 37.8% in the best case (cost -20% and traffic + 20%). 16

26 3. Fiduciary The financial management assessment concluded that the existing systems at the PIU, including accounting, financial reporting, internal controls, staffing, loan disbursements and auditing arrangements are considered adequate for the implementation of the proposed Highway 2 Project. Although the PIU staff are experienced in implementing Bank-financed projects, having implemented the ongoing Highway Project, additional training of PIU and RTSD staff would be required to mitigate project implementation risks. The existing 1 C accounting and financial reporting system at the PIU is fully operational and automatically generating the required quarterly FMRs. The internal controls and procedures are documented in a Financial Management Manual. The systems and controls ensure recording of transactions and balances, support the preparation of regular project financial statements, safeguarding the assets, and are subject to auditing arrangements acceptable to the Bank. Overall financial management risk is considered moderate. The procurement assessment, based on the country s procurement environment (CPAR conclusions are summarized in Annex 7), focused on the weak past procurement capacity of the PIU, and rated the procurement risk as high. The assessment identified the need to reinforce the PIU s procurement capacity. To that end, two additional procurement specialists were recently hired. These new specialists, having experience in multilateral-bank-financed procurement in the road sector, should be trained in the Bank s specific procurement guidelines and procedures at the beginning of implementation, immediately after effectiveness (a training program line is provided in the Procurement Plan). Post review thresholds would be reassessed and likely to be increased on a yearly basis after Bank s supervision missions to reflect progress in procurement capacity building (see Appendix 1 in Annex 8). 4. Social The proposed project is expected to entail expropriation of about 816 hectares of land along 136 km of roads. Physical resettlement of households may also be required. Since the exact road alignments are not determined yet, a RPF has been prepared in accordance with the OP/BP The RAP will be developed once exact road alignments are determined and civil works are identified, as per policies and procedures set forth in the RPF. RTSD, together with the Local Land Commissions, will prepare and implement the RAPS. The RPF: (i) describes broad socioeconomic and demographic characteristics of project areas and compare social impacts of alternative alignments; (ii) sets out resettlement entitlements of different categories of impact, describe procedures for valuation, compensation and other assistance provided to the affected people, and delineates responsibilities for the development and implementation of the RAP; and (iii) presents rough estimates of the scale of land acquisition and physical relocation, and that of the cost of compensation, for the implementation of the proposed project. The Azeri legal framework covers broad issues of land acquisition and resettlement. The Azeri constitution provides that the state is not allowed to dispossess private properties by force without a decision of the courts, and that private property can only be expropriated through fair 17

27 reimbursement of their value. According to the Land Code, properties are valued based on full market price, but actual terms of compensation are determined through negotiation with the property owners. While many key tenets of Azeri laws are in compliance with OP/BP 4.12, gaps also exist. Major gaps include: 0 Income restoration measures are not explicitly recognized as legal entitlements of the Project Affected People (PAP); 0 Land ownerdusers without legal titles or legally recognizable rights are not entitled to compensation; and, 0 Moving costs are not explicitly recognized as legal entitlements of the PAP. These gaps are addressed in the RPF. A more detailed description of the gaps and how the RPF addresses them is provided in Annex 10. While RTSD's experience in land acquisition is considerable, the proposed project will require an unprecedented effort both in that area and in involuntary resettlement, a subject in which RTSD familiarity is more limited. The strengthening of the LAD within RTSD, which started with technical assistance under the ongoing Highway Project, will be continued during the implementation of the proposed project to in order to satisfactorily address the expected scale of resettlement. Public consultations were carried out along the Alat-Astara and the Baku-Shamakhi roads, where the general description of the proposed project was explained to the representatives of the Local Executive Bodies, local representatives of RTSD and community members. Since the exact alignments and therefore exact impact are not determined yet, the discussion centered on the preferred location of new highways as well as road safety issues. Community members supported the proposed highway since less transit traffic would pass through residential areas and thus the road would become safer, but they also stressed that adequate compensation must be provided. Concerns were raised that new highways running far away from existing settlements can damage the local economy, especially if no roads are built to connect the new highways and existing towns. Under the proposed projects, the new highway will cross over the existing roads at various points to ensure that existing settlements are accessible to and from the highway. The construction of new highways often triggers the transmission of HIV/AIDS due to the inflow of migrant workers and increase of transit traffic. Azerbaijan is currently facing a "concentrated" HIV epidemic with high concentration of HIV infection among vulnerable population such as drug users and commercial sex workers. To minimize the impact of HIV/AIDS in the project areas, the project will implement measures such as: 0 Preferential employment policies for local people; 0 HIV/AIDS awareness programs for contractors and local people. 5. Environment In accordance with the World Bank's safeguard policies and procedures, including OP/BP/GP Environmental Assessment this proposed highway development program has been classified as a Category A project for environmental assessment purposes. The highway development 18

28 program will be implemented over a number of years and it is envisaged that there will be between eight and 12 Category A or B sub-projects. The proposed project will upgrade sections of the 242 km long M3 motonvay between Alat and Astara that runs south from Baku through seven administrative districts to Iran. The project would involve the expansion of the existing two lane road to a four lane road. Several alignments are under consideration and include the construction of new 4 lane roads and bypasses around key towns along the highway. It will also rehabilitate a 124 km section of Znd category road linking Baku to Muganli, a village to the west of Shamakhi. Since the exact alignment is not yet known, a Regional RER has been prepared covering the entire scope of the development. The RER describes the existing environment, discusses and compares project alternatives, and identifies risks and issues to be addressed during project implementation. In addition, an EMF has been developed that outlines the procedures for the environmental screening, management, consultation and disclosure related to the proposed Category A and B sub-projects. The EMF is compatible with the national Law on Environmental Protection and the guidelines contained in Azerbaijan s EIA Handbook, which, while not legally binding, contains a framework for EIA that is consistent with international environmental assessment practices. In accordance with the EMF, site specific environmental assessments and/or management plans will be developed for each sub-project in accordance with national requirements and the Bank s safeguard procedures. For category A projects independent EA experts not affiliated with the project will carry out this work and it is probable that a single contract will be awarded for the environmental assessment work for all sub-projects. Within RTSD, the Ecology and Safety Sector (ESS), a recently established unit that is responsible for environmental management, will oversee the implementation of the EMF and related environmental management plans. Construction contractors will be responsible for implementing the environmental management plans for sub-projects. The capacity of the ESS needs to be considerably strengthened and on the job training is proposed prior to Board approval, to raise awareness of national and Bank environmental assessment and management requirements, as well as the impacts associated with highway construction and their management. The independent EA consultants that will be engaged to prepare the sub-projects will also have a follow-on capacity building and training component included in their contract. The RER identifies the Alat-Astara study corridor as most sensitive to the proposed development. The area is very diverse, ranging from less populated dry semi-desert in the north to more densely populated areas in the southern lowlands (including swampy areas) and foothills of the Talysh Mountains. There are many rivers, canals, and wetland systems in the corridor as well as some lakes and mineral springs. Numerous protected areas and other significant natural sites of both national and international importance are found in the study corridor including cultural heritage sites. Biodiversity is high and fish resources are abundant. The southern area is largely agricultural. 19

29 The area of most sensitivity is the construction of the new road section between Shorsulu and Masalli. Three alignments (direct and railway alignments, and expansion of the existing road) have been reviewed at this stage for traversing the area and both the direct and railway options traverses through existing natural wetlands. The direct alignment of 52 km includes a 12 km section that passes through the Madmudchala and Akhchala wetlands, Important Bird Area (IBA) sites that are proposed for future Ramsar designation but are currently unprotected. The railway alignment is 55 km long and includes an 11 km section between Mugan Channel and Uzuntapa that runs in parallel and approximately 2-3 km to the northwest of the railway line and that also routes through the Akhchala wetland. The Madmudchala and Akhchala wetlands provide natural habitats for numerous rare and endangered wildlife species and have significance as a buffer zone for the adjoining wetlands that form part of the Gizilagach State Reserve, an official Ramsar site located 3-5 km from this area. The water balance in the Akhchala wetland is unstable and under constant threat of drying out. Controlled hunting is permitted here and there is pressure from poaching and fishing. Routes through these wetland areas have significant potential for adverse environmental impacts including large scale sedimentation due to construction on unstable ground, habitat fragmentation and the creation of barriers for wildlife movement, disruption of breeding colonies for rare and endangered species and to the hydrology in the area. Natural wetlands and areas with saline soils also raise concerns for construction: saline soils are prone to collapse under load or vibration and may lead to the corrosion of steel reinforcements and also require high volumes of construction materials. Based on the analysis conducted to date the railway alignment between Shorsulu and Sarcuvar, near Masalli, combines the least environmental impacts with, on balance, the greatest potential for stimulating economic development in the region. However, during project implementation engineering feasibility studies together with environmental and social assessment and economic analysis will be conducted for all route alignments prior to the selection of a preferred alternative for development. Site specific environmental assessment, appropriate study work and environmental management plans will be developed during project implementation to specifically address the issues and concerns raised in the RER. Preliminary consultations were held with local stakeholders in each administrative district in August Questions revolved on basics facts about the proposed development, the impacts on existing settlements and compensation. Public comments on the draft RER and EMF have been sought. The draft final reports in English and Azeri languages for the RER, EMF and RPF of Alat Astara and Baku Shamakhi roads were distributed by the Cabinet of Ministers to relevant ministries and agencies, and to the local executive offices along the proposed development where they could be accessed by the public. On October 20, 2005 an advertisement was placed in the local press to notify the public of the availability of these reports. A three week comment period closed on November 10,2005 and comments have now been incorporated into the final RER. Environmental Assessments and Environmental Management Plans are under preparation for the Baku- Shamakhi road and have been drafted for the first 22 km south of Alat. They assess the 20

30 issues and impacts associated with the rehabilitation of these sections and are being developed to ensure that appropriate and site specific management measures are in place to prevent or mitigate and monitor environmental impacts associated with these works. These road sections have both been assessed as Category B subprojects for environmental assessment purposes and works are expected to commence in For the first 22 km south of Alat, all works would take place within the existing right of way (ROW). The final few kilometres of this section run in the immediate vicinity of the western borders of Shirvan National Park that was established for the protection of the Sand Gazelle (Gazella subgutturosa) and wintering, breeding and migratory birds. Other protected or sensitive areas or sites do not exist in the possible area of influence of the proposed intervention. For the Baku-Shamakhi road, the rehabilitation effort will also take place within the existing ROW. Impacts are likely to be temporary and short term and associated with construction such as noise, heavy vehicle traffic, dust, traffic disruption and loss or impaired access to properties adjacent to the ROW but no impacts on cultural properties are anticipated. Within the ROW, some sections of tree plantations and shrubs that fall under the ownership of the State Forest Fund may require removal and management plans need to take careful account of IBAs. 6. Safeguard policies Safeguard Policies Triggered by the Project Yes No Environmental Assessment (OP/BP/GP 4.01) [XI [I Natural Habitats (OP/BP 4.04) [XI [I Pest Management (OP 4.09) [I [XI Cultural Property (OPN I 1.03, being revised as OP 4.11) [XI [I Involuntary Resettlement (OP/BP 4.12) [XI [I Indigenous Peoples (OD 4.20, being revised as OP 4.10) [XI [I Forests (OP/BP 4.36) [I [XI Safety of Dams (OP/BP 4.37) [I [XI Projects in Disputed Areas (OP/BP/GP 7.60) [I [XI Projects on International Waterways (OP/BP/GP 7.50) [I [XI 7. Policy Exceptions and Readiness The Project complies with all applicable Bank policies. The engineering design documents for the first year's activities are complete and ready for the start of project implementation. The draft Operational Manual has been appraised and found to be realistic and of satisfactory quality. 21

