Proposed Loan to the People's Republic of China for the Henan

Report and Recommendation of the President to the Board of Directors

Project Number: PRC 34473 November 2005

Proposed Loan to the People’s Republic of China for the Henan Wastewater Management and Water Supply Sector Project

CURRENCY EQUIVALENTS (as of 1 November 2005)

Currency Unit – yuan (CNY) CNY1.00 = $0.124 $1.00 = CNY8.08

ABBREVIATIONS

ADB – Asian Development Bank DSCR – debt-service coverage ratio EIA – environmental impact assessment EMP – environmental management plan EPB – environmental protection bureau FIRR – financial internal rate of return GDP – gross domestic product HDRC – Henan Development Reform Commission HECC – Henan Engineering Consulting Company HHRP – Henan Hai River Plan HPG – Henan provincial government HPMO – Henan project management office HRB – Hai River Basin HRP – Hai River Plan IA – implementing agency LCB – local competitive bidding LIBOR – London interbank offered rate MDG – Millennium Development Goals MIS – management information system MLG – minimum living guarantee O&M – operation and maintenance PMO – project management office PPMS – project performance monitoring system PRC – People’s Republic of China RP – resettlement plan SAR – subproject appraisal report SEIA – summary environmental impact assessment SNWTP – South-North Water Transfer Project TA – technical assistance WACC – weighted average cost of capital WTP – water treatment plant WWTP – wastewater treatment plant

NOTES

(i) The fiscal year of the Government ends on 31 December. (ii) In this report, "$" refers to US dollars.

Vice President J. Eichenberger, Operations 2 Director General H. Satish Rao, East and Central Asia Department (ECRD) Director R. Wihtol, Social Sectors Division (ECSS), ECRD

Team leader I. Keum, Project Administration Unit Head, ECSS, ECRD Team members D. Dole, Sr. Economist, Economics and Research Department S. Ferguson, Sr. Resettlement Specialist, ECSS, ECRD C. Gautrot, Counsel, Office of the General Counsel S. Handayani, Poverty Reduction Specialist, ECSS, ECRD A. Leung, Social Sector Unit Head, PRC Resident Mission, ECRD S. Popov, Project Specialist (Environment), ECSS, ECRD

CONTENTS

Page LOAN AND PROJECT SUMMARY iii MAP ix 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 6 A. Impact and Outcome 6 B. Outputs 7 C. Special Features 8 D. Cost Estimates 8 E. Financing Plan 8 F. Implementation Arrangements 10 IV. PROJECT BENEFITS, IMPACTS, ASSUMPTIONS, AND RISKS 15 A. Environmental Impacts and Benefits 15 B. Social Dimensions 15 C. Institutional Benefits 16 D. Economic Analysis 17 E. Financial Evaluation 17 F. Risks 18 V. ASSURANCES 18 A. Specific Assurances 18 B. Conditions for Disbursement 20 VI. RECOMMENDATION 20

APPENDIXES 1. Design and Monitoring Framework 21 2. Policy Framework 24 3. Candidate Subprojects 26 4. Process for Subproject Identification, Selection, Preparation, and Appraisal 27 5. Institutional Capacity Building 30 6. Detailed Cost Estimates 35 7. Flow of Funds and Onlending Arrangements 36 8. Organization Chart of Project Management Arrangements 37 9. Implementation Schedule 38 10. Contract Packages 39 11. Outline Terms of Reference for Consulting Services During Implementation Phase 40 12. Outline Project Performance Management System 45 13. Summary Poverty Reduction and Social Strategy 46 14. Summary Resettlement Plan 50

15. Economic Analysis 53 16. Financial Analysis 57 SUPPLEMENTARY APPENDIXES (available on request) A. Sector Institution Assessment B. Summary Appraisal Report C. Subproject Appraisal Reports and Feasibility Study Reports for Eight Representative Subprojects D. Physical Description of Eight Representative Subprojects E. Detailed Assessment of Project Institutions and Capacity-Building Measures F. Subproject Appraisal Criteria G Resettlement Plans for Eight Representative Subprojects H. Resettlement Framework I. Health Benefit Estimation and Monitoring J. Summary Environmental Impact Assessment K. Financial Projections of Implementing Agencies

LOAN AND PROJECT SUMMARY

Borrower People’s Republic of China (PRC)

Classification Targeting Classification: General intervention Sector: Water supply, sanitation, and waste management Subsectors: Water supply and sanitation, waste management Themes: Environmental sustainability, sustainable economic growth Subtheme: Urban environmental improvement

Environment Category A. An environmental impact assessment was undertaken Assessment and the summary was circulated to the Board on 29 March 2005.

Project Description The development objective of the Henan provincial government (HPG) for the sector is to enhance (i) quality of life of the rapidly increasing urban population in the Hai River Basin (HRB), and (ii) economic competitiveness to sustain economic growth in key municipalities, by alleviating degradation of water resources and improving the quality of the urban environment.

To meet this objective, the Project is designed to increase the collection and treatment of wastewater, and to reduce reliance on abstraction of groundwater from shallow wells (most of which are polluted by wastewater) in the project cities through physical investment, and institutional and financial reforms. The Project will support water quality improvement in several canal and river systems in the project cities through physical investment and improved water management. In addition, the Project will help strengthen water resource protection in the HRB through improved and integrated planning, water quality monitoring, and environmental management.

The Project has identified 19 physical investment subprojects (8 representative and 11 candidate subprojects) to provide improved wastewater collection and treatment, and water supplies in the 15 project cities. The Project also identified the need for capacity building and training for the project institutions, including county water utility companies. The Project adopts a sector loan approach and will support an area and time slice of the Government’s Henan Hai River Basin Plan, which serves as a sector development plan for the HRB.

Rationale Rapid economic growth and continuing urbanization over the last 25 years in the PRC has resulted in increasingly severe problems related to water shortage and pollution, especially in the north. Water shortages for domestic consumption and urban industry have increased in magnitude and frequency, resulting in severe economic losses. Surface and groundwater pollution now

represent a major problem not only for the environment but also for public health. Given the degree of water scarcity, pollution also diminishes the resources available for essential beneficial uses. Pollution represents a growing constraint on national and local development objectives.

The northern part of Henan province, which is within the HRB, comprises five municipalities and 17 counties. The main rivers in this part of the basin are heavily polluted by domestic and industrial wastewater. This pollution adversely affects the local environment, impacts public health, and contributes to transboundary pollution disputes with the downstream provinces of Hebei and Shandong.

The Project will address the major issues involved in the rapid deterioration of surface and groundwater quality and urban environmental quality, including (i) lack of environmental infrastructure, (ii) inadequate water resource management, and (iii) financial and institutional weakness of municipal service providers.

The Project will assist the participating cities in formulating a practical approach to provide urban environmental infrastructure and to introduce the principles of integrated water resource management and pollution control. The Project will help improve the urban environment and public health through improved wastewater management and more secure water supply, and improve the quality of surface and groundwater in and downstream of the project cities. It will also help water and wastewater utility companies provide financially and operationally sustainable water supply and wastewater services.

Impact and Outcome The overall impact of the Project is to improve the urban environment and public health through improved wastewater management and water supply. The outcome will be that water and wastewater utility companies in the project cities will provide sustainable water supply and wastewater services managed on commercial principles and environmentally sound practices by (i) increasing collection and treatment of domestic and industrial wastewater, (ii) providing adequate public water supplies, and (iii) improving the quality of surface and groundwater in and downstream of the project cities.

The Project comprises physical components covering construction of wastewater management and water supply facilities, and an associated capacity-building component to support project management and implementation through capacity building for the project management offices (PMOs) and the implementing agencies. Policy dialogue under the Project supports these components and contributes to ongoing dialogue with the central and local governments.

Cost Estimates The total project cost is $200.0 million equivalent, including a foreign exchange cost of $100.0 million (50%) and a local currency cost of $100.0 million equivalent (50%).

Financing Plan ($ million equivalent) Foreign Local Total Source Exchange Currency Cost Percent A. Asian Development 100.0 0.0 100.0 50.0 Bank B. Domestic Bank 0.0 27.2 27.2 13.6 Cofinancing C. Counterpart Funding 0.0 72.8 72.8 36.4 (central, local governments, and water companies) Total 100.0 100.0 200.0 100.0

Loan Amount and Terms A loan of $100 million from the ordinary capital resources of the Asian Development bank (ADB) will be provided under ADB’s London interbank offered rate (LIBOR)-based lending facility. The loan will have a 25-year term, including a grace period of 5 years, an interest rate determined in accordance with ADB’s LIBOR- based lending facility, a commitment charge of 0.75% per annum, and such other terms and conditions set forth in the draft loan and project agreements.

Allocation and Relending The loan proceeds will be relent by the central Government to Terms HPG. HPG will onlend the loan proceeds to the municipal governments. The municipal governments will onlend the loan proceeds to the county and city governments. These local governments will onlend the loan proceeds to the wastewater or water utility companies serving the project cities. All onlending will be on the same terms and conditions as the ADB loan. The utility companies will assume the foreign exchange and interest rate variation risks for the ADB loan.

Period of Utilization Until 30 June 2011

Estimated Project 31 December 2010 Completion Date

Implementation The Henan PMO (HPMO), under the overall direction and Arrangements guidance of the HPG leading group headed by the deputy governor of Henan province, will coordinate project implementation work through the various design institutes, and implementing agencies responsible for day-to-day project management. HPMO is supervised on a day-to-day basis by Henan Provincial Financial Bureau.

Executing Agency Henan Provincial Government

Procurement ADB-financed civil works, equipment, and materials will be procured in accordance with ADB’s Guidelines for Procurement. Major contracts for equipment and materials will be tendered through international competitive bidding or international shopping procedures, depending on the contract amount. Civil works contracts will be procured through local competitive bidding. In accordance with ADB guidelines, foreign contractors may participate in the bidding for local competitive bidding contracts.

Consulting Services Twenty-eight person-months of international and 300 person- months of domestic consulting will be required, with expertise in international competitive bidding and international shopping procedures, including international specifications, bid evaluation, contracts, quality control, and project performance management systems. The consultants will provide guidance and training for capacity building to ensure that (i) the implementing agencies in the project cities are able to function as effective project management units; (ii) appropriate institutional, managerial, financial, and operational arrangements are in place to enhance operational effectiveness, management efficiency, and financial sustainability; (iii) the water supply and wastewater companies become effective operating companies upon completion of implementation; and (iv) social, resettlement, and environmental impacts are monitored and mitigated. Consultants will be recruited in accordance with ADB’s Guidelines on the Use of Consultants and other arrangements satisfactory to ADB on the engagement of domestic consultants. Detailed design engineering and construction supervision will be carried out by qualified local design institutes recruited by the project cities; these services will not be financed by ADB.

Project Benefits and The Project will directly benefit 1.5 million urban residents in the Beneficiaries project cities whose living conditions and public health standards will be improved through (i) the collection and treatment of about 590,000 cubic meters per day of untreated sewage, of which half will be heavily polluting industrial wastewater, and (ii) improved water supply of 150,000 cubic meters per day. The savings to industry, through avoidance of advanced wastewater treatment required for discharge to surface waters, will support sustainable economic growth, promote clean technologies and water conservation, and ameliorate the poverty impacts of enterprise closures imposed on environmental grounds.

The Project will contribute to the achievement of downstream benefits of improved water quality through the collection and treatment of wastewater generated in each project city. Downstream beneficiaries include residents of Hebei and Shandong provinces and coastal areas of Bohai Bay. These water quality improvements will contribute to integrated water resource management and pollution control; the basin management program; and transboundary pollution prevention and control. vii

The Project will have a positive impact on the environment; the benefits greatly outweigh the negative impacts. The Project is designed to mitigate all construction-related environmental impacts. Adequate provision is made to fully compensate the estimated 7,500 people adversely affected by the Project, primarily due to temporary and permanent loss of land. Extensive consultation with those affected was undertaken as outlined in the resettlement plans for the representative subprojects, which were made public after approval of domestic feasibility studies.

The Project will support poverty reduction by (i) reducing the incidence of waterborne disease, cost of medical care, and sick days taken, thus reducing household health expenditures; (ii) providing safer and more reliable urban water supplies; (iii) improving the quality of life of the urban poor by eliminating uncollected sewage in poor neighborhoods and improving water quality in urban drainage channels; and (iv) providing employment opportunities to the poor.

Risks and Assumptions The Project has potential institutional, financial, and policy risks related to (i) implementation of institutional reforms in project cities; (ii) generation of public support for higher water tariffs to meet cost recovery targets; (iii) project cities’ ability to meet the cash/equity transfer required to construct the Project; (iv) weak operational and managerial capacity of water utility companies; and (v) capacity of municipal environmental protection bureaus to prepare and enforce industrial pollution control plans, affecting the ability of wastewater companies to meet treatment standards.

The Project includes the following measures to mitigate these risks: (i) project cities’ assurances on water utility companies’ financial and managerial autonomy and institutional strengthening; (ii) regular tariff reviews and adjustments by the Government following national guidelines as well as public awareness programs; (iii) provision of counterpart funding; and (iv) various training, staff exchanges, and secondment programs. Moreover, HPG has extensive experience in preparing citywide pollution control plans with other cities. ADB review missions will monitor compliance with the financial and operational covenants to ensure the financial sustainability of the water utility companies. Experienced domestic and international consultants will give implementation advice and support to mitigate specific construction and other implementation risks. HPG’s project leading group, headed by a provincial vice governor, and HPMO, which has experience in oversight of large internationally funded projects, will mitigate project management risk.

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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 Henan Wastewater Management and Water Supply Sector Project.

2. In December 2003, the Asian Development Bank (ADB) provided technical assistance (TA) to help the Henan provincial government (HPG) formulate the Project.1 The Fact-Finding Mission visited the PRC in January–February 2005 to discuss the Project with the central, provincial, municipal, and county governments. The Appraisal Mission fielded from 21–30 April 2005 finalized various aspects of the project design. A summary environmental impact assessment (SEIA) was circulated to the Board on 29 March 2005. This report is based on the draft final report of the TA; government feasibility studies; findings of ADB missions; the environmental impact assessment (EIA); and discussions with government officials, other aid agencies, and stakeholders. Appendix 1 gives the design and monitoring framework.

II. RATIONALE: SECTOR PERFORMANCE, PROBLEMS, AND OPPORTUNITIES

A. Performance Indicators and Analysis

3. Henan province includes 18 municipalities and 117 counties and county-level cities with a total population of 96.7 million in 2003, growing at around 0.7% annually. The current proportion of urban dwellers is 27%, but the urban population has been growing at over 6% annually over the past decade. This urban growth results from a steady rural–urban migration; more than half the population will live in cities by 2030. Provincial gross domestic product (GDP) has increased by over 10% per year on average, and presently stands at CNY700 billion─6% of the national GDP. Industry and the service sectors have been the main engines of growth.

4. Henan covers the upper part of the Hai River Basin (HRB), one of the three most polluted river systems2 in the PRC. The northern part of Henan within the HRB includes five municipalities: Anyang, Hebi, Jiazhou, Puyang, and Xingxiang. The main rivers in this part of the basin flow into Wei River and Zhangweinan Canal, and then eventually into Bohai Bay. Like other parts of the HRB, this subbasin is heavily polluted by domestic and industrial wastewater. The polluted surface water contaminates shallow groundwater sources, on which a significant proportion of urban and rural residents depend for drinking water.

5. Despite the region’s dependence on the basin’s water resources for water supply, the provision of environmental infrastructure and services, including the collection and treatment of wastewater, has failed to keep up with the region’s rapidly growing economy. Increasing flows of untreated domestic and industrial wastewater into the basin have put the basin’s water resources under severe pressure. Despite water shortages, the rate of wastewater treatment and reuse is very low and only 34% of urban wastewater is being treated. More investment is needed to supply clean drinking water and treat wastewater.

6. Reported investment in environment-related infrastructure (water supply, water conservancy management, environmental management, and sanitation) in Henan province fluctuated from $540 million to $780 million per year over the last 4 years. This accounts for approximately 1% of provincial GDP or $6–$8.5 per capita. Wastewater charges are below the cost of treatment, providing little commercial incentive to invest in wastewater treatment facilities.

1 ADB. 2003. Technical Assistance to the People’s Republic of China for Preparing the Henan Hai River Wastewater Management Project. Manila. The title of the Project was adjusted to reflect project content. 2 The others are the Huai and Liao river systems.

Increasing water tariffs would encourage water conservation and help finance the construction of new water supply projects.

7. Pollution control for the upper HRB is of particular importance due to the relevance of the Zhangweinan Canal watercourse to boundary disputes between Henan, Hebei, and Shandong provinces, mainly caused by upstream pollution and the planned use of the watercourse as part of the South-North Water Transfer Project (SNWTP).3 Approximately 225 kilometers (18%) of the canals under the SNWTP will pass through Henan, including four project counties. Pollution in the project area has the potential to adversely affect SNWTP. Thus protecting the conveyor from local sources of pollution along the entire route, including the route passing through the project area, is vital.

8. The Government recognizes that adequate environmental protection and pollution controls are preconditions for sustainable economic growth. The Green Plan4 emphasizes wastewater management and pollution control, including in the HRB. The Hai River Plan (HRP), an action program under the Green Plan, sets pollution control targets for 2000 and 2010, requiring that urban environmental pollution and ecological damage be controlled by 2010.

9. ADB has provided significant assistance in the HRB, including a TA5 to the Government to develop an implementation strategy for the HRP. The TA built on the Government's plans by developing prioritized and suitably phased investment packages; and formulating financial management, regulatory enforcement, and institutional frameworks for pollution control. Subsequently ADB approved two wastewater treatment projects in the HRB in Tianjin6 and Hebei7 province, and a TA8 to strengthen water resource management, focusing on the HRB. The Government has requested ADB assistance to control pollution in Henan and Shandong provinces, which are upstream areas of the HRB.

10. To address the major HRB pollution issues, the State Environmental Protection Administration prepared the 10th Five-Year Plan for water pollution prevention and control in the HRB (2001–2005). The plan highlights several key actions: (i) reduce the gross amount of pollutants, (ii) protect drinking water source areas, and (iii) address transboundary water pollution issues. The strategy focuses on integrating municipal and industrial wastewater treatment facilities supported by establishing effective wastewater companies with sound cost recovery to ensure sustainable facility operations. The central and provincial governments are committed to providing supporting investment resources.

