Document of The World Bank Public Disclosure Authorized

Report No. 13206-PE Public Disclosure Authorized STAFF APPRAISAL REPORT

PERU

LIMA WATER REHABILITATION AND MANAGEMENT PROJECT

Public Disclosure Authorized NOVEMBER 1, 1994

Public Disclosure Authorized LA3 Department Environment and Urban Development Division Latin America and the Caribbean Regional Office Currency Equivalents

Currency unit = sol US$1 = 2.16 soles (March 31, 1994) 1 figures in U.S. dollars unless otherwise noted Weights and Measures Metric Fiscal Year

January 1 - December 31

Abbreviations and Acronyms

CEPRI-SEDAPAL SEDAPAL's privatization committee COPRI Interministerialcommittee for privatization CORTAPA Former tariff-settingboard FONAVI National Housing Fund SEDAPAL Servicio de Agua Potable y Alcantarilladode Lima (Lima Water and Sewerage Service Company) SENAPA SuperintendenciaNacional de Agua Potable y Alcantarillado(former urban water agency) SLA Subsidiaryloan agreement Peru Lima Water Rehabilitation and Management Project Staff Appraisal Report Contents

Loan and Project Summary ...... v

I. Water and Sanitation Sector Overview ...... 1

A. Economic background ...... 1 B. Institutional and legal framework .1...... I C. Current sector issues ...... 2 D. SEDAPAL ...... 3 E. Lessons from Bank experience ...... 4

II. The Project .5

A. Objectives and rationale .5 B. Water demand .5 C. Description .6 D. Cost .. 7 E. Economic evaluation ...... 8 F. Poverty alleviation and affordability .9 G. Financial analysis .10 H. Environmental impact .14 1. Risks ...... 14

III. Project Implementation .14

A. Arrangements .14 B. Subproject selection criteria .16 C. Project supervision .17 D. Procurement ...... 17 E. Disbursement .18 F. Advance contracting and retroactive financing .18 G. Auditing arrangements .18 H. Reporting and monitoring .19

IV. Agreements Reached and Recommendation ...... 19

This report is based on the findingsof an appraisal missionthat visited Peru from April 26 to May 13, 1994. The mission was comprised of Messrs./Mmes. Abel Mejia, Yoko Katakura, Caroline Van Den Berg, Eid Nouhra (LA1IN), Alex Bakalian, Thelma Triche (TWUWS),Robert Taylor (LAIIE), Rudy Van Puymbroeck(LEGLA), Orville Grimes (LA1DR), Luz Maria Gonzales (consultant),and Makoto Nakao (OECF). Rita Cestti, Manuel Mariffo(TWUWS), Carlos Velez (LA1IN), Jerson Kelman, DominiqueBerthon, Jean Louis Olivier, Roberto Chama, Eduardo Baso, and Eduardo Buroz (consultants)also participated in project missions. Carlos Olle from SEDAPALcoordinated project preparation.Juan Barandiaran,Ana Mendoza, Carlos Oyafuso,Alfredo Garcia, R. Rojas, E. Rojas, M. Sheen, and Carlos Paredes comprisedthe ProjectPreparation Team in Peru. Thelma Triche (TWUWS)and Walter Stottmann(EMTIN) are peer reviewers. Mr. Asif Faiz was the responsibleDivision Chief during projectpreparation and appraisal.The sector DivisionChief, ProjectsAdvisor, and DepartmentDirector are Messrs. Eugene D. McCarthy, Robert Crown, and YoshiakiAbe. - 1i - Tables

1. Project costs ...... 8 2. Financing plan, 1994-2000 ...... 11 3. Financial data, SEDAPAL, 1987-93 ...... 12 4. Sensitivity analysis for two tariff rate structures ...... 13 5. Project costs by procurement method ...... 18 Annexes .21

1. Bank Loans to Peru for Water and Sanitation Sector and Related Loans ...... 23 2. Experience and Lessons Learned from Previous Projects ...... 24 3. Peru's Privatization Program ...... 26 4. SEDAPAL Management Plan ...... 28 5. SEDAPAL Investment Plan ...... 30 6. Detailed Project Cost ...... 38 7. Technical Assistance ...... 43 8. Water Demand in Metropolitan Lima ...... 47 9. Cost Benefit Analysis: Methodology and Results ...... 55 10. Marginal Cost Pricing Analysis: Methodology and Results ...... 66 11 Financial Projections ...... 74 12. Notes and Assumptions for Financial Forecasts ...... 77 13. Procurement Plan and Implementation Schedule ...... 84 14. Implementation Plan ...... 90 15. Project Flows: Legal, Financial and Technical ...... 95 16. Project Review ...... 96 17. Guidelines for Evaluation of Subprojects ...... 98 18. Supervision Plan...... 103 19. Monitoring Indicators...... 104 20. Loan Disbursement Schedule ...... 108 21. Selected Documents Available in Project File ...... 109

Maps .112

IBRD 26211 IBRD 26212 IBRD 26213 - iii -

Peru Lima Water Rehabilitation and Management Project Staff Appraisal Report Loan and Project Summary

Borrower: Republic of Peru.

Beneficiary: Lima Water and Sewerage Service Company (SEDAPAL). Amount: US$150 million equivalent. Terms: Repayment in 17 years, includinga grace period of five years, at the Bank's standard variable rate, with level repayment of principal. The Government will extend the loan to SEDAPAL under the same terms and conditions. SEDAPAL will bear the foreign exchange risk.

Project objectives: The project's goal is to improve the efficiency of water and sanitation delivery in the Lima-Callao metropolitanarea. The project will promote water conservation, support SEDAPAL's privatization, rehabilitate damagedwater supply and sewerage systems, expand services to the urban poor in the pueblosjovenes, and support reforms in the legal and institutionalframework of the water and sanitation sector. Project description: The project has four components. The water conservationcomponent includes preparing a customer cadastre, reconstructingwater meter boxes, and installing 406,000 water meters. This componentwill also initiate conjunctiveuse of surface and groundwater in three districts where groundwater is depleted and the risk of saline contaminationis serious. The rehabilitationcomponent will improve water supply and sewerage in the twelve districts that comprise 40 percent of SEDAPAL's water sales and 75 percent of total revenue. Wells will also be rehabilitated under this component.The pueblosjovenes componentwill expand and improve water and sanitation services for 600,000 of Lima's poor. The institutionalstrengthening component involves studies and technical assistance programs for SEDAPAL and the Superintendencyof Sanitary Services. Poverty aspects: The pueblosjovenes componentis targeted toward the poor. At project's end, 600,000 beneficiaries-about 26 percent of the total number of beneficiaries-will be the urban poor living in the outskirts of Lima. In addition, the water conservation componentwill install water meters in high-incomehouseholds. Water savings obtained from this component will be directed to the pueblosjovenes.

Environmental aspects: A detailed environmentalassessment was prepared for the project. The project is classified as Category B under the Bank's rating system. Although construction impacts are expected from the rehabilitation,their effects on land use and ecological systemsare expected to be minimal. - iv - Project benefits: The project will provide 834,000 people with improved water supply and 788,000 people with improved sewerage. The pueblos jovenes componentwill provide an additional600,000 low-incomeresidents with both new and improved services. Other project benefits include savings from reducing unaccounted-forwater and water consumptionin high-incomeareas, health benefits from the pueblos jovenes component, increased reliability of water supply services, reduced water costs in low-incomeareas, and preservationof water resources. Project risks: The project's main risks include political opposition to the sectoral reform- including privatization-that may slow the reform process, ineffectiveexecution of the project during the transition from public to private sector operation, insufficient counterpart funding, and non-acceptanceof Bank funds by the concessionaire. The risk of political opposition is minimizedby three factors. First, the new regulatory and institutionalframework is the result of two years of consensus-buildingby the Government of Peru to advance reform. Second, the timing and social environment for privatization is favorable-the current administrationwants to advance SEDAPAL's privatization before the April 1995elections. Finally, successful privatization in other sectors and public utilities has created social support for privatization. The risk of ineffectiveexecution of the project during the transition period is minimizedby a managementagreement to be signed between SEDAPAL and the government. This agreement defines key operational and investment performance objectivesand will be evaluatedevery three months until the private operator assumes responsibility. If privatizationis unsuccessful, terms for a second managementagreement will be discussed with SEDAPALand the government during the Project Review. Annual managementagreements should be signed thereafter. If privatization is successful, a performance plan-as part of the concession contract-will be signed between the private operator and SEDAPAL. The risk of insufficientcounterpart funding is minimizedthrough the new tariff regulations, which allow for adequate levels of revenue and automatic adjustments based on five-year tariff formulas, and through the monitoring of investment decisions and operational efficiency through the managementagreement (before privatization)and the performanceplan (after privatization). The risk that the concessionairemay not enter into a subsidiary loan agreement with SEDAPAL for the use of the Bank funds, and hence the possibilityof an early partial cancellation of the Bank's loan, is minimizedby the fact that prequalified private operators have already shown considerable interest in the Bank loan which would finance urgent rehabilitation work.

Table 1 Project costs (millionsof U.S. dollars)

Project component Foreign Local Total

Rehabilitation 53.4 95.5 148.9 Water Conservation 22.2 22.0 44.2 Network Expansion 25.6 14.5 40.1 Institutional Development 3.4 15.4 18.8

Total Base Cost 104.6 147.4 252.0 Physical Contingencies 10.5 14.7 25.2 Price Contingencies 12.1 17.0 29.0 Total Project Cost 127.1 179.1 306.2 v -

Table 2 Financingplan, 1994-2000 (millionsof U.S. dollars) Bank-financedprojecta SEDAPALtotad investnent plan

Source of funds Amount Percent Amount Percent

World Bank 150.0 49.0 150.0 22.6 Cofinancier 76.2 24.8 76.2 11.5 SEDAPAL 80.1 26.2 317.0 47.8 Other loansb 120.3 18.1 Total 306.2 100.0 663.6 100.0

a. Does not include US$40.5 million interest accrued during constnuction, to be financed by SEDAPAL's internal resources. b. A majority of these loans are provided by FONAVI and other domestic institutions for primnaryand secondary works (US$66 million).

Table 3 EstimatedBank project disbursements,1995-2001 (millionsof U.S. dollars) Bankfiscal year 1995 1996 1997 1998 1999 2000 2001

Annual 26.5 38.2 40.4 26.1 10.2 6.0 2.6 Cumulative 26.5 64.7 105.1 131.2 141.4 147.4 150.0

Rates of return: The internal economic rate of return of the project is estimated at 22 percent, and the financial rate of return at 17 percent.

I. Water and Sanitation Sector Overview

1. Water and sanitation services in Peru have deterioratedbecause of poor management. A widespread, deadly cholera epidemic began in January 1991-reflecting the state of water and sanitation infrastructure, particularly in urban areas. Although structural reform has improved the sector's operation, the system requires considerablephysical and institutionalrehabilitation. Investmentneeds and weak institutionalcapacity led the Governmentof Peru to encourage private sector participation in the managementof Lima's SEDAPAL-the country's largest water and sanitation services company. A. Economic background 2. Peru has long suffered from politicaland macroeconomicinstability. Until recently, the governmentfollowed a state-led developmentstrategy containing extensive legal controls. Government intervention in economic activities led to misallocatedresources, fostered inefficient public enterprises, and hindered the developmentof social, economic, and physical infrastructure. Utility tariffs were politically influencedwith little regard for costs. During 1985-90 the Garcia administrationimplemented expansionary fiscal policies, includingtargeted credits, subsidies, and reductions in taxes and public sector prices. These policies initially induced economic growth but eventually increased deficits, created hyperinflation, and aggravated resource misallocation. By mid- 1990 annual inflation peaked at nearly 36,000 percent. GDP had dropped to the 1960 level. Scarce resources were used inefficiently,and few were allocated to public utility systems. 3. The Fujimori administrationintroduced a macroeconomicstabilization and structural reform program in mid-1990. The stabilizationprogram included a tight monetary policy, instituted temporary taxes, and increased public utility rates. Structural reforms promoted competition and private investment. An extensiveprivatization program seeks to privatize all major public holdings by mid-1995 (Annex 3). 4. Water and sanitation reform includes enactmentof the Water and Sanitation Services Law in July 1994 and preparation of accompanyingregulations, a draft Water Resources Law currently before Congress, a supervisory agency (the Superintendencyof Sanitary Services) was created in January 1994, increasedwater and sewerage tariffs, restructured municipal water companies, and a privatization committee for SEDAPAL (CEPRI-SEDAPAL).

5. By mid-1991, water and sanitation infrastructure had deteriorated such that considerable rehabilitation was needed to guarantee its operation. Water resource managementwas also urgent, particularly in urban centers with limited water resources. The governmentrequested the Bank's assistance in rehabilitatingand privatizing the system, strengtheningsupervisory capacity, and supporting the creation of a Water Resource ManagementAuthority in Lima. B. Institutional and legalframework 6. The institutionalenvironment of the water and sanitation sector has changed considerably in the past five years. Until 1989 the Servicio Nacional de Agua Potabley Alcantarillado(SENAPA) provided service in urban areas. The Rural Sanitation Program of the Ministry of Health provided service in rural areas. Water sector operations were decentralized in 1989, and responsibilitieswere transferred to local governments. Except for the water utilities in Lima and Trujillo, all subsidiary companiesand operational units were decentralized. 7. SENAPA was abolished in 1992, when the Ministry of the Presidency assumed responsibilityfor the water and sanitation sector. Policies favoring viable and autonomous water - 2 - companies were developed, and CEPRI-SEDAPALwas established to promote private participation. The Superintendencyof Sanitary Services was created to regulate the sector and to help develop efficient water companies at the municipallevel. This agency reports to the Vice Minister of Infrastructurein the Ministry of the Presidency and is financed with water and sewerage revenues. A staff of 20 is formulating regulationsand a strategy for sector development. There are currently about 30 local companies and more than 100 direct managementmunicipal services.

8. Other supervisory institutionsinclude the Ministries of Agriculture and Health. The Ministry of Agriculture has recently drafted a Water Resources Law emphasizingprivate water-use rights. The Ministry of Health oversees water quality standards; its responsibilitieswill be better defined once pollution control arrangementsare developedthrough the Water Resources Law.

9. The Water Resources Law, presently in draft, introduces changes that facilitate water market development, promote private sector investment, and encourage water conservation. Water-use rights will be granted to private users, developmentand managementdecisions will be made at the lowest appropriate level, and resource coordinationand managementwill be determined by river basin authorities. The concept of private water-use rights is different from the existing system, which grants substantial discretionarypower to the public sector.

10. The Constitution adopted in 1993 affirmed that water and sanitation services are the responsibilityof local government.The Water and Sanitation Services Law (Ley General de Servicios de Saneamiento) , defines institutionalresponsibilities for service provision and regulation. It also establishes a framework for private sector participation. It also uses transparency, financial viability, and social equity as basic principles for tariff setting. This is a departure from the previous tariff regime, in which water and sewerage tariffs were set by the ComisionReguladora de Tarifas de Agua Potable y Alcantarillado(CORTAPA) with little concern for transparency or financial viability. Regulationsthat specify the functions of the Superintendencyof Sanitary Services have also been drafted. Tariffs are currently set on interim arrangements. In Lima, SEDAPAL proposes a tariff increase to the Ministry of the Presidency, which makes a decision after consulting with the Ministry of Economy and Finance. C. Current sector issues

11. Peru's water resources are geographicallyunbalanced. The sparsely inhabited East Andes have abundant and untapped water sources, while the western slopes, including Lima, have less than 15 millimeters of annual precipitation. Most of the country's population is concentratedin coastal urban centers. Water supply and sanitation services do not meet the demand in these areas-water rationing is a daily occurrence in Lima. Poor resource managementhas worsened the problem. The Rimac river-the main source of water for Lima-is polluted with untreated mining, industrial, and domestic waste. Lima's sewage is discharged into the sea or diverted for irrigation. In addition, underground water develops an alarming degree of contaminationand salinity when the water table near the ocean drops. These factors-along with the network's poor condition-are responsible for the persistent cholera.

12. Service coverage. Peru's 1993 population was 22 million, with average annual growth of 2.2 percent. Urban areas (defined as populationcenters with more than 2,000 inhabitants)account for about 70 percent of the total population. Urban population is growing at an annual rate of 2.9 percent, while the rural populationis growing at less than 1 percent. About 6.4 million people-29 percent of the country's population-live in the Lima-Callaometropolitan area. Urban migration accelerated in recent years as terrorism drove rural populationsto the outskirts of Lima. Here they formed low-incomecommunities called pueblosjovenes, and now account for 58 percent of Lima's population. By 2000 Lima's populationis expected to reach 7.7 million.

13. Water and sanitation services have not kept up with population growth. In 1991 national service coverage was estimated at 58 percent for water and 42 percent for sewerage. In urban centers, the figures were 74 percent for water and 62 percent for sewerage. In Lima, the coverage was 79 percent for water and 75 percent for sewerage at end-1993. These figures represent the population physicallyconnected to the water supply and sewerage systems-not service quality. According to the Living Standards MeasurementSurvey conducted in 1991, 48 percent of Peru's population received water for less than 12 hours each day. Twenty-eightpercent received less than six hours of service each day. Sewerage is also inadequate, with most domestic, industrial, and mining wastes discharged untreated into rivers and the ocean. 14. Sector investment. During 1985-89 investmentsin water and sanitation infrastructure representedjust 0.15 percent of GDP. This is one of the lowest figures in Latin America. Countries with better service invested about 1.0 percent of GDP. For decades, policies ignored the economics of water supply and sewerage. Tariffs were set below cost and driven by political and social interests, making it impossiblefor revenues to cover investment. 15. Increasing coverage has taken priority over maintenance needs. In Lima maintenance of existing assets has been negligible. About 3 kilometers of water pipe were replaced during 1987 and 1989-in a system with more than 6,700 piped kilometers. Few investmentswere made in sewerage. National rehabilitationneeds are estimated at US$400 million in the next five years.

16. Health impacts. Water availabilityhas declined substantially, particularly in low-income areas. The true cost of inadequate supply was evident after the 1991 cholera outbreak. In the first ten weeks of the epidemic, Peru lost US$1 billion in exports, tourism, and emergency health expenditures. Poor hygiene conditionshave also increased the incidence of diarrhea-in the pueblos jovenes, eight episodes of diarrhea per person are reported annually. Medical expendituresand lost wages put a heavy burden on the poor's household income. Improved water supply could contribute significantlyto poverty alleviation. D. SEDAPAL 17. SEDAPAL provides service to the Lima-Callaometropolitan area. For more than a decade, it has suffered from low tariffs, high inefficiency, and increasingoperating costs. The company did not generate positive net income between 1982 and 1992. Government intervention deprived the company of the ability to make its own investmentand financial decisions. SEDAPAL has suffered a drastic decline in real revenue as a result of governmentpolicy keeping public utility prices low. Average tariffs were a mere US$0.10 per cubic meter in 1989, much lower than the unit operating cost. The company was unable to pay its suppliers, cover debt service, or maintain and expand service. It depended on user donations, governmentconcessionairy loans (through FONAVI), and transfers to cover operating and investmentcosts. Government investmentsin SEDAPAL were minimal, since the government itself was on the verge of bankruptcy. 18. As part of the 1991 sectoral reform, SEDAPAL went through a drastic restructuring. The number of employeeswas reduced from 3,769 in 1988 to 1,965 in 1993 through a voluntary retirement plan. Managementwas streamlined to five operational divisions. A Chairman of the Board, also a member of the CEPRI-SEDAPALprivatization committee, was appointed in November 1992. The Governmenthas increased the water and sewerage tariff-to an average of US$0.28 per cubic meter in May 1994. Increased tariffs and decreased costs generated positive net income in 1993 for the first time in more than a decade. 19. SEDAPAL's operational efficiency has room for improvement. The company's reported unaccounted-forwater (the difference between water produced and billed) was 38 percent of production in 1992. This figure, however, is underestimated.Only 4 percent of connectionsare billed on the basis of metered consumption,and actual consumptionand billed volumes are often different. The remaining 96 percent of connectionsare billed at notional consumptionlevels in most cases that are higher than actual consumption.A district-by-districtstudy revealed that unaccounted- for water at end-1993 was about 46 percent-30 percent from physical losses (leakage) and 16 percent from commercial losses (consumedbut not billed). This level of loss is unacceptablein a water-scarce environment. - 4 - 20. Privatization. The Government's strategy for SEDAPAL is consistent approach with its overall to privatization. CEPRI-SEDAPAL,the committee for SEDAPAL's privatization, advisors in June hired 1993 to examine options for increasingprivate sector participation. A team of technical and financial advisers was hired in late 1993 to assist CEPRI-SEDAPAL implementing in preparing and privatization. The first task was the assessmentof the various options for privatizing. Several options were analyzed: sale of shares, sale of assets, management arrangement, contract, lease concession contract, and build-operate-ownand build-operate-transferarrangements. The consultants recommended the concessionapproach, in which a private operator makes a long- term commitmentto invest and operate water and sanitation services. This option management for private of public services is widely used in France and Spain, and it was the option the privatization of adopted in Buenos Aires' water utility in 1993. The operator assumes all financial risks, and is responsible for capital expenditures(such as rehabilitationand expansion). service Pricing and obligationsare also specified. A price cap is used to adjust tariffs. Ownership assets remains of SEDAPAL with the Government. The concession would be awarded through public bidding. 21. The interministerialcommittee for privatization (COPRI) approved a 30-year strategy in March concession 1994. Three internationaloperators were prequalified prior to loan negotiations. During loan negotiations CEPRI-SEDAPALprovided the Bank with draft bidding documents for the privatization, including terms of the subsidiary loan to the concessionaire, and draft concession contract, performance plan. Interested bidders will require about three months to prepare proposals. The their public tender process, selection of the private operator, and finalization of the contract will take another nine to twelve months. A timetable for the privatization is in Annex 3. 22. Privatizationhas several benefits. A private operator would improve operational service quality and efficiency. This would reduce production requirements, delay the need for new water supplies, investment in and facilitate lower water rates. A private operator would also bring the capital needed to rehabilitate and expand the Lima water and sanitation network. 23. Public sector management.Private sector participationis not guaranteed. If it fails, SEDAPALwill continue under public sector management-in a policy environment that has clear performance incentives. The new regulatory framework for water and sanitation cost pricing, introduced marginal managerialautonomy, and accountability.These are essential for efficient management, public utility or private. SEDAPAL's institutionalcapacity should be strengthenedby clearly defining its responsibilitiesand relationshipswith other public sector entities. agreements Management should be used to clarify objectivesand define responsibilitiesamong the different entities overseeing SEDAPAL management. A summary of SEDAPAL's managementplan and specific targets for managementagreements are in Annex 4. E. Lessonsfrom Bank experience 24. Most water and sewerage projects in Latin America have fulfilled their physical objectives, but not their institutionalones. Regional experience indicates that water and subject to sanitation projects are poor macroeconomicperformance and frequent managementchanges and lengthy implementationcompromise objectives. In addition, physical and institutionalobjectives should be linked, project scope and design should be simple, better demand and needed, productivity forecasting is and projects should emphasizecost recovery, operational efficiency, and internal contribution to investment. 25. Since 1976 the Bank has made three loans for water and sanitationprojects in Peru, Lima. These loans all in amountedto US$55.9 million. Earlier projects had objectives similar to this project: expanding service, particularly in low-incomeareas, improving strengthening resource management,and SEDAPAL's managerial, technical, and financial capabilities. The projects achieve their failed to objectives because of political and economic constraints, macroeconomicinstability, and the lack of institutionalreform. - 5 -

26. This project, the Bank's first in ten years in Peru's water and sanitation sector, takes these lessons into account. The Bank's assistance with regulatory and institutionalreform has helped ensure sustainability-both the Government and SEDAPAL are committedto reform. The macroeconomicenvironment is now considered stable. Institutionalreform is underway-and will be advanced with private sector participation,also supportedby the project. 27. The proposed project is needed whether SEDAPAL is privatized or remains publicly managed. The Bank-financedproject is a small portion-less than 20 percent-of the capital expenditure required for the Lima water and sanitation system in the next decade, but contributes to establishingdirection for further system improvement.The bulk of investment will be undertaken by the private operator under the concession contract.

II. The Project

28. The project was conceived and designed by the Vice-Ministryof Infrastructure and by SEDAPAL. The Bank helped design and implementa new institutionalframework and improve SEDAPAL's efficiency. Achievementsduring project preparation include:

* Creating and strengtheningCEPRI-SEDAPAL. * Creating the Superintendencyof Sanitary Services and eliminatingSENAPA and CORTAPA. * Preparing the Water and SanitationServices Law. * Increasing tariffs by more than 100 percent and gaining consensus on long-term marginal costs as a basis for tariff setting. * Hiring internationalconsultants to assist with SEDAPAL's privatization. * Preparing a managementplan for SEDAPAL that will guide managementduring the transition to privatization. 3 Training Peruvian officials through seminars and study tours. - Administeringa Japanese Policy and Human Resources Development(PHRD) grant that evaluated rehabilitationrequirements of the water and sewerage network, appraised alternatives for disposal and reuse of domestic sewage, and assessed hydrological data from the Rimac river basin and the environmentalimpacts of the entire investment.

A. Objectives and rationale 29. After Peru resumed its debt service payments to the Bank in 1990, the Bank's lending strategy included an adjustment program supportingmacroeconomic stabilization and structural and sectoral reform. During 1992-93, four loans were approved: the Structural AdjustmentLoan (3452- PE), the Trade Reform Loan (3437-PE), the Financial Sector Reform Loan (3489-PE), and the PrivatizationAdjustment Loan (3595-PE). The Bank has also supported reforms with technical assistance-principally through the PrivatizationTechnical AssistanceLoan (3540-PE) and a series of PHRD (Japanese) grants. Now that economic stability and initial sectoral reforms have been achieved, the Bank is promotingeconomic developmentand poverty alleviation. As stated in the Country Assistance Strategy, discussed by the Board on April 20, 1993, and in the May 2, 1994 draft version, the Bank's objectivesare sustainingmacroeconomic stability, developing institutional capacity, improving income distribution, alleviating poverty, rehabilitatingcritically damaged infrastructure, and supportingprivatization. 30. This project pursues these goals. It will expand water and sanitation services in the pueblos jovenes, rehabilitate Lima's damaged water supply and sewerage system, and support SEDAPAL's privatization. Privatizationwill be facilitated by onlending of the Bank's loan for emergency investmentsthat will be made soon after the concession is granted. If privatizationdoes not succeed, the project will assist further in the modernizationand reform of SEDAPAL, a process initiated during project preparation. -6 -

B. Water demand

31. Water demand projectionsare based on estimated populationgrowth, SEDAPAL's planned increase in coverage, and trends in per capita consumption.The populationof the Lima-Callao metropolitanarea will increase from 6.4 million in 1993 to 8.7 million in 2005. By 2005, 90 percent of the population should have direct access to piped water because of system expansion in the pueblos jovenes.

32. Per capita water consumptionis the key variable in demand projection. Despite rationing, domestic water consumptionin the Lima-Callaometropolitan area is high. Average consumptionin September 1993 was 169 liters per day, compared with 236 liters per day in June 1987. These data are not directly comparable because of the impact of seasonalityon consumption-1993 data were collected during the dry season, when rationing is more stringent. Still, although average household incomes had dropped and water rates had increasedsince 1989, it is mainly rationing that is responsible for lowered demand. Without rationing and excludingseasonality, the demand forecast assumes that consumers would have consumed236 liters per capita per day.

33. Water consumptionlevels differ substantiallywithin the Lima metropolitanarea. This is mainly caused by the degree of rationing, which differs among districts. Income level also plays a role. Water consumptionforecasts are based on district averages rather than systemwide consumptionestimates. Demand forecasts for the districts are presented in Annex 8.

34. A major goal of this project is reducing water use and water losses. The project uses two tools to achieve water conservation(demand management).It will manage demand through the installationof water meters. And it will reduce physical losses through rehabilitationof the supply network. These two measures will be supplementedwith a conjunctiveuse program that will optimize surface and groundwateruse to increase water supplies. Rehabilitationhas two major impacts. Reducing unaccounted-forwater will increase the available supply. Since the current water supply system is characterized by rationing, this will result in higher consumption.But the introduction of water meters will offset this increase. The use of reliable water meters has an impact similar to a real rate increase. Instead of paying a minimumconsumption level, householdspay for actual consumption-resulting in higher water bills. The impact of higher rates was estimated using an average price elasticity of demand -0.30-a value comparable to that used in recent studies by the Superintendencyof Sanitary Services. Based on this value, per capita domestic water demand will decline from 236 liters per day in 1994 (without rationing) to 188 liters per day in 2005. Because service coverage will increase by 2005, total domestic water consumptionwill rise to about 17 cubic meters per second.

35. Non-domesticwater demand is expected to increase in line with population growth-about 2.5 percent a year. Total non-domesticwater consumptionwill increase to about 5 cubic meters per second by 2005. Physical losses currently account for about 31 percent of total water production. Because of the limited scope of the rehabilitationprogram, these losses will decline only to about 29 percent in 2005. Total production capacity in 2005 will therefore increase to nearly 32 cubic meters per second. Populationprojections and water demand methodologiesare explained in Annex 8.

C. Description

36. Until this project was prepared, SEDAPAL's investmentswere based on annual reviews of the public expenditure budget in conjunctionwith other government institutions. With Bank assistance, SEDAPALdeveloped an investmentplan for 1994-2000. This plan follows SEDAPAL's water and sewerage master plan from the early 1980s, financedby a previous Bank loan. This plan is still valid because of low investment in the past decade. Neglected maintenanceduring this period increased investmentrequirements. The Bank-financedproject-totalling US$306.2 million-is part of the US$663.6 million investment plan for 1994-2000. 37. Investment priorities. Improving infrastructureand SEDAPAL's commercial base are the top priorities. Operational assets have priority for reducing water losses and improvingservice quality. The commercial base will be improved by updating the customer cadastre and installing water meters. The conjunctive use of surface and groundwater will optimize the use of existing water resources. Investment in a major trans-basin scheme could be postponed, since major water source expansion will not be required before 2003 (according to the demand forecast). Studies should be completed in the next five years to determine the least-cost solution for long-term water supply. A means of sewage disposal should be implementedafter studies determine the best wastewater managementscheme for Lima. Engineeringfor sewage disposal could be financed through the Bank project. Studies to evaluate wastewater managementwill be financedthrough a Japanese Policy and Human Resources Development(PHRD) grant, already approved by the Peruvian Government.

38. Project components. The project consists of a water conservationprogram, rehabilitation of existing water and sewerage infrastructure,expansion of water supply and sewerage networks to low-incomeareas (pueblosjovenes), and technical assistance for institutionaldevelopment. These components are described in detail in Annex 5.

39. The water conservationcomponent (18 percent of total project cost) has two subcomponents. The first is a program for reducing unaccounted-forwater, includingthe preparation of a customer cadastre, reconstructing substandardwater boxes, and installing 406,000 new water meters for 56 percent of SEDAPAL's customers. The second develops conjunctive use of surface and groundwater in three areas of Lima where groundwater is depleted and saline contaminationis a threat. This subcomponentprovides secondary network pipes, nine reservoirs, rehabilitation of wells, and reinforcementof 35 kilometers of primary network pipe to accommodateadditional flow from the treatment plant. 40. The rehabilitationcomponent (59 percent of total project cost) has three subcomponents.The first will rehabilitate water supply networks in twelve districts. This involves replacing or repairing 42 kilometers of primary pipes and 622 kilometers of secondary pipes, reconstructionof 117,000 house connections, rehabilitating 129 unused reservoirs and repairing 156 defective ones, and supplying basic maintenanceequipment. The second subcomponentwill rehabilitate sewer networks in these same districts, replacing 77 kilometersof concrete pipes and 616 kilometers of secondary lines. This subcomponentwill also repair 123,000 house connectionsand 12,300 manholes. The final subcomponentwill rehabilitate 39 wells with diminishedyields and provide equipment for 85 new wells. 41. The service expansion component (16 percent of total project cost) will provide works to serve up to 600,000 low-incomepeople in the pueblos jovenes. Works include transmission lines, pumping stations, reservoirs, interceptors, and wastewater treatment plants. Engineering for these projects does not involve complex technical solutions. Cost estimates are based on recently executed projects of similar complexity. Priorities will be set through a participatory process that mobilizes potential beneficiaries. 42. The institutionalstrengthening component (7 percent of total project cost) includes about 1,500 staff-monthsfor consultant services, training, equipment, and logistical support in six subcomponents:management assistance, modernizationof financial management,assistance with SEDAPAL's transformation from direct service provider to contract administrator, capacity-building for the Superintendencyfor Sanitary Services, baseline studies to support a water basin authority in the region, and feasibility studies for wastewater disposal and the Chillon water treatment plant.

D. Cost 43. The total cost of the project is estimated to be US$306.2 million. Project costs are summarized in Table 1 and detailed in Annexes 5 and 6. The foreign exchange requirement is estimated to be US$127.1 million (41.5 percent of total project cost). Costs are based on end-1993 - 8 - prices, and include physical contingencyallowances of US$25.2 million-10 percent of equipment, works, and services. Price contingenciesof US$29.0 million-10 percent of the December 1993 project costs-are based on estimated international inflation of 2.5 percent per year during project implementation. Cost estimates are expressed in U.S. dollars because of high local inflation.

Table 1 Project costs (millionsof U.S. dollars)

Project component Local Foreign Toal

Rehabilitation 95.5 53.4 148.9 Water conservation 22.0 22.2 44.2 Network expansion 14.5 25.6 40.1 Institutional development 15.4 3.4 18.8

Total base cost 147.4 104.6 252.0 Physical contingencies 14.7 10.5 25.2 Price contingencies 17.0 12.1 29.0 Total project cost 179.1 127.1 306.2

44. Cost estimates for equipment, materials, and works for the rehabilitationand conservation componentsare based on engineering designs and unit prices of similar recent works. The rehabilitation componentis based on a least-cost solution. Its engineering has been evaluated and found satisfactory. The network expansion componentdoes not yet have detailed engineering- appraisal was based on engineeringand cost estimates from similar recent works. Engineering for this componentwill also be financedbased on a least-costsolution, and will require intense coordination with beneficiary communities.Conditions for individual subprojects in the pueblos jovenes are presented in Annex 17. Institutionaldevelopment estimated are based on the terms of reference for each subcomponentand on current consultant fees.

E. Economic evaluation

45. Each project componentgenerates different benefits. Water conservationand rehabilitation will increase the available water supply. Rehabilitationwill also reduce production costs, provide 834,000 people with improved water supply and 788,000 people with improved sewerage, and extend the lifetime of the network-postponing the need for new investment. Service expansion will either provide or improve access to water supply and sewerage for 600,000 low-income residents- improving hygiene and generating health benefits. And institutionalstrengthening will improve the managementand efficiency of Lima's water resources.

