Xichuan Integrated Ecological Protection and Environmental Improvement Project (RRP PRC- 53053-001)

ECONOMIC ANALYSIS

A. Macroeconomic and Sector Context

1. in Nanyang City, Henan Province in the People’s Republic of (PRC) is rural, and was one of the PRC’s 53 remaining national poverty counties in 2020, with a low human development index ranking. In 2018, Xichuan County had a population of 724,600 (including 387,000 males and 337,600 females); about 80% are rural residents, with an average per capita income of CNY12,114, below the PRC’s national average rural per capita income of CNY14,671.1 Annual population growth in the county is estimated at 4.6%, which is the highest in the province. Xichuan County is located on the southwest border of Henan Province, and borders , and Shanxi provinces. The county is the headstream of the middle line of the South-to-North Water Diversion Project (SNWDP); as such it is part of SNWDP’s controlled development zone, which aims to secure water quality and quantity in the Reservoir, which is the SNWDP’s source. Xichuan County faces various development restrictions that seek to limit degradation of water quality and quantity in the (the SNWDP serves 50 million people in 30 major cities in the northern PRC, including Beijing, and Tianjin). The main sources of pollutants in the rivers feeding Danjiangkou Reservoir (such as Danjiang and Laoguan rivers) are rural households with improper sanitation, villages without solid waste and wastewater management, and farmlands with unsustainable farming practices.

B. Economic Rationale

2. Xichuan County lacks adequate water supply and wastewater treatment infrastructure and environment protection services. Water supply, wastewater management, and drainage systems lack capacity and cannot meet required quality standards; and untreated wastewater pollutes the environment. Water supply, sewer, and drainage pipe networks do not reach many rural areas and do not meet the requirement that sanitary sewers and drainage pipes be separated. Water supply pipes are aging and leakage causes significant water loss. Problems include rivers that overflow, causing floods during heavy storms and spring snowmelt; serious soil erosion that results from the lack of slope protection of riverbanks and steep slopes; narrow river courses that are scattered with solid waste; and water that is polluted from untreated discharge of domestic and non-domestic wastewater. Fatal flash floods were recorded in 2010, 2011, 2017, and 2018. In 2010 alone, Xichuan County lost about CNY658 million from flash flood events, mostly from impacts to agriculture. Flash flood events are exacerbated by poor drainage infrastructure and clogging of natural creeks in low-lying areas.

C. Project Output and Least Cost Options

3. The project has three outputs: (i) institutional capacity of Xichuan County Government on environmental management and knowledge services developed, (ii) soil and water conservation practices improved, and (iii) rural water services improved.

4. Least cost analysis was conducted for alternative engineering options for sewage pipe and slope protection materials: (i) collector sewer options for the wastewater subprojects, and (ii) bank slope reinforcement for the natural drainage management subproject. The major assumptions used for the least cost analysis were the same as for the overall economic analysis. The least cost option for slope protection was selected for the project design. For the sewage pipe design,

1 National Bureau of Statistics of China. China Statistical Database. (accessed 14 April 2021).

2 the least cost-option (pre-stressed concrete pipe) was not chosen because the relatively high weight impedes transport and construction.

5. Demand projections were prepared to establish the existing and future consumer demand for water supply, wastewater treatment, and solid waste services to be produced by the project. The water supply subproject will meet water demand in 2030, forecasted at 120,000 cubic meters (m3) of water produced per day in urban areas and 5,000 m3 per day in rural areas. It is estimated that the project will provide clean and safe water for 155,441 households by 2030. The total demand for water will increase from about 50,327 m3 per day in 2020 to about 125,734 m3 per day in 2030. Service provision is expected to increase from 63% in 2020 to 100% in 2030. The demand for improved water supply services is further reinforced by the incremental willingness to pay (WTP) for improved services, which exceeds the existing water charges.

6. Xichuan produces 553 tons of solid waste per day, including 83 tons of food waste. The existing sewage treatment facilities yield 69 tons of sludge per day. The sludge facility is sized to service existing demand, while just 36% of the existing food waste demand can be serviced. Sanitation facilities connected to wastewater treatment facilities are not available to the rural population of 450,000. Wastewater components under the project will provide about 15% coverage.