31 Annex 1: Country and Sector or Program Background AZERBAIJAN: Highway 2 Azerbaijan stands on the verge of a major oil boom and an important economic transition. Over the past few years Azerbaijan has put into place both the infrastructure needed to realize rapid growth in oil and gas exports as well as a credible framework to effectively manage the increase in resource flows. With the oil boom expected to last maybe 15 years only, the challenge ahead is for Azerbaijan to ensure growth in the non-oil economy and a sustainable reduction in poverty, In the coming years it will be essential for Azerbaijan to maintain its fiscal discipline to avoid inflation and Dutch disease, while at the same time investing in the non-oil economy and broadening participation in economic growth by rebuilding crucial infrastructure and removing barriers for doing business. With the location of Baku as the only major city at the Caspian Sea, Azerbaijan has a unique opportunity to become a prosperous transit hub for energy and goods flowing along the East-West and North-South corridors at the crossroads between Europe and Asia. The non-oil economy is developing rapidly, with average growth of 13 percent during the last five years, which is faster than the oil sector. At present, 70 percent of GDP and 99 percent of employment comes from the non-oil economy, which has tripled since Although still a low-income country, Azerbaijan will grow rapidly in the years ahead because of the oil and gas resources which it is currently developing. Overall GDP is estimated to increase from US$8.5 billion in 2004 to US$22.2 billion in This includes revenues from the ACG oil field and the Baku-Tbilisi-Ceyhan (BTC) pipeline, where oil has already started to flow from Azerbaijan in late With the support of the IMF and the Bank, Azerbaijan has put in place a strong governance framework for managing these oil revenues. In particular, the State Oil Fund (SOFAZ) was established in 1999 as the mechanism to separate commercially oriented resource extraction decisions from prudent public expenditure policies16. The Government has repeatedly demonstrated its commitment to transparent oversight and control over SOFAZ resources and was an early participant in the Extractive Industries Transparency Initiative (EITI). While Azerbaijan s oil and gas resources are considerable, they are also finite, peaking in about six years and then declining rapidly. The most difficult challenge Azerbaijan faces, which is well understood by the Government, is to avoid the path followed by many natural resource rich countries, wherein their citizens derive little benefit from the influx of oil revenues. This requires implementing a policy agenda that leads to poverty reduction and improves incomes as well as equity for current and future generations, while maintaining macroeconomic and financial stability. Continued growth in the non-oil sector will be critical to achieving the objectives of the State Program on Poverty Reduction and Economic Development (SPPRED). While the oil sector will contribute to the majority of GDP growth in the next few years, the magnitude of poverty l5 World Bank, Program Document for a Proposed Poverty Reduction Support Credit to the Republic of Azerbaijan, Annex 111, April l6 The Fund s main objective is to ensure intergenerational equality of benefit with regard to the country s oil wealth, whilst improving the economic well-being of the population today and safeguarding economic security for future generations. The Fund also provides a sterilization mechanism for foreign exchange inflows in order to avoid the Dutch Disease. Audited reports on the Fund s activities are published annually, see 22

32 reduction will be dependent on achieving the projected growth in the non-oil sectors, Azerbaijan has already put into place a number of critical structural reforms to achieve this. In particular, privatization of small businesses and land has largely been completed and the basic legal framework for a market economy has been established including strengthening the policies and institutions for expenditure management and improved service delivery and financial discipline, Well-focused rapid infrastructure improvements, after years of neglect due to fiscal restraint, are crucial for continued non-oil sector growth. Achieving Azerbaijan s potential as a transit economy is essential for non-oil economic development. Azerbaijan s geographical position makes it an important link between the Black and Caspian Seas and between Russia and Iran. There are a number of reasons to expect that the long anticipated regional transit corridor will take off over the next few years. First, the large oil and gas pipeline projects now in place will likely result in increased oil products and equipment trade, as well as build confidence in cooperation between South Caucasus countries. Second, there is the likelihood of two of Azerbaijan s biggest and fastest growing neighbors - Russia and Kazakhstan -joining the WTO in Azerbaijan itself has set a target of joining WTO by Third, the recent start of EU accession negotiation with Turkey and the inclusion of the three South Caucasus countries as European Neighborhood Policy (ENP) countries are likely to bring closer trade links within the region and with Europe. Fast paced growth, not just in Azerbaijan, but in neighboring countries is generating strong demand for goods and services. Fourth, Baku, as the only capital city on the Caspian Sea, is well situated to become a competitive logistical trade hub. At present, several companies based in Baku service regional markets by storing and packaging transit goods. In fact, Azerbaijan s non-oil exports are consistently growing at more than 25 percent p.a., and transport infrastructure needs urgently to keep up with these developments. Given the small size of domestic markets, and enhanced trade potential with its neighbors, trade infrastructure is an important and growing feature of the Azeri economy. Bank studies project a dramatic rise in transit cargo volumes, in line with oil and non-oil related investments. With much of the non-oil trade being small sized shipments transported by road to neighboring countries, access to international markets requires the provision of suitable road transport infrastructure on corridors ready to meet mid-term strong traffic increase rather than the presently narrow, low quality roads. The development of infrastructure (in particular utilities, telecom, and transport) is one of the six major strategic pillars of the SPPRED and is as critical to further expansion of the non-oil sector, as it is for improving the living standards of the lowincome population. Transport Sector Overview. Much of the road network, the railway track and rolling stock need reconstruction or replacement. Road transport accounted for 54% of all freight in 2003, up from about 48% in The railways have lost market share in recent years taking just 18% of freight in 2003, compared with 21% in Poor condition of the transport infrastructure is hindering the growth of the non-oil economy. Improvement of the road network, the main objective of the proposed project, has been identified as one of the priorities for the production diversification and economic development of the country. 23

33 Azerbaijan has access to the high seas either from the Caspian Sea via Volga-Don Canal or through Georgia to the Black Sea, or through Iran to the Persian Gulf. The export of the country s main product, oil, is transported through three major pipelines: Baku-Novorossisk to the Russian Black Sea, Baku-Supsa to the Georgian Black Sea and the recently inaugurated Baku-Tbilisi-Ceyhan to the Turkish Mediterranean port of Ceyhan through Georgia. Azerbaijan also has direct maritime connections to other Caspian littoral states. Baku is the largest port on the Caspian Sea, but needs repairs and modernization of its operations. National policies. The Government s transport sector objectives and strategic directions are defined in a Draft Transport Policy, which identifies the following development directions for roads and railways; the road sector objectives having the highest priority: protect and improve roads through repair and maintenance; expand or repair existing roads and bridges and raise their design to international standards; reduce congestion, especially in the Baku area; overlay local roads at the settlements; improve road traffic safety; support the State Program for the Development of Regions; and acquire modern road construction and maintenance equipment. The Government is also encouraging the improvement of cross-caucasus transit routes, the Transport Corridor Europe-Caucasus-Asia (TRACECA), to link Azerbaijan and Central Asian countries to European markets. According to official statistics, transit trade along TRACECA routes has trebled since 1999, and revenue from goods transported along the route has doubled. The Road Sector. The public road network in Azerbaijan comprises 25,013 km of roads, out of which 4,498 km are in the Nagorno-Karabakh area. The total length also includes 2,078 km of roads in the Nakhchivan Autonomous area. The public road network in the main Azerbaijan (excluding Nakhchivan) falls under RTSD. Nakhchivan has its own road agency, named Nakhavtoyol. In terms of ownership, roads in Azerbaijan are divided into state, municipal and private roads. The state roads are divided into three classes: Major arterial roads (M), Minor arterial roads (R), collector and local roads17. Eight roads are classified as M-roads, and sixty-six roads as R- roads. The M-roads are the following: Baku - Guba - Russian Border (Ml- 199km); Baku - Alat - Yevlakh - Georgian border road (M2-498km); Alat - Astara - Iranian Border (M3-243km); Baku - Shamakhi -Yevlakh (M4, 180km); Yevlakh - Zagatala - Balaken (M5); Hajiqabul- Ali Bayramili - Saatly - Zangilan (M6); Ordubad - Nakhchivan (M7); Nakhchivan - Sadarak (M8). This classification and the numbering of the roads are presently being revised as part of the Technical Assistance program in the ongoing Azerbaijan Highway project. 24

34 The M2, part of the Great Silk Road, is the main route between Baku and Tbilisi and is being rehabilitated under the ongoing Azerbaijan Highway project. Table 1.1: Public Roads in Azerbaijan (in kilometers) Total length (km) Source RTSD local roads 1, ,013 The proposed project would rehabilitate sections of the roads Baku-Shamakhi-Yevlakh (M4) up to Muganli and Alat-Astara-Iranian Border (M3) up to Masalli. Other IFIs are financing the rehabilitation of the remaining segments of the M3 road (Masalli-Iranian Border) and of the Baku - Guba - Russian Border road (Ml). The total vehicle fleet in Azerbaijan was about 5 17,000 in 2004, with about 49 private passenger cars per 1,000 inhabitants, which is quite low and increase in car ownership and traffic growth potential are substantial. Azerbaijan public road network is, however, of comparable length with countries of similar size and population density, but higher car ownership. Thus, Azerbaijan s road network has sufficient capacity for its current level of motorization, but the quality of that capacity is poor. The key issue is, therefore, rehabilitation and modernization of the road network. Capacity increases and new roads are, however, needed in or near urban areas, especially near Baku, or to bypass towns and villages where direct access to land has diminished the quality of road capacity and traffic safety, and prevents adequate speeds amidst urban congestion. Road Network Condition. In the context of technical assistance of the ongoing Azerbaijan Highway project, quantitative information on road service quality was collected. The condition of the roads is, generally speaking, poor (Table 1.2). There is little difference between the functional classes. Operating costs to users are high and many rural communities lack year-round service and can be cut off from access to the arterial roads for several months of the year. The condition of the roads is poor due to construction quality in the past and lack of later maintenance. The road network rightly deserves the ongoing or planned major rehabilitation or reconstruction, followed by skillful and steady maintenance thereafter. It is of importance that local roads are those listed in December 1985, but the list is likely to be outdated. Because of their importance to Azerbaijan rural economy and the poor condition of the local roads, RTSD is at the moment in the process of revising the list. The ongoing Azerbaijan Highway project includes five pilot local road rehabilitation projects. In the proposed project, the local.roads will be identified in detail and a road data bank completed describing their location and physical parameters and structural and surface condition in order to make appropriate financing and engineering plans for their rehabilitation and maintenance. 25