46. Data limited the benefits that could be quantified. Project benefits have been limited to direct-use benefits and exclude those from capacity-building,reduced pollution, and postponed new investment. Project benefits also include an estimate of the consumer surplus. Calculating the consumer surplus is difficult because of the lack of data on water consumptionbehavior in Lima (see Annex 9). Based on investmentcosts, projected operating and maintenancecosts, and economic benefits, the internal economic rate of return is 22 percent. The net present value is US$209 million and the benefit-cost ratio is 1.85.

47. Subproject analysis. A separate cost-benefitanalysis was prepared for the water meter program, water supply network rehabilitation, and expansion of the water supply and sewerage network in the pueblos jovenes. The water meter program will install 406,000 water meters in districts with excessive consumption.Assuming an average price elasticity of -0.30, per capita water consumptionin these districts will decline from 292 liters per day in 1993 to 200 liters per day when the project is implemented.Billing efficiency should also improve with the use of reliable meters. Commercial water losses should decline from nearly 16 percent of total production in 1993 - 9 - to 10 percent in 2005. The internal economic rate of return of this component is 119 percent. The net present value is US$213 million and the benefit-costratio is 6.06. 48. Savings generated from rehabilitationof the water supply network will amount to 1.3 cubic meters a second when this componentis complete. Rehabilitationwill cost US$47 million (adjusted for taxes and subsidies and excluding price contingencies). Based on these costs, the internal economic rate of return of this componentis 13 percent. The net present value is US$9 million and the benefit-costratio is 1.19. 49. The number of beneficiariesfrom water supply and sanitation network expansion is 600,000. Of these, 276,000 will receive improved service. The rest will receive direct access to the system. This componenthas direct-use benefits in the form of reduced rationing. Households that currently depend on indirect water supply (such as vendors and standpipes)consume about 30 liters a day per capita-and pay high prices for water. Once households are connected to the piped water system, it is likely that the decline in prices will be accompaniedby an increase in consumption. Analysis indicates the internal economic rate of return of this component is 43 percent. The net present value is US$143 million and the benefit-cost ratio is 2.88. 50. Tariff analysis. SEDAPAL's current water and sewerage rates do not reflect actual costs. Long-run marginal costs of water and sewage are estimated at US$0.45 per cubic meter-the current average is US$0.28 per cubic meter. An analysis of SEDAPAL's marginal cost structure is in Annex 10. 51. SEDAPAL's water rate schedule is complex, with different rates for residential, commercial, industrial, public, and social customers. Since meter reading is rare, the rate structure has been effectively replaced by a flat rate equal to a notional monthly consumption.The rate schedule has a high level of cross-subsidization-commercialand industrial customers pay rates that subsidize social and residential consumers (Annex 10, Table 5). Cross-subsidiesseriously impair efficient resource allocation-industries and commercialenterprises often use their own groundwater sources to avoid paying high rates. A lower level of cross-subsidizationcould increase the number of commercialand industrialusers in the system, reducing the strain on groundwater sources. The current tariff structure makes no distinction between water and sewerage costs. 52. The Water and SanitationService Law-enactment of which was a condition for loan negotiations-should make the tariff structure meet basic financial requirements and satisfy social equity concerns. New tariff regulationsshould be approved by executive decree prior to loan effectiveness.The following criteria are expected: * Marginal costs will be used as a reference value in rate structure and levels. * A distinctionwill be made between water and sewerage rates to improve the transparency of tariff-setting procedures. * The rate structure will be simplifiedby reducing the number of consumptionblocks from seven to three. The range of these consumptionblocks will be set according to current consumptionlevels. The first block will cover the minimum volume of water needed by a typical household. The second block will cover the volume that is still not considered excessive--25 to 30 cubic meters a month. Consumers that go beyond this upper limit will be considered excessive users. Such users should pay at least the marginal cost of water supply and sewerage to induce more rational water use. * Cross-subsidizationwill be limited to the lowest residential consumptionblock. * Tariffs will be set so that SEDAPAL can finance operating expenses, debt service, and investment. * The tariff schedule will include an adjustment formula to avoid real tariff declines, while promotingefficiency and the financial sustainabilityof SEDAPAL. - 10 - F. Poverty alleviation and affordability

53. In Lima 79 percent of the population has access to piped water, and 75 percent has access to sewerage. The remainder relies on standpipes, group taps, or vendors. Improving service and access for low-incomehouseholds will increase water consumptionand sewage collection. This will be offset by lower water consumptionin districts with high-volumeuse-where meters will be installed.

54. It is difficult to determine the capacity to pay for water and sewerage. SEDAPAL is preparing a study to determine willingnessto pay. Since these studies are not yet available, the affordability of water and sewerage services was determined using ability-to-payindicators.

55. SEDAPALapplies a minimum water consumptionlevel of 22 cubic meters a month to low- income householdsconnected to the network.' This level is high compared with minimum standards in other countries. The minimum consumptionlevel should provide enough water to satisfy basic needs and maintain minimal hygienic conditions. The minimum monthly consumptionrate is equal to 1.0 percent of monthly household income for poor 2 householdsand 1.9 percent for extremely poor households. Water vendor costs range from 2 percent to 13 percent of monthly household income (dependingon season and distance) for a daily per capita use of 30 liters.3 Households that purchase water from vendors pay 12 to 24 times more per unit of water than households connected to the piped water network.

56. Total charges for water supply and sewerage also include connection costs. Connection charges are high in Lima because they include the investmentcosts of secondary works. The average connection cost in the pueblosjovenes is estimated to be US$850. Residents can apply for short-term loans at FONAVI. FONAVI loans have a repaymentperiod of five years and a monthly interest rate of 1.5 percent. Based on these rates, total charges for water supply and sewerage (including monthly installmentsfor the payment of the connections)amount to 8.3 percent of monthly household income for the poor and 16.2 percent for the extremely poor. For households without a connection, such high entry costs mean piped water is not a viable option.

57. The rate structure could be further adjusted to favor low-incomehouseholds. The monthly minimum consumptionlevel should be reduced from 22 cubic meters to 10 cubic meters-a level sufficient for maintainingminimal hygienic conditions.To reduce the impact of connection costs, a more liberal credit system should be introduced. A loan with a repayment period of ten years and a monthly interest rate of 1.5 percent would reduce connection costs to 6.2 percent of monthly household income for the poor and 12.1 percent for the extremely poor. Another option is incorporating connectioncosts in the water rate. If the marginal cost of water was applied, the cost of water would be 3.1 percent of monthly householdincome for the poor and 6 percent for the extremely poor. This would lower dramatically the barriers to piped water access. The Ministry of the Presidency will submit to the Bank a proposal that incorporatesthese changes prior to loan effectiveness. In the second phase of project implementation,SEDAPAL will start to finance the secondary network, and these costs will be incorporated into water and sewerage tariffs.

1. SEDAPAL's rate structure has six rate categories,but only five are used. District incomelevel determineswhich rate is applied. The rate categoriesrange from 22 to 65 cubic meter a month.

2. Poverty thresholdsat the end of 1993were S/ 1,549 (about US$707)per capita per year for the poor and S/ 791 (about US$361) per capita per year for the extremelypoor. These data are basedon the October1991 poverty threshold in Lima(World Bank data) and adjustedfor GDP and exchangerate trends.

3. According to a survey of water vendorsin December1993, water costs range from SV. 0.80 to S/. 1.50 for a cylinder of 200 liters. Averagemonthly household use is 5 cubic meters, which correspondsto daily per capita use of 30 liters. - 11 -

G. Financial analysis

58. A Bank loan equivalent to US$150 million will help finance foreign and local costs amounting to about 49 percent of total project cost (Table 2). A cofinancier--theOverseas Economic Cooperation Fund--is expected to provide a loan of about US$76 million for specific project subcomponents. The remaining US$80 million will be provided by SEDAPAL. Table2 Financingplan, 1994-2000 (millionsof U.S. dollars)

Bank-financedprojecta SEDAPAL total investment plan

Source offunds Amount Percent Amount Percent World Bank 150.0 49.0 150.0 22.6 Cofinancier 76.2 24.8 76.2 11.5 SEDAPAL 80.1 26.2 317.0 47.8 Other loansb 120.3 18.1 Total 306.2 100.0 663.6 100.0

a. Does not include US$40.5 million interest accrued during construction, to be financed by SEDAPAL's intemal resources. b. A majority of these loans are provided by FONAVI and other domestic institutions for primary and secondary works (US$66 million).

59. SEDAPAL'sfinancial perfonnance, 1987-93. SEDAPAL's financial performance has been affected by Peru's unstable macroeconomicenvironment. During 1986-92, Peru experienced hyperinflation-reaching 7,650 percent annually in 1990. Financial performance has also deteriorated because of poor financial managementand inefficientoperations. As a result, SEDAPAL has not been able to maintain its physical assets, leading to rapid deterioration of service quality. Financial statements with notes and assumptionsare in Annexes 11 and 12. 60. SEDAPAL's net internal cash generation turned negative in 1988. As liquidity worsened, the company stopped paying its debts and delayed payments to suppliers. By end-1993 SEDAPAL had US$45 million of external debt in arrears. This debt was assumed by the Government according to agreements reached at the Paris Club and other bilateral meetings. But SEDAPAL still carries this debt as an obligation to the Government. The company has depended increasinglyon state transfers and user contributionsto cover minimal investmentand working capital needs. With scarce financial resources, SEDAPAL's investmentstagnated between US$15 and US$26 million in the past several years-much lower than the level required to maintain service quality. 61. Restructuring SEDAPAL. Financial performance started to improve in 1991 as inflation abated and restructuring began. Tariffs increased from a low of US$0.10 per cubic meter in 1989 to US$0.28 per cubic meter in May 1994-still lower than the estimated marginal cost of US$0.45 per cubic meter. A voluntary retirement plan reduced the number of employeesby 33 percent between 1987-93, and personnel costs dropped from 75 percent of operatingcosts in 1987 to 40 percent in 1993. The number of employeesper 1,000 water connections improved from 6.38 in 1987 to 2.74 in December 1993 (Table 3). This figure compares favorably with water companies of similar size elsewhere in Latin America. Because of increasedtariffs and decreased operating costs, SEDAPAL generated positive net income in 1993 for the first time in more than a decade. 62. SEDAPAL's financial managementsystems have considerable room for improvement. Medium- and long-term investment and financial planning has not been done until recently. Monthly financial statementstake three or four months to process. And the commercial system needs improvement. In late 1993 SEDAPAL launched a billing and collection program that seeks to reduce by 40 percent the amount of bills uncollectedafter three months past due. If successful, accounts receivable would be reduced to 75 days of revenue by 1995. The program has not been as - 12 -

effective as expected because of a recent tariff increase. In addition, SEDAPAL's fixed assets (US$432 million at end-1993) have not been revalued sufficiently in the last several years, and are thought to be significantlyundervalued.

Table 3 Financialdata, SEDAPAL, 1987-93

1987 1988 1989 1990 1991 1992 1993 Financialindicators Water and seweragetariff (per cubic meter) 0.21 0.13 0.10 0.15 0.21 0.20 0.21 Operating revenue (millionsof U.S. dollars) 82.4 53.0 41.3 60.1 85.6 91.0 101.8 Operating expenses(millions of U.S. dollars) 66.3 64.7 62.5 59.2 77.4 74.0 69.4 Net income(millions of U.S. dollars) -27.7 -128.5 -98.6 -115.1 -23.4 -14.9 20.2 Working ratio (percentage) 80.5 122.1 151.3 98.6 90.4 81.2 68.2 Operating ratio (percentage) 119.4 261.3 291.6 209.7 120.5 99.5 79.0 Investment (millionsof U.S. dollars) 15.0 17.8 20.2 18.9 26.4 18.1 39.5 Operationalindicators Accounts receivablecomparator (days) 78 116 100 116 90 100 119 Employees per 1,000 water connections 6.38 6.35 5.79 5.44 4.81 3.49 2.74

63. Projectedfinancial perfonnance, 1994-2000. The financial projections presented in Annex 11 assume operational efficiency and investmentthat could be attained by a reasonably well- managed public utility in Latin America. These conservative projectionsassume that: SEDAPAL will increase water service coverage to 88 percent by 2000 (from 79 percent in 1993), there will be no Government transfers, the average water and sewerage tariff will increase to US$0.37 per cubic meter, and SEDAPAL will refinance its external debt in arrears and repay its obligations to the Government.

64. Under this base-case scenario, operating and financial performance will improve gradually. By 2000, SEDAPALwill reduce its unaccounted-forwater level to about 41 percent (from 46 percent in 1993). Employeeproductivity will improve further, to 1.96 employees per 1,000 connections, through a gradual reduction of SEDAPAL's staff. With decreased personnel costs, SEDAPAL will maintain a working ratio of less than 60 percent and an operating ratio of 75 percent, while increasing needed maintenancecosts. Commercial efficiency should reduce the accounts receivable to about 75 days of revenue by 1995, thereby increasing funds for investment. SEDAPAL will generate sufficientcashflow to pay its debts and cover a substantialportion of projected total investment(US$664 million, not including capitalized interests). By 2000, SEDAPAL's internal cash will cover more than 50 percent of investment, including26 percent of the Bank project.

65. Sensitivityanalysis. A sensitivityanalysis was conducted on key variables to determine their impact on SEDAPAL's internal cash generation and the level of investment that could be executed between 1994 and 2000. This analysis highlightedthe importance of operational efficiency and tariff increases to SEDAPAL's financial performance and to timely execution of the investmentprogram. Three efficiency scenarios and two tariff structures were used to determine possible impacts on SEDAPAL's investmentcapacity. The "private sector" scenario estimates efficiency under private management. The "improved public sector" scenario, which includes the base case scenario described above, assumes that SEDAPAL's operational efficiency will improve to the level of a reasonably well-managedpublic utility elsewhere in Latin America. The "business-as-usual" scenario assumes no improvement. Each scenario is analyzed under two tariff structures-a gradual increase to US$0.37 per cubic meter and the May 1994 level of US$0.28 per cubic meter. Internal investment sources were calculated for each combinationto determine the level of investment afforded under each scenario (Table 4). - 13 -

Table 4 Sensitivityanalysis for two tariff rate structures

Gradual increase to Efficiency scenario US$0.37 per cubic US50.28 per cubic meter meter

Private sector (lowers unaccounted-for water to 30 percent) Investnent level (millions of U.S. dollars) 752 541 Maximum working ratio (percent) 57 65

hnproved public sector (lowers unaccounted-for water to 41 percent) Investment level (millions of U.S. dollars) 664 474 Maximum working ratio (percent) 60 73

Business as usual (unaccounted-for water remains at 46 percent) Investment level (millions of U.S. dollars) 633 450 Maximum working ratio (percent) 64 78

66. Under the private sector scenario, at tariffs of US$0.37 per cubic meter, investmentwould be US$752 million-10 percent more than planned. The financial performance of the company could improve even further under this scenario, since the Government will likely assume all or part of SEDAPAL's debt obligation once a concession is awarded. Under the improved public sector scenario, with increased tariffs, the total investmentprogram (US$663.6 million) will be completed in seven years. With no tariff increase, investmentwould be limited to about US$541 million-83 percent of what is planned. Under the business-as-usualscenario, with a tariff increase, internal cash generation and investment will fall short of what is planned. Without a tariff increase, SEDAPAL would be able to execute only about 68 percent of total investment. The investment program in this case would be delayed by more than four years, which defers the net incremental benefit of the investments.Under the business-as-usualscenario, the internal financial rate of return of the project is reduced to 10 percent, compared with 17 percent under the base-case scenario. Details of the assumptionsand results are presented in Annex 12. 67. To strengthen SEDAPAL's financial standing, assuranceswere obtained during loan negotiationsthat SEDAPAL will:

* Generate sufficientcashflow to cover 30 percent of the total investmentprogram. * Revalue its fixed assets and incorporate the study's recommendationsinto 1995 end-year financial statementsin a form acceptableto the Bank. * Improve employee productivity-the number of employeesper 1,000 water connections-to less than 2.5 by end-1995, and less than 2.0 by end-2000. * Maintain a debt service coverage ratio no lower than 1.5. * Sign annual managementagreements to contain physical, operational, and financial performance targets.

In addition, the Governmentand SEDAPAL should agree on a timetable for settling SEDAPAL's external debt in terms acceptableto the Bank, before the closing of the concession contract. If privatization is successful, the Government should cancel at least the overdue portion of SEDAPAL's external debt (US$45.8 million at end-1993). SEDAPAL could then pay on the current portion of the debt. If privatizationis unsuccessful,the Governmentand SEDAPAL should agree on a debt refinancing plan, and possibly a debt cancellation scheme tied to the second management agreement.

H. Environmental Aspects

68. The project is classified as Category B under the Bank's environmentalguidelines. An Environmental Impact Assessmenthas been carried out for the project and is available in the project - 14 -

files. Temporary adverse impacts are the disruption of road traffic during constructionand increased wastewater from connectionsin the pueblosjovenes. The first impact will be mitigated by careful scheduling of construction. The second will be addressed by the comprehensivewastewater managementproject whose preparation is partly financedby this project. Since the project emphasizesrehabilitating existing infrastructure, conservingwater, and expanding service to low- income areas, it will deliver significantenvironmental benefits. These benefits include improved health, quality of life, and supply reliability and reduced flooding, odor, and groundwater depletion and contamination.

L. Risks

69. The project's main risks are political oppositionto the sectoral reform-including privatization-that may slow the reform process, ineffectiveexecution of the project during the transition from public to private sector operation, insufficientcounterpart funding, and non- acceptance of Bank funds by the concessionaire.The risk of political opposition is minimizedby three factors. First, the new regulatory and institutionalframework is the result of two years of consensus-buildingby the Governmentof Peru to advance reform. Second, the timing and social environment for privatization is favorable-the current administrationwants to advance SEDAPAL's privatizationbefore the April 1995 elections. Finally, successfulprivatization in other sectors and public utilities has created social support for privatization. The risk of ineffectiveexecution of the project during the transition period is minimized by a managementagreement to be signed between SEDAPALand the Government. This agreement defines key operational and investment performance objectives and will be evaluated every three months until the private operator assumes responsibility. If privatizationis unsuccessful, terms for a second managementagreement will be discussed with SEDAPAL and the Government during the Project Review. Annual management agreements should be signed thereafter. If privatization is successful, a performance plan-as part of the concession contract-will be signed between the private operator and SEDAPAL. The risk of insufficientcounterpart funding is minimized through the new tariff regulations, which allow for adequate levels of revenue and automatic adjustmentsbased on five-year tariff formulas, and through the monitoring of investmentdecisions and operational efficiency through the management agreement (before privatization) and the performanceplan (after privatization). The risk that the concessionairemay not enter into a subsidiary loan agreement with SEDAPALfor the use of the Bank funds, and hence the possibility of an early partial cancellation of the Bank loan, is minimized by the fact that prequalified private operators have already shown considerable interest on the Bank to finance urgent rehabilitationwork.

III. Project Implementation

70. The borrower is the Republic of Peru. The executing agency is SEDAPAL. The project will be managed by a project managementunit within SEDAPAL.The project managementunit will be responsible for overall managementof the project, and will ensure consistency in the application of Bank guidelinesand compliancewith the loan agreement, the subsidiary loan agreements, and project agreement conditions. A. Arrangements

71. Although the project is a conventionalBank project-with an investmentcomponent and an institutionalcomponent-project implementationis linked to SEDAPAL's privatizationprocess. The Loan Agreementwill be signed by the Republic of Peru (represented by the Ministry of Economy and Finance) and the Bank. A Project Agreementwill be signed by SEDAPAL and the Bank to directly execute the project during the transitionalperiod before privatization, and through the private contractor after privatization. SEDAPAL, representingthe Governmentof Peru, will sign a concession contract with the private operator. - 15 -

72. Firstphase. Project implementationwill have two phases. The first phase, expected to last up to 12 months, corresponds to the project execution period while privatization takes places, and ends with a comprehensive project review. During this phase, up to 20 percent of the project-about US$56 million-would be committedby SEDAPAL. Operational indicators and investment goals will be monitoredand managedby a managementagreement to be made between SEDAPAL and the Government of Peru, in a form satisfactoryto the Bank. As condition of effectiveness,the Government and SEDAPAL will sign the managementagreement for 1995. 73. Second phase. The second phase will be initiatedafter the project review. Two scenarios are possible. If privatization is successful, SEDAPAL, representingthe Government of Peru, will sign a concession contract with the private operator. SEDAPAL will continue to exist as the owner and administrator of the concessioncontract. Its project managementunit will be responsible for institutionaldevelopment and the investmentcomponent of the project accepted by the private concessionaire. Once privatizationoccurs, however, SEDAPAL's statutes will have to be adjusted to allow for such arrangements. Bank staff provided comments on the draft revised statutes during loan negotiations. SEDAPAL's project managementunit would continue to manage the institutional developmentcomponent of the Project, handle all disbursement requests, and if so agreed with the concessionaire, it would carry out the procurement for the investmentcomponent of the Project accepted by the concessionaire. This would facilitate the applicationof the Bank's requirements with respect to procurement as stipulated in the Project Agreement. The concessionairemay elect to carry out all procurement itself. If it elects to receive the benefit of the terms of the Bank loan by entering into a subsidiary loan agreement with SEDAPAL, it will have to agree to assume all obligations of SEDAPAL for the execution of the investmentcomponent of the Project under its Project Agreement with the Bank--includingthe Bank procurement rules. A draft of the subsidiary loan agreement will be included in the bidding documents of the concession. Because it is possible that the plans of the concessionairemay call for a somewhat different execution or a different timing of the urgently needed rehabilitationmeasures described in the Project Description in the Loan Agreement, a comprehensiveproject review would be carried out jointly by the Bank, the Government, SEDAPAL, and the concessionaireprior to the closing of the concession transaction to determine to what extent the Loan Agreement, the Project Agreement, and the first Subsidiary Loan Agreement (SLA-1) would have to be changed, if at all, includingpossibly the cancellation of a portion of the Bank loan. The second Subsidiary Loan Agreement between SEDAPAL and the concessionaire(SLA-2) would incorporate, by reference, all the relevant obligations of SEDAPAL under the revised Loan and Project Agreements. The performanceobligations of the operator will then be monitored by the Bank until the project is completed. If privatization is unsuccessful, the project will still be modified at Project Review, with institutionalstrengthening expanded as needed. Annual managementagreements between the Governmentand SEDAPAL, approved by the Bank, would ensure monitoringof project implementationduring the second phase. In both scenarios, the Bank loan would be fully recovered through tariffs. 74. Project management. The project managementunit will report to a project committee at SEDAPAL chaired by the general manager. This unit is responsible for overall project execution, including all bidding processes, preparation of disbursement requests, managementof project accounts, and preparation of progress reports. It will be composed of at least a project manager, a financial analyst, a sanitary engineer, and a procurement officer. The project manager was appointed prior to loan negotiations. The project managementunit will be assisted by management consultants to be firnancedthrough the project. The project managementunit will carry out the project directly during the first phase of implementation,investing up to 20 percent of the Project. The remaining 80 percent of the proceeds of the Bank Loan, or the amount accepted by the concessionaire, will be used for the procurement of works, goods and services through the concessionaireapplying Bank rules on procurement. The institutionalcomponent will also be assessed at Project Review to reflect the outcome of the privatization process. Terms of reference for the project managementunit were agreed on during loan negotiations, with staffing concluded by loan effectiveness. The main functions of the project managementunit, the project committee, and the managementconsultant are outlined in Annex 14. As conditionof effectiveness, SEDAPAL will have formally establishedthe project managementunit and the project consultative committee and - 16 -

will have staffed the PMU as agreed at negotiations. Agreementwas reached with SEDAPAL to operate and maintain the unit and the committee during project implementationwith functions and responsibilitiessatisfactory to the Bank.

75. Legal documentsand conditionality.Project legal documents include a loan agreement between the Republic of Peru (representedby the Ministry of Economy and Finance) and the Bank, a subsidiary loan agreement (SLA-1) between the Ministry of Economy and Finance and SEDAPAL, and a project agreement between SEDAPALand the Bank to execute the project. Financingterms and conditionsare the same in the subsidiary loan as in the Bank loan, with foreign exchange risk borne by SEDAPAL. There is a second subsidiary loan agreement (SLA-2) between SEDAPALand the concessionaire for any parts of the project carried out by the concessionaire using the proceeds of the Bank loan. Terms and conditionsof the SLA-2 must be satisfactory to the Bank, and will be stipulated in bidding documents for the concession. The concessionairecould decline to take the subsidiary loan, and any part of the Bank funds not accepted by the concessionairewill be canceled. The Governmentof Peru will countersign the SLA-2 to confirm its agreement. Agreement was reached during loan negotiationsthat the project will be carried out in accordance with the managementagreement prior to Project Review. After the Project Review, the project must be in accordance with the concessioncontract and SLA-2 or, if privatization fails, the project will be carried out in accordance with the second managementagreement and subsequent annual agreements (as approved by the Bank). A summary of the legal documents and institutions involved is in Annex 15.

76. Special account. A Special Account will be established in U.S. dollars in a commercial bank acceptable to the Bank. The authorized allocation-sufficient for about four months of expenditures-will be US$8.0 million. It was agreed during loan negotiationsthat the authorized allocation will be limited to US$4.0 million until the aggregate amount of withdrawalsexceed US$20.0 million. The threshold under which use of this account is obligatory is US$800,000. The Bank will replenish the special account upon receipt of disbursement requests from the Government. SEDAPAL's project managementunit will control the special account and be responsible for disbursement requests. Requests will be submitted monthly, or when the account balance is 67 percent of its initial deposit, whichever comes first. SEDAPALwill also establish a separate account in local currency. Counterpart funds will be deposited at regular intervals to match requirements for each component under execution, according to a schedule to be presented every three months. Both accounts will be managed in accordance with internationalaccounting standards. 77. Project review. Once the results of the privatizationprocess have been published by the Government of Peru, a Project Review involvingthe Government, the Bank, and the private operator will occur prior to the second phase of the project. This review is essential to project implementation.A draft terms of reference for the review was discussed during appraisal and agreed to during loan negotiations(Annex 16). Prior to Project Review, SEDAPALshould have reached a final agreement with the Governmenton settling its external debt and submittedproposals to the Bank for modificationof the loan agreement, project agreement, and subsidiary loan agreement, if necessary. If privatization is successful, the Project Review will accommodate, to the extent possible, the proposed investmentand financing plan proposed by the concessionaireand determine any amendmentsto the legal documents--includingany cancellationof a portion of the loan--as necessary. If privatization is unsuccessful,and SEDAPALremains as the service provider, the Project Review will adjust the institutionalsupport componentto strengthen SEDAPAL's institutionaland managementcapacity, particularly in financial and commercialareas. The Project Review will take place either ninety days within the award of the concession, or not later than December 31, 1995, or when aggregated loan disbursementsamount to US$40 million, whichever comes first, in the event that the concessionhas not been previously awarded. In addition to the Project Review, two workshops will be held to explain Bank procedures. The first will be held at the beginningof the first phase of project implementation,and no later than two months after loan signature. The second will be held after Project Review to initiate the second phase of project implementation. - 17 - B. Subproject selection criteria

78. There are two types of subprojects related to water supply and sanitation service in Lima-rehabilitation and expansion. Rehabilitationsubprojects will be selected based on technical criteria agreed on during project preparation relating to maintenanceurgency, district location, and pipe material. Expansion subprojects in the pueblos jovenes will be chosen based on two principles. First, districts are prioritized based on service demand-the community is responsible for preparing and submitting subproject proposals. Second, project managementshould be limited to defining and disseminatingthe "rules of the game" (technical and financial criteria for feasibility) and quality control. A more detailed descriptionof the selection criteria for subprojects is in Annex 17. C. Project supervision 79. SEDAPAL's project managementunit will supervise all project components, including SEDAPAL's compliancewith the Project Agreement. A project implementationmanual prepared by SEDAPAL contains basic project managementprocedures. An acceptableversion of this manual was agreed to during loan negotiations, and the final version will be formally adopted prior to loan effectiveness. Project reviews and supervisionwill be based on well-definedand measurable institutional,physical, operational, and financial indicators developed during appraisal. Monitoring indicators were agreed with the Government during loan negotiations(Annex 19). 80. The project will require considerableBank supervision-20 staff-weekshave been allocated for the first phase of implementation(Annex 18). The Project Review will be a key instrument of Bank supervision. Supervisionwill be based on SEDAPAL's 1994-2000 investment and financial plan, performance indicators and targets in the concession contract, the set of project monitoring indicators indicated above, and the targets in the managementagreement between SEDAPAL and the Government. During loan negotiations, agreement was reached that SEDAPAL and the Bank will conduct annual reviews of the progress in the implementationof the project based on an annual operating plan presented by SEDAPAL, including a review of the implementationschedule, monitoring indicatorsand budget for the incomingyear. These reviews will take place not later than October 31 of each year. Progress in the implementationof the Project will be based on the indicators in Annex 19. D. Procurement 81. Civil works represent about 83 percent of total project cost. Equipment and materials used in civil work contracts account for 25 percent of this percentage. Consultant services (studies, supervision, management,technical assistance, and engineering designs) account for 9 percent of total project cost, and equipment and materials, 8 percent. All equipment and materials contracts estimated to cost less than US$250,000up to an aggregate amount of US$2.0 million, and civil works estimated to cost less than US$3 million up to an aggregate amount of US$42.9 million, could be procured under local competitivebidding. Above these limits, procurement will be carried out through international competitivebidding, using Bank's standard bidding documents for goods and works. Seventy percent of works will be procured under internationalcompetitive bidding (Table 5). Draft standard bidding documents for local competitive bidding are being prepared taking into considerationthe most recent Country ProcurementAssessment Report, which concludes that regulations for local competitive bidding procedures in Peru are not entirely consistent with Bank procedures. Consultant services, includingengineering, supervisionand technical studies will be procured according to Bank Guidelines. Supervisionand engineering designs amounting to more than US$50,000 for firms and US$20,000 for individualswill require prior Bank review. The ProcurementPlan and ImplementationSchedule is in Annex 13, including a preliminary bidding package. - 18 -

Table 5 Project costs by procurementmethod (millionsof U.S. dollars)

Internatonal Local compedtve Project ekment competitive bidding bidding Other Total

Civil works 210.0 42.9 252.9 (69.8) (30.6) (100.4) Equipment and materials 22.4 2.0 24.4 (22.4) (1.4) (23.8) Consulting services 28.9 28.9 (25.8) (25.8) Total 232.4 44.9 28.9 306.2 (92.2) (32.0) (25.8) (150.0)

Note: Figures in parenthesesare amountsfinanced by the Bank loan.

82. Internationalbidding will be subject to Bank review of advertising, bidding documents, bid evaluation, and contract awards. To expedite project execution, only local bidding for works exceeding US$500,000and US$100,000for goods will be subject to ex ante review. These prior review arrangements would result in a coverage of above 85 percent of Bank finance of contracts for goods and works. If the Bank determinesthat procurement is inconsistentwith agreed procedures, said expenditurescannot be financedby the loan and the Bank may cancel an equivalent amount of the loan. E. Disbursement

83. The loan will cover 100 percent of foreign expendituresfor consultants, works and goods, 85 percent of local expenditures for consultants,and 66 percent of local expenditures for civil works, equipment, and materials. Funding will be disbursed through the special account to expedite project implementation.Disbursements for civil works contracts of less than US$500,000 and goods of less than US$100,000, and also for consultingcontracts with firms and individualscosting US$100,000 and US$20,000 respectively, will be made under the statements of expenditure procedure prepared and certified by SEDAPAL's project managementunit. Documentationwill be retained by the managementunit for inspectionduring supervision missions and for auditing. No force account works are envisaged. The estimated schedule of disbursement(Annex 20) lasts six years, ending on December 31, 2000. The closing date will be June 30, 2001. F. Advance contracting and retroactive financing

84. The loan will finance works between 1994 and 2000. Some emergency rehabilitation and consultant services have already been funded to allow full implementationby mid-1995. Advance contracting-about US$20 million-began on May 15, 1994, and retroactive financing-about US$10 million-will be provided for eligible expendituresincurred since that day. Advance contracting and retroactive financingmust follow Bank procurement guidelines. To ensure a prompt project start and loan disbursement, SEDAPALprovided the Bank with bidding documents for subprojects expected to be eligible for retroactive financingand terms of reference for selected studies and technical assistance. G. Auditing arrangements

85. During loan negotiationsthe Bank and SEDAPAL agreed that external auditors will perform an annual audit of SEDAPAL's project accounts, statements of expenditure, the special account, and financial statements. Each year's audit report will be submittedto the Bank by June 30 of the following year. - 19 - H. Reporting and monitoring

86. Quarterly progress reports, as described in the project implementationmanual, will describe and compare project progress with the progress envisaged at appraisal, review compliance with the monitoring indicators in Annex 19, and assess problems and issues arising during project execution. The reports will also propose adjustmentsand remedial action in case of unsatisfactoryprogress. Agreement was reached during loan negotiationsthat progress reports will be submitted to the Bank by March 31, June 30, September30, and December 31 of each year. A final report analyzing key issues and containing the borrower's assessmentof the project will be submitted to the Bank within six months of the loan closing date.

