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

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1 Public Disclosure Authorized Project Name Region Sector Project ID Borrower(s) Report No. PID10465 India-Community Infrastructure Project South Asia Regional Office Other Urban Development INPE68691 GOVERNMENT OF INDIA Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Implementing Agency Environment Category Date PID Prepared September 1, 2000 Projected Appraisal Date October 2001 Projected Board Date May 2001 Address HOUSING DEVELOPMENT FINANCE CORPORATION Housing Development Finance Corporation, Ramon House, 169 Backbay Reclamation, Mumbai Contact Person: Mr. Deepak Satwalekar Tel: , Fax: F 1. Country and Sector Background Insufficient and poor quality of community infrastructure are reflected in the high ratios of 'slum settlements' in Indian cities, the relatively low level of access to safe water for low income groups, and the totally inadequate level of sanitation services. While the rather limited available information indicates that access to water and sanitation has improved over time, the quality of services is poor and access to independent services is very limited. The problem of inadequate access to community infrastructure also reflects a failure to meet the 'untapped demand' from communities. Evolution of Government Strategy: Efforts to improve community infrastructure through slum related programmes in urban areas and delivery of water and sanitation in both urban and rural areas have been pursued since independence. However, over the years, strategic focus of these efforts has changed and new areas of intervention which indirectly affect these services such as community mobilization and access to credit for the poor have emerged. Some cities and states have also been innovative in introducing special programmes which help to improve community infrastructure. The major trends are traced below. From Slum Removal to Improvement: Initial emphasis in the post independence period was on eradication of slum settlements and it was believed that with a dominant government role this was possible. However, after two decades of efforts it was evident that it was not possible to remove the slum settlements and more importantly that the slums represented a cost-effective solution to the problem of inadequate housing for the urban poor. A change over to a slum improvement strategy that began with the first project in Calcutta, had taken root by the late eighties. A nationwide Government of India (GoI) programme, Environmental Improvement of Urban Slums (EIUS) was launched in 1972 and later transferred to the state sector. According to the official statistics almost 20 million slum

2 dwellers (an estimated 45 percent of total slum dwellers) were covered by this programme by In addition, many municipal authorities have also used this approach to ensure at least shared minimum basic services to the 'slum settlements', with allocations made from their own municipal budgets. However, this programme was largely implemented as a supply driven departmental activity with little or no community involvement. Evaluations suggest that the services provided are generally inadequate in magnitude, poor in quality, inappropriately located within slum settlements and suffer from poor maintenance. As a result community infrastructure assets are in disrepair and deteriorate rapidly. As a typical government programme, the emphasis was often on meeting the targets without adequate local municipal capacity to incorporate community concerns and ensure its ownership. While the EIUS continues as a state sector scheme in several states, a new National Slum Development Programme (NSDP) was launched in 1996 as an integrated slum improvement scheme with a focus on physical amenities such as water supply, road, soak pits, drainage as well as social components such as education, health, entertainment and immunization. This is funded fully by the central government and is being undertaken throughout the country. The GoI also provides 45 percent subsidy under the low cost sanitation scheme where funds are available for construction of toilets as well as for rehabilitation of scavengers. Focus on Community Mobilization: A different genre of programme started in late 50s was through the Urban Community Development (UCD) projects in over 20 cities. It met with considerable success in Hyderabad and this experience was translated to a GOI programme of Urban Basic Services (UBS) in 168 towns during late eighties with UNICEF support. This approach focused on building community organizations to articulate local needs. The National Commission of Urbanization set up by the GOI in late eighties recommended mainstreaming of this approach. A separate Poverty Alleviation cell was set up in the Ministry of Urban Development which later led to a separate department focusing on urban poverty and employment, followed by the establishment of a separate Ministry of Urban Affairs and Employment. This department launched a new programme focusing on community mobilization called Urban Basic Services for the Poor (UBSP) during the Seventh Five Year Plan. Under the Eighth Plan, a coverage of 500 cities and 12.5 million urban poor was envisaged under the UBSP. The two main strategies under UBSP were: i) to develop a structured approach to community mobilization leading to a hierarchy of community structures and development of community based plans, and ii) to work through convergence with a large number of government programmes and service delivery to meet the plan needs, rather than separate investments. Thus, the UBSP approach went beyond the project level to larger issues of capacity building, empowerment, and through these, improving effectiveness of other governmental programmes. Initially limited only to the notified and authorized slums, scope of UBSP was widened in 1993 to include the urban poor in squatter settlements or unauthorized slum settlements. However, in actual implementation there have been some shortcomings as convergence has been difficult and "selection of slums is often on political consideration". The programme has been especially successful in some states such as Kerala and Andhra Pradesh. However, while convergence has been possible in these places through local initiatives, its sustainability "will require basic institutional reforms". Some of the key elements of this approach have been incorporated in state government programmes such as the Janmabhoomi in Andhra Pradesh which also relies on community led development. Urban Employment Programmes for the Poor: -2 -

