THIRD TAMIL NADU URBAN DEVELOPMENT PROJECT. Report No: IN PROJECT APPRAISAL DOCUMENT ON A PROPOSED LOAN IN THE AMOUNT OF USD 300 MILLION

Transcription

1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY PROJECT APPRAISAL DOCUMENT ON A PROPOSED LOAN IN THE AMOUNT OF USD 300 MILLION TO THE REPUBLIC OF INDIA FOR THE THIRD TAMIL NADU URBAN DEVELOPMENT PROJECT May 25,2005 Report No: IN Infrastructure and Energy Sector Unit South Asia Region 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 May 9,2005) Currency Unit RS 1 US$1 = Indian Rupee = US$0.023 = Rs FISCAL YEAR April 1 - March 3 I BOT CAS CCP CCTP CMA CMC CMDA DHRW DMAWS DMC ESF FIs GO1 GOT" HUDCO HDFC ICICI IDC IL&FS MUDPA PPP RDMA SFC TNIUS TNUDF TNUIFS TNUITCL TUFIDCO ULB URIF ABBREVIATIONS AND ACRONYMS Build Operate Transfer Country Assessment Strategy City Corporate Plan Chennai City Traffic Police Commissioner for Municipal Administration Chennai Municipal Corporation Chennai Metropolitan Development Authority Department of Highways and Rural Works Department of Municipal Administration and Water Supply Debt Monitoring Cell Environmental and Social Framework Financial Institutions Government of India Government of Tamil Nadu Housing and Urban Development Corporation Housing Development Finance Corporation ICICI Ltd. Institutional Development Component Infrastructure Leasing and Finance Society Ministry of Urban Development and Poverty Alleviation Public Private Partnerships Regional Directorate of Municipal Administration State Finance Commission Tamil Nadu Institute for Urban Studies Tamil Nadu Urban Development Fund Tamil Nadu Urban Infrastructure Financial Services Ltd. Tamil Nadu Urban Infrastructure Trustee Company Ltd. Tamil Nadu Urban Finance and Infrastructure Development Corporation Urban Local Body Urban Reform Incentive Fund Vice President: Country Managermirector: Sector Manager: Task Team Leader: Praful Patel Michael F. Carter Sonia Hammam Abha Joshi-Ghani

3 INDIA FOR OFFICIAL USE ONLY Third Tamil Nadu Urban Development Project CONTENTS Page A. STRATEGIC CONTEXT AND RATIONALE Country and Sector Issues Rationale for Bank Involvement Higher level objectives... 4 B. PROJECT DESCRIPTION Lending Instrument Project Development Objective and Key Indicators Project Components... 6 A. Institutional Development component... 7 B. Urban Investment component Lessons Learned Alternatives Considered C. IMPLEMENTATION Partnership Arrangements Institutional and Implementation Arrangements Monitoring and Evaluation Sustainability Critical Risks Component A: Institutional Development Component Component B: Urban Investment Component Loan Conditions D. APPRAISAL SUMMARY Fiscal Impact ofthe Project 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 be otherwise disclosed. without World Bank authorization. I

4 ANNEXES Annex 1: Country and Sector Background Annex 2: Major Related Projects Financed by the Bank andor other Agencies Annex 3: Results Framework and Monitoring Annex 4: Detailed Project Description Annex 5: Financing Plan Annex 6: Implementation Arrangements., Annex 7: Financial Management and Disbursement Arrangements Annex 8: Procurement Arrangements Annex 9 A: Economic and Financial Analysis Annex 9 B: Economic and Financial Analysis Annex 9 C: Economic and Financial Analysis Annex 12: Project Processing Schedule Annex 13: Documents in Project File Annex 14: Statement of Loans and Credits Annex 15: Country at a Glance Additional Annex 16: Analysis of Technical & Institutional issues in Sub-project Cycle Map(s): IBRD General Map of Tamil Nadu

5 INDIA THIRD TAMIL NADU URBAN DEVELOPMENT PROJECT Date: May 25,2005 Country Director: Michael F. Carter Sector Manager: Sonia Hammam Project ID: PO83780 PROJECT APPRAISAL DOCUMENT SOUTH ASIA SASE1 Team Leader: Abha Joshi-Ghani Sectors: General water, sanitation and flood protection sector (65%); Roads and highways (25%); Sub-national government administration (10%) Themes: Municipal finance (P); Municipal governance and institution building (P); Other urban development (P) Environmental screening category: Financial Intermediary (FI) Lending Instrument: Specific Investment Loan Safeguard screening category: Financial Intermediarv (FI),-. I [XILoan [ ]Credit [ ]Grant [ ]Guarantee [ ]Other: For Loans/Credits/Others: Total Bank financing (US$m.): 30?Y FY06 lnnual 30 lumulative 30 FY07 FY08 FY09 FYI0 FYI

6 Ref: PAD C.5 Does the project meet the Regional criteria for readiness for implementation? Ref: PAD D. 7 [XIYes [ ]No 1. The objective of the project is to improve the delivery of urban services through enhancing the quality- of urban infrastructure and strengthening the institutional and financial framework. The proposed repeater project would build on and consolidate the achievements of TNUDP 11, continuing to improve urban infrastructure services in Tamil Nadu in a sustainable manner, The two main objectives are: to strengthen the empowerment of Urban Local Bodies (ULBS)' by continuing the decentralization process through delegation of powers from state level bodies to ULBs; and through continuing and expanding the capacity building programs started under TNUDP 11; and to mobilize resources on a sustainable basis for urban infrastructure investments through: - mobilizing private financing for ULB infrastructure investments by linking ULBs to the financial markets through the intermediation of the Tamil Nadu Urban Development Fund (TNUDF); - providing incentives for investments in low income neighborhoods through the use of supporting capital grants. Project description: The Project will consist of two complementary components, an Institutional Development component (IDC) and an Urban Investment component. The IDC provides the Technical Assistance (TA) and training needed to build capacity to further the devolution process. The Urban Investment component finances: i) part of the ULBs urban infrastructure pipeline over the next five years through a line of credit and capital grants to the TNUDF; and ii) a grant for the development of urban roads and related components in the Greater Chennai Metropolitan Area through the Chennai Metropolitan Development Authority (CMDA). (Ref: PAD B.3, Technical Annex 4) Which safeguard policies are triggered, if any? Ref: PAD D.6, Technical Annex 10 Environment Assessment (OP/BP/GP 4.01) Significant, non-standard conditions for: (Ref: PAD C.6) Board presentation: None Loadcredit effectiveness: None Covenants applicable to project implementation: TNUDF to complete Business and Risk management strategy by December 3 1, 2005; TNUDF to raise at least US$ 40 million in co-financing BY September 30,2009. Government Order enhancing delegation of powers for clearance of infrastructure projects will be in place by December 31, The term ULB, wherever it appears in this document, shall mean Corporations, Municipalities and such special village Panchayat's as may be decided to be urban by GoTN fiom time to time. 2

7 A. STRATEGIC CONTEXT AND RATIONALE 1. Country and Sector Issues 1. Key elements of India s urban sector strategy: With nearly 300 million urban residents, India s cities contribute over 60% of GDP and account for more than 90% of Government revenues. Their efficiency has a significant and direct bearing on the country s overall economy. Yet, few cities, if any, are able to provide the kinds of urban services required on a regular and sustainable basis. In addition, even fewer adequately collect tariffs for the services provided or have credible financing systems that would allow them to access India s emerging financial markets. India s cities could contribute more effectively to the country s economic growth, and poverty reduction, if they did not suffer from severe infrastructure bottlenecks, service deficiencies, weak finances, poor local governance and distortions in land and factor markets. The National Planning Commission estimates that achieving meaningful urban reform, could add percentage points to India s economic growth rate over the Tenth Plan Period ( ). Thus for India, accommodating the needs of its growing urban populations is now and will continue to be a strategic policy issue for many years to come. 2. The Tenth Plan estimates urban investment needs to be about US$7 billion for the Plan period ( ) of which only about a third is available through budgetary resources. Over the past decade, growing concern about the ability of cities to provide the level of urban services commensurate with their contribution to economic activity has led to significant changes in India s urban development policies, through complementary strategies of decentralization and financial sector reform. The 74 Constitutional Amendment aimed to decentralize what had been highly centralized and regulated policies which had directed investments away from cities, particularly away from long term urban infrastructure investments. Financial sector reforms, begun in 1991, allow for urban local bodies (ULBs) to raise financial resources to meet their infrastructure needs independently of state loans or grants. Together, these policies aim to empower ULBs through greater self sufficiency. Part of these reform efforts and new approaches aim at tapping additional private resources for traditionally public investments. 3. Key issues constraining achievement of better urban sector results: Despite reforms at the central level, urban development has remained very much a state issue. The resources provided to cities as well as the regulations governing their management have continued to be decided lar ely at the state level. While the process of establishing elected local governments under the 74t a Amendment has been largely successful, the devolution of functions and funds to the newly elected bodies and ULBs remains incomplete. State governments continue to take decisions on such matters as rates of user charges, property tax, octroi and the role of parastatals in water supply and sanitation services with little reference to the ULBs,that are affected by these decisions. Few ULBs have the wherewithal to be demand responsive or to access India s emerging financial system. Despite major reforms since 1992 and a high degree of liberalization, the financial sector is not yet able to meet the resource needs of ULBs because of, among other factors, sector policies and ULB institutional constraints. The result is that urban institutions are not yet integrated into the fabric of the broader deregulation and financial reforms of the Indian economy. This is an important issue that the project aims to address. 4. Actions to address the above issues: Recognizing that continuing reform in governance and service delivery arrangements of Indian cities is required to position them as engines of national 3

8 growth and development, the Government of India s (GOI) Tenth Plan ( ) emphasizes urban reform as critical to growth and poverty alleviation. It underscores the centrality of reforms at both State and local levels to achieving sustainable investments. Given the important role that States play in determining local revenues and the regulations that govern urban economies, the GO1 introduced the Urban Reform Incentive Fund (URIF) in 2002 to provide incentives for reforms of State policies on housing and local finances (taxes and user charges). 2. Rationale for Bank Involvement 5. Rationale based on defined country/sector issues and alternatives considered: The Bank recognizes the importance of efficiently functioning cities in India s overall economic development and poverty alleviation strategy. As outlined in the 2004 Country Strategy (CAS), the Bank s strategy is to support the urban reform agenda of the Tenth Plan in the context of the broader decentralization framework, while strengthening citizens empowerment, urban management, governance and resource mobilization. The proposed project would directly contribute to the strategy by connecting financial markets with urban infrastructure, assisting in mobilizing private financial resources and by strengthening the financial and administrative capacity of ULBs to plan, finance and deliver services in a fiscally sustainable manner. The proposed project also addresses the issue of urban roads and traffic management through costeffective long-term solutions. 6. Bank s comparative advantage/@ with other stakeholders: Both the GO1 and the Government of Tamil Nadu (GoTN) have strong interests in continuing the Bank s assistance to urban sector development in the state of Tamil Nadu. The Second Tamil Nadu Urban Development Project (TNUDP 11) made a very strong impact on urban reform and strengthening of ULB capacity. The Tamil Nadu Urban Development Fund as established under TNUDP I1 has been successful in bringing ULBs to the market and exposing them to commercial borrowing practices. Both GoTN and GO1 see the continuation of this collaboration as a way to consolidate urban reforms in Tamil Nadu and to provide sustainability and continuity to the access to financial markets for urban local bodies. In addition, GO1 sees this as a way to bring to fruition a model that could be replicated at the national level and in other states as they reach Tamil Nadu s level of urbanization and implement reforms similar to those that have been implemented there: while GoTN sees it as a continuation of a long and fruitful relationship with the Bank. 3. Higher level objectives 7. Project contribution to India s overarching urban sector development objectives and to poverty reduction: The proposed Third Tamil Nadu Urban Development Project (TNUDP 111) would contribute directly to a number of the GOI s urban reform objectives for the Tenth Plan period ( ). The Plan proposes a reform agenda which, inter alia, aims to begin the process of: (i) enhancing the capacity of ULBs to assume their functions in accordance with the 74th Constitutional Amendment to ensure greater sustainability and accountability; (ii) strengthening local finances through rationalization and improvement of property tax and levy of sufficient user charges; (iii) ensuring better maintenance of existing assets; and (iv) introducing better accounting and financial management. TNUDP I11 will provide additional momentum to * Tamil Nadu is the most urbanized state in India, with 43 percent of the population living in cities. As discussed later in the text, it is also one of the most advanced reformers in terms of its urban policies. 4

9 the overall reform process being undertaken at GO1 and State levels. The project will support sound financing at the local level, enabling ULBs to access capital markets and reduce their dependence on limited central and state budgetary resources for their capital investment needs. 8. Project contribution to CAS objectives: The project is consistent with the Bank Group Country Strategy discussed by the Executive Directors on August 26, To achieve its primary goal of poverty reduction, the CAS aims to foster the decentralization process, support effective governance and promote private sector-led growth. TNUDP I11 would directly contribute to these CAS objectives by extending the benefits of privately mobilized financial resources to the financing of urban infrastructure investments of newly empowered ULBs and by strengthening the financial and administrative capacity of ULBs to plan, finance and deliver services in a fiscally sustainable manner. It is fully consistent with the CAS focus on working with interested states through both its governance dialogue and its sectoral projects in three priority areas: (i) clarifying the roles and functions of the three levels of local governments; (ii) promoting financial devolution and improving local taxation and cost recovery; and (iii) improving accountability to local constituents. The urban roads and traffic management component supports the CAS objective of minimizing high cost investments in mass transit schemes through more cost effective traffic engineering and management improvements. The selected low cost sub-projects aim to relieve congestion at key choke-points in the metropolitan transport network and contribute to improved traffic safety. The Bank loan size was envisaged in the CAS to be in the amount of US$ 200 million. However, in view of the large number of municipalities undertaking underground sewerage projects and the addition of the transport and traffic component for the Greater Chennai Metropolitan Area, the loan amount was increased to US$ 300 million. The proposed project is a repeater of TNUDP 11, which closed on November 30, In accordance with the procedures for repeater projects, approved by the Board in January 2003, a Regional Review Panel was constituted to review the advisability of preparing a repeater project. The Panel s recommendations were positive, based on: performance to date, project design, sustainability, financial management and procurement performance, and performance related to social and environmental safeguards. The panel s recommendations have been incorporated into the proposed project. B. PROJECT DESCRIPTION 1. Lending Instrument 9. A sector investment loan is considered the most suitable instrument to finance the variety of infrastructure investments proposed under the project. The proposed loan is directed to the urban sector and meets the requirements of OP 8.30 for Financial Intermediary Lending as it aims at removing the impediments in the development of market access to ULBs. Subsidized credit is not an issue for the project since funds will be provided to ULBs at market rates3. The project would facilitate access to financial markets by ULBs, by changing policies affecting their creditworthiness, by building their financial management capabilities, introducing financial discipline and by supporting their efforts to access the markets for their resource needs. The project design supports the long term sustainability of the financial intermediary, TNUDF, by underscoring market orientation, flexibility and range of financing instruments, the articulation While there is an opportunity cost of funds directed to the urban sector, this is out weighed by benefits such as creation of fiscal space and enhancement in the capacity and efficiency of ULBs to deliver improved urban services in a sustainable manner to the citizens. 5

10 of a long term strategy including a long term business plan and risk management strategy as well as profitability goals. 2. Project Development Objective and Key Indicators 10. The objective of the project is to improve the delivery of urban services through enhancing the quality of urban infrastructure and strengthening the institutional and financial framework. The proposed repeater project would build on and consolidate the achievements of TNUDP 11, continuing to improve urban infrastructure services in Tamil Nadu in a sustainable manner. The two main objectives are:. to strengthen and deepen the empowerment of ULBs by continuing the decentralization process through delegation of powers from state level bodies to ULBs; and through continuing and expanding the capacity building programs started under TNUDP 11; and to mobilize resources on a sustainable basis for urban infrastructure investments through: mobilizing private financing for ULB infrastructure investments by linking ULBs to the financial markets through the intermediation of the Tamil Nadu Urban Development Fund (TNUDF); - providing incentives for investments in low income neighborhoods through the use of supporting capital grants Project performance indicators are:.. enhanced financial soundness of ULBs, as indicated by improvement in own source revenues of participating ULBs and better debt management; improved urban governance and accountability in ULBs, through reforms undertaken such as accounting and financial management reforms and e-governance; improved cost recovery with regard to urban services and improvements in urban services delivery coverage; reduction in travel time on key transport project corridors, and reduction in fatal accidents in Chennai; and improved long- term sustainability of TNUDF through market orientation, diversification of its resource base and products and implementation of a business and risk management strategy. 3. Project Components 12. The Project will consist of two complementary components, an Institutional Development component (IDC) and an Urban Investment component. The IDC provides the Technical Assistance (TA) and training needed to build capacity to further the devolution process. The Urban Investment component finances: i) part of the ULBs urban infrastructure pipeline over the next five years through a line of credit and capital grants to the TNUDF; and ii) a grant for the development of urban roads and related components in the Greater Chennai Metropolitan Area through the Chennai Metropolitan Development Authority (CMDA). The first and second State Finance Commissions established the deficit in urban infrastructure in Tamil Nadu at around US$2.5 billion, while studies undertaken during project preparation established the effective capacity of ULBs to invest in sustainable urban infrastructure over the next five years to be 6

11 approximately US$950 million (Rs. 41,390 million). The project provides funding for US$254 million equivalent, or 27% of this overall investment capacity. INDIA: Third Tamil Nadu Urban Development Project Component cost Bank financing Us% Mill % of Total US$ Mill % A Institutional Development component A1 Capacity Building of Municipal Staff 7* Front End Fee Total Project Cost A. Institutional Development component 13. This component provides support for management improvements and institutional changes, including provision of goods, technical assistance, workshops, and staff training to support the implementation and sustainability of urban policy reforms, organizational performance, and urban services delivery. The component includes: (a) (b) (c) (d) (e) Managerial capacity enhancement within ULBs and related urban and municipal sector organizations to enable and sustain effective urban policy reforms. Information communication and technology support to streamline work flows within and between ULBs and strengthen ULBs global information system mapping capacities. Establishment of a Debt Monitoring Cell within the CMA for ULBs. Establishment of a Tamil Nadu Project Preparation Facility within CMA to provide consultancy services to ULBs to prepare and implement infrastructure projects. Project management support including the financing of incremental operating costs of CMA and RDMA. 7

