RESTRUCTURING PAPER ON A PROPOSED PROJECT RESTRUCTURING OF THE THIRD HIGHWAY PROJECT. IBRD 7889-AZ (May25, 2010) AND IDA 4723-AZ (May 25, 2010) TO THE

Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Transport Sector Unit Europe and Central Asia Region Document of The World Bank RESTRUCTURING PAPER ON A PROPOSED PROJECT RESTRUCTURING OF THE THIRD HIGHWAY PROJECT IBRD 7889-AZ (May25, 2010) AND IDA 4723-AZ (May 25, 2010) TO THE REPUBLIC OF AZERBAIJAN October 31, 2013 Report No: RES11945 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

ABBREVIATIONS AND ACRONYMS ARS AADT EIRR IBRD IDA NPV PDO PIU VAT AzerRoadservice JSC Annual Average Daily Traffic Economic Internal Rate of Return International Bank for Reconstruction and Development International Development Association Net Present Value Project Development Objective Project Implementing Unit Value Added Tax Regional Vice President: Country Director: Sector Manager: Task Team Leader: Laura Tuck Henry G R Kerali Juan Gaviria Jacques Bure

REPUBLIC OF AZERBAIJAN THIRD HIGHWAY PROJECT RESTRUCTURING PAPER CONTENTS A SUMMARY 7 B PROJECT STATUS 7 C PROPOSED CHANGES 8 D APPRAISAL SUMMARY 11 ANNEX 1 RESULTS FRAMEWORK AND MONITORING 12

DATA SHEET Azerbaijan Third Highway Project (P118023) EUROPE AND CENTRAL ASIA ECSTR Report No: RES11945 Basic Information Project ID: P118023 Lending Instrument: Specific Investment Loan Regional Vice President: Laura Tuck Original EA Category: Full Assessment (A) Country Director: Henry G R Kerali Current EA Category: Full Assessment (A) Sector Director: Laszlo Lovei Original Approval Date: 25-May-2010 Sector Manager: Juan Gaviria Current Closing Date: 31-Mar-2015 Team Leader: Jacques Bure Borrower: Responsible Agency: Republic of Azerbaijan Ministry of Finance Restructuring Type Form Type: Full Restructuring Paper Decision Authority: Board Approval Restructuring Level: Level 1 Financing (as of 07-Oct-2013) Key Dates Project Ln/Cr/TF Status Approval Date Signing Date Effectiveness Date Original Closing Date Revised Closing Date P118023 IBRD-78890 Effective 25-May-2010 11-Aug-2010 08-Nov-2010 31-Mar-2015 31-Mar-2015 P118023 IDA-47230 Effective 25-May-2010 11-Aug-2010 08-Nov-2010 31-Mar-2015 31-Mar-2015 Disbursements (in Millions) Project Ln/Cr/TF Status Currency Original Revised Cancelled Disbursed Undisbursed % Disbursed P118023 IBRD-78890 Effective USD 17160 17160 000 2676 14484 16 P118023 IDA-47230 Effective USD 7000 7000 000 000 7085 Policy Waivers Does the project depart from the CAS in content or in other significant respects? Yes [ ] No [ X ] Does the project require any policy waiver(s)? Yes [ ] No [ X ] 1