3 Though there have been many employment programmes for the rural poor, the first such scheme for the urban poor, Self-Employment Programme for the Urban Poor (SEPUP) was introduced only in late eighties. A larger scheme, Nehru Rozgar Yojana (NRY) in 1991 subsumed this rather unsuccessful first attempt. NRY had three components, linked to self employment, wage employment and shelter upgradation. An evaluation by Operation Group Research Group suggests that despite its greater success in terms of meeting targets, its performance was constrained by a lack of community involvement in selection of beneficiaries, a lack of emphasis on cost recovery and an excessive emphasis on fulfillment of targets. In 1997, the Government of India decided to merge the urban employment programme with the UBSP through a new integrated Swarna Jayanti Shahri Rozgar Yojana (SJSRY). The community structures developed under the UBSP strategy were to be the base for implementing this new scheme. The two main components of SJSRY continue to be for self employment and wage employment. The latter is meant for small infrastructural works in cities with less than half a million population. For both the components, actual activities are to be identified through the community groups and poor women. For self employment, credit is provided through the government banking system. Special groups of poor women and children are also provided access to income earning activities. Besides access to credit, SJSRY also incorporates a component for training for poor women and elected leaders. Comprehensive evaluation of these new approaches is not available. Decentralization and role of local authorities: With decentralization following the 73rd and 74th Constitution Amendment Acts, role of local authorities in ensuring provision of community services, especially for the poor, is envisaged to be enhanced. Particularly, the urban local bodies are now charged with tasks related to poverty alleviation and social justice. While the actual experience with decentralization has been quite varied across different states in India, in some states, the local authorities have now been given these responsibilities. However, municipal capacities to financially and administratively fulfil these new roles is limited. Considerable support for capacity building for developing appropriate planning, delivery systems, financing and regulatory framework will be needed. Considerable innovations in service delivery, especially for the poor at individual settlement level have been made in a number of cities such as Ahmedabad and Vadodara. However, scaling up of these efforts to the city level has been difficult. Supporting community based financing systems: While not directly involved with community infrastructure, government's role in supporting development of community based financial systems has been considerable over the last few years. In fact, this has happened both through government efforts as well as by the emerging micro-finance institutions themselves. Government of India through the NABARD, SIDBI and Rashtriya Mahila Kosh (RMK) has provided funding to self help groups, NGOs and micro-finance institutions either directly or through financial institutions such as the commercial banks. Most of this has been for income generating activities. While this has helped to create a base of institutions providing financial services to the poor and low income groups, most of this financing has been at subsidized rates. This has also been true of the limited funding available for low income housing through HUDCO and HDFC for financing shelter for the poor and low income groups. This in the long run is likely to inhibit integration of the sector with overall financial systems. Other recent developments are the attempts at developing networks and associations of community development finance institutions (CDFIs) and NGOs/civil society - 3-

4 associations working for the poor in the areas of housing and infrastructure. For example, Sa-dhan has been formed as an association of the CDFIs and has taken up work on issues such as self-regulation and capacity building. An association of agencies working in the habitat sector has also been recently formed as India Habitat Forum (INHAF). Another important development has been Task Force on Supportive Policy and Regulatory Framework for micro-finance, set up as a result of a policy forum organized in Its first Report was made in 1999 and provided an important step in identifying the constraints for micro-finance in India and changes required to develop it along sustainable lines. Issues in Improving Community Infrastructure: Despite a number of different slum related and urban poverty alleviation programmes, which had a component of community infrastructure, limited available statistics and studies indicate inadequate coverage, poor condition and often poor maintenance of available services. Even in rural areas while new community driven models for rural water supply and sanitation have emerged, their wider acceptance and practice remain to be achieved. It is within this context that following issues will need to be addressed to achieve a significant and sustainable improvement in community infrastructure: Need for a total slum / total community approach: It has been common to take piecemeal approaches to slum development, and, depending upon the funds allocated in a given year, some activities are taken up in different slum areas. This approach, however, does not recognize the overall needs of the slum area with an appropriate plan to raise it to a 'normal' development level in relation to the community demand. Though achieving minor improvements, the area remains a 'slum settlement' and dependent on political favours. Recent slum development efforts in Indore and Ahemdabad, however, reflect an approach which focuses on improving the entire slum area in a comprehensive manner, to integrate it with the city's 'normal' housing developments. This represents a shift from