12 B. Urban Investment component 14. The Urban Investment component will aim at developing sustainable urban investments such as water supply, waste water collection, solid waste management, storm water drains, roads and common facilities such as transportation networks, and sanitation facilities, based on demand driven investment plans developed by ULBs. While investments will be spread over ULBs throughout the State, part of the component will also support grants for urban road infrastructure and traffic management programs in the Greater Chennai Metropolitan Area which includes surrounding peri-urban areas. The investments would include road widening, small bridges, traffic studies and traffic management, and road safety sub-components. 15. The Urban Investment component includes support to TNUDF through a line of credit and provision of grant funds for the Project Development Advisory Facility (PDAF) for preparing and/or supervising projects that involve innovative sub-proj ect financial structuring and Capital Grant component to finance environmental and social mitigation actions, sub-projects serving the lowest income groups where required viability gap funding for Public Private Partnerships (PPP). However, in addition to the line of credit, project design would seek to expand TNUDF s financial role to include credit enhancement support through other instruments-such as debt service reserve funds, partial guarantees, first loss guarantees, bond insurance and subordinated debt instruments which would assist the overall objective of providing sustainable access to the capital markets and commercial financing to ULBs. Collaboration and participation with subsovereign funds such as IFC Municipal Fund is also envisaged. 16. The Urban Investment component also includes a grant for transport and traffic management sub-projects which fall within multi- jurisdictional areas and as such no single ULB is responsible for undertaking these investments. These investments would include road widening and strengthening, pedestrian walkways, Road Under Bridges, Road Over Bridges, grade separators as well as traffic management measures. A Comprehensive Urban Transport Study would also be carried out under this component. These investments would address a key urban and economic growth issue in terms of infrastructure choke points around Greater Metropolitan Chennai. In order to facilitate these investments, it was agreed that this component would be overseen by the Chennai Metropolitan Development Authority (CMDA), a statutory body under GoTN responsible for urban planning in the Greater Chennai Metropolitan Area. The CMDA would therefore act as the nodal agency for the implementation of these specific urban roads components and would be supported by the Department of Highways and Rural Works (DHRW) and the Chennai City Traffic Police (CCTP) in their implementation. Project management support including the incremental operating costs of CMDA would also be financed under this component. TNUDF, however, would have over all monitoring role for all fiduciary and safeguards aspects of the investment component (for implementation details see Annex 6). 4. Lessons Learned 17. Substantial experience has been gained from previous projects implemented in India and specifically in Tamil Nadu. On the sectoral level the Operations Evaluation Department s review of Bank s assistance (April 2000) in the urban sector underscores the importance of local capacity and client ownership of projects as ingredients of success. The review also underscores that the Bank s decreased involvement in the urban sector in the 90 s led to many lost opportunities. In the current climate where devolution and decentralization are a priority for GO1 8

13 and both state and urban reforms are on the agenda, there is an opportunity for the Bank to further strengthen urban reform initiatives and assist with capacity building and financial strengthening of the ULBs. 18. Lessons learned and reflected in the project design include: State-level commitment to urban policy reform is essential to enhancing fiscal, administrative, and management capacities at the local level. It requires agreement on the scope of reform and demonstrated up-front actions at both state and local level. GoTN has proved its commitment in previous projects and has now adopted a very proactive strategy to transfer more responsibilities to urban local bodies within the broader framework of the medium term fiscal framework. A consistent state wide policy towards financial institutions will be essential to maintain a level playing field for participating financial institutions and ensure maximum resource mobilization for ULBs. Transparent rules of engagement for sub-loans help ULBs to understand the cash flow implications of borrowing and to plan and prioritize the commitments entered into. TNUDF will actively market a range of financing products to the ULBs to help them make better informed choices. Information on ULBs loan repayment capabilities has been relatively limited. The ongoing improvements in ULB accounting practices, which will be consolidated and extended under the project, will make their financial statements more transparent and enhance their creditworthiness. The debt monitoring cell to be established in CMA will be responsible for consolidating this information on a consistent basis. In the past there have been long delays in obtaining technical approval for ULB subprojects from the overseeing state agency, CMA. This was due partly to lack of qualified and experienced staff in CMA, but also due to lack of ownership by CMA. To resolve this issue, CMA s human resources have been strengthened and a closer working relationship established between TNUIFS4 and CMA, with CMA participating actively on the Board of TNUIFS. In the case of roads sub-projects where multiple jurisdictions are involved, the use of a nodal agency would facilitate the implementation of these sub-projects by streamlining implementation issues. Under TNUDP I1 such projects had to be heavily escrowed due to a lack of debt reflows and therefore the use of a grant facility is considered more practical to implement this category of sub-projects under the nodal agency, CMDA. One of the most important lessons learnt from TNUDP I1 is the need for more flexible interest rate guidelines. TNUDF was caught in a downward interest rate market with lagged benchmarks and fixed margins which made its on-lending rates uncompetitive. Tamil Nadu Urban Infrastructure Financial Services ltd. (TNUIFS), is the asset management company for TNUDF. 9

14 New, more market responsive benchmarks have been designed under the proposed project. 0 Achievement of long term sustainability is critical for TNUDF to achieve it s stated objectives and have a greater impact on linking ULBs to the capital markets for their infrastructure investment needs. 5. Alternatives Considered 19. Although several alternatives were considered, they were mainly variations on the theme of how to ensure sustainability. The underlying issue was one of private versus public sector involvement, which, in the proposed project has been resolved in favor of continuing private sector participation and maintaining market orientation of the Fund. This would be achieved through the continued partnership with the Financial Institutions (FIs) in the Fund and the Asset Management Company, TNUIFS, and also through mobilization of debt by TNUDF in the capital markets. Arguments favoring public funding of urban infrastructure through Government departments were overruled by the size of the investments needed, which could only be met through the mobilization of funds on the market. In the case of the roads and traffic component for the Chennai Greater Metropolitan Area, it was first considered that TNUIFS should be the implementing agency. However, given the fact that this component is grant financed by GoTN, it was agreed that CMDA is better placed for the implementation of this multi-jurisdictional non - revenue component. C. IMPLEMENTATION 1. Partnership Arrangements 20. As in TNUDP 11, the project envisages continuing private participation in TNUDF. TNUDF was established in 1996, by restructuring the Government owned Municipal Urban Development Fund. As of date, about 30% of TNUDF s capital is provided by three private financial institutions: ICICI, Housing Development Finance Corporation (HDFC) and Infrastructure Leasing and Financial Services (IL&FS). 2. Institutional and Implementation Arrangements 2 1. Executing Agencies: The agencies involved in the execution of TNUDP I1 would also execute most of the components of TNUDP 111. There are however some changes with some changes in responsibilities to benefit from lessons learnt, and the addition of specialized agencies to implement the Chennai Metropolitan Area transport and traffic component. The Department of Municipal Administration and Water Supply (DMAWS) will have overall responsibility for project coordination and urban sector reform. A Government Committee, headed by the Chief Secretary has been established to lead the implementation of the project and provide policy direction. In addition, a Monitoring Committee, headed by Secretary DMAWS would be established, to review project progress on a quarterly basis and provide coordination support. Institutional Development component. CMA under DMAWS will implement the Institutional Development component. The Project Management Unit of TNUDP I1 has been mainstreamed into CMA to carry out the technical assistance, training programs and reform related assignments 10

15 for the ULBs. CMA will also manage a Project Preparation Facility (PPF) funded by GoTN and establish a Debt Monitoring Cell (DMC) to maintain a data base on ULB finances and to monitor debt servicing capabilities of ULBs. 22. Urban Investment component. Tamil Nadu Urban Infrastructure Financial Services Limited (TNUIFS) as the manager of TNUDF will implement the urban investment component, making loans to ULBs, administering the capital grants to ULBs and channeling grant funds to CMDA. The administration of TNUDF is entrusted to a Board of Trustees nominated by GoTN and participating financial institutions. The Board has been incorporated as the Tamil Nadu Urban Infrastructure Trustee Company Limited (TNUITCL) and, as such, approves the business and financial plans proposed by the asset management company, TNUIFS. The TNUDF is run as an autonomous Fund with full management autonomy to the Board. 23. TNUIFS will manage a separate Project Development and Advisory Facility (PDAF) funded by the Bank, to allow for preparation and/or supervision of more complex and innovative projects, including Public Private Partnerships (PPPs), BOTS, and projects with energy efficiency and new technology aspects. 24. For Sub-components related to investments in the municipalities, CMA will take the primary responsibility for project preparation progress. CMA will help ULB s prepare the sub-projects and give Technical and Administrative sanctions. TNUIFS will be responsible for implementing the sub-projects and the implementation would be jointly reviewed by TNUIFS and CMA. 25. CMDA will be responsible for planning and oversight of the transport and traffic subcomponent within the CMDA area, to be executed by the Department of Highways and Rural Works (DHRW) and Chennai City Traffic Police (CCTP). A multi-agency PMU would be constituted in CMDA, fully responsible for implementing this sub-component. The management of funds for the transport and traffic sub- component will be carried out by TNUIFS. 26. Implementation Arrangements: Implementation will follow broadly the same procedures as those established under TNUDP 11. Institutions wishing to borrow for infrastructure investments (predominantly ULBs, but also including Statutory Boards and private investors) will submit applications for sub-project financing to TNUDF, which will undertake a detailed appraisal of the proposed project, including review of technical, financial, economic, social, environmental and legal aspects. In practice, project preparation will be undertaken by consultants in accordance with TNUDF s operational manual, including the Environmental and Social Framework (ESF), and financed out of the PPF or PDAF. The preparation process would be concurrently reviewed both by TNUIFSL and CMA as it progresses, as part of a joint review committee. After a satisfactory appraisal, financing of the sub-project would be approved by the relevant authority. TNUDF along with CMA will monitor the implementation of sub-projects, for which the borrowers will be required to submit regular progress reports, and will undertake post-implementation evaluations. CMDA will supervise the preparation and implementation of transport and traffic sub-projects in the Chennai Metropolitan area. The benefits of the initiatives taken and the lessons learned under TNUDP I1 have been integrated into the design of the institutional arrangements (see Annex 16). 11

16 27. Implementation Capacity: TNUIFS has a proven capacity for selection of well designed and sustainable urban infrastructure projects and supervision of their implementation. It s capacity will be further strengthened by the actions listed below which have been and initiated and/or completed: hiring of additional project finance staff to assist with project identification, appraisal and. supervision; strengthening project development and marketing skills by appointing adequate and appropriate staff to support ULB s; focus by senior level staff on areas such as financial advisory, project appraisal and social. and environmental issues. It is expected that the social development specialist will also focus on consultation on key project related policies at the local level; adoption of an Operations Manual which would also address generic issues raised through sector guidelines as part of the operating procedures; and establishment of joint review procedures with the office of the Commissioner of Municipal Administration (CMA) on technical assistance and approvals. 28. At the ULB level, implementation will be supervised by consulting engineers, where necessary. The capacity of CMA to implement the institutional strengthening component will be strengthened by training and recruitment of qualified personnel (see Annexes 6 and 7 for details of institutional development and financial management action plans). 29. CMDA has experience of implementing Bank financed projects under Madras Urban Development Project I, while DHRW is currently the main implementing agency for the Bank funded Tamil Nadu State Roads Project; as such it has adequate capacity to implement the road improvement sub-projects. CMDA will also be able to call upon the experience of TNUIFS in project implementation through assistance to the Technical Review Committee. TNUIFS will provide clearance for Environmental and Social Safeguards and monitor ESF compliance during implementation for CMDA sub-projects. 30. Flow of Funds and Financial Reporting: Bank funds will be channeled through GOI, which will operate the Project s Special Account. GoTN will, in turn, on-lend funds to TNUDF under a subsidiary loan agreement. GoTN will disburse funds through its budget, for all project components. For the Institutional Development component, funds will flow to CMA as grant. Funds for on lending to ULBs on sub projects will flow to TNUDF through an on-lending agreement. Funds which will be provided as capital grant to ULBs will flow to Grant Fund I. Funds for Technical Assistance through PDAF will flow through to Grant Fund 11. The grant funds on account of the CMDA component will flow to Grant Fund 111. All the Grant Funds I, I1 and I11 as well as TNUDF will be managed by TNUIFS through management agreements. Financial Monitoring Reports will be prepared on a quarterly basis for all project components. Audit Reports for each component including TNUDF, undertaken by auditors acceptable to the Bank will be submitted within six months of the close of each financial year. (See Annex 7 for details). 3. Monitoring and Evaluation 31. Project performance indicators and the agencies responsible for monitoring them are as follows: 12

17 enhanced financial soundness of ULBs, as indicated by improvement in own revenues of participating ULBs and better debt management; to be monitored by the Debt Monitoring Cell; improved urban governance and accountability at ULBs, as indicated by the number of ULBs undertaking reforms such as accounting and financial management reforms, and computerization of functions, including e-governance; to be monitored by CMA on a regular basis; improved cost recovery with regard to urban services; to be monitored by DMC; improvements in urban services delivery coverage; benchmarked with information collected by the State Finance Commissions (described in Annex 3); to be monitored by CMA; improved market orientation of TNUDF through realistic market based costing of funds and adoption of a more commercially oriented lending policy; to be monitored by GoTN and World Bank. improved long-term sustainability of TNUDF through diversification of its resource base and products, and implementation of a business plan and risk management strategy; to be monitored by GoTN and World Bank; and, reduction in travel time along project corridors, decrease in congestion and choke points, decrease in fatal accidents in Chennai; to be monitored by CMDA. 4. Sustainability 32. Commitment to the project and relevant policies: Both GO1 and GoTN have demonstrated strong commitment to urban sector reforms and to continuing the Bank s assistance in this area, which would help ensure project sustainability. Considerable progress has been made towards implementing the reforms under the Urban Reform Initiative Fund (URIF) in Tamil Nadu, particularly the following: (i) reduction in stamp duty on transfer of property from 15 percent to 8 percent and further agreement to reduce the Stamp Duty to 5 YO by 2007; (ii) implementation of accrual accounting system in all 107 urban local bodies; (iii) introduction of modified area based property tax system; (iv) computerization of sub-registrar s offices; (v) repeal of the Land Ceiling Act, while a reformed Rent Control Act is being considered ; (vi) commitment to levy user charges, and improvement in rate setting and collection levels for water and sanitation services. Tamil Nadu is one of the leading states in undertaking urban reforms. (See Annex 1). 33. Other factors critical to sustainability: At the TNUDF level, sustainability will need to be ensured by GoTN through: (i) evolving a consistent approach to urban financing in the state between the different state financed institutions ensuring a level playing field for different institutions; (ii) ensuring that the state on-lending interest rates to TNUDF remain largely competitive, flexible and consistent with market rates; and (iii) TNUDF is able to offer a larger selection of products, including credit enhancement products. 34. TNUDF s long-term role in infrastructure finance would require for it to develop a strategy to become a self-sustaining commercially viable institution, drawing its financing from the domestic market. India has a high savings rate and high liquidity in the financial sector. The role of an intermediary financial institution like TNUDF should be to tap the domestic credit Currently there are only 50 rent controlled properties in Chennai and 25 in Coimbatore. No new properties have come under Rent Control Since

18 market for urban infrastructure finance, and reduce its dependency on external lines of credit and government funds in the medium term, and be self sustaining in the long term. As a first step towards becoming a self-sustaining financial intermediary, TNUDF would develop as part of the project by December 3 1, 2005: e A comprehensive lending strategy. This strategy would identify and price a variety of lending and credit enhancement instruments to replace the single 15-year fixed rate loan instrument now available. Lending rates would be differentiated by credit risk. 0 An investment strategy. This strategy would establish procedures and consider the opportunities/risks for equity investments in local infrastructure projects, typically in collaboration with other FIs and private sector partners. Funds for this purpose would be raised on the domestic market or via international financing that permits equity participation. Following its strategy assessment, TNUDF may or may not conclude that equity investment should be part of its operations. e A risk management strategy. This strategy would identify and price the risk associated with different lending and investment opportunities, then determine an overall risk profile that is appropriate for TNUDF, given its sources of financing. The risk management strategy would also address term intermediation risk of the kind that has been experienced by TNUDF over the past three years. This will require it to match the overall tenor and terms of its borrowing with the tenor and terms of its on-lending (see below). e A domestic Jinancing strategy. This component would identify a specific strategy for raising financing fiom the domestic market so as to make TNUDF self-sustaining in terms of financial sources. TNUDF currently has an under-leveraged balance sheet. Therefore, the first steps in such a strategy should involve accessing the domestic credit market. Eventually, a self-sustaining TNUDF will need to increase the equity on its balance sheet. It should develop a specific strategy for doing so, including targets for the proportion of equity that will be held by private investors and how this goal will be achieved. e A commercial operations strategy. Many of the services that TNUIFS has provided free on a pilot basis should appropriately be fee-based in the future. Services include bundling of local loans for pooled financing, advisory services to other states looking to establish infrastructure financing intermediaries, assembling comprehensive packages for financing local infrastructure projects, etc. This component of strategy development should establish guidelines as to when fees will be charged for services and how fee levels will be determined. In addition, the management fee basis of TNUIFS, the Asset Management Company, would also be reviewed to make it more performance linked and incentive based. 35.At the ULB level, sustainability will be enhanced by the project s capacity building component, which will improve transparency and accountability. The scope of investments will also be strictly correlated with ULB s creditworthiness in terms of demonstrated financial performance and investment capacity, which in turn would promote the enhancement of ULB financials, primarily through increased mobilization of user charges and property tax. At the project level, increased community participation will help ensure cost recovery and long term sustainability. O&M arrangements, which will be a key part of investment decisions, will also help guarantee the sustainability of assets. 14

19 36. For the CMDA road and traffic management components, sustainability will depend largely upon adequate O&M provision by the Department of Highways and Rural Works (DHRW). DHRW is responsible for the maintenance of all the main roads in the state and they have indicated that the CMDA roads component would be incorporated under their O&M program and would be fully funded by GoTN. Sustainability will also depend partly on selection of the most appropriate schemes through rigorous economic analysis, on the increase in economic activity generated and, in part, on peoples' perception of the benefits generated and on acceptance of the sub-projects through appropriate information dissemination, public consultation and satisfactory compensation. 5. Critical Risks 37. The key risks are primarily related to the viability of the local bodies supported under the project. ULB viability will be significantly strengthened by implementation of key elements of the Common Municipal Act and the resulting enhancement of the delegation of powers to local bodies. This will also involve some restructuring of the state level Municipal Administration from the current system of control to one of greater facilitation, together with further reduction of the role of para-statals in urban infrastructure investments. To assist the Municipal Administration in developing its role as a facilitator, the implementation of the proposed project would be placed within the administration rather than through a PMU structure. The Debt Monitoring Cell to be established under the project will maintain an up to date database on municipal finances. 38. On the investment front, as regards the line of credit component, the risk will depend to a large extent on TNUDF's competitiveness in terms of interest rates and tenor, the financial credibility of ULBs, market conditions during the course of implementation, the pace of ongoing reforms and sustainability of investments. This competitiveness could be enhanced in a number of ways: by developing a more market-based interest rate setting policy, by adjusting the rate setting formula to follow market trends more closely; by focusing on a range of investment products by TNUDF rather than just the standard loans used in TNUDP 11; by increased flexibility in funding structures; and by continuing to increase the transparency and accountability of ULBs. The sustainability of investments would be enhanced through a set of investment guidelines for each sector, which are described in the TNUDF Operations Manual. 39. In the case of the urban roads component in the Greater Chennai Metropolitan Area, there is the risk related to the fact that CMDA was not an implementing agency under TNUDP If. However, CMDA's roads and traffic component will be implemented by DHRW. DHRW has gained experience, implementing a number of other projects including the Bank supported Tamil Nadu Road Sector Project. The roads sub-projects have been selected as those with the least expected land acquisition. Moreover, this component will fall under the well established TNUDF framework for safeguards and fiduciary reviews which will mitigate this risk. The CMDA's traffic safety program will be implemented by the Chennai City Traffic Police which although new to implementing Bank supported projects has demonstrated as very good ongoing traffic safety program. CMDA has previously implemented Bank projects such as Madras Urban Development Project and the roads component under TNUDP I Project, and is familiar with Bank's Guidelines and requirements. 15