IV. AgreementsReached and Recommendation 87. During loan negotiations, SEDAPAL agreed:

a. To generate sufficient internal funds to cover at least 30 percent of the total investment program throughout the project execution period (para. 67). b. To revalue its fixed assets and incorporate the study's recommendationsinto 1995 end-year financial statements in a form acceptableto the Bank (para. 67). The asset revaluation study, satisfactory to the Bank, would be completed by no later than December 31, 1995. c. To improve employee productivity-the number of permanent employeesper 1,000 water connections-to less than 2.5 by end-1995, and to less than 2.0 by end-2000 (para. 67). d. To maintain a debt service coverage ratio no lower than 1.5 (para. 67). e. On the contents of the terms of reference for the project managementunit (para. 74). f. To carry out the project in accordance with the first managementagreement prior to project review. After the Project Review, the project must be in accordance with either the concession contract and second subsidiary loan agreement or, if privatization fails, the second managementagreement and subsequentannual managementagreements (para. 75). All agreements are subject to Bank approval. g. On the selected indicators and targets to be monitoredduring project implementation(para. 79). h. To hold with the Bank annual reviews on the implementationof the Project. These reviews will take place not later than October 31. Progress in the implementationwill be based on the indicators in Annex 19. i. That external independentauditors, satisfactoryto the Bank, will perform an annual audit of project accounts, statements of expenditures,the special account, and SEDAPAL's financial statements. Each fiscal year's audit report should be submittedto the Bank by June 30 of the following year (para. 85). j. That quarterly progress reports will be submittedto the Bank by March 31, June 30, September 30, and December 31 of each year (para. 86). k. To hold a Project Review in accordance with the timing and terms of reference as described in annex 19 (para. 77). 1. To establish and maintain a project account for purposes of depositingthe necessary counterpart funds in accordance with schedulesto be presented to the Bank on March 31, June 30, September30 and December 31. m. To prepare and present to the Bank, not later than November 30 each year, an annual operating plan with a review of the implementationschedule, monitoring indicators and budget for the incoming year (para.80). 88. During loan negotiations, the Governmentof Peru and SEDAPAL agreed:

a. To submit proposals for modificationof the loan agreement, project agreement, and subsidiary loan agreement to the Bank before Project Review (para. 77). b. On the terms of reference for the Project Review (para. 77). - 20 -

c. To amend SEDAPAL's Bylaws, in a form satisfactory to the Bank, to adapt such Bylaws to the Water and Sanitation Services Law (para. 73). 89. Prior to loan effectiveness:

a. New tariff regulations should be approved by an executive decree as part of the regulations of the Water and Sanitation Services Law (para. 52). b. The Ministry of the Presidency should submit to the Bank a proposal satisfactory to the Bank for financing secondary works in accordance with the Water and Sanitation Services Law (para. 57). c. SEDAPAL has formally establishedthe project managementunit and the project consultative committee and has staffed the project managementunit according to the terms of reference agreed at negotiations. d. SEDAPAL should formally adopt the project implementationmanual (para. 79). e. The Government of Peru and SEDAPAL have executed the subsidiary loan agreement. f. The Government and SEDAPAL have executed the managementagreement for 1995. g. SEDAPALhas opened the project account.

90. An agreement between the Superintendencyof Sanitary Services and SEDAPAL, satisfactoryto the Bank, will be a condition to disburse the institutionalstraightening subcomponent of the Superintendency.

91. Recommendation.Subject to the above conditions, the project is suitable for the Bank loan of US$150 million equivalent, to be repaid over 17 years, including a grace period of five years, at the Bank's standard variable rate. - 21 -

PERU

LIMA WATER REHABILITATIONAND MANAGEMENTPROJECT

STAFF APPRAISALREPORT

ANNEXES - 22 - PERU ANNEX 1 LIMA WATER REHABIUTATIONAND MANAGEMENT PROJECT BANK LOANS TO PERUWITH WATER AND SANITATION COMPONENTS Status as of April 30, 1994

.,,,,- -- ... .moi,rn . ..,.... Bo1wer:, ,. ' ""'' . , ' ' ' ' 'C

1976 1283-PE 21.6 Banco de la Urban Sites and Services 100% The project did not achieve its cost recovery objectives. Vivienda Development

1979 S-1 1-PE 8.8 Republic Water Supply and 93% 7% of the loan was cancelled. There were initial delays of Peru Power Engineering due to non-compliance with legal and financial conditions of the Loan Agreement.

...... - tSA niPply-...... Up_ .: . :f pt o e :Iui w c l : ...... '......

1983 2204-PE 10.2 Republic Public Sector 99% 1 % of the approved loan amount was cancelled. The of Peru Management project was designed to improve overall performance of Government.

1985 2451-PE 60.1 Republic Lima Metropolitan 40% 60 % of the approved loan amount was cancelled. The of Peru Development erosion of sectoral institutions and policies led to the suspension of loan disbursements in May 1987.

1993 3540-PE 30 Republic Privatization 10% Various options have been assessed for privatizing of Peru Technical Assist SEDAPAL. The recommendation by the consultants is to pursue the concession approach.

1993 3595-PE 250 Republic Privatization 30% The successful privatization of the government's telecom of Peru Adjustment holdings has given an enormous boost of confidence

I______I ______I___to the privatization strategy of the country.

1 Only one project sector specific has been approved in Peru. - 24 -

Annex 2 Bank Experience and Lessons Learned

1. Most water and sanitation projects provide substantial economic and health benefits. Since the 1960s-when Bank lending in this sector began-projects have become larger, with many involvingassistance to multiple entities under one operation. Some operations relied on intermediaries to control implementationand to provide assistance. Many operations aimed to consolidate water entities. The main lessons from this experience are:

* Achieving institutionaland cost recovery objectives is slow and difficult. * Adequate project preparation, early land acquisition, and manageable procurement procedures are essential to avoid project implementationdelays. * The quality of Bank supervision during project implementationis a key factor in achieving objectives. * Sound managementand adequate maintenanceare important to avoid endangering the sustainabilityand benefits of new facilities. * Attention should be paid to wastewater disposal in densely populated areas. * More attention should be given to the high levels of unaccounted-forwater that are commonly observed in water companies throughout Latin America.

Experience in Latin America

2. Most water and sewerage projects in Latin America have met their physical objectives-and in some cases surpassed them-but have suffered from implementationdelays (averaging about two years longer than estimated during appraisal) and failure to meet their institutional objectives. The main lessons from the regional experience are:

• Water and sanitation projects are affected by macroeconomicperformance. * Frequent managementchanges and delayed implementationcompromise project objectives. * Physical and institutionalcomponents should be linked. * Project scope and design should be simple. * Projects should emphasize cost recovery, lower operational costs through higher operational efficiency, and a larger internal contribution to investment. * Better demand and productivity forecasting are needed.

Experience in Peru

3. Since 1976 the Bank has made three loans for water supply and sewerage projects in Peru. These loans amounted to US$55.9 million. Assistance has focused on helping Lima's water supply and sewerage company expand coverage-particularly in low-incomeareas-and on strengthening managerial, technical, and financial capacity. Overall, these projects failed to achieve their objectives.

4. Urban Sites and Services Development Project. This 1976 project (Loan 1283-PE), the first urban development project in Peru, financed an extension of water supply and sewerage to low- income areas in southern Lima. Although the project exceeded targets for water and sewerage connections, it fell short of its cost recovery objective. - 25 -

Annex 2

5. Water Supply and PowerEngineering Project. This 1978 project (Loan S-11-PE) attempted long-termsolutions to problems in Lima's water supply and power sectors. It also supported organizationaland financial improvementsin Lima's water utility. Most of the engineering studies includedin the project were completed,but the utility's managerialand organizationalprocedures did not improve. The operationclosed two-and-a-halfyears behind schedule. It failed to have a strong institutionaldevelopment impact because of:

* Frequent changes in the utility's Board of Directors; * Lack of executivecapacity-the Board of Directors was hesitantto set policies or action plans that conflicted with the governmentor the utility's political strategies; * Slow contractingprocedures; * Conflictsbetween the utility and its consultants;and * Insufficientcounterpart funds-created by the utility's low tariffs and poor billing.

6. Lima Water Supplyand SewerageProject. This 1981project (Loan 2139-PE) tried to improvehealth and living conditionsin Lima by improvingwater and sewerageservices, managementof surface and groundwaterresources, and the company's managerial,technical, and financial capacity. The project failedto achieve the coverageproposed during appraisaland did not strengthentechnical and managerialcapacity. The loan and project scope were reduced to 67 percent of the original amount at the request of the governmentand the utility. In November 1986, with 46 percent of the new loan amount disbursed(31 percent of the original amount), the Bank suspendeddisbursements. The loan was suspendedbecause of the lack of governmentcommitment to institutionalreform, adverse macroeconomicconditions (particularly the acceleratinginflation rate), and governmentpricing policies.Another reason was inadequategovernment direction and control of the utility. The entity was burdened with regulationsand restrictionsthat hindered its operatingefficiency. Procurementprocedures, tariff rates, budgets, personnelpolicies, and salary structureswere regulated by external agencies-reducing managerialaccountability. Other reasons for the loan suspensionincluded the lack of qualifiedpersonnel, frequent changes in the utility's Board of Directors, protracted procurementprocedures, and delays in the productionof final designs.

7. Main lessons. The main lessons from Bank experiencein the water and sanitationsector in Peru are:

* Previous experiencewith the proposed borrower or executingagency should be evaluated. * Evidence of governmentand utility commitmentto reform should be requested before committingto a new project. The Bank shouldnot overestimatethe extent to which its supervisionefforts can influencegovernment strategy and policies. * Institutionaldevelopment is a long-termprocess that requires careful planning. The Bank should be aware of the complexitiesof institutionalreform, and the need to have precise objectivesand a strategy for meetingthese objectives. * The Bank should be more rigorous in enforcingcompliance with loan agreements.Delays in applying remedies result in inefficientuse of the borrower's and the Bank's financial and human resources. * Project design sufferedfrom lack of a long-termstrategy for institutionalimprovement, overestimationof the utility's absorptivecapacity, and underestimationof the political constraints to reform. The Bank did not grasp the implicationsof institutionaldevelopment as a long-termstrategy, particularlygiven the utility's low level of technical,administrative, and financial performance. - 26 -

Annex 3 Peru's Privatization Program

1. The collapse of the state sector led the Fujimori administrationbeginning in 1990 to adopt an extensive privatization program. The objective is to privatize all state-owned enterprises by mid- 1995. In September 1991, a privatization law (Law for the Promotion of Private Investment) establishedthe legal and institutional framework for the privatization program. An interministerial commission(COPRI) oversees the program. Individual privatizations are carried out by special privatizationcommittees (CEPRIs). These committeeshave been establishedto carry out more than 60 privatizations.

2. Privatizationhas been preceded or accompaniedby legal and regulatory reform in every sector. New laws have been enacted in mining, hydrocarbons, telecommunications,electricity and water. All are designed to promote competitionand private participation. New regulatory agencies have been created for telecommunications,electricity, and water. And in hydrocarbons, policy and regulatory functions (such as contracting with foreign oil companies for exploration or production) have been transferred from Petroperu (which is being privatized) to a new arms-length agency. As a result of these reforms, foreign investmentincreased from US$41 million in 1990 to US$150 million in the first nine months of 1993. Major new foreign investmentshave been announced in mining and petroleum.

3. By end-March 1994, the government had successfullyprivatized about 30 companies (or units) for about US$2.5 billion. Completed privatizationsinclude: a 35 percent control in the telecommunicationscompanies (CPT, Entel), sold to Telefonicade Espatsain February 1994 for US$2 billion (US$1.4 billion to the Treasury, with the remaining US$600 million to be invested in CPT), the national airline (Aeroperu), sold to Aeromexicoin January 1993 for US$54 million, seven mining holdings, including the iron ore company (sold to the Chinese ShougangCorporation for US$120 million) and the Cerro Verde copper mine, four subsidiaries of Petroperu, three urban transport companies (buses were auctioned to employees), two banks, and six manufacturing companies. Sixty percent of Electrolimawas sold in two units in July 1994 for US$388 million to two consortia of Chilean, Spanish, Canadian and Peruvian companies.

4. Technical preparations are well-advancedin other major privatizations, including the national electricity generation company (Electroperu,to be sold in several units to promote competitionin generation), the national oil company (Petroperu), the remaining mining holdings (Centromin, Tintaya, and the remaining units of Minero Peru), and two state-ownedbanks.

5. The Bank has supported privatization through policy advice, technical assistance (PrivatizationTechnical Assistance Loan 3540-PE and Japanese grants), and a US$250 million, three-trancheadjustment operation (PrivatizationAdjustment Loan 3595-PE) that supports legal and regulatory reform and privatization, particularly in mining, hydrocarbons, telecommunications, fisheries, and water. In the water and sanitation sector, release of the second tranche of the PrivatizationAdjustment Loan is contingent on the submissionof the Water and Sanitation Services Law to Congress and the preparation of draft regulations for the law. Release of the third tranche is contingent on enactment of the law and issuance of the regulation. PERU ANNEX 3 LIMA WATER REHABILITATIONAND MANAGEMENTPROJECT SEDAPAL PRIVATIZATIONTIMETABLE (May 31, 1994)

__m J* 19 Octabe l_w D*rDwA 2I1nL59 S 2br5 D Elt-|11i ]ag " tl 2 1 31 4, t2i34itZ|MsI21 93, |44 111 L13.4 2|14

pro h~Keada MaVy23'94 Jan 16'95

1 Copn Appr Stategy and Ma 23 '94 pm 30 '94 PrmQuiCon Conrde

2 Amnm PraOudflcan Ji3y 1 '94 July 1 '94 P~h

3 Rleceiv PreQudfication Cradential Jy 18 '94 kuy 19 '94 (L%o 0okabr

4 Evekntion PraQuNicationand Aug 8 '94 Auig 12 '94

5 Bidn Doamwt (FRat Draft) Sept 27 '94 Sapt 27 '94

6 ConcionCo.wict (FI aDt) Oct 12'94 Oct 12'94

7 1dRt Piew Bid Documnnts Sept27 '94 Nov 18 '94 and Dat Roarm

8 Cpd DhtzhA. And Bid Doaw and Dec 5 '94 Doec5 '94 Conmo Cot

9 kides Pruat Pi Dec22 '94 Dec22 '94

10Clebi Cral Caitact Fab 29 '95 Feb28 '95 - 28 -

Annex 4 SEDAPAL Management Plan

1. SEDAPALhas been drastically restructured as a result of the sectoral reform initiated in 1991. The managementstrategy chosen for SEDAPAL is privatization by means of a concession contract. Successfulprivatization is not guaranteed, even given the favorableeconomic and politicalenvironment and the interest shownby foreign water utility operators. If privatizationfails, SEDAPALwill continue under public management. Management agreements-based on experience with contract plans in francophone countries-will be used to clarify objectives, supervise performance, and delineate responsibilitiesamong the entities overseeing SEDAPAL. The first management agreement (Acuerdo de Gestion)will guide SEDAPALtoward privatizationand improve operationalperformance during the transition period. It will be signed before loan negotiations. If SEDAPAL remains under public management,annual managementagreements will be signed with the Governmentin a form satisfactory to the Bank.

2. Objectivesand rationale. Ambiguityof goals and shifting objectives have long been obstacles to SEDAPAL's efficient performance. Insufficient managerialautonomy and constraining government supervision have further undermined SEDAPAL's institutionalcapacity. The proposed management strategy for SEDAPAL will use management agreements to clarify SEDAPAL's objectives, expand managerial autonomy, improve performance supervision, and develop a formal negotiationprocedure with government supervisory institutions.

3. Basic assumptions. The success of the management agreement is related to four basic assumptions. First, it must be stable and capable of adjusting to changes in the macroeconomic environment. Second, the Water and Sanitation Services Law must be enacted. Third, the Superintendencyof Sanitary Services must have the institutionalcapacity to regulate sector entities. Finally, the Ministry of the Presidency must approve detailed tariff regulations.

4. Institutions.SEDAPAL and the Ministry of the Presidency, as governmentsupervising agency, will sign the management agreement. SEDAPAL is responsible for meeting the following quarterly indicators: operational efficiency and physical targets, commercial efficiency, financial management, productivity, and service quality. The Ministry of the Presidency will be responsible for effective and timely application of regulations-particularly in relation to tariffs. The Ministry of Economy and Finance, CONADE, and CEPRI-SEDAPALshould participate in the preparation and supervisionof the managementagreement.

5. Supervision. Because of the asymmetry of negotiatingpower between the Government and SEDAPAL, and the conflicts between short-term interests and long-term economic and management gains, a special committee will supervise the implementation of the management agreement. The committee will be comprised of two members from SEDAPAL representing the board and the management, one member from the Vice Ministry of Infrastructure representing the Ministry of the Presidency, one member from the Superintendencyof Sanitary Services, one member from CONADE, one member from the Ministry of Economy and Finance, and one member from CEPRI-SEDAPAL. The committeewill evaluate the managementagreement on a quarterly basis and will propose changes and remedies as needed. The committeewill also be responsiblefor the transparency of the evaluation and will publish the results of the analysis and recommendations.The committee should be nominated for the duration of the managementagreement and have the independenceto define its own rules and procedures. - 29 -

Annex 4

6. Action plan. A first management agreement lasting six months will be signed prior to loan negotiations. It is designed to verify the usefulness and enforceability of this managementtool within the public sector in Peru, and to test the validity of indicators and supervisory arrangements. Upon evaluation of the first agreement, a second management agreement will be designed (in a form satisfactory to the Bank) and signed for one year or until the project review, whichever comes first. After the project review, if privatization is successful, key indicators for monitoring the utility and supervisingthe project will be incorporated into the performance plan of the concession contract. If privatization fails, annual management agreements will be used to manage SEDAPAL, with improvementsand adaptations introduced through the supervisory process described above.

7. Key targets for the first managementagreement include:

* Increasing average water and sewerage tariff from $0.28 per cubic meter (June 1994) to $0.32 per cubic meter by December 1994 (Ministry of the Presidency). * Target indicators (SEDAPAL management): Operatonal efficiency: 4,000 unpluggings a month during June-December 1994. Physicaltargets: rehabilitation of 25 kilometers of water pipes and 39 kilometers of sewerage pipes in 1994. Commercialtargets: increase metered connectionsfrom 23,000 in June 1994 to 33,000 by December 31, 1994. Financial management: reduce overdue accounts receivable from 114 to 96 days by December 31, 1994. Productvity index: ratio of personnel cost to operatingcost of 31 percent by December 31, 1994. c Long-term debt: if privatizationis successful,secure approval for cancellationof long-termdebt negotiated under Paris Club and under separate bilateral negotiations (CEPRI-SEDAPAL). * Incentive plan: study incentive and fines system associated with achievement of managementagreement (SEDAPALBoard).

8. Annexes to the managementagreement:

* Quarterly monitoringindicators, includinga clear definitionof the indicator and the way it will be measured and evaluated. * SEDAPAL investment and financing plan for the period 1994-2000. - 30 -

Annex 5 SEDAPALInvestment Plan

1. During project preparation SEDAPAL developed, with Bank assistance, a multiyear investmentplan for 1994-2000. This plan totals US$663.0 million and includes US$306.2 million for the Bank-fnanced project.

2. Multiple criteria were used to select investmentsin SEDAPAL's investment plan. To reduce water losses and improve service quality in the shortest time, rehabilitation of existing operational assets has the highest priority. A decision regarding a major transbasin scheme may be postponed since, according to the water demand forecast, no new major water source is required until after 2003. To increase revenues and reduce waste, the company's commercial base will be rehabilitated by updating the customer cadastre and installing water meters. Conjunctive use of surface and groundwater will optimizewater resource utilization. Finally, a solution for final sewage disposal will be implementedafter studies are completed to select the best wastewater management alternative. The Bank-financedproject includes those components from SEDAPAL's multiyear investment plan with the highest economic return. Engineering for final sewage disposal could be fmancedthrough the project once the best alternative for wastewater managementis selected. Basic studies to evaluate wastewater managementalternatives will be financed through a Japanese Policy and Human Resources Development (PHRD) grant, already approved by the Peruvian Government.

Table 1 Summary of investment program (thousands of U.S. dollars)

Subproject Total Year

Amount percent 1994 195 1996 1997 1998 1999 2000

Bank-financed project 306,247 46 5,087 44,346 74,416 72,307 46,014 40,426 23,651

Investments outside Bank 357,327 54 66,265 76,248 45,194 39,226 32,142 56,358 41,893

Total investment plan, 1994-2000 663,574 100 71,352 120,594 119,610 111,534 78,156 96,784 65,544

I. Investments under the Bank-fmanced project

3. The water supply and sewerage network in Lima has deteriorated because of inadequate maintenanceresulting mainly from a shortage of funds for spare parts and replacement of old pipes and appurtenances. Lack of financing has also limited the development of new capital works and expansion of existing networks, widening the gap between supply and demand- particularly in periurban areas. A large investmentprogram is needed to restore the system to an acceptable level of reliability, minimizeunaccounted-for water, increase SEDAPAL's revenues, and prevent water-related diseases, particularly for vulnerable segments of the population.

A. 1 Rehabilitationof the water distributionnetwork (US$52,671,C000)

4. The water supply system consists of a primary network with a total length of 286 kilometers and a secondary network of 6,340 kilometers. The system includes 35 pressure reducing stations, 122 pumping stations, 304 reservoirs, and 302 operating wells. The current water supply system has - 31 -

Annex 5 many problems. Because of the system's age and the lack of maintenance, there are high levels of leakage in the network and in house connections. Pipes have reduced carrying capacity because of incrustations. System expansion has not kept pace with the rapid population growth in Lima and the consequent increase in water demand. This has resulted in undersized distribution mains and low storage capacity-leading to low pressure and service shortages. These problems are critical in the districts of Miraflores, Barranco, Chorrillos, Lima Cercado, La Victoria, Brena, Pueblo Libre, and Callao.

5. Rehabilitationof the primary network. Rehabilitationof the primary network consists of cleaning and lining 26 kilometers of cast-iron pipe (11 to 15 inches in diameter) and replacing 13 kilometers of reinforced concrete (Hume) pipe (12 to 24 inches in diameter), including appropriate appurtenances.

6. Rehabilitation of the secondarynetwork. This subcomponentincludes replacing 39.5 kilometers of thin-wall, cast-iron pipe (4 to 6 inches in diameter), cleaning and lining 524.2 kilometers of cast-iron pipe (4 to 10 inches in diameter), replacing 40.1 kilometers of cast-iron pipe (4 to 10 inches in diameter), replacing 17.7 kilometers of reinforced concrete (Hume) pipe (4 to 10 inches in diameter), replacing 632 gate valves (4 to 10 in diameter), installing 806 fire hydrants, and replacing 117,500 house connections.

7. Rehabilitationof the water storage reservoirs. This subcomponentinvolves rehabilitating 129 unused storage reservoirs and repairing 156 damaged reservoirs. A complete survey of the condition of the reservoirs was carried out during project preparation.

8. Equipmentfor operationand maintenance.There is an urgent need for equipment for the operation and maintenanceof the existing system. This subcomponentincludes equipment such as tanker trucks, pneumatic compressors, generators, backhoes, and portable leak detectors.

A.2 Rehabilitationof the sewage collection network (US$84,215,000)

9. The Lima sewerage network consists of primary collectors with a total length of 400 kilometers and secondary collectors of about 5,900 kilometers. Most sewer pipes in Lima are made of simple or reinforced concrete. The system is in poor condition. Hydraulic capacity is inadequate, particularly in older sections of the city. During project preparation, a field survey indicated that large portions of the network need to be replaced-ranging from 27 percent of the system in the city center to 85 percent of the system in the Brena district. System problems include nonfunctionalpumping stations, corrosion of pipes caused by industrial waste and hydrogen sulfide, a large number of blockages because of small pipes, and sedimentationcaused by inadequate slopes, lack of preventive maintenance, and introductionof solid wastes.

10. RehaiNlitaton of the primary collectors. This subcomponentincludes replacing 46.8 kilometers of concrete pipes (14 to 18 inches in diameter), 30.6 kilometers of reinforced concrete pipes (21 to 42 inches in diameter), and about 770 manholes.

11. Rehailitation of the secondarynetwork. This subcomponentincludes replacing 615.8 kilometers of concrete pipes (8 to 12 inches in diameter), 123,000 house connections, and 12,300 manholes. -32 -

Annex 5

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::A:::::AC':::: .... fli:0.

ofthe pip Tse aS EPAdcudIi -il ai illbemd w tlegi2 ye-u Swuu.wabltatio cou ,nldeA pipe-4f I rqtest :0 C,,0t£,,...0..,, ,. ks,,alwaiv,. ....: it0 <: Aseso ,.. bee',s-re.-.ze byf,:"'the-mn

X-j-)-|4--~~~~~~~~~~~~~~~ ~~~~~~~~~~~......

i'- "'-'ilo.-_f * ' j.0 ".'t.',in: B"'...s,latedi'X t prc.jecs (:. ,E .''' .ses- ~~~~~~~~~~~~~~~~~....,Esa..t -. Sowi,k.'.... ." 99). . i . :X 3 . i i ...... :::...... j ... -t-...jj Th1a2.sEqip enth eforc operationatIndmetenonce. qimnabs to iberov thet opeatiowl n aountd. faintennceofte seatigote oallhectinsyseo inclutdei asewerti cliedandnequaipmet, sml ruls

.3hehablitti. wreetaof Psteo Aresouces(U.S$12A Is~e,032,b000)al aotin prdu. inlanydistrctACepipe.d The wellwas dverclinedinOcetoyear 1 s. Therbasre threimiatin healtnsfrs. dhelnn pipels.wFirstde,i thereuctioan agiuturaof arias haseb elosuredthe airouneo infiltrtionfuromg iprgaed areas Secnd,iutheao oveexploitatino grounhdweaterhatresaiulted inr arpi decipesougrounductirtales arndsralinoe intrqusionially,rs many elscreeqipedtpi with anfcumpsA taaregube s ondterirg dsestgnli ane d aint efunctionWWeficinaly ,Jl installeThe92. no inalcapaiti provcuisinmtor prevrsecndwhatileo asbestoageproductioni 7.1 uicmtrsprseod

12. ESurpventfwU.Sresoperatronnad forilb maintenane.lEquipmen odce imrvgeeoeaito nerand dmaintsenaceo theldsewg coletiniysedeemnwill heainludeio swrclaigequipmensTeentsresmailltrcs equimen0 caprcen sav uptooftotl eectrcit cots.To mintin deqate pertio an A.o3pRemaeintationuvemaneac,thOrjcOil of groundwaterrvd resourcesuc qimn(Us$12i032 a une(edn tetehiclasitacmcie eevso aea resos.o declinn yeaieldsi.First,o the reductioof agricultural aurveasthas lumoweedheaont oflite inilraionewelom irar eigatednswihlmtditrnareasSeodth oexpition ofepgrandwae hlasrexsuteding aels rapi

9.ocbiecti meters per sncecodahleaeaeproduction cubicis 7.3t1. meters second.pe

14. Surameyofo weUs.SUrveys whi sbeconductednfo850pretoth wells knownavtohe genquaerate oediminishoe rsligfoThismen yields. deterivn eued thewill rhbltiorequirements. Theeesquystil complementthe suaveyu o2 gonwtersource ecnof desecrAibedunder. The technicalnassisaneoprtnad

omardiensinced (hroesutwingfromvrdued yieldequipmenta willdnrecivenew tequipmeontcadequate - 33 -

Annex 5 mobile workshop, and lift-truck. Emphasis will be placed on providing essential operational equipment, including spare parts.

17. Groundwaterevaluation. This evaluation involved field work testing well conditions and deep well pumping. These tests were required to refine the rehabilitationwork that has been proposed. In addition, all relevant informationon groundwater was analyzed to plan the developmentof the Rimac, Lurin, and Chillon basin-including areas in the highlands around Lima where water resources appear to be underutilized.

B. Water conservation (US$44,221,000)

B. 1 Water metering program (US$24,996,000)

18. In Lima only 51 percent of water connectionsare metered, while only 4 percent of the meters are in working condition. Most of these meters are beyond their design life, and the use of minimum consumptionlevels for purposes of billing has resulted in poor maintenanceof the water meters. Using water meters to measure consumptionwill increase water bills-creating a proper incentive for efficient water use. To promote effective metering the project will provide for a cadastre update, the rehabilitation of water meter boxes, and micrometering(to be targeted mainly at districts characterized as having high consumptionlevels). The project is designed to install new meters in 46 percent of the connectionsby the year 2000. This subcomponentwill also finance a pilot program in the Pueblo Libre district to determine the extent of water wastage in the distribution network and identify appropriate solutions. To increase the reliability of metering, a program will be implementedthat prevents the total emptying of pipes connected to the main distribution (La Atarjea-Centro).This program consists of flow-limitingand pressure-reducing valves that automaticallyadjust flows and pressures.

B.2 Conjunctive use (US$19,225,000)

19. Conjunctiveuse of surface and groundwater will take advantage of the availability of surface water during the rainy season while allowing the wells to rest (and the aquifer to recharge) during this period. The areas selected for conjunctiveuse are San Miguel, Los Olivos, and Callao-areas where saline intrusion is quickly becoming irreversible or groundwater levels are dropping rapidly. These three areas are served largely by groundwater. This project component foresees connecting the distribution network of these areas to the La Atarjea treatment plant, so they will be alternatively supplied by surface water and groundwater. The project will provide for pipes (150-800 millimeters), nine reservoirs (2,000 and 16,000 cubic meters), valves, and well rehabilitation. In addition, the project will reinforce sections of the primary network (35.7 kilometers of pipes with diameters ranging from 800 to 1200 millimeters)to accommodatethe flow from the treatment plant to these areas.

C. Network expansion in the Pueblos Jovenes (US$40,087,000)

20. This componentwill install primary networks that extend water supply and wastewater services to the low-incomeareas (pueblosjovenes) of Lima. About 800,000 people living in the pueblos jovenes do not have direct access to water and sanitation services. They have to rely on - 34 -

Annex S

water supplied by tanker trucks or standpipes connected to SEDAPAL's system. This component supports network expansionto unserviced areas (302,000 beneficiaries)and system improvement (276,000 beneficiaries). A detailed description of this component is contained in the project files. D. Institutionalsupport (US$18,780,0000)

21. The institutionalstrengthening component includes managementassistance, detailed engineering, and constructionsupervision of the Bank-financedproject, modernizationof SEDAPAL to improve its marketing and financial management, assistance to SEDAPAL for effective implementationof its transformationfrom a direct provider of services to an administrator of the concession contract with a private operator, capacity-buildingfor the Superintendencyfor Sanitary Services, baseline studies to support the creation of a water basin authority in Lima, and feasibility studies for the final disposal of wastewater and the Chillon water treatment plant.

II. Investments Outside the Bank-financed Project

22. Total investment outside the Bank-financedproject amounts to US$357 million (including price and physical contingencies) for 1994-2000. These investments relate mainly to system expansion.

A. Fixed assets (US$11,964,000)

23. This componentincludes office equipment, operation and maintenance equipment, and an update of the information system. The component also includes funds for constructing new headquartersand an operational center for SEDAPAL in La Atarjea. B. Rehabilitation(US$57,329,000).

24. Water treatment investmentsinclude the renovation of ten presettling tanks and six settling tanks in the La Atarjeaplant, the rehabilitation of infiltration galleries to increase their yield from 0.2 to 0.3 cubic meters per second, and a series of works that includes a chemical treatment building for the regulating tank, roofs for two reservoirs, rehabilitation of the chlorination building at the La Menacho reservoir, implementationof gauging and telemetry systems, and the rehabilitation of filter floors. The water supply and wastewater collection network under the administrationof the zonal groups will be expanded and improved. Reinforcementof the Costanero discharge in the San Miguel district will be completed. Groundwater supplies will be rehabilitated with pumping equipment and electrical supplies to replace obsolete or failing equipment. Some wells will be rehabilitated through cleaning or increasingtheir depth; new wells will also be drilled near poorly performing wells. This componentwill also finance the construction of concrete screens to retard flow and induce infiltration in the Rimac river. Screens will be placed at a depth of 2 meters at 200-meter intervals. - 35 -

Annex5

C. Water conservation (S$10,339,C000)

25. This componentwill purchase and install water meters for high-volumeconsumers and 200 private wells, construct 61 stations for pitometry and macrometers, and build a small plant to recover about 0.25 cubic meters a second of filter backwash water.

D. Systems expansion (US$271,399,000)

26. Water treatment (plan 2) will expand design capacity from 15 to 20 cubic meters per second. Ongoing work for the new regulating tank will be completed, increasing available volume from 400,000 to 1,200,000 cubic meters. In addition, a new treatment plant of 5 cubic meters per second will be added to the existing plant-bringing La Atarjeatotal capacity to 25 cubic meters per second. A number of works will be undertaken to provide water and sewerage networks to selected pueblosjovenes (funded through FONAVI). These works include drilling of wells, a pumping station, a reservoir, water mains, and the secondary network. The demand-basedselection of secondary works will determine the prioritization of the corresponding primary works to be constructedby SEDAPAL. Under this subcomponent-with cofinancing from Italy-16 wells will be constructed on the Rimac to supply up to I cubic meter per second of water to the Cono Norte and Canto Grande districts; four reservoirs will be built and about 10 kilometers of piping will be laid. The necessary works will be provided for wastewater treatment and disposal of the retained solids at the preliminary treatment plant in La Chira. In addition, works will be completed for the disposal of Lima's wastewater through marine outfalls. (Selected alternativeswill have to be developed and designed based on ongoing work at the Ministry of the Presidency.)

E. Studies (US$6,296,000)

27. SEDAPAL will finae two major studies. The first will be a thorough review of all available water resources for Lima, including a least-cost ranking of alternatives. The second study will explore the possibilitiesof conjunctive use of the aquifers and irrigation channels in Huachipa, Surco, Ate-Vitarte, and Carapongo to avoid using the Rimac river during the dry season.

Im. Emergency Investments and Institutional Support Prior to Privatization

28. Up to 20 percent of total project costs can be committed prior to SEDAPAL's privatization, which is expected to occur in the first half of 1995.

A. Investmentprogram

29. In the period before privatization, investment in water and sewerage systems will focus mainly on the rehabilitation of the primary and secondary networks in the districts of Brena, La Victoria, and Pueblo Libre. Work on the survey of the first set of wells will be carried out and urgently needed maintenanceequipment will be procured. Work on the groundwater modeling study will be initiated. - 36 -

Annex S 30. In the water conservationcomponent, water meters for the first phase of the program will be purchased and installed at the same time as the meter boxes are rehabilitated. Work on conjunctive use in the critical areas should be underway; the reinforcementof the main distribution pipes to supply these critical areas will also be initiated.

31. It is expected that a number of the pueblos jovenes will solicit financing immediatelyfor secondary works. This will lead to the identification of a relatively small number of primary works that can be committed prior to privatization.

