Province Water Supply Development Project (RRP UZB 46135)

ECONOMIC ANALYSIS

A. Macroeconomic Context

1. has grown rapidly in the last 10 years, with economic output expanding annually at an average of 8%. A robust industry sector has driven the country's sustained growth, fueled by a strong natural resources sector and a manufacturing base led by the automobile, chemical, and machinery industries. Construction activities spurred by a vibrant public investment program and a dynamic services sector have also boosted growth.1 In 2015, despite a challenging external environment caused by the economic slowdown of the Russian Federation (Uzbekistan's largest trading partner and source of remittances), growth of 8% was still achieved through expansionary fiscal policies comprising increased public spending and cuts in business and personal taxes.

2. The weak global environment and historically low energy prices exerted downward pressures on the economy in 2016, slowing down growth to less than 7% for the first time in years. Faster growth is expected from 2017 and beyond, driven by an investment-led industry and propelled by a program of structural reforms, modernization, and diversification. The program will develop a high-tech industry, make production less energy intensive, and increase the output of goods with high value added, potentially generating a more diverse and sophisticated export base.2 Over the long term, the government's main challenge is to sustain the country's remarkable economic growth by increasing the economy’s competitiveness, improving the business environment, and developing infrastructure to support rapid job creation.

B. Urban Sector Context

3. Apart from Tashkent city which is governed independently, Tashkent province is made up of 14 districts, 12 component cities, 61 urban villages, 146 rural councils, and 981 settlements. It is endowed with natural resources which include , coal, gold, silver, natural gas, , and granite. Kibray and Zangiota, two districts in the province which are closest to Tashkent city, are strategically important to accelerating growth and strengthening urban–rural linkages. Kibray has growth prospects in agro-industrial development, the textile industry and, to a lesser extent, in coal energy production. Zangiota is similarly positioned in agro-industrial development and the textile industry but has stronger tourism potential with its outstanding monuments reminiscent of medieval architecture. The district has also been identified as a potential special industrial zone.3 The project will respond to the anticipated increase in the demand for clean and reliable water as the districts of Kibray and Zangiota prosper to keep pace with the development of Tashkent city and the rest of Tashkent province.

C. Economic Rationale for Government Intervention

4. Uzbekistan’s development goal and economic growth projections underscore the need for adequate municipal infrastructure and services. The country’s level of urbanization and robust growth prospects are generating increased demand for basic infrastructure and utilities. Aging infrastructure which must be replaced has become synonymous with poor quality and unreliable

1 With an average annual rate of growth of 8% over the last 10 years, Uzbekistan has emerged as one of the fastest growing economies in Europe and Central Asia. 2 Currently, Uzbekistan's exports depend heavily on prices of a few major commodities and developments in a handful of countries. Minimizing external shocks and achieving export competitiveness will entail reforms towards a more diversified and advanced export mix. 3 Tashkent Region's Socio-Economic Development Strategy. 2015. Institute of Forecasting and Macroeconomic Research under the Cabinet of Ministers of the Republic of Uzbekistan, Tashkent city mayor's office, and the offices of the United Nations Development Programme (UNDP) in Uzbekistan. 2 utility services. They manifest market failure and the inadequacy of private sector investment, necessitating government intervention. In the districts of Kibray and Zangiota, households and business activities are hampered by the constant interruptions in their piped water supply, forcing them to use alternative water supply sources such as shallow wells, stand pipes, and trucked water. The situation will only worsen as Kibray and Zangiota develop further as agro-industrial, textile, and tourism centers and attract more migrants from other provinces because of their proximity to Tashkent city. The project will address the market’s failure to rehabilitate and expand the 46-year- old regional water distribution system servicing the districts of Kibray and Zangiota. It is essential to the development plan of the government for the province of Tashkent to double its gross domestic product in the next 10–15 years. The project will also foster the sustainable urban development of Tashkent city, transforming the capital and its nearby areas into a more economically competitive, inclusive, and livable urban agglomeration.