11. As a subsidiary plan to the HRP, HPG formulated the Henan Hai River Plan (HHRP). The plan principles include an integrated approach for pollution control, pollution control by river reach to ensure that water quality targets are achieved, and local administrative initiatives to improve responsibility for pollution control. The HHRP proposes 25 municipal wastewater treatment projects and 49 industrial pollution control projects, and requires that all municipalities have at

3 The SNWTP proposes to move 44 billion cubic meters of water per year through three canals from the Yangtze River Basin to parched areas of northern PRC. 4 An umbrella program across the country with the long-term target for 2010. 5 ADB. 1998. Technical Assistance to the People’s Republic of China for Hai River Basin Wastewater Management and Pollution Control. Manila. 6 ADB. 2000. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to the People’s Republic of China for the Tianjin Wastewater Management and Water Resources Protection Project. Manila. 7 ADB. 2000. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to the People’s Republic of China for the Hebei Province Wastewater Management Project. Manila. 8 ADB. 2002. Technical Assistance to the People’s Republic of China for the Study on the Carrying Capacity of Water Resources. Manila. 3 least one municipal wastewater treatment plant by 2005 and that all counties have at least one municipal wastewater treatment plant by 2007.

12. Of the 25 planned municipal wastewater treatment projects, 6 are being implemented with national funds, 9 are proposed for ADB financing under the Project, and the remaining 10 will be implemented by other means. Most of the industrial pollution control projects are in progress with domestic financing sources. On 2003, the HHRP was expanded to include an additional 24 municipal wastewater treatment plants in the counties—4 of these are included for ADB financing under the Project.

13. In the PRC domestic water sector, responsibility for urban water and wastewater services rests with municipal and county governments. Responding to national priority plans and provincial strategies, locally funded county programs are under way to rehabilitate and expand urban wastewater systems. The key limitations of the counties’ response to the national planning initiatives have been financial constraints and weak technical capacity for planning and management of environmental infrastructure.

14. The Government recognizes the need to strengthen the technical and financial capabilities of agencies responsible for wastewater management to improve the efficiency and sustainability of the substantial investment required. In particular, government policies aim to strengthen the commercial orientation of wastewater and water services by promoting the establishment of autonomous and financially viable wastewater and water enterprises with limited private sector participation, including through partnerships with private sector operators.

B. Analysis of Key Problems and Opportunities

15. The major issues involved in the rapidly deteriorating quality of surface and groundwater and the urban environment are (i) lack of environmental infrastructure, particularly in counties in the HRB; (ii) inadequate water resource management; and (iii) weak financial and institutional capacity of the municipal service providers.

16. The Project will support physical investments to reduce the present high level of untreated wastewater. Demands for water for domestic and industrial use have been steadily increasing, imposing increasing pressure on water resources. The Project’s physical components for wastewater management will increase collection and treatment of urban wastewater in the project cities to more than 70%; the water supply component will provide adequate water supply in terms of quantity and quality to 98% of urban residents in the project cities.

17. Improving water quality across an area as large as the HRB presents many technical challenges in water resource management. Actions or investments to reduce pollution may have widely dispersed effects, well beyond the immediate area, and may show their effects slowly over time. Improving water quality therefore requires a basin perspective, considering and coordinating the interests of all stakeholders. It also requires a long-term focus on environmental indicators, recognizing that investments in wastewater management are vital. The Project will help the project municipalities and counties prepare integrated water resource management plans to achieve comprehensive watershed management.

18. Although HPG’s strong capacity is expected to reduce risks posed by weak capacity in county, municipal, and city governments, the Project faces two different challenges in institutional capacity. First, most of the project treatment plants will be built in counties and cities without existing plants. New capacity to effectively manage and operate the plants must be acquired and maintained. Second, the Project will mainly involve county implementing and operating agencies, a lower level of government than usually involved in ADB projects. Capacity of these agencies is

4 lower than in other ADB projects in the PRC, and ADB lacks experience in anticipating and managing the problems counties may face in implementing subprojects.

19. The Project’s institutional capacity-building component addresses the issue of capacity of implementing and operating agencies. Supplementary Appendix A presents an assessment of the technical and managerial capacities of the sector institutions. The limited operations capacity presents an opportunity for private sector participation, through contracts to operate the treatment plants. The Project will help create the environment necessary for private sector participation by pursuing tariff reform, full cost recovery, and corporatization, which are the necessary prerequisites for such private sector involvement.

20. Policy Dialogue. In support of the Project, policy dialogue involved (i) promotion of integrated water resource management; (ii) municipal wastewater management; (iii) industrial pollution control; (iv) cost recovery and tariff reform; and (v) enterprise reform, governance, and promotion of investment diversification in the sector. Appendix 2 provides the policy framework addressing issues and actions required.

21. The HRP provides a policy and strategic framework for pollution control and prevention in the HRB. The Project will help HPG implement its HRP water quality improvement strategies. An integrated and coordinated basin approach to water resource planning and environmental management is vital for optimum results. Treated wastewater is a potentially valuable water resource to be considered in water resource planning, and demand management can play an important role in water conservation and alleviating water stress.

22. The success of municipal wastewater management policy will impact on the sector objective of pollution reduction and on the cost-effectiveness of wastewater management and operations. Allowing industries to discharge their wastewater to urban sewer systems (provided their wastewater has been properly pretreated to required standards) can greatly improve the cost-effectiveness of industrial wastewater treatment. The centralized municipal wastewater treatment plant (WWTP) normally results in overall economies of scale. Local regulations are needed to ensure that (i) household connections and local tertiary sewers are provided, (ii) effluent strength is maintained, and (iii) wastewater collection and treatment facilities are protected from hazardous pollution discharges.

23. Centralized treatment of pretreated industrial wastewater is only viable where effective monitoring and enforcement arrangements are implemented. Currently in the project cities, only limited pretreatment of industrial wastewater exists; thus local governments must take actions before allowing these enterprises to discharge their wastewater to the WWTPs constructed under the Project.

24. Adequate funds for the repayment of loans, operation and maintenance (O&M), and ultimate replacement of project facilities by the project wastewater/water companies must be assured. Tariff structures and levels should promote the economic use of resources as well as meet financial objectives. Tariffs, therefore, need to meet the principle of full cost recovery and be designed to meet local circumstances. To protect the poor from water tariff increases, some counties introduced water tariff waivers and the government implemented social assistance or a minimum living standard scheme for households with income below the poverty line.

25. Sustainability requires establishing wastewater/water companies that are managerially and financially autonomous. High governance standards are required to retain public confidence. The public sector cannot finance the large investments needed in the PRC water sector. Diversified investment channels must be promoted to achieve sector goals. Private investors can also add value by improving efficiency and service standards. 5

26. External Assistance. To help the Government develop and implement its strategies in the wastewater management and water supply sector, external assistance has been provided mainly by ADB, World Bank, and Japan Bank for International Cooperation. ADB has provided 11 loans including 2 within the HRB in Tianjin and Hebei, totaling more than $1 billion, for urban wastewater management and water supply projects. To maximize development impact, ADB’s involvement has been targeted in densely populated urban areas.

27. ADB has financed 32 TAs in the PRC for more than $20 million to address issues relating to water resource management, urban wastewater, and water supply. ADB assistance has resulted in more rational pricing of water, introduction of wastewater tariffs, major increases in water tariffs, implementation of commercial principles, and introduction of private sector participation. These improvements are fundamental for making the wastewater management and water supply sector financially and operationally sustainable.

28. The World Bank has participated in 21 urban environment projects, including wastewater management-water supply. It is currently preparing a similar project that will assist county cities in the Huai River Basin of Henan. The ADB Project is designed to complement the World Bank project, and be consistent in terms of sector policy and institutional development issues. Japan, through Japan Bank for International Cooperation, is the largest bilateral source of aid to the PRC and is mainly involved in physical infrastructure, water resource development, and environmental improvement projects. Bilateral aid agencies, from Australia, Canada, Finland, Germany, Italy, Norway, Sweden, United Kingdom, and United States, are also involved in the wastewater management and water supply sector, although on a smaller scale.

29. Lessons Learned. Experience in the wastewater management and water supply sector in the PRC, although limited, indicates that projects are well planned and implemented, and wastewater and water tariffs are increased as required. Willingness-to-pay analysis indicates that consumers are willing to pay substantially higher prices for water, and to a certain extent, are willing to pay for wastewater treatment. Issues related to tariff levels, cost recovery, and commercial orientation of water utilities were carefully addressed during project preparation. Lessons learned from previous projects, particularly from the two ongoing HRB projects, are reflected in the project design. These lessons include (i) greater focus on institutional strengthening measures to improve corporate governance, (ii) improved provincial coordination, and (iii) financial and institutional arrangements for proper O&M.

30. ADB’s three strategic objectives for the PRC are to (i) improve economic efficiency, (ii) promote growth to reduce poverty in poor interior provinces, and (iii) enhance environmental protection and natural resource management. Proper management of wastewater and adequate water supply is essential to enhance the living standards and productivity of urban populations, protect water resources, and sustain levels of economic growth. In the wastewater management and water supply sector, ADB is focusing on (i) improving wastewater and water supply services through investment on physical infrastructure; (ii) promoting improved corporate governance and commercial management to enhance the potential for future private sector involvement; (iii) improving cost recovery by strengthening tariff systems and structures; and (iv) ensuring water resource conservation and environmental protection through continuing support for legislative and regulatory provisions. The Project is consistent with ADB’s country operational strategy.

31. Sector Loan Approach. The Project was formulated in line with the HHRP, which requires that each municipal city have at least one municipal WWTP by 2005, and each county city have at least one municipal WWTP by 2007. In view of the many small similar subprojects9

9 The physical investment size ranges from $6 million to $13 million, except for the Anyang subproject.

6 and the tight schedule for construction, the Project could not be processed as a standard project loan. The Project has followed procedures described here for a sector loan.

32. The Project will support an area and time slice of the Government HHRP. The physical investments will be limited to the priority cities and counties in the HRB with serious environmental infrastructure deficiencies, and interest and commitment of the local government. The sector loan approach is based on the following:

(i) The Government’s sector policies, development objectives, and approach to urban environmental infrastructure development are well formulated. Progress in implementing policies has been satisfactory and the Government is continually updating its sector policies with ADB support.

(ii) The sector institutions are well developed, and with additional strengthening and support provided under the Project, they will have the capacity to implement the sector investment plan, particularly municipal and county governments. The Executing Agency, HPG has substantial experience implementing similar projects.

(iii) The sector investment plan and the planned subprojects are well conceived and appropriately formulated to meet the priority needs of the HHRP.

(iv) The Government has submitted the three documents required for sector lending: (a) sector development plan, (b) description of sector policies, and (c) assessment of capacity to implement the plan.

III. THE PROPOSED PROJECT

A. Impact and Outcome

33. The overall impact of the Project is to improve the urban environment and public health through improved wastewater management and water supply. The outcome is that water and wastewater utility companies in the project cities provide sustainable water supply and wastewater services managed on commercial principles and environmentally sound practices by (i) increasing collection and treatment of domestic and industrial wastewater, (ii) providing adequate public water supplies, and (iii) improving the quality of surface and groundwater in and downstream of the project cities. To achieve this outcome, the Project will support (i) creating municipal wastewater companies and making them efficient and commercially managed, (ii) improving cost recovery from users through improved tariffs with gradual increases to full cost recovery, and (iii) using a comprehensive approach to river basin pollution prevention and control.

34. The Government has proposed 19 subprojects10 (15 for wastewater management and 4 for water supply) in four municipalities and 15 counties in the HRB. Appendix 3 lists the candidate subprojects. The Fact-Finding Mission reviewed 8 of the 19 candidate subprojects, representing the four municipalities in the HRB. The review was to demonstrate the approaches and procedures of subproject selection and appraisal. The appraisal indicates that all 8 subprojects are ready for implementation and viable in terms of technical, institutional, social, financial, economic, and environmental aspects. Supplementary Appendix B presents the summary appraisal of the 8 representative subprojects. Supplementary Appendix C presents individual appraisal reports for the 8 subprojects, with their feasibility study reports.

10 A subproject is defined as a package of infrastructure investment for wastewater management or water supply in one municipal city or county city. 7

35. The remaining possible 11 subprojects are being formulated in accordance with the agreed selection criteria and appraisal procedures. The formulation procedures mainly include (i) preparation of a feasibility study based on the draft final TA report, and (ii) appraisal including preparation of a subproject appraisal report (SAR). For the selection of subprojects, priority was given to subprojects that conform to key actions identified in the HHRP, including (i) reduction of the gross amount of pollutants, (ii) protection of drinking water source areas, and (iii) resolution of transboundary water pollution disputes. Appendix 4 provides details on additional subproject identification, selection, preparation, and appraisal.

B. Outputs

36. The Project comprises physical components covering construction of wastewater management and water supply facilities, and an associated capacity-building component to support project management and implementation by building capacity of the project management offices (PMOs) and implementing agencies (IAs). Policy dialogue under the Project supports these components and contributes to ongoing dialogue with the Government. Supplementary Appendix D describes the 8 representative subprojects.

1. Wastewater Management Component

37. The wastewater management component addresses the infrastructure deficiencies for domestic and industrial wastewater collection and treatment. The wastewater subprojects will serve urban areas of a municipal city or a city proper of a county. Facilities include sewers, pump stations, WWTPs, and treatment facilities for effluent reuse. Most existing collection systems were developed piecemeal and have many deficiencies related to inadequate ground cover, adverse slope, and inappropriate routing of sewers. Most are combined and collect storm-water run-off during wet weather, as well as wastewater. Major portions of the collection systems will be rebuilt under the individual subprojects. Wastewater treatment will improve surface and groundwater quality in and downstream of the project cities and contribute to reduced transboundary pollution between Henan, Hebei, and Shandong provinces.

2. Water Supply Component

38. The water supply component addresses the immediate need to resolve the pollution problem with drinking water sources by reducing reliance on abstraction of groundwater from shallow wells. Raw water sources for urban water supplies are becoming severely affected by wastewater pollution of both surface and shallow groundwater. In addition, shallow groundwater sources are being severely drawn down, causing consolidation of soils and consequent subsidence of urban areas. Typical facilities under the water supply subproject include distribution pipelines and water treatment plants. The improved quality and availability of treated water will bring health, environmental, and social benefits to the communities.

3. Institutional Capacity-Building Component

39. The institutional capacity-building component addresses the weak capacity of implementing and operating agencies and will help ensure the financial and institutional sustainability of the Project. The component comprises a combination of consulting services and various training programs, and will predominantly target local IAs and PMOs. Specifically, this component will help the project companies (i) establish themselves as autonomous and financially sustainable utility companies that can effectively and efficiently meet the service obligations set out; and (ii) prepare a common operating manual and financial reporting manual, as well as improve public awareness of key project-related issues such as benefits accruing from sanitation investments. In addition it will help the project companies and their parent municipal

8 and county governments (i) comply with relevant national policies for cost recovery, tariff, and enterprise reform of the water and wastewater management sector; and (ii) develop plans and programs for private sector participation in the water and wastewater management sector that support government policies for improving efficiency and service standards. Appendix 5 provides details of the capacity-building measures/activities.

C. Special Features

40. Focus of Capacity Building on Counties. The Project is one of the first ADB projects in the PRC wastewater and water supply sectors to involve mostly fourth-tier governments. This characteristic has several implications. First, the physical size and cost of the possible subprojects are much smaller than previously ADB-financed wastewater or water projects. Second, the majority of participating cities and counties will have limited or no previous involvement with foreign-financed infrastructure projects, and certainly no substantive experience with ADB requirements.

41. At this level, project management and professional skills capacity are significantly less than that found in municipal and provincial cities. A partial counterbalance is that the subprojects are generally smaller and use well-proven approaches and technologies. However, the need for significant capacity building during project implementation is evident. The Project will provide consulting services and training with a focus on human resource development.

42. The project implementation consultants to be recruited under the Project will work with the provincial PMO, local IAs, and relevant officials from municipal and county governments. They will provide assistance and advice in the following areas: (i) project management and implementation support; (ii) institutional and managerial improvements; (iii) financial management; (iv) utility tariff setting, billing, and income collection; and (v) operational management. Other capacity-building activities include training in project implementation and utility operations, staff exchanges and secondments, and exposure to best practices in the PRC and internationally.

43. Integrated Water Resource Management. ADB has assisted the Government in formulating policy and designing investment programs based on an integrated approach to water and environmental management. The ADB assistance has drawn upon its growing experience in addressing basin environmental issues through ongoing projects in the HRB and in other environmental improvement projects in the PRC. The Project will complement these efforts by assisting the project municipal and county governments in formulating a practical approach to provide urban environmental services and introduce the principles of integrated water resource management and pollution control.

D. Cost Estimates

44. The total project cost is estimated at $200.0 million equivalent, comprising $100.0 million in foreign exchange costs and $100.0 million equivalent in local currency costs, including taxes and duties of approximately $16.3 million. Table 1 provides a summary of the cost estimates, and Appendix 6 gives detailed cost estimates and the assumptions behind them. The cost estimates are based on the 8 representative subprojects and the remaining candidate subprojects at mid- 2005 prices.

E. Financing Plan

45. The Government has requested a loan of $100 million from ADB’s ordinary capital resources to help finance the Project. The loan will have a 25-year term, including a grace period 9 of 5 years, an interest rate to determined in accordance with ADB’s London interbank offered rate (LIBOR)-based lending facility, a commitment charge of 0.75% per annum, and such other terms and conditions set forth in the draft loan and project agreements. 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.

46. The ADB loan will cover the foreign exchange cost of the Project, including interest during construction. The PRC Government will relend to HPG. HPG will onlend to municipal governments, which will onlend to city and county governments, which will onlend to the IAs. HPG will retain $1,595,000 of the loan proceeds for implementation of the capacity building and training programs under the Project. All relending and onlending will be on the same terms and conditions as the ADB loan. The IAs will assume the foreign exchange and interest rate variation risks for the ADB loan. Appendix 7 illustrates the flow of funds and relending and onlending arrangements. Table 1: Cost Estimates ($ million) Component Foreign Exchange Local Currency Total A. Base Cost 1. Representative Subprojects a. Wastewater Management 32.9 34.5 67.4 b. Water Supply 8.3 9.8 18.1 Subtotal (1) 41.2 44.3 85.5 2. Provision for Remaining Subprojects 42.1 43.0 85.1 3. Capacity Building 2.7 0.0 2.7 Subtotal (A) 86.0 87.3 173.3 B. Contingencies 1. Physical 5.8 4.5 10.3 2. Price 0.0 4.2 4.2 Subtotal (B) 5.8 8.7 14.5 C. Financing Charges during Implementation 8.2 4.0 12.2 Total 100.0 100.0 200.0 Source: Asian Development Bank estimates.

