Kunming Qingshuihai Water Supply Project

Report and Recommendation of the President to the Board of Directors

````````````````````````````````````````````````````````Sri Lanka Project Number: 40052 November 2007

Proposed Loan People’s Republic of China: Kunming Qingshuihai Water Supply Project

CURRENCY EQUIVALENTS (as of 15 November 2007)

Currency Unit – yuan (CNY)

CNY1.00 = $0.1347 $1.00 = CNY7.43

ABBREVIATIONS

AAOV – average annual output value ADB – Asian Development Bank AH – affected household AP – affected person ASEAN – Association of Southeast Asian Nations EDZ – East Development Zone EIA – environmental impact assessment EIRR – economic internal rate of return EMDP – ethnic minority development plan EMP – environmental management plan FYP – five-year program GDP – gross domestic product IA – implementing agency ICB – international competitive bidding JBIC – Japan Bank for International Cooperation JV – joint venture KMG – Kunming municipal government KWSG – Kunming Water Supply Group Company Limited LIBOR – London interbank offered rate MDG – Millennium Development Goal MLSS – minimum living standard scheme NADZ – New Airport Development Zone NCB – national competitive bidding O&M – operation and maintenance PLG – project leading group PMO – project management office PPMS – project performance monitoring system PRC – People’s Republic of China PSP – private sector participation QCBS – quality- and cost-based selection RP – resettlement plan SEPA – State Environmental Protection Administration TA – technical assistance WACC – weighted average cost of capital WSC – water supply company WWTP – wastewater treatment plant YPG – Yunnan provincial government

WEIGHTS AND MEASURES

km2 – square kilometer m2 – square meter m3 – cubic meter m3/s – cubic meter per second mu – unit of land measure, 667 m2

NOTES

(i) The fiscal year (FY) of the Government ends on 31 December. FY before a calendar year denotes the year in which the fiscal year ends, e.g., FY 2007 ends on 31 December 2007. (ii) In this report, “$” refers to US dollars.

Vice President C. Lawrence Greenwood, Jr., Operations Group 2 Director General H. S. Rao, East Asia Department (EARD) Director R. Wihtol, Social Sectors Division, EARD

Team leader T. Villareal, Urban Development Specialist, EARD Team members A. Djusupbekova, Senior Counsel, Office of the General Counsel M. Gupta, Social Development Specialist, EARD S.W. Handayani, Senior Social Development Specialist, Regional and Sustainable Development Department S. Popov, Senior Environment Specialist, EARD J. Wang, Project Officer (Urban Development and Water Supply), PRC Resident Mission, EARD

CONTENTS

Page LOAN AND PROJECT SUMMARY i MAP I. THE PROPOSAL 1 II. RATIONALE: SECTOR PERFORMANCE, PROBLEMS, AND OPPORTUNITIES 1 A. Performance Indicators and Analysis 1 B. Analysis of Key Problems and Opportunities 3 III. THE PROPOSED PROJECT 7 A. Impact and Outcome 7 B. Outputs 7 C. Special Features 8 D. Project Investment Plan 9 E. Financing Plan 10 F. Implementation Arrangements 10 IV. PROJECT BENEFITS, IMPACTS, ASSUMPTIONS, AND RISKS 14 A. Benefits and Impacts 14 B. Social Dimensions 14 C. Financial Aspects 16 D. Economic Aspects 17 E. Environmental Aspects 17 F. Risks and Mitigation Measures 18 V. ASSURANCES AND CONDITION 19 A. Specific Assurances 19 B. Condition for Disbursement 20 VI. RECOMMENDATION 20

APPENDIXES 1. Design and Monitoring Framework 21 2. Water Sector Analysis 25 3. External Assistance 30 4. Description of Project Components 32 5. Detailed Cost Estimates and Financing Plan 34 6. Flow of Funds and Onlending Arrangements 36 7. Project Organization 37 8. Implementation Schedule 38 9. Procurement Plan 39 10. Summary Resettlement Plan 41 11. Summary Poverty Reduction and Social Strategy 45 12. Financial Analysis 48 13. Tariffs and Affordability 52 14. Economic Analysis 57

SUPPLEMENTARY APPENDIXES (available on request) A. Detailed Sector Analysis B. Policy Dialogue C. Detailed Description of Project Components D. Detailed Cost Estimates and Financing Plan by Component E. Detailed Implementation Plan F. Detailed Institutional Analysis G. Terms of Reference for Consulting Services H. Resettlement Plan I. Detailed Poverty and Social Assessment J. Health Impact Assessment K. Detailed Ethnic Minority Development Plan L. Detailed Financial Analysis and Financial Management M. Detailed Economic Analysis and Least-Cost Analysis N. Detailed Summary Environmental Impact Assessment (SEIA) and Environmental Management Plan (EMP)

LOAN AND PROJECT SUMMARY

Borrower People’s Republic of China (PRC)

Classification Targeting Classification: General intervention Sector: Water supply, sanitation, and waste management Subsector: Water supply and sanitation Themes: Sustainable economic growth, environmental sustainability, inclusive social development Subthemes: Developing urban areas, urban environmental improvement, human development

Environment Category A. A summary of the environmental impact assessment Assessment was circulated to the Asian Development Bank (ADB) Board of Directors and uploaded onto the ADB website on 26 June 2007.

Project Description The Project is a key urban infrastructure initiative of Kunming municipal government (KMG). It will provide safe, secure water supply and ensure sustainable economic growth of the city of Kunming. The Project will help Kunming to (i) ensure better raw water quantity and quality in the main city and the new development zones; (ii) protect water resources; (iii) encourage more effective water demand management; (iv) strengthen integrated water resources development and environmental management; (v) improve the environment, living conditions, and public health standards; and (vi) ensure effective corporate governance and enterprise reform to improve sector efficiency.

The Project consists of three components (i) water resources development, (ii) water conveyance systems, and (iii) capacity development and project management. The Project supports the Government’s 11th Five-Year Program (2006–2010) to improve living conditions and health in the cities of the PRC, and to promote their sustainable economic development. The Project will contribute to achieving Millennium Development Goal (MDG) 7, target 10, which calls for halving by 2015 the proportion of people without access to safe drinking water and basic sanitation. The Project is consistent with ADB’s water policy.

Rationale Yunnan provincial government and KMG have identified a priority list of investment projects covering water supply and wastewater management and environmental improvement projects that will help to improve the urban environment, reduce water pollution of reservoirs and lakes, and ensure long-term sustainable development in Kunming. In the medium term, a better quality and low-cost water supply source is needed to meet the projected water demand of Kunming. Without these measures, Kunming will have to revert to the use of the highly polluted water sources of Dianchi Lake with class V water quality. The polluted water source remains a threat to public health, apart from being costly to treat. ii

To support these developments, additional raw water supplies are required. The existing water supply, without using Dianchi Lake, is projected to be fully utilized within the existing city because of population growth and the related urban, commercial, and industrial development through to 2010 and beyond. The New Airport Development Zone (NADZ) is a new greenfield development area that has no substantial local water supply source. Because of topography, it can only be supplied with water from the existing city system by pumping, which is contrary to the expressed policy for energy saving. NADZ will be developed from 2007 onwards, to have a projected population of 70,000 in 2010 and 180,000 in 2020. Development of the East Development Zone (EDZ) has already started, but the provision of adequate water supply will soon be a significant constraint as the population grows to 390,000 by 2010, and 950,000 by 2020.

KMG has accorded priority in its 11th Five-Year Program to addressing water scarcity through policy reform, increased investment, and improved water and urban infrastructure management. KMG’s strategy focuses on (i) protecting drinking water sources by controlling upstream water pollution, industrial pollution, and other point and nonpoint sources in urban areas; (ii) support to watershed protection and management; (iii) introducing water and energy efficient technologies and operations; and (iv) using appropriate pricing mechanisms to encourage water conservation and generate the necessary funds for operation, maintenance, and investment. In line with the Government’s economic and enterprise reform programs, KMG has taken steps to ensure that water supply and wastewater projects are financially sustainable and capable of cost recovery.

The Project will address the critical water requirements of KMG beyond 2012. The Project will provide 111 million cubic meters (m3) of water annually to meet the demand of Kunming city, 104 million m3 for EDZ and NADZ, and 7 million m3 for Xundian County from 2012. In both zones, residents currently depend largely on water from springs and wells to supply water to their homes by village-level systems for domestic use.

Impact and Outcome The impact of the Project is improved urban environment, public health, and quality of life for urban residents of Kunming; and sustained economic development of the city through the provision of safe and reliable water supply. The outcome of the Project is the provision of more efficient, reliable, affordable, safe, and clean raw water supply; and effective protection and management of water resources in Kunming (contributing to the achievement of MDG 7, target 10).

Project Investment Plan The total project cost is estimated at $255.9 million equivalent, including taxes and duties.

iii

Financing Plan Amount ($ million Percent Source equivalent) Asian Development Bank 80.0 31.3 Kunming Municipal Government 76.8 30.0 Local Bank 99.1 38.7 Total 255.9 100.0 Source: Asian Development Bank estimates.

The Government has requested a loan of $80 million to finance about 31.3% of the total project cost. Provincial and municipal governments will provide equity equivalent to $76.8 million, or 30.0% of total project cost. The balance of $99.1 million (38.7%) will be provided by a domestic loan from the Agricultural Bank of China. The ADB loan will come from its ordinary capital resources. The loan will carry an interest rate to be determined in accordance with ADB’s London interbank offered rate for US dollar loans, a commitment charge of 0.35% per annum, and such other terms and conditions as set forth in the draft loan agreement. The loan will have a term of 25 years, including a grace period of 5 years.

Allocation and The Government of the PRC will relend the loan proceeds to Relending Terms Yunnan provincial government, which will onlend the loan proceeds to KMG, on the same terms and conditions as those of the ADB loan. The loan proceeds will then be onlent to Kunming Water Supply Group Company Limited (KWSG) on the same terms and conditions as those of the ADB loan.

Period of Utilization Until 30 June 2013

Estimated Project 31 December 2012 Completion Date

Implementation A project leading group (PLG) will be responsible for project Arrangements coordination, and will provide policy guidance during implementation. Headed by the vice mayor, the PLG will comprise representatives from municipal government agencies and county governments. The project management office (PMO) has been established within Kunming Development and Reform Commission. It will serve as the secretariat of the PLG and will be responsible for coordinating implementation of project activities.

Executing Agency Kunming Municipal Government

Procurement Goods and works will be procured in accordance with ADB's Procurement Guidelines (2007, as amended from time to time). Contracts for goods estimated to exceed $1.0 million and contracts for works estimated to exceed $10.0 million will be procured using international competitive bidding (ICB) procedures. Contracts for goods and contracts for works estimated to cost equal or less than

the ICB values, but more than $100,000, will be procured using national competitive bidding procedures in accordance with the PRC Tendering and Bidding Law, 1999, subject to clarifications agreed with ADB. Contracts for goods and works estimated to cost $100,000 or less will be procured using shopping procedures.

Consulting Services Provision has been made for about 18 person-months of international and 72 person-months of national consulting services, to be funded under the Project to support the PMO and implementing agency in project implementation and capacity development. A consulting firm will be recruited in accordance with ADB’s Guidelines on the Use of Consultants (2007, as amended from time to time). The consulting firm will be selected in accordance with the quality- and cost-based selection method using full technical proposal procedures. A fixed quality-cost ratio of 80:20 will be applied. The consulting services will cover (i) project management and construction supervision; (ii) improvement of financial management and setup of project performance management system; (iii) safeguards management and monitoring; (iv) corporate and business planning; (v) tariff review; (vi) dam and reservoir management, safety, and operation; (vii) online water quality monitoring; and (viii) development of public awareness training on water demand measures and social impact monitoring.

Project Benefits and The Project supports the achievement of the MDG for Beneficiaries environmental sustainability (Goal 7), which aims to halve the proportion of people without sustainable access to safe drinking water and basic sanitation by 2015 (target 10). The Project will directly benefit about 3.4 million people living in the project areas, of whom about 6.9% are poor. All the residents of Kunming will benefit indirectly, as their living conditions will improve as a result of (i) improved water quality and quantity; (ii) improved security of water supply, which will mean less likelihood of rationing in drought years; (iii) reduced use of polluted water sources; and (iv) reduced incidence of waterborne diseases and the associated reduction in medical costs. In addition, the Project will lead to employment creation during construction and operation of project facilities. Health benefits are expected to be felt disproportionately by women and children. Value-added features include supporting an enabling environment for the joint venture between KWSG and Veolia for water treatment and distribution in Kunming through ensuring KMG’s stricter enforcement of “one household, one meter” policy, and supporting KMG to move towards uniform nondomestic tariffs and to continue to monitor the price subsidies and lifeline tariff to cushion the impact of tariff increases on the poor. Further, the Project shall undertake corporate governance reform through the introduction of water users’ representative in the board of directors of KWSG, and improving managerial capacity of KWSG in dam/reservoir management, safety, and operation. The Project will implement capacity development of v

KWSG on financial management and project performance management system, safeguards management and monitoring, corporate and business planning, tariff review, dam and reservoir management, safety and operation, online water quality monitoring and public awareness on water demand measures, and social impact monitoring.

The Project will create employment for about 4,200 people in construction work each year for 5 years, and an additional 10,920 people will be employed annually in jobs created indirectly as a result of construction. It is estimated that at least 50% of the construction jobs will be unskilled, and the poor should benefit disproportionately from this job creation. The Project will contribute to the prevention of up to an estimated 1.5 million cases of waterborne diseases from 2013 to 2020, and the associated increase in median medical costs is estimated to be likely to rise from CNY18 to CNY30 per capita (at current values) by 2020. Health benefits are expected to be felt disproportionately by women since they are more at risk of waterborne diseases, and by children, who have least resistance to such diseases.

Risks and Assumptions The Project has no unusual technical risks. Conventional engineering designs with proven records of safety and reliability will be adopted for water storage and transfer (tunneling) systems. During project implementation, consultants and dam technical specialists will support the PMO and implementing agency to ensure that equipment and works comply with design requirements and quality standards. Further, the Yunnan Design and Research Institute is now undertaking substantive on-ground and subsurface surveys to quantify the potential risks more fully prior to finalizing the conveyance system alignment.

The following risks could affect timely implementation and economic viability, and reduce the intended benefits of the Project: (i) failure to implement the projects on water treatment and wastewater treatment plant capacity within the new development zones by the time of project completion/commissioning; (ii) failure of KMG to prevent groundwater use completely to utilize Qingshuihai water supply fully as soon as it becomes available (given the additional capital costs of Qingshuihai water, and if this will not be fully utilized, this would put pressure on tariffs to cover debt servicing); (iii) failure of KMG to increase tariffs to meet the cost recovery targets, considering the impact of comprehensive sector investments; and (iv) failure of KMG to undertake detailed studies and surveys on catchment areas and formulate regulations for the Project’s water resources protection.

Risk (i) will be mitigated through assurances from KMG on the provision of the water treatment and wastewater treatment plant capacities to coordinate with project implementation and commissioning. Risks (ii) and (iii) will be mitigated through

assurances from KMG on improving control and regulation of groundwater use, imposing additional charges on groundwater use in excess of water tariffs to discourage groundwater use, and regular tariff reviews and adjustments. Risk (iv) will be mitigated through assurance that KMG shall develop a pollution inventory, and establish a catchment modeling system, which will form the basis for prioritization of Qingshuihai reservoir protection options and development of an environmental monitoring program. Map 1

99o 00'E 104o 00'E

KUNMING QINGSHUIHAI WATER SUPPLY PROJECT IN THE PEOPLE'S REPUBLIC OF CHINA

X I Z A N G

S I C H U A N

Shuifu 28 o 00'N 28 o 00'N Maliuwang Zhongdian

Xinmin Lijiang

Jianchuan Heqing Huize Pangxieqing G U I Z H O U Shangcun Wase Hongshan Dali

Xiaguan Qujing Longyang KUNMING Lianghe Songming Chuxiong Shilin Anning Longling Lunan

Ruili R e Yuxi d Mile R G U A N G X I Y U N N A N iv e r Lincang Suo Long Si Luocunkou

R Kaiyuan Funing g Jianshui n Mengzi Yanshan o k e M Gejiu MYANMAR Pu'er Mohei Simao Jiangcheng

Hekou

o Xiaomengyang o 22 00'N VIET NAM 22 00'N

Mohan Project Area Provincial Capital LAO City/Town PEOPLE'S DEMOCRATIC REPUBLIC Major Expressway/Highway National Road N Existing Railway River Provincial Boundary 0 50 100 150 International Boundary Boundaries are not necessarily authoritative. Kilometers

99o 00'E 104o 00'E

07-2121a HR Map 2

KUNMING QINGSHUIHAI WATER SUPPLY PROJECT IN THE PEOPLE'S REPUBLIC OF CHINA

Jinsha River

i a

o Huize

j i a

i v

Dongchuan

r e v i R

r n e D a v l i a u R i b i N a a Z u i

h R K r a i e n v v e g i

r j R i u u

R d i u v P e r Shiqiao Tabizi Banqiao Qingshuihai Luquan Xintian Reservoir Wuding Xundian

Malong Songming

Fumin

er iv R Jinzhongshan Lake g n la g n Jinzhongshan a T KUNMING N Anning Chenggong Dianchi Lake Yangzonghai Lake 0 25 50 75 100

Kilometers

City County Seat Fuxian Lake Hydrologic Station Existing Stage Gauging Station Proposed Stage Gauging Station Existing Reservoir Proposed Reservoir Proposed Water Intake Diversion Line River

07-2121b HR Shiqiaohe Reservoir

Banqiaohe Reservoir Tabilzi Dragon Pool Xintianhe Reservoir Qingshuihai Reservoir XUNDIAN R. an Xundian KUNMING QINGSHUIHAI nti Xi WATER SUPPLY PROJECT IN THE PEOPLE'S REPUBLIC OF CHINA

Fenglongwan Xundian County Reservoir Songming County Provincial Capital County Spring Water Shangyou Water Transmission Channel Reservoir Supply Pipeline Dashitou Reservoir Reservoir Songming River SONGMING County Boundary Tongxin Gate City/District Boundary Dashiba Reservoir Niulan River Boundaries are not necessarily authoritative. Jinzhongshan Reservoir

Songhuaba Reservoir Xibeishahe Bajiacun Reservoir Reservoir New Airport Development Zone

Dongbeishahe Reservoir Baoxianghe Reservoir N 0 7

KUNMING M - 2 1 a 2 Dianchi Lake 1 East p c

Development H 3 R Zone

I. THE PROPOSAL

1. I submit for your approval the following report and recommendation on a proposed loan to the People’s Republic of China (PRC) for the Kunming Qingshuihai Water Supply Project.

2. In line with its long-term goals for the urban sector of improving living conditions, providing safe and reliable water supply, protecting water resources, and enhancing effective water demand management, the Government of the PRC (the Government) requested Asian Development Bank (ADB) assistance in implementing the water resource development project in Kunming. The Project is consistent with the PRC’s 11th Five-Year Program (FYP) (2006–2010), ADB’s water policy,1 and will help the PRC to achieve Millennium Development Goal (MDG) 7, target 10, which calls for halving, by 2015, the proportion of people without access to safe drinking water and improved sanitation. The design and monitoring framework is in Appendix 1.

II. RATIONALE: SECTOR PERFORMANCE, PROBLEMS, AND OPPORTUNITIES

A. Performance Indicators and Analysis

3. Since the PRC initiated market-oriented economic reforms in 1978, rapid urbanization has accompanied high levels of economic growth. The urban population has nearly tripled from about 190 million in 1980 to more than 560 million in 2005, and accounts for more than 43% of the national population. Urbanization increased 1.4% annually from 2001 to 2005 and it is projected that the urban population will reach 45% of the total population by 2010, 49% by 2015, and 55% by 2020. Urban growth and industrialization will considerably increase the need for water supply and sanitation services, and the investments required to provide these services. The growing need for basic urban services resulting from urban population increase, rapid industrialization, and economic development is increasingly constraining the physical and financial capacity of most cities to provide adequate water infrastructure for delivery of a clean and safe water supply.

4. Many cities are facing challenges related to managing resource scarcity and environmental concerns. Recognizing the impacts of rapid urbanization on the environment, the Government has supported environmentally sustainable development through policy and pricing reforms, increased investment, and improved urban infrastructure management. It continues to address critical water resources constraints and water supply facilities that limit development. The Government has emphasized the need for improvement in water resources management, demand management, and complementary investment in water-related infrastructure with increasing attention to water policy, planning, management, and conservation. These principles were included in the amended National Water Law, 2002; Law on Water and Soil Conservation, 1991; and Law on Prevention and Control of Water Pollution, 1996.2

5. Municipal water supply in PRC cities has increased steadily since 1990s, reaching a service coverage ratio of 64% in 2000 and 91% in 2005. Access to piped water supply in major cities is expected to reach 95% by 2010 and 100% in 2015 in accordance with MDG 7, target 10. However, these high service coverage rates do not reflect the water shortages occurring in most cities

1 ADB. 2001. Water for All: The Water Policy of the Asian Development Bank. Manila. 2 The National Water Law included the following basic principles: (i) water is a strategic resource and lifeline for social and economic development; (ii) the focus needs to be shifted from a construction orientation to a management orientation; (iii) conserve the quantity and maintain quality of water; (iv) optimize planning/allocation/use, conservation, and protection of water rather than maximum utilization; (v) combine structural and nonstructural measures; (vi) increase demand management, and not entirely depend on supply augmentation; (vii) treat water as an economic good and price it accordingly; (viii) establish a functioning water rights and discharge control system; (ix) people need to live in harmony with nature and not only exploit it; and (x) place more emphasis on comprehensive integrated water resources management. 2

caused by lack of good quality raw water, inefficiencies in water distribution, and inadequacy in wastewater management and treatment capacities. Currently, two thirds of all PRC cities do not have enough water all year round. Supply is not keeping pace with increasing demand caused by rapid urbanization, shortage of available water resources, increasing water pollution, and overextraction of groundwater acquifer. Hence, about 420 out of 651 municipalities have been classified “water short”, of which 110 municipalities have serious water problems and 14 municipalities are critically short of water.

6. The Government has identified the water sector as a priority since 2000 and recognizes the water issues confronting the sector—water shortages, flooding, and water pollution. To address water shortages, the Government has developed a strategy with focus on: (i) developing suitable water sources, (ii) protecting existing water resources by controlling point and nonpoint pollution, and (iii) effective water demand management. Overexploitation of groundwater and overuse of surface water has resulted in inadequate environmental flows along with groundwater and surface water pollution contributing to the decline of water resources. Watersheds and upper catchments have been degraded because of pressures from economic activities, resulting in deforestation and inadequate agricultural and soil management practices. The main challenges are to halt groundwater overexploitation and surface water overextraction, restrict and control pollution, increase the levels of flood protection, and stabilize watersheds. Without a concerted effort to improve water resources management, the damage to the environment will become irreversible, with a substantial negative impact on the quality of life of the people and the economy.

7. Kunming is the capital city; and the political, economic, and cultural center of Yunnan Province. The city covers a total land area of 21,111 square kilometers (km2) and had a total population of 5.08 million in 2005 with average annual growth of 6.5% during 2001–2005. In 2005, Kunming’s gross domestic product (GDP) reached CNY106.23 billion. Kunming is strategically located and is a focal point for the PRC’s regional development strategy in the southwestern provinces. In Kunming’s 11th Five-Year Plan (2006–2010), the strategy is for Kunming to become a regional hub and gateway for the PRC’s trade and cultural relations with the Association of Southeast Asian Nations (ASEAN) and Greater Mekong Subregion. Consequently, Kunming city is set for further rapid expansion. The current Kunming municipal government (KMG) urban development plan3 is centered on revitalization of the old city, with migration of government and education institutions to a new East Development Zone (EDZ) and the establishment of a New Airport Development Zone (NADZ).4 Kunming is urbanizing rapidly, and there is growing demand for urban and water infrastructure and services. This has taken its toll on the environment and water supply resources, and has challenged the capacity of KMG to promote good governance, effective planning and management, sustainable financing, and timely delivery of public services.