B. Institutionalsupport

32. The institutionalsupport componentwould concentrate on three main tasks. First, managementconsultants should be financed to assist SEDAPAL's project managementunit through project review. Second, individual consultantswould assist SEDAPALduring the privatization process with asset valuation and management,debt management,SEDAPAL's new role and its relationshipwith the rest of the water and sanitation sector, and management and administrative procedures for SEDAPAL after privatization, including personnel and financing policies. Finally, individual consultantswould assist the Superintendencyof Sanitary Services in establishingand formalizing specific regulation mechanismsfor the concession model for Lima. - 37 -

ANNEX 5 PERU LIMA WATERREHABILITATION AND MANAGEMENTPROJECT SEDAPALINVESTMENT PLAN

sumirttboject Total - US 000 % 1994 1995 1969 1897 1888 1698 2000 I INVUTMENTS WIT1N THE SANK P0QJ8CT

A SYSTEbMISMWHUTATION 14S.016 s9 1.444 16.416 30.038 32A418 .01 -100338. 14.00

Al PRd*"elion otf O Wow ei0bulo. HNtwe* 82.S71 21 432 5.031 10.440 11.714 10.143 - .02 , .018

A2 R*eIebflwonof*wSwo8a CoiioaNow**A 84.215 33 683 8.727 17.113 17.114 14.78 na0-t4 B.30$

AS Ouwwt - l03211 1838 1.994 *17 1,.60 -- J7 1.017

8 WATX COtlS fATIQN 44.221 16 2.7S7 16.037 18.367 7.138 46* 400

311 Wow 111,01111ott"qv.n 24.998 1 0 2.787 8.378 14 3.832A4 43X0

82 Qolrmgstll Ut.In 1ptod D1I1Itk 0 19.22E 3 0.480 *.8S2 4.205

C NETWORKEXPANSION IN UR11S JOVIES - 40.0S7 10 , 4.18S 6872 :17. 72 78 7

0 INS1TT1ONAL SUPPORT 18.780 7 300 3.732 4.712 2.772 2.42? ,A3 2.422

8RDPFIOJECT BASE COST 262.00S 100 4.E11 08.372 r2.821 l9.681 3S.72 3t. I.1 1I.098

PHYSICALCONTINGENCIES (10%) 2E.201 4I 3l.837 8.202 6.966 3.887 4.188 - -0lA

PRICEcwO Nil04c3su (2.4% ANNUAU 28.040 124 2.137 E.313 6.80 144 1.881117 ,.7--

TOTALCOST 308.247 5.0a7 44.340 74.418 72.307 4S.014 4,,-A" 23.61

1 INVESTMENTS OUTSIDE THE BANK PROJECT

A FIXED ASSETS 11,904 3 2,301 4,653 1,022 1.022 1,022 1,022 1.022

B REHABILITATION 67,329 18 16,091 9,384 6,363 10,696 8,934 3,063 3,816 aB Water Treatment 2,997 1 1,297 1.700

B2 Water Network 38,162 11 8,777 4,961 4.961 7,632 4,961 3,063 3,916

B3 Sewage Collection Network 398 0 398

84 Groundwater 16,772 4 4,819 2,723 1,392 3,084 3.973

C WATER CONSERVATION 10,339 3 2,044 8,296

D SYSTEMS EXPANSION 271,399 76 46,430 62,641 36.281 26.623 22,186 52,283 37,065

DI WaterTreatment 36,898 10 S,811 18,987 8.000

D2 Network Expaneron: Water and Sewaeo 168,040 44 36.812 33,665 27,281 20.023 17,186 13,973 3,610

D3 Waetewater Treatment and Dispoae( 77,481 22 706 6,000 33,310 33,446

E STUDIES a,298 2 1.399 1,475 2,37 S85

TOTAL COSTt" 357,327 100 86,265 76.248 45,194 39,226 32,142 56,358 41,393

III TO TAL INVESTM ENT PLAN (19 94- 2 00n0) pric 71,362 737 1133 1017 4,713 93.260 6l928

1. Include all engirnering and supervision coets, price andtechtnical contingencies - 38 -

PERU ANNEX LIMA WATERREHABILITATION AND MANAGEMENTPROJECT DETAILEDPROJECT COST ANNUAL INVESTMENTPLAN

M_ i4rjc Total ___Y us$ '00 1994 1996s 1996 1991 IBose 1999 2000o

A SYSTEMS REHABILITATION 148,918 59 1,444 15,415 30,039 32,415 26,601 28,103 14,900 Al WATER NETWORK 52,671 21 432 5,031 10,460 11,784 10,143 9,802 5,019

Primary networks 3,243 1 973 1,94a 324 Secondary Networks * Miraflores 4,042 2 606 1,011 1,213 808 404 * Barornco 1,207 0 362 845 * Chorilbs 676 0 676 * Uma Cercedo 8,199 3 1,230 2,050 2,460 1,640 820 * La Victoria 3,835 2 384 767 1,151 767 767 * Brana 2.882 1 432 865 1,297 288 *Pueblo Ubre 1,055 0 317 739 Callao 2,418 1 725 1,209 484 Rlmac 2,850 1 570 713 998 570 Unce 2.755 1 413 827 1.240 276 * Jesus Maria 1,140 0 570 570 San Isidro 4,750 2 1,188 1,426 1,425 713 Reservoirs 1,965 1 295 393 589 688 Equipment for O&M 1,653 1 827 827 Other Rehabilitation 10,000 4 1,667 1,667 1,667 1,667 1,667 1,667 A2 SEWAGE COLLECTIONNETWORK 84,215 33 853 6,727 17,593 19,114 14,778 16,784 8,365

Primary Collectors 8,681 3 2,170 5,209 1,302 Secondery Networks * Mlreflores 8,929 4 1,339 2,232 2,679 1,786 893 * Baranco 1,965 1 589 1,375 Chorillos 1,412 1 1,412 * Umr Cercedo 10,879 4 1,632 2,720 3,264 2.176 1,088 * La Victoria 8,515 3 851 1,703 2.554 1,703 1,703 * Brens 5,689 2 853 1,707 2,560 569 * Pueblo Llbre 2,386 1 716 1,670 * Caillo 2,509 1 753 1,254 502 * Rimac 5,890 2 1,178 1,473 2,062 1,178 * Unce 6,365 3 955 1,910 2,864 637 * Jesus Maria 5,890 2 2,945 2,945 * Sen Isidro 10,830 4 2,708 3,249 3,249 1,825 Equipment for O&M 4,275 2 1,283 2,138 856 A3 GROUNDWATER 12,032 5 158 3,658 1,986 1,517 1,680 1,517 1,517

Survey of Wels 480 0 158 158 183 Rehabilitation of wells 6,322 3 1,012 1,012 1,075 1,076 1,075 1,075 Equipment for wells 2,600 1 416 416 442 442 442 442 Equipment for O&M 630 0 630 Groundwater modelling 2,000 1 1.600 400

B WATER CONSERVATION 44,221 18 2,767 15,037 18,397 7,139 480 400 81 WATER METERING PROGRAM 24,996 10 2,767 6,579 11,835 2,934 480 400

Cadaster 840 0 210 630 Rehabilitation of meter boxes 10,777 4 3,233 4,850 2,694 Mcrometoering 11,579 5 2,547 2,316 6,716 Sectoriztlon of the central main 1,600 1 240 240 240 480 400 Pilot Progrom for UFW in P. Libre 200 0 10 160 30

82 CONJUNCTIVE USE IN SELECTEDDISTRICTS 19,225 8 8,458 6,562 4,205

Sen Miguel DistrIt 3,045 1 3.045 Los Olivos District 5,770 2 1,731 4,039 Caleo District 8,410 3 1,682 2,523 4,206 Reinforcement of mains 2,000 1 2,000 - 39 -

PERU ANNEX 6 LIMA WATER REHABILITATIONAND MANAGEMENTPROJECT DETAILEDPROJECT COST ANNUAL INVESTMENTPLAN

Item-- - 8 bP c t - - I Toal- - ':- USe '00 % 1994 1995 1960| 1997 t98 | 9 2000

C NETWORK EXPANSION IN PUEBLOSJOVENES 40,087 1 8 4,188 9,672 17,225 7,469 766 766

NORTH Puente Pledra IZapallall I - sewerage 2,780 1 2,780 Puente Pledra 11- sewerage 8,953 4 5,819 3,133 El Carmen iComasl - water 517 0 517 El Empleado IS. Martin) - water 796 0 796 Elnaranjal (Los Olivos) - water 8,218 3 5,342 2,876 Carabsyllo - water 1,169 0 1,169 Palso IS. Martin) - water and sewerage 694 0 694

EAST Maria Tegul ISJ Lurigancho)-water 714 0 714 Viarte - sewage collector 1,078 0 1,078 27 de Abril (Vitartnl - water 531 0 631 La Merced (Vktarte) - water 152 0 152 H. Zevallos (Vltartes - sewerage 1,207 0 1,207 Tayacaja - water 1,021 0 1,021 Cerro Candela (Vltarte) - water and sewerage 4,921 2 3,199 1,722

SOUTH Vila El Salvador- water 1,644 1 1.644 F. Tablada IVM del Triunfol - water 1,095 0 1,096

Other Expansion 4,596 2 766 766 766 766 766 766

D INSTITUTIONAL SUPPORT 18,780 7 300 3,732 4,712 2,772 2.422 2,422 2,422

Project Management Unit 6,000 2 300 1,200 900 900 900 900 900 Engineering & Supervision 7,130 3 438 438 438 438 438 438 Strengthening of the Regulatory Body 500 0 100 200 200 Water Rasources Management 450 0 260 200 Financial and Commercial Systems 2,000 1 333 333 333 333 333 333

Studies: * Feasibility Study for the Chillon Plant 1,200 0 360 840 * Feasibility study for wagtewater disposal 1,500 1 300 1,050 16O

IBRD PROJECT BASE COST 252,006 100 4.511 38.372 62,821 69,551 36,972 31,691 18,086

PHYSICAL CONTINGENCIES 25,201 451 3,837 6,282 5,955 3,697 3,169 1,809

PRICE CONTINGENCIES 29,040 124 2,137 6,313 6,800 5,344 5,567 3,754

TOTAL PROJECT COST 306,247 5,087 44,346 74,416 72,307 46,014 40,426 23,661 - 40 -

PERU ANNEX 6 LIMA WATER REHABILITATION AND MANAGEMENT PROJECT DETAILED PROJECT COST PROCUREMENTCATEGORY

Item i Total Inwneatme __F 1_ US$ '000 % Works 9% Goods ' Cons ___im

A SYSTEMS REHABILITATION 148,918 59 137,280 92 9,158 6 2,480 2 Al WATER NETWORK 52,671 21 51,018 34 1,653 1 Primary networks 3,243 1 3,243 2 Secondary Networks Mirafiores 4,042 2 4.042 3 Barrnco 1,207 0 1,207 1 Chorios 676 0 676 0 Urna Cercado 8,199 3 8,199 6 La Victoria 3,835 2 3,835 3 Br ns 2,882 1 2,882 2 Pueblo Ubre 1,055 0 1,055 1 * CaIao 2,418 1 2,418 2 Rimac 2,850 1 2,850 2 Unce 2,755 1 2,755 2 Jesus Maria 1,140 0 1,140 1 * Son sidro 4,750 2 4,750 3 Reservoirs 1,965 1 1,965 1 Equipment for O&M 1,653 1 Other Rehabilitation 1,653 1 10,000 4 10,000 7 A2 SEWAGE COLLECTIONNETWORK 84,215 33 79,940 54 4,275 3 Prlmnry Colectors 8,681 3 8,681 10 Secondary Networks *Mirattoras 8,929 4 8,929 11 Brarranco 1,965 1 1,965 2 Chorillor 1,412 1 1.412 2 Lrma Cercado 10,879 4 10,879 13 * La Victoris 8,516 3 8,515 10 Bmna 5,689 2 5.689 7 Pueblo Libre 2,386 1 2,386 3 Callao 2,509 1 2,509 3 * Rimac 5,890 2 5,890 7 Unce 6,365 3 6,365 8 Jesus Maria 5,890 2 5,890 7 * San Isidro 10,830 4 10,830 13 Equlpment for O&M 4,275 2 4,275 3 A3 GROUNDWATER 12,032 5 8,322 4 3,230 2 2,480 2 Survey of Wells 480 0 Rehabillation of wails 480 0 6,322 3 6.322 4 Equipment for wells 2,600 1 2,600 Equipment for O&M 2 630 0 630 0 Groundwater modelling 2,000 1 2,000 1

B WATER CONSERVATION 4,221 18 30,002 68 11,579 26 2,840 a Bi WATER METERING PROGRAM 24,996 10 10,777 24 11,579 26 2,640 a Cadawtor 840 0 Rehabilitaton 840 2 of metr boxes 10,777 4 10.777 Micromteritng 24 11,579 5 11,679 26 Soctorizatlon of the central main 1,600 1 1.600 4 Pilot Program for UFW In P. Libre 200 0 200 0 82 CONJUNCTIVEUSE IN SELECTEDDISTRICTS 19,225 8 19,225 43 San Migual District 3,045 1 3,045 7 Los Olivor District 5,770 2 5,770 13 Callo District 8,410 3 8,410 19 Reinforcement of mains 2,000 1 2,000 5 - 41 -

PERU ANNEX LIMA WATER REHABILITATIONAND MANAGEMENTPROJECT DETAILEDPROJECT COST PROCUREMENTCATEGORY

Item 8ub-Project Total | Investniment _ -_| US* '000 96 Wotk %ks Goods % Cona -___

C NETWORK EXPANSION IN PUEBLOSJOVENES 40.087 16 3549 1 89

NORTH Puente Pledra IZapallel) I - sewerage 2.780 1 2.780 7 Puente Piedra II - sewerage 8.953 4 8,953 22 El Carman (Comar) - water 517 0 617 1 El Emplado (S. Martin) - water 796 0 796 2 Elnaranjal lLoasOliva) - water 8.218 3 8.218 21 Carabayllo - water 1.169 0 1.169 3 Palso IS. Martini - water and sewerage 694 0 694 2

EAST Maria Tegui ISJ Lurigancho)-water 714 0 714 2 Vitarte - sewage collector 1.078 0 1.078 3 27 do Abril lVitarte) - water 531 0 531 1 La Morced Viterte) - water 152 0 152 0 H. Zovallo. (Vitarte) - sewerage 1.207 0 1.207 3 Tayacaja - water 1.021 0 1,021 3 Cerro Candela (Vitarte) - water and sewerage 4.921 2 4.921 12

Vila El Salvador - water 1,644 1 1.644 4 F. Tablada (VM del Triunfol - water 1,095 0 1.095 3

Other Expansion 4.596 2 4.596 11

D INSTITUTIONAL SUPPORT 18.780 7 18.780 100

Project Management Unit 6.000 2 8,000 32 Engineering & Supervision 7.130 3 7.130 38 Strengthening of the Regulatory Body 500 0 500 3 Water Resources Management 450 0 450 2 Financial and Commercial Systems 2.000 1 2.000 11

Studies: Feasibility Study for the Chillon Plant 1.200 0 1.200 6 Feasibility study for wastewater disposal 1.500 1 1.S00 8

IBRD PROJECT BASE COST 252.006 100 202.773 80 20.737 8 23.900 9

PHYSICAL CONTINGENCIES 25 201

PRICECONTINGENCIES 29,040

TOTAL PROJECT COST 306. 247 - 42 -

ANNEX 6 PERU UMA WATERREHABIUTATION AND MANAGEMENTPROJECT DETAILEDPROJECT COST SOURCESOF FINANCING

__ :a#u.A*. ME- E...t.0ni4tM' : '1"-'" ""-0":

A WYSTEMSREHA3ILUTATION 148,918 59 S ,126 53,039 49,754

Al WATERNETWORK 52,071 21 18,918 10,343 17,410

A2 SEWAGECOLLECTION NETWORK 84,215 33 23,598 30,696 23,921

A3 GROUNDWATER 12,032 5 3,610 8,422

8 WATERCONSERVATION 4,22 18 11,771 0,308 26,142

81 WATERMETERING PROGRAM 24,990 10 0,749 18,247

82 CONJUNCTIVEUSE IN SELECTEDDISTRICTS 19,225 8 6,023 0,308 7,895

C NETWORKEXPANSION IN PUEBLOSJOVENES 40.037 _ 16 13.761 26.320

D INTITUTIONALSUPPORT 19,730 7 645 1.930 16,199

IB1DPROJECT BASE COST 252,006 100 72.304 61.292 118,421

PHYSICALCONTINGENCIES 26,201 3,590 6,834 14,527

PRICECONTINGENCIES 29,040 4,215 8,022 17,053

TOTALPROJECT COST 306,247 80,109 76,139 150,000 - 43 -

Annex 7 Technical Assistance

The project contains various technical assistance components that will improve SEDAPAL's ability to effectivelymanage the water and sanitation sector. Funding will cover managementissues, institutionalcapacity, and sector knowledge.

A. Project managementunit (US$6,000,000)

1. For details about technical assistance regarding the project managementunit, refer to Annex 14.

B. Engineeringand supervision (US$7,130,000)

2. This subcomponentcovers all consultant expenses relating to the development of detailed engineering designs, preparation of tender documents, and field supervision of contractors. Water supply and sewerage rehabilitation in selected aistricts will be bid in packages for the entire district to minimize disruptionsby the larger rehabilitationprogram (Annex 13). This packaging of bidding will permit more efficient use of resources and economiesof scale-minimizing construction costs- and simplify coordination with municipal authorities and other public utilities. There are many qualified local consultants that could conduct field engineering, supervisephysical execution, and assess quality control in each district.

C. Strengtheningthe regulatory body (US$500,000)

3. The Superintendencyof Sanitary Services will be assisted through the project with financing for the design and initial implementationof a system of basic sector indicators. The restructured SEDAPAL will have primary responsibilityfor monitoringthe concession contract and ensuring compliancewith its terms. The Superintendencyof Sanitary Services will help resolve any disputes and convey lessons of the concession to the rest of the country. This technical assistance component will be aimed at the Superintendency'swider sector responsibilities.The Superintendencywill be encouragedto limit its information collectionto a small number of easily produced and analyzed indicators-enabling it to track sector performance and provide feedback to operators and consumers on a timely basis. This component includes short-term consultancies,computers, and training. It will enable the Bank to maintain close working relations with the Superintendencywhile a broader sector operation is prepared.

D. Water resourcesmanagement authority (US$450,000)

4. The Government of Peru is considering legislationthat would establish a water-use rights system recognizing historical use and the availability of water within a hydrological basin. This legislationincorporates well-definedwater rights that are tradable in a market-basedsystem and will improve the efficiency of water use and distribution in the longer term. The equity of the initial allocationprocess for water-use rights will be as important as the establishment of a strong regulatory system to ensure the long-term integrity and registration of these rights. The government has also introduced legislationto strengthen water user organizations, giving them legal rights and responsibilities.Water user organizations are entitled to collect tariffs, implementoperation and - 44 -

Annex 7

maintenanceplans, administer organization funds, incur indebtedness, and contract services and construction.

5. This subcomponentwill finance consultants, equipment, and training in three key activities: supporting the water user organization for the Rimac river basin (including the Lurin and Chillon rivers), assisting the Ministry of Agriculture, INRENA, and the water user organization of the Rimac basin in the initial allocation of water-use rights, and partial support for preparation of the proposed WastewaterManagement and Coastal PollutionControl project. This project's preparation will be financed mainly by a Japanese Policy and Human Resources Development(PHRD) grant of US$1.2 million, under Bank administration. A project preparation unit has been appointed by the Ministry of the Presidency, and the French government and the World MeteorologicalOrganization have offered to finance consultantsto prepare this project. Donations should formalize once the project preparation unit is fully operational.

E. Modernizing SEDAPAL: Commercialization and financial management (US$2,000,000)

6. Since 1992 SEDAPAL has undergone a drastic restructuring. The privatization strategy requires SEDAPALto be further transformed from a public provider of services to the administrator of a concession contract and other complimentaryfunctions. If privatization is unsuccessful, SEDAPALwill continue as a public sector-operatedutility. In this scenario, SEDAPAL should continue its restructuring within the framework provided by the new sector law. The project will support improvement of financial managementand modernizationof commercial operations. Developing a solid financial managementfunction is essential to performing with the independence allowed for in the new sector law. Improvementsin commercial practices, the customer cadastre, billing, and consumer relations should be improved to fully exploit the potential for increased revenue.

F. Studies

7. Sectorizationof the central main (US$1,600,000). The continued physical deterioration of the water supply network combined with diminishingflows and increased consumptionhas resulted in intermittentwater supply in Lima. Managing this intermittentsupply according to a predeterminedschedule is complicatedbecause of the difficulties of isolating service areas with appropriate appurtenancesand derivations.

8. This study will determine which districts should be supplied by the main distribution line of La Atarjea-Centrowith flow-limitingand pressure-reducingvalves. This effort will automatically adjust the flows and pressures in the various districts and prevent the total emptying of the pipes.

9. To meet the objective of simplified, equitable, and automated water distribution, this study will:

* Conduct the necessary testing and suggest a constant production regime in La Atarjea based on available seasonal flows. This will guarantee a stable supply of water in the network at a predeterminedschedule. * Define distributionsectors in the network, preferably with one derivation line from the main network and eliminating the crossing of pressure zones. - 45 -

Annex 7

* Purchase and install pressure reducing valves operated by telemetry in the above derivation points. * Propose a program of rationing with minimum or normal pressures to avoid the complete emptying of networks during off-hours.

10. Groundwatermodeling (US$2,000,000).The overexploitationof groundwater and the deteriorationof groundwater quality require a review and update of available information on groundwater resources. The need for future water resources brought about by an increasing population requires investigationof possible resources and an optimizationof water resource managementfor the basins.

11. This study will review all relevant information on groundwater to plan the developmentand exploitationof groundwater in the Rimac, Lurin, and Chillon basins-including areas in the highlandswhere water resources seem to be underutilized.

12. During 1969-72 the Ministry of Agriculture carried out an extensive study of groundwater resources in the Lima metropolitanarea that covered the area from Cordillera Andina to the sea. The study included a review of existing data, a compilationof functioningwells, observation of water table movements,geophysical tests, and mathematicalmodeling that resulted in a program for groundwater exploitation. In the years since no study of comparable magnitude has been conducted, except for a recent limited modeling by Binnie & Partners.

13. The proposed study includes:

e Analysis and revision of the existing information, including all studies completed or under completion. * Hydrogeologicalstudies using field information, satellite images, and other sources. * A complete inventory of all available resources, including sampling for chemical and isotope analyses. This inventory will be used to prepare maps that indicate the sources, productivity, potential, quality, vulnerability, and typology of groundwater resources. * Preparation of a complete map of soil use in the area. * Hydrological and hydroclimatologicalstudies to determine the hydraulic balance of the basins. * An estimation of the water demand for irrigation, domestic use, and other uses. * An inventory of all pollution sources. * Models to project the safe yield of the aquifers.

14. Pilot program for unaccounted-forwater in Pueblo Libre (US$200,000). The water shortage in Lima in recent years has necessitated rationing in almost all parts of the city. The rationing program includes progressive restrictionsthat create a total emptying of the pipes, making it impossibleto develop an unaccounted-for-waterreduction program. Although it is widely known that the levels of unaccounted-for-waterin the water supply network are high, no systematic evaluation has been carried out because of the intermittentsupply.

15. This study will seek understanding of the extent of wasted water in the distribution network and house connectionsand identify the required solutions. To achieve these objectives, the following activities need to be undertaken in an isolated area of the Pueblo Libre district: - 46 -

Annex 7 * Identificationand isolation of a well-definedsector in Pueblo Libre; * Purchase and installationof two electrically operated pressure reducing valves at main derivations from primary networks; * Purchase and installationof two macrometers; * Purchase and installation of 1,062 water meters; and * Monitoring of water flows and determination of water balance.

On the basis of the metering, solutions should be proposed to control unaccounted-forwater.

16. Feasibilitystudy for the Chillonplant (US$1,200,000). To provide an additional source of water supply for Lima, many studies have suggestedconstructing a treatment plant using the Chillon river to supply the northern part of Lima. A number of technical and economic aspects need to be studied for this proposal, particularly in regard to other alternatives (SEDAPAL is evaluating other options for additionalwater supply). This study would determine the feasibility of a treatment plant and associated works for the safe exploitationof the Chillon river.

17. Feasibilitystudy for wastewaterdisposal (US$1,500,000). With the exception of a few small treatment plants, Lima's wastewater is discharged into the sea with almost no treatment. An initiative is underway in the Ministry of the Presidency to prepare a prefeasibility study for the safe final disposal of all wastewater. This subcomponentwill finance the preparation of the terms of reference and the execution of a feasibilitystudy for the solutions that will be proposed in the prefeasibility study. - 47 -

Annex 8 Water Demand in Metropolitan Lima

1. Despite rationing, water consumptionis high in the Lima metropolitanarea. In September 1993, SEDAPAL customers used on average 169 liters per capita per day, compared with 236 liters per capita per day in 1987'. Increased rationing is the major reason for this sharp decline in consumption. Water demand projections are based on the estimated population growth in the service area, SEDAPAL's planned increase in coverage, and the trend in per capita domestic consumption.2 Consumptiondepends on many variables, including the evolution of real water rates and household income, the impact of rationing, and the effect of widespread installation of water meters.

A. Populationforecasts

2. According to census data from 1993, the populationof the Lima metropolitanarea is 6.4 million. Except for some districts in outlying areas, SEDAPAL's service area covers the entire metropolitanarea. The population growth rate is expected to decline to 2.5 percent a year until 2005-mainly because of an expected decline in immigration. The population in the metropolitan area will therefore be 8.7 million in 2005. About 79 percent of the population in Lima has direct access to piped water. The remainder use either water supplied through standpipes or group taps (6.8 percent), vendor water (7.1 percent) or other sources (7.1 percent). The project assumes that expansion of the water supply network in the pueblosjovenes will increase direct access to the piped water system to 90 percent of the populationby 2005.

B. Water demandforecasts

3. Domestic water consumption.Domestic water consumptiondeclined rapidly between 1987 and 1993. In September 1993 the average daily consumptionper residential connection was 169 liters per capita per day. In 1987 the average per capita domestic water consumptionwas 236 liters per day. This period was characterized by a sharp drop in household incomes and production capacity shortages. Since 1989 real water rates have been rising, though the impact of increasing rates on water consumptionappears rather small. Only 4 percent of connections are currently effectivelymetered and billed. The majority of households are charged a flat rate instead of progressive block rates. The flat rate structure does not offer users any incentive to use water efficiently-there is no relationshipbetween price and consumption.

4. Within Lima there are large differences in per capita domestic water consumption.These differencesare partly due to the impact of rationing levels, which differ for each district. Income differentials also explain the differences. Water demand forecasts are based on a district-by-district analysis of water consumptionpatterns. In the attachmentto this annex, daily per capita domestic water consumption, population coverage, and total water demand forecasts are presented for 1993-2005.

1. These data are not entirely comparable because of the impact of seasonality on water consumption. Data from 1993 capture the full impact of the dry season, when rationing is important. The 1987 data are from June, when the impact of the dry eaon is less important.

2. In this section, water demand is equal to water consumption combined with physical losses. - 48 -

Annex 8

5. The main variable in forecasting water demand is the change in per capita domestic water consumption.Consumption depends on, among other things, changes in real water rates and household income, the impact of the installationof water meters, and the effect of rationing. Most SEDAPAL customers have problems with water supply either because of the lack of pressure in the system or because of insufficienthours of service delivery. According to recent studies from Black and Veatch e.o., adjusting water consumptionfor the impact of rationing could increase per capita 3 consumptionby 36 percent. Thus, without rationing and excluding seasonability in the demand forecast, it is assumed that customers would have used 236 liters per capita per day.

6. Water rates are an important factor in forecastingwater demand. Since 1989 real water rates have increased rapidly-to US$0.28 per cubic meter in May 1994. To guarantee financial viability in the near future, the real average water tariff should be increased gradually-to $0.37 per cubic meter by 19974. No real rate increases are foreseen after 1997 in this base-case scenario. The Water and Sanitation Services Law specifies a tariff-setting methodologyusing full cost recovery based on the economic costs of water supply and sewerage. The consequences of the use of cost recovery principles on water demand is discussed in detail in the sensitivity analysis.

7. The impact of real rate increases depends on the value of the price elasticity of demand. No price elasticity studies have been conducted in Lima. Based on the results of recent studies in other parts of Peru and Latin America, it has been assumed that the average price elasticity is -0.30. Price elasticity varies among different income groups. For districts dominatedby high-income groups, a price elasticity averaging -0.15 has been assumed. For middle- and low-incomedistricts, the price elasticity averaged about -0.30 and -0.40, respectively. The value of the price elasticity usually can be applied only for a specific interval. Nonetheless, this elasticity will be used for the total period since there is insufficient informationto predict changes in the demand function. Also, no real price increases are foreseen after 1997, so the price elasticity will lose its importance thereafter. The price elasticity for householdswith an unmetered connection is assumed to be zero, since these householdscannot react to price increases by decreasing their consumption.

8. One of the major goals of the proposed project is inducing water conservation. The installationof water meters will encourage water conservation, particularly since the program is targeted at districts characterized by high water use. The use of water meters has an impact similar to that of a real rate increase. Instead of paying the minimum consumptionlevel, users pay for actual consumption. Based on assumptionson the rate category to be applied, water rates will increase substantially. This increase results in a significant decline of demand when an average price elasticity of -0.30 is assumed.

9. Domestic water consumptionforecasts take 1987 water consumptionlevels as a starting point for calculations (section 5 of this Annex). Per capita domestic water consumptionwill decline from 236 liters a day in 1994 to 188 liters a day in 2005 (graph 1). In view of the expected increase in coverage, domestic water consumptionwill increase to 17 cubic meters per second by 2005.

3. Black and Veatch International, Binnie and Partners, and Inforrnation for Investment Decisions Inc. March 1994. i?fornm sobre la Estirnacion de la Demanda Futura de Agua Potable para LimnaMetropolitana. Lima.

4. In the base-case scenario, no real rate increases are foreseen after 1997. But it is assumed that nominal rates will be adjusted annually for the impact of inflation throughout the project. - 49 -

Annex 8

GRAPH 1: DOMESTIC WATER CONSUMPTION In lIttor rs cwDlta per day

240

230

220 -

210

200

190

180 1993 | 1997 I 1999 I 2001 | 2003 | 2005 1994 1998 199- 2000 2002 2004

10. Non-domesticconsumption. In Lima non-domesticwater consumers use both piped water and groundwater. Private groundwater resources amounted to 2.9 cubic meters per second in 1993. Most private wells are thought to be used by non-domesticusers. Together with the non-domestic use supplied by SEDAPAL, total non-domesticconsumption was 7.1 cubic meters per second in 1993. Future non-domesticpiped water consumptionwill be determined by, among other things, industrialproduction, the type of industries located in Lima and their water needs, quality of supply, and the price of piped water and its alternatives. Most large industries use groundwater. These industries can afford the investmentsrequired to use groundwater since they encounter economies of scale. For small-scale industries, piped water is the most viable alternative. Their water use depends on production levels, which are supposed to increase with population growth. It is assumed that large industries will continue to use groundwater sources, so the costs of groundwater pollution and the decline of groundwater tables will not change the relative price of groundwater in favor of piped water. On the basis of these assumptions,non-domestic water consumptionsupplied by SEDAPAL will increase to 5.4 cubic meters per second in 2005.

11. Total water demand. Total water demand is presented in graph 2. Assuming that only a small real rate increase occurs, total demand will increase to nearly 32 cubic meters per second in 2005. Water demand accounts for about 23 cubic meter per second of this total-the rest is caused by physical losses. Althoughthe rehabilitation componentwill aim at reducing these losses, its scope is too small to cause a significant decline in physical losses. In the project scenario, water losses will decrease from almost 31 percent of total production in 1993 to 29 percent in 2005. Thus, production capacity will have to be expanded substantiallyto satisfy demand. - 50 -

Annex 8

12. Production capacity will increase from 20.5 cubic meters per second in 1993to nearly 32 cubic meters per second in 2005. However, this capacity will not always be sufficient to satisfy water demand. The actual demand that can be satisfied will be lower because of production capacity shortages that will be addressed only in 1997 (graph 2). Because of the rapid network expansion, SEDAPAL will be confronted with production constraints again after 2003. Further price increases after 1997 would result in lower water demand-reducing the need for rationing afterwards.

GRAPH 2: WATER DEMAND IN LIMA In lItwrs owr second 33

32-

31

30-

29-

rN29 27

220 25

24

23-

22-

21-

201993 j 1995119b7 I19,99 22001 I 2003 J200D5 19 1996 11e 200 20102 2004

a wIthout rationing + with rationing

13. Sensitivityanatysis. In the sensitivity analysis the impact of a number of key variables has been tested. These variables concern the effect of the installation of water meters, the impact of changes in the price elasticity value, and the impact of real rate increases according to the full cost recovery principles detailed in the sector law.

14. One of the most important variables affecting demand is the real water rate. It has been proposed to use the long-run average incrementalcost as a reference for tariffs. The marginal cost pricing analysis shows that the proposed investment schedule will result in a long-run average incrementalcost of US$0.45 per cubic meter consumed (Annex 10). Long-run average incremental costs are thus considerablyhigher than the current average water rate of US$0.28 per cubic meter. A real rate increase to US$0.37 per cubic meter has been assumed in the base-case scenario-full cost recovery will require a further increase of real water rates of about 20 percent. It is assumed this increase will be implementedbetween 1997 and 2005. It is also presumed that tariff increases will be equal for all user groups. If SEDAPAL charged according to cost recovery principles, water demand would be about 3 percent lower than in the proposed investmentscenario. The - 51 -

Annex 8

impact of a further real rate increase is limited, since water meters will be installed only in about half the householdswith a connection.

15. The value of the price elasticity affects the impact of both the installation of water meters and real rate increases. In the base-case scenario, price elasticity was set at -0.30. If the average price elasticity is equal to zero, production requirements are about 14 percent higher than in the base-case scenario. The impact of the installationof water meters is substantial. The proposed water meter program will cover about 50 percent of the total number of domestic connections. Based on these assumptions, production requirementswill be 32 cubic meters per second in 2005. If no water meters are installed, production requirementswould be 16 percent higher than in the proposed project. If all domestic connectionswere metered by 2000, water production requirementswould be 12 percent lower. The change in production requirements results from the project's installationof water meters in districts characterized by high-volumeuse. A second phase in which the remaining customers receive water meters will include the majority of lower-volumeusers.

C. Sewerage projections

16. The projected amount of sewage collected each year depends on the number of sewerage connectionsand the annual volume of sewage produced per connection. The coverage of sewerage collectionand treatment is expected to increase from 75 percent in 1993 to 90 percent in 2005. The annual volume of sewage produced per connection is estimated at 85 percent of the total volume of water consumed. This increases the amount of sewage collected to about 19 cubic meters per second in 2005 (graph 3).