20 Risks from Components in achieving: PDOs I - Risk I- I I Risk Minimization Measure Timely implementation of ULB level Institutional Development activities across the target ULBs and ULB s commitment and capacity to undertake the same. GoTN commitment to undertake state level facilitation measures for implementation of this activity, including utilization of Technical Assistance for state level reform measures. Component B: Urban Investment Component ULBs commitment to urban sector reforms in general and willingness to participate and meet the requirements under TNUDP 111. ULBs institutional, financial and technical capacities to identify and implement viable investment sub-projects across different sectors. TNUDF s ability to access the domestic capital markets and other funding resources to finance the pipeline of investment projects. CMDA s capacity to oversee the implementation of the roads sub-component for the greater Chennai Metropolitan Area. Compliance with safeguards under all sub-projects. 16 M M M M M M M The capacity enhancement program was successfully started under TNUDP I1 with high uptake levels. TNUDP I11 will continue and consolidate this. Additionally, the program under TNUDP I11 is demand driven with high level of ULB uarticiuation expected. GoTN is among the leading states in undertaking urban reforms. TNUDP I11 is designed as a demanddriven project wherein all ULBs are not automatically selected for participation and open to only those ULBs that meet certain access criteria and agree on a reform program. Access to funds for ULBs would be preceded by detailed sub-project preparation support as well implementation support provided through TNUDF and CMA, and funded out of the grant facility. TNUDF has successfully accessed the markets before and has an under leveraged balance sheet. It will develop a comprehensive domestic finance strategy to move towards self sustainability. CMDA has previously implemented Bank supported projects; they will have implementing assistance from DHRW and CCTP. Implementation arrangements including a PMU based in CMDA and a multi organizational Technical Review Committee. A robust Environment and Social Framework has been put in place for the urban investment component. Safeguards and Fiduciary requirements will be overseen and

21 ~ capacity I Risks from Comuonents in achievinp PDOs I - Risk 6. Loan Conditions I- I I Risk Minimization Measure closely monitored by TNUIFS. for monitoring and implementation will be suitably enhanced both at the TNUIFS and CMDA level. Dated covenants:. TNUDF to complete Business and Risk management strategy by December 3 1, 2005; TNUDF to raise at least US$40 million in co-financing by September 30,2009; and, Government Order enhancing delegation of powers for clearance of infrastructure projects to be issued by December 31, Financial Covenants: CMA to maintain a qualified Financial Officer (FO) with experience and qualifications agreed with the Bank throughout the project period. CMA to produce accounts in the formats specified and acceptable to the Bank. The audited financial statements fkom all implementing entities specified to be provided to the Bank within 6 months of the close of the financial year. TNUIFS to employ during the life of the project a qualified senior officer in finance who will be the single contact point for the Bank on all matters relating to accounting, financial reporting, submission of accounts to audit, claims, disbursements and work plan for all project components being implemented by TNUIFS. CMDA to employ an Accountant with qualifications acceptable to the Bank throughout the life of the project to liaise with TNUIFS and GoTN on funds flow, accounting, disbursements, claims and other FM issues. D. APPRAISAL SUMMARY 1. Fiscal Impact of the Project 40. Fiscal situation of the state: While the state --onom ' 1 growing at a reasonable ra -, 1 investments were constrained by a large revenue (current) deficit. To address the fiscal imbalance, the Government initiated a series of fiscal reform measures beginning late The reform program focused on increasing the state's revenue and controlling growth in current expenditure such as salaries, pensions, interest and subsidies. The highlights of the reform program implemented over the last three years are: the development of a multi-year framework for fiscal adjustment; improving legislative oversight and fiscal transparency; improving the efficiency and equity of tax administration; rationalizing user charges and reforming state-owned enterprises and ailing manufacturing cooperati\;es. Power tariffs were raised 30%, free power to agriculture was done away with and the Tamil Nadu Electricity Board's (TNEB) payment arrears of Rs crores securitized with GoTN taking over the debt. This contributed to improving the 17

22 financial position of the TNEB, the key source of balance sheet risk to fiscal adjustment for the Government of Tamil Nadu. 41. The impact of the reform program has been favorable. The fiscal turnout in 2003/04, the base year for the Medium Term Fiscal Program (MTFP) has improved upon the MTFP targets. As against a projected fiscal deficit of 4.1 % of GSDP in 2003/04, the realized fiscal deficit has been 2.4%. Similarly, as against projected current deficit of 2.2% for 2003/04, the realized current deficit was 0.9%. GoTN achieved a primary surplus against a projected primary deficit. Tamil Nadu has thus embarked on a solid path towards fiscal sustainability. 42. However, following national elections in April-May 2004, certain critical reforms were reversed. Electricity was made free for agriculture. But more importantly, power tariffs were slashed by over 30% for the domestic consumer segment. The resulting subsidy of close to Rs crore in (Rs. 900 crore in a full year) is being provided to the Tamil Nadu Electricity Board as budget support for domestic consumers. Public Distribution System reform involving subsidy targeting was given up and subsidized bus transportation was restored to private school and college students. These actions will expand revenue expenditure by over Rs crore over the budgeted estimates for 2004/05. However, with reduction in expenditure, salaries and pension related items, the revised estimates for 2004/05 shows an increase of only Rs. 606 crores over the budget estimate of 2004/ Expenditure on Tsunami relief and rehabilitation is expected to be largely deficit neutral since the expenditure will be met mostly out of revenue grants received by the government. But four broad sets of factors will help the state to generally stay on the fiscal adjustment path: (i) salaries and pensions have remained virtually flat in nominal terms in 2002/03 and 2003/04; (ii) the government expects conservatively to realize Rs. 1,380 crore of savings under salaries as compared to the budget in 2004/05; (iii) interest expenditure savings consequent to debt restructuring in 2004/05; and (iv) revenues have been growing well during the fiscal year 2004/05 exceeding the Budget projections ( 21-96% y-0-y growth achieved up to December 2004 end as opposed to annual 9% in the projections). If the revenue trend holds through the rest of the year, the budgeted revenue target for the year will be exceeded. Together with anticipated expenditure savings detailed above, budgeted fiscal deficit target will most likely be achieved in 2004/ The MTFP has provided adequate budgetary resources for externally aided projects. For instance, in 2005/06 the MTFP provides for Rs. 800 crore against Externally Aided Projects (EAP), Rs. 900 crore in 2006/07 and Rs crore in 2007/08. Against this, the preliminary indications are that the GoTN will initially provide Rs. 700 crore in the 2005/06 budget with possibilities of budgeting more resources should project spending pick up. This is adequate for sustaining projected expenditure under the two outstanding World Bank projects in the health and road sectors while supporting new projects in their initial phase. Since recoveries from TNUDF have been good under TNUDP 11, the fiscal impact of the project is expected to be minimal and manageable. 2. Economic and Financial Analyses Economic Analysis 18

23 45. The proposed line of credit will be instrumental in increasing the efficiency of delivery of urban services and the sustainability of ULBs. Although the proposed line of credit does not have an explicit subsidy, the opportunity cost of dedicated funding, difficult to quantify, is expected to be more than compensated by the benefits of increased efficiency of delivery of urban services and the sustainability of ULBs. The demand-driven nature of the Project implies that ULBs will determine the nature and scope of each sub-project. Therefore, the costs and benefits of individual sub-projects can not be completely identified and, hence, the economic rate of return for the whole Project estimated ex-ante. The cost-benefit analysis will be carried out for each sub-project with total costs of US$ 500,000 and above, except sub-projects with nonquantifiable benefits. Such cost and benefit analysis for the individual sub-projects shall demonstrate a positive NPV and an ERR equal or above the appropriate opportunity cost of capital estimated at 12%. This is consistent with recently Bank approved projects and is above the current real interest on long-term deposits. The Project Team will review on a no-objection basis all sub-projects with total costs of US$ 750,000 and above and a sample of sub-projects below this threshold at its discretion. This procedure will be reviewed as needed to ensure adequate quality of the investment analysis. The detailed methodology for economic analysis for typical sub-projects is included in Annex 9. Economic analysis of the transport and traffic management sub-projects in the CMDA area would be based on traffic counts, using savings in vehicle operating costs and vehicular and travel time savings. 46. International experience suggests that infrastructure investments have broad positive economic benefits such as: 0 0 e Investments in local infrastructure will create jobs for local contractors and develop local technical skills and raise demand for local inputs by small local contractors. Improved water supply and sewage services will result in substantial direct and indirect benefits such as better health and reduced household costs of fetching water. Rehabilitation of access roads, sidewalks and street drainage will improve mobility of the population and develop trade and local service activities in previously inaccessible neighborhoods. Investments in street lighting will, among other things, increase security and extend potential hours for education and economic activities. 47. While the impact of technical assistance for institutional development and capacity building of ULBs in planning and management infrastructure investments is very hard to quantify, Bank assistance in this area is expected to result in significant benefits. In particular, the Project will empower communities and establish a partnership between communities and ULBs. It will lay the basis for more participatory development planning, more responsive local services and better accountability of the ULBs towards communities. In addition, it will facilitate: e Better city planning and management processes that are more responsive to the local needs and conducive to local economic development. 0 Improved financial management capacity of ULBs to implement and operate infrastructure projects. 0 Incorporation of currently substandard neighborhoods into the service delivery area and the municipal revenue stream. Financial Analysis 48. The financial assessment methodology would focus on three aspects: 19

24 Sub-Droiect level viabilitv: This would apply only to green-field revenue generating subprojects (water, waste-water, solid waste projects) and would seek to ascertain sub-project level Net Present Value (NPV) / Internal Rate of Return (IRR). At the sub-project level, most urban projects are not expected to be financially viable on a stand-alone basis (i.e. based on sub-project revenues alone), TNUDP I11 would seek to improve cost-recovery levels for such sub-proj ects. Overall ULB level financial sustainabilitv: This assessment seeks to ascertain that the subprojects being undertaken are financially sustainable for the ULB as a whole, taking into account all its revenue and expenditure drivers. This assessment was carried out at a broad level for all ULBs in TN by projecting the overall revenue and expenditure position of the ULBs into the future under reasonable assumptions and calibrating the extent of sustainable investment capacity such that the following conditions are met: (i) ULB has no cash deficit in any year, after taking into account additional operating costs, ULB counterpart funding and debt servicing obligations; (ii) debt service ratio (principal repayment and interest payable, divided by total revenue) is maintained at a maximum of 30 percent; (iii) debt service amount, including existing debt service obligations, is maintained at less than 40 percent of operating surplus. This assessment indicated that overall borrowing capacity of all ULBs in TN was about US$ 4 18 million and on an aggregate basis, ULBs would be in a position to absorb the line of credit component under TNUPD I11 of US$ 110 million. In addition a more detailed assessment of a sample of 29 ULBs (out of the total 151 ULBs in the state of Tamil Nadu) was carried out in-house by TNUIFSL and the findings are summarized in Annex 9E. Financial Viabilitv of TNUDF: TNUDF s financial statement for the years 1999/00 until 2003/04 are shown in Annex 9D. External factors such as the macroeconomic conditions, financial markets and urban sector conditions have had a major impact on TNUDF s financial performance. Over the past five years Government security yields in general have fallen and the financial system has experienced high levels of liquidity, resulting in a declining interest rate regime. At the same time, competition in the financing of urban infrastructure projects has been increasing, with the existence of multiple government owned specialized agencies with access to large amounts of low cost funding resources. The time lag in the adjustment of TNUDF s interest rate setting and the inability to renegotiate lending rates have rendered TNUDF s lending rates inflexible and non- responsive to market conditions impacting adversely the competitiveness of TNUDF s lending products. This has in the last two years, resulted in significant loan assets reduction, excess cash in hand and, in turn, reduced profitability for TNUDF. In terms of competition from other state owned agencies, GoTN would on its part ensure that there is a level playing field between its agencies. Other state agencies would also be encouraged to co-finance projects with TNUDF where appropriate and beneficial to borrowers. The issue of refinancing of TNUDF loans by other state agencies would also be addressed by the fact that under TNUDP 111, TNUDF would have more flexible lending terms and would be able to respond to changing market conditions in a more agile way than before. 49. TNUDF has taken steps to minimize the impact on its financial position by repaying its outstanding high cost borrowings and by maintaining a steady average return on loans. Consequently, TNUDF s financial position remains profitable. Overall, TNUDF s financial performance as of FY is summarized as follows: 20

25 Profitability indicators and interest spread remained positive, with gross interest margin of 48.25%, net margin of 23.71%, average return on loans of 8.04%, average cost of borrowings of 5.18% and average cost of funds of 4.77%; Post Tax surplus was Rs. 10 crores (USD 2.2 million equivalent), down Rs. 1.6 crores (USD 0.36 million) or 14% from FY ; Loan assets were Rs crores (USD 19 million), about 77% lower than in the previous FY of Rs crores (USD 83 million). This significant decline was due to prepayment of loans by borrowers who had refinanced their loans with other state government funding agencies at lower rates of interest. Investments, on the other hand, increased by 45% from Rs crores (USD 63 million) to Rs crores (USD 91 million); As loan assets declined and investments rose, the income structure of TNUDF has shifted considerably since FY Investment income to total income increased from 40% to 56%, whereas lending income to total income decreased from 60% to 44%; The significant ratios as of FY04, with projections at appraisal in parenthesis, are as follows: return on net worth 3.72% (13.7%); return on assets 1.48% (4.09%); debt to equity ratio 1.36 (2.3); and debt service coverage ratio (DSCR) 2.47 (1.42); and, Loan recovery rate was at 99%, higher than the projected 95%. 50. Factors such as ULB s financial creditworthiness, market conditions, sub-project pipeline, pace of sector reforms and sustainability of investments would remain key, and the following measures are being undertaken under TNUDP I11 for enhancing and maintaining TNUDF s competitiveness and will be developed as a part of the business strategy and strategic plan for TNUDF by December 2005: a more market-based interest rate setting policy through regular but more frequent adjustments to the base rate and also linked to TNUDF s own market borrowings and cost of funds has been developed and agreed; expanding the range of investment products outside standard loans, such as credit enhancement; increasing the flexibility in TNUDF s funding structures through market borrowings and thereby allowing it to offer more tailored loan structures to clients in terms of tenors and rates; and continuing to increase the transparency and accountability of ULBs; TNUDF to mobilize co-financing aggregating at least US$ 40 million from any or all of the following sources: (i) proceeds from TNUDF public bond issues; (ii) TNUDF private placements; (iii) co-financing with TNUDF by private financial institutions / banks at the sub-project level; (iv) securitization of TNUDF loans or secondary market purchases by private financial institutions / banks of TNUDF loans to ULBs, or re-financings of TNUDF loans to ULBs (through local bond issues, pooled bond issues, or loans from private financial institutions) as arranged by TNUDF; (v) net increases in equity investment in TNUDF by private financial institutions; and, accelerating the pipe-line of sub-projects for TNUDF through better marketing / outreach to ULBs and faster processes for clearances for ULBs wanting to take up sub-projects. 3. Technical 51. The likely investments under the project include water supply, sewerage, solid waste management, storm water drainage, urban roads, vegetable markets, bus stands, street lights, 21

26 crematoria, urban transport, etc. Substantial investments are expected under the sewerage sector, as GoTN is giving priority to providing improved sanitation in municipalities. The project would thus finance most of the municipal obligatory services, some of which are remunerative and some non-remunerative, contributing to the improvement of living standards of the urban population. The project would not finance commercial facilities such as shopping complexes, power or telecommunication facilities. 52. The subprojects will be designed primarily on the basis of Indian Standards, following respective technical guidelines issued by the line ministries / agencies (e.g. Central Public Health and Environmental Engineering Organization, Indian Roads Congress etc.). The subprojects will comply with CentraUState Pollution Control Board norms. The borrower s needs will be reflected by following the sustainable local adaptations being used by Tamil Nadu Water and Drainage Board, Chennai Metro Water Supply and Sewerage Board etc; and taking up the subprojects identified as priority by the ULBs. 53, To ensure sustainability of investments, Sector Investment Guidelines have been developed, including appropriate technical design standards and these would be complied with for sub-project investments. To ensure readiness for both appraisal and implementation, and avoid the risk of implementation delays or weaknesses in operationalizing the sub-projects, a set of Readiness Filters have been developed. These are also incorporated in the Operations Manual (OM) of TNUDF. The consideration of technical and institutional issues arising during the sub-project cycle, integrating the lessons learned from implementation of TNUDP 11, is discussed in Annex TNUIFS has prepared a list of likely sub-projects costing US$254 million to be included in the Project. Out of this list of likely sub-projects, the first year s pipeline of US$88 million would be ready for implementation in the first year. 4. Fiduciary Procurement 55. The current Operations Manual of TNUIFS documents its internal procedures, steps involved from borrower s loan application stage till project completion. It covers an outline of project preparation, appraisal procedures, project sanctioning, progress monitoring during implementation, procurement, disbursement and audit. The lending and investment guidelines of TNUDF are discussed separately. 56. The proceeds of the Loan will be used to finance the procurement of civil works such as construction and maintenance of water pipe lines, solid waste management works, storm water drainage, bus stands, widening and strengthening of roads, road over bridge, road under bridge, grade separators, pedestrian subways etc; goods (machinery, equipment, waste collection vehicles, traffic control equipment etc.) and services (consulting services, training, etc) under sub-loans by TNUIFSL, CMA and CMDA. 57.Under the project, procurement of goods and works by the implementation agencies including ULBs will follow the Guidelines for Procurement under IBRD Loans and IDA Credits of May Similarly, consultants will be selected and employed according to the 22

27 Guidelines for Selection and Employment of Consultants by World Bank Borrowers of May Detailed procurement arrangements are discussed in procurement Annex 8. Finan cia1 Man agemen t 58. A financial management (FM) assessment was carried out to evaluate the FM arrangements of the proposed project and to assess the capacity of the executing agencies to effectively manage and implement the project and to provide the Bank with accurate and timely information. On the basis of the assessment conducted, the financial management team concluded that, although some project specific adjustments will be needed, the existing financial management arrangements for TNUDP I1 are operational and are considered to form a sound basis. For the CMDA implemented component FM risks are rated as medium. As for CMA, intensive supervision is envisaged in the early stages of the project as FM capacity in CMA is enhanced. (See Annex 7 for a complete description of FM arrangements). 5. Social 59. Under the previous project, TNUDP 11, TNUIFS had incorporated the suggestions made by the Bank to address issues related to social safeguard requirements of the Environmental and Social Report (ESR) in the context of OD 4.30 on Involuntary Resettlement. Since social safeguard requirements of the Bank are currently based on OP 4.12 and BP 4.12, TNUDF has updated its ESR by replacing its existing Appendix 5 - Social Impact and Entitlement Framework for World Bank Financed Projects, with a new Environmental and Social Framework (ESF), to meet Bank s current requirements. TNUIFS has also strengthened its social safeguards framework by including field tested formats for social screening, classification of categories, reporting and monitoring. The appointment of an officer or a consultant in TNUIFS to specifically focus on social safeguards related issues would be an important aspect of institutional strengthening of TNUIFS. The social safeguard arrangements in the proposed TNUDP I11 cover lending by TNUDF to Urban Local Bodies (ULBs), including up-gradation of services in low income areas, and to grants for transport and traffic improvements in the CMDA area. 6. Environment 60. The Project will directly contribute to the improvement of environmental conditions in urban areas by providing basic infrastructure, including solid-waste and sanitation facilities, storm drainage and water supply facilities and urban roads. Nevertheless, some of the subprojects to be financed under the project may have adverse environmental implications/issues requiring careful assessment and mitigation. The framework approach used under TNUDP I1 will continue to be used to identify and mitigate the potential negative environmental impacts of such sub-projects under TNUDP 111. As part of the preparation for TNUDP 111, a comprehensive review of the existing environmental framework (titled Environmental and Social Report) has been undertaken to identify the gaps/concerns/inadequacies and opportunities for enhancing the effectiveness of the framework. The updated framework, renamed as Environmental and Social Framework (ESF) has the following critical enhancements: 0 Reflecting the regulatory changes related to environment in the context of the project and changeshpdates in applicable Bank policies/guidelines. 0 Strengthening the framework including formats for monitoring and reporting progress of EMP implementation. 23