8. The planning and development of new water resources has not kept pace with rapid population and economic growth, particularly in Kunming which is declared a water shortage area. The lack of a cohesive water resources protection and demand management in Kunming, as well as widespread pollution, have caused the quality of current water sources to deteriorate to levels that make them unacceptable for further water use. Kunming’s major water sources, Dianchi Lake and Songhuaba reservoirs, are experiencing problems with upstream pollution. Dianchi Lake water

3 Summary of Modern New Kunming Water and Wastewater Master Plan; Medium Term Construction Plan for Kunming Main City, 2006–2010; Long Term Development Plan for Kunming New Airport Development Zone (NADZ), (2006– 2020). 4 EDZ is a new industrial and education zone, with an area of 107 square kilometers (km2) and population of 0.95 million. NADZ, with an area of 160 km2 and population of 0.40 million, is planned as the regional transport and air logistics hub to link Kunming with ASEAN countries and South Asia. 3 is class V5 and needs treatment to meet adequate drinking standards. Songhuaba reservoir is becoming polluted from agricultural pollutants, and the groundwater source is experiencing overextraction. Other reservoirs (Baoxianghe, Chaihe, Dahe, and Shalang) are inadequate to meet local water demand. Without significant investment in new water resources development and water resource protection and management, the quality of life for urban residents will decline, the urban environment will deteriorate, and the sustainability of economic development will be put at risk.

B. Analysis of Key Problems and Opportunities

9. Project Background. KMG is committed to the development and growth of Kunming as a regional economic and communications hub, with close links with member nations of ASEAN and the Greater Mekong Subregion. This growth will encourage further commercial activity and population increase, leading to an increase in overall water demand in Kunming city. Further, the NADZ and Chenggong EDZ, which are integral components of KMG’s “New Kunming” Master Plan through to 2030, also need secure and stable water supply.

10. With increased urbanization, industrialization, and concomitant water shortages, Kunming’s economy will be severely affected without the provision of additional water supply. Hence, KMG, since 1994, has identified and evaluated 14 water source alternatives, including the recently commissioned Zhangjiuhe Water Supply Project (Japan Bank for International Cooperation [JBIC] 2002–2007), as alternatives to using polluted water from Dianchi Lake. However, even with the Zhangjiuhe project, and after ceasing the use of Dianchi water, shortage is projected to occur in Kunming with the new development zones in 2010. KMG would prefer to avoid having to use the Dianchi water, which is class V and costly to treat to make it suitable for drinking. Further use will contribute to its further environmental decline, as it will reduce the thorough flow of water in the Lake. By 2010, Kunming will need additional water supply, sufficient for continued growth and development in the future. Among the alternatives evaluated, Kunming Qingshuihai Water Supply Project, which is gravity-fed and can provide class II water, will address Kunming’s water shortage by 2012 and is considered the least-cost option. An analysis of the water sector is in Appendix 2, and details are in Supplementary Appendix A.

11. Project Rationale. Yunnan provincial government (YPG) and KMG have identified a priority list of investment projects covering water supply and wastewater management and environmental improvement projects that will help to improve the urban environment, reduce water pollution of reservoirs and lakes, and ensure long-term sustainable development in Kunming. In the medium term, a better quality and low-cost water supply source is needed to meet the projected water demand of Kunming. Without these measures, Kunming will have to revert to the use of the highly polluted water sources of Dianchi Lake with class V water quality. The polluted water source remains a threat to public health apart from being costly to treat.

12. To support these development zones, additional raw water supplies are required. The existing water supply, without using Dianchi Lake, is projected to be fully utilized within the existing city because of population growth and the related urban, commercial, and industrial development through to 2010 and beyond. The NADZ is a new greenfield development area that has no substantial local water supply source. Because of topography, it can only be supplied with water from the existing city system by pumping, which is contrary to the expressed policy for energy saving. The NADZ will be developed from 2007 onwards, to have a projected population of 70,000

5 The PRC environmental quality standards have five classes for surface water quality based on their use. Class I is the best in quality and class V is the worst. Class I is for water resources and nationally protected water bodies. Class II is for high-value fish protection areas, class A protection areas, and spawning habitats for fish. Class I, II, and III can be used for potable water resources. Class IV is for general industrial water sources and noncontact recreational areas. Class V is suitable only for agricultural use.

in 2010 and 180,000 in 2020. Development of the EDZ has already started, but the provision of adequate water supply will soon be a significant constraint as the population grows to 390,000 by 2010, and 950,000 by 2020.

13. The KMG has accorded priority in its 11th Five-Year Plan to addressing water scarcity through policy reform, increased investment, and improved water and urban infrastructure management. KMG’s strategy focuses on (i) protecting drinking water sources by controlling upstream water pollution, industrial pollution, and other point and nonpoint sources in urban areas; (ii) support to watershed protection and management; (iii) introducing water and energy efficient technologies and operations; and (iv) using appropriate pricing mechanisms to encourage water conservation and generate the necessary funds for operation, maintenance, and investment. In line with the Government’s economic and enterprise reform programs, KMG has taken steps to ensure that water supply and wastewater projects are financially sustainable and capable of cost recovery.

14. The Project will address the critical water requirements of KMG beyond 2012. The Project will provide 104 million cubic meters (m3) of water to meet the demand of Kunming city EDZ and NADZ, and 7 million m3 for Xundian County from 2012. In both zones, residents currently depend largely on water from springs and wells to supply water to their homes by village-level systems for domestic use.

15. To address water scarcity and achieve the water recycling rate of 20% for Kunming to be declared a National Water Conservation City by 2020,6 KMG is implementing multiple and cross- sectoral interventions. These include (i) promoting appropriate technologies for water delivery, conservation, reuse, pollution control, domestic and industrial recycling, and rainwater use; (ii) further reduction and eventual restriction on the use of groundwater; (iii) innovative educational means to motivate present and future users to monitor consumption and conserve water; and (iv) formulating regulations concerning the monitoring and management of surface and groundwater, pollution control in water bodies, and incentives for wastewater reuse. It is currently implementing the “one household, one meter” policy, which will enable Kunming Water Supply Group Company Limited (KWSG) to reduce non-revenue water from 38% to 20% by 2015.

16. Policy Dialogue. Building on policy dialogue with the PRC under previous ADB-funded urban development projects, the Project will engage in policy dialogue with KMG in several key areas: (i) cost recovery and tariff reforms; (ii) sustainable integrated water resources development, protection, and environmental management; (iii) integrated water resources and water demand management; (iv) regulatory enforcement and monitoring for environmental management; (v) corporate governance and enterprise reform; and (vi) private sector participation (PSP). KMG has endorsed medium- and long-term water supply strategies, and developed master plans and environmental management programs, including measures on the prevention and control of point and nonpoint pollution on water bodies. These plans and programs are formulated to ensure sustainable economic development without jeopardizing the environment and living conditions in Kunming.

17. Supporting an integrated approach to urban development and environmental management has been a key element of ADB’s policy dialogue and operational activities. Policy dialogue on key reforms is a significant aspect of ADB’s operations in the PRC, and ADB has supported the tariff reform process through three technical assistance (TA) projects which have contributed

6 The overall targets for the city’s development are for Kunming to become a National Garden City, a Model City for Environmental Protection, a National Sanitary City, and a Green Kunming. 5

significantly to water and wastewater tariff reforms and resources conservation. 7 The tariff guidelines include tariff calculation methodologies that will allow full cost recovery, taking into consideration affordability and social constraints. Further, ADB provided TA support to strengthen policy reform on the use of market-based instruments to enhance PSP in public utilities, and a TA to support the water utilities in Nanjing to develop sustainable access to the private long-term capital finance market sector.8

18. Kunming is very advanced in incentive and regulatory structures related to tariffs. The present tariff setting mechanism adheres to full cost recovery, and provides a subsidized lifeline tariff to the poor up to 6 m3/month and raw water fee made up of a water resource fee of CNY0.23/m3 and a water management fee of CNY0.20/m3. The raw water fee is levied on water supplied to the water treatment plant. The water resource fee is used to support compensation to affected persons (APs) in the watershed, where adopting environment-friendly farming practices would lead to loss of income. The water management fee of CNY0.20/m3 is transferred to the reservoir operator to cover operation and maintenance (O&M), water quality monitoring, and sedimentation control measures to ensure sustainability. The Project will support KMG’s timely implementation of required tariff increases based on the sector’s real cost requirements.

19. KMG has taken significant steps towards PSP through a joint venture (JV) agreement between its subsidiary, Kunming CGE Water Supply Company (with 51% equity), and Veolia (49%) equity. The key objective is to improve operational efficiency and service provision in (i) maintaining drinking water quality to national standards through introduction of new water treatment technology; (ii) improving technical and operational efficiency by reducing non-revenue water, metering, increasing connections, and a leakage reduction program; (iii) improved customer service focus; and (iv) improved managerial capacity in financial management, business planning, and management information system development. The Project will support KMG to provide an enabling environment for the JV, including tariff reforms and regulation, ensuring timely implementation of required tariff increases based on meeting efficiency targets and service standards, and strict enforcement of the “one household, one meter” policy to promote water conservation and effectively reduce system losses. In addition, groundwater licensing and use will be phased out in Kunming by 2012, once Qingshuihai water becomes available.

20. The management of water resources and catchment protection in Kunming is currently governed by regulations on pollution control in and around the reservoirs. KMG undertakes multi- level and cross-sectoral consultations, detailed surveys, and consensus-building prior to drafting water protection regulations specific to each reservoir. Policy dialogue on developing a watershed management plan has been initiated during project preparation and it was agreed that the Government will inform ADB on the progress of developing and implementing the plan. To ensure a more rational allocation and sustainable development of water resources, KMG will explore the scope for overall water management administration—integrating water resources, urban and rural water supply, water usage, wastewater management, and water conservation programs, and institutional arrangements between and among the municipal and county level agencies. The policy dialogue is in Supplementary Appendix B.

7 ADB. 1997. Technical Assistance to the People’s Republic of China for Water Tariff Study. Manila; ADB. 1999. Technical Assistance to the People’s Republic of China for Water Tariff Study II. Manila; and ADB. 2001. Technical Assistance to the People’s Republic of China for National Guidelines on Urban Wastewater Tariff and Management Study. Manila. 8 ADB. 2003. Technical Assistance to the People’s Republic of China for Policy Reform Support. Manila; and ADB. 2005. Technical Assistance to the People’s Republic of China for the Nanjing Water Utility Long-Term Capital Finance in Commercial Markets. Manila.

21. External Assistance. External assistance to KMG in developing and implementing its water supply and environmental infrastructure has come mainly from the World Bank and JBIC. The Project will be the first ADB-financed project in Kunming. Since 1992, ADB has provided 23 loans to the PRC, totalling $2.639 billion for urban development and environment projects. ADB has also provided about $44.1 million for more than 67 TAs to prepare projects—to review and study key issues in water resources management, urban water supply, wastewater treatment, pollution control, and urban transport. The external assistance is in Appendix 3.

22. Lessons. Lessons from ADB’s experience in the water sector were considered in policy dialogue with the Government, engineering design of the project facilities, and capacity development programs. Lessons from previous projects in Kunming city and Yunnan Province were also considered. One of the most important lessons is the need for integration of strategic master plans with the overall cross-sectoral issues on water, urban, and environment rather than as stand-alone distinct documents. Since the Project covers water supply, extensive policy dialogue is needed with the Government on linking the water supply master plan with the Kunming city master plan with its infrastructure plans on water resource protection and management, wastewater, and the master plans on the new development zones. The Project conforms with the above master plans. A second lesson is the importance of cost recovery and tariff reform. These were discussed as part of the policy dialogue and it was agreed that the review of tariffs should include operational efficiency targets, include support to water resource protection and management, discourage groundwater use, and promote water conservation and reuse. KMG’s existing tariff setting has established a cost recovery mechanism in ensuring proper protection and management of existing and future water resources. 9 A third lesson is that increased public awareness is one of the most effective measures to improve the sector’s performance and urban environment. In view of this, KMG will embark on a comprehensive multimedia public awareness campaign on water metering, conservation, reuse, and effective environment protection and management. Further support is needed to ensure strict enforcement of metering to reduce water losses by users. A lesson related to resettlement is the need for the establishment of an effective internal and external monitoring mechanism of resettlement implementation by resettlement agencies. Municipal and county-level arrangements for monitoring and evaluation have been fully incorporated in the resettlement plans (RPs).

23. A recent review of the water supply, sanitation, and waste management sector undertaken in the PRC, identified success and deficiencies, and lessons from portfolio performance.10 Among the major issues identified were delays in the startup of projects and in procurement, and weak institutional arrangements for project implementation and sustainable operations. These issues have been reviewed in detail during project preparation and the lessons have been incorporated in the project design. Implementation arrangements have been strengthened within KMG, the project management office (PMO), and the Implementing Agency (KWSG). Clear roles and responsibilities and effective coordination between provincial, municipal, and county level governments are in place to ensure smooth domestic processing, approval, and project implementation.

9 Part of the tariff is the raw water fee (currently CNY0.43/m3). Part of this fee (CNY0.20/m3) is allocated for water resource protection, which is used in compensating the local farmers on shifting to organic farming and environment- friendly farming practices. Municipal, county, and village programs are coordinated mainly between the Agriculture, Forestry, and Water Resources Bureaus. Historically, any shortfall in funding has been provided by Kunming Finance Bureau and YPG. 10 ADB. 2005. People’s Republic of China: Water Supply, Sanitation and Waste Management Portfolio Performance Review. Manila (Final Report, July). 7

III. THE PROPOSED PROJECT

A. Impact and Outcome

24. The impact of the Project is improved urban environment, public health, and quality of life for urban residents of Kunming; and sustained economic development of the city, through the provision of safe and reliable water supply. The outcome of the Project is the provision of more efficient, reliable, affordable, safe, and clean raw water supply; and effective protection and management of water resources in Kunming (contributing to the achievement of MDG 7, target 10).

B. Outputs

25. The Project consists of three components, broken down into 12 subcomponents and 40 activities, which provide fundamental support to Kunming’s 11th FYP and beyond. The three components are (i) water resources development, (ii) water conveyance systems, and (iii) capacity development and project management. Details are in Appendix 4 and Supplementary Appendix C.

26. Water Resources Development. This component will (i) increase water inflow to and perennial storage in the existing natural Qingshuihai water storage and distribution facilities (34 km2) and (ii) construct Qingshuihai and Jinzhongshan reservoirs. Transit dams and reservoirs will be constructed to store water in Qingshuihai reservoir from the four surrounding catchments temporarily (Banqiaohe, Shiqiaohe, Xintianhe, and Tabizi Longtan Springs). From Qingshuihai, water will be transferred as a steady flow to Jinzhongshan reservoir. With the Project, the quality of raw water will be maintained at class II and will serve about 30% of domestic water and other nonindustrial demands in Kunming in 2012; a sustained level of 24-hour water service and quality, and prevention of subsequent shortages in Kunming urban area as demand increases; and improved overall public satisfaction with water supply services.

27. Water Conveyance Systems. This component will take water from Qingshuihai under gravity which is energy efficient, to NADZ and Kunming through Jinzhongshan water storage and distribution facilities, and to the EDZ through Songhuaba reservoir. The conveyance works which is about 72.8 kms comprise: (i) 12.5 km of tunnel and other structures between Shiqiaohe reservoir to Qingshuihai; (ii) 4.0 km of tunnel and other structures between Banqiaohe reservoir to Qingshuihai; (iii) 50.78 km of tunnel and other structures from Qingshuihai to Jinzhongshan, with 43.1 km to Tongxin Gate (where the flow can be divided or directed to either Jinzhongshan and/or Songhuaba reservoirs) and 6.9 km from Tongxin Gate to Jinzhongshan; and (iv) rehabilitation of 5.7 km of channel from Tabizi Longtan to Qingshuihai.

28. Capacity Development and Project Management. This component will ensure that the PMO, KWSG, and other stakeholders are able to implement the Project effectively and manage the project facilities. This component will include project management consulting services, capacity development, and various trainings during Project implementation. Capacity development will strengthen the capacity of the implementing agency (IA) to ensure proper and sustainable operation, management, and maintenance of the water storage facilities and conveyance works. Further, focus is on enhanced operational efficiency and financial sustainability and compliance with all relevant national policies for cost recovery and enterprise reforms of the water supply sector, and linking with different agencies and institutions on proper water resource protection and environmental management. The component will include (i) project management and construction supervision; (ii) improvement of financial management and setup of project performance monitoring system (PPMS); (iii) safeguards management and monitoring; (iv) corporate and business planning; (v) tariff review; (vi) dam and reservoir management, operation, and safety; (vii)

online water quality monitoring; and (viii) development of public awareness training on water demand measures and social impact monitoring.

C. Special Features

29. The Project is the first ADB-financed project in Kunming, and aims to support ongoing integration of water sector management policy and strategic reforms to ensure Kunming’s long- term sustainable growth. The Project builds on and advances ADB policy dialogue and initiatives with the Government in several key areas, including: (i) cost recovery and tariff reform, (ii) pro-poor features, (iii) corporate governance reform, and (iv) PSP. The Project has been designed to continue supporting KMG in creating an enabling environment to ensure the success of its current public-private partnership through tariff reform, strict enforcement of groundwater use restriction, enforcement of metering, and improved corporate governance.

30. Cost Recovery and Tariff Reform. The current tariff structure is well established and provides a strong foundation for project sustainability. It includes mechanisms to (i) ensure financial sustainability and full cost recovery; (ii) provide the poor with access to water through a lifeline block tariff; (iii) promote economic efficiency by adopting a progressive tariff structure; and (iv) meet the social objective of affordability, with households meeting their basic water needs at an affordable price. Tariffs meet the full cost recovery of O&M cost plus depreciation of water supply operations (treatment and distribution) and related water resources development, reservoir management, water source protection, reasonable return to the JV operator, and provision for debt service of all water supply sector loans. 11 The tariff structure allows transparent and administratively efficient charging where the amount charged to each type of customer is easily calculated and billed. Any application for tariff increase by KWSG is reviewed by KMG and approved by YPG, and is based on reasonable grounds of increase in costs and meeting efficiency standards. The financial sustainability of water resource investments is assured through water resource and water management fees which cover the costs of reservoir operations and management and catchment protection; and channeling to reservoir operators is transparent and efficient. The Project will support further tariff reform by (i) assisting KWSG to undertake annual reviews of tariffs to ensure full recovery of O&M cost; (ii) policy dialogue with KMG, to move gradually towards equalization of nondomestic tariffs for industries and commercial users earliest by 2012 to promote water conservation and efficiency; and (iii) monitoring timely tariff increases.

31. Pro-Poor Features. The Project will benefit approximately 3.4 million people, of whom 6.9% are classified poor. It incorporates several features to ensure that the poor, women, and vulnerable groups benefit from investments under the Project, including (i) a strong focus on health impacts, which are expected to benefit women and children disproportionately; (ii) support for continued provision of price subsidies and lifeline tariffs to contribute to cushioning the impact of tariff increases on the poor; and (iii) support for KMG’s cross-sectoral water source protection programs to ensure that communities take ownership of environmental protection.

32. Corporate Governance Reform. The Project will support corporate governance reform of KWSG through: (i) introduction of a water users’ representative on KWSG’s board of directors— providing a greater understanding of water supply and distribution issues in the community, ensuring improved accountability, improved services, and stakeholders’ welfare; (ii) further improvement in the billing and collection and reduction in accounts receivables through full metering of households; (iii) improving the managerial capacity of KWSG in dam and reservoir management, operation, and safety; and online water quality monitoring, which is a new

11 These include World Bank and JBIC loans for water treatment plants, Zhangjuhe reservoir, and water treatment plant no. 7. 9

undertaking for the company; and (iv) enhancing the capacity of KWSG in corporate and business planning functions to coordinate closely with the JV in investment planning and system improvements. There is an assurance for undertaking corporate governance reforms, and this will be supported through consulting services during project implementation. Further, UN-Habitat will provide grant financing to assist KMG in capacity building to (i) implement water conservation and demand management measures, including tariff review; (ii) develop community-based water and sanitation services in poorer areas in Songhuaba reservoir; and (iii) develop human value based sanitation and hygiene education among water users in Kunming.12

33. Private Sector Participation. KWSG has an operating PSP arrangement in the form of a JV between a KWSG subsidiary and Veolia (para. 19) to ensure the efficient provision of safe and secure water supply to the growing urban population of Kunming. The Project will support the enabling environment for the successful operation of the JV through (i) continued tariff reform and regulation, (ii) ensuring that tariff increases are based on meeting efficiency targets and service standards, and (iii) the enforcement of the “one household, one meter” policy.

D. Project Investment Plan

34. The total project cost is estimated at $255.94 million equivalent, including taxes and duties. Table 1 provides a summary of the project investment plan, and details are in Appendix 5 and Supplementary Appendix D.

Table 1: Project Investment Plan ($ million) Item Total Costa A. Base Costb 1. Water Resources Development 55.74 2. Water Conveyance Systems 113.27 3. Capacity Development and Project Managementc 23.58 Subtotal (A) 192.59 B. Contingencies 1. Physical Contingenciesd 18.66 2. Price Contingenciese 11.39 Subtotal (B) 30.05 C. Financial Charges During Implementationf 33.30 Total (A+B+C) 255.94 a Includes taxes and duties of $10.0 million before contingencies. b In May 2007 prices, with an exchange rate of CNY7.6 to $1.0. c Includes construction management, research and design, environmental monitoring, project management, and capacity development. The training and consulting services budget currently estimated at $1 million may be adjusted based on needs during project implementation. d Physical contingencies computed at 10% for civil works, equipment, and land acquisition and resettlement; and 10% for capacity development and consulting services; and 6% for environment protection. e Price contingencies computed by year and expenditure type based on cumulative domestic and foreign price inflation. Exchange rate fluctuations are estimated using a purchasing power parity model of adjustment. f Includes interest during construction and commitment charges for Asian Development Bank (ADB) and domestic loan. Interest during construction for ADB loan has been computed at the 5-year forward London interbank offered rate plus a spread of 0.6%. Note: Totals may not be exact because of rounding. Source: ADB estimates.

12 UN Habitat will identify the scope of grant financing in coordination with KMG; and ADB’s Energy, Transport and Water Division (RSID) and East Asia Department (EARD).

E. Financing Plan

35. The Government has requested a loan of $80 million to finance about 31.3% of the total project cost of $255.94 million. The proceeds of the ADB loan will be used to finance civil works, equipment, and consulting services. Provincial and municipal governments will provide equity equivalent to $76.8 million or 30% of the total project cost. The balance of $99.1 million, or 38.7%, will be provided by a domestic loan from the Agricultural Bank of China. The loan will carry an interest rate of 6.5%, a term of 15 years, including a grace period of 5 years. Both the municipal government and the Agricultural Bank of China have provided commitment letters confirming the availability of the domestic loans and equity funding. The equity injection by KMG would represent about 0.4% of annual expenditure over 2008 to 2012 (Appendix 12, para. 14).

36. The ADB loan will come from its ordinary capital resources. The loan will carry an interest rate to be determined in accordance with ADB’s London interbank offered rate (LIBOR) for US dollar loans, an annual commitment charge of 0.35%, and such other terms and conditions set forth in the draft Loan Agreement. The loan will have a term of 25 years, including a grace period of 5 years. The financing plan for the Project is summarized in Table 2 and detailed in Appendix 5. Disbursements for eligible expenditures will be made based on different ratios specified for each cost category.

Table 2: Financing Plan ($ million) Source Total Costs % A. Asian Development Bank 80.00 31.3 B. Kunming Municipal Government 76.80 30.0 C. Local Bank 99.14 38.7 Total 255.94 100.0 Source: Asian Development Bank estimates.

37. The Government has provided ADB with (i) the reasons for its decision to borrow under ADB’s LIBOR-based lending facility on the basis of these terms and conditions, and (ii) an undertaking that these choices were its own independent decision and not made in reliance on any communication or advice from ADB. The Government will relend the loan proceeds to YPG, which will onlend the loan proceeds to KMG on the same terms and conditions as those of the ADB loan. The loan proceeds will then be onlent to KWSG on the same terms and conditions as those of the ADB loan. KWSG will assume the foreign exchange and interest rate variation risks for the ADB loan. The flow of funds and onlending arrangements are in Appendix 6.

