Document of The World Bank

FOR OFFICIAL USE ONLY Public Disclosure Authorized

Report No: 363 17-PH

PROJECT APPRAISAL DOCUMENT

ON A Public Disclosure Authorized

PROPOSED LOAN

IN THE AMOUNT OF JAPANESE YEN 11.710 MILLION (USSl 00 MILLIONEQUIVALENT)

TO THE

LAND BANK OF THE

WITH THE GUMTEEOF THE REPtlBLIC OF THE PHILIPPINES

Public Disclosure Authorized FOR A

SUPPORT FOR STRATEGIC LOCAL DEVELOPMENT AND INVESTMENT PROJECT

May 3 1,2006

Urban Development Sector Unit East Asia and Pacific

Public Disclosure Authorized This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS

(Exchange Rate Effective May 1,2006)

Currency Unit = Philippine Pesos (PhP) PhP51.5 = US$1 PhP 1.00 = US$0.019

FISCAL YEAR January 1 - December 3 1

ABBREVIATIONS AND ACRONYMS

ADB Asia Development Bank BAC Bids and Awards Committee BSP Bangko Sentral ng Pilipinas CAS Assistance Strategy CDS Development Strategy CIDA Canada International Development Agency COA Commission on Audit DBP Development Bank of the Philippines DENR Department of Environment and Natural Resources EA Environment Assessment ECC Environmental Compliance Certificate EIS Environment Impact Study EMP EnvironmentalManagement Plan FM Financial Management FS Feasibility Study FSL Fixed Spread Loan GFI Government Financial Institution GOP Government of the Philippines GPPB Government Procurement Policy Board HBD Harmonized Bidding Document IBRD InternationalBank for Reconstruction and Development ICB International Competitive Bidding IEE Initial Environmental Examination IFC International Finance Corporation IRA Internal Revenue Allotment IRR ImplementationRules and Regulations LBP Land Bank ofthe Philippines LCP League of of the Philippines LGU Unit LGUGC Local Government Unit Guarantee Corporation MDFO Municipal Development Fund Office NCB National Competitive Bidding NEDA National Economic Development Authority NPL Non-performing Loan ODA4 Overseas Development Assistance PDF Philippines Development Forum ROPOA Real and Other Properties Owned or Acquired PCN Project Concept Note PFI Private Financial Institution PhP Philippines Peso PMO Project Management Office PMU Project Management Unit SBD Standard Bidding Document SIL Specific Investment Loan TA Technical Assistance TOR Terms of Reference VSL Variable Spread Loan WBI World Bank Institute WDDP Water Development Project

Acting Vice President: Jeffery Gutman Country Director: Joachim von Amsberg Sector Director: Keshav Varma Task Team Leader: Ming Zhang PHILIPPINES Support for Strategic Local Development and Investment Project

CONTENTS

Page

A . STRATEGIC CONTEXT AND RATIONALE ...... 1 1. Country and sector issues...... 1 2 . Rationale for Bank involvement ...... 3 3 . Higher level objectives to which the project contributes ...... 5 B. PROJECT DESCRIPTION...... 6 1. Lending instrument ...... 6 2 . [IfApplicable] Program objective and phases ...... 6 3 . Project development objective and key indicators...... 6 4 . Project components ...... 6 5 . Lessons learned and reflected in the project design ...... 7 6. Alternatives considered and reasons for rejection ...... 8 C. IMPLEMENTATION ...... 9 1. Partnership arrangements (if applicable) ...... 9 2. Institutional and implementation arrangements ...... 9 3 . Monitoring and evaluation ofoutcomeslresults ...... 9 . *. 4 . Sustainability...... 10 5 . Critical risks and possible controversial aspects ...... 10 6 . Loadcredit conditions and covenants ...... 11 D. APPRAISAL SUMMARY ...... 12 1. Economic and financial analyses ...... 12 2 . Technical ...... 13 3 . Fiduciary ...... 13 4. Social...... 14 5 . Environment...... 15 6 . Safeguard policies ...... 15 7 . Policy exceptions and readiness ...... 16 Annex 1: Country and Sector or Program Background...... 17 Annex 2: Major Related Projects Financed by the Bank andlor other Agencies ...... 23 Annex 3: Results Framework and Monitoring ...... 24 Annex 4: Detailed Project Description...... 28 Annex 5: Project Costs ...... 33 Annex 6: Implementation Arrangements ...... 35 Annex 7: Financial Management and Disbursement Arrangements ...... 40 Annex 8: Procurement Arrangements ...... 47 Annex 9: Economic and Financial Analysis ...... 54 Annex 10: Safeguard Policy Issues ...... 61 Annex 11: Project Preparation and Supervision ...... 65 Annex 12: Anti-Corruption Measures ...... 66 Annex 13: Documents in the Project File ...... 70 Annex 14: Statement of Loans and Credits ...... 71 Annex 15: Country at a Glance ...... 74

Map: IBRD 34814 PHILIPPINES

SUPPORT FOR STRATEGIC LOCAL DEVELOPMENT AND INVESTMENT PROJECT

PROJECT APPRAISAL DOCUMENT

EAST ASIA AND PACIFIC

EASUR

Date: May 3 1,2006 Team Leader: Ming Zhang Country Director: Joachim von Amsberg Sectors: General water, sanitation and flood Sector ManagerlDirector: Keshav Varma protection sector (30%); Sub-national government administration (20%); Roads and highways (20%); Solid waste management (20%); Housing construction (10%) Themes: Other urban development (P); Municipal finance (P); Decentralization (S) Project ID: PO64925 Environmental screening category: Financial Intermediary Assessment Lending Instrument: Specific Investment Loan

Project Financing Data [XI Loan [ ] Credit [ 3 Grant [ ] Guarantee [ 3 Other:

For LoanslCreditslOthers: Total Bank financing (uS$m.): 100.00 Proposed terms: Variable spread, with a maturity of 20 years, inclusive of five years grace, and front-end fee of 1% ofthe loan (with a waiver of 0.75%)

NSTRUCTION AND

~~ Borrower: Land Bank ofthe Philippines 1598 M. H, Del Pilar St. Malate Metro Philippines 1004 Tel: (632)812-4056 Fax: (632)812-4056 www.landbank.com

Responsible Agency: Land Bank of the Philippines Manila, Philippines FY 07 08 09 10 11 12 13 Annual 3 -00 6.00 11.00 22.00 26.00 26.00 6.00 Cumulative 3 -00 9.00 20.00 42.00 68.00 94.00 100.00

Does the project depart from the CAS in content or other significant respects? Re$ [ ]Yes [XINO PAD A.3 Does the project require any exceptions from Bank policies? Re$ PAD D. 7 [ ]Yes [XINO Have these been approved by Bank management? r-- ]yes r INO Is approval for any policy exception sought from the Board? E ]yes jNo Does the project include any critical risks rated “substantial” or “high”? [ ]Yes [XINO Re$ PAD C.5 Does the project meet the Regional criteria for readiness for implementation? Re$ [XIYes [ ]No PAD D.7

Project development objective Re$ PAD B.2, Technical Annex 3 The project development objective is to improve local public service provision and management by facilitating LGU access to viable financing to implement strategic infrastructure investments. Project description [one-sentence summary of each component] Re$ PAD B.3.a, Technical Annex 4 Component 1: Sub-projects for Infrastructure and Finance Improvement (US$99 Million): subloans to LGUs, public utilities and private operators providing local infrastructure services, for strategic local infrastructure and financial management investments,

Component 2: LGU Capacity Building and Project Implementation Support (USts8.0 million): to provide assistance to LGUs with sub-loans for sub-project preparation and implementation, and to support the Borrower for project implementation. Which safeguard policies are triggered, if any? Re$ PAD D. 6, Technical Annex 10 The project is Environmental Category FI. Safeguard policies likely to be triggered by potential sub- projects include Environment Assessment (OPIBPIGP 4.01), Involuntary Resettlement (OPIBP 4.12), Natural Habitats (OPIBP 4.04), and Cultural Property (OPN 1 1.03). A Social and Environment Framework was developed and will guide implementation to ensure compliance with safeguard policies, Significant, non-standard conditions, if any, for: Re$ PAD C. 7 Board presentation: No significant, non-standard conditions. Loan effectiveness: No significant, non-standard conditions.

1. The Project Operations Manual, acceptable to the Bank, has been adopted by LBP;

2. At least two LGU sub-borrowers have entered into a Subsidiary Loan Agreement with LBP satisfactory to the Bank.

Covenants applicable to project implementation: No significant, non-standard conditions.

1. Disbursement Conditions;

The signing of contract with a consultant firm for Project Implementation Support, is a condition of disbursement for goods and consultants services under component 2 of the Project. 2. Implementation Covenants: i)LBP will ensure that the Project is implemented in accordance with the Project Operations Manual and will not amend or otherwise change the Operations Manual except with the prior written consent of the Bank. LBP will ensure that approved sub-projects are identified, appraised, documented, implemented, supervised, monitored and evaluated in accordance with the Operations Manual and the Environmental and Social Safeguards Framework. ii)LBP will maintain the Project Management Office (PMO) throughout implementation, with competent staff in adequate numbers for the duration ofthe project; iii)LBP will submit sub-project proposals and appraisal reports to the Bank for prior review : (a) when the sub-borrower isnot an LGU; (b) for the first sub-project proposal that involves a program of infrastructure investments rather than a single infrastructure investment ; (c) as required under the procurement plan; (d) for each sub-project that requires a resettlement action plan; and (e) for (i)the first sub-project that requires an environmental impact statement report in each of the areas ofhousing and new site development, sewerage, sanitary landfill, drainage and flood control, hospital and medical facilities, and (ii)for the first sub-project that requires an initial environmental examination report in each ofwater supply systems, roads, and bridges. iv) LBP will enter into Subsidiary Loan Agreement with each sub-borrower, on terms and conditions satisfactory to the Bank; v) LBP will, no later than January 3 1 in each year, furnish to the Bank, for review and approval, a draft annual plan of Project activities, including a work program, proposed budget and proposed commitment plan for that year; vi) LBP will furnish to the Bank semi-annual reports integrating the results of the monitoring and evaluation activities on the progress achieved, and setting out the measures recommended for project implementation during the remaining periods; vii) LBP will furnish to the Bank quarterly financial monitoring reports; viii) LBP will furnish to the Bank a Mid-Term Review ofthe Project in May 2009. A. STRATEGIC CONTEXT AND RATIONALE 1. Country and sector issues Decentralization. The Local Government Code of 1991 empowered local government units (LGU) to manage the growth of their areas, including giving them the mandate for providing local public services. However, LGUs continue to confront a myriad of problems - uncertain access to potable water and electricity, declining literacy rates, environmental degradation, high unemployment, lack of low-cost housing, and inadequate rural services. In addition, the national government’s tight fiscal situation has squeezed central transfers, and policies on municipal finance have hamstrung LGU access to private capital. As a result, local government investment in infrastructure and social services has been constrained and operations and maintenance expenditures curtailed. Low technical capacity among local governments and weak support from national government agencies also impede a large number ofLGUs from effectively carrying out their responsibilities. Fragmentation at the local level further undermines urban and metropolitan growth, which requires strong coordination and collaboration among LGUs. Urbanization Challenges. The Philippines has one of the highest rates of urban growth in the developing world. More than half of the population is already living in urban areas, and every year over 1.3 million people will be added. Urban and peri-urban areas are the centers of manufacturing and services, accounting for 7580% of the country’s economic output. However, the declining performance of the urban system in the last two decades relative to other in East Asia is seriously undermining the country’s overall development. Promoting growth and reducing poverty are key challenges facing LGUs in the Philippines today. The League of Cities of the Philippines (LCP), an association of 115 cities, plays an important advocacy role. The World Bank (the Bank), with funding from the Cities Alliance and PHRD Grants, has been working with 47 cities to help them develop comprehensive long-term development strategies, or City Development Strategies (CDS) as part ofthe CDS program under the LCP. Prepared through a participatory process, the CDS has resulted in a large number of prioritized projects. To implement these projects, cities require access to financing and technical assistance (TA). The LCP is committed to working with the national govemment and the Bank to secure financing for these priority projects, and to spread the success of well-performing cities to other local governments in the country. Beyond these cities, similar financing needs exist as a result of other strategic planning processes. In fact, many development partners have provided assistance on local planning - for example, the Asian Development Bank implemented provincial planning with National Economic Development Authority (NEDA), The Local Government Support Program financed by the Canadian International Development Agency (CIDA) assisted a wide range of on planning for the Executive-Legislative Agenda. Similar to the experience of cities participating in CDS, these LGUs are facing the challenges of implementing priority investments arising from these strategies through appropriate access to financing. The Need for Additional Local Government Financing While financial resources have been a key constraint for urban and local development, progress has been slow at the LGU level in finance mobilization. There are several key, closely linked, impediments to local govemment financing in the Philippines:

1 First, LGU own source revenue mobilization remains low and currently covers only one-third of LGU expenditures on average, even though local revenue authority has increased significantly under the 1991 Local Government Code. It should be noted, however, that there is significant variation among LGUs in terms of own-resource mobilization. In particular, cities collect more revenue from their own sources than either or municipalities. In 2004, own source revenue accounted for 56% of cities’ total revenue, while only 18% for provinces and 23% for municipalities (see Annex 9 table on LGU finance). Second, LGUs remain dependent on intergovernmental transfers and grants from the national government. Internal Revenue Allotment (IRA), or unconditional transfer, finances the majority of LGU expenditure. While the IRA distribution formula has the advantage of being simple and predictable, it is also perceived as being inequitable, with poorer provinces and municipalities considerably under funded. Moreover, as an automatic block grant, IRA is not designed to foster LGU financial discipline or influence agenda setting at the LGU level. Non-IRA (conditional) transfers, though small compared to IRA (approximately 18% of IRA in 2003), play a critical role for LGU investment financing, as non-IRA grant from national government finances approximately half of LGUs’ capita2 expenditure. As detailed in a recent Bank policy note (Annex 12), the current non-IRA grants suffer from the lack of overall allocation rationale and fragmentation. In fact, they often undermine, rather than strengthen, LGUs’ incentives for more resource mobilization - either from higher revenue collection or borrowing. Third, private sector financing to LGUs is limited. There has been some progress in this area, the most significant development being the creation of the LGU Guarantee Corporation (LGUCC) to guarantee debt issues of local governments financed from private sources. Since its inception, ten LGUs have floated bonds with the backing of LGUCC. Further progress is dependent on addressing institutional and regulatory issues, such as information asymmetry between potential issuers (i.e., local governments) and potential bond investors, higher costs in issuing bonds than direct borrowing, lack of reliable information about LGUs, the possibility of political interference in project management or in debt servicing, uncertainty about LGU management capacity and the quality of feasibility studies, lack ofan independent rating agency, lack of a market for secondary trading, and lack of access by private financial institutions (PFI) to IRA or LGU depository accounts as security for LGU obligations. Fourth, while LGU borrowing has expanded in the last ten years, it still makes up a small share of LGU spending. In 2004, according to the Bureau of Local Government Finance (BLGF), loans and borrowings only account for 1.8% of LGUs’ total revenue, and debt service only accounts for 2.8% of their total expenditure. Prudent expansion of LGU borrowing for development investments can promote stronger discipline and accountability, and introduce a longer term horizon in planning and implementation. A number of factors contribute to the low level ofborrowing. Fiscally conservative Local Finance Commissions often see borrowing as an instrument of last resort. They may also regard borrowing as entailing excessive accountability, especially compared with grants. The availability of various grants, including congressional allocations, presents a disincentive for local borrowing. Another impediment is the low LGU capacity to prepare “bankable” projects and implement these projects. The Government Financial Institutions (GFI), including the Land Bank of the Philippines (LBP) and the Development Bank of the Philippines (DBP), and the Municipal Development Fund Office (MDFO), have played an instrumental role in the last ten years in increasing credit financing to LGUs. GFIs’ lending to LGUs increased significantly. The LBP is the largest

2 lender, with approximately 75% market share. More importantly, a significant portion of LBP’s lending to LGUs is from funding mobilized by LBP’s own depository and other financial transactions. While lending to LGUs from LBP’s own funds entails shorter tenures (usually between five to seven years), this has nevertheless placed LBP as a sustainable financier for LGUs without external assistance. The quality of the LGU lending portfolio is good across all GFIs, and the level of non-performing loans (NPL) has been almost negligible. GFI lending also faces many of the same difficulties as private financing to LGUs: low LGU revenue, limiting the base; non-transparent grant financing limiting LGU incentives to borrow; low capacity, delaying project implementation (thus slow funding disbursement); and competition from other funding windows, One issue is the existence of a multitude of “windows” as specified by funders, often with specific sectoral focus and donor-specific requirements. Such requirements, while enabling heightened attention to sector priorities and approaches, have limited the use of fhnding, and have sometimes been unnecessarily cumbersome. There is a need to simplify the process, and create an “open menu” type of operation. In addition to providing financing, GFIs have also provided technical assistance to LGUs, sometimes in specific sectors such as water supply, sanitation, and drainage. The implementation experience has highlighted the difficulty of imposing sectoral and technical requirements through the on-lending windows of GFIs. Overall, GFIs do not, and are not supposed to, have strong technical expertise in particular sectors. They also have extremely limited mandates in supervising sectoral areas. GFIs also have valid concerns about the cost implications of the technical assistance cost, which they have to absorb in their lending operations. The Way Forward. To improve local government financing so that LGUs can more effectively undertake public service delivery functions as mandated by the Local Government Code, three inter-related issues need to be addressed: increasing LGU own-source revenue generation; rationalizing grants to LGUs; and facilitating LGU access to credit in a prudent manner to increase local public investment. For LGU access to credit, the long term objective is to establish a competitive market where the majority of financing to local governments will be provided by PFIs and bonds. Policy reform, particularly with regard to opening LGU deposit accounts to selected PFIs, is critical for achieving such a long term objective, and is being pursued in the ongoing Philippines Development Forum (PDF), where the Working Group on Decentralization and Local Government is actively pursuing policy dialogues with participation of national government, local governments, the private sector and development partners. Close coordination among various funding institutions is important to ensure that efforts to develop private financing to LGUs are not being undermined. In the immediate future, LGU demand for financing can be met with more responsive GFI lending. 2. Rationale for Bank involvement The Bank has been a key partner of the Government of the Philippines during its on-going decentralization process, providing policy advice, TA and investment support. It has supported over ten operations involving local governments from which it has accumulated considerable sector knowledge and experience, as well as developed long-standing institutional relationships with a number of key stakeholders. The Bank has also been providing TA on LGU financing

3 policy issues, including the recent study on “Decentralization in the Philippines: Strengthening Local Government Financing and Resource Management in the Short Term” (‘jointly with ADB), and ongoing technical advice in this area. The Philippines Country Assistance Strategy (CAS, for 2006-2008) gave high importance to local governments, and sketched out the overall strategy for the Bank’s assistance at the local level. As one of the three platforms to implement the key CAS objectives, the Bank’s Local Platform will “involve greater integrated cross-sectoral focus on the local government units (LGU) as the direct client in order to increase the likelihood of better outcomes across all services delivered by the LGU.” Bank assistance will strengthen decentralization by empowering LGU decision-making and supporting LGU-led programs. This emphasis reflects a shift to dealing with LGUs as clients, rather than implementers ofnational projects, The overall local platform is to be anchored in an LGU performance and capacity framework. The Bank’s financial assistance to LGUs is to be offered with a combination of loans and grants, as both forms are important at the current stage for LGU financing. Bank support to national government grants to LGUs includes both cross-sectoral performance-based grants and sector- specific grants channeled through line agencies. Grant financing to LGUs is being undertaken through sectoral operations (such as the Second Rural Development Project) and the proposed Performance Grant Project. Bank support to lending to LGUs will be mainly. channeled through the GFIs, while support for PFIs will be provided by IFC (or the Bank-IFC Municipal Fund, which may also lend directly to LGUs without sovereign guarantee). Loans and grants for investments, however, should be implemented by separate entities - with GFIs and PFIs providing loans on a commercial basis, and government agencies providing grants following national government policies and priorities. The local platform strategy under the new CAS proposes a new mode of engagement with LGUs which places LGUs at the center, as implementers and movers of the Philippine development agenda. The point of departure between the Project and previous urban operations in the Philippines is its integrated approach which makes available to both LGUs and even public and private operator alike, a wide range of sub-projects (open menu) which can be financed under project. This approach provides LGUs with more choices in terms of financing, and greater autonomy in determining their priorities, and will lead to faster funding utilization, At the same time, it enables the Bank to establish closer partnerships with a wider range ofLGUs. While the on-going Local Government Finance and Development (LOGOFIND) project has some of the similar features of an open menu operation, the project uses a well established banking institution that has branches and lending centers all over the country, and already has a much larger LGU loan portfolio than this project is intended to finance. Significant efforts have been made to simplify procedures and utilize as much local process as possible. This is expected to significantly speed up implementation. Finally, the proposed project can be an important vehicle for launching innovations and good practice in service delivery. Through CDS and other TA efforts, the Bank is well positioned to identify and support progressive LGU clients using loans to undertake innovations in local service delivery. Successful examples in the past include the first local sanitary landfill development under the Design-Build-Operate scheme (San Fernando City), the first Output-Based-Aid approach for water supply (La Union ), and community and cost-recovery based water and sanitation expansion (Panabo City, Province, etc.). With its flexibility, the project provides an opportunity to scale up such innovations.