GRAPH 3: SEWAGE DEMAND IN LIMA In I Iter per mcoold

19

1 99 tSS tS9 2000 213

O without rattoning 4. with r ttoning ANNEX8 PERU LIMA WATER REHABILITATION AND MANAGEMENT PROJECT PER CAPITA DOMESTIC WATER CONSUMPTION (IN LITERS PER CAPITA PER DAY) WITH PROJECT SCENARIO 1993 - 2005

DSrICTS IIETERJG01IEpric621 REHAB3 1093 1994 1905 196 1907 1 19o9 2000 2001 2002 2003 2004 2005 Ccls 147 147 147 147 147 147 147 147 147 147 147 147 147 S.M.P YES -040 172 172 172 172 123 119 116 116 116 116 116 116 116 Los Ovos 172 172 172 172 172 172 172 172 172 172 172 172 172 Rimoc YES -040 YES 229 229 229 229 177 172 167 167 167 167 167 167 167 6Idepwideiian 172 172 172 172 172 172 172 172 172 172 172 172 172 Cara~oynIo 174 174 174 174 174 174 174 174 174 174 174 174 174 Pueft Poedr 187 187 187 187 187 187 187 187 187 187 187 167 187 NRH SanJunLuisg. 195 195 195 196 195 196 195 195 195 196 195 196 195 Abele 244 24 244 244 24 244 24 244 244 24 24 244 24 BAAnoIm 167 167 167 167 167 167 167 167 167 167 167 167 167 Swrt Arjb 168 168 168 168 168 168 168 168 168 168 168 168 168 Liz1xd, 211 211 211 211 211 211 211 211 211 211 211 211 211 La M* YES -013 560 560 560 560 443 439 435 435 435 435 435 435 435 Son Lis YES -0 33 239 239 239 187 182 178 174 174 174 174 174 174 174

SLniht InoS_ 158 158 158 158 158 158 158 158 158 158 158 158 168 V Ltmsaim 121 121 130 140 150 180 150 150 150 150 150 150 150 U S6vodor 108 108 120 130 150 150 150 150 150 150 150 150 150 LLrin 105 105 106 105 10S 105 105 105 105 105 105 105 105 P KCmc 159 159 159 159 159 159 159 159 159 159 159 159 159

YES -0.30 YES 243 243 243 243 189 18 18 181 181 l18 181 181 181 SXode oO YES -0.19 405 405 405 320 315 311 306 306 306 306 306 306 306 Son Bo YES -0.20 369 369 369 365 359 353 348 348 348 348 348 348 348 Su"Ao YES -0.30 234 234 192 189 184 180 176 176 176 176 176 176 176 ofahre YES -0.15 YES 567 567 344 341 337 333 330 330 330 330 330 330 330 Lice YES -0.30 YES 324 324 324 148 142 139 136 136 136 136 136 136 136 SW dh YES -0.12 YES 465 465 369 367 363 360 357 357 357 357 357 357 357 Bwu~c YES -0.19 YES 307 307 303 210 207 204 201 201 201 201 201 201 201

thuCAIrcado YES -0.25 YES 372 372 372 140 137 136 132 132 132 133 132 132 132 LaMckrim YES -0.30 YES 231 231 231 231 192 167 163 183 183 183 183 183 183 son YES -0.30 235 235 235 193 188 184 180 180 1so 180 180 180 180 elm YES -0.37 YES 261 261 261 179 173 169 164 164 164 164 164 164 164 PU" LbU YES -0.28 YES 272 272 272 201 196 192 188 188 188 188 188 188 188 mae YES -0.37 YES 264 264 264 181 175 170 166 166 156 166 166 166 166 YES -0.25 325 325 325 176 172 169 166 166 166 166 166 166 166

YES -0.40 YES 243 243 243 243 175 170 165 16s 165 16s 165 165 165 B db~4n~ YES -0.30 231 231 231 231 192 187 1u3 183 183 183 183 183 183 La Par YES -0.41 254 254 254 254 172 167 162 162 162 162 162 162 162 .de sLA YES -025 252 252 252 252 124 122 120 120 120 120 120 120 120 LPuts YES -0.19 312 312 312 312 215 211 209 209 209 209 209 209 209

1/ Dk*tdt in oodi m_ts ow be h 21 Prce odty of dsld bond on Ihcme Wv 31 lld ds pid cvAI in to rehdItdon o waw sniaw sMwoap noorka .

Sauce: W4sbrlo do I PraordalSED3APAL, EcApo de Propwadon Pryoclo BIRF.Proyncdoros de Poobdon y Dewnmo. LhUr,Mwrh 1994. ANNEX 8 PERU LIMA WATER REHABILITATIONAND MANAGEMENT PROJECT POPULATIONCOVERED BY DIRECT PIPEDWATER SUPPLY WITH PROJECTSCENARIO 1993 -2005

DISTRICTS METING It REHM 21 19S6 94 1 199 1997 199 1s9 2000 2001 2002 2003 2004 2005 Comas 345,113 354,884 3738655 397,556 427.059 447,186 458.507 479,713 482,014 493.613 505,490 517,654 530,110 S.M P YES 367,059 379.288 393,986 409,244 425,080 439,805 455,028 470,765 487,034 503,736 520,996 538,835 554.498 Los Olivos 192,907 204,024 220,513 237,875 250,975 266,320 274,125 282,159 290,248 298.871 307,558 316,498 325,698 Rimac YES YES 175,241 179,519 184,924 190,486 196,208 202,097 208,156 214,391 220,807 227,407 234,198 241,186 247,074 Independencia 159,748 165,070 171,573 178,325 185,649 191,872 198,830 205,820 212,849 220,273 227,950 235,883 242,744 Carabrayallo 87,228 90,071 93,828 97,320 101,153 104,739 108,449 112.285 116,251 120,308 124,499 128,833 132,483 PuentePiedra 28,849 35,772 49,285 63,858 78,935 96,854 100,355 104,731 109,277 113,973 117.287 120,695 124,204 1H ______1.350.144 1,408,608 1,487,563 1,574,454 1,885,058 1,748,874 11,803,250 1,869,663 1,918,481 1,978,180 2,037,978 2,099,584 2,156,811 San Juan Lung. 408,668 434,043 473,087 501,360 530,973 546,230 575,973 606,975 639,283 672,682 707,460 727,503 748,114 Ata-Vitarte 162,310 181,694 216,631 253,694 277,565 288,874 297,341 306,056 318,487 318,545 313,038 350,848 364,930 ElAugustino 95368 98,438 104,990 111,863 119,070 126,158 133,552 141,263 149,305 155,549 159,892 164,357 168,946 SantaAnita 101,247 104,504 110,404 116,576 123,030 129,300 135,827 139,679 143,841 147,652 151,775 156,013 160,369 Lungancho 5,239 5,414 11,186 23,122 35.838 49,184 62,782 78,164 87160 96593 99,401 102,290 105,263 La Molina YES 78,443 79,896 81,375 82,882 84,416 85,860 87,329 88,823 90342 91,587 92,850 94.129 95,427 San Luis YES 49,085 50,475 51,904 53,373 54,884 56,438 58,036 59,679 61,369 63,107 64,893 66,731 68,620 EASr 90D,361 9s4482 1,049,578 1,142,869 1,225,775 1,282,043 1,350,839 1,420,640 1,489,587 1,545,714 1,589,309 1,661,870 1,711,666 San Juan Miraftores 200,320 206.994 220,000 233,645 247,954 261,937 276,526 291,747 307,621 324,100 341,278 359,179 369,6Q0 Villa Mana 188,293 200,046 212,367 228,227 235,831 242,742 256,263 263,774 271,504 282.888 291,112 303,272 312.088 Villa Salvador 233,525 244,153 257,728 275,175 284,343 292,675 301,253 310,082 319,170 328,105 337,995 347,820 357,931 Lurin 12,136 12,541 12,958 15,822 18,448 21,362 24,431 27,662 31,061 34,827 38,375 42,312 43,542 Pachacamac 4,645 4,800 4,960 5,125 6,60 8,177 9,820 11,551 13,376 15,294 17,312 19,435 21.666 8D _i1 6389t9 88,533 708,014 757,794 793,195 826,894 868,293 904,815 942,732 985,01t 1,t26,072 1,072,018 1,104,847 Chorrilbs YES YES 121,222 125,260 136,246 145,477 155,072 164,712 174,877 185,084 195,952 207,250 219,038 231,336 244,166 Santiagode Surco YES 202,426 210,364 218,612 227,184 238,000 245,200 254,850 264,760 275,200 286,050 297,277 308.900 321.156 San Boa YES 98,791 101,633 1D4,559 107,566 110,661 113,845 117,120 120,490 123,957 127,524 131,193 134,967 138,851 Lii Sunquillo YES 90,054 92,806 98,842 98,565 101.578 104,682 107,881 111,178 114,576 118,078 121,686 125,405 129,238 Miraflores YES YES 86,778 86.761 86.744 86,727 86,710 86,693 86,676 86,659 86,642 86,625 86,608 86,591 86,574 Unce YES YES 63,119 62,599 62,082 61,570 61,063 60,559 60,060 59,565 59,073 58,586 58,103 57,624 57,149 San Isidro YES YES 61,785 81,276 60,770 60,269 59,773 59,280 58,791 58,306 57,826 57,349 56,876 56,407 55,942 Bananco YES YES 40,688 40,688 40,680 40,672 40,664 40,564 40,844 40,634 40,624 40,616 40,609 40,601 40,593 WEST 7U4883 781,357 808,335 828,D30 851,521 875,535 900,69M 926.676 953,850 982,078 1,011,390 1,041,831 1,073,.W Lima Cercado YES YES 332,181 332,116 342,321 342.254 342,187 342,120 342,053 341,986 341,920 341,853 341,786 341,719 341,652 La Victoria YES YES 227,113 229,888 232,696 235,539 238,417 241,329 244,278 247,262 250,283 253,341 256,436 259,569 262,740 San Miguel YES 118,598 122,241 125,996 129,866 133,584 137,966 142,204 146,572 151,074 155,714 160,497 165,427 170,508 Brena YES YES 90,593 90,575 90.558 90,540 90,522 90,505 90,487 90,489 90,462 90,434 90,417 90,399 90,381 Puebb Libre YES YES 73,443 72,837 72,237 71,641 71,050 70,464 69,883 69,307 68.736 68.169 67,607 67,049 66,496 Jesus Marna YES YES 64,713 64,700 64.688 64,675 84,662 64,650 64.637 84,626 64,612 64,599 64,587 64,574 64,562 Magdalena YES 49.088 48,880 48,634 48,408 48,183 47,960 47,737 47,518 47,295 47.076 46,857 46,640 48,424 C 956,729 961,217 977,130 982923 988,80 994,994 1,001,279 1,007,737 1,014,382 1,021.18a 1,028,187 1,035.377 1,042,703 CallaoCercado YES YES 282,124 291,523 309,267 327,871 347,370 366,379 386,119 406,876 428,428 450,789 474,089 498,361 512,848 Bellavista YES 76,863 79,254 81,719 84,260 88,881 89,271 91,727 94,250 96,843 99,437 102,101 104,836 107,644 La Perba YES 58,919 60.827 62,796 84,289 66,928 68,841 70,808 72,831 74,912 77,019 79,185 81,411 83,701 C de la Legua YES 34,423 35,570 37,572 39.668 41,862 43,986 48,199 47,553 48,947 50,370 51,834 53.341 54,891 La Punta YES 5,788 5,795 5,801 5,808 5,815 5,821 5,827 5,832 5,838 5,844 5,825 5,799 5,774 C:ALLAO 458,117 472,9 497,155 521,89 548,58 574,299 60D,0 627,342 654,988 683,459 713,034 743,748 764,858 TOTAL = 074,133 5,24t,178 5,526,775 S.807,976 8,073,010 5,302.,8 8,525,040 6,758,874 6,974,00f 7,t15.633 7,4bs,970 7,654,429 7,854.618

11 Distrit in which water mets will be installed. 2t Distict which will participate in the rehablitation of water supply and sewerage networks.

Source: Minmstenode Is Presidencia/SEDAPAL, Equipo de Preparacion Proyecto BIRF, Proyeccionesde Poblacion y Demands Lima, March 1994 ANNEX8 PERU UMA WATER REHABIUTATIONAND MANAGEMENTPROJECT TOTAL WATER DEMAND IN UMA ONUTERS PER SECOND) WITH PROJECT SCENARIO 1993 -2005

______11401 R1I'3"2t 1U $9364 $66 $366 196 1366 comas 111 2006 2001 2002 2003 2004 2000 994 1,022 1073 135 1.212 126 S.M.P. 1.297 1,357 1,364 1,397 1,430 1,465 1,500 YES 1,263 1,305 1354 1,405 1,154 1,192 LosOlivos 1,231 1272 1,314 1,357 1402 1448 1,490 784 825 882 942 989 1,042 Rimac 1,073 1,104 1,136 1,170 1,204 1.239 1,275 YES YES 961 984 1,013 1.042 904 Independncia 930 956 920 940 972 1,000 1,028 1,053 567 586 808 631 658 Carab-yaio 878 701 725 749 775 801 828 852 321 331 344 357 370 383 Puente Piedra 396 409 423 437 452 467 480 192 217 263 311 362 422 435 452 NORTH ______470 489 503 517 532 508 5,271 -5,53 5,623 5,847 5,911 San 6,066 85,239 6,402 8,508 6.701 6,991 7,182 Juan Lung. 1,489 1,551 1,672 1,763 1,3858 Ala-anrte 1,912 2.007 2,105 2,208 2,314 2,425 2,493 2,564 832 912 1,050 1,197 1.294 1,344 El Augusino 1,383 1,424 1,478 1,478 1,450 1,625 1,687 303 313 332 353 374 395 SanbaAnila 417 439 4S3 481 495 509 523 390 402 423 443 465 488 Lungancho 508 522 537 552 567 583 600 143 148 179 238 301 367 433 509 555 La Mdina YES 603 620 638 657 789 803 818 833 688 699 711 San Luis 724 736 746 756 767 777 YES 264 272 279 242 247 254 SAnfJuan Miribies4,19D 261 268 276 284 292 300 309 4,401 4,753 5,069 5,227 5,450 San 5,7217 5,991 e625 8,4* 6,eo5 8,915 7,116 Juan Mirafiores 966 996 1,050 1,105 1,161 Villa 1,216 1,273 1,332 1,394 1,457 1,524 1,592 1,639 Mara 478 505 585 640 701 VillaSakvador 721 758 780 803 835 680 894 920 666 694 796 904 1,055 1,086 Lunn 1,118 1,150 1,184 1,217 1.254 1.290 1.328 55 57 59 85 71 Pachacwnac 77 84 91 98 105 113 121 125 32 33 34 35 40 45 50 ... 55 60 66 72 78 85 :__ .. .. 2, 2,78: . ._ 3,504 248 Chomiibs 3,4 39 3 3,821 _ 3, 4098 YES YES 575 594 641 681 593 827 619 SanbagodeSurno 653 688 725 763 803 84 YES 1,491 1,550 1,611 1,347 1,392 1,446 1,503 San Boija 1.562 1,623 1,687 1,753 1,822 1,894 1 YES 710 731 752 766 784 807 Surquillo 830 854 879 904 930 957 984 YES 474 488 436 439 449 LA Miraorsa 4B3 477 492 507 522 538 555 572 YES YES 1,102 1.101 739 734 731 632 632 632 632 631 631 631 631 Lince YES YES 352 349 348 181 178 177 175 163 162 160 159 158 158 San lairo YES YES 591 58B 491 485 480 476 472 436 433 429 426 422 Bananoo YES YES 234 234 232 169 188 419 168 156 157 157 157 157 157 157 _W______7 5:A*4 5,20 4.801 Linia Cardo 4776 4,795 4,#1S 4p49 5,081 5,217 5:358 YES YES 3,046 3,045 3,108 1,821 1,815 5,505 6,666 1,815 1,698 1.898 1,697 1,S97 1,897 1,696 1,696 LaVVicbna YES YES 1,320 1,336 1,352 1,389 1,051 1,063 1,076 1,090 1,103 1,116 1,130 San Miguel YES 571 588 1,144 1,158 6W6 532 544 562 579 597 615 634 Brwn YES YES 468 488 653 673 694 468 348 345 323 323 323 323 322 Pueblo Uibre YES YES 337 322 322 322 335 332 241 238 236 234 232 230 Jean Maue YES YES 228 226 224 223 319 319 319 240 238 238 238 226 M YES 226 226 228 226 226 277 275 274 162 160 15S 158 CEWMAL ____8,337 158 157 158 155 155 154 6,3806 0456 4,712 4,390 4,396 4,808 CallaoCercado 4.32$ 4,351 4,380 4,410 4,441 4,473 YES YES 1,948 2013 2,114 2,219 1,948 1,774 Bevajta 1,860 1930 2,013 2,096 2,187 2,279 2,345 YES 397 409 422 435 397 408 La Parts 419 430 442 454 486 479 492 YES 280 289 296 305 232 238 C.dela Lgua 245 252 259 266 274 282 290 YES 170 176 185 195 118 123 La Punta 128 132 136 140 144 148 153 YES 38 36 36 36 28 28 CALLAO 28 28 28 28 28 28 28 : 2,81 2,Z9 3.055 3,1S0 2,720 2,570 2,70 2.772 2,a78 2,987 3,W9 3,215 3,3t7 SOCIAL CONNECTIONS 253 260 208 184 IOTOtAJ. 159 140 124 109 95 81 69 60 ______2B,419= 27,141 27,759 26 95,°46 59 26,412 27 , 2 057,792 26,59 2S,401 50154 31,104 31,P 1/ DOaict in which water meers will be inaltlled. 2/ District which will pasripate in Me rehabilibtion o water supply and sewerage netwoilca Source: Based upon data Irorn MiniterioSEDAPAL, Equipo de Preparacion Proyacto BIRF, Proyecciones de Poblacion y Demanda Lima, March 1994. - 55 -

Annex 9 Cost-benefit Analysis: Methodology and Results

A. Methodology

1. The economic rate of return was calculated by comparing the costs and benefits of piped water and sewerage services in two scenarios: one in which the project is implementedand one In which the project is not implemented. All costs and benefits are expressed in constant prices. The prices used in the analysis are adjusted for the impact of taxes and subsidies. Shadow exchange rates and prices were not estimated. Due to ongoing macroeconomicreform, these shadow prices are difficult to estimate.

2. The project scenario includes investmentsaimed at water conservationthrough demand and supply management. Demand managementincludes the installationof water meters and rehabilitationof the network to reduce unaccounted-forwater. The conjunctive use component will lead to more efficient use of supply. The water conservationcomponent will be supplemented by an expansion of water supply and sewerage services in the pueblos jovenes. The project will also finance technical assistance to strengthen the institutionalcapacity for water resource management. Without the project, these investmentswill not take place-resulting in higher water demand and an increased need to ration consumption.

B. Calculation of project benefits

3. The economicjustification for the project is based on the benefits it would generate in the form of higher water sales and cost savings from investmentsthat promote efficiency in water supply and sewerage. This componentinvolves rehabilitatingthe water supply and sewerage network and installing water meters to reduce unaccounted-forwater, and the conjunctive use of water resources. The expansion of the water supply and sewerage network on Lima's outskirts will also generate health benefits. In addition, the incremental consumer surplus could be substantial because of an increase in aggregated water consumptionand improved service quality-increasing users' willingness to pay. The project will improve the reliability of the water supply network. Increased reliability will reduce the impact of rationing on the consumer. The benefits of reliable supply in the project are calculated as the reduction in rationed volume and associatedcosts compared with the scenario in which the project is not implemented.

4. The project would also foster a number of non-quantifiablebenefits. Data limitations have precluded an estimation of these benefits. These benefits include environmentalbenefits, cost savings from postponed investment, increased property values, and benefits associated with the institutionalstrengthening of the capacity to plan and manage water resources. The conjunctive-use program and the rehabilitation of the network will induce several environmentalbenefits. The program will optimize the use of water resources in Lima by improvingcontrol of surface and groundwater flows. High water production levels currently deplete the aquifer because production levels exceed natural recharge flows. Optimizing surface and groundwater flows could arrest this process. In addition, rehabilitating the sewerage system could reduce groundwater pollution. Rehabilitationwill extend the lifetime of the water supply and sewerage network-postponing the need for new investment. An indirect benefit of the pueblos jovenes componentwill be increased property values for householdsthat get access to the piped water system. A survey carried out by SEDAPAL in December 1993 found that this increase can be substantial-property values can - 56 -

Annex 9

quadruple when a house gets a water connection. The benefits associated with institutional strengtheninginvolve improved efficiency of the other project investments.

5. The project components aimed at water conservationwill result in significant cost savings that will enable SEDAPAL to reduce rationing and increase coverage. The water conservation component consists of network rehabilitation, water meter installation, and conjunctive use of water resources. The rehabilitationcomponent will result in a reduction of unaccounted-forwater that could translate into lower production costs. It will benefit 834,000 people with improved access to water supply and 788,000 people with better sewerage services. Total savings from the rehabilitation of the water supply network amount to 1.3 cubic meters per second. The water meter program aims to reduce excessive consumptionthrough metering and better administrativecontrol. The total available water supply will increase by 5.2 cubic meters per second as a result of metering.

6. The project component involving expansion of the water supply and sewerage network will ensure direct access to the water supply and sewerage system in poorly served low-income communitiesin the outskirts of Lima. The number of beneficiariesis estimated at 578,000, with 276,000 receiving improved services and the remainder gaining direct access to the water supply and sewerage network. A large part of this populationpays high prices for water since most depend on water sold by vendors. The project will reduce their financial burden substantially. Moreover, because of the high prices these consumers pay for vendor water, they reduce their consumptionto levels that jeopardize public health. This contributed to a cholera outbreak in 1991 and is the main cause of the high incidence of diarrhea in the pueblos jovenes.

7. The incrementalrevenues from the sale of future water and sewerage services have been used as a proxy for direct-use benefits. The average water and sewerage rate is currently US$0.28 per cubic meter. To ensure financial viability, the average water tariff has to be gradually increased to US$0.37 per cubic meter by 1997. This higher rate has been used as a proxy to calculate project benefits. This tariff is higher than the tariff domestic consumerswill actually pay, since cross- subsidies in the water rate have been neglected in the calculation of project benefits.

8. Calculatingthe value of the consumer surplus requires estimatingthe water demand function in the relevant range. For this analysis, a demand curve has been estimated based on a price elasticity of -0.30. After the demand curve and the quantities consumed have been estimated both with and without the project, the consumer surplus can be calculated. Some methodological problems occur that are caused by the lack of information available about the water consumption patterns of different water users. A survey carried out in December 1993 found that the average daily water consumptionof a person supplied by vendors is about 30 liters. The average price of vendor water fluctuates substantiallydepending on the distance to the household and the season. The survey indicates the average price of vendor water is about US$2.50 per cubic meter. It has been assumed that the consumptionof 30 liters per capita per day observed in the survey represents the total water use of people dependenton vendor water.

9. According to an earlier Bank study, it is not lack of hygiene that causes waterborne diseases, but lack of water. It has been assumed that householdscurrently using indirect forms of piped water supply are victims of waterborne disease. But it is likely that householdswith access to piped water but experiencing intermittentsupply are also susceptibleto waterborne diseases, so the - 57 -

Annex 9

Water vending survey in the Lima metropolitanarea

In December 1993, SEDAPAL's project preparation unit interviewed water vendors:o obtain iformation about water vending practices in the pueblos jovenes. Twelv, watWevWors.vwer'e interviewedabout water costs, the householdsthey served, and the profitabilityof their OWterr* Te. study indicatedthat householdsuse an averageof 150 liters a day, for which they pay anaveae$.50. to $2.75 a cubic meter (at the end of the dry season). The actual price varies accordingto season.nd"' distance. In December 1993households purchasing from water vendors paid up to 20 times moe pe." unit of water than householdsconnected to the piped water system. If households usingvendor water are connectedto the pipedwater system, they benefit fromimproved service and health conditons. The surveyalso indicatedthat householdproperty value increasessharply once a connectionto piped water is in place. The averageproperty value quadrupledfrom $1,542 to $6,375.

Water vending is big business in Lima. At end-1993, about 7 percent of the population m i the, metropolitanarea relied on vendors for their water supply. These householdspurchased an average. of 30 liter per capita per day. Annual gross revenue for water vendors in 1993was about $12.5wmiflioc. This compares with the $85,4 million that SEDAPAL collected from domestic and, ion-dm .s..... consumersin the same period.

The high prices paid for vendor water may generate substantialsurpluses that could be absored as. economic rents. Vendors charge substantiallyhigher prices than necessary to earn their wage. On average, a vendor sells about 23 cubic meters of water a day. Assuminga five-day worweek, daily revenuesare almost $59. The survey showedlarge variationsin the costs of supplyingwater. among t'. twelve vendors. Costs includethe cost of water, fuel, vehicle maintenance,and salaiesW orthedr.ver' and his assistant.Vehicle costs are high-about 74 percent of total daily costs of $44. Monthlyaerage net revenues are about $320. The average wage in December 1993 was $159, sggestin , the implicitwage of water vendors is twice that of other workers. Free entry in the . Ve m ark.t would limit the vendor's implicit wage rate to that of the average wagerate. The water v"endingxat:. in Lima has high entry barriers-mostly because of the cost of acquiringor renting a tank. .

current calculation underestimates health benefits. Health benefits reflect the avoidance of medical costs and lost wages. In this study, annual medical costs and lost wages brought about by waterborne diseases were estimated at US$12.92 per capita in the pueblos jovenes in 1991.1To calculate health benefits, it is assumedthat these costs have remained constant in real terms.

C. Internal economic rate of return

10. Evaluating the economic viability of the project includes the benefits described in the preceding sections, the investment costs, and operation and maintenancecosts projected for the period under review. A discount rate of 10 percent is used to calculate the net present value resulting from the project. To reflect true costs and benefits, financial prices have been transformed into economic prices. The major difference between financial and economic prices involves the impact of taxes and subsidies. In addition, price contingencies are not included in the total

1. Data for the costs of medication and lost working days are taken from Sheila Webb and Associates. 1992. 'Waterborne Diseascs in Peru." Working Paper 959. World Bank, Washington, D.C. - 58 -

Annex 9 investmentcosts since it is assumed that the prices of goods and services acquired under the project will rise in line with general inflation. Investment and operation and maintenancecosts are adjusted for the value-addedtax of 18 percent. The base-case scenario is defined as the scenario in which only the direct-use benefits and the consumer surplus are included. The net present value of the project is US$209 million, the internal economic rate of return is 23 percent, and the benefit-cost ratio is 1.85.

D. Sensitivity analysis

11. In the sensitivity analysis the impact of a number of variables has been tested. These variables concern the impact of consumer surplus, health benefits, reliable supply, cost overruns, and cost recovery.

12. Impact of consumer surplus. The consumer surplus is an important benefit of the project. In the unlikely event of the absence of a consumer surplus, the project's feasibility is still ensured. The net present value is US$29 million, the internal economic rate of return is 12 percent, and the benefit-cost ratio is 1.12.

13. Impact of health benefits. Health benefits increase the total benefits of the project. But since the health impact is restricted to 302,000 people in the pueblos jovenes, the impact is not as large as may have been expected.

14. Impact of reliable suppty. The water supply system in Lima is unreliable. Customers have tried to cope with rationing by building reservoirs. Lower-incomehouseholds have constructed reservoirs, while higher-incomehouseholds have added pumps to the reservoir. The savings from reduced rationing are based on costs that the poor pay to cope with rationing. In this case, the net present value increases to US$363 million, the internal economic rate of return is 32 percent, and the benefit-cost ratio is 2.48. Since it can be assumed that savings from reduced rationing are spread over the population, affecting both low and high-incomehouseholds, the actual benefit is likely to be larger.

15. Impact of cost overruns. The project's sensitivity to cost overruns has also been tested. The switch value for cost overruns of total investment is about 95 percent. If investment (and the fixed operation and maintenancecost) increases by more than 95 percent, the project will become economicallyunfeasible.

16. Impact of cost recovery. Cost recovery is a guiding principle in tariff setting in the new Water and Sanitation Sector Law. In Annex 10, the economic costs of water supply and sanitation services are estimated to be US$0.45 per cubic meter consumed. It has been assumed that cost recovery will be introducedgradually in the project, so that by 1999 water rates will have increased to the level of the long-run average incremental cost. No water rate increases are foreseen without the project. The overall impact of cost recovery is positive (Table 1).

E. Cost-benefit analysis for separate project components - 59 -

Ann 9

17. Water meter program. The average domestic water consumptionin Lima is high. There are several reasons for high water consumption. In the past, water rates did not keep pace with inflation because of political interventions in tariff-setting-resulting in low real water tariffs. And only 4 percent

Table 1 Resultsof the sensitivityanalysis Net present Internal value economicrate of Impact (US$million) return(percent) Benefit-costratio Base-casescenario 209 22 1.85 Withoutconsumer surplus 29 12 1.12 Withhealth benefits 233 24 1.95 With reliablesupply 363 32 2.48 With costrecovery 460 36 2.89 of the water connections in Lima are actually metered and billed according to the meter reading. T-heabsence of metering has changed the water rate structure from an increasing block rate structure to a flat rate structure. There is no price incentive for high-volume users to control consumption. Instead of reading actual consumptionfrom the water meter, consumptionis estimated using the minimum consumptionassignment of the user rate category. Billing the minimum consumptionlevel results in significantunderestimation of consumed water, particularly in a non-rationedwater supply system.

18. The water metering program aims to install water meters in 24 districts in central Lima and Callao with excessive water consumptionlevels. 2 This program will have two main benefits. First, the installation of water meters has an impact similar to a real rate increase-customers have to pay for the water they actually consume, resulting in increased water bills. On the basis of price elasticity studies elsewhere, the average value of the price elasticity is assumed to be -0.30. This elasticity implies that water consumptionwill decline from 292 liters per capita per day in 1993 to 200 liters per capita per day in 1997 (when the program is implemented in these districts). Total water savings from the metering program are estimated to be 5.2 cubic meters per second. These savings can be used to either expand the number of customers or improve the service level to rationed consumers-generating additional income for SEDAPAL. Second, the installation of water meters is expected to coincide with an improvement in billing efficiency. It is assumed that administrative losses estimated at almost 16 percent of total water production in 1993 will decline to 10 percent in 2005.

19. Investment costs of the project involve the installationof 406,269 water meters and the rehabilitation of water meter boxes in selected districts in central Lima. Operation and maintenance costs include the metering and reading of these connections. On the basis of these costs and the

2. Thesedistricts are Miraflores,San Isidro, San Borja, Santiago de Surco,Surquillo, Barranco, Lince, Jesus Maria, Magdalen de la Mar, San Miguel, Pueblo Libre, Brena, SanLuis, Lirna Cercado, La Victoria,Chorillos, La Molina, Rimac, SanMartin de Porras,Callao, Bellavista,La Perla, Carmende la Legua, and La Punta. - 60 -

Annex 9

above-mentionedbenefits, the internal economic rate of return for this project component is 119 percent. This return is far above the cutoff point of 10 percent used in the calculation. The net present value of the project is US$213 million, and the benefit-cost ratio is 6.06. These indicators show that this project component is economically quite viable.

20. Domestic consumption in the districts targeted for the water meter program makes up 68 percent of total domestic consumption; unmetered consumptioncomprises 32 percent of total domestic consumption. By 2005, unmetered consumptionwill increase to 49 percent of total domestic consumption;metered consumptionwill decline to 51 percent. Since unmetered householdsdo not have any incentive to conserve water, the consumption of an unmetered connection will remain high (about 178 liters per capita per day), even though these are lower- income districts. A more rational consumptionpattern for unmetered consumptionrequires a full- scale expansion of water meters in a follow-upprogram.

21. Water supply rehabilitationprogram. Unaccounted-forwater losses are high in Lima. Physical losses amount to 31 percent of total water production. Administrativelosses amount to almost 16 percent of total water production. Only 53 percent of total water production is paid for -burdening the financial sustainabilityof SEDAPAL. Reducing administrativelosses is part of the water conservationcomponent; reducing physical losses is the objective of the rehabilitation component.

22. The rehabilitation componentwill be carried out in twelve districts.3 These districts are mainly concentrated in the central part of Lima and Callao (part of the metropolitan area). Districts were selected because they had high consumption. Because of the age of the water supply system in these areas, physical water losses are also high. These twelve districts are responsible for 56 percent of the total physical losses that occur in the Lima metropolitan area. Physical water losses range from 28 percent of total consumptionin Pueblo Libre to 63 percent in La Victoria. The average physical water losses in these districts amount to 31 percent of total production and will decline to less than 25 percent once rehabilitation is complete.

23. The rehabilitationof pipelines and reservoirs and the replacementof connections will reduce physical water losses, adding an additional 1.3 cubic meters per second to the water supply system. These savings can be used to reduce rationing in SEDAPAL's service area. The rehabilitation componentwill be implementedover a period of seven years. It is assumed that savings will become available gradually, depending on the level of investmenttaking place. Rehabilitationwill extend the lifetime of the water supply network and postpone the need for new investment. Rehabilitationwill also lead to pressure gains, reducing the impact of unreliable supply. Because of data limitations,these last two impacts have not been taken into account in these calculations.

24. Rehabilitationinvestment consists mainly of capacity costs, including operation and maintenancecosts. Total investmentcost for the water supply rehabilitationprogram is US$47 million (adjusted for taxes and subsidies, and excluding price contingencies). Based on these costs and benefits, the internal economic rate of return of this project component is 13.1 percent. This

3. Thesedistricts are Lima Cercado, La Victoria, Brena, Pueblo Libre, Miraflores, Barranco,Chorillos and Callao Cercado, Rimac, Lince, Jesus Maria, and San Isidro. - 61 -

Annex 9 rate of return is higher than the 10 percent opportunitycost of capital. The net present value of the project is US$9 million and the benefit-cost ratio is 1. 19. All indicators show the project to be economicallyviable.

25. Expansionprogram for pueblos jovenes. The pueblos jovenes are located on the outskirts of Lima. Currently, 2.7 million people live in these areas. About two-thirds of this population has access to a piped water connection. But these customers face low service levels-supply usually lasts only a few hours a day. The 800,000 people without a connection depend on water supplied by standpipes, group taps, or vendors. SEDAPAL currently applies a reduced tariff of US$0.09 for standpipes and group taps. However, about half of the households with no direct access to the piped water system must use water supplied by water vendors, which is expensive.

26. The pueblos jovenes component will improve water supply and sewerage services for customers already connected to the piped water system. It will also expand the water supply and sewerage system to households currently using standpipes, group taps, or vendor water. The number of beneficiaries is estimated at 578,000 people, with 276,000 receiving improved service and 302,000 being enabled to switch to direct system access. The benefits of the pueblos jovenes project component consist of direct-use benefits. An increase in service levels is likely to result in higher per capita consumption. Households currently using indirect forms of water supply use only about 30 liters per capita per day. Per capita consumptionof these households will increase to 178 liters per day (current water consumptionin the pueblos jovenes adjusted for rationing impact and with no water meter attached) once they have access to piped water. Because physical losses will amount to 25 percent, the total required production capacity will have to be expanded by 1.6 cubic meters per second.