35 Table 1.2 Road Condition in 2004 Condition 2004 ( 14% 4% Good 5 YO 0% 4% 5% Fair 6% 24% 30% 19% Poor I 61% I 75% I 64% I 58% Bad 1 28% I 1% I 2% I 18% 61% 1 0 mor condition 1 rn Bad condition 1 Legend: M- Major arterial roads; R- Minor arterial roads; K- Collector roads; Y - Local roads Good 5% [ Fair 30% 1 19% Poor 64% I 58% Road Sector Development. The Government continues to give priority to the rehabilitation and upgrading of its principal corridors, in order to facilitate trade and regional co-operation with its neighbors and facilitate economic development across the country as a whole. Accordingly, RTSD is presently implementing a sizeable capital works program, which covers both rehabilitation and upgrading. This is financed both from the budget and a number of IFIs. Within the roads sector itself the underlying theme is to undertake restructuring initiatives in accordance with the corporate plan, which has been prepared with the assistance of RTSD consultants. The aim is to ensure that the much needed investments in, the sector are being accompanied by the institutional changes to secure the long term quality of service and financial soundness of the system. A summary of the IFIs program, together with the source of funds is presented in Table 1.3 below. Table 1.3: Program financed by IFIs M1 Hajigabul - Kyurdamir EBRD M1 Kyurdamir - Ujar Kuwait Fund M1 Ujar - Yevlakh Islamic Development BanWOPEC Fund MI Yevlakh - Ganja Arabic FundOPEC FundADB M1 Ganja - Gazakh World Bank (IDA) M1 Gazakh - Georgian border ADB M2 Sumgait - Zarat EBRD M2 Zarat - Samur Czech Export Bank A start was made as part of agreements with different bi-lateral and multi-lateral donors through the requirements that there be improvements to road sector finance and that a service-level arrangement be established between MOT and RTSD, together with the possibility of establishing a road Board with advisory functions. All these are key themes of the corporate * This classification is presently being revised. 26

36 ~~ plan. Longer term plans include the possible privatization of maintenance work units to introduce competition and a higher level of efficiency in maintenance activities. Until 2000, the road sector in Azerbaijan was financed through a Road Fund, funded primarily from earmarked charges on road users (fuel excise tax, annual vehicle inspection tax, vehicle sales tax, transit tax) and a turnover tax. The vehicle sales tax and the turnover tax have been abolished and, with the abolition of the Road Fund, all of the revenues allocated directly to the central budget. Hence, RTSD is now a direct recipient of allocations from the government budget. Road Sector Budget. In 2003 RTSD (road sector) budget was 70 billion Manats (US$22.4 million). The budget for 2004 was 85 billion Manats ($25.5 million), and for billion Manats (US$33.3 million). The proposed budget for 2006 includes US$56 million equivalent for the sector. These figures include the salaries for the personnel both in RTSD HQ in Baku and in the Maintenance Units in the Rayons, and other administrative costs - offices, vehicles, emergencies, etc. (app. US$8 million), which are neither included in nor paid for by RTSD budget, These administrative and overhead costs, over 3%, are a large proportion of the road maintenance and rehabilitation expenditures, and as the country moves forward on its efforts to develop program-based budgets, these costs should be accounted for in RTSD expenditures. Proposed Road Sector Public Investment Plan (PIP). The government of Azerbaijan, with the support of the international financial organization is only recently starting to prepare multiannual expenditure programs. Thus projections for investments and recurrent expenditures for the sector are tentative. It is clear that in terms of road expenditures the aim should be to gradually reduce dependence on the external sector and increase reliance on domestic resources. The second target would be to reach by 2010, when the whole main network is expected to be maintainable, an adequate allocation of funds to that end. Table 1.4 below, shows estimated budget projections for the period Capital Investments - Azeri Machinery Periodic Maintenance and Rehabilitation Routine Maintenance Emergency Works Planning and Design Headquarters expenses Total Azeri Financing Capital Investments - IFIs GRAND TOTAL

37 Institutional Issues. An important sector issue is institutional development, which must accompany the modernization of the road network. MOT, patterned in an EU funded study, was established two years ago after a long process. Its authority on the sector s legal, policy and financing decisions is still evolving. The framework for shared power between the Ministry and the modal organizations has not been articulated, and important issues of accountability and freedom to manage remain unaddressed. The project will continue to support institutional strengthening of both the Ministry and RTSD. This will include the following areas: Policy formulation. This multidimensional issue deserves a broad-based approach, involving: 0 The road law, and information management: data resources and computer systems; 0 Road planning (modernization of standards and norms, multi-year programming); 0 Maintenance of Road Assets; Traffic Safety (road data bank, maintenance management); 0 Quality of products and services (human resource development, service agreement between RTSD and its regional offices to introduce competition). Structure of the sector budget. The road sector budget is an important document to guide development and monitor performance. The current budget is not serviceable and must be improved, In addition, RTSD should have a balance sheet with realistically valued assets, and an income statement. Otherwise it is impossible to know if the budget is sufficient to maintain asset values, or whether a devaluation of assets, a disinvestment, is taking place. Support to human resource development. Currently, the investment projects are selected based on political decisions when they should serve the goals and objectives set forth in the transport policy. RTSD needs human resources support to apply engineering-economic management systems, developed in the ongoing Highway Project, to conceive a multi-year road investment program, while minding the importance of the equity, environment and voice of the people. Support under the project to continue the mainstreaming of the HDM model within RTSD should help to address this issue. Mobilization of domestic resources. Sector budgeting should be increasingly driven by domestically mobilized resources, which IF1 funds supplement. Therefore, continued attention should be paid to increasing road user charges and linking them to road access and road use. The government is aware of the need to properly fund the sector in order to finance with domestic resources recurrent road maintenance expenditures. Maintenance allocations have been increasing at a rate of more than 30% per year since 2003, and the budgetary appropriation for 2006 (US$33.3 million) appears to be adequate for current needs. The proposed project, in coordination with other donors, will continue to monitor the allocation of funds for routine and periodic maintenance to make sure that it does not fall from the present level. Strengthening Road maintenance Capacity. The institutional assessment carried out by the Finnish consultants under the ongoing Road Transport Project identified the need to: (i) improve the organizational structure of the Maintenance Department in RTSD; (ii) streamline work procedures; (iii) gradually change the Department s culture to empower middle level ranks to make decisions; and (iv) develop the planning and programming capacity to create long term work programs for the road network based on actual needs. The proposed project will support I 28

38 the government s efforts to gradually move RTSD towards a more commercial vision for road management, while acknowledging the difficulties of replacing long established traditions. As a first step, the project will finance the mainstreaming of basic planning and programming tools in order to build RSTD s capacity to prepare multi-year road maintenance programs based on actual needs and sound technical and economic foundations. The following dated Action Plan was agreed with the government and summarizes the different milestone expected to be achieved during the life of the project: 29

39 Annex 2: Major Related Projects Financed by the Bank and/or other Agencies AZERBAIJAN: Highway 2 The Government continues to give priority to the rehabilitation and upgrading of its principal corridors in order to facilitate trade and regional co-operation with its neighbors and facilitate economic development across the country as a whole. Accordingly, RTSD is presently implementing a sizeable capital works program, which covers both rehabilitation and upgrading. A summary of the IFIs program, together with the sources of funds is presented in the table below. M1 Hajigabul - Kyurdamir EBRD M1 Kyurdamir - Uj ar Kuwait Fund M1 Ujar - Yevlakh Islamic Development BanWOPEC Fund M1 Yevlakh - Ganja Arabic FundOPEC FundADB M1 Ganja - Gazakh World Bank (IDA) MI Gazakh - Georgian border ADB M2 Sumgait - Zarat EBRD M2 Zarat - Samur Czech Export Bank The World Bank - Azerbaijan Highway Project (31570-AZ). US$40 Million. The main component of the project rehabilitates a 90 km segment of the Baku - Georgian border road, the East-West highway which is the backbone of the country s road network and trade. The project also finances the rehabilitation of five rural roads to gain experience on the issues and problems before, eventually, beginning to support the rehabilitation of this poorly maintained but important class of roads. The project also includes an extensive TA program to modernize the recently established RTSD. This TA has been widely used by other donors to develop their own projects. This project s Implementation Progress and Development Objective ratings are satisfactory. Closing date is September EBRD - The ongoing Azerbaijan East-West Highway project ( 40 million) finances the rehabilitation of the Hajigabul - Kuyrdamir segment of the East-West Highway. Its technical assistance component is coordinated with and continues the World Bank s TA program started with the Azerbaijan Highway Project (Cr AZ). The EBRD TA program also overlaps and is coordinated with the new EBRD highway project Baku - Samur (USSlOO million). The new EBRD loan includes several conditions that derive directly from the TA program in the ongoing Bank-financed Highway Project. Among them are: 0 Formal adoption of the principles of the corporate plan 0 Implementation of a new organizational structure 0 Service level agreements between the road maintenance units and work units (separation of the client and supplier organizations eventually leading to the privatization of the latter) Establishment of the Road Board and improvement of financial management and audits 30

40 0 Gradual increase in road maintenance funding consistent with the multi-year road program. The EBRD also financed a railway project focusing on track infrastructure improvements and modernization of rolling stock. The project has been completed. Other Donors - As listed in the above table, other donors are also financing some sections of the main road network. 31

41 Annex 3: Results Framework and Monitoring AZERBAIJAN: Highway 2 Results Framework PDO The main project development objective is to reduce road transport costs and improve access, transit and road safety within Azerbaijan's East- West and North-South corridors, through upgrading some sections of the Alat-Astara road of the Baku- Iran highway (M3) and rehabilitating the Baku-Shamakhi road (M4) Intermediate Outcomes Component One Upgrade of some sections of the M3 highway between Alat and Astara Rehabilitation of the existing M4 road Baku-Shamakhi Component Two Technical assistance and goods to support RTSD strengthening and project implementation: Updating and modernization of the Road Transport Law Complete the Road Data Bank (RDB) Establish technical road classes superimposed on the functional road classification through: Review and update geometric and structural design standards to replace the existing Soviet era standards Develop road condition norms for each technical class Project Outcome Indicators Reduction in transit timeivehicle operating cost from Alat to Masalli Reduction in transit timehehicle operating cost from Baku to Shamakhi Number of road accidents in the project roads Intermediate Outcome Indicators Component One Number of km upgraded for Alat- Masalli Number of km rehabilitated for Baku-Shamakhi Component Two Preparation of the revised Road Transport Law Number of km of road data introduced in the RDB Number of people trained in its use Preparation of new geometric and structural design standards Preparation of the new norms for maintenance Use of Project Outcome Information The information will be used bv MOT and RTSD to monitor thecondition of the road network and to feed RTSD road management policy ~ ~~ Use of Intermediate Outcome Monitoring Component One The information will be used by MOT and RTSD to monitor implementation progress and prepare an action plan to address possible delays Component Two The information will be used by MOT and RTSD to monitor implementation progress and prepare an action plan to address possible delays The information will be used by MOT and RTSD to update the MYP Use of new technical classes in annual maintenance planning, use of new standards in design. 32

