Report No. PID10560

Project Name KAZAKHSTAN-Northeastern Kazakhstan Water Supply and (@) Sanitation Project

Region Europe and Central Asia Region

Sector Water supply (50%); General water/sanitation/flood protection sector (25%); Sub-national government

Public Disclosure Authorized administration (25%)

Project ID P070008

Borrower(s) GOVERNMENT OF KAZAKHSTAN

Implementing Agency Address PARTICIPATING WATER UTILITIES Water and wastewater enterprises (vodokanals) of the cities of Karaganda (JSC Vodokanal), Temirtau (Nizhny Bief Ltd.) and Kokshetau (Gorvodokanal). Address: JSC Vodokanal, Karaganda City; Nizhny Bief, Temirtau City;

Public Disclosure Authorized Gorvodokanal, Kokshetau City: Contact Person: S.B Uteshov; Deputy Governor of Karaganda; Mr. Erbol Toleuov, Director, Nizhny Bief Ltd.; S.V. Kulagin; Governor of Akmola Oblast, Kokshetau; Tel: 7(3212) 482970; 7(32135) 51644, 62292; 7(32135) 44555; 7(31622) 70963 Fax: 7(3212) 482970; 7(32135) 51644; 7(32135) 44555; +7(31622) 70963

State Committee for Water Resources Address: 28-A Mozhaiskiy Str., 473201, Astana, Kazakhstan Contact Person: Anatoly Ryabtsev, Chairman Public Disclosure Authorized Tel: 7-3172-356727 Fax: 7-3172-356770 Email: [email protected]

Ministry of Agriculture Address: Contact Person: A.K. Kurishbayev, Deputy Minister Tel: 7 (3172) 32 37 84 Fax: 7 (3172) 32 39 73

Environment Category F

Date PID Prepared February 4, 2003

Auth Appr/Negs Date January 27, 2003 Public Disclosure Authorized

Bank Approval Date July 15, 2003

1. Country and Sector Background Water and wastewater services in the urban centers of Kazakhstan are provided by water and wastewater enterprises (vodokanals). In 1993, the central government decentralized the responsibility for the water and wastewater sector to municipalities and phased out operating and capital subsidies to the sector. As a result, all vodokanals are required to be self-financing. In practice, most vodokanals are unable to cover operations and maintenance costs from revenues, and without any subsidies, their financial situation is extremely difficult and many of them cannot raise tariffs sufficiently and are able to survive only by delaying payments to their suppliers, particularly the energy suppliers.

Although over 80% of the households in Kazakhstan have piped water connections in their houses, the water supply service in Temirtau, Kokshetau and Karaganda is poor, both in terms of quantity and quality. A social assessment carried out as part of project preparation showed that about 559 of the people interviewed in the three cities are dissatisfied with water services. Among those who are not satisfied, the main reason for their dissatisfaction was the quality of the water supply, particularly problems with salinity and turbidity of the water, as well as sedimentation that ends up in household taps. A second reason for dissatisfaction with the service, was irregular supply. This problem was considerably higher in Temirtau, but to a lesser extent in Kokshetau where the second biggest problem was insufficient water pressure. Because of these problems, a lot of the families have adopted a variety of coping mechanisms, which include storing water in tanks, pots and containers; filtering drinking water; to buying bottled water for drinking. Data collected during project preparation also indicates significant wastage of water through leakage, and poor raw water quality (including heavy metals pollution in parts of the Nura River, a major source of raw water for Temirtau and Karaganda).

The high level of water losses and wastage is of particular concern. For example, the estimated demand for the Karaganda urban area is equivalent to 420 liters per capita per day, with losses in the system conservatively estimated at 55% or more. This very high consumption estimate is not a reflection of actual consumption, but the lack of water conservation measures in the system, and the poor condition of the system. The water requirements associated with these levels of losses and wastage put a significant strain on the water resources of the catchment and does not provide an adequate level of service to the population.

Much of the existing water supply and wastewater infrastructure is in dire need of replacement and repair. Almost all infrastructure in the three cities, including water intakes, water distribution and wastewater collection networks, pumping stations, and water and wastewater treatment plants, suffer from advanced deterioration. The current financial performance of the vodokanals, coupled with the withdrawal of state subsidies to the sector, and lack of maintenance, has exacerbated the situation even further.