27. Consumers that currently depend on water from standpipes and group taps will have to pay higher water rates as the service level increases. But these householdswill save the costs associated with the time required to obtain water from standpipes and group taps. Customers using vendor water pay high prices for water. Water rates will decline substantiallyfor these customers once they are connected to the SEDAPAL system. This decline in water rates will cause an increase in consumption-generating important health benefits. Improved access to water supply and sewerage collectionwill substantially reduce the risk of waterborne diseases. Health benefits are estimated separately from the base-case scenario.

28. The costs of the pueblos jovenes component consist of investment costs in water supply and sewerage and operation and maintenancecosts. Because the project is not financing any secondary works in the pueblos jovenes, additional connection costs should be added. The methodologyused to estimate the consumer surplus was described earlier in para. 8. The base-case scenario includes direct-use benefits. The consumer surplus generates a net present value of US$143 million, the internal economic rate of return is 43 percent, and the benefit-cost ratio is 2.88. These indicators show the project is viable. Introducing health benefits has a positive impact on the profitability of the project (Table 2).

29. A sensitivityanalysis has been conducted for the pueblos jovenes component. Because of high connection costs, the sensitivityof the results to changes in both the cost of connections and the coverage rate has been tested. - 62 -

Annex 9

30. Impact of connection costs. The results of the cost-benefitanalysis rely on a number of assumptions; those relating to connectioncosts are critical. Connectioncosts in the pueblos jovenes include the constructionof a secondary network. These costs are about US$850 per connection. If the current FONAVI credit system is maintained,the cost of water supply and sewerage (including connection costs) would be a substantial part of the average monthly income of the poor. These costs could be a significantbarrier for the population in the pueblosjovenes-affecting both affordability and willingness to pay. A sensitivityanalysis has been carried out to investigate the impact of lower connection rates. The US$850charge is rather high because of the tendency to overdimensionthe network. A more efficient design-using simpler standards and low-cost technologies, as in Brazil-could reduce connectioncosts by US$350 to US$500. The positive impact of lower connection costs on the pueblos jovenes component is substantial (Table 2).

Table 2 Results of the sensitivityanalysis Net present Internal value economicrate of Impact (millions) return(percent) Benefit-costratio Base-casescenario 143 43 2.88 Withhealth benefits 168 49 3.19 Withreliable supply 154 46 3.01 Withlower connection costsa 163 57 3.89 a. Connectioncosts are assumedto declineto US$350.

31. Impact of coverage. High connection costs could be a serious impedimentto system access, resulting in much lower coverage rates than anticipated. In the base-case scenario, it is assumed that 276,000 people will get access to improved service and 302,000 people currently using water from standpipes, group taps, or vendors will acquire connections. Changes in connection coverage will alter significantlythe economic viability of the project. The break-even point (switching value) lies at 27 percent of new customers. If less than 27 percent of the householdsthat currently depend on vendor or standpipe water in the pueblos jovenes connect to the system, the investment is no longer economicallyviable. ANNEX 9 PERU LIMA WATER REHABILITATIONAND MANAGEMENT PROJECT COST-BENEFITFLOWS WITH PROJECTSITUATION BASE CASE SCENARIO (in thousands of US$ as of December 1993)

WAR . WITHPROJECT SITUA'flOtd NE~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~...... I....E...... ,...... - ....'... , ' , T, '-- ...... '"''' ~~~~~~~~...... y..:..:.:5-. . -.-.--...... -...... ^::. ______.Ue~~~~~~~mfIt* T*e*tf.~~~u*vft~~~e.. ~~ wttt...... 0 RedI~~~~~~g ......

1994 421.152 0.32 134,769 (632) 134,137 66,938 3,347 151 382 70.817 63.320 1995 435,556 0.34 148.089 (1.886) 0 146,203 99,175 8,306 488 263 108,231 37,972 1996 445.268 0.36 160,297 1,933 0 162.230 89.118 12.762 936 151 102.967 59,263 1997 470,834 0.37 174.209 3,435 0 177.644 80,372 1 6,780 1,267 0 98.419 79,225 1998 486,878 0.37 180.145 13.704 0 193.849 58,589 1 9.710 1,267 229 79,794 114,055 199 510.459 0.37 188.870 25,551 0 214.421 77,269 23,573 1,267 680 102,789 111,632 2000 526.319 0.37 194.738 27,062 0 221.800 52,313 26,189 1,267 1,227 80.995 140,804 2001 541.129 0.37 200,218 28,547 0 228,764 10,421 26,710 1,267 1.803 40.201 188.563 2002 555,744 0.37 205.625 30,110 0 235.736 10,640 27,242 1,267 2.299 41,448 194.288 2003 579,094 0.37 214.265 30,990 0 245,255 9,705 27.727 1.267 2,790 41.489 203,766 2004 581,906 0.37 215,305 31,457 0 246,762 11,386 28,296 1.267 2,830 43.779 202,983 2005 581,144 0.37 215,023 31.737 0 246.760 9,209 28.757 1,267 2.763 41.996 204.764 2006 581,144 0.37 215,023 31,737 0 246.760 0 28.757 1.267 2.763 32.786 213.974 2007 581.144 0.37 215.023 31.737 0 246,760 0 28.757 1,267 2.763 32,786 213.97 2008 581.144 0.37 215.023 31.737 0 246.760 0 28,757 1.267 2.763 32.786 21 3.974 2009 581,144 0.37 215,023 31.737 0 246.760 0 28,757 1.267 2.763 32.786 213.974 2010 581,1 44 0.37 215.023 31,737 0 246.760 0 28.757 1.267 2,763 32.786 213.974 2011 581.144 0.37 215.023 31.737 0 246.760 0 28.757 1.267 2,763 32.786 213,974 2012 581,144 0.37 215.023 31.737 0 246.760 0 28.757 1.267 2.763 32.786 21 3.974 2013 581.1 44 0.37 215.023 31.737 0 246.760 0 28.757 1.267 2.763 32.786 213,974 2014 581.144 0.37 215.023 31.737 0 246.760 0 28.757 1.267 2.763 32.786 213.974 2015 581,144 0.37 215.023 31,737 0 246,760 0 28.757 1,267 2.763 32.786 213.974 2016 581.144 0.37 215,023 31.737 0 246.760 0 28,757 1.267 2.763 32.786 21 3,974 2017 581.144 0.37 215.023 31.737 0 246.760 0 28.757 1,267 2.763 32.786 213.974 2018 581.144 0.37 215.023 31.737 0 246,760 0 28,757 1.267 2,763 32.786 213.974 2019 581.144 0.37 215.023 31.737 0 246,760 0 28.757 1,267 2,763 32,786 21 3.974 2020 581.144 0.37 215,023 31.737 0 246.760 0 28.757 1,267 2,763 32.786 213.974 2021 581.144 0.37 215,023 31.737 0 246.760 0 28.757 1.267 2,763 32,786 213.974 2022 581.144 0.37 215.023 31,737 0 246,760 0 28.757 1.267 2,763 32.786 21 3.974 2023 581,144 0.37 215.023 31.737 0 246.760) 0 28,757 1,267 2,763 32.786 213.974 NPV ______1,771.821 180.592 0 1,952,412 391.547 198.871 10.035 13.817 614,270 1.338,142 ANNEX9 PERU LIMAWATER REHABIUTATION AND MANAGEMENTPROJECT COST-BENEFITFLOWS WITHOUT PROJECT SITUATION BASECASE SCENARIO (in thousandsof US$as of December1993)

YEAR WITHOUT PROJECT SITUATION NET BENEFITS TOTAL BENEFITS TOTAL COSTS WITHOUT Billing Average Totkal Investment FixedO&M Total PROJECT Volume Tariff Benefits Costs costs costs SITUATION 1994 411,531 0.32 131,690 62,235 3,112 65,347 66,343 1995 424,798 0.34 144,431 66,130 6,418 72,549 71,883 1996 430,957 0.36 155,144 34,319 8,134 42,454 112,691 1997 442,280 0.37 163,643 32,298 9,749 42,047 121,597 1998 445,546 0.37 164,852 22,374 10,868 33,242 131,610 1999 444,747 0.37 164,556 53,034 13,520 66,554 98,002 2000 443,161 0.37 163,969 42,858 15,662 58,520 105,449 2001 442,188 0.37 163,610 9,974 16,161 26,135 137,475 2002 443,084 0.37 163,941 10,172 16,670 26,842 137,099 2003 443,381 0.37 164,051 9,720 17,156 26,876 137,175 2004 445,036 0.37 164,663 11,453 17,728 29,182 135,481 2005 446,165 0.37 165,081 9,045 18,181 27,225 137,856 2006 446,165 0.37 165,081 0 18,181 18,181 146,900 2007 446,165 0.37 165,081 0 18,181 18,181 146,900 2008 446,165 0.37 165,081 0 18,181 18,181 146,900 2009 446,165 0.37 165,081 0 18,181 18,181 146,900 2010 446,165 0.37 165,081 0 18,181 18,181 146,900 2011 446,165 0.37 165,081 0 18,181 18,181 146,900 2012 446,165 0.37 165,081 0 18,181 18,181 146,900 2013 446,165 0.37 165,081 0 18,181 18,181 146,900 2014 446,165 0.37 165,081 0 18,181 18,181 146,900 2015 446,165 0.37 165,081 0 18,181 18,181 146,900 2016 446,165 0.37 165,081 0 18,181 18,181 146,900 2017 446,165 0.37 165,081 0 18,181 18,181 146,900 2018 446,165 0.37 165,081 0 18,181 18,181 146,900 2019 446,165 0.37 165,081 0 18,181 18,181 146,900 2020 446,165 0.37 165,081 0 18,181 18,181 146,900 2021 446,165 0.37 165,081 0 18,181 18,181 146,900 2022 446,165 0.37 165,081 0 18,181 18,181 146,900 2023 446,165 0.37 165,081 0 18,181 18,181 146,900 NPV 4,135,378 1,497,614 244,508 124,060 368,568 1,129,046 - 65 -

ANNEX 9 PERU LIMA WATER REHABILITATIONAND MANAGEMENTPROJECT SUMMARY COST-BENEFITANALYSIS BASECASE SCENARIO (in thousandsof US$ as of December1993)

.YEAR NE BEF ITS NE BEEFT 'INCRENLj

... PROJECT~~~~~~~~~...... JCT.ENE.. i- . 0g 0 X~ ~ o a: ____ STUATIN . SITUATIO... 1994 63,320 66,343 (3,023) 1995 37,972 71,883 (33,911) 1996 59,263 112,691 (53,428) 1997 79,225 121,597 (42,372) 1998 114,055 131,610 (17,555) 1999 111,632 98,002 13,630 2000 140,804 105,449 35,355 2001 188,563 137,475 51,088 2002 194,288 137,099 57,188 2003 203,766 137,175 66,591 2004 202,983 135,481 67,501 2005 204,764 137,856 66,909 2006 213,974 146,900 67,073 2007 213,974 146,900 67,073 2008 213,974 146,900 67,073 2009 213,974 146,900 67,073 2010 213,974 146,900 67,073 2011 213,974 146,900 67,073 2012 213,974 146,900 67,073 2013 213,974 146,900 67,073 2014 213,974 146,900 67,073 2015 213,974 146,900 67,073 2016 213,974 146,900 67,073 2017 213,974 146,900 67,073 2018 213,974 146,900 67,073 2019 213,974 146,900 67,073 2020 213,974 146,900 67,073 2021 213,974 146,900 67,073 2022 213,974 146,900 67,073 2023 213,974 146,900 67,073 NPV 1,338,142 1,129,046 209,096 Net PresentValue (r = 10%) 209,096 Internal Rate of Return 22.47% Benefit-CostRatio 1.85 - 66 -

Annex 10 Marginal Cost Pricing Analysis: Methodologyand Results

1. Marginal cost pricing has been used to evaluate SEDAPAL's current rate schedule. Long- run average incremental costs were calculated separately for SEDAPAL's water supply and sewerage system. The planning horizon covers 30 years and the opportunitycost of capital is set at 10 percent. In the marginal cost calculations, all cost components have been transformed from market prices into economic prices by excluding the impact of taxes and subsidies.

A. Capacity expansion costs

2. Incremental costs in water supply and sewerage systems result from new investmentand the operation and maintenanceof this additionalcapacity. Investment or capacity costs for water supply consist of investments for institutionaldevelopment, water intake, water treatment, transmission, distribution, and connections. They also include rehabilitation investmentsto reduce water losses. Rehabilitationinvestments are considered equivalent to investments in water intake since they result in increased water supply. For sewerage, capacity costs include investmentsfor project management,sewerage connections, collectors, pumping stations, interceptors, and final disposal and treatment. Incremental fixed operation and maintenancecosts are estimated at 5 percent of the accumulatedcapacity investment. Total capacity costs are equal to the sum of capacity investment costs and incremental fixed operation and maintenancecosts. The net present value of these costs is calculated using the assumed opportunitycost of 10 percent.

B. Incremental operating costs

3. Marginal operating costs are calculated for each season as the cost of the last water source used to satisfy demand in that season. The last water source (marginal source) can be calculated when the water supply and sewerage system is optimized(the least-cost solution). When the marginal source is known, the unit costs of all inputs (mainly energy and chemicals) needed to produce an additionalcubic meter of water must be determined. In Lima, where water supply capacity is insufficientto satisfy demand, marginal operating costs have been estimated assuming that customers would construct reservoirs to cope with unreliable supply. The average cost of rationing is estimated at US$0.27 per cubic meter produced.' The net present value of this flow of operating costs is calculated using a discount rate of 10 percent.

4. The main type of variable operation costs in a sewerage system are energy costs. Because the sewerage system in Lima is gravity-based,variable operation costs are assumedto be zero.

C. Long-run average incremental costs

5. Long-run average incrementalcosts have been calculated at each stage of the project as the ratio of the sum of the present value of capacity expansion costs, and incremental operating costs to

1. Thes costs have been calculatedusing the followingassumptions: investment costs for the constructionand installation of a reservoir (includingpumps and connections)-S$1O00;costs of operation and maintenance-S percent of investmentcosts; economiclifetime of investment-1S years with a discountrate of 10percent. Requiredconsumption is 45 cubic meters a month, while rationedconsumption applies to 40 cubic meter a month.Total costsare $0.38per cubic meter consumed.With physical losses at 30 percent, rationingcosts are $0.27per cubic meter produced. - 67 -

Annex 10 the sum of present values of the incremental volume of water. In this project, the incremental volume of water results from a reduction of unaccounted-for-water,demand management, optimizationof water resources, and an expansion of the supply network. The long-run average incremental cost has not been adjusted seasonally-expansion capacity costs have been allocated evenly over the dry and wet season. The long-run average incremental cost is computed based on incrementalwater production (Annex 8). It is thus necessary to adjust for water losses to calculate the marginal cost per consumed cubic meter. Based on the current distribution of water losses and the expected change in these losses once the project is implemented, a loss adjustment factor has been calculated (Figure 1). The chart on the bottom of page 72 presents long-run average incrementalcosts for different stages of the water production process. The total long-run average incremental cost is US$0.40 per cubic meter consumed.

6. Since the sewerage network does not face variable operating costs, long-run average incremental costs are equal to the ratio of the present value of expansion capacity cost to the present value of the incremental volume of water sold. The volume of sewerage produced per connection is estimated at 85 percent of the volume of water consumed. Based on these assumptions,the long- run average incremental cost for sewerage is US$0.05 per cubic meter consumed.

D. Marginal cost pricing and the tariff schedule

7. The long-run average incrementalcost for water supply and sewerage is US$0.45 per cubic meter consumed-significantly higher than the average current tariff of US$0.28. If draft regulations for the water sector use economic costs as the basis for proposed water and sewerage rates, this significantly increases water and sewage rates. Apart from physical losses, SEDAPAL also incurs substantial administrativelosses. In 1993 these losses were estimated to be nearly 16 percent of total production. These costs are not included in the calculation of the marginal cost of water and sewerage since it is assumedthese losses can be avoided.

8. SEDAPAL's current water rate schedule is rather complicated. It consists of an increasing block rate schedule that applies different rates to residential, commercial, industrial, public, and social customers. But since meter reading rarely occurs, the increasing block rate structure has been replaced by a flat rate equal to the minimum monthly consumptionlevel. The rate schedule also includes a high level of cross-subsidization. Commercial and industrial customers pay high rates that are used to subsidize social and residential consumers. Although some cross-subsidization may be justified on the grounds of social equity, current subsidies impair efficient resource allocation. Another characteristic of the current tariff structure is that SEDAPAL uses a combined rate-no distinction is made between costs for water supply and sewage collection and treatment- that obstructs the transparency of the tariff structure.

9. To enable SEDAPAL to meet the basic requirements of financial sustainabilityand social equity, SEDAPAL needs to rationalize its rate structure according to the new sector law. The following criteria should be applied under the new law:

* Marginal costs should be used as a reference value in defining the rate structure and levels- draft regulationsuse economic costs. SEDAPAL should also make a distinction between water and sewerage rates to improve the transparency of tariff-setting procedures. - 68 -

Annex 10

* The rate structure should reduce the number of consumptionblocks to three. The range of these blocks will be set according to current consumptionlevels. The first block will cover the minimum volume of water needed by a typical household to meet basic requirements. The upper limit of the second block will be the volume of water used by a household that is still not considered excessive. Customers who use more than this limit will be considered excessive users. Customers with excessive consumptionlevels should pay at least the marginal cost of water supply and sewage to induce more rational water consumption.

* Cross-subsidizationwill be limited-only the basic residential consumptionblock deserves a subsidy.

* Tariff levels should be set to allow SEDAPALto generate sufficient cash to finance operating expenses, debt service, and investment.

* The tariff schedule should include an inflation adjustment formula to avoid deterioration of the tariff in real terms. This would promote SEDAPAL's efficiency and financial sustainability.

10. The current rate structure results in large economic subsidies for residential, social, and public customers. Industrial and commercial customers are heavily charged (See chart on page 73). Residentialcustomers receive an economic subsidy of 45 to 250 percent, while industrial and commercial customers are overcharged by 59 percent. Financial subsidies are also substantial. With the current average rate of US$0.28, residential customers receive subsidies. But high-incomeusers in the two highest rate categories pay slightly more than the average water rate. Customers in other rate categories receive financial subsidies ranging from 4 to 115 percent. Industrial and commercial water users are substantially overchargedand pay 157 percent more than the average rate. - 69 -

ANNEX 10 PERU LIMA WATERREHABILITATION AND MANAGEMENTPROJECT WATERBALANCE IN LIMA METROPOLITANAREA AS OF APRIL 1994

FIGURE1

SURFACE WATER _ _ _ ~~~~~~~~~~GROUND WATER_

1.5 % Treatmewnt WATER TREATMENT Losses R'ANT

Transmission Losses _ 1 0 %

| RESERVOIRS| Reservoir Losses 1.7 %

Distribution Network 27 3 % Losses 0

|DISTRIB UTION | NETWORK |

(68(55 %

l I | ~~~~~~WsterEfflladto Residences, | omrcblLsees ||Commerce, Industry, and P'ubik t ~~~Entities

( 68.5%) FINAL DISF'OSAL|

SEWERAGE| ANNE)t 10 PERU UMA WATER REHADIUTATION AND MANAGEMENT PROJECT TOTAL CAPACITY INVESTMENT COSTS 11 fI thouaando of US$ - of May 19941

YEAR ' bw1ituUmnd wowm TmransmisIo Tiatmeat OlutQmdonl Cowfls TOTAL Olotglbe~Ee. OneUat TOT'AL OL h~~btsk ~~~ ______W &WU" t mely 1994 3,938 6,593 1.115 4.377 37.020 9.272 62,315 0 4,623 4,623 66,938 1996 9843 5,027 0 16.181 34,761 25,920 91,732 0 7,443 7,443 99,175 1996 8,486 4,142 0 7,429 28,146 31,296 79,501 0 9,618 9,618 89,118 1997 4,777 6,829 0 0 37.263 22,516 71,386 0 8,987 8,987 80.372 1998 3.667 0 0 0 19,812 19,564 42,944 4,419 11,226 156,46 58,689 1999 3,54 0 0 0 9.924 19,280 32.749 33,036 11.486 44.519 77,269 2000 3.524 0 0 0 4.053 10,104 17,681 28,1 36 6,496 34,632 52.313 2001 0 0 0 0 0 4,311 4,311 0 a,611 6,111 10,421 2002 0 0 0 0 0 4,401 4,401 0 6,239 6,239 10.640 2003 0 0 0 0 0 4,016 4,016 0 5,690 5,690 9.706 2004 0 0 0 0 0 4,711 4,711 0 6,675 6,675 11,386 2006 0 0 0 0 0 3,811 3,811 0 5,399 5,399 9.209 2006 0 0 0 0 0 0 0 0 0 0 0 2007 0 0 0 0 0 0 0 0 0 0 0 2008 0 0 0 0 0 0 0 0 0 0 0 2009 0 0 0 0 0 0 0 0 0 0 0 2010 0 0 0 0 0 0 0 0 0 0 0 2011 0 0 0 0 0 0 0 0 0 0 0 2012 0 0 0 0 0 0 0 0 0 0 0 2013 0 0 0 0 O 0 0 0 0 0 0 0 - 2014 0 0 0 0 0 0 0 0 0 0 0 2015 0 0 0 0 0 0 0 0 0 0 0 2016 0 0 0 0 0 0 0 0 0 0 0 2017 0 0 0 0 0 0 0 0 0 0 0 2018 0 0 0 0 0 0 0 0 0 0 0 2019 0 0 0 0 0 0 0 0 0 0 0 2020 0 0 0 0 0 0 0 0 0 0 0 2021 0 0 0 0 0 0 0 0 0 0 0 2022 0 0 0 0 0 0 0 0 0 0 0 2023 00 0 0 0 0 0 0 0 0 NPV 27,380 17,925 1,014 22,933 128,963 105,248 303,463 35,829 52,254 88,083 391,647 1/ Thasa cosu include the inveswent cost outside of the Bank project. 2V The hnvestmentcosts associated with the Watr Meter Program are ditbuted among the Connection Costs of the systm. The conection costs for watr are estimated at US$ 120 in an existing network and US$ 350 when a new network has to be created (including the coats of the seconday network cumntly fitncd by consune through FONAVI banal. 3/ The conn ction cost foir sewrage ae estimated at US$ 170 in an existig network and US$ 500 when a new network hasto be cmeted ncluding the cost of the scondery network cuirndy finnced by consumrs thxugh FONAVI loane. ANNEX 10 PERU LIMAWATER REHABILITATION AND MANAGEMENTPROJECT TOTAL OPERATIONAND MAINTENANCECOSTS 1/ (inthousands of USSas of May 1994)

YEAR Watr Transmission Treatment Disi1buton Connection TOTAL Distrlbut4n Connecton TOTAL TOTAL Intke WATERSUPPLY SEWERAGE PROJECT 1994 330 56 219 1,851 464 2,919 0 231 231 3,150 1995 581 56 1,028 3,589 1,760 7,013 0 603 603 7,617 1996 788 56 1,399 4,996 3,324 10,564 0 1,084 1,084 11,648 1997 1,130 56 1,399 6,859 4,450 13,894 0 1,533 1,533 15,428 1998 1,130 56 1,399 7,850 5,428 15,863 221 2,095 2,316 18,179 1999 1,130 56 1,399 8,346 6,392 17,323 1,873 2,669 4,542 21,865 2000 1,130 56 1,399 8,549 6,898 18,031 3,279 2,994 6,273 24,304 2001 1,130 56 1,399 8,549 7,113 18,247 3,279 3,299 6,579 24,826 2002 1,130 56 1,399 8,549 7,333 18,467 3,279 3,611 6,891 25,358 2003 1,130 56 1,399 8,549 7,534 18,668 3,279 3,896 7,175 25,843 2004 1,130 56 1,399 8,549 7,769 18,903 3,279 4,230 7,509 26,412 2005 1,130 56 1,399 8,549 7,960 19,094 3,279 4,499 7,779 26,873 2006 1,130 56 1,399 8,549 7,960 19,094 3,279 4,499 7,779 26,873 2007 1,130 56 1,399 8,549 7,960 19,094 3,279 4,499 7,779 26,873 2008 1,130 56 1,399 8,549 7,960 19,094 3,279 4,499 7,779 26,873 2009 1,130 56 1,399 8,549 7,960 19,094 3,279 4,499 7,779 26,873 2010 1,130 56 1,399 8,549 7,960 19,094 3,279 4,499 7,779 26,873 2011 1,130 56 1,399 8,549 7,960 19,094 3,279 4,499 7,779 26,873 2012 1,130 56 1,399 8,549 7,960 19,094 3,279 4,499 7,779 26,873 2013 1,130 56 1,399 8,549 7,960 19,094 3,279 4,499 7,779 26,873 2014 1,130 56 1,399 8,549 7,960 19,094 3,279 4,499 7,779 26,873 2015 1,130 56 1,399 8,549 7,960 19,094 3,279 4,499 7,779 26,873 2016 1,130 56 1,399 8,549 7,960 19,094 3,279 4,499 7,779 26,873 2017 1,130 56 1,399 8,549 7,960 19,094 3,279 4,499 7,779 26,873 2018 1,130 56 1,399 8,549 7,960 19,094 3,279 4,499 7,779 26,873 2019 1,130 56 1,399 8,549 7,960 19,094 3,279 4,499 7,779 26,873 2020 1,130 56 1,399 8,549 7,960 19,094 3,279 4,499 7,779 26,873 2021 1,130 56 1,399 8,549 7,960 19,094 3,279 4,499 7,779 26,873 2022 1,130 56 1,399 8,549 7,960 19,094 3,279 4,499 7,779 26,873 2023 1,130 56 1,399 8,549 7,960 19,094 3,279 4,499 7,779 26,873 NP/ 9,212 526 11,811 66,031 53,325 140,904 17,827 26,161 43,988 184,892

1/ Inremental fied O&M costs are assumed at 5% of capacity invesTuent costs. There are no fixed O&M costs assoced with lnstitonal Devebpment. - 72 -

ANNEX 12 PERU LIMA WATERREHABILITATION AND MANAGEMENTPROJECT MARGINALWATER SOURCE AND MARGINALOPERATING COST (in US$ a of May 19941

YEAR CRY EASO...... ) .)...... SON: .- ,, N ...E,- .:-...... ,-i l --0j-.-.. .-. '...- '.'-.'., .. j...... t... 4-4...... '; "'4''-

1994 Rationing 0.27 Rationing 0.27 1995 Rationing 0.27 Rationing 0.27 1998 Rationing 0.27 Rationing 0.27 1997 Wells 0.03 Wellb 0.01 1998 Wells 0.03 Wells 0.01 1999 Wells 0.03 Wells 0.01 2000 Wells 0.03 Wells 0.01 2001 Wells 0.03 Wells 0.01 2002 Wells 0.03 Wells 0.01 2003 Wells 0.03 Wells 0.01 Annual Equivalent Cost at 10% (1994 - 2003) 0.13 0.11

1/ Differences in marginal operational costs of wells in seasons due to changes in water tables.

PERU LIMA WATERREHABILITATION AND MANAGEMENTPROJECT AVERAGEINCREMENTAL COSTS OF WATERAND SEWERAGE (in US$ as of May 1994j

tAttid.f-'','-..'.'"i'"' '-.' ...... ' ".. .=.',...... 't'"' ...... i.. WATERSUPPLY SYSTEM Water Intake 0.024 1.000 0.02 0.13 0.15 Transmission 0.001 1.005 0.03 0.13 Treatment 0.15 0.01e 1.015 0.04 0.13 0.17 Distribution 0.087 1.120 0.14 0.15 0.29 Connections 0.071 1.135 0.23 0.17 0.40 TOTAL 0.23 0.17 0.40 SEWERAGESYSTEM Connections 0.035 0.850 0.03 0.00 0.03 Disposal of Untreated Sewage 0.024 1.000 0.02 0.00 0.02 TOTAL 0.05 0.00 0.05 AVR INCREMENTALCOSTS WATER AND SEWERAGE I _I I I 0.45 1/ The Loss Adjustment Factor of 0.85 is applied for the sewerage system, at the connection stage, to allow charging sewerage users based on their consumption of water. ANNEX 10 PERU LIMA WATER SECTORMANAGEMENT PROJECT SEDAPAL'S MARGINALCOST AND TARIFF STRUCTURES (in US$ as of May 1994)

TARIFF CATEGORY MARGINALCOST AVERAGETARIFF RATIO TARIFFI (US$ 1m3) (US$ /m3) MARGINAL COST Water Water & Water Water & Water Water & .______Sewage, Sewage Sewage RESIDENTIALCUSTOMERS based on minimum consumption Category A 0.40 0.45 0.13 0.13 0.32 0.28 Category B 0.40 0.45 0.14 0.14 0.36 0.32 Category C 0.40 0.45 0.17 0.17 0.41 0.37 Category D 0.40 0.45 0.21 0.21 0.52 0.47 Category E 0.40 0.45 0.27 0.27 0.68 0.60 Category F 0.40 0.45 0.31 0.31 0.77 0.69

NON-RESIDENTIALCUSTOMERS Industries 0.40 0.45 0.72 0.72 1.79 1.59 Commerce 0.40 0.45 0.72 0.72 1.79 1.59 Public 0.40 0.45 0.37 0.37 0.93 0.82 Social 0.40 0.45 0.09 0.09 0.23 0.20 ANNEX I 1 PERU LUMAWATER AND SANITATION MANAGEaENT PROJECT SEDAPAL: ICONE STATEMENT Current US Inilon

______HISTORIC v smtkm PROJECTED 19: 1991 1:2 199 194 1999 199 99 1s9 1999 -2000

Water and Sewerage Billed (m3 million) 348.1 370.1 383.0 405.2 430.0 435.0 445.0 467.0 483.0 507.0 522.0 Average Water and Sewerage Tariff (US$/m3) 0.15 0.21 0.20 0.21 0.32 0.34 0.36 0.37 0.37 0.37 0.37 Average Revenue (US$/m3) 0.17 0.23 0.24 0.25 0.36 0.40 0.41 0.41 0.41 0.41 0.40

Water and Sewerage Revenues 52.5 76.0 75.1 85.4 136.9 150.1 162.1 171.1 177.0 185.8 191.3 Sewerage Revenues 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Connection Fees & Others 0.5 0.0 6.4 6.9 4.4 7.8 3.8 4.2 4.0 4.1 4.0 Industrial Discharges 4.4 5.5 5.1 5.2 8.3 9.0 9.5 9.5 9.5 9.5 9.5 Own Sources 2.7 4.2 4.4 4.3 5.4 5.9 6.2 6.2 6.2 6.2 6.2

Operating Revenues 60.1 85.6 91.0 101.8 155.0 172.7 181.6 191.1 196.7 205.7 211.1 Personnel Costs 34.7 38.3 33.5 27.5 31.0 31.7 32.4 33.1 33.8 34.5 35.2 Chemical Costs 1.2 2.6 2.1 2.4 3.2 3.3 3.3 3.4 3.5 3.6 3.6 Power Costs 7.3 7.7 7.6 9.5 13.6 13.9 14.1 14.4 14.8 15.1 15.5 Operation and Maintenance 1.7 2.8 4.7 3.5 5.7 9.2 15.1 21.2 27.3 32.1 37.8 Third Party Service Costs 0.9 1.1 3.2 8.4 13.4 17.9 17.9 17.9 17.9 17.9 17.9 Administration Costs 12.2 22.7 20.2 17.1 17.6 16.8 15.9 15.1 14.4 13.7 13.0 SNSS Contribution 1.3 2.2 2.6 1.0 3.1 3.5 3.6 3.8 3.9 4.1 4.2 Total Operating Costs 59.2 77.4 74.0 69.4 87.6 96.2 102.4 109.0 115.5 120.9 127.4

Income Before Depreciation 0.9 8.3 17.1 32.4 67.4 76.5 79.2 82.1 81.2 84.7 83.7 Depreciation 66.8 25.8 16.7 11.1 13.3 15.9 18.7 21.5 24.0 26.4 28.7

Operating Income (65.9) (17.5) 0.4 21.3 54.1 60.7 60.5 60.6 57.2 58.3 55.0 Interest Expenses 32.3 10.9 14.8 8.1 2.7 5.2 4.8 5.3 5.5 5.4 5.5 Change Adjustments 24.6 5.8 (3.3) 1.7 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Other Non-Operating Income 7.7 10.8 (3.2) 8.7 8.5 7.9 8.3 8.8 9.0 9.4 9.4 Taxes 0.0 0.0 0.6 0.0 3.1 3.5 19.2 19.2 18.2 18.7 17.7 Net Income (115.1) (23.4) (14.9) 20.2 56.8 60.0 44.9 44.9 42.5 43.6 41.3 .~~~~~~~~~~~~~~~~~~~~~~~~~~ WORKING RATIO 98.6% 90.4% 81.2% 68.2% 56.5% 55.7% 56.4% 57.0% 58.7% 58.8% 60.3% OPERATING RATIO 209.7% 120.5% 99.5% 79.0% 65.1% 64.9% 66.7% 68.3% 70.9% 71.6% 73.9% RATEOFRETURN .11.1% -3.7% 0.1% 7.6% 17.9% 16.3% 13.4% 11.4% 9.5% 8.8% 7.6% ANNEX 11 PERU UMA WATERAND SANITATIONMANAGEMENT PROJECT SEDAPAL:FLOW OF FUNDS Current US$ million