the approach of 'full subsidy spread thinly over all settlements' to 'partial subsidy with full improvements in all settlements where the demand exists'. It then becomes possible to charge the residents for the services received, because willingness to pay also tends to be higher for availing services at preferred standards. It also enables more rational planning at the settlement level, considering terrain conditions and possibilities of commercial development and reduction in infrastructure costs while achieving higher service levels. There is considerable social status and dignity value derived from such improvements. Further, following the integration with ''normal' housing, the settlement may be denotified as a slum and often, normal property taxes and service charges can be levied subsequently, enhancing municipal revenues. Distortions in pricing of local services and credit: Most approaches at providing infrastructure services within slum settlements or in rural communities have been supported with considerable subsidies. However, it is important to recognize that subsidies are common, not only for the poor, but also for most of the domestic sector in urban water supply and sewerage systems. It is paradoxical that, while low tariffs for urban water are justified on the ground of a lack of affordability by the poor, these services often do not reach the poor at all. Further, the subsidized systems constrain a wider coverage as more investments become difficult. It is thus necessary to evolve a system of financing and tariffs which, while ensuring better access for the disadvantaged, does not become riddled with unsustainable subsidies. To ensure this, city level programmes to provide utility networks within slum settlements at affordable infrastructure and - 4 -

5 connection charges are necessary. An important consideration in such approaches will be the link to land use and land development regulations. In a similar vein, distortions in pricing of credit for the poor and low income groups has generally limited their access. The belief that credit for the housing and infrastructure needs poor has to be at low rates has forced this to be within subsidized regime with only a limited reach. Recent developments in micro-finance and social banking clearly highlight the need for an emphasis on sustainable access to credit for the poor, rather than low interest rates. Limitations to scaling up: Despite the success in provision of services at settlement level, efforts at scaling up to city level have not met with adequate success. The type of efforts and capacity needed for a time-bound and financially feasible municipal plan have not been available. Besides the problems related to political will, at least two other problems have been evident, related to level of subsidies and allocation mechanisms, as well as, difficulty of ensuring secure tenure to low income residents. The limited evidence from several municipal authorities in the country would suggest that in fact, considerable subsidies are being poured into slum areas, but without adequate overall planning, transparency and accountability. Such subsidies should ideally be internalized at the city level or linked to the available programmes of the state and central governments. They must also be fixed transparently in relation to the overall magnitude of disadvantaged population in the city. Subsidies may be linked to acceptable minimum standards as well as availability of total funds to reach the total target population within a defined time-frame. Financing for infrastructure at standards above this minimum level can then be linked to effective demand and willingness to pay at the community level. In order to make this process transparent, setting up a special fund is often advocated. Other sources outside of local budgets such as the local corporate sector and other government programmes can be combined to maximize the contribution to such a fund. However, operation of such a fund will need to be linked to demand based inclusion of low income communities with certain performance levels. A major hurdle in enhancing coverage to slum settlements relates to the lack of legal tenure. While this issue is generally difficult to resolve, it would be useful to shift the focus from the issue of legal tenure to security of tenure for providing infrastructure services in all low income communities as possible within the prevailing legislation. It would be also useful in the long run to review and amend the relevant legislation in this regard. In the short term, however, approaches such as land sharing which have been used successfully in India (Hyderabad) and elsewhere (Bangkok) need to be explored. Capacity building of Community Management Organizations (CMOs): A key lesson emerging from the domestic and international experiences is the need for participatory approaches to provision of services within slum settlements or other low income communities. It is clear that evolving approaches at individual settlement level do exist. However, these need to be well documented and disseminated for wider application in several cities. Local involvement in planning and management also necessitates strong community management organizations. Similarly, a greater emphasis on local capacity to pay for services necessitates building up this capacity through community credit systems which can help to extend the time period of payments. Both CMOs and CCSs will provide the institutional base on which participatory approaches can be developed. The role of women in both CMOs and CCSs is likely to be crucial as managers, decision-makers and active participants. Basic municipal services impact on the lives of - 5-