4 The role ofthe project in supporting the overall LGU finance strengthening, however, should be looked at in the context of other Bank assistance mentioned above, beyond the proposed project. Policy dialogues on LGU financing, performance framework, and capacity building are being undertaken in parallel in a government-partner working group ofthe Philippine Development Forum (PDF) on decentralization and local government. 3. Higher level objectives to which the project contributes The government’s Medium Term Philippines Development Plan (MTPDP) 2005-2010 laid out an ambitious agenda for poverty reduction, good governance, and efficient delivery of basic services. Achieving the goals set out in the MTPDP will require significant contributions from LGUs, who are responsible for a substantial part of the improvement in service delivery. Similarly, in order for the Philippines to achieve the Millennium Development Goals, LGUs have to rise to the challenges of improving basic local service delivery. For the CAS period 2006-08, the Bank Group aims to focus its program towards making a contribution in two primary objectives of the Bank’s mission-economic growth and social inclusion. This assistance will be strategically focused on two key levers: fiscal reforms as the essential short-term challenge, and more effective public institutions as the critical medium to long term challenge. The strategy is to support Islands of Good Governance in those government agencies, local governments, and dynamic sectors in the Philippines that demonstrate how improved accountability and service delivery will lead to better economic and social outcomes. The CAS aims to expand these successful experiences and thus stimulate a virtuous cycle of more effective public institutions, fiscal improvements, economic growth, poverty reduction, and greater social inclusion. The Local Platform is a key pillar in the Bank’s engagement strategy to support islands of good governance. As successful and well-managed LGUs have become a visible example of islands of good governance, the CAS intends to support a strand of LGUs committed to performance improvement by helping them achieve a cycle of improved service provision which, in turn, generates citizens’ trust and increased resources to the public sector. As a key element of the Local Platform of the CAS, the Project will engage LGUs differently from previous project by enabling them to decide which priority investment to be funded under the project will contribute to: (a) improving service delivery and governance at local level by providing financing to LGUs to implement their strategic priorities, and (b) strengthening decentralization and empowering LGU decision-making with a credit facility responsive to LGU priorities in a financially prudent way, while reducing their reliance on, and the burden to, national government expenditure. On LGU financing, the CAS envisages separate lending and grant financing windows, with loans being channeled through GFIs, and grants through line agencies. The proposed lending window will make funds available if LGUs want to borrow as counterpart funding to implement other Bank-funded projects which provide grants to LGUs. At the level of policy reform, coordination has been taken up by the Decentralization Working Group of the PDF. This the lack of coordination in the past, and collaboration among donors started to take place in terms of the overall local government capacity building initiatives, Much closer collaboration is still needed in terms of financing, and the financing partners are starting to work on a common position paper with regard to LGU borrowing strategy.

5 B. PROJECT DESCRIPTION 1. Lending instrument The lending instrument is a Specific Investment Loan. The loan will be a variable-spread, with a maturity of 20 years, inclusive of five years grace, and front-end fee of 1% of the amount of the loan (with a waiver of 0.75%). The Borrower’s main reason for selecting a VSL rather than a fixed-spread loan (FSL) is that FSL charges are slightly higher than VSL charges and the Borrower does not foresee using the conversion option of the FSL. VSL repayment terms are governed by standard country terms. 2. [If Applicable] Program objective and phases Not applicable. 3. Project deveiopment objective and key indicators

The project development objective is to improve local public service provision and management by facilitating LGU access to viable financing to implement strategic infrastructure investments. To be eligible for funding, investment sub-projects should be part of a long-term development strategy prepared by the LGUs. The Project will also finance revenue improvement and enhancement programs for LGUs including fiscal and management improvements to ensure financial sustainability. The key indicators are: (a) the number of households benefiting from the project with improved access to basic social, economic and environmental infrastructure services from baseline year to end-of-Project year; and (b) increase in proportion ofcapital expenditure to total expenditure among participating LGUs by end-of-proj ect.

4. Project components The project includes two components. Component 1: Sub-projects for Infrastructure and Finance Improvement (US$99 Million): The objective ofthis component is to enable LGUs to implement infrastructure sub-projects that have been identified in development plans and multi-year investment programs as a result of CDS or similar participatory, multi-year planning exercises. The LBP will provide sub-loans to LGUs, public utilities and private operators providing local infrastructure services. In principle, all investments projects prioritized from the CDS or CDS-type planning process are eligible for finance. Examples of eligible sub-projects include: water supply and sanitation facilities; solid waste management facilities; wastewater treatment and disposal; housing and new site development; road and bridges; drainage and flood protection facilities; mini-hydropower development; schools and health clinics; improvement of municipal enterprise structures such as public markets; slaughterhouses, bus terminals, and other related income generating projects; and equipment for local infrastructure construction and maintenance. Details ofthe eligibility of sub- projects to be financed will be specified in the Operations Manual. The first batch of sub- projects to be financed is listed in Annex 4. The component will finance costs of civil works, goods and consultant services for the preparation and implementation ofLGU sub-projects. This component also supports LGU revenue generation efforts through improved real property and business tax mapping operations, codification, updating of records and automation in tax assessment, billing and collection automation, and other related revenue enhancement measures. The component will provide sub-loans to LGUs for the acquisition of consulting services and information technologies (hardware and software) that are necessary for the automation and

6 implementation ofrevenue enhancement program. Sub-loans may also be provided to municipal enterprises, public service utilities for improving their financial management and reporting. Component 2: LGU Capacity Building and Project Implementation Support (US$ 9.75 million). This component will provide assistance to LGUs participating in the sub-projects for: (i)the preparation of TOR for sub-project preparation work including feasibility studies and detailed engineering design; (ii)procurement; (iii)supervision and management including monitoring of outcomes during construction; and (iv) improved management and operations of municipal enterprises and services. Funding allocated under this component for LGU capacity building will be used as matching funds to additional grant funding for various types of assistance to LGUs, particularly in the area of environment management and improvement (for example, solid waste management), pro-poor intervention (for example, upgrading of informal settlements), and enhancing LGU investment quality and sustainability (for example, improving sub-project design quality, construction supervision, and monitoring of development effectiveness). The component will also support the LBP in the screening and evaluation of sub- projects, and strengthen the capacity of the LBP to provide technical guidance and support to sub-borrowers in sub-proj ect identification, preparation and implementation. A Project Management Office (PMO) will help sub-project evaluation, assist LGUs in sub-project preparation and implementation, and identify training requirements for LGUs. This component will also support training and study visits of LBP staff. Funding allocation for this component will be reviewed during project mid-term review and may be reallocated with Component 1. 5. Lessons learned and reflected in the project design

The Bank has supported a range of urban and local investment projects, and has an on-going portfolio of six projects that on-lend partial or full amount of IBRD loans to local governments, three of which are in the urban and water sector: the Water Development Project (WDDP) implemented by LBP; the LGU Urban Water and Sanitation Project implemented by DBP; and LOGOFIND Project implemented by MDFO. In addition, three projects in the rural, environment and health sectors have on-lending components with MDFO (Annex 2). Other Bank operations with LGUs currently only involve grants. The difficulties encountered in these on-lending operations include: low demand (LGUs unwilling to borrow for investments in the selected sectors; credit facilities having to compete with numerous grant facilities); 0 inadequate capacities (LGUs not able to meet preparation requirements or failed in implementation, particularly for more complicated infrastructure); 0 governance issues, particularly with regard to procurement; and 0 lack of capacity at the level offinancial intermediaries in assisting LGUs. Despite these difficulties, implementation experience with these operations over the last seven years (starting with WDDP), demonstrated that lending to LGUs, though challenging, can be successful and can lead to significant development impact with very limited fiscal burden on the national government. Through these operations, the Bank established critical partnerships with a number ofprogressive LGUs that set the models of “islands of good governance”. In fact, out of the six ongoing Bank projects with on-lending to LGUs, five have funds fully or close to fully committed.

7 LBP has been performing satisfactorily in implementing WDDP (to close December 2006), after difficulties at startup were overcome. The project targets a relatively narrow and difficult segment of the LGU credit market (for drainage and sewerage only), and LBP is credited for moving this difficult agenda forward without any grant assistance from the government. From these implementation lessons, the project will advance the agenda on LGU partnership and financing enhancement with the following approaches: Create stronger LGU demand for infrastructure financing by: offering a broad menu of eligible sub-projects instead of being limited to specific sectors, which is more responsive to LGU needs, and enables LGUs to select and finance development priorities from their multi- year investment program; and fostering close partnership with LGUs, including the League of LGUs, to help build awareness of the program and to obtain commitment for a strong pipeline of sub-projects from local governments. The on-going dialogue under the PDF with regard to policies on rationahing LGU grants, including the separation of loans and capital grants, will also help improve the environment for LGU borrowing. e Streamlining sub-project processing. The Operations Manual for the Project will use streamlined process to make it easy for LGUs to access funding. Sub-loan approval is to be based principally on LGU creditworthiness or borrowing capacity, instead of technical evaluation. The credit approval process will be close to the LBP’s own process. LBP will also adopt a “programmatic” approach for selected LGUs where a package of investment projects will be approved under a sub-loan, instead of requiring the approval of each single investment. Providing TA to LGUs on sub-proj ect development, preparation and implementation, which has been a key bottleneck. However, it is important to ensure that the lending operation is financially viable from the perspective of the LBP as primarily a financial institution (instead of a government agency). Financing is allocated in the Project for TA to LGUs on a matching basis. Further grant funding in this area is being sought from other development partners. For example, JSDF will be approached for technical assistance on improving community infrastructure in informal urban settlements. Past experience also shows that direct involvement by the Bank with the LGUs can make a critical difference in enhancing LGU capacities. 6. Alternatives considered and reasons for rejection

The Adaptable Program Loan (APL) was rejected in favor of a single project as a Specific Investment Loan (SIL) which may be continued with a follow-up repeater project. The SIL was selected primarily because the activities to be supported are priority investments identified through the participatory planning process. APLs are better suited for complex reform programs with clear triggers and multi-phased implementation ofreforms and physical investments.

The model of using two borrowers - with the government as an additional borrower for technical assistance through the Department of Interior and Local Government (DILG) - was proposed at the project concept stage. However, it was rejected during the preparation phase because of potential problems in coordination and the lack of fiscal space by the national govemment. An ADB-financed project which uses a similar approach is incurring significant implementation delays.

8 The model of a lending window through a PFI was tried but found not to be feasible at this stage, as more work is needed in terms of policy decisions, institutional setup, market research and process designs. It will involve major policy reform measures (e.g., opening LGU deposit accounts to PFIs), which are still being studied by the government. The activities will be pursued further in on-going efforts by the IFC-Bank Municipal Fund.

C. IMPLEMENTATION 1. Partnership arrangements (if applicable) The project is free-standing and does not involve any co-financing; however, a number of partnership arrangements are in place (or are being explored) to support effective project implementation. Partnerships are established with the LGU Leagues. In particular, the LCP has demonstrated strong commitment to working with the national government and the Bank in securing financing for projects identified through the CDS process. A new phase of CDS, financed by the Cities Alliance, will enable more cities to participate in the CDS process, while the process itself will be improved to strengthen the implementation aspects, especially with regard to access to financing. Similar efforts are being explored with the League of Provinces. A JSDF application for co-financing for slum upgrading has been submitted. Other partnerships are being explored on the TA component aimed at strengthening the capacity ofLGUs to deliver effective and sustainable urban services. 2. Institutional and implementation arrangements The LBP is the executing agency for the Project. LBP has the largest and most diversified LGU portfolio, and is presently the biggest source of credit to the LGUs. The LBP also has substantive experience in implementing Overseas Development Assistance (ODA) projects including Bank financed projects that are designed to support LGUs’ infrastructure rehabilitation and upgrading program. Over the years, LBP’s implementation capacity has been strengthened through implementation ofODA projects. With LBP’s vast network in all administrative in the country (293 branches and 33 Lending Centers strategically located in 224 citieslmunicipalities), the project will reach out to a large number ofqualified LGU borrowers. As the executing agency, LBP will be responsible for screening LGUs, evaluating their net borrowing capacity and technical capacity to implement the sub-projects, and for approving LGU loan applications. LBP lends to LGUs on the basis of well-defined procedures for credit evaluation and monitoring, including an internal LGU credit risk rating system. This system has been in use for more than three years and reflects prudent banking principles. LBP also provides technical assistance to LGUs in project development. The LBP will retain a small PMO which will be responsible for general implementation of the project. A draft Operations Manual has been reviewed by the Bank and will be followed during implementation. The Operations Manual contains simplified, and to the extent possible, local procedures on sub-project identification, preparation, technical appraisal and implementation (procurement process, construction supervision, financial management, and monitoring and evaluation) to facilitate PMO’s implementation of the project and to make it easy for LGUs to understand and refer to during sub-project preparation and implementation. 3. Monitoring and evaluation of outcomeslresults A robust but simple Monitoring and Evaluation (M&E) system is being developed to support management decision-making processes. It will be coordinated by the same team in the LBP’s

9 PMO for WDDP and maximally integrated with the existing government M&E systems, e.g., NEDA requirements. Through the PMO, the LBP’s Account Officers in provincial offices and the LGUs, a regular quarterly reporting of the physical and financial progress ofactivities will be undertaken using a computer-based Management Information System (MIS). The system application for the project’s MIS will be developed by LBP. For baseline data, the project would draw from public use files and from feasibility study reports that are required for sub-project approval. Details ofthe M&E system are described in Annex 3. The TOR for evaluation activities are detailed in the Operations Manual. 4. Sustainability LBP is committed to the objectives of the project. LBP has an outstanding loan portfolio of 20 billion Pesos with LGUs, the majority of which are from hnds generated by LBP. The Bank’s loan for the Project will enable LBP to provide loans of longer tenure to LGUs for investment in long-life infrastructure assets, and provide technical assistance to LGUs. The operations procedure adopted for the project tries to maximize the use of the existing LBP process, also in consideration of sustainability. The proposed terms will enable LBP to recover the cost of operations, and achieve a reasonable return, even with the inclusion ofTA. Financial sustainability at LGUs is being promoted with the prudential credit assessment by LBP, and the component included in the project on LGU financial management. Sustainability of sub-projects will be a critical issue. The technical guidelines for sub-project appraisal in the Operations Manual will help ensure that sub-projects meet the minimum required criteria, However, LBP itself not being a sectoral agency, the ability of LBP in controlling quality for a wide range of sub-projects is unavoidably limited. Mitigating measures include the LGU capacity building component, the engagement of a technical consultant (by LBP) for implementation support, and the PMO’s planned liaison with responsible government agencies on technical standards. Grant support will be sought to strengthen quality and sustainability of the results. 5. Critical risks and possible controversial aspects Potential Risks and Proposed Mitigation Measures

Risks Risk Mitigation Measures Risk Rating with Mitigation

Low LGU demand for loans Open menu approach to finance a wide Modest for the proposed investment range ofLGU priorities; component Close partnership with LGU Leagues; LBP’s large existing LGU lending portfolio

Inadequate LGU capacity to TA provided to LCP through the PHRD Modest prepare and implement sub- grant; simplified Operations Manual, projects with clear guidance on each type ofsub- projects; adoption ofharmonized

10 bidding documents for NCB; partnership with CDS assistance with LCP; most sub-projects will be relatively simple; additional donor co-financing for capacity building being sought. LGU's default on repaying LBP loans will be secured by Low LBP assignment ofIRA andlor real estate mortgages. LGU borrowing subject to quite conservative statutory limits. High dropout rate of LGUs Secure early commitments from LGUs Modest on sub-projects; closer outreach to LGUs and monitoring of status; dropout possibility included in project planning and processing. Risk related to LBP capacity Implementation support assistance Low to implement the project provided to LBP for effective sub- project implementation.

6. Loanlcredit conditions and covenants

Loan Effectiveness Conditions None. - The Project Operations Manual, acceptable to the Bank, has been adopted by LBP. B At least two LGU sub-borrowers have entered into a Subsidiary Loan Agreement with LBP satisfactory to the Bank. Disbursement Conditions m The signing of contract with a consultant firm for Project Implementation Support is a condition of disbursement for goods and consultants services under component 2 of the Project. Implementation Covenants LBP will ensure that the Project is implemented in accordance with the Project Operations Manual and will not amend or otherwise change the Operations Manual except with the prior written consent of the Bank. LBP will ensure that approved sub-projects are identified, appraised, documented, implemented, supervised, monitored and evaluated in accordance with the Operations Manual and the Environmental and Social Safeguards Framework, LBP will maintain the Project Management Office (PMO) throughout implementation, with competent staff in adequate numbers for the duration ofthe project; 9 LBP will submit sub-project proposals and appraisal reports to the Bank for prior review: (a) when the sub-borrower is not an LGU'; (b) for the first sub-project proposal that involves a program of infrastructure investments, rather than a single infrastructure investment to the Bank for review; (c) as required under the procurement plan; (d) for each sub-project that

' Prior review requirements for non-LGU sub-borrowers should be reviewed by the World Bank and LBP from time to time as project progresses.

11 requires a resettlement action plan; and (e) for (i)the first sub-project that requires an environmental impact statement report in each of the areas of housing and new site development, sewerage, sanitary landfill, drainage and flood control, hospital and medical facilities, and (ii)for the first sub-project that requires an initial environmental examination report in each ofwater supply systems, roads, and bridges. LBP will enter into Subsidiary Loan Agreement with each sub-borrower, on terms and conditions satisfactory to the Bank; LBP will, no later than January 3 1 of each year, furnish to the Bank, for review and approval, a draft annual plan of Project activities, including a work program, proposed budget and proposed commitment plan for that year; LBP will furnish to the Bank semi-annual reports integrating the results of the monitoring and evaluation activities on the progress achieved and setting out the measures recommended for project implementation during the remaining periods; LBP will furnish to the Bank quarterly financial monitoring reports; LBP will furnish to the Bank a Mid-Term Review ofthe Project in May 2009.

D. APPRAISAL SUMMARY 1. Economic and financial analyses Economic Analysis The key criterion for sub-project selection is the priority given by the local government as indicated by the participatory strategic development plans approved by the local councils. Sub- project appraisal criteria in terms of economic and financial analysis will depend on sub-project types. For simple and non-revenue generating sub-projects, such as school buildings, health centers and local roads, simplified least cost analysis will be applied. A financial analysis model has been developed for revenue generating sub-projects to assist LGUs in analyzing and determining appropriate user charges. For more complicated sub-projects, cost-benefit analysis will be required as part ofFeasibility Studies. These are specified in project Operations Manual. Details ofthe criteria for economic analysis of sub-projects are provided in Annex 9. Financial Analysis Land Bank ofthe Phi~~pines.LBP meets the eligibility criteria recommended under OP 8.30 for Financial Intermediary Lending. As a GFI, LBP has been effective in discharging its development finance mandate while maintaining progress in improving its balance sheet and operational performance. NPLs were brought down from about 23% of Gross Loans in 2000 to about 15% in 2004, and the ratio will decline significantly, pursuant to two transactions in 2005 involving sale of two pools of NPLs aggregating to about 13.5 billion Pesos. LBP’s financial performance rates well in comparison to a peer group of the top twenty banks in the Philippines. On most balance sheet items LBP ranks among the top five. Areas of weakness include low return on average assets (less than l%),low loan loss reserves on Real and Other Properties Owned or Acquired, (ROPA, about 48%), and financial disclosure. LBP management is aware ofthese issues and is taking remedial measures on all fronts. LBP has successfklly increased its exposure to LGUs: from about PhP 12 billion in 2000 to about PhP 20 billion in 2004. LGU related exposure now accounts for about 16% of LBP’s total outstanding loans. Loan losses in the LGU loan portfolio have been negligible, in large measure because of LBP’s resource to IRA transfers to LGUs. LBP, along with other GFIs, is the

12 designated depository for such transfers. Its operations, including lending, are conducted on the basis of well-defined policies, procedures, credit manuals, etc. LBP has been improving its internal control, internal audit and information systems, and these meet the standards prescribed by Bangko Sentral ng Pilipinas (BSP). Local Government Units. LGUs, overall, have consistently been in surplus situations over the past decade. However, LGUs’ own source revenue effort has stayed at a relatively low level and LGU revenues have been heavily dependent on national transfers (IRA), which provide nearly two-thirds of LGU income. Significant variation exists among LGUs: cities are least dependent on national tax sharing (44%), while provinces are the most dependent (82%). The total level of borrowing for all LGUs is very low. LGU borrowing accounts for only 1.8% of LGUs income in 2004. LGUs’ debt service expense, at 2.8% of total LGU expenditure, also shows that debt repayment has not been a burden for the vast majority of LGUs. In fact, the Local Government Code and BSP regulations provide conservative limits on LGU borrowing - expected LGU debt service should not exceed 20% of LGU’s expected revenue. These regulations have been strictly followed by the lending institutions and LGUs. LBP lending to LGUs is primarily based on LGU creditworthiness instead ofthe underlying cash flow from sub-projects. The Project Operations Manual provides guidance to LGUs on recovering costs for revenue-generating sub-projects, but such cash flow will not be relied on as repayments. LBP has an internal LGU credit rating system which rates LGUs according to their financial capacity, political condition, and economic condition. 2. Technical A classifications system has been developed where the requirements for sub-proj ect preparation will differ by the complexities of sub-project types. Sub-projects prioritized in approved strategic development plans ofLGUs can be classified into: (i)those that are relatively small and technically simple; and (ii)those that are complicated and would require technical assistance in design, implementation, operation and maintenance. The technical requirements for participating LGU sub-projects and the criteria to guide LBP in technically appraising each sub- project type are addressed in detail in the Project Operations Manual. These requirements differ by project types. While simple projects will only require LGUs completing a Detailed Project Description (DPD) form, or the equivalent of a simplified feasibility study, more complicated projects will require additional technical analysis, Of the 16 sub-projects that are in the pipeline for potential implementation, 10 are considered technically simple, and the remaining six, as complicated. Three out of 16 reached feasibility study stage, and were appraised based on a review of their FS reports; the remaining 13 have been appraised based on a review of their completed detailed project descriptions. All 16 sub- projects are technically feasible in addressing target problems; have proposed cost-effective and appropriate technologies, and will contribute to the realization of their respective Cityhhnicipality Development Vision. Sub-projects’ compliance to technical standards will be monitored and evaluated during the feasibility study andor detailed engineering, construction and operation stages. 3. Fiduciary In accordance with the Financial Management Sector Board guidelines, the task team conducted an assessment of the financial management arrangements for the project and concluded that it

