Document of The World Bank

FOR OFFICIAL USE ONLY

Public Disclosure Authorized Report No: 52478-AZ

PROJECT APPRAISAL DOCUMENT

ON A

PROPOSED LOAN Public Disclosure Authorized IN THE AMOUNT OF US$171.6 MILLION

AND

A PROPOSED CREDIT IN THE AMOUNT OF SDR46.2 MILLION (US$70 MILLION EQUIVALENT)

TO THE

REPUBLIC OF AZERBAIJAN

Public Disclosure Authorized FOR A

THIRD HIGHWAY PROJECT

April 29, 2010

Sustainable Development Department South Caucasus Country Unit Europe and Central Asia Region Public Disclosure Authorized

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

CURRENCY EQUIVALENTS

(Exchange Rate Effective March 31, 2010)

Currency Unit = Azeri New Manat (AZN) 1 AZN = US$1.24 1 SDR = US$1.51824

FISCAL YEAR January 1 – December 31

ABBREVIATIONS AND ACRONYMS ADB Asian Development Bank ISDS Integrated Safeguard Data Sheet AZN Azerbaijan Manat MENR Ministry of Environment and Natural Resources ARS AzerRoadService OJSC MoF Ministry of Finance BEEPS Business Environment and Enterprise MoT Ministry of Transport Performance Survey CAS Country Assistance Strategy MU Motorway Unit CPS Country Partnership Strategy NCB National Competitive Bidding EA Environmental Assessment NPV Net Present Value EBRD European Bank for Reconstruction and PAD Project Appraisal Document Development ECA Europe and Central Asia PAP Project Affected People EIA Environmental Impact Assessment PIC Public Information Center EIRR Economic Internal Rate of Return PID Project Information Document EITI Extractive Industries Transparency PIU Project Implementation Unit Initiative EMF Environmental Management Framework POM Project Operation Manual EMP Environmental Management Plan PQ Prequalification ESS Ecology and Safety Sector in ARS RAP Resettlement Action Plans EU European Union RDB Road Data Bank GDP Gross Domestic Product RER Regional Environmental Review HDM Highway Development and Management ROW Right Of Way Model IBRD International Bank for Reconstruction and RPF Resettlement Policy Framework Development ICR Implementation Completion and Results RVP Regional Vice President Report IC SSS Individual Consultant Single Source SBD Standard Bidding Documents Selection IDA International Development Association SNIP Former Soviet Union Technical Standards IFC International Finance Corporation TA Technical Assistance IFI International Financial Institution TRACECA Transport Corridor Europe-Caucasus-Asia IRF International Road Federation VAT Value Added Tax IRI International Roughness Index VOC Vehicle Operating Costs

Vice President: Philippe H. Le Houérou Country Director: Asad Alam Country Manager: Gregory T. Jedrzejczak Sector Director: Peter D. Thomson Sector Manager: Henry G. R. Kerali Task Team Leader/Co-Leader: Jacques Buré / Elizabeth Wang AZERBAIJAN Third Highway Project

CONTENTS

Page

I. STRATEGIC CONTEXT AND RATIONALE ...... 1 A. Country and Sector Issues ...... 1 B. Rationale for Bank Involvement ...... 3 C. Higher-Level Objectives to which the Project Contributes ...... 4

II. PROJECT DESCRIPTION ...... 4 A. Lending Instrument ...... 4 B. Program Objective and Phases ...... 5 C. Project Development Objective and Key Indicators ...... 6 D. Project Components ...... 7 E. Lessons Learned and Reflected in the Project Design ...... 7 F. Alternatives Considered and Reasons for Rejection ...... 8

III. IMPLEMENTATION ...... 9 A. Partnership Arrangements ...... 9 B. Institutional and Implementation Arrangements ...... 9 C. Monitoring and Evaluation of Outcomes/Results ...... 10 D. Sustainability...... 10 E. Critical Risks and Possible Controversial Aspects ...... 10 F. Loan/Credit Conditions and Covenants ...... 11

IV. APPRAISAL SUMMARY ...... 14 A. Economic and Financial Analyses ...... 14 B. Technical ...... 15 C. Fiduciary ...... 16 D. Social...... 16 E. Environment ...... 17 F. Safeguard Policies ...... 17 G. Policy Exceptions and Readiness...... 19 Annex 1: Country and Sector or Program Background ...... 20

Annex 2: Major Related Projects Financed by the Bank and/or other Agencies ...... 33

Annex 3: Results Framework and Monitoring ...... 36

Annex 4: Detailed Project Description ...... 40

Annex 5: Project Costs ...... 44

Annex 6: Implementation Arrangements ...... 45

Annex 7: Financial Management and Disbursement Arrangements ...... 46

Annex 8: Procurement Arrangements ...... 52

Annex 9: Economic and Financial Analysis ...... 59

Annex 10: Safeguard Policy Issues ...... 63

Annex 11: Project Preparation and Supervision ...... 67

Annex 12: Documents in the Project File ...... 68

Annex 13: Statement of Loans and Credits ...... 69

Annex 14: Country at a Glance ...... 71

Annex 15: Map No. IBRD 37356 ...... 73

AZERBAIJAN THIRD HIGHWAY PROJECT

PROJECT APPRAISAL DOCUMENT

EUROPE AND CENTRAL ASIA ECSSD

Date: April 29, 2010 Team Leader: Jacques Buré / Elizabeth Wang Country Director: Asad Alam Sectors: Roads and highways (85%); Public Sector Manager: Henry G. R. Kerali administration- Transportation (15%) Themes: Infrastructure services for private sector development (50%); Trade facilitation and market access (20%); Administrative and civil service reform (15%); Rural services and infrastructure (15%) Project ID: P118023 Environmental category: Full Assessment Lending Instrument: Specific Investment Loan Joint IFC: Joint Level:

Project Financing Data [X] Loan [X] Credit [ ] Grant [ ] Guarantee [ ] Other:

For Loans/Credits/Others: Total Bank financing (US$m.): 241.6 Proposed terms: (i) The US dollar denominated IBRD flexible loan is commitment linked with a variable spread and a final maturity of 17 years including a 4 year grace period; (ii) IDA credit terms are 20 years to maturity including a grace period of 10 years. Financing Plan (US$m) Source Local Foreign Total BORROWER/RECIPIENT 114.55 0.00 114.55 International Bank for Reconstruction and 120.00 51.60 171.60 Development International Development Association 51.00 19.00 70.00 (IDA) Total: 285.55 70.60 356.15

Borrower: Republic of Azerbaijan 83 Samed Vurgun Street Baku AZ1022 Republic of Azerbaijan

Responsible Agency: AzerRoadService (ARS) Uzeyir Hajibayov str. 72/4 Baku AZ 1010, Republic of Azerbaijan

Estimated disbursements (Bank FY/US $m) FY 2011 2012 2013 2014 2015 Annual 20 70 80 50 21.6 Cumulative 20 90 170 220 241.6 Project implementation period: September 1, 2010. End: September 30, 2014 Expected effectiveness date: September 1, 2010 Expected closing date: March 31, 2015

Does the project depart from the CAS in content or other significant respects? [ ]Yes [X] No Ref. PAD I.C. Does the project require any exceptions from Bank policies? Ref. PAD IV.G. [ ]Yes [X] No Have these been approved by Bank management? [ ]Yes [ ] No Is approval for any policy exception sought from the Board? [ ]Yes [ ] No Does the project include any critical risks rated “substantial” or “high”? [ ]Yes [X] No Ref. PAD III.E. Does the project meet the Regional criteria for readiness for implementation? [ X]Yes [ ] No Ref. PAD IV.G.

Project development objective Ref. PAD II.C., Technical Annex 3 The Project Development Objective is “to contribute to a more efficient and safer Baku-Shamakhi road and higher quality road services as part of the upgrading to motorway standards, and to improve the management of the nascent motorway network.” Project description Ref. PAD II.D., Technical Annex 4 Component 1: Motorway Improvement; Upgrading a 100km section of existing two lane M4 Baku- Shamakhi road into a four-lane motorway (US$296 million without VAT). This component comprises civil works for Baku-Shamakhi road, consultancy services for supervision of works, technical audit, road safety activities on this corridor and design of priority investments of the main road network. Component 2: Institutional Development (US$5.0 million without VAT), including: (a) preparation of a study to explore options for a policy on management and financing and efficient allocation of resources for Azerbaijan’s motorways; and (b) institutional development of the ARS in motorway operation and maintenance by (i) establishing motorway guidelines; (ii) testing a small experimental motorway management unit at ARS; and (iii) carrying out an operations and maintenance pilot on sections of the existing motorways. Component 3: Project Management (US$1.0 million without VAT), including technical assistance for supporting the project management capacity of the PIU. Which safeguard policies are triggered, if any? Ref. PAD IV.F., Technical Annex 10 Environmental Assessment (OP/BP 4.01) Involuntary Resettlement (OP/BP 4.12) Significant, non-standard conditions, if any, Ref. PAD III.F.

Additional Conditions for Effectiveness:  The Subsidiary Agreement has been executed by the Ministry of Finance and the Ministry of Transport on behalf of the Recipient/Borrower and the ARS.  The Project Account has been opened by the Recipient/Borrower in a local commercial bank satisfactory to the Bank, and an initial deposit in an amount of not less than two million Manats have been made by the Recipient/Borrower into the respective account.  The Financing Agreement has been executed and delivered and all conditions precedent to its effectiveness or to the right of the Borrower to request disbursement thereunder, except only the effectiveness of the Loan Agreement, have been fulfilled.  The Loan Agreement has been executed and delivered and all conditions precedent to its effectiveness or to the right of the Recipient to request disbursement thereunder, except only the effectiveness of the Financing Agreement, have been fulfilled.

Project Covenants

Institutional Arrangements:  Except as the Bank shall otherwise agree, the Recipient/Borrower shall: (a) ensure that the criteria, policies, procedures and arrangements set out in the Operational Manual, the EMF, and the RPF are applied by the ARS; and (b) not amend or waive, or permit to be amended or waived, the Operational Manual, the EMF, and/or the RPF, or any provision thereof, in a manner which, in the opinion of the Bank, may materially and adversely affect the implementation of the Project.  The Recipient/Borrower shall, until the completion of the Project, cause the ARS to maintain the PIU and shall ensure that the PIU is adequately staffed by personnel with qualifications and under terms of reference and functions at all times in accordance with procedures necessary and appropriate for the carrying out of the Project, and satisfactory to the Bank.  The Recipient/Borrower shall permit the use of standards for design, construction and planning of motorways and highways adopted by the European Union or standards adopted by the American Association of State Highway and Transportation Officials (in addition to the national standards), acceptable to the Bank, in the design, construction and maintenance of road works under the Project.  By not later than December 31, 2010, the Recipient/Borrower shall cause the ARS to recruit a financial auditor under terms of reference and conditions satisfactory to the Bank.  The Recipient/Borrower shall prepare, under terms of reference satisfactory to the Bank, and furnish to the Bank, six months as of the completion of the works for upgrading the Baku- Shamakhi road under Component 1 of the Project, a report on the execution of such works and the related plan on operations and maintenance of the Baku-Shamakhi road.