42 Arrangements for results monitoring Project monitoring during the course of project implementation will be carried out by the PIU staff, with the assistance and guidance provided by RTSD, under close supervision from MOT and MoF. This would entail close supervision of the works and TA to RTSD, auditing of financial statements, and monitoring project performance indicators for the duration of the project. Close following of the monitoring indicators will be particularly important to ensure a timely completion of the project and flag any delays. In view of the selected indicators, data collection should not be a major problem and therefore no capacity issue is foreseen. Project progress reports will be prepared by the PIU on a quarterly basis and submitted to the Bank s review. The progress reports will focus on results rather than providing process related information. 33

43 m m B E, 8 8 W W B P & w 0 4 m 0 m 0 W 0 0 d W 0 0 Y I p m a 2 W F w W F w W 6 3 Q P w 0 0 E 3 s : g M x 0 0 W i W

44 Annex 4: Detailed Project Description AZERBAIJAN: Highway 2 Component 1: Upgrading sections of the M3 highway between Alat and Masalli and Rehabilitation of the M4 road Baku-Shamakhi and key access roads (US$ 259 million): This component comprises the civil works for the above-mentioned two roads and some access roads as well as the consultancy services for the alternative analysis of Alat-Astara, engineering design, environmental and social studies of Alat-Masalli and the supervision of the works. Land acquisition and resettlement costs required for the 136 km alignment of the Alat-Masalli road (about 800 hectares) would be financed by the Government. Component Description: M3 highway between Alat and Masalli: the project will finance the upgrade of about km of the M3 highway between Alat and Masalli, including expansion of the existing two-lane roadway to a four-lane roadway under a mostly new alignment; and the construction of bypasses around key towns. The project is divided in sections and each section design would include appropriate specific Environmental Assessments, Environmental Management Plans and Land Acquisition PlardResettlernent Action Plans with adequate disclosure. In order to allow starting the works by March 2006, the first year s program would consist of a section of 22 km about 5 km south of Alat between PK 80 and PK 102 where the four-lane carriageway would be constructed within the existing right of way which is free of encroachment (i.e. no land acquisition or resettlement) and without major environmental issues. M4 highway between Baku and Shamakhi: the project will finance the rehabilitation within the existing right of way of the Baku-Shamakhi road, a 124 km section of the much traveled road to the good farming areas West of Baku. The road serves Azerbaijan s East-West traffic corridor and its more densely populated cities and villages, such as Shamakhi and Sheki, and ultimately leads to the North-Eastern part of Georgia. The works are divided in sections and each section design would include appropriate specific Environmental Assessments and Environmental Management Plans. The rehabilitation is done within the existing right of way which is free of encroachment (i.e. no land acquisition or resettlement) and without major environmental issues. Improvement of about 120 km of access roads: the project will finance the upgrade of about 120 km of access roads connecting to the M3 highway between Alat and Masalli, and connecting to the Baku-Shamakhi road to enhance accessibility from villages nearby. Design and Supervision: the project will finance the necessary studies for carrying out the above works and consultants for supervising their execution. Component 2: Provision of technical assistance, training and goods to support MOT S and RTSD s strengthening, RTSD road maintenance capacity and project implementation (US$ million): RTSD administers and manages the road network. Until recently reorganized, road management was ad hoc and not based on timely data and management systems. Technical assistance in the ongoing Highway Project is helping RTSD restructure its road network and road 35

45 management operations, establish regional organizations, competitive procurement of works, excepting routine maintenance, and create management systems and practices. The new project will continue to provide technical assistance to RTSD and to MOT. The component comprises specialized consultancy studies, technical assistance, human resource development training, services, and equipment as needed to support RTSD and MOT strengthening and project implementation. The loan will also finance basic equipment (and spare parts) to support the agreed increased level of routine maintenance since the existing equipment is mostly obsolete and/or in a state of disrepair that results in low levels of availability. The estimated total cost of the equipment is US$ 1 million. Component Description: The component would build on the comprehensive TA program of the Highway Project, respond to new issues, and be coordinated with the institution and capacity building programs of the ADB and EBRD loans. The following components are envisaged: Updating and modernization of the Road Transport Law. The need for such modern law was recognized during the ongoing project s TA program. The law should emulate those in the EU countries of comparable size. It also should develop and take into use a new structure for the road sector chapter of the state budget. Improving and expanding the computer systems in MOT, RTSD (and later RTSD s Regional Offices). The systems should include appropriate software, Local Area Network servers, and facility. Provision should be made for assistance to develop RTSD Intranet to distribute manuals and procedures, and also describe the mission and strategic directions of RTSD for the benefit of the employees. The computer system should also provide appropriately protected access and environment for the road data bank and the financial management system. Completing the Road Data Bank. This task would include monies for the purchase of road measuring equipment for collecting road and traffic data, and for consultancy services to update the road and traffic data for the M roads, and collect the road and traffic data for all the other public roads over a two-year period. The task would also include the development of systematic data collection procedures and cycle to update the road data bank periodically and a protocol to enter all road improvement actions to the data bank. Establishing technical road classes superimposed on the functional road classification. The technical classes would be based on traffic volume and, if appropriate, the proportion of heavy traffic. These would serve planning, design, pavement selection, and maintenance activities. Two specific tasks would then be carried out by a consultant using the technical and functional classification (the latter having been defined in the ongoing Highway project) a. Review and update geometric and structural design standards to replace the existing Soviet era standards. These standards would be specific to technical and b. functional road classes. Develop road condition norms for each technical class. Although HDM gives road condition, optimal or budget constrained, it does not describe in practical terms what actions are needed to reach or maintain that condition. The objective 36

46 of this task is to establish road condition norms for each technical class and to develop model maintenance activities to reach or maintain that condition. Developing a model for the Service Agreement between RTSD and its Regional Offices, and to provide training to the Regional Office staff in carrying out their responsibilities. Developing the capacity of ESS/LAD for environmental and resettlement issues, including possible use of GIS system to manage environmental and social impacts. Delivering a training component including: (a) consultant services to train RTSD staff in the use of the HDM model for the preparation of multi-year road investment and maintenance programs; and (b) study tours to familiarize officials of MOT and RTSD on current best practices in the area of road management. In addition, the component will include resources to fund a workshop to be hosted by MoF to exchange ideas with officials from developed and developing countries on current thinking and experiences for the financing of road investments and maintenance. Also, training will be provided by experienced consultants to LAD and ESS of RTSD on matters of resettlement and environmental management, including the use of GIs. Maintenance Equipment for RTSD: the loan will finance basic maintenance equipment (and spare parts) such as bitumen sprayer, water truck (with broom), truck (UAZ), crushed stone spreader (for surface treatment), mowing machine (base on Belarus tractor), hot bitumen tank and crack filler (trailer, pneumo wheel), crack sealer with compressor (on asphalt-concrete surface), drilling machine for installation of delineators (base on Belarus tractor). Project implementation: the component will fund consultant services to staff the PIU and will comprise the equipment and TA to support implementation of the project as well as RTSD and MOT: office computers, software, office equipment/furniture, training and seminars, financial management TA, and project financial audits. 37

47 Annex 5: Project Costs AZERBAIJAN: Highway 2 Project Cost By Component and/or Activity Local Foreign Total US$ million US$ million US$ million Road works including design and supervision Land acquisition and resettlement costs' Technical assistance and goods to support RTSD strengthening and projectimplement%on Total Baseline Cost Physical Contingencies Price Contingencies 10% included in above amounts 20% included in above amounts Total Project Costs Interest during construction Front-end Fee Total Financing Required Land acquisition and resettlement costs required for the 136 km alignment of the Alat-Masalli road (about 800 hectares) would be solely financed by the Government. The rehabilitation of the road Baku-Shamakhi will be carried out within the existing right of way. The land acquisition and resettlement costs are not accurate because the alignment is not yet fully determined and therefore the exact land surface and the number of buildings to be purchased are unknown. The costs have been tentatively estimated at US$15 million for computational purpose. All activities funded by IFIs in Azerbaijan are VAT exempt. Therefore all the above costs are excluding VAT. There are no other identifiable taxes and duties, and the total project cost, net of taxes, is US$ million. Therefore, the share of project cost net of taxes is 75.51%. Cofinancing Arrangement By Component and/or Bank Government Total Activity US$ million US$ million US$ million Road works including design and supervision Land acquisition and resettlement costs Technical assistance and goods to support RTSD strengthening and project implementation Front-end Fee Total Financing The Bank finances 80% of all activities with the exception of land acquisition and resettlement costs which would be solely financed by the Government. Therefore, the Bank share of project cost i s 75.51% and the Government counterpart funds amount to 24.49%. 38

48 Annex 6: Implementation Arrangements AZERBAIJAN: Highway 2 The Loan Agreement will be established between the Bank and the Republic of Azerbaijan. The Project will be implemented by RTSD with the assistance of a PIU. The PIU has already been established to implement the Highway Project (Credit AZ-3517) and will also assist RTSD in the implementation of this project. The PIU is administratively under RTSD within MOT. The preparation and supervision of this project under the proposed schedule is very challenging and will definitely require a strong implementation capacity of RTSD and the PIU. After discussion of RTSD it was proposed to increase the number of staff of the PIU from 5 to 11 stafflg. The hiring process is ongoing and some of the positions have already been filled. The PIU has the overall responsibility for project implementation and coordination, including planning, procurement, disbursement of funds, monitoring the use of funds, auditing arrangements, monitoring and evaluation, and reporting on the progress of implementation and use of project funds in close cooperation with RTSD and MOT. The PIU will prepare a draft operational manual. The manual inter alia clarifies (i) the organization of the PIU, (ii) the mandate and powers delegated to the PIU, (iii) the procurement procedures, (iv) the financial management and disbursement procedures and (v) the guidelines related to the implementation of the project, in particular for the phasing, environmental and social issues. The approval of the operational manual by RTSD is a condition of effectiveness. It is expected that the PIU will also assist RTSD in the implementation of ADB project which is currently being negotiated. l9 1 director; 3 engineers; 2 procurement specialists; 1 financial specialist; 2 secretariesitranslators; 2 drivers. 39