A Summary of Proposed Changes The Third Highway Project ( the Project ) is providing US$2416 million in lending to the Republic of Azerbaijan through (i) the IBRD loan (7889-AZ) of US$1716 million and (ii) IDA credit (4723-AZ) of SDR 462 million, both approved on May 25, 2010 The proposed Project restructuring was prepared in response to the request letters from the Republic of Azerbaijan dated August15, 2013 and October 8, 2013 The restructuring envisages revision of the Project Development Objective, change in co-financing share of the Government, changes in the scope of the Project, revision of related Monitoring Indicators and extension of the Closing Date as defined in the corresponding Loan and Financing Agreements The restructuring does not modify the safeguard category or trigger new safeguard policies Change in Implementing Agency Yes [ ] No [ X ] Change in Project's Development Objectives Yes [ X ] No [ ] Change in Results Framework Yes [ X ] No [ ] Change in Safeguard Policies Triggered Yes [ ] No [ X ] Change of EA category Yes [ ] No [ X ] Other Changes to Safeguards Yes [ ] No [ X ] Change in Legal Covenants Yes [ ] No [ X ] Change in Loan Closing Date(s) Yes [ X ] No [ ] Cancellations Proposed Yes [ ] No [ X ] Change to Financing Plan Yes [ X ] No [ ] Change in Disbursement Arrangements Yes [ ] No [ X ] Reallocation between Disbursement Categories Yes [ ] No [ X ] Change in Disbursement Estimates Yes [ X ] No [ ] Change to Components and Cost Yes [ X ] No [ ] Change in Institutional Arrangements Yes [ ] No [ X ] Change in Financial Management Yes [ ] No [ X ] Change in Procurement Yes [ ] No [ X ] Change in Implementation Schedule Yes [ X ] No [ ] Other Change(s) Yes [ ] No [ X ] Appraisal Summary Change in Economic and Financial Analysis Yes [ X ] No [ ] Appraisal Summary Change in Technical Analysis Yes [ ] No [ X ] Appraisal Summary Change in Social Analysis Yes [ ] No [ X ] Appraisal Summary Change in Environmental Analysis Yes [ ] No [ X ] Appraisal Summary Change in Risk Analysis Yes [ ] No [ X ] B Project Status The Project s progress towards achievement of the PDO and implementation progress are rated Moderately Satisfactory After initial technical difficulties related to the preparation of detailed designs, important progress was recently made in procurement and signing of two major civil works contracts 2

(Sections 2 & 3 of the M4 Baku-Shamakhi road) As of early October 2013, about half of the Project funds are committed and US$26 million are disbursed Currently, three out of the four original civil works contracts are being implemented The works on Section 4 of the M4 Baku-Shamakhi road require significant additional geo-technical investigations and redesign due to active landslide process in the area These studies will still be carried out and completed under the Project Given that the works on this section cannot start within the next 2-3 years, the Government has requested exclusion of the civil works for the above road section from the Project The Government has also suggested inclusion of civil works for sections 1C and 2 (Yenikend-Shorsulu section) of the M3 Alat-Masalli road to the scope of the Project after these sections were excluded from the ongoing Second Highway Project also financed by the World Bank Similar to M4 Baku-Shamakhi road, M3 Yenikend-Shorsulu highway is part of the trunk road network that the Government aims to upgrade to four lanes The proposed modifications in the scope will secure commitment of all project funds in early 2014 and completion by September 30, 2016 The implementing agency revised the implementation plan and developed a set of actions to be undertaken to ensure completion of all project activities by the proposed new Closing Date of September 30, 2016 The revised implementation plan was reviewed and found acceptable by the Bank team On the institutional development side, the implementation of the technical assistance on modernization of motorway operation and maintenance is well advanced The road administration has developed options for modernization of motorway operation and maintenance practices The organizational structure of the road administration has been revised to include establishment of a new Motorway Management Unit, which is considered as a major achievement under the Project Development Objectives/Results Project Development Objectives (P118023 - Third Highway Project) Original PDO The Project Development Objective is "to contribute to a more efficient and safer Baku-Shamakhi road and higher quality road services as part of the upgrading to motorway standards, and to improve the management of the nascent motorway network" Change in Project's Development Objectives Please describe the change and explain the reason for change The original PDO is to contribute to a more efficient and safer Baku-Shamakhi road and higher quality road services as part of the upgrading to motorway standards, and to improve the management of the nascent motorway network The proposed restructuring adds a new road section that was not captured under the original PDO (Yenikend-Shorsulu section of M3 Alat-Masalli motorway) The revised PDO will reflect this addition Proposed New PDO To contribute to a more efficient and safer Baku-Shamakhi and Yenikend-Shorsulu roads and higher quality road services as part of the general network upgrading to motorway standard, and to improve the management of the nascent motorway network Change in Results Framework Explanation: The PDO Level Results Indicators and the Intermediate Outcome Indicators and their target values will be adjusted to reflect the proposed changes in the scope of the Project They will be incorporated in two new amended Supplemental Letters each one corresponding to the Loan and the Financing Agreements respectively, to be signed by the Bank and the Republic of Azerbaijan as part of the restructuring package 3