47. Local costs will be financed by contributions from (i) the central Government (state bonds), HPG (grants and the newly created Provincial County Economic Development Special Fund), and municipal/county governments as well as water companies, and (ii) domestic borrowing (local cofinancing). All loans, including the ADB loan, will be repaid from user charges. The financing plan is summarized in Table 2. The availability of counterpart financing was confirmed for the 8 representative subprojects during the ADB Fact-Finding Mission.

Table 2: Financing Plan ($ million) Source Foreign Local Currency Total Percent Exchange A. Asian Development Bank 100.0 0.0 100.0 50.0 B. Local Banks Cofinancing 0.0 27.2 27.2 13.6 C. Counterpart Funds 1. Central Government 0.0 4.8 4.8 2.4 2. Provincial Government 0.0 5.0 5.0 2.5 3. Municipal/County Governments and water companies 0.0 63.0 63.0 31.5 Subtotal (C) 0.0 72.8 72.8 36.4 Total 100.0 100.0 200.0 100.0 Source: Asian Development Bank estimates.

F. Implementation Arrangements

1. Project Management

48. HPG will be the Executing Agency responsible for overall project implementation. A project leading provincial group has been established to oversee preparation and implementation of the Project. This group─comprising staff from the Financial Bureau, Development and Reform Commission, Construction Bureau, Water Resources Bureau, and Environmental Protection Bureau─is led by the executive vice governor of Henan province.

49. HPG has set up the Henan PMO (HPMO) to coordinate implementation of externally funded projects. HPMO will play a vital coordination role during both project preparation and project implementation, and ensure smooth communications with the local PMOs and IAs. HPMO will recruit the consultants to be engaged under the Project. It has considerable capacity for project implementation, and is experienced and has performed well in implementing major foreign-funded projects, including the ongoing ADB-funded agriculture project.11

50. Each municipality involved in the Project has or will set up a local project leading group and a municipal PMO to coordinate aspects of project preparation and implementation falling within their respective jurisdictions. Each county city planning to participate has set up a local project leading group and a county PMO to coordinate aspects of project preparation and implementation falling within their respective jurisdictions. These municipalities and county cities have experience managing domestic projects but not foreign-funded wastewater management and water supply projects. As the capacity of the institutions is considered weak, appropriate capacity-building measures were identified and institutional capacity will be strengthened through the Project. Supplementary Appendix E presents a detailed assessment of the project institutions and the capacity-building measures included under the Project. Appendix 8 shows the project management arrangements.

51. For each subproject, a wastewater or water supply utility company will be the IA. The IA either is or will be established and will (i) be a properly constituted enterprise company established under the provisions of PRC law, and become largely managerially and financially autonomous; (ii) act as IA for the relevant subproject, working and liaising closely with the relevant local PMO, and various departments and agencies of local government; (iii) carry out procurement of civil works and equipment under its subproject; (iv) carry out O&M of project facilities; and (v) will be responsible for debt servicing. The Project’s capacity-building component is designed to take into account weaknesses identified by the financial management assessment of the 8 representative subprojects. With this provision, the Project’s financial management arrangements are considered satisfactory.

2. Subproject Preparation and Appraisal

52. In addition to the 8 feasibility studies reviewed by ADB, the identification, selection, preparation and appraisal of the remaining 11 subprojects for inclusion in the Project will follow the three stage approach below.

53. Subproject Identification and Selection. The subprojects have been or will be selected in accordance with the following basic criteria: (i) inclusion of the subproject in the HHRP; (ii) confirmation by the participating local government on its ability and willingness to arrange counterpart financing; (iii) confirmation by the participating local government on its willingness to

11 ADB. 2000. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to the People’s Republic of China for the West Henan Agriculture Development Project. Manila 11 comply with ADB safeguard policies and other requirements; and (iv) the implementation period of the subproject being in 2005-2010.

54. Subproject Preparations. The participating city government and IA will, with the assistance of HPMO, prepare a feasibility study for each of the remaining 11 subprojects. The feasibility study report will include EIA; resettlement plan (RP) (if required); rationale; scope and components; technical description and analysis; cost estimates and financing plan; implementation arrangements; and financial, economic, and institutional analysis, including financial management assessment and social dimensions. The consultants to be engaged under the Project and responsible staff of the county/municipal PMO will review the report, before submitting it to HPMO for appraisal.

55. Subproject Appraisal and Approval. HPMO will be responsible for the appraisal of the subprojects and has commissioned the Henan Engineering Consulting Company, a subsidiary organization of Henan Development Reform Commission (HDRC), to undertake detailed appraisals on its behalf. HDRC will prepare a subproject appraisal report (SAR) for consideration by HPG. The SAR will follow the format of the SARs for the 8 representative subprojects. HPG will appraise the subprojects in accordance with the criteria agreed upon by the Government and ADB. The SARs for the first subproject and for any subproject exceeding $10 million equivalent will be sent to ADB for approval. The remaining SARs will be sent to ADB for information. Supplementary Appendix F provides details on the subproject appraisal criteria.

56. For the environmental safeguard requirements, an SEIA covering the 8 representative subprojects was prepared in accordance with the PRC’s EIA Technical Guidelines and ADB’s Environmental Assessment Guidelines (May 2003). The EIA reports for individual subprojects used methodologies and standards consistent with relevant guidelines established by the State Environmental Protection Administration, in compliance with applicable laws and regulations. The individual EIA reports were approved by municipal or provincial environmental protection bureaus following domestic procedures. ADB reviewed the SEIA and posted it on the ADB website in March 2005 to meet the 120-day disclosure requirement.

57. The remaining 11 subprojects have received the same extent of environmental safeguard scrutiny, modeled on the EIAs for the 8 representative subprojects and the SEIA. The EIAs for the remaining subprojects were approved by the municipal or provincial environmental protection bureaus. HPMO completed the SEIA for the remaining subprojects following the format of the first SEIA, reviewed by the Appraisal Mission, and submitted for confirmation to the provincial environmental protection bureau. Upon confirmation by the bureau, the SEIA has been posted on the ADB website to meet the 120-day disclosure requirement.

58. RPs for the 8 representative subprojects were prepared in accordance with the PRC Land Law and the ADB involuntary resettlement policy.12 In April 2005, ADB reviewed and approved the draft RPs. The RPs were subsequently finalized based on ADB comments, approved by local government, and disclosed to relevant offices, villages, and people affected. (Supplementary Appendix G). For the remaining subprojects, a resettlement framework was prepared and approved by ADB (Supplementary Appendix H). Draft RPs have been prepared for other candidate subprojects and will be upgraded using the representative subproject RPs as models. A poverty and social assessment conducted for the 19 subprojects indicates no ethnic minorities will be affected by the Project.

12 ADB. 1998. The Bank’s Policy on Involuntary Resettlement. In Handbook on Resettlement. Appendix 1. Manila.

3. Implementation Period

59. The Project will be implemented over 5 years from 2005 to 2010 (Appendix 9). This schedule is considered realistic because the project implementation structure is already in place, and preparatory works are under way. ADB’s successful experience with similar projects in the PRC and the basic level of technology and modest scale of the individual subprojects indicate that this schedule is realistic and achievable.

4. Procurement

60. ADB-financed goods and services will be procured in accordance with ADB’s Guidelines for Procurement, and the PRC’s Tendering and Bidding Law and procurement regulations. Appendix 10 provides indicative procurement packages. All civil works contracts are estimated at below $10 million, and will be procured through local competitive bidding procedures as local contractors have the expertise and capacity to undertake these works. Since these works involve mainly labor costs, international contractors are not likely to be interested in the work. However, in accordance with ADB requirements, foreign contractors may participate in bidding for local competitive bidding contracts.

61. Major contracts for equipment and materials estimated at more than $1 million will be undertaken through ADB international competitive bidding procedures, while lower value contracts will be procured by international shopping or direct purchase if below $100,000. The internationally tendered equipment packages for the main process equipment will include the technical support necessary for ensuring proper system coordination and integration, as well as installation, testing, commissioning, and training. This approach will ensure quality control in equipment installation and operator training, utilizing the manufacturers’ and suppliers’ specialist technical experts for successful execution of the total process system.

5. Advance Procurement Action and Retroactive Financing

62. The Government requested, and ADB approved, advance procurement action for civil works, and recruitment of project implementation consultants up to contract signing. To meet the target of construction of wastewater collection and water supply systems by 2007, the six project counties for the nine subprojects have to initiate early rehabilitation of pumping stations, sewer networks, and water distribution systems; and construction of wastewater treatment plants and water treatment plants (Appendix 10). Advance procurement action is necessary to support these works. ADB has also in principle approved retroactive financing up to $8 million equivalent for expenditures incurred on the nine subprojects from 30 April 2005 to the date of loan effectiveness.13 The Government was advised that ADB approval of advance procurement action and retroactive financing will not in any way commit ADB to approve the proposed loan, and ADB financing will be dependent upon compliance with all aspects of ADB procedural requirements, including compliance of the Government and HPG with relevant provisions of the loan and project agreements and ADB guidelines.

6. Consulting Services

63. Provision is made for 28 person-months of international and 300 person-months of domestic consulting services to support HPMO, local PMOs, and IAs in project implementation and capacity building to be funded under the Project. The staff of IAs need to strengthen their expertise in (i) project management and implementation support, (ii) efficient operating

13 These actions were reported in ADB Business Opportunities (internet edition) in May 2005. 13 procedures, (iii) preventive maintenance, (iv) financial management, (v) social impact and environmental monitoring, (vi) business planning and management information system development, (vii) human resource development, and (viii) corporate governance. Capacity building for IAs will be achieved through consultant inputs, hands-on training on project facilities, training in the PRC, and international training financed by the loan. The majority of the consulting services will be provided by domestic, not international, consultants. Because this type of capacity building is generally not new to the PRC, domestic experts have this knowledge and can provide more cost-effective support. However, the overall capacity-building program is large and diverse, and international consultants will provide general direction to capacity-building content. An international consulting firm will be recruited in accordance with ADB’s Guidelines on the Use of Consultants using the quality- and cost-based selection method with simplified technical proposals and other arrangements satisfactory to ADB on the engagement of domestic consultants. Domestic consultants will also be recruited for social impact and environmental monitoring in accordance with arrangements satisfactory to ADB on the engagement of domestic consultants. Appendix 11 presents outline terms of reference for consulting services.

7. Anticorruption

64. ADB’s Anticorruption Policy (1998) was explained to and discussed with the Government/Borrower and Executing Agency. 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 support these efforts, relevant provisions of ADB’s Anticorruption Policy are included in the loan regulations and the 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 the Executing Agency and all contractors, suppliers, consultants and other service providers as they relate to the Project.

8. Disbursement Arrangements

65. HPMO will establish an imprest account after loan effectiveness in accordance with ADB’s Loan Disbursement Handbook (January 2001). Disbursements from the imprest account will be supported by an appropriate withdrawal application and related documentation. Such documentation will demonstrate, among other things, that the goods/services (i) were produced in and procured from ADB members, and (ii) are eligible for ADB financing. The initial amount to be deposited into the imprest account will not exceed the estimated capital expenditure for the next 6 months, or 10% of the loan amount, whichever is lower. The statement of expenditures procedure may be used for reimbursement of eligible expenditures; any individual payment to be reimbursed or liquidated under the procedure will not exceed $200,000.

9. Accounting, Auditing, and Reporting

66. HPMO will prepare quarterly progress reports indicating progress made, problems encountered during the review period, steps taken or proposed to remedy the problems, proposed program of activities, and progress expected for the following quarter. HPMO will ensure that reports are consolidated and submitted to ADB in a timely manner. Within 6 months of physical completion of the Project, HPMO, with support from the municipal and county PMOs and IAs, will submit to ADB a completion report that describes institutional strengthening and water sector policy reform; implementation of the wastewater management and water supply systems; other project implementation matters; actual costs incurred in relation to cost estimates, benefits, and beneficiary consultations; and other information requested by ADB.

67. HPG and each IA will maintain records and accounts that identify the goods and services financed from the loan proceeds, financing resources received, expenditures incurred for the Project, and use of local funds. The accounts will be established and maintained in accordance with sound accounting principles and appropriate accounting standards. The annual project accounts of HPG and the IAs, and each set of financial statements for the IAs, will be audited by auditors acceptable to ADB. A separate audit report on the use of imprest account and statement of expenditure procedure will be provided to ADB. The audit reports, management letter, and related financial statements will be submitted to ADB not later than 6 months after the end of the fiscal year to which they relate, or the project closing date if earlier. ADB informed the Government of its policy on submission of audited accounts, which covers failure of submitting audited accounts and financial statements by the due date. A formal warning will be issued for accounts more than 6 months overdue, and disbursements will be suspended for accounts that are 12 months overdue.

10. Project Performance Monitoring and Evaluation

68. Project performance monitoring system (PPMS) indicators include service levels, treated wastewater quality and other measures of operational performance, percentage of wastewater collected and treated, user satisfaction with the urban environment, and relevant economic and health data to monitor project impacts. The relevance and practicability of data collection for the indicators were confirmed with HPMO. Appendix 12 outlines the contents of the PPMS. Supplementary Appendix I presents methodologies for health benefit estimation and monitoring health benefits to be achieved.

69. At the beginning of project implementation, HPMO and the municipal PMOs, with the assistance of consultants, will develop comprehensive PPMS procedures to systematically generate data on inputs and outputs of the project components; and the socioeconomic, health, and environmental indicators to measure project impacts. HPMO and the municipal PMOs will refine the PPMS framework, confirm achievable targets, firm up monitoring and recording arrangements, and establish systems and procedures no later than 6 months after project inception.

70. Under the PPMS framework, baseline and progress data will be reported at the requisite time intervals by the local PMOs to HPMO, including semiannual reporting on the environmental management plan (EMP). HPMO will be responsible for analyzing and consolidating the data through its management information system. The PPMS will be designed to permit adequate flexibility to adopt remedial action regarding project design, schedules, activities, and development impacts. HPMO, with assistance from the consultants, will monitor and assess activities, and report to ADB quarterly on the physical implementation and financial aspects of the Project to ensure that impacts are monitored and reported in line with ADB requirements.

11. Project Review

71. Review missions will be undertaken twice a yea, for the first 2 years and once a year thereafter; ADB and the Government will undertake a midterm review 2 years after project implementation begins. This review will include a detailed evaluation of the scope, implementation arrangements, resettlement, achievement of scheduled targets, and progress with the policy reform agenda and capacity-building measures. Feedback from the PPMS activities will be analyzed.

IV. PROJECT BENEFITS, IMPACTS, ASSUMPTIONS, AND RISKS

A. Environmental Impacts and Benefits

72. The Project provides the most sustainable prospect for reducing waterborne pollution, improving the quality of surface water and groundwater, reducing transboundary pollution disputes, and protecting drinking water sources. The wastewater collection systems will improve the urban environment by reducing exposure of the community to untreated wastewater with its associated impacts on public health and nuisance. The provision of centralized wastewater treatment facilities allows cost-effective treatment of industrial wastewater through pretreatment at individual enterprises prior to discharge to a wastewater collection system for subsequent treatment at a municipal WWTP. This provides greater assurance of protecting receiving waters through the efficient operation of centralized wastewater treatment facilities that can be more easily monitored than treatment facilities at individual enterprises. Treated effluent can potentially be reused beneficially either for industry or for irrigation: this forms a component of some subprojects.

73. The proposed use of new sources of water of improved quality and reliable yield for municipal water supply from either deep groundwater or from protected upland reservoirs will ensure improvements in the availability of water of an acceptable quality to the urban population served by each water supply subproject. The proposed extension, replacement, and refurbishment of water distribution systems will increase the size of the population provided with access to piped water supplies. These improvements in the distribution system will reduce water losses and the risk of contamination of treated water within the distribution system.

74. The SEIA for the 8 representative subprojects and the SEIA for the remaining subprojects, including the EMP, cover all phases from project design to construction and operation. They conclude that the adverse impacts generated by the Project could be successfully mitigated to acceptable levels through the mitigation and monitoring measures specified in the EMP. The EMP proposes institutional strengthening and training to address the weak capacity of county governments and IAs. Supplementary Appendix J summarizes the environmental impacts, mitigation measures, and monitoring plans.

B. Social Dimensions

1. Poverty Reduction and Social Benefits

75. The poverty and social assessment for the 8 representative subprojects and the 11 candidate subprojects indicates that the Project will benefit a total urban population of about 1.5 million people through the provision of clean water and improvement of wastewater services. Of the total beneficiary population, about 170,000 or 11% are categorized as living below the poverty line of CNY1,348 per capita per year. The Project will support poverty reduction by (i) reducing the incidence of waterborne disease, cost of medical care, and sick days taken, thus reducing household health expenditures; (ii) providing safer and more reliable urban water supplies; (iii) improving the quality of life of the urban poor by eliminating uncollected sewage in poor neighborhoods and improving water quality in urban drainage channels; and (iv) providing employment opportunities for the poor.

76. The Project will improve public health by reducing waterborne disease through improved water supply and wastewater management services. Annual economic losses due to waterborne disease, which currently stand at CNY30 million are expected to be reduced by 40%. The Project will also create job opportunities for both skilled and unskilled labor during implementation. The

Project will utilize about 6,000 person-years of labor during construction; about 30% of the job opportunities can be filled by the poor and women. The Project will stimulate local economic development, particularly in construction and tourism, and consequently will continue to provide a source of employment for local communities.

77. In the project area, three major social measures are designed to protect urban residents from falling into poverty. These include (i) a living allowance for laid-off employees, (ii) unemployment insurance, and (iii) a social support program under the minimum living guarantee scheme. All project cities have, through various social support programs, implemented a water tariff waiver or reduction for households with incomes below the poverty line.

78. The Project will promote public awareness and education programs about project benefits, social acceptance of user fees and tariffs for wastewater, public hygiene, and behavior of consumers on water saving and managing wastewater disposal. The Project will also provide gender-awareness training to project management staff to promote women’s participation in key areas such as employment opportunities, and set up gender-specific indicators to monitor and evaluate project impacts on men and women. Appendix 13 provides a summary poverty reduction and social strategy for the Project.