49 Annex 7: Financial Management and Disbursement Arrangements AZERBAIJAN: Highway 2 A. Financial Management Summary and Conclusion. A financial management assessment of the proposed Highway 2 Project was carried out during project preparation, and will be updated at appraisal. The objective of the assessment was to affirm the adequacy of the existing financial management systems of the Project Implementation Unit (PIU) that reports to RTSD within MOT, and which has the overall responsibility for project implementation, fiduciary oversight and accountability. The PIU systems include: accounting, financial reporting, internal controls, staffing, disbursements and auditing arrangements for project implementation. The PIU has a 1C accounting and financial reporting system (multi-currency and multi-language) that is already customized to automatically generate the required Financial Monitoring Reports (FMRs). The staff is experienced in implementing Bank-financed projects, having implemented the ongoing Highway 1 Project. The project chief accountant, a former deputy chief accountant of RTSD and accountant for the ongoing Highway Project will remain the chief accountant for the proposed Highway 2 Project, with proposal to hire an additional accountant during the second year of project implementation. RTSD is currently recruiting additional technical staff to manage and implement the two World Bank projects, and projects of other donors. The conclusion derived from the assessment is that the overall financial management systems at the PIU are considered satisfactory, and overall risk is assessed as moderate for implementation of the proposed Highway 2 Project. Project Accounting and Financial Reporting. The PIU s accounting books and records are maintained on cash basis of accounting. The multi-currency and language Project accounting software - 1C Bookkeeping software is used for project accounting and financial reporting, including preparation of the quarterly Financial Monitoring Reports (FMRs). The project accounts and FMRs are denominated in United States dollars for Bank reporting and in Azeri Manat for reporting to the Azerbaijan authorities. The PIU has demonstrated through the implementation of the ongoing Highway Project that the existing system is capable of reporting on all sources and uses of funds, and generating FMRs automatically. The customized FMRs for the proposed project will be used for project monitoring and supervision throughout the life of the project. Indicative formats of these reports are included in the PIU Accounting and Financial Reporting Manual, and will include: (i) financial reports showing sources and uses of funds, and detailed uses of funds by project component; (ii) physical project monitoring indicators; and (iii) procurement monitoring reports that are consistent with the procurement plan. Format and content of FMRs was discussed and agreed at negotiations. Internal Controls and Staffing. The PIU has instituted a set of appropriate accounting procedures and internal controls including authorization and segregation of duties. These procedures are documented in an Accounting and Financial Reporting Manual. The existing staff of the PIU, complemented with the support of consultants, have the capacity and experience to implement the proposed project. It was agreed that, given the complexity of the proposed project, the staff of the PIU would be increased to 11 people, and progressively integrate the PIU 40

50 in RTSD as a way of building capacity of the Investment Department of RTSD. The PIU will continue to use the available international consultants expertise made available through the ongoing supervision consultant s contract for the preparation of the new project. The Bank provided a two-day workshop on financial management, disbursements and auditing to all PIU and Government agencies staff involved in financial management aspects of Bank-financed projects. Additional training will be required to maintain the level of Bank requirements on financial management. Funds Flow and Budgeting. The total project cost estimated at about US$265 million will be financed with the IBRD Loan of US$200 million and Government funding of about US$65 million equivalent including funding for land acquisition. The Borrower will be the Republic of Azerbaijan, represented by the MoF. The IBRD loan will be lent on standard IBRD terms2 and disbursed through Bank transaction based disbursements method to finance eligible expenditures for works, goods, consultant s services, training and incremental operating costs. Counterpart funding will be provided by the Government of the Republic of Azerbaijan through budgetary allocations disbursed through a Project Account opened by MoF and managed by the PIU. Further details on flow of funds are provided in the disbursement arrangements section of this Annex. Auditing Arrangements. No significant accounting and administrative controls or related issues have arisen in the audits of the ongoing project implemented by the PIU. The current auditing arrangements and findings are satisfactory to the Bank. Similar audit arrangements will be adopted for the Highway 2 Project, to include audit of Project Financial Statements, Statements of Expenditures and Special Account. The audit of the proposed project will be conducted by independent auditors acceptable to the Bank, and under terms of reference acceptable to the Bank. Acceptable auditing standards are International Standards on Auditing (ISA). The audit report with accompanying audited Project Financial Statements and Management Letter will be provided to the Bank within six months of the end of each fiscal year and also at the closing of the project. The contract for the audit will be awarded under Least Cost Selection method during the first year of project implementation, and extended thereafter year-to-year with the same auditor, subject to satisfactory performance of prior year s audit. The cost of the audit will be financed from the proceeds of the loan. Financial Covenants. The PIU will be required to maintain a financial management system, including records and accounts, and prepare financial statements adequate to reflect operations, resources and expenditures related to the project, in a format acceptable to the Bank. The quarterly Financial Monitoring reports will be submitted to the Bank no later than 45 days after end of each quarter. The project records and accounts will be audited annually by independent auditors under terms of reference acceptable to the Bank, and the audit report submitted to the Bank no later than six months after each year audited. Adequate and timely counterpart funds will be provided by the Government to finance eligible project expenditures financed by the Government, by making an initial deposit of 1.5 Million New Manat (US$1.6 Million equivalent) to be increased to 3 Million New Manat (US$3.2 Million equivalent) when the authorized allocation will reach US$16 million in a Project Account, to be replenished quarterly. 2o IBRD terms depend on choice of the loan product i.e. Fixed-Spread Loan (FSL) or Variable Spread Loan (VSL). 41

51 Supervision Plan. During project implementation, the Bank will supervise the project s financial management arrangements in two main ways: (a) review the project s quarterly financial management reports as well as the project s annual audited financial statements and auditor s management letter; and (b) during the Bank s supervision missions, review the project s financial management and disbursement arrangements (including a review of a sample of SoEs and movements on the Special Account) to ensure compliance with the Bank s minimum requirements. As required, a Bank-accredited Financial Management Specialist will assist in the supervision process. Country Issues. The Azerbaijan Country Financial Accountability Assessment diagnostic work carried out in 2002 recommended accounting and auditing regulatory and institutional reforms to increase accountability and good governance in the country. The proposed reforms are addressed in the Poverty Reduction Strategy Credits (PRSCs). In particular, enactment of the new Accounting Law and related secondary regulation mandating use of International Financial Reporting Standards (IFRS) for public interest entities and governmental enterprises and International Public Sector Standards (IPSA) for the public sector. The Law will assure greater transparency and accountability of public funds. In parallel, the enactment of the new Audit Law and establishment of regulatory and institutional frameworks for the Chamber of Accounts, the Country s Supreme Audit Institution, and capacity building of the Chamber of Auditors, the audit profession regulator and standard-setters will provide greater transparency and comparability in financial reporting. The Country Portfolio Performance Review (CPPR) of May 2005 identified some generic issues affecting Bank-financed projects in the country. The key issues that are monitored by the Bank and MoF include: (i) amendment to the Public Procurement Law in line with international standards; (ii) need to improve and monitor provision of technical assistance through inclusion of local consultants as a means of developing local capacity; and (iii) enhancing capacity of PIUs and government entities implementing Bank-financed projects through training in procurement, financial management, and disbursements. The Bank provided training in procurement, financial management and disbursements in June 2005 to all PIUs, government agencies and Ministries staff implementing Bank-financed projects. Risks. Financial management related risks that the Project might face are included in Section C5 of the PAD. The risk that adequate counterpart funds may not be made available on time is mitigated by ensuring realistic cost-sharing, phased start of project implementation, and requiring that a deposit of 1.5 Million New Manat (US$1.6 Million equivalent) to be increased to 3 Million New Manat (US$3.2 Million equivalent) when the authorized allocation will reach US$16 million is deposited in a Project Account by the Government for financing its share of project expenditures, and replenished at least quarterly to ensure timely and adequate provision of finds for project implementation. Based on the Financial Management Questionnaire available in project files, and the CFAA diagnostic work, the inherent risk associated with factors arising from the country s rules and regulations is considered high for Azerbaijan. The control risk that the project accounting and internal control frameworks are capable of ensuring the project funds are used efficiently and for the purposes intended, and that the use of funds is properly reported is considered moderate. 42

52 Impact of Procurement Arrangements. Based on diagnostic work carried out under the Country Procurement Assessment Report (CPAR) issued in 2002, the following key factors have a direct effect on the financial management arrangements: Legal Framework and Enforcement Regime. Azerbaijan has introduced a new Public Procurement Law that is based extensively on the United Nations Commission for International Trade Law (UNCITRAL) model. The Public Procurement Law has set up a three-tier review system that consists of an internal administrative review by the State Procurement Agency (SPA) and judicial review. Perception of the courts ability to deal with procurement disputes is poor, thus jeopardizing the SPA S level of confidence and overall transparency in the review process. Regulatory Functions. The SPA has been vested with the procurement regulatory functions and has shown willingness to ensure compliance with the Public Procurement Law. The Law is being amended to fully confirm to international standards. MoF requested the Bank during the Country Portfolio Review meeting to assist the SPA in the amendment of the law. Institutional Capacity. The CPAR had identified lack of planned training system for procurement staff in the country, in that staffs who undertake procurement tasks often do so without sufficient or any formal training. The SPA has taken steps to build procurement capacity by initiating training in public procurement to the line ministries and in the regions. The Bank provided a three-day procurement workshop in June 2005 on procurement of works, goods and consultant s services to all PIUs, and Government agencies and Ministries staff involved in procurement activities of Bank-financed projects. B. Disbursement Arrangements. Retroactive financing. Disbursements from the Loan will only be made for expenditures that have not been made earlier than December 1,2005. Retroactive financing is limited to 5% of the Loan amount (US$ 10 million). Allocation of Loan Proceeds. The expected Loan disbursement period is five years (CY2006- CY 2010). Disbursement will follow transaction-based loan disbursement procedures made against eligible expenditures. Table 7.1 shows allocation of the Loan proceeds. The financing percentages are in line with the Country Financing Parameters (CFP) of the Republic of Azerbaijan. Land acquisition and resettlement costs required for the 136 km alignment of the Alat-Masalli road (about 800 hectares) would be solely financed by the Government. Table 7.1: Allocation of Loan Proceeds Expenditure Category Amount in US$ million Financing Percentage Works, goods, consultancy services, training % and incremental operating costs Total Project Costs Front-end Fee 0.50 Total

53 Use of Statements of Expenditures (SoEs). Statements of Expenditures (SoEs) will be used for: (a) goods contracts with estimated costs less than US$200,000 each; (b) works contracts less than US$1,000,000 each; (c) consultants contracts with firms less than US$lOO,OOO and individuals up to US$50,000; and (d) incremental operating costs and training. For all above contracts, full documentation in support of the SoEs will be retained in the PIU and made available for review by Bank missions during project supervision and by the project's auditors. Disbursements for expenditures above SoE thresholds will be made against presentation of full documentation relating to those expenditures. The SoEs documents will be retained in the PIU for at least two years after closing of the project. The minimum application size for payments directly from the Loan Account or for issuance of Special Commitments is 20 percent of the special account authorization. SoEs will be audited in conjunction with the annual audit of the project (see description of the project's financial management arrangements below). There is no plan to move to periodic disbursements through use of Financial Monitoring Reports, as this method of disbursements has not yet been agreed with the Government on Bank-financed projects in Azerbaijan. Special Account. To facilitate the project implementation, PIU will establish a Special Account and maintain it until project completion. The Special Account will be opened in a bank acceptable to the Bank, and on terms and conditions acceptable to the Bank. The Special Account will be drawn upon to meet payments to contractors, suppliers and consultants under the project. The Special Account will be audited in conjunction with the annual audit of the project, The selected bank to hold both the Special Account (Bank loan) and Project Account (Government counterpart funds) should meet the following criteria: (i) have a significant foreign correspondence network covering all currencies; (ii) have reasonable capacity and experience for issuing letters of credit, for making direct foreign payments and other international transactions; (iii) have capacity to perform a wide range of banking services at local branches, including cash payments, transfers to other domestic and regional banks, issuance of debit notes, application of conversion rates from foreign currencies; (iv) have the capacity to maintain adequate accounts for the Special Account as required by the Bank and provide monthly statements to the PIU; (v) have the capacity and willingness to issue Comfort Letter to ensure that amount deposited in the Special Account will not be set off or otherwise seized or attached to satisfy amounts due to a commercial bank by the Borrower; and (vi) have willingness to charge competitive rates for their services and provide reasonable interest income to the balances held. The total authorized allocation will be limited to US$16 million. The initial deposit to the SA will be limited to 50% of the authorized allocation until the aggregate amount of withdrawals from the Loan plus the total amount of all outstanding special commitments entered into by the Association (Bank) shall be equal to or exceed U S24 million. Replenishment applications should be submitted at least every three months and must include reconciled bank statements as well as other appropriate supporting documents. Project accounts will be operated for discrete activities and funded from the Special Account based on disbursement applications signed by the authorized officials. 44

