Issyk-Kul Wastewater Management Project (RRP KGZ 50176)

ECONOMIC ANALYSIS

A. Country Context

1. The Kyrgyz Republic is a mountainous, landlocked country of about 6 million people in the heart of Central Asia. Despite its agriculture, hydropower, and tourism resources, the country has experienced political and social instability since it declared independence in 1991. The country’s economy is highly vulnerable to external shocks because of its reliance on the mining sector, which accounts for about 10% of gross domestic product (GDP), and on worker remittances, which have produced about 30% of GDP in the last 5 years. The Kyrgyz economy has recovered from external shocks during 2014–2015—growth was 4.5% in 2017, up from 3.8% in 2016—and is supported by continued improvements in the Russian and Kazakh economies and by expansionary macroeconomic policies. Real GDP growth is expected to reach 5% by 2020, driven mainly by remittances and trade. To maintain political stability and embark on a sustainable path to economic development, the country needs more inclusive economic growth.

2. The National Sustainable Development Strategy (NSDS) for 2013–2017 of the Kyrgyz Republic aims to achieve a successful, stable democracy, along with inclusive growth.1 The strategy recognizes persistent poverty and regional disparities as key challenges. It focuses on mining, energy, finance, transport and communications, tourism and services, and agro-industry. These sector priorities will help alleviate poverty by creating new jobs and better access to good education and training to increase employability, and by improving social assistance to pensioners and low-income groups. The government will address regional disparities by attracting investment to areas outside the traditional growth centers such as the lakeshore cities of Balykchy and Karakol in the Issyk-Kul region.

B. Sector Context

3. The NSDS for 2013–2017 identified tourism as a key pillar of economic development and established the Issyk-Kul region, with its tourism potential centered on the popularity of Lake Issyk-Kul, as an essential driver of inclusive growth. Lake Issyk-Kul is the world’s second largest saline lake, a Ramsar site of globally significant biodiversity, and a The reserve was designated by the United Nations Educational, Scientific and Cultural Organization (UNESCO) in 2001- designated biosphere reserve.2 It has significant environmental and natural resource values to the Issyk-Kul region, and the government is committed to ensuring its long-term environmental sustainability.

4. However, increasing tourism has resulted in the construction of many resorts around the lake's northern shores. Tourism growth is slated to continue, but it is impacting the fragile environment and ecosystems of the lake and its vicinity. The lake is oligotrophic (nutrient-poor) and endorheic (without conventional outflows), making it is extremely sensitive to elevated nutrient and contaminant inflows, and highly vulnerable to excessive liquid and solid waste pollution that typically accompany increased commercial and other human activities, including

1 National Council for Sustainable Development of the Kyrgyz Republic. National Sustainable Development Strategy for the Kyrgyz Republic 2013–2017. 2 The Ramsar Convention is an international treaty relating to the sustainable use and conservation of wetlands. The reserve was designated by the United Nations Educational, Scientific and Cultural Organization (UNESCO) in 2001. 2 tourism. These impacts are of significant concern in relation to wastewater pollution, notably in the primary lakeshore cities of Balykchy and Karakol.

5. Although vodokanals (water supply and sanitation [WSS] companies) provide basic services in the two lakeshore cities, they face considerable service delivery difficulties, primarily because of limited institutional capacity, financial constraints and obsolete Soviet-era assets. Similar to other vodokanals in the region, they are locked in a cycle of poor WSS service provision, reduced consumer confidence and willingness-to-pay, and a reluctance to raise tariffs because of poor-quality services, which unfortunately reinforces funding limitations and poor WSS service provision. Overall, the WSS regulatory framework in the Kyrgyz Republic is relatively fragmented, regulatory compliance and oversight are largely ineffective, and WSS sector planning capabilities weak.