28 a 0 Strengthening institutional and implementation framework including contractual obligations between the borrower (such as municipalities) and the civil contractors. Strengthening the policy framework to include environmental enhancement as part of environment management at sub project levels. 61. Based upon the potential magnitude of environmental impacts involved, sub-projects would be classified into three categories (El major impact, E2 moderate impact, and E3 no impact) and appropriate mitigation and enhancement actions will be included in sub-project design. As the manager of the Fund, TNUIFS will be responsible for ensuring that all sub-projects including those implemented by CMDA have carried out appropriate levels of environmental and social assessments and have prepared EAPs and RAPS as per the guidelines provided in ESF (Annex 11). TNIUFS will further ensure that EA/EMPs of all E-I category sub-projects are approved by the Bank during sub-project appraisal stage and before finalization of the DPRs. Process details are included in the Operations Manual. 62. To strengthen the institutional capacity, and to improve environmental management in TNUDP 111, TNUIFS will recruit environment specialist or contract the services of a reputable firm with the dedicated responsibility of overseeing the environment management process in TNUDP 111. Suitable training and capacity building initiatives will be designed and implemented to ensure effective implementation of the ESF. 7. Safeguard Policies 63. The subprojects to be financed under the project are likely to have varying levels of environmental impacts depending upon the location of subprojects, and scale and nature of activities envisaged in the subproject. Since the subprojects are restricted to urban areas, which have higher than normal population density, the environmental impacts associated with the subproject activities are expected to be significant warranting proper assessment and mitigation and OP4.01 is therefore triggered. Applicability of other safeguard policies such as OPN on Cultural Properties, OP/BP 4.12 on involuntary resettlement, etc. and the need for appropriate mitigatiordmanagement plans will be evaluated and addressed during subproject preparatiodscreening stage. Safeguard Policies Triggered by the Project Yes No Environmental Assessment (OP/BP/GP 4.0 1) [XI [I Natural Habitats (OPBP 4.04) 11 [XI Pest Management (OP 4.09) [I [X 1 Cultural Property (OPN 11.03, being revised as OP 4.11) [xi7 [I Involuntary Resettlement (OP/BP 4.12) [XI 11 Indigenous Peoples (OD 4.20, being revised as OP 4.10) [XI [I Forests (OPBP 4.36) 11 [XI Safety of Dams (OP/BP 4.37) E l [XI Projects in Disputed Areas (OPBP/GP 7.60)* [I [XI Projects on International Waterways (OPBP/GP 7.50) [I [XI Applicability of these safeguard policies will be determined at a subproject level through screening and assessment tools provided in the Environment and Social Framework. If applicable suitable mitigation plans will be developed as part of subproject preparation. * By supporting the proposedproject, the Bank does not intend to prejudice the final determination of the parties' claims on the disputed areas. 24

29 7. Policy Exceptions and Readiness 64. The first year s pipeline of projects has been reviewed in relation to certain readiness filters to ensure that the sub-projects are ready to be implemented. These readiness filters include: 0 draft Detailed Project Reports (DPR) ready; 0 generic and sector specific guidelines complied with; 0 Administrative Sanction and Technical Sanction obtained; 0 bid documents under preparation; 0 statutory approvals obtained from other agencies; 0 land acquisition complete; and, 0 proposed implementation and O&M arrangements substantially developed. 65. The sub-projects currently reviewed as being ready to start implementation in the first year amount to approximately US$88 million which is approximately 20 percent of the total project cost. 25

30 Annex 1: Country and Sector Background INDIA: Third Tamil Nadu Urban Development Project 1. In recognition of the key role played by India s cities in the drive for economic growth, the past decade has seen significant changes in India s approach to urban development through decentralization of powers and reform of the financial sector. Highly centralized and regulated policies which had directed investments away from cities, particularly away from long term infrastructure investments, were decentralized under the 7 4 Constitutional ~ Amendment, which gave constitutional status to municipal governments. Municipal responsibilities were defined in broad terms, leaving the task of defining financial relations between state and local governments to individual State Finance Commissions (SFC). In parallel, financial sector reforms, begun in 1991, allowed for Urban Local Bodies (ULBs) to raise financial resources to meet their infrastructure needs independent of state loans or grants. 2. However, despite the reforms at the central level, urban development has remained very much a state issue and the resources provided to cities as well as the regulations governing their management have continued to be decided large1 at the state level. While the process of establishing elected local governments under the 74 P amendment has been largely successful, the devolution of functions and funds to the newly elected bodies and ULBs remains incomplete. State governments continue to take decisions on such matters as rates of user charges, property tax, octroi and the role of parastatals in water supply and sanitation services with little reference to the ULBs that are affected by these decisions. Few ULBs have the wherewithal to be demand responsive or to access India s emerging financial system. The result is that, for the most part, urban institutions are not yet integrated into the fabric of the broader deregulation and financial reforms of the Indian economy. 3. Recognizing that continuing reform in governance and service delivery arrangements of Indian cities is required to position them as engines of national growth and development, the GOI s Tenth Plan emphasizes urban reform as critical to growth and poverty alleviation. It estimates that about U S $7 billion are needed for urban development over the Plan period, but underscores the centrality of reforms at both State and local levels to achieving sustainable investments. Given the important role that States play in determining local revenues and the regulations that govern urban economies, the GO1 introduced the Urban Reform Incentive Fund (URIF) in 2002 to provide incentives for reforms of State policies on housing and local finances (taxes and user charges) in particular: 0 Reform of the Urban Land Ceiling Regulation Act; 0 Rationalization of Stamp Duty; 0 Reform of rent control laws; 0 Introduction of computerized processes of land registration; 0 Reform of property tax; 0 Levy of user charges; and 0 Introduction of double entry accounting in ULBs. Tamil Nadu 4. Tamil Nadu, one of the most highly urbanized states in India, with an urbanization level of 43% out of a state population of 62 million (2001 census), has been one of the showcases of the 26

31 new approach to municipal development. Two SFCs have laid the groundwork for the state- ULB relationship and, with the assistance of two previous World Bank funded projects, TNUDP I and 11, considerable progress has been made in developing an independent, sustainable Fund for financing urban infrastructure. 5. Urban Tamil Nadu consists of 6 Municipal Corporations, 102 Municipalities and 43 upgraded ULBs. The rate of growth of urban population in the State has been in the region of 4.2% ( ), one of the highest since While Chennai is the most populous urban center (4.6 million), urban population is fairly evenly distributed in secondary centers and other towns. Progress in implementation of URIF in Tamil Nadu Tamil Nadu is one of the most advanced states in India in implementing urban reforms and URIF compliance. 6. Property taxes: Property tax in Tamil Nadu was revised after a gap of 16 years in The Municipal Corporations and District Municipalities Act, requires a quin-quennial revision (every five years) to the base (Annual Rental Value). The revision due in October 2003 has been delayed', and is now postponed to The State as part of URIF is committed to adoption of an objective assessment, doing away with exemptions in a phased manner and improving collections to 85% through a concerted effort of mapping un-assessed and under assessed properties, Currently the tax computation is based on a modified area method. 7. Accounting Reforms: The conversion of cash based municipal accounts to the accrual system of accounting was initiated in and was piloted in 10 ULBs. Under the previous system, the local bodies had a multiple fund based accounting system (General, Water and Sanitation, Remunerative, Lighting and Education Fund).Under the accrual system, the local accounts are maintained under three heads: General, Water and Sewerage and Education. 8. In , the new accounting system was rolled out statewide covering the remaining 97 local bodies and has now been successfully in operation for three years. Under the new system, local bodies generate trial balances on a monthly basis and are in a position to assess their financial status more clearly of the Town Panchayats have also implemented an accrual system of accounting. 9. Urban Land Ceiling: The Tamil Nadu Urban Land (Ceiling and Regulation) Repeal Act, 1999 (Tamil Nadu Act 20/99) was enacted to replace the Tamil Nadu Urban Land (Ceiling and Regulation) Act, 1978 with effect from June The Repeal Act does not apply to the lands already acquired and possession of which was taken over by the Government as on the date of repeal and also to the lands exempted under section 2 1 (1) of the Principal Act. One of the reasons that the revision in property tax has not been effected is the fact that the State Government is considering a proposal to revise the method of property tax assessment fiom the present annual rental value method to the unit area method. A switchover to the unit area method may also involve the constitution of Property Tax Guidelines Committees in each Urban Local Body to classify zones and suggest rates for each zone. GoTN has decided to refer the issue of modification in property tax assessment methodology to the Third State Finance Commission which has been recently constituted. The Commission is expected to give its fmal recommendations by May, 2006 and based on this, it is expected that the system of property tax assessment in the State would be revised towards the latter part of

32 Rent Control Act (RCA): The revision/ repeal of the RCA is under consideration. Rent controls are no longer applied to new properties and have not been applied since Currently, there are a small number of properties [Chennai (50) and Coimbatore (25)] under rent control with minimal impact on ULB revenue sources. 10. Cost Recovery: The State is committed to cost recovery policies and municipalities seeking financing from previous Bank funded projects have been required to demonstrate willingness to revise tariffs and to focus on improvements in revenue realization. Current levels of overall revenue realization indicate that five major municipalities present a very high level of collection performance of around 80% of current billing and are in a position to meet O&M costs and also cover part of debt servicing. In ongoing sewerage projects, deposits from beneficiaries are being collected upfront to meet up to one third of the project costs. Comparatively, the progress amongst Town Panchayats has been slow. 11. Stamp Duty: The State reduced Stamp Duty to 8% in November This is an important first step with regard to one of the key requirements of URIF. Furthermore, GoTN has recently concluded a supplementary Memorandum of Agreement with GO1 under the URIF in which GoTN has agreed to achieve the rationalization of Stamp Duty in phases to bring it down to no more than 5%. 12. Computerization of Land Registration: The computerization of land registration (REGINET) was launched in TN was one of the first States to initiate computerization of registration functions and currently 350 of the 650 Sub-Registrar s offices are computerized and networked. Computerization has resulted in a remarkable improvement in service delivery. Encumbrance certificates and copies of scanned documents can now be obtained on request in less than 15 minutes as compared to number of days before the introduction of computerization. Developing the municipal finance market and other achievements under TNUDP 11: 13. TNUDP I1 has significantly advanced progress towards sustainable market finance for urban infrastructure. It has financed the creation of US$128 million of urban infrastructure in Tamil Nadu by investing in projects undertaken by creditworthy ULBs. TNUDF has leveraged World Bank funds (US$60 million) by issuing bonds, raising co-financing and raising contributions from beneficiaries. Additionally, grant funds provided under the project have assisted the preparation of US$154 million worth of sub-projects. Throughout the implementation of TNUDP 11, TNUDF has proven to be financially sustainable, meeting or exceeding the financial ratios specified in the World Bank Loan Agreement. The project has contributed to capacity building and institutional strengthening through training of ULB staff, support for computerization of ULBs and implementation of accrual based accounting. The implementation performance for TNUDP I1 has been strong in general and exceptionally good in comparison to similar projects in developing countries. Over all disbursements have exceeded projections throughout most of the project period. More specifically, the achievements under the investment and institutional building and capacity enhancement component are listed below. 28

33 Kev Achievements under TNUDP I1 Investment Component (TNUDF) Institutional and Capacity Building Component 1. US$60 million of Bank financing catalyzed urban infrastructure investments of US$ 128 million by TNUDF. 2. TNUDF mobilized US$28 million of private cofinancing for infrastructure. 3. TNUDF raised US$25 million through issuance of non -guaranteed bonds in the domestic markets. 4. Outstanding repayment performance on sub-loans with a 99.7% recovery rate from ULBs. 5. Return on Equity was 12.6% in FY03 6. TNUDF has pioneered: - the first pooled finance initiative in India with USAID (US$6.3 million); - the first revenue bond in India for Madurai ring road (US6 m); - PSP in municipal solid waste management; and - BOTS for toll bridge and underground sewerage. e e TNUDF has encouraged better cost recovery in water by requiring tariff increases before approving loans to ensure sustainability of projects. TNLJDF is recognized as an effective and capable institution in Tamil Nadu and as a model for urban development funds. The project has completed implementation (by way of training and services) of statewide double-entry accrual-based accounting in all 107 Urban Local Bodies. Through computerization and web enabled systems, local bodies have facilitated collection of property taxes and user charges. Revenue realization between increased by 130% primarily due to properly tax revision and increased state devolutions. Some 5400 municipal officials have been trained under TNLJDP I1 on various aspects of municipal functions. Bank s presence helped sustain reform momentum in Tamil Nadu e.g., state-wide double-entry accounting, fiscal devolution, partial reform of property tax, partial relaxation of state regulation of ULB decision making, compliance with URIF requirements. Under the Integrated Sanitation Program (US$lO million)- US$7.9 million has been invested for providing community run sanitation facilities in low income areas resulting in a vast improvement of quality of life for women and children. The project has contributed to significant improvements in service levels in beneficiary ULBs. 14. The systems and structures set up under TNUDP-I and I1 have enabled Tamil Nadu to make good progress in addressing existing and emerging urban infrastructure problems; in particular the TNUDF has been an effective instrument in enabling urban local bodies to improve finances and support them in the introduction of fiscal and other reforms. This has enabled them to develop sustainable projects and in a number of cases, strengthened their capacity to tap the capital markets for additional financing for new capital projects. It is clear that the urban local bodies in the State will continue to need additional assistance in capital investment in the medium term to improve core civic services, particularly in water supply, sewerage and solid waste management, urban roads and transport. 29

34 Annex 2: Major Related Projects Financed by the Bank and/or other Agencies INDIA: Third Tamil Nadu Urban Development Project Sector Issue Ban k-financed Project I Latest Supervision (PSR) Ratings (Bank-financed Implementation I Progress (IP) Improvement of Urban Management Tamil Nadu Urban Development S Capacity and Support Basic Urban Project 1 (Cr " completed Service Investment on Sep.30, 1997) Improvement of Urban Management Tamil Nadu Urban Development S Capacity and Support Basic Urban Project I1 (Ln IN, closed Service Investment and access to Nov. 30,2004) sustainable forms of infrastructure financing Improvement in cost recovery and Karnataka Urban Water Supply service delivery levels. Provision of and Sanitation Project (ongoing) water and sanitation facilities. Provision of WaterISeweragel Solid Hyderabad Water Supply Project S Waste facilities and improvement of the (Cr INLn IN) (closed) related sector policies Cost-recovery, service delivery Madras Water Supply Project I1 S (Ln.3907-IN) (closed) Provision of sewerage facilities Bombay Sewerage Disposal S I Project (Cr.2763-InLn.3923-IN) Promotion of Private Infrastructure I Private Infrastructure Finance [ S Investment (IL&FS) Project (Ln.3992-IN) (closed) Other development agencies USAID Asian Development Bank Financial Institutions Reform and Expansion Project (FIRE I) (completed) FIRE I1 (ongoing) Karnataka Urban Development Project (ongoing) Karnataka Urban Development and Coastal Environment Management Project (ongoing) Rajasthan Urban Infrastructure Development Project (Ongoing) I 'ojects only) Ievelopment Objective (DO) S S S S Department for International Development Andhra Pradesh Urban Poverty Support Project (Ongoing) Kolkata Urban Service Project I (Ongoing). IPDO Ratings: HS (Highly Satisfactory), S (Satisfactory), U (Unsatisfactory), HU (Highly Unsatisf :tory) 30

35 Annex 3: Results Framework and Monitoring INDIA: Third Tamil Nadu Urban Development Project Project Development 0 bj ectives Improve urban infrastructure services in TN in a sustainable manner. Intermediate Results Component I 1. Strengthen empowerment of ULBs and increase credit worthiness and financial sustainability. Component 2 2. Expand resource mobilization for urban infrastructure investments Results Framework Outcome Indicators Improved urban service delivery, in terms of coverage and quality to be tracked by monitoring improvement from baseline indicators. Results Indicators 1. Increased Delegation of powers to ULBs; 2.Improved financial soundness of ULBs through cost recovery, increased own revenues, better debt management; 3. Improved governance and accountability of ULBs through accounting reforms. 1. Expanded resources of TNUDF through private equity contributions and bond issues; 2. Increased lending to wider range of ULBs through loan product diversification (rates and terms). Use of Outcome Information Outcome information will be used to modify state level policies on provision of urban services. Use of Results Monitoring 1. Use successful delegation of powers to modify State - ULB relations. 2. Use improved financial management of ULBs to enhance their creditworthiness. 3. Use improved transparency to develop access to capital markets. 1. Learning from initial market borrowings will help develop capacity to raise funds on capital markets. 2. Feedback on successful loan products will be used to improve financial services to ULBs. Monitoring 1. Overall Project performance indicators and the agencies responsible for monitoring them are as follows: enhanced financial soundness of ULBs, as indicated by improvement in own revenues of participating ULBs and better debt management; to be monitored by the Debt Monitoring Cell; improved urban governance and accountability at ULBs, as indicated by the number of ULBs undertaking reforms such as accounting and financial management reforms, and computerization of functions, including e-governance; to be monitored by CMA on a regular basis; improved cost recovery with regard to urban services; part of the monitoring functions of the DMC; improvements in urban services delivery coverage; based on the information collected by the State Finance Commissions and described in Annex 3, to be monitored by CMA; improved market orientation of TNUDF through realistic market based costing of funds and adoption of a more commercially oriented lending policy; to be monitored by GoTN and the Bank; improved long-term sustainability of TNUDF through diversification of its resource base and products, and implementation of a business plan and risk management strategy; to be monitored by GoTN and the Bank; and, reduction in travel time on key transport project corridors, and reduction in fatal accidents in Chennai; these will be monitored by the responsible agency, CMDA.