Therefore, one of the critical challenges facing the Government, is to mobilize private and public resources to stem the deterioration in the economy's water supply physical infrastructure. This infrastructure, which was heavily subsidized by the Soviet Union until 1992, now faces important challenges as maintenance is being postponed due to resource constraints while new investments are being delayed. The continued deterioration has become one of the main causes of increased water borne diseases, deterioration of health indicators and decline in living

- 2 - standards. Bank support in financing basic infrastructure, emphasizing rehabilitation and improved efficiency of existing assets rather than new investments, will therefore be very critical to the sustainability of the sector.

In addition to the poor state of the distribution network, the following constraints also plague the urban water and sanitation sector, and in particular the three vodokanals in the project:

Inefficient operations: Water and wastewater treatment plants were inappropriately designed and are poorly maintained and operated. As a consequence, these plants perform badly in terms of quality of output and efficiency. Other components of the water and sewage systems (e.g., distribution systems) are similarly inefficient. All these inefficiencies increase operating costs unnecessarily.

Poor financial viability: Most of the vodokanals in the country, including the Nura-Ishim basin are facing reduced government transfers due to fiscal constraints. At the same time, they are not allowed to raise tariffs sufficiently to cover all operating and maintenance costs. Tariffs levels are controlled by the State Anti-Monopoly Committee (AMC) through a set of formulas that do not allow for adequate provision for all operating and maintenance costs. The collection efficiency is also very poor. The result is a poor financial situation that does not allow adequate maintenance of vodokanal assets. Most vodokanals have accumulated large debts to their suppliers, most notably electricity providers. Additionally, the utilities and municipalities have made little or no investments in rehabilitation, repair and/or expansion of facilities for years.

Lack of incentives for water conservation: Inefficient water use in the municipal, industrial and irrigation sectors seems to be the norm. The low level of water charges for raw and bulk water and the low tariffs for treated water provide very weak signals to water users about the value of the resource. At the municipal level, households, industries and public agencies, not accustomed to water conservation and not faced with appropriate water tariffs waste significant amounts of water, driving up operating costs unnecessarily.

The Government strategy is to address these inefficiencies through decentralization of responsibilities for managing utilities and service provision to local government institutions, revising the legislation regulating tariffs, and encouraging full cost recovery of operational, maintenance and debt service costs, including efficient utilization of public resources. The approach followed in the project, which focuses on rehabilitation and institutional and capacity building, using public/private partnerships to support service improvements, is consistent with the Government's strategy. The project approach focuses on: (i) halting the deterioration of urban water supply infrastructure; (ii) strengthening market incentives and institutions involved in service delivery; (iii) supporting private sector involvement where appropriate to improve efficiency; (iv) scaling up investments in rehabilitation of water supply and sanitation systems; and (v) increasing cost recovery and introduction of commercial practices in utility management and ensuring proper operations and maintenance, including allowing the vodokanals to

- 3- finance system rehabilitation from own resources. The Central Government, as well as the local and regional governments, are in full support of this project approach.

2. Objectives The development objective of the project is to improve the quality and sustainability of the water supply and wastewater services in the cities of Termitau, Karaganda and Kokshetau, located in the Nura/Ishim river basin. The development objective would be achieved through: (a) strategic rehabilitation and efficiency improvements of existing water and wastewater facilities; and (b) institutional strengthening of the Nizhny Bief Vodokanal (NBVK) in Termitau, the JSC Vodokanal (JVK) in Karaganda, and Gorvodokanal (GVK) in Kokshetau, through a performance-based management and operation contract with an internationally experienced water utility operator (the Operator).