F. Implementation Arrangements

1. Project Management

38. KMG will be the Executing Agency for the Project. The project leading group (PLG) will be responsible for project coordination, and will provide policy guidance during implementation. Headed by the vice mayor, the PLG will comprise representatives of the Kunming Financial Bureau, Kunming Development Reform Commission, related agencies, and county governments.13 The PLG will meet as required and will be maintained until project completion.

13 Related agencies include the Construction, Environment Protection, Land and Resources, Planning, Public Utility, and Resettlement Bureaus, NADZ Management Commission, Forest Administration Bureau, Lake Dianchi Investment Company, and Kunming Drainage Company. County governments are Songming and Xundian County, and Guandu district. 11

39. The PMO has been established within Kunming Development and Reform Commission. It will serve as the secretariat of the PLG and will be responsible for coordinating the implementation of project activities. The PMO will (i) ensure adequate interdepartmental cooperation and interagency coordination, (ii) monitor the progress of project implementation, and (iii) coordinate communication and interaction among ADB, KWSG and agencies concerned. The IA is KWSG, which is a limited liability company incorporated under the PRC company law, 2004. The KWSG will be responsible for operating and managing project facilities, direct day-to-day Project management, construction supervision, preparing progress reports to the PMO for submission to ADB, and planning strategic direction of water supply and management services and operations. KWSG is well organized, with experience implementing World Bank and JBIC loan projects. A project implementation unit has been established in the KWSG and is responsible for undertaking detailed implementation activities. The project organization is in Appendix 7. The internal controls and accounting and auditing procedures of KWSG were reviewed through a financial management assessment; these are generally in order and will be fully functional and available for use for the construction and operational phase of the Project. The financial management assessment is summarized in Appendix 12 and presented in Supplementary Appendix L. An assessment was undertaken of KWSG’s technical and institutional capacities, which are adequate for project implementation. KWSG will retain the services of design institutes, procurement agencies, and construction supervision companies to assist in implementation activities. The PMO and KWSG will have a number of their staff trained in project management and relevant ADB procedures during project implementation.

2. Implementation Period

40. The Project will be implemented over 5 years from 2008 to 2012 (Appendix 8).14 This schedule is considered realistic and achievable, because the project implementation structure and arrangements are already in place and preparatory works are under way. The detailed implementation plan is in Supplementary Appendix E.

3. Procurement

41. Goods and works will be procured in accordance with ADB's Procurement Guidelines (2007, as amended from time to time). Contracts for goods estimated to exceed $1.0 million and contracts for works estimated to exceed $10.0 million will be procured using international competitive bidding (ICB) procedures. Contracts for goods and contracts for works estimated to cost equal or less than the ICB values, but more than $100,000, will be procured using national competitive bidding (NCB) procedures in accordance with the PRC Tendering and Bidding Law, 1999, subject to clarifications agreed with ADB. Contracts for goods and works estimated to cost $100,000 or less will be procured using shopping procedures.15 The procurement plan is in Appendix 9.

4. Consulting Services

42. Provision has been made for about 18 person-months of international and 72 person- months of national consulting services to be funded under the Project to support the PMO and IA in project implementation and capacity development. A consulting firm will be recruited in accordance with ADB’s Guidelines on the Use of Consultants (2007, as amended from time to time). The consulting firm will be selected in accordance with the quality- and cost-based selection method using full technical proposal procedures. A fixed quality cost ratio of 80:20 will be applied. The consulting services will cover (i) project management and construction supervision; (ii)

14 Preparatory works such as detailed designs, land acquisition, and resettlement are scheduled in late 2007. 15 ADB will require KMG to use ADB-approved standard bidding documents (to be developed as necessary) to ensure high quality and consistency of the documents to facilitate ADB review.

improvement of financial management and setup of PPMS; (iii) safeguards management and monitoring; (iv) corporate and business planning; (v) tariff review; (vi) dam and reservoir management, operation, and safety; (vii) online water quality monitoring; and (viii) development of public awareness training on water demand measures and social impact monitoring. The PMO will initiate advance action for the recruitment of consultants, including short-listing of qualified consultants. Detailed institutional analysis is in Supplementary Appendix F, and the outline terms of reference for consulting services are in Supplementary Appendix G.

5. Advance Contracting and Retroactive Financing

43. To expedite project implementation, the Government requested ADB to approve advance contracting, which includes recruitment of consultants and procurement of goods and civil works; and the request for retroactive financing of eligible expenditures for civil works and equipment for site preparation and construction up to $8 million (equivalent to 10% of the ADB loan) to be incurred prior to loan effectiveness but not earlier than a maximum of 12 months before signing of the Loan Agreement. 16 Advance contracting will include (i) prequalification of contractors, tendering, and bid evaluation for civil works contract packages; (ii) preparation of tender documents for the procurement of materials and equipment; (iii) award of contracts; and (iv) recruitment of consultants. The issuance of invitations to bid under advance procurement action will be subject to ADB approval. All advance procurement actions will be undertaken in accordance with ADB’s Procurement Guidelines or Guidelines on the Use of Consultants. The Government has been advised that approval of advance contracting and retroactive financing does not commit ADB to finance the Project.

6. Disbursement Arrangements

44. The loan proceeds will be disbursed in accordance with ADB’s Loan Disbursement Handbook (2007, as amended from time to time). To facilitate project implementation and funds flow, an imprest account will be set up upon loan effectiveness and will be exclusively used to finance ADB’s share of eligible expenditures. The initial advance to be deposited to an imprest account will not exceed either 6 months of estimated expenditures or 10% of the loan amount, whichever is lower. The direct payment procedures will apply for the large work contracts. If the Government initially funds eligible expenditures from its own resources, the reimbursement procedures will be used. To expedite funds flow and simplify documentation process, the statement of expenditures procedure will be used for liquidation and replenishment of imprest account and reimbursement of eligible expenditures not exceeding $200,000 per individual payment. Payments in excess of the statement of expenditures procedure ceiling will be reimbursed, liquidated, or replenished based on full supporting documentation process. 17 The imprest account will be opened and managed by Yunnan Provincial Finance Bureau on behalf of YPG at a commercial bank acceptable to ADB.

7. Accounting, Auditing, and Reporting

45. The PMO will prepare semiannual progress reports indicating progress made, problems encountered during the period under review, steps taken or proposed to remedy the problems, proposed program of activities, and progress expected in the next half year. The IA will keep records to identify goods and services financed from the loan proceeds, and follow accounting principles and practices prescribed by the Accounting Law of the PRC, 2000. The law requires

16 The advance action for the procurement and recruitment of consultants, and the uploading of the general procurement notice on the ADB website, will facilitate the start of the advance action process. 17 In line with adequate financial capability of the Executing Agency/IA based on the financial management assessment, the ceiling of the statement of expenditures is identified at a higher level to facilitate disbursement. 13 enterprises to prepare financial statements and generally follow internationally accepted accounting standards. The IA will maintain separate project accounts and records. The financial statements of the project accounts and the annual corporate financial statements for the IA will be subject to audit by KMG Audit Bureau, Yunnan Provincial Audit Bureau, and State Audit Administration. The audits will be carried out in accordance with regulations for auditing approved by the State Council and will meet ADB requirements. A separate auditor’s opinion on the use of the imprest account and statement of expenditures procedure will be part of the audit reports. The IA’s annual audited financial statements and audited project accounts will be submitted to ADB no later than 6 months after the end of the fiscal year for the entire implementation period.18 YPG and KMG were informed of ADB’s policy requiring the submission of audited financial statements on time. YPG, KMG, and the IA will submit audited financial statements and reports to ADB concerning the use of the loan proceeds, project implementation, and IA performance. These reports will include (i) semiannual progress reports on project implementation; (ii) annual reports; and (iii) a project completion report, not later than 6 months after completion of the Project.

8. Project Performance Monitoring and Evaluation

46. The PPMS indicators include (i) quantity of clean water provided, (ii) improvements in management arrangements for project facilities, (iii) adoption of least-cost project designs, (iv) enforcement of environmental regulations, (v) strengthening of water sector governance, and (vi) improved management capacity for water supply. The relevance and practicability of data collection for indicators was confirmed with the PMO.

47. At the start of project implementation, the PMO and IA, with the assistance of consultants, will develop comprehensive PPMS procedures to generate data systematically on the inputs and outputs of the project components, as well as the agreed socioeconomic, environmental, and health indicators to be used to measure project impacts. A set of indicators for monitoring the future performance of the project facilities will be designed by the loan implementation consultants before the start of operations. The PMO and IA will (i) refine the PPMS framework, (ii) confirm achievable targets, (iii) firm up monitoring and recording arrangements, and (iv) establish systems and procedures no later than 6 months after project inception.

48. Under the PPMS framework, baseline and progress data will be reported at the required time intervals by the IA, including semiannual reporting of the environmental management plan (EMP). The PMO will be responsible for analyzing and consolidating the data through its management information system that will be established at the time of loan implementation. The PPMS will be designed to permit adequate flexibility to adopt remedial action for project design, schedule, activities, and development impacts. The PMO, with the assistance of the consultants, will monitor and assess activities, and report to ADB on a semiannual basis on the physical implementation and financial aspects of the Project from start of project implementation to 2 years after project completion to ensure that impacts are monitored and reported in line with ADB requirements.

9. Governance and Anticorruption Measures

49. ADB’s Anticorruption Policy (1998, as amended to date) was explained to and discussed with the Government, KMG and IA. Consistent with its commitment to good governance, accountability, and transparency, ADB reserves the right to investigate, directly or through its agents, any alleged corrupt, fraudulent, collusive, or coercive practices relating to the Project. To

18 The IA now has three tiers of audit: (i) internal audit, (ii) municipal government audit, and (iii) provincial and state government audit.

support these efforts, relevant provisions of ADB’s Anticorruption Policy are included in the loan covenants and bidding documents for the Project. In particular, all contracts financed by ADB in connection with the Project shall include provisions specifying the right of ADB to audit and examine the records and accounts of KMG, IA, and all contractors, suppliers, consultants, and other service providers as they relate to the Project. For the Project, KMG and IA will undertake the following anticorruption actions: (i) involve full-time officials from assigned relevant bureaus to investigate corrupt practices in bidding and construction to enhance construction quality control and supervise effective work; (ii) introduce a dual-signing system in which the civil works contract winner also signs an anticorruption contract with the employer; (iii) periodically inspect the contractor’s activities related to fund withdrawals and settlements; (iv) engage the project management consultant to support the PMO and IA to ensure good governance, accountability, and transparency in project operations; and (v) in consultation with relevant central government ministries, update rules and regulations on local and corporate governance and anticorruption, and enhance the transparency of IA operations. Specific governance actions will be undertaken related to financial control and management, performance audits, public disclosure of financial statements, and any proposed tariff increases on the project website.

10. Project Review

50. ADB, the Government, YPG, KMG and IA will review project implementation jointly at least once a year and will undertake a comprehensive midterm review 2 years after the start of project implementation. This review will include detailed evaluation of the scope, implementation arrangements, resettlement, achievement of scheduled targets, and progress on the agenda for policy reform and capacity development measures. Feedback from the PPMS activities will be analyzed.

IV. PROJECT BENEFITS, IMPACTS, ASSUMPTIONS, AND RISKS

A. Benefits and Impacts

51. The Project will directly benefit about 3.4 million people living in the project areas, of whom about 6.9% are poor. All residents of Kunming will benefit indirectly, as their living conditions will improve as a result of (i) improved water quality and quantity; (ii) improved security of water supply, which will mean less likelihood of rationing in drought years; (iii) reduced use of polluted water sources; and (iv) reduced incidence of waterborne diseases and the associated reduction in medical costs. In addition, the Project will lead to employment creation during construction and operation of project facilities. Health benefits are expected to be felt disproportionately by women and children.

B. Social Dimensions

52. Land Acquisition and Resettlement. Land acquisition and house demolition will impact on local residents at the reservoir inundation areas, and where infrastructure will have to be constructed—mainly the dam and diversion complex, water conveyance routes, and permanent access roads. In total, about 5,571.2 mu of land will be permanently acquired for the Project, including 2,619.4 mu of farmland and 2,214.0 mu of woodland. Some structures will have to be demolished, including 56,633.9 square meters (m2) of residential houses and 7,080.93 m2 of nonresidential buildings. In total, 177 households (702 APs) will be permanently affected by land acquisition and 492 households (2,093 APs) will be affected by house demolition. In addition, 2,114.3 mu of land will be occupied temporarily, including 627.0 mu of farmland and 1,260.2 mu of woodland. Based on recent estimates, temporary land acquisition will affect 103 households (385 APs). All households affected by land acquisition and house demolition will be compensated 15 at replacement costs for their assets and will receive other allowances for relocation and income restoration. Households suffering from house demolition will be relocated within their existing villages. Land acquisition, resettlement, and all associated costs are estimated at CNY185.68 million, which is equivalent to 10.2% of the total project costs. The summary RP is in Appendix 10. KMG has complied with the ADB full disclosure policy for resettlement activities. KWSG will construct and upgrade water and wastewater treatment plants (WWTPs) and lay the water distribution networks, which would entail land acquisition and resettlement impacts.19 An RP will be prepared for these facilities based on the agreed resettlement framework (Supplementary Appendix H) during implementation of the Project.

53. ADB requires resettlement monitoring and evaluation of APs during implementation. The PMO will retain the services of a national external monitor for this purpose. The external monitor will visit the subcomponents every 6 months to (i) review resettlement progress and the general welfare of those affected, (ii) make recommendations to resolve any issues or problems, (iii) provide advice to the IA and local officials, (iv) evaluate the results through annual survey updates for 2 years after completion of resettlement, and (v) prepare a summary of the final resettlement audit for the Project to be provided to ADB. The external monitor will pay special attention to vulnerable groups, including women and the poor, to assess whether they have fully regained their standard of living. Monitoring and evaluation reports will be prepared every 6 months during implementation and annually for 2 years after completion of resettlement. These reports will be submitted simultaneously to ADB, PMO, and IA. These will also be uploaded to the ADB website.

54. Poverty Reduction, Health, and Social Benefits. The Project supports the achievement of the MDG for environmental sustainability (Goal 7), which aims to halve the proportion of people without sustainable access to safe drinking water and basic sanitation by 2015 (Target 10). The Project will directly benefit 3.4 million people, 6.9% of whom are classified poor, by ensuring that the expanding urban population of Kunming continues to have access to safe water. The Project will support a tariff structure that includes price subsidies and a lifeline tariff to cushion the impact of tariff increases on the poor. The summary poverty reduction and social strategy is in Appendix 11, and the full poverty and social assessment is in Supplementary Appendix I.

55. The Project will create employment for approximately 4,200 people on construction work each year for 5 years, and an additional 10,920 people will be employed annually in jobs created indirectly as a result of construction. It is estimated that at least 50% of the construction jobs will be unskilled, and the poor should benefit disproportionately from this job creation. Project construction alone will generate approximately CNY236.25 million in wages per year. The Project will contribute to the prevention of up to an estimated 1.5 million cases of waterborne diseases from 2013 to 2020, and the associated increase in median medical costs is projected to be likely to rise from CNY18 to CNY30 per capita (at current values) by 2020. Health benefits are expected to be felt disproportionately by women since they are more at risk of waterborne diseases, and by children who have least resistance to such diseases. The health impact assessment is in Supplementary Appendix J.

56. Stakeholder Consultation. During project preparation, local government and line agencies, villagers, enterprises, local groups, and other people likely to be directly affected by the Project were consulted. These consultations covered project scope, technical design, environmental concerns, land acquisition and resettlement issues, ethnic minority issues, and economic development potentials. The project team conducted household interviews, focus group discussions, village leader interviews, and key informant interviews to assess potential project

19 Associated facilities include the water treatment plants and distribution networks and the WWTPs in NADZ, EDZ, and in Xundian County.

benefits and adverse impacts, and generate comments and suggestions in formulating mitigation measures. Over 1,300 people were interviewed during project preparation. To ensure equal benefit from the Project, separate consultations were conducted with the poor, women, minority groups, and other vulnerable groups. For the assessments on environment, resettlement, and ethnic minorities, consultations were held with representatives of affected counties, townships, and villages. Both rural and urban people were familiar with the Project and public support was high. The consultations were taken into consideration in the project design and the formulation of the EMP, RP, ethnic minority development plan (EMDP), and watershed management strategy.

57. Ethnic Minorities. The poverty and social analysis indicates that there are a number of ethnic minority groups in the project areas. In the rural project-affected areas, where there is a significant ethnic minority population, ethnic people live intermixed with the majority Han people, and the project impacts that they will experience will be the same. The Project poses no threat to traditional land rights or cultural or communal integrity. It will seek to maximize the benefits for all poor and vulnerable households regardless of ethnicity. It is important that (i) ethnic minority people are able to benefit equally from the Project; (ii) any negative impacts that might affect them, alongside the Han majority, are mitigated; and (iii) they participate in project implementation and monitoring. The detailed EMDP is in Supplementary Appendix K.

C. Financial Aspects

58. A financial impact analysis of the Project and a financial management assessment of the IA have been undertaken. The financial internal rate of return for the Project was computed on an after-tax basis of 5.7%, which compares favorably with the after-tax weighted average cost of capital in real terms of 3.7%, demonstrating the financial sustainability of the Project. The result is robust to a range of sensitivity analyses. The average incremental financial cost of treated water (CNY2.74/m3) compared with the average tariff (CNY3.33/m3) demonstrates that water users as a group are paying in excess of the average incremental financial cost by CNY0.59/m3 (excluding taxes), so that the cost of the water distribution operations and water source reservoir management are being fully recovered. The affordability analysis demonstrates that a low-income household would pay only 1.7% of household income in 2007 (for 60 liters per capita per day) and an average income household 1.1% (for 100 liters per capita per day). Even where wastewater tariffs were increased to full cost recovery levels (about CNY2.00/m3 by 2016) a low-income household would pay only 2.3% of income and an average income household 1.2% of household income for both their water and wastewater requirements. The financial analysis is in Appendix 12, the tariff and affordability analysis is in Appendix 13, and the detailed financial analysis and financial management assessment is in Supplementary Appendix L.

59. The historical financial performance of KWSG water operations indicates that it has been able to operate without any subsidies and within the tariff structure. However, because of lack of investment, water losses have risen from 24% to 40%. The JV will address water losses in Kunming and the introduction of full metering to customers, while KWSG will be responsible for the development of new distribution systems in the EDZ and NADZ.

60. Overall revenues of KWSG will increase from a forecasted CNY784 million in 2007 (the first full year of JV operations) to CNY2,270 million in 2020—mainly as a result of KWSG’s share of increased water sales, which account for 54% of revenues in 2020. In addition, KWSG will receive funds from the tariff for loan repayment and water management fees to cover reservoir operations, as well as lease payments from the JV for use of water treatment plant no. 7. KWSG’s net profit after tax is projected to increase from CNY25 million in 2007 to CNY439 million in 2020. The debt service ratio is adequate in all years, with cash available for debt service exceeding 1.6 times debt service. With the inclusion of Zhangjiuhe in KWSG’s balance sheet from 2007, the debt-equity ratio 17 increases to 46% from 7% in 2006; with Qingshuihai assets and funding, it remains at 46% in 2009 before decreasing over the remainder of the forecast period to 22% by 2020.

61. KWSG financial management procedures and capacity are adequate to undertake the Project. KWSG has had experience in preparing and implementing three JBIC and World Bank funded projects between 1991 and 2007. Its extensive experience and demonstrated project implementation capacity should facilitate smooth and successful implementation of the Project. Training will be provided on ADB loan processing policies and capacity development, including reservoir management and long-term corporate and financial planning.

D. Economic Aspects

62. The economic analysis provides the rationale and justification for the Project based on policy, sector, and local area analysis. The economic rationale is sound, based on addressing Kunming water supply requirements with sufficient quantity and class II water quality. This will improve both the water security and water quality, and it will no longer be necessary for Kunming to rely on polluted sources. This will improve overall living conditions, especially for the poor. The water quality targets are clearly defined, legally established, and consistent with international practice. The plan to meet water quality targets uses low-cost gravity-fed raw water bulk supply from Qingshuihai Lake, and is demonstrated to be both the best technical and least-cost option. The economic internal rate of return for the Project is 20.1%, which is above the economic opportunity cost of capital of 12%. The result is robust to a range of sensitivity analyses. A summary economic analysis is in Appendix 14 and details are in Supplementary Appendix M.

E. Environmental Aspects

63. Extensive public consultation—involving surveys, meetings with stakeholders, and focus group discussions—was undertaken during preparation of the environmental impact assessment (EIA). The EIA is based on the national laws, regulations, and standards applicable in PRC.20 The project approach to water resources use, environmental protection, and project infrastructure management was thoroughly discussed and technical studies were undertaken during EIA preparation to meet the stringent government approval process. These include (i) comprehensive technical analysis for the Water Use Certificate related to all project water users and the provision of environmental flows, and (ii) water source environmental management planning. It was also confirmed that the Project will abide by the national guidelines for protection of water sources in accordance with the technical specifications issued by State Environmental Protection Administration.

64. The overall strategy and action plan for water sector activities within Kunming Municipality were discussed with KMG and it was agreed that environmental issues related to the Project be confined to (i) Qingshuihai watershed area, (ii) source river areas downstream of the project reservoirs that may be impacted during operations, (iii) project associated facilities, and (iv) issues arising for treatment of wastewater generated as a result of the Project.

65. The Project will (i) relieve the water supply pressure in Kunming city, (ii) save water by replacing inefficient groundwater wells, (iii) have positive effects on economic development of

20 Yunnan Environment Protection Bureau will approve the EIA, including the Strategic Environmental Planning Proposal. It is anticipated that Yunnan Environment Protection Bureau, following due review, will approve the EIA in mid-June. The TA consultant has reviewed the EIA against criteria specified in ADB’s Environmental Assessment Guidelines and the PRC’s Environmental Impact Assessment Guidelines (SEPA 1993). Overall, the application methods and standards for preparation of an EIA have been observed, and are assessed as compliant with the above guidelines, and are in agreement with all existing national and local laws and regulations.

Kunming, (iv) improve health status by supplying clean water, (v) provide temporary and permanent jobs during the construction and operation period, and (vi) benefit the ethnic minority. It also concludes that various existing and potential water users have been considered and will not be affected significantly. The ecological impacts on Jinshajiang and Xiaojiang rivers will be minimal since the proportion of water transferred from the Xiaojiang will be well below the globally established Water Resource Development Indicator for river basins in the Project, at 11.78% of the Xiaojiang and just 0.08% of the average annual discharge in the Jinshajiang. Environmental impacts during construction on air, water, and the acoustic environment will be temporary and localized, and if proper mitigation measures are implemented, the impacts on sensitive receptors can be minimized. The implementation of the EMP and soil erosion prevention plan will mitigate the construction-related impacts, especially in the 65 spoil disposal sites. Environmental flows, an adaptive management plan for riparian releases, and further survey on water use and in-stream ecology in the downstream reaches of Xiaojiang River will mitigate the downstream impacts. Indirect impacts will be mitigated through additional wastewater collection and treatment capacity to be installed in the NADZ and EDZ to prevent additional untreated wastewater flows returning into the environment, in particular into Dianchi Lake.

66. The summary EIA complies with the PRC’s environmental policy, and ADB’s Environment Policy (2002) and Environmental Assessment Guidelines.21 It concludes that the Project will have substantial positive environmental and socioeconomic benefits, and provide lasting benefits to assist poverty reduction. The Project will result in (i) contribution to Kunming’s water supply for residential and industrial needs in new development zones; (ii) clean and safe drinking water for project beneficiaries; (iii) disproportionately more benefits for the poor in the form of improved access to safe drinking water supply, given that they are less able to afford bottled or boiled water; (iv) positive health implications for all through reduced risk of contaminated water supply; (v) a reduction in demand for overstressed groundwater resources in Kunming city area; and (vi) strengthening expansion of water conservation and water reuse programs. The summary EIA and EMP are in Supplementary Appendix N.