6 women to a far greater degree. Additionally, evidence from successful community based credit systems indicate that role of women has been critical in most successful cases. Development of these community based systems for credit and management will need to receive priority as both require considerable lead time before mature and responsible organizations can emerge at the local level. It is otherwise common to find a municipal authority ready with engineering plans for large water and sewerage projects without any plans to integrate slum settlements, as the planning and implementation capacity for developments within the slum settlements does not exist. Participatory approaches, though more time consuming initially, are more effective in the long run. It is therefore, necessary that work related to formation of community based organizations, community credit systems and developing community consultation processes become routine activities of the municipal or the water utility. Limited reach and capacity of CBFIs and prevalent subsidies: Despite the efforts made both by the government and CBFIs themselves, it appears that the overall reach of these institutions is limited. However, recent efforts to develop a regulatory framework and provide capacity building assistance are likely to help widen the base over time in a more sustainable manner. These measures would also help to bring the wide variety of arrangements within a broader regulatory framework. Key issues identified for capacity assessment by the Bank's sector work on micro-finance include : organizational/legal forms, lending methodologies, role of self-help groups, lack of emphasis on financial performance, and role of apexes in the sector. In relation to legal and regulatory framework, main issues pertain to access to capital markets, institutional transformation and self-regulation. The proposed project will need to incorporate these developments in selection of CBFIs and their capacity building efforts. An important consideration here would be to ensure that involvement of CBFIs in financing community infrastructure helps to strengthen the institutional and financial base of the CBFIs and not weaken them. Some of the programmes which currently use the CBFI networks for on-lending, do not provide adequate spreads for the CBFIs to operate in a sustainable manner. 2. Objectives The primary development objective of the proposed Project is to improve the living conditions in poor and low income communities / neighbourhoods through innovative financing mechanisms. A secondary objective of the project is to demonstrate, the sustainability of small scale infrastructure investments associated with capacity building at the community and local level. Community infrastructure includes water supply, drainage, waste collection and disposal, community toilets, solid waste collection, access and other community roads, street lighting, community halls, home improvement including starter units, structural reinforcement and expansion, electric connections, buildings for community level education and health facilities, and, on plot water and sanitation facilities. The shelter component is envisaged to be included only to the extent that it is required due to re-building, relocation or new construction due to implementation of an infrastructure element. Some flexibility will be permitted to include related components which enhance the effectiveness of community infrastructure. For example, facilities such as shopping may also be included if these help to lower the contributions required by households and communities. In select cases, this will also include facilities required to provide external connections - 6 -

7 to infrastructure in low income neighbourhoods. This objective will be achieved through: a) strategic alliances of the main financial intermediary, Housing Finance Development Corporation (HDFC) with community based financial institutions (CBFIs) in the non-governmental and private sector for providing market-based financial services, to improve access to credit and participation of one or more additional commercial intermediaries; b) community driven, participatory approach to neighborhood infrastructure upgrading and a municipal level integrated plan to ensure external linkages for community infrastructure; and c) development of a Community Support Fund (CSF) to channel World Bank funding and other donor resources, as possible, for sub-project development and capacity building for the targeted CBFIs, municipal authorities and communities. 3. Rationale for Bank's Involvement The Bank has a long history of experience in lending for community infrastructure, especially with local participation. While most of this has been with public agencies, this experience will be helpful in supporting appropriate design of sub-projects. More importantly, the Bank has worked with the HDFC during its early years and supported successful expansion of its retail activities. In that project HDFC was able to ' absorb and apply the gains and features of the Bank-assisted project to other activities'. HDFC's success has led later to the entry and development of similar institutions on a large scale. The Bank can provide similar support to the HDFC again to demonstrate the feasibility of market based lending for the community infrastructure sector and sustainable support facilities. 4. Description This project is designed as a pilot project to help demonstrate a sustainable planning and financing mechanism for community infrastructure among low income and poor communities. As it will be implemented through a commercially oriented financial intermediary, its successful implementation will enable dissemination and use of the model through integration with financial markets. The main guiding principles of the project include: demand driven selection of community projects, ensuring market based financing arrangements, de-linking financing from project preparation and investment subsidies through appropriate institutional arrangements, ensuring institutional sustainability by gradually incorporating cost of project preparation into project costs, and, maximizing convergence with existing government programmes to enhance their effective utilization and better targeting of subsidies. These guiding principles will help to develop approaches for scaling up of community infrastructure investments by converging government programmes with market based lending and technical assistance. This will aid development of sustainable access to finance for community infrastructure. The focus on community participation, with necessary technical assistance support, will ensure effectiveness of investments. The three main components of ICIP are: Sub-project development and capacity building: to cover the costs of services for developing sub-project plans through community participation in selecting and designing the sub-projects and to meet the costs of capacity building support. This will be funded through the CSF. CIPs will include detailed design of community infrastructure, estimation of project costs, environmental and social analysis, and, analysis to show financial viability of the project. It will ensure -7 -