36 2. The following urban service and performance indicators have been collected for the most recent year available for all ULBs in Tamil Nadu (6 Municipal Corporations, 102 Municipalities and 43 upgraded ULBs). These indicators will be updated regularly (at least annually) as a measure of project performance. Baseline indicators are available from the State Financial Commissions and from the studies undertaken during project preparation. The extent of improvement expected during project implementation will be determined on a case by case basis. 6 Municipal 102 Corporations Municipalities 43 ULBs (upgraded) Average Water Supply Sewerage and Sanitation 2 Percentage Assessment Covered by House Service Connections, % 3 Slum Population per Public Stand Post, persons Daily Per Capita Supply (Year 2003/2004), liters Percentage Assessment having Sewer Connections ( /I Roads, Storm Water Drains and Street Lighting 19 /Percentage Municipal Roads Surfaced (%) I Density of Surfaced Roads (Km per sq. km) Percentage of Road Length Covered with Pucca Drains (%) 25 No. of Streetlights per km Road Length A16 Percentage High Power Fixtures in Streetlights (%) ~ Solid Waste Management 28 ]Estimated Waste Generation per Capita per Day I I I I Percentage Waste Collected (as per the Estimates of ULB) 32 Vehicle Rated Capacity to Waste Generated (%) A26 No. of Sanitary Workers per 1000 Population Expenditure to Income Ratio Share of Personnel Cost (Establishment) Outstanding Loan Per Capita (Rupees) DS/TR (Debt Service as % of Total Revenue) /Slum Concentration (%) I 19.12

37 Annex 4: Detailed Project Description INDIA: Third Tamil Nadu Urban Development Project 1. The project comprises of two components: (i) Institutional Development (ID) component and (ii) Urban Investment component. A. Institutional Development Component (US$25 million) 2. The institutional development component focuses on advancing the urban sector reforms in Tamil Nadu, building capacity of urban local bodies, improving managerial and financial performance of ULBs through performance benchmarking and monitoring. The sub-components are listed below: 3. Sub-component Al: Municipal Capacity Building (US$7.65 Million): This subcomponent will consolidate and advance the capacity building work under TNUDP 11. The Government of Tamil Nadu acknowledges the need for continuous institutional as well as human resource capacity enhancement leading towards the professionalization of urban management at state and ULB levels. Under this project, financial resources will be provided for technical assistance and capacity building (CB) activities which support the implementation and sustainability of urban reforms including the enhancement and professionalization of managerial capacity within ULBs and related urban and municipal sector organizations. CB inputs will be provided at the state and local levels to enable and sustain effective policy reform as well as improve organizational performance and service delivery. Training requirements of Municipal accounts staff will be met through this component. Al.l Mainstreaming capacity enhancement for urban management at the state and ULB Levels {$O.lOOmillion): This sub-component will provide resources to: (a) establish a Capacity Enhancement Cell (CEC) within the CMA headed by a Capacity Enhancement Coordinator; (b) assist in the development of a state-level Urban Management Capacity (UMC) framework to institutionalize, mainstream and guide institutional as well as human resource capacity enhancement for urban management in the state; (c) based on experience gained during TNUDP 11, establish a roster of training institutions specializing in select areas from whom state, ULB and related organizations can receive training; (d) assist ULBs to articulate demands and prioritize investments through consultative workshops; and (e) design and implement an information system for monitoring and evaluation of urban sector institutional and human resource CB activities in the state. A1.2 Professionalization of municipal management (US$1.30 million): There is a lack of standardized and up to date knowledge management in the urban sector. Creating a standardized system of knowledge and skill training with testing and accreditation is therefore essential in creating and retaining a professional body of staff that are responsible for different aspects of urban management. This sub-component will fund the establishment and operationalization of a system of professional certification programs for (a) City Management for Municipal Commissioners; (b) Municipal Accounting and Finance for Municipal Accountants and Revenue Officers; and (c) Municipal Public Health Management for Municipal Engineers and Public Health Officers. This will involve the design of a system of certification including the listing of core competencies for each sub-group of staff and the incorporation of social and environmental safeguards in the regular work stream of municipal management. This sub 33

38 component will make efforts to establish a Tamil Nadu State program in close consultation with similar efforts which will be underway in the neighboring state of Andhra Pradesh under the AP: Urban Reform and Municipal Services Project. A1.3 Training;, Skills Transfer and Dissemination (US$5.90 million): The project will fund a state-wide training initiative to be managed by the CEC. Training will be provided to (a) elected municipal officials; (b) new staff; (c) staff members who have been in-service for at least five years; and for (e) specialized training for specific skill upgrading. A1.3 (a) Training (US$ 5.87 million): A1.3 (a) (i) Orientation Traininn for Elected Representatives (USI. 74 million): Using lessons learned during TNUDP 11, CMA will continue orientation training programs for elected representatives of municipalities including those currently in office and those elected in municipal elections expected in A1.3 (a) (ii) Staff Training (US$ 4.13 million): Training will be divided in three different segments. (a) New Stafi staff promoted to the next management / supervisory level will go through a basic orientation through key courses similar to those conducted as part of TNUDP I1 (b) Intermediate Stafl those staff members who have received training under TNUDP 11 can opt for intermediate programs which will provide advanced skill and knowledge input in select subjects related with the staff members position and job profile; and (c) Advanced Program: This will address specific nature of reforms and/or projects to be taken up by ULBs. This would include a combination of classroom-oriented programs, exposure visits, transfer of skills and specialized training programs. A1.3 (b) Dissemination (US$0.03 million): The project will support (a) design and organization of workshops, seminars and conferences; (b) documentation of case studies and effective initiatives; and (c) web as well as non-web based news letters. A1.4 Evaluation and Monitoring of Capacitv Building: Activities (US$ 0.35 million): The project will support the design and conduct of evaluation and monitoring of all activities undertaken under this component. Each learning activity will be evaluated through participant feedback and post-training satisfaction polling of immediate supervisors regarding knowledge and skills obtained by participants. Sub Component 1 - Municipal Capacity Building I Mainstreaming capacity enhancement for urban management at the state & ULB Levels A. Caoacitv Building Cell Trainees ' Rs. US $m 1.o IB. UMC Framework Preparation I I 1.51 C. Establish a roster of training institutions D. Assist ULB articulate CB demands E. Information system for monitoring CB activities Sub-total 11. Professionalization of municipal management A. Curriculum Development for three certification programs B. 1 Certification of City Managers B.2 Certification of Municipal Finance & Accounts Officers

39 Sub Component 1 - Municipal Capacity Building B.3 Certification of Municipal Services Managers Sub total Trainees Rs. US %m Sub-component A2: Information and Communication Technology (US$4.30 million): This sub component includes procurement of goods and services to complete the e-governance initiatives in the recently upgraded 45 ULBs and to bring them to the level of connectivity of the remaining 106 ULBs which were beneficiaries under TNUDP 11. In the upgraded 106 ULBs, support would continue to be provided for streamlining workflow and strengthening mapping with the use of GIs. This would include procurement of goods and consultants services for design of software applications. B In US$ Million IA /Goods I 2.20 I Services 2.10 Total Sub component A3: Debt Monitoring Cell (US$030million): The knowledge of ULB creditworthiness will be improved through the establishment of a Debt Monitoring Cell within CMA. The objective of the DMC will be to collect financial information on individual ULBs, to assist the ULBs in making realistic financial projections and to facilitate ULB access to financial markets by disseminating financial information to potential lenders. The project would fund consultancy services to establish the DMC within CMA. 6. Sub component A4: Project Preparation Facility (PPF) (US$9.2million): The GoTN funded PPF would make available grants to all municipalities for consultancy services to assist them prepare and implement projects. Eligibility criteria for access to the Facility have been 35

40 agreed with the Bank. Additionally as part of advisory work, Technical Assistance will be made available to ULBs for developing an operational development strategy. Units Unit US$ Costs Mill ~4.1 Project Preparation Grants* 6.9 ~4.2 Advisory 2 Comprehensive Traffic and Transport Plan for other Corporations I 4 Operationalizing InvestmentNision Plans of ULBs through Strategic Plans slothers I I I 0.11 Total Sub-component A5: Project Management (US$3.55million): This would include financing of incremental operating costs for strengthening the office of the CMA and RDMA for US$ 2.55 million. Remaining would be financed by GoTN. CMA would need additional technical staff for review and approval of technical designs for the ULBs under its newly expanded role under the Project and also for the establishment of the Debt Monitoring Cell. B. Urban Investment Component: (US$407.5 million) 8. The urban investment component will be channeled through TNUDF/TNUIFS and will consist of: B. 1 (a) line of credit sub-component to the TNUDF for lending to ULBs (US$l 10 m) plus funds raised by TNUDF ( US$40 m) plus ULB funds (US$lO m); B. 1 (b) Capital Grants for ULBs (Grant Fund I) managed by TNUIFS (US$46.5 m) plus financing from existing GoTN grants (US$48 m); B. 1 (c) Project Development Advisory Facility for project preparation including innovative sub-project financial structuring (US$3 m); B. 2 (a) Grant (Grant Fund 111) for transport sub-projects in CMDA (US$121.5 m). B.2 (b) Project Management for CMDA including incremental operating (US$ 2.50 m) plus financing from GoTN (US$2.6m) Sub-component B.l (a): Line of credit (US$ 110 m): 9. The line of credit to TNUDF will be on lent to ULBs, statutory boards and private investors for sustainable investments in basic urban infrastructure such as water supply, waste water collection, solid waste management, storm water drains, roads and common facilities such as transportation networks, and sanitation facilities. The capital grant funds will finance environmental and social mitigation actions and the capital grant element of sub-projects serving the lowest income groups. However, besides the line of credit, project design would seek to expand TNUDF s financial role to include credit enhancement support through other instruments-such as debt service reserve funds, partial guarantees, first loss guarantees, bond insurance and subordinated debt instruments which would assist the overall objective of attaining more commercial involvement in financing decisions. Collaboration and participation with subsovereign funds such as IFC Municipal Fund would also be considered. 36

41 ~~ 10. The capacity of ULBs in Tamil Nadu to invest in sustainable urban infrastructure subprojects over the next 5 years is about US$950 million, of which a major portion relates to water and sanitation and solid waste management. The Project is expected to finance US$254 million equivalent of this pipeline over a five year period. The project will also finance US$l50 million of transport projects within the CMDA area. 11. The Bank will provide a long term loan of US$l 10 million through TNUDF in the form of a line of credit. The Banks loan proceeds would not be used for commercial complexes which can be financed through short term commercial financing. In order to increase the private capital inflow in to urban sector and leverage the Bank s limited resources to the maximum, the TNUDF will mobilize US$ 40 million equivalent at their own risk through issuing securities including bonds and debentures or any other debt instrument. TNUDF should be able to use various credit enhancement instruments available in the Indian capital markets. Raising funds through the capital markets will provide TNUDF with the much required market orientation, flexibility of tenor and interest rate in its offering and would also lead to long term sustainability of the Fund. 12. To ensure that TNUDF raises financing in the markets, a covenant has been included in the project agreement stating that TNUDF will raise at least US$ 40 million in co-financing from diverse market sources by September 30, Sub-component B.l (b) - Capital Grant Component (US$46.5 million): 13. Under TNUDP 11, capital grants were available to ULBs under Grant Fund I managed by TNUIFS for urban projects (though not funded under the Bank line of credit). The guidelines for access to the same stipulated that such grants could not exceed 30% of project cost (excluding cost of land acquisition) or Rs. 3 crores, whichever is lower, provided more than 20% of the beneficiaries of the project are below the poverty line and the projects were in eligible sectors such as water supply, sanitation, solid waste management, urban transport and bus stands. Under TNUDP 111, the Grant Fund (GF I) would have the same criteria which would be applied to projects: (i) for meeting the cost of Resettlement and Rehabilitation of the urban poor related sub-project assisted; and (ii) which directly benefit the urban low income group such as water supply, sanitation, storm water drain, street lighting, sewerage systems and bus stands. 14. Under TNUDP 111, bearing in mind that much of the sub-project pipeline consists of underground sewerage projects, the level of capital grants available to ULBs would be: The limit per sub-project would be up to 30% of project cost (excluding cost of land acquisition) or Rs. 10 Crores, whichever is lower; Within the aforesaid limit, part of the capital grant may be used for sub-project viability gap funding within the first 3 years of operation of the sub-project; Capital grants under Grant Fund 1 would amount to US$ 46.5 million out of the total urban investment component for ULBs of US$156.5 million funded by the Bank. The capital grants TNUDF would raise co-financing aggregating at least US$40 million fiom any or all of the following sources: (i) proceeds from TNUDF public bond issues; (ii) TNUDF private placements; (iii) co-financing with TNUDF by private financial institutions I banks at the sub-project level; (iv) secondary market purchases by private financial institutions / banks of TNUDF loans to ULBs, or re-financings of TNUDF loans to ULBs (through local bond issues, pooled bond issues, or loans fiom private financial institutions) as arranged by TNUDF; (v) net increases in equity investment in TNUDF by private financial institutions. 37

42 would apply to urban infrastructure projects only, such as water supply and sanitation, solid waste management, urban transport and bus stands; and, Poverty criteria would include percentage of population in low income areas covered under the infrastructure sub-project. Sub-component B.l (c) - Project Development and Advisory Facility (PDAF) (US$ 3.0 m): 15. PDAF would assist in preparation and supervision of more complex and innovative projects such as PPPs and BOTS, for such projects and technologies which can reduce the cost of services, or for a variety of purposes based on TNUIFS s assessment of global innovations, and the need from municipalities, in support of sector sustainability. Sub-component B.2 (a) - Financing of Traffic and Transport Grant (US$121.5 m): 16. The Urban Investment component also includes a grant for transport and traffic management sub-projects which fall within multi- jurisdictional areas and as such no single ULB is responsible for undertaking these investments. These investments would include road widening and strengthening, pedestrian walkways, Road Under Bridges, Road Over Bridges, Grade separators as well as traffic management measures. A Comprehensive Transport Study would also be carried out under this component. These investments would address a key urban and economic growth issue in terms of infrastructure choke points around Greater Metropolitan Chennai. In order to facilitate these investments, it was agreed that this component would be overseen by the Chennai Metropolitan Development Authority (CMDA), a statutory body under GoTN responsible for urban planning in the Greater Chennai Metropolitan Area. The CMDA would therefore act as the nodal agency for the implementation of these specific urban roads components and would be supported by the Department of Highways and Rural Works (DHRW) and the Chennai City Traffic Police (CCTP) in their implementation. Project management support including the incremental operating costs of CMDA would also be financed under this component. TNUDF, however, would have over all monitoring role for all fiduciary and safeguards aspects of the investment component (for implementation details see Annex 6). Sub-component B.2 (b) - Project Management Support for CMDA (US$2.50 m): 17. This would provide project management support for CMDA and would finance incremental operating costs for the Project Management Unit for this sub-component. Lending Terms and Conditions for the Line of Credit to TNUDF (US$ 110 m): 18. Lending terms and conditions of: (i) GoTN loan to TNUDF (On-lending of Bank Loan) and (ii) TNUDF loan to ULBs are as follows: From GoTN to TNUDF e 20 year loans, with 5 year grace period for principal e Fixed interest rate, set equal to: - The average yield of 10-year Government of India securities issuances in the primary market (hereafter termed Index ) for the preceding six months. The average yield is calculated as the six month average of GO1 10-year securities issuances prior to the date of release of a tranche (the Reference Date). In the event that there are no GO1 38

43 0 IO-year securities issuances in the primary market in the six-months preceding the Reference Date, the average yield of the IO-year Government of India security issuance in the primary market in the twelve month period immediately preceding the Reference Date shall serve as the Index. - Plus margin, if any, to be mutually agreed between GoTN and TNUDF and in any event not to exceed 100 basis points. TNUDF has prepayment option if interest rate on an outstanding loan from GoTN to TNUDF exceeds by 150 basis points or more the Index, as defined above. TNUDF Loans to Sub-borrowers: 0 Interest rate shall not be less than TNUDF s blended cost of capital. 0 No restrictions on loan maturities or other loan terms. 0 No restrictions regarding on-lending margins above cost of borrowings by TNUDF. e The option of a pre-payment premium would be included in TNUDF loan agreements with its borrowers. lo For this purpose the return on equity will be calculated as equal to the return on 10 year GO1 bonds. 39

44 ~ I --- Component Annex 5: Financing Plan INDIA: Third Tamil Nadu Urban Development Project /Cost Bank financing IUS% Milll% of Total US$ Milll% B Urban Investments through TNUDF B1 (a)loans to ULBs (b) Capital Grants to ULBs (c) Project Development Advisnrv Fmilitv I 3.00 I ? no d."" ---- I I I I I I I I 40

45 Annex 6: Implementation Arrangements INDIA: Third Tamil Nadu Urban Development Project 1. Executing Agencies. The same agencies which executed TNUDP I1 will execute most of the components of TNUDP 111, with relatively minor changes in responsibilities to benefit from lessons learnt and the addition of specialized agencies to implement the Chennai Metropolitan Area transport and traffic component. The Department of Municipal Administration and Water Supply (DMAWS) will have overall responsibility for project coordination and urban sector reform. A Government Committee, headed by the Chief Secretary has been established to lead the implementation of the project and provide policy direction. In addition, a Monitoring Committee, headed by Secretary DMAWS would be established, to review project progress at least on a quarterly basis and provide coordination support. Amongst other things, it would review the status of project appraisal and sanctions, progress toward meeting sector guidelines and achievement of monitoring indicators. 2. The key agencies responsible for various sub-components of the project, their roles, responsibilities and coordination aspects are described below. Some of the benefits of the initiatives taken and the lessons learned under TNUDP I1 (see Annex 16) have been integrated while designing the institutional arrangements. 3. Institutional Development component (A). The CMA under DMAWS will be responsible for implementation of the Institutional Development Component (IDC). The Project implementation Unit under TNUDP I1 has been mainstreamed into the CMA to carry out the TA, training programs and reform related assignments for the ULBs. CMA will also manage a project preparation facility (PPF) financed by GoTN and establish a Debt Monitoring Cell (DMC) to maintain a data base on ULB finances and to monitor their debt servicing capabilities. 4. Institutional Urban Investment component (B). Tamil Nadu Urban Infrastructure Financial Services Limited (TNUIFS) will be responsible for the implementation of the urban investment component, managing the TNUDF, making loans to ULBs, administering the capital grants to ULBs and channeling grant funds to CMDA. The administration of TNUDF is entrusted to a Board of Trustees nominated by GoTN and participating financial institutions. The Board has been incorporated as the Tamil Nadu Urban Infrastructure Trustee Company Limited (TNUITCL) and, as such, approves the business and financial plans proposed by TNUIFS. The TNUDF is run as an autonomous Fund with full management autonomy to the Board. 5. TNUIFS will manage a separate Project Development and Advisory Facility (PDAF) to allow for preparation and supervision of more complex and innovative projects such as PPPs and BOTS, for new projects and technologies which can reduce the cost of services, or for a variety of purposes based on TNUIFS s assessment of global innovations, and the need from the municipalities, in support of sector sustainability. 6. For Sub-components B1 (a) and (b) related to investments in the municipalities, CMA will take the primary responsibility for project preparation progress. CMA will help ULB s prepare the sub-projects and give Technical and Administrative Sanctions. TNUIFS will be responsible for implementation which would be jointly reviewed by TNUIFS and CMA. 41

46 CMDA will be responsible for planning and oversight of the transport and traffic sub-component B2 within the CMDA area, to be executed by the Department of Highways and Rural Works (DHRW) and Chennai City Traffic Police (CCTP). A multi-agency PMU would be constituted in CMDA, fully responsible for implementing this sub-component. The management of funds for this component will be done by TNUIFS. CMDA will be responsible for auditing the projects implemented under the CMDA component. This audit will be part of the statutory agency audit of CMDA. 7. Implementation Arrangements. Implementation will follow the procedures established under TNUDP 11. Additional operating procedures have been established for IDC activities and for the CMDA s transport and traffic sub-component. 8. For Component A, the CMA will prepare a rolling plan to be updated annually for the implementation of ID approved by the Government Committee. All training programs will be outsourced. 9. For Sub-components Bl (a) and (b), institutions wishing to borrow for infrastructure investments (predominantly ULBs, but also including Statutory Boards and private investors) will submit applications for sub-project financing to TNUDF, and inform CMA. CMA will take the primary responsibility for project preparation progress, and will hire the consultants for subproject preparation through its PPF. Preparation would be reviewed jointly by CMA and TNUIFS through a committee, consisting of CMA, TNUIFS, ULB and experts. Based on this concurrent review of project preparation, CMA will provide Administrative and Technical Sanctions without any further review / requests for revisions in preparation. Similarly, based on this concurrent review, TNUIFS will undertake and complete a detailed appraisal of the proposed project, including review of technical, financial, economic, social, environmental and legal aspects. For the projects to be reviewed by the Bank, the intermediate reports would be sent to the Bank during the preparation process, and Bank s comment sought. In practice, project preparation will be undertaken by consultants in accordance with the Operations Manual, including the Environmental and Social Framework (ESF), and financed out of the PPF for standard engineering designs or routine projects or PDAF for more innovative projects. Efforts would be made to complete the Administrative and Technical Sanctioning process at CMA and the TNUIFS s appraisal almost at the same time to avoid any delays in loan approvals. After a satisfactory appraisal, financing of the sub-project would be approved by TNUIFS. TNUIFS along with CMA will monitor the implementation of sub-projects, for which the borrowers will be required to submit regular progress reports, and will undertake post-implementation evaluations. The Operational Manual outlines the process framework and requirements. The roles and responsibilities of CMA, TNUIFSL and the ULBs for components B1 (a) and (b) are described in Attachment- 1 to this Annex. 10. At the ULB level, for implementation supervision of sub-projects, the municipal engineers would essentially be responsible. They would be assisted in supervision by consulting engineers on important sectors such as water supply, sewerage; and for other sectors, to the extent required on a case by case basis. Where there is no external consultancy support, CMA shall ensure that there is adequate institutional support to the ULBs through an active role of its regional RDMA offices in implementation monitoring, and through capacity building of ULB engineers. 42