Subsidiary Agreement:  To facilitate the carrying out of the Project by the ARS, the Recipient/Borrower shall make the proceeds of the Loan and Credit available to the ARS under two subsidiary agreements (“Subsidiary Agreement”) between the Ministry of Finance and the Ministry of Transport on behalf of the Recipient/Borrower and the ARS, under terms and conditions approved by the Bank, which shall include, without limitation ARS’s undertakings to carry out the Project in accordance with the provisions set forth in the Loan and Financing Agreement, the Operational Manual, Anti-Corruption Guidelines, EMF and the RPF.

Anti-Corruption:  The Recipient/Borrower shall ensure that the Project is carried out in accordance with the provisions of the Anti-Corruption Guidelines.

Reporting:  The Recipient/Borrower shall monitor and evaluate the progress of the Project and prepare Project Reports in accordance with the provisions of Section 5.08 of the General Conditions and on the basis of the indicators agreed with the Bank. Each Project Report shall cover the period of one calendar semester, and shall be furnished to the Bank not later than forty five (45) days after the end of the period covered by such report.  The Recipient/Borrower shall prepare, under terms of reference satisfactory to the Bank, and furnish to the Bank, on or about October 1, 2012, a mid-term report integrating the results of the monitoring and evaluation activities performed pursuant to paragraph 1 of this Section, on the progress achieved in the carrying out of the Project during the period preceding the date of said report and setting out the measures recommended to ensure the efficient carrying out of the Project and the achievement of the objectives thereof during the period following such date.  For purposes of Section 5.08 (c) of the General Conditions, the report on the execution of the Project and related plan required pursuant to that Section shall be furnished to the Bank not later than six months after the Closing Date.

Safeguards:  The Recipient/Borrower shall ensure that the Project is carried out in accordance with the provisions of the EMF, EIA(s), EMP(s), RPF and RAP(s). The Recipient/Borrower shall not assign, amend, abrogate or waive the EMF, EIA(s), EMP(s), RPF and/or RAP(s) or any provision thereof, without the prior approval of the Bank.

 For the purpose of Component 1 of the Project, the Recipient/Borrower shall: (a) prior to the issuance of the bidding documents for the works contract for each segment of the Baku- Shamakhi road, prepare and submit to the Bank for its approval: (i) the proposed design and site for said works and, the related site-specific EIA and/or EMP in form and substance satisfactory to the Bank; and (ii) the draft contract for said works to ensure that the provisions of said site-specific EIA and/or EMP are adequately included in said contract; (b) prior to the signing of the contract for said works, prepare and submit to the Bank for its approval the site-specific land acquisition and/or resettlement action plan(s) (RAP(s)) in form and substance satisfactory to the Bank; and (c) prior to the commencement of the works, ensure that the owners and users of the land where said works are to be implemented are fully compensated in accordance with the provisions of the RAP(s).

 The Recipient/Borrower shall: (i) ensure that all activities undertaken for the purpose of carrying out of the Project comply with environmental standards and guidelines satisfactory to the Bank; (ii) ensure that the selection of any road section under Component 1 of the Project is done in accordance with the provisions of the EMF; (iii) ensure the complete implementation of the EMPs in a manner acceptable to the Bank, including all necessary measures to minimize and to mitigate any adverse environmental impacts caused by the implementation of the Project; and (iv) maintain the ARS’s environmental management office with competent staff in adequate numbers and with such responsibilities and functions acceptable to the Bank as shall enable the ARS to manage, coordinate and monitor the implementation of the EMPs.

 The Recipient/Borrower shall (i) ensure that the ARS prepares RAPs according to the RPF, (ii) maintain or cause to be maintained by ARS, and publicize or cause to be publicized by ARS, the availability of, grievance procedures to hear and determine fairly and in good faith, in accordance with the RPF, all complaints raised in relation to the implementation of the RAP by those being resettled or by those in host communities who are adversely affected by the implementation of the RPF, and take all measures necessary to implement the determinations made under such grievance procedures; (iii) through the ARS, employ a resettlement expert, satisfactory to the Bank, to conduct an ex post review of the implementation of the RAPs, (iv) through the ARS, furnish promptly to the Bank the findings and recommendations for follow up action resulting from each such review, and (v) through the ARS, implement all such recommendations for follow up action as are agreed with the Bank.

I. STRATEGIC CONTEXT AND RATIONALE

A. Country and Sector Issues

1. The Republic of Azerbaijan is the largest and most populous country in the South Caucasus, home to 8.9 million people; 54 percent live in urban areas. The capital city Baku is home to about 2.1 million. Per capita income in 2008 was US$3,830 (Atlas method). Recently, Azerbaijan’s economy has grown rapidly due to an oil and gas boom that is expected to last for about 20 years. Azerbaijan’s GDP rose at an annual average rate of 17.3 percent during 2001- 07.1 In 2008, growth was slower, but still reached 10.8 percent.

2. The global economic crisis of 2008 and 2009 affected Europe and Central Asia very significantly – the region was the hardest hit in the world. Azerbaijan has been less affected than other countries, posting a GDP growth rate of 9.3 percent for 2009 owing to a recovery in its oil production. The country has nevertheless been affected by lower oil prices since the latter half of 2008 (despite their gradual recovery), a shortage in foreign financing, and a depressed ECA region. Reduced inflow of oil revenues and lower than expected budget expenditures combined with external factors, contributed to much lower inflation (1.5 percent during 2009 versus 20.8 percent in 2008) and curtailed pressures for appreciation of the Manat, but also a weaker economy. While the 2009 GDP growth was 9.3 percent, the non-oil economy grew at 3.2 percent due to a contraction in construction and in non-oil industry (steel, petrochemicals, etc.) and single digit service sector growth. In 2006-2008 Azerbaijan had seen double digit growth in non-oil sector and services.

3. The Government has an ambitious development agenda. Since independence in 1991, Azerbaijan has aimed to develop natural resources and use hydrocarbon wealth to combat poverty and transform the country into a diversified sustainable market economy. Diversifying the non-oil economy has required improving utilities and infrastructure services, investing in human capital, building a supportive business environment, strengthening public sector management, and expanding the financial sector. Over the last decade, Azerbaijan’s efforts, supported by development partners, have begun to yield results. In the World Bank 2009 ‘Doing Business’ Report, Azerbaijan showed the most improvement in business climate among 181 surveyed countries - ranked 38 up from the 2008 ranking of 97. The Government aims to maintain this progress by further diversifying the economy and making gains on business licensing, tax and customs administration, and reducing corruption.

4. Infrastructure investments are essential to implement Azerbaijan’s development agenda. Infrastructure is among the important factors that enable and stimulate economic growth and reduce poverty. Prior to the oil boom, infrastructure investment rates in Azerbaijan were low and the country faced an investment deficit. Investments in non-oil infrastructure were about 4.0 percent less per year than the average among Commonwealth of Independent States (CIS), and about 8.0 percent of annual GDP less than the average transition economy during 1995-2002, according to the 2009 World Bank Country Economic Memorandum for Azerbaijan.2 As a result, most infrastructure is beyond its useful lifespan of 25-30 years and overall infrastructure quality and reliability are generally poor. During 2005-09, Government invested about US$9 billion in infrastructure; of which about US$4.5 billion was for roads. In the medium term, the Government plans to invest over US$13 billion to develop national physical infrastructure

1 World Development Indicators 2008, World Bank. 2 Azerbaijan – Country Economic Memorandum, “Staying Focused on Diversification,” March 19, 2009 Report No. 44365-AZ. 1 networks. The aim is to facilitate regional development within Azerbaijan, reduce transportation costs, and improve goods transit along the main transport corridors (North-South and East-West), a valuable contribution to the national diversification strategy.

5. The Government aims to rapidly upgrade infrastructure to international serviceability standards. Azerbaijan is well-placed to absorb growing regional transport demands; it shares borders with Russia, Iran, Georgia, Armenia, and Turkey (through the Nakhchivan enclave). Relations are good with Georgia, Azerbaijan’s main access to the high seas, but the border with Armenia is closed. Regional conflicts and changing dynamics substantially affect trading patterns and potential for developing intra- and inter-regional trade. Azerbaijan has about 800km of Caspian Sea coastline with potential to attract East-West transit movements from Central Asian neighbors.

6. In 2009, transport accounted for 6.6 percent of GDP. Road transport dominates, accounting for over 60 percent of freight in 2009, up from 54 percent in 2003. In 2009, railways’ market share dropped to 15 percent from 18 percent in 2003. Most passenger transport is by roads: 1,034 million person trips against 207 million person trips by rail. Railways have a higher modal share in ton-km terms (11 percent), but road transport hauls greater total tonnage: 88 million tons versus 27 million by rail. Railways are key in oil-dominated transit. But road infrastructure and services dominate in daily life and economic development.

7. Economic growth correlates strongly with road investment. Government support for infrastructure development, roads in particular, emerged from the strong correlation between road infrastructure development and economic growth due to Azerbaijan products’ increased competitiveness, improved regional integration, and rural communities’ access to markets and social services such as health and education. Azerbaijan was identified as among the countries with the poorest road infrastructure in the region, according to a 2006 study examining the impact of road network quality on intraregional trade in ECA.3 The study suggested that about 75 percent of gains from increased regional trade could be achieved by upgrading road infrastructure in countries with the poorest networks.

8. Road network serviceability needs to be improved. Public road network length and coverage is sufficient for interregional road transport and international connections with neighboring countries. It comprises some 25,000km of roads, of which 2,000km are in the Nakhchivan Autonomous Republic. However, the quality of this network is poor with 45 percent of M-roads, 30 percent of R-roads, 16 percent of paved Y-roads and only 9 percent of unpaved Y-roads in good condition.

9. The road network is structured along one North-South corridor (M1, M3) and two East-West corridors (M2, M4). The M1 links Baku to the Russian border and M3 links Baku to Iran. The M2, part of the Great Silk Road, is the main route between Baku and Tbilisi and the Transport Corridor Europe-Caucasus-Asia (TRACECA)4 route E-60, a main corridor between Western Europe and China.5 The M4 runs from Baku to Shamakhi and merges at Yevlakh into the M2. The World Bank, through the Highway and Second Highway Projects, has been

3 Shepherd, Ben and John S. Wilson, Road Infrastructure in ECA: Does Network Quality Affect Trade ? 2006. 4 TRACECA is an international transport program involving the European Union and 14 Member States of the Eastern European, Caucasian and Central Asian region; since 2009, entirely financed by member countries. 5 The Bank is supporting the Georgian section of the E-60 upgrading from two to four lanes through sequential projects: the First, Second, and Third East-West Highway Improvement Projects. 2 supporting Government in upgrading this network. The proposed Third Highway project would continue this assistance through upgrading existing road infrastructure into a motorway grid and improving motorway management.

10. Since 2004, the condition of major arterial (M class) roads has improved due to significant Government investment and support from International Financial Institutions (IFIs). However, network condition remains fragile due to a lack of programmed maintenance, vehicle axle overloading, and low traffic safety. During 2005-09, total rehabilitation and upgrade investments for major arterial roads was about US$1.5 billion; conditions have deteriorated for the rest of the road network. In general, road user operating costs are high and some local roads are impassable for part of the year, preventing rural population from accessing vital services. Poor road condition results from quality of construction and materials, and lack of regular scheduled preventive maintenance following road construction or rehabilitation.