F. Risks and Mitigation Measures

67. The Project has no unusual technical risks. Conventional engineering designs with proven records of safety and reliability will be adopted for water storage and transfer (tunneling) systems. During project implementation, the consultants and dam technical specialists will support the PMO and IA to ensure that equipment and works comply with design requirements and quality standards. Yunnan Design and Research Institute is undertaking substantive on-ground and subsurface surveys to quantify the potential risks more fully prior to finalizing the conveyance system alignment.

68. The following risks could affect timely implementation and economic viability, and reduce the intended benefits of the Project: (i) failure to implement the water treatment plant and WWTP projects within the new development zones by the time of project completion/commissioning; (ii) failure of KMG to prevent groundwater use completely to utilize Qingshuihai water supply fully as soon as it becomes available (given the additional capital costs of Qingshuihai water and if the water will not be fully utilized, this would put pressure on tariffs to cover debt servicing); (iii) failure of KMG to increase tariffs to meet cost recovery targets; and (iv) failure of KMG to undertake detailed studies and surveys on catchment areas and formulate regulations for the project water resources protection.

21 ADB. 2003. Environmental Assessment Guidelines. Manila. 19

69. Risk (i) will be mitigated through assurances from KMG on the provision of the water treatment plant and WWTP capacities to synchronize with project implementation and commissioning. Risks (ii) and (iii) will be mitigated through assurances from KMG on improving control and regulation of groundwater use, and regular tariff reviews and adjustments. KMG shall levy additional charges on groundwater use in excess of water tariffs to discourage groundwater use. Risk (iv) will be mitigated through assurance from KMG that it shall develop a pollution inventory, and establish a catchment modeling system, which will form the basis for prioritization of Qingshuihai reservoir protection options and development of an environmental monitoring program. ADB review missions will monitor compliance with the financial, environmental, resettlement, and operational covenants to ensure the required institutional coordination and project arrangements are established for effective project implementation and operation.

V. ASSURANCES AND CONDITION

A. Specific Assurances

70. In addition to the standard assurances, the Government and KMG have given the following assurances, which are incorporated in the legal documents.22

71. Financial. KMG shall (i) cause KWSG to undertake annual reviews of tariffs, and if necessary, review of reasonable adjustments, to ensure full recovery of O&M, interest charges, depreciation, debt repayment, together with a reasonable profit margin, and to encourage enterprise efficiency; (ii) undertake reviews of water resource fees and water management fees every 2 years to ensure full recovery of O&M, and adequate protection of the reservoir catchment area; (iii) ensure and cause KWSG to ensure that active support is provided for any potential PSP; (iv) commencing from the second year of full commercial operation of the Project, cause KWSG to maintain a minimum debt service ratio of 1.2:1 and a minimum ratio of current assets of 1.2:1; (v) cause KWSG to maintain a debt-equity ratio of 70:30; and (vi) in coordination with Yunnan Development and Reform Commission, undertake thorough review of the tariff structure during project implementation, gradually moving towards equalizing the nondomestic tariffs for industries and commercial users, earliest by 31 December 2012, to promote water conservation and efficiency.

72. Change in Ownership Structure. In the event KWSG plans to (i) change the ownership structure of any of the Project facilities; or (ii) sell, transfer, or assign any of its shares; or (iii) otherwise make any material organizational change, either financial or operational, where such change may have an adverse effect on KWSG’s ability to perform its obligations under the Project Agreement or the Onlending Agreement, YPG, KMG or KWSG shall consult with ADB at least 6 months prior to implementation of such change. In the event any such change is agreed by ADB, YPG, KMG and KWSG shall ensure that the change in ownership structure is carried out in a transparent manner and does not affect repayment of the loan made under the Loan Agreement. Depending on the nature of the agreed change in ownership structure, ADB shall have the right to modify the repayment terms of the loan.

73. Land Acquisition, Resettlement, and Ethnic Minority Development. KMG through the relevant local governments and KWSG, shall ensure that the RP is implemented promptly and efficiently in accordance with its terms, all applicable PRC laws and regulations, and ADB’s Involuntary Resettlement Policy (1995). KMG shall: (i) ensure that in the event of changes in the detailed design resulting in land acquisition and resettlement impacts, no civil works contract is awarded under the relevant component unless the RP has been updated and such updated RP is

22 The full list of assurances is included in the draft Loan and Project Agreements.

submitted to ADB for its concurrence prior to award of any related civil works, and disclosed to APs in accordance with ADB’s Involuntary Resettlement Policy; (ii) cause KWSG to prepare and implement resettlement plans for the associated facilities, listed in the resettlement framework in accordance with ADB’s Involuntary Resettlement Policy; and (iii) ensure that any activities recommended under an action plan to be prepared by KMG to ensure proper environment and water quality protection, which are likely to trigger ADB’s Involuntary Resettlement Policy, meet compliance requirements, and appropriate resettlement planning documents are prepared. KMG shall ensure that an appropriate indigenous people’s development plan or framework for the ethnic minorities in the water catchment areas affected by the future action plan for the protection of water resources/catchment areas is prepared accordingly.

74. Wastewater Treatment Facilities. KMG shall (i) collect wastewater and increase treatment capacity for the wastewater generated by the Project, and (ii) submit the relevant plan to ADB for review within 1 month of loan effectiveness. KMG shall ensure that implementation of water treatment and WWTP projects within the new development zones is coordinated with Project implementation and commissioning.

75. Corporate Governance Reforms. KMG shall cause KWSG to: (i) undertake representation of water users on the board of directors of KWSG by 1 January 2010; (ii) undertake capacity development in a timely manner on reservoir management, safety and operation, and online water quality protection; (iii) improve corporate and business planning; and (iv) improve the financial management by 1 January 2009. Further, KMG shall continue strict enforcement of “one household, one meter” policy by KWSG to ensure that full metering is in place by 31 December 2009. KMG shall cause KWSG to (i) implement a water loss reduction plan to achieve 20% reduction by 31 December 2015; and (ii) continue to monitor that JV expands its distribution network to include industries, currently using groundwater, to connect to the distribution system by 1 January 2011. KMG shall cause KWSG, in coordination with other appropriate agencies identified by KMG, to ensure that public awareness and education programs on managing water conservation are conducted in the project area.

B. Condition for Disbursement

76. No withdrawals shall be made from the Loan Account until the following condition shall have been met: the Government shall have certified to ADB that the Onlending Agreement, which shall include the terms and conditions specified in the Loan Agreement, shall have been duly executed and delivered on behalf of KMG and KWSG, and shall have become fully effective and binding upon the parties thereto in accordance with its terms.

VI. RECOMMENDATION

77. I am satisfied that the proposed loan would comply with the Articles of Agreement of Asian Development Bank (ADB) and, acting in the absence of the President, under the provisions of Article 35.1 of the Articles of Agreement of ADB, I recommend that the Board approve the loan of $80,000,000 to the People’s Republic of China for the Kunming Qingshuihai Water Supply Project from ADB’s ordinary capital resources, with interest to be determined in accordance with ADB’s London interbank offered rate (LIBOR)-based lending facility; a term of 25 years, including a grace period of 5 years; and such other terms and conditions as are substantially in accordance with those set forth in the draft Loan and Project Agreements presented to the Board.

Liqun Jin Vice President 20 November 2007 Appendix 1 21

DESIGN AND MONITORING FRAMEWORK

Design Summary Performance Data Sources/Reporting Assumptions and Targets/Indicators Mechanisms Risks Impact Assumptions

Improved urban Raw water supply Monitoring reports of Water • All applicable national, environment, public increased from Resources Conservancy provincial, and health, and quality of 459.5 million m3 in 2007 Bureau, Water Supply municipal life for urban residents to 558 million m3 in 2015 Group, Health Bureau, environmental in Kunming city and with water quality Environmental Protection protection and new development sustained at class II Bureau, and Kunming management policies zones Utilities Bureau in the PRC are effectively enforced Incidence of waterborne Health Bureau and Center • Timely construction of infectious diseases for Disease Control data on associated water reduced by 6% by 2015 drinking water quality and treatment plants, water from 2006 levels of incidence of water distribution networks, 6,827 cases infectious diseases and wastewater treatment plants in Raw water treatment Operations reports from NADZ and EDZ costs decreased from Water Supply Group • Maintenance of water 3 CNY57/m in 2007 to subsidy under MLSS to 3 CNY54/m by 2012 Routine water testing ensure that poor because of clean and results households can afford low-cost gravity-fed raw access to water water supply from • Continued growth in Qingshuihai demand for water supply service to Reduction in water Operations reports from achieve full capacity losses from 40% in 2007 Water Supply Group utilization to 20% by 2015 Risks Overall public Annual socioeconomic satisfaction with water surveys undertaken as part • Lower tariffs approved supply services and of the PPMS and KWSG than were projected tariff increased from customer satisfaction • Urban growth, 75% in 2007 to 90% in surveys. Tariff monitoring including influx of 2015 reports by KDRC and KUB. migrants, in Kunming exceeds forecasts and Groundwater use by Monitoring reports of Water exerts more pressure industries reduced by Conservation Office within on improved water 50% by 2015 from KUB, Water Resources 3 supply infrastructure 63.1 million m in 2007 Bureau, and Water Supply • Changes to pro-poor Group policy make water less affordable for poor Increased investment Quarterly monitoring households and business reports on the investments opportunities, with and GDP of Kunming increased GDP rising Development Reform annually by 9% until Commission and Kunming 2015 from Finance Bureau CNY120 billion in 2006

22 Appendix 1

Design Summary Performance Data Sources/Reporting Assumptions and Targets/Indicators Mechanisms Risks Outcome Assumptions

Improved provision of Supply of additional Environment monitoring • Sustained government more efficient, reliable, 111 million m3 of raw reports and periodic review support to water affordable, safe, and water of Class II quality of raw water quality and resources protection clean raw water supply; from 2013 quantity by KWSG. Water and management and effective protection pollution monitoring data • Supporting institutional and management of Sustained level of by KEPB and water and regulatory water resources in 24-hour water service sampling analysis report of mechanisms are put in Kunming (contributing and quality, and National City Water Quality place for water to the achievement of prevention of Monitoring Network’s demand management MDG 7, target 10) subsequent shortages in Kunming monitoring • KMG continued Kunming from 2012 station. assistance to mitigating negative impact on Ecological environment KWSG regular monitoring livelihood of villages of Dianchi Lake is report on the level of soil through more improved through particles in the lake; sustainable cropping, reduction in soil particles monitoring report on land agroforestry, etc. by 2013 by 30% use restrictions around the • Strong institutional compared to the 2007 reservoirs and their arrangements in place level watersheds (baseline to be to ensure equitable established by PPMS) allocation of water between rural and Existence of an overall Documentation of strategy urban areas integrated watershed by KMG • Reduced use of management strategy agricultural chemicals and regulations by 2012 and adoption of farming practices that Increased employment To be collected by PMO reduce erosion opportunities with the from contractors’ • Sustained willingness creation of about employment records to pay for increased 4,200 temporary tariffs to cover full unskilled jobs during costs construction and full- • No major population time permanent jobs by expansion in the 2012 for operation and catchment areas maintenance Risks Up to 20% of skilled and unskilled construction • Lack of effective jobs going to women coordination and

monitoring At least 70–80% of mechanisms of unskilled construction relevant agencies on jobs going to local environmental people, including ethnic protection and minority groups management • Insufficient enforcement and control systems of environmental regulations

Appendix 1 23

Design Summary Performance Data Sources/Reporting Assumptions and Targets/Indicators Mechanisms Risks Outputs Risks

Component I 1.1 New reservoirs Storage capacities of Site inspection and project • Resistance by civil Shiqiaohe and 79,000 m3 (29 m high) implementation reports of society, stakeholders, Banqiaohe and 2.515 million m3 KWSG and affected people operational (61.5 m high), • Local geological respectively, available ADB review missions conditions affect from December 2012 construction activities

1.2 Rehabilitated Storage capacity is Construction supervision Xintianhe reservoir 1.835 million m3 (28.9 m and monitoring reports operational high), available from from KWSG December 2012

1.3 Qingshuihai Storage capacity is Environment monitoring reservoir 154.17 million m3 (13 m reports from KWSG operational high), available from December 2012

1.4 Tabizi dragon pool Possible diversion with diversion weir design flow of 1 m3/s operational from December 2012

Component II Conveyance systems are operational 2.1 Shiqiaohe and Operation of 6 tunnels, Site inspection and project Banqiaohe to 3 aqueducts, and other implementation reports of Qingshuihai structures, start by KWSG December 2012

2.2 Tabizi Longtan to Operation of ADB review missions Qingshuihai 10 channels, 7 structures and other Construction supervision construction, start by and monitoring reports December 2012 from KWSG

2.3 Qingshuihai to Operation of 23 Environment monitoring Tongxin gate Tunnels, 16 Aqueducts reports from KWSG and other construction, start by December 2012

2.4 Tongxin gate to Operation of 9 tunnels Jinzhongshan and 9 channels and reservoir other construction, start by December 2012

Component III Project management About 200 PMO and PMO reports on training and capacity KWSG staff trained in conducted development project management by 2008

About 150 KWSG staff trained in dam construction, operation, and maintenance by 2011

24 Appendix 1

Activities with Milestones Inputs

1. Component I: Water Reservoirs ADB Inputs • $80.00 million loan Activity 1: Design the facilities, acquire land, implement resettlement activities Activity 2: Construction of reservoir and associated infrastructure KMG and IA Under each reservoir, the height of the reservoir is specified • About $175.94 million Activity 3: Monitor EMP and social impacts equivalent in counterpart funds 1.1 Construction of Qingshuihai reservoir (13 m) by Q4 2009 ($76.80 million in 1.2 Construction of Jinzhongshan reservoir (39 m) by Q4 2009 government funds and 1.3 Construction of Xintianhe reservoir (28.9 m) by Q3 2010 $99.14 million 1.4 Rehabilitation of Tabizi spring weir and conveyance canal (design flow - domestic bank loan) 1 m3/s) by Q3 2010 1.5 Construction of Shiqiaohe reservoir (29 m) by Q2 2011 1.6 Construction of Banqiaohe reservoir (61.5 m) by Q1 2012

2. Component II: Conveyance Systems

Activity 4: Design the facilities, acquire land, implement resettlement activities Activity 5: Construction of conveyance system with design flow specified Activity 6: Monitor EMP and social impacts

2.1 Dapindi tunnel to Tongxin gate bifurcation, including tunnels, siphons, aqueducts, siphons, channels/pipes, and structures (6 m3/s) by Q4 2010 2.2 Improve conveyance works and Maichong tunnel from Qingshuihai to new bifurcation structure at entrance to Dapindi tunnel (10 m3/s) by Q2 2011 2.3 Tongxin gate to Jinzhongshan reservoir, inclusive of tunnels, channels, and an outfall structure into the reservoir (6 m3/s) by Q4 2011 2.4 Tongxin gate to outfall into Songhuaba reservoir catchment stream (6 m3/s) by Q4 2011 2.5 Conveyance system from Shiqiao and Banqiao rivers to Qingshuihai (15 m3/s) by Q1 2012 2.6 Improve conveyance tunnel and other works from Xintian to Qingshuihai (4 m3/s) by Q1 2012

3. Component III: Project Management and Capacity Development Activity 7: Complete organizational arrangements for PMO and IA by 2007 Activity 8: Develop plans, budgets, procedures for loan by 2008 Activity 9: Complete KMG, PMO, and IA staff training by 2012 Activity 10: PMO and IA have refined PPMS and established targets and procedures no later than 6 months after loan effectiveness ADB = Asian Development Bank, EDZ = east development zone, EMP = environmental management plan, GDP = gross domestic product, IA = implementing agency, KDRC = Kunming Development Reform Commission, KEPB = Kunming Environmental Protection Bureau, KMG = Kunming municipal government, KUB = Kunming Utilities Bureau, KWSG = Kunming Water Supply Group Company Limited, m = meter, m3 = cubic meter, m3/s = cubic meter per second, MDG = Millennium Development Goal, MLSS = minimum living standard scheme, NADZ = new airport development zone, PRC = People’s Republic of China, PMO = project management office, PPMS = project performance monitoring system, Q = quarter.

Appendix 2 25

WATER SECTOR ANALYSIS

A. Introduction

1. The urban population in the People’s Republic of China (PRC) has grown from about 160 million (17% of total population) in 1975 to 562 million (43%) in 2005, with 359 million in municipal cities.1 The urban population is expected to grow further to 45% in 2010, 49% by 2015, and 55% by 2020. The number of cities has also grown from 122 in 1949 to more than 661 in 2005. The rapid expansion poses significant challenges for the provision of urban services— including increased demand for potable drinking water supply throughout the PRC—putting increasing pressure on the environment and posing a threat to water quality of available supplies. Currently, many cities across the PRC experience a shortage of raw water supply, while water supply capacity and wastewater treatment facilities are still below targets set in the PRC’s 11th Five-Year Program (FYP).

2. A key priority for the PRC under the Millennium Development Goals is to ensure environmental sustainability by moderating economic growth and enforcing environmental protection measures. By 2015, the proportion of people without sustainable access to safe drinking water is targeted to be reduced by 50%. In the mid-1980s, the need for water sector reform and increased tariffs was recognized. Under the Government’s market-based reforms, all water supply companies and new water supply projects, including those dealing with raw water supply delivery, are required to be financially sustainable and capable of full cost recovery. The Government is also increasingly concerned about the need for policy reform and capacity development to improve water resources management.2 People are more aware of the need for water conservation and many cities have established a Water Conservation Office. Because of the severity of urban environmental problems, the Government has made cities the focal point of its environmental protection efforts under the 11th FYP.

B. Water Sources and Supply

3. Kunming, the capital of Yunnan Province, is located on the Panlong River at the head of the Dianchi Lake, in a region that has lower than average rainfall. As early as 1994, Kunming municipal government (KMG) identified 14 possible schemes anticipating the need for increased water supplies. The proposed Qingshuihai project is the preferred technical and least-cost option. The existing water sources for Kunming are shown in Table A2.1. The majority of the water supply is managed through surface water reservoirs, including the use of water from Dianchi Lake up to March 2007. Zhangjiuhe was commissioned in April 2007, and Kunming will no longer depend on the poor quality water of Dianchi Lake (the lake has deteriorated because of increased urbanization, limited wastewater treatment, and overuse of its water sources over the past 25 years). Kunming CGE Water Supply Co., Ltd. entered into a joint venture (JV) with Veolia to treat raw water to comply with drinking water standards and distribute water to the population of Kunming.

4. The water sector continues to have priority under the 11th FYP for the Economic Development of Kunming City (2006–2010). The Government’s strategy focuses on (i) developing water sources; (ii) protecting existing sources by controlling industrial and residential pollution in

1 Background Information Report for Asian Development Bank (ADB). 2006. Urban Sector Road Map for the People’s Republic of China. Manila (July). 2 New technical guidelines for water resources protection were issued by the State Environmental Protection Administration (SEPA) in 2007. These promote and regulate PRC policy to protect and prevent pollution in all reservoirs intended as sources for drinking water supply, and for the long-term management and sustainability of water resources for water supply. 26 Appendix 2 rivers, lakes, and reservoirs; (iii) controlling overextraction from groundwater resources; and (iv) improving demand management with the introduction of water saving technology, more efficient operations, and the adoption of appropriate pricing mechanisms. Under water conservation and energy saving policies, Kunming is encouraged to develop effluent reuse, rainwater harvesting, and recycling practices to mitigate overall raw water demand. During project preparatory technical assistance, the Project provided a customer satisfaction survey model to Kunming Water Supply Group Company Limited (KWSG) to ensure that needed water supply services improvements are implemented.

Table A2.1: Existing Kunming City Water Sources (2006) Annual Supply Associated Water Source (million m3) Water Quality Class Treatment Plant Songhuaba Reservoira 149.4 III Nos. 1, 2, 4, and 6 Baoxianghe Reservoir 15.6 II Dahe and Chaihe Reservoirs 35.8 II Shalang River Diversion 11.0 Groundwaterb 63.1 II–III Chenggong Groundwater 2.6 II Local treatment Dianchi Lake 109.5 V Nos. 3 and 5 Total 387.0 m3 = cubic meter, no. = number. a Songhuaba water is also directed to Water Treatment Plant No. 3, now that the need for Dianchi Lake water has been superseded with supply from Zhangjiuhe. b Because of water shortage, groundwater consumption has been increasing, with potential risk for increased pollution from surface ingress. With the Zhangjiuhe project, and later the Qingshuihai project, it is planned that use of groundwater will be phased out. Source: Kunming Water Supply Group Company Limited.

C. Urban Wastewater Management 5. Wastewater management relates to the collection, treatment, and disposal of both urban storm water and wastewater. Kunming Drainage Company, under Dianchi Lake Investment Company, is responsible for operating and maintaining the storm water and sewer drainage network in Kunming city. This network is old, and because of limited investment, has not kept pace with the rapid development of the city. Under the 11th FYP, the objective is to achieve an improvement in the lake’s water quality. Therefore, more wastewater treatment capacity is required to reduce the quantity of untreated wastewater or to improve the quality of treated effluent that is discharged to the lake. Table A2.2 summarizes the current and future projected wastewater treatment capacity in Kunming.

Table A2.2: Kunming City Wastewater Treatment Plant Capacity, 2006–2010 Current Capacity (2006) Future Capacity (2010)a Wastewater Treatment Plant ’000 m3/day ’000 m3/day No. 1 WWTP 120 120 No. 2 WWTP 100 100 No. 3 WWTP 150 210 No. 4 WWTP 60 60 No. 5 WWTP 75 170 No. 6 WWTP 50 130 No. 7 WWTP 0 200 Total 555 990 Coverage 60% 90%b m3/day = cubic meter per day, No. = number, WWTP = wastewater treatment plant. a Estimated capacity with proposed new developments or expansion of existing WWTPs to 2010. b Estimated treatment capacity for city wastewater treatment by 2010. Source: Kunming Water and Wastewater Master Plan. Appendix 2 27

6. Kunming currently has six wastewater treatment plants (WWTPs) with total capacity of 555,000 cubic meters per day (m3/day), sufficient to treat 60% of the dry season flow. However, the wastewater collection network in Kunming is far from complete, so not all of this capacity is utilized. Some untreated wastewater is discharged to the city’s rivers and drains, and flows directly to Dianchi Lake, especially during the wet season. The annual discharge of combined wastewater and storm water into Dianchi Lake each year overloads the natural biodegrading capacity of the Lake. In 2006, Kunming municipal government (KMG) initiated the Dianchi Lake Environmental Improvement Project for the northern part of Dianchi Lake, funded by the Japan Bank for International Cooperation (JBIC) of CNY3.83 billion ($500 million) over a 6-year period.3

D. Water Demand and Development Considerations 7. The main future water demand growth will come from development of the New Airport Development Zone (NADZ) and East Development Zone (EDZ). Current local sources are overstressed, and in some cases water quality is poor (Table A2.1). The overall objective will be to provide clean and affordable water to Kunming city and two new development zones, and relieve pressure on existing overused sources. The projected total raw water requirement for the new development zones would be about 107 million m3/year by 2015, rising to an estimated 149.0 million m3/year by 2020, even after allowing for improved water supply, treatment, and distribution efficiencies through to 2020. Future water supply and demand for Kunming and the new development zones is summarized in Tables A2.3 and A2.4.4

Table A2.3: Kunming Base Case Water Supply, 2007–2020 2007 2010 2015 2020 Water Source (million m3) (million m3) (million m3) (million m3) Songhuaba Reservoir 140.4 140.4 140.4 140.4 Baoxianghe Reservoir 15.6 15.6 15.6 15.6 Dahe and Chaihe Reservoir 35.8 35.8 35.8 35.8 Shalang Diversion 11.0 11.0 11.0 11.0 Groundwater 63.1 63.1 30.0 30.0 Chenggong Groundwater 2.6 2.6 2.6 2.6 Dianchi Lake 27.0 0.0 0.0 0.0 Zhangjiuhe 164.0 218.6 218.6 218.6 Qingshuihai 0.0 - 104.0 104.0 Total 459.5 487.1 558.0 558.0 m3 = cubic meter. Note: It is anticipated that groundwater will be reduced by 2012, once Qingshuihai is commissioned. Sources: Kunming Water Supply Group Company Limited, Yunnan Design Research Institute and project preparatory technical assistance model.