13 meets minimum Bank financial management requirements, as stipulated in BPlOP 10.02. The project will use the same financial management policies and procedures as currently used by LBP; these were assessed and found to be adequate. The financial management arrangement for the Project has been included as part ofthe Project Operations Manual. Where sub-project costs of the procurement packages fall within the thresholds of US$5 million for civil works and US$500,000 for goods, National Competitive Bidding (NCB) procedures will be followed in accordance with paragraphs 3.3 and 3.4 of the Procurement Guidelines. The Philippines’ harmonized bidding documents will be adopted for NCB contracts. While some differences between the national law and the Bank’s Guidelines still remain (for example, exclusion ofprovincial preferences as allowed under RA 9 184, and these are clearly stated in the harmonized bidding documents), these are kept to a minimum, and these will all be listed as an Annex on NCB Procurement in the Procurement Schedule of the Loan Agreement. Depending on sub-project types, sample bidding documents for Design-Build-Lease (DBL) and Design- Build-Operate (DBO) [both approved and tested for the Philippines under ongoing Bank- financed projects for LGUs] may be used. In addition, Design-Build contract may be explored during Project implementation. International Competitive Bidding (ICB) procedures will be followed above the thresholds, and may be used for sub-projects that are complex and where the local contracting industry does not have adequate expertise. As most of the procurement packages are expected to be below prior review thresholds, post- reviews will be conducted. To mitigate risks, for each LGU, LBP will conduct a simple procurement assessment with a questionnaire adapted from the form currently used by the government. For LGUs not passing a minimum score, LBP may require prior review of procurements. Anomalies found in post reviews or audits should be referred to DILG, Commission on Audit (COA), and Government Procurement Policy Board (GPPB) for follow-up action through the oversight mechanisms built into the procurement law. LBP has the capacity and organization structure to review procurements by LGUs, per its implementation experience with WDDP. During implementation, a monitoring system will be established at LBP’s PMO to monitor LGU compliance with the procurement process, Anti-corruption Measures. In addition to the above fiduciary measures, the project will also promote the anti-comption agenda with a focus on supporting the implementation of government’s procurement and financial reforms at the local level. The key measures, including strengthening the procurement process, monitoring, fund flow control and the Bank’s ex-post reviews, are highlighted in Annex 12 ofthe PAD. 4. Social The Project contributes to social development through sub-proj ect investments that would contribute to job creation and better access to public services by the population, including the poor. Potential social issues associated with the Project include: (a) affordability of tariffslfee structures such as water tariffslprice, public market stall rentals, and public parking fees; and (b) involuntary resettlement, land acquisition, or loss of assets due to choice of sub-project location. These issues will be addressed during sub-project preparation. When triggered by sub- projects, the Social Safeguards on Involuntary Resettlement OP 4.12 and Indigenous Peoples and Indigenous Cultural Communities O.D.4.20 will be applied.

14 Participation. Stakeholder participation takes place during the process of developing LGUs’ participatory long term plans, as well as during sub-project preparation and implementation, when social assessments and target group studies will be undertaken. The specific investment proposals financed under the project are required to be a result of such a participatory planning process (see Annex 10). Land Acquisition and Resettlement. Some LGUs may need to acquire private lands andlor rights-of-way for the site of their proposed infrastructure sub-projects. At project appraisal, no involuntary resettlement issues were identified for the current sub-project pipeline. If, during project implementation, involuntary resettlement becomes necessary for any sub-project, the Environment and Social Safeguard Framework, which is compatible with the Bank’s Policy on Involuntary Resettlement, OP 4.12, will be applied. In addition, for lands where there are Indigenous Peoples or Cultural Property, OP4.10 will be applied. 5. Environment The project will support investments of varying sizes. The current potential sub-project pipeline includes sub-projects ranging from PhP18 million to PhP190 million. The majority of sub- projects will most likely range between PhF50 million to PhP150 million (or US$1 million to US$3 million). Most sub-projects are expected to have limited environmental impacts. Some will aim directly at improving environmental conditions through drainage, sewerage and solid waste management, and other investments. LBP has prepared an Environment and Social Safeguard Framework, which is consistent with national policies and the Bank’s safeguard policies, particularly OP 4.01 and BP 4.01, to provide guidance for the LBP, LGUs, and other sub-borrowers. It is anticipated that only a minority of the sub-projects may be required to and mitigate critical environmental concerns. Where appropriate, the sub-borrowers will hire consultants for the preparation and implementation of the Environmental Assessment. LBP will require and monitor LGUs and other sub-borrowers to comply with environmental requirements, following the Environment Safeguards Framework. Day-t o-day implementation and monitoring will be carried out by the sub-borrowers. LBP has sufficient capacity and dedicated staff to supervise and monitor compliance with the safeguards framework. To ensure that the sub-borrowers possess adequate capacity to plan, prepare and implement projects in a sustainable manner, necessary costs for environmental management support will be allocated as part ofthe sub-loan agreement. 6. Safeguard policies

Safeguard Policies Triggered by the Project Yes No Environmental Assessment COPIBPIGP 4.01) Natural Habitats (OPIBP 4.04) Pest Management (OP 4.09) Cultural Property (OPN 11.03, being revised as OP 4.1 1) Involuntary Resettlement (OPlBP 4.12) Indigenous Peoples (OD 4.20, being revised as OP 4.10) Forests (OPIBP 4.36) Safety ofDams (OPIBP 4.37) Projects in Disputed Areas (OPIBPIGP 7.60) Projects on International Waterways (OPIBPIGP 7.50)

15 Environmental screening category: FI As a project implemented by a financial intermediary, where the majority of sub-projects are yet to be defined, LBP prepared a Social and Environmental Safeguards Framework to guide the project and the sub-borrowers to adequately address safeguard issues if any of the policies are triggered. An initial safeguard screening will determine the policies that will be triggered by each sub-proj ect. As of project appraisal, no requirements for involuntary resettlement were identified for the potential pipeline of sub-projects. Similarly, these sub-projects will not affect natural habitats or cultural property. However, appropriate guidelines have been included in the Safeguards Framework in case these policies are triggered as feasibility studies progress. Responsibility. According to the project Safeguards Framework, it is the responsibility of the sub-borrower of the loan, the LGUs, to cany out both Environmental Assessment and Social Assessment, as required under the Philippine regulatory framework and the Bank’s safeguard policies, and obtain clearances required of each individual sub-project before starting project implementation. On the other hand, it is the responsibility of the Borrower, the LBP, to supervise and monitor the participating province, city and municipal LGUs with regard to the process and requirements prescribed in the Safeguards Framework. LBP is IS0 14001 certified, and its corporate environmental policy states that it is fully committed to support environmental protection and sustainable development, and shall ensure implementation of effective environmental management practices in its banking operations, services and decisions. LBP has demonstrated its capacity to implement the Safeguards Framework with its recent experience in satisfactorily implementing several Bank assisted projects, particularly the WDDP, an Environment Category A project. The PMO for WDDP, under the Program Management Department, with the assistance of the Environment Unit ofthe Program Lending Group, will also be used for the implementation ofthe Project. The Project’s Social and Environmental Safeguards Framework has been made available locally and at the InfoShop before project appraisal mission departs. 7. Policy exceptions and readiness No exceptions are sought to any Bank policies for this project Readiness criteria: Fiduciary arrangements have been made. Financial management staffing, fund flows, and FMR formats have been agreed. Disbursement projection has been developed taking into account historical experience. Project staff mobilized and advertisements for key consultants have been published, Preparation of detailed design and tender documents for sub-proj ects has been substantially advanced. Terms of Reference and Requests for Proposals for consultancy services to be procured in the first year have been prepared, Baseline data and intermediate and end-project targets have been established for key monitoring indicators, and benchmarks have been agreed for a satisfactory project rating. Assessment of LBP’s environment and social safeguards capacity has been completed.

16 Annex 1: Country and Sector or Program Background PHILIPPINES: Support for Strategic Local Development and Investment Project

Decentralization and rapid urbanization have placed local government units at the forefront of development and poverty alleviation in the Philippines. While LGUs have responded to these challenges in the last 12 years, important issues remain to be addressed, particularly in the areas of performance, capacity, financing and policy. The Philippine CAS 2006-2008, approved in May 2005, gave high importance to local governments and outlined the overall strategy for the Bank’s assistance at the local level. Bank assistance will support decentralization by empowering LGU decision-making and supporting LGU-led programs. This emphasis reflects a shift in dealing with LGUs as clients, rather than implementers of national projects. The local government platform strategy is anchored in an LGU performance and capacity framework, which will guide the technical assistance and selection of financing instruments offered to LGUs. The development context and key issues in these areas are discussed below. Background Decentralization: The Local Government Code of 1991 (RA 7160), as the key instrument of decentralization in the Philippines, fundamentally shifted the manner in which resources are administratively and financially managed at the regional, territorial and political subdivisions. It has shifted revenues and most functions that could be carried out at the local level to the Local Government Units (LGU). The most dramatic revenue shift is the system of intergovernmental fiscal transfers known as Internal Revenue Allotment (IRA). In addition, the Code grants substantial financial autonomy and, appropriately, also accountability to the LGUs and decentralizes to these units important functions previously handled by the National Government. This shift presents a significant opportunity for the country to expand infrastructure and public service throughout its cities and municipalities. LGUs received also enhanced governmental and corporate powers: full autonomy in the exercise of proprietary rights and management of economic enterprises; authority to secure domestic or foreign grants without need for NGA approval; cooperative undertaking among LGUs; exemption from payment of customs duties for imported heavy equipment; and authority to extend loans to other LGUs and to provide assistance to calamity stricken LGUs. As a result, LGU expenditures rose steadily from 1990 to 2002 relative to both GNP and general government expenditures. The distribution of expenditures across levels of government also shifted, with the sub-national government’s share expanding from 31 percent in 1991 to 41 percent in 2003. Nevertheless, available resources to meet rising expenditures are significantly restricted, producing excessive dependence on the IRA to meet budgetary needs. Urbanization Challenges: The Philippines has one of the highest urbanization rates in the developing world, registering 5.1% annual urban population growth from 1965 to 1995. Though expected to slow down, urban population will continue to grow faster than average population growth, and will account for 75% ofthe total population by 2030. The country’s fast population growth will all occur in the urban areas, as rural population is actually projected to decline slightly over the next 30 years. According to projections by the United Nation, close to 1.4 million people will be added into the urban system each year in the next 10 years.

17 Urban areas are beacons ofopportunity; urban incomes are 2.3 times rural incomes. They already account for the vast majority (70%) of economic output. The contribution of urban areas to economic growth is even greater. For example, in 2000, the largely urbanized Philippines heartland (National + Regions I11 and IV) alone accounted for 60% of economic growth. The Philippine economy has already been successfully transformed to an urban economy where most of the economic activity emanates from the services and industry sector. The future of economic growth and employment generation will largely depend on the competitiveness and productivity of the urban areas. However, the declining performance of the urban system in the last two decades relative to other countries in East Asia is seriously undermining the country’s overall development. Poor local infrastructure and public service provision have been top factors in undermining the competitiveness ofPhilippines’ urban areas. City Development Strategies The Bank, with hdingfrom the Cities Alliance, has worked with 41 cities to help them develop comprehensive long-term development strategies (CDS) as part of the CDS program under League of Cities of the Philippines (LCP). As the association of 115 cities, LCP plays an important advocacy role in the country’s urban and decentralization agenda. CDS is an action plan for equitable growth in cities and their surrounding regions, developed and sustained through participation, to improve the quality of life for all stakeholders. CDS is anchored on the principles of livability, competitiveness, bankability, and good governance. The CDS is a dynamic process that guides participants in the definition of their problems and opportunities (assessment); formulation of a common vision for the city (visioning); map out strategies for attaining the vision (strategy formulation); prioritize programs, projects and actions (project identification and prioritization); determine resources and identify resource needs and corollary resource mobilization schemes (capital investment planning); and participate in the implementation of their strategies and programs (project implementation). The intended result of the CDS process is to inculcate local ownership and commitment oftheir economic, physical and social development processes, and to develop a strategic platform that provides the foundations and impetus for development actions. The participatory planning aspect of the CDS differentiates it from other planning processes in that local stakeholders are involved in the entire process-from assessment to visioning to project identification and implementation. Public consultations are carried out in each phase of the process, thus ensuring that their inputs and concerns are integrated into the plans. Some cities have successfully institutionalized the participatory process through the establishment of tri-partite partnerships involving government, people’s organizations and civil society who are regularly consulted on local issues. Other cities conduct regular “” or -level consultations in validating or seeking consensus on their programs. Since the program was piloted in 1998, 47 Philippines cities have participated in the process, including six new cities assisted through the PHRD grant during project preparation phase. The process has resulted in a large number ofprioritized projects. To implement these projects, cities require access to financing and technical assistance. Beyond these cities, similar financing needs exist as a result of other strategic planning processes. In fact, many development partners have provided assistance on local planning - for example, the Asia Development Bank implemented provincial planning with NEDA. The Local Government Support Program financed by CIDA

18 assisted a wide range of municipalities on planning for the Executive-Legislative Agenda. Similar to the experience of cities participating in CDS, these LGUs are facing the challenges of implementing priority investments arising fi-om these strategies through appropriate access to financing. Working Group on Decentralization and Local Government The Working Group on Decentralization and Local Government of the Philippine Development Form (PDF), chaired jointly by the DILG and the Bank, has become an important forum for coordination and harmonization, for different voices to be presented and heard, and both informal and formal coordination of activities, and most importantly for stakeholders to work together with the government toward taking policy decisions. Its work has focused on four key challenges with the decentralization scenario:

a Capacity building: formulate the framework and mechanisms for improving coordination and harmonization of capacity building interventions e Performance benchmarking: institutionalize performance benchmarking system e LGU financing: improve the environment for LGU financing a Policy reforms: undertake policy reforms in priority areas of local governance Performance and Capacity Building Framework Performance Framework: Developing a credible, commonly accepted performance framework is important for strengthening LGU accountability and therefore reinforcing the decentralization process. The government just completed rolling out the two existing local government performance systems: the Local Government Performance Management Systems (LGPMS, maintained by DILG), and the Local Government Financial Performance System (LGFPS, maintained by BLGF under DOF). While there remains the need for improving the current systems, particularly in light of their intended purpose of usage, the Decentralization Working Group has decided to support and strengthen them. The Government also committed to the design of a Performance Grant System, which will utilize and strengthen these two systems. This will be financed by an IDF grant. Capacity Building: Another reason for the lack of full realization of decentralization potentials is capacity constraint at the local level, particularly in the areas of governance, local service delivery, and investment planning and preparation. An inventory for the capacity building activities commissioned by the Decentralization Working Group indicated that while there is no shortage of training and capacity building programs for LGUs, provided by different National Government Agencies, donors, and projects, many ofthem are supply-driven, often overlapping, tied to specific program needs and inconsistent with each other. Capacity building programs can become more effective if they are closely linked to core competency requirements of local governments, and a common performance framework whereby the impacts can be measured in terms of performance outcomes. Three sub-committees under the Working Group have been set up to tackle actions in the capacity building areas of planning and project development, fiscal and financial management, and overall management of the LGU capacity building programs. Many development partners are active in these sub-committees, together with DILG, NEDA, BLGF, and various non-governmental institutions.

19 Technical Assistance to LGUs In addition to CDS mentioned above, technical assistance to LGUs has proceeded in the following areas: Partnerships with the Leagues of Local Government. Dialogues with LGU Leagues was initiated with the League of Provinces, the League of Cities and the League of Municipalities with regard to more effective Bank assistance to LGUs, using the full range of instruments as outlined under the CAS. Decentralization Studies. The Bank, along with other partners, has supported studies on the review of devolutions of functions, as mandated by Executive Order 444, The Bank’s support for a consultant to assist the League of Cities on LGU financing policies, is complemented by the reviews of agricultural, environmental and social service devolution supported by other partners for LPP and LMP. , WBI Collaboration for LGU Capacity Building. WBI is also supporting capacity building of LGUs, particularly through enhancement of the planned training under LOGOFIND for local development strategy, capital investment planning, and urban upgrading. Coordinate Donor Response. Donor coordination and harmonization efforts under the Decentralization Working Group as highlighted above. Among the various outputs, one notable item is the concept paper on LGU financing framework, which was presented to the working group but has not yet led to a consensus on some ofthe issues raised. Local Government Financing Local government financing is hampered by several key, closely linked, issues: First, LGU own source revenue mobilization remains low and currently covers only one-third of LGU expenditures on average even though local revenue authority has increased significantly under the 1991 Local Government Code. It should be noted, however, that there is significant variation among LGUs in terms of own-resource mobilization. In particular, cities collect more revenue from their own sources than either provinces or municipalities. In 2004, own source revenue accounted for 56% of cities’ total revenue, while only 18% for provinces and 23% for municipalities (see Annex 9 table on LGU finance). Second, LGUs remain dependent on intergovernmental transfers and grants from the national government. IRA (unconditional transfer) finances the majority of LGU expenditure. While the IRA distribution formula has the advantage of being simple and predictable, it is also perceived as being inequitable, with poorer provinces municipalities considerably under funded. Moreover, as an automatic block grant, IRA is not designed to foster LGU financial discipline or influence agenda setting at the LGU level. Non-IRA (conditional) transfers, though small compared to IRA (approximately 18% of IRA in 2003), play a critical role for LGU investment financing, as non-IRA grant from national government finances approximately half of LGUs’ capital expenditure. As detailed in a recent Bank policy note (Annex 12), the current non-IRA grants suffer from the lack of overall allocation rationale and fragmentation. In fact, they often undermine, rather than strengthen LGUs’ incentives for more resource mobilization - either from higher revenue collection or borrowing. Third, private sector financing to LGUs is limited. There has been some progress in this area, the most significant development being the creation of the LGU Guarantee Corporation (LGUCC) to guarantee debt issues of local governments financed from private sources. Since its

20 inception, fourteen LGUs have floated bonds with the backing of LGUCC. Further progress is dependent on addressing institutional and regulatory issues, such as information asymmetry between potential issuers (Le., local governments) and potential bond investors, higher costs in issuing bonds than direct borrowing, lack of reliable information about LGUs, the possibility of political interference in project management or in debt servicing, uncertainty about LGU management capacity and the quality of feasibility studies, lack of an independent rating agency, lack of a market for secondary trading, and lack of access by private financial institutions (PFI) to IRA or LGU depository accounts as security for LGU obligations. Fourth, while LGU borrowing has expanded in the last ten years, it still makes up a small share of LGU spending. In 2004, according to BLGF, loans and borrowing only account for 1.8% of LGUs’ total revenue, and debt service only accounts for 2.8% oftheir total expenditure. Prudent expansion of LGU borrowing for development investments can promote stronger discipline and accountability, and introduce a longer term horizon in investment planning and implementation. A number of factors contribute to the low level of borrowing. Fiscally conservative Local Finance Commissions often see borrowing as an instrument of last resort. They may also regard borrowing as entailing excessive accountability, especially compared with grants. The availability of various grants, including ad hoc congressional allocations, presents another disincentive for local borrowing. Another impediment is the low LGU capacity to prepare “bankable” projects and implement these projects. The Government Financial Institutions (GFI), including the Land Bank of the Philippines (LBP) and the Development Bank of the Philippines (DBP), and the Municipal Development Fund Office (MDFO), have played an instrumental role in the last ten years in increasing credit financing to LGUs. GFIs’ lending to LGUs increased significantly. The LBP is the largest lender, with approximately 75% market share. More importantly, a significant portion of LBP’s lending to LGUs is from non-ODA funding sources, that is, funding mobilized by LBP’s own depository and other financial transactions, While lending to LGUs from LBP’s own funds entails shorter tenures (from 5 up to 10 years), this has nevertheless placed LBP as a sustainable financier for LGUs without external assistance. The quality of the LGU lending portfolio is excellent across all GFIs, and NPL has almost been zero. GFI lending also faces many of the same difficulties as private financing to LGUs: low LGU revenue limiting the base; non-transparent grant financing limiting LGU incentives to borrow; low capacity delaying project implementation (thus slow funding disbursement); and competitions from other ftnding windows. One issue is the existence of a multitude of “windows” as specified by funders, often with specific sectoral focus and donor-specific requirements. Such requirements, while enabling heightened attention to sector priorities and approaches, have limited the use of funding, and have sometimes been unnecessarily cumbersome. There is need to simplify the process, and create “open menu” type of operations. Past experiences with GFI lending operations have also highlighted the risk of LGUs dropping out of borrowing at various stages of project processing. For example, the ICR of the LGU Urban Water Supply and Sanitation APLl stated that a critical fact that affected the unsatisfactory development outcome of the project is that many LGUs eventually withdrew their interest, despite the fact that more than 100 prospective LGUs submitted letters of intent (LOI) before Board approval. Numerous causes accounted for the high dropout rate: political changes at LGUs after the elections, which resulted in reversal of LGU commitments, inconsistent national policies on LGU financing which drove most LGUs to seek grant financing from

21 various other sources even when there was actually none, and lack of quick responses by GFI’s to LGU and market circumstances. In response to the high dropout rate, LBP has undertaken measures to mitigate the risk. For example, under WDDP, LGUs enter into sub-loan agreements with LBP before the feasibility studies are completed. LBP can also respond to LGUs faster and process sub-proj ects more speedily to reduce uncertainties. However, dropout will likely continue as a key risk for the project. In addition to providing financing, GFIs have also been used to provide technical assistance to LGUs, sometimes in sector specific areas such as water supply, sanitation, and drainage. The implementation experience has highlighted the difficulty of imposing sectoral and technical requirements through the on-lending windows of GFIs. Overall, GFIs do not, and are not supposed to, have strong technical expertise in particular sectors. They also have extremely limited mandates in supervising sectoral areas. GFIs also have valid concerns about the cost implications of the technical assistance cost, which they have to absorb in their lending operations. The Way Forward. To improve local government financing so that LGUs can more effectively undertake public service delivery fbnctions as mandated by the Local Government Code, three inter-related issues need to be addressed: (a) increasing LGU own-source revenue generation; (b) rationalizing grants to LGUs; and (c) facilitating LGU access to credit in a prudent manner to increase local public investment. For LGU access to credit in particular, the long term objective is to establish a competitive market where the majority of financing to local governments will be provided by PFIs and bonds. Policy reform, particularly with regard to opening LGU deposit accounts to selected PFIs, is critical for achieving such a long term objective, and is being pursued in the ongoing Philippines Development Forum (PDF), where the Working Group on Decentralization and Local Government is actively pursuing policy dialogues with participation of national government, local governments, private sectors and development partners. Close coordination among various funding institutions is important to ensure that efforts to develop private financing to LGUs are not being undermined. In the immediate future, LGU demand for financing can be better met with GFI lending that responds to LGU priorities.