The proposed changes are reflected in the revised Results and Monitoring Framework which is provided in the Annex 1 of the Restructuring Paper Change in Loan Closing Date(s) Explanation: Financing The Project Closing Date will be extended by 18 months, from March 31, 2015 to September 30, 2016, bringing the total implementation period to 58 years This is the first extension of the Closing Date The Closing Date is proposed to be extended based on the assessment of time needed for completion of remaining project activities, including construction works for Sections 1C and 2 of M3 Alat-Masalli Road and conducting comprehensive feasibility and design studies for the M4 Shamakhi-Agsu road section along the alternative alignment Ln/Cr/TF Status IBRD- 78890 IDA- 47230 Original Closing Date Current Closing Date Proposed Closing Date Previous Closing Date(s) Effective 31-Mar-2015 31-Mar-2015 30-Sep-2016 31-Mar-2015 Effective 31-Mar-2015 31-Mar-2015 30-Sep-2016 31-Mar-2015 Change to Financing Plan Explanation: The Government co-financing share in the Project will be increased from 20% to 25% to ensure sufficient funding for implementation of the additional Project activities Thus, total Government co-financing share in the Project will increase from US$114 million to US$138 million The Bank financing will stay at original US$2416 million, but will now represent 75% of Project costs Source(s) At Approval Current (from AUS) Proposed BORR 114,550,00000 114,550,00000 13827 IBRD 171,600,00000 171,600,00000 17160 IDA 70,000,00000 70,000,00000 7000 Disbursement Estimates Change in Disbursement Estimates Explanation: Total 356,150,00000 356,150,00000 37987 The disbursement estimates are updated in accordance with the revised project implementation schedule which provides sufficient time for completion of remaining Project activities by the new Closing Date Fiscal Year Current (USD) Proposed (USD) 2010 000 000 2011 20,000,00000 000 2012 70,000,00000 5,189,21785 2013 80,000,00000 5,193,99529 2014 50,000,00000 50,759,11674 4

2015 21,600,00000 100,000,00000 2016 000 50,000,00000 2017 000 30,457,67012 Total 241,600,00000 241,600,00000 Change to Components and Cost Explanation: Components Component 1: The Government requests to remove civil works in Section 4 of the Baku-Shamakhi road (km 92-116) from the scope of the Project, as the required complex and lengthy geotechnical investigations make the original technical solutions obsolete and would delay the start of the works by about two-three years Funds earmarked for these works, together with savings under the Project, represent about US$ 120 million The Government has proposed to utilize these funds for completion of 48 km Yenikend-Shorsulu Section of the Alat-Masalli road, another priority motorway corridor to be upgraded to four lanes The works contracts on this road section were partially implemented under the Bank financed Second Highway Project, but the construction contracts were recently terminated due to poor performance of the contractor The remaining civil works were deleted from the Second Highway project in a restructuring dated October 18, 2013 Based on the above, the scope of the Project will be adjusted to: (i) exclude civil works on Section 4 of the Baku-Shamakhi road and (ii) include the remaining works under Yenikend-Shorsulu Section of the M3 Alat-Masalli road The Borrower is currently preparing a new set of bidding documents for remaining works on Yenikend-Shorsulu section of the M3 Alat-Masalli road, with the objective to resume the works by the new construction season in spring 2014 The revised scope of the Project will also include preparation of comprehensive feasibility and design documents for construction of the M4 Shamakhi-Agsu road section along the new alignment, which would bypass the active landslide and problematic mountainous areas One of the activities envisaged under the Component 1 of the Project is implementation of civil works to improve road safety on the existing 15 km four-lane section of the M4 Baku-Shamakhi road The design of the civil works has been completed The design suggests that the works should be conducted in conjunction with other works to increase the capacity of the road which is the key exit from the capital city The road safety works will be therefore implemented at a later stage by the Government with state budget resources In this regard, road safety component of the Project will be adjusted to exclude implementation of the above civil works from the scope of the Project Component 2: The Ministry of Transport and Road Administration have agreed to follow recommendations of the technical assistance under the Project on modernization of motorway management and maintenance practices by establishing dedicated regional motorway maintenance units In this context, implementation of the originally proposed pilot on motorway operations and maintenance is not considered relevant any longer and is proposed to be excluded from the scope of the Project Accordingly, the institutional development component under the Project will now focus on the establishment of the (i) new Motorway Management Unit, (ii) development of the motorways management and maintenance strategy, and (iii) preparation of motorway guidelines and service level agreements The original and revised costs of project components are provided in below table (excluding VAT) 5