11. State budget and IFI loans finance road sector capital investments; maintenance budget is from earmarked state funding sources. During 2005-09, road investments totaled about AZN 3.1 billion (about US$3.8 billion); about 85 percent was funded through the state budget and the remainder from development partners and IFI financing. For this period, maintenance expenses were about AZN 560 million (about US$690 million). A road fund was reinstated in 2007. This Fund accumulates revenues from six state budget lines.6 In 2009, the Fund budget was AZN 145 million (about US$180 million). In 2010 it is approved at AZN 170 million (US$210 million). According to legislation, revenues collected in the Fund are earmarked for operations and maintenance of arterial, local, and urban roads.

B. Rationale for Bank Involvement

12. Developing transport corridors to motorway standards is key to Azerbaijan’s non- oil growth. Motorway development will enhance connectivity between regions within Azerbaijan, and create potential to command main trade routes between the Central Asia and the Far East on one side, and Europe and other western countries on the other. The 2001 Highway Project and the 2006 Second Highway Project began Bank support for road network development in Azerbaijan. Those projects provided a platform for the Bank and the Government to start improving the road network and road sector institutions, incentives, and policies. The Third Highway Project will advance sector policy dialogue to the next stage by addressing issues specific to the nascent motorway network.

13. Bank engagement in the transport sector is the longest and deepest among IFIs. Other IFIs are also active; the Asian Development Bank (ADB) is financing 132km of roads on M2 and M3; the European Bank for Reconstruction and Development (EBRD) is financing 102km of roads on M1 and M2; and the Islamic Development Bank is financing 103km of roads on M2. The Government’s road program is currently focused on investments in developing the motorway network, which requires more focus on improving motorway engineering design, operations and maintenance strategies. The Bank, through the Third Highway Project, is best positioned to support the Government through the next stage in Azerbaijan’s road development.

6 Annual road tax, based on vehicle engine capacity; passenger and cargo transportation tax; excise, applied to imported cars; customs applied to imported motor vehicles;, state fees for annual technical inspection of vehicles; state fees for international car transports transiting through Azerbaijan. 3 C. Higher-Level Objectives to which the Project Contributes

14. Road network development supports the Government agenda to diversify the economy. Economic diversification is central to the FY07-10 World Bank Country Partnership Strategy (CPS) (Report No. 37812-AZ) under implementation. The CPS has four pillars: (i) improve quality and transparency of public sector governance; (ii) support sustainable and balanced growth of the non-oil economy; (iii) increase social services quality and access; and (iv) improve the environment. The CPS emphasizes that, “significant investment in infrastructure and transit corridors will be needed to develop Azerbaijan’s non-oil growth potential.” In this post-financial crisis environment, stimulating non-oil export growth is a priority for Azerbaijan. The Project will also support the objectives of the CPS for FY11-14 currently under preparation.

15. The Project is expected to enhance regional development of the Shamakhi area. The Project will serve the Mountainous Shirvan economic region in central Azerbaijan. A recent study7 confirms the region’s strategic location, due to its proximity to Baku, the easy road access to Georgia and Turkey, and the attraction of an educated and affordable labor force. Government wants to promote the region’s potential for tourism and industrial production. Recently, substantial investments have been made in light industry such as televisions, air-conditioning systems, refrigerators, and other household appliances; and automotive assembly. High-end tourism development is evidenced by more than 20 hotel facilities and visits from about 65,000 tourists each year.

16. It is expected that many ongoing economic activities in the region could benefit from improved transport links. The region is strategically located on the shortest route from Baku to the Georgian border, therefore, an important transit location for neighboring economic regions for transportation to and from the metropolitan Baku area, particularly the Sheki-Zagatala region, a major producer of food products and a major tourism destination. Agriculture contributes 72 percent of economic production in the region, about 4.2 percent of national agricultural output. In 2009, productivity in the region increased 8.8 percent over that of 2008.

II. PROJECT DESCRIPTION

A. Lending Instrument

17. The Bank will finance the project through a Specific Investment Loan (SIL) comprising an IDA credit and an IBRD Loan. For the Loan, the Borrower has selected the US dollar denominated IBRD flexible loan, commitment linked, with a variable spread and a final maturity of 17 years including a 4 year grace period. The IDA credit terms are 20 years to maturity including a grace period of 10 years. IBRD and IDA will finance respectively 80% of expenditures under parallel financing arrangements.. The Government will be responsible for VAT and other taxes.

7 A Study, carried out with the support of the Turkish Development Bank, on “Potential Investment Areas in the Mountainous Shrivan Region, Kalkinma”, September 2009.

4 B. Program Objective and Phases

18. The proposed Third Highway Project begins a third phase of Bank support for the road sector of Azerbaijan.8 Government describes the proposed investment in a draft “State Program for Rehabilitation and Development of Azerbaijan Republic’s Road Network (2006- 2015).”9 The Government objective is that M1, M2, M3 and M4 will eventually attain international motorway standards for technical and geometrical specifications, traffic safety and signage, road-user amenities such as motorway rest stops, operating and maintenance protocols, and a sustainable funding mechanism. The four M-roads total some 1,230km; about 300km are already upgraded to four or more lanes, but lack efficient and sustainable mechanisms for operation and maintenance. In the next five years, Government plans to upgrade an additional 700km; by end-2015 about 1,000km roads should be motorway standard (see Annex 1).

19. Future Bank support in the road sector would be two-fold: (i) to develop Azerbaijan motorway network and transport corridors; and (ii) to upgrade main, secondary, connecting, and local roads as a part of a regional development strategy. This third phase of Bank support will provide specialized assistance based on road function. The Third Highway Project would focus on upgrading the existing motorway and developing the future motorway grid. The Project would address motorway issues commonly encountered worldwide and those specific to Azerbaijan. Capacity development would target motorway operations and maintenance; proposed Third Highway Project technical assistance would be motorway-specific and complement general road sector-wide technical assistance ongoing under the Second Highway Project. Many countries of similar size to Azerbaijan, such as Croatia and Slovakia, have had good results from separating motorway management from management of regional roads.10 Technical standards, and operations and maintenance differ for motorways and non- motorway roads; specifications, safety standards, development objectives, financing methods, and human resource requirements can also differ. Separating motorways and regional roads would focus much-needed capacity building and institutional development on modernizing the AzerRoadService JSC (ARS).

20. Bank future support for regional roads would maintain the approach begun under the Second Additional Financing11 for the Second Highway Project with the focus on regional development. Azerbaijan’s regional and local roads are crucial to social and economic development in rural areas, and in several regions, poor conditions hamper year-round connections and roads linking rural areas with main transport corridors are derelict. In fact, up to

8 The first phase of the Bank support began with the Highway Project launched in 2001. This Project provided US$40 million equivalent to reconstruct a section of M2, to provide technical assistance for rural road maintenance and begin road sector modernization. Phase two is substantive and broad totaling US$675 million to improve over 450 km of major roads through the ongoing Second Highway Project. Sector-wide technical assistance covers policy, institutional, and technical issues. The Third Highway Project begins phase three, which would focus on developing the motorway, about 10 percent of the total road network. 9 In June 2006, the MoT finalized the draft, but it is under revision and has not yet been adopted. 10 Essentially, Europe has two types of motorways institutional structure. In most Western European countries such as United Kingdom, Netherlands, and Germany, motorways are the highest category in the national road network. A single road administration covers the entire network, and in most cases, implements motorway projects with state funds, frequently using private contractors. In other countries, such as Croatia, Slovenia, Hungary, France and recently, Russia, motorways are special roads requiring special skills that differ from traditional road management and maintenance. These countries have established separate motorways agencies that implement state-funded projects often using sovereign loans; these autonomous public agencies have a focused mandate to construct, operate, and maintain motorways. 11 In June 2009, the Second Additional Financing for Azerbaijan Second Highway Project (7725-AZ/4615-AZ) was approved. The project covers road network rehabilitation for the Hajigabul-Bahramtapa region to foster area development; it will finance 116km of the M6 highway between Hajigabul and Bahramtapa and rehabilitate about 200km of local roads connecting villages to M6. 5 45 percent of these roads have exceeded their useful lifespan. Azerbaijan should develop regional roads in parallel with the motorway to maximize the economic impact of road network improvements.

C. Project Development Objective and Key Indicators

21. The project development objective (PDO) is “to contribute to a more efficient and safer Baku-Shamakhi road and higher quality road services as part of the upgrading to motorway standard, and to improve the management of the nascent motorway network”.

22. For road users the project would provide improved road quality and serviceability through a modernized motorway environment, including adequate safety features, interchanges, signage, rest stops, and other standard features associated with modern motorway networks.

23. For the Ministries of Transport and Finance the project would establish a framework to develop and manage the motorway network. This would include a sustainable road infrastructure management and financing scheme that embraces modern operations and maintenance practices and user-pay principles. At project Mid-Term Review it is anticipated that the Ministries of Transport and Finance will have reviewed options for a motorway framework and selected one for implementation.

24. For ARS the project would test the Motorway Management Unit concept as well as an operations and maintenance pilot on sections of the existing motorways. The Unit would oversee motorway operations, specific investments, operations and maintenance strategy, and maintain motorway-level standards for users. This Unit would help ARS separate motorway network management from that of other roads which could boost resource efficiency and allow the unit to focus on road-user oriented services. The project would finance the initial costs of establishing a small ARS team that could evolve into a Motorway Management Unit (MMU). In the medium term, this MMU would manage a modern motorway network, including providing sound road operation approaches, maintenance budgeting, planning, programming, and implementation. In addition, ARS will test new arrangements in operations and maintenance through a pilot on sections of the existing motorways. At project Mid-Term Review, the progress towards establishing a MMU and the implementation results of the pilot will be reviewed.

25. Key Indicators. Project performance would be measured against several qualitative assessments and quantitative indicators which would be monitored and evaluated regularly by the Ministry of Transport (MoT), ARS and the Project Implementation Unit (PIU). They align with the indicators already in place under the Second Highway Project and include the following:

Project Outcome Indicators  Efficiency: Reduction in road user costs from Baku to Shamakhi.  Safety: Reduction of personal injury accident per 100-million vehicle-km along Baku- Shamakhi.  Quality: Increased percentage of M Roads in Good and Fair Condition as a share of total M network roads

Intermediate Outcome Indicators  Increased number of km upgraded for Baku-Shamakhi.

6  Percentage of safety audits conducted on road accidents recorded during construction.  Safety audits of detailed designs and at construction completion.  Design of a Motorway Operations and Maintenance Manual.  Assessment of operations and maintenance pilot on sections of the existing motorway network.  Presenting assessment and motorway financing and management recommendations to MoF, MoT and ARS.  Development of a pilot MMU.

D. Project Components

26. Component 1: Motorway Improvement - Upgrading a 100km section of the existing two lane M4 Baku-Shamakhi road into four-lane motorway and related road safety activities (US$296 million without VAT). This component comprises civil works for the Baku- Shamakhi road and consultancy services for works supervision. It also finances road safety activities to be implemented throughout the project duration including design, construction, and opening of new four-lane road. Government would finance land acquisition and resettlement costs. The component also includes consultancies for technical audit of works and design of priority investments of the main road network.

27. Component 2: Institutional development (US$5.0 million without VAT), including: (a) preparation of a study to explore options for a policy on management and financing and efficient allocation of resources for Azerbaijan’s motorways (US$0.5 million without VAT); and (b) institutional development of the ARS in motorway operation and maintenance (US$4.5 million without VAT) by (i) establishing motorway guidelines (US$0.5 million without VAT); (ii) testing a small experimental motorway management unit at ARS (US$0.5 million without VAT); and (iii) carrying out an operations and maintenance pilot on sections of the existing motorways (US$3.5 million without VAT). Included are some traffic safety related equipment and goods, training, and study tours on motorway administration for MoT, ARS, and officials from other government agencies.