22 Annex 2: Major Related Projects Financed by the Bank andlor other Agencies PHILIPPINES: Support for Strategic Local Development and Investment Project

Latest Supervision Ratings Sector Issue Project Implementation Development Progress (IP) Objective (DO) Loan and grant financing Local Government S S to local governments; Financed and Development resource mobilization; Project (LOGOFIND) LGU capacity building. Loans to support LGU LGU Urban Water and U U urban water and sanitation Sanitation Project APL1 Loans to support LGU LGU Urban Water and U U urban water and sanitation Sanitation Project APL2 Loan to LGUs for Water Districts S S investments in local Development Project sewerage and sanitation (WDDP) projects Grant and loan support for Community-Based S S local natural resource Resource Management management Project (CBRMP)

Financial intermediary Rural Finance 3 S operation by LBP for rural finance and micro finance. Support LGUs to undertake integrated and Safe Motherhood women’s health services Project through loan and grant financing.

Support LGUs in Laguna Laguna de Bay S Lake Watershed for water Institutional Strengthening environment interventions and Community through loans and grants. Participation Project

23 Annex 3: Results Framework and Monitoring PHILIPPINES: Support for Strategic Local Development and Investment Project

Results Framework

PDO Outcome Indicators Use of Results Information To facilitate LGU access to Number ofhouseholds Year 5: viable financing for benefiting from the project Flags the Project as having a implementing strategic with improved access to positive impact on infrastructure investment and basic social, economic and participating LGUs. improving local public service environmental infrastructure provision and management. services in participating LGUs by EOP Increase in proportion of infrastructure investment to total expenditure among participating LGUs by end- of-project (EOP)

Intermediate Results Results Indicators for Each Use of Outcome Monitoring

One Per Component Component ~~ Component 1: Sub-projectsfo, Infrastructure and Finance In rovem ent Participating LGUs undertake = At least 50 sub-projects Year 1 to 5: priority local investments and complete at EOP; Flags assumption on sufficient revenue enhancement No. of sub-projects with number ofLGUs with measures. revenue enhancing borrowing capacity is not measures at EOP. correct, If correct, flags = Non-performing loans of problems in implementation LBP’s LGU portfolio and triggers review of remains low policies, systems and orocedures. Output indicators Length ofbridges in Year 1 to 5: participating LGUs Difference in as-built and as completed at EOP based on designed flags need for approved design validation. specifications, No. ofmarket stalls in participating LGUs completed at EOP as designed;

9 No. of slaughter- houses completed in participating LGUs at EOP as designed; = No. of drainage systems completed in participating

24 LGUs at EOP as designed. I = No. of solid waste disposal facilities completed Component 2: LGU Capacity j vilding and Project Implemeni ion Support LGUs have improved capacity 100% oftargeted Year 1 to 4: in conducting pre- and participating LGUs receive Flags ability ofPMO to cope implementation activities for training and other forms of with demand for training and Local investments; assistance by EOP; other assistance activities. Planning, coordinating and PMO is established and Year 1 to 5: implementation mechanisms supported by technically Flags readiness ofkey are established and supported equipped staff before stakeholders to implement the by technically equipped staff project starts and PMO is Project. Implementation functioning : issues that may arise as a Operations Manual result ofunclear policies, completed before Project systems or procedures flag the start, disseminated to need to revisit and to refine participating LGUs before the key operating manuals. sub-project start, updated and followed; Financial system in place & corresponding manual completed, disseminated to participating LGUs before sub-project starts, updated and followed:

9 M&E system installed at and corresponding M&E manual completed by PMO before Project start, installed in participating LGUs before sub-project start, and updated.

25 4 E 3 3

7 o\8

7 8m

I

Annex 4: Detailed Project Description PHILIPPINES: Support for Strategic Local Development and Investment Project

Project Development Objective and Key Indicators The proposed Project development objective is to improve local public service provision and management by facilitating LGU access to viable financing to implement strategic infrastructure investments. The investment sub-projects eligible for financing should have been included in the participatory and long-term development strategy prepared by the LGUs. The project will also finance revenue improvement and enhancement programs for LGUs including fiscal and management improvements to ensure financial sustainability. The key indicator is: a. the number of households benefited from the project with improved access to basic social, economic and environmental infrastructure services from baseline year to end-of-Project year; and b. increase in proportion of capital expenditure to total expenditure among participating LGUs by end-of- project Project Components The project includes two components. Component 1: Sub-projects for Infrastructure and Finance Improvement (US$99 Million): The objective of this component is to enable LGUs to implement infrastructure sub-projects that have been identified in development plans and multi-year investment programs as a result ofCity Development Strategy or similar participatory, multi-year planning exercises. The LBP will provide sub-loans to LGUs, public utilities and private operators providing local infrastructure services. In principle, all investments projects prioritized from the CDS or CDS-type planning process are eligible for finance. Examples of eligible sub-projects include: water supply and sanitation facilities; solid waste management facilities; wastewater treatment and disposal facilities; housing and new site development; road and bridges; drainage and flood protection facilities; mini-hydropower development; schools and health clinics; improvement of municipal enterprise structures such as public markets; slaughterhouses, bus terminals, and other related income generating projects; and equipment for local infrastructure construction and maintenance. Details of the eligibility of sub-projects to be financed will be specified in the Operations Manual. The component will finance costs of civil works, goods and consultant services for the preparation and implementation of LGU sub-projects. This component also supports LGU revenue generation efforts through improved real property and business tax mapping operations, codification, updating of records and automation in tax assessment, billing and collection automation, and other related revenue enhancement measures. The component will provide sub-loans to LGUs for the acquisition of consulting services and information technologies (hardware and software) that are necessary for the automation and implementation of their revenue enhancement program. Sub-loans may also be provided to municipal enterprises, public service utilities for improving their financial management and reporting. Component 2: LGU Capacity Building and Project Implementation Support (US$ 9.75 million). This component will provide assistance to LGUs participating in the sub-projects for the: (i)preparation of TOR for sub-project preparation work including feasibility studies and detailed engineering design, (ii)procurement, (iii)supervision and management including

28 monitoring of outcomes during construction, and (iv) improved management and operations of municipal enterprises and services. Funding allocated under this component for LGU capacity building will be used as matching funds to additional grant funding for various types of assistance to LGUs, particularly in the area of environment management and improvement (for example, solid waste management), pro-poor intervention (for example, upgrading of informal settlements), and enhancing LGU investment quality and sustainability (for example, improving sub-project design quality, construction supervision, and monitoring of development effectiveness). The component will also support the LBP in the screening and evaluation of sub- projects, and strengthen the capacity of the LBP to provide technical guidance and support to sub-borrowers in sub-project identification, preparation and implementation. A Project Management Office (PMO) will help sub-proj ect evaluation, assist LGUs in sub-proj ect preparation and implementation, and identify training requirements for LGUs. This component will also support training and study visits of LBP staff. Funding allocation for this component will be reviewed during project mid-term review and may be reallocated with Component 1. Key Eligibility Criteria for LGUs Seeking Project Financing a. LGU submits Letter ofInterest to LBP ofthe Philippines b. Local Government Council Resolution stating that they will enter into a loan agreement with LBP with the Local Executives as the signing representative c. Possess adequate borrowing capacity d. Prepared a long term development plan for their LGUs showing that the proposed project is included in the long term development plan(s). Key Eligibility Criteria for Sub-projects includes: a. Should be initiated and undertaken under the authority ofthe LGU b. Should be approved by the corresponding Local Council c. Should be based on the LGU’s local development strategy and identified as priority in the strategy d. Should result in benefits to public services in the LGU e. All LGU sub-projects should meet the requirements noted under the Environmental and Social Safeguards framework. Summary Description of Potential Sub-projects The following sub-projects have been proposed by LGUs for financing under the project. The respective LGUs have acquired local council approval of borrowing funds from LBP to finance these projects, and LBP has conducted credit assessment and tentatively agreed to finance these sub-projects. Preparation ofthese sub-projects, however, is at varying stages, While some are at the stage of detailed design and bidding documents preparation, most others are still at the stage of feasibility study preparation. 1. Urban Potable Water Supply Project in Bayawan City, Negros Oriental (PhP 119 million). This sub-project aims to improve the present water supply service being provided by the Bayawan Water District by tapping a new water source, the Tagubang Spring located in Barangay Narra. A pipeline will be laid along the Nangka-Tavera Road and down to the city proper. Sedimentation and reservoir tanks will be constructed within Sitio Tavera. The beneficiaries of the water supply and sanitation project will cover the entire population of the urban center including the 800 households of the Fishermen’s Village, business entrepreneurs,

29 stall owners, markets of and Banga, government offices, bus terminals and commercial establishments. 2. Mini-Hydropower Development in Calbayog City, Western (PhP 127.85 million). This small-scale hydroelectric power development sub-proj ect seeks to develop an alternative energy source which is less dependent from oil importation. The Bangon Falls will be the source for hydroelectric power. Major construction works will include excavation, casting concrete, penstock installation, hydraulic turbinelgenerator installation, transmission works, electrical and mechanical works, construction of private guest rooms, environmental mitigation, etc. This project will benefit the city’s population of 165,018, and will not involve construction of a dam. 3. Flood Protection and Drainage Facilities in Dapitan City, Zamboanga del Norte (PhP 18.03 million). This proposed flood protection and drainage facilities sub-project aims to redirect the flow of storm and sewerage from residential areas away from the Bay into the Dapitan and Liboran Rivers. This proposed project has 2 components: Component A is the formulation of the Comprehensive City Drainage and Sewerage Master Plan wherein the proposed funding will be through grant funds; and Component B is the completion of the Poblacion Island Drainage System which is estimated at Php 18.03 million. Component B will include the construction of a total of 3,557.7 linear meters of square drainage channels, 1.20m x 1.20m concrete-lined (4”) CHB walls with lOmm steel bars, and RC floor and cover, to be constructed within the sidewalk ROW (fixed covers to serve as paved sidewalk). For maintenance purposes, manholes measuring 0.50m x 0.50m shall be provided at every 4 lm of the drainage channels, totaling to approximately 900 units. 4. Solid Waste Management Facilities in Barangay Villa Isla, Munoz City, Nueva Ecija (PhP 196.57 million). This sub-project aims to effectively plan, manage and regulate solid waste generated within the urban area of Munoz City and neighboring barangays of the of Talavera. Project component will include collection (MRF, trucks and equipments), composting, sanitary landfill, leachate treatment plant and community education and communications. 5. Solid Waste Management Facilities in Barangay Batino, Calapan City, Oriental (PhP 100.78 million). This sub-project will utilize a 15-hectare land for its sanitary landfill. Materials recovery facility (MRF) will be installed as well as other site utilities and landfill structures. Improvement of the existing 8-km gravel road leading to the disposal facility is also included. This project will benefit the entire population of 120,641 ofCalapan City. 6. Solid Waste Management Facilities in Barangay New Malitbog, Panabo City, Davao del Norte (PhP 165 million). This sub-project will improve the garbage collection and disposal practice, reduce the health risks to the population, will enhance environmental condition and promote the aesthetic value of the city. Sub-project components will include upgrading of the receptacle system providing a fully containerized storage in the service area, upgrade the collection system including new collection trucks with compacting units, new segregation at source system with compostable, recyclable and residual, new landfill, citylcentral MRF, citylcentral composting system, system for handling hazardouslinfectious wastes, centralized solid waste management operation, segregation garbage receptacles in public places, markets and commercial areas and residential areas and formulation of an effective collection route scheme

30 and scheduling. This sub-project will initially benefit 11 urban barangays covering a population of 88,300. 7. Housing Project in Barangay Sibuan-Otong, San Fernando City, LaUnion (PhP 22.008 million). This sub-project will provide affordable and decent housing for city government employees, particularly those belonging to the low-income bracket. The sub-project components are: Feasibility Study and Preliminary Design, land development and construction of housing units. This sub-project will finance the land development component which will include survey works, site clearing, cut and fill, concrete pavement, drainage system, water supply system, sewerage system and electrical distribution system. 8. Integrated Satellite Market and Transport Terminal along the diversion road, East District, Sorsogon City (PhP 60.285 million). This sub-project is to construct and operate a new public market and transport terminal located outside the central business district, The design of the market building shall be based on the modular concept which allows flexibility in construction since only the required number of modules may be constructed with additional modules added on as the need arises. The market will have the following facilities such as parking spaces, hawker’s plaza, garbage area, toilets, water tawwater supply, commodity unloading area, market administrative office, firefighting equipments, electricity, and security posts. A wastewater treatment facility will also be constructed. The total land area where the satellite market will be constructed is 49,337m2 and the total floor area of the satellite market is 2,212.60 m2. The transport terminal will include clearing, construction of perimeter fence and road network within the terminal, parking spaces, water and electrical and drainage facilities, and landscaping of the terminal area. The terminal building will have a floor area of 2,526.46 m2. Bus bays will be constructed with passengers’ waiting area, waiting sheds and roof overhang will be provided for jeepneys, vans and tricycle. This will ease the traffic congestion in the Central Business District. 9. New Sites Development, Western Barangays, Tuguegarao (PhP 190 million). This proposed sub-project includes the acquisition of 30-meter right-of-way, the construction of4kms road and construction of drainage lines, landscaping and parks development. The project aims to develop a new commercial and service center in the western barangays of the City to enhance productivity and improve environmental conditions in the provincial capital and regional center ofRegion 2. 10. Public Market, Civic Center and Fencing of Motorpool in the Municipality of Monkayo, Compostela Valley (PhP 24.355 million). This proposed sub-project will include the construction of a 2-storey public market costing around Php 7 million, 2-storey civic center costing around Php 16 million and the fencing of the motor pool costing around Php 1.355 million. 11. Public Market in the City of Ozamis, Misamis Occidental (PhP 120 million). This sub- project intends to construct a new 2-storey public market to replace the existing old market. The lot where the new public market will be constructed is owned by the City LGU and is located at the commercial center of the city. The lot area is around 15,518 sq. meters. The new public market will have a total of 1,014 stalls, water supply and sanitation facilities, electricity and waste management facilities. Around 14 coastal barangays of Ozamis City are foreseen to benefit from this.

31 12. Integrated Transport Terminal in the Municipality of Isulan, Sultan Kudarat (PhP 27.5 million). This sub-project is embodied in the Municipality’s Medium-Term Development Plan. This integrated transport terminal will have 2 functions: (i.)terminal operations; and (ii.)revenue generation. Sub-project component will include construction of the main building which will house the administration office, 14 commercial stall spaces, comfort rooms, 28 berthing bays for buses, jeeps, vans, multi-cabs and parking spaces for other vehicles. The terminal building will have a floor area of 1,782 square meters. This sub-project will facilitate and enhance the transport of farm produce to the market centers of Cotabato City, Tacurong, Koronadal, General Santos City and the western part of Sultan Kudarat. Around 16,382 small farmers will be benefited. 13. Water supply system for the Municipality of Libangon, Southern (PhP 21.60 million). This sub-project aims to provide 1,956 households, 15 commercial and 17 institutional consumers with adequate and clean water supply. The sub-project will include the improvement of the production of water supply and efficient distribution by increasing the number of connections. 14. Water supply system for the Municipality of La Paz, Tarlac (PhP 25 million). This sub- project intends to expand the municipality’s existing waterworks system and to acquire 1 unit reconditioned backhoe loader, 1 unit brand new service vehicle and 1 unit brand new concrete cutter to be used for the maintenance, further improvement and expansion of the water supply system. The proposed water supply system improvement and expansion will cover 3 barangays with a total population of 13,195 (Year 2000). This will include the construction of a pumping station, a 150 cubic-meter elevated steel water tank, and installation of gas chlorinator and distribution and transmission pipes. 15. Public High School Building in the Municipality of Tagkawayan, Quezon (PhP 32.7). This sub-project will include the construction of a 3 storey public high school building covering a floor area of 2,551.50 sq. meters on a property owned by the Municipal Government. It will consists of 30 classrooms (10 classrooms per floor), and 2 toilet and bath rooms per floor. Around 45 barangays will benefit from this sub-project. 16. Farm-to-Market Facilities in the Municipality of Kapalong, Davao del Norte (PhP 25 million). This sub-project aims to improve the transport of agricultural produce from the farms to the market by acquiring heavy equipments that will be used in the construction of roads, drainage and bridges. Farming residents ofoutlying barangays will benefit mostly from this sub- project,

32 Annex 5: Project Costs PHILIPPINES: Support for Strategic Local Development and Investment Project

i Foreign Total 'inn US $million US $million ucture and 84.15 14.85 99.00 Finance Improvement Component 2: LGU Capacity Building and Project 7.60 2.15 9.75 Implementation Support

Total Project Costs 91.75 17.00 108.75 Front-end Fee 0.25 0.25 Total Financing Required 91.75 17.25 109.00

Funds shall be provided by the World Bank through a loan to the LBP. The LBP as the Borrower and the Executing Agency of the Project will on-lend these funds to the eligible participating LGUs, and public utilities or private operators providing local infrastructure services'. The LGUs and other eligible sub-borrowers will provide counterpart funds to every sub-loan. The project does not finance land acquisition cost, but resettlement costs may be included.

Total project cost is estimated at US$ 109.00 million. Cost allocation per component will be re- programmed and re-aligned to a component needing additional funds to satisfy demand. Details of cost per component are presented in Table 1 as follows:

Components Sources ofFunds Total % Distribution (US$ million) CuS$ World LGUs million) World LGUs Bank Bank Component 1: Sub-projects for 90.00 9.0 99.00 90 10 Infrastructure and Finance Improvement Component 2: LGU Capacity 9.75 0.00 9.75 100 0 Building and Project j ~-~ Front End Fee 0.25 0.25 Total Amount 100.00 9.00 109 91.7 8.3 (US$ million)

Sub loan Agreement needs to be executed between LBP and LGU before a sub loan becomes effective and proceeds are released.