47 11. For Sub-Component B2 to be managed by CMDA, a Project Management Unit will be established within CMDA under the Member Secretary CMDA, for day to day management. The officials for the posts in the PMU will be drawn on deputation from the respective implementing agencies, DHRW and CCTP. Overall coordination and management will be undertaken by a Project Management Committee which will comprise senior representation of all agencies concerned and will meet on a monthly basis. A Technical Review Committee (TRC), will approve all Detailed Project Reports (DPRs) for sub-projects. TNUIFS will ensure that CMDA meets the ESF safeguards and compliance requirements during preparation and implementation of their sub-projects under TNUDP Implementation Capacity. TNUDF/TNUIFS has a proven capacity for selection of well designed and sustainable urban infrastructure projects and supervision of their implementation. Its capacity will be further strengthened by the actions listed below which have been agreed: hiring additional experienced project finance specialist for project identification, implementation and supervision; enhancing project development and marketing skills by appointing adequate and appropriate. staff to support ULB s; making senior level staff focus on areas such as financial advisory, project appraisal and social and environmental issues. It is expected that the social development specialist/consultants will also focus on consultation on key project related policies at the local level; adopting the operations manual and addressing generic issues raised through sector guidelines as part of its operating procedure; and instituting joint review procedures with the Commissioner Municipal Administration (CMA) on technical assistance and approvals. 14. CMDA has had experience of implementing Bank financed projects under MUDP I, while DHRW is currently the main implementing agency for the Bank funded TN Roads Project, for which its implementation capacity has been appraised. As indicated above, experienced personnel from the implementing agencies will be seconded to CMDA s PMU for the duration of the project. CMDA will also be able to call upon the experience of TNUIFS in project implementation in the Technical Review Committee. TNUIFS will also ensure ESF compliance and that all subprojects satisfy the same high standards of ESF safeguards as those in TNUDF. TNUIFS will employ experienced consultants to prepare and supervise the environmental and social aspects of subprojects and their compliance with the ESF. (See responsibility matrix in Annex 11). 15 CMA will be strengthened with adequate staff to carry out the expanded responsibility. A senior officer will have overall responsibility for the day to day implementation of the IDC and the Financial Advisor will be responsible for accounting, reporting and audit of this component. The capacity of CMA to implement the institutional strengthening component will be enhanced by training and recruitment of qualified personnel. 16. Procurement: Under component B1, ULBs will procure works, goods and services. They will have the option to outsource these functions with the use of grants from the Project Preparation Facility or the Project Development Advisory Facility (PDAF). At the ULB level, implementation of works will be supervised by consulting engineers, where necessary. 43

48 17. Under component B2, CMDA will primarily coordinate the transport and traffic sub projects and the responsibility to procure and implement works will be with DHRW. CCTP will procure equipment and services for the traffic management sub-component, with assistance from CMDA. Where consultancy services are concerned, CMDA will undertake to prepare Request for Proposals (RFPs) following the Bank guidelines and submit the same to the Bank for clearance. For civil works, DHRWKCTP will prepare the bidding documents following Bank guidelines. CMDA would, however, verify and ensure that the World Bank guidelines are followed in the preparation of the bidding documents and submit the bidding documents to the Bank for prior review. Bid documents cleared by Bank would be sent by CMDA to DHRWKCTP for tendering. DHRW and CCTP would thereafter undertake the tendering of work following the Bank procurement guidelines. The contracts will be signed by the respective implementing agencies viz. DHRW or CCTP. DHRW has vast experience in the implementation of various urban road/bridge schemes in the Chennai Metropolitan Area in the past several years, and the engineers in the department have adequate competence in contract management and supervision. 18. Institutional Development Component: As indicated above, the management of institutional development activities will be mainstreamed within the CMA system. The office of the CMA has evolved a structure that will be more responsive to the local bodies, with Regional Directors being strengthened with sufficiently qualified technical staff to address technical issues at ULB level. The proposed strengthening also includes senior advisers on governance and social development programs including Information and Education Campaigns on state programs. 19. The institutional development activities include strengthening capacity of staff to manage services, upgradation of e-governance specifically on software applications, a demand based migration to GIS or other applications and a series of technical assistance inputs to improve municipal management systems. CMA will continue mandatory orientation programs for municipal elected representatives (present and those to be elected in 2006). 20. Skill transfer: Staff from the municipal system will be deputed to work in the offices of CMA and TNUIFSL to absorb skills on project planning, appraisal and management. 21, TraininP Delivery: CMA in consultation with TNUDF and select Municipal Chairpersons, Commissioners and key municipal staff will define the capacity building plan. Training programs will be conducted in the Tamil Nadu Institute for Urban Studies (TNIUS) and other training institutions. Based on positive feedback from training institutions, CMA will identify select municipal staff and elected officials and develop them as trainers so that programs could be handled at the regional level. 44

49 I Phase I To monitor overall process Facilitates identification of special projects ULBs to identify and prioritize as part of their road map /business planj master plan / vision document CMA to help ULBs prepare and implement projects, by appointing consultants for standard engineering designs and routine project management activities. Primary responsibility for project preparation financed out of the Project Preparation Facility TNUDF operations manual to be followed in project preparation TNUIFS to assist CMA in oroiect I " preparation by agreeing TORS, participating in review committees and supervising adequacy of consultant outputs TNUIFS to assist ULBs in structuring of PPPs and other complex project structures, including O&M contracts. Primary responsibility for project preparation and supervision financed out of the Project Development Advisory Facility. TNUIFS to assist the ULBs with special purpose studies such as -- developing city corporate cum business plans, energy efficiency, water efficiency, reuse of waste water, rejuvenation of water supply source, laying Fly Ash-cement concrete roads, privatization of civic services, identification of BOT operators, development of -projects - under BOT format etc. ULBs to highlight local requirements, that need to be integrated in design 45

50 I Phase I Role of CMA CMA can use Generic TORS ureuared by TNUIFS (under TNUDP ii) CMA appoints individual experts in various fields, region wise, to assist it in Proof Checking the designs before they are sent to SE, CMA office CMA to ensure that TNUIFS is involved in project preparation monitoring CMA s Debt Monitoring Cell would collect financial information on individual ULBs, to assist ULBs in making realistic financial projections and to facilitate ULB access to financial markets by disseminating financial information to potential lenders CMA can outsource certain jobs of this cell to TNUIFS on fee basis or by bidding out Preparation review - by a Committee consisting of CMA (Chair), SE/CMA, MD & CEO / TNUIFS, concerned Municipal Commissioner & Engineer and other experts. The committee meets once in a fortnight for monitoring project preparation, approval, sanctioning and implementation. Rnle nf TNIJIFS All TORS to be cleared by TNUIFS To participate in project preparation review. To promote efficiency improvement / innovative approaches through special purpose studies. TNUIFS can advise CMA in cash flow projections for ULBs, reduction of indebtedness of ULBs, forming right size of project loan, based on a fee. Disseminate TNUIFS s Operations Manual (external) to all concerned Disseminate Environmental and Social Framework to all concemed + Hire consultants for special studies at opportune time. Role of ULB ULB commissioner and engineer to participate in the committee for project preparation and implementation review. 46

51 47... ^_.^.^_...^.._.^."XI "I I"

52 Implementing Entities Annex 7: Financial Management and Disbursement Arrangements INDIA: Third Tamil Nadu Urban Development Project 1. DMAWS through the office of the Commissioner of Municipal Administration (CMA) will implement project subcomponents Al, A2, A3, A4 and A5 under the Institutional Development Component (IDC). The CMA will receive funds, maintain accounts, procure and receive goods and services under this component. A Financial Officer (FO) at CMA will be responsible for maintaining accounts, submitting claims and reporting expenditures on this component. 2. TNUIFS (Tamil Nadu Urban Infrastructure Financial Services Limited), a private limited company established by GoTN and three FIs will implement the following project components: a. Sub loans to ULBs component B1 (a) b. Capital Grants to ULBs component Bl(b) c. Project Development Advisory Facility B. 1 (c) d. Grants to CMDA (B2) On all of the above components, Trust Funds [called TNUDF, Grant Fund I, Grant Fund I1 and Grant Fund I11 for Bl(a), Bl(b), B.l (c) and B2] will be set up to hold project moneys (both Bank and Counterpart contribution). TNUDF is a registered Trust under the Indian Trusts Act, while Grant Funds I, I1 and I11 are GoTN held Funds. 3. TNUIFS will be appointed the Manager of TNUDF and the Grant Funds under a management agreement as was the arrangement under TNUDP 11. TNUIFS will be responsible for managing, monitoring and implementing all project activities on Bl(a), Bl(b) and B.l (c) where it will be appointed as Fund Manager. For project component B2, while TNUIFS will act as Fund Manager and will fulfill all the requirements relating to accounting, expenditure reporting and audit both for GOI/GoTN as well as for the Bank, actual implementation will be done by Chennai Metropolitan Development Authority (CMDA). Implementation Chart and Responsibility Matrix Component Funds Flows Fund Management and FM responsibility A Institutional Development AI Component Capacity Building of Through GoTN budget to CMA (DMAWS) A2 Municipal Staff Information and Commercial Bank account of CMA Through GoTN budget to CMA (DMAWS) Communication Technology Commercial Bank account of CMA A3 ULB Borrowing Through GoTN budget to CMA (DMAWS) Framework/ Debt Commercial Bank account of I Monitoring I CMA A Implementation Arrangements CMA (DMAWS) CMA (DMAWS) CMA (DMAWS) A4 I Project Preparation Facility I Through GoTN budget to I CMA(DMAWS) I CMA(DMAWS) I I I Commercial Bank account of I I I CMA Project Management Through GoTN budget to CMA (DMAWS) 1 CMA (DMAWS) 48

53 B Component Funds Flows Fund Management and FM responsibility Incremental Operating Cost Commercial Bank account of CMA Urban Investments I through TNUIFS Implementation Arrangements BUa) I Loans to ULBs I Through GoTN to Tamil Nadu I TNUIFS I TNUIFS.. Bl(b) B. l(c) UrbanDevelopment Fund (TNUDF) Capital Grants to ULBs Through GoTN Capital Grant TNUIFS TNUIFS Fund I managed by TNUIFS Pro-iect Development Through GoTN Capital Grant TNUIFS TNUIFS I Adiisory Facility I Fund I1 managed by TNUIFS I Fund I11 managed by TNUIFS B2 I Grants to CMDA I Through GoTN Capital Grant I TNUIFS I CMDA I Funds Flow 4. GO1 will open a Special Account with RBI to receive the disbursements under the project. It will make the funds available to GoTN as per the arrangements for development assistance from GO1 to states. 5. The entire funds requirement of the project including the counterpart contribution will be budgeted by GOTN as an identifiable, single head budget item annually. This allocation will cover the fund requirements of all project components and will be based on the work plans prepared by the implementing entities annually. An expected schedule of payments will also be provided by the implementing entities to the Finance Department to help the state plan its cash flows appropriately. 6. The funds flow arrangements on different project components will be as follows: a) For Bl(a), GOTN will credit funds to TNUDF s account in the Public Account of the state for on lending to ULBs. TNUIFS, on behalf of TNUDF will be allowed to draw funds into a commercial bank account on a quarterly basis in accordance with annual work plans. The repayment and on lending arrangements will be governed by a subsidiary loan agreement. b) For Bl(b), B.l (c) and B2, GoTN will credit funds to the respective accounts of the Grant Funds (GFs) I, I1 and 111 in the Public Account of the state from where TNUIFS shall be allowed to withdraw into the commercial Bank accounts of the GFs in accordance with the guidelines and management agreements of the GFs. For project component B2 where TNUIFS is the Fund Manager but CMDA is the implementing agency, TNUIFS will advance funds to CMDA s commercial bank account on a quarterly basis for the transport and traffic sub projects on the basis of estimates prepared by CMDA. CMDA will disburse funds to DHRW and CCTP for payment to contractors engaged on subprojects. c) For Al, A2, A3, A4 and A5, the CMA shall be allowed to withdraw from the GoTN Treasury on a quarterly basis and deposit moneys into a commercial bank account from 49

54 Staffing where project expenditures will be made. The Financial Advisor in CMA will present a bill to the Pay and Accounts Officer (P&AO) for drawing the funds, based on this, the P&AO will issue a cheque in the name of the CMA and the funds will be physically transferred to the commercial bank account of the CMA. 7. TNUDF: The finance wing of TNUDF comprises a Senior Vice President, Finance, supported by a Manager and Deputy Manager (TNUDF), Deputy Manager Investments, Deputy Manager, and several other support staff. A senior financial executive in TNUIFS will be responsible for providing timely consolidated financial reports to the state authorities and the Bank, monitoring of expenditures, providing overall guidance, facilitating smooth flow of funds and conduct of timely audit and ensuring consolidation of withdrawal/ reimbursement claims. 8. CMA: The financial management arrangements and functionally responsibility for accounting and financial reporting for the institutional development component within the CMA will rest with the Financial Officer (FO). The FO will be supported by an Accounts Superintendent and Accountants. 9. CMDA: CMDA has an experienced and qualified Accountant who will be responsible for liaising with TNUIFS on withdrawal of funds, payments and rendering of accounts. Accounting Policies and Procedures 10. CMA: CMA will maintain project accounts for the components that it will implement on cash basis. A separate account code will be created for the project in the Department s overall accounting system. A simple Operations Process Note based on the manual developed for TNUDP I1 will be written by the FO and shall be regularly updated for changes and amendments through the life of the project. The process note will lay down in detail the applicable accounting policies and procedures to enable data to be captured and classified by expenditure center, project sub components and disbursement categories in the accounting format agreed. Standard books of accounts (cash and bank books, journals, ledgers, etc.) would be maintained at the CMA. Records of assets created for the project will be separately maintained and will be subject to verification by the internal auditors of the Department. 11. TNUIFS: TNUDF follows double entry accounting book keeping in accordance with statutory guidelines applicable to limited companies in India. The company also follows an operations manual and accounting is fully computerized. Well defined policies relating to accounting, disbursement, assessment of sub project proposals, classification of loans and loss provisioning are in practice. 12. ULBs: The ULBs incur project expenditures as per sub-project agreements, maintain records showing expenditures incurred on the Project on accrual basis and report quarterly progress through FMRs (formats to be agreed) to TNUIFS. 50

55 External Audit 13. The following audit reports will be received within six months of the close of the financial year: Implementing Agency Audit Auditors CMA Grant Fund I, Grant Fund I1 and Grant Fund I11 TNUDF ULBs DEA / GO1 SOE / Project Audit Report Accountant General (Audit) of Tamil Nadu Entity Report (including a separate Firm of Chartered Accountants disclose on project expenditures) acceptable to the Bank Audit report of the Trust Firm of Chartered Accountants acceptable to the Bank Entity Report (including a separate Local Fund Audit Department disclose on project expenditures) Special Account Comptroller & Auditor General of India Internal Audit 14. In addition to the external audit, a firm of chartered accountants will carry out an internal audit of TNUDF and GFs I, I1 and 111. The internal audit department of the CMA will carry out the internal audit of the CMA. The internal auditors will ensure that the correct accounting, payment and procurement procedures are followed. Reporting and Monitoring 15. TNUIFS shall prepare FMRs on the following project components: a. Sub loans to ULBs component B1 (a) b. Capital Grants to ULBs component Bl(b) c. Project Development Advisory Facility B1 (c) d. Grants to CMDA (B2) 16. DMAWS will submit FMRs for the entire project to the Bank. 17. All FMRs will show comparisons of budgeted and actual expenditures and analysis of major variances, including on aspects such as sources of funds and application of funds classified by components and expenditure. The FMRs will also show the physical progress against financial progress. Country Issues 18. The following country issues identified as generic to India, will apply to this project: a. That CMA s existing accounting system concentrates on transactional control over expenditures with financial information seldom being used for decision making. This will be addressed through encouraging the use of FMRs for using and analyzing financial data. 51

56 b. Timely availability of funds for the project: This will be circumvented by allowing all implementing entities to draw funds into commercial bank accounts on a quarterly basis. c. Quality of audit reports may be an issue, as the audit of the CMA will be conducted by the state Auditor General (AG). This will be addressed by agreeing a Terms of Reference with the state AG. Risk Analysis I Risk Project Complexity: Although there are only two implementing agencies, project design is complicated by the outflow of funds under the on lending component to multiple ULBs. Funds Flow: Project moneys will flow to TNUDF and GFs I, I1 and I11 and to DMAWS through well established procedures and as per agreed work plans. Under the sub loan component, funds will flow to multiple ULBs under the same mechanism as that used for TNUDP 11. There is a risk that own cash flow problems may impede project flows. Disbursement Arrangements: TNUDP I11 will replicate the disbursement arrangements under TNUDP I1 except for the CMDA and DMAWS component. While the disbursement arrangements from TNUDF to the ULBs are well established, there could be a risk of delays in disbursements to CMDA. Borrower Staffing: There has been considerable attrition of staff at TNUIFS and so there is a risk that new staff will not be familiar with Bank procedures. CMA staff are new to Bank procedures. Internal Control and Accounting Systems are well established in the implementing entities. Rating Medium Medium Medium Medium Low Risk Mitigation Although funds will flow to many ULBs, these will be selected in accordance with stringent screening norms set up by TNUIFS". Assurance on ULBs sub loans will be received through quarterly expenditure reporting by the ULBs and their annual audit reports. The risk of cash flow crunches affecting project funds flows will be mitigated by allowing implementing entities to draw funds on a quarterly basis into commercial bank accounts based on work plans. Possible risks of delays of disbursement to the CMDA will be mitigated through the inclusion of timelines within which TNUIFS shall make funds available to CMDA. This time frame will be included as a Financial Covenant. This risk will be mitigated by providing training to new staff at TNUIFS and CMA in Bank procedures. Mitigation measures not required l1 Screening criteria will include an assessment of the accounting system, presence of competent accountants and the financial viability of the sub projects proposed. 52

57 Risk Flags Rating Risk Mitigation Audit Arrangements are working well under Medium TNUDP 11. Reports are submitted in time and are unqualified. However quality of AG reports has been an issue elsewhere in India. Overall Risk Rating Medium Audit arrangements will be strengthened through the agreement of TORS with the AG and the LF auditors. Strengths and Weaknesses 19. The Project has the following strengths in the area of financial management: (i) (ii) DMAWS and TNUIFS have successfully implemented two Tamil Nadu Urban Development Projects An operations manual (both for CMA and TNUIFS) has been prepared and is in use for the TNUDP 11. This will be amended to set out details of the fund flow process, accounting arrangements, financial reporting and auditing that would be followed for the current project as well. Significant weaknesses 20. The existing accounting system of GOTN followed by DMAWS/CMA focuses on bookkeeping rather than on strategic use of information. However, quarterly progress reporting and FMRs would help encourage use of financial information for decision making. Disbursement Arrangements 21. Disbursements from IBRD loan will initially be made in the traditional system (reimbursement with full documentation and against statement of expenditure) and can later be converted to Financial Management Report (FMR) based disbursement at the option of GO1 and GOTN after the Project successfully demonstrates generation of quality FMRs. 22. A Special Account will be maintained in the Reserve Bank of India; and will be operated by the Department of Economic Affairs (DEA) of the Government of India (GOI). The authorized allocation of the Special Account would be US$ 15 million, which represents about 3 months of average estimated disbursements from the IBRD Loan. 23. Retroactive financing up to an amount of US$60 million would cover eligible expenditure for implementing activities on contracts which follow Bank procurement guidelines for 12 months prior to loan Signing. Retroactive financing would support all project activities. 53

58 Action Plan Action Responsible Agency Agree audit TOR with AG, pre-approved by the CMA, DMAWS Bank Financial Officer at CMA to prepare an CMA, DMAWS Operations Note and agree that with the Bank Completion Date Within 3 months of Loan effectiveness Within 3 months of Loan effectiveness Financial Covenants i. CMA shall maintain throughout the project period a Financial Officer with experience and qualifications agreed with the Bank; ii. CMA shall produce accounts in the formats specified and acceptable to the Bank; iii. The audited financial statements from all implementing entities specified shall be provided to IBRD within 6 months of the close of the financial year; iv. TNUIFS shall employ during the life of the project a Senior Executive - Finance who will be the single contact point for the Bank on all matters relating to accounting, financial reporting, submission of accounts to audit, claims, disbursements and for all project components being implemented by TNUIFS; and, v. CMDA shall employ an Accountant with qualifications acceptable to the Bank throughout the life of the project to liaise with TNUIFS for GF I11 and GoTN on funds flow, accounting, disbursements, claims and other FM issues. Supervision Plan 24. From a financial management perspective, the project will need intensive supervision in the initial stages for establishing systems in CMA and initiating new staff at TNUIFS. Thereafter biannual supervisions would suffice. 54

59 ~ ~ Expenditure Category Allocation of Loan Proceeds Amount in US$ m Financing Percentage Subloans under Part B. l(a) of the Project Capital Grants under Part B.l(b) of the Project 110,000,000 46,500, % 100% (4) _. (5) Transport and Traffic Grants under Part B.2 of the Project Project Development Advisory Facility Consultants Services and Training Goods under Part A of the Project Incremental Operating Costs Fee TOTAL 121,500, % 3,00, % 10,950, % 1,500, % 5,050, % 1,500,000 Amount due under Section 2.04 of this Agreement 300,000, The term incremental operating costs means the incremental costs of operation and maintenance of buildings, equipment and vehicles, office rental and expenses, hiring of vehicles, salaries of Project staff, and travel and other allowances, incurred by CMA and RDMA (US$2.55 million) and CMDA ( US$2.50 million) for the purposes of carrying out the Project. 55

60 ~~~~~~... I I f + s 4 W T-... F I I I I I I I I I I I I I I I I I I I I I 1, L ~......