3. Rationale for Bank's Involvement Through its water supply operations (either ongoing or under preparation) and sector work in neighboring countries (Kyrgyz Republic, Tajikistan, Uzbekistan) and the two ongoing sector operations in Kazakhstan, the Bank has acquired a strong understanding of sectoral issues in Central Asia and is therefore in a good position to provide Kazakhstan with comparative and relevant experiences. Additional value added of Bank support in this project lies in: (a) the introduction of commercial and cost-recovery practices in water and sanitation services in transition economies; (b) facilitating the selection and contracting of the Operator for the project; (c) acting as catalyst for various policy and sector reforms; (d) assuring transparency in the selection of the most attractive offer from international operators through the use of Bank's procurement procedures; (e) supporting the project management and implementation arrangements; and (f) providing support to mobilize trust funds for the preparation of the project.

4. Description

Project Component 1 - Repair and Rehabilitation Fund (RRF): This component would support essential short-term expenditures and a least-cost capital investment program aimed at improving operations and achieving the performance targets in the management contract. The short-term expenditures would include tools, equipment, computers, and inputs for repairs and maintenance, metering equipment, cars and vehicles, among other items. A preliminary capital investment program for each city was prepared, based on a technical assessment that was carried out during preparation. The most optimal investment program for each city involves rehabilitation of key components of the water and wastewater system, such as the distribution and collection networks, treatment plant and pumping station efficiency, and also support demand management. The Operator, will identify on an annual basis, a detailed investment program for implementation, and will propose how the Repair and Rehabilitation Fund would best be used to improve efficiency and quality of services and to achieve the management contract targets (for example sections of the water distribution network, specific components of the water treatment plant, pumping stations), as well as specific measures to improve financial management, accounting and other commercial systems. All annual investments under the Repair and rehabilitation Fund will be subject to

- 4 - Bank approval and the use of Bank procurement guidelines.

Project Component 2 - Management Contract (MC): This component would finance costs of the management contract. These costs include a base fee and a performance based incentive fee to the Operator, based on achievements of the targets in the Operator's contract. The Operator would have full responsibility for the management of the utilities' investment program, operating the water supply systems, developing and implementing the demand management program, managing the personnel and establishing and managing the commercial (billing and collection) and financial management systems of the three vodokanals. NBVK, JVK and GVK will continue to operate under their present independent status as municipally owned enterprises. The relationship between these vodokanals and the municipalities is supposed to be at arms-length basis. However, in reality, particularly in the cases of Karaganda and Kokshetau, the vodokanal decisions are strongly influenced and in many cases determined by the municipalities. One of the objectives of this project is to change the role of municipal governments to provide an enabling environment that will give the utilities real autonomy and opportunities to strengthen their institutional and financial capacity. The involvement of the Operator in strengthening the vodokanals technical capacity and institutional and financial performance will help in clearly defining and clarifying the roles and responsibilities of each party in relation to the municipalities.

Project Component 3 - Engineering designs, Studies, and Supervision of Construction: This component would finance the preparation of engineering designs and bidding packages for the construction program and supply of goods financed under the Repair and Rehabilitation Fund. This component would also finance other construction supervision related to the project activities.

Project Component 4 - Consulting Services and Project Management Unit: This component would finance: (a) consulting services to support the Project Management Unit (PMU), including the incremental operating costs of the PMU; (b) independent technical and financial auditors that would monitor the Operator's performance in relation to the targets in the management contract; independent consultants to conduct project audits and financial audits of JVK, GVK, and NBVK and other consulting and legal advisory services as required; (c) consultants to support institutional and legal reforms to facilitate the longer-term involvement of the private sector in the provision of water and wastewater services; and (d) training for PMU and vodokanal staff.

5. Financing Total ( US$m) BORROWER $25.33 IBRD $80.82 IDA Total Project Cost $106.15

6. Implementation Implementation period: FY2004-2008

-5- Executing agencies: The Nizhny Bief Vodokanal (NBVK) in Temirtau; JSC Vodokanal (JVK) in Karaganda; and Gorvodokanal (GVK) in Kokshetau.