D. Least-Cost Analysis

5. The project has been designed to address water supply shortages, quality, and operational and maintenance issues. A two-phased technical feasibility study was followed. In the first phase, technically practicable water supply system development options were formulated to improve water supply in four districts—, Kibray, Yangiyul, and Zangiota. These options include surface water sources, ground water sources, and a combination of the two. In the second phase, because of fiscal considerations the project was geographically restricted and oriented towards the improvement of water supply in Kibray and Zangiota districts. Alternative technical options were further analyzed and the optimum design solution was identified based on the earlier schemes, taking into account local water resource availability, investment efficiency, future operational expenditures, and reduction of social and environmental impacts. The project development technology, which is in essence a component in each of the options developed in the first phase, was ultimately selected based on a criteria that focused on sustainability, highlighting the conservative use of water resources, use of materials, and construction technologies.

E. Demand Analysis

6. Residential demand for water was based on the Institute of Forecasting and Macroeconomic Research’s population projections for Kibray and Zangiota over the benefit period.4 For Kibray, the population in the project area was projected at 55,520 in 2022, reaching 63,980 at the end of the benefit period in 2047. For Zangiota, the population in the project area in 2022 was estimated at 269,211, reaching 367,911 by 2047. Using the Institute of Forecasting and Macroeconomic Research population projections for the two districts, nonincremental demand which will replace the existing, more costly water supplies from alternative sources was estimated based on the survey conducted in the project areas.5 In Kibray, the survey showed that 42.2 liters/capita/day were consumed from alternative water sources; in Zangiota, a higher consumption rate of 87.2 liter/capita/day was reported.

7. For incremental demand which pertains to the additional demand for water induced by the project, the consumption rate was assumed to be in the range of 90–120 liters/capita/day based on the government’s planning parameters, supplemented by the socioeconomic survey conducted in

4 The demand projections used were based on the population estimates of the Institute of Forecasting and Macroeconomic Research for Kibray and Zangiota. The Institute of Forecasting and Macroeconomic Research was established in 2008 and it provides the forecasts used for Uzbekistan’s socioeconomic development and structural transformation plans. 5 A socioeconomic and willingness to pay survey was conducted by the Uzbekistan Agency under the project preparatory technical assistance during April–June 2016. 3 the project areas. For commercial and institutional users, it was assumed that their consumption will be equivalent to 30% of residential demand as concluded by the Uzbekistan Agency (UCSA) based on an analysis of its historical sales performance. This was increased by a factor of 5% annually to incorporate the incremental increase in water demand coming from the expansion of existing businesses and the establishment of new ones as a result of the planned economic growth in the two districts. Unaccounted-for water losses were estimated at 30% of total residential demand as determined by the UCSA.

F. Cost–Benefit Analysis

8. The cost–benefit analysis of the project was conducted in accordance with relevant ADB guidelines.6 The analysis was based on forecasts of capital and operation and maintenance (O&M) costs and the estimated costs and benefits of the project which were valued using the domestic price numeraire. This valuation methodology converted border price equivalent values to their equivalent domestic price levels by applying shadow prices. The shadow price adjustment factors used were taken from a similar recent Uzbekistan project.7 The factors used were 1.11 for tradeable goods and 0.80 for unskilled labor. The annual costs and benefits of the project were assessed over a 30-year period, allowing a 5-year construction period followed by a benefit period of 25 years.

9. Economic costs. Capital and recurrent O&M costs, including physical contingencies and in constant 2016 prices, were converted into economic costs by subtracting all transfer payments, including taxes and duties, before applying the shadow prices. The analysis took into account project life cycle costs and considered not only the capital costs required for the investment but also the O&M costs throughout the benefit–cost evaluation period.

10. Economic benefits. The benefits were derived primarily from the following sources: (i) incremental water consumption calculated according to the willingness to pay of the consumers, existing water demand, and water demand projections; and (ii) nonincremental water sales benefits equivalent to the resource cost savings from income and time saved by the households as a result of switching from alternative water sources to the project. The socioeconomic and willingness to pay survey conducted in the project areas showed that households were willing to pay an average of SUM3,616 per capita per month for improved water services.8 The resource cost savings from switching to the project from alternative water sources were estimated at SUM46,300 per capita per month based on the same survey. Additional resource cost savings were calculated in accordance with the survey results, which reported that households spent an average of 1.2 days per month accessing water from vendors, pumping stations, hand pump boreholes, public water reservoirs, and water bodies. This can be traced to the unreliability of the water supply for households connected to the system and the lack of access to clean water by those who have yet to be connected to the system.