54 Annex 8: Procurement Arrangements AZERBAIJAN: Highway 2 A. General Procurement for the proposed project would be carried out in accordance with the World Bank s Guidelines: Procurement Under IBRD Loans and IDA Credits dated May 2004; and Guidelines: Selection and Employment of Consultants by World Bank Borrowers dated May 2004, and the provisions stipulated in the Legal Agreement. The various items under different expenditure categories are described in general below. For each contract to be financed by the Loan, the different procurement methods or consultant selection methods, the need for prequalification, estimated costs, prior review requirements, and time frame are agreed between the Borrower and the Bank in the Procurement Plan. The Procurement Plan will be updated at least annually or as required to reflect the actual project implementation needs and improvements in institutional capacity. For bidding and contracting of consulting firms, the Project executing agencies would use standard Bank documents, for National Competitive Bidding (Works) and for Shopping, ECA regional sample documents, and for individual consultants, national documents satisfactory to the Bank. Procurement of Works: Works represent most of the total Project cost. Works procured under this project would include several large civil works contracts for the construction of the new Alat-Astara Highway and the rehabilitation of the Baku-Shamakhi Highway, and, would be procured under International Competitive Bidding method (ICB), using the Bank standard bidding document for Works. There would be pre-qualification of firms for Works estimated US$10 million or more. The aggregate estimated cost is around US$240 million and several large contracts would require procurement clearance from the Bank Operations Procurement Review Committee (OPRC). Works for rehabilitation of small connecting roads and bridges on the other part of the network, and safety works, estimated less than US$1 million, might be procured under National Competitive Bidding (NCB) procedure taking into account the NCB procedural waiver (conditions of broad compatibility with Bank s guidelines) included in the Legal Agreement, using the Bank ECA Regional sample bidding documents for NCB of works. Very small minor works contracts estimated less than US$lOO,OOO, would be awarded on the basis of three or more written quotations (Shopping for works). Procurement of Goods: Goods procured under this project would include supply of Equipment for RTSD (maintenance equipment as well as road testing and laboratory equipment), to be procured under ICB for equipment costing US$lOO,OOO or more and Shopping method for equipment costing less than US$lOO,OOO. Office furniture, as well as for Information Technology equipment with software, estimated to cost less than US$lOO,OOO would be procured using the Shopping method. Shopping will be carried out using ECA Regional sample Invitation to Quote (ITQ) Document. Procurement of non-consulting services: Surveying, mapping, and geological tests may be procured under the project. 45

55 Selection of Consultants: Consulting services under this project would include: (i) environmental studies, design and supervision of works; (ii) institutional strengthening; (iii) financial management assistance; (iv) training; (v) financial audit services; and (vi) individual consultants to staff the PIU. Short lists of consultants for services estimated to cost less than US$lOO,OOO equivalent per contract may be composed entirely of national consultants in accordance with the provisions of paragraph 2.7 of the Consultant Guidelines. Consultancy services to be provided by consultancy firms estimated to cost US$200,000 or more will be procured through Quality and Cost Based Selection (QCBS) method. Consultancy Services estimated to cost less than US$200,000 may be procured through Consultant s Qualifications Selection (CQS) method. The consultancy firm for project entity and project financial audits will be selected through Least Cost Selection (LCS) method. Individual Consultants will be selected in accordance with Section V of the Consultancy Guidelines. Operating Costs: PIU s operating costs would be financed by the project and procured using the implementing agency s administrative procedures. The procurement procedures and Standard Bidding Documents (SBD) to be used for each procurement method, as well as model contracts for works and goods procured, are presented in the procurement section of the World Bank s website. B. Assessment of the agency s capacity to implement procurement Procurement activities will be carried out by the PIU under the responsibility of RTSD, which is an Agency part of, and under the supervision of MOT. RTSD has appointed a Project coordinator, to lead a PIU including specialists hired as consultants based on their qualifications, such as two or more procurement specialists, and a procurement analyst or assistant. Implementation activities for the project will be supervised and controlled by RTSD through the PIU. Although the previous PIU set within RTSD for the implementation of the first Azerbaijan Highway Project has had some exposure to procurement under the Bank s guidelines for procurement and selection of consultants, the procurement capacity appeared to be very weak so far. The procurement capacity needs to be built anew through specific hiring of the two above mentioned procurement dedicated PIU professionals, quickly followed by a fiduciary training program involving them and the financial management staff. An assessment of the capacity of the old PIU, to implement the previous Project s procurement was deducted from the two last post review missions carried out by the team s procurement specialist. The implementation of the following Action Plan will help minimize the risks which have been identified. Description I Objective I Time-frame Procurement Plan/Packaninn I Identifv eventdwork flow I Amraisal Operational Manual Define operational rules Negotiations Project Launch Seminar I Train/disseminate rules I Prior to disbursement Procurement Ex-Post Reviews Adm. Support to the PIU Supervision Assure satisfactory supervision/control. 3 in the Project Implementation period, to be scheduled. Appraisal 46

56 The Bank will prior review all ICBs and the two first NCBs and Shopping procedures. Regarding services, the Bank will prior-review all consultant contracts with firms estimated to cost more than US$lOO,OOO and the first two individual contracts with individual consultants, plus any individual consultant contract estimated to cost more than US$50,000. Bank procurement supervision would be more than average, and very frequent. The overall project risk for procurement is rated high. C. Procurement Plan The Borrower, prior to appraisal, developed a procurement plan for project implementation which provides the basis for the procurement methods. This plan has been agreed between the Borrower and the Project Team in October 2005 and is available at the PIU offices (same address as RTSD). It will also be available in the project s database and in the Bank s external website without indication of the estimated costs. The Procurement Plan will be updated in agreement with the Project Team annually or as required to reflect the actual project implementation needs and improvements in institutional capacity. D. Frequency of Procurement Supervision In addition to the prior review supervision to be carried out from Bank offices, the capacity assessment of the Implementing Agency has recommended three supervision missions to visit the field to carry out post review of procurement actions. E. Details of the Procurement Arrangements Involving International Competition 1. Goods, Works, and Non Consulting Services (a) List of contract packages to be procured following ICB and direct contracting: Ref. No. Contract (Description) Estimated cost (US$ million) Procurement Method P-Q Domestic Preference (yeslno) Review by Bank (Prior I Post) Expected Bid- Opening Date Comments AA 1 Road works 30 ICB Yes No Prior Apr 2006 Sect. 1 AA2 Road works 60 ICB Yes No Prior Nov 2006 Sect. 2 AA3 Road works 60 ICB Yes No Prior Feb 2007 Sect. 3 BS 1 Road works 20 ICB Yes No Prior June 2006 Sect. 1 BS2 Road works 20 ICB Yes No Prior Aug 2006 Sect. 2 BS3 Road works 20 ICB Yes No Prior Oct 2006 Sect. 3 BS4 Road works 20 ICB Yes No Prior Dec 2006 Sect. 4 GD 1 Equipment 0.80 ICB No No Prior June

57 GD2 GDx SE1 Equipment 0.50 ICB No No Prior Sep 2006 Equipment 0.50 ICB No No Prior Dec 2006 Several lots Data Coll. 1.o ICB No No Prior Nov 2007 Services (b)all ICB contracts and all direct contracting will be subject to prior review by the Bank. 2. Consulting Services (a) List of consulting assignments with short-list of international firms Ref. No. DESignl DESign2 DESign3 DESign4 Description of Estimated Selection Review Expected Comments Assignment cost Method by Bank Proposals (US$ (Prior / Submission million) Post) Date Preliminary/Det 1.50 QCBS Prior Nov 2005 ailed Design Alat-Masalli Detailed Design 0.5 QCBS Prior Feb 2007 Tagiyev - Sahil Connecting 2x0.15 CQS Prior Mar 2007 Roads Environmental 0.50 QCBS Prior Jan 2006 studies (b) Consultancy services estimated to cost above US$lOO,OOO per contract for firms, US$50,000 for individual consultants and Single Source selection of consultants (firms or individuals) will be subject to prior review by the Bank. (c) Short lists composed entirely of national consultants: Short lists of consultants for services estimated to cost less than US$lOO,OOO equivalent per contract may be composed entirely of national consultants in accordance with the provisions of paragraph 2.7 of the Consultant Guidelines. 48

58 Appendix 1 to the Procurement Plan: Prior Review Thresholds Thresholds for prior review are specified hereafter as Appendix 1 to the initial Procurement Plan for the starting year of implementation, and may be revised after one year. The updates issued by the Bank are to be construed as Appendix 1 to the current Procurement Plan replacing previous Appendix 1. Thresholds for prior review are set as follows for the first year: A). Goods and Works. The following contracts are subject to the Bank s prior review as set forth in paragraphs 2 and 3 of Appendix 1 to the Guidelines: 1. all ICB contracts; all contracts estimated to cost the equivalent of US$200,000 or more; and the first two contracts procured under NCB (regardless of contract value), and Shopping or Minor Works (S or MW). B). Consulting Services. With respect to consulting services, prior Bank review will be required for all terms of reference for consultants. Contracts for services estimated to cost the equivalent of US$lOO,OOO or more for firms and US$50,000 or more for individuals, and the first contract under CQS, FBS and LCS are subject to Bank s prior review as set forth in paragraphs 2 and 3 of Appendix 1 to the Guidelines (CQS Method may be used for contracts estimated to cost less than US$200,000 equivalent). C). All other contracts are subject to post review, in a ratio of one contract in five. D). Thresholds for Procurement Methods and Prior Review Contract Value Threshold (Method) Procurement Contracts Subject to Prior Review Expenditure Category (US$) Method (US$) 1. Works Over 1,000,000 ICB All less than 1,000,000 NCB 2 first contracts less than 100,000 S (MW) 2 first contracts 2. Goods Over 200,000 ICB All Less than 100,000 S 2 first contracts 3. Services (local and Over 200,000 QCBS All foreign firms) Less than 200,000 CQS First and above 100,000 Less than 300,000 LCS First and above100,ooo IC First and above 50,000 49