61 Annex 8: Procurement Arrangements INDIA: Third Tamil Nadu Urban Development Project General 1. Procurement for the project would be carried out by the implementing agencies including ULBs 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. Attachment 1 to this Annex summarizes the procedures for undertaking procurement on the basis of National Competitive Bidding (NCB). The general description of various items under different categories is described below. For each contract to be financed by the Loan, the different procurement methods or consultant selection methods, the need for pre-qualification, estimated costs, prior review requirements, and time frame have been agreed between the Borrower and the Bank project team. Procurement of Works 2. Works procured under the project include : widening and strengthening of roads, road over bridge, road under bridge, grade separators, pedestrian subways, construction and maintenance of water pipe lines, solid waste management works, storm water drainage, bus stands etc. International Competitive Bidding (ICB) will be adopted for contracts estimated to cost more than US$ 10 million each. National Competitive Bidding (NCB) will be adopted for contracts valued more than US$ 100,000 but up to US$ 10 million equivalent. Shopping may be adopted for contracts estimated to cost the equivalent of US$ 100,000 or less per contract. 3. Invitation for Bids (IFB) will also be published in UNDB and dgmarket for all ICB contracts. Bank s standard bidding documents (SBDs) for ICB and Government of India (GOI) Task Force model documents for NCB (civil works) will be adopted. 4. Since loan to Urban Local Bodies (ULBs) is demand driven, value and number of all packages of civil works can not be specified in advance. Procurement of Goods 5. Procurement of goods includes machinery, equipment, waste collection vehicles, etc. Each contract of goods and equipment estimated to cost more than US$ 1.O million equivalent would be procured under International Competitive Bidding (ICB) and that estimated to cost more than US$ 100,000 but up to US$ 1.0 million under National Competitive Bidding (NCB), and contracts valued less than US$ 1 00,000 equivalent each under Shopping procedures. Directorate General of Supplies & Disposals (DGS&D) rate contracts will be acceptable under shopping. Rate contracts of State Government will be treated as one quotation under shopping procedures. Direct contracting may be resorted to for procurement of satellite imagery (fiom national Remote Sensing Agency of the GO1 which is the sole supplier), computer software, audio, video cassettes, books, periodicals and other proprietary items etc. costing less than US$ 100,000 equivalent per contract. 57

62 6. Invitation for Bids (IFB) will also be published in UNDB and dgmarket for all ICB contracts. Bank s standard bidding documents (SBDs) for international competitive bidding (ICB) and Government of India (GOI) Task Force model documents for NCB (Goods) will be adopted. Selection of Consultants 7. Consultants services will include individual consultants for various activities, services for proof checking, preparation of detailed project reports, training & workshops, study and option for overhnder bridge, study on parking solutions, feasibility study for area traffic control, construction supervision, environmental and social impact, economic analysis and air quality monitoring system for road network etc. 8. Quality and Cost Based System (QCBS) will generally be followed. Advertisement for Expression of Interest shall be published in UNDB and dgmarket also for all assignments costing more than US$ 200,000 equivalent. Short list may comprise entirely national consultants for consultancy services valued up to US$ 500,000 equivalent each. 9. Consultancy services valued less than US$lOO,OOO equivalent may be awarded on sole source basis keeping in view the provisions of the Bank s Consultancy Guidelines. Services for audits, engineering design, strengthening the capacity of ULBs etc. estimated to cost less than US$ 100,000 equivalent per contract may be procured by least cost method of selection. Contracts for Individual would be small in value and may not exceed US$ 10,000 equivalent each. For hiring of individuals job description, minimum qualification and terms of employment shall be prepared. Bank s standard request for proposals (RFP) for consultancy services and Government of India (GOI) Task Force model documents for other consultancy services will be adopted. Assessment of the Agency s capacity to implement procurement 10. The Department of Municipal Administration and Water Supply (DMAWS) will assume over all responsibility for implementation of Institutional Development Component through the office of the Commissioner of Municipal Administration (CMA). Tamil Nadu Urban Infrastructure Finance Services Limited (TNUIFS) on behalf of Tamil Nadu Urban Development Fund (TNUDF) will be responsible for implementation of the urban investment component including the project development advisory facility grants. CMA will implement the institutional development component. Chennai Metropolitan Development Authority (CMDA) will implement the transport and traffic component in the Chennai metropolitan area. 11. Procurement/project management system of the TNUIFS and the CMA was reviewed to determine whether the systems are in conformity with the Bank s guidelines for procurement in the investment projects. As agreed to with the Bank under TNUDP I1 Project, Tamil Nadu Urban Infrastructure Finance Services Limited (TNUIFS) will take the following measures to maintain its strength in procurement management: 58

63 (i) TNUIFS will continue to employ one procurement management expert (with engineering background and having experience in the Bank procurement procedures) and one support engineer staff to assist the procurement management expert in monitoring and providing guidance to various urban local bodies (ULBs) on procurement; and, (ii) ULBs will procure the works and goods under the loan sanctioned to them with help from TNUIFS. 12. Widening and strengthening of roads under CMDA component will be implemented by Department of Highways and Road Works (DHRW), Government of Tamil Nadu. DHRW is presently executing Tamil Road Sector Project (Loan 4706) funded by the Bank. and has previously executed road works as part of World Bank financed projects such as National Highways - I1 Project-I [Cr.2365-IN], Agricultural Development Project -Tamil Nadu [Cr IN], Tamil Nadu Urban Development Project [Cr IN] etc. In addition, the GOTN has implemented some other externally aided projects. The engineers who have worked on these projects are generally conversant with the systems and procedures to be followed for procurement in World Bank funded projects. DHRW, if need be, shall create an additional cell to implement this component. Chennai City Traffic Police (CCTP) will implement the traffic management component. 13. A Project Management Unit (PMU) will be set up in CMDA who will be fully responsible for implementation of the component. DHRW and CCTP would execute their corresponding sub-components of the project, the PMU would coordinate and monitor implementation of these sub-components. PMU in CMDA will be responsible for undertaking consultancy studies for the detailed project reports and other consultants wherever required. DHRW/CCTP will prepare the bidding documents following World Bank Guidelines and Bidding Documents. PMU would verify and get clearance from the Bank as required. Similarly, PMU will refer the evaluation reports to the Bank for clearance. Keeping in view the above mentioned arrangements, the procurement risk is considered average. Procurement Plan 14. Since most of the procurement under sub-loan component will be carried out by ULBs and it is uncertain at this stage for what specific activities ULBs will request for a loan, it is difficult to assess the quantum of procurement of goods and works. Therefore, no procurement plan can be prepared at present for this sub-component. However, TNUIFS would get the procurement plan prepared from ULBs at the time of sanctioning the loan to facilitate monitoring of the procurement activities pertaining to that loan. 15. Procurement of office equipment, works and consultancy services required by TNUIFSL, CMA and for use in offices of ULBs will be of small value and will fall under shopping. 16. CMDA has prepared a procurement plan for the first eighteen (1 8) months of the project and is placed with the project documents. 59

64 17. Threshold for prior review by the Bank are :- Works: Goods: Consultancy Services: the first three contracts awarded under NCB (applicable to CMDA component only) and each contract > US$3.0 million equivalent > US$ 1.O million equivalent > US$250,000 equivalent for firms and > US$ 100,000 equivalent for individuals 18. For works to be financed by TNUDF, the prior review by the Bank would apply only to contracts estimated to cost more than US$ 3.0 million equivalent. These thresholds are indicated in the procurement plan also. The procurement plan will be updated annually including prior review thresholds, if necessary, in agreement with the project team or as required to reflect the actual project implementation needs and institutional capacity. 19. The World Bank will carry out ex-post review of contracts not subject to prior review, on random selection basis as per the procedure set in paragraph 5 of the Bank s procurement and consultants guidelines. Frequency of Procurement Supervision 20. In addition to the prior review supervision to be carried out from the bank offices, the capacity assessment of the Implementing Agencies has recommended six monthly supervision missions to visit the field to carry out post review of procurement actions. 60

65 PROVISIONS APPLICABLE TO NCB-BASED PROCUREMENT 1. The model bidding documents for NCB agreed with the Government of India Task Force [and as amended from time to time], shall only be used for bidding. 2. Invitations to bid shall be advertised in at least one widely circulated national daily newspaper, at least 30 days prior to the deadline for submission of bids. 3. No special preference will be accorded to any bidder when competing with foreign bidders, state-owned enterprises, small scale enterprises or enterprises from any given State, etc. 4. Except with prior concurrence of the Bank, there shall be no negotiations of price with the bidders, even with the lowest evaluated bidder. 5. Extension of bid validity shall not be allowed without the prior concurrence of the Bank (i) for the first request for extension if it is longer than four weeks; and (ii) for all subsequent requests for extension irrespective of the period. 6. Re-bidding shall not be carried out without the prior concurrence of the Bank. The system of rejecting bids outside a pre-determined margin or bracket of prices shall not be used. 7. Rate contracts entered into by DGS&D will not be acceptable as a substitute for NCB procedures. Such contracts will be acceptable for any procurement under National shopping Procedures. 8. Two or three envelop system will not be used. 61

66 A. ECONOMIC ANALYSIS Annex 9 A: Economic and Financial Analysis INDIA: Third Tamil Nadu Urban Development Project 1. The proposed line of credit does not have an explicit subsidy, the opportunity cost of dedicated funding, difficult to quantify, is expected to be more than compensated by the benefits of increased efficiency of delivery of urban services and the sustainability of ULBs. The costbenefit analysis will be carried out for each upgrading sub-project with total costs of US$ 500,000 and above, except sub-projects with non-quantifiable benefits. For ease during implementation, a set of criteria have been developed to help during the evaluation of individual investments. Sub-projects will have to satisfy the following criteria: 0 it is given high priority in the ULB's corporate plan prepared in a participatory manner; 0 it supports remunerative and non-remunerative urban infrastructure contributing to the improvement of the living standard of the urban populations; 0 the Cost-effectiveness Indicator (the cost of investment per beneficiary household as a share of the beneficiary household income) for the sub-project does not exceed the established hurdle rate of around 10%; and, 0 the cost and benefit analysis for the individual sub-projects of US$500,000 or more shall demonstrate a positive NPV and an ERR equal or above the appropriate opportunity cost of capital estimated at 12%. This requirement will not be applied to sub-projects with nonquantifiable benefits or those costing less than US$500,000. Should the NPV be negative or the ERR below 12%, additional qualitative analysis will be carried out. 2. To ensure that the proposed investments do not artificially support one another in terms of the economic returns, and to establish cost-effective investment parameters, the economic analysis will be conducted for each sector investment separately, if feasible. 3. The Bank will review on a no-objection basis all sub-projects with total costs of US$ 750,000 and above for works and a sample of sub-projects below this threshold at its discretion. This procedure will be reviewed as needed to ensure adequate quality of the investment analysis. Methodology - Overview 4. The net incremental economic costs and benefits of the proposed sub-projects will be assessed by constructing "with" and "without" sub-project scenarios. The cash flows will be discounted using the appropriate opportunity cost of capital in India (12%). The analysis will include calculation of the Net Present Value (NPV) and the Economic Rate o f Return (ERR). Finally, sensitivity analyses by testing a number of scenarios will be conducted to assess the impact of changes in critical assumptions on the economic viability of the sub-project. The base year will be 2004 and all amounts used in the models will be in 2004 Rupees. The period of analysis will be at least 10 years after each investment becomes operational and no less than then expected useful life of the asset without re-investment during this period. 5. Data used for sub-project analysis must be actual in the specific city where the proposed investment will be undertaken and should be obtained from socio-economic indicators, surveys, 62

67 interviews, focus groups, or actual on-site observations. Willingness to pay surveys should be undertaken when necessary. 6. Estimating Economic costs and benefits. For estimating economic costs and benefits economic prices will be used, i.e. financial prices adjusted for the impact of taxes, implicit taxes, subsidies and externalities, mainly on material and labor costs. Alternatively, economic costs will be estimated by applying standard conversion factors for India (e.g. those suggested by the IRC), if possible making distinction between conversion factors for skilled and unskilled labor. 7. For the purposes of estimating economic costs all costs associated with the proposed investment shall be considered, including: 0 capital costs (including designing, planning and engineering costs, construction costs, etc.); 0 operating and maintenance costs (O&M); and, 0 contingencies and complementary actions necessary to achieve the expected benefits - for physical contingencies during the construction stage a ratio of about 15% of the estimated construction costs (or one appropriate for Tamil Nadu) will be used. 8. Once all financial costs are converted into economic costs, incremental costs will be calculated based in the comparison of the "with" and "without" sub-project scenarios. No residual value will be included in the analysis. A factor of about 10.5% shall be applied to total investment costs to capture the costs of program administration, community outreach and related contingencies. 9. Some estimation of economic benefits may require direct measurement techniques based on potential expenditures saved (e.g. savings relative to replacement costs) or willingness to pay (i.e. contingent valuation methods) by the beneficiaries for the new improved services (more details on assessing the willingness to pay are discussed below). 10. The methodology to be used depends on whether or not the ULB/Area currently has or not access to the service. For facilities in ULB/Areas with existing services, the benefits from the investment will be established based on the direct use benefits (e.g. measured by the tariffs charged to customers) and the opportunity cost of not having access to these services (e.g. time savings, health benefits in the form of increased water consumption, productivity benefits and/or other benefits that apply in the Indian context). For facilities in ULB/Areas with very limited or nonexistent services, direct-use benefits method cannot be applied. Therefore, contingent valuation techniques will be used instead and demand curves and consumer surplus reflecting all benefits arising form the rehabilitation estimated. Projects Roadsand Streets Street Per capita Economic Benefit Calculation Method Indicators New Time saved in travel time for [Avg. Reduction in Travel specific type of road and actual level time]* av. actual wage, of pedestrian and vehicular traffic Rehabilitation Ibid Ibid New Increase in productive time due to [Increased Time of - 63

68 Projects. Per capita Economic Benefit Indicators Calculation Method lighting increased safety nocturnal traffic in streets]* av. actual wage Rehabilitation Ibid Ibid Water Rehabilitation Increased and continuous access to [Increase in Avg. water ~onsumptionj *;ea1 cost of water Sewage New Reduction in health costs due to [Avg. reduction in number water-borne diseases, of patients] * av. actual Cost contamination, or the like of Treatment Drainage New Time saved in travel time for [Avg. Reduction in Travel specific type of road and actual level time]* av. actual wage of pedestrian and vehicular traffic due to reduction in congestion Rehabilitation Ibid Ibid 12. The Economic Rate of Return (ERR): ERR is an Internal Rate of Return of the sub-project when NPV calculated based on economic prices equals zero. Sub-projects to be funded should yield an ERR equal to at least the appropriate opportunity cost of capital (1 2%). 13. The cost-effectiveness indicator will be used to determine a reasonable magnitude of the investment costs. The hurdle rate will be set on the basis of the average expenditures of the lowincome households in each city and is expected to be around 10%. Assessment of the Willingness to Pay (AWP) 14. The purpose of the AWP is to collect and analyze sufficient data to estimate what the potential beneficiaries would be willing to pay for the improved or new services. Based on the collected data on the beneficiary willingness to pay a demand curve and the consumer surplus reflecting all benefits arising form the rehabilitation will be estimated. 15. In order to assess the willingness to pay a survey questionnaire shall includes the basic socioeconomic characteristics of the target population, characteristics of water supply and/or sanitation or other services as applicable, and the willingness to pay for the new or improved services under different assumptions. The following are the main steps to be taken to carry out an AWP: a. Designing sampling procedure. The sampling procedure should result in a representative sample comprising enough customers from different income groups, locations within the ULB/Area, and distinguishing between customers with and without access to the service: b. Pre-testing and, if necessary, adjusting the questionnaire. C. Analyzing the socio-economic indicators and water and sanitation characteristics of the target population. d. Analyzing the data from the willingness to pay survey and investigating the significance of various socio-economic and service specific (for example, water and sanitation) characteristics. This may be done in Probit or Logit regression models so as to quantify the willingness to pay for tariffs and the willingness to use standpipes and the like. 64

69 Sensitivity analysis/switching values of critical items 16. For the purposes of the sensitivity analysis the variables conveying major risk to the subprojects will be identified and the impact of these variables analyzed. This analysis will show whether or not the results of the economic analysis are robust for all cases analyzed. The following are some of the potential critical variables to be considered for sensitivity analysis: 0 two-year delay in sub-proj ect implementation; 0 1 O%increase in costs; 0 10% decrease in revenues (for revenue-generating sub-projects only), and others. Distributive Analysis 17. Distributive analysis will be carried out to identify the winners and losers from the subprojects financed, and indicate whether the distribution of costs and benefits is acceptable to the society. 65

70 A. Past Performance Annex 9 B: TNUDF Financial Analysis and Projections INDIA: Third Tamil Nadu Urban Development Project 1, A financial assessment of TNUDF for the period was undertaken through external consultants and the key highlights of the same are presented below: 1, Profitability Indicators DSCR Collection Performance (in %) TNUDF has seen a declining trend in profitability and this is also observed in the net interest margin which is a result of the declining interest rate environment over the last four year period. Similarly the return on assets and net worth also display a declining trend. The average cost of funds for TNUDF has come down from % ( ) to 8.10 % (current). 66