7. The project will construct a food waste and sludge treatment center with an estimated capacity of 100 tons per day. Generated food waste and sludge for the service area are projected at 100 tons per day. The project will construct embankment, slope protection, revetment, and river training along two rivers in Xichuan. Rainfall in Xichuan is high in intensity and short in duration, resulting in large stormwater runoff and flooding hazards. Xichuan experiences severe flooding incidents; a large number of residents are affected, with damage to infrastructure, agricultural land, and private property. Production from the project includes fresh fruits; production is aimed at the rapidly expanding numbers of middle-class urban consumers, among whom demand is growing rapidly.

D. Economic Analysis

8. The economic analysis was undertaken in accordance with the Asian Development Bank (ADB) and other good-practice guidelines.2 The analysis (i) assumes project investments will be made over a 6-year implementation period starting in 2021; (ii) assumes a project life of 20 years for the improved wastewater treatment, improved solid waste, improved water supply, integrated river and lake rehabilitation, post-harvest facilities, and smart irrigation; (iii) values economic costs and benefits in domestic price numeraire and expresses these in yuan; (iv) calculates economic costs of capital works and annual operation and maintenance from project cost estimates (price contingencies, financial charges, and taxes and duties excluded, but physical contingencies of 5% are included in the analysis); (v) values prices and costs as of the third quarter of 2020; (vi) adjusts traded goods by a shadow exchange rate factor estimated at 1.01; and (vii) adjusts skilled labor to its economic value using an opportunity cost of scarce labor of 1.0, with unskilled labor adjusted to its economic value using a shadow wage rate of 0.80.

2 ADB. 2017. Guidelines for the Economic Analysis of Projects. Manila; ADB.1997. Handbook of Economic Analysis of Water Supply Projects. Manila.

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E. Economic Costs and Benefits

9. Economic costs. The economic costs include (i) capital costs of civil works, equipment, materials, and land acquisition and resettlement; and (ii) operation and maintenance costs, including the cost of replacing depreciated assets. The overall cost for the investment project component is CNY3,200.2 million.

10. Smart irrigation. The project involves construction of smart irrigation in 10 towns covering an area of 38,537 mu.3 Benefits considered include the economic value of the incremental increase in fruit tree production. The economic value was computed by establishing crop budgets for the four main fruit crops planted in the project area. The incremental benefit is calculated by deducting the without-project situation from the with-project situation. For the four fruit crops, quantified benefits include an increase in average yield (from CNY235 of fruits per mu in the without-project scenario to CNY317 fruits per mu in the with-project scenario). Other benefits that were not quantified and valued in the analysis include improved health and nutrition of the project beneficiaries, increased water availability for agricultural activities, and more efficient management and monitoring of water resources.

11. Fruit cold storage. Construction of cold storage facilities for storage fresh fruit with a total capacity of 20,000 tons or 120,000 m3 will be undertaken in 10 towns. Implementation of the project will also improve the efficiency of the existing transport industry and rural network sales, and e-commerce logistics. Benefits are derived from averted post-harvest losses through construction of the cold storage facilities. The losses are calculated as the post-harvest value of 86,631 tons of fruit products, with an estimated economic value of CNY32.5 million. 4 Other benefits not quantified include the expected increase in net revenues through enhanced market access and improved food security.

12. River improvement. The project intervention includes river embankment, slope protection, revetment, river training, a flood warning system, and greening for Xi and Danjiang rivers. Benefits are based on average avoided annual flood damage to tangible assets. The average annual damage avoided is estimated by: (i) using historic reference case flood-event damages and estimates of flood probabilities to construct a reference case damage-frequency curve; (ii) constructing a project damage-frequency curve for each alternative level of flood defense; and (iii) calculating the area between the curves for each project case and the reference case. The estimated annualized economic values for protecting up to a 20-year flood frequency are CNY16.5 million for Xi River and CNY93.8 million for Danjiang River. 5 Additional non-quantified benefits include environmental improvements to rivers and water quality, benefits from the recreational value of the riverfront greenway system with continuous pathways, and intangible benefits in the form of less anxiety and illness.