3 The project will (i) achieve a wastewater collection rate of 90% by rehabilitating 144 kilometers (km) of drainage pipelines and 207 km of sewage pipelines; and (ii) increase the WWTP capacity by 410,000 m3/day by renovating three existing WWTPs, building a new WWTP, and upgrade the six existing WWTPs to output effluent to or above the required standard. 4 As NADZ is at an elevation that cannot be serviced from the existing city supply without pumping, KWSG prefers to develop an alternative source that can supply water to NADZ under gravity, to minimize energy requirements in accordance with national policy.

28 Appendix 2

Table A2.4: Water Demand and Supply Balance, 2007–2020 2007 2010 2015 2020 Area Water Demand (million m3) (million m3) (million m3) (million m3) Kunming Main City 404.0 415.8 398.8 408.3 Eastern Development Zone 29.4 52.4 88.6 125.3 New Airport Development Zone 0.0 9.2 18.5 23.7 Total Water Demand 433.4 477.4 505.9 557.3 Water Availability with Qingshuihai 459.9 487.1 558.0 558.0 Net Projected Balance 26.1 9.8 52.0 0.7 m3 = cubic meter. Sources: Kunming Water Supply Group Company Limited, Yunnan Design Research Institute and project preparatory technical assistance model.

8. The water supply from the existing reservoirs,5 while generally reliable, is declining with severe limitations during drought periods. In recent years, rainfall has been less than average, so there has been insufficient water during summer months to meet demand fully, and this has led to rationing and restrictions on commercial users. The new Zhangjiuhe supply will replace water previously drawn from the polluted Dianchi Lake, and provide additional supply to meet current demands and alleviate demand on the other small surface reservoirs—Baoxianghe, Chaihe, Dahe, and Shalang. Although they are generally adequate to meet existing requirements, their size (catchment and storage) necessitates restriction to supply during drought periods. The provision of new supplies will alleviate the stress on these small catchments and help reduce any demand to utilize groundwater. This will also enable any conflict with declared government policy— environment protection, groundwater protection, reduction in pumping—to be avoided.

9. Qingshuihai water sources are located in the mountains of Xundian County, to the north of Kunming.6 Because of the mountains, there is more rainfall than in Kunming, and with limited development in these catchments, the water is of good quality (class I or II) while the demand is lower. Analysis shows that water transfer of the indicated volumes to Kunming will not have any detrimental impact on inhabitants of the source catchments or the downstream communities. Further, Qingshuihai makes good use of existing facilities—the natural Qingshuihai Lake and the existing Jinzhongshan reservoir—thus minimizing the overall need for new inundation areas. This helps to minimize the need for any resettlement and associated compensation, while minimizing environmental impacts because of the development. This new source is essential for the development of the NADZ, and the system can readily be extended to the EDZ utilizing the benefits of the natural topography. This would then give additional water security and good quality raw water for the population of Kunming city, especially for drought years.

10. Urban development in Kunming city confirms that water demand already exceeds the availability of primary class (I to III) drinking water supply, and existing constraints to supply have led to suppressed demand. To satisfy future demand, KMG has made a long-term water supply project plan,7 and the Project is proposed as a medium-term action to meet water demand in Kunming city from 2012. The Project will transfer water from four small mountainous catchments— (Banqiaohe, Shiqiaohe, Qingshuihai, and Xintianhe, with a total catchment area of 220 square

5 The existing Songhuaba reservoir is the main water source for the northern and central city districts of the main city. Luojiaying groundwater is currently the main source for existing development in the EDZ but, as this is unreliable, water from Songmao reservoir and the Hei and Bai Longtan (springs) will be used as an interim supply for the EDZ from 2007 until Qingshuihai water can be made available. Baoxianghe, together with local groundwater, is currently used to supply some parts of central and east Kunming city, but now Zhangjiuhe water is available, this source will be redirected to the NADZ during the initial construction period, prior to Qingshuihai commissioning. 6 The main advantage of sourcing water in the mountains is that all conveyance can be achieved under gravity (no pumping, no energy consumption, therefore energy saving policy compliant), through surface contour canals, with connecting aqueducts and tunnels. 7 Planning references: Kunming City Water Supply Master Plan (1987 to 2020); New Kunming City Water Supply Planning (2004); and Water Supply Plan for Kunming Main City (2002). Appendix 2 29

kilometers [km2]) in the upper reaches of tributary streams to the Xiaojiang River (catchment area of 3,122 km2), which is a first level tributary of the Jinshajiang (catchment area of 473,200 km2 and upstream reach of the Changjiang (Yangtze) River (1.8 million km2). The total volume of water to be transferred from the Xiaojiang River will be less than 12% of its annual average discharge at the Xiaojiang hydrological monitoring station (134.4 km upstream of the Xiaojiang confluence with the Jinshajiang), at which point the Xiaojiang catchment area is 2,241 km2. The overall impact of the water transfer is to withdraw about 0.0787% of the annual average flow in the Jinshajiang.

11. KMG has now recognized, following experience with Songhuaba and Yunlong reservoirs that, in accordance with national policy, there is an urgent need to quantify and plan for the implementation of watershed management as part of a holistic approach to integrated water resources and environment management. The Asian Development Bank (ADB) has initiated policy dialogue with relevant government agencies on this, to assess understanding and future intentions, which will extend well beyond the construction phase of the Qingshuihai Project. Following the PRC law on Provision for Drinking Water Source Pollution Prevention (1980), after project completion, KMG will delineate the Qingshuihai drinking water source protection zones in accordance with technical guidelines8 and issue “Qingshuihai Drinking Water Source Protection Regulations” that will specify objectives, principles, and monitoring requirements to ensure the sustainable protection of Qingshuihai and associated water sources for drinking water supply.9

12. Necessary due diligence on the associated facilities was undertaken. KWSG will construct the water treatment plants in the EDZ (detailed design completed) starting December 2007 and NADZ during the period 2009–2012. The Project will also increase the quantities of wastewater to be treated in Kunming City, the EDZ, and NADZ. Under KMG’s 11th Five Year Plan, the target is for 80% of all wastewater to be treated by 2010, in line with national policy. With a JBIC loan (CNY3.83 billion), KMG has just commenced the North Dianchi Lake (Caohai) and Wastewater/Environmental Management Project10 over a 6-year period.

13. Kunming Drainage Investment Company will construct two new WWTPs in the NADZ and another will be constructed in the EDZ by Kunming Xindu Investment Company of Chenggong from 2009 to 2012 as planned in readiness for the arrival of new water supply from Qingshuihai. In the NADZ, WWTPs are to be constructed at the north (40,000 m3/day) and south (25,000 m3/day) ends of the runway. In the EDZ, all the collection system was constructed at the time of developing the road network, which includes a pipe network to recycle water for landscaping and parks. The objective is to minimize the amount of treated water discharged to Dianchi Lake. Based on population forecasts and water demand projections in the EDZ, wastewater treatment capacity requirements are projected at 120,000 m3/day in 2011 and 200,000 m3/day in 2015. In Xundian County, two WWTPs will be upgraded. According to the respective city development master plans (for Kunming New City, the EDZ, NADZ, and overall water supply and wastewater management), the wastewater will be treated to approved national standards, suitable for reuse or for discharge to Dianchi Lake.

8 SEPA. 2007. Technical Guideline for Delineating Source Water Protection Areas. Beijing. 9 This plan will comprise a schedule of actions related to land use, soil erosion and environmental management, reforestation, controls on rural wastewater, and solid waste control and disposal—with defined responsibilities, budgets, institutional arrangements, and periodic compliance monitoring. A strategy entitled “Water Resource Pollution Control Plan for Yunlong Reservoir Water Resource Area” has recently been prepared and is under review by KMG and Yunnan provincial government (YPG). 10 JBIC. 2006. North Dianchi Lake Environmental Improvement Project. Kunming.

30 Appendix 3

EXTERNAL ASSISTANCE

Table A3.1: Assistance Funded by the Asian Development Bank for Urban Development and Environment Date of Amount No. Name Approval ($ million) A. Loans 1205 Qingdao Environmental Improvement Project 10 Dec 92 103.00 1270 Tangshan and Chengde Environmental Improvement Project 25 Nov 93 140.00 1313 Dalian Water Supply Project 20 Sep 94 160.00 1336 Beijing Environment Improvement Project 29 Nov 94 157.00 1490 Anhui Environmental Improvement Project 26 Nov 96 28.00 1491 Anhui Environmental Improvement Project (Industrial Component) 26 Nov 96 112.00 1543 Xian–Xianyang–Tongchuan Environmental Improvement Project 24 Sep 97 156.00 1544 Zhejiang–Shanxi Water Supply (Phase I) Project 24 Sep 97 100.00 1636 Fuzhou Water Supply and Wastewater Treatment 30 Sep 98 102.00 1692 Suzhou Creek Rehabilitation Project 29 Jun 99 300.00 1797 Tianjin Wastewater Treatment and Water Resources Protection 11 Dec 00 130.00 1985 Hebei Province Wastewater Management Project 19 Dec 02 82.36 1995 Harbin Water Supply Project 11 Mar 03 100.00 1996 Wuhan Wastewater Management Project 25 Apr 03 83.00 2175 Jilin Water Supply and Sewerage Development 27 Jun 05 100.00 2176 Fuzhou Environmental Improvement 8 Jul 05 55.80 2207 Henan Wastewater Management and Water Supply 18 Nov 05 100.00 2237 Shandong Hai River Basin Pollution Control Project 31 May 06 80.00 2239 Guangxi Nanning Urban Environmental Upgrading Project 5 Jun 06 100.00 2240 Wuhan Wastewater and Stormwater Management Project 5 Jun 06 100.00 2297 Nanjing Qinghuai River Environmental Improvement 18 Dec 06 100.00 2328 Anhui Hefei Urban Environment Improvement 24 Apr 07 150.00 2360 Jilin Urban Environmental Improvement 29 Oct 07 100.00 Total for Loans 2,639.16 B. Advisory Technical Assistance 987 Institutional Strengthening of National Environmental Protection Agency 10 Jun 88 0.34 1436 Environmental Impact Assessment and Training 10 Dec 90 0.60 1464 Management of Environment and Natural Resources in Hainan 11 Jan 91 0.60 1772 Institutional Strengthening of the Qingdao Environmental Protection 30 Oct 92 0.60 1835 Haihe Basin Environmental Management and Planning Study 31 Dec 92 1.24 1916 Institutional Strengthening of the Environmental Protection Bureau 28 Jul 93 0.45 1988 Environmental Impact Assessment and Training Phase II 18 Nov 93 0.90 2015 Urban Environmental Improvement Planning 14 Dec 93 0.48 2090 Legislative Reform for Protecting the Environment and Natural Resources 18 May 94 0.50 2210 Capacity Building of the Beijing Municipal Environmental Protection Bureau 29 Nov 94 0.60 2398 Improving Environmental Monitoring and Enforcement in Henan 15 Sep 95 0.09 2456 Pilot Environmental Plans for Selected Medium-Size Cities 4 Dec 95 0.60 2504 Seminar on BOT in Water Supply Sector 22 Dec 95 0.10 2505 Strengthening the Environmental Standards and Enforcement 22 Dec 95 0.60 2693 Formulation of Integrated Environmental Management Plans for the Chao Lake Basin 26 Nov 96 0.80 2726 Water Quality Management for Suzhou Creek 23 Dec 96 0.60 2726 Water Quality Management for Suzhou Creek (Supplementary) 13 Feb 98 0.40 2751 Capacity Building of Wastewater Treatment Operations in Anhui 27 Jan 97 0.20 2773 Water Supply Tariff Study 24 Mar 97 0.60 2804 BOT Chengdu Water Supply Project 2 Jun 97 0.60 2817 Strategic Operations for the Water Sector 26 Jun 97 1.18 2873 Improvement of Environmental Management in Shanxi Province 24 Sep 97 0.94 2906 Leadership Training on Urban Environmental Management in Key Cities 3 Nov 97 0.60 2951 Promotion of Market-Based Instruments for Environmental Management 16 Dec 97 0.70 2975 Environmental Impact Assessment Training and Curriculum Development 31 Dec 97 0.60 3079 TA Cluster to the PRC for the Promotion of Clean Technology 29 Sep 98 3.50 3095 Hai River Basin Wastewater Management and Pollution Control 10 Nov 98 0.57 3211 Improving Environmental Management in Suzhou Creek 29 Jun 99 0.84 3250 Water Tariff Study II 3 Sep 99 0.95 3377 Urban Poverty Study 27 Dec 99 0.41 3447 Strengthening Urban Solid Waste Management 25 May 00 0.60 3588 Transjurisdiction Environment Management (TA Cluster) 11 Dec 00 2.10 Appendix 3 31

Date of Amount No. Name Approval ($ million) 3749 National Guidelines for Urban Wastewater Tariffs and Management Study 25 Oct 01 0.90 4061 Songhua River Water Quality and Pollution Control 10 Jan 03 1.00 4095 Policy Reform Support 11 April 03 0.15 4215 Safe Drinking Water and Sanitation for the Rural Poor 12 Nov 03 0.40 4335 Town-Based Urbanization Strategy Study 06 May 04 0.75 4694 Urban Poverty Strategy Study II 23 Nov 05 0.30 4702 Study on Sustainable Urbanization in Metropolitan Regions 28 Nov 05 0.50 Subtotal (B) 27.89 C. Project Preparatory Technical Assistance 1549 Qingdao Environmental Improvement Project 18 Jun 91 0.10 1831 Tangshan and Chengde Environmental Improvement Project 31 Dec 92 0.10 1852 Dalian Water Supply Project 10 Mar 93 0.10 1917 Beijing Environment Improvement Project 28 Jul 93 0.60 2187 Anhui Environmental Improvement Project for Wastewater Component 19 Oct 94 0.28 2445 Xian–Xianyang–Tongchuan Environmental Improvement Project 16 Nov 95 0.50 2770 Fuzhou Water Supply and Wastewater Treatment 14 Mar 97 0.60 2901 Shanxi Environment Improvement Project 21 Oct 97 0.59 3049 Zhejiang–Shanxi Water Supply (Phase II) 21 Jul 98 0.54 3095 Hai River Basin Wastewater Management and Pollution Control 10 Nov 98 0.57 3215 Heilongjiang Water Supply 1 Jul 99 1.00 3216 Tianjin Wastewater Treatment and Water Resources Protection 2 Jul 99 0.80 3488 Hebei Province Wastewater Management Project 30 Aug 00 0.85 3571 Harbin Water Supply 12 Dec 00 0.72 3638 Wuhan Wastewater Treatment 19 Mar 01 0.50 4014 Fuzhou Environmental Improvement Project 5 Dec 02 0.60 4223 Shandong Hai River Basin Pollution Control Project 21 Nov 03 0.60 4227 Jilin Water Supply and Sewerage Development 26 Nov 03 0.65 4233 Henan Wastewater Treatment 3 Dec 03 0.80 4385 Guangxi Nanning Urban Infrastructure Development Project 3 Sep 04 0.56 4436 Wuhan Wastewater and Storm-Water Management 18 Nov 04 0.70 4617 Nanjing Qinhuai River Environmental Improvement Project 19 Jul 05 0.60 4628 Hefei Urban Environment Improvement 15 Aug 05 0.75 4804 Jilin Urban Infrastructure Project 22 Jun 06 0.50 4805 Xinjiang Municipal Infrastructure and Environmental Improvement Project 23 Jun 06 0.80 4808 Kunming Qingshuihai Water Supply Project 29 Jun 06 0.60 4818 Gansu Baiyin Urban Development Project 19 Jul 06 0.50 4930 Xinjiang Urban Transport and Environmental Improvement Project 11 May 07 0.70 4959 Small Cities and Towns Development Demonstration Sector Projects 6 Aug 07 1.70 4960 Guangxi Wuzhou Urban Development Project 9 Aug 07 0.50 4971 Songhua River Basin Water Pollution Control and Management Project 28 Sept 07 1.30 Subtotal (C) 19.71 Total for Technical Assistance (B+C) 47.60 BOT = build-operate-transfer, No. = number, PRC = People’s Republic of China, TA = technical assistance. Source: Asian Development Bank.

Table A3.2: Assistance Funded by other Aid Agencies for Kunming in Urban Development and Environment, 1999 to Date Year of Total Investment Lending Implementi Project Approval (million) Agency ng Agency Status Kunming 6th Water Plant 1991 ¥2,648 JBIC KWSG Completed Kunming 2nd Wastewater Plant 1997 SKr27.70 SIDA KDC Completed Kunming Water Supply Project 1999 $19.31 World Bank KWSG Completed Kunming 3rd Wastewater Plant 2000 $4.98 AusAID KDC Completed Zhangjiuhe Water Supply Project 2000 ¥20,903 JBIC KWSG Completed Yunnan Environmental Protection 2002 SDR12.20 (Soft Loan) World Bank YPG Ongoing $95.67 (Hard Loan) Northern Dianchi Lake Water 2007 ¥23,100 JBIC Dianchi Lake Ongoing Treatment Project Authority AusAid = Australian Agency for International Development, JBIC = Japan Bank for International Cooperation, KDC = Kunming Drainage Company, KWSG = Kunming Water Supply Group Company Limited, SDR = special drawing rights, SIDA = Swedish International Development Cooperation Agency, YPG = Yunnan provincial government. Source: Kunming Finance Bureau.

32 Appendix 4

DESCRIPTION OF PROJECT COMPONENTS

A. Project Scope and Components

1. There are three main project components: (i) water resources development; (ii) water conveyance systems; and (iii) capacity development and project management. Component 1 relates to the development of infrastructure to transfer water from several small catchments into Qingshuihai Lake, a natural lake that already provides water to Xundian Town and the adjacent agricultural area. Component 2 involves the tunnels and associated works needed to convey the water from source to Qingshuihai, and from Qingshuihai to Jinzhongshan reservoir for release to Kunming and the development zones. Component 3 covers the required capacity development and project management to ensure timely project implementation and future operation of project facilities.

1. Component 1: Resources Development

2. The Project involves the development of two new reservoirs (Banqiaohe and Shiqiaohe) and the increase in capacity of three reservoirs (Xintianhe; Qingshuihai, a natural lake; and Jinzhongshan). Jinzhongshan is a receiving reservoir for water transfer from Qingshuihai. It is located in Songming County, to the northwest of the proposed New Airport Development Zone (NADZ), and will act as the balancing and emergency storage for incoming flows for Kunming and new development zones.

3. Qingshuihai is currently supplemented by the water transfer of flow from the neighboring Xintianhe reservoir that lies to the west. However, as the existing reservoir is silted up, water transfer to Qingshuihai is limited to “run of river” through the existing tunnel. The inlet portal to this tunnel also needs rehabilitation. The Tabizi Longtan springs transfer to Qingshuihai has fallen, so the small diversion weir and control gates need to be rehabilitated to restore the supply to the conveyance channel (to be rehabilitated). Two dams (Banqiaohe and Jinzhongshan) are more than 30 meters high and both sit across narrow valleys, so they are not very long embankments. The planned storage for these reservoirs is quite small, with only Qingshuihai (already at 117 million cubic meters [m3]) greater than 10 million m3. Key concerns that have been assessed with the design of these dams by the project preparatory technical assistance are (i) hydrology and yield; (ii) sediment inflow and management; (iii) active storage capacity; (iv) flood management; (v) structure monitoring, stability, and safety (in a seismically active region); (vi) operational characteristics to effect transfers; and (vii) impacts on existing catchments, environment and downstream riparian water users. The design and planning were in accordance with People’s Republic of China (PRC) safety and quality standards and safeguard measures. Details are in Supplementary Appendix C.

4. The implementation plan (Appendix 8) groups all the water source dam and transfer system works infrastructure together, for completion and commissioning by 2012. The works will be divided into four construction contracts (Appendix 9), with the Shiqiaohe and Xintianhe dams and appurtenant river management (during construction) and water transfer works grouped under one contract. Banqiaohe, Qingshuihai, and Jinzhongshan dams and appurtenant structures will each be an individual contract, and by virtue of their location, there is no dependency between them. The Qingshuihai to Tongxin Gate conveyance works are foreseen as the most critical link for completion.

5. The operations rules for the reservoirs will include periodic flushing of sediment in conjunction with major runoff from the catchments. Dam designs have included appropriate water pressure, settlement, and movement monitoring systems; and will be linked by telemetry to the Appendix 4 33 central Qingshuihai management office. A panel of experts will review and advice in relation to the dams’ design, construction, and monitoring.

2. Component 2: Water Conveyance Systems

6. The feasibility study report outlines the scale of the proposed conveyance works to transfer the required quantity of water each year effectively from the four sources to Qingshuihai, and from Qingshuihai to Xundian and Kunming. The conveyance channels have been sized to allow for variable rate discharge, up to a maximum sufficient for the design transfer volume to be delivered each year. As the source river flow will be variable because of unpredictable rainfall patterns and runoff, the conveyance channels have a flow capacity some 3–4 times greater than the required average transfer flow requirement.

7. New conveyance works will be required from Shiqiaohe and Banqiaohe reservoirs to Qingshuihai, and from the outlet of the Qingshuihai Maichong tunnel to Xundian, and Jinzhongshan reservoir. The outlet at Xintianhe and the existing outlet (Maichong tunnel) from Qingshuihai will be rehabilitated while the transfer outlet from Jinzhongshan will be part of water supply to the NADZ. The levels for the transfer inlets at Banqiaohe, Shiqiaohe, and Xintianhe are set to manage sediment in the reservoirs effectively, with flushing capability through the dams, to minimize the risk of sediment transfer to Qingshuihai, and associated risk for sediment deposition in the conveyance tunnels. For implementation, development of the conveyance systems comprising of tunnels, aqueducts, and channels (about 72.8 kilometers in length) will be implemented in three groups: (i) Shiqiaohe, Banqiaohe, and Tabizi to Qingshuihai (source inflows); (ii) Qingshuihai to Tongxin Gate (regulated flow to Jinzhongshan and/or Songhuaba); and (iii) Tongxin Gate to Jinzhongshan (regulated flow to Jinzhongshan). The testing and commissioning of the completed conveyance works to Jinzhongshan is scheduled on the third quarter of 2012.

3. Component 3: Capacity Development and Project Management

8. This component comprises (i) project management to ensure that the project performance monitoring system and reporting requirements are put in place; and (ii) assistance for capacity development and training on dam/reservoir management and water quality online monitoring, public awareness, corporate and business planning and strategic financial planning and management, tariff review, and safeguards management and monitoring. The consulting services will ensure close alignment between Kunming municipal government and Asian Development Bank (ADB) management procedures and requirements while ensuring project activities are completed without delay. The capacity development will (i) support timely monitoring and reporting on the resettlement, environment and social impacts management activities, (ii) establish baseline indicators for monitoring project progress and performance, and (iii) strengthening financial and managerial capacity of project management office and Kunming Water Supply Group Company Limited during project implementation and subsequent operation and maintenance stages.

9. Capacity development shall strengthen the understanding of ADB implementation guidelines and requirements, and facilitate strengthened coordination between the project stakeholders. ADB has provided general training in Kunming on procurement and resettlement during project processing, in coordination with the Ministry of Finance, which integrates PRC domestic processing and ADB project preparation processes. Further training on project-specific procurement and disbursement procedures will be undertaken at project inception to reinforce compliance with financial management, procurement, and resettlement procedures associated with the ADB loan funded project.