6. The vodokanals also endure acute funding constraints for both capital investments and operation and maintenance (O&M), exacerbated by low tariff levels, limited public funding, and a virtually absent private sector. Less than half of urban consumers are connected to centralized wastewater systems, with the balance forced to dispose of wastewater through septic tanks and pit latrines. The wastewater systems are also severely dilapidated, having deteriorated substantially since their construction during the Soviet era. In Karakol for example, the wastewater treatment plants (WWTPs) provide only basic, inadequate treatment, and in Balykchy, the WWTP is not even operational. Up to half of the pipeline networks in the cities need to be replaced.3 Institutionally, the vodokanals urgently require skills and resources needed to plan, operate and maintain viable and sustainable WSS utility services. The proposed project aims to improve and expand access to reliable, sustainable, and affordable wastewater services in Balykchy and Karakol. It is fully aligned with the long-term goal of improved living standards, health, and economy in the Issyk-Kul region of the Krygyz Republic.

C. Project Rationale

7. The Kyrgyz Republic through the NSDS 2011-2017 continues to emphasize environmental sustainability and the need to protect Lake Issyk-Kul while fostering tourism growth in the Issyk-Kul region to promote inclusive growth. The proposed project addresses the need to improve and expand reliable, sustainable and affordable wastewater services in Balykchy and Karakol as tourism, business and residential activities increase in these lakeshore cities. The project will have the following outcome: improved and expanded access to reliable, sustainable, and affordable wastewater services in Balykchy and Karakol. Under output 1 of the project, the Balykchy and Karakol wastewater systems will be improved through the (i) the rehabilitation of the Balykchy and Karakol wastewater treatment plants, (ii) construction of 21.6 kilometers (km) of sewerage and 1.7 km of effluent outfall pipelines, (iii) a new pump station and pumping main in Karakol, (iv) desludging of a reservoir in Karakol, and (v) the provision of septage vacuum trucks. Under output 2, the institutional capacity of the vodokanals in each city will be strengthened and project implementation improved. Under output 3, septage management services will be improved and sanitation and hygiene awareness increased through a septage management program aimed at rationalizing and expanding vodokanal septage collection services, aligning and regulating private sector septage collection operators, and regularizing septage collection tariffs and tariff collection mechanisms.

3 Although condition surveys of the collection networks are not available, it is estimated that 25%–50% may need replacing in Balykchy, and 20%–30% in Karakol.

3

8. The project will ensure the environmental preservation of Lake Issyk-Kul amid increasing economic activities spurred by reinvigorated tourism, and address growing concern for public health in the project cities associated with increased incidence among residents and tourists of water-borne diseases resulting from environmental pollution in the wake of inadequate investments in WSS by the public and private sector.

D. Cost–Benefit Analysis

9. The project cost–benefit analysis was conducted in accordance with relevant ADB guidelines,4 using cost estimates based on the preliminary engineering design prepared under the project preparatory technical assistance. The estimated costs and benefits of the project were quantified using the domestic price numeraire. For the analysis, the shadow price adjustment factors (1.08 for tradeable goods and services, and 0.85 for unskilled labor) were calculated based on the applicable Kyrgyz Republic labor and trade statistics. Annualized benefits and costs of the project were estimated over 25 years (a 5-year construction period followed by a 20-year operating period).

10. Economic costs. Capital and recurrent O&M costs, inclusive of physical contingencies but excluding all transfer payments (i.e., taxes and duties as well as price contingencies), expressed in constant mid-2018 prices, were converted into economic prices by applying the appropriate shadow price adjustment factors (Table 1).

Table 1: Conversion of Financial Costs into Economic Costs (in Som million, in constant mid-2018 prices) Breakdown of Financial Cost Excluding Tax Tradeable Financial Nontradeable Goods Total Financial Cost Less Unskilled Skilled Goods and and Economic Output Cost Tax Labor Labor Services Services Cost 1. Balykchy WWTP (i) Investment cost 1,102.5 879.4 37.78 139.88 243.23 450.61 905.5 (ii) O&M (2023–2027) 25.0 20.8 1.07 3.28 5.74 10.75 21.5 (iii) O&M (2028–2044) 29.0 24.2 1.26 3.81 6.66 12.48 24.9 2. Karakol WWTP (i) Investment cost 1,624.0 1,255.9 52.03 172.20 347.60 584.32 1,195.1 (ii) O&M (2023–2027) 39.7 33.1 1.61 5.05 9.82 16.59 34.2 (iii) O&M (2028–2044) 58.2 48.5 2.36 7.41 14.40 24.33 50.1 O&M = operation and maintenance, WWTP = wastewater treatment plant. Source: Asian Development Bank estimates.