59 Annex 9: Economic and Financial Analysis AZERBAIJAN: Highway 2 A. Economic Analysis The economic evaluation of the project covers the following two project components: 0 upgrading the M3 highway between Alat and Masalli2 including expansion of the existing two-lane roadway to a four-lane roadway under a mostly new alignment, and 0 Rehabilitating the existing road between Baku and Shamakhi. The analysis is based on the actual traffic volumes and forecasts, vehicle operating costs (VOC) and time-savings for users, and estimated economic project costs. The main inputs for the evaluation are: 0 capital investment and maintenance costs, reflecting June 2005 prices; 0 the benefit stream, also reflecting June 2005 prices, that comprises savings in VOC, travel time savings, and maintenance savings; 0 implementation of investments during the period in a phased construction schedule in line with the optimal timing of the investments, and an evaluation of the benefits during a 25 years long period; and 0 benefits accruing to each section at the end of its construction and/or rehabilitation period, starting in This Annex comprises four parts: (A) the preceding general considerations, (B) the economic evaluation of the upgrading of the Alat-Masalli road; (C) the economic evaluation of the rehabilitation of the Baku-Shamakhi road; (D) economic evaluation of the connecting roads; and (E) the overall economic evaluation of the project, including a sensitivity analysis to check the robustness of the results. B. Upgrading of the Alat-Masalli Road Section 1- Alat-Shorsulu (km ) 2- Shorsulu-Masalli (km ) TOTAL Massali-Astara (km , ADB) Investment Cod2 Nb of km Nb of km after (US$ million) before project projed The first component (Alat-Masalli) is part of a broader program, the complete upgrading of the Alat-Astara road (about 243 km), which is to be financed by the Bank up to Masalli while the Government asked the Asian Development Bank (ADB) to finance the southern section Masalli-Astara. Estimated undiscounted initial investment costs. These costs do not compare directly with the project costs taken into account for the project, although they are the basis for them. The project costs have been escalated to reflect, inter alia, a 20% price contingencies over the construction period. 23 The exact number of km will depend of the selected alternative in the near future. 50

60 ~ Current Traffic and Growth Projections. Traffic counts on the key road sections were carried out by RTSD for a period of two days, and traffic levels were seasonally adjusted. Base traffic in the main counting sites is shown below. Average Daily Traffic in [All veh] Salyan (km 120) H Jalilabad (km210) 0 Liman (km 1, North of Lenkoran ~~ (km275) I1 1 I I Trafic on Alat-Astara road - Source: RTSD For the purpose of determining future road traffic levels, the following assumptions have been made regarding traffic diversion and traffic growth. The upgrading of the first section will mostly follow the existing alignment. In the case of the second section the new road will create a 38 km shortcut between Shorshulu and Masalli, but will be distant from the cities of Bilasuvar (25,000 inhabitants) and Jalilabad (35,500 inhabitants). Therefore, local traffic between these cities is expected to remain in the old alignment. Based on origin destination surveys carried out during project preparation, traffic diversion was estimated at 50%. Estimated rates of traffic growth have been determined on the basis the projected growth of nonoil GDP, an estimated income elasticity of demand of 1.0 for the transport of goods and 1.3 for the movement of people, and supported by an expected substantial increase in car ownership24. Levels of car ownership reflect the level of economic development in a country, standards of living and the demand for personal travel. On the basis of car registration data, car ownership in Azerbaijan was of the order of 49 vehicles in 2004, and is expected to reach 73 by the year A number of studies have examined how vehicle ownership and use are affected by price and income (Jansson, 1989; Golob, 1989). Generally, as people become wealthier vehicle ownership increases, but at a declining rate (Schafer and Victor, 2000). Kopits and Cropper (2003) find that vehicle ownership nearly levels off at about US$16,000 per capita annual income. Glaister and Graham (2000) concluded that the long-run elasticity of vehicle travel with respect to income is 1.1 to 1.8, with the higher values corresponding to lower income groups. 51

61 and 300 by the year Future growth in car ownership was estimated by examining the relation between per-capita income and car ownership on a cross-sectional basis for a range of European countries across the low, middle and high income spectrum. The analysis, based on the expected growth of income, assumes that Azerbaijan will gradually approach during the life of the project the levels of motorization consistent with the middle to higher income countries25. *Non-oil GDP per capita. Generated traffic is expected to be above normal for an already existing road, since the project would substantially reduce travel time to Lankaran, an area that had preeminence as one of the main producers of fruits and vegetables for the Moscow market before the breakdown of the Soviet Union, attracts domestic tourism from Baku as the only sub-tropical region in the country, and is a key link for the Azerbaijan-Iran-Russia trade. For the purpose of the economic analysis, generated traffic was estimated to be 10% of normal traffic. 25 The analysis further assumes that the expected substantive growth of the economy will be accompanied by successful income distribution policies. Present programs such as the creation of a fund from oil revenues to be earmarked for social investments and the policies of the Azeri government to encourage the growth of the non-oil economy, supports this assertion. 26 Source: WBI & GDF central, WB. Source: DG TREN, European Union. 52

62 700, Car ownership and Per Capita Income (US Dollar) in selected European countries, $0 $5,000 $10,000 $15,000 $20,000 $25,000 $30,000 Per capita GNI (PPP) Costs and benefits. The cost benefit analysis was performed with the help of the Highway Design Model (HDM IV) comparing the without project case, assumed to be a do little case, with the proposed project and yielded an estimated EIRR of 25 percent for the first section and of 29.2 percent for the second section. Exogenous variables introduced to the model were limited mostly to the conditions of the highly urbanized and congested Shorsulu-Masalli section and the diversion of traffic to the proposed alignment. Project costs and the cost of routine and periodic maintenance are based on ongoing pre-feasibility studies. All costs were based on border prices. Labor costs were based on ongoing market wages since in spite of the high level of unemployment in the country, the current boom in construction has produced a shortage of foremen and equipment operators and ongoing wages accurately reflect the opportunity cost of construction labor. For the calculation of savings in travel time it was assumed that 50 percent of private car drivers and 50 percent of all passengers (despite of vehicle type) are on business related trips. The other half of the trips would be related to leisure or social purposes. Bus and truck drivers were assumed to be on a business related trip 100 percent of the time. Occupation figures used for the analysis were two passengers for cars, ten for minibuses, 40 for buses and none for trucks. The average hourly wage rate used was US$2.44 per hour2*. Because of the poor quality of currently available traffic accident data benefits derived from a reduction of accidents, which are expected to be important, were not quantified. The current average hourly wage is 92 cents and is expected to grow substantially over the life time of the project to reach 6.81 dollars by 2030, following the trend of the GNI per capita (cf: the feasibility study of RRI, September 2005 draft report). The figure used for the analysis is an average over the time period, weighted to approximate the average actualized value of the real wages over the period. 53

63 ~ ~ ~ 0 ~ 0 C. Rehabilitating the Baku-Shamakhi Road Current Traffic and Growth Projections. The same methodology as above has been applied for this section of the 124 km Baku-Shamakhi road, a section of one of the major arteries linking the capital Baku with Georgia, the main gateway to the high seas. Base average annual daily traffic of about 4000 vehicles is expected to grow following the income elasticity relations developed for the Alat-Astara Road. a Average Daily Traffic in km from Baku I I [All veh] W 78 km from Baku - East of Maraza I Entrance of Shamakhi (120 km i from Baku) i~ I Exit of Shamakhi (123 km from Baku) I I 0 I Traflc on Baku-Shamakhi road - Source: RTSD Costs and benefits. The economic evaluation was calculated with the use of the HDM IV model and yielded an estimated EIRR of percent. The base case, considered to be the do little case, is compared to the project case, in which VOCs (as a function of road roughness) and travel time (as a function of speed) are reduced by an average of 10.3% through the life of the project, Economic costs are estimated to reach about US$500,000 per kilometer on the basis of recent procurement of similar projects in the country. D. Connecting Roads The rehabilitation of about 120 km of access roads to the M3 and M4 highways is also a key element in revitalizing the economic - and especially agricultural - activity in the region. The current condition of most of these roads is such that they truly represent an obstacle to economic activity and accessibility to basic services, such as health and education, generating benefits that are not readily quantifiable in low volume roads. The selection of the connecting roads will meet the following economic criteria depending on annual average daily traffic: (a) above 250 vehicles, have an economic rate of return of at least 12%; (b) between 150 and 250 vehicles, have an economic rate of return of at least 10%; and (c) below 150 vehicles, have an economic rate of return of at least 8%, all to be calculated in accordance with a methodology acceptable to the Bank For very low volume roads, (less than 100 vehicles per day) the Bank could consider the use of the producer surplus method or simpler methods based on relevant thresholds. 54

64 E. Economic Analysis and Sensitivity Tests The estimated economic returns of the proposed road sections range from 21.3% to 29.2%. Section Alat-Shorsulu Shorsulu-Masalli Total Alat-Masalli B aku-shamakhi Whole Project EIRR NPV29 (US$ million) 25% % % % % The economic evaluation of the total upgrading of the M3 road (from Alat to the Iranian Border) indicates an economic internal rate of return of 25.4% for a net present value of US$366.5 million. Sensitivity analysis. The following tables present the results of the sensitivity analysis for each road section, In general all the analyzed road sections can withstand a combined occurrence of a 20% percent drop in traffic and a 20% increase in costs with the Baku-Shamakhi rehabilitation becoming marginal (Le. EIRRs between 10 and 12%). The project is therefore sound, with an economic internal rate of return of 17.5% in the worst case scenario. (NPV in US$ million) costs +20% Traffic +20% NPV: EIRR: 25% Traffic -20% NPV: 56.7 EIRR: 17% costs -20% NPV: 217 EIRR: 34% NPV: 97.2 EIRR: 23% Section 2: Shorsulu-Masalli L - costs +20% costs -20% Traffic +20% NPV: NPV: EIRR: 29.9% EIRR: 39.3% Traffic -20% NPV: 68.3 NPV: EIRR: 18.9% EIRR: 25.6% c Total Alat-Masalli costs +20% costs -20% Traffic +20% NPV: 355 NPV: I EIRR: 27.1% EIRR: 36.1% Traffic -20% NPV: NPV:

65 costs +20% Traffic +20% NPV: 55.7 EIRR: 28.2% Traffic -20% NPV: 10.9 EIRR: 10.7% costs -20% NPV: 75.1 EIRR: 47.5% NPV: 14.7 EIRR: 16.8% costs +20% Traffic +20% NPV: EIRR: 27.3% Traffic -20% NPV: EIRR: 16.5% costs -20% NPV: EIRR: 37.8% NPV: EIRR: 22.81% * The Net Present Value is computed with an annual discount rate of 12%. 56

66 Annex 10: Safeguard Policy Issues AZERBAIJAN: Highway 2 A. Environmental Safeguards a. Environmental Assessment and Management Since the exact alignments are not known at this stage a Regional Environmental Review (RER) has been prepared covering the entire scope of the program to describe the existing environment. The RER discusses and compares project alternatives and identifies risks and issues to be addressed during project implementation. An Environmental Management Framework (EMF) has also been developed that outlines the procedures for the environmental screening, management consultation and disclosure of Category A and B sub-projects. RTSD will oversee the implementation of the EMF and related environmental management plans. Key issues associated with the implementation of the EMF include: 0 Capacity of RTSD - The Ecology and Safety Sector (ESS) of RTSD is a relatively new department with responsibility for implementation of the EMF; coordination of environmental assessments including associated consultation and disclosure; liaison with relevant ministries and agencies; and supervision of the practical implementation of environmental management plans. As the ESS has limited relevant environmental background and experience a program of on-the-job training is currently proposed with the objective of strengthening their capacity to manage environmental impacts related to highway rehabilitation and development. This is a practical program that shall support ESS with the development and implementation of procedures for environmental management and monitoring. Further follow-on capacity building and training will be provided during project implementation by the independent environmental consultants that will be engaged to work on the Category A sub-projects. 0 Implementation of the Environmental Management Plans (EMPs) for sub-projects - construction contracts will include environmental performance measures including the requirement to ensure full implementation of the relevant ENEMP. b. Sub-project - first 22 km south of Alat An Environmental Assessment and Management Plan has been drafted in accordance with the EMF for Category B sub-projects for the rehabilitation and extension to a four-lane road of the first 22 km of the M3 south of Alat. These documents have been disclosed and approval is being sought from the Ministry of Environment. All works would take place within the existing right of way and no land acquisition or resettlement issues are envisaged. The final few kilometres of this section run in the immediate vicinity of the western borders of Shirvan National Park which are currently fenced. The Park was established for the protection of the Sand Gazelle (Gazella subgutturosa) and wintering, breeding and migratory birds. In recent years, the population of the Sand Gazelle has significantly increased and individuals and herds are now also found outside of the park s border. Other protected or sensitive areas or sites do not exist in the possible area of influence of the proposed intervention. 57