DETAILED COST ESTIMATES AND FINANCING PLAN 34

Table A5.1: Summary Cost Estimates Appendix 5 Appendix CNY ’000 $ ’000 % Foreign % Total Item Local Foreign Total Local Foreign Total Exchange Base Costs A. Base Cost 1. Civil Works 325,850 485,148 810,998 42,875 63,835 106,710 59.8 55 2. Equipment 0 24,326 13,907 0 3,201 3,201 100 2 3. Preparatory Works 172,019 182,438 22,634 22,634 4. Land Acquisition and Resettlement 179,421 179,421 23,608 23,608 12 5. Environmental Management and 6,412 6,412 844 844 0 Monitoring 6. Soil and Water Conservation 22,049 22,049 2,901 2,901 2 7. Construction Management and 54,910 54,910 7,225 7,225 4 Preparation for Operation 8. Preliminary and Detailed Design 109,892 109,892 14,459 14,459 8 9. Capacity Development and Project 0 7,600 7,600 0 1,000 1,000 100 1 Management 10. Taxes and Duties 76,093 76,093 10,012 10,012 5

Subtotal (A) 946,646 517,074 1,463,720 124,558 68,036 192,594 35 100

B. Contingencies Physical Contingencies 141,776 141,776 18,655 18,655 10 Price Contingencies 86,536 86,536 11,386 11,386 6

Subtotal (B) 228,312 228,312 30,041 30,041 16

C. Financial Charges During Construction Interest During Construction 151,776 93,914 245,690 19,971 12,357 32,328 38 17 Commitment Charges 7,432 7,432 978 978 100 1 Subtotal (C) 151,776 101,346 253,122 19,971 13,335 33,306 40 17

Total (A+B+C) 1,326,734 618,420 1,945,154 174,570 81,371 255,941 32 133 Note: Includes taxes and duties of CNY76.09 million ($10.012 million). Source: Asian Development Bank estimates.

Table A5.2: Summary Cost by Financier ($ ’000) ADB KMG Local Bank Loans Total Item Amount % Amount % Amount % Amount % A. Base Cost 1. Civil Works 75,799 71.0 0 0.0 20,911 29.0 106,710 51.1 2. Equipment 3,201 100.0 0 0.0 0 0.0 3,201 0.7 3. Preparatory Works 22,634 100.0 22,634 8.8 4. Land Acquisition and Resettlement 23,608 100.0 23,608 9.2 5. Environmental Management and 844 100.0 844 0.3 Monitoring 6. Soil and Water Conservation 2,901 100.0 2,901 1.1 7. Construction Management 7,225 100.0 7,225 2.8 8. Research and Design 14,459 100.0 14,459 5.6 9. Capacity Development and Project 1,000 100.0 0 0.0 1,000 0.4 Management 10. Taxes and Duties 7,693 76.8 2,319 23.2 10,012 3.9

Subtotal (A) 80,000 34.6 56,730 29.5 55,864 29.0 192,594 75.2

B. Contingencies Physical Contingencies 3,946 21.2 14,709 78.8 18,655 7.3 Price Contingencies 2,789 24.5 8,597 75.5 11,386 4.4

Subtotal (B) 6,735 22.4 23,306 77.6 30,041 11.7

C. Financial Charges During Construction Interest During Construction 0.0 12,357 38.2 19,971 61.8 32,328 12.6 Commitment Charges 0.0 978 100.0 978 0.4

Subtotal (C) 0.0 13,335 40.0 19,971 60.0 33,306 13.0

Total Disbursement 80,000 31.3 76,800 30.0 99,141 38.7 255,941 100.0 Appendix 5 Appendix ADB = Asian Development Bank, KMG = Kunming municipal government. Source: ADB estimates. 35

36 Appendix 6

FLOW OF FUNDS AND ONLENDING ARRANGEMENTS

Asian Development Bank

ADB Loan

Ministry of Finance (on behalf of the Government)

a Onlending

Yunnan Provincial Government

a Onlending

Kunming Municipal Government

Subloan Agreement

Kunming Water Domestic Bank Supply Group Company Limited

User Charges

Contractors, Consultants, County Governments, Affected Villages

ADB loan

ADB repayments

User charges

Domestic bank repayments

Domestic bank loan

Project disbursements

ADB = Asian Development Bank, PRC = People’s Republic of China. a The ADB loan will be onlent on the same lending terms and conditions as those received by the Ministry of Finance. Appendix 7 37

PROJECT ORGANIZATION

Kunming Municipal Government

Project Leading Group

Vice Mayor Agency and County Representativesa

Project Management Office Director Deputy Directors Staffb

Project Implementing Agencyc Kunming Water Supply Group Company Limited (KWSG)

a Staff from Kunming Development and Reform Commission, Kunming Finance Bureau, Kunming Water Bureau, Kunming Municipal Government Administration, Kunming Construction Bureau, Environment Protection Bureau, Planning Bureau, Water Supply Group, Land and Resources Bureau, Resettlement Bureau, Public Utility Bureau, New Airport Management Commission, Forest Administration Bureau, Lake Dianchi Administration Bureau, Songming County, Xundian County, and Guandu District. b Fourteen full-time staff on administration (6), engineering/ technical (5), and accounting/finance (3). c KWSG Qingshuihai Water Source Development and Construction Branch will be the project implementing unit responsible for project management and operations, implementation of resettlement, and environmental monitoring.

IMPLEMENTATION SCHEDULE 38

2007 2008 2009 2010 2011 2012

Activity 8 Appendix 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 1 2 3 4 A. Water Resources Development Design and Tender Documentation Land Acquisition and Resettlement Bid Invitation, Evaluation, Contract Award Civil Works Construction Equipment Installation Testing and Commissioning B. Water Conveyance Works 1. Banqiaohe, Shiqiaohe, Tabizi to Qingshuihai Design and Tender Documentation Land Acquisition and Resettlement Bid Invitation, Evaluation, Contract Award Civil Works Construction Equipment Installation Testing and Commissioning 2. Qingshuihai to Tongxin Sluice Gate Design and Tender Documentation Land Acquisition and Resettlement Bid Invitation, Evaluation, Contract Award Civil Works Construction Equipment Installation Testing and Commissioning 3. Tongxin Sluice Gate to Jinzhongshan Design and Tender Documentation Land Acquisition and Resettlement Bid Invitation, Evaluation, Contract Award Civil Works Construction Equipment Installation Testing and Commissioning C. Project Management and Capacity Building Project Management Activities Consulting Services and Capacity Development Source: Asian Development Bank. Appendix 9 39

PROCUREMENT PLAN

1. This procurement plan shows the thresholds and particular contracts required to carry out the Project. Project information for the procurement plan is in Table A9.1

Table A9.1: Project Information Country People’s Republic of China Name of Borrower People’s Republic of China Project Name Kunming Qingshuihai Water Supply Project TA Reference TA 4808–PRC Date of Effectiveness Amount $80 million Of which committed Executing Agency Kunming Municipal Government Approval Date of Original Procurement Plan Approval of Most Recent Procurement Plan Publication for Local Advertisements Period Covered by this Plan 2008–2012

2. Equipment, materials and goods, and services financed under the loan will be procured in accordance with the Asian Development Bank’s (ADB’s) Procurement Guidelines (2007, as amended from time to time) and follow ADB procedures. Necessary thresholds for all contract packages envisaged on this Project are shown in Table A9.2.

Table A9.2: Procurement Thresholds – Goods and Works Contracts Procurement Method Threshold (Value $) International Competitive Bidding (ICB) Works > 10,000,000 ICB Goods > 1,000,000 National Competitive Bidding (NCB) Works > 100,000 NCB Goods > 100,000 ≤ 1,000,000 Shopping Works ≤ 100,000 Shopping Goods ≤ 100,000 Exceptional Methods None anticipated

3. Consulting services will be principally selected using quality- and cost-based selection.1 The threshold for consulting services selection is in Table A9.3.

Table A9.3: Procurement Thresholds – Consultants Services Procurement Method Threshold (Value $) Quality- and Cost-Based Selection (QCBS)a > 200,000 Alternative Methods No alternative methods are proposed a A fixed quality-cost ratio of 80:20 will be used.

Table A9.4: List of Indicative Procurement Packages Expected Prior Procurement Ref No. Contract Package Type and Description Date for Review Method Advertisement Yes/No A. Preparatory Works 1. Preparatory Worksa NAb Aug 2007 No Component 1 : Water Resources Development – B. Civil Works 1. Shiqiaohe and Xintianhe Reservoirs NCBc Oct 2008 Yes 2. Banqiaohe Reservoir NCB March 2008 Yes

1 The estimated base cost for the consulting contracts is set at $1,000,000. Therefore, the selection method for the consulting services will be quality and cost-based selection and a full technical proposal will be requested.

40 Appendix 9

Expected Prior Procurement Ref No. Contract Package Type and Description Date for Review Method Advertisement Yes/No Post 3. Qingshuihai Reservoir and Tabizi Longtan NCB Aug 2007 Reviewd 4. Jinzhongshan Reservoir NCB March 2008 Yes Component 2: Water Conveyance System – Civil C. Works 1. Shiqiaohe and Banqiaohe to Qingshuihai Shadi tunnel and Xiatuoqi tunnel (including aqueduct a. NCB March 2008 Yes works) Post b. Enija tunnel NCB Dec 2007 Reviewd Haidang tunnel c. NCB March 2008 Yes (including aqueduct works) d. Banqiaohe tunnel #1 and #2 NCB July 2008 Yes 2. Qingshuihai to Tongxin Sluice Gate Post a. Dapindi and Xixiangou tunnels NCB Dec 2007 Reviewd b. Bailiqing and Dashuidong tunnels NCB March 2008 Yes c. Qinjiazhuang, Longjacun, and Yujiazhuang tunnels NCB March 2008 Yes d. Pujiashan, Shiliquin, and Yudingshan tunnels NCB March 2008 Yes e. Dahushan tunnel and Dongcun tunnels #1 to #4 NCB March 2008 Yes f. Baishishan, Dashanqin, Moshiqin, and Niuluzhuang NCB March 2008 Yes tunnels g. Gegentan, Jinjishan, and Xincun tunnels NCB March 2008 Yes 3. Tongxin Sluice Gate to Jinzhongshan a. Tunnel No. 1 to No. 9 NCB March 2008 Yes 4. Concrete pipe production and installment NCB June 2009 Yes 5. Steel pipe production and installation NCB June 2009 Yes Equipment and Installation Under Components 1 D. and 2 1. Gates and gate lifting devices NCB July 2008 Yes Hydrological observation system 2. Hydrological observation and management system NCB July 2008 Yes E. Equipment: Structural Observation System 1. Structural observation NCB March 2008 Yes F. Equipment: Vehicles and management equipment NCB July 2008 Yes Component 3: Capacity Development and Project G. Management 1. Capacity development and consulting services QCBS Dec 2007 Yes NA = not applicable, NCB = national competitive bidding, No. = number, QCBS = quality- and cost-based selection. a Road and house for construction, power and water supply, earth and stones supply sites, etc. b No Asian Development Bank (ADB) financing. c For NCB, the first draft English language version of the NCB procurement documents should be submitted for ADB review and approval regardless of the estimated contract amount. Remaining procurement documents under NCB are subject to post review. ADB will review the bid evaluation report and award of contract on a post-review basis. For international competitive bidding (ICB), prior review and approval by ADB of procurement documents, bid evaluation reports, and proposed awards of contracts is required. d May use ADB retroactive financing. Source: Kunming Project Management Office. Appendix 10 41

SUMMARY RESETTLEMENT PLAN

A. Background

1. The impact of the Kunming Qingshuihai Water Supply Project (the Project) is to provide water supply for Kunming, Xundian County, and the East Development Zone and New Airport Development Zone. The Project involves the development of five reservoirs (Banqiaohe, Jinzhongshan, Qingshuihai, Shiqiaohe, and Xintianhe) and the submergence of land, reservoir impoundment structures, the development of water transfer and conveyance systems, and the establishment of permanent access roads. Once the Project is completed, about 104 million cubic meters (m3) of water will be supplied annually to the new Kunming city development areas and 7 million m3 to Xundian County. Kunming Water Supply Group Company Limited (KWSG) is the Implementing Agency (IA) for the Project. The project management office (PMO), KWSG, Yunnan Water Resources and Hydropower Survey, Yunnan Design and Research Institute (YDRI), and relevant local county and town/township governments have worked together to identify the project impact areas, carry out physical indices survey at the reservoir and infrastructure areas, and conduct social and economic survey, with assistance from specialists of Hohai University, YDRI and KWSG have drafted a resettlement plan (RP) with assistance from technical assistance consultants.

B. Resettlement Impacts

2. Land acquisition and house demolition will impact upon local residents at the reservoir inundation areas or where infrastructure will have to be constructed—mainly the dam and water transfer complex, water conveyance routes (entry and exit to tunnels as well as interconnecting surface facilities: siphons, aqueducts, channels, and pipes) and areas for permanent access road construction. There will also be some temporary land occupation and use during the construction period. To avoid or minimize resettlement impacts, local officials and village and village committees were consulted extensively during the feasibility study stages. The number of affected households (AHs) and affected persons (APs) are in Table A10.

3. Land acquisition and house demolition will involve 2 counties, 7 towns, 21 administrative villages, and 41 village groups. In total, about 6,702.0 mu of land will be permanently acquired for the Project, including 3,070.1 mu of farmland and 2,685.7 mu of woodland. In addition, 2,216.5 mu will be occupied temporarily, including 830.0 mu of farmland and 1,240.1 mu of woodland. Some structures will have to be demolished, including 80,891.1 square meters (m2) of residential houses and 5,982.0 m2 of nonresidential houses. In total, 1,374 households with 5,147 persons will be affected directly by land acquisition and/or house demolition, of which 1,137 households (4,295 persons) will be affected by land acquisition without house demolition, 38 households (113 persons) will be affected by house demolition without land acquisition, 202 households (753 persons) will be affected by both land acquisition and house demolition, and 292 households (1,059 persons) will be affected by temporary land acquisition. Existing infrastructure affected by the Project includes 1 pumping station, 3 water intake dams, 3 transformer stations, 12 bridges (culverts), a 9.6 kilometer (km) electricity transmission line, 20.7 km of water diversion channels, 29.3 km of roads, and 5.1 km of telecommunication lines.

42 Appendix 10

Table A10: Project Impacts County Xundian Songming Total Township (No.) 4 3 7 Village (No.) 16 5 21 Village Group (No.) 26 15 41 Total 4,099.1 2,602.9 6,702.0 Permanent LA (mu) Including farmland 1,528.0 1,542.0 3,070.1 Temporary land Total 1,563.6 652.9 2,216.5 occupation (mu) Including farmland 744.0 85.9 830.0 Residential 17,062.5 63,828.6 80,891.1 House demolition (m²) Nonresidential 1,628.7 4,353.3 5,982.0 AHs by LA 758 378 1,137 APs by LA 2,923 1,371 4,295 AHs by LA and HD 39 163 202 Directly affected population APs by LA and HD 150 603 753 AHs by HD 10 28 38 APs by HD 38 75 113

Subtotal - directly AHs 804 569 1,374 Subtotal - directly APs 3,097 2,049 5,147 Households 221 71 292 Temporary APs Persons 798 261 1,059 AH = affected household, AP = affected person, HD = house demolition, LA = land acquisition, m2 = square meter, mu = unit of land measure, 667 m2, No. = number. Note: The number of APs and AHs are calculated based on the impacts by both LA and HD or by LA only. Source: Resettlement Plan, June 2007.

C. Policy and Legal Framework

4. The development of this RP is mainly based on the Land Administration Law of PRC, 2004; Regulation on Land Acquisition Compensation and Resettlement for the Construction of Large and Medium Size Water Conservancy and Hydropower Works, 2006; Opinions of the State Council on Improvement of Post-Resettlement Support Policies for Reservoir-Induced Resettlers, 2006; and relevant policies on land acquisition and house demolition in Kunming city and Yunnan province. The RP has been prepared in accordance with the Asian Development Bank’s (ADB’s) Involuntary Resettlement Policy (1995), as well as other related requirements on social security policies.

5. An entitlement matrix prepared for the Project based on the following set of resettlement principles was adopted as follows: (i) involuntary resettlement should be avoided or minimized where feasible; (ii) compensation and entitlements provided must be able to allow those affected to maintain their pre-project standard of living, with the prospect of improvement; (iii) all the APs, both registered and non-registered, are entitled to compensation and assistance; (iv) economic compensation must be adequate to allow those affected to at least maintain their pre-project standard of living; (v) where remaining farmland per capita is not sufficient to maintain food supply, cash or real-object compensation for those whose land has been expropriated, and other income- generating activities will be provided; (vi) all those affected will be (a) adequately informed about eligibility, compensation rates and standards, livelihood and income restoration plans, and project timing; and (b) encouraged to be involved in the implementation of the RP; (vii) no land acquisition or demolition shall start until compensation and resettlement benefits has been agreed by all the APs; (viii) compensation and resettlement will be monitored by the IA and independent monitors; (ix) special assistance and treatment will be provided to vulnerable groups, to ensure their Appendix 10 43 standard of living is not impaired, and that opportunities are provided to all APs to retain benefits from the Project; (x) resettlement must be adequate to cover all the affected aspects; and (xi) all resettlers will receive the post-resettlement support fund to restore their livelihoods.

D. Compensation Standard, Income, and Livelihood Restoration Scheme

6. The compensation for land acquisition includes a land compensation fee, relocation subsidy, and standing crop compensation. The land compensation fee is CNY25,120/mu, 16 times the average annual output value (AAOV) for paddy field; CNY18,700/mu for dry land, 16 times its AAOV; CNY22,448/mu for orchard land, 13 times its AAOV; CNY6,936/mu for forestland and CNY2,774/mu for shrubbery land, both 6.8 times their own AAOV; and CNY18,360/mu for shelter forest land, 18 times its AAOV. For unused land, compensation payable will be half that for dry land, which equals CNY9,350/mu. The standing crop compensation is CNY785 for paddy fields and CNY575 for dry land. In regard to temporary land acquisition, CNY4,710/mu will be paid for irrigated land and CNY3,450/mu for dry land. The compensation standard for house demolition is set at CNY800/m2 for framework structures, CNY500/m2 for brick-concrete structures, CNY300/m2 for brick-wood structures, and CNY230/mu for adobe-wood structures. In addition, infrastructure compensation, resettlement transportation cost, and other related fees will be provided to the affected resettlers. A post-resettlement support fund will be developed, with a standard rate set at CNY600 per resettler per year, which will be payable for 20 years.

7. Measures for income-generation will include cash compensation, land adjustment, industrial structure adjustment, preferential employment, skills training, and post-resettlement support. After negotiation with the affected counties, village officials, and resettlers, it has been agreed that all compensation fees will be paid directly to APs, and land will not be adjusted in the affected villages, except for Laoba Village. APs will use the compensation for agriculture structural adjustment, livestock breeding, and nonagricultural industries. In Laoba village, the land compensation fee will be distributed to all villagers and land will be readjusted in each existing village. In all villages, direct cash support will be provided to resettlers. During construction, some unskilled work will be offered to the APs, for up to 2,100 persons/day. The APs will be given preference to undertake the available labor jobs, and about 20–30% of these will be provided to women. In association with the agricultural department(s) and social security department(s), the PMO will also contribute to a special fund (CNY320,000) for technical training of those affected workers, of which at least 50% of the opportunities will be offered to women. Meanwhile, CNY250,000 will be set aside by the PMO to provide support to vulnerable groups, together with assistance to be provided by the civil administration department. Minority groups will be given the same rights in relation to land acquisition and house demolition as all other APs.

8. All households affected by house demolition will be relocated within their existing villages. In line with the new rural construction planning for each county and town, the Government will provide funds for the construction of infrastructure, such as water, power, and roads; and the Qinghai No. 2 group, Haiwei village, Laoba group, Deshi group, and Gegentang group’s farm households will be allowed to build their own houses at planned housing areas. In the groups that are less affected by house demolition (Huaqing and Laohaitou and Xiaobeidang No. 5 group), affected farm households can choose to have residential land and build houses themselves, through agreement with village committee.

E. Institutional Arrangement and Implementation Schedule

9. The PMO (KWSG) will take full responsibility for implementing project resettlement in accordance with the approved RP. KWSG will be in charge of transactions and the review of procedures for land acquisition, house demolition, and resettlement, as well as being responsible

44 Appendix 10 for coordination, management, payments, and monitoring. YDRI will be in charge of deciding the impact area of land acquisition and house demolition, and providing technical assistance for updating the RP report based on designs during project implementation. Xundian and Songming county governments will carry out resettlement implementation and will be responsible for contract signing for compensation and subsidy payments; procedure handling; compensation standard identification; compensation payments, and implementation of living rehabilitation requirements. No land acquisition or demolition will start until the RP is updated based on designs and approved by ADB. The RP will be implemented from September 2007 to December 2011.

F. Information Disclosure, Participation, and Grievance Procedures

10. In accordance with PRC national, provincial, and municipal policies and regulations for land acquisition, house demolition, and resettlement, together with ADB policies and guidelines, the PMO/IA will hold public consultations, negotiation, and information disclosure sessions with the affected people, villages, and county governments during the project preparation stage. AHs, village cadres, town/township and county governments participated in the physical indices survey and social and economic survey, and confirmed the survey results. Through consultations and negotiation, APs will be informed about the key contents of the RP. Further negotiation will be arranged for county/town government leaders and AP representatives prior to RP implementation, to discuss the detailed impacts for each village and the planned resettlement measures. By August 2007, a resettlement brochure will be provided by the PMO and IA to all affected villages and households. This brochure will confirm the project affected areas, the implementation schedule and framework, the compensation standards for land acquisition and other assets, relocation assistance, livelihood rehabilitation strategy, and dispute resolution procedures. In accordance with ADB’s Public Communications Policy (2005), the draft RP was posted on the ADB website following the endorsement from Kunming Municipal Government and Environment and Social Safeguard Division on 18 July 2007. The final RP was posted on the ADB website on 9 November 2007. The PMO will set up project resettlement agencies to supervise implementation, continue the public consultations, monitor progress, and deal with grievances.

G. Monitoring and Evaluation

11. Internal and external monitoring of resettlement will be conducted. The PMO will carry out internal supervision and monitoring to ensure compliance with the provisions of the RP. The PMO will engage an independent agency for semiannual monitoring and evaluation. The independent agency will monitor and evaluate the progress of resettlement implementation, payment, and dispute resolution. It will identify the impacts for APs on: (i) whether they have received the approved compensation and entitlements on time, and (ii) whether their living standard and income level have been restored to pre-project status. A baseline survey will be carried out before the start of land acquisition and house demolition. Monitoring and evaluation reports will be prepared every 6 months during implementation and annually for 2 years after completion of resettlement. External monitoring reports will be forwarded directly to the PMO and ADB.

H. Budget

12. Based on the May 2007 base price, the total resettlement cost of the Project is estimated to be CNY185.68 million, which is 10.2% of the total project cost. The cost estimates include costs of compensation for land acquisition, house demolition, reestablishment of special facilities, planning, management, training, monitoring and evaluation, and resettlement infrastructure improvement budget. The CNY17.65 million of post-resettlement support fund will be paid to resettlers out of the total project budget. KWSG will provide counterpart budget for resettlement activities, including support in case of any shortfall in funds during resettlement implementation. Appendix 11 45

SUMMARY POVERTY REDUCTION AND SOCIAL STRATEGY

A. Linkages to the Country Poverty Analysis

Is the sector identified as a national Yes Is the sector identified as a national Yes priority in country poverty analysis? priority in country poverty partnership No agreement? No

Contribution of the sector or subsector to reduce poverty in the People’s Republic of China (PRC):

The Kunming Qingshuihai Water Supply Project (the Project) has the potential to benefit 3.4 million Kunming urban residents by preventing increasingly serious shortages in their supply of water for both domestic and commercial use. The Project will enhance quality of life and reduce the risk of an increase in waterborne diseases. By ensuring that there is sufficient water for projected population increases, the Project will facilitate the proposed economic development of Kunming as a regional center. Specifically:

(i) The Project will assist in sustaining the PRC’s current achievements of 93% (2004) against Millennium Development Goal 7, target 10 to halve the proportion of people without sustainable access to safe drinking water by 2015. It will ensure that by 2015 up to 3.4 million Kunming residents will have access to safe water. (ii) The Project will contribute to the prevention of up to an estimated 1.5 million cases of waterborne diseases from 2013 to 2015, and the associated increase in median medical costs is projected to be likely to rise from CNY18 to CNY30 per capita (at current values) by 2015. Health benefits are expected to be felt disproportionately by women since they are more at risk of waterborne diseases, and by children who are likely to have least resistance to such diseases. (iii) There will be an average of approximately 4,200 people employed each year on construction work over 5 years, plus 10,920 people employed annually in jobs created indirectly as a result of construction. At least 50% of the construction jobs will be unskilled, and the poor should benefit disproportionately from this job creation. A further 88 permanent jobs will become available in operation and maintenance (O&M), and 10%–20% of these are to be for unskilled workers. (iv) The Project will support continued provision of price subsidies and lifeline tariffs to contribute to cushioning the impact of tariff increases on the poor. (v) In the rural catchment areas, the Project has the potential to reduce poverty both directly through the direct and indirect creation of a total of 15,120 jobs per year over the 5-year construction period, and an additional 229 permanent jobs in O&M. Contracts will require contractors to employ a proportion of local people, and as some 50% of the construction jobs will be unskilled, many of these will be likely to go to poor people. Indirectly, the Project will act as a stimulus to local economic development in Songming County and, in particular, Xundian County. The supply of additional water for irrigation and commercial use in Xundian County, the money spent locally on procurement, and the upgrading of roads in a number of sub-villages should further contribute to economic development in Xundian, estimated to affect over 30,000 people. Songming County will also benefit from jobs created and procurement.