2. Land Acquisition and Resettlement

79. Resettlement impacts were identified for the 8 representative subprojects and 11 candidate subprojects. ADB reviewed and approved RPs for the 8 representative subprojects and the resettlement framework for subsequent subprojects; these were uploaded on the ADB website on 9 July and 6 June 2005, respectively. Resettlement under the Project includes permanent and temporary land acquisition, and building demolition; but the resettlement impacts are relatively small. Considering the good experiences with other urban projects and the strong commitment of local authorities to the safeguard policies, significant problems are unlikely to be encountered. The IAs will fund the resettlement costs according to the standards set out in the RPs. Entitlements will be provided to those affected before demolition and ground-leveling commence, and before any loss of land. A resettlement information booklet was distributed to those affected through village offices, and the full RPs for the 8 representative subprojects were made available at the village offices. Appendix 14 provides a summary RP.

80. For subsequent candidate subprojects, the RP will be finalized based on the detailed engineering designs. HPMO, assisted by the IAs, will be responsible for monitoring RP implementation and submitting reports to ADB. A regular reporting system was established to ensure that key resettlement activities are implemented on schedule. HPMO has engaged a domestic institute to carry out independent monitoring of resettlement implementation. Surveys will be conducted for annual evaluations for 2 years upon completion of resettlement, and the findings reported to HPMO and ADB.

C. Institutional Benefits

81. The capacity-building component under the Project and continued policy dialogue with the municipal governments will support institutional and financial reforms that will provide a more viable, commercially oriented basis for managing and operating water and wastewater systems, particularly by counties. The maturity of county institutional arrangements vary considerably between cities. Of the 15 project cites, 8 have established water utility companies and the remaining 7 will establish water utility companies no later than when their onlending agreements are signed. Of the 8 cities, 5 have established or will establish water group companies that have responsibility for both water supply and wastewater. HPG considers this water group company 17 arrangement to be the preferred institutional arrangement for subproject implementation. The integrated approach supported by the Project may also serve as a model in similar cities in the PRC.

82. During the Fact-Finding Mission, broad financial management assessment was conducted, covering the areas of implementation arrangements, sustainability, and fiduciary risks and mitigation strategy. A detailed financial management assessment will be conducted at project inception. Based on the detailed financial management assessment, each wastewater or water utility will be assisted to establish a sound and solid financial management system at the beginning of project implementation. The financial management system will be in line with ADB's Guidelines for Governance and Financial Management of an ADB Investment Project (November 2003). Each utility will keep accounts in accordance with commercial accounting principles and be subject to independent external audit by a suitably qualified firm of commercial auditors. Accounting will be in accordance with relevant PRC accounting standards, which are largely in accordance with international norms.

D. Economic Analysis

83. The economic analysis covers both the Project as a whole, and the individual subprojects. Appendix 15 provides details. For the Project as a whole, the analysis covers the economic rationale for public intervention, and goals and general design of the investment plan. The economic rationale is sound, based on control of externalities (water pollution) and managing natural monopolies (water supply and wastewater treatment). The goals of the investment plan are to meet targets for surface water quality. The water quality targets are clearly defined, legally established, and consistent with international practice. The plan to meet the water quality targets is based on centralized WWTPs. Centralized WWTPs are a valid part of a least-cost plan to achieve water quality targets under three basic conditions: (i) sewer connections are comprehensive, (ii) wastewater tariffs provide appropriate economic incentives for water conservation and wastewater management, and (iii) WWTPs are designed as least cost. The Project addresses the first two conditions through its assurances as well as through policy dialogue. The third condition is part of the appraisal criteria for individual subprojects.

E. Financial Evaluation

84. The financial evaluation of the 8 representative subprojects was undertaken in real terms using constant 2005 prices (Appendix 16). The project cost estimates and financial projections in nominal terms after tax were converted to real terms by adjusting for foreign and domestic inflation and currency fluctuation. The financial internal rate of return for each subproject is more than the weighted average cost of capital, also computed on an after-tax basis. These subprojects are considered both financially viable and sustainable. The average financial internal rate of return for the 8 subprojects is 6.3%, which compares favorably with the weighted average cost of capital of 2.4%. Sensitivity and risk analysis indicates that the financial internal rate of return is robust under adverse conditions.

85. Financial projections were prepared for each of the subproject entities in accordance with ADB’s Guidelines for the Financial Governance and Management of Investment Projects Financed by the ADB to assess the financial viability and sustainability of each subproject (Supplementary Appendix K). The projected financial statements indicate that financial revenues will be sufficient to cover O&M costs, income taxes, and debt service; and provide a reasonable rate of return. Based on the financial projections, each project company will be in a position to maintain a minimum debt-service coverage ratio of 1.2:1, a maximum debt-equity ratio of 70:30, and a minimum current ratio of 2.1:1.

F. Risks

86. During project preparation, a comprehensive analysis of project risk was undertaken and sensitivity analysis was performed accordingly on both the benefit and cost streams. This analysis gives satisfactory results. The Project has potential institutional, financial, and policy risks related to (i) implementation of institutional reforms in project cities; (ii) generation of public support for higher water tariffs to meet cost recovery targets; (iii) project cities’ ability to meet the cash/equity transfer required to construct the Project; (iv) weak operational and managerial capacity of water utility companies; and (v) capacity of municipal environmental protection bureaus to prepare and enforce industrial pollution control plans, affecting the ability of wastewater companies to meet treatment standards. Other risks include unforeseen construction difficulties and inadequate project management.

87. The Project includes the following measures to mitigate these risks: (i) project cities’ assurances on water utility companies’ financial and managerial autonomy and institutional strengthening, (ii) regular tariff reviews and adjustments by the Government following national guidelines as well as public awareness programs, (iii) provision of counterpart funding, and (iv) various training and staff exchange/secondment programs. Moreover, HPG has previous experience in preparing citywide pollution control plans. ADB review missions will monitor compliance with the financial and operational covenants to ensure financial sustainability of the water utility companies. The Project does not have any unusual technical risks; this minimizes the risk of unforeseen construction conditions. Experienced domestic and international consultants will give implementation advice and support to mitigate specific construction and other implementation risks. The project leading group in HPG, headed by a provincial vice governor, and HPMO, which has experience in oversight of a large internationally funded project, will mitigate project management risk.

V. ASSURANCES

A. Specific Assurances

88. In addition to the standard assurances, the Government and HPG have given the following assurances, which are to be incorporated in the legal documents:

(i) HPG will ensure that each wastewater company develops and implements a connection program that will include the following provisions (a) any new development provides connections to the trunk sewer connections, (b) household connection provisions are available, (c) all major industries are connected to the sewer system, and (d) poor households are connected to the sewer system. (ii) HPG and the local governments will undertake a review and revision of local regulations for management of the local wastewater/drainage systems by the end of December 2006. Regulations should include a clear assignment of responsibilities between involved agencies, and provide for effective collection of the wastewater tariff, monitoring of wastewater discharges to sewers, and regulatory control of sewer connections. (iii) HPG will ensure that each subproject appraisal criteria and implementation procedures agreed upon with ADB are followed, including environmental and social safeguard requirements. 19

(iv) HPG will ensure that each local wastewater company/water supply company (a) is a properly constituted enterprise company established under the provisions of PRC law; and (b) has appropriate financial and managerial autonomy. (v) HPG, through the relevant local governments and IAs, will ensure that (a) all land and rights-of-way required by the Project are made available in a timely manner; (b) the RPs are implemented promptly and efficiently in accordance with their terms, all applicable PRC laws and regulations, and ADB’s Policy on Involuntary Resettlement; (c) all those affected are given adequate opportunity to participate in resettlement planning and implementation; (d) counterpart funds are provided on a timely basis for land acquisition and resettlement activities; (e) any obligations in excess of the RP budget estimates are met; (f) those affected will be at least as well off as they would have been in the absence of the Project; (g) adequate staff and resources are committed to monitoring and supervision of the RP of each subproject, and ADB is provided with quarterly reports on implementation and a resettlement completion report for each subproject; and (h) an independent agency, acceptable to ADB, is engaged to monitor progress semiannually, and to evaluate results through annual survey updates for 2 years after completion of resettlement and these monitoring reports are submitted simultaneously to ADB and the Borrower. (vi) For the remaining subprojects to be selected under the Project, HPG, through the relevant local governments and IAs, will (a) make all land and rights-of-way required for subprojects available in a timely manner, (b) prepare an RP for each subproject in consultation with those affected and in accordance with the resettlement framework, (c) submit the RPs to ADB for approval at least 3 months prior to dispossession and displacement of affected persons from their houses and assets, (d) disclose subproject RPs to those affected prior to submitting to ADB and for publication on the ADB website upon ADB approval, and (e) implement the RPs in accordance with ADB’s Policy on Involuntary Resettlement. (vii) HPG will cause each local government, and the IAs to construct, operate, maintain, and monitor the project facilities in strict conformity with (a) all applicable laws and regulations, including national and local regulations and standards for environmental protection, health, labor, and occupational safety; and (b) ADB’s Environment Policy and the environmental mitigation and monitoring measures detailed in the approved EIAs, SEIAs, and EMPs for the Project. (viii) HPG, through the local governments, will ensure that the IAs (a) provide monthly monitoring reports to HPMO, which will prepare and submit to ADB semiannual environmental reports in a format acceptable to ADB until loan closure; (b) make an SEIA available to the general public at least 120 days before each subproject is approved; and (c) for each subproject, carry out public consultations during the early stages of the EIA field work and when the draft EIA is available. (ix) The Government, through HPG, the local governments and the IAs, will ensure that (a) all local currency counterpart financing necessary for the Project is provided in time to enable completion of project activities, and (b) additional counterpart funding will be provided for any shortfall of funds or cost overruns. (x) HPG will ensure that each local government participating in the Project undertakes annual reviews of wastewater tariffs/water tariffs, and determines tariffs in accordance with project financing needs and the need to maintain the financial autonomy of the water companies, subject to compliance with laws and regulations in the PRC. This includes adjusting tariffs to ensure full recovery of O&M, interest

charges, and the greater of depreciation or debt repayment, together with a reasonable profit margin. (xi) HPMO in consultation with the IAs will prepare and submit a training plan(s) to be implemented under the Project to ADB for review and concurrence. (xii) HPG will ensure that the IAs maintain (a) minimum debt-service coverage ratio of 1.2:1, (b) maximum debt-equity ratio of 70:30, and (c) minimum current ratio of 2:1 or quick ratio of 1:1. (xiii) HPG will ensure that each local government reviews the impact of increased water and wastewater tariffs on the poor, and maintains the provision of water tariff waiver and minimum living standard scheme to protect the basic living standard of the poor.

B. Conditions for Disbursement

89. A condition for disbursement of the loan for the ultimate benefit of the relevant water company requires that the Government certify that an onlending agreement has been executed between the municipal or county government concerned and the relevant water company, which includes (i) interest at the same rate as the loan, (ii) a repayment period including a grace period identical to that of the loan, and (iii) the water company bears the foreign exchange and interest variation risk of such onlending.

VI. RECOMMENDATION

90. I am satisfied that the proposed loan would comply with the Articles of Agreement of 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 $100 million to the People’s Republic of China for the Henan Wastewater Management and Water Supply Sector 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.

Joseph Eichenberger Vice President

16 November 2005 Appendix 1 21

DESIGN AND MONITORING FRAMEWORK

Design Performance Data Assumptions Summary Targets/Indicators Sources/Reporting and Risks Mechanisms Impact Assumptions Improved urban Public satisfaction with Annual socioeconomic • Improved water and environment and public the urban environment surveys undertaken as wastewater services health in the southern increased (to be part of a performance by utility companies part of the Hai River quantified when management system are effective and will Basin baseline is established be sustained. through a social survey Public health • The project city at project inception). department statistics governments remain committed to Incidence of Socioeconomic surveys implementing the waterborne disease Henan Hai River reduced from 26,600 in Asian Development Plan. 2004 to 16,000 in 2015 Bank (ADB) Project performance audit Risk Average number of sick reports • Initiatives to curb days per person per upstream pollution month attributable to are ineffective. waterborne disease reduced from 15 in 2004 to 9 in 2015

Average amount spent per person per month attributable to waterborne disease reduced from CNY3.0 in 2004 to CNY1.8 in 2015

Outcome

Strengthened water Commercial-oriented Operating and financial Assumptions and wastewater utility operations and financial reports of wastewater • Political will exists to companies in 19 project autonomy, and full cost- and water supply reform water utility cities providing recovery water tariff companies management and sustainable water revenues, as well as financing supply and wastewater satisfactory level of Reports by external managements. services managed on capital utilization by auditors and municipal • Sound financing commercial principles, 2012 regulators plans limit debt to and environmentally prudent levels. sound practices • Existing Urban residents of 0.5 Water supply unsatisfactory water million in the project companies information sources are closed cities provided with systems down. uninterrupted potable • Sewer networks are water supplies that Public health built and residences/ meet People Republic department audits on businesses of China’s (PRC) water quality connected. quality standards by 22 Appendix 1

Design Performance Data Assumptions Summary Targets/Indicators Sources/Reporting and Risks Mechanisms 2010 Risks • Water demand Total pollution load Annual environment exceeds forecast reduced by 33,500 tons reports and operational estimates. of chemical oxygen reports by wastewater • Wastewater treatment demand per year by companies plants (WWTPs) are 2010 built or expanded in the project cities. Technical, financial, ADB project completion • Required training and and managerial report staff exchanges/ capacity of water secondment supply and wastewater programs are utility companies provided on a timely developed by 2015 basis.

Project Outputs

1. Increased 80% of urban Wastewater company Assumptions collection and wastewater in municipal management • Water sources prove treatment of urban cities and 70% in information system reliable. wastewater in the country cities treated by (MIS) • Water quality project cities 2008 standards do not Environnemental change. All sludge used or protection bureau • Political support for disposed of in (EPB) compliance reform process compliance with PRC audits continues. regulations by 2010 • Political support for Wastewater company tariff increases is MIS present. • Governments and EPB compliance audits agencies concerned provide support. EPB monitoring

2. Adequate urban Total new water Water supply company Risks water supplies (in treatment capacity of MIS • Increase in terms of quantity and about 150,000 cubic wastewater flow quality) for project meters (m3)/day Water supply company exceeds estimates. cities available by 2008 MIS • Disposal regulations are changed. All new water treatment Public health • No suitable disposal plants meet PRC water department audits sites are made quality standards by available. 2008 3. Reformed and Utilities all managerially ADB supervision • Industries do not integrated water autonomous by 2008 mission reviews implement adequate and wastewater pretreatment. utilities Water and wastewater Review of wastewater • Wastewater is too services fully self- company and water weak for effective financed by 2008. supply company treatment. financial statements

Appendix 1 23

Design Performance Data Assumptions Summary Targets/Indicators Sources/Reporting and Risks Mechanisms 4. An effective WWTP All project WWTPs EPB monitoring operating regime meet discharge introduced standards from 2008 Wastewater company MIS WWTPs exceed PRC efficiency norms from Comparative unit costs 2008 and trends 5. Improved public Increased public Socioeconomic surveys awareness of awareness (to be health and quantified when environment baseline established)

Activities with Milestones Inputs 1.1 Engineering design completed by June 2005 • ADB 1.2 Land acquisitions and resettlement completed by June 2005 ADB project loan of 1.3 Construction of WWTPs with a total capacity of 590,000 m3/day $100 million complete by 2008 1.4 Associated intercepting/trunk sewers with a total length of 670 Procurement review kilometers (km) completed by 2008 and approval 1.5 70% of properties connected to public sewers by 2008 Regular review 2.1 Engineering design completed by June 2005 missions 2.2 Land acquisitions and resettlement completed by June 2005 3 2.3 Total water treatment capacity of 150,000 m /day added by 2008 • Government 2.4 About 230 km of water pipelines completed by 2008 Counterpart financing of $100 million 3.1 About 95% of capacity-building milestones related to managerial financial, and operations training achieved by 2009 Project management offices established and 4.1 Development of operational procedures for the WWTPs and 80% of staff maintained at all levels achieved necessary skill level by 2008 4.2 Development of operational procedures for the water treatment plants Capacity building and and 80% of staff achieved necessary skills level by 2008 training budget of $2.7million 5.1 Publicity initiatives for public awareness campaigns carried out by 2010 Operation and maintenance budget and staffing (to be quantified during implementation)

• Cofinancing Domestic borrowing of $31.1 million.

. 24 Appendix 2

POLICY FRAMEWORK

Policy Issue and Explanation Action Required

1. Promotion of Integrated Water Resource Management • An integrated and coordinated basin (i) Prepare integrated water resource plans to approach to water resource planning and achieve comprehensive watershed environmental management has been shown management. to give optimum results. (ii) Improve coordination of water resource • Treated wastewater is a potentially valuable planning with water quality planning. water resource to be considered in water (iii) Promote the beneficial reuse of treated resource planning. wastewater wherever this is economic. • Demand management can play an important (iv) Undertake demand management initiatives role in water conservation and alleviating (leakage control, and promoting water water stress. saving).