67 The Environmental Assessment and Environmental Management Plan outline the issues and impacts associated with the rehabilitation of this section of highway to ensure that appropriate management measures are identified to prevent, mitigate and monitor environmental impacts associated with these works. Construction is planned to start in March c. Sub-project - other sections south of Alat Beyond the first 22 km, the proposed project will also upgrade other sections of the 240 km long M3 motonvay between Alat and Astara that runs south from Baku through seven administrative districts to Iran. The project would involve the expansion of the existing two-lane road to a fourlane road. Several alignments are under consideration and include the construction of a new four-lane road and by-passes around key towns along the highway. The environment of the study corridor is diverse, ranging from less populated dry semi desert in the north to more densely populated areas in the southern lowlands (including swampy areas) and foothills of the Talysh Mountains. Coastal sea plains dominate ranging from km width in the north to between 2-4 km width in the south between the sea and the foothills of the Talysh Mountains. Mud volcanoes stand out in the plain in the first km south of Alat, and the Kura-Talysh area is known for seismic activity with earthquakes registering magnitudes of between 6 and 7 on the Richter scale. There are many rivers, canals, and wetland systems in the corridor as well as some lakes and mineral springs. Flooding is common, especially on the Kura River. Numerous protected areas and other significant natural sites of both national and international importance are found in the study corridor. Biodiversity is high and fish resources are abundant. The southern area is largely agricultural. Tea plantations abound, vegetable growing is common as is viticulture. Lankaran i s a developing industrial region. Cultural heritage is rich with archaeological finds dating back to the Neolithic period. The 45 km section to the south of the first sub-project (Le. the 22 km section south of Alat) between Yenikand and Shorsulu is heavily influenced by agriculture and is crisscrossed by a dense network of drainage and irrigation channels and collectors. There is no evidence that valuable or sensitive natural habitat that could be directly or indirectly impaired by construction and operation of a new road if appropriate management measures are employed and road design takes account of the existing water regime. South of this section, three alignments (direct and railway alignments, and expansion of the existing road) have been reviewed at this stage for traversing the area between Shorsulu and Masalli and both the direct and railway options route through existing natural wetlands. The direct alignment of 52 km includes a 12 km section that routes through the Madmudchala and Akhchala wetlands, IBA sites that are proposed for future Ramsar designation but are currently unprotected. The railway alignment is 55 km long and includes an 11 km section between Mugan Channel and Uzuntapa that runs in parallel and approximately 2-3 km to the northwest of the railway line and that also routes through the Akhchala wetland. The first 23 km of the railway alignment up to the Mugan Channel runs through irrigated land and the final 30 58

68 km after Uzuntapa crosses largely agricultural land gradually becoming more densely populated to the south. A number of tree plantations could be affected in this latter section depending upon the final alignment selected. The Madmudchala and Akhchala wetlands provide natural habitats for numerous rare and endangered wildlife species and have significance as a buffer zone for the adjoining wetlands that form part of the Gizilagach State Reserye, an official Ramsar site located 3-5 km from this area. The water balance in the Akhchala wetland is unstable and under constant threat of drying out. Controlled hunting is permitted here and there is pressure from poaching and fishing. Routes through these wetland areas have significant potential for adverse environmental impacts including large scale sedimentation due to construction on unstable ground, habitat fragmentation and the creation of barriers for wildlife movement, disruption of breeding colonies for rare and endangered species and to the hydrology in the area. Natural wetlands and areas with saline soils also raise concerns for construction: saline soils are prone to collapse under load or vibration and may lead to the corrosion of steel reinforcements and also require high volumes of construction materials. Based on the analysis conducted to date the RER assesses the impacts associated with the railway alignment to be less significant than the direct alignment, due to the presence of the existing line, but notes there is no reliable baseline data on the hydrological setting, the interrelation of the railway route with the adjacent wetlands or the geotechnical requirements for road construction in terms of design and construction and their impact on local hydrology. The most southern section between Masalli and Astara is about 60 km long. Sensitive natural areas are in the south western part of the corridor and alignments need to be carefully selected to minimize their direct and indirect impact on natural forest vegetation of the Hirkan Forest to the west of Lankaran and the Talysh Relict Forest in Hirkan National Park. A wide range of people and businesses have the potential to be impacted particularly in areas of new road construction. Potential adverse construction impacts may be minimized by avoiding wildlife breeding and fish spawning seasons, developing pollution controls, implementing strict hunting controls within the construction workforce, designing drainage structures to minimize impacts on local hydrology in wetland areas and designing bridges and culverts to minimize impacts on fish habitats. Borrow pits for construction materials should avoid areas of national park or known ecological value. Material haulage also raises issues with traffic congestion, safety, noise, dust and damage to existing roads. While rail transport represents a possible alternative the cost implications need to be carefully weighed. During project implementation engineering feasibility studies together with environmental and social assessment and economic analysis will be conducted for all route alignments prior to the selection of a preferred alternative for development. Site specific environmental assessments, appropriate study work and environmental management plans will be developed during project 59

69 implementation to specifically address the issues and concerns raised in the RER for the subprojects that are proposed in this study area. d. Sub-project - Baku-Shamakhi An Environmental Assessment and Management Plan is currently under preparation in accordance with the EMF for Category B sub-projects to rehabilitate a 124 km section of M4 road linking Baku to Muganli, a village to the west of Shamakhi. As well as many long straight sections through areas of unpopulated semi desert the road includes a number of steep winding sections through mountains with tight blind corners. Sections of this road are known for unstable ground and landslide conditions, and flooding is reported to regularly affect Maraza town. The rehabilitation effort will take place within the existing right of way (ROW). Within the ROW, some sections of tree plantations and shrubs that fall under the ownership of the State Forest Fund may require removal. There are likely to be temporary and short term impacts associated with construction on the local population such as noise, heavy vehicle traffic, dust, traffic disruption and loss or impaired access to properties adjacent to the ROW but no impacts on cultural properties are anticipated. Careful planning and management is required to ensure that breeding sites near the river Jeyrankechmez for the globally threatened Lesser Kestrel are not affected by construction activities and that sites selected for material extraction do not impact Important Bird Areas in the region. B. Social Safeguards The proposed project will build four-lane highway that will cut through the narrow and densely populated stripe of land between mountains and the Caspian Sea, and the expropriation of about 816 hectare of land along 136 km roads between Alat and Masalli. Physical relocation of households may also be necessary. Consultants are estimating social and environmental impacts of alternative alignments, and the alignments of least impact will be selected. The land expropriation and physical relocation will not be necessary during the first year when the first 22km of roads from Alat are expanded, and exact alignments for the rest of the road will be determined during the first year. Therefore, the Resettlement Policy Framework (RPF) has been developed in order to identify negative impacts that may result from the implementation of the proposed project and define policies, procedures and institutional arrangement for the development of the Resettlement Action Plans (RAP). The RAP will detail plans and procedures for the expropriation of land and physical relocation of the Project Affected People (PAP). The RPF will (i) describe local socioeconomic conditions and expected impacts of resettlement, in terms of loss of land, homes/ structures and livelihood and income opportunities; (ii) define the legal, institutional and implementation framework for the preparation and implementation of RAP. In the RPF, Azeri laws regarding involuntary resettlement are assessed and the gaps with Bank safeguard policies identified, and the measures to fill them proposed. Among other issues raised in the RPF include: 0 Approximately 816 hectare of land will need to be expropriated. The scale of physical relocation cannot be determined since alignments are not determined yet; however, it should not be considerable since the project will not finance the most densely populated areas close to Iranian border. RTSD does not have the experience to manage the 60

70 involuntary resettlement of this scale. RTSD recently opened the Land Acquisition Department (LAD) in charge of involuntary resettlement, but further capacity development will be necessary for satisfactory implementation of land acquisition and resettlement. The environmental and social TA that is being provided to RTSD under the Highway I project will help strengthen the capacity of RTSD, but consultants will be hired during the implementation of the proposed project who will provide hands-on support to the LAD from preparing the TOR for the RAPs to monitoring of their implementation. Also, RTSD will attach more local staff to the LAD to meet the scale of tasks expected under the project.. 0 Major gaps between Azeri law and Bank OP.BP 4.2 include: Income restoration measures are not included as part of legal entitlements for the PAP under the Azeri law, though in practice, assistance of some kind is often provided to the PAP when needed. The RPF requires the Local Executive Bodies to provide income restoration measures such as privileged access to employment in the physical works carried out under the project, and the RAPs will specify packages of measures. that will be provided to the PAP. Only those land ownerdusers with legal titles or legally recognizable documents are entitled for compensation. While illegal squatting is not very prevalent in Azerbaijan currently, the PAP may include the users/ occupants of land without formally recognizable status. Under the proposed project, those PAP without legal rights to the land will receive rehabilitation assistance to restore livelihood to the levels prior to the project. The Local Executive Bodies will be responsible to carry this out. Census will be taken when the RAPs are developed so the number of those without legal rights to land will be determined. Under the Azeri law, moving costs are not recognized as part of the entitlements of the PAP. In practice, the Local Executive Bodies and RTSD often offer help to those who are relocated, by requiring contractors to allow the free use of vehicles to transport possessions to new settlements. The proposed project will ensure that moving costs are included as part of cash compensation or in-kind assistance is provided to the PAP who will be relocated. 0 Compensation of lost properties will be calculated based on the market value of the full replacement cost, as set forth in the RPF. Under the Azeri land code, compensation is calculated based on the market value of properties, which should be equivalent to the replacement cost of affected assets. While local land market is not always very active and the "market value'' is estimated and determined by experts attached to local governments, actual terms of compensation is determined through negotiation between individual PAP and RTSD. The proposed project will implement a strong information dissemination campaign to ensure all PAP are aware of their entitlements related to compensation at the full market value of affected assets. Income restoration measures, including privileged access to employment created under the project will also be provided to severely affected people. 0 Farmers who elect land swap will be provided with alternative land of the same value from state/municipal land acceptable to them. Many local executive bodies and municipalities retain the land allocated to them at the time of land privatization. If local governments do not have sufficient size of fertile land acceptable to affected farmers electing land swap, cash compensation as well as support to find out alternative farmland 61