6 These include the following: (i) ADB. 1997. Guidelines for the Economic Analysis of Projects. Manila; (ii) ADB. 1998. Economic Analysis of Water Projects. Manila; and (iii) ADB. 2002. Handbook for Integrating Risk Analysis in the Economic Analysis of Projects.Manila. 7 These shadow price adjustment factors are consistent with similar projects of the same nature in Uzbekistan. See for example: ADB. 2015. Report and Recommendation of the President to the Board of Directors: Proposed Loan to the Republic of Uzbekistan for the Djizzak Sanitation System Development Project .Manila. 8 See World Health Organization. 2014. Estimated DALYs ('000) by cause, sex, and WHO Member State (1) 2012. http://www.who.int/healthinfo/global_burden_disease/estimates/en/index2.html. For the purpose of this analysis, the following estimated environmental burden of diarrhea in Uzbekistan in terms of DALYs was used: equivalent to 14 days per 1,000 people per year people aged 15–59. This is a more conservative approach than using the DALYs for all ages, which was reported to be 250 per 1,000 people per year, reflecting the fact that in Uzbekistan the estimated DALY for ages between 0–4 is significantly higher than the DALYs estimated for the remaining age groups..

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11. The project is anticipated to improve public health with the construction of the new water treatment plant in Kadirya and the planned rehabilitation and expansion of water transmission and distribution facilities. The public health benefits of the project were quantified through savings in (i) the disability adjusted life years (DALY)9 as a result of the improved access to clean water and resultant reduction in the incidence of waterborne diseases particularly diarrhea, and (ii) the medical expenses of households exposed to pollution through untreated groundwater. In estimating the health benefits, the approach of the World Health Organization in determining the annual economic value of a DALY to be equivalent to a country’s gross national income per capita was adopted. Using a modest annual growth rate of 5%, Uzbekistan’s gross national income per capita was calculated to reach $4,720 by 2022, which is when the benefit period is expected to start. For the purpose of this analysis and based on a conservative estimate of the environmental burden of diarrhea in Uzbekistan, it was assumed that the project will result in savings of 14 DALYs per 1,000 people (footnote 8).

12. Economic internal rate of return calculation and sensitivity analysis. The resulting base-case economic internal rate of return is 14.54%, which exceeds the economic opportunity cost of capital of 12.00% (Table 1). This confirms that the project is economically viable, with anticipated economic benefits greater than estimated economic costs. A sensitivity analysis, undertaken to further test economic viability, ascertained that the project will remain economically robust under the following scenarios: (i) a 10% increase in investment cost possibly arising from a delayed implementation schedule or inflation that is higher than expected; (ii) a 10% increase in O&M costs which can result from personnel salaries and other related costs being higher than budgeted; (iii) a 10% decline in benefits possibly resulting from resource cost savings, consumption benefits, and health benefits being lower than projected, (iv) a combination of scenarios (i), (ii), and (iii); and (v) a delay in subproject benefits by 1 year (Table 2).