8 convergence with other available government schemes and programmes. CIPs will generally be prepared at the community level. However, for the municipal component, planning and selection of communities will be within a municipal level CIP, incorporating design of municipal system to ensure external connections for community level infrastructure. Capacity building for CBFIs, communities and municipal authorities will also be funded through the CSF. Capacity building will also be required for HDFC, especially for some of the new products which it will have to design and appraise. HDFC will cover its own staff development and project management costs under the project through the spread earned on the loan from GOI. Community infrastructure investment: to at least partially meet the costs of integrated community infrastructure plans at community or city level. This will be funded through the loan by the GOI to HDFC, the proceeds of which will be used to provide finance either a) to communities or to community based finance institutions (CBFIs) for on-lending to communities or households, or b) to finance municipal or other local governments for investments in facilities required to provide external connections to infrastructure in low income or poor communities. Remaining cost of infrastructure investments will be met through additional community share or converging with governmental contributions. While financing these investments, adequate care will have to be taken to ensure that necessary legal provisions are adhered to. In case of communities staying in 'unauthorized areas', necessary commitment from the owners, either public authorities or private owners, will be necessary. An additional sub-component is envisaged to be contribution to a Guarantee Fund which will offer partial guarantees to cover the risks faced by the HDFC in lending for this sector. This would especially address the possibility that local governments may provide subsidized financial assistance to similar projects near and around the HDFC funded projects, which may jeopardize the repayments to HDFC. Additional concerns in financing community infrastructure, as opposed to loans for income generation and for shelter to individual households relate to the lack of a cash-flow generated by the investments and an effective collateral. Repayment responsibility with the community as a whole rather than households also put additional risks in such lending. During project preparation, other alternatives to cover such risks, such as additional lending spread for HDFC will also be explored. Detailed structure and size of the guarantee fund will be worked out based on the extent of risk mitigation requirements emerging during project preparation. Market Development: to cover the costs of expanding the activities to one or more commercial financial intermediaries during implementation. This will involve identification of potential institutions and developing a proposal for their inclusion at least by mid term review. An allocation of about $20 million has been made at this stage. This will be reviewed and firmed up during project preparation. To finance these different components, an IDA Credit (LOC) of about $ 43 million is proposed to the Government of India. In the first phase, GOI will in turn on-lend about $ 19.5 million to the HDFC under a subsidiary loan agreement under the same terms and conditions of the Credit, but with HDFC assuming the foreign exchange risk. About $ 2 million will be for use in the Community Support Fund (CSF). HDFC will provide fee based management support to the CSF. Additional resources for the proposed CSF will also have to be sought from other multi-lateral or bilateral funding agencies. The final size of CSF is expected to be about 10 percent of total project cost. The remaining $ 23.5 million will be for the component of market expansion. In addition to the IDA credit, about $ - 8 -

9 3.5 million will be mobilized from GOI or other donors for the guarantee fund. Size of the guarantee fund is expected to be about 20 to 25 percent of total lending by HDFC and will be firmed up during project preparation. The envisaged scale of the project is large for a pilot operation. However, this reflects the need for cost-effective management inputs by a commercially oriented financial intermediaries. Further, the municipal sub-projects which are considered necessary are likely to be larger and will require larger resources for both project development and capital investments. The final project size will be determined on the basis of demand assessment for community infrastructure projects and an initial pipeline of projects being developed by HDFC and/or other financial intermediaries. Costs shown below are only indicative in nature and will be firmed up during project preparation with more detailed demand assessment and development of sub-projects, as well as overall viability of the financing arrangements.. a. Sub-project development and capacity building b. Community Infrastructure Investments i. CIPs at the municipal level ii. CIPs at the municipal level iii. Guarantee Fund contribution c. Market expansion 5. Financing Total ( US$m) GOVERNMENT 0 IBRD IDA 43 LOCAL COMMUNITIES 5 LOCAL GOVTS. (PROV., DISTRICT, CITY) OF BORROWING COUNTRY 5.5 BILATERAL AGENCIES (UNIDENTIFIED) 6.5 Total Project Cost Implementation The broad institutional and fund flow arrangements are illustrated in Figure 1. The main institutional actors and their roles are envisaged as: Housing development Finance Corporation (HDFC): HDFC is the premier housing finance company in India, with a net worth of over Rs. 20 billion (about US$ 500 million in 1999), primarily focusing on retail housing finance. It has recently taken a policy decision to also initiate lending for urban infrastructure sector. Over the last decade, it has been active in the field of lending for housing and micro-finance to the poor and low income groups through a variety of initiatives including its own Shelter Assistance Reserve, using the KfW lines of credit for low income housing through NGOs and CBOs, and, introduction of a new instrument micro enterprise-finance facility. Value of the Shelter Assistance Reserve as per the balance sheet was Rs.80 million of which 20 million was utilized during the year, the total value of three KfW lines of credit was DM85 million. Total project exposure under the KfW in 1999 was Rs.973 million. Total loan exposure under the micro enterprise - finance facility was Rs.15 million in "These operations are co-ordinated and managed by HDFC's wide-spread network of branches, and these products have been streamlined into the normal business activities of HDFC". Over these years, HDFC has developed an expertise in lending to CBFIs for shelter and has the requisite capacity for their detailed institutional - 9-