11. Economic benefits. The project’s economic benefits derive from two major sources: (i) the public health benefits ensuing from access to cleaner, safer water in the project areas; and (ii) the potential tourism benefits of improved sanitation for the local economies of Balykchy and Karakol as a result of the enhancements in their wastewater collection and treatment systems.

12. The project’s estimated health benefits were quantified through savings in disability- adjusted life years (DALY) associated with the reduced incidence of waterborne diseases in the project areas resulting from improved water sanitation and hygiene. The project preparatory technical assistance socioeconomic survey revealed concern among residents that they were constantly at risk from waterborne diseases as a result of the severely deficient wastewater treatment in the two cities. Inadequate water, sanitation and hygiene account for a large part of

4 ADB. 2017. Guidelines for the Economic Analysis of Projects. Manila, ADB. 2002. Handbook for Integrating Risk Analysis in the Economic Analysis of Projects. Manila..

4 the burden of illness and death in developing countries.5 In determining the annual economic value of a DALY, the per capita gross regional product (GRP) of the Issyk-Kul region (used as a proxy for per capita gross national income) was projected to 2024, when benefits are anticipated to begin.6 Using modest annual growth rates of 2%–3%, the GRP per capita of Issyk-Kul was calculated to approximate the GRP per capita in Balykchy and Karakol by 2024. Based on the estimated environmental burden of diseases in Kyrgyzstan—in particular, those associated with poor sanitation such as diarrhea, parasitic and vector diseases, and worm infections—savings associated with the project totaled 8.55 DALYs/1000 inhabitants in the two cities.7

13. The proposed project is expected to reduce environmental pollution and generate incremental tourism benefits. A recent study by the University of Central Asia revealed that the quality of accommodation and services at many Issyk-Kul resorts leaves much to be desired. Vacationers face numerous inconveniences, with environmental pollution from sewage and solid waste underscored as a major concern.8 The project will address this, making Balykchy and Karakol more competitive compared to rival tourist destinations.

14. Balykchy’s hotels, resorts and spas (excluding informal tourism service providers) receive about 14,264 international visitors per year.9 With the project, it was assumed (based on data from the World Trade & Tourism Council) that international visitor numbers will grow at an annual rate of 8% from 2019 to 2044,10 while the without-the-project scenario assumed a more conservative annual growth rate of 3% given other planned developments in the city. Foreign visitors spend an average of $70 per day and stay an average of 1 day without the project. With the project, it was estimated that international visitors will extend their stay for an average of 1 day and spend an additional $30 per day (footnote 9).

15. Karakol is renowned for its beach tourism during summer and resort skiing during winter.11 Issyk–Kul oblast hotel, resort and spa data (excluding informal tourism service providers) indicate Karakol attracts about 34,960 international visitors per year. With the project, it was assumed that international visitors will grow at an annual growth rate of 8% from 2019 to 2044, while the without- the-project scenario assumed a more conservative annual growth rate of 5%. Foreign visitors

