Public Disclosure Authorized. Public Disclosure Authorized. Public Disclosure Authorized. Public Disclosure Authorized. Report No.

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1 Report No. PID6809 Project Pakistan-Punjab Municipal Development (+) Fund Project Region Sector Project ID Borrower Implementing Agencies South Asia Urban PKPE55293 Government of Pakistan (GOP) Date PID Prepared August 11, 1998 Project Appraisal Date January 1, 1999 Project Board Date March 31, 1999 The (proposed) Punjab Municipal Development Fund Company The Local Government and Rural Development Department, The Province of Punjab, Civil Secretariat, Lahore. Tel: (92) The Planning & Development Board, The Province of Punjab, Civil Secretariat, Lahore Tel: (92) Background: The cities and towns of Punjab suffer from inadequate provision and poor operation and maintenance of basic urban infrastructure and services. The intermittent supply of water, even in major cities, for example, averages up to six hours per day at varying pressures. The treatment of sewerage is almost non-existent, resulting in raw or partially treated sewerage being discharged into drains and rivers. Drains generally serve the dual roles of carrying storm water as well as sewerage, posing severe environmental and health hazards. Solid waste management services in most urban areas are grossly inadequate; the rate of collection being less than 30w, resulting in drains becoming clogged with uncollected refuse. Formal solid waste disposal sites are rare, even in major cities. The municipal road networks are also inadequate and very poorly maintained. Meeting the pressing urban infrastructure needs of the province is constrained by a number of factors including: (i) inadequate local resource mobilization by urban local bodies (ULBs) due to inappropriate billing, poor tax collection, inability to raise user fees in line with inflation etc.; (ii) unpredictable and discretionary inter-governmental transfers; (iii) weak ULBs (their administrative, managerial, technical and financial capacities are low, and they do not have clear authority, responsibility and corresponding resources to provide urban services); (iv) lack of an efficient mechanism for allocating resources for urban infrastructure investments; and (v) lack of long-term financing for urban development. Project Objectives: The overall objective of the proposed project is to improve urban infrastructure services in the Province of Punjab. This will be achieved through: - mobilizing additional resources for urban infrastructure development; - developing an efficient mechanism for allocating resources for urban

2 infrastructure investments; and - strengthening the financial, administrative and managerial capacities of the ULBs Project Description: The project has two main components: (a) an Institutional Development Component; and (b) an Urban Investment Component. The project would further support up front urban sector reforms aimed at devolving greater authority, responsibilities and resources to local government. The proposed Bank loan/credit will be channeled through the Punjab Municipal Development Fund Company (PMDFC) -- a private company (limited by guarantee) to be established with an autonomous governance structure. This company would provide long-term-loans, capital grants, technical assistance and training to ULBs for urban infrastructure investments and institutional strengthening. The Institutional Development Component (US$25 million) would finance technical assistance (TA), training, studies and related equipment pertaining to: (a) building administrative, technical and financial capabilities of ULBs; (b) identifying, preparing and implementing sub-projects by the ULBs; (c) supporting the activities of the PMDFC during the initial period and (d) helping the provincial government with the implementation of urban sector reforms. The PMDFC would maintain a roster of eligible consulting firms which may be deployed by the ULBs. The Urban Investment Component (US$161 million) would provide long-term loans and capital grants for urban infrastructure projects sponsored by ULBs, Cantonment Boards, Water and Sanitation Agencies (WASAs) and Development Authorities (DAs) based on clear and transparent eligibility criteria. Subprojects eligible for financing would include basic infrastructure services such as water supply, sewerage, sanitation, solid waste management, urban roads, storm-water drains, street lighting, community centers, bus terminals amongst others. The Urban Investment Component would finance up to 90% of the capital cost of urban infrastructure projects sponsored by the ULBs. Such financing would comprise a mix of loans (at commercial rates) and grants in order to make debt-servicing affordable to the ULBs. The ULB concerned would be initially required to contribute the remaining 10% of the capital cost. The ULB share will be gradually increased to 20%. Sub-projects targeted at well-defined groups of the urban poor could receive up to 90% of the capital cost as a grant. The sponsoring ULB would provide the remaining 10%. Project Benefits: The proposed project would provide a number of direct and indirect benefits, including: (i) an improvement in the quality of life of the citizens in Punjab; (ii) an improvement in the capacity and the authority of ULBs to undertake, operate and maintain urban investments in a sustainable manner; (iii) an increase in the allocative efficiency of public expenditure; (iv) an improvement in the enabling environment for promoting investment in industrial and commercial activities; (v) an improvement in the urban environment and public health, particularly of the urban poor; and (vi) an impetus to driving municipalities to seek commercial sources of borrowing in the long-term. Project Risks: The proposed project could face the following risks: (i) the proposed reforms not being implemented by the Province of Punjab; (ii) political interference in PMDFC's decision-making; (iii) a deterioration of -2 -