Current Component Name Component 1: Upgrading a 100km section of existing two lane M4 Baku-Shamakhi road into a four-lane motorway Component 2: Institutional development (management and financing Azerbaijan Motorways; institutional development of the ARS) Component 3: Project Management including technical assistance and financing additional costs for project implementation Proposed Component Name Component 1: Upgrading a 77 km section of M4 Baku- Shamakhi and 48 km section of M3 Yenikend- Shorsulu roads into a four-lane motorway Component 2: Institutional development (management and financing Azerbaijan Motorways; institutional development of the ARS) Component 3: Project Management including technical assistance and financing additional costs for project implementation Current Cost (US$M) Proposed Cost (US$M) Action 29600 31592 Revised 500 500 100 100 Total: 30200 32192 Change in Implementation Schedule Explanation: Other Change(s) The Borrower has updated the project implementation schedule which provides sufficient time for completion of remaining Project activities by the new Closing Date The revised implementation schedule envisages (i) completion of civil works for M4 Baku-Shamakhi Road (Sections 1, 2 & 3) by fall 2015, (ii) implementation of institutional development activities and design and feasibility studies by the end of 2015; and (iii) completion of works for Sections 1C and 2 of M3 Alat-Masalli by mid-2016 Change(s) in Appraisal Summary Appraisal Summary Change in Economic and Financial Analysis Explanation: The economic evaluation of the upgrading of the Yenikend-Shorsulu road section indicates the estimated economic internal rate of return of 173% for a net present value of US$1035 million, as per the Table 3 in the Restructuring Paper A sensitivity analysis was conducted on results of the economic modeling to assess potential impacts of the variation in capital costs and traffic (Table 4 in the Restructuring Paper) Analysis shows that the road section can withstand an occurrence of 20% decrease in AADT EIRR falls slightly below 12% only with 20 % cost increase, which is very unlikely to materialize given that the cost estimate already includes contingency and is thoroughly calculated based on the actual recent construction experience on this road section 6

AZERBAIJAN THIRD HIGHWAY PROJECT and RESTRUCTURING PAPER A SUMMARY 1 The Third Highway Project ( the Project ) is providing US$2416 million in lending to the Republic of Azerbaijan through (i) the IBRD loan (7889-AZ) of US$1716 million and (ii) IDA credit (4723-AZ) of SDR 462 million, both approved on May 25, 2010 The proposed Project restructuring was prepared in response to the request letters from the Republic of Azerbaijan dated August15, 2013 and October 8, 2013 The restructuring envisages revision of the Project Development Objective (PDO), change in co-financing share of the Government, changes in the scope of the Project, revision of related Monitoring Indicators and extension of the Closing Date as defined in the corresponding Loan and Financing Agreements The restructuring does not modify the safeguard category or trigger new safeguard policies B PROJECT STATUS 2 The Project s progress towards achievement of the PDO and implementation progress are rated Moderately Satisfactory After initial technical difficulties related to the preparation of detailed designs, important progress was recently made in procurement and signing of two major civil works contracts (Sections 2 & 3 of the M4 Baku-Shamakhi road) As of early October 2013, about half of the Project funds are committed and US$26 million are disbursed Currently, three out of the four original civil works contracts are being implemented The works on Section 4 of the M4 Baku-Shamakhi road require significant additional geo-technical investigations and redesign due to active landslide process in the area These studies will still be carried out and completed under the Project Given that the works on this section cannot start within the next 2-3 years, the Government has requested exclusion of the civil works for the above road section from the Project The Government has also suggested inclusion of civil works for sections 1C and 2 (Yenikend-Shorsulu section) of the M3 Alat-Masalli road to the scope of the Project after these sections were excluded from the ongoing Second Highway Project also financed by the World Bank Similar to M4 Baku-Shamakhi road, M3 Yenikend-Shorsulu highway is part of the trunk road network that the Government aims to upgrade to four lanes The proposed modifications in the scope will secure commitment of all project funds in early 2014 and completion by September 30, 2016 The implementing agency revised the implementation plan and developed a set of actions to be undertaken to ensure completion of all project activities by the proposed new Closing Date of September 30, 2016 The revised implementation plan was reviewed and found acceptable by the Bank team 3 On the institutional development side, the implementation of the technical assistance on modernization of motorway operation and maintenance is well advanced The road administration has developed options for modernization of motorway operation and maintenance practices The organizational structure of the road administration has been revised to include establishment of a new Motorway Management Unit, which is considered as a major achievement under the Project 7