33 Proposed Terms and Condition of the Loan (Between WB & LBP)

Source of Funds World Bank Loan Amount US$lOO Million Borrower Land Bank ofthe Philippines (LBP) Guarantor Government ofthe Philippines (GOP) Interest Rate Linked to LIBOR Repayment Terms Maximum of20 years, including 5 year grace period Forex Risk Cover To be provided by the GOP under a fee-based arrangement Commitment Fee 0.75% on the un-drawn loan balance

Re-lending Terms and Conditions (Between LBP & LGUs)

LBP’s standard credit policies, guidelines and procedures in LGU lending shall be used as follows:

Amount of Loan Shall be based on the requirement ofthe sub-project but shall in no case exceed net borrowing capacity (for LGU borrowers) or the projected sub-project cash flow (for institutions) Interest Rate Market based (indicative rates 9-12%, see Annex 9) Repayment Term : Maximum of 15 years, including a maximum of 3 year grace period. Collateral Requirement Any one or a combination of (i)Real estate mortgage, (ii)hold-out on deposit, (iii)chattel mortgage, and (iv) assignment of IRA (for LGU borrowers)

34 Annex 6: Implementation Arrangements PHILIPPINES: Support for Strategic Local Development and Investment Project

The Borrower and Implementing Agency The Land Bank of Philippines (LBP) will be the borrower of the Bank loan, which will be on- lent to the LGUs, public utilities or private operators providing local infrastructure services. The Government ofthe Philippines will be the loan Guarantor. LBP is a government-owned bank established in 1963 as the primary financial agent for the agricultural land reform program. LBP is the first universal bank by charter with expanded commercial banking powers to strengthen its mail social mission. LBP is the largest lender to LGUs in the country, with a 20 billion PhP outstanding loan portfolio to LGUs at the end of 2004. LBP implemented a number of World Bank financed projects. The Water District Development Project (WDDP), which is scheduled to close by December 31, 2006, finances LGU investments in drainage and sanitation improvements. LBP developed experiences with LGU lending and the World Bank process through the project, and the same PMO will be used for the implementation of the Project. In addition, LBP also implemented Bank-financed Third Rural Finance Project. Most recently, the Manila Third Sewerage Project was approved in June 2005. LBP, as the borrower for the project, will on-lend the funds to the Manila Water Company, Inc. for sewerage investments in . Implementation Framework and Process The overall project implementation framework and process are illustrated in Figure A6.1 and are described in detail in the Operations Manual. The project implementation framework I process has three features designed to draw the interest ofLGUs to participate, as these will fast track the realization of LGUs’ priority projects and development visions I goals: a It offers two loan approaches: (i)project approach; and (ii)program approach. a It employs streamlined procedure in evaluation, review, appraisal and approval. a It has differential requirements for sub-project preparation and analyses, depending on the complexity of a sub-project. Project Loan Approach. Under this scheme, maximum allowable loans shall be based on sub- project requirements and financial capacity of sub-borrowers. Loan application approval will follow existing LBP lending policy and procedures. The Loan will be covered by a Sub-Loan Agreement detailing the amount, terms, conditions ofthe loan, as well as sub-project objectives, scope, components, cost sharing arrangement, and implementation schedule. Program Loan Approach. Subject to LBP’s evaluation, the “program approach” is recommended to selected LGUs, including those that have undergone the CDS-type comprehensive Long-Term Participatory Planning process and have reached a certain level of maturity in investment planning as demonstrated by their ability to prepare and produce Comprehensive Land Use Plan, Annual Investment Plans, and Annual Budgets. In terms of lending operations, the program approach offers flexibility and simplicity in loan applications as well as in actual implementation of sub-projects. The maximum allowable loans to be considered to LGUs shall be based on their borrowing capacity limits. On the basis of their limits, LBP shall give LGUs an Omnibus Credit Facility for the fimding of the priority sub-projects that are listed in their approved or proposed investment program or development plan.

35 Streamlined Reauirements for Sub-proiect Preparation and Analyses Relatively small and technically simple sub-projects may not be required to conduct full-blown feasibility studies. Instead LGUs may submit detailed project descriptions with possible detailed analyses that may be required on certain aspects. The Operations Manual specifies a screening system for determining the required level of preparation for proposed sub-projects. Table A6.1 provides a matrix ofindicative analysis requirements for different types of sub-projects. Implementation Arrangements Execution ofthe Project by LBP LBP will be responsible for implementing the Project in accordance with the Project framework and with guidance from the approved Operations Manual. LBP lends to LGUs on the basis of well-defined procedures for credit evaluation and monitoring. LBP lending to LGUs is based on an internal LGU credit risk rating system. This system has been in use for more than three years and reflects prudent banking principles. LBP’s responsibilities include, but are not limited to: (i)screening and approving LGU’s or loan applicant’s3 eligibility to participate; (ii)evaluating LGU’s or loan applicant’s credit worthiness and proposed sub-projects; (iii)assessing LGU’s or loan applicant’s technical capability to implement, operate and maintain sub-proj ectls; and (iv) approving loan applications. Sub-lending and actual sub-loan disbursements will follow the policies and procedures as detailed in the Project Operations Manual. For day-to day operations and management of the Project, the LBP will use a Project Management Office (PMO) within its Program Management Department. The PMO, which is the same one implementing WDDP, comprises of a core team of full-time LBP technical and administrative staff and LBP-engaged individual consultants (e.g., engineer, financial and economic specialist‘s, procurement specialist, social and environmental safeguard specialists, whichever among them islare not available from LBP) to perform technical review of sub-projects that are being applied for financing and to provide technical assistance, where needed, to lending centers. The PMO will provide oversight functions in the implementation of the sub-projects of the LGUs and Private Sector Group; and for monitoring the progress ofall Project components. Implementation of Sub-proiects by LGUslSub-Borrowers Implementation of sub-projects will be the responsibility of the LGUslsub-borrowers. If not yet existent, LGUslsub-borrowers will be required to establish a Project Management Unit (PMU) to handle the day-to-day operations and management of sub-project implementation. This will ensure proper and effective implementation of sub-projects. PMUs shall be set up within, and headed by the head or chief of, the most appropriate department in the LGUs or sub-borrowing institutions. For participating LGUs, the PMUs shall be formed through a local Executive Order. The PMU head shall be assigned at least one (1) technical and one (1) administrative support staff, but shall draw on officially nominated senior staff from other departments with specific technical and administrative responsibilities on an “as and when needed” basis. The total number of staff will depend on the scale and type of sub-project to be implemented, and the required staff specializations will be recommended in the Operations Manual.

~~ Outside LGUs, eligible sub-borrowers include the public utilities and private operators providing local infixstructure services.

36 Submits LM & LBP rquiied

,...... * ......

~ comp+w Desild projet ~esdpton.j

1

~ prepares CFP for Pmgram Loan,

~ MsCFP and appmves loan.

I Slgning Of SLA PPT .Prajed Profife Template cos - aiy oeveiopmentStrataoY LGU .mal Government Unit w - Piequalification CFP - Credit Fadlity PmW LOI. ~~olln~l/lnfe~st SLA .Subsidiary Loan Agreemen! ED.Detailed Enoineenw Design LTPP .LongTen Patddpatary Planning TA .Te&nical ASSiStane DPD - Oeiaiied Pmied DeScnpbon NTP - ~timto procaed WB. The Wodd 8ank FS .Feasbtiity SMy OM -Operations Manual

37 I

I

38 URBANDEVELOPMENT

INFRASTRUCTURE WATER

SEWERAGE &SANITATION

DRAINAGE & FLOOD CONTROL

SOLID WASTE M~AGEME~

ROADS / HIGHWAYS

TPANSPORTATION

SHELTER cPOWER SECTOR/Sub9ec$r SOCIAL School INFRASTRUCTURE PUNK:markel/saellite market

Acquisibon of health care equipment

Cmenbon CO~~X

r Sports complex / pa8 playgoufld LivelihoodI poducbon centers city library City medical 8 research center / diagMMiC center AGRICULTURAL Cold storage facility SUPPORT Agri-irhiuslnal Complex

Municipal Rshporl

Meat processing Slaug~~use/aba~~r OTHER Foreshore protection /sea wall

39 Annex 7: Financial Management and Disbursement Arrangements PHILIPPINES: Support for Strategic Local Development and Investment Project

Overall Conclusion An assessment of the adequacy of the project financial management system (carried out in accordance with the guidelines issued by the Financial Management Sector Board on October 15, 2003) concluded that the Project meets the minimum Bank financial management requirements, as stipulated in BPlOP 10.02. The Project will have in place an adequate project financial management system that can provide with reasonable assurance, accurate and timely information on the status of the Project in the reporting format agreed with the Land Bank of the Philippines (LBP), executing agency. On the overall the Project financial management is considered moderate risk. There are no outstanding audit reports with LBP. The Commission on Audit (COA) has rendered an unqualified opinion on the 2004 financial statements of LBP and on the three existing Bank-financed projects, with an additional paragraph after the opinion paragraph of the report describing the issue on effect of the different exchange rates used on foreign assisted projects. This issue was elevated to the Department of Finance (DOF) for resolution as this involves interpretation of a memorandum of agreement between the LBP and DOF. Country Issues The country issues highlighted in the Country Financial Accountability Assessment (September 2002) do not directly have significant impact to the Project. One issue affecting LBP relates to the December 23, 2004 BSP circular requiring financial institutions to adopt International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS), locally the Philippine Accounting Standards (PAS) and Philippine Financial Reporting Standards (PFRS) in its 2005 financial statements. Financial institutions that will not be able to comply with this new set of accounting standards will get a qualified opinion from their external auditors on their financial reports. The adoption ofthese Standards by ASC makes the USthe generally accepted accounting principles in the country. BSP reporting for 2005 still follows the prudential reporting, The general purpose financial statements of LBP, however, will already reflect the required adjustments in the adoption of IAS in 2005. In February 2006, BSP issued a circular that amended the Manual of Accounts and the BSP reportorial requirements to align with the PFRSIPAS.

40 Risk Analysis A summary ofthe financial management assessment ratings is provided in the table below. The detailed discussion of each subject immediately follows hereunder.

Risk Subject Ratin Comments and Mitigating Measures g

~ Inherent risk M The Project involves sub-loans to LGUs and other sub-borrowers of varying financial management capacities and involving different types of sub-projects. Sub-borrowers under the Project are located in several locations in the country. This situation, however, is mitigated by the employment of a technical consultant by LBP to supervise the most complex sub-projects and the adoption of an Operations Manual that shall serve as guidance to all concerned on the processes including financial management. Further, sub-borrowers shall be given brief orientation by LBP on the overall processes, including financial management arrangement of the Project.

Control risks

0 Implementing N LBP as a whole and the departments, in particular, involved in this Project has entity adequate experience in Bank-financed projects. Fundsflow M Please see below for the discussion on the funds flow of the Project. The procedures in the Operations Manual are very well defined in terms of the withdrawal of funds from the Bank and the release of funds to the sub-borrowers. Availability of counterpart funding by the LGUs or sub-borrowers might delay payment to creditors.

Staffing N The departments in LBP involved in financial management of the Project are highly qualified and have adequate experience in handling Bank-financed projects.

Reportingand N LBP has well defined reporting and monitoring policies. Please see below for the monitoring reports required under the Project. These are also defined in the Operations Manual.

Accounting M LBP’s policies and procedures are guided on rules and regulations issued by the policies and Commission on Audit (COA) and BSP. Please see discussion on the requirement to procedures adopt IAS & IFRS in 2005 under Country Issues.

Internal audit N LBP’s internal audit also covers Bank-financed projects. See discussion below.

0 External audit N For the audit ofthis Project COA will be the auditor. Based on the review ofthe audit reports of COA on the existing Bank-financed projects implemented by LBP, COA’s audit is found to be adequate, Information N LBP has a computerized general ledger system and other stand alone systems which system are still to be interfaced. The computerized general ledger system though cannot generate separate financial statements for the project. This is not a significant issue because a financial management staff is assigned to consolidate the financial reports submitted by all the various departments and accounting centers involved in the Project. Overall control N risk Overall project financial M management risk

Risk Rating: H (High Risk), S ubstantial Risk), M (Modest Risk), N (Negligible or Low Risk)

41 Strengths 1. LBP has a well defined organization, with clear roles and responsibilities. LBP has also assigned a team from its Program Management Department (PMD) who will ensure that funds are released to the sub-borrowers on a timely and efficient manner, The accounting staff ofthe International Treasury and Operations Department (ITOD) and PMD of LBP and staff at some ofits accounting centers located in various parts of the country have experience in handling and reporting on Bank-financed projects such as WDDP. SSLIDP is similar to WDDP as both involve sub-loans to LGUs. 2. The finance staff in ITOD, and PMD of LBP assigned for this Project is adequate in number and are degree holders or certified public accountants with an adequate number of years of related work experience. 3. Each department andlor sector of LBP have manual of operations containing their policies and procedures. LBP has a program ofupdating these manuals this fiscal year for any policy changes issued in the recent past. The financial arrangement for the project including the release of funds to the LGUs together with the detailed processesiprocedures and documentation requirements is already established. Weakness LBP’s computerized accounting system is not yet capable of generating separate financial statements for the project. This is not a major concern though because under the existing Bank- financed projects that LBP is currently handling, LBP has assigned a dedicated FM staff to handle the consolidation of the project transactions and the generation of the project financial reports. This has been ascertained to be adequate. ~~plementing Entities LBP, the borrower in the loan agreement, is a government-owned financial institution established in 1963 as financial intermediary of the Land Reform Program of the government and then became a universal bank by charter with expanded commercial banking powers to sustain its social mission of spurring countryside development. LBP is the main depositary bank of the government and its various institutions. As of December 3 1, 2005 and the past fourteen years, LBP consistently has been ranked among the top five commercial banks in the country. As ofDecember 29,2005 based on the unaudited financial data, LBP was the fourth largest bank in terms of assets (Peso 310.0 billion) and loan portfolio (Peso 140.8 billion) and third in terms of deposits (Peso 242.8 billion). LBP as the borrower and the executing agency will be responsible for screening LGUs, evaluating their net borrowing capacity and technical capacity to implement the sub-project, and approving of LGU loan applications. LBP will utilize the project management office (PMO) currently handling the WDDP in the implementation of the Project, An operations manual shall be adopted for the Project that shall contain the procurement process, construction supervision, financial management, and monitoring and evaluation among others to facilitate the LGU’s understanding ofthe requirements under the Project, LGUs are the main targeted sub-borrowers under this Project. Each LGU participating under this Project shall be required to create a project implementation unit to monitor the progress and completion of the sub-projects. This will be composed of organic staff of the LGU who will closely work with the LGU accounting, treasury and budget office and LBP PMO. The FM capacity ofthe LGU may vary depending on the size and type ofthe LGU. All LGUs, however,

42 Category Amount Financing Percentage (1) Goods, works and consultants services for Part 1 ofthe Project 10,539,000,000.00 100% of amounts disbursed (2) Goods and consultants' services for Part 2 ofthe Project 1,141,725,000.00 100% of amounts disbursed (3) Front-end fee 29,275,000.00 100% of expenditures Total amount 11,710,000,000~00

The Project funds are composed of the loan proceeds and LGUs' counterpart fund. LBP shall open and maintain a Designated Account (DA) in Japanese Yen, in a commercial bank acceptable to the Bank (similar to those of its three existing Bank-financed projects), with an authorized allocation of JPY1,171 million. LBP shall release hnds to the sub-borrowing LGUs based on eligible expenditures incurred, which shall be deposited to a bank account with LBP opened and maintained by the LGU for the sub-project. Withdrawal of funds from the Bank shall be through the submission of duly signed Withdrawal Application and Statement of Expenditures (SOEs). Disbursements under the Project shall comply with the Bank policies and procedures on disbursements and financial management as reflected in the Bank's Disbursements Handbook and Financial Monitoring Report Guidelines. All reimbursements to the SA shall only be for eligible expenditures based on the agreed eligibilitylfinancing percentage in the Loan Agreement and shall have adequate supporting documents. Attachments of supporting documents to the SOEs for withdrawal applications shall be based on threshold limits of SOEs. In addition, other disbursement mechanism such as direct payments and special commitments shall also be available for this Project. The withdrawal application shall be supported by SOEs for all expenditures not meeting the prior review thresholds as defined in Annex 8. LBP shall also have the option to use report-based withdrawal of funds from the Bank. Retroactive financing will be provided under the project for up to Y1,171 million of the Bank loan to finance eligible expenditures for project activities incurred after 20, 2006. The services, civil works, and goods to be eligible for retroactive financing should be contracted following World Bank's "Guidelines: Procurement under IBF2D Loans and IDA Credits" dated May 2004; and "Guidelines: Selection and Employment of Consultants by World Bank Borrowers" dated May 2004.

43 FM Organization and Staffing The departments in LBP involved in financial management have adequate highly qualified officers and staff, who are degree holders andlor certified public accountants and adequate experience in bank operations. All of the officers and staff in ITOD, PMD and accounting centers involved in this Project have experience in handling Bank-financed projects. Accounting Policies and Procedures~eporting& ~onitoring~nformation System The Project will adopt the same financial management policies and procedures of LBP. The financial management policies and procedures of LBP have been assessed and found to be adequate for this Project. The PMD PMO finance staff will be responsible in consolidating the project transactions recorded and submitted by ITOD and the various LBP accounting centers and generating the financial report for the Project using a spreadsheet. Currently, the computerized general ledger system of LBP does not allow generating financial report by project. This method of preparing reports for the Project has been tested to be adequate under WDDP. LBP has adequate controls in place for procurement processing, processing of payments to suppliers, recording and reporting. The financial management arrangement with the LGUs (similar to the one currently observed under WDDP) shall be contained in the Project Operations Manual that will be adopted before loan effectiveness. LBP uses the accrual method of accounting. On December 23, 2004, BSP issued circular requiring financial institutions to adopt International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS) in its 2005 financial statements. BSP reporting for 2005 still follows the prudential reporting. The general purpose financial statements of LBP however will already reflect the required adjustments in the adoption of IAS in 2005. In February 2006, BSP issued a circular that amended the Manual ofAccounts and the BSP reportorial requirements to align with the PFRSPAS. Internal Audit LBP’s internal audit group (IAG) is headed by a First Vice President and is composed of the following three departments: (a) credit review; (b) field operations; and (c) head office and systems technology audit department. IAG has adequate manpower that is well experienced and trained. All have degrees in banking, finance or accounting andor CPAs. LBP recently has invested significantly in providing IAG with infrastructure and trainings in internal auditing, risk-based audit, computer audit, use of electronic working papers, etc. IAG has started to implement risk-based audit approach and no longer implement sole compliance audit. IAG now looks at possible improvements on existing systems of controls and procedures. IAG reports directly to the Audit Committee (AuditCom). The auditable units of LBP are classified into high, moderate and low risks. Risk classification becomes the basis of determining the allocation of the IAG’s resources such as the frequency and length of time of IAG’s review, etc. The credit review department in IAG covers all the lending operating units of the Bank at least annually and the sampling size they have adopted in their review of a unit’s operation is 65%. Based on its prior years’ audit, the team covered foreign-fbnded projects including those financed by Bank funds. In addition to the IAG, CMO was created in compliance with the requirement of BSP. CMO also reports directly to the AuditCom. CMO is tasked to ensure proper compliance by LBP of the rules and regulations of BSP, Philippine Deposit Insurance Commission, Securities and Exchange Commission (SEC), COA, among others. In addition to IAG & CMO, BSP also required the creation of the Risk Management Group (RMG) that reports

44 directly to the Risk Management Committee of the Board of Directors. RMG is responsible in developing the risk management framework of LBP and closely works with the credit and treasury operating units of LBP. It is also responsible in reviewing the credit and treasury operations manual of all credit and treasury operating units to ensure that they are updated and contains well defined policies on the management ofrisks in close coordination with the Systems and Methods Department ofthe Controllership Group. External Audit The Commission on Audit (COA), the supreme audit institution in the country, is the auditor of LBP as a government owned entity. COA has assigned an audit team located in LBP to audit all LBP transactions, including Bank-financed Project financial statements. COA conducts its audit of the financial statements in accordance with laws, COA and International Organization of Supreme Audit Institutions (INTOSAI) standards and applicable generally accepted auditing standards. COA has rendered an unqualified opinion on the 2004 financial statements of LBP, with a paragraph after the opinion paragraph of the report drawing the users of the financial statements attention to an issue on the effect of the different exchange rates used on foreign funded projects. This issue was elevated to the Department of Finance (DOF) for resolution as this involves interpretation of a memorandum of agreement between the LBP and DOF. For the audit ofthis Project, COA will be the auditor ofLBP and its TOR will be similar to what it does with current Bank-financed projects. The required audit reports to be submitted by LBP and the due date are as follows: Audit ReDort I Due Date a. Entity’s annual financial statements (balance sheet, income No later than 6 months statement, statement of cash flows), together with the notes to after end of LBP’s fiscal the financial statements Year

b. Project financial statements (Balance sheet, income statement No later than 6 months and statement of cash flows), together with the notes to the after end of LBP’s fiscal financial statements year

c. Auditor’s management letter issued to LBP No later than 6 months after end of LBP’s fiscal vear

Other reporting requirements LBP shall furnish the Bank with quarterly Financial Monitoring Reports (FMRs) throughout the life ofthe Project within 45 days after the end of each quarter, which shall consist of: (a) a brief description of the project progress; (b) financial reports for the current period and cumulative to date, which shall include (i)project sources and uses of funds (loan proceeds and counterpart funds), (ii)uses of funds by components and sub-project activities, and (iii)balance sheet; (c) physical accomplishment; and (d) procurement. The physical accomplishment report must be linked to the financial report. Draft formats of these FMRs will be finally agreed prior to loan negotiation.

45 Supervision plan FM supervision mission visit shall be undertaken once a year during project implementation to ensure that the loan proceeds are used for the purpose it was granted, with regard to economy, efficiency, and achievement of the Project’s objectives. This should cover the total project financial management arrangement including the counterpart funds of the LGUs. The project supervision may be done twice a year considering the diversity of the sub-projects and the number of participating LGUs. Every project supervision mission may take around 6 to 8 days and must include sub-project visits. FM supervision can also be performed by telephone and emails in cases of follow up of certain issues. The scope of the supervision is left to the professional judgment ofthe FM specialist. It may cover any ofthe following: (1) Review ofthe continuous maintenance ofadequate FM system by LBP and the participating LGUs; (2) Review of SOEs, where deemed necessary; (3) Follow-up of timeliness of FM reporting and actions taken on issues raised by external auditors; (4) Review of financials as well as progress of the project; and (5) Review ofcompliance with the financial covenants.