10 and financial assessment. It has worked with CBFIs in both rural and urban areas. HDFC is keen to initiate lending for community infrastructure sector as this has been often expressed as an important community demand. Its interest lies in developing a structured approach to lending for this sector on a commercial basis mainly through CBFIs and local authorities. HDFC will be the main financial intermediary under this project. Besides its long experience in lending to the CBFIs, selection of HDFC also reflects the need for selecting an innovative financial intermediary during the pilot phase which is also known for its commercial rigour and integrity in the sector. However, HDFC will have to develop capacity for urban infrastructure and specifically municipal sector. HDFC will receive the funds from the Government of India under a separate subsidiary loan agreement. HDFC's on-lending will be to: i) community based financial institutions, including NGOs and community based organizations; ii) in select cases, directly to the households with facilitation by an NGO. In case of lending at household level, however, care will be taken to ensure that wider community concerns are addressed adequately; and iii) to municipal or other local authorities for financing facilities required to provide external connections to infrastructure in low income communities. HDFC will also provide strategic fee based management assistance to the proposed CSF. Community Support Fund (CSF): The technical assistance and capacity building funds under the ICIP will be routed through the proposed CSF. It will meet the costs of project development for the NGOs/CBFIs and municipal authorities in developing community infrastructure plans (CIPs), CIPs would entail a rationally sequenced project pipeline of physical investments to be implemented over say a 2 to 5 year period. They would be jointly prepared by the communities with support from planners, engineers and social workers, and ould be based on a survey of the settlement and its inhabitants, covering existance and state of repair of infrastructure, service availability, land tenure status, and socio-economic situation. as well as the costs of capacity building and institutional development component. CSF is expected to be set up parallel to the sub-project lending facility at HDFC with an initial allocation by the HDFC from the IDA credit for its capitalization. Its legal, governance and operating structure would be developed during project preparation to ensure autonomy, demand-responsiveness, ability to reach targeted communities, and capacity to leverage resources from other sources. Specifically, additional grant based resources will be mobilized from other bilateral agencies. The CSF would not identify or implement projects. Instead, it would receive proposals from the NGOs/CBFIs or municipal authorities and evaluate them according to pre-established social, environmental, technical and economic criteria. On approval, CSF would fund the technical assistance for development of these projects. HDFC will assist the CSF in appraising and selecting sub-projects for technical assistance through a fee based management agreement. Alternatively, it is also possible to engage services of an NGO or a private firm to provide management assistance. HDFC may provide assistance to the CSF in selection of this consultant. CSF may also consider consolidated funding to one city (or a local authority) to set up a local fund operating on similar lines to meet the costs of preparation of ICIPs in that city. CSF will also provide capacity building support to CBFIs and community based organizations. The CSF is envisaged to be initially funded through grants and subsidies. However, over time it is envisaged that the cost of project development will be built into the total project cost for community infrastructure to ensure long-term

11 institutional sustainability of CSF. Towards this aim, CSF will recover the project development costs on an increasing basis after mid term review. For example, after mid-term review the CSF may require that at least 20 percent of the project development costs are build into the project costs and repaid to it. By completion of the project, 40 percent may be repaid. This will apply only to fresh proposals taken up after the review. Community Based Financial Institutions (CBFIs): Selection of CBFIs by HDFC will reflect both institutional and financial assessment to ensure project effectiveness and sustainability. Commitment of CBFIs for sub-project development will also be a critical consideration. In the initial phase, there will be no geographical restriction on CBFI selection. The main role of CBFIs will be to a) first facilitate development of ICIPs at the community level, and b) on approval of ICIPs, to provide credit facilities to households, self-help groups and/or communities to meet their share of investments for community infrastructure, from the funds lent to them by HDFC. Responsibility of servicing these sub-loans will be entirely with the CBFIs. It is likely that in some cases NGOs may have extensive experience with the communities, though there may not be a financial institution. This will need to be assessed properly by HDFC. Alternatives such as HDFC directly lending to households may be explored, though priority should be given to development and strengthening of CBFIs. In case of small savings and credit groups (SCGs), emphasis will be on developing a federated structure. The recommendations