5 Consumption of contaminated water may result in water-borne diseases including diarrhea, intestinal nematode infections, lymphatic filariasis, trachoma, schistosomiasis, and other infectious disease. Globally, in 2016, inadequate and unreliable water supply, in addition to poor sanitation and hygiene, was responsible for about 800,000 deaths due to diarrhea and almost 2% of the global burden of disease (in disability adjusted life years or DALYs). See http://www.who.int/gho/phe/water_sanitation/burden_text/en/. 6 A DALY is a life expectancy indicator combining mortality and morbidity into one summary measure of population health to account for the number of years lived in less than optimum health. The World Health Organization (WHO) determines economic values of a DALY by equating it with the gross national per capita income. 7 WHO. Health statistics and information systems. Global Health Estimates 2016: Disease burden by Cause, Age, Sex, by Country and by Region, 2000-2016. The estimated environmental burden of diarrhea, parasitic and vector disease, as well as worm infections in Kyrgyzstan in terms of DALYs was used. Specifically, 8.55 DALYs per 1,000 capita was applied as a proxy to estimate the potential health benefits in the cities. This assumed that 30% of the DALYs that could be saved due to a reduction in the incidence of diarrhea can be attributed to the project, while 10% was used for parasitic and vector diseases and worm and other infections. Z. Bekturganov, et.al. 2016. Water Related Health Problems in Central Asia—A Review. Water. 8 (16), p. 4 states “Reviews indicate that improved sanitation can reduce diarrheal diseases by 32%–37%.” 8 N. Jenish. 2017. Tourism Sector in Kyrgyzstan: Trends and Challenges. University of Central Asia Institute of Public Policy and Administration Working Paper No. 42 9 Tourism data for the two cities are based on data directly obtained from the Issyk-Kul Administrative Region and from hotels. Balykchy is a port located on the western shore of Issyk-Kul with a local economy that centers on the food industry. The town serves as a major transportation center and has a shipyard, and a soon-to-open railway will link the city to Tashkent. 10 World Travel and Tourism Council. Travel and Tourism Economic Impact 2018 Kyrgyzstan. London. 11 Karakol, the fourth largest city in Kyrgyzstan, serves as a base from which to access skiing and alpine trekking.

5

spend an average of $100 per day and stay an average of 3 days without the project. With the project, international visitors would likely stay an additional day, spending an incremental $20 per day (footnote 9). For both cities, the latest tourism report on Kyrgyzstan indicates that direct tourism benefits generated by international visitors’ net spending is 70% (footnote 10).

16. Economic internal rate of return calculation and sensitivity analysis. The resulting base case economic internal rate of return for the proposed Balykchy wastewater treatment plant was 12.3% and for the proposed Karakol wastewater treatment plant, 13.4%. Both exceed the prescribed minimum discount rate of 9%. These results confirm that both components of the project are economically viable, with anticipated economic benefits that are greater than the estimated economic costs. A sensitivity analysis, undertaken to further test economic viability, determined that the two wastewater treatment plants will remain economically robust under the following scenarios: (i) a 10% increase in investment cost, possibly arising from delayed implementation or higher-than-expected inflation; (ii) a 10% increase in O&M costs, which can result from higher-than-budgeted personnel salaries and other related costs; (iii) a 10% decline in benefits, possibly resulting from lower-than-projected resource cost savings, consumption benefits, and health benefits; (iv) a combination of scenarios (i), (ii), and (iii); and (v) a delay in subproject benefits by a year (Table 2).

Table 2: Summary Economic Evaluation and Sensitivity Analysis Balykchy Karakol Base Case/Sensitivity Scenario Wastewater Wastewater Treatment Plant Treatment Plant Net present value (Som’000) 370,236 708,935 Base case EIRR 12.33% 13.36% Sensitivity tests: Case 1: Capital cost +10% EIRR 11.57% 12.55% Switching value 4.37 16.84 Sensitivity indicator 22.88 5.94 Case 2: O&M cost +10% EIRR 12.21% 13.20% Switching value 26.46 85.79 Sensitivity indicator 3.78 1.17 Case 3: Benefits –10% EIRR 11.36% 12.30% Switching value 3.42 12.85 Sensitivity indicator 29.23 7.78 Case 4: Combination of cases 1, 2, and 3 EIRR 10.62% 11.52% NPV (Som‘000) 181,475 414,327 % drop in NPV 50.98 41.56 Case 5: Benefits delayed by 1 year EIRR 10.87% 11.78% NPV (Som’000) 202,421 443,742 % drop in NPV 45.33 37.41 EIRR = economic internal rate of return, NPV = net present value, O&M = operation and maintenance, WWTP = wastewater treatment plant. Source: Asian Development Bank estimates.