46 Annex 8: Procurement Arrangements PHILIPPINES: Support for Strategic Local Development and Investment Project

A. General 1. Procurement for the proposed project would be carried out in accordance with the World Bank's "Guidelines: Procurement under IBRD Loans and IDA Credits" dated May 2004; and "Guidelines: Selection and Employment of Consultants by World Bank Borrowers" dated May 2004, and the provisions stipulated in the Legal Agreement, The various items under different expenditure categories are described in general below. For each contract to be financed by the Loan, the different procurement methods or consultant selection methods, the need for pre- qualification, estimated costs, prior review requirements, and time frame are agreed between the Borrower and the Bank in the Procurement Plan. The Procurement Plan will be updated at least annually or as required to reflect the actual project implementation needs and improvements in institutional capacity. 2. Procurement Reform and Harmonization: The government has embarked on an important procurement reform process with the passage ofthe Government Procurement Reform Act (Republic Act 9184) since January 2003. Significant progress was made since then, including implementation at the LGU level. In the meantime, significant achievement was made in harmonization and alignment of procurement. Bidding documents for works, goods and consulting services have been harmonized across many government agencies and with the international development partners' policies and procedures, and are now being used for all national public procurement by every entity, including the LGUs. While kept to a minimum, some differences still remain between RA 9184 provisions and World Bank Guidelines. These differences will be listed as an Annex on NCB Procurement in the Procurement Schedule of the Loan Agreement. 3. Procurement of Works: Works procured under this project would include sub-projects for infrastructure development, rehabilitation, upgrading and expansion, i.e., water supply and sanitation facilities, mini hydropower development, solid waste management facilities, wastewater treatment and disposal, housing and new site development, road and bridges, drainage and flood protection facilities, schools and health clinics; and improvement of municipal enterprise structures such as public markets, slaughterhouses, bus terminals, and other related income generating projects. The procurement will be done using the Bank's Standard Bidding Documents (SBD) for all ICB and National SBD agreed with the Bank for all NCB, in accordance with the provisions of paragraphs 3.3 and 3.4 of the Procurement Guidelines. Shopping will also be used for small item procurement in accordance with the provisions of paragraph 3.5 of the Procurement Guidelines. In a case where the sub-borrower is a private enterprise, procurement may be undertaken in accordance with established commercial practices, subject to the Bank's prior agreement. 4. Procurement of Goods: Goods procured under this project would include heavy equipment for local infrastructure construction and maintenance, and for implementation support at LBP, The procurement will be done using the Bank's SBD for all ICB and National SBD agreed with the Bank for all NCB, in accordance with the provisions ofparagraphs 3.3 and 3.4 of the Procurement Guidelines. Shopping will also be used for small item procurement in accordance with the provisions ofparagraph 3.5 ofthe Procurement Guidelines. In a case where

47 the sub-borrower is a private enterprise, procurement may be undertaken in accordance with established commercial practices, subject to the Bank’s prior agreement. 5. Selection of Consultants: Consulting firms and individual consultants would be required for: a) services necessary for LGU revenue enhancement and fiscal management program; b) LGU strengthening and capacity building, including hands on training on: (i)preparation of TOR for the preparation of feasibility studies and detailed engineering design, (ii)procurement, (iii)supervision and management including monitoring of outcomes during construction, and (iv) improved management and operations of municipal enterprises and services; and c) project implementation support. Short lists ofconsultants for services estimated to cost less than $200,000 equivalent per contract may be composed entirely of national consultants in accordance with the provisions ofparagraph 2.7 ofthe Consultant Guidelines. 6. The procurement procedures and SBDs to be used for each procurement method, including possible use of Design-Build-Lease (DBL) and Design-Build-Operate (DBO) bidding documents4, as well as model contracts for works and goods procured, are presented in the Project operations manual. B. Assessment of the agency’s capacity to implement procurement 7. Procurement activities for all civil works will be carried out by participating LGUs. They will also be selecting consultants, if needed, to assist them in the preparation of detailed engineering designs, construction supervision and other required studies. LBP will also be involved in the selection of consultants for the required assistance in the overall implementation ofthe project. The LGUs are staffed by experienced civil servants, and the procurement function is staffed by Bids and Awards Committee members who have been trained on the national law on procurement (R.A. 9184) and the use of the Philippine harmonized bidding documents (HBDs). 8. An assessment of the capacity of the Implementing Agencies (LBP and representative LGUs) to implement procurement actions for the project has been carried out by the Bank’s Procurement Specialist assigned on the project on various dates during the project’s preparation stage. The assessment reviewed the organizational structure for implementing the project and the interaction between the project’s staff responsible for procurement and relevant units for administration and finance. 9. In as much that it is expected that majority of the sub-projects will be procured through NCB procedures, use of the HBDs is expected, and some of the key issues and risks concerning procurement for implementation of the project have been identified and include: i)non-usage by some LGUs of the HBDs; ii)some members of the BAC and TWG not having been trained by GPPB or other government entities in the use of R.A. 9184 and the HBDs; iii)absence of civil society observers in public bid openings and bid evaluation; and iv) incomplete compliance with the required publication ofbid notices and contract awards in the GPS. The corrective measures which have been agreed are: i)full adoption of the HBDs by all participating LGUs for this project; ii) ensuring that the BACs of the implementing LGUs are created in accordance with R.A. 9184; (iii)ensuring that the BAC and TWG members received training on R.A. 9184, its IRR and in the use of the Philippine harmonized bidding documents; (iv) ensuring that

DBL is being used under the Philippines LGU Urban Water and Sanitation ApL2, and DBO is being used under the LOGOFIND Project.

48 representatives from civil society and NGOs are present as observers in bid openings and evaluation ofbids; v) ensuring compliance by LGUs in publication ofinvitation for bids in their respective websites, in the Bank’s client connection website, and in the GEPS, in addition to publications in a newspaper of national circulation, to attract as many bidders as possible; (vi) ensuring LGU compliance ofthe publication ofbid awards, in the Bank’s client connection website, and in the GEPS. 10. For any contracts to be procured through ICB procedures, LGU staff handling procurement has limited knowledge of the Bank’s procurement guidelines and SBDs, but considering the experience they have generated in the implementation oflocally funded projects, it is expected that they can easily adapt to such procedures. In order to ensure this, an in-depth traininglseminar on the use ofthe Bank’s procurement guidelines and SBDs will be provided by the project Procurement Specialist; and participation in the AIM Seminar on Procurement will be encouraged. 11. With due consideration of the reforms brought about by the new procurement law, and the formulation of the Philippine harmonized bidding documents, and the LGUs adoption of these, the assessment concluded that the overall project risk for procurement by the LGUs is Average. 12. LBP’s procurement activity will mainly revolve around the selection of one (1) big consultancy services aimed at assisting LBP in the implementation of the project, Selection will be through QCBS method. Based on the previous experience generated by LBP on the Water District Development Project (WDDP) and in the ongoing PHRD preparation grant, the risk associated with LBP’s procurement activities can be concluded as in the Average category. One thing that LBP needs to maintain on the project is the presence of a fdl time Procurement Specialist who should be available to assist the LGUs in their procurement activities. C. Procurement Plan 13. The Borrower, at appraisal, developed a procurement plan for project implementation which provides the basis for the procurement methods. This plan has been agreed between the Borrower and the Project Team on May 10, 2006 and is available at LBP’s head office in Manila, and the respective LGUs. It will also be available in the project’s database and in the Bank’s external website. The Procurement Plan will be updated in agreement with the Project Team annually or as required to reflect the actual project implementation needs and improvements in institutional capacity. D. Frequency of Procurement Supervision 14. In addition to the prior review supervision to be carried out fkom Bank offices, the capacity assessment of the Implementing Agencies has recommended semi-annual supervision missions to visit the field to carry gut post review ofprocurement actions. 15. During ex-post project reviews, the Bank will undertake a joint procurementlFM review which will involve representatives from the LBP and the Internal Audit Unit ofthe implementing LGU so any findings can be immediately acted upon. Any deviation in the procurement process found during post reviews shall be referred to COA, GPPB and DILG for follow-up action through the oversight mechanisms built into the procurement law (RA 9 184) with specific cases to be dealt with as follows: (i)any report ofnon-compliance with agreed procurement procedures will be forwarded to COA, GPPB and DILG for proper reprimand and corrective action; (ii)any

49 report on fraud and corruption issues will be submitted to LBP, and both LBP and DILG will demand an explanation for the concerned LGU, and it the report is found to be true, the amount of the contract may not be funded from the loan; (iii)in cases of anomalies, an investigation will be requested by the Bank to be conducted jointly by GPPB, COA, LBP and the WB; and (iv) where sub-borrowers have been proven not following the procurement and financial management processes described in the Operations Manual, World Bank funds will not be disbursed for the sub-projects.

50 E. Details of the Procurement Arrangements 16. Goods and Works. Proposed contract packages for works and goods are as follows:

11 2 131 4 151 6 7 8 9

Ref. Contract Est. Procurement P-Q Domestic Review Expected Comments No. (Description) Cost Method Preference by Bank Bid-Opening (%m)* (y eslno) (PriorlPost) Date S2LDI- Water Supply, 2.05 NCB NO No Prior 02125107 First of two 01 Bayawan City NCB contracts S2LDI- Hydropower 2.21 NCB No No Prior 03107107 Second of 02 Development, two NCB Calbayog City contracts S2LDI- Drainage and 0.50 NCB No No Post 03107107 Below 03 Sewerage, Dapitan threshold City S2LDI- Sanitary Landfill, 2.86 NCB No No Post 0311 1107 Below 04 Panabo City threshold S2LDI- Housing, San 0.38 NCB No No Post 0311 1107 Below 05 Fernando City threshold S2LDI- New Sites 3.29 NCB No No Post 05/17/07 Below 06 Development, threshold Tuguegarao City S2LDI- Sanitary Landfill, 3.40 NCB No No Post 0511 7107 Below 07 Munoz City threshold S2LDI- IntegratedTransport 0.54 NCB No NO Post 02125107 Below 08 Terminal, Sorsogon threshold

51 Zamboanga del Norte S2LDI- Water Supply, 0.14 NCB No No Post 0311 0108 Below 22 Jasaan, Misamis threshold Oriental S2LDI- Integrated SWM, 0.26 NCB No No Post 02/15/08 Below 23 Lala, Lana0 del threshold Norte

17. The Bank’s prior review thresholds were determined based on the Procurement Capacity Assessment, and such thresholds are as follows:

0 ICB Works (if any), estimated to cost above $5,000,000 equivalent per contract; 0 ICB Works, for sub-projects that may be procured through DBL or DBO procedures, where local contracting industry has not had much involvement with; 0 First two (2)NCB contracts for Works, regardless of estimated cost and LGU; 0 ICB Goods, estimated to cost above $500,000 equivalent for contract; e First two (2) NCB contracts for Goods, regardless of estimated cost and LGU. 18. Consulting Services. Proposed consulting services are as follows:

* Representing amount to be funded from the loan.

52 19. Consultancy services estimated to cost above US$350,000 per contract for consulting firms and above US$lOO,OOO for individual consultants and all single source selection of consultants (firms or individuals) will be subject to prior review by the Bank. 20. Retroactive financing will be provided under the project for up to Y 1,17 1 million of the Bank loan to finance eligible expenditures for project activities incurred after March 20, 2006. The services, civil works, and goods to be eligible for retroactive financing should be contracted following World Bank's "Guidelines: Procurement under IBRD Loans and IDA Credits" dated May 2004; and "Guidelines: Selection and Employment of Consultants by World Bank Borrowers" dated May 2004.

53 Annex 9: Economic and Financial Analysis PHILIPPINES: Support for Strategic Local Development and Investment Project

A. Financial Analysis of the Financial Intermediary - LBP

LBP is a financial institution wholly-owned by the Government of Philippines. Established in 1963 to finance the acquisition and distribution of land under the Comprehensive Agrarian Reform Program; it has since grown into a universal commercial bank. Consistent with the Government of the Philippines (GOP) policy objectives, LBP has a development finance focus with lending operations concentrated primarily in GOP designated priority ~ectors.~LBP lends directly to LGUs, and government-owned and private corporations involved in agribusiness and rural infrastructure. Agriculture lending to farmers is largely conducted through rural banks, co- operatives and government agriculture development agencies, LBP also engages in a small way in insurance brokering, leasing, commodities trading and real estate operations via four wholly- owned subsidiaries.

The following provides a summary assessment of LBP’s operational and financial performance during the years 2000 to 2004.

1. As of end-2004, LBP was the fourth largest bank in Philippines in terms of assets; fifth largest in terms oftotal equity and fourth most profitable in terms ofoperating income. 2. LBP has been effective in discharging its development finance mandate while maintaining progress in improving its balance sheet and operational performance. Loans to the priority sectors increased from 36% of total portfolio in 2000 to 62% of total loan portfolio in 2004. The remaining loans went mainly into financing National and LGU infrastructure development; housing, non-agricultural corporations, schools and hospitals. 3. Given the national government strategy of strengthening LGU level development expenditures, LBP has consciously and successfully increased its exposure to LGUs; from about 12bn Pesos in 2000 to about 20bn Pesos in 2004. LGU related exposure now accounts for about 16% of LBP’s total outstanding loans. (Figure 9.1) Loan losses in the LGU loan portfolio have been negligible. 4. As of end-2004, 75% of LBP resources were funded by deposits. As the largest of the only three official government depository banks, LBP funds its operations mainly from government deposits; 65% oftotal deposits. However, LBP has been attempting to diversify its resource base; private sector deposits increased from 62bn Pesos in 2000 to about 75bn Pesos at end-2004. Consistent with its development mandate LBP, has developed an extensive rural branch network especially in those rural areas where banking services are limited or non-existent. LBP also has an aggressive nationwide ATM deployment program and is investing in internet based banking and payment services. 5. The day to-day operations of LBP are managed by a five person team headed by the President and CEO. LBP operations are organized into three main sectors: Agrarian and Domestic Banking Sector; Operations and Corporate Services Sector and the Institutional Banking and Subsidiaries Sector. The Agrarian and Domestic Banking Sector is responsible

Priority sector includes loans to farmers, fisher folk, micro enterprises, SMEs, Livelihood Loans, Agri- infrastructure and Agri Projects by LGUs and GOCCs.

54 for loan originations to LGUs via its Lending Centers. Consistent with good practices, LBP has also separated originations from credit appraisal, investigation and monitoring. The LBP Board of Directors is reasonably representative of various stakeholder interests: four directors are cabinet officials; two directors represent agrarian reform interests and two are independent directors drawn for the private sector and academia. The President and CEO of LBP is the Vice-chairman of the Board. At the Board level, the Audit Committee and the Risk Management Committee oversee credit policy, credit review, and risk and portfolio management.

Figure 9.1: Distribution of LBP Loan Portfolio (as YOof Gross Loans)

25

6. Financial Performance. Table 9.1 provides summary balance sheet and income statement for the years 2000 to 2004. Table 9.2 provides key performance indicators for the same period. LBP accounts are subject to COA audits which are conducted in accordance with generally accepted accounting principles. In the past four years, LBP has received unqualified reports from COA. The main features ofLBP's performance are as follows: a. LBP has shown steady improvements in its financial performance. Loans have increased without deterioration in loan asset quality. This has been accompanied by increases in both operating and net income notwithstanding the fact that as the main lender to the priority sector it has higher operating costs. b. LBP has succeeded in bringing down NPLs from about 23% of Gross Loans in 2000 to about 15% in 2004. However, the decline is primarily through build up of new loan assets and less so on account of enhanced recoveries. However, in this regard, the NPL ratio will decline significantly pursuant to two transactions in 2005 involving

55 the sale of two pools of NPLs aggregating to about 13.5bn Pesos. These were sold under the Special Purpose Vehicle Law that facilitates commercial bank sale of NPLs. The lower NPL ratio will be reflected in the 2005 balance sheet. c. The LGU component of LBP’s overall loan book has performed very well with very low levels of NPL. This is in large measure because of LBP’s recourse to IRA transfers to LGUs. LBP is the designated depository for such transfers. d. Balance sheet liquidity has also improved with liquid assets now covering more than 50% of deposit and short-term liabilities. Provisions for loan losses increased significantly from 52% of NPLs in 2001 to about 73% in 2004; much higher than the average for the banking system. e. Capital Adequacy Ratio of 13.67% at end-2004 is well-above the BSP minimum requirement of 10%. This ratio has consistently improved over the past five years, with a slight decline in 2004 over 2003 due to redemption of preferred shares amounting to 2bn Pesos issued to GOP owned National Development Company and due to a dividend payment of600mn Pesos to GOP. f. LBP’s financial performance rates well in comparison to a peer group of the top twenty banks in Philippines. On most balance sheet items LBP ranks among the top five. g. LBP enjoys the same rating as the GOP, and its ratings change identically to changes in GOP ratings. Other than these changes, LBP has not been subjected to any special ratings watch or ratings downgrades by the rating agencies. As a wholly-owned GOP bank, it also enjoys considerable depositor confidence with private depositors. h. Notwithstanding these positive features there are some areas ofweakness: i. LBP’s return on average assets while improving are less than 1% and lower than many of the leading commercial banks in Philippines. This is in part due to its development financing role which limits fee income and results in a high cost to income ratio. ii, ROPOAs (real and other properties owned or acquired), at around 10% of total, are still high. Unlike NPLs, loan loss reserves on ROPOAs are only at about 48%. These need to be reserved at a higher level, and doing so would adversely affect LBP’s equity base. In anticipation of this need, LBP is planning a US$lOO million ten-year bond issue. These bonds will qualify as lower Tier-2 capital and will enable LBP to step up loss reserves on ROPOAs. iii, Financial disclosure, while considerably improved over the years, needs further improvements particularly with regard to measurement and disclosure of major risks and management discussion ofportfolio quality and risks. 7. LBP management is aware of these issues and is taking remedial measures. Cost cutting measures resulted in savings of about 265mn Pesos in 2004. Sale of NPLs and ROPOAs is being pursued and this will lower the aggregate level of non-performing assets. Further, under regulatory forbearance losses on such sales are allowed to be amortized over a period of ten years thus minimizing the balance sheet impact on equity. Finally, LBP has been strengthening its risk management procedures including putting into place an internal credit risk rating and management system for defining, segregating and managing the loan portfolio. With regard to quality of disclosure, BSP has issued detailed guidelines for measurement, accounting and disclosure of risks by commercial banks in Philippines as part of implementation of Base1 2 guidelines by 2007. LBP has initiated measures to ensure full

56 compliance with these enhanced requirements. This would materially improve the quality of disclosure. 8. LGU Lendinn Policies of LBP, LBP has established guidelines and procedures for evaluating and monitoring LGU credit risks. These reflect prudent banking principles. LBP has a formal internal system for rating LGUs based on three factors: (i)Financial capacity (70% weight); (ii)Political Condition (10% weight); and (iii)Economic Condition (20% weight). As of 30th September 2005; LBP had assigned ratings to 665 LGUs distributed as follows: Prime: 7%; High Grade: 21%; Medium Grade: 42%; Lower Medium or Poor Credits: 30%. Under normal circumstances LBP lends to Lower Medium or Poor Credits only against deposit holdouts that filly cover the loan amount. LBP’s existing LGU loan portfolio is reasonably well diversified. LGUs qualifying for a High and Medium grade rating account for more than 70% of LBP’s LGU loan portfolio. Loan Loss Rates on LGU loans are very low; less than 2%. Interest rates charged to LGUs are based on the ratings and these rates reflect credit quality and enable LBP to earn a spread of 2-3% on its LGU loans. LBP has been prudent in expanding its LGU borrower base and has not engaged in aggressively expanding lending by underpricing loans or diluting credit quality standards. 9. Eligibility with regard to OP8.30, LBP meets the eligibility criteria recommended under OP8.30. LBP’s financial performance has shown steady and sustained improvement in terms of key balance sheet and performance indicators. The bank is in good standing with BSP, the supervisory authority which exercises largely independent oversight over LBP. LBP is in compliance with all key prudential regulations prescribed by BSP. While LBP enjoys regulatory forbearance it is in no way better than what has been afforded to the entire banking system. LBP’s risk based capital adequacy ratio is higher than the prescribed minimum; it maintains adequate liquidity and has been improving its risk profile. The operations of the Bank, including lending operations, are conducted on the basis of well- defined policies, procedures, credit manuals, etc. The Board exercises adequate oversight over lending operations. LBP has been improving its internal control, internal audit and information systems and these meet the standards prescribed by BSP. 10. LBP’s lending interest rates are positive in real terms and it has the flexibility to price loans to reflect cost of fimds as well as credit quality. LBP pricing matrix is based on the prime rate which reflects market conditions. The pricing matrix requires LBP to take into account credit quality. A final pricing of between 9-1 1% envisaged under this project is in line with what private banks are charging to private customers, who should generally be higher credit risks. LBP does not receive any operating or capital subsidies from the government. However it does enjoy some competitive advantages over private banks. As one of the three designated government depository banks, LBP enjoys access to government deposits, while on the other hand, LBP is also required by the government to pursue developing financing, such as significantly expanding loans to SMEs and agricultural sectors. LGUs are required, by law, to maintain their deposits in LBP and two other govemment-owned banks. On these deposits, LBP enjoys the right of offset and this enhances the ability of LBP to lend to LGUs. These privileges are not available to private banks. This needs to be tackled as a broad policy issue with the Government ofthe Philippines.

57 Table 1: LBP Summary Balance Sheet and Income Statement (in bn Pesos) 2004 I 2003 I 2002 I 2001 I 2000 BALANCE SHEET

Profit before Tax 2.3 2.2 1.5 1.1 -0.1 Tax 0.1 0.2 -0.2 -0.5 -0.6 Net Income 2.3 2.0 1.7 1.5 0.5

Total Capital Ratio 13.67 14.65 14.56 10.60 10.57 Equity I Net Loans 15.70 18.07 18.70 18.38 16.02 Equity I Dep & ST 8.46 9.87 9.64 9.60 9.36 Funding Equity / Liabilities 7.85 8.98 9.03 8.98 8.70

58 B. Financial Analysis of Sub-borrowers: Local Government Units LGUs overall have consistently been in surplus situations over the past decade. However, LGU revenues have been heavily dependent on IRA, which provides nearly two-thirds of LGU income. Significant variation exists among LGUs: cities are least dependent on national tax sharing (44%), while provinces are the most dependent (82%). The total level of LGU borrowing is very low. LGU borrowing accounts for only 1.8% of LGUs income in 2004. LGUs’ debt service expense, at 2.8% oftotal LGU expenditure, also shows that debt repayment has not been a burden for the vast majority of LGUs. In fact, the Local Government Code and BSP regulations provide conservative limits on LGU borrowing - estimated LGU debt service should not exceed 20% of LGU’s expected revenue. These regulations have been strictly followed by the lending institutions and LGUs. LBP lending to LGUs is primarily based on LGU creditworthiness instead of the underlying cash flow from sub-projects. The Project Operations Manual provides guidance to LGUs on recovering costs for revenue-generating sub-projects, but such cash flow will not be relied on as repayments. LBP has an internal LGU credit rating system which rates LGUs according to their financial capacity, political condition, and economic condition.