71 Investment Income vs. lending income 3. Typically about 20-30% of TNUDF s earnings since have been from treasuryhnvestment income. In , however, investment income was 55 %. As seen from the table below lending income has been a healthy % in the first four years of TNUDP 11, however, has seen sharp fall in total income and the lending income. As the lending terms of TNUDF funds needed to factor in a) the cost of its borrowings from the Go% (based on a formula linked to 10- year GO1 security yields during the previous year with a one year lag for reviewheset options) and b) the fixed lending terms to ULBs (where a markup of at least 150 bp over cost of borrowing was required), the cost of TNUDF loans were higher than its competitors. The fall in lending income therefore appears to have been a consequence of this inflexible lending policy leading many ULBs to borrow from other government financial institutions such as TUFIDCO (TNUDF lowered its lending rates in following large pre-payments of their high cost loans). Figures in brackets represent percentage to total income. Source: Consultant report, staff calculations 4. While, the profitability of the fund has been declining due to a range of factors mentioned above, the overall performance of the fund has been satisfactory. Over the period of implementation of TNUDP 11, TNUDF s operations have been consistently profitable, with high rates of loan recovery (over 98% in all of the years). TNUDF has been able to maintain high rates of loan recovery due to its rigorous appraisal skills, lending to creditworthy ULBS, requiring cost recovery in projects and in the case of certain loans (urban roads) having access to intercepts of state devolutions to ULBs. Balance Sheet: As on March 3 1, 2004, the loan assets of TNUDF stood at Rs. 85 crores, down from a peak of Rs. 418 crores in FY02. The reduction in loan assets has been due to take over of TNUDF s loans mainly by other state government financial institutions, besides some by other commercial sources of financing. Part of this refinancing was driven by dramatic reduction in general interest rates in the financial markets (covered below in greater detail). Over the period of implementation (till September 30, 2004), TNUDF has approved sub-loans amounting to Rs. 768 crores and disbursed Rs. 452 Crores (implying ratio of sanctions to disbursements at 62.36%). Partly owing to pre-payment of its loans, TNUDF had high levels of liquidity with ratio of current assets to current liabilities (working ratio) at 6.1 as on March 3 1, 2004, however the same is expected to be used as pipeline of new sub-projects pick-up. For all sub-loans made under TNUDP 11, TNUDF has been making loan loss provisions as per RBI (Reserve Bank India) guidelines on Asset Classification and Provisioning norms applicable to Indian Financial Institutions and this would continue to be case during TNUDP I11 as well. Liabilities include Rs. 275 crores of loans borrowed and about Rs. 202 crores of Unit Capital, Reserves and Surplus. Loans borrowed include Rs. 44 crores outstanding out of bonds raised by TNUDF for satisfying 67

72 one of the financial covenants under the earlier Bank project. TNUDF has low levels of leverage (debt / equity ratio is 1.36 as on close of FY04 as against a cap of 4: 1 stipulated under TNUDP II), implying that it is in a position to take on additional debt and ramp up lending operations. Income & Expenditure: The main sources of income are interest on long term loan assets and also interest income from cash and liquid investments held by TNUDF in various financial instruments. The returns on liquid investments are much lower than core lending operations and high levels of liquidity carried by TNUDF also to an extent adversely impacts income of TNUDF. For the FY , TNUDF had a total income of Rs. 42 crores and a net profit after taxes of Rs. 10 crores. On expenditure side, besides interest on borrowings, the main operating expenses are management fees paid to TNUIFSL, the Asset Management Company (AMC) for managing the funds. Starting from FYOl, TNUDF has had to pay taxes on net income, something that was not envisaged at the time of TNUDP IP2. This, combined with the lower volume of lending operations have meant that TNUDF, while continuing to be profitable, has lower than projected levels of profits and returns on equity. Restoring the levels of profitability would require TNUDF to have progressively higher volumes of lending operations during TNUDP 111. B. Issues 5. The most critical issue is the future sustainability of TNUDF, resolution of which will require flexible, market based costing of its funds, adoption of a more commercially oriented lending policy/rates, diversification of its narrow resource base and widening of its product range from its existing single business product. Under TNUDP I11 all these issues are being addressed. 6. Overview of the Financial Sector. Financial reforms were central to India s economic liberalization program initiated in the early 1990s. After more than a decade of reforms, India s financial sector is now substantially liberalized, competitive and sound. While the banking sector continues to dominate the financial system and remains overwhelmingly govemmentowned, prudential norms have been tightened and competition has increased. Capital markets are deeper, more liquid and much more open, whereas private entry has also been progressively allowed into Non Bank Financial Institutions such as mutual funds and insurance. However, success with mobilization of the much needed long-term capital to finance infrastructure remains limited, and India s financial sector has not been able to efficiently allocate resources to the private sector, to finance the higher levels of investment demands. As an illustration, the ratio of private credit (from deposit money banks and other FIs) to GDP in India remains low at below 40%, compared to over 100% for countries such as China, Korea and Malaysia. 7. Infrastructure Finance Market Interest Rates. The interest rates regime in India has declined significantly, particularly during the period of Market interest rates have declined both at the short end as well as for long term (See chart below). This has impacted TNUDF in two ways: first, the lower lending rates offered by competitors has weaned borrowers away from TNUDF, whose lending rates have tended to be higher. Secondly, the average return on cash and short-term surplus has declined. The former has proven to have significant impact on TNUDF performance, as reflected in the sharp decline their in loan assets. Two principal l2 The Trust structure of TNUDF was considered to be tax exempt. The same however has been contested by tax authorities on the grounds that private FIs are a part of this company 68

73 agencies in the market for urban infrastructure in Tamil Nadu are TUFIDCO (a State owned entity) and HUDCO (an all-indian financial institution). Apart from market borrowings, both these agencies receivehake a fairly large amount of low cost resources from both GO1 and GoTN, which enables them to maintain an overall cost of funds that is much lower than that of TNUDF s. I I4.O d! !. +GO1 sec - -Call money 2.00 ~ Year 8. Borrowing/On lending Terms. Under TNUDP 11, Bank funds were on lent by Tamil Nadu State to TNUDF at a weighted average yield of GOI s 10 year bond (previous one year) plus 100 basis points. In turn, TNUDF lent, at fixed rates, to its customers at its borrowing rate plus 250 basis points (water supply and sewerage subprojects) and 300 basis points (all other). Because of the recent fall in the general interest rates in the country, this mechanism resulted in a situation whereby TNUDF s lending rates exceeded the market interest rates forcing many borrowers to refinance their loans from other lenders (mostly, State/GOI owned). This phenomenon reduced the loan assets of TNUDF by over 75% in 2004, threatening its business prospects and financial viability. While in a strict sense the competition did not emerge from real market player^'^, the fact remains that TNUDF had not been operating under a commercially realistic regime. The revised lending terms agreed for TNUDP I11 will address these issues:. The on lending rate from Tamil Nadu State to TNUDF will be such that it reflects the currently prevailing market conditions. This will be achieved by continuing to use the current reference index (GOI s 10 year bonds) and mark-up, but, instead of the weighted average of the previous year, the most recent issue will be used. TNUDF s own lending rates to subprojects will be more commercially priced by linking to the credit worthiness of the borrower rather the sector. Also, the sub-loan maturity will be linked to cash-flow prospects rather a uniformly fixed period (1 5 years). Such changes will provide an incentive to ULBs to strive for better efficiency and creditworthiness and l3 It should be noted that the financial market liberalization did not bring a resource flow to the municipal fmancing sector due to policy and institutional constraints. Municipal bond issues and commercial borrowings remain largely limited. In the case of TNUDF re-financings, the state government is reported to have played a proactive role in encouraginglasking public sector financial entities to provide the refinancing to assist ULBs discharge their high interest debt. 69

74 minimize the risk of prepayments. Moreover, the proposed flexibility in sub-loan maturity will generate re-flows that can be re-cycled for lending purposes.. A prepayment premium in the legal agreements with ULBs would also be adopted. 9. Diversification of resources. At present, TNUDF is almost totally dependent on Bank Line of Credit. Under the project, TNUDF will diversify its resources through bond issues, short term borrowings, co-financing arrangements, securitizations as described in the forecasts shown below. TNUDF would raise co-financing aggregating at least US$ 40 million, in the medium term, from any or all of the following sources: (i) proceeds from TNUDF public bond issues; (ii) TNUDF private placements; (iii) co-financing with TNUDF by private financial institutions / banks at the sub-project level; (iv) secondary market purchases by private financial institutions / banks of TNUDF loans to ULBs, or re-financings of TNUDF loans to ULBs (through local bond issues, pooled bond issues or loans from private financial institutions. 10. Widening the Product Range. Similarly, the range of financial products offered by TNUDF will be reviewed in the Business Plan and Strategic Vision Study to be completed by December 31, 2005, and it is expected to include medium term loan products (5-7 years) for urban sub-projects/initiatives with shorter economic life cycles, credit enhancements products, and bridge financing among others. I. Summarized Financial Results of TNUDF (FY 1999/00 - FY2003/04) (Financial yr ended Mar) INCOME Interest recd on Loans Interest recd from Invest. Income from cash balances Profit on sale of investments Other Income Excess provision written back TOTAL INCOME EXPENDITURE Interest paid on borrowings Operating expenses Provisions made TOTAL EXPENDITURE LACTUAL INCOME AND EXPENDITURE FOR ) Rs. Lakhs SURPLUS KEY RATIOS ROA RONW DebtIEquity DSCR LIABILITIES Unit Capital Reserves % 13.56% % 13.51% % 6.58% % 4.33% % 3.72%

75 (ACTUAL INCOME AND EXPENDITURE FOR ) (Financial yr ended Mar) Borrowings GoTN borrowings Current Liabilities & provisions TOTAL LIABILITIES ASSETS Net Loans Outstanding Investments Current Assets Loans and advances TOTAL ASSETS Financial Projections of TNUDF (FY2004/05-FY2009/10) Rs. Lakhs Detailed financial projections will be made under the Business Strategy to be prepared by TNUDF by December These will then determine the interest rate policy and other parameters. Pending that an attempt is made below to carry out financial projections of operations, income and expenditure, cash flow and balance sheet for the six-year period to These are broadly indicative but form a good basis to demonstrate that TNUDF is financially viable. A brief summary of the assumptions underlying the projections, salient features of projected operations, financial performance and cash flows are given below: Assumptions Underlying Financial Projections for TNUDF 15. The major assumptions made for the base case scenario for TNUDF for the period are given below. TNUDP I11 is expected to be operational only from onwards and therefore the projections for are based on current half-year performance and estimates provided by TNUIFS. 71

76 Disbursement (Rs.cr) existing projects@ipeline) short termprojects 5 50.OO - new projectspnudp Rate of interest yo) - existing projects@ipeline) 9.00% 9.00% 9.00% - short termprojects 7.50% 7.50% 7.50% - new projects(tnudp IIT) 9.00% 9.OOYo 9.00% New borrowings (Rsxr) TNUDP-I short term brgs. 40.oo 40.oo - market access brgs. 0.oo 0.oo Rate of interest on brgs - eisting loans (GoTN) 7.63'%0 - existing loans ponds) 11.85% - new brgs ONUDP-III) 6.50% - new brgs (short term) 6.50'Xo - new brgs (market access) 7.00% Return on investments 11 l6yo Return on cash surplus 5.50Yo Projected NPAs 1% in 2005 (% ofgross loan oh) 2% in 2006 and % in % in % in2010 Provisioning for NPAs 10% of the increase in NPAs Short term loans repayable in 5 years (1 year moratorium) Short term borrowings repaid in 5 equal annual instalments Market access brgs repaidin 10 equal annualinstalments Projected Income and Expenditure Statements (Base Case scenario) % 9.0OYo 7.50'%0 7.50% 9.00% 9.00% oo 183.OD 9.00% 7.SO% 9.OO% The projected Income and Expenditure statement for TNUDF for the six-year period till is given below. This is the base-case scenario based on the assumptions stated in the previous section. The base case scenario has been formulated. On the basis of gradually achieving a ROE of around 10% in the final year of projections (Le ). 17. Total income from lending operations is projected to increase from Rs labs in to Rs lakhs in , reflecting the increase in disbursements and loan assets. The projected income takes into account the proposed reduction in lending rates on existing loans to 9%, in order to be more competitive in the present market conditions. Income from short term cash balances is projected to decline steeply from Rs lakhs in to Rs lakhs in This reflects both the steady drawdown of cash surpluses to meet increased level of disbursements as also the declining rate of return on short-term funds. 72

77 TAMILNADU URBAN DEVELOPMENT FUND (TNUDF) {PROJECTED INCOME AND EXPENDITURE FOR ) Rs. Lakhs (Financial yr ended Mar) INCOME Interest recd on Loans Interest recd fiom Invest Income from cash balances Other Income TOTAL INCOME EXPENDITURE Interest paid on borrowings Operating expenses TOTAL EXPENDITURE Provisions made for tax NETSURPLUS On the expenditure side, total interest expenses are projected to increase steeply from Rs crore in to Rs crore by , which is due to the increased level of borrowing projected under TNUDP I11 (Rs. 500 crore) and also short term borrowings (Rs.lOO crore) and market access borrowings (Rs.lOO crore). Provisions for bad and doubtful debts have been made based on a graded increase in NPAs. Other expenditures are expected to follow past trends. Though the tax liability of the Fund is still under arbitration, provisions for taxation have been made at 30% of the surplus. 19. The net surplus of the Fund is thus projected to increase from Rs crore in to Rs crore by TAMILNADU URBAN DEVELOPMENT FUND (TNUDF) (PROJECTED BALANCE SHEET FOR ) Rs. Lakhs (Financial yr ended Mar) LIABILITIES Unit Capital Reserves Borrowings - GoTN (TNUDP 11) Non Conv Bonds (11 AS%) New Borrowings(TNUDP 111) Short term borrowings Market access brgs Current Liabilities & provisions O oo TOTAL LIABILITIES ASSETS Loans disbursed (Gross) Less: provisions Net Loans Outstanding Investments

78 LIABILITIES Current Assets Loans and advances TOTAL ASSETS The total assets of the Fund are expected to grow from Rs crore as at end of March 2005 to Rs crore by end of March 2010, representing almost a three-fold growth. This is driven largely by the increased loan disbursements. Loan assets are projected to grow from Rs crore as at end of March 2005 to about Rs crore by end of March The increased level of operations has necessitated large level of borrowings and therefore the total debt outstanding is projected to increase from Rs crore as at end March 2004 to Rs crore by end March Thus the Debt Equity ratio (DER) is projected to gradually increase from 1.02 in March 2005 to 4.00 by March The largest requirement of funds is for disbursement of loans, which is projected to range from a level of Rs crore during to Rs crore in To meet the increased requirement, cash deposits (which were at Rs crore as at end March 2004) are projected to be steadily drawn down (since the return on such balances has been declining steeply). Further, borrowings under TNUDP I11 are estimated to be Rs.500 crore (USD 11 1 m). Short term borrowings during (Rs.100 crore) would be to meet short term lending requirements. Market access borrowings of Rs.100 crore are projected during to meet the overall gap in resources. Thus, total borrowings during the period are estimated at Rs. 700 crore, of which under TNUDP I11 would be Rs.500 crore (approx $ 11 1 m). Projected Balance Sheets TAMILNADU URBAN DEVELOPMENT FUND (TNUDF) {PROJECTED BALANCE SHEET FOR ) Rs. Lakhs (Financial yr ended Mar) LIABILITIES Unit Capital Reserves Borrowings - GoTN (TNUDP 11) Non Conv Bonds (1 1.85%) New Borrowings(TNUDP 111) Short term borrowings Market access brgs Current Liabilities & provisions TOTAL LIABILITIES O oo ASSETS Loans disbursed (Gross) Less: provisions Net Loans Outstanding Investments Current Assets Loans and advances TOTAL ASSETS

79 22. The total assets of the Fund are expected to grow from Rs crore as at end of March 2005 to Rs crore by end of March 2010, representing almost a three-fold growth. This is driven largely by the increased loan disbursements. Loan assets are projected to grow from Rs crore as at end of March 2005 to about Rs crore by end of March The increased level of operations has necessitated large level of borrowings and therefore the total debt outstanding is projected to increase from Rs crore as at end March 2004 to Rs crore by end March Thus the Debt Equity ratio (DER) is projected to gradually increase from 1.02 in March 2005 to 4.00 by March Projected Cash-Flow Statements TAMlLNADUUREANDEVELOP113ENTFUNI)LTNLTI)~ (PROJECTED CASHFLOW FOR Rs.lakhs. (Financial yr ended Mar) SOURCES OF FUNDS Increase in Unit Capital Increase in Resemes Increase in Bot~o~hgs - GoTNTNUDP Short term brgs - Market access brgs Increase in provisions Increase in other cwliab Decrease ininvestments Internal accruals - principal -income TOTAL SOURCES 0.oo oo oo OO 2000.oo oo 0.oo USES OFFLTNDS Disbursement of assistance - existing projects(pipeline) short termprojects new projects(tnudp Payment of interest Repayment of borrowings -GQTN Bonds 2201.oo 2201.oo -TNUDP oo -short term brgs 80 -market access brgs Other expenses/provns Increase incurrent assets Income distribution TOTAL USES oo 0.oo oo oo 0.oo 0.oo 1600.OO 0.oo M7.45 Opening Cash & bank balanl Add: increase/(decrease) Closing Cash& bank balanc

80 23. The largest requirement of funds is for disbursement of loans, which is projected to range from a level of Rs crore during to Rs crore in To meet the increased requirement, cash deposits (which were at Rs crore as at end March 2004) are projected to be steadily drawn down (since the return on such balances has been declining steeply). Further, borrowings under TNUDP I11 are estimated to be Rs.500 crore (USD 11 1 mn.). Short term borrowings during (Rs.100 crore) would be to meet short term lending requirements. Market access borrowings of Rs.lOO crore are projected during to meet the overall gap in resources. Thus, total borrowings during the period are estimated at Rs. 700 crore, of which under TNUDP I11 would be Rs.500 crore (approx $ 11 1 mn). The closing cash balances as at end March 2010 are estimated to be around Rs crore. 24. Scenario/ Sensitivitv Analysis: Further as part of this financial assessment, sensitivity analyses was also carried out to examine the likely impact of changes in key variables such as volume of disbursements, drop in lending rates / spreads, etc. and results of this analyses is available in project files. 25. Oualitv of Portfolio: The portfolio of assets for TNUDF consists mainly of loans for water supply (8 %), sewerage and sanitation (38 %), street lighting (l%), storm water drains (1% bus stations and markets (4%), and urban bridges and roads projects (48%)14. The loan recovery rate has been very good at close to 99.7 percent. This is largely due to high quality of appraisals and their careful selection of creditworthy ULBs. Cost recovery under financed projects, community contributions and escrow accounts have also played a significant role in the good quality of their portfolio. The fact that a large proportion of their loans were refinanced with other institutions is indicative of a good portfolio. 26. The Annual Financial Statements of TNUDF have received unqualified audit opinions from independent auditors acceptable to the Bank. Under TNUDP I11 TNUDF will continue to submit Audited financial statements to the Bank within six months of the end of the financial year (See Annex 7). 27. In conclusion, TNUDF is a sustainable financial intermediary and has had a satisfactory performance under the Second Tamil Nadu Urban Project despite the interest rate down turn and its inability to be responsive to market changes. Under TNUDP 111, changes have been made to ensure that TNUDF would have the benefit of market orientation, a diverse resource base and a wider product range ensuring its sustainability in the long term. TNUDP I11 also addresses the institutional constraints which impeded loan approvals under the previous project. This has been addressed by integrating approval processes between the municipal administration governing ULBs and TNUDF. Moreover, the proposed project aims at removing the impediments in the development of market access of ULBs through changes in policies affecting their creditworthiness (greater empowerment through decentralization, property tax revisions, etc.), strengthening their financial management capabilities, and support to their efforts to access the markets for their resource needs. The project meets the requirements of OP 8.30 as TNUDF is structured to play the critical role of a sustainable financial intermediary for the ULBs through its market based borrowing and on-lending terms and the diversification of its resource base and line of products. l4 TNUDF Annual Report ) 76