3 political or economic conditions which will reduce the ULB's revenues in real terms; (iv) not enough ULBs qualifying for borrowing, and therefore, slow disbursement of the fund; and (v) the ULBs' inability to sustain good practices/services over time. These risks would be mitigated inter alia through: - making the implementation of several key reforms a condition for loan appraisal or negotiation, and making other critical reforms dated covenant conditions for disbursement; - ensuring an autonomous governance structure for the PMDFC with a significant proportion of non-political members; entrusting the PMDFC's subproject appraisal to a private fund management agency; establishing clearly defined, transparent eligibility criteria for ULBs and sub-projects; and putting in place effective financial and operational controls, procurement expertise and independent review arrangements; - increasing the ULBs' own-source revenues to buffer against a reduction in provincial transfers; - providing TA and training for capacity building of ULBs; - deciding the size of the Bank loan/credit based on a realistic assessment of the pipeline sub-projects and the ULBs' loan absorptive capacity; making project appraisal contingent on the PMDFC having appraised a sufficient pipeline of sub-projects; and - ensuring active community participation in project identification and implementation, which will put pressure on the ULBs to maintain/improve their services. Project Cost and Financing: The total cost of the project is expected to be US$186 million, of which the Bank would contribute about US$150 million (a blend of IBRD and IDA funds). The Province of Punjab is expected to contribute another US$20 million. The ULBs' contribution (by way of 10% of their subproject costs) would amount to about US$16 million. Project Implementation: The main project implementation agencies are as follows: (i) The PMDFC (the Urban Investment Component & Institutional Development Component); (ii) the ULBs (implementation of sub-projects under the Urban Investment Component); (iii) the Local Government and Rural Development Department of the Province of Punjab (project co-ordination and the implementation of urban sector reforms). The Project Advisory Team to the Province of Punjab will take the lead in co-ordinating the establishment the PMDFC, the appointment of its board/staff and contracting out its activities. Project Sustainability: The sustainability of this project would ultimately depend on: (a) the ability of the municipalities to improve their fiscal and financial strength and become creditworthy; and (b) the ability of the PMDFC to graduate to a sustainable financial intermediary. The Institutional Development Component is designed to improve the financial, managerial, technical and administrative capacities of the ULBs. Such assistance, coupled with the urban sector reforms sought by the project for devolving greater authority and resources to local government, are expected to strengthen the fiscal capacity of the ULBs, improve their ability to recover costs and generate surpluses, and enhance their creditworthiness. Furthermore, the participation of the communities in the identification and implementation of sub-projects is expected to put pressure on the municipalities to sustain their services. The project's support for establishing the PMDFC as a private company with an autonomous governance structure, entrusting the PMDFC's sub- - 3-

4 project appraisal to a private fund management agency, putting in place transparent eligibility criteria, and establishing intercept arrangements for ensuring loan recovery are important steps towards facilitating the PMDFC's graduation to a sustainable financial intermediary in the long-run. Lessons Learned from Previous Bank Operations: The Bank's global experience with municipal development funds and intermediaries has been mixed. Some of the key lessons learned and reflected in the proposed project's design are as follows: - the validity of any lending program depends on the creditworthiness of its borrowers, improving the creditworthiness of local government may necessitate up front major urban sector reforms for devolving greater authority, responsibilities and resources to local government; - the fund/intermediary should be operated on a commercial basis including: (i) professional management and staff; (ii) efficient loan appraisal and processing procedures based on clear and transparent eligibility criteria; (iii) sound loan disbursement and collection systems; and (iv) independent audits and supervision; any subsidies (grants) should be separated from loans; - there must be strong government commitment to the financial integrity of the fund/intermediary; there should not be any political interference affecting its lending and collection decisions; - reasonable debt-service limits should be imposed on the borrower (typically about 15t of a municipality's revenues); loan guarantees, particularly through intercept provisions, have been useful in reducing municipal loan arrears but should not obfuscate the need for prudent credit risk analysis and the due diligence of potential sub-projects; - any assistance to local governments should be "demand-driven"; a "topdown" approach should not be imposed; municipalities should also contribute to the equity of their sub-projects (usually about 10t of the sub-project cost); - there must be strong local ownership of sub-projects, with full participation of key stakeholders; - on-lending rates should be ideally set at market rates in order to encourage graduation to private sources of funding over time. Poverty Category: This project is not explicitly targeted to low-income groups per se. However, the project would offer significant benefits to the urban poor given its focus on improving basic urban services such as water supply and sanitation. In particular, about US$10 million under the Urban Investment Component would be set aside for providing grants for up to 90t of the capital cost of sub-projects targeted at clearly defined groups of citizens living in dire poverty. Environmental and Social Aspects: Given that the loans/grants from the PMDFC would be demand-driven, it is not possible to precisely predict at this point the specific sub-projects which will be financed through this project. However, the sub-projects will be in the sectors of water supply, sanitation, drainage, solid waste management, urban roads, bus terminals and other municipal infrastructure. While the project is being designed to realize overall environmental improvements in Punjab, some of the sub-projects could give rise to localized negative environmental impacts. Similarly, some subprojects could have negative social implications, particularly if they entail land acquisition. During project preparation, an environmental and social assessment framework will be developed in the form of an Environmental and - 4 -

5 Social Framework Report (ESFR) which will: (a) specify a screening criteria to assess the environmental and social impacts of different sub-projects; (b) set out the institutional process to be followed by the ULBs and the PMDFC; (c) prescribe a monitoring program to assess the implementation of sub-projects; and (d) identify human resources needs and skills required to manage and implement the framework. This framework will guide the preparation, appraisal, and implementation of sub-projects. This approach is being applied to other projects of this nature in the South Asia Region. Environment Category: B. Program Objective Categories: categories of the World Bank -- Sustainable Development (EN). This project falls under two program objective Economic Management (EA) and Environmentally Contact Point: The InfoShop The World Bank 1818 H Street, N.W. Washington, D.C Telephone No. (202) Fax No. (202) Note: This is information on an evolving project. Certain activities and/or components may not be included in the final project. Processed by the InfoShop week ending September 4,

6 Annex Because this is a Category B project, it may be required that the borrower prepare a separate EA report. If a separate EA report is required, once it is prepared and submitted to the Bank, in accordance with OP 4.01, Environmental Assessment, it will be filed as an annex to the Public Information Document (PID). If no separate EA report is required, the PID will not contain an EA annex; the findings and recommendations of the EA will be reflected in the body of the PID. -6-