HISTORIC ESnMAME PROJECTED 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 SOURCESOF FUNDS INTERNALSOURCES: 170.8 86.5 64.0 84.1 109.9 138.1 139.7 137.7 117.1 119.1 101.6 Net Income(Loss) After Tax (115.1) (23.4) (14.9) 20.2 56.8 60.0 44.9 44.9 42.5 43.6 41.3 Add back: Depreciation 66.8 25.8 16.7 11.1 13.3 15.9 18.7 21.5 24.0 26.4 28.7 Net FinancialExpenses 32.3 10.9 14.8 8.1 2.7 5.2 4.8 5.3 5.5 5.4 5.5 Monetary Correction 23 6 4. 2 (6.8) (02) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Internal Cash Generation 7.6 17.4 9.7 39.2 72.8 81.0 68.3 71.6 72.0 75.5 75.5 EXTERNALSOURCES: IBRDLoan 0.0 0.0 0.0 0.0 0.0 33.4 46.8 34.2 17.9 10.1 7.5 Co-FinancierLoan (OECF) 0.0 0.0 0.0 0.0 0.0 2.9 7.9 19.2 16.2 19.9 10.0 Other Loan (Internal) 8.4 12.9 10.0 30.2 26.5 20.3 16.7 11.6 9.0 7.0 3.6 Other Loan (External) 1.8 2.4 1.7 13.7 4.3 0.0 0.0 0.0 0.0 6.5 5.0 Gain (Loss)--- 143.4 30 7 27.1 0.0 6.4 0. 0 0 0 0.0 0.0 0. 0.0 Total Loans 153.6 46.1 38.9 43.9 37.1 56.6 71.4 65.0 43.1 43.6 26.2 Equi-ty 9 5 22.9 15.4 1 0 0 0 0.5 0 0 1.0 2.0 0.0 -0.0 Total Cash from FinancingActivities 163.2 69.1 54.3 44.9 37.1 57.1 71.4 66.0 45.1 43.6 26.2 APPLICATIONSOF FUNDS 171.3 81.1 62.0 85.2 91.6 139.2 146.6 143.0 109.1 128.9 96.4 Investments ProposedProject 0.0 0.0 0.0 0.0 5.1 44.3 74.4 72.3 46.0 40.4 23.7 Other Projects 11.1 17.6 17.1 39.5 66.3 76.2 45.2 39.2 32.1 56.4 41.9 DonatedInvestments 7.8 8.8 1.0 0.0 0.0 0 0 0 0 0 0 0.0 0 0 0 0 Subtotal- Investments 18.9 26.4 18.1 39.5 71.4 120.6 119.6 111.5 78.2 96.8 65.5 Interest During Construction 5.0 4.0 1.3 2.7 2.2 4.8 7.2 8. 9.6. . Total Investment Costs 23.9 30.4 19.4 42.2 73.6 125.4 126.8 120.1 87.3 106.1 75.2 Inflation Adjustment 113.8 24.5 22.5 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Debt Service Amortization 0.6 0.4 1.5 2.0 5.2 8.6 13.3 16.1 17.0 14.4 15.5 Of which IBRDand OECF 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 5.8 Of which other debt already contracted 0.6 0.4 1.5 2.0 5.2 6.8 8.6 9.4 10.3 8.1 3.2 Of which other debt to be contracted 0.0 1.8 4.7 6.7 6.7 6.3 6.4 Interest ------56.9 16 7 11.5 9 8 2.7 5 2 48 5.3 5.5 5.4 5.5 Total Debt Service 57.5 17.1 13.0 11.8 7.9 13.7 18.1 21.4 22.5 19.8 21.0 Working Capital Needs (15.7) 18.4 1.0 24.8 10.1 0.0 1.8 1.5 (0.7) 2.9 (0.7) OtherAssets and Liabilities Increases (8.2) (9.3) 6.0 6.4 0.0 0.0 0.0 0.0 0.0 0.0 1.0 CHANGEIN CASH (0.5) 5.4 2.0 (1.1) 18.4 (1.1) (6.9) (5.3) 8.0 (9.8) 5.2 CASHAT BEGINNINGOF YEAR 0.7 0.2 5.6 7.6 6.5 24.9 23.8 16.9 11.6 19.6 9.8 CASHAT END OF YEAR 0.2 5.6 7.6 6.5 24.9 23.8 16.9 11.6 19.6 9.8 15.0

DEBTSERVICE RATIO 0.12 0.83 0.68 2.71 7.18 4.37 2.71 2.39 2.27 2.59 2.47 INTERNALSOURCES OF FUNDS(ISF) (25.9) (8.8) (10.3) (3.8) 54.8 67.2 48.5 48.8 50.2 52.7 54.2 ISF / INVESTMENT 0% 0% 0% 0% 77% 56% 41% 44% 64% 54% 83% ANNEX 11 PERU UMA WATER AND SANITATION MANAGEMENT PROJECT SEDAPAL: BALANCE SHEET Current US rnmilon

ISTOW AORIC: PROJECTED 19 1991 19:2 1993 194 1995 19"6 1997 1898 19i 2000

ASSETS

Cash 0.2 5.6 7.6 6.5 24.9 23.8 16.9 11.6 19.6 9.8 15.0 Accounts Receivable 7.0 16.7 19.3 31.0 38.7 36.0 37.8 39.8 41.0 42.9 44.0 Inventory 1.2 6.0 2.8 1.7 4.1 6.9 6.8 6.4 4.5 5.5 3.7 Other Current Assets 3.7 14.4 18.3 29.5 29.5 29.5 29.5 29.5 29.5 29.5 30.5

Total Current Assets 12.1 42.7 48.0 68.7 97.2 96.2 91.0 87.2 94.5 87.6 93.2 Fixed Assets 657.5 831.6 522.8 432.0 476.7 550.2 643.4 746.6 844.7 945.3 1037.2 Less: Accumulated Depreciation (232.4) (308.1) (199.5) (162.6) (175.9) (191.8) (210.5) (232.0) (255.9) (282.4) (311.1) Net Fixed Assets 425.1 523.5 323.3 269.4 300.7 358.4 432.9 514.7 588.7 663.0 726.1 Work in Progress 21.7 40.8 38.0 51.1 80.0 131.9 165.5 182.3 171.6 177.1 160.4 Intangible Assets 3.2 6.6 9.4 12.1 12.1 12.1 12.1 12.1 12.1 12.1 12.1

Total Long-term Assets 450.0 570.8 370.7 332.6 392.9 502.4 610.5 709.1 772.5 852.2 898.6 Total Assets 462.0 613.5 418.7 401.3 490.0 598.6 701.6 796.4 867.0 939.8 991.8

LIABILITIES AND EQUITY

Accounts Payable 3.5 8.1 7.9 7.4 7.4 7.4 7.4 7.4 7.4 7.4 7.4 Long-tern Debt, Current Portion 25.2 26.5 25.8 27.9 31.2 35.9 38.7 39.7 37.0 38.1 37.3 Other Current Liabilities 14.2 17.6 24.9 26.1 26.1 26.1 26.1 26.1 26.1 26.1 26.1

Total Current Uabilities 42.8 52.2 58.5 61.4 64.7 69.5 72.2 73.2 70.5 71.7 70.8

Long-term Debt 31.0 38.2 42.0 62.4 91.0 134.3 189.7 237.7 266.5 294.5 306.0 Social Benefit Provision 6.3 15.5 10.1 6.8 6.8 6.8 6.8 6.8 6.8 6.8 6.8

Total Long Term Uabilities 37.3 53.6 52.1 69.3 97.8 141.2 196.5 244.5 273.3 301.4 312.9

Total Uabilities 80.1 105.8 110.6 130.7 162.6 210.6 268.7 317.7 343.8 373.0 383.7

Equity 382.0 507.7 308.1 270.7 327.5 388.0 432.8 478.7 523.2 566.8 608.1

Total Equity and Liabilities 462.0 613.5 418.7 401.3 490.0 598.6 701.6 796.4 867.0 939.8 991.8

DEBT/(DEBT+EQUITY) RATIO (%( 12.8% 11.3% 18.0% 25.0% 27.2% 30.5% 34.5% 36.7% 36.7% 37.0% 36.1% CURRENT RATIO 0.28 0.82 0.82 1.12 1.50 1.38 1.26 1.19 1.34 1.22 1.31 - 77 -

Annex 12 Notes and Assumptions for Financial Forecasts

1. Financial projections are based on SEDAPAL's audited financial statements for 1987-92, the 1993 budget, and SEDAPAL's financial projections and explanatory notes for 1994-2000.

2. Because of high inflation during the several few years, financial statements have been translated into current U.S. dollars (using year-end exchange rates for balance sheets and average exchange rates for income statements). Projections are also prepared in current U.S. dollars, using 1993 as the base year. Domestic inflation is assumed to stabilize at about 16 percent a year in 1996, with domestic currency depreciating against the dollar accordingly. The projected international inflation is 2.5 percent. Historic domestic inflation and exchange rates are shown in Table 1.

Table1 Domesticinflation and exchangerates = =d-ya Average 1nEsaaMxsa exchange- rate exchnge rate ome cinfai aon -Yea L$ItS$ L$1US (pret ; 9=1 1987 33.00 7.00 115 81.3 1988 500.00 129.00 1,722 87.1 1989 5,261.00 2,666.00 2,775 86.5 1990 516,989.30 187,885.64 7,650 91.5 1991' 0.96 0.77 139 93.6 1992 1.63 1.25 56 97.6 1993 2.31 2.01 35 100.0

a. The nuevo sol (NS), equivalentto I million intir, was introducedon July 1, 1991

I. Income statement

Revenues

3. Operatingrevenue. These revenues consist of water and sewerage tariffs, service and maintenance fees (includingrepairs and connection fees), treatment and sewerage service fees for industrial discharges, and sewerage revenue from consumers with own water sources. The underlying assumption for the volume of water sold is that both commercial and physical losses will decrease as the water meter and rehabilitationprograms advance. Increased metering will decrease the amount of water consumed per customer. Overall volume of water sold, however, will increase as service coverage and commercial efficiency increases. The projected volume of water sold is based on the demand projections presented in Annex 8.

4. Retailprices (taniff). The average water and sewerage tariff is expected to increase gradually to US$0.37 per cubic meter by the end of projection period to better reflect economic cost. The average revenue (including non-tariff revenue) will increase accordingly-to US$0.41 per cubic meter by the end of project execution. - 78 -

Annex 12

5. Unaccounted-forwater. This is measured by the difference between water produced and water billed, and includes physical and commercial losses caused by meter errors, illegal connections, differences between actual consumptionand billed volume caused by theft, and other items. Unaccounted-forwater averages about 46 percent of total production. The base-case projection assumes that SEDAPAL will meet the targeted unaccounted-forwater level of 41 percent by the end of the project.

6. Metering. Although 49 percent of connectionsreportedly had meters, only 7 percent of these meters are functioningwell, about 50 percent need adjustment, and more than 40 percent are totally nonfunctionalbecause of neglected maintenancein the past several years. SEDAPALwill increase the percentage of metered billing from 3.8 percent of total connectionsin 1993 to 46 percent by 2000.

apenses

7. Operatingexpenses. These include expenses for personnel, chemicals, electricity, operation and maintenance, third-party labor, administrationcosts, and contributionsto the Superintendencyof Sanitary Services. The number of employees is expected to stay at the 1993 level (1,965 permanent employees)throughout the forecast period, while the salary per employee is expected to increase by 2 percent a year. Projected electricity consumptionis based on the production volume of water at the pumping stations. The estimated electricity cost is estimated to be US$0.0174 per cubic meter, while chemical costs are estimated to be US$0.0041 per cubic meter throughout the project period.

8. One of the main reasons for deterioration in SEDAPAL's service quality was neglect of maintenance. Operation and maintenancecosts are estimated to be 5 percent of total investment, and increase with the number of water connections. This translates into an increase in maintenance costs from 5 percent of operating costs in 1993 to about 30 percent of operating costs in 2000 (Table 2). This increase in maintenancedemonstrates SEDAPAL's commitment to sustaining service quality. Contributionsto the Superintendencyof Sanitary Services are estimated to be 2 percent of operating revenue.

Table2 Changein structureof operatingcosts (percent)

Ebgxpeditr categoryS ;: tt0 1988AL :: 1993 1995 19 Personnel 73.7 39.6 32.9 29.3 27.7 Chemical 2.6 3.4 3.4 3.0 2.9 Electricity 4.3 13.6 14.5 12.8 12.2 Operationand maintenance 2.5 5.0 9.6 23.6 29.7 Third-partyservice 2.6 12.1 18.6 15.5 14.1 Administration 11.5 24.7 17.4 12.4 10.2 SNSScontribution 2.6 1.5 3.6 3.4 3.3 Total 100.0 100.0 100.0 100.0 100.0 Workingratio (percent) 151.3 68.2 55.7 58.7 60.3 Operatingratio (percent) 291.6 79.0 64.9 70.9 73.9 - 79 -

Annex 12

9. Deprecianon is calculated on a straight-line basis, assuming an expected useful life for different types of assets. Depreciation is estimated to be 2.8 percent of average gross assets-the historical average-assuming an average asset life of 36 years.

10. Interest expenses are estimated to be 35 percent of total annual financial charges. About 65 percent of financial charges are directly related to investmentsand thus are capitalized.

11. Other non-operaing income is net of provisions for bad debt and income from customers' delayed payment charges.

12. Income tax is estimated to be 30 percent of net income after financial costs. For 1994 and 1995, SEDAPAL is paying only about 2 percent of net income after financial costs since it still carries accumulated losses from previous years.

II. Balance Sheet

Assets

13. Accowus receivable are expected to decrease to 90 days of annual operational revenue by end-1994, and will decrease to 75 days by end-1995. The net of accounts receivable is accounts billed and unpaid and provisions for bad debts. As of March 31, 1994, SEDAPAL had about US$21 million worth of bills that were more than six months overdue. The company launched a bill collectionprogram offering customers favorable payment terms (payments in monthly installmentswith no interest charges), and cutting off services for customers who did not respond after a certain period of time. The results of the program have so far been disappointing.

14. Inventory consists of materials (such as chemicals), estimated to be 5.7 percent of total investment, while work in progress is assumed to be the sum of 65 percent of total investment and the previous year's work in progress, less 37 percent of previous years' work in progress, which is transferred to fixed assets.

15. Other current assets include other receivables such as delayed payment charges and IGV (sales tax of 18 percent) charged to customers on their bills. The amount is forecast to be constant throughout the forecast period.

16. Fixed assets are revalued with inflation every year. They increase annually with investmentsfor the forecast period. SEDAPAL's current book value of net fixed assets is undervaluedbecause of insufficientrevaluation in the years of hyperinflation, as well as insufficient valuing of surface and underground assets. SEDAPAL is undertaking studies to determine the real value of its assets. The first, completed recently, reviewed the applicationof the inflation index (re- expression index) to fixed assets. The results of the study are incorporated in the 1993 financial statements. The second study involves the revaluation of visible fixed assets, and should be completed within a few months. The results of this second study will be incorporated in the 1994 financial statements. The third study will revalue invisible assets, includingunderground pipes and connections, that account for about 70 percent of SEDAPAL's total assets. This study has not - 80 -

Annex 12

started. A terms of reference for the invisible asset revaluation study will be discussed during loan negotiations.

Liabilities and equity

17. Long-tern debt consists of local and external debt with the Bank, FONAVI, and other financial institutions. At the end of 1993, SEDAPALhad external debts in arrears of US$45 million (includingprincipal, interest, and late charges). These debts were discussed at the Paris Club (May 1993) and other bilateral meetings. They were refinancedand subsequentlyassumed by the Government of Peru. SEDAPAL's obligation to the Government regarding these debts is not clear, and SEDAPAL still carries these debts on its balance sheet. The projection assumes that these debts will be refinanced by the government with a repaymentperiod of ten years without grace, at an annual interest rate of 8 percent. SEDAPAL, with the help of CEPRI-SEDAPALand COPRI, is negotiatingwith the Governmentto cancel its obligation regarding these debts.

18. Share capital has increasedwith equity participationof the Govermnent through transfers, user contributionsthrough transfer of user financedassets to SEDAPAL(mainly secondary works financed by users through FONAVI loans), inflation adjustmentsfor user contributed assets, and SEDAPAL's retained earnings.

III. Borrowing and Investments

Project financing

19. Proposed Bank loan. The Bank will finance US$150 million equivalent, with 17 years to maturity, including a 5-year grace period, at the Bank's variable lending rate (currently 7.27 percent). The first disbursement is expected during the first quarter of 1995, and the first repayment will start in early 2000 (Table 3). The commitmentfee is assumed at 0.75 percent of the undisbursed balance. There will be retroactive financing of about US$10 million for the portion of investmentcommenced before the first disbursement. A Special Account of US$8 million will be established to ensure the necessary liquidity.

20. Cofinancing. The Peruvian Governmenthas requested OECF of Japan to finance about US$76 million at its standard fixed lending rate (currently about 3 percent). The loan, once confirmed by the Japanese Governmentafter approval by the Bank, would finance specific subcomponentsof the project not financed by the Bank (parallel financing). The first disbursement is expected during the first quarter of 1995. There is no commitmentfee.

21. Internal cash generation. SEDAPALwill finance 26 percent of the projected Bank investment program-not including interest during construction-with internally generated resources. SEDAPAL will pay the full amount of interest during construction from its internal cash generation. - 81 -

Annex 12

Non-project financing

22. During the forecast period, SEDAPAL is estimated to borrow about US$120 million from FONAVI and other financial institutions.

Table 3 Financingof the investment project (millions of U.S. dollars) TOtWl

Sources 1994 1995 1996 1997 1998 1999 2000 Amount :trcrut Financing plan for Bank project

Bank loan 0.0 33.4 46.8 34.2 17.9 10.1 7.5 150.0 49.0 Cofinancier 0.0 2.9 7.9 19.2 16.2 20.0 10.0 76.2 24.9 SEDAPAL's internal cash 5.1 8.1 19.7 18.9 11.9 10.3 6.1 80.0 26.1 Total 5.1 44.3 74.4 72.3 46.0 40.4 23.7 306.2 100.0

Financing for total investment plan

Bank loan 0.0 33.4 46.8 34.2 17.9 10.1 7.5 150.0 22.6 Cofinancier 0.0 2.9 7.9 19.2 16.2 20.0 10.0 76.2 11.5 SEDAPAL's internal cash 34.2 63.5 48.2 45.5 33.0 53.2 39.4 317.0 47.8 FONAVI and other internal sources 26.5 20.3 16.7 11.6 9.0 7.0 3.6 94.7 14.3 Other external financing 10.6 0.5 0.0 1.0 2.0 6.5 5.0 25.6 3.8 Total 71.4 121.6 119.6 111.5 78.2 96.8 65.5 663.6 100.0

Total investment costs

23. SEDAPAL's total investmentduring 1994-2000is estimated to be US$663 million (US$714.3 million including capitalized interests), of which US$306 million represents the Bank project (US$338.2 million includingcapitalized interests).

IV. Sensitivity Analysis

24. Three basic scenarios were analyzed to determine the impact of operational efficiency (representedby the unaccounted-forwater level) and tariff levels on SEDAPAL's investment capacity. SEDAPAL's investmentcapacity was determined by its internal cash generation under each scenario, keeping the level of financing constant. The "improved public sector" scenario assumes that SEDAPAL's operational efficiency will improve gradually to the level of a reasonably well-managedpublic water and sanitation company elsewhere in Latin America. The "private sector" scenario assumes what SEDAPALcould achieve if a private concessionairetakes over and introduces private sector efficiency. The "business-as-usual"scenario assumes no efficiency improvement. Each of these scenarios is analyzed under two tariff scenarios: a gradual tariff increase to US$0.37 a cubic meter and tariff remaining at the May 1994 level of US$0.28 a cubic meter. SEDAPAL's internal investment sources were calculated under each scenario (Table 4). - 82 -

Annex 12

25. The sensitivityanalysis highlightsthe importance of operational efficiency and tariff increases to the timely execution of the planned investment program. Internal cash generation is particularly sensitive to changes in the tariff level. Under the public sector scenario, with tariff increases, the total investment program of US$663.6 million will be complete in seven years. With no tariff increase, Table4 Sensitivityanalysis summary

'''X'.'.'''.~~ f' ~ ~~ 'S"~~~. d' ..'"""'',','...... '...... ' Taidff:$adoall ...... TrIffsa.a, w

Private sector (Gradual decrease of unaccounted-for water to 30 percent) Internal sources of fundsa(millions of U.S. dollars) 460 250 Investment levelb (millions of U.S. dollars) 752 541 Maximum working ratio (percent) 57 65 Estimatedyears to project completion' Lesthan ffiL 7. More than 9 Improved public sector (Baa .Ecase) (Gradual decrease of unaccounted-for water to 41 percent) Internal sources of funds (millions of U.S. dollars) 376 183 Investment level (millions of U.S. dollars) 664 474 Maximumworking ratio (percent) 60 73 Estimated years to project completion X 7 More than 10 Business as usual (Unaccounted-forwater stays at 46 percent) Internal sources of funds (millions of U.S. dollars) 342 15$ Investmentlevel (millionsof U.S. dollars) 633 A450 Maximumworking ratio (percent) 64 ...... Estimatedyears to project completion More than 8 0-Morethan 11 Note: Shaded areas represent the most likely outcome under each scenario. a. SEDAPAL's internaly generated cash net of debt ervice between 1994-2000. b. The maximum amount of investment possible between 1994-2000, from a financial point of view. For all scenarios, SEDAPAL will keep cash balance of about one month of operating cost, and keep debt service coverage ratio of more than 1.2. c. 'he minimum years needed to complete the project, determined by an average annual intermal cash generation calculated for each scenario.

SEDAPAL's investmentwould be limited to about US$541 million between 1994-2000-83 percent of the planned level-without hurting the financial health of the company (measured by debt service coverage, cash balance, and so on). The working ratio will reach more than 70 percent under such a scenario. Under the private sector scenario, with tariff increases, SEDAPAL would be able to invest up to US$752 million. With no tariff increase, it can invest only about US$541 million, but can keep the working ratio at less than 65 percent. The financial performance of the company could improve further, since the government will likely assume all or part of SEDAPAL's debt obligation once a private concessionoccurs. Under the business-as-usualscenario, even with tariff increases, SEDAPAL's investmentwill fall short of what is planned. Without tariff increases, SEDAPAL would be able to execute only about 68 percent of the total investment program, and the working ratio would reach 78 percent. - 83 -

Annex 12

26. Under the worst-case scenario presented here (business as usual with no tariff increases), the planned investmentprogram could take more than 11 years to complete-a four-year delay in implementation. The delay in investment execution will defer the net incremental benefit from the investments. Under this scenario, the internal financial rate of return for the project will be reduced to 10 percent, compared with 17 percent under the base-case scenario.

V. Ratio Analysis

27. The definition and explanation of the financial ratios presented with the financial statements (Annex 11) are:

28. The operating ratio is the ratio of operating expenses plus depreciation to operating revenue. This ratio improved dramatically in the past four years because real water rates increased and personnel costs were reduced through successful reorganization. The operating ratio will rise slightly toward the end of the project as depreciationexpenses increase with investment.

29. The working ratio is the ratio of operating expenses to operating revenues. This ratio will not exceed 60 percent throughout the projected period.

30. The rate of return on average net fixed assets is the percentage of net operating income after depreciation in relation to average net fixed assets. Rates of returns have been erratic in the past several years because of the fluctuation of real tariffs and thus of tariff revenues. The rates presented here, however, do not assume a revaluation of assets. Once the fixed assets are revalued, the rate of return is expected to be much lower.

31. The current ratio is defined as the ratio of current assets to current liabilities.

32. The debt-to-equityratio is the ratio of long-term debt to equity. SEDAPAL's total long-term debt does not include the current portion of long-term debt.

33. The accounts receivable comparatoris calculated by multiplyingthe accounts receivable plus the provision for bad debt by 360 days, then dividing this product by SEDAPAL's operating revenue.

34. The debt service coverage ratio is defined as the ratio of the sum of net income after tax, depreciation, interest on long-term debt, and monetarycorrection to the sum of amortization and interest.

35. The percentage of SEDAPAL's internal sources ofjfnds to investments is calculated as the sum of interest during construction, increases in working capital, and debt service subtracted from the sum of income after tax, depreciation, and financial expenses. This difference is then divided by SEDAPAL's total investments(project and non-project), not including interest during construction. ANNEX 13 PERU LIMA WATER REHABILITATIONAND MANAGEMENT PROJECT PROCUREMENTPLAN AND IMPLEMENTATIONSCHEDULE

&-ibProject cowt Metowd Category. 1904 1905 isee 1907 199* 1900 2000 US$ 1000 0I0102 03 04 Qi 02 Q3 04 Qi Q2 03 04 01 02 Q3 04 01 Q203 04 Ql 0203 04 01 2 03 04 A. YSYTEiS REHILITATION

WATE & aWt NE1WORKS

Cnral & Emt Zones 6,368 CB Works . . South Zoe 302 LCB Works ...... Callao 12013 LCB Works *._ Weot Zroe 1,999 LCB Works

Ckm &I Unir04 939 LCB Works Replacemen ofoPipes 2,304 Works

Seconswy NetwrorksIn fseleced DltIctem SUrafloreed W_ 168Works CdBEn_4 om co W Ntorks _ _ 3W172 ICB Works Chorillc 2.088 LCB Works UrE Crecado 19e078 ICB Works La Victoria * CS Works0 Bren. 8.57 1 ICB Works0 Pueblo Libre 3.44 2 Ice Wors ~ Casllo Wok RimscSv_ta Mf Po 168 CctnBS::.+ Workstd Lins Works jemst Ms"i Works S. Iawo Worksi Roeewvhk 1.965 LCB Work Equ*mnwt for 0&M 6.928 Ice Goods Otiw eletaon10.000 ICB Works

GrOINMDATB

Survey of Wae160 Conrtittnt Studie Rel~~~~delIltOdon ~~~~~~~2.023 LCS Works Equipmain for Webl 932 ICB Goode

Survey of Web 159 Coneuittart Studme Rehllton ~~~~~~~~~~LCR ~~~2,149Works Equinent for Wiebs 084 ICB Goods

Staveyof Web 163 Cormuutant Studies RelideWtMlon ~~~~~~~~~~~2,160LC9 Works Equilirment for we884N Ice Goode

Equipmnot for 0&Ml 630 Ice Goods Grounidwater modebi 2.000 Coriuitwit Studim ANNEX 13 PERU LIMA WATER REHABILITATIONAND MANAGEMENT PROJECT PROCUREMENTPLAN AND IMPLEMENTATIONSCHEDULE

Sub tCoa M....d CetO" le0 10" le" 19j117 I l*" 190* 2000 . . ~~~US$VW I 1 Q2 03 Q410102 03 041Q1 02 004SQ-1Q (2 Q3 0401 Q.203 041Q1:Q2 03 04 IQj Q2 03 041 S. WATY CONSEVATION

WATM METNO POaRAM

Cadtr 040 Coneuttan. Studies Phabieitaton of mete boxes 1,616 LCB Worke A.qiton of Mirometrer 2,647 ICe Goode

Pikt Program for UPW in P. Libre 200 Coraumtrt Studies

phoe S Pehabiltation of meter boxe 1,616 LCB Worke Aqtielton of Mir r 2,317 ICB Goode

PhaseU RehebIltetor of mee boxes 7.644 ICB Work, AqiMtionof Micronee 6.716 lCS Goode

CONJIN4CTrVEUSE IN SELECTWDISTUCTS 00 Sen Miguel 3.046 Ice Work. L Loe Olivee 6.370 ICe Work0 Los Olivo, Wells 400 LCB Works Celieo Work, Reiforceente of mein. 2,000 LC8 Works

C. NETWOR EXPANSON IN PUBLOS JOVBES

North Pusris Piedre (Zepfll I - Sewerg 2,780 LCB Work, Puerte Piedre 11 8963 Ice Works El Camen (Come) - wetr 617 LCe Works El Empleedo 1S. Martin - wtr 796 LCe Works El Nerajel Lo Olbosl - wetr 8,218 Ice Works Carebayll - water 1 1B9 LOS Works Peo IS. Martini - war end ew g LC8 Works

Merie Tega ISJ Lugen cho-watr 714 LCe Workse Vitklw - ewge coewtor 1.078 LCe Works 27 de Abri Mtwite) -waer '631 LCe Works LaMercedMt tel- wstw 162 LCe Week, H. ZovelheeMtfflel - r 1.207 LCe Work_ Toyacals - water 1021 LCe Works Cerro C_nde Mierte - we ael inverage 4,921 ICe Worx_

VMl a Svador 1.844 LCB Work, F. Tabiede (VM de Trkivol - w_a 1,096 LCB Works

Other Expanion 4,696 Ice Wor"- ANNEX 13 PERU LIMA WATER REHABILITATIONAND MANAGEMENT PROJECT PROCUREMENTPLAN AND IMPLEMENTATIONSCHEDULE

* gtPt4ict ~~~~ ~~~~~~~COW1111ii1 CUVstv~ Ifl I 11WU M7 5W t* 0 ...... ____0___:0_U0S*tOC 0 1 03 010203"G01003 00: 0 03 001 0 02 3 00100200 _ 1: 0. Ss1TITUtIONAL sUwOwT

Project Moinw Usnit a- 6m000rntCtaitns Enirgins.q & Supervision Bor*t.4 ors Ud

StrmihwIe* of the Regulatory Body 0 Coftw Sbd We'tsr RMatson-F mangeme.rw 450 ConaitoLta Studi.s indw Cd2,0C dis.5:iJs------Rneid a id Cormmera Systwems00Caota SLdo

FoastilityStudy for t ClionP 1,200 C FesbIt study for wtwater dposal 1600 : Cen Stud ---- -.- _-__

TOTAL 170,297

* To be finscd by OECF

00 0% - 87 -

PERU ANNEX 13 LIMA WATER REHABILITATION AND MANAGEMENT PROJECT BIDDING PACKAGE

WORKS/ICB

Sub-Project ;;i ______u s ' iooo PrimwyCollectors Central& EastZones 5,368

SecondaryNetworks In SelectedDistricts Miraflores Barranco 3,172 LimaCercado 19,078 LaVictoria Brena 8,571 PuebloLibre 3,442 Callao- Rimac' Lince ' JesusMaria S. Isidro ' OtherRehabilitation 10,000

WaterMetering Program Rehabilitationof meterboxes, Phase III 7,544

ConjunctiveUse In SelectedDistricts SanMiguel 3,045 LosOlivos 5,370 Callaoc

NetworkExpansion In PueblosJovenes PuentePiedra II 8,953 El Naranjal(Los Olivos) - water 8,218 CerroCandela IVitarte) - waterand sewerage 4,921 OtherExpansion 4,596 Sub-Total 92,277 * Co-FinancedProject

GOODS/ICB

Sub-Projoct - .:

SecondwyNetworks Equipmentfor O&M 5,928

Groundwater Equipmentfor Wells,Phase I 832 Equipmentfor Wells,Phase II 884 Equipmentfor wells,Phase III 884 Equipmentfor O&M 630 WatsrMetering Progran Aquisitionof Micrometers,Phase I 2,547 Aquisitionof Micrometers,Phase II 2,317 Aquisitionof Micrometers,Phase III 6,716 Sub-Total 20,738 - 88 -

PERU ANNEX13 LIMA WATER REHABILITATIONAND MANAGEMENT PROJECT BIDDING PACKAGE

WORKS/LCB

Sub-Project Coat ___ USt.'000 Primary Collectors South Zone 302 Callao 1,013 West Zone 1,999

Primary Networks Cleaning & Lining 939 Replacementof Pipes 2,304

SecondaryNetworks In SelectedDistricts Chorillos 2,088 Reservoirs 1,965

Groundwater Rehabilitation,Phase I 2,023 Rehabilitation,Phase II 2,149 Rehabilitation,Phase III 2,150

Water Metering Program Rehabilitationof meter boxes, PhaseI 1,616 Rehabilitationof meter boxes, PhaseII 1,61 6

Conjunctive Use In SelectedDistricts Los Olivos Wells 400 Reinforcementof mains 2,000

Network ExpansionIn PueblosJovenes PuentePiedra (Zapallal) I - Sewerage 2,780 El Carmen(Comas) - water 517 El Empleado(S. Martin) - water 796 Carabayllo- water 1,169 Palao(S. Martin) - water and sewerage 694 Maria Tegui (SJ Lurigancho)-water 714 Vitarte - sewage collector 1,078 27 de Abril (Vitarte) - water 531 La Merced (Vitarte) - water 152 H. Zevallos (Vitarte) - sewerage 1,207 Tayacaja- water 1,021 Vila El Salvador 1,644 F. Tablada (VM del Triunfo) - water 1,095 Sub-Total 35,963 - 89 -

PERU ANNEX 13 LIMA WATER REHABILITATIONAND MANAGEMENTPROJECT BIDDING PACKAGE

CONSULTANT/LOCAL

Sub-Project Cost | :______US. '000 Groundwater Survey of Wells, PhaseI 158 Survey of Wells, PhaseII 158 Survey of Wells, PhaseIII 163

Water Metering Program Pilot Programfor UFW in P. Libre 200 Sub-Total 680

CONSULTANT/INTERNATIONAL

Sub-Project Coil US$ '000 Groundwater Groundwatermodelling 2,000

Water Metering Program Cadaster 840 Sectorization of the central main 1,600

Institutional Support Project Management Unit 6,000 Engineering& Supervision 4,549 Engineering& Supervision Strenghteningof the RegulatoryBody 500 Water Resourcesmanagement 450 Financialand CommercialSystem 2,000

Studies FeasibilityStudy for the Chillon Plant 1,200 Feasibilitystudy for wastewater disposal 1,500 Sub-Total 20,639 Project BaseCost 170,297 * CofinancedProject

Contingenciesare not included in Project Base Cost. Cofinanced project not included in Project Base Cost. - 90 -

Annex 14 Implementation Plan

I. Management Structure

1. As the executing agency, SEDAPAL, through its project managementunit, will be responsible for the implementationof the proposed project. To provide guidance to the project managementunit and to ensure proper coordinationbetween the Bank-financedproject and the rest of SEDAPAL's investments, a project consultativecommittee comprised of top SEDAPAL's managers will be established. The manager of the project managementunit will act as the executive secretary of the consultative committee. To avoid creating a large managementunit made up entirely of SEDAPAL's own staff, a team of external managementconsultants will be recruited to work under the supervision of the project managementunit (see Attachment 1 for overall structure). In designing this managementstructure, a number of objectives have been considered at each level:

* At the project consultative committee level, the responsibilitiesof the group are intended to strengthen the ownership element within top managementwhile minimizingtheir undue involvementin day-to-day project management. * At the project managementunit level, the well-defined responsibilitiesof the unit should enhance the accountabilityof the project managementunit to the consultative committee. e At the managementconsultant level, the structure provides efficient implementationby the private sector and flexibility in the type and number of specialistsneeded at the various stages.

Tasksfor the project consultative committee

2. The project consultative committee includes high-level SEDAPAL managers under the chairmanshipof the general manager; the manager of the project managementunit (and the managementconsultants, when required) will also participate in the meetings of the project consultativecommittee. The agendas of these meetingswill be determined by the manager of the project managementunit. Since SEDAPAL is the executing agency, its managementis responsible for implementingthe project. The project consultative committee will provide managementsupport to project execution and follow-upby the managers within their own areas of influence. The minutes of the meetings will be transmittedto the chairman of the board. The main tasks and responsibilities of the consultative committee will be:

* Overseeing the agreement between the Bank and SEDAPAL; * Providing opinions on project programming; * Identifying (administrative)implementation bottlenecks, and suggesting adequate solutions; * Coordinatingthe progress and phase-in of project componentswith other SEDAPAL investments; * Nominatingan independentbidding evaluation committeeto be approved by SEDAPAL's board of directors. This committee will evaluate and present recommendationsto the project managementunit, which will later be presented to the project consultative committee; * Approving bidding schedules and winning bidders. The general manager, also head of the project consultative committee, will sign all contracts; - 91 -

Annex 14

* Managing relationshipswith other agencies regarding project subcomponents(such as regulation and water resources management); * Approving progress reports prior to submissionto the Bank; and * Reviewing compliancewith covenants (such as financial and audit requirements of project accounts).