13. Drainage and waterlogging alleviation facilities. The project includes drainage rehabilitation along nine roads in low-lying, flood-prone areas to prevent accumulation of water that can lead to flooding and soil erosion. The project also involves river training of the Shiban Creek and improvement of Nei River, including reinforcing embankments and revetments to

3 A mu is a Chinese unit of measurement (1 mu = 666.67 square meters). 4 Food and Agriculture Organization. 2019. The State of Food and Agriculture 2019. Moving forward on food loss and waste reduction. Rome. http://www.fao.org/3/ca6030en/ca6030en.pdf. Post-harvest losses are estimated at 9% (average rate calibrated for South and East Asian countries) based on a United Nations Food and Agriculture food loss index of 13.8% recorded at different stages (production, post-harvest, and processing) of the supply chain. The lost harvest is valued at an average 2020 constant price of CNY4.6 per kilogram. 5 The proposed flood warning system will also reduce flood damage. The benefit is estimated to be about CNY5.6 million. As this estimate is highly uncertain, it is not considered in the analysis.

4 prevent and mitigate floods and general flood control. Benefits are based on avoided damages to vulnerable assets from floods with a maximum 20-year return period. Annual damages estimated at CNY17.61 million will be averted by the subproject. The subproject will benefit 41,429 households.

14. Water supply. The project will construct a water treatment plant (with capacity of 125,000 m3 per day) in Madeng town and the central urban area of Xichuan. Benefits were derived from (i) incremental water consumption for connected and unconnected households, estimated at 6.9 million m3 derived by multiplying the total additional volume of water consumed by the economic value (represented by water users’ WTP, which was derived using a close-ended contingent valuation approach administered during the household survey, and estimated at CNY4.32 per m3). The WTP was adjusted annually to reflect the expected growth in real income of 5% per year to 2031, 3% per year to 2036, and 2% per year thereafter; and (ii) non-incremental water valued at resource cost savings. Resource cost savings for non-incremental water (estimated at 2.1 million m3) were computed by multiplying the volume of water consumed by those who are not currently connected by the economic value of non-piped water estimated at CNY27.0 per m3 per day; this value was based on the estimated costs of treating and storing water, water deliveries, bottled water, and the economic value of time saved by households who will not need to collect water from wells and other sources. Benefits from improved health and environment have not been quantified.

15. Wastewater treatment. This includes construction of 14 wastewater treatment plants in rural areas with an estimated annual capacity of 1.1 million tons per year including installation of 280 kilometers of collection pipelines. The subproject will benefit 5,817 households in five towns. WTP was derived using a close-ended contingent valuation approach estimated at CNY1.72 per m3. The WTP was adjusted annually to reflect the expected growth in real income by 5% per year to 2031, 3% per year to 2036, and 2% per year thereafter. Benefits for wastewater services were valued at 80% of water consumed for those connected to the sewer services. An additional benefit for improvement of water quality was considered because this was not captured by the WTP survey. In the absence of any survey for improved water quality, a benefit transfer approach was employed. WTP values were taken from results of several comparable WTP scenarios elsewhere in the PRC, and a mean WTP for improved water quality of CNY17.96 per household per month was used.6

16. Solid waste. The project will construct a food waste and sludge treatment center with an estimated capacity of 100 tons per day. A WTP of CNY26.5 per month in 2019 prices for solid waste management was calculated using a benefit transfer approach.7

F. Evaluation of Economic Performance

17. The economic viability of the project was determined by computing the economic internal rate of return (EIRR) and comparing it with the economic opportunity cost of capital of 9%. The overall project is economically viable with an EIRR of 11.9% and net present value of CNY492.4 million (Table 1). The EIRRs for each project output exceed 9% and are provided in Table 1.

18. The viability of the project was tested through a sensitivity analysis that examined the impact of changes in costs, benefits, and implementation delay on economic performance. The estimated EIRRs for the overall project remain above 9% in all scenarios (Table 2). The analysis suggests that the project economic performance is generally robust against identified risks.

6 ADB. 2013. Anhui Huainan Urban Water Systems Integrated Rehabilitation Project. Manila. 7 H. Wang et al. August 2011. Municipal Solid Waste Management in Small Towns: An Economic Analysis Conducted in Yunnan, China. Policy Research Working Paper No. 5767. Washington DC: World Bank.

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G. Project Beneficiaries and Poverty Impact

19. The economic analysis of the project also assessed the distribution of benefits for various beneficiaries. Farmers, workers, municipal and provincial governments, industries, and communities (direct recipients of improved wastewater and water supply services) are expected to benefit from the project. The community will receive the largest share, accounting for 60% of the total benefits. The distributional analysis yields a poverty impact ratio of 0.20, i.e., the poor are expected to receive 20% of project benefits, equal to CNY125.9 million.