Project administration and coordination arrangements: The Committee for Water Resources (CWR) under the Ministry of Agriculture would have the overall responsibility for project oversight. CWR is a national agency under the Ministry of Agriculture whose responsibility is to carry out water resources planning and management, including the planning of water supply infrastructure investments in Kazakhstan. CWR manages the largest World bank portfolio in Kazakhstan (8 projects and activities) and is well staffed, familiar with Bank procedures and guidelines and can provide the necessary oversight. The Chairman of CWR would be responsible for coordinating project implementation between the Ministry of Agriculture and other relevant agencies, including the local government authorities, and other government agencies. The chairman of CWR would also head a Project Coordinating Committee, consisting of representatives of the municipal governments in each city, key agencies of the Government, (Ministry of Finance, the AMC, and the Ministry of Environment). The key responsibilities of the Project Coordinating Committee would be to provide oversight and guidance on policy and strategic matters in the implementation of the project, including financial matters. It will meet on a regular basis to review and approve annual procurement plans prepared by the Operator on behalf of NBVK, GVK and JVK.

Within CWR, a PMU headed by a Technical Coordinator (TC) and reporting to the Chairman of CWR has been established to carry out the day-to-day management and implementation of the project. The PMU is located in Astana, but has sub-offices in Karaganda (for both Karaganda and Temirtau) and in Kokshetau, each headed by a Deputy Coordinator. The PMU would handle procurement processing, including the evaluation, preparation of loan withdrawal applications and financial matters, including audits. The PC would also supervise the implementation of the management contract, and coordinating with NBVK, JVK and GVK, the Operator, and the Municipalities of Temirtau, Karaganda and Kokshetau. The PMU will also jointly report to the Project Coordinating Committee and seek its guidance on policy matters relating to the implementation of the project.

NBVK, JVK and GVK would sign a single management contract with the Operator. The contract will include separate service agreements to reflect the technical differences in each city's system. The Operator will have the responsibility for management of the water supply an sanitation services in each city under a four year performance based contract. The Operator will also manage the existing staff of the water supply and financial departments of NBVK, GVK and JVK during project execution. Ownership of the assets will remain with the vodokanals and the Municipalities, and the authority for setting tariffs with the Municipalities. The Operator, with the assistance of NBVK, GVK and JVK would prepare the annual investment programs, including designs, procurement and supervision of construction. All procurement would be done in accordance with Bank guidelines. Bank funding for investments would be available through the Repair and Rehabilitation Fund and released only for investments proposed by the Operator subject to Bank and vodokanals' review and agreement. The Project Coordination Committee (PCC) will review and approve the annual investment and procurement plans, and the PMU will submit these to the World Bank for review and no

- 6 - objection.

Financial Management Arrangements: A preliminary financial management capacity assessment was carried out for the project and a summary report is at Annex 6B. The necessary improvements to ensure that the project has in place, adequate financial management systems, including internal controls, accounting and reporting satisfactory to the Bank, as required by OP/BP 10.02 were discussed and agreed with the Government. These improvements are to be implemented under a time-bound action plan, following which the Bank's financial management specialist will certify the project as meeting the minimum financial management requirements of the Bank. The PMU has already installed an interim financial management system (financed through project preparation trust funds), for the provision of information on project sources and uses of funds. A more comprehensive financial management system for each vodokanal that integrates each vodokanal's financial accounts and project finances will be installed by the Operator.

The PMU will ensure the preparation and distribution of consolidated periodic progress reports to NBVK, JVK and GVK, and relevant government institutions, including the World Bank, to reflect: (i) sources and uses of funds, by component and activity; (ii) project progress; and (iii) procurement activities. In this context, the PMU will prepare quarterly Project Monitoring Reports (PMRs), which would be submitted to the Bank within 45 days of the end of each quarter.

Audit Arrangements: The PMU, would be responsible for ensuring that the project financial statements, Special Accounts (SA), and Statement of Expenditures (SOEs) are audited by an independent auditor, acceptable to the Bank, in accordance with International Auditing Standards (IAS). The Operator is responsible for providing financial statements to the PMU. The PMU will maintain responsibility for the management of project funds and the Special Accounts. It will also monitor and keep track of the use of funds. The audits will cover all funds related to the project, including counterpart funds, for all project components. The annual audit will be carried out in accordance with the Guidelines for Financial Reporting and Auditing of Projects Financed by the World Bank. In addition, the financial statements of NBVK, JVK and GVK will be audited and sent to the Bank along with the project audit.