Table 1: Summary Cost–Benefit Analysis ($'000) Economic Costs Economic Benefits Resource Savings/Consumption Benefits Health Benefits Nonincremental Medical Capital Incremental Water Incremental Costs DALY Year Cost O&M Cost Consumption Water Sales Avoided Savings Net Benefits 2017 345 0 0 0 0 0 -345 2018 23,259 0 0 0 0 0 -23,529 2019 33,277 0 0 0 0 0 -33,277 2020 32,931 0 0 0 0 0 -39,231 2021 25,332 0 0 0 0 0 -25,332 2022 0 4,616 6,224 6,480 1,626 3,257 12,971 2023 0 4,616 6,411 6,645 1,725 3,454 13,618 2024 0 4,616 6,603 9,769 1,829 3,663 17,248 2025 0 4,616 6,801 10,879 1,943 3,891 18,898 2026 0 4,616 7,005 10,980 2,060 4,126 19,555 2027 0 4,616 7,215 12,103 2,184 4,374 21,260 2028 0 4,616 7,432 12,215 2,316 4,637 21,984 2029 0 4,616 7,655 12,338 2,456 4,918 22,750 2030 0 4,616 7,884 13,474 2,597 5,201 24,541 2031 0 4,616 8,121 13,544 2,741 5,488 25,278 2032 0 4,616 8,365 13,670 2,906 5,819 26,143 2033 0 4,616 8,616 13,854 3,095 6,198 27,146 2034 0 4,616 8,874 14,012 3,289 6,586 28,145 2035 0 4,616 9,140 14,060 3,463 6,934 28,981 2036 0 4,616 9,414 14,191 3,671 7,352 30,012

9 A DALY is an indicator of life expectancy combining mortality and morbidity into one summary measure of population health to account for the number of years lived in less than optimum health. 5

Economic Costs Economic Benefits Resource Savings/Consumption Benefits Health Benefits Nonincremental Medical Capital Incremental Water Incremental Costs DALY Year Cost O&M Cost Consumption Water Sales Avoided Savings Net Benefits 2037 0 4,616 9,697 14,324 3,892 7,794 31,091 2038 0 4,616 9,988 14,457 4,127 8,264 32,219 2039 0 4,616 10,287 14,532 4,355 8,720 33,278 2040 0 4,616 10,596 14,591 4,590 9,191 34,351 2041 0 4,616 10,914 14,667 4,843 9,699 35,506 2042 0 4,616 11,241 14,743 5,111 10,234 36,713 2043 0 4,616 11,579 14,819 5,393 10,800 37,975 2044 0 4,616 11,926 14,896 5,691 11,397 39,293 2045 0 4,616 12,284 14,973 6,006 12,026 40,673 2046 0 4,616 12,652 15,051 6,338 12,691 42,115 2047 0 4,616 13,032 15,129 6,688 13,392 43,624 EIRR 14.54% NPV @ 12% 21,861 DALY = disability adjusted life year, EIRR = economic internal rate of return, NPV = net present value, O&M = operation and maintenance Source: Asian Development Bank estimates.

Table 2: Economic Evaluation and Sensitivity Analysis EIRR NPV Switching Sensitivity Scenario (%) (%) Value Indicator Base case 14.54 21,861 Case 1: 10% increase in capital cost 13.53 14,077 25.13 3.98 Case 2: 10% increase in O&M 14.31 19,793 108.01 0.93 Case 3: 10% decrease in benefits 13.18 9,823 0.93 5.35 Case 4: 10% increase in capital cost 12.00 0 10% decrease in benefits Case 5: Delay in project benefits by 1 year 12.85 7,679 EIRR = economic internal rate of return, NPV = net present value, O&M = operation and maintenance. Source: Asian Development Bank estimates.

G. Financial and Institutional Sustainability

13. A financial sustainability analysis was prepared from the perspective of the TPS, which will not only implement the project but will also handle O&M. The tariffs to be imposed by the TPS, which take into account the affordability limits of project beneficiaries, will be sufficient to recover O&M costs, depreciation, and interests on borrowings.10 The financial management assessment of the TPS concluded that the overall financial management risk rating is substantial, mainly because the TPS was constituted in its present form only in December 2015. The proposed principal mitigation measure is that the UCSA, with its prior experience in implementing large capital expenditure projects with international financial support, will supervise and guide the TPS. Details of the financial sustainability analysis conducted under the project are in the Financial Analysis (accessible from the list of linked documents in Appendix 2 of the report and recommendation of the President).

10 The TPS was constituted as a state unitary enterprise in December 2015 by the Decree of Cabinet of Ministers 306 dated 30 October 2015, by merging 19 existing district vodokanals and other water utilities in Tashkent province.