Summary of LGU Revenue and Expenditure (Source: Bureau of Local Government Finance),

Total Expenditure (bn Peso) 37.1 37.4 61.8 64.7 57.3 58.4 156.2 160.6 General Public Service 31.9% 30.5% 37.3% 36.7% 49.3% 49.6% 40.4% 39.9% Department of Education 4.5% 5.2% 11.1% 10.4% 3.9% 3.4% 6.9% 6.7% Health, Nutrition, Population Control 19.0% 19.9% 8.1% 8.0% 8.6% 8.4% 10.9% 10.9% Labor and Employment 0.0% 0.1% 0.1% 0.0% 0.1% 0.1% 0.1% 0.1% Housing and Community Development 1.7% 0.9% 3.7% 3.7% 1.5% 1.1% 2.4% 2.1%

59 Social SecuritylSocial Services and Welfare 1.8% 1.6% 2.6% 2.3% 3.0% 3.1% 2.6% 2.4% Economic Services 16.8% 17.2% 16.5% 17.7% 14.3% 13.3% 15.8% 16.0%

Debt Service 2.7% 2.9% 4.2% ’ 3.5% 1.6% 1.8% 2.9% 2.8% Other Purposes 21.5% 21.9% 16.4% 17.8% 17.7% 19.2% 18.1% 19.2%

C. Economic Analysis As a financial intermediary operation which supports on-lending to LGUs for a broad range of municipal infrastructure projects, the focus of economic analysis is two-fold: the soundness of the overall framework of the project in assessing economic viability of LGU sub-projects, and assessment ofthe specific investment proposals submitted for funding as potential pipelines. The framework for economic analysis of LGU sub-projects is specified in the Project Operations Manual. Proposals from the LGUs are evaluated from two viewpoints: First the sub-project is assessed on its contribution to the general welfare of the population and its relative priority given competing needs. The proposals with the highest economic returns are given higher priority for inclusion in the LGU’s pipeline of projects that could possibly be supported by the Project. In the absence of a rigorous prioritization (or investment programming) process, the selection of projects at the LGU level is carried out through the participatory, long-term development planning process. In many of the pipeline LGUs, the proposals emanate from the highly participatory City Development Strategies (CDS) process (see Annex 1). Finally, the priority to identified projects (that lend themselves to inclusion in the Project) is affirmed through the formal review process within the governance structure of the LGU, i.e., city council in the case of cities, municipal councils in the case of and provincial boards in the case of provinces. So far, all sub-project proposals in the pipeline are backed by council resolutions ofsupport. The second dimension ofthe framework for economic analysis is on the internal efficiency of the proposed investment. It seeks to establish that the proposed project provides the most cost- effective solution. Thus, the economic viability is measured by the project’s net present value, economic internal rate of return and benefit-cost ratio. Under the Project, it is expected that many supported projects will not lend themselves to easy benefit-cost ratio analysis. Water supply, sewerage, solid waste management and similar environment-related projects are examples of investments whose costs and benefits are normally difficult to fully quantify or capture in the analysis, specifically the externalities that arise out of their implementation. In such cases, the least-cost analysis will be applied whereby the proposal presents the least cost option for attaining the project objectives. Guidelines are provided in the Project Operations Manual.

60 Annex 10: Safeguard Policy Issues PHILIPPINES: Support for Strategic Local Development and Investment Project

The project will be implemented by a financial intermediary, the Land Bank of the Philippines (LBP), which onlends IBRD funding to LGUs. In accordance with the Bank guidelines, the project has been classified as Environmental Category FI (Financial Intermediary). As a financial intermediary operation, the location and nature of the investment sub-projects will be determined by the development priorities and bding requirements put forward by the LGUs and LBP’s appraisal of specific LGUs’ financial creditworthiness. A comprehensive social and environment safeguard framework was developed by LBP for the project to provide adequate procedural guidance for the LBP and LGUs and to ensure that all the sub-projects comply with Bank safeguard policies and Philippines national laws. The Framework includes guidelines and requirements on environmental assessment, indigenous peoples and involuntary resettlement. It also addresses aspects related to due diligence, public disclosure, and resettlement and compensation. Institutional Responsibilities: According to the project Safeguards Framework, it is the responsibility of the sub-borrower of the loan, LGUs in most cases, in carrying out both Environmental Assessment and Social Assessment required by the Philippine regulatory framework and the Bank’s safeguards policies, and obtaining the necessary clearances required of each individual sub-project before starting sub-project implementation. On the other hand, it is the responsibility ofthe borrower, LBP, to monitor the compliance ofparticipating LGUs and other sub-borrowers that they follow the process and requirements prescribed in the Environmental and Social Safeguards Framework. The Bank provides guidance, and reviews the project’s compliance with its safeguards policies. Capacity Assessment. An assessment of LBP capacity in implementing social and environment safeguards was conducted. The assessment concluded that LBP has demonstrated its capacity to implement the Safeguards Framework, particularly in light of its recent experience in satisfactorily implementing several Bank assisted projects, including the Water Districts Development Project (WDDP), an Environment Category A project. The PMO for WDDP, under the Program Management Department, will also be used for the implementation of the Project. The LBP has sufficient capacity and dedicated staff for the coordination and monitoring of compliance with the safeguards framework. Through the implementation of the ongoing WDDP, the LBP has developed effective working procedures for on-lending activities, including providing necessary guidance and assistance to LGUs on safeguards compliance. The PMO has been conducting field visits to sub-projects and has guided the local consultants in conducting project orientations and consultation meetings with various stakeholders at the local level. Both the environmental and social safeguards specialists have exhibited their capacity in presenting, discussing and analyzing environmental and social issues with LGUs, communities and NGOs. They have provided guidance to LGU staff, NGOs and community-based organizations in following community participatory procedures and process and the Safeguards Framework. Participatory Approach. All of the city LGUs participating in the pipeline underwent a long- term participatory planning process under the Cities Development Strategy (CDS) approach.

61 The CDS approach is a “partnership” approach which relies on the full involvement and commitment of key stakeholders in preparing a strategy for development. Stakeholder participation includes consultations with the local government, business enterprises, academe, community groups, NGOs, people’s organizations and citizens at large. The choice and design ofprojects and programs of the cities are determined and formulated during the CDS workshops. In the CDS workshop, the stakeholders

0 Define the city’s problems and opportunities 0 Formulate a common vision and strategy to attain the city’s vision 0 Prioritize programs, projects and actions 0 Determine resources and mobilization schemes 0 Determine implementation, monitoring and evaluation One of the CDS forms used for prioritized investments is the Detailed Project Description. This document helps determine whether a proposed project will have issues on environment, resettlement, cultural properties andor indigenous peoples. Environment Impact Assessment. The Philippines environmental assessment regulatory framework is compatible with the Bank’s safeguards guidelines, particularly OP 4.01 and BP 4.0 1, and adequate for mitigating and securing the necessary environmental safeguards. Through the Administrative Order No. 2003-30 (DAO 2003-30) of the Department of Environment and Natural Resources (DENR), all sub-projects will be required to assess environmental impacts prior to the start of the construction activities. Depending on the agreed Category (A, B, C, or D), a full Environment Impact Study (EIS), an Initial Environmental Examination (IEE), an Environmental Management Plan (EMP), or an Environmental Checklist may need to be prepared to obtain an Environmental Compliance Certificate (ECC). All these are reflected in the Environment and Social Safeguard Framework ofthe project. The project will support investments in varying sizes. The current potential sub-project pipeline includes sub-projects ranging in costs from Php 18 million to Php 190 million. The majority of sub-projects will most likely be between Php 50 million to Php 150 million. Most of the sub- projects are expected to have limited environmental impacts. Some sub-projects will aim directly at improving environmental conditions through drainage, sewerage, solid waste management and other improvements. Adverse environmental impacts are generally limited to standard construction impacts and can be mitigated. It is anticipated that only a minority of the sub-projects may be required to address and mitigate critical environmental concerns. Where appropriate, the LGUs will hire consultants to support the preparation and implementation ofthe Environmental Assessment. To ensure that the LGUs possess adequate capacity to plan, prepare and implement projects in a sustainable manner, adequate budget for environmental management support will be allocated as part ofthe sub-loan agreement. Critical Impacts and Risks: The project will not have potential large scale, significant and irreversible environmental impacts. Short term impacts will be minimized by proper planning and application ofpreventive measures and mitigated by corrective actions in the Environmental Management Plans of each sub-project. There are also no indirect or long term impacts anticipated due to the implementation ofthe sub-projects, Possible risks to the project are the limited exposure and implementing capacity of the LGUs regarding the Philippines and the Bank’s environmental safeguards requirements. Particularly first-time sub-loan borrowers, mostly municipal LGUs, may need closer guidance from LBP,

62 with the LGUs possibly outsourcing technical support and supervision in preparing, implementing and monitoring the environmental and social safeguards. Land Acquisition and Resettlement: Some LGUs may need to acquire private lands andor rights-of-way for the site for the location oftheir proposed infrastructure sub-projects. One LGU has acquired private agricultural land following the prescribed procedure of the Comprehensive Agrarian Reform Law. Titles for Land Conversion have been issued by the Department of Agrarian Reform for land conversion from agricultural use to commercial and industrial use. In cases where the land identified has occupants, the Bank’s Policy on Involuntary Resettlement, OPBP 4.12 will be applied. The Safeguards Framework provides detailed procedures and requirements guiding land acquisition and resettlements. Monitoring, Auditing and Reporting: Monitoring, auditing and reporting procedures related to the implementation of the sub-proj ects, covering both biophysical and socio-economic parameters, will be described in the EMP and in the DENR-issued ECC for the sub-projects. More specific resettlement-related monitoring may be provided in the Land Acquisition, Resettlement and Rehabilitation Policy Framework and in the Resettlement Action Plans that may have been prepared for specific sub-proj ects. Monitoring arrangements include: ’ Internal monitoring: The LGU PMO staff, under the overall supervision of the LBP, will be responsible for compliance monitoring that the Environmental Mitigation Plan (EMiP) and the Environmental Monitoring Plan (EMoP) are being observed during the pre-construction, construction and operation of each sub-proj ect, ’ External monitoring: During the operations of the sub-projects, DENR Central or Provincial Staff will monitor the compliance with the ECC and DENR standards. Monitoring, auditing and reporting procedures related to the EA implementation, covering both biophysical and socio-economic parameters, will be described in the sub- project EMF’ and in the DENR-issued ECC for the project. Additionally, the implementation support consultant retained by LBP will also assist LBP monitoring of compliance with the EMiP and EMoP. The costs of mitigating construction impacts will be included in the costs of sub-projects. Other mitigating and monitoring costs will be born by the LGUs. As part of the monitoringlimpact assessment to be done at the end of the project, the proponents will evaluate the effectiveness and implementation of the EMP. The evaluation will be attached to the final report on the project and lessons learned will be incorporated into the EMP and EA process for future projects, as appropriate. Consultation and Participation: Public information dissemination about the Project and the environmental and social safeguard policies will be undertaken by both LBP’s PMO and the lending centers on a regular basis during project implementation, and the participating LGUs during project preparation and during the conduct of the EIS or IEE for the sub-projects in accordance with the Bank’s guidelines on public participation. Consultations will be conducted in a participatory manner between the LGUs and the project beneficiaries, communities, NGOs, indigenousltribal groups and other affected persons or groups where the sub-project will be implemented. During the project appraisal, no critical social issues were identified for the proposed sub- projects, The Bank will include the monitoring of potential social issues that may arise during

63 project implementation and will address these issues, if any, during the regular implementation supervision missions. Disclosure: LBP regularly posts in its public bulletin boards and newsletters in their Central Office and at their Lending Centers throughout the country current information on projects and notices on the availability ofenvironmental impact assessment reports for projects. This practice will be observed by LBP for all types of sub-projects under this project. The DENR publishes regularly in national newspapers notices of scheduled public hearings for proposed projects, especially for Category A. Likewise, the LGUs will be posting notices to the public relevant information on their sub-projects under this project. DENR also posts in its website the list of Environmental Compliance Certificates (ECC) issued on a daily basis. Environmental Impact Assessment documents, including monitoring reports are regularly published by DENR in its annual reports and are also available upon request from DENR and its Regional offices nationwide. LGUs issue notices in their public bulletin boards current information on their proposed and ongoing projects. Barangay councils assist in the conduct of consultations with project stakeholders. The which is multi-sectoral, provides to the public by posting on bulletin boards, its resolutions and ordinances on the approval of projects. Projects under construction put up billboards to show basic information and the ECC number issued for the project. All environmental documents prepared for sub-projects which were approved for consideration by the LBP were publicly disclosed at the InfoShop in Washington and in the Knowledge Development Center of the World Bank Manila Office. These documents have likewise been submitted to and reviewed by the Regional Safeguards Committee for review at a meeting held on January 5,2006. The availability ofthe documents was posted by LBP.

64 Annex 11: Project Preparation and Supervision PHILIPPINES: Support for Strategic Local Development and Investment Project

Planned Actual PCN review 0711512004 0711512004 Initial PID to PIC 08/17/2004 0811712004 Initial ISDS to PIC 0811712004 0811712004 Appraisal 0310512006 0411612006 Negotiations 0511 112006 0511 112006 BoardlRVP approval 0612912006 Planned date of effectiveness 1012912006 Planned date ofmid-term review 0611512009 Planned closing date 0613012012

Key institution responsible for preparation ofthe project: Land Bank of the Philippines

Bank staff and consultants who worked on the project included: Name Title unit Ming Zhang Senior Economist - TTL EASUR Christopher Ancheta Municipal Engineer EASUR Christopher Pablo Operations OfficerlEconomist EASUR Arvind Gupta Lead Financial Specialist EASFP Luiz Claudio Tavares Senior Water and Sanitation Specialist EASUR Evangeline Cuenco Senior Operations Officer (Urban WBIFP Specialist) Melinda Good Senior Counsel LEGEA MeiWang Senior Counsel LEGEA Jitendra Shah Lead Environmental Engineer EASEN Maya Villaluz Environment Specialist EASEN Roberto Tordecilla Social Specialist EASSD Rene Manuel Procurement Specialist EAPCO Preselyn Abella Financial Management Specialist EAPCO Victoria Florian Lazar0 Social Specialist EASEN Karen Jacob Social Specialist Consultant Delfa Uy Infrastructure Specialist Consultant Reynaldo Asturizaga MIS Specialist Consultant Frank Radstake Environment Specialist Consultant Rowie Garcia Environment Specialist Consultant Irene Villapando M&E Specialist Consultant Mariles Navarro Economist Consultant Rosanna Martin Manuel Project Analyst Consultant Anthony Pellegrini Peer Reviewer Krishnaswamy Rajivan Peer Reviewer Gia Mendoza Program Assistant EACPF Teresita Plata Program Assistant EACPF

65 Annex 12: Anti-Corruption Measures PHILIPPINES: Support for Strategic Local Development and Investment Project

The Philippines presents a paradox where governance is concerned. There is a strong presence of civil society in the country, an open media and highly capable, professional civil servants working in public administration. Despite these characteristics, corruption remains an important barrier in the achievement of good governance. Governance indicators from a cross-country database indicate that, despite democratic processes, rule of law, political stability and control of corruption are lower in the Philippines than in comparable East Asian economies. (See Figure 1 below) Additionally, about 35 % of Filipino firms surveyed in the Investment Climate Survey reported corruption as a major constraint in doing business in the Philippines, second only to macroeconomic instability.6 Corruption and collusion also pose significant challenges for government expenditures, including those financed by the Bank. Therefore, it has been an important part ofthe Bank's work program in our past operations to address how the government is responding to corruption and what specific strategies the program has employed to help mitigate the risk of corruption. Figure 1 Governance Indicators Among East Asian Countries

Rule of Law Regutatow

Government Effectwenass

-1 0 -0 5 05

Mate The sx indicators ag regate several hundred suwey-basad va+iaMes on percepti- of gave-ce ?or almost 200 countries and tenitones The indicatom are normally distributed wrth a mean of 0 and a standard deviatton of 1. Th0 nine other East Asran %COIXLII~IBSare Chma. Hong Komg (China). Indonesa. Korea, Malapa, Singapore, Tarwan

Government Efforts to Reduce Corruption The government, with support from the Bank and other donors, is making some progress in improving governance and combating corruption. This has been primarily supported through national level reforms, but innovative efforts have also been instituted at the local level. The key reforms are described as follows: Ofice of the Om~~dsmun The Office of the Ombudsman has a major anti-corruption role within the program of the government. Among its functions to prevent graft, is the power to investigate, prosecute and adjudicate cases involving govemment entities and employees. In 2003, the Office formally adopted the government's LifesstyZe Checks Progrum, which allows it to undertake life-style

Asian Development Bank and World Bank, 2004; 716 Philippine fm surveyed.

66 checks on government employees and if warranted, remove them from their positions and initiate prosecution. Further, the Government has committed to doubling the Office’s budget over the next two years, allowing for the hiring and training of a significant number ofnew investigators and prosecutors. Procurement and Financial Management Imurovenzents The foundation of the reform lies in the promulgation of the Government Procurement Reform Act (Republic Act No. 9184) in January 2003 and the issuance of its Implementing Rules and Regulations (IRRs) in September of the same year, which covers all government entities, including local government units. As part ofthe reform, the government’s Procurement Policy Board was established with the mandate to establish and monitor procurement performance benchmarks, provide for protest mechanisms, coordinate training within the government and among civil society organizations who observe on bid and evaluation committees and to issue generic and department-specific procurement manuals and related bidding documents. Concurrent with procurement reform, the government also instituted financial management improvements through the implementation of the Electronic National Government Accounting System (E-NGAS) and the strengthening ofinternal and external audit fuflctions. Increased Involvement of Civil Society in Government The Philippines has increased transparency by recently increasing the participation of civil society in government. This has been achieved primarily by involving civil society observers in the public bid committees, providing greater transparency in the bidding process. Civil society groups have also initiated their own activities to fight corruption. For example, Government Watch (G-Watch) is an initiate from several civil society groups that monitors government projects and provides reliable information on project performance. Findings from the group have prompted the Office ofthe Ombudsman to initiate investigations into alleged corruption. At the local level, the Procurement Law repealed the procurement related sections of the Local Government Code, thereby making the new law and its Implementation Rules and Regulations mandatory for all LGUs. One of its major reforms is prohibiting the Local Chief Executive being directly involved in the bidding process, since it provides that the BAC Chairman should not be the head of the procuring entity. The government has been undertaking a vigorous program to disseminate the procurement law to LGUs and capacitate them. Training of LGUs’ staff on the new procurement system made significant progress and was mostly completed. As of December 2004, seventy-two (72) provinces, or 91% of the total number of provincial governments, one thousand one hundred seventy nine (1179) municipalities or 79% of the total number ofmunicipal governments, and one hundred nine (109) cities or 92% ofthe total number ofcity governments, were trained. World Bank Efforts to Reduce Corruption As ofJuly 2004, the Bank had channeled over US$5 million in grants to support improvements in governance. These grants have worked to address systemic issues such as procurement and judicial reform and increase the role of civil society in monitoring the government. Further, to guard against corruption in Bank programs, the Bank has strengthened its procurement and financial management staff in Manila. The Bank also began implementing a Judicial Reform Project that will assist the Supreme Court implement institutional reforms to strengthen public confidence in the judiciary system.

67 Steps to Mitigate Corruption under the Proposed Project In addition to the various fiduciary measures, the project will promote the anti-corruption agenda with a focus on supporting the implementation of government’s procurement and financial reforms at the local level. The critical reforms include the Procurement Reform Act (Republic Act 9 184), implementation of the E-NGAS accounting system, and the strengthening of internal and external audit functions. In the meantime, significant progress was made at the harmonization and alignment efforts in the procurement area. The bidding documents for works, goods and consulting services have been harmonized with the international development partner policies and procedures, including those of the World Bank’s. The harmonized bidding documents are now being used for all public procurement by every entity, including the LGUs. The progress in harmonization enables the project to focus on assisting LGUs in furthering the procurement and financial reforms which have been initiated by the government. Key elements of the anti-corruption measures include:

Process: With the harmonization progress, for NCB contracts, where the majority of the sub- projects are expected to fall into, the Harmonized Bidding Documents will be used. The procurement process outlined in the Project Operations Manual is close to the national system required under RA 9184, making it easier for LGUs to understand and follow. Remaining differences between World Bank and Government requirements are highlighted in the Harmonized Bidding Documents themselves and specified in the Loan Agreement, Fiduciary monitoring and review work by LBP and the World Bank will therefore focus on compliance with the agreed system instead of educating LGUs on unfamiliar procedures.