28. Component 3: Project Management (US$1 million without VAT). The project will finance consultant services, equipment and TA to support project management capacity of the PIU, including office equipment, software, training (especially financial management), seminars, financial management TA, and project financial audits.

E. Lessons Learned and Reflected in the Project Design

29. Readiness of civil works is critical. Bank experience with its highway portfolio in general, and Azerbaijan in particular, shows that Client satisfaction and project implementation success depend on prompt disbursement after project effectiveness12. The Third Highway Project is not expected to encounter delays for the following reasons. First, by the project effectiveness date, procurement will be completed for about US$70 million in civil works for the first 30km road section near Baku. Second, no land acquisition is required for the first section; road improvements are within the right-of-way and land acquisition for subsequent sections is

12 Under the Second Highway Project, disbursements are improving but were slow initially due to unforeseen technical issues during project preparation and because of delays with land acquisition. 7 limited.13 Preparation of the detailed design for the rest of the project road has begun; it will be designed in sections so more time can be devoted to the technically complex Shamakhi bypass section without delaying the rest of the civil works.

30. Technical assistance design should aim to ensure ownership, and this should not cover too many activities. Technical assistance for the Project is focused on developing and managing the nascent motorway network in Azerbaijan, which will comprise 10 percent of the total paved road network when fully developed. There will be a few well-defined technical assistance activities, tailored to local capacity. Technical assistance focused on the road sector in general, addresses overarching issues, and provides comprehensive support, such as preparing new road laws, road data systems, etc., is being provided under the Second Highway Project.

31. Project technical specifications should align with local capacity. The project requires one road segment to be expanded from two to four lanes. The Bank is involved in rehabilitating the existing two lanes through the Second Highway Project; ARS and the PIU are familiar with technical, geographical, and safeguards issues. Project scope and size conforms to ARS and PIU ability and track record to implement.

32. Rising vehicle ownership requires more road infrastructure capacity. While car ownership in Azerbaijan is relatively low at 105 vehicles per 1,000 inhabitants,14 it is increasing rapidly and traffic growth potential is substantial, a trend that should gain momentum following strong GDP growth and a burgeoning middle class that will continue to seek vehicle ownership. During 2005-2009 the number of motor vehicles in Azerbaijan increased by 70% and reached about 926 thousand vehicles by early 2010. Urban centers, Baku in particular, are major engines of growth in Azerbaijan. Rapidly expanding urban populations need transportation within cities and between cities. The project is financing infrastructure capacity increases between the capital and a major city/region that could be reached within a one-hour drive when construction is completed.

F. Alternatives Considered and Reasons for Rejection

33. Initially, Government preferred the Project to include upgrading a segment on M3 to the north of Alat from four to six lanes. Financing this investment would have been technically challenging because it required designing large interchanges and analyzing and addressing complex road safety patterns for which designs are not available. As a result, it was agreed that the project would cover the Baku-Shamakhi segment only; support to upgrade the M3 segment to the north of Alat will be revisited later. Another consideration was whether to include a traffic safety subcomponent or to wait for completion of the Traffic Safety Strategy being implemented under the Second Highway Project. The decision was made to include a set of traffic safety activities, mainly for implementation of good practices for road safety and traffic management during construction works, because some traffic safety issues were observed during rehabilitation of the Baku-Shamakhi road under the Second Highway Project. Finally, the project could continue supporting the Government road sector without advocating for a Motorway Management Unit, but given the Government objective of having about 1,000km of motorway

13 40 hectares in the Third Highway Project versus 270 hectares in the Second Highway Project. 14 The official figure - 105 vehicle per 1,000 inhabitants - is around the worldwide average of 100/1,000 vehicle per inhabitant but far below the 466/1,000 average of EU 27 countries and 307/1,000 average of new EU countries (lowest ratio Romania with 167/1,000). 8 operational by 2015, a pilot testing a Motorway Unit is a necessity to ensure that staff are trained and attain technical expertise necessary to manage the motorway network.

III. IMPLEMENTATION

A. Partnership Arrangements

34. Development partners in the Azerbaijan transport sector have a coordinated approach, and informal consultation and coordination will continue under the Project. For example, in 2006 EBRD began financing using the same sector conditions as those used in the Second Highway Project. For the past 5-7 years, EBRD, ADB, and the World Bank have been supporting the MoT and ARS in several important works programs rehabilitating and upgrading the arterial road network. On the institutional side, all development partners’ investment activities have been accompanied by initiatives to modernize road sector administration and management practices. Development partners have coordinated and supported each others’ activities.15 The Government has requested the Bank to organize a workshop among the IFIs to coordinate the technical assistance activities. The Project will focus on the motorway network and will benefit other IFI-financed operations in the sector. Both EBRD and ADB agreed that given the level of investments in the motorways, policy and institutional development activities in this area should be intensified.

B. Institutional and Implementation Arrangements

35. The MoT and ARS have extensive experience with World Bank-financed operations. The Project will be implemented by ARS under supervision of the MoT, the policymaking and regulatory authority in the transport sector. The existing PIU responsible for the Second Highway Project will support the proposed project. The PIU is staffed with seasoned local consultants, including engineering, procurement, and financial management staff, and has significant capacity developed through implementing Bank-financed projects. Two international consultants will be hired; one to help the PIU with daily operations and implementation of technical assistance, and one to help ARS with policy implementation of the Road Asset Management System, and share international best practice and help to tailor it to Azerbaijan.

36. Under the Third Highway Project, the PIU will be responsible for procurement and disbursement, and gathering information on project monitoring and reporting. The PIU will continue with existing systems used under the Second Highway Project, and will be in charge of daily activities for project implementation and coordination, including planning, budgeting, procurement, disbursement, auditing arrangements, monitoring and evaluation, and implementation progress reports. MoT will lead the technical discussions on the management and financing policy and efficient allocation of resources for Azerbaijan motorways (Component 2), since it better corresponds to MoT’s mandate and scope of responsibilities. Under this arrangement, ARS and the PIU will be in charge of daily implementation of Project. The ARS, the agency in charge of managing the road network, will test a pilot program that will include setting up a dedicated MMU and an operations and maintenance pilot on the sections of the

15 The EBRD financed consultancy services to implement the ARS’s Corporate Plan, which aims to develop a new model of road maintenance practices. When this consultancy ends, the Bank proposes to continue EBRD efforts by providing subsequent; training and equipment to pilot maintenance units proposed under the recommended Plan. Ongoing ADB-supported consultancies for Road Sector Institutional Strengthening include traffic safety program, axle load-control measures, and road management system development. The ADB Institutional Strengthening technical assistance ended January 2010. Based on experience and lessons learned, the Bank will continue institutional strengthening activities for ARS. 9 existing motorways. TA financed under Component 2 will specify MMU structure, responsibilities, and relationships with stakeholders.

C. Monitoring and Evaluation of Outcomes/Results

37. ARS, under the supervision of Ministries of Transport and Finance, will monitor project implementation. This includes supervising works and TA, auditing financial statements, and monitoring project indicators during the project lifetime. The ARS will submit bi-annual reports to the Bank covering implementation progress and key issues, in a format satisfactory to the Bank, one month after the end of each calendar semester. Progress reports will focus on results, not process-related information. The monitoring by ARS will be supplemented by regular Bank implementation support missions and project implementation monitoring by Bank Baku- based specialists. In view of the selected indicators, no data collection difficulties or capacity issues are anticipated.

D. Sustainability

38. The Project is in line with the draft State Road Network Development Program of the Azerbaijan Republic (2006-2015). The Government is committed to developing about 1,000km of the motorway network by 2015. To ensure the Project yields the expected return, activities financed under Component 2 will include assistance to Government to design an operations, maintenance and financing scheme for the motorway network. Technical assistance to improve the management and financing for the overall road network is beyond the project’s scope, but would be included in general Bank dialogue on public expenditure16.

E. Critical Risks and Possible Controversial Aspects

39. Project risk is rated Moderate after mitigation. The table below describes operation- specific risks to project development objectives and project implementation.

Rating Rating Project Risk before Risk Mitigation Measures after Mitigation Mitigation Technical Design. The project expands M Detailed design and construction are to be phased; M from two to four lanes 100 km of the M4 the first section is already designed and Baku-Shamakhi road. Many sections have arrangements are in place for detailed design of a 60m right-of-way that would provide subsequent sections. The Bank is involved in the sufficient access for four lanes. The rehabilitation of the existing two lanes through the greatest challenge is the mountainous Second Highway Project and thus is familiar with sections, where a new alignment might be the technical, geographical, and safeguards issues. required, and the Shamakhi bypass. Implementation Capacity and S A repetition of the Second Highway Project low M Sustainability. MoT’s institutional disbursements are not anticipated under the Third capacity is still evolving. Implementation Highway Project because (i) hiring of two capacity at ARS is already stretched; it has international consultants to support PIU and ARS is a heavy portfolio of projects under underway, (ii) advisor is to be hired for motorway implementation and the Second Highway operations and maintenance technical support, and Project disbursement has been slow. (iii) the Bank and other IFIs are financing ongoing general capacity-building activities.

16 Nevertheless, the Bank would assist with maintenance practice modernization by helping implement three maintenance unit pilots under the Second Highway Project as follow-up to the EBRD Corporate Plan study. 10 Financial Management. Overall, there is S FM weaknesses identified during preparation of M substantial inherent risk due to weak FM Second Additional Financing for the Second systems in ARS, possible inadequate Highway Project were addressed. An experienced budget allocations, weak internal controls FM team of the PIU will handle FM aspects of the or processes evidenced in payment delays project. The Bank will monitor on a regular basis for invoices, and potentially delayed audit timely appointment of auditors, budget allocations reports due to Project scale and and invoice processing to mitigate FM risks. Third complexity. Highway Project includes targeted TA to continue strengthening PIU FM capacity. Governance and Procurement. S Under Third Highway Project, procurement M Governance remains an important concern consists of a few large contracts, which should and constraint to development. facilitate Bank procurement oversight. The Bank Coordination among public agencies is procurement specialist and highway engineer are often limited; country systems are weak; based in Baku, allowing closer monitoring. The and capacity constraints exist throughout PIU did a good job of handling procurement under the public sector. The major corruption the Second Highway Project. International risk for this project relates to procurement technical supervision of works will provide further and supervision of large civil works governance safeguards. contracts. Social and Environmental Safeguards. S The EMP and project supervision will reflect M Third Highway is an environment category lessons learned from a recent review of A Project; land acquisition is required and environmental management in South Caucasus resettlement will occur. The record of roads projects, e.g., mitigation measures will be EMP implementation on road projects has specified; bidding documents will specify key been spotty and land acquisition was a mitigation actions; civil works contracts will major cause for delay in disbursement specify penalties for EMP provision non during the Second Highway Project. compliance. Land acquisition is at a much smaller scale than under the Second Highway Project - acquisition of 40 hectares of private land is required versus 270 hectares for the Second Highway Project. Most works will occur within existing ROW. Government personnel will have gained familiarity in applying the new land Expropriation Law. Sustainability. The full estimated S The Project will provide technical assistance to M economic benefits for the Project will only improve motorway management. The Government materialize if there is proper maintenance is committed to motorway reform and the Project after Project completion. While will fund a pilot operation for improving maintenance budget appears to be maintenance on sections of the already existing adequate, ARS’ maintenance practice has motorways so lessons learned can be applied to the to be modernized. Project road upon implementation completion. Overall Risk S M

H – High S – Significant M – Moderate L – Low

F. Loan/Credit Conditions and Covenants

40. The following conditions and covenants17 were agreed with the Government during negotiations.

Additional Conditions for Effectiveness  The Subsidiary Agreement has been executed by the Ministry of Finance and the Ministry of Transport on behalf of the Recipient/Borrower and the ARS.