B. Poverty Analysis Targeting Classification: General intervention

What type of poverty analysis is needed?

A poverty and social analysis was undertaken in accordance with Asian Development Bank (ADB) guidelines. The analysis collected information to assist in the design of the Project by identifying the poor, examining causes of poverty, and recommending poverty reduction measures within the scope of the Project. It also examined social safeguard issues in both the rural and urban areas of the Project, especially with respect to vulnerable groups and ethnic minorities. Water users’ demands and needs, and their willingness to pay health benefits and afford different tariff levels were examined.

The project area includes a diverse range of social groups, poor and nonpoor, Han and ethnic minorities, urban and rural populations. The project area is all within Kunming Municipality. The water transfer area is located across two of the municipal counties, Songming and Xundian. The water recipient areas are Kunming city, the Economic Development Zone (EDZ) located within Chenggong County, and the New Airport Development Zone (NADZ) part of the Guandu District of Kunming city. In 2006, Songming county had a population of 312,000, of which 2.7% was living below the absolute poverty line (CNY638/capita/year) and 11.5% below the relative poverty line (CNY944/capita/year). Xundian County, classified a National Impoverished County, had a total population of 479,000, of which 9% was living below the absolute poverty line and 37.6% below the relative poverty line. In the project transfer area, two of the 12 villages are classified poverty villages. A detailed poverty and social analysis is in Supplementary Appendix I. The health impact assessment is in Supplementary Appendix J.

46 Appendix 11

Kunming city has an urban population of nearly 3 million people. The poverty line in Kunming city is CNY210 per capita per month, which is the threshold for the Minimum Standard of Living Scheme subsidy. Some 41,784 people, or 1.7% of the city population, benefit from this subsidy. Although all Kunming residents will benefit from the enhanced water supply, the primary beneficiaries will be residents in the NADZ and EDZ where the projected development is dependent on an adequate water supply. In the NADZ in particular, the majority of current residents are farmers, and although these will be only a small part of the projected population expansion in the future, the majority are currently living in poverty and will benefit disproportionately from the economic opportunities that will be brought by the development facilitated by the increased water supply.

C. Participation Process

Is there a stakeholder analysis? Yes No

A stakeholder analysis and consultations were carried out throughout project preparation. Data collection carried out during the project preparatory technical assistance involved interviews with over 400 households in different parts of the project-affected area. It also included 30 focus group discussions and key informant interviews with village leaders; representatives of Xundian and Songming County Water Boards; Poverty Alleviation and Development Offices; Dianyuan, Jinsuo, Liushao townships; NADZ; and EDZ. Participants were encouraged to raise issues that might concern them about the Project and its impacts, as well as give their overall opinions on the Project. Positive and negative effects to these groups caused by the Project.

In addition, in the initial design phase of the Project, the technical team from the Design Institute carried out a number of consultations with government agencies, villagers, enterprises, and local groups. Discussions were focused on technical issues, environmental assessment and resettlement planning.

Is there a participation strategy? Yes No

Project information related to resettlement and environment will be further disclosed before the Project starts. Local people will have the opportunity to participate in the implementation of the resettlement plan (RP), environmental management plan, ethnic minority development plan (EMDP), and project construction.

In addition to ongoing discussions with those who will be affected by resettlement, further consultations will be implemented throughout the implementation phase concerning the effect of current farming practices on watershed management, which will be critical for maintaining water quality in the catchment area. The desired outcome of this consultation process would be an integrated strategy for watershed protection, as far as farmers are involved, that is practical and acceptable to all concerned. Details of consultation and participation plans for implementation are included in the RP, environmental management plan, and EMDP.

D. Gender Development

Strategy to maximize impacts on women:

Men and women will benefit from the unskilled jobs generated by the infrastructure construction. The project management office will encourage contractors to employ as many women as possible. The Executing Agency will encourage that 30% of the new O&M jobs go to women, assuming suitably qualified women can be recruited.

Women are fully involved in consultation processes relating to environment protection in the catchment areas, as well as in resettlement planning. A procedure is in place to ensure women are integrated into any income restoration activities associated with resettlement, while an environmental protection plan will ensure that women in catchments areas will be actively involved in training and livelihood activities.

Has an output been prepared? Yes No

Appendix 11 47

E. Social Safeguards and Other Social Risks

Significant/ Item Not Significant/ Strategy to Address Issues Plan Required None Significant A full RP has been prepared in accordance with government Full regulations and ADB’s Involuntary Resettlement Policy Resettlement Not significant (1995). The RP has been disclosed to the affected people Short and the public. Internal and external monitoring None arrangements will be put in place. None

Significant Willingness to pay and affordability analyses were carried out. For the absolute poverty group, the average water cost Yes Affordability Not significant of the poor is currently 1.9% of the monthly disposable household income. The Minimum Standard of Living No None Scheme guarantee includes a water tariff subsidy that entitles those who qualify to a discount price of CNY1.8 per cubic meter (m3) for up to 6 m3 per month. The household survey showed that the average monthly consumption of water per poor household is 5 m3. Even with an increase of 50%, this will still be within the international threshold of 3%.

Significant Yunnan municipal government will ensure that all the employment and labor standards, as provided in the Yes Labor Not significant applicable laws and regulations, are complied with. Contractors’ labor policies with respect to minimum wages, No None equal wages for equal work, and occupational health and safety will be regulated by both the contracts and government regulations. Use of local labor will be encouraged, and related basic training will be supported by government.

Significant The total ethnic minority population in the project areas is 0.5 million, some 13% of the total population. Yi (35% of the Yes Indigenous Not significant total minority population), Hui (30%), and Bai (17%) are the Peoples main ethnic groups. There are no basic differences in the No None livelihood patterns of the different minority groups in the project area villages, as they live in mixed villages. While they have their own language, most minorities also speak Han. Land acquisition will affect less than 10 ethnic minority households. Related mitigation measures are included in the RP. Other social risk mitigation and enhancement measures are included in the EMDP in Supplementary Appendix K.

Villagers also recognized that there may be some regulation Other Risks Significant of land use in buffer zones around the project dams and Yes and/or reservoirs, and that this would affect some farmers who Vulnerabilities Not significant would not be relocated or subject to land acquisition. There No might also be the need to change some farming practices None outside buffer zones to reduce the risk of contamination of reservoir water with agricultural chemicals, or siltation of the reservoirs because of slope erosion. A preliminary watershed management strategy has been prepared by Kunming municipal government to protect the reservoirs.

Although the Project poses no significant risks, it will take preventive actions by disseminating information to staff, workers, their families, and local communities on sexually transmitted infections including HIV/AIDS.

48 Appendix 12

FINANCIAL ANALYSIS

A. Financial Return Analysis of Project

1. The financial analysis of the Project has been carried out in accordance with Asian Development Bank’s (ADB’s) Financial Management and Analysis of Projects.1 The tariffs for water sales used to estimate the net financial benefits for raw water supplies are those approved by Yunnan Provincial Development Reform Commission, December 2005 and implemented in two steps (January 2006 and January 2008). Tariffs adopted in the project evaluation are those approved for July 2007, which will result in an estimated weighted average tariff for all consumers of CNY3.53/cubic meter (m3). After deducting value-added tax of 6%, plus water supply treatment and distribution costs of CNY1.03/m3, then CNY2.30/m3 may be attributed to the raw water source.

2. The weighted average cost of capital (WACC) is computed based on Kunming municipal government (KMG) equity contributions and the ADB loan and local bank loan, which are assumed to carry different nominal interest rates. The WACC for the Project is 3.7% (Table A12.1).

Table A12.1: Weighted Average Cost of Capital Item ADB Loan Domestic Loan Equity Total Amount ($ million) 80.0 99.2 76.8 255.9 Weighting 31.3% 38.7% 30.0% 100.0% Nominal Cost 6.2% 6.5% 10.0% Tax Rate 15.0% 15.0% 0.0% Tax Adjusted Nominal Cost 5.2% 5.5% 8.0% Inflation Rate 1.2% 3.0% 3.0% Real Cost 4.0% 2.5% 4.9% Weighted Component of WACC 1.3% 0.9% 1.5% 3.7% ADB = Asian Development Bank, WACC = weighted average cost of capital. Source: ADB estimates.

3. Results. The financial internal rate of return is calculated at 5.7% for the Project (Table A12.2), which compares favorably with the WACC at 3.7%, substantiating the financial viability of the Project. The net present value is CNY453.6 million. Regulatory or tariff revision risk for this Project is minimal. The current tariff is sufficient to recover the operating costs and capital costs. There is limited risk of downward revision since proposed tariffs have already being approved through public hearings held by Yunnan Provincial Development Reform Commission in November 2005. The Project is most sensitive to delays associated with corresponding cost increases, falling to 4.1%. Accordingly, efforts must be made in project implementation to avoid delays and cost increases.

Table A12.2: Financial Internal Rate of Return and Sensitivity Analyses (%) Sensitivity Analyses FIRR SI SV Base Case 5.7 Capital +10 5.1 11.0 33.0 Operating +10 5.5 4.6 78.3 Benefits -10 4.8 16.8 -21.5 All the above 4.3 2-year delay plus 20% increase in CAPEX 4.1 Weighted Average Cost of Capital 3.7 CAPEX = capital expenditure, FIRR = financial internal rate of return, SI = sensitivity indicator, SV = switching value. Source: Asian Development Bank estimates.

1 ADB. 2006. Handbook for Borrowers on the Financial Management and Analysis of Projects. Manila. Appendix 12 49

B. Financial Projections of Kunming Urban Water Sector

4. Kunming Water Supply Group Company Limited (KWSG) and Joint Venture Distribution Company. KWSG, a company fully owned by KMG with a registered capital of CNY534 million was formed in 2004. In November 2005, the water treatment and distribution assets of Kunming city were transferred to a newly established subsidiary, KWSG, which in turn established a joint venture (JV) with Veolia Water Kunming Investment Company Limited, to form Kunming CGE Water Supply Company Limited. It has a contract to operate specific parts of the Kunming water supply facilities for up to 30 years. KWSG holds 51% of the shares in the JV. The JV operation came into effect on 1 May 2006.

5. KWSG Operations and Subsidiaries. Water supply operations are the core business and contribute most revenues and profit to KWSG.2 Table A12.3 lists the revenues, operating profit, and assets of all the consolidated subsidiaries. The water supply operation accounted for 65% of total revenues, 71% of the total operating profit, and 80% of the total asset values. Other subsidiaries can stand by themselves without subsidy from the core business. At the end of 2006, KWSG had a total asset value of CNY2.24 billion ($292.8 million). The asset value of water production was CNY1,792.6 billion in 2006, an increase of 24.7% from 2001.

Table A12.3: KWSG Analysis of Subsidiaries in 2006 (CNY million) Operating Item Revenue % % Assets % Profit Kunming General Water Co. (the JV) 451.4 64.5 50.2 71.0 1,792.6 79.8 Li Yuan Tap Water Engineering Co. 25.1 3.6 1.2 1.7 51.3 2.2 Dian Shen Water Pipe Co. 9.0 1.3 0.2 0.2 3.4 0.2 Long Teng Hotel 4.3 0.6 0.4 0.6 7.1 0.3 Tap Water Equipment and Installation Co. 54.9 7.8 2.3 3.2 120.9 5.4 Water Engineering Design Institute 9.0 1.3 0.4 0.6 13.9 0.6 Kunming Tap Water Engineering Co. 95.5 13.7 2.3 3.3 257.7 11.5 Other Businesses of KWSG parent 31.7 4.5 9.4 13.2 Other Businesses of the JV 19.1 2.7 4.4 6.2 Total 700.0 100.0 70.8 100.0 2,246.9 100.0 Co. = company, JV = joint venture, KWSG = Kunming Water Supply Group Company Limited. Source: KWSG.

6. KWSG Historical Financial Analysis. The results of financial analysis are shown in Table A12.4. The financial profitability improved in 2006 as a result of the increase in tariffs. The debt service ratio is very satisfactory (5.3 in 2006) once the movements in the cash flow of short-term borrowings have been isolated. The current ratios are 1.07 in 2005 and 1.68 in 2006, indicating that KWSG has the liquidity to meet its short-term liabilities. The ratio of account receivables to sales, as months of sales, has fallen from a high of 3.4 months in 2002 to 1.9 months of sales in 2006. The JV is working to reduce accounts receivables further. However, given that meters are read and bills issued later in the month for payment with 21 days, accounts receivable will always be at least 1 month of sales at year-end. The return on net fixed assets is low at 2.2% in 2006, which increased from 1.3% in 2004. It is expected that, with tariff increases in January 2008 and improved operations under the JV, the return on assets employed will increase in the future. The ratio of long-term debt to total equity and liabilities is low at 7.3% since the JV has no short-term or long-term loans at this time. While KWSG borrowings are essentially long-term (World Bank and Japan Bank for International Cooperation [JBIC] loans), KWSG has also short-term borrowings for the balance. This reflects the availability of funding to KWSG on the domestic market where only

2 The other businesses of KWSG are mainly land leasing, construction, and engineering. The other business of the JV company is engineering and renovation of the existing water pipe network, with the results included in the JV’s operations.

50 Appendix 12

short-term funding is available, but is able to be renewed when it falls due. In general, the historical financial performance of KWSG water operations indicates that it has been able to operate without any subsidies, within the tariff structure.

Table A12.4: Key Financial Indicators Item 2001 2002 2003 2004 2005 2006 Return on NFA 1.5% 1.7% 1.6% 1.3% 1.5% 2.2% DSR 3.2 6.1 1.1 22.5 10.0 5.3 Current Ratio 0.8 0.8 1.0 1.0 1.1 1.7 Quick Ratio 0.8 0.8 0.9 1.0 1.0 2.0 Receivables/Sales (months) 3.0 3.4 1.7 1.8 2.3 1.9 Long-term Debt Equity Ratio 19.4% 18.0% 15.9% 15.1% 10.9% 7.3% DSR = debt service ratio, NFA = net fixed assets. Source: Asian Development Bank estimates.

7. Financial Projections for JV Distribution Company and KWSG. Financial projections were prepared for the JV and KWSG over the period 2007–2020 to ascertain the overall financial sustainability of the water sector.

8. JV Financial Projections. For the JV, water sales will almost double over the forecast period from 229 million m3 in 2007 to 444 million m3 in 2020. Total revenues will increase from CNY719 million in 2007 (the first full year of operation) to CNY2,390 million in 2020 because of increased water sales and periodic adjustments to water tariffs for inflation assumed at 3-yearly intervals. After-tax profit of CNY21 million in 2007 will rise to CNY584 million in 2020. Return on average net fixed assets (historic) will increase from 0.6% to 20.0% over the same period.

9. KWSG Financial Projections, Sector Level. KWSG financial projections include consolidation of 51% of the JV’s revenues and expenditures and fixed assets with other KWSG subsidiaries. KWSG is also responsible for the management and operation of Zhangjuhe reservoir, for which it receives water management fees out of the tariff. KWSG is responsible for funding the extension of distribution and water treatment facilities in the East Development Zone (EDZ) and New Airport Development Zone (NADZ) (about CNY1.56 billion) and Qingshuihai water source development over the forecast period. Overall expenditure totals CNY4.68 billion from 2007 to 2020, with Qingshuihai water source accounting for CNY1.95 billion. This will be financed by the proposed ADB loan of $80 million, a domestic bank loan, and KMG equity contributions. KWSG received CNY774 million from the JV shareholders for 49% of Kunming’s water supply assets. As of 31 December 2006, KWSG had cash of CNY1.021 billion which it is utilizing to finance the EDZ developments. The Zhangjuhe water source and water treatment plant no. 7 assets are assumed to be transferred to KWSG, which is responsible for repaying the JBIC loan and short-term loans taken out to meet cost overruns.3 KWSG’s debt servicing is summarized in Table A12.5 and will be met from its share of JV income plus the loan repayment tariff levy, and its own revenues.

Table A12.5: KWSG Summary Debt Servicing, 2007–2020 (CNY million)

Item 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Interest 67.2 87.5 81.3 74.5 67.1 32.0 112.8 87.5 94.5 144.7 131.2 119.1 106.5 92.5 Principal 19.0 120.1 120.1 190.1 190.1 190.1 295.9 285.1 295.9 368.9 359.0 348.4 247.3 257.9 Total 86.2 207.6 201.4 264.6 257.2 222.1 408.7 372.6 390.4 513.6 490.2 467.5 353.8 350.4 Source: Asian Development Bank Estimates.

3 The JBIC loan amounts to CNY1.4 billion, while domestic loans in December 2006 totaled CNY958 million, with an estimated project cost of CNY4.5 billion. Appendix 12 51

10. KWSG Water Supply Operation Forecasts. The main revenue sources are from JV water sales and increase from 47% in 2007 to 54% in 2020. Income/payments from the loan repayment fund levy, water treatment plant no. 7 lease payments, and water management fees would account for a further 20% in 2007 and 21% in 2020. Thus, the JV water distribution operations provide from the tariff and in other revenues KWSG with 66% of its income in 2007 and 75% in 2020. Overall revenues increase from CNY784 million in 2007 to CNY2,270 million in 2020, mainly as a result of KWSG’s share of the JV’s increased water sales. Net profit after tax increases from CNY25 million in 2007 to CNY439 million in 2020. The debt service ratio is adequate in all years, with cash available for debt service exceeding 1.6 times debt service.4 With the inclusion of Zhangjiuhe in KWSG’s balance sheet from 2007, KWSG’s debt-to-equity ratio increases to 46% in 2009 (from 7% in 2006) before decreasing to 22% by 2020 (in the absence of further debt funding for further expansion and development of new zones). Cash in bank in 2020 is CNY3 billion, suggesting that KWSG has adequate reserves to meet ongoing capital expenditure and extending water supply to new development zones in the future. KWSG may also obtain further investment capital by leasing or selling out the rights to undertake the water distribution activities in EDZ and NADZ. Thus, as long as tariffs are periodically adjusted for inflation (3-yearly intervals are assumed) in the projections, the 2007 tariff levels appear adequate to fund the water sector developments and meet debt service over the period 2007–2020. 5 Details of the financial analysis are in Supplementary Appendix L.

C. Kunming Municipal Government Fiscal Assessment

11. KMG’s total fiscal revenues nearly doubled from 2003 to 2006, with average growth of more than 20%, and maintained a fiscal surplus since 2001. The counterpart fund of KMG for the Project is CNY546.6 million, accounting for 2.2% of the 2006 fiscal revenue and 54% of fiscal surplus in 2006. The funding requirement will be spread from 2008 to 2012 so that annually this would represent 0.4% of the 2006 revenue base, or about 10% of the 2006 surplus. Further details of KMG’s fiscal capacity are in Supplementary Appendix L.

D. Financial Management Assessment

12. Based on the results of the financial management assessment, it was noted that KWSG has a satisfactory financial accounting system with adequate and qualified staff to manage, monitor, and report on the flow of accounting, financial, and physical progress. Financial statements are prepared monthly, quarterly, semiannually, and annually to be submitted to senior management, board members, and the State-owned Assets Monitoring and Administration Bureau. KWSG’s current reporting has the capacity to link the financial information with the Project’s fiscal progress. There is also a regular review for budget utilization and physical progress by KWSG management. Further, internal and external audit controls are in place and effective. There are no problems in the auditing reports in the past 3 years. Any project, including the current Project, will be subjected to a special project completion audit, executed by Kunming Branch of the General Auditing Office of the People’s Republic of China. KWSG has had experience in preparing and implementing three foreign-funded projects from 1991 to 2007, funded by JBIC and World Bank. Its strong team in project implementation, financial and disbursement management, and resettlement will facilitate smooth implementation of the ADB-financed project. However, training on ADB project-specific procurement and disbursement arrangements and procedures needs to be undertaken at project inception.

4 A debt service ratio of 1.2 times and current ratio (current assets/current liabilities) of 1.2:1. are covenanted for KWSG. 5 The water demand projections, when calculating response to price elasticity, assume real increases in tariffs in 2011 and 2016 to bring wastewater tariffs more in line with full cost recovery, assumed at an average of CNY2.0/m3 compared with CNY0.75/m3 for domestic water users and CNY0.90/m3 for nondomestic water users in 2007.

52 Appendix 13

TARIFFS AND AFFORDABILITY

A. Kunming Water and Wastewater Tariffs

1. Kunming water and wastewater tariffs are set out in Table A13.1 for 2005 to 2008. In December 2005, Yunnan Development and Reform Commission (YDRC) approved tariff increases for 1 January 2006 and 1 July 2007 (to be implemented 1 January 2008), to cover operating costs and loan repayments for Zhangjuhe water source. In each customer category, tariffs are uniform for all levels of consumption except for domestic, where a block tariff exists, together with a lifeline block for the card-carrying poor. The lifeline block tariff is set at CNY1.8/cubic meter (m3) for up to 6 m3/month.

Table A13.1: Kunming Water and Wastewater Tariffs Calendar Year 2005 2006 2008a Water Tariffs CNY/m3 CNY/m3 CNY/m3 Residential 1.30 2.05 2.45 Governmental 1.70 2.90 3.60 Industrial 1.90 3.30 4.10 Commercial 2.40 3.70 4.60 Specialb 5.20 11.10 14.10 Wastewater Tariffs CNY/m3 CNY/m3 CNY/m3 Residential 0.50 0.75 0.75 Nondomestic 0.60 0.90 0.90 m3 = cubic meter. a Tariff Increase from 1 January 2008. b Includes sauna, car washing, etc. Source: Kunming Water Supply Group Company Limited.

2. The current domestic tariff consists of a water tariff of CNY2.05 plus a wastewater charge of CNY0.75, resulting in a charge of CNY2.80/m3. The water tariff (excluding wastewater) increases by 50% above the basic water tariff for consumption from 11 m3/month to 15 m3/month, by 100% for consumption between 16 m3/month and 20 m3/month, and by 150% for consumption above 21 m3/month. It is evident from the structure that there is cross-subsidization between the classes, with domestic receiving the subsidy where the weighted average tariff in 2006 was CNY3.60/m3 (water and wastewater), compared to a domestic tariff of CNY2.80/m3 (water and wastewater) where the average family consumes less than 10 m3/month (90 liters per capita per day).

Table A13.2: Current Domestic Tariff Structure Block Water Wastewater Total (m3/month) (CNY/m3) (CNY/m3) (CNY/m3) 0–10 2.05 0.75 2.80 11–15 3.08 0.75 3.83 16–20 4.10 0.75 4.85 >21 5.13 0.75 5.88 m3 = cubic meter. Note: Card-carrying poor are entitled to first 6 m3 at CNY1.8/ m3. Source: Kunming Water Supply Group Company Limited.