C PROPOSED CHANGES 4 The proposed restructuring entails changes in the PDO, scope of the Project, related monitoring indicators, co-financing share of the Government and extension of the Closing Date The restructuring does not modify the safeguard category or trigger new safeguard policies The proposed changes are specified below in detail Project s Development Objective 5 The original PDO is to contribute to a more efficient and safer Baku-Shamakhi road and higher quality road services as part of the upgrading to motorway standards, and to improve the management of the nascent motorway network The proposed restructuring adds a new road section that was not captured under the original PDO (Yenikend-Shorsulu section of M3 Alat- Masalli motorway) The revised PDO will read: to contribute to a more efficient and safer Baku-Shamakhi and Yenikend-Shorsulu roads and higher quality road services as part of the general network 1 upgrading to motorway standard, and to improve the management of the nascent motorway network The Project outcome indicators and their values will be modified accordingly Project Components 6 Component 1: Motorway Improvement The Government requests to remove civil works in Section 4 of the Baku-Shamakhi road (km 92-116) from the scope of the Project, as the required complex and lengthy geotechnical investigations make the original technical solutions obsolete and would delay the start of the works by about two-three years Funds earmarked for these works, together with savings under the Project, represent about US$ 120 million The Government has proposed to utilize these funds for completion of 48 km Yenikend-Shorsulu Section of the Alat-Masalli road, another priority motorway corridor to be upgraded to four lanes The works contracts on this road section were partially implemented under the Bank financed Second Highway Project, but the construction contracts were recently terminated due to poor performance of the contractor The remaining civil works were deleted from the Second Highway project in a restructuring dated October 18, 2013 Based on the above, the scope of the Project will be adjusted to: (i) exclude civil works on Section 4 of the Baku-Shamakhi road and (ii) include the remaining works under Yenikend-Shorsulu Section of the M3 Alat-Masalli road The Borrower is currently preparing a new set of bidding documents for remaining works on Yenikend-Shorsulu section of the M3 Alat-Masalli road, with the objective to resume the works by the new construction season in spring 2014 The revised scope of the Project will also include preparation of comprehensive feasibility and design documents for construction of the M4 Shamakhi-Agsu road section along the new alignment, which would bypass the active landslide and problematic mountainous areas 1 The words general network were indicated in description of Project objectives in the original legal documents, while they were not captured in the original PDO statement in the Project Appraisal Document The revised PDO eliminates this discrepancy and ensures full consistency between definitions of project objectives in legal and project documents 8