17 The conditions and covenants for the IDA credit and the IBRD loan are the same unless otherwise stated. 11  The Project Account has been opened by the Recipient/Borrower in a local commercial bank satisfactory to the Bank, and initial deposit in an amount of not less than two million Manats have been made by the Recipient/Borrower into the respective account.  The Financing Agreement has been executed and delivered and all conditions precedent to its effectiveness or to the right of the Borrower to request disbursement thereunder, except only the effectiveness of the Loan Agreement, have been fulfilled.  The Loan Agreement has been executed and delivered and all conditions precedent to its effectiveness or to the right of the Recipient to request disbursement thereunder, except only the effectiveness of the Financing Agreement, have been fulfilled.

Project Covenants

Institutional Arrangements

 Except as the Bank shall otherwise agree, the Recipient/Borrower shall: (a) ensure that the criteria, policies, procedures and arrangements set out in the Operational Manual, the EMF, and the RPF are applied by the ARS; and (b) not amend or waive, or permit to be amended or waived, the Operational Manual, the EMF, and/or the RPF, or any provision thereof, in a manner which, in the opinion of the Bank, may materially and adversely affect the implementation of the Project

 The Recipient/Borrower shall, until the completion of the Project, cause the ARS to maintain the PIU and shall ensure that the PIU is adequately staffed by personnel with qualifications and under terms of reference and functions at all times in accordance with procedures necessary and appropriate for the carrying out of the Project, and satisfactory to the Bank.

 The Recipient/Borrower shall permit the use of standards for design, construction and planning of motorways and highways adopted by the European Union or standards adopted by the American Association of State Highway and Transportation Officials (in addition to the national standards), acceptable to the Bank, in the design, construction and maintenance of road works under the Project.

 By not later than December 31, 2010, the Recipient/Borrower shall cause the ARS to recruit a financial auditor under terms of reference and conditions satisfactory to the Bank.

 The Recipient/Borrower shall prepare, under terms of reference satisfactory to the Bank, and furnish to the Bank, six months as of the completion of the works for upgrading the Baku-Shamakhi road under Component 1 of the Project, a report on the execution of such works and the related plan on operations and maintenance of the Baku-Shamakhi road.

Subsidiary Agreement

 To facilitate the carrying out of the Project by the ARS, the Recipient/Borrower shall make the proceeds of the Loan and Credit available to the ARS under two subsidiary agreements (“Subsidiary Agreement”) between the Ministry of Finance and the Ministry of Transport on behalf of the Recipient/Borrower and the ARS, under terms and conditions approved by the Bank, which shall include, without limitation ARS’s undertakings to carry out the Project in accordance

12 with the provisions set forth in the Loan and Financing Agreement, the Operational Manual, Anti- Corruption Guidelines, EMF and the RPF.

Anti-Corruption

 The Recipient/Borrower shall ensure that the Project is carried out in accordance with the provisions of the Anti-Corruption Guidelines.

Reporting

 The Recipient/Borrower shall monitor and evaluate the progress of the Project and prepare Project Reports in accordance with the provisions of Section 5.08 of the General Conditions and on the basis of the indicators agreed with the Bank. Each Project Report shall cover the period of one calendar semester, and shall be furnished to the Bank not later than forty five (45) days after the end of the period covered by such report.

 The Recipient/Borrower shall prepare, under terms of reference satisfactory to the Bank, and furnish to the Bank, on or about October 1, 2012, a mid-term report integrating the results of the monitoring and evaluation activities performed pursuant to paragraph 1 of this Section, on the progress achieved in the carrying out of the Project during the period preceding the date of said report and setting out the measures recommended to ensure the efficient carrying out of the Project and the achievement of the objectives thereof during the period following such date.

 For purposes of Section 5.08 (c) of the General Conditions, the report on the execution of the Project and related plan required pursuant to that Section shall be furnished to the Bank not later than six months after the Closing Date.

Financial Management, Financial Reports and Audits

 The Recipient/Borrower shall maintain or cause to be maintained a financial management system in accordance with the provisions of Section 5.09 of the General Conditions.

 The Recipient/Borrower shall cause the ARS to prepare and furnish to the Bank not later than forty five (45) days after the end of each calendar quarter, interim unaudited financial reports for the Project covering the quarter, in form and substance satisfactory to the Bank.

 The Recipient/Borrower shall cause the ARS to have the Project Financial Statements audited in accordance with the provisions of Section 5.09 (b) of the General Conditions. Each audit of the Financial Statements shall cover the period of one fiscal year of the Borrower. The audited Financial Statements for each such period shall be furnished to the Bank not later than six months after the end of such period.

Safeguards

 The Recipient/Borrower shall ensure that the Project is carried out in accordance with the provisions of the EMF, EIA(s), EMP(s), RPF and RAP(s). The Recipient/Borrower shall

13 not assign, amend, abrogate or waive the EMF, EIA(s), EMP(s), RPF and/or RAP(s) or any provision thereof, without the prior approval of the Bank.

 For the purpose of Component 1 of the Project, the Recipient/Borrower shall: (a) prior to the issuance of the bidding documents for the works contract for each segment of the Baku-Shamakhi road, prepare and submit to the Bank for its approval: (i) the proposed design and site for said works and, the related site-specific EIA and/or EMP in form and substance satisfactory to the Bank; and (ii) the draft contract for said works to ensure that the provisions of said site-specific EIA and/or EMP are adequately included in said contract; (b) prior to the signing of the contract for said works, prepare and submit to the Bank for its approval the site-specific land acquisition and/or resettlement action plan(s) (RAP(s)) in form and substance satisfactory to the Bank; and (c) prior to the commencement of the works, ensure that the owners and users of the land where said works are to be implemented are fully compensated in accordance with the provisions of the RAP(s).

 The Recipient/Borrower shall: (i) ensure that all activities undertaken for the purpose of carrying out of the Project comply with environmental standards and guidelines satisfactory to the Bank; (ii) ensure that the selection of any road section under Component 1 of the Project is done in accordance with the provisions of the EMF; (iii) ensure the complete implementation of the EMPs in a manner acceptable to the Bank, including all necessary measures to minimize and to mitigate any adverse environmental impacts caused by the implementation of the Project; and (iv) maintain the ARS’s environmental management office with competent staff in adequate numbers and with such responsibilities and functions acceptable to the Bank as shall enable the ARS to manage, coordinate and monitor the implementation of the EMPs.

 The Recipient/Borrower shall (i) ensure that the ARS prepares RAPs according to the RPF; (ii) maintain or cause to be maintained by ARS, and publicize or cause to be publicized by ARS, the availability of, grievance procedures to hear and determine fairly and in good faith, in accordance with the RPF, all complaints raised in relation to the implementation of the RAP by those being resettled or by those in host communities who are adversely affected by the implementation of the RPF, and take all measures necessary to implement the determinations made under such grievance procedures; (iii) through the ARS, employ a resettlement expert, satisfactory to the Bank, to conduct an ex post review of the implementation of the RAPs; (iv) through the ARS, furnish promptly to the Bank the findings and recommendations for follow up action resulting from each such review; and (v) through the ARS, implement all such recommendations for follow up action as are agreed with the Bank.

IV. APPRAISAL SUMMARY

A. Economic and Financial Analyses

41. Economic evaluation covers the main project component: upgrading from two to four lanes for 100km of the Baku-Shamakhi highway. The cost-benefit analysis is based on savings in vehicle operating costs and reduced travel times for users. Baseline 2009 traffic-level estimates were based on projections from 2005 traffic counts; counting traffic on the existing two-lane project road is impossible due to ongoing rehabilitation works. Updates were arrived at

14 by applying the rate of GDP growth to traffic during 2005-09 (assuming an income elasticity of demand equal to 1.3). The resulting Baku-Shamakhi traffic growth rate for the period is consistent with growth rates observed in the rest of the motorway network. Included in the traffic projections are generated traffic calculated at 10 percent of the normal traffic level. This is to capture the increased economic and other activities as a result of the implementation of the project. Traffic for the baseline year for road sections ranges from about 11,000 to 22,000 vpd.

42. Cost-benefit analysis was performed with the help of the Highway Development and Management Model (HDM 4). The “without project” case is the rehabilitated existing two-lane road, which was compared with the proposed upgrade to a four-lane road. Exogenous variables introduced to the model were limited to quantifying benefits derived from a 20 percent reduction in traffic accidents. Accident statistics gathered during 2002-05 (until the road closed for rehabilitation) show an annual average of 10 fatal accidents and 25 personal injury accidents. Project costs and routine and periodic maintenance costs are based on the detailed design for the km15 to km45 section and on prefeasibility studies for the rest of the itinerary. All costs were based on border prices. Work and business time was valued at the full economic travel time rate and non work travel time was valued at 30 percent of the full rate. Work/business trips values assume that employee value is equal to wage rate plus other employment costs, valued at 33 percent of the estimated average wage/ hour at US$2.28.

43. The economic evaluation yielded an Economic Internal Rate of Return (EIRR) of 14.5 percent. Sensitivity analysis results are within the range of acceptability for different assumptions of costs and benefits. In addition to returns expected from civil works, important but unquantifiable benefits would result from project technical assistance to improve motorway management. Details of economic evaluation, economic activity, and regional development in the project area of influence are in Annex 9.

B. Technical

44. The project will upgrade a 100km section of the M4 Baku-Samakhi Road from km15 to km116 from two-lane to a four-lane motorway. Rehabilitation of the existing two- lane road is Bank-financed under the Second Highway Project, as is construction of two additional lanes for the first 15km. Detailed design is ready for the four lanes from km15 to km45; this 30km section follows the existing alignment and requires no land acquisition. The existing two-lane road traverses some settlements and several sections are in hilly terrain, requiring heightened prudence from the designer, otherwise construction is not expected to be challenging. The project finances an 8.0km bypass around Shamakhi, which will be built as a two-lane road, with the potential to expand to four lanes when transit traffic volumes justify additional investment.

45. The project will use the same asphalt concrete pavement construction adopted earlier. The Project will also fund road safety improvements, through the auditing of designs, traffic safety measures implemented during construction, safety audits prior to construction completion and traffic safety measures for motorway operation. Independent auditors will ensure that civil works meet standard bidding document requirements.

46. The Third Highway Project will not compromise the Second Highway Project investment in Baku-Shamakhi. The Second Highway Project builds two lanes from Baku to Shamakhi, but the design anticipated an eventual expansion to four lanes and the detailed design

15 for the four-lane motorway will not compromise the investment in the newly rehabilitated road. The project will call for the application of EU norms or equivalent for designs, as did the Second Highway Project.