3. The Kunming domestic water tariff approaches the ideal in terms of its structure. It provides an affordable lifeline rate for the card-carrying poor up to 6 10 m3/month. The initial block provides Appendix 13 53 for 10 m3/month, while further blocks are narrow (5 m3) and the steps progressive (plus 50%), resulting in effective demand management and water conservation.

4. Wastewater charges represent an allowance for collection and treatment rather than the full cost of providing collection, treatment, and disposal. Wastewater charges are included on the water bill and based on 100% of the billed water consumption.

5. The tariff-setting process in Kunming now reflects standard practice in the People’s Republic of China. Tariff applications made by Kunming Water Supply Group Company Limited (KWSG) are reviewed and if necessary adjusted through a process of negotiation between concerned government bureaus. Approval for the adjustment is given by the city mayor, after which the application for final approval is forwarded to the provincial authorities. As in other cities, proposals to adjust the tariffs are publicized and public hearings are held on the tariff proposals. The use of public hearings, the recent tariff increases, and the introduction of wastewater tariffs indicates that tariff reform promoted by the state government is well developed in Yunnan. Kunming is currently introducing the “one user, one meter” policy. It is estimated that, at the end of 2006, there were 2.42 households per meter. It is expected that this program implemented by KWSG/joint venture company (JV) will be completed in 31 December 2009.

B. Water and Wastewater Tariff Policies, Objectives, and Structures

6. The following objectives are of particular importance when developing water and wastewater tariff structures and levels.1

7. Financial Sustainability and Full Cost Recovery. These are the most important objectives in tariff setting. Kunming municipal government (KMG) has set water tariffs to incorporate proper operation and maintenance (O&M) costs of providing treated water. Apart from O&M costs to be covered, the tariff provides for specific charges to meet water resource fees of CNY0.23/m3 and water management fees averaging CNY0.23 m3. Financial analysis of the JV and KWSG suggests that tariffs provide a fair rate of return on distribution assets of water supply and distribution; and provide for reservoir O&M and protection of the watershed area, sector expansion using retained earnings and external funding, and overall sector debt service. In addition, financial projections indicate that, where the current water tariffs are maintained in real terms with periodic adjustments for inflation, then increased water sales should be adequate to meet O&M, provide for capital expansion, meet debt service, and allow the JV to recover its investment with an adequate return.

8. Economic Efficiency. The purpose of economic efficiency is to promote the efficient use of national resources. Kunming domestic water tariffs promote economic efficiency through demand management and conservation by adopting a progressive tariff, while tariffs set at full cost recovery signal the cost of consumption to the consumer.

9. Price Equity. The aim of price equity is to base tariffs on “fair” criteria, and this is best done when the charge is based on costs traced to or caused by each customer. In water supply, there will be few variations in costs caused by individual entities. In Kunming, there are four main classes of customer and these will in most cases face similar costs of supply. It could be argued that domestic customers place greatest costs on the system as their consumption is in the morning and evening peak periods, and additional capacity and storage needs to be provided to meet these peak demands.

1 ADB. 2003. Economics and Research Department Technical Note Series Numbers 9 and 10. Manila.

54 Appendix 13

10. Administrative Efficiency and Good Governance. Tariffs can promote good governance in many ways. The charges resulting from the tariff should be clear and understandable to customers, so that they can understand how they might modify their use of the service. Essentially, this means that any classes, categories, and/or blocks used to vary the tariff are predictable and not open to manipulation. Administrative efficiency and good governance require that the amount payable by a consumer can be easily calculated and billed. In general, this will depend on whether, in the area served, individual consumer connections: (i) take their water from a water company connection, and (ii) have their own water meter. The progressive tariff is only operable where households have individual meters. This is expected by 31 December 2009.

11. Affordability and Universal Access. Affordability is a sociopolitical rather than an economic concept, and it relates to enterprises such as water supply and wastewater utilities only if the national or local government so decides. The Kunming domestic tariff meets social objectives of ensuring that households meet their basic needs at an affordable price, while the lifeline block ensures that the poor receive their basic needs at a price they can afford.

C. Kunming Water and Wastewater Tariff Recommendations

12. Water Tariffs. The domestic water tariff provides a lifeline block and a graduated tariff that allows poor and average households to meet their needs at prices they can afford. Thereafter, a progressive increase in tariff blocks makes sure that a demand management and conservation function ensures progressive consumption is charged at higher rates. Above 20 m3/month, domestic households receive no concession and, at the current tariff, would pay more than other classes of customers. Accordingly, Kunming should continue with the present structure, with the top charge in line with other nondomestic tariff categories. All nondomestic customers should be charged the same tariff. There is no economic argument for charging industrial customers less. This leads to economic inefficiency and excess consumption. There are also problems with classification, as customers seek to be classified in customer categories that attract a lower tariff. A rationalization study of non-domestic tariffs will be undertaken by Price Division of Kunming Development and Reform Commission in 2008 in coordination with YDRC to move towards gradually equalizing non-domestic tariffs by 2012.

13. Wastewater Tariffs. KMG should move wastewater tariffs to full cost recovery as soon as practicable to meet costs of the Japan Bank for International Cooperation loan for current rehabilitation and expansion projects. KMG should consider setting tariffs on pollutant loading on the basis of the “polluter pays” principle. As part of the wastewater tariff guidelines study2 carried out by the Asian Development Bank on behalf of the Ministry of Construction, the following charging mechanisms were evident. For domestic customers, wastewater charges are usually based on water supply volumes with a uniform volumetric charge applied per m3 of water consumption. For nondomestic customers, wastewater is again charged on the basis of a uniform flat fee for wastewater of similar strength to domestic or to some prescribed limit. In most countries where pollutant loadings are above domestic levels or a prescribed upper limit, customers require a discharge permit and are charged on the basis of their pollutant loadings.

14. In Kunming, all customers, including domestic, should be charged a uniform wastewater charge based on domestic strength effluent. For those customer categories with effluent pollutant loadings in excess of domestic, they should pay a higher charge reflecting the cost of treating higher pollutant loadings. As in the case of Hong Kong, China, trade waste charges could be based on banded customer industry classifications for higher effluent discharges applied to

2 ADB. 2003. Technical Assistance to the People’s Republic of China for Preparing the National Guidelines for Urban Wastewater Tariffs and Management Study. Manila. Appendix 13 55

industrial customers and similarly to commercial customers discharging trade wastes, especially restaurants, laundries, hospitals, etc.

D. Affordability Analysis of Water and Wastewater Tariffs

15. There is no standard poverty line for urban areas in Yunnan Province. Levels of poverty are assessed using the number of people below the minimum living standard scheme (MLSS) threshold, which varies from city to city. The average annual disposable income in Kunming in 2005 was CNY9,616 per capita, compared to CNY8,871 per capita for the whole of Yunnan.3 The poverty line in Kunming city is CNY210 per capita per month or CNY2,520 per annum—the threshold for the MLSS subsidy. Some 34,122 people, or 1.4% of the city population of 2.399 million, benefit from this subsidy and 1.7% of those live in the project area. However, based on information from the 2005 household survey, the annual per capita income of the bottom 5% of households was CNY2,831, which is just over the annual per capita income threshold for the MLSS subsidy.

Table A13.3: Urban Poverty under Minimum Living Standard Scheme (2005) Urban Poverty Poverty Population in MLSS County/District Population No. HHs Population Poverty (CNY/capita/month) (’000) Kunming (4 districts) 239.9 20,527 34,122 1.4% 210 Chenggong 4.3 544 919 2.1% 210 Subtotal (Water 244.2 21,071 35,041 1.4% 210 Beneficiary Area) Songming 3.5 2,071 2,883 8.2% 183 Xundian 3.3 1,847 3,860 11.7% 169 Subtotal (Water 6.8 3,918 6,743 9.9% 169–183 Source Area) Project Area Total 251 24,989 41,784 1.7% 169–210 HH = household, MLSS = minimum living standard scheme. Sources: Yunnan Province Yearbook 2006, Xundian County Yearbook 2005, and Songming County Yearbook 2005.

16. Water Consumption. Data provided by the JV indicates that average per capita domestic consumption is about 95 liters per capita per day. However, water restrictions result in some suppressed demand estimated at 5%, resulting in consumption of 100 liters per capita per day or 8.6 m3/month. The social survey indicated that the poor consume 5 m3 per month, while nonpoor households consume 6.1 m3/month. While the Project does not result in any real increases in tariffs, the approved tariff increase of January 2008 will impact consumption, with elasticities adopted in the economic analysis used to modify consumption.

17. KMG Poverty Alleviation Policies. The primary program supporting registered poor families is the MLSS designed to maintain a minimum level of income and includes 6 m3 at CNY1.8 m3 plus a wastewater tariff of CNY0.75 per month.

18. Tariff Impacts on Poor Households. The Project will not result in any real increases in tariffs over those of YDRC approved tariffs for July 2007. Estimates were made of monthly household water use and the resulting household water and wastewater bill for the categories: (i) for low-income (MLSS lowest 5%), (ii) average of lowest decile (10%), and (iii) average household (third quintile) based on household size. Based on the analysis summarized in Table A13.4, households in the lowest income class will not have a problem with affordability of a tariff increase

3 YPG. 2006. Yunnan Province Statistical Yearbook. Yunnan.

56 Appendix 13 since the share of income expended on water and wastewater is 1.7%, which is well below the benchmark of 5% of household income per month. Likewise, the average income household would only spend 1.1%.

Table A13.4: Affordability Analysis (2008 Tariff Levels) Income Group Lowest 5% Lowest Decile (10%) Average Household Size (number) 2.89 3.10 2.85 Monthly Disposable Income CNY CNY CNY Per Capita 269 328 909 Per Household 778 1,017 2,590 Water Use (cubic meter/month) 5.3 6.2 8.6 Water and Wastewater Tariff (CNY/cubic meter) 2.55a 3.20b 3.20b Water and Wastewater Bill (CNY/month) 13.5 19.9 27.7 % Household Income 1.7 2.0 1.1 a Based on lifeline rate of CNY1.8 per cubic meter (m3) for the card-carrying poor up to 6.0 m3/month plus CNY0.75 per meter (m) wastewater tariff. b Based on first block tariff of CNY2.45/m3 up to 10.0 m3/month plus CNY0.75/m wastewater tariff as per Table A13.1. Sources: Kunming Social Survey Results, February 2007 and Kunming Water Supply Group Company Limited’s records.

19. Mitigation of Tariff Impacts. Poor households have little scope for absorbing even small tariff increases given their current allocation of expenditures. The households most likely to be adversely affected by the tariff increase are those within the classes of low-income households experiencing the most extreme poverty. Factors contributing to extreme poverty include elevated health care costs associated with poor health of a household member, and single person households where there is no opportunity to share common costs with other people. Such households may require additional support in the face of an increase in their water and wastewater bill. The existing 6 m3 at CNY1.8/m3 is targeted and appears to provide the best means of assisting poor families. However, it is necessary to ensure that tariffs are affordable to low-income groups. The proportion currently spent on income is 2.0%, which is regarded acceptable.

20. In the case of nondomestic customer affordability survey by KWSG in 20054 to support their tariff application, found that water tariffs accounted for a very small proportion of expenses, so that any increase would not cause undue hardship. While water tariffs to non-domestic sector have risen sharply and reflect the increasing cost of new sources, wastewater tariffs represent the recovery of the costs of the collection, treatment and disposal of wastewater. Presently, wastewater tariffs to non-domestic customers are CNY0.90/m3 of water billed. Full cost recovery tariffs are of the order of CNY2.0/m3. It is necessary for industry, where they discharge to a water course to meet the effluent standards, which is consistent with polluter pays principle. Discharging to a collection system for treatment in a wastewater treatment plant should be a less costly option for most industries, where proper on site inspection and standards are enforced.5

4 The water consumption cost accounted for 0.046% and 0.605% of total costs. For example, Camellia Hotel accounted for 0.167%, Acetate Fiber Factory accounted for 0.601%, while Kunming Yunnei Power Co., Ltd. accounted for 0.046%. KWSG Survey 2005. 5 Where the Municipal wastewater tariffs are based on polluter pays principles, then industries should only pay charges associated with collection costs and the treatment of their pollutant loading. Given that centralized treatment achieves economies of scale then wastewater tariffs should be affordable, when compared with on-site options of wastewater treatment to meet effluent discharge standards to water courses. However, it is likely that average wastewater tariffs for domestic type biological oxygen demand/chemical oxygen demand concentrations are likely to need to increase to CNY 2.0/m3 to achieve full cost recovery. In addition, those industries with industrial standard effluent concentrations should be paying additional charges to meet the specific costs of their effluent treatment. Appendix 14 57

ECONOMIC ANALYSIS

A. Introduction

1. The economic analysis of the proposed Project for Kunming city has been carried out in accordance with ADB’s Guidelines for Economic Analysis of Projects.1 The Project is analyzed as a new bulk water supply to Kunming city, and the new East Development Zone (EDZ) and New Airport Development Zone (NADZ). Accordingly, an allowance is made for water treatment, water distribution, meter reading and billing, and payment of water resource fees so that the cost of the raw water supply project can be directly related to willingness to pay.

B. Rationale of the Project

2. The water sector continues to be a priority sector under the 11th Five-Year Program (2006– 2010). The Government’s strategy focuses on (i) developing water sources; (ii) protecting existing sources by controlling industrial and residential pollution in rivers, lakes, and reservoirs; (iii) controlling overextraction from groundwater resources; and (iv) improving demand management with the introduction of water saving technology, more efficient operations, and the adoption of appropriate pricing mechanisms. Under water conservation and energy saving policies, Kunming is encouraged to develop effluent reuse, rainwater harvesting, and recycling practices to mitigate overall raw water demand.

3. The provision of new supply from the Project will provide water supply for the NADZ and EDZ, improve water security for Kunming North, alleviate the stress and overuse of existing reservoirs, and help reduce any demand to utilize groundwater. This will also enable any conflict with declared government policy—environment protection, groundwater protection, reduction in pumping—to be avoided. A potential benefit of using less water from the small catchments that feed Dianchi Lake is that flow through the lake would be partially restored, helping to stabilize if not actually lead to an improvement in the lake’s environmental condition.

4. Based on projected growth and future water demand for Kunming and new development zones, and after assessment of existing water sources (quantity and quality), there is clearly an identified need for Kunming to develop new water sources in the near future. Of the identified alternatives available for development, Qingshuihai was evaluated as the best least-cost option. The Project will also be: (i) beneficial for Kunming by supporting urban development and economic growth; (ii) positive for overall public health, sanitation, and the well-being of beneficiaries; and (iii) provide opportunities to relieve the environmental stress on local groundwater sources and surface sources.

C. Economic Assumptions

5. For the present study, the following assumptions are adopted: (i) all costs are expressed in early 2007 prices, and (ii) civil works and bulk transmission facilities/pipelines are assumed to have a useful economic life of 50 years after construction. Residual values are assumed in year 20 for reservoir assets of 30 years of the assumed 50-year life. The real opportunity cost of capital employed in the economic analysis is assumed to be 12% per annum. Capital costs include physical contingencies but exclude price contingencies and interest during construction (as a result of any debt financing). Taxes and duties are assumed at 3.3% for civil works and other structures and 14.5% for mechanical and electrical equipment. Operation and maintenance costs are assumed at 1.5% of project capital costs, with labor costs assumed for 88 persons at

1 ADB. 1997. Guidelines for the Economic Analysis of Projects. Manila.

58 Appendix 14

CNY4.44 million per annum, a water resource fee at CNY0.23 per cubic meter (m3) of water supply and an allowance for incremental water treatment and water distribution costs, and meter reading and billing of CNY1.03/m3 of water sales.

D. Least Cost Analysis

6. A Kunming city long-term water supply plan was prepared in 1994 and reviewed in 2003. The plan assessed 14 options or combined options for water delivery. Most options were rejected because (i) water quality at source was below drinking water standards, (ii) assured water source volume was insufficient to provide adequate alternative water supply without combination with other options, and (iii) electricity pumping cost was too high.

7. As a result of the 2003 review, four primary options (Fenglongwan, Niulangjiang, Qingshuihai, and Zhangjiuhe) were identified. Of these, Qingshuihai was initially favored on a least-cost basis (low unit costs for water and no pumping) but administrative issues related to Qingshuihai could not be resolved (Xundian and Songming counties were not then a part of Kunming municipality). For administrative reasons, Zhangjiuhe was chosen over Qingshuihai for implementation under Japan Bank for International Cooperation and was commissioned in April 2007. The discounted costs per m3 over a 20-year period at a 12% discount rate are CNY1.90 for Zhangjiuhe, CNY1.85 for Qingshuihai, and CNY2.41 for Fenglongwan. Accordingly, Qingshuihai is now regarded the least-cost option for proposed water resource development.

E. Water Demand Projections

8. Future water demand projection for the period 2006–2020 has been prepared in line with ADB guidelines which relate demand to expected future increases in income and changes in water tariffs for domestic consumption assuming 100 liters per capita per day, and the equivalent of 175 liters per capita per day for nondomestic consumption. The population of Kunming is projected to increase from 2.76 million in 2006 to 3.1 million in 2020, at less than 1% per annum. Population growth in Kunming is based on EDZ population increasing from 0.16 million in 2006 to 0.95 million in 2020, and NADZ population increasing from around 20,000 (predominantly rural) in 2006 to 180,000 by 2020. On this basis, the projected additional raw water requirement for Kunming, EDZ, and NADZ would be about 107 million m3/year by 2015, rising to an estimated 149.0 million m3/year by 2020, even after allowing for improved water supply, treatment, and distribution efficiencies through to 2020. In practice, Kunming municipal government (KMG) is likely to reduce the use of existing water sources and utilize the better quality water available from Qingshuihai from 2013. The overall future water supply and demand for Kunming and the new development zones is summarized in Table A14.1. Details are in Supplementary Appendixes A and M.

Table A14.1: Summary of Water Demand and Supply Balance, 2007–2020 2007 2010 2015 2020 Area Water Demand (million m3) (million m3) (million m3) (million m3) Kunming Main City 404.0 415.8 398.8 408.3 Eastern Development Zone 29.4 52.4 88.6 125.3 New Airport Development Zone 0.0 9.2 18.5 23.7 Total Water Demand 433.4 477.4 505.9 557.3 Water Availability with Qingshuihai 459.9 487.1 558.0 558.0 Net Projected Balance 26.1 9.8 52.0 0.7 m3 = cubic meter. Sources: Kunming Water Supply Group Company Limited, Yunnan Design Research Institute and project preparatory technical assistance model.

Appendix 14 59

F. Raw Water Fees for Reservoir Operations and Management, Catchment Protection

9. The tariff provides for the payment of raw water fees made up of a water resource fee of CNY0.23/m3 and a water management fee of CNY0.20/m3. These fees are levied on water supplied to water treatment plant. The water management fee is transferred to the reservoir operator to meet operation and maintenance costs, while the water resource fee is transferred to Provincial and Municipal Finance Bureaus to be used for compensation to affected persons in the catchment areas because of change to environment-friendly farming practices.

10. In respect to reservoir management, the Qingshuihai feasibility study report provided for staff of 88 persons and 1.5% of capital costs for reservoir operation and maintenance (O&M). This represents CNY26 million per annum, or a fee of CNY0.25/m3. Benchmarking material costs against Australian experiences indicates that this fee would be adequate to meet O&M costs over the first half (25 years) of the assets’ lives. Capacity development also provides for Kunming Water Supply Group Company Limited to prepare a detailed budget to support an application to KMG for the level of fee necessary to support adequate O&M for Qingshuihai reservoir.

11. The water resource fee (50% represents CNY12.0 million per annum) transferred to Kunming Financial Bureau will be used directly to support compensation policies for affected persons in the watershed area, where adopting more environment-friendly policies would lead to loss of income. In addition, ongoing KMG programs and subsidies can be applied to affected persons to compensate them for adopting more environment-friendly farming practices and/or poverty alleviation measures. It is unnecessary to establish a specific project fund for this purpose under the Project. ADB will encourage KMG to provide a comprehensive program of compensation and support.

G. Project Benefits

12. Benefits are associated with the improvement in water supply treatment and distribution services and include the provision of a 24-hour service in areas currently experiencing interrupted service, increased security of supply, improved drinking water quality, improvements in system pressure, reduced risk of exposure to waterborne pathogens in delivered tap water, and reductions in non-revenue water.

13. Water supply benefits are estimated using a willingness to pay approach. Consumer willingness to pay for water was estimated for domestic consumers through contingent valuation approach as part of the socioeconomic survey. The value of domestic water was estimated based on expected improvement in present water quality and the increased quantity of water that will be provided in the future. The value of present quality water was taken as the CNY2.8/m3 tariff now paid, which includes CNY0.75/m3 for wastewater. Respondents were then asked how they felt about the approved rise of 20% in the tariff on 1 July 2007 to CNY3.2/m3 tariff, which includes CNY0.75/m3 for wastewater. The value of higher quality water was taken from household survey data, which indicated that people on average were willing to pay CNY4.35/m3 for such water because of increased observed quality and expected increases in quantity.

14. In the case of nondomestic customers, which have also faced severe quota restrictions, with quotas being reduced to service domestic areas, over the last 3 drought years, it is assumed that their willingness to pay for improved water quality and volumes would be at least as high as domestic customers, i.e., a minimum of 36% above the proposed tariffs. This would equate to a willingness-to-pay tariff of CNY5.76/m3 based on a proposed average nondomestic tariff of CNY4.24/m3 by 1 July 2007. This fits within the range of the value of industrial water estimated

60 Appendix 14 from the value added to industrial output by water input.2 The estimate for the People’s Republic of China (PRC) as a whole was CNY5/m3 in 2002; for northern PRC, the average was CNY6.32.

15. The willingness to pay results reflect the provision of treated potable water to urban users. To determine the share of willingness to pay that can be attributed to the raw water source, it is necessary to deduct the share of the benefit related to water treatment and distribution. This has been achieved by calculating the average incremental economic cost for potable water and for raw water, by deducting the costs of water treatment and distribution amounting to CNY1.03/m3. The results are summarized below, and demonstrate that 78% of the willingness-to-pay value can be allocated to the raw water source over the life of the Project. The benefit attributed to the Project is CNY3.38/m3.

H. Summary of Economic Analysis Results

16. The economic internal rate of return (EIRR) for the Project is 20.1%. The EIRR of the Project exceeds 12%. The net present value at 12% is CNY1,084.1 million. An analysis to test the sensitivity of the EIRR of the water supply projects to adverse changes in key variables was undertaken. The Project is most sensitive to delays that may result in real capital cost increases and a delay in benefits, as the plant is commissioned later. In particular, a project-specific sensitivity that reflects cost increases and delays demonstrates that a 2-year delay with 20% cost increases results in the EIRR declining to 16.2%. Although the EIRR is still well above 12%, efforts must be made in project implementation to avoid such delays and cost increases. Where groundwater use continues at half of 2007 levels rather than eliminated, the EIRR falls to 16.5% as utilization of Qingshuihai is delayed. Where the willingness to pay of nondomestic users was reduced by 50%, the EIRR falls to 15.1%.

Table A14.2: Qingshuihai Project EIRR and Sensitivity Analysis

Sensitivity Analysis EIRR SIa SVb Base Case 20.1% Capital +10% 18.8% 6.5% 61.9% Operating +10% 19.9% 0.8% 524.1% Benefits -10% 18.5% 8.0% -50.4% All the above 17.1% 2-year delay with 20% increase in CAPEX 16.2% Groundwater use continues at 30 million m3/year 16.5% Willingness to pay of nondomestic reduced by 50% 15.1% EOCC 12.0% CAPEX = capital expenditure, EIRR = economic internal rate of return, EOCC = economic opportunity cost of capital, m3 = cubic meter, SI = sensitivity indicator, SV = switching value. a Sensitivity indicator is the ratio of percentage change in the net present value (NPV) to the percentage change in a variable. A high value for this indicator indicates project sensitivity to the variable. b Switching value shows the percentage increase in a cost item (decline in a benefit item) required for the NPV to become zero (which is the same as the EIRR reducing to the cutoff level of 12%). Source: Asian Development Bank estimates.

2 As estimated by Hua Wang and Somik Lall of the World Bank’s Development Research Group, 2002. Unadjusted for inflation to 2007.