7 One of the activities envisaged under the Component 1 of the Project is implementation of civil works to improve road safety on the existing 15 km four-lane section of the M4 Baku- Shamakhi road The design of the civil works has been completed The design suggests that the works should be conducted in conjunction with other works to increase the capacity of the road which is the key exit from the capital city The road safety works will be therefore implemented at a later stage by the Government with state budget resources In this regard, road safety component of the Project will be adjusted to exclude implementation of the above civil works from the scope of the Project 8 Component 2: Institutional Development The Ministry of Transport and Road Administration have agreed to follow recommendations of the technical assistance under the Project on modernization of motorway management and maintenance practices by establishing dedicated regional motorway maintenance units In this context, implementation of the originally proposed pilot on motorway operations and maintenance is not considered relevant any longer and is proposed to be excluded from the scope of the Project Accordingly, the institutional development component under the Project will now focus on the establishment of the (i) new Motorway Management Unit, (ii) development of the motorways management and maintenance strategy, and (iii) preparation of motorway guidelines and service level agreements 9 The modified scope of the Project activities will be reflected in the revised Project description in the Legal and Credit Agreements and the Project Performance Monitoring Indicators Results/indicators 10 The PDO Level Results Indicators and the Intermediate Outcome Indicators and their target values will be adjusted to reflect the proposed changes in the scope of the Project They will be incorporated in two new amended Supplemental Letters each one corresponding to the Loan and the Financing Agreements respectively, to be signed by the Bank and the Republic of Azerbaijan as part of the restructuring package The proposed changes are summarized in below Table 1 and reflected in the revised Results and Monitoring Framework provided in Annex 1 New Table1 Summary of Changes in Results Framework and Indicators Indicators Revisions Efficiency: Reduction in road user New PDO indicator is added to measure the efficiency of costs from Yenikend-Shorsulu upgrading Yenikend-Shorsulu road section newly included to Safety: Reduction of Personal Injury per 100-million vehicle-km along the Yenikend-Shorsulu road Number of km upgraded for Yenikend-Shorsulu Roads constructed, non-rural Revised Number of km upgraded for Baku Shamakhi Development of motorways management and maintenance strategy the scope of the Project New PDO indicator is added to measure safety improvements as a result of upgrading Yenikend-Shorsulu road section newly included to the scope of the Project New Intermediate Outcome Indicator is added to reflect inclusion of the Yenikend-Shorsulu road section to the scope of the Project New core indicator added to measure total length of non-rural roads constructed under the Project Target value for this indicator is adjusted to reflect exclusion of Section 4 of Baku-Shamakhi road from the scope of the Project The revised indicator is broader and reflects the recommendations and findings of the ongoing technical assistance under the Project 9

Dropped Assessment of operations and maintenance pilot on sections of the existing motorways The Ministry of Transport and Road Administration now consider establishing several dedicated regional motorway maintenance units based on recommendations of the technical assistance under the Project Thus, implementation of the originally proposed pilot is not considered relevant any longer FINANCING 11 The Government co-financing share in the Project will be increased from 20% to 25% to ensure sufficient funding for implementation of the additional Project activities Thus, total Government co-financing share in the Project will increase from US$114 million to US$138 million The Bank financing will stay at original US$2416 million, but will now represent 75% of Project costs 12 The original and revised breakdown of Project costs is indicated in the Table 2 Table 2 Project Costs Table (US$ million, VAT included*) Costs Original** Revised WB Government WB Government Upgrading Sections 1, 2and 3 of the M4 Baku-Shamakhi road 23637 11227 11562 6629 Upgrading Yenikend-Shorsulu section of the Alat-Masalli road - - 11475 6579 Preparation of feasibility and design for Shamakhi-Agsu - - 600 344 bypass Institutional development 400 190 400 229 Project management 080 038 080 046 Front-end Fee 043-043 - Subtotal 24160 11455 24160 13827 TOTAL 35615 37987 * All VAT related costs will continue to be covered by the Government ** The original cost breakdown is per the PAD for the Third Highway Project Financial Management 13 The Financial Management rating of the Project is Moderately Satisfactory based on the latest financial management review by the Bank The Borrower is in compliance with the financial management requirements of the Project The audit report for 2012 was received and found acceptable to the Bank Closing date 14 The Project Closing Date will be extended by 18 months, from March 31, 2015 to September 30, 2016, bringing the total implementation period to 58 years This is the first extension of the Closing Date The Closing Date is proposed to be extended based on the assessment of time needed for completion of remaining project activities, including construction works for Sections 10