Tasksfor the project managementunit

3. The project managementunit will be responsible for the day-to-day management of project implementation.To minimize the disruption of SEDAPAL's work caused by transferring permanent staff to the project managementunit, it has been decided that external consultants will be hired to work as a team under the project managementunit. The project managementunit will consist of a small number of SEDAPAL staff-a manager, three specialists (a technical specialist, a procurement specialist, and an accountant), and support staff. The main responsibilitiesof the project managementunit will be:

* Organizing a project launch workshop to review coordination and project implementation procedures; X Preparing an agenda for the meetings of the project consultativecommittee; * Managing the managementconsultant contracts; * Establishingand maintaining guidelinesand procedures for project implementation; * Reviewing and approving bidding documents prepared by the managementconsultants, approving short lists, signing contracts on behalf of SEDAPAL; * Approving payments to suppliers and contractors on receipt of appropriate documentation from the managementconsultants, approving disbursement of the loans (Bank, OECF) obtained to finance the project, and managingSEDAPAL's counterpart funding and the special accounts; * Overall project monitoring, including maintaininga project implementationschedule, expenditure forecast, and control system; * Preparing quarterly reports to the Bank to be approved by the project consultative committee, showing agreed program targets and actual performance. Tasksfor the managementconsulants

4. The magnitude of the project-coupled with the desire to avoid creating a large internal project managementunit-have suggestedthe need for an external consultant group to carry out day- to-day implementationof tasks. The team leader of the consultant group will be responsible for managingthe team and will report directly to the project managementunit manager. Management consultants will be contracted initially for the first phase until the project review. Specific tasks for the managementconsultants include:

* Overall programming responsibilityfor the various subcomponentsunder the direction of the project managementunit; * Setting appropriate methods, work organization, and managementprocedures for project implementation; * Preparing bidding documents (to be approved by the project managementunit and the Bank); - 92 -

Annex 14

* Preparing terms of reference for hiring engineering and supervision consultants (to be approved by the project managementunit and the Bank); * Assisting the project managementunit in the bidding process (advertisement, answering question from interested potential bidders, and so on); * Assisting the Bidding Evaluation Committee as required; * Monitoring the progress of works through the supervisionconsultant; * Maintaining all project files (reports, drawings, correspondence, invoices from contractors, payments by SEDAPALto services, and so on); * Preparing progress reports for the project managementunit; * Reviewing payment invoices submittedthrough the supervision consultant and forwarding them to the project managementunit.

II. Project Manual

5. As in any large-scale project, a project manual will be prepared before the initiation of implementation.The manual will define clearly the responsibilities,procedures, and tools required for proper execution of the project. This manual will be updated by the project managementunit as new informationor procedures are made available. The managementconsultants will assist the project managementunit in updating and maintainingthis manual. Efforts have been initiated to compile the content of the manual to include, but not be limited to, the following sections:

e Procurement:procurement plan, bidding packages, standard bidding documents (internationaland local competitivebidding), bidding procedures, distribution of responsibilities, and standard forms. * Disbursement:procedures for approval, standard forms, replenishmentprocess, maintenance of records, payments, money flows, and responsibilities. * Project supervision:Terms of reference for the managementconsultants, monitoring of the contracts, quality control, record keeping, and progress reports. * Engineering:specifications, standards, approval responsibilities,preparation of drawings, technical cadastre, and record keeping. * Communication:correspondence (internal and external), filing code system (project documents and other correspondence). * Reporting: type, frequency, responsibilityfor preparation, circulation route, and approval process. * Administrative issues: directives for internal procedures and job descriptions for project managementunit and managementconsultant positions. * Subproject selection criteria: Subproject evaluation methods as summarized in Annex 17.

III. Cost Estimates for Implementation Arrangements

6. The inputs contained in Table 1 will be required to manage project implementation.All calculationsare based on a project implementationof six years and average base salaries including benefits. - 93 -

PERU ANNEX14 LIMA WATER REHABILITATION AND MANAGEMENT PROJECT MANAGEMENT RESESOURCES

Table 1.

6e"ipto ube - Orkhs ':":T:OWCast: ProjectManagers Unit

ProjectManager 1 72 Specialist 3 216 Assistant 2 96

Sub-Total 384

ManagementConsultants

Team Leader 1 72 TechnicalSpecialist 7 324 Accountingand FinancialSpecialist 3 204 Assistant 4 216

Sub-Total 816

Total Direct Costs 3,500,000 Total Indirect Costs 2,500,000 Total Cost 6,000,000 PERU ANNEX 14 LIMA WATER REHABILITATION AND MANAGEMENT PROJECT Attachment 1 IMPLEMENTATION STRUCTURE

PROJECTCOMMITTEE

MANAGEMENT PROJECTMANAGEMENT UNIT

CONSULTANT CONTRACTOR PERU ANNEX 15 LIMA WATER REHABILITATION AND MANAGEMENT PROJECT RELATIONSHIP BETWEENPROJECT ENTITIES AND FLOW OF FUNDS

MEF | (1) | IBRD I.

l [~~~~~~~~2

SEDAPAL COMMERCIAL BANK

(5) (4)

CONTRACT CONCESSIONAIRE SUPPLIER CONSULTANT

Legal Document Accountability of Expenses FinancialResources

(1) Loan Agreement (2) ProjectAgreement (3) SubsidiaryLoan Agreement 1 (4) SubsidiaryLoan Agreement 2 (5) ConcessionContract - 96 -

Annex 16 Terms of Reference for the Project Review Since the project considers two possible outcomes of SEDAPAL's privatization efforts, the project review plays a key role in the early stages of project implementation.If privatization succeeds, the project could be adjusted to reflect the concessionaire's investmentplan. The concessionaire will have the option of taking all, part, or none of the undisbursed portion of Bank the loan. If the concessionaireaccepts some or all of the loan, the subsidiary loan agreement between SEDAPAL and the concessionaire (SLA-2) must be confirmed during the project review. SLA-2 contains all the terms and conditions specified in the loan agreement, project agreement, and sub-loan agreement between SEDAPAL and the Government of Peru (SLA-1). If privatization fails, the project needs to be adjusted to focus on SEDAPAL's institutionaldevelopment. Prior to project the review, CEPRI-SEDAPAL's report regarding the results of the privatization will be submitted to the Bank.

Project Review Objective: To discuss modificationof the project design, if necessary, based on the results of SEDAPAL's privatization efforts. lIming: Within ninety days of the award of the concession, or not later than December 31, 1995, or when aggregate loan disbursementsamount to $40 million, whichever comes first, in the event that the concession has not been previously awarded. Duration: One week.

Location: World Bank headquarters.

Participants: SEDAPAL, the Ministry of Economy and Finance, the Bank, the Cofinancier, Peruvian government institutionsrelated to the project, and the concessionaire (if privatization succeeds).

Contents of the project review

* Physical progress of the project, procurement, disbursement, auditing, legal covenants, and project monitoring indicators, as agreed at loan negotiations. A report prepared by the project managementunit on these topics must be submittedto the Bank prior to project review.

If privatization is successful, participants in the project review will:

* Discuss and review investment and financingplans proposed by the concessionaire. * Decide on the amount and structure of Bank-financedproject to be executed by the concessionaire. * Discuss loan cancellation procedures (if applicable)and amendmentsto legal documents, if necessary. - 97 -

Annex 16

* Confirm the terms and conditions of a subsidiary loan agreement (SLA-2) between SEDAPAL and the concessionaire. * Review SEDAPAL's functions and responsibilitiesunder the new statutory conditions, including adjustmentsto the project managementunit organization. * Review project procedures such as procurement, disbursement, auditing, and reporting. * Agree on the overall monitoring of the project by the Bank. * Agree on a new set of monitoring indicators reflecting the concessionaire's performance plan. * Discuss the need for the government's counterpart fund to be ensured for the execution of the institutionaldevelopment component.

If privatization is not successful, participants in the project review will:

* Discuss and review future investment plans and modificationof the project structure. * Modify the project structure to focus on improving the institutionalcapacity of SEDAPAL- strengthening its commercial systems, financial operations, and overall management efficiency. * Review the new managementplan to be signed between SEDAPAL and the Ministry of the Presidency. Prior to the project review, SEDAPAL must submit a revised managementplan to the Bank. * Discuss the second-best options for private sector participation in achieving operational efficiency. - 98 -

Annex 17 Guidelines for Evaluation of Subprojects

1. This annex describes the basis for the selection of subprojects (districts) included in the rehabilitation component and the selection and prioritization of subprojects in the pueblosjavenes. It is expected that the same guidelines would be followed for the selection of additional subprojects when using the unallocated funds.

I. Subprojects for Rehabilitation

2. As a result of the lack of preventive maintenanceand rehabilitation, SEDAPAL's service quality has steadily deteriorated. Consultants were hired to evaluate the condition of the primary and secondary networks. For this assessment, five districts representativeof larger areas were selected.I The selection of these districts was based on the historic and urban pattern of developmentand the number of breakages and repairs in the districts. The assessment consisted of a study to analyze existing informationon maintenance and a field investigationto examine the physical condition of pipes and other appurtenances. Survey results indicate that the major problems in the water distributionnetwork are caused by cast-iron pipes-the oldest type in the network. Pipes made of other materials (concrete, asbestos cement, and galvanized iron) that are older than 40 years also exhibit frequent breakages and severe corrosion. The main problems affecting the sewage collection network are also related to the age of the pipes. Pipes older than 50 years exhibit serious corrosion and frequent collapse. Survey results are shown in the attachment to this Annex.

3. In the second step of the selection procedure, the length of cast-iron pipe in each district was estimated. The districts with the highest percentage of cast-iron pipe were selected for replacement and rehabilitation. It was assumed that the sewers in these districts would be in similarly poor condition given the age of the pipes, so the same districts were chosen for rehabilitationof sewerage networks. Based on the two-staged selection procedure, the following districts are eligible for rehabilitationunder the project: Barranco, Brena, Callao, Chorrillos, Jesus Maria, La Victoria, Lima Cercado, Lince, Miraflores, Pueblo Libre, Rimac, and San Isidro. The use of asbestos-cement pipes should be approved by the Bank for each individual contract to ensure least-cost engineering design. Contracts including asbestos-cementpipes should enforce specific safety provisions to prevent inhalationof asbestos fibers during installation.

II. Subprojects for Expansion in the PueblosJovenes

4. It is estimated that 49 percent of Lima's population has an income below the poverty line and that the poor generally live in the pueblosjovenes. To minimize selection costs, all pueblosjovenes will be eligible for financingunder this program. However, given the number of pueblosjovenes without direct service, selection will be based on two guiding principles.

1. These districts were Brona, Callao, La Victoria, Lima Cercado, and Miraflores. - 99 -

Annex 17

5. The first principle is demand-basedprioritization. The responsibility for subproject proposals will be vested in the communities. Experience from earlier projects indicates that when service users participate in the decisionmakingprocess (based on perceived needs about service priorities, standards, methods of delivery, and cost recovery), they tend to choose cost-effectivesolutions. The second principle relates to a confined role for government agencies. Project managementwill be limited to defining and disseminatingthe "rules of the game" (technical and financial criteria) and quality control. Empirical evidence indicates that when project management is shifted to service users or their agents, sustainabilityis vastly improved.

6. Although only primary networks will be financedunder this loan, the design and construction of these networks will depend on the demand for secondary networks. To coordinate these linked components (with two different funding sources), a subunit will be set up within the management consultant group. The subunit will manage the Bank-assistedcomponent for the extension of primary networks and the corresponding line of credit from FONAVI for secondary networks. To ensure this component is successful, FONAVI and SEDAPAL should seek agreement on these lines of credit before loan effectiveness.

7. Since this is the first project of this scale, project adjustmentswill likely be made, based on informationcollected and evaluated during implementation.The steps involved in the implementationprocess for the initial phases of the component are as follows:

* The subunit of the managementconsultant group will disseminate information about the funds and methods of securing access to all pueblos jovenes (through media, documents, and distribution of guidelines for subproject preparation and criteria for selection). It will provide information about potential facilitators (nongovernmentalorganizations, consulting firms, contractors, and so on) who could assist the community in the preparation of a subproject. Based on cost informationfrom past subprojects, the per household budget ceilings of the proposed schemes for secondary networks will be set below US$200 for water and U$300 for sewerage services.

* Any of the pueblos jovenes will be eligible to submit proposals. The pueblos jovenes will form a water and sanitation committee to organize initial assemblies of residents, to disseminate information about the project, and to assess the interests of the community.

* The committee can contract a facilitator or work through its members. The principal responsibilitiesof the committee or facilitator include mobilization of the community, preparation of alternative technical solutions, discussion of solutions and their implications on costs and community participation, preparation of a detailed design of the selected solution (including cost estimates), specification of cost recovery procedures, and presentation of the project to the subunit of the managementconsultant group for technical and financial approval. The community will have to negotiate the cost of preparing the subproject in advance and will pay for the services of the facilitator.

* At the same time, the subunit will prepare designs for expansion of the primary scheme and the cost implicationsfor each householdbased on the number of pueblos jovenes connected to each primary scheme. The per household cost ceilings for the primary schemes will be - 100-

Annex 17

US$150 for water and US$200 for sewerage.2 Cost recovery of extension of the primary networks will occur through the tariff system.

* Once the subproject is presented, the subunit will carry out its technical and financial evaluation. It will review the basic criteria used in the technical design and the soundnessof the design. The financial evaluation will check adherence to cost ceilings and a survey of the capacity of potential beneficiariesto pay back the loan for secondary systems. After the evaluation the subunit will inform the pueblos jovenes about the loan terms (which would carry the ongoing FONAVI rate but could provide flexibility in the amortization period).

* When the subunit of the managementconsultant group approves the subproject, the community will ratify the terms of the agreement. When ratified, at least 80 percent of the beneficiaries of the subproject will have to sign an agreement for the repayment of their share of the loan-using their land as collateral.

3 Once the subproject is approved and the loan terms are accepted by the community, the community (either by itself or with the assistance of the facilitator) will select a contractor through competitivebidding. The subunit of the managementconsultant group will provide, if requested, informationabout contractors. However, the communitywill make the selection and bear all risks.

3 The subunit will initiate procurement of services for the construction of primary networks following Bank procedures and with project managementunit approval.

3 The facilitator and the water committeewill provide supervision of the contractor's work.

3 At completionof works, the project managementunit, on behalf of SEDAPAL, will inspect and receive the works; the community will have the option of assuming the responsibilityof maintainingthe systemsto negotiate a reduced tariff.

* Residents will pay the water bill, which will include the FONAVI loan (amortized over 60-84 months) and the water and sewerage tariff. Including the FONAVI loan repayment in the water bill is expected to cut down on the delinquency rate since potential delinquents will try to avoid disconnectionof water service.

2. Current connectioncosts are $850.Higher costs ar caused by the tendency to overdimensioncapacity. A more realistic design of the primary and econdarynetwork reauks in lower connectioncosts, ranging from $350to $500. - 101 -

ANNEX 17 PERU LIMA WATER REHABILITATIONAND MANAGEMENTPROJECT WATER SUPPLYNETWORK RESULTSOF FIELDSURVEY

DESCRIPTION AGE CONDITIONS SOLUTIONS PIPES Cast iron (fierro 70-95 High level of incrustation, Replacement dulce) breaks and corrosion Cast iron 50-70 High level of incrustation, Cleaningand lining breaksand corrosion Reinforced 50-60 Frequentbreaks Replacement concrete (Hume) Asbestos cement 40-50 Longitudinal break (10 percent Replacementand additional (Magnani) of length) study Galvanizediron 40-50 Localizedexternal corrosion Replacement and internal incrustation Asbestoscement <35 Good conditions (Mazza) Prestressedsteel 25-30 Good conditions Prestressed <30 Corrosion and high level of Replacementof deteriorated concrete breaks segments and further study PVC <25 Good conditions l

Ductile iron <10 Good conditions l

VALVES = l Cast iron; Gate <95 Old ones in disrepair; newer Replacementof old valves ones in good conditions and corrective maintenance Cast iron: butterfly <25 Good conditions Corrective maintenance

FIRE HYDRANTS l Cast iron <95 Old ones in disrepair; newer Replacementof old hydrants ones in good conditions and corrective maintenance CONNECTIONS

Lead 50-95 High level of breaksand Replacement openings Galvanizediron 25-50 Corrosion, breaksand Replacement incrustation PVC <25 Good conditions - 102 -

ANNEX17 PERU LIMA WATERREHABILITATION AND MANAGEMENTPROJECT SEWERAGENETWORK RESULTSOF FIELDSURVEY

DESCRIPTION AGE CONDITION SOLUTIONS

PIPES l Brick > 95 70 percent in poor Replacementof those in poor condition condition and further study Ceramic 60 30 percent in poor Replacementof those in poor condition condition and of 6 in; further study of the rest Concrete < 60 50 percent in poor Replacementof those in poor condition condition and of 6 in; further study of the rest Reinforced 50-60 50 percent in poor Replacementof those in poor concrete (Hume) condition condition and of 6 in; further study of the rest Reinforced < 50 10 percent in poor Replacementof pipes in poor concrete (rigid condition condition connection) Asbestos cement < 30 good condition

Concrete < 30 Older segments in poor Replacementof those in poor (Normalized) condition condition and of 6 in;

Reinforced <25 Small proportion in poor Replacementof pipes in poor concrete (flexible condition condition connections) PVC <25 Good condition MANHOLES

Concrete < 95 Condition similar to pipe Changeor repair condition CONNECTIONS

Ceramic 60-80 Condition similar to pipe Changeor repair condition Concrete < 50 Condition similar to pipe Changeor repair condition Concrete < 30 Condition similar to pipe Change or repair (normalized) condition PERU ANNEX 18 LIMA WATER REHABILITATIONAND MANAGEMENTPROJECT SUPERVISIONPLAN

Apjwbe '' - "''::'" :e -:.--:"--. t

11-12/94 SupevisIon Mission: Procurent 61 Project Launch Workshop Disbursement Enginrtng Final Analysis Wat ity Regulation ___ 3-4/95 Supervision Mission: rocureme 4 Emphasison overal understanding Enghoerng of Bank procedures Privatization 5-9/96 Project Review: (To be hld in Washiton) Econonics/Finncial Analysis 15 1) Assess accomplishment of privatization Engineerig objectives Environment

2) Ams completion of studies nd implementtion Disbursnemnt of recommendations, progress made in inprovig Procurement commercial performance,effectiwness of Lawyer institutiond strengthening, and compiance with covenwats 3) Approve oniendingagreements 11-12/95 Second Workshop on project Procureent Implementation Disbursement Engineerg

______Privatization 1996 Three Supervsion Missions: Ficial Analysis 15 Reviewoverall progress Enaginer/Procurment 1997 Three Supervision Missons: Fancial Analysis 1 Reviewoveral proe Enginer/Procureoret 1998 Two Supervision Missions: RnFincialAnadysis 8 Reviewovrwal progr"s Engirr/Proc t 1999 Two Supervision Missions: Economics/FinancialAnalys 8 Including one to prepare ICR (implmenttion Enginering/Procurement _Compltion Report) Environment ANNEX 19 PERU LIMA WATER REHABILITATIONAND MANAGEMENTPROJECT MONITORINGINDICATORS

...... - .-~~~~~~~~~~~~~......

PHYSICAL Water Connectionsas a % of Total NA 14 38 49 63 75 88 100 Executionof Investment(%) NA 11 29 47 64 76 90 100 Executionof Investment(US$ million) NA 71 121 120 112 77 96 65 Rehabilitationof Water Network (Km) NA 7 28 96 157 129 125 54 Rehabilitationof SewerageNetwork (Km) NA 7 29 91 150 126 142 70 Numberof ConnectionsRehabilitated ('000) NA 1 5 19 31 26 25 11 OPERATIONAL Water ServiceCoverage (%) 79 80 82 84 85 86 87 88 o SewerageService Coverage (%) 75 76 79 82 84 85 85 86 1 Volume of Water Produced(million m3) 640 780 800 807 825 847 867 890 Volume of Water Billed(million m3) 405 430 435 445 467 483 507 522 Unaccounted-forWater (%) 37 45 46 45 43 43 42 41 ConnectionsBilled by Metering/TotalConnections (%) 3.8 4.4 14.2 22.4 46.2 46.2 46.2 46.2 Number of Connections (000) 732 771 840 874 912 947 984 1020 # of Permanent Employees/1000 Connections 2.74 2.61 2.44 2.29 2.20 2.11 2.04 1.96 # of Permanentand TemporalEmployees/1 000 Connections 3.58 3.75 3.82 3.56 3.39 3.23 3.09 2.96 PersonnelCost/Operating Cost (%) 40 35 33 32 30 29 29 28 FINANCIAL AverageOperating Revenue (US$/m3) 0.25 0.36 0.40 0.41 0.41 0.41 0.40 0.40 AverageWater and SewerageTariff (US$/m3) 0.21 0.32 0.34 0.36 0.37 0.37 0.37 0.37 AverageOperating Cost (US$/m3) 0.17 0.20 0.22 0.23 0.23 0.24 0.24 0.24 Working Ratio(%) 68 57 56 57 57 59 59 60 OperatingRatio (%) 79 65 65 67 68 71 72 74 Accounts ReceivableComparator (days) 119 90 75 75 75 75 75 75 Debt ServiceCoverage (times) 3.5 14.3 7.2 4.7 3.9 3.5 4.2 3.8 InternalCash Generation /Investment (%) 0 77 56 41 44 64 54 83 - 105 -

Annex 19 Glossary of Monitoring Indicators

Physical indicators

Water connections as a percentage of total connections is equal, in year t, to the sum of all water connectionsactually installed from year 0 (1994) to year t, divided by the total number of water connectionsto be installed under the project.

Executionof investment in percentage of total investment is equal, in year t, to the total investmentactually disbursed from year 0 (1994) to year t, divided by total investment. The total investmentprogram includes the proposed project financed by IBRD, OECF, and SEDAPAL, and SEDAPAL's regular investmentprogram

Execution of investment in U.S. dollars is equal, in year t, to the total investment disbursed in year t.

Rehabilitationof water network is equal, in year t, to the length in kilometers of the water supply network rehabilitated in year t.

Rehabilitationor sewerage network is equal, in year t, to the length in kilometers of the sewerage network rehabilitated in year t.

Number of connectionsrehabilitated is equal, in year t, to the number of connections rehabilitated in year t.

Operational indicators

Water service coverage is the estimated number of people in the Lima metropolitanarea served by SEDAPAL's water services on December 31 of year t divided by the estimated number of people living in SEDAPAL's service area on December 31 of year t.

Sewerage service coverage is the estimated number of people in the Lima metropolitanarea served by SEDAPAL's sewerage system on December 31 of year t divided by the estimated number of people living in SEDAPAL's service area on December 31 of year t.

Volume of water produced is the volume of water produced by SEDAPAL. The production volume at La Atarjea will be registered by water meters at the outlets of the plant. The volume produced by wells will be estimated based on individual samples. When water meters are installed, the average annual flow will be used as a reference value.

Volume of water billed is the volume of water billed to SEDAPAL's customers in year t. It does not include the volume of water billed to customers with an own water source or to industrial wastewater (for wastewater treatment and collection).

Unaccounted-for water is calculated as a percentage of the volume of water produced in year t less the volume of water billed in year t divided by the total volume of water produced in year t. - 106 -

Annex 19

Water connectionsbilled by metering as a percentage of total water connections is calculated as the total number of SEDAPAL's water connectionswith a working meter that is read for billing divided by the total number of SEDAPAL's water connections.

Number of water connectionsis the total number of water connections in year t.

Number of permanent employees per 1,000 water connections is calculated by dividing SEDAPAL's total number of permanent employees on December 31 of year t by the total number of operating water connections on December 31 of year t.

Number of permanent and temporaryemployees per 1,000 connections is calculated by dividing SEDAPAL's total number of temporary and permanent employees (regular staff and third-party contract labor) on December 31 of year t by the total number of number of operating water connections on December 31 of year t. The number of third-party employees is estimated by dividing the total cost of third-party contract labor by the average annual salary (including benefits) of SEDAPAL's employees.

Personnel cost as a percentage of operatingcost is calculated as the personnel cost divided by the operating cost, not including depreciation.

Financial indicators

Average operating revenues are calculated as the total operating revenues in year t divided by the volume of water billed in year t. The average operating revenue per cubic meter billed is recalculated in U.S. dollars by using the average U.S. dollar exchange rate in year t.

Average water and sewerage tariff is equal to SEDAPAL's water and sewerage revenues in year t divided by the volume of water billed in year t. The average water tariff is then recalculated in U.S. dollars per cubic meter using the average U.S. dollar exchange rate in year t.

Average operating costs are calculated as the operating costs in year t divided by the volume of water billed in year t. The average operating costs per cubic meter billed is recalculated in U.S. dollars using the average U.S. dollar exchange rate in year t.

Working ratio is calculated as the operating costs (excludingdepreciation) in year t divided by the operating revenues in year t.

Operating ratio is calculated as the operating costs (includingdepreciation) in year t divided by the operating revenues in year t.

Accounts receivablecomparator is calculated by multiplyingthe accounts receivable (including provision for bad debts) by 360 days and dividing this product by SEDAPAL's operating revenues. This indicator is expressed in days. - 107-

Annex 19

Debt service coverage is the internally generated flow of funds (the sum of net income after tax in year t, depreciation in year t, interest payments in year t and, if applicable, the monetary corrections in year t) divided by the debt service payments in year t (amortization and interest of long-term debt).

Internal cash generation as a percentage of investmentis defined as the cashflow from operations (the sum of net income after tax, depreciation, interest payments and, if applicable, the monetary corrections) less the sum of interest during construction, the increase in working capital, and the debt service payments in year t. This total is then divided by SEDAPAL's total investment (investmentsrelated to both the Bank-financedproject and SEDAPAL's regular investment program) excluding interest during construction. - 108 - ANNEX 20

PERU LIMA WATERREHABILITATION AND MANAGEMENTPROJECT LOAN DISBURSEMENTSCHEDULE

Bank SlYeand AfitQuarefr Q tr Cumulative Disburs Ending ~ Disbursemens_____ US million US$ million N of Tot -

FY 1995 March 31, 1995!' 15.1 15.1 10 June 30, 1995"' 11.4 26.5 18 FY 1996 September30, 1995 7.4 33.9 23 December 31, 1995 7.4 41.3 28 March 31, 1996 11.7 53 35 June 30, 1996 11.7 64.7 43 FY 1997 September30, 1996 11.7 76.4 51 December 31, 1996 11.7 88.1 59 March 31, 1997 8.5 96.6 64 June 30, 1997 8.5 105.1 70 FY 1998 September30, 1997 8.5 113.6 76 December31, 1997 8.6 122.2 81 March 31, 1998 4.5 126.7 84 June 30, 1998 4.5 131.2 87 FY 1999 September30, 1998 3.8 135 90 December31, 1998 3.0 138 92 March 31, 1999 1.7 139.7 93 June 30, 1999 1.7 141.4 94 FY 2000 September30, 1999 1.7 143.1 95 December31, 1999 1.7 14.8 97 March 31, 2000 1.3 146.1 97 June 30, 2000 1.3 147.4 98 FY 2001 September30, 2000 1.3 148.7 99 December31, 2000 1.3 150.0 100.0 IncludesUS$4 milliondeposit into the project's SpecialAccount. - 109 -

Annex 21 Documents Available in Project File

A. General reports and studies of the water and sanitation sector:

Al. Empresa De Acueducto Y AlcantarilladoDe Bogota E.A.A.B.: Con Vision Positiva Del Futuro, Plan De RehabilitacionY Expansion Del Sistema De Acueducto Y Alcantarillado De Santa Fe De Bogota, May 1986.

A2. AmericanWater Works Association. 1993. Evaluating Urban Water Conservation Programs:A ProceduresManual.

A3. Instituto Nacional De Estadistica, INEI, Censos Nacionales, IX De Poblacion, IV De Vivienda,LimaMetropolitana (EstadisticaPreliminar), Direccion Nacional De Censos Y Encuestas No. 1, October 1993.

A4. Rischard, Jean-Francois. 1993. "Financingof Infrastructure." Internal Memorandum. Financial and Private Sector DevelopmentDepartmet, World Bank.

A5. Aiyer, Sri-ram. 1993. "Private Sector InfrastructureFinancing, Issues. Bank Role and Strategic Options." Internal Memorandum. Latin America and the Caribbean Region, World Bank.

A6. Glynn, Dermot, Bill Baker, Chris Jones, and Jeremy Liesner. 1991. "Major Economic Issues in Privatization and Regulation." DiscussionPaper. London: NERA.

A7. Overestimation Of Demand For Water Is Much Too Common, As Reported By Gamn,H.A., 1987, Patterns In The Data Reported On Completed Water Supply Projects.

A8. World Bank. 1993. "Peru: Poverty Assessment and Social Policies and Programs for the Poor." Report 1191-PE.

A9. World Bank. 1994. "Peru: Public Expenditure Review for the Infrastructure Sectors." World Bank, Latin America and the Caribbean Department, Infrastructure Operations Division. Confidential.

AIO. World Bank. 1990. "Peru: Review Of Infrastructure Sector."

All. World Bank. 1990. "Peru: Sector Reform And InvestmentReview."

A12. Proceedings From The InternationalWorkshop In Urban Water Conservation, April 1993, China.

A13. Revista Ingenieria, Aidis, Vol XVIV, Nos. I And 2, 1990.

A14. Santos, E. 1993. "The Changing Role of Multilateral Institutions in Funding Latin America Infrastructure Projects." InternationalFinance Corporation. - 110-

Annex 21

A15. Kahn, Alfred. 1988. 7he Economics Of Regulation, Principles, and Institutions. MIT Press.

A16. UNICEF. 1991. "Programa De Apoyo Sectorial De Agua Y Saneamiento, Plan De Accion Por La Infancia."

A17. Sheila Webb & Associates. 1992. "Waterborne Diseases In Peru."

B. General reports and studies relating to the project:

B1. Anuario Estadistico SEDAPAL, 1992.

B2. Black and Veatch International, Binnie and Partners, and Information for Investment Decisions Inc. 1994. "Evaluacion Tecnica de los Servicios de Agua Potable y Alcantarillado para Lima Metropolitana." Lima.

Volume I Evaluacion de los Recursos de Agua Volume II Evaluacion de Expansion y Rehabilitaciondel Sistema de Agua Potable Volume III Evaluacion de Rehabilitaciony Desarrollo del Sistema de Alcantarillado

B3. ---. 1994. "Informe sobre la Estrategia de Participacion del Sector Privado en la Prestacion de Servicios de Agua Potable y Alcantarilladoen la Gran Lima. " Lima.

B4. ---. 1994. "Informe sobre la Estimacion de la Demanda Futura de Agua Potable para Lima Metropolitana." Lima.

B5. ---. 1994. "Evaluacion Financieria del Servicio de Agua Potable y Alcantarillado de Lima (SEDAPAL) para el Incentivo de la Participaciondel Sector Privado. " Lima.

B6. Boletin Estadistico de SEDAPAL. 1990, 1991, and 1992.

B7. Memoria Anual SENAPA and SEDAPAL. 1991.

B8. Ministerio de Agricultura. 1994. "Ley Organica de Aguas." Lima.

B9. Binnie and Partners. Sewage Discharge Measurements. (RIOS 1991). Project preparation documents.

B1O. "Proyecto Especial Programa Nacional de Agua Potable Y Alcantarillado,Proyecto de Ley General de Servicios de Saneamiento." October 1993, Exposicion de Motivos.

B11. "Proyecto de Ley General de Servicios de Saneamiento." December 1993.

B12. "Reglamentode la Ley General de Servicios de Saneamiento." 2nd edition. Lima. February 1994. Annex 21

B13. "Reglamentode la Ley General de la SuperintendenciaNacional de Servicios de Saneamiento, Documento de Trabajo." 3rd edition. Lima. February 1994.

B14. "Reglamentode la Ley General de la SuperintendenciaNacional de Servicios de Saneamiento." 2nd edition. Lima. January 1994.

B15. SEDAPAL. "Anuario Estadistico 1992." Oficina de Sistemas, Unidad de Informacion Gerencial.

B16. SEDAPAL. "BoletinEstadistico 1990." Gerencia de Planificaciony Presupuesto, Area de Estadistica e Informacion.

B17. SEDAPAL. "Memoria 1989." Ministro de Vivienda y Construccion.

B18. SEDAPAL. Equipo de Preparacion Proyecto BIRF, Proyecto de Rehabilitacionde los Sistemas de Agua Potable y alcantarilladode Lima y Callao. Lima. March 1994.

Volume 1 Resumen Ejecutivo Volume 2 Proyecciones de Poblacion y Demanda Volume 3 Rehabilitacionde los Sistemas de Agua Potable y Alcantarillado Volume 4 Anexos al Proyecto de Rehabilitacion(Anexos 1 - 9) Volume 5 Anexos al Proyecto de Rehabilitacion(Anexos 10-13) Volume 6 Proyecto de Rehabilitacionde Pozos Volume 7 Reduccion y Control del Agua No Contabilizado Volume 8 Redes y Empalmes para Uso ConjunctivoEsquemas San Miguel y Los Olivos Volume 9 Uso Conjunctivode las Aguas Superficialesy Subterraneasdel Rio Chillon Volume 10 Ampliacionde la Cobertura en los Pueblos Jovenes Volume 11 Proyectos de Asistencia Tecnica

B19. SEDAPAL. Equipo Preparacion Proyecto BIRF, Evaluacion Global del Programa de Rehabilitacionde los Sistemas de Agua Potable y Alcantarillado. Lima. April 1994.

B20. SNC and Lavalin. 1994. "Technical Assistanceto SEDAPAL: Chillon River Water Supply Schemes." Lima.

C. Working Papers:

Cl. LMG Consultants. 1993. "Analisis de la Situacio Financiera de la Empresa SEDAPAL: Periodo 1987 -2003. Informe Preliminar." Lima.

C2. Hart, Ing. Roberto. 1993. Personal notes.

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