Disbursements: Disbursements from the Loan will be made based on traditional disbursement methods (i.e., from the Special Account with reimbursements made based on Statements of Expenditures (SOEs) and full documentation, and direct payments from the Loan Account). The proceeds of the World Bank Loan will be allocated in accordance with Table C, Annex 6. To facilitate timely project implementation, the PMU will establish, maintain and operate, three Special Accounts (one each for NBVK, GVK and JVK) under terms and conditions acceptable to the Bank.

On-lending Arrangements: Loan proceeds will be passed on to NBVK, JVK and GVK though a Loan Agreement with the Ministry of Finance and a Subsidiary Loan Agreement between the Ministry of Finance (MoF) and NBVK, JVK and GVK. The on-lending terms to NBVK, JVK and GVK will be on IBRD terms (including a five year grace period and a repayment period of 20 years). During appraisal, the Bank will confirm with the Government whether the

- 7- foreign exchange risk would be passed on to NBVK, GVK and JVK (i.e., sub-loan repayments would be made using the official Tenge/USD exchange rate on the day of payment).

Monitoring and evaluation arrangements: The PMU, with the support of international independent technical and financial auditors acceptable to the Bank, will monitor progress against agreed performance indicators specified in the management contract. One of the tasks of the Operator will be the implementation of monitoring mechanisms to gather the necessary technical data to better manage the water supply system. This data will also serve as basis to determine performance improvements in a way that can be independently verified by auditors. The Operator will furnish the PMU with quarterly and annual reports summarizing the service contract operations and the utilization of project funds. The PMU will prepare and provide to the Bank, on a quarterly basis, consolidated reports on project implementation progress covering: (i) projections for project financing and implementation; (ii) status of project finances, procurement of goods and works; (iii) status of utilization of the RRF; (iv) statements of income and expenditure for the current and previous quarter; and (v) monthly cash flow projections for the next six months. All project financial information presented would be in compliance with International Accounting Standards (IAS). These reports would be submitted to the World Bank within one month of the end of the relevant quarter, and would provide the basis for monitoring the progress of the project. Draft annual action programs for the upcoming year will be included with the corresponding quarterly report for the Bank's review and comment. The Government of Kazakhstan and the World Bank will conduct joint reviews annually during supervision missions. The PMU would prepare a detailed mid-term report to serve as the basis for a Project Mid-Term Review, to be undertaken no later than two years after project effectiveness. The Government will prepare and discuss with the World Bank, no later than three years after project effectiveness, a report on the future institutional and managerial arrangement for the provision of water and wastewater services in Temirtau, Kokshetau and Karaganda and with the consideration of the various options for private and public sector participation. The PMU, with guidance from the World Bank, would also prepare and submit an Implementation Completion Report (ICR) to the World Bank within six months of the closing date of the IBRD Loan. Included in the ICR would be an assessment of the execution of the project, its costs and benefits, the performance of the Borrower, NBVK, GVK, and JVK, the Operator, the PMU, the Bank, and Government agencies involved in the project regarding their respective obligations and accomplishments, and lessons learned.

7. Sustainability The sustainability of the project during the implementation phase depends on the following factors:

The Operator is selected through an open and transparent competition to achieve the best price for the scope of services requested; The Operator is able to work successfully with the local staff of the vodokanals of the three cities and effectively transfer managerial, technical and financial know-how; The financial resources available to the Operator are sufficient to implement the rehabilitation activities necessary to bring noticeable

- 8 - benefits in the quality and reliability of the water and sanitation services and, furthermore, these benefits are perceived by consumers to be commensurate with the tariff increases; The operating revenues of NBVK, GVK and JVK that the Operator is able to collect are sufficient to cover the operating and maintenance costs and make the counterpart contributions to the project; The populations of Karaganda, Temirtau, and Kokshetau agree to the increases in tariffs and the vodokanals are able to increase collection efficiency from all user categories; and The regulatory environment of all aspects related to the management and operations of the systems (e.g., construction permits, procurement, water shut-off) are flexible and agile enough to allow the Operator to carry out its functions.