C. Fiduciary

47. Procurement will be carried out under World Bank “Guidelines: Procurement under IBRD Loans and IDA Credits” published May 2004 and revised October 2006 (Procurement Guidelines) and “Guidelines: Selection and Employment of Consultants by World Bank Borrowers” published May 2004 and revised October 2006 (Consultant Guidelines) and provisions stipulated in the Loan and Financing Agreements. The PIU has demonstrated capacity to carry out procurement for the new project. The Third Highway Project will add to the PIU procurement specialists’ workload, but the number of contracts is limited. In addition, an international consultant currently being recruited will also provide the PIU with high-level advice on procurement issues. Due to these factors, and the PIU’s good track record under Bank financed projects, procurement risk is rated “Moderate.”

48. The PIU within ARS will be responsible for financial management, loan and credit disbursements, and auditing arrangements. The PIU’s financial management (FM) arrangements were assessed during preparation of the Second Additional Financing for the Second Highway Project and again during preparation of the Third Highway Project; identified weaknesses were addressed. Current arrangements, systems, and controls are adequate and meet Bank FM requirements. The existing 1C accounting and financial reporting system is being customized to accommodate proposed project needs. The FM staff capacity has been strengthened by adding a Financial Specialist Assistant in 2009, who has improved her skills through on-the-job training. The PIU staff will participate in FM and disbursement trainings organized by the Bank and Bank-financed projects. Current FM staff capacity is adequate, and will be strengthened by technical assistance to upgrade FM capacity for PIU staff under the Project. The PIU is experienced in implementing Bank-funded projects. Internal policies and procedures are documented in the Second Highway Project Operational Manual (POM) and the Third Highway Project-specific controls and procedures can be added as necessary. Overall FM risk before mitigation is assessed as ‘Substantial’. After mitigation measures such as monitoring of timely appointment of auditors, budget allocations and invoice processing the residual FM risk is assessed as ‘Moderate’. Country Level FM risk is assessed as ‘High’ due to weak PFM systems in the country. (See Annex 7 for FM assessment).

D. Social

49. The Project will contribute to regional socioeconomic development and is supported by the population. Overall, the project will have a positive impact on the livelihood of the local population. The project will provide immediate benefits to four districts with a total population over 280,000, or about 3 percent of the total population of Azerbaijan. The local economy is small, and main agricultural markets are located in Baku. The Project will better connect four districts in the Mountainous Shirvan region to growth centers in and around Baku, and improve local population’s access to markets. Also, the development of the M4 motorway can potentially trigger tourism development both in the project region and further northwest region. During public consultations, the local population expressed support to the Project as it will ease the

16 access of Baku to the west and Ganja and Sheki to the east, and also because a considerable amount of short term jobs can be created in road construction.18

E. Environment

50. Overall along the study corridor flora biodiversity is high featuring between 600- 729 plant species. The area is characterized by saltwort and ephemeral deserts and wormwood- saltwort semi-deserts. The topography is represented mainly by undulating arid hills and mountains. The road crosses a series of wide river terraces and ancient river canyons which all represent erosion types of landscape. Significant portions of the land immediately adjacent to the road are under the ownership of the State Forest Fund (Jangi Forestry). The area also harbors a number of species, including threatened species of national and international importance. The environmental aspects of the road operation will be air pollution from automobile emissions, noise and pollution of soil and surface water with litter and drainage from the highway. Traffic safety will be an important issue with health, social, and environmental implications, which, however, will be improved from the current situation by providing a dual-carriageway road.

F. Safeguard Policies

Safeguard Policies Triggered by the Project Yes No Environmental Assessment (OP/BP 4.01) [X] [ ] Natural Habitats (OP/BP 4.04) [ ] [X] Pest Management (OP 4.09) [ ] [X] Physical Cultural Resources (OP/BP 4.11) [ ] [X] Involuntary Resettlement (OP/BP 4.12) [X] [ ] Indigenous Peoples (OP/BP 4.10) [ ] [X] Forests (OP/BP 4.36) [ ] [X] Safety of Dams (OP/BP 4.37) [ ] [X] Projects in Disputed Areas (OP/BP 7.60)* [ ] [X] Projects on International Waterways (OP/BP 7.50) [ ] [X]

51. Land acquisition of a limited scale is anticipated. For most road sections the road can be expanded within the existing right-of-way, however, for about 9.75km section land immediately next to the existing road is owned by private owners whose land needs to be acquired. Also, some land will need to be acquired for the construction of a new bypass around Shamakhi. The project area passes through sparsely populated areas with a few small villages near the road. A few kiosks and restaurants are visible near the road, which may be impacted depending on the final alignment selected. The Government prior to the commencement of works under the Project will ensure that the owners and users of the land where works are to be implemented are fully compensated in accordance with the provisions of the Resettlement Action Plan (RAP)(s).

52. Resettlement Policy Framework (RPF) has been prepared. Since the exact alignment is known only for the first 30km section, which will not result in land acquisition or other impacts that will trigger OP 4.12, a Resettlement Policy Framework (RPF) was prepared to set out policies and procedures that apply to the project with regards to the acquisition of private land, closure of businesses, and loss of income or access. No physical relocation of households is expected to occur under this project. Specific resettlement action plans will be drafted, discussed

18 Anecdotal evidence suggests that local population have access to cars when they need to travel, and that improvement of road conditions will benefit a wide range of local population.

17 and disclosed once the detail design will be available for the remaining sections (West from the first 30km - km15 to km45).

53. The proposed road widening has been classified as a Category A project. The main environmental issues are associated with the construction activities and destabilization of slopes due to high erodibility of soil in sensitive areas, loss of tree plantations in various sections alongside the existing road (Jangi Forestry Department of MENR), disturbance of drainage systems specifically in the Gobustan town and Sabir village, extraction of road construction materials and operation of access roads, increased dust production and air and noise pollution, disturbance to protected mud volcanoes, construction and domestic wastes to be collected, transported and disposed in a sustainable manner.

54. An Environmental Management Framework (EMF) and a Regional Environmental Review (RER) were initially prepared for the first Highway Project in 2005 and then updated in 2009 to incorporate the road widening. The EMF outlines the procedures for the environmental screening, management, consultation and disclosure of sub-projects. The RER covers a one km strip of land on either side of the Baku-Shamakhi road. The RER describes the existing environment, discusses and compares project alternatives and identifies potential environmental risks and issues to be addressed by site-specific EIAs and EMPs. The updated EMF and RER were discussed with public in February-March 2009, with final documents disclosed in country and in the InfoShop in August 2009. As the detailed design has been developed only for the first 30 km section of the road, and is not yet defined for the remaining sections, site-specific EIA and EMP were prepared for the first 30 km section (km 15 to 45) accordingly. The site-specific EIA and EMP provide detailed consideration of the impacts identified by the RER. They will be followed by site-specific EIAs/EMPs for the remaining sections. The draft EIA and EMP for the first section were publicly discussed in January 2010 in the Khirdalan town. Feedback received on location of the underpasses and crossings for pedestrians, domestic animals and wildlife are incorporated into the section design. The final EIA and EMP for the first 30 km section have been completed and will also undergo in-country and InfoShop disclosure.

55. The Ecology and Safety Sector (ESS) is responsible for overall environmental management of ARS activities. Together with the PIU, the ESS staff should be involved in regular overseeing the implementation of site-specific EIAs/EMPs. Construction contractors will be responsible for implementing the EIAs/EMPs for sub-projects. Training sessions were delivered by EIA consultant under the Second Highway Project to strengthen the capacity of the ESS, which, however, remains weak and will be further improved under the ongoing Bank financed Public Investment Capacity Building Project. Independent EA consultants that will be engaged to prepare site-specific EIAs will also have a follow-on capacity building and training component included in their contract. An Environmental Specialist will be hired by the PIU to deal with environmental issues of the Project and communicate with public.

Disclosure of Safeguard Documents Date of Disclosure Report In Country Posted to Infoshop Final RER August 4, 2009 August 5, 2009 Final RER Executive Summary August 4, 2009 August 5, 2009 Final revised RER (re-posted) November 24, 2009 November 24, 2009 Final revised RER Executive Summary (re-posted) November 24, 2009 November 24, 2009 Draft EIA for the first 30km section January 27, 2010 February 4, 2010

18 G. Policy Exceptions and Readiness

56. The project complies with all applicable Bank policies. Engineering design documents for the first 30km are complete and procurement of civil works is underway so that contractors should be ready for deployment at project effectiveness. Government is tendering in one stage the detailed design for remaining sections. Procurement of subsequent sections is expected to start in third quarter 2010; contractors for those sections are expected to mobilize by end-2010. The Project is ready for implementation.

19 Annex 1: Country and Sector or Program Background AZERBAIJAN: Third Highway Project

Country Background

57. The Republic of Azerbaijan is the largest and most populous country in the South Caucasus, home to 8.9 million people; 54 percent live in urban areas. The capital city Baku is home to about 2.1 million. Per capita income in 2008 was US$3,830 (Atlas method). Recently, Azerbaijan’s economy has grown rapidly due to an oil and gas boom that is expected to last for about 20 years. Azerbaijan’s GDP rose at an average annual rate of 17.3 percent during 2001- 07.19 In 2008, the growth was slower, but still reached 10.8 percent.

58. The global economic crisis of 2008 and 2009 affected Europe and Central Asia very significantly - the region was the hardest hit in the world. Azerbaijan has been less affected than other countries, posting a GDP growth rate of 9.3 percent for 2009 owing to a recovery in its oil production. The country has nevertheless been affected by lower oil prices since the latter half of 2008 (despite their gradual recovery), a shortage in foreign financing, and a depressed ECA region. Reduced inflow of oil revenues and lower than expected budget expenditures combined with external factors, contributed to much lower inflation (1.5 percent during 2009 versus 20.8 percent in 2008) and curtailed pressures for appreciation of the Manat, but also a weaker economy. While the 2009 GDP growth was 9.3 percent, the non-oil economy grew at 3.2 percent due to a contraction in construction and in non-oil industry (steel, petrochemicals, etc.) and single digit service sector growth. In 2006-2008 Azerbaijan had seen double digit growth in non-oil sector and services.

59. Government strategy to address the financial crisis has been prudent. Still, the post- crisis environment would require the Government to diversify the economy and ensure non-oil economic growth, which will require the following:

 Developing a sustainable fiscal framework  Improving the business environment and preparing strategies to attract investors  Committing to sustained investment in human capital  Implementing regional development and inclusive growth

Government Development Agenda

60. Government has an ambitious development agenda. Since independence in 1991, Azerbaijan has aimed to develop natural resources and use hydrocarbon wealth to combat poverty and transform the country into a diversified sustainable market economy. Diversifying the non-oil economy has required improving utilities and infrastructure services, investing in human capital, building a supportive business environment, strengthening public sector management, and expanding the financial sector. Over the last decade, Azerbaijan’s efforts, supported by development partners, have begun to yield results. In the World Bank 2009 ‘Doing Business’ Report, Azerbaijan showed the most improvement in business climate among 181 surveyed countries - ranked 38, up from 97 in 2008. The Government aims to maintain this progress by further diversifying the economy and making gains on business licensing, tax and customs administration, and reducing corruption.