of the RBI Task Force on "micro-finance Institutions" will be reviewed for this. Alternatively, the CBFIs may create or upgrade the infrastructure directly and recover the loan through collection of market based development charges from the community. Responsibility for appraising the CBFIs will be with HDFC. The terms and conditions for HDFC to CBFI lending will be market determined and will reflect HDFC's costs of funds. These will be jointly evolved with the potential CBFIs during project preparation. Communities: The role of communities in the CIP will be to clearly express their demand by agreeing to meet their share of the project costs as well as participate in the development of detailed CIPs. Appropriate community management organizations (CMOs), either existing or newly formed, will participate in project development and related decision-making. Adequate capacity building support will also be provided to the CMOs. There may be flexibility in the lending arrangements, with either households, savings and credit groups (SCGs) or CMOs entering into loan agreements with the CBFIs or directly with HDFC as appropriate. Appropriate legal forms for the CMOs will be used, as relevant in given contexts. Municipal or other Local Authorities: In select cases (for up to three municipal or local authorities) CSF will also fund municipal/local authorities to develop a municipal level ICIP, incorporating additional investments by the municipal authority to ensure provision of city/zone level facilities required to provide external connections to infrastructure in low income or poor communities, such as water or sewerage network extensions, road linkages and provision of solid waste collection points. Appropriate delineation of external linkages which may be financed under this will be done during project preparation. HDFC will provide finance for these investments directly to the municipal authority. Appropriate security for these loans through measures such as escrow accounts or intercepts of state transfers will need to be developed, so that it is not necessary to rely on blanket state government guarantees which have been generally used in the sector. Selection of municipal authorities will be on the basis of

12 their financial appraisal to undertake such a programme, commitment of the local authority to provide enhance community infrastructure in poor and low income communities, agree to the minimum reforms envisaged and a presence of CBFIs, NGOs or CBOs at an adequate scale to enable sustainable financing of the community component. Project Scope: Project scope is kept wide initially, to include both urban and rural communities, a variety of community infrastructure as indicated in paragraph 1, and, geographically CBFIs or municipal projects may be drawn from anywhere in the country depending on an expressed demand and HDFC's appraisal. While the scope will be kept wide initially, this will be reviewed and, if found necessary, may be made more focused during project preparation. Implementation Arrangements: Two categories of sub-projects are envisaged. The first is lending through CBFIs, where these are identified by HDFC, on the basis of expressed demand supported by development of CIPs and appraisal of the CIPs by HDFC. Based on the preliminary demand assessment already conducted by HDFC, it is likely that these proposals may come from different parts of the country. Within this category of sub-projects, based on the results of the preliminary demand assessment, there is need for some flexibility to enable a variety of sub-projects, including for example, settlement level infrastructure improvement projects as well as wider programmes of on-plot water or toilet connections. HDFC has already initiated the process of assessing demand. It has identified a number of CBFIs to work with for further development of CIPs. It is expected that at least three sub-projects of this type would have been appraised by HDFC at the time of project negotiations and will be ready for implementation by project effectiveness. The second category is envisaged as the municipal sub-project. This will include both a loan to municipal authority for external linkages as well as to CBFIs for a planned programme of on-site community infrastructure investments. The municipal sub-project will be within a city-wide perspective and converge resources from other government programmes as appropriate. HDFC plans to initiate preliminary demand assessment for such sub-projects through its branch offices. Further development of municipal CIPs is expected to be done with about three municipal authorities. Financing Arrangements: As indicated above, the Government of India will on-lend from receipt of IDA credit from the World Bank to the HDFC under a subsidiary loan agreement under the same terms and conditions of the Credit, but with HDFC assuming the foreign exchange risk. HDFC will on-lend to the CBFIs or local authorities for the two types of sub-projects. HDFC's on-lending terms will be determined on the basis an assessment of the likely market conditions and CBFI and municipal demand. It is expected that this will be in the range of 10 to 15 percent rate of interest given the current down trend in most Bank and FI PLRs. On the other hand, HDFC's cost of funds will include the service charge, GoI guarantee fee, swap costs to cover the foreign exchange risk, its project management (development and supervision) costs and a cover for the credit risk. A detailed assessment of credit risks will be done by HDFC for each sub-project. A general assessment of the risks associated with community infrastructure projects done by HDFC include: joint ownership of assets by the community, inability of HDFC to have recourse to individual households, absence of cash-flows resulting from the new investments and possibility of initial limited capacity of CBFIs. For municipal borrowers also, though financial viability can be rigorously assessed, there is a possibility of lack of effective credit history of commercial borrowing. Thus, HDFC's cover for credit risk along with the partial cover from the guarantee fund will include these elements. Other