The sustainability of the project after implementation depends on the following main factors:

Improvements in the water supply services and operational efficiency are in line with the increases in tariffs and collection through which the population is expected to support the reform of the sector; The management and know-how brought by the Operator is effectively transferred to the personnel of vodokanals and leads to fundamental changes in the management and operating practices of the utilities; Arrangements are in place to ensure continued good management of the water supply services after completion of the project. Prior to the completion of the project, a specific plan will be prepared for the continued management of the three participating vodokanals. This plan would be decided after careful analysis of the lessons learned during implementation of the project and evaluation of the full spectrum of future options to continue with private management and operations possibly through a higher level of private involvement, such as a lease contract; The Operator not only fulfills the minimum obligations under the contract, but is also able to achieve significant improvements beyond the agreed minimum targets, thereby demonstrating to the Government and citizens of Temirtau, Kokshetau and Karaganda that the involvement of the Operator was worthwhile. The local governments provide the Operator with the tools to collect charges and enforce payments, and The central and local government continue to provide the necessary resources to institutional customers to pay their water charges.

8. Lessons learned from past operations in the country/sector The Bank's involvement in the water and wastewater sector in Kazakhstan is still in the early stages, and the proposed operation will be the third, with one completed and another operation still under implementation. None of the two earlier projects supported the involvement of the private sector in the provision of water and wastewater services. Both projects were pilot programs, and required substantial learning by both the Bank (to understand the water sector, in a country that was still undergoing transition to a market economy) and the Government (to gain familiarity with Bank objectives and ways of doing business). It is too early to draw meaningful lessons from these projects, but some of the key lessons emerging from the completed as well as the on-going projects are that implementation of investments, without sufficient consideration of financial issues such as cost recovery can affect the sustainability of

-9- investments.

In other transition countries, the Bank's involvement in the sector has also just started. Some of the projects in the region have suffered from a lack of focus in project design, inadequate and clear implementation arrangements that have caused delays. Three projects similar to this operation are just beginning in Albania, Tajikistan, and Uzbekistan, and one is currently under implementation in Armenia and Kosovo. In all these projects, an operator would be hired under a management contract to manage and operate the water and sanitation services. Some of the key challenges in these projects include a lack of understanding on the side of government and the utility of the key reforms needed; a possible waning of commitment and interest to reform and institutional strengthening during implementation (especially on politically sensitive issues), initial unrealistic and over-ambitious expectations at the local level, particularly in terms of the financial and service improvement of vodokanals and the required capacity of facilities; and a tendency to discuss investments first while keeping institutional and financial matters for later. A series of up-front actions have been agreed with the Government for implementation before negotiations and effectiveness, including a financial recovery action plan, implementation of the required tariff increases, and the selection of the Operator through an international competitive process.

Among the lessons that can be learned from the Bank's general experience in the sector, and in transition economies in particular, that are applicable to this project are as follows:

Project preparation requires strong involvement and ownership by the Borrower, the project executing agencies and other parties concerned, particularly in transition countries, where the need for reform, change in behavior on part of utilities, consumers and municipalities in terms of paying for service rendered; the unfamiliarity with the Bank's procedures, and the lack of a strong private sector, are more pronounced than in other client countries. Implementation of this project will require intensive and close work with the client and continuous interaction to ensure an adequate understanding of the reforms and the consequences of not implementing them with conviction. Client commitment should also be demonstrated through implementation of the first steps of the reform program, prior to project approval.

The project scope should be based on a realistic assessment and projection of the financial capabilities of the utilities and the commitment of the municipalities and Oblasts to support a revenue increase program based on higher tariffs and collections. This assessment will require a transformation of the vodokanals' financial statements to International Accounting Standards in order to understand the true financial position of the vodokanals and their borrowing capacity. During preparation, a financial recovery action plan was agreed with a specific tariff increase program. The implementation of the first steps of this program, i.e., initial tariff increases, were the milestones to proceed with the completion of project preparation.