19 World Development Indicators 2008, World Bank. 20 61. Infrastructure investment is essential to implement Azerbaijan’s development agenda. Infrastructure is among the most important factors to enable and stimulate economic growth and reduce poverty. Prior to the oil boom, infrastructure investment rates in Azerbaijan were low and the country was facing an investment deficit. The 2009 World Bank Country Economic Memorandum for Azerbaijan notes that annual investments in non-oil infrastructure were about 4.0 percent less than those in the average CIS country, and about 8.0 percent of GDP per year less than the average transition economy during 1995-2002.20 As a result, by 2005, most infrastructure had outlived its useful lifespan of 25-30 years and overall infrastructure quality and reliability was poor. During 2005-09, Government invested about US$9.0 billion in infrastructure, about US$4.5 billion of that in the road sector, representing a significant commitment to infrastructure development. In the medium term, Government plans to invest about US$13 billion to develop the physical infrastructure network, with the expectation of reducing transport costs, facilitating regional development and transit of goods along the country’s main corridors (North-South and East-West), and contributing to Azerbaijan’s economic diversification strategy.

Transport Sector Overview

62. In 2009, transport accounted for 6.6 percent of GDP. Road transport dominates, accounting for over 60 percent of freight in 2009, up from 54 percent in 2003. In 2009, railways’ market share dropped to 15 percent from 18 percent in 2003. Most passenger transport is by roads: 1,034 million person trips against 207 million person trips by rail. Railways have higher modal share in ton-km terms (11 percent), but road transport hauls greater total tonnage: 88 million tons versus 27 million by rail. Railways are key in oil-dominated transit, but road infrastructure and services dominate in daily living and economic development.

Cargo Traffic by Modal Share, (million ton-km) 2000 2003 2004 2005 2006 2007 2008 Total 15948 22291 23283 26534 43294 78007 88607 Railways 5770 77197536 9628 11059 10375 10021 Sea 5192 6555 6771 7521 8043 5989 6076 Air 102 204 315 310 291 204 129 Pipelines 1371 1572 1696 1539 15679 52305 62434 Oil pipes 646 649 655 624 14690 50892 58759 Gas pipes 725 923 1041 914 989 1413 3675 Roads 3513 6241 6965 7536 8222 9134 9947 Cargo Traffic by Modal Share, (thousand tons) 2000 2003 2004 2005 2006 2007 2008 Total 80180 110001 117314 128328 145596 167533 183093 Railways 15876 20345 20671 26522 30205 28276 27432 Sea 8779 13272 13209 13680 13506 10173 11898 Air 37 52 75 74 75 52 43 Pipelines 15054 17262 18145 18534 27426 47409 55731 Oil pipes 11774 11283 11589 11692 19947 39999 44383 Gas pipes 3280 5979 6556 6842 7479 7410 11348 Roads 40434 59070 65214 69518 74384 81623 87989

63. As the country at the crossroads for goods flowing between Europe and Asia along the East-West and North-South corridors, Azerbaijan could become a prosperous transit hub. The country has access to the high seas from the Caspian Sea through Volga-Don Canal or

20 Azerbaijan - Country Economic Memorandum, “Staying Focused on Diversification,” March 19, 2009 Report No. 44365-AZ. 21 through Georgia to the Black Sea, or through Iran to the Persian Gulf. The major transportation and transit corridors are North-South corridor (M1 and M3) and East-West corridor (M2 and M4). The M1 links Baku to the Russian border and M3 links Baku to Iran. The M2, a part of the Great Silk Road, is the main route between Baku and Tbilisi and a part of the Transport Corridor 21 Europe-Caucasus-Asia (TRACECA) route E-60, a main corridor between Western Europe and 22 China. The M4 runs from Baku to Shamakhi and merges at Yevlakh into the M2. The World Bank, through Highway and the Second Highway Projects has been supporting Government to upgrade this network.23 The proposed Third Highway project would support upgrading a portion of road infrastructure into the motorway grid for Azerbaijan.

64. Since 2005, Azerbaijan has boosted infrastructure spending to accommodate rapid traffic growth and user expectations for better roads. However, substantial reconstruction or replacement remains to be carried out on the road network, railway tracks, and rolling stock.24 The Project would improve high-traffic segments of the motorway network, identified as a priority for diversification and economic development. Azerbaijan is increasingly aware that investments are more effective if accompanied by institutional reform of the subsectors and modernization of transport entities.

65. Highway investments are guided by Government’s proposed “State Program for Rehabilitation and Development of Azerbaijan Republic’s Road Network (2006-2015).”25 Activities are to be implemented by 2015 to develop an efficient, but affordable road network capable of meeting the needs of Azerbaijan’s rapidly growing economy. The Program plans to construct, upgrade, and rehabilitate about 9,500 kilometer (km) of 121 roads, comprising 3,570km of 63 state roads and 5,928km of 58 secondary roads, financed from Government budget and external sources.

66. Transport sector reform requires a national transport policy. In 2005, Government formulated a draft Transport Policy with the following priorities:

 Protect and improve roads with planned repairs and maintenance  Expand or repair existing roads and bridges using designs consistent with international standards  Reduce congestion, especially in the Baku area  Overlay local roads connecting main settlements  Improve road traffic safety  Support the State Program for the Development of Regions  Purchase modern road construction and maintenance equipment

21 TRACECA is an international transport program involving the European Union and 14 member States of the Eastern European, Caucasian and Central Asian region. Since 2009, the organization has been financed by member countries. 22 The Bank is supporting upgrading of the Georgian section of the E-60 from two lanes to four lanes through sequential projects: the First, Second, and Third East-West Highway Improvement Projects. 23 The first Bank transport sector project was the Highway project (IDA-35170) approved by the Board in May 2001. The project reconstructed and upgraded about 94km of selected portions of the existing East-West Highway (M2) from Ganja to Gazakh. The Azerbaijan Second Highway Project (7356-AZ) was approved in January 2006 and focuses on upgrading the Alat-Masalli section of the Baku-Alat-Astara highway (M3) and rehabilitating the Baku–Shamakhi road, which the proposed project would upgrade from two to four lanes. The First Additional Financing for Azerbaijan Second Highway Project (7516-AZ), approved in April 2008, finances upgrades and rehabilitation of sections of M3 Alat-Masalli road not covered by Second Highway Project. 24 Railways have recently lost market share: 15 percent of freight in 2009, down from 18 percent in 2003. 25 MoT finalized the Program in June 2006, but it is being revised and not yet formally adopted.

22 67. Government achievements since 2005 offer an opportunity to reassess priorities. Given the substantial progress and investments in the transport sector and roads, Government can now review priorities to ensure their continuing relevance. Transport policy could be surmised from Government annual budgets wherein many projects require multi-year financial commitments. An articulated multi-year transport program would be useful to clarify strategic Government objectives in the sector. Thus, a Transport Policy and priorities expressed as Strategic Directions, complemented by good engineering-economic studies is a necessary next step in sector development. The Second Highway Project is supporting through technical assistance the formulation of a Road Development Master Plan to be initiated in 2010.

The Road Sector

68. Government aims to upgrade infrastructure rapidly to international serviceability standards through substantial investments. Developing the national road network supports the Government agenda to diversify economy and stimulate non-oil growth by improving access to markets and promoting regional development. Diversifying the economy is a pillar of the FY07- 10 CPS26 and one of Azerbaijan’s key challenges. Government support for infrastructure development, and roads in particular, is based on the strong correlation observed between infrastructure development and economic growth due to increased competitiveness of Azeri products, better regional integration, and enhanced access of rural communities to markets and social services such as health and education. A 2006 study identified Azerbaijan as one of the countries with the poorest road infrastructure in the ECA region and suggested that over 75 percent of gains from increased regional trade could be achieved by upgrading road infrastructure in countries with the poorest networks.27

69. Azerbaijan has about 25,000km of roads. The total length includes 2,000km of roads in the Nakhchivan Autonomous Republic. The public road network in Azerbaijan (excluding Nakhchivan) falls under ARS. Nakhchivan has its own road agency, named Nakhavtoyol.28 Roads ownership in Azerbaijan is divided into state, municipal, and private roads. State roads are divided into three classes: Major arterial roads (M), Minor arterial road (R), and collector and local roads.29 Eight are classified as M-roads, and sixty-six as R-roads. The M-roads include the following:

 Baku-Guba-Russian Border (Ml- 208 km)  Baku-Alat-Yevlakh-Georgian border road (M2-503km)  Alat-Astara-Iranian Border (M3-243km)  Baku-Shamakhi-Yevlakh (M4 - 280km)  Yevlakh-Zagatala-Balaken (M5 – 164km)  Hajiqabul-Shirvan-Saatly-Zangilan (M6 – 286km)

In Nakhchivan:  Ordubad-Nakhchivan (M7 – 87km)  Nakhchivan-Sadarak (M8 – 100km)

26 CPS FY07-10 has four pillars: (i) improving public sector governance quality and transparency; (ii) supporting sustainable and balanced growth of non-oil economy; (iii) increasing quality and access to social services; and (iv) improving the environment. 27 Shepherd, Ben and John S. Wilson, Road Infrastructure in ECA: Does Network Quality Affect Trade? 2006. 28 This Annex excludes the Nakhchivan network and road budget, of which little is known. 29 The classification and road numbering are being revised under the Technical Assistance program. 23 70. The future main motorway network of Azerbaijan will comprise M1, M2, M3, and M4 arterial roads plus bypasses around the capital, Baku. The M1 and M3 are North-South corridors, some parts of which are already upgraded to four lanes and some are being upgraded. The M1 links Baku to the Russian border and M3 links Baku to Iran. The M2 and M4 are East- West corridors. The M2 is part of the Great Silk Road, the main Baku-Tbilisi route. The M4 runs from Baku to Shamakhi and merges into the M2 at Yevlakh.

71. The Third Highway Project is the third phase in Bank support for the Azerbaijan road sector.30 The Government describes the proposed investment in a draft “State Program for Rehabilitation and Development of Azerbaijan’s Republic Highways (2006-2015,)” still to be approved.31 The Government’s objective is that M1, M2, M3 and M4 will eventually attain international motorway standards for technical and geometrical specifications, traffic safety, signage, road user amenities such as motorway rest stops, operating and maintenance protocols, and a sustainable funding mechanism. The four M-roads total some 1,230km; about 300km are already upgraded to four or more lanes but clear mechanisms for operation and maintenance are lacking. In the next five years, Government plans to upgrade an additional 700km so by the end- 2015 about 1,000km roads should be upgraded to motorway standards. See table below:

30 The 2001 Highway Project launched the first phase of the Bank support and provided US$40 million equivalent to reconstruct a section of M2, provide technical assistance for rural road maintenance, and begin modernizing the road sector. The second phase is substantive and broad totaling US$675 million and improving over 450 km of major roads through the Second Highway Project. Technical assistance is sector-wide, covering policy, institutional, and technical issues. The Third Highway Project is the third phase; it focuses on motorway development, about 10 percent of the total motorway network. 31 In June 2006, MoT finalized the draft, but it is now under revision and has not been formally adopted. 24

Azerbaijan Highway Network Development Plan (2009-13) Current Status Planned for 2015 Annual Average Road Length Road Length Daily Traffic Highway Category32 (km) Category (km) (vehicles as of 10/01/2009) M-1 Baku-Guba- I 134 I 198 Russian border road 6 lanes 28 6 lanes 28 20 571 (208km) 4 lanes 106 4 lanes 170 II 67 III 7 M-2 Baku-Alat- I 127 I 496 7 106 Gazakh-Georgian II 337 border road III 39 (503km) M-3 Alat-Astara- I 22 I 202 Iranian border road II 105,2 8 250 (243km) III 115,8 M4 Baku-Shamakhi- I 19 I 109 Yevlakh road II 160 II 108 6 504 (280km) III 101 III 63

72. The public road network has sufficient length and coverage for interregional road transport in Azerbaijan, and for international connections to neighboring countries. However, the road network serviceability needs upgrading. In 2009, the total Azerbaijan vehicle fleet was about 926 000, or 105 vehicles per 1,000 inhabitants, about 22 percent of car ownership of Western European countries, but during 2004-10, vehicle ownership in Azerbaijan was rapidly increasing due to high economic growth. Since vehicle ownership is expected to climb further, the road network must have additional capacity. Most highways are in fair condition due to investments financed by the Bank and other IFIs over the last five years. However, these highways need upgrading to international standards to accommodate growing traffic volume. The main of regional importance and rural roads are in poor condition and in urgent need of rehabilitation and maintenance.