2. Municipal Wastewater Management Effective policies, guidance, and procedures (i) Build capacity of local implementing are required to ensure agencies in the management and operation • comprehensive collection of wastewater, of sewerage networks. • sewerage separation policies that fit local (ii) Issue guidance on standardized application circumstances and can be effectively of a discharge permit system, with a implemented and policed, deadline for practical implementation. • maintenance of effluent strength, and (iii) Review and consider strengthening • protection of wastewater facilities from penalties for noncompliance with discharge pollution discharges. standards. 3. Industrial Pollution Control • People’s Republic of China (PRC) laws and (i) Promote centralized wastewater treatment regulations define permitted discharge with pretreatment of industrial effluents. standards for different industrial effluents, but (ii) Implement wastewater discharge permitting these are frequently not adhered to in systems for discharges to the urban practice. sewerage system. • Centralized treatment of pretreated industrial (iii) Implement comprehensive monitoring and effluents is normally the most economic enforcement for compliance with industrial means of treatment, but is only viable where discharge standards. effective monitoring and enforcement (iv) Clarify respective responsibilities of arrangements are implemented. implementing agencies and the local environmental protection bureaus once wastewater treatment plants are commissioned. 4. Cost Recovery and Tariff Reform • Tariff levels based on the principles of full cost (i) Implement Circular (1999) 1192, which recovery will allow water and wastewater encapsulates full cost recovery as an companies to be financially autonomous. objective in tariff setting. • Government subsidies must be eliminated or (ii) Develop more specific guidance to support significantly reduced. Tariffs structures and policy implementation. levels should promote the economic use of (iii) Refine social policies to protect financially resources. disadvantaged customers. • Adequate funds for loan repayment, (iv) Improve arrangements for enforceability of operation, maintenance, and ultimate wastewater charges. replacement of project facilities must be assured. Appendix 2 25

5. Enterprise Reform, Governance. and Diversification of Investment • Sustainability of wastewater facilities requires (i) Implement Government policies for establishing implementing agencies as separation of government and enterprises. financially and managerially autonomous (ii) Promotion of combined water supply and enterprises. wastewater companies • High standards of corporate governance are (iii) Development of governance best practice required to ensure public confidence. and guidance on its application • Large investments needed in the PRC water (iv) Promote a fuller understanding of the sector cannot be financed by the public sector different financing options, for these to be alone. Diversified investment channels need considered early in the project life cycle. to be promoted to achieve sector goals. (vi) Develop best practice guidelines on private Private investors can also add value by sector procurement and market testing for improving efficiency and service standards. outsourcing contracts

26 Appendix 3

CANDIDATE SUBPROJECTS

Plant Pipeline Approximate Cost Subproject Location Capacity / Sewer $ million Type 3 CNY million (m /day) (km) equivalent Anyang Municipality Anyang (Zongcun)a Wastewater 100,000 51.8 243.9 29.4 Huaxian County Wastewater 30,000 71.9 110.3 13.3 Linzhou County a Wastewater 50,000 43.3 99.8 12.0 Neihuang County Wastewater 30,000 27.7 60.6 7.3 Jiaozuo Municipality Boai Countya Wastewater 50,000 36.1 102.4 12.3 Boai Countya Water supply 50,000 45.5 67.5 8.1 Wen County Wastewater 20,000 13.1 50.6 6.1 Wuzhi County Wastewater 30,000 32.9 66.0 8.0 Puyang Municipality Nanle County Wastewater 30,000 42.6 74.7 10.9 Puyang Countya Wastewater 50,000 41.2 110.9 13.4 Puyang Countya Water supply 40,000 80.9 59.5 7.2 Qingfeng County Wastewater 30,000 67.3 82.6 9.0 Qingfeng County Water supply 30,000 88.9 57.9 5.5 Xinxiang Municipality Changyuan County Wastewater 30,000 26.7 72.6 8.7 Fengqui County Wastewater 30,000 34.9 75.7 9.1 Huojia County Wastewater 30,000 24.7 63.7 7.7 Weihui Countya Wastewater 50,000 45.6 98.3 11.8 Weihui Countya Water supply 30,000 50.0 53.1 6.4 Yanjin County Wastewater 30,000 37.8 72.2 8.7 km2 = square kilometer, m3 = cubic meter. a Representative subproject. Source: Henan provincial government.

Appendix 4 27

PROCESS FOR SUBPROJECT IDENTIFICATION, SELECTION, PREPARATION, AND APPRAISAL

A. Background

1. Under the sector loan approach, the Henan provincial government (HPG) (the designated Executing Agency), in consultation with the loan Fact-Finding Mission from Asian Development Bank (ADB), has established a three-stage approach for identification, selection, preparation, and appraisal of subprojects for inclusion in the Project.

2. Now in operation, these procedures will be used to appraise the remaining subprojects, and identify and select additional subprojects needed to ensure a full utilization of the ADB loan.

3. HPG has delegated various actions and decisions to the Henan project management office (HPMO) and Henan Development Reform Commission (HDRC).

B. Stage 1: Subproject Identification and Selection

4. HPG has invited municipal and county governments in the southern part of the Hai River Basin in Henan province to express their interest in participating in the Project to be partly financed by ADB loan. In issuing this invitation, HPG refers to basic selection criteria.

(i) The subproject must be either involve wastewater management or water supply and be included in relevant sector or development plans (Henan Hai River Plan). (ii) The local government must confirm its ability and willingness to arrange counterpart finance. (iii) The local government must confirm a willingness to subject the subproject to ADB safeguard policies and other requirements. (iv) The preferred implementation period is during 2005–2010.

5. For subprojects meeting these selection criteria, HPG then asked the relevant local government to undertake detailed preparations.

C. Stage 2: Subproject Preparations

6. Preparations by local governments involves designating an implementing agency (or initially an office of the government) to prepare a detailed project proposal, feasibility study, environmental impact assessment, and (if required) a resettlement plan to standards necessary to meet both domestic and ADB requirements. Governments must also determine suitable institutional arrangements for project implementation and prepare a detailed financing plan.

7. Local governments are supported by local design and other specialist institutes (locally appointed) for their work and compliance with ADB requirements.

8. To facilitate an orderly and consistent appraisal of the subprojects, HPMO requires an integrated feasibility study in a common format to be prepared (to ADB standards) for each proposed subproject, including technical, social, financial, economic, and institutional analysis.

28 Appendix 4

D. Stage 3: Subproject Appraisal and Approval

9. The ADB project team developed a detailed set of evaluation criteria, which was discussed and agreed with HPG. This was to ensure that individual subproject appraisal is conducted in accordance with ADB standards.

10. HPG is responsible for subproject appraisal and has commissioned the Henan Engineering Consulting Company, a subsidiary organization of HDRC, to undertake detailed appraisals on its behalf. The company is qualified under domestic accreditations to conduct project reviews of provincial urban infrastructure projects. The project team reviewed the company’s qualifications and experience and considers it suitable for this task.

11. Henan Engineering Consulting Company will review the subproject feasibility studies and prepare a subproject appraisal report (SAR) for consideration by HDRC and HPMO.

12. Rejected subprojects are to be referred to the relevant local government with indications of where the preparations and proposals are deficient; and for additional preparation work (assuming the subproject has a realistic chance of meeting the agreed evaluation criteria).

13. Subprojects that are approved by HPMO will be forwarded to ABD for approval or for information purposes as appropriate:

(i) ABD will approve the first feasibility study and its SAR. (ii) ADB will approve all SARs for subprojects with a total cost estimate in excess of $10 million equivalent. (iii) ADB will receive other SARs for its record purposes only.

14. All subproject approvals by ADB or HPG will only be made if

(i) the subproject is included in an summary environmental impact assessment that has been endorsed by Henan Environmental Protection Bureau and ADB, and been subject to relevant public consultation and disclosure; and

(ii) a resettlement plan meeting ADB requirements has been prepared and approved by the relevant local government, and endorsed as satisfactory by ADB.

PROCESS FOR SUBPROJECT IDENTIFICATION, SELECTION, PREPARATION, AND APPRAISAL

Stage 1 Stage 2 Stage 3 Identification and Selection Preparation Appraisal

HPMO invites local Local government HPMO commissions HECC to governments to submit commissions the project review the integrated feasibility proposals based on agreed preparation process and study report against the appraisal selection criteria establishes a project criteria. management office

HECC prepares summary appraisal reports with subproject recommendation Local governments submit Preparation of Preparation of safeguard project proposals domestic feasibility documents study (environmental impact assessment and 4 Appendix resettlement plan) HPMO and HDRC review summary appraisal report and make appraisal decision

HPMO reviews project Financial and Public participation proposals and confirms institutional plans and consultation compliance with selection criteria Subproject rejected Subproject approved Integrated feasibility study report prepared in format issued by HPMO with financial and economic analysis in accordance with ADB procedures. Required documents sent to ADB for information or approval. 29

ADB = Asian Development Bank; HDRC = Henan Development and Reform Commission; HECC = Henan Engineering Consulting Company; HPMO = Henan project management office. Source: Henan provincial government.

INSTITUTIONAL CAPACITY BUILDING 30

Reference Capacity Building Types of Capacity Building to be Applied Appendix 5 Appendix Number Requirement Consulting Services Domestic Training Familiarization Staff Exchanges Remarks Visits and Secondments A. Physical

Implementation 1. Set up internal land Give advice and guidance Workshop(s) to be held by Independent external acquisition and on setting up monitoring consultants on Asian monitoring institute resettlement procedures, with follow up Development Bank (ADB) will give technical monitoring and visits to each requirements advice on reporting implementing agency (IA). resettlement plan procedures (RP) implementation. 2. Design and Design the PPMS, and Workshop to be held to Spreadsheet to be operation of project provide guidance to explain PPMS provided to facilitate performance ensure consistency in its standard data monitoring system use. Follow-up visits to IAs presentation and (PPMS) to be made as necessary. collation 3. Project planning Ad hoc support as Training workshop by loan Provision of project necessary consultants planning and Selective extended training management for key staff. software 4. Project Ad hoc support as Training workshop by loan Visits to ongoing Provision of project management necessary consultants ADB projects planning and Selective extended training under management for key staff implementation software Training in MS Project or (e.g., Hebei equivalent province) 5. Procurement and Ad hoc support as Training in ADB bid evaluation necessary requirements and People’s Republic of China (PRC) bidding law 6. Environmental Provide advice and Workshop(s) to be held by monitoring guidance on setting up consultants on ADB monitoring procedures, requirements with follow up visits to each IA B. Institutional Development 1. Design and Review IA proposals and Principles of organizational Discussion with Case studies of improvement of recommend improvements design other water and similar PRC and

Reference Capacity Building Types of Capacity Building to be Applied Number Requirement Consulting Services Domestic Training Familiarization Staff Exchanges Remarks Visits and Secondments organizational based on best practice. wastewater international structures companies organization charts 2. Development of Review IA plans and Principles of human Reference to Ministry staffing plans suggested modifications. resource planning of Construction (MOC) standards and comparisons with similar utility companies 3. Development of Make recommendations Regulatory requirements Participatory standards of based on common (e.g., MOC guidelines) approaches to be service practices. used where relevant 4. Development of Work with each IA to Principles of business business plans prepare initial plan. planning Workshops on business plan preparation 5. Development of Provide conceptual design Information management Demonstration of Provision of EIS executive and support each IA with Use of EIS software working EIS in software information customization. modern water systems (EIS) and wastewater companies 6. Corporate Review existing Principles of corporate Discussions with Circulation of case governance arrangements and suggest governance management studies on improvements on (i) role of Role and responsibilities of teams of fully governance failings board, (ii) internal audit, members of the board established (iii) external audit, (iv) Internal auditing enterprises internal control procedures, and (v) Presentations on transparency and public international reporting. arrangements C. Financial Management 5 Appendix 1. Financial control Review controls and Principles of financial Financial staff of IAs procedures procedures, and control to spend time recommend measures to Practical application of PRC working in municipal strengthen them. financial control regulations water companies and guidelines 31 2. Financial Help IAs specify their Supplier-provided training in Visits to Software supplier to Provision of personal information needs, select hardware/ the new financial software companies provide some on- computers with

Reference Capacity Building Types of Capacity Building to be Applied 32 Number Requirement Consulting Services Domestic Training Familiarization Staff Exchanges Remarks Visits and Secondments Appendix 5 Appendix systems software, and complete Workshop(s) on identifying running site support financial software the initial transfer to the needs, and implementing computerized IAs will create user new system. the new system(s) financial systems group(s) to support and learn from each other. 3. Budgeting and cost Review existing process, Concepts of budgetary Discussions on Secondment of Process to be control including budget control practical financial staff to supported by new preparation methods and Budget preparation budgetary issues larger companies to software cost allocation (chart of Budget/cost monitoring and be involved in their accounts). control techniques budget process Prepare model reporting formats. 4. Financial planning Assist in developing Role of financial planning Viewing the IAs to create user simple financial models. and basic concepts practical use of group(s) to support Provide on-the-job support Developing and using financial models and learn from each and training. financial models in practice to aid decision other taking 5. Improved tariff Review existing Income budgeting Viewing modern Secondments of Improved (new) collection procedures, record Principles of debt recovery PRC and staff from larger billing and collection keeping, and systems. and practical procedures to international companies to software Conduct workshop(s) to be followed billing and support local Explore interutility identify and discuss collection collection staff cooperation current issues. systems 6. Financial Identify detailed training Seminars on key financial Secondment of awareness for needs. concepts (to include senior managers to senior managers Promote the financial control, financial larger, more understanding of financial planning, performance financially aware management as a key analysis) organizations management skill. D. Operational Management Capacity 1. Wastewater Prepare commissioning Overview workshop on Visits to other Secondment of Provision of treatment plant plans, including commissioning process WWTP at operations staff with operation and (WWTP), water assignment of Supplier provided training commissioning prior commissioning maintenance treatment plant responsibilities. on equipment operation stage and operations manuals from (WTP), and asset Provide support during experience suppliers commissioning commissioning.

Reference Capacity Building Types of Capacity Building to be Applied Number Requirement Consulting Services Domestic Training Familiarization Staff Exchanges Remarks Visits and Secondments 2. WWTP and WTP Develop operating Wastewater treatment Visits to Secondment of Provision of operations procedures and manuals. operations operating experienced operational Advise on process Water treatment operations WWTP/WTP with operators from equipment to be monitoring and control. Operational quality similar processes other WWTP/WTP specified in Conduct safety and assurance mechanical and performance audits. Operational safety electrical contracts, such as that needed for process measurement and operational safety. 3. Asset maintenance Provide advice on asset Supplier provided Visits to Supplier provided records and maintenance maintenance training suppliers maintenance planning. Maintenance planning and facilities manuals record keeping Consideration to be given to computerized asset management 4. Industrial pollution Review record keeping, Permitting and other record Reviews of Possible use of loan control responsibilities, extent of keeping for industrial national and savings to improve monitoring, and wastes international the extent and enforcement procedures. Monitoring of discharges practices capability of Tracing the source of automatic monitoring pollutants entering the of key discharges WWTP 5. Sewerage system Review existing Inspections Review of equipment operation and arrangements and advise Confined space entry needs and possible management on adjustments in Sewer maintenance and use of loan savings operating regimes needed rehabilitation techniques to upgrade to get best use of the new operations WWTP equipment

6. Management of Review procedures for Visits to cities Staff exchange with 5 Appendix house connections inspection, record- where sewer larger cities with keeping, and initiating separation and already separated required work. house sewer systems connection programs have recently been completed 33 7. Leakage and Review current Equipment supplier training Visits to cities Exchange of staff Review of equipment

Reference Capacity Building Types of Capacity Building to be Applied 34 Number Requirement Consulting Services Domestic Training Familiarization Staff Exchanges Remarks Visits and Secondments Appendix 5 Appendix nonrevenue water procedures, record (where relevant) with active with cities with needs and possible control keeping skills, and Leakage control planning, leakage control active leakage use of loan savings equipment. techniques, and methods programs (such control programs to upgrade as Beijing) operations equipment E. Other Capacity Building Needs 1. Public awareness Visits to Inclusion of a pilot domestic and public awareness international program in project cities where budgets successful public awareness campaigns have been conducted 2. Gender awareness Advise on gender Gender awareness awareness programs and workshops development of gender sensitive performance indicators. 3. Regular customer Make design Survey design and conduct Utilize experienced feedback and recommendations for of surveys to give reliable institutes where participatory regular socioeconomic feedback budgets allow approaches surveys. Survey enumerator training/briefing Source: Asian Development Bank estimates.

Appendix 6 35

DETAILED COST ESTIMATES

1. The cost estimates exclude routine operation and maintenance costs of the provincial/ municipal project management offices and the infrastructure by the Project. Table A6 gives total project costs by cost type and the assumptions behind them.

Table A6: Project Costs by Category CNY Million $ Million Equivalent Item Foreign Local Total Foreign Local Total A. Representative Subprojects 1. Civil Works 224.0 176.0 400.0 27.1 21.3 48.4 2. Advance Site Works 0.0 4.0 4.0 0.0 0.5 0.5 3. Materials and Equipment 117.0 0.0 117.0 14.1 0.0 14.1 4. Environmental Management Plan 0.0 10.0 10.0 0.0 1.2 1.2 5. Land and Resettlement 0.0 65.0 65.0 0.0 7.9 7.9 6. Project Management 0.0 44.0 44.0 0.0 5.3 5.3 Subtotal 341.0 299.0 644.0 41.2 36.2 77.4 B. Other Subprojects, Capacity Building, and Taxes and Duties 1 Other Subprojects 348.0 288.0 636.0 42.1 34.8 76.9 2. Capacity Building, All 16.0 0.0 16.0 2.0 0.0 2.0 3. Training, All 6.0 0.0 6.0 0.7 0.0 0.7 4. Taxes and Duties 0.0 135.0 135.0 0.0 16.3 16.3 Subtotal 370.0 423.0 793.0 44.8 51.1 95.9 C. Contingencies 1. Physical Contingency 48.0 37.0 85.0 5.8 4.5 10.3 2. Price Contingency 0.0 35.0 35.0 0.0 4.2 4.2 Fixed Investment Cost 48.0 72.0 120.0 5.8 8.7 14.5 D. IDC 1. ADB Loan IDC 68.0 0.0 68.0 8.2 0.0 8.2 2. Other Loan IDC 0.0 33.0 33.0 0.0 4.0 4.0 Subtotal 68.0 33.0 101.0 8.2 4.0 12.2 Total 827.0 827.0 1,654.0 100.0 100.0 200.0

ADB = Asian Development Bank, IDC = interest during construction. Note: The project costs estimates are based on cost and price data as of mid-2004 and use the following general assumptions and parameters: (i) The exchange rate is assumed at CNY8.27 = $1. (ii) Domestic inflation of 3.0% for 2004, 2.7% for 2005, and 3.0% thereafter, as given by ADB. Foreign exchange inputs adjusted at International Bank for Reconstruction and Development manufacturer’s unit value (July 2004) annual rates of 6.0% for 2004, -1.6% for 2005, 0.0% for 2006, 0.8% for 2007, 0.8% for 2008, and 0.6% for 2009. (iii) Physical contingencies included at 5% for materials and equipment and at 8% for civil works. (iv) Interest during construction estimated using an interest rate of 4.11% per annum, the rate applicable to the 5-year swap London interbank offered rate for US dollars at loan fact-finding, plus 0.6% ADB mark- up and moderated down by 25% to recognize current rates are significantly lower. (v) Commitment charges at 0.75% of the shortfalls in disbursement from the disbursement thresholds indicated in the loan agreement. The thresholds are 15% of the total loan amount for the first year of project implementation, and 45%, 85%, and 100% for the second, third, and fourth years, respectively. (vi) The front-end fee is assumed to be waived. (vii) Local currency costs include taxes and duties of approximately $16.3 million equivalent at 10% on materials and equipment, and 14% on civil works. (viii) The foreign exchange content will be 100% of materials and equipment, 56% of civil works, and 100% of capacity building and training. Source: Asian Development Bank estimates.