1C and 2 of M3 Alat-Masalli Road and conducting comprehensive feasibility and design studies for the M4 Shamakhi-Agsu road section along the alternative alignment Implementation schedule 15 The Borrower has updated the project implementation schedule which provides sufficient time for completion of remaining Project activities by the new Closing Date The revised implementation schedule envisages (i) completion of civil works for M4 Baku-Shamakhi Road (Sections 1, 2 & 3) by fall 2015, (ii) implementation of institutional development activities and design and feasibility studies by the end of 2015; and (iii) completion of works for Sections 1C and 2 of M3 Alat-Masalli by mid-2016 D APPRAISAL SUMMARY 16 The appraisal of the restructuring confirms that with the proposed changes in the scope of the Project, the PDO continues to be achievable and the Project remains justified in accordance with the Project documents and requirements of relevant Bank policies Economic and Financial Analysis 17 The economic evaluation of the upgrading of the Yenikend-Shorsulu road section indicates the estimated economic internal rate of return of 173% for a net present value of US$1035 million, as per the below Table 3 A sensitivity analysis was conducted on results of the economic modeling to assess potential impacts of the variation in capital costs and traffic (Table 4) Analysis shows that the road section can withstand an occurrence of 20% decrease in AADT EIRR falls slightly below 12% only with 20 % cost increase, which is very unlikely to materialize given that the cost estimate already includes contingency Table 3 The estimated Economic Return and NPV for the Proposed Road Section Project name Length (km) NPV at 12% discount rate (US$ million) EIRR Yenikend-Shorsulu 496 1035 173 % Table 4 Results of the Sensitivity Analysis Project EIRR Cost Cost AADT AADT +20% -20% +20% -20% Yenikend- Shorsulu 173 % 115 % 208 % 225 % 147 % Risks 18 No additional risk has been identified that would be associated with the proposed restructuring 11

ANNEX 1 Results Framework and Monitoring AZERBAIJAN: THIRD HIGHWAY PROJECT Project Development Objective (PDO): To contribute to a more efficient and safer Baku-Shamakhi road and higher quality road services as part of the upgrading to motorway standards, and to improve the management of the nascent motorway network Revised Project Development Objective (PDO): To contribute to a more efficient and safer Baku-Shamakhi and Yenikend-Shorsulu roads and higher quality road services as part of the general network upgrading to motorway standard, and to improve the management of the nascent motorway network PDO Level Results Indicators* Efficiency: Reduction in road user costs from Baku to Shamakhi Efficiency: Reduction in road user costs from Yenikend to Shorsulu Core D=Dropped C=Continue N= New R=Revised Unit of Measure Baseline Cumulative Target Values 2011 2012 2013 2014 2015 2016 Frequency Data Source/ Methodology C % 100 100 100 100 90 80 80 Every year Technical Reports and Road Data Bank N % 100 100 100 100 90 80 80 Data Collection PIU and ARS Safety: Reduction of Personal Injury per 100-million vehicle-km along the C % 100 100 100 100 90 70 70 Baku-Shamakhi road Safety: Reduction of Personal Injury per 100-million vehicle-km along the % 100 100 100 100 90 90 70 Yenikend-Shorsulu road N Quality: Percentage of M Roads in Good and Fair Condition as a share of total M Roads of the network C % 55 57 59 61 65 70 70 Intermediate Outcome Indicators (Component One) Number of km upgraded for Baku Shamakhi R km 0 0 0 0 30 77 77 Number of km upgraded for Yenikend- Shorsulu N km 0 0 0 0 20 30 48 Roads constructed, non-rural N km 0 0 0 0 50 107 125 Every 6 months Project Monitoring reports ARS and PIU Percentage of safety audits conducted on road accidents recorded during construction stage of Baku Shamakhi Safety audits on detailed design C % 0 25 60 80 80 80 80 C Yes/No No Yes Safety audits on construction completion C Yes/No No Yes 12

Intermediate Outcome Indicators (Component Two) Design of a Motorway Guidelines C Yes/No No Assessment of operations and maintenance pilot on sections of the D existing motorways Development of motorways management and maintenance strategy Development of a pilot Motorway Management Unit C Yes/No No R Yes/No No Yes Yes Every 6 months Yes Project Monitoring reports ARS and PIU 13