Table 1: Evaluation of Project Overall Economic Performance Benefits- Benefits: Output 2 Benefits: Output 3 Output 1 Total Total Net Year I R Fruit Smart River Cost Drain- Water Waste Solid Benefits Benefits Cold Irriga- Improve- age Supply Water Waste Storage tion ment 2021 137.5 0.0 137.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (137.5) 2022 455.6 0.0 455.6 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (455.6) 2023 556.6 0.0 556.6 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (556.6) 2024 390.3 0.0 390.3 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (390.3) 2025 178.5 0.0 178.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (178.5) 2026 17.5 0.0 17.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 (17.5) 2027 0.0 90.1 90.1 32.5 22.1 109.5 17.6 108.0 34.0 11.4 335.1 245.0 2028 0.0 90.1 90.1 32.5 25.9 109.5 17.6 113.2 37.3 11.9 347.9 257.8 2029 0.0 90.1 90.1 32.5 29.8 109.5 17.6 118.8 40.9 12.5 361.7 271.5 2030 0.0 90.1 90.1 32.5 33.9 109.5 17.6 124.7 45.0 13.0 376.4 286.2 2031 0.0 90.1 90.1 32.5 38.3 109.5 17.6 129.4 49.4 13.6 390.4 300.3 2032 0.0 90.1 90.1 32.5 42.8 109.5 17.6 134.3 53.2 14.3 404.3 314.1 2033 202.0 90.1 292.2 32.5 47.6 109.5 17.6 139.4 57.3 14.9 418.9 126.8 2034 0.0 90.1 90.1 32.5 52.7 109.5 17.6 144.7 61.8 15.6 434.4 344.3 2035 0.0 90.1 90.1 32.5 57.9 109.5 17.6 150.2 66.5 16.3 450.7 360.6 2036 0.0 90.1 90.1 32.5 63.5 109.5 17.6 155.4 71.7 17.1 467.3 377.1 2037 0.0 90.1 90.1 32.5 69.3 109.5 17.6 160.7 76.5 17.9 484.0 393.8 2038 0.0 90.1 90.1 32.5 75.4 109.5 17.6 166.1 81.6 18.7 501.5 411.4 2039 0.0 90.1 90.1 32.5 81.8 109.5 17.6 171.9 87.1 19.6 520.0 429.8 2040 0.0 90.1 90.1 32.5 88.6 109.5 17.6 177.8 92.9 20.5 539.4 449.2 2041 0.0 90.1 90.1 32.5 95.6 109.5 17.6 183.9 99.1 21.4 559.7 469.6 2042 0.0 90.1 90.1 32.5 103.1 109.5 17.6 190.3 105.8 22.4 581.1 491.0 2043 0.0 90.1 90.1 32.5 110.9 109.5 17.6 196.9 112.8 23.4 603.6 513.5 2044 0.0 90.1 90.1 32.5 119.1 109.5 17.6 203.7 120.4 24.5 627.3 537.2 2045 0.0 90.1 90.1 32.5 127.7 109.5 17.6 210.8 128.4 25.6 652.2 562.1 2046 0.0 90.1 90.1 32.5 136.7 109.5 17.6 218.2 137.0 26.8 678.4 588.3 NPV 1,408.2 490.7 1,898.9 177.1 300.9 596.2 95.9 787.0 347.5 86.7 2,391.2 492.4 EIRR 14.7% 11.% 11.7% 11.9% ( ) = negative, EIRR = economic internal rate of return, I = Investment costs, NPV = net present value, R = recurrent costs for operation and maintenance. Source: Asian Development Bank estimates.

Table 2: Sensitivity Test Results NPV Sensitivity Test EIRR SI SV (%) (CNY million) Base Case 11.9% 492.4 Increase in capital cost by 10% 11.0% 359.2 0.8 32.0 Increase in operating costs by 10% 11.6% 435.7 0.3 91.8 Decrease in benefits by 10% 10.6% 253.2 1.1 21.7 All of the above 9.4% 63.4 2.1 11.5 1-year lag in implementation 11.6% 394.3 0.2 EIRR = economic internal rate of return, NPV = net present value, SI = sensitivity indicator, SV = switching value. a Switching value is the percentage change in costs or benefits to result in an EIRR equal to 9%. Source: Asian Development Bank estimates.