36 Appendix 7

FLOW OF FUNDS AND ONLENDING ARRANGEMENTS

Asian Development Bank

ADB ADB Loan Loan ($100 ($100 million) million) Direct payment to Ministry of Finance suppliers, consultants, and (on behalf of the Government) contractors

Relending (note 1) Relending (note 1)

Henan Finance Bureau for Henan Provincial Government

Subloan AgreementsOnlending

Municipal Finance Bureau on behalf of Municipal Governments Onlending Subloan Subloan AgreementsOnlending

AWAG County Finance Bureau Anyang IA (note 2) on behalf of County Governments

Onlending/Subloan Agreements Onlending

Individual County Subproject IAs

Water and Wastewater Water and Wastewater Charges Charges

Users Domestic Banks

ADB/ Counterpart funds ADB Repayments Local Bank funds/ User charges Local Bank repayments

ADB = Asian Development Bank, AWAG = Anyang Water Authority Group, IA = implementing agency.

Notes: 1. ADB funds will be onlent on the same terms and conditions as those received by the Ministry of Finance 2. Anyang Water Authority Group has the same relationship with domestic banks and users as county IAs. Source: Henan provincial government.

ORGANIZATION CHART OF PROJECT MANAGEMENT ARRANGEMENTS

Asian Development Bank People’s Republic of China Government

Henan Provincial Government Active and Monitoring Consulting Services Provincial Vice Governor Resettlement Plan Monitoring Project Leading Group Henan Finance Bureau (lead) Institute Henan Development Reform Commission Auditing Bureau Henan Construction Bureau Henan Project Management Henan Environmental Protection Bureau Office (PMO) Others as required

Anyang MG, Puyang MG, Xinxiang MG, Jiaozuo MG, (including PMO) (including PMO) (including PMO) (including PMO)

County Governments (each with local PMOs)

Individual County Implementing Agencies Appendix 8 Appendix

Local implementation support from local design institutes, design review agencies, tendering companies. Construction supervision companies, resettlement agencies, and others as required. 37 MG = municipal government, PMO = project management office. Source: Henan provincial government.

38 IMPLEMENTATION SCHEDULE

2005 2006 2007 2008 2009 2010 9 Appendix Components Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 A. Wastewater Management 1. Land Acquisition 2. Resettlement 3. Design and Prepare Bidding Documents 4. Bidding and Evaluation 5. Construction and Commissioning B. Wastewater Management 1. Land Acquisition Resettlement 2. Design and Prepare Bidding Documents 3. Bidding and Evaluation 4. Construction and Commissioning

C. Capacity Building 1. Technical and Engineering Management 2. Institutional and Managerial Development 3. Financial Management 4. Operation Management 5. Resettlement Monitoring 6. Project Preparatory Monitoring System Framework 7. Environmental Manage- ment and Reporting 8. Training Q1 = first quarter, Q2 = second quarter, Q3, third quarter, Q4 = fourth quarter. Source: Henan provincial government estimates.

Appendix 10 39

CONTRACT PACKAGES

1. Procurement packages are divided into two phases: (i) retroactive financing, and (ii) the remaining procurement.

Table A10.1 Procurement Packages for Retroactive Financing Amount Loan Financing Procurement Package (CNY million) ($ million) Mode A. Wastewater Management 1. Civil Works for Anyang 17.3 1.2 LCB 2. Civil Works for Boai 13.0 0.9 LCB 3. Civil Works for Linzhou 14.2 1.0 LCB 4. Civil Works for Puyang 5.5 0.4 LCB 5. Civil Works for Weihui 13.0 0.9 LCB 6. Civil Works for Wuzhi 19.5 1.3 LCB B. Water Supply 1. Civil Works for Boai 8.2 0.6 LCB 2. Civil Works for Puyang 14.2 1.0 LCB 3. Civil Works for Wuzhi 13.5 0.9 Total 118.4 8.0 LCB = local competitive bidding Source: Henan provincial government.

Table A10.2: Procurement Packages Beyond Retroactive Financing Total Cost Estimate Number of Procurement Package Subpackages CNY $ million Mode million equivalent A. Wastewater Management 1. Civil Works 44 659.5 79.46 LCB 2. Equipment and Materials 50 288.0 34.70 ICB/IS/DP Subtotal (A) 947.5 114.16 B. Water Supply 1. Civil Works 12 113.1 13.62 LCB 2. Equipment and Materials 10 15.0 1.81 ICB/IS/DP Subtotal (B) 128.1 15.43 C. Capacity Building 1. Office Equipment Various 4.0 0.50 IS 2. Project Management 1 13.0 1.55 ICB Consultant 3. International Training Various 2.0 0.25 ICB 4. Domestic Training and Various 3.0 0.30 LCB Other Consulting Services Subtotal (C) 22.0 2.60 DP = direct purchase, ICB = international competitive bidding, IS = international shopping, LCB = local competitive bidding. Source: Henan provincial government.

40 Appendix 11

OUTLINE TERMS OF REFERENCE FOR CONSULTING SERVICES DURING IMPLEMENTATION PHASE

A. Introduction

1. The Henan project management office (HPMO) will recruit the project implementation consultants, although most of the consulting services will be provided to the various project implementing agencies (IAs) located in 15 cities (mostly at the county level) within the municipalities of Anyang, Jiazou, Puyang, and Xinxiang, . HPMO will act in a coordinating and supervisory role, ensuring the consulting services are provided in a timely and effective manner.

2. The majority of the consulting services are expected to be provided by domestic experts as the type of capacity building is generally not new to the People’s Republic of China (PRC). Domestic consultants can provide more cost-effective support. However, the overall capacity- building program required is large and diverse, and international consultants will be required to provide direction (capacity building, content, etc.), to establish the monitoring systems to Asian Development Bank (ADB) standards, and for some special advisory inputs.

3. Almost all direct consulting support to the individual IAs will be provided by domestic consultants operating in the PRC to minimize difficulties in communication and interpretation. This will ensure advice provided takes account of the specific conditions found in the PRC, such as local laws, regulations, and standards.

B. Scope of Work

4. The consultant will work with HPMO, the general manager, other senior management of the IAs, and relevant local government officials to provide assistance and advice on the following:

5. Project Management and Implementation Support. The consultant will undertake the following: (i) Develop comprehensive project implementation plans and procedures for monitoring and control. (ii) Review designs, drawings, and bidding documents; identify potential technical problems; and suggest means of resolving these, including incorporating environmental mitigation measures where appropriate. Recommend a practical and effective design supervision system. (iii) Develop detailed reporting formats for submission to ADB, including the preparation of the initial progress report. (iv) Help prepare detailed commissioning plans and provide support as required during the wastewater treatment project (WWTP) commissioning process. (v) Provide training and on-the-job guidance on items (i) to (iv). (vi) Establish a framework for the project performance monitoring system (PPMS), including its design, data collection, and analysis procedures, and provide training in its use. (vii) Undertake a review of both the internal and independent external resettlement monitoring and reporting arrangements, and the reports produced. Recommend actions necessary to ensure compliance with approved resettlement plans. Provide Appendix 11 41

training in resettlement monitoring in accordance with ADB requirements and follow up advice and support to local IAs. (viii) Develop and help implement public awareness and education programs to help increase public awareness of project-related issues such as public health improvement, benefits of wastewater treatment, personal responsibilities for environmental protection, and water conservation. (ix) Develop and help implement a gender awareness program, provide training on mainstreaming gender into project design and implementation, and develop gender sensitive indicators as part of the PPMS. (x) Develop and implement an environmental monitoring program and reporting procedures to ensure that appropriate mitigation measures are undertaken during construction and operation of the project facilities. Provide training in environmental monitoring in accordance with ADB requirements and follow up advice and support to local IAs. (xi) Provide support to IAs in preparing, refining, and processing supplementary feasibility studies, environmental impact assessments, and resettlement plans that might become necessary if new subprojects are included within the sector loan.

6. Institutional and Managerial Improvements. The consultant will undertake the following:

(i) Review the overall management organization of the utility companies to identify where changes in organizational structure (the management model) might lead to improvements in the business performance of the organization. (ii) Review human resource planning procedures and assessment of staffing requirements. Make recommendations for improving human resource planning and assist in preparing a revised human resource plan in accordance with these recommendations. Develop a practical strategy for adjusting staffing levels to match assessed staffing needs. (iii) Develop (or review) standards of service with special emphasis on the service provided to customers, and gain agreement to these. (iv) Develop and agree on a set of strategic performance indicators and targets to measure and assess the overall performance of the company. These targets and indicators will include financial, operational, construction, human resources, and external relations. (v) Develop (or refine) integrated 3–5-year business plans that cover all main activities of the companies. The business plans should incorporate progress toward defined standards of service and a quantification of planned business performance based on the strategic indicators and targets. The plans should incorporate resource needs in terms of operating budget, capital investment, human resource, etc. and the resulting pricing implications necessary to meet financial targets. (vi) Design and help develop an executive information system to allow senior management of the company to monitor actual company performance against plans. Advise on the broader development of management information systems within the company consistent with the business plan and operational management needs.

42 Appendix 11

(vii) Using the business plans as a base, develop a model performance contract between the companies and the relevant governments to allow strategic arms length supervision on the part of the local government. (viii) Assist relevant departments of local governments in developing procedures for effective regulation of the utility companies based on agreed business plans. Include the use of comparability studies as appropriate and a definition of information needs to facilitate proper regulation and supervision by local governments. (ix) Identify requirements and make recommendations for the development of human resource policy to improve the skills and performance of the workforce, including consideration of (a) staff appraisal and performance measurement, (b) identification of training needs, and (c) reward mechanisms and levels. (x) Provide advice on arrangements for corporate governance and how these arrangements can be made more effective. (xi) Prepare, agree on, and implement a program of management training to include international and in-country training for the implementation phase of the Project, and make recommendations on how longer term training needs should be met.

7. Strengthening of Financial Management. The consultant will undertake the following:

(i) Review financial information systems and procedures in the IAs and propose modifications. Include a review of the use and potential use of financial information as an aid to management decision taking within the companies. (ii) Prepare and gain agreement to a financial management development plan (FMDP) to modernize companies’ financial management arrangements. The scope of the plan will include (a) recurrent and capital budget reporting and controls, (b) improved cost control, (c) use of job costing and activity-based costing as appropriate, (d) development of relevant financial performance indicators and ratios, (e) control of working capital and cash flow, (f) use of financial planning and financial input to business plans, (g) computerization of systems as appropriate, (h) financial training for financial staff, (i) financial training for nonfinancial managers, and (j) improvements in financial procedures and regulations. . (iii) Assist in implementing the FMDP by helping select software for computer-based systems for financial and management accounting and other financial systems (payroll, payment of suppliers, etc.). (iv) Assist in implementing the FMDP by helping prepare implementation plans for computerized systems and ensure adequate attention is given to (a) training (basic computer awareness and systems specific), (b) systems testing, (c) transfer of live data, (d) systems security (physical location, hardware, and software related) and disaster recovery, and (e) systems documentation for users and system managers. (v) Prepare a program of financial training seminars and courses for different levels of accountants, economists, and financial managers, with content reflecting the development needs identified in the FMDP. (vi) Prepare and deliver a series of training courses in financial management for nonfinancial managers, including (a) financial and budgetary control, (b) unit cost accounting, and (c) financial ratios. Appendix 11 43

8. Utility Tariff Setting, Billing, and Income Collection. The consultant will undertake the following:

(i) Develop a methodology for the periodic review of water supply and wastewater tariffs so that the various different interests of the local government, customers, and IAs are safeguarded. This methodology will include (a) compliance with national and provincial pricing regulations and guidance, (b) systematic examination of customer affordability (industrial and domestic), (c) review of company performance in terms of service and efficiency, (d) provision for the financial viability of the IAs, (e) review and justification of any cross-subsidization in pricing, (f) surveys of customer satisfaction and willingness to pay and other uses of public consultation in the price setting process, and (g) setting a defined timetable for price reviews. (ii) Design, for implementation by Henan provincial government, a socioeconomic survey to regularly measure customer satisfaction with utility services and willingness to pay. (iii) Review tariff billing and income collection arrangements, and develop an action plan for improving these where effectiveness or efficiency of income collection is in need of improvement. This review will include (a) the extent of computerization and scope for systems enhancement; (b) need for staff training; (c) management information to aid debt recovery; (d) methods of billing, payment, and payment processing; and (e) bill layout and explanations given to customers.

(iv) Develop proposals for a program of activities to improve public awareness of environmental and wastewater management, including measures to improve willingness-to-pay for water and (especially) wastewater charges.

9. Improvements in Operation Management. The consultant will undertake the following: (i) Identify options for alternative operation and maintenance arrangements, including full or partial contract operation by the private sector or other relevant forms of private sector participation. Assess and evaluate options that appear viable and make recommendations accordingly. Assist in procuring operation contracts where relevant. (ii) Review local IA operation practices and procedures, and make recommendations for improvements to create possible cost savings and/or enhanced performance. (iii) Provide guidance in operation standard setting and in preparation of operational procedures to improve reliability and consistency of service provision. (iv) Investigate and make recommendations on other local operational issues identified during the course of the work, by local management, or from other sources. (v) Undertake a general review of the compilation of maintenance programs and the degree to which these are adhered to. Make recommendations on any improvements needed in maintenance planning or resources. (vi) Review procedures for the control of discharges of industrial waste and recommend improvements, including (a) licensing and record keeping of discharges, (b) monitoring regimes and methods, and (c) enforcement procedures.

44 Appendix 11

(vii) Review and recommend improvements to sewer inspections and maintenance programs and available equipment, including activities to reduce infiltration and unauthorized connections. (viii) Review policies and procedures for sewer connections programs, use of septic tanks, and arrangements for protecting the structural integrity of buried assets. Include any specific arrangements made or required to ensure access to services by the poor. (ix) Review policies and procedures for water supply connections and their financing. Include any specific arrangements made or required to ensure access to services by the poor. (x) Review existing water leakage from water networks and make proposals for how this can be reduced to economic levels. Include details of supplementary metering, equipment, staffing, and training needs.

C. Indicative Resourcing

10. An indicative resource schedule for consulting services was prepared based on the IAs’ needs as assessed during project preparation (Table A11).

Table A11: Indicative Consulting Inputs Required for Project Implementation Area of Expertise International Domestic Person-Months Person-Months Technical and Engineering Management 10 57 (including Tendering and Procurement) Institutional and Managerial Development 6 38 Financial Management 6 76 Operation Management 3 76 PPMS Framework and Resettlement 2 19 Monitoring Social Development - 6 Public Awareness - 15 Environmental Monitoring and Reporting 1 19 Total 28 300 Source: Asian Development Bank estimates.

Appendix 12 45

OUTLINE PROJECT PERFORMANCE MANAGEMENT SYSTEM Reference Indicator Baseline Monitoring Mechanism A. General Urban Development Measures 1. Public satisfaction with urban environment Socioeconomic surveys 2. Level of environmental public awareness Socioeconomic surveys 3. Per capita gross domestic product and gross Official government statistics domestic product growth in project cities 4. Level of disposable income Official government statistics Socioeconomic surveys 5. Number (and %) of urban poor Official government statistics 6. Unemployment rate in project area Official government statistics 7. Satisfaction of affected persons (%) Socioeconomic surveys B. Project Implementation Measures 1. Compliance with environmental management plans Independent monitoring reports 2. Compliance with resettlement plans Independent monitoring reports 3. Incidence of waterborne disease Health statistics (i) Total incidence Socioeconomic surveys (ii) Deaths from waterborne disease Cause of death records (iii) Cost of medical care Socioeconomic surveys and hospital records (iv) Sick days taken Socioeconomic surveys C. Wastewater and Water Supply Measures 1. Water quality in receiving rivers EPB monitoring data 2. Urban wastewater collected (%) Utility information system 3. Properties connected to sewer (%) Utility information system 4. Urban wastewater treated (%) Utility information system 5. Total WWTP capacity Utility information system 6. Length of main sewer Utility information system 7. Water and wastewater tariff levels Price Bureau data 8. Cost recovery (%) Utility financial statements 9. WWTP/water treatment plant cost efficiency Utility information system 10. Customer affordability of water and wastewater Calculated from government statistics services Socioeconomic surveys 11. Customer willingness to pay Socioeconomic surveys 12. WWTP operational performance EPB)/ Utility monitoring data 13. Utilization of WWTP (%) Utility information systems 14. Number of industrial discharges licensed EPB Utility information systems 15. Number of discharge license violations EPB/Utility information systems 16. Total water treatment plant capacity Utility information system 17. Total water demand Utility information system 18. Per capita water consumption Utility information system 19. Urban supplies meeting PRC water quality Utility information system standards (%) 20. Level of nonrevenue water Utility information system 21. Closure of private wells Time-bound action plan 22. Assessment of job skills Utility information system 23. Institutional capacity-building milestones Project reviews EPB = Environmental Protection Bureau, WWTP = wastewater treatment plant. Notes: 1. Baseline performance will be added once the project performance monitoring system framework is agreed. 2.Utility refers to either a water supply or wastewater company. Source: Henan provincial government.

46 Appendix 13

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:

In 2003, the total population in Henan province was about 96.7 million (7.7% of the national total), of whom 27% are classified as urban and 73% as rural. Since 1990, the urban growth rate has risen from about 3% per year to more than 6%, while the rural rate has been consistently negative since the mid-1990s. These figures indicate a strong trend in rural–urban migration. It also implies increasing pressure on urban public services and increasing environmental pollution. Provision of clean drinking water and wastewater management will improve living conditions and quality of life, and reduce waterborne disease of local residents. Due to higher vulnerability to unfavorable environmental conditions, the poor will particularly benefit from the clean water supply and cleaner waterways, and improved ambient environment and public health. The Project will support the Government in achieving the Millennium Development Goals (MDGs) for environmental sustainability (MDG Goal 7) to halve the population without sustainable access to safe drinking water and basic sanitation by 2015 (MDG targets 10 and 11). Although the Project does not include direct poverty intervention, it supports poverty reduction directly and indirectly through job creation and promotion of sustainable economic development in areas where the poor are particularly likely to gain, such as the construction and tourism industries.

The Project will benefit a total urban population of about 1.5 million in 15 city/counties in Henan province through the provision of clean water and improvement of wastewater services. Of the total beneficiary population, about 170,000 or 11% of the total beneficiaries are poor as measured by weighted-average of 15 urban counties poverty lines of CNY1, 348 per capita per year. One of the important project benefits will be improvement in public health, especially related to the reduction of waterborne disease such as typhoid, cholera, hepatitis, skin disease, and diarrhea, particularly to the poor, women, children, and elderly. Annual economic losses due to reported waterborne disease among the direct beneficiary population are estimated currently at CNY30 million per annum; these can likely be reduced by 40% with the Project. To realize the full health benefits, parallel improvements are required in public health education, higher standards of personal hygiene, and improved housing and living conditions especially for the poor who are likely to suffer most from water-borne disease. Women, with more chances of contact with water from household chores, will also benefit disproportionately from the improvement in sanitation, water quality, and urban environment. Awareness and education programs will be provided to promote public hygiene, and health indicators related to waterborne disease will be monitored annually as part of the project performance monitoring system.

The Project will create employment opportunities in construction and management of water and wastewater services for both skilled and unskilled workers. Construction of project facilities will require a total of 6,000 person-years of labor. Of these, 1,200 person-years will be managerial and technical personnel, 3,300 person-years skilled, and 1,600 person-years unskilled workers. About 1,800 person- years of the construction-related employment are expected to be available for the poor and women. When the Project is fully operational, the staffing requirement is estimated at 2,000, including 1,200 technical and managerial, and 800 skilled and unskilled workers. About 400 jobs or 20% of the operational jobs will be available for women and the poor.

Appendix 13 47

B. Poverty Analysis Proposed Classification: General intervention

What type of poverty analysis is needed?

Poverty and social analysis were treated as an integral part of project preparation and are based on quantitative and qualitative methodologies. Project selection and design included the analysis of poverty data based on data at the country, province, and project area; and involved field assessment, household income, and expenditure survey of 1,400 respondents in 15 counties of the project area; stakeholder consultations through focus group discussion; key informant interviews; and workshops to understand the issues of multidimensionality of poverty, willingness to pay, affordability, stakeholder participation, gender and development, and any social safeguard issues. Poverty and social development criteria were developed for the selection of additional subprojects.

In the People’s Republic of China (PRC), no standard national poverty lines have been developed for urban areas. The official poverty line for urban residents in each city/county varies. The data from Henan Civil Affairs Bureau showed 1.325 million out of 19.5 million or 6.8% if the urban population living under the minimum living guarantee (MLG).a In the project area, about 170,000 people or 70,000 households are classified as urban poor and are entitled to receive the MLG from the respective city/county Civil Affairs Bureau. They accounted for about 11% of the total urban population in 2004, which is higher than the poverty rate of Henan province at 6.8%. Data from Henan Civil Affairs Bureau indicates that more poor people live in these counties than in larger municipal cities. This trend is similar to other parts of the PRC, which is mostly attributed to less employment opportunities in the nonagriculture sector, recent migration of unskilled and poor workers from rural to county areas, and geographic expansion of county administration to include some of the rural areas.

The Project will help improve the urban environment and public health through improved wastewater management and water supply. However, increases in the fees for water and wastewater services may have a negative impact on the poor. This impact is considered to be minimal, given that the total amount paid by each household for water supply and wastewater treatment services is a small percent (3.2% of their total income). To protect the poor, the local municipal/county Civil Affairs Bureau operates a social support program for the lowest income bracket households under the MLG scheme, which provides assistance in paying utility charges including water and wastewater.

C. Participation Process

Is there a stakeholder analysis? Yes No

Is there a participation strategy? Yes No

Stakeholder analysis was conducted during project preparation to identify their needs, interest, capacity, and level of influence in the project design, implementation, and monitoring. Based on this analysis, the primary and secondary stakeholders were identified. The primary stakeholders include ADB; the PRC Government; Henan provincial, municipal, and county governments; implementing agencies, and communities in the project beneficiary areas. The secondary stakeholders are the major beneficiary groups in a broad sense, including finance bureaus, development reform commissions, labor and social security bureaus, civil affairs bureaus, poverty reduction offices, health bureaus, women’s federations, environmental sanitation bureaus, environmental protection bureaus, water resources bureaus, agriculture commissions, real estate bureaus, tourism bureaus, and investment offices.

Stakeholder participation is the core element of project design and planning, particularly in the area of poverty, social, environmental, and involuntary resettlement. Based on the public consultations, focus group discussion, and rapid participatory appraisal, a participation strategy was developed to (i) promote active participation of the beneficiary and affected population in project planning, implementation, and monitoring and evaluation; (ii) promote active participation of the primary and secondary stakeholders in the implementation of awareness and education program on public health and improvement of personal

48 Appendix 13

hygiene; (iii) enhance the project benefits to the beneficiary populations, obtain their support for the Project, and raise their social acceptance of the user fees; and (iv) promote gender awareness of water and wastewater to management staff and other key stakeholders.

D. Gender Development

Strategy to maximize impacts on women:

The full participation of women in the water and wastewater sectors implies that, to a very great extent, project benefits will accrue to women as well as to men. This is true of economic and noneconomic benefits arising from improved environment, in particular most household work is water related, which is mainly performed by women. Benefits resulting from access to clean and stable water supply and improved water quality, employment opportunities from the project activities, increased health status, and time saving from performing water-related household activities will all benefit women to a certain degree. To improve gender awareness in the water and wastewater sectors, the Henan provincial government, the Executing Agency, with the assistance of a gender specialist will (i) encourage women to participate in project implementation activities, in particular on awareness of public health and hygiene; (ii) conduct gender awareness training for management staff and other key stakeholders to promote women’s participation in the Project, and (iii) monitor project impact on health and hygiene. The public awareness will target women’s engagement as promoters in the public awareness and educational program on public health, hygiene improvement, and project benefits.

Has an output been prepared? Yes No

E. Social Safeguards and Other Social Risks

Item Significant/ Plan Required Not Significant/ Strategy to Address Issues None Significant Resettlement impacts were identified for the eight Full representative subprojects and resettlement plans were Resettlement Not significant prepared in accordance with PRC Land Law and ADB Short (7) guidelines. A resettlement framework was prepared and None approved by ADB for other candidate subprojects. None Plus RF In very broad terms the implementation of full cost- Significant recovery tariffs is likely to result in a real increase of about Yes Affordability 65% in the combined water and wastewater tariff. This Not significant tariff increase will be implemented progressively by 6% No every 2 years. This will increase the average cost of water None services from around 2% of average household income to between 3% and 3.5%, based on current earning levels. For poor households, the local municipal/county civil affairs bureau operates a social support program for the lowest income bracket households under the MLG scheme, which provides assistance in paying utility charges including water and wastewater. The Project will not have any negative impact on the Significant existing water and wastewater companies. No labor Yes Labor Not significant retrenchment will be introduced in the Project. No None No indigenous people or ethnic minorities will be affected Significant by the Project. Yes Indigenous Appendix 13 49

Peoples Not significant No

None Employees involved in the Project will be protected in Other Risks Significant accordance to the International Core Labor Standard and Yes and/or the PRC Labor Law, as well as other regulations and Vulnerabilities Not significant guidelines issued by the Henan provincial government No and the respective local governments. None aThe standards for the MLG guarantee is formulated based on (i) kind and quantity of goods that can meet the minimum living demand, (ii) expense of the requisites for daily life, (iii) marketable composite price index, especially the price index of the requisites for daily life, (iv) average income and consumption level of the local residents, (v) economic development and the revenue situation, and (vi) other standards for social security.

50 Appendix 14

SUMMARY RESETTLEMENT PLAN

1. The Project comprises 19 possible subprojects that will be implemented by county government agencies. Eight core subprojects were selected under a sector approach; the remaining subprojects will be processed during loan implementation. All of the subprojects involve some land acquisition and population resettlement, but the impacts are relatively small. The land acquisition and resettlement program is designed to ensure that those affected will be better-off as a result of the Project.

2. The Project’s resettlement impacts are summarized in Table A14. Based on the 19 subproject surveys, the Project will permanently acquire 155 hectares (ha) of land, including 115 ha of farmland affecting 846 rural households (2,987 people). The Project will temporarily occupy 173 ha of state and collective land, affecting 1,183 urban and rural households (4,663 people). Only 8 residential houses with 33 people need to be relocated.

3. For the eight representative subprojects, the Project will permanently acquire 35 ha of land, of which 91% is farmland. The Project will also require 90 ha of temporary land occupation, of which 37% is farmland. When construction is completed, the land temporarily occupied will be restored and returned to the owner. In addition, 180 square meters (m2) of mud-wood houses and simple structures will be demolished. One enterprise and one cultivation farm, which are not in operation, will be affected by demolition; the affected structure area is 1,960 m2. One enterprise and one cultivation farm, which are not in operation, will be demolished; the affected structure area is 1,960 m2. Some auxiliaries, such as trees, tombs, fences, and vegetable sheds will also be affected. A total of 464 households (1,388 people) will be affected by permanent land acquisition, 1,061 households (4,104 people) by temporary land acquisition, and 2 households (8 people) by house demolition. All of those affected are rural residents.

Table A14: Summary of Land Acquisition and Resettlement Impacts Temporary Land Building Permanent Land Acquisition Occupation Demolition Total Area Of which Land People People People Affected Area Affected Farmland Area Affected Affected (number) (m2) Components (ha) (ha) (ha) (number) (number) A. Eight Representative Subprojects 1. Anyang WW 465 13.27 13.27 37.54 279 1,960a 0 2. Linzhou WW 411 4.20 4.20 0.45 123 0 0 3. Puyang WW 250 4.59 4.59 8.20 n/a 0 0 4. Puyang WS 0 0 0 11.33 n/a 0 0 5. Weihui WW 148 5.73 5.73 0.67 105 180 8 6. Weihui WS 19 1.35 0 32.27 3,720 0 0 7. Boai WW 95 4.00 4.00 – – 0 0 8. Boai WS 0 2.00 0 – – 0 0 Subtotal (A) 1,388 35.14 31.79 90.46 4,227 2,140 8 B. Other Subprojects 1,599 120 45 82.48 560 288 25 Total 2,987 155 77 173 4,663 2,428 33 ha = hectare, m2 = square meter, WS = water supply, WW = wastewater. a Unused industrial buildings. Source: Henan provincial government.

Appendix 14 51

4. Resettlement planning and implementation is designed to ensure that those affected will be better-off or at least not worse-off as a result of the Project. To avoid or minimize land acquisition and resettlement, local officials and village committees/street committees were closely consulted during the preliminary and final feasibility study stages.

5. Compensation for permanent land loss is based on the Land Administration Law of the PRC (1998) and associated provincial and municipal laws and regulations. Seven separate resettlement plans (RPs) were prepared for the eight core subprojects, which conform to the Asian Development Bank (ADB) policy on involuntary resettlement.1 Of the seven RPs, one covers both water supply and wastewater subprojects for Boai. For the remaining subprojects, a resettlement framework was prepared and approved by ADB (Supplementary Appendix H). Once a subproject is selected for inclusion in the Project, the RP will be submitted to ADB for approval prior to commencement of land acquisition. Draft RPs have already been prepared for other candidate subprojects and will be upgraded using the representative subproject RPs as models.

6. Based on consultations with local governments and those affected, and general practice in the project city/counties, the city project management offices (PMOs) and implementing agencies (IAs) adopted a set of compensation standards. The resettlement principles established for the Project are (i) land acquisition and involuntary resettlement should be avoided or minimized where feasible by developing and comparing a series of design alternatives; (ii) compensation and entitlements provided must be adequate to allow those affected to at least maintain their preproject standard of living, with the prospect of improvement; (iii) land temporarily occupied and the period for disruption are to be kept to a minimum; (iv) all the people affected, legal and illegal, are to be taken into consideration and accounted for; (v) the per capita landholding after land acquisition will be sufficient to maintain the previous livelihood standard; (vi) where land allocation per capita is not sufficient to maintain the previous livelihood standards, other income-generating activities will be provided; (vii) a preferential policy will be provided to vulnerable groups, including housing assignment, training, and employment; (viii) all those affected will be adequately informed about eligibility, compensation rates and standards, livelihood and income-restoration plans, and project timing; and (ix) close monitoring and timely actions will be carried out to identify and resolve any problems.

7. For the eight representative subprojects, those affected have been notified about the key elements of the RP. On various occasions during meetings, interviews, focus group discussions, public consultation workshops, and community consultation meetings, local representatives have participated in the planning; concerns were integrated into the RP. The resettlement information booklets were distributed to affected villages and households in February 2005. The RPs were provided to village offices and resident committees and will be posted on the ADB website. The respective project IAs will establish project resettlement units for supervising implementation, continuing public consultation, monitoring progress, and responding to grievances. The grievance address procedures are well established and explanations are included in the resettlement information booklets.

8. For land acquisition, the compensation of land and resettlement subsidy will be paid to the affected village. If land is adjusted, the village will retain the resettlement subsidy. Otherwise, the subsidy will be paid to the affected household. For the structure of residential houses, the closed enterprise and farm to be demolished, compensation will be paid to owners.

1 ADB. 1998. The Bank’s Policy on Involuntary Resettlement. In Handbook on Resettlement. Appendix 1. Manila.

52 Appendix 14

The payment will be made in cash according to the appraised value of the property. Households that have to relocate will also receive a transfer and transportation allowance. Compensation for standing crops, auxiliaries, and other assets will be paid directly to affected farmers.

9. The measures for economic rehabilitation include (i) provision of employment opportunities during the project construction and operational phases; (ii) arrangement for those affected to be employed in local enterprises and businesses; (iii) land redistribution where possible; (iv) intensify and diversify farm operations to raise the value of production and income per unit of land; and (v) training on scientific and diversified agricultural business to assist those affected increase their income. New livelihoods may include courtyard economic activities, animal husbandry and economic crop planting, greenhouses, and tertiary business (e.g., transportation and catering services). The compensation paid to village committees will be used to improve village production and infrastructure.

10. During investigations, 46 vulnerable affected people were identified for the eight core subprojects, including poor, disabled, and elder households and those headed by women. Special measures will be taken to ensure these vulnerable people receive adequate compensation and assistance to restore their living conditions and incomes.

11. The staff from each subproject resettlement unit will take the lead responsibility for coordinating the planning, implementation, financing, and monitoring of land acquisition and resettlement. Each PMO will have at least two full-time staff responsible for land acquisition and resettlement. They will work closely with relevant village/street officials, land administration bureaus, and house demolishment offices, and will be responsible for supervising and monitoring resettlement (e.g., delivery of entitlements, selection of new housing sites, restoration of incomes, provision of replacement land, and other economic measures). A training program will be organized for the PMO resettlement units.

12. For the eight representative subprojects, the cost estimate for land acquisition and resettlement program is CNY65 million ($7.9 million) in 2004 prices, excluding contingencies. Resettlement implementation will be scheduled to precede the overall project construction schedule. However, before those affected are moved and land is acquired, a detailed measurement survey will be conducted in each village, which will be the basis for village and household agreements to be negotiated.

13. Internal and external monitoring is planned for RP implementation following methodologies specified in the RPs. Internal supervision and monitoring will be done by the project resettlement office of each IA to ensure compliance with RP provisions. The project resettlement office has agreed to a set of supervision milestones with ADB, which should be followed to ensure timely and effective implementation of resettlement activities. HPMO will prepare quarterly monitoring reports on resettlement and submit them to ADB. HPMO will contract an independent agency to conduct external monitoring and evaluation, and report to ADB and the HPMO every 6 months. Appendix 15 53

ECONOMIC ANALYSIS

A. Introduction

1. The economic analysis covers both the Project as a whole, and the individual subprojects. For the Project as a whole, the analysis covers the rationale for public intervention; the goals of the investment plan; and the general design of the plan, including selection criteria for subprojects. The economic analysis then evaluates the individual subprojects relative to the selection criteria, focusing on the least-cost analysis.

B. Analysis of the Project

1. Rationale for Public Intervention

2. The primary motivation for the Project results from increasing concern over the effects of economic growth on environmental quality. Rapid economic growth and continuing urbanization has resulted in increasing water shortages and pollution, especially in northern People’s Republic of China (PRC). The Hai River Basin (HRB) is one of the PRC's most polluted basins, with more than 80% of river reaches failing to meet their targeted water quality. Surface and groundwater pollution pose risks for public health and the environment in general. Pollution is also starting to constrain national and local development objectives, including the incipient south–north water transfer.

3. The existence of serious and growing problems with water pollution demonstrate that private sector responses alone are inadequate. Generators of wastewater have the incentive only to convey their wastewater sufficiently downstream so that they do not pollute themselves, and have no incentive to treat the wastewater at the point of discharge.

4. The Project involves government intervention at several different levels. The central Government is coordinating the management of surface water quality in the HRB (as well as other basins in the PRC). The Henan provincial government contributed to the basin plan, and is coordinating and implementing the elements of the basin plan that are in Henan province. Municipal and county governments are making individual investments in the water supply and wastewater treatment works, and will be involved in managing the completed facilities.

5. Government involvement is sound at each level. Government has a role in controlling the externalities from discharges of untreated wastewater, and coordinating the management of surface water quality. Government management of surface water has effectively allocated to water users the right to surface water of a given quality, thereby denying the right of generators to pollute, and requiring generators to pay the cost of wastewater treatment. Involvement of the central Government is justified since the HRB spans several provinces.

6. Government involvement in individual projects is justified since both urban water supply and wastewater management are natural monopolies. Local governments are adopting a variety of strategies to manage the water supply and wastewater utilities. All utilities will be owned by local governments, and managed as independent public enterprises. Contracting operation and maintenance of the wastewater treatment plants with the private sector is encouraged, especially for local governments without prior experience in wastewater management.

54 Appendix 15

2. Goals of the Project

7. The Project has both general and specific goals. The general plans for economic growth and development, for Henan province as well as the PRC as a whole, provide the basis or context for the goals specific to the Project. For example, the 10th Five-Year Plan for Henan province aims to (among other things) double per capita gross domestic product in real terms by 2010, and double it again by 2020. The plan recognizes that achieving these goals will require protecting, improving, and maintaining environmental quality, including surface water quality in particular.

8. The goals most directly relevant to the investment plan come out of the Hai River Plan (HRP), which aims to improve and maintain surface water quality throughout the HRB. The HRP was formulated by the State Environmental Protection Administration, and approved by the State Council in 1999. The Henan provincial government developed a subsidiary plan for managing water quality in the part of the province contained in the HRB.

9. Goals for surface water quality are a key feature of the HRP. They are based on five main classifications of surface water quality, set according to the intended use of the water. Class I applies to pristine waters; classes II and III apply to surface water that is used as a source of raw water for urban water supply; and classes IV and V are for surface water that is intended only for irrigation and industrial use. Each class is defined by 30 criteria, prescribing numeric ranges for the physical, chemical, and biological properties of water (such as temperature, pH, and coliform counts). The State Environmental Protection Administration sets water quality goals for some key, strategic, river reaches. Generally, the relevant environmental protection department—county, municipal, or provincial—sets the water quality goal.