73. The Azerbaijan road network database needs updating. The most recent data collection for the entire network was in 2002. The Second Highway Project is funding a consultancy to collect data on road network conditions, which should be available by late 2010. Nonetheless, ARS and its maintenance units conduct routine empirical reviews of the network. Since 2002, condition of major arterial roads (M-roads) have improved through significant investments. However, condition of the rest of the network is presumed to have deteriorated; International Road Federation (IRF) information supports this. The table below estimates the current condition of the road network.

32 According to the SNIP classification used in Azerbaijan, first category roads should have minimum four lanes with a median width of minimum five meters; second category roads have two lanes of 3.75 m; third category roads have two lanes of 3.50 m. 25 Azerbaijan Road Network and Estimated Condition (2009)33 Total Total Road Category %Good %Fair %Poor %Bad (km) ( %) M-roads 45 10 45 0 1 713 100 R-roads 30 10 50 10 2 590 100 Y-roads (paved) 16 20 52 12 4 908 100 Y-roads 9 19 55 17 8 115 100 (unpaved)

74. Operating costs to road users are generally high and part of local roads are impassable during winter. Some rural communities lack access to services for several months of the year.34 The condition of the roads is poor due to quality of construction and materials and lack of regular preventive maintenance after road construction/rehabilitation.

Structure of the Road Sector Budget

75. The Bank plans to assist the Government through the ongoing Public Expenditure Review, to improve the budgeting process for ARS. The process of preparing a road budget would focus decision makers’ attention on spending priorities and efficient expenditures.35 The road sector budget is key to guiding development and monitoring performance, but the current budget lacks a framework to monitor the road administration performance. Preparing a road sector budget that is based on international good practice is a development milestone that Azerbaijan MoF/MoT/ARS can achieve with Bank support.

Road Sector Budget Financing 2005-10 (in Million AZN) 2005 2006 2007 2008 2009 2010 Funding Purpose (actual) (actual) (actual) (actual) (actual) (plan) Road maintenance and remedial works funding (Road Budget Fund) 30.0 50.0 131.2 182.3 166.3 170.0  Arterial roads (11.6) (17.8) (65.0) (91.7) (88.5) TBD  Local roads (18.4) (32.2) (49.2) (58.7) (56.5) TBD  City roads - - (17.0) (31.9) (21.3) TBD Investments (excluding MDB/IFI etc. financing) (new construction, reconstruction, 25.7 152.5 312.7 1,215.0 958.7 800 rehabilitation, major repair) Total state road sector expenditures 55.7 202.5 443.9 1,397.3 1125.0 970 Total MDB and IFI funding (New construction, major repair 19.5 41.3 87.7 159.0 165.0 670 reconstruction, rehabilitation) Total Road Sector Funding 75.2 243.8 531.6 1,556.3 1, 290.0 1,640

33 The estimate is based on the International Roughness Index (IRI) for each category of paved road: M Roads – Good (2), Fair (4.5), Poor (6), Bad (8); R Roads - Good (3), Fair (5), Poor (7), Bad (9); Y Roads (paved) - Good (4), Fair (6), Poor (8), Bad (10). 34 The Bank’s first highway project built a bridge over the Pirsaat River near Poladli village; during a recent visit, residents expressed satisfaction with the bridge and improved road, but reported that during winter the road still cannot be snowplowed which prevents access to hospital. However, the visit confirmed significant community benefits from the bridge and road. 35 In the published budget, funding for road sector projects is a subset of “construction/state investments”. Based on negotiations involving MoF,MoT, ARS, and other state agencies, funding is allocated for individual projects and approved by the Cabinet of Ministers. If reallocation of funds is needed among listed projects during the fiscal year, approval must be sought from the Cabinet of Ministers. 26 76. Since 2005, the road sector budget has increased regularly and significantly. Government has recognized the importance of road infrastructure and Azerbaijan’s improved fiscal situation due to oil revenues has made it possible to invest. The IFI financing provided during the same period was substantial but pales in comparison to state budget financing. Typically, IFI financing requires economic criteria; for example, World Bank, EBRD, and ADB project funding requires economic analysis. The IFI involvement helps Government achieve high-quality results, realize savings in works design and contracting, and ensure that environmental and social safeguards are met. For budget-financed operations, economic evaluation is not required, which can lead to misallocation of resources, over-design, and inefficient use of budget resources. Recently, maintenance funding has also increased significantly. Based on preliminary analysis, maintenance funds appear adequate to upgrade the national road network to a maintainable level within a decade, if funds are used efficiently.36

Road Fund

77. The Road Fund was reinstated in 2007. During 1994-2000, a Road Fund formed from charges on road users - taxes on fuel excise, annual vehicle inspection, vehicle sales, transit, and turnover, financed the road sector. The Road Fund was abolished in 2001 and then reinstated in January 2007 by Presidential Decree as the “Budget Fund on Roads,” administered by the Ministry of Finance. In 2009, the Fund received revenues of about AZN 145 million, or US$180 million, from the following six sources37.

 Annual Road Tax, based on vehicle engine capacity (2009 budgeted: 36.3 million AZN)  Vehicle transport tax for passengers and loads (2009 budgeted: 11.5 Million AZN)  Imported car excise tax (2009 budgeted: 55.0 Million AZN)  Customs charges from inbound transport (2009 budgeted: 31,7 Million AZN)  State fees for annual vehicle technical inspections (2009 budgeted: 7 Million AZN)  State fees on international car transport transit (2009 budgeted: 3.5 Million AZN)

78. The Road Fund is channeling revenues for road maintenance. The Fund is not extra- budgetary; whatever amount is collected as revenue for the Fund is earmarked for road maintenance and road repairs.38

 During the budgeting process, the amount to be collected is estimated, but the amount released to the Fund equals actual revenue collected - shown as a single line item39.

 ARS requests and justifies funding needs for maintenance and remedial works. The principles for allocating Fund money are determined by the Cabinet of Ministers and then approved by the President.

 Typically, about 50 percent of revenue is allocated to arterial roads; of the remaining 50 percent, 75 percent goes to local roads, and 25 percent to urban roads. ARS selects

36 Project file contains details on the preliminary analysis. 37 The new Road Fund does not tax fuel, unlike most European countries in which fuel tax is a major source of state revenue and only a small percentage goes back to the road sector. 38What constitutes ‘road maintenance’ and ‘road repairs’ are not defined. 39 Maintenance budget allocations are not fixed in the government budget; the total amount for maintenance and repairs is one line item; the 2010 Project list will be approved in February-March 2010; typically, it is not publicly disclosed. 27 specific geographic, road segment, and work-type distribution for maintenance funds and, if needs, changes or reallocates during the budget year.

79. Maintenance funding is sufficient if used efficiently. Preliminary analysis reveals that maintenance funding to be adequate if properly used, which is not the case now, due to lack of planning and inefficient resource allocation. A target of rehabilitating the entire road network to a year-round maintainable condition within 10 years is realistic if maintenance funds are managed efficiently. Timely application of less expensive surface dressings or asphalt overlays not only conserves budget but also is less disruptive to traffic than road reconstruction, which costs five times as much per kilometer as overlay, and 25 times as much as bituminous surface dressing. Allowing roads to deteriorate to the emergency repair stage is wasteful and avoidable. The Project will not focus on maintaining the entire road system, but it will finance technical assistance to develop a strategy for operating and maintaining the nascent motorway network.40 The Bank is financing a study to review the efficiency and effectiveness of road management and financing; the study will recommend options for improving maintenance of the entire road network. 41

80. Maintenance is now managed through ARS headquarters with the maintenance budget being allocated among 63 regional maintenance units throughout the country. No overall plan exists for routine repairs or maintenance; instead, funds are used on an emergency basis, which is wasteful. Better management will require a comprehensive picture of road network condition, and the ARS has begun collecting road data.42 The Government lacks a system to track maintenance budget spending or outcomes. The Bank, through the Second Highway Project, is assisting ARS to gather data on the national road network. When this task is complete, the Government would have sufficient information to modernize ARS maintenance practices and improve efficiencies of expenditures. However, modernizing maintenance of road networks, other than motorways, is beyond the scope of this project43.

81. The Third Highway Project will upgrade maintenance and operations of motorway. In general, the Government efforts in the sector have not been on maintenance. It has been focused on investing in new roads, and Bank involvement has helped the Government to achieve high-quality design and significant savings in contracting works for Bank-funded projects. The Second Highway Project is helping to establish a road management system and continues to support ARS development as a road administrator and manager, while MoT provides sector policy direction. Under the Third Highway Project, the Bank will support MoT and ARS to develop an operations and maintenance strategy focused on Azerbaijan motorways.

Traffic

82. Growth of Azerbaijan’s total vehicle fleet is outstripping road infrastructure expansion. The growth of vehicle ownership and traffic is expected to continue outpacing strong

40 Under the Second Highway Project, technical assistance for Road Asset Management is ongoing. 41 Improving the Sustainability of Road Management and Financing in South Caucasus (ESW) (P120837) 42 Azerbaijan is investing substantial funds in roads; the next step is to establish a modernized maintenance department with an accounting information system that can monitor performance, and better-equipped with right-sized workforce. Now, most of the maintenance budget is for the salaries of the 6,000 to 7,000 ARS maintenance department staff. The Bank is attempting to upgrade maintenance practices. 43 The Bank through the Second Highway Project will start to assist in modernizing maintenance practices for the rest of the road network. 28 GDP growth. In 2009, there were about 926 000 vehicles.44 The length of Azerbaijan’s road network is sufficient but its capacity must increase to meet rising motorization rates, especially on sections of the main network destined to become motorways, where increased traffic creates unsafe conditions and congestion. As a result, Government has embarked on a 1,000km of motorway development for completion by 2015. Road investments will increase capacity to meet rising travel demand, improve traffic flow, and reduce travel times. Road capacity increases and new roads are also needed in urban/peri-urban areas, especially around Baku, where congestion is a major problem.

83. In the short term, traffic growth could lead to increased injuries and fatalities. Road traffic safety in Azerbaijan is poor and requires a comprehensive approach to improvements.45 The Second Highway Project is supporting a Traffic Safety Strategy, which is underway. In 2009, there were about 10 fatalities per 10,000 vehicles, more than five times in the rate of the best countries (see chart below). In 2007, 43 percent of road crashes involved pedestrians. The Third Highway Project, though the design of the Motorway guidelines and the road safety measures implemented between Baku and Shamakhi, will work towards mitigating traffic accidents on motorways due to traffic growth.

Road traffic accidents in Azerbaijan (1995‐2009)

4,000

3,500

3,000

2,500

2,000

1,500

1,000

500

0 1995 2000 2003 2004 2005 2006 2007 2008 2009

injured fatalities accidents

Fatalities, serious