13 terms related to tenor and collateral will be developed during project preparation and in consultation with potential CBFIs and local authorities. In the CBFI sub-projects, CBFIs will in turn on-lend for community infrastructure investments. The specific lending arrangements are likely to vary in different sub-projects, ranging from lending to individual households, savings and credit groups or registered community based organizations. CBFIs will assess the relative risks and their own transaction costs for fixing the on-lending rates. Other terms will be developed during project preparation in consultation with HDFC and the Bank. More detailed assessment of the incentives and related risks for HDFC, CBFIs, community groups and local authorities will be done during project preparation. Scaling Up the Pilot: The project envisages scaling up through market integration. This will require a good assessment of incentives and risk perception of other potential market players. This will be done during project implementation, once adequate experience and demonstration sub-projects are available for sharing with other potential market players. Arrangements will also be made to learn from project development and implementation to derive lessons for further adaptation. A dissemination strategy to share the project experience with other potential market players, other CBFIs and municipal authorities will also be developed. More importantly, a provision is made for addition of one or more commercial financial intermediaries during project implementation. A review of critical project elements will also be done at this stage to enable the process of market integration of this difficult and riskier sub-sector. 7. Sustainability Sustainability of the project is contingent on: a) its market based approach including an emphasis on cost recovery, b) use of an existing domestic institution, namely HDFC, which is the premier housing finance company in India, and c) a focus on capacity building at all levels from the community, CBFIs or NGOs, municipal authorities as well as for the HDFC itself. It will help to strengthen the CBFIs and support municipal authorities to enhance their poverty alleviation related functions in a financially sustainable manner. An attempt will be made as a part of project preparation to identify the possible interest and incentives required for other domestic commercial financial institutions to get involved in lending to community infrastructure for the poor and low income groups on a commercial basis. This will help to design the critical project elements in a manner which make it conducive for later scaling up through the market. Adequate and detailed documentation of the project for later dissemination will also be incorporated in the monitoring system. Project sustainability will also be enhanced through addition of one or more commercial FIs during implementation. 8. Lessons learned from past operations in the country/sector A number of different type of projects as reviewed in the above table, provide important lessons for design of the proposed project. Slow disbursement: In many of the projects which envisage community participation, disbursement has generally been slower than anticipated. Adequate emphasis will be given to preparation of pipeline projects by providing the necessary technical assistance to CBFIs and community groups. To ensure this, a pipeline of projects is planned to be developed along with project preparation. Special TA funds will later be available through the proposed Community Support Fund. Further, participation of

14 more financial intermediaries will also help create a healthy competition. Limitations of subsidized financing regimes: In many earlier attempts, funds are provided at subsidized rates, thus limiting integration of the sector with the financial system and participation of commercial financing institutions in the sector. This project aims to have the main intermediary, HDFC, demonstrate lending on terms and conditions which are likely to be acceptable to the commercial institutions later on. This will be a critical element of the proposed project. Need for flexibility in lending models: Experience of many of the apex institutions in micro-finance and of HDFC and HUDCO for housing finance suggest that a wide variety of local situations are likely to be encountered locally. This necessitates that, while the basic terms and conditions are specified, actual lending model will need to be quite flexible. HDFC will, however, need to develop methods for assessment of CBFIs and community infrastructure projects while permitting local flexibility in arrangements. Focus required on local capacity building: Experience with community based housing and water supply projects provide evidence of the need for capacity building of both communities themselves and the support organizations for such projects. Another key area is the capacity of CBFIs to take up financing for this totally new area for which generally a high level of demand exists among the communities. Most CBFIs focus largely on financing income related activities. New skills and human resources are needed for introduction of financing products for community infrastructure. The project aims to provide support to such capacity building through the community support fund. Demand orientation and community controlled projects: Clear evidence of local demand for services and community's control on decision making are essential ingredients of successful community level projects. This will, therefore, be incorporated in development of ICIPs at the community level with a facilitative role played by the CBFIs. 9. Program of Targeted Intervention (PTI) Y 10. Environment Aspects (including any public consultation) Issues : While in general the environmental impacts are expected to be positive, it would be necessary to avoid possible adverse impacts in specific sub-projects through appropriate design and planning. As a part of project preparation, environmental parameters to be used in sub-projects, will be identified and mitigation guidelines included in the project manual. Capacity building of CBFIs and HDFC for environmental assessment as a part of sub-project appraisal will receive emphasis. 11. Contact Point: Task Manager Meera Mehta The World Bank 1818 H Street, NW Washington D.C For information on other project related documents contact: The InfoShop The World Bank 1818 H Street, NW