Institutional strengthening programs for weak public utilities based on the provision of technical assistance have proven to be insufficient. The

- 10 - basic approach of this project would be to initiate the path towards institutional strengthening and financial viability through the involvement of the Operator with adequate delegation of managerial and operational responsibilities, combined with clear incentives to achieve the performance targets. The strengthening of the vodokanals will take place through implementation of the project, particularly the operational improvement programs to be carried out by Operator, and through specific training programs that the Operator will provide.

Project readiness is fundamental to achieve the project objectives and avoid delays in implementation and loan disbursements. Implementation arrangements must be clearly defined, including the responsibilities of all parties involved

Innovative projects like the proposed one require intensive technical, procurement and managerial Bank supervision during project preparation and implementation.

The institutional and policy reforms required for the success of the project need the involvement, commitment and support of the authorities with clear demonstrations of commitment during project preparation. Implementing the first steps of the reforms needed prior to project implementation will not only demonstrate the government commitment but will also facilitate the transition of the operation and management of the water and wastewater systems to the Operator.

These lessons have been taken into account in the preparation of this project.

9. Environment Aspects (including any public consultation) Issues : At this point of project preparation, the project is not expected to finance the construction or expansion of new facilities such as those used by the vodokanals for water production, water treatment, wastewater collection, wastewater treatment, or other vodokanal activities. The Immediate Investment Program will support urgent repair and rehabilitation of small components of the water systems. The Operating Investment Fund will only support essential short-term expenditures aimed at improving operations and achieving the performance targets in the management contract and urgent investments needed to rehabilitate certain components of the system that already exist and are under operation. Overall, no new structure of significant size is envisaged to be constructed under the project. All components currently envisioned in the project are planned to be of rehabilitation nature in properties owned by water companies and wastewater departments or rights-of-way assigned to municipal infrastructure. The project is not expected to entail any resettlement. Given the above considerations, the environmental rating for the project is proposed to be B.

Potential negative impacts of the project are expected to be preventable and localized. Furthermore, they could be minimized through adequate construction practices. The most important expected environmental benefits would be: (i) reduction of health risks associated with inadequate microbiological quality of drinking water; and (ii) reduction of impacts on water resources (both quality and quantity). The potential negative impacts, to be minimized through adequate mitigation measures,

- 11 - would relate to: (i) inappropriate disposal of excavated materials, construction debris, and small quantities of hazardous wastes related to construction activities; (ii) environmental damage caused by contractors during construction activities; (iii) nuisance during construction (noise, dust, damage to existing utilities, and traffic disruption); and (iv) safety hazards from chlorination process. The contract documents will include provisions acceptable to the Bank for avoidance and mitigation measures of these impacts.

During project preparation, special attention will be paid to OP 7.50 (International Waterways), as Paragraph 2 states that the policy applies particularly to water and sewerage projects that involve the use or potential pollution of international waterways. The current plan of investments to be financed under the project, may indicate that the exceptions for notification under Paragraph 7(a) of OP 7.50 could apply, as it is expected that the investments will not adversely change the quality or quantity of water flows to the other riparians and will not be adversely affected by the other riparian's possible water use. However, such determination will be made after further evaluation of the type of investments required and specific consultations.

As part of project preparation, the facilities of all participating vodokanals will be evaluated with particular attention to any possible dam structure that may fall within the criteria of OP 4.37 under paragraph 6. Although no construction of dams will be financed by the project, it is possible that some of the retention structures used in the operation of the vodokanals may fall under the category of large dams. This identification will be done early in project preparation and adequate steps will be taken to ensure compliance with OP/BP 4.37, including an independent inspection of the safety status of such dams, their appurtenances, performance history, the operation and maintenance manuals, as well as recommendations for any remedial work or safety-related measures to achieve acceptable standards of safety. If necessary, these measures will be included in the operational requirements of the utility operator under the management contract.

10. Contact Point:

Task Manager Jonathan S. Kamkwalala The World Bank 1818 H Street, NW Washington D.C. 20433 Telephone: (202) 473-1870 Fax: (202) 614-0902

11. For information on other project related documents contact: The InfoShop The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 458-5454 Fax: (202) 522-1500 Web: http:// www.worldbank.org/infoshop

- 12 - Note: This is information on an evolving project. Certain components may not be necessarily included in the final project.

- 13 -