3. Design of the Plan

10. There is no unique, least-cost plan to achieve the water quality goals, and any plan that minimizes cost is acceptable, in principle. Standard economic theory provides one least-cost plan, based on economic incentives. Although implementing that (or any other) least-cost plan perfectly is not feasible in the HRB, a plan based on economic incentives provides a simple standard for evaluating the actual plan.

11. The water quality goals may be achieved at least cost through a centralized wastewater management system, under the following conditions. All point-sources discharging to a given reach should be connected to a sewer system, with the sewer system discharging to a centralized treatment plant. The Henan Hai River Plan (HHRP) aims to meet that condition, although it has known limitations to achieving comprehensive house connections. Those limitations will be addressed in implementing the Project.

12. All discharges to the sewer must be similar, or else be classified according to the nature of the waste load. Commercial and domestic discharges are similar, by their nature. Industrial discharges to the sewer must meet given standards, and when those standards are met industrial discharges can be considered as uniform. Enforcing the standards for industrial discharges is therefore an important element in implementing the HHRP and will be addressed during Project implementation.

13. All wastewater generators within a given type should face the same charge per unit discharge. This condition applies to industrial generators, but under the proposed tariffs, discharges from commercial sources will face a higher usage charge than domestic discharges. Appendix 15 55

This feature of the tariff increases the total economic cost of wastewater management across the system, with either commercial discharge too low, or domestic discharge too high, or both.

14. The charge per type of discharge should equal the marginal cost of conveyance and treatment. Usage charges are expected to be set at an average cost, and average cost equals marginal cost when the plant is operating at the minimum efficient scale. Economies of scale in building and operating a treatment plant mean that plants are designed with excess capacity relative to current wastewater generation, so the treatment plants will not operate initially at their minimum efficient scale. Installing excess capacity is economically justified, but the proposed usage charge is not economically efficient, at least for the initial operation of plants. This feature of the tariff increases the total economic cost of wastewater management, with the spare capacity perhaps unnecessarily idle; the extent of the inefficiency depends on the price elasticity of wastewater discharges. Wastewater tariffs will be reviewed after construction of the treatment plants, and will be set according to the PRC's latest standards or guidelines.

15. Each treatment plant should be designed at least cost, in terms of location, scale (or planning horizon), and treatment technology. The investments must be prioritized, since the size and scope of the plan prevents all investments from being made simultaneously. Construction of the treatment plants is prioritized informally, through various targets. For example, each municipality must have a treatment plant by 2005, and each county by 2007. Conditions relating to plant design and priorities are stipulated in the selection criteria, and are discussed in the context of the analysis of individual subprojects.

16. In addition to the wastewater treatment plants, the HHRP also includes several urban water supply investments. The HHRP cannot expect to immediately improve surface water quality. Although the water supply investments are not directly relevant to meeting the surface water quality goals, the water supply plants are relevant to mitigating the effects of water pollution during HHRP implementation. The water supply plants will be designed at least economic cost, and will replace polluted sources of raw water.

17. The HHRP has the potential to achieve the water quality goals at least cost, but the potential is not fully realized through inefficiencies in the wastewater tariff. Aside from limitations in the tariff, the HHRP is economically sound provided the individual investments meet the economic selection criteria, and policies regarding connections and industrial discharges are adequately implemented.

C. Analysis of Individual Subprojects

1. Least-Cost Analysis of Individual Subprojects

18. The least-cost analysis ensures that each subproject is optimally designed both to meet the goals of the HHRP, and does not involve unnecessary extra costs. The least-cost analysis should cover all feasible alternatives for a given subproject, including variations in location and treatment technology. Ideally, least-cost analysis will also cover the planning horizon or capacity of the plant, but capacity is constrained by other factors.

19. For each subproject, a minimum of two and a maximum of four alternatives were assessed based on the options presented in the feasibility study reports, with various additions and variations by the project preparatory technical assistance study team. The alternatives are generally characterized as follows:

56 Appendix 15

(i) option proposed in the feasibility study reports, (ii) same as (i), with alternative treatment process, (iii) same as (i), with alternative treatment site location, and (iv) same as (i), with alternative pipeline layouts.

20. The results of the analysis confirm that the preferred options stated in the feasibility study reports for the representative subprojects are the least-cost alternatives.

2. General Assessment of Individual Subprojects

21. In addition to being least-cost, each individual subproject must be economically justified. The first standard by which to judge a subproject's justification is with respect to the HHRP. Any subproject that is least-cost and identified as an integral component of the HHRP is, therefore, fully justified. All subprojects are indeed integral to the HHRP, as shown during the project preparatory technical assistance.

22. Applying standard benefit-cost analysis can strengthen the economic justification of individual subprojects. Such analysis is ultimately unnecessary for subprojects confirmed as integral to the HHRP, but is a useful confirmation, considering that benefit-cost analysis is standard under ADB guidelines.

23. Economic internal rates of return were, therefore, derived for the individual subprojects. The main benefits were quantified under the following categories: (i) wastewater management component: (a) willingness to pay by nonindustrial beneficiaries, (b) industrial wastewater treatment savings, (c) health benefits, and (d) recycled effluent (Anyang City only─for cooling at local power plant); and (ii) water supply component: willingness-to-pay for improved and expanded water delivery services.

24. The rates of return for the representative subprojects range from 14% to 18% for the wastewater management projects and from 17% to 20% for the water supply projects. Sensitivity tests on the main parameters indicate that the results are robust and the proposed investments are economically justified.

Appendix 16 57

FINANCIAL ANALYSIS A. Introduction

1. Financial analysis was prepared in accordance with the Guidelines for the Financial Governance and Management of Investment Projects Financed by the Asian Development Bank (ADB) and the Framework for the Economic and Financial Appraisal of Urban Development Sector Projects of ADB. An assessment of financial performance was completed for operations once the Project is implemented. The evaluation determines the level of cost recovery from users required to service the ADB loan and achieve financial health. The assessment was done for each of the eight representative water supply and wastewater subprojects and each sector. Details of the financial analysis and financial projections are given in Supplementary Appendix K, which contains income statements, balance sheets, sources and application of funds, financial internal rates of return (FIRRs), and domestic affordability.

B. Financial Forecasts

2. Projections are based on information in the draft final reports prepared by the project preparatory technical assistance (TA) consultants funded by ADB, and information gathered from discussion with each of the project management offices. System investments include water volumes sufficient to satisfy demand in 2020. Treatment plant investments were estimated for 2010 demand, and so operations are forecast at those levels. Growth in wastewater tariff revenues is based on forecast growth in total water consumption, with the balance beyond sales of water supply companies met by self-supply. Forecasts for water and wastewater volumes agree with those in the economic analysis.

3. The projections for the water supply companies in Boai and Weihui incorporate historical audited accounts for fiscal years 2001, 2002, and 2003, as they operate as full utility companies. The remaining projections are based on the assumption that the operators will be full utility companies at least by the completion of the project investments. Uncertainty remains as to whether the wastewater and water supply companies in a town will be combined into a single agency; thus separate accounting results are shown for each.

4. Accounting results are shown through to 2020, but all flows were extended for a further 5 years for the FIRR calculation, which also includes a residual value, equal to net asset value. Annual domestic inflation is assumed at 3.0% through the projection period. Depreciation is assumed as 2.5% for civil works and 7.5% for mechanical and electrical equipment. Deferred expenses are amortized at 10%. Terms for ADB onlending are assumed at 4.71% interest, and a 5-year grace period followed by a 20-year repayment period. Terms for domestic borrowing are assumed at 7%, grace with interest accumulated until start operations, and then 10 years repayment.

C. Tariffs

5. Tariffs either directly or indirectly relevant to the project are (i) water resource charges, (ii) urban water supply tariffs, and (iii) the recently introduced wastewater charges. Such tariffs do not just raise revenues to finance utility services, but are also policy instruments that might be used for several purposes. At this point, the main purpose is to ensure that water and wastewater tariffs will cover long-term costs. A policy dialogue with local and national governments regarding other possible goals and aims of tariffs continues.

1. Water Resource Charges

6. Existing private sources of urban supply are boreholes tapping the shallow aquifer. The shallow aquifers are already polluted and abstracting from them is causing subsidence. Water resource charges levied on nonagricultural users are based on either measured or assessed

58 Appendix 16

consumption. Charges are set on a municipality-by-municipality basis and range from CNY0.05 per cubic meter (m3) in Jiaozuo cities to CNY0.45 per m3 in Puyang cities. Industrial and domestic users are levied the same unit charge. For most small users, the charge is based on assessed volumes with only larger industries being metered. Industries that exceed water usage quotas are liable to a surcharge levied by the local water conservancy bureau. The higher charge in Puyang municipality appears to reflect a combination of the more acute water situation in that area and greater municipal government awareness that price will affect demand; consumption there is always measured and charged.

2. Urban Water Supply Tariffs

7. Urban water supply tariffs in all the project cities are levied on volume taken. The tariff structure differentiates between domestic, institutional, industrial, and commercial users, with a higher rate applying to special users such as public baths and other high consumption users. The water tariff rates cross-subsidize between the different user categories, with domestic users paying less than industrial, commercial, and special users.

3. Wastewater Tariff

8. In all of the project areas, wastewater charges are a user fee based on water use. Henan provincial government has taken the lead in introducing wastewater charges and urged county and municipal governments to take appropriate action on this. Henan provincial government has issued a guidance document recommending a provincial standard, with charges of CNY0.6, CNY0.7, and CNY0.8 per m3 to be levied on domestic, industrial, and commercial customers, respectively. The guidance also asks that wastewater charges be jointly billed with the water supply charge and that the same charge be levied on estimated self-use water.

9. As a charge on water consumed rather than wastewater treated, the charge can be seen more as a general pollution charge than a treatment charge. As such, it will (i) not deter customers from using the wastewater system when it is available, (ii) have a cross-subsidization element as it is based on the water bill, and (iii) raise revenue to allow the introduction of new systems. Consideration may have to be given to introducing more sophisticated charges for industry, with the heavier polluters paying a higher charge. The tariff will be considered during project execution.

10. Anyang city has had a wastewater tariff in force for several years, which was higher than the provincial guidance. Some county cities introduced charges during 2004, while others plan to do so from the start of 2005. All the project cities, including Anyang, have either adopted or plan to adopt the provincial standard tariff. None have any plan to vary the tariff to reflect local circumstances, preferring to deflect criticism to higher levels of government. Public awareness and willingness to pay the new wastewater charges are low and action may be needed to improve this situation.

11. Since the wastewater charge is (or will be) added to the water supply bill using the same metered consumption, consumers can be expected to adjust their demand for water based on the total charge. Studies in the country have shown that demand is sensitive to tariffs, but that this sensitivity is less when the existing tariff is low. Demand is also sensitive to incomes. The local and TA consultants did not study demand as related to tariffs. This gap will be filled during project implementation.

12. In very broad terms, implementation of full cost-recovery tariffs is likely to result in a real increase of some 65% in the combined tariff (the situation will vary from city to city) and increase the average costs of water services from around 2% of average household income to up to 3.5% of household income. These are not high according to international norms, but they are significant. The socioeconomic survey suggests that a poor household currently consumes about 20% less Appendix 16 59 water than a non-poor household. Their 30% lower earnings imply a fairly standard income elasticity of around 0.60; demand will increase significantly as incomes grow.

D. Water and Wastewater Revenue Projections

13. Wastewater companies will have two revenue streams. The first comprises revenues billed and collected by the water supply companies, in addition to the water supply charges. Since the wastewater charge is now classified as an administrative fee, it is currently transferred from the water supply company to the local government finance bureau and distributed according to need. Proposals to change the fee to a user charge would result in it being distributed directly to the wastewater company, since the finance bureau is allowed by law to deal only in taxes. This should be kept under review, however.

14. The second revenue stream is from charges levied on self-supply. These are now collected either by the water resource bureau or sometimes the wastewater company. Currently, they are transferred to the finance bureau but that should change. Self-supply volumes are now substantial in each of the eight subproject areas. Reducing this when new water supply company capacity comes online will require local government enforcement. Institutional changes will be required to levy the charge efficiently. Collection is assumed to reach 75% by 2010, and ultimately 90% over the projection period. The sensitivity to this is modeled in the financial projections.

15. Revenues will depend on the tariff. In the case of wastewater this is assumed to be the charges recommended by the province and approved by the cities. Per m3, they are domestic, CNY0.6; institutional, CNY0.7; commercial, industrial, and other, CNY0.8. The province has recently increased its recommended guideline by about 15%, but as this has not yet been approved by local governments cannot be used as a base. The presently approved charges have been increased biannually at the maximum of (i) inflation, and (ii) the rate necessary to ensure that possible financial covenants are satisfied. For the FIRR, a 4% minimum rate is assumed since it is ADB’s minimum rate test for the weighted average cost of capital (WACC). The WACC will vary slightly by project since it, like the FIRR, is after tax. Calculations for individual projects show that it is less than 3%.

16. For water supply, existing tariffs are forecast to increase biannually at the maximum of: (i) inflation, and (ii) the rate necessary to ensure that possible financial covenants are satisfied.

E. Financial Results─Wastewater

17. Table A16.1 shows the results for six key project indicators for each representative wastewater subproject: base FIRR, the sensitivity FIRR, the earned FIRR, financial ratios, and affordability. The table also shows the real biannual tariff increase assumed and the resulting level of the tariff in 2015. In practice, these increases are necessary to give a debt-service coverage ratio of 1.2; they are not required to provide an FIRR above the WACC. Discussions imply that tariffs up to around CNY1 could be introduced without difficulty.

18. The sensitivity FIRR (Table A16.1) shows the effect of change in the variable considered most uncertain. This is revenues from self-supplied water since billings for these revenues will be based on assumed consumption and the requirement to pay will not be backed by the possibility of a supply cut-off. The indicator shows the effect of a 50% decrease in these revenues as well as an increase of 20% in operating expenses.

19. Both the base and sensitivity FIRR are based on the total revenues from the wastewater charge, not on revenues related to the volume of water treated. Since, it was agreed that the wastewater companies will keep those revenues once they are established, these FIRRs are correct; the wastewater company will make the investments, pay the operating costs, and receive the revenues. If the company does not have the capacity, however, it will not be able to treat all the

60 Appendix 16

wastewater produced and so cannot be said to have fully earned the revenues. About 30% of wastewater will not reach the sewers in any case, through no fault of the company. Since the planning horizon assumed was only 2010, investment included in the cash flow will sometimes not provide the required capacity over the forecast period. Adjusting for this factor provides the estimates for the earned FIRR (Table A16.1).

20. The financial ratios (Table A16.1) are those for which specific assurances are being asked or covenanted. These are for the maintenance of (i) minimum debt-service coverage ratio of 1.2, (ii) maximum debt over debt plus equity ratio of 70/30, and (iii) minimum current ratio of 2. Some leeway is allowed in the current ratio, which measures current assets over current liabilities, if the ratio is below 2 only for a few years at the start of project operations.

21. The affordability indicators are the percentages of urban poor household incomes taken by the combined water and wastewater charges. A standard international assumption is that 5% is affordable.

Table A16.1: Representative Wastewater Project Financial Results Item Anyang Boai Linzhou Puyang Weihui Real Tariff Increase, per 11.2% to 2010 9.3% to 2010 0% 14.7% to 2010 4.1% to 2010 annum Real Tariff, 2015 CNY1.2 CNY1.0 CNY0.7 CNY1.1 CNY0.8 Base FIRR (%) 5.0 5.2 5.4 7.4 5.1 Sensitivity FIRR (%) 1.5 2.6 (2.2) 2.9 (0.3) Earned FIRR (%) 5.0 3.5 3.2 7.4 3.5 Minimum DSCR 1.2 1.2 1.3 1.2 1.2 Maximum Debt/Equity 40/60 64/36 57/43 63/37 59/41 Minimum Current Ratio 1.8 2.2 3.2 1.3 1.9 Affordability (%) 1.7 2.4 2.8 3.5 3.6 ( ) = negative value, DSCR = debt-service coverage ratio, FIRR= financial internal rate of return. Source: Asian Development Bank estimates.

F. Financial Results–Water Supply

22. Table A16.2 provides similar results for the representative water supply projects. In this case, the sensitivity FIRR assumes a 20% variation in costs and revenues. Affordability results are not shown since they are subsumed within the combined results shown in Table A16.1.

Table A16.2 Representative Water Supply Project Financial Results Item Boai Puyang Weihui Real Tariff Increase (%) 0 0 0 Base FIRR (%) 10.3 13.4 5.1 Sensitivity FIRR (%) 0.1 2.9 (5.6) Minimum DSCR 1.3 1.6 3.4 Maximum Debt/Equity 66/34 52/44 45/55 Minimum Current Ratio 2.2 3.5 6.1 ( ) = negative value, DSCR= debt service coverage ratio, FIRR= financial internal rate of return. Source: Asian Development Bank estimates.

G. Weighted Average Cost of Capital

23. The WACC was calculated in real terms for the Project. Funding sources are the ADB loan (50%), local bank loans (16%), and capital contributions from local governments (34%). Assumed nominal cost of funds are 4.71%, 7%, and 8% for the ADB loan, local loan, and government funds respectively. The cost of government funds is the assumed opportunity cost and is the amount included in the country’s water tariff guidelines, prepared with ADB assistance. Long-term inflation Appendix 16 61 is estimated at 2.4% and 3.0% for foreign and local costs. Allowing for taxes at 30% on loans but not equity, the WACC is estimated as 2.4%.

H. Sensitivity Analysis

24. In addition to the combined sensitivity results shown in the preceding tables, separate analyses were performed to show the effects of (i) a 30% decrease in revenues, (ii) a 20% increase in operation and maintenance, and (iii) a 10% cost overrun coupled with a 1-year construction delay. Table A16.3: provides the base FIRRs, and the combined sensitivity FIRRs, for the total eight representative subprojects. They indicate that revenues are likely to be the most sensitive item.

Table A16.3: Sensitivity Analysis, All Eight Representative Subprojects Wastewater Water Supply Total Item (%) (%) (%) Base Case 5.6 9.7 6.3 30% Decrease in Revenues (1.0) (0.1) (0.9) 20% Increase in Operation and Maintenance 3.2 6.2 3.8 10% Cost Overrun Plus 1-Year Delay 4.4 8.3 5.1 Combined (as in tables A16.1 and A16.2) 1.1 (0.7) 0.8 ( ) = negative value. Source: Asian Development Bank estimates.