Monitoring: LBP will be monitoring the key steps of LGU compliance with the agreed procurement process, including: the Bids and Awards Committees (BACs) of the LGUs should be created in accordance with the requirements of RA 9 184; members of the BAC should have been trained on RA 9184, its IRR and in the use of the Philippines harmonized bidding documents; compliance with publication ofinvitation for bids in their respective websites, and in the GEPS (Philippines Government Electronic Procurement System), in addition to publications in a newspaper of national circulation; compliance by the LGUs in publication of contract awards, also in their respective websites, and in the GEPS; compliance that representatives from the civil society and NGOs are present as observers during bid openings and in the evaluation of bids.

Fund Flow Control. Under this project, the controls on the flow of funds to the sub-borrowers are very well defined. Drawdowns by the LGUs of funds against the sub-loan are based on the presentation ofprogress billings of the contractors duly approved by the LGU executive after the PMU engineer has verified the physical progress reports. LBP will also engage a technical consultant who can conduct physical inspection of the sub-projects while they are in-progress. To ensure that funds have been received fully by the contractors, the LGUs are asked to open a dedicated bank account for the sub-project with LBP to which funds drawn from the sub-loan are deposited. The LGUs will then issue a check for payment to the contractor or a debit instruction to credit the bank account of the contractor. In either case, the LGUs are also required to submit the official receipts evidencing payment before any further release of funds to the LGUs can be made.

68 World Bank ex-post review: During ex-post reviews, the Bank will undertake joint procurement/ FM reviews and will involve representatives from LBP and the Internal Audit Unit of the implementing LGU. Any deviations in the procurement process found in post reviews shall be referred to COA, GPPB and DILG for follow-up action through the oversight mechanisms built into the procurement law (RA 9184), with specific cases to be dealt with as follows:

any report ofnon-compliance with agreed procurement procedures will be forwarded to COA and the GPPB, and to DILG for proper reprimand and corrective action; any report on findings with fraud and corruption issues will be submitted to LBP, and both LBP and DILG will demand an explanation from the concerned LGU, and if report is found to be true, the amount of the contract may not be funded from the loan; in cases of anomalies, an investigation will be requested by the Bank to be conducted by GPPB, COA, LBP and the Bank; and where sub-borrowers have been proven to not be following the procurement and financial management processes described in the Operations Manual, World Bank funds will not be disbursed for the sub-projects.

69 Annex 13: Documents in the Project File PHILIPPINES: Support €or Strategic Local Development and Investment Project

1. Project Proposal for the Support for Strategic Local Development Investment Project, by the Land Bank of the Philippines to the Investment and Coordination Committee of the NEDA Board. 2. Revised Project Proposal for the Support for Strategic Local Development Investment Project, by the Land Bank of the Philippines to the Investment and Coordination Committee ofthe NEDA Board. 3. Draft Project Operations Manual, dated May 10,2006 4. Social and Environment Safeguard Framework, dated May 10,2006 5. Draft Terms ofReference for Project Implementation Support Consultant. 6. Financial Management Assessment Report for SSLDIP. 7. Procurement Capacity Assessment Report for SSLDIP. 8. Project Implementation Plan fi-om LBP. 9. Report on Non-IRA Fiscal Transfers to LGUs. 10. Aide Memoires, Appraisal Mission, dated April 12, 2006, 11, Philippines CDS Reports, League of Cities ofthe Philippines.

70 Annex 14: Statement of Loans and Credits PHILIPPINES: Support for Strategic Local Development and Investment Project

~~ ~ ~~~~ ~~~ Difference between expected and actual Original Amount in US$ Millions disbursements

Project ID FY Purpose IBRD IDA SF GEF Cancel. Undisb. Orig. Fm. Rev'd PO66076 2004 JUDICIAL REFORM SUPPORT 21.90 0.00 0.00 0.00 0.00 21.14 -0.76 0.00 PROJECT PO66397 2004 PH-Rural Power Project 10.00 0.00 0.00 0.00 0.00 10.56 0.19 0.00 PO70899 2004 PH LAGUNA DE BAY 5.00 0.00 0.00 0.00 0.00 4.95 -0.05 0.00 INSTITUTIONAL STRENGTHE PO75184 2004 PH: Diversified Farm Income & Mkt. 60.00 0.00 0.00 0.00 0.00 59.40 -0.60 0.00 Devt PO72096 2004 PH-GEF-Rural Power Project 0.00 0.00 0.00 9.00 0.00 8.75 0.05 0.00 PO73488 2003 PH - ARMM Social Fund 33.60 0.00 0.00 0.00 0.00 30.56 8.66 0.00 PO77012 2003 PH KALAHI-CIDSS PROJECT 100.00 0.00 0.00 0.00 0.00 87.71 12.77 0.00 PO71007 2003 Second Agrarian Reform Communities 50.00 0.00 0.00 0.00 0.00 47.67 13.02 0.00 Dev PO69916 2002 PH-2nd Social Expenditure Management 100.00 0.00 0.00 0.00 0.00 50.23 -6.44 0.00 PO69491 2002 PH-LGU URBAN WATER APU 30.00 0.00 0.00 0.00 0.00 32.08 13.67 0.00 PO66509 2001 PH-GEF-MMURTRIP-BicycleNwk 0.00 0.00 0.00 1.30 0.00 0.95 0.67 0.00 PO66069 2001 LAND ADMIN & MANAGEMENT 4.79 0.00 0.00 0.00 0.08 1.46 1.56 0.00 PO57731 2001 PH-Metro Manila Urban Trans. 60.00 0.00 0.00 0.00 0.00 52.06 33.37 0.00 (MMUTRIP) PO58842 2000 PH - MMDANAO RURAL DEV 27.50 0.00 0.00 0.00 6.96 2.16 9.12 3.62 PO59933 2000 PH - COASTAL MARINE 0.00 0.00 0.00 1.25 0.00 0.71 1.60 0.64 PO39019 2000 PH-First Nat'l Rds Improve. 150.00 0.00 0.00 0.00 0.00 76.36 76.36 0.00 PO48588 1999 PH-LGU FINANCE & DEV. 100.00 0.00 0.00 0.00 40.00 42.39 60.79 12.12 PO57598 1999 PH-RURAL FINANCE 111 150.00 0.00 0.00 0.00 0.00 46.01 46.01 0.00 PO04566 1998 PH-EARLY CHILD DEV. 19.00 0.00 0.00 0.00 0.00 2.58 2.58 -0.85 PO04576 1998 PH-WATER DISTRICTS DEV. 56.80 0.00 0.00 0.00 10.73 12.33 41.27 2.66 PO04595 1998 PH - COMMUNITY BASED RES0 50.00 0.00 0.00 0.00 12.00 14.26 26.26 14.26 PO04602 1997 PH-THIRD ELEMENTARY 113.40 0.00 0.00 0.00 20.10 25.86 45.96 25.86 EDUCATION PO04613 1997 PH - WATER RESOURCES DEVE 58.00 0.00 0.00 0.00 16.27 4.27 20.54 1.04 PO0461 1 1996 PH-MANILA SEWERAGE I1 57.00 0.00 0.00 0.00 20.90 11.93 32.83 9.57 Total: 1,256.99 0.00 0.00 11.55 127.04 646.38 439.43 68.92

71 PHILIPPINES STATEMENT OF IFC’s Held and Disbursed Portfolio In Millions ofUS Dollars

Committed Disbursed IFC IFC FY Approval Company Loan Equity Quasi Partic. Loan Equity Quasi Partic. - 200 1 AEI 1.oo 0.00 0.00 0.00 0.75 0.00 0.00 0.00 2001102 APW Trade 0.00 0.00 0.66 0.00 0.00 0.00 0.66 0.00 Alaska Milk 0.00 0.62 0.00 0.00 0.00 0.62 0.00 0.00 2000 Asian Hospital 7.00 0.00 0.00 0.00 5.00 0.00 0.00 0.00 2002 Banco de Oro 20.00 0.00 20.00 0.00 0.00 0.00 20.00 0.00 1998 Drysdale Food 8.97 0.00 0.00 5.13 8.97 0.00 0.00 5.13 2002 Eastwood 20.00 0.00 0.00 0.00 20.00 0.00 0.00 0.00 2001 Filinvest 20.93 0.00 0.00 0.00 14.93 0.00 0.00 0.00 2004 Globe Telecom 20.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1998 H&Q PV 111 0.00 5.76 0.00 0.00 0.00 5.76 0.00 0.00 1989 H&QPV-I 0.00 0.59 0.00 0.00 0.00 0.59 0.00 0.00 1993 H&QPV-I1 0.00 1.11 0.00 0.00 0.00 1.11 0.00 0.00 2004 LARES 22.00 2.70 0.00 0.00 0.00 0.00 0.00 0.00 2000 MFI MEP 0.00 0.12 0.00 0.00 0.00 0.12 0.00 0.00 2001 MNTC 46.00 0.00 0.00 0.00 34.30 0.00 0.00 0.00 2003104 MWC 30.00 14.96 0.00 0.00 0.00 14.96 0.00 0.00 2000 Mariwasa 11.27 0.00 3.12 0.00 11.27 0.00 3.12 0.00 1993 Mindanao Power 0.00 4.26 0.00 0.00 0.00 4.26 0.00 0.00 1993 Mirant Pagbilao 15.00 10.00 0.00 0.00 15.00 10.00 0.00 0.00 200 1 PEDF 1.so 0.00 0.00 0.00 0.75 0.00 0.00 0.00 2002 PSMT Philippines 2.100 0.00 0.00 0.00 0.00 0.00 0.00 0.00 1992 Pilipinas Shell 0.00 1.56 0.00 0.00 0.00 1.56 0.00 0.00 2000 PlantersBank 0.00 0.00 8.71 0.00 0.00 0.00 8.71 0.00 1998 Pryce Gases 13.00 0.00 0.00 5.00 13.00 0.00 0.00 5.00 2000 STRADCOM 11.99 0.00 8.00 0.00 9.59 0.00 8.00 0.00 2003 SVI 0.00 4.00 0.00 0.00 0.00 2.00 0.00 0.00 1995 Sua1 Power 22.75 17.50 0.00 68.92 22.75 17.50 0.00 68.92 1992 Union Cement 0.00 5.63 0.00 0.00 0.00 5.63 0.00 0.00 1994 Walden Mgmt 0.00 0.05 0.00 0.00 0.00 0.05 0.00 0.00 1994 Walden Ventures 0.00 0.58 0.00 0.00 0.00 0.58 0.00 0.00 Total portfolio: 273.51 69.44 40.49 79.05 156.31 64.74 40.49 79.05

72 Approvals Pending Commitment FY Approval Company Loan Equity Quasi Partic 2004 Coastal Road 0.02 0.00 0.02 0.04 2002 Eastwood 0.00 0.00 0.00 0.00 2001 PEDF 0.00 0.00 0.00 0.00 2002 S&R Price 0.00 0.00 0.00 0.00 Total pending commitment: 0.02 0.00 0.02 0.04

73 Annex 15: Country at a Glance PHILIPPINES: Support for Strategic Local Development and Investment Project East Lower- POVERTY and SOCIAL Asia & middle- Philippines Pacific Income Development diamond' 2003 Population,m id-year (millions) 8 15 1855 2,855 GNI per capita (Atlas method, US$) 1080 1,080 f480 GNi (Atlas method, US$ billions) 88.0 2p11 3,934

Average annual growth, 1997-03 Population ("/d 2.2 10 0.9 Labor force (%) 2.8 11 iz GNI Gross per primary Most recent estimate (latest year available, 1997-03) capita enrollment Poverty (% ofpopulation belo wnationalpoverfyline) 37 Urban population(%of totalpopulafion) 61 40 50 Life expectancy at birth (years) 70 69 69 Infant mortality(per jOOOllve birfhs) 28 32 32 Child malnutrition(%of children under5) 32 8 n Access to improvedwatersource Access to an improvedwatersource ~%ofpop~lation~ 88 76 81 Illiteracy (%ofpopulation age 59 7 0 0 Gross primaryenrollment (%ofschool-agepopulation) IP 111 1P -----Philippines Male 113 IP 113 Lo wer-middle-income group Female ni 111 in

KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1983 1993 2002 2003 Economic ratios' GDP (US$ billions) 33.3 54.4 78.0 80.8 Gross domestic investmentlGDP 29.8 24.0 8.3 18.7 Trade Exports of goods and sewiceslGDP 218 314 48.9 48.3

Gross domestic savingslGDP 23.1 5.5 18.8 B2 T Gross national savingslGDP .. 18.6 26.1 28.8 Current account baiancelGD P -8.3 -5.5 5.4 2.5 Interest paymentslGDP 2.8 3.3 3.6 Total debtlGDP 72.8 68.5 78.1 Total debt servicelexports 38.4 25.6 202 Present valueof debtlGDP 78.8 04.8 Present value of debtlexports Indebtedness 1983-93 1993-03 2002 2003 2003.07 (average annualgrowth) ---Philippines GDP 2.1 3.9 4.4 4.5 42 GDP wrcapita -0.3 l.8 2.3 2.5 22 Lo wer-middle-income group

STRUCTURE of the ECONOMY 1983 1993 2002 2003 I Growth of investment and GDP (Oh) I (%of GDP) Agriculture 22.4 216 14.7 14.5 2o Industry 392 32.7 32.5 32.3 10 Manufacturing 242 23.7 22.8 22.9 Q Services 38.4 45.7 52.8 53.2 - 10 Private consumption 68.8 74.4 69.1 72.3 .20 General government consumption 8.3 t3.1 P.l 114 Imports of goods and services 28.1 39.8 49.4 50.7 -GO1 -GOP

1983-93 1993-03 2002 [Growth of exports and Imports (Oh) (average annual groulh) I Agriculture 18 2.3 3.3 3.9 20 Industry 10 3.8 3.7 3.0 XI Manufacturing 19 3.5 3.5 4.2 o

Sewices 3.4 4.7 5.4 5.9 .x) Private consumption 3.4 4.0 7.9 9.5 -20 General government consumption 2.9 2.8 2.4 Gross domestic investment 2.8 3.4 -3.5 -Exports -Inports Imports of goods and Services 9.1 4.4 4.7

74 Philivvines

PRICES and GOVERNMENT FINANCE 1983 1993 2002 2003 Inflation (%) Domestic prices I 15 (%change) 7.6 3.1 19 /15 T Consumer prices 10 Implicit GDP deflator 142 6.8 4.9 3.7 5 Government finance (%of GDP, includes current gr3ntSl 11:0 I Current revenue n.7 14.1 14.0 98 99 00 01 02 03 Current budget balance 2.3 -5.2 -13 Overall surplusldeficit -5.2 -4.6

TRADE 1983 1993 2002 2003 Export and import levels (US$ mill.) (US$ mii/ions) Total exports (fob) 11375 34,383 35,414 40,000 Electro nicslTeleco m 3,551 8,583 19,053 Garments 2272 2,391 2,348 30.000 Manufactures 8,729 3181 1252 Total imports (cif) n,597 33,975 36,972 20,000 714 2,376 Food 1384 10,000 Fuel and energy 2,016 3973 3,699 Capital goods 5,6a 0,532 6,889 0 97 98 94 00 01 02 03 Export price index (S9SWO) Import price index(895=730) Exports olworts Terms of trade (?395=00) I BALANCE of PAYMENTS 1983 1993 2002 2003 Current account balance to GDP (Oh) (US$ millions) Exports of goods and services 6,613 16,046 37,439 41604 Imports of goods and services 9,197 20,700 36295 43,859 ~ Resource balance -2,384 -4,652 -856 -2,055 Net income -859 937 4,550 1660 Net current transfers 472 699 503 2445 Current account balance -2,771 -3,016 4,87 2,050 Financing tems (net) -725 2850 -4857 -1601 Changes in net reserves 3,496 S6 660 -449 Memo: Reserves includinggold (US$ mi//iOnS) 5,922 8,80 16,115 Conversion rate (DEC, /ocal/US$) 111 27.1 516 54.1

EXTERNAL DEBT and RESOURCE FLOWS 1983 1993 2002 2003 (US$ millions) :omposition of 2002 debt (US$ mill.: Total debt outstanding and disbursed 24,211 36,135 59,343 A 3,325 IBRD 2,046 4,596 3,325 G 5,568 B 208 IDA 61 167 206 Total debt service 3,026 4,920 9,192 IB RD 205 669 460 IDA 1 3 7 Compositionof net resourceflows Official grants 83 270 n8 Official creditors 10.6 964 -32 Private creditors 769 564 2,027 Foreign direct investment a5 t238 tni Portfolio equity 0 0 41) World Bank program Commitments 369 428 200 L - IBRD E- Bilaterl Disbursements 613 673 l76 I-IDA 0-Olhermdtilatffal F-Privata Principal repayments 72 340 327 Z-IMF G- Short-tff

75 IBRD 34814 120°E PHILIPPINES I Ilocos X Northern Mindanao Batan 1. Ilocos Norte Islands 58. Bukidnon Basco 2. Ilocos Sur 59. SUPPORT FOR STRATEGIC 3. La Union 60. Lanao del Norte 11 4. Pangasinan 61. Misamis Occidental LOCAL DEVELOPMENT AND 62. Misamis Oriental 20°N CAR Cordillera Admin. Region Strait INVESTMENT PROJECT 5. Abraa XI Davao Region 6. Apayao 63. Compostela Valley 7. Benguet 64. Davao del Norte POSSIBLE FIRST YEAR PARTICIPATING CITIES 8. Ifugao 65. Davao del Sur 9. Kalinga Babuyan 66. Davao Oriental Islands 10. Mountain Province PROVINCE CAPITALS XII SOCCSKSARGEN Babuyan Channel II Cagayan Valley 67. South Cotabato REGION CAPITALS 11. Batanes 68. Sarangani NATIONAL CAPITAL 12. Cagayan 69. North Cotabato 13. Isabela 70. Sultan Kudarat Laoag City 1 RIVERS 14. Nueva Vizcaya 6 Kabugao12 15. Quirino XIII Caraga MAIN ROADS 71. Agusan del Norte III Central Luzon 72. Agusan del Sur Vigan Tuguegarao RAILROADS 16. Aurora 73. Surigao del Norte 5 9 17. Bataan 74. Surigao del Sur Tabuk PROVINCE BOUNDARIES 18. Bulacan 19. Nueva Ecija ARMM Autonomous Region Bontoc 10 REGION BOUNDARIES 20. Pampanga 2 in Muslim Mindanao Lagawe 13 21. Tarlac 75. San 8 INTERNATIONAL BOUNDARIES 22. Zambales Luzon 76. Lanao del Sur Fernando 3 La Trinidad Cabarroguis 77. Maguindanao Baguio Bayombong NCR National Capital Region 78. Sulu 7 79. Tawi-Tawi 14 15 125°E IV-A CALABARZON 23. Batangas 16 4 Munoz 24. Cavite Baler 25. Laguna Palayan 26. Quezon Tarlac 19 27. Rizal Iba 21 22 IV-B San Fernando Polillo 20 18 28. Malolos Islands PHILIPPINES 29. Mindoro Occidental Balanga Quezon 30. Mindoro Oriental 17MANILA 31. Palawan 34 32. Romblon Trece Martires 27 Santa Cruz 24 Daet V Bicol 25 26 33. Albay 23 Lucena 35 36 34. Camarines Norte Lubang Batangas Pili 35. Camarines Sur Islands Virac 36. Catanduanes Boac Calapan 28 37. Masbate Mamburao 30 Marinduque Legaspi 38. Sorsogon 33 Mindoro Sibuyan Sorsogon VI Western 29 Sea 38 39. Aklan Philippine Mindoro Strait Romblon 40. Antique Ticao Catarman Tablas 41. Capiz 32 Sibuyan Masbate 52 Samar 42. Sea Busuanga 37 Calbayog 43. Iloilo Masbate 44. Negros Occidental 53 Semirara Visayan Islands Kalibo Catbalogan Roxas City VII Central Visayas Sea Borongan 45. Linapacah 39 Naval 49 50 46. 41 47. Negros Oriental Tacloban 48. Cuyo 40 Islands 43 51 Leyte Leyte VIII Eastern Visayas San Jose de Iloilo Jordan Cebu Gulf 49. Buenavista Bacolod 42 50. Eastern Samar Dumaran 46 51. Leyte Cebu 54 Dinagat 52. Northern Samar Maasin 53. Western Samar Negros 10° N 54. Southern Leyte Bohol 44 45 Surigao Tagbilaran 73 IX Zamboanga Peninsula 31 47 55. Zamboanga del Norte Bayawan Dumaguete Mindanao Mambajao 56. Zamboanga del Sur Palawan Siquijor Sea 71 57. Zamboanga Sibugay 59 48 Siquijor Camiguin Tandag 74 Dapitan Butuan Cagayan Dipolog Oroquieta de Oro Prosperidao 62 61 72 Bugsuk Iligan 55 58 Malaybalay 60 Marawi Balabac 76 Mindanao 57 56 64 63 Tagum 67 Panabo 66 Cagayan Cotabato Davao Zamboanga Mati Sulu Moro Gulf 77 Maganoy Kidapawan Isabella Digos Mount Apo Isulan (2,954 m) Basilan 70 Davao 75 Koronodal This map was produced by 65 Gulf MALAYSIA 69 the Map Design Unit of The Sulu Alabel World Bank. The boundaries, colors, denominations and 68 any other information shown 78 on this map do not imply, on the part of The World Bank 0 50 100 150 Kilometers Tawi-Tawi Group, any judgment on the Sarangani 79 Celebes Sea legal status of any , o r a n y e n d o r s e m e n t o r 5°N Bongao a c c e p t a n c e o f s u c h 0 50 100 Miles 125°E 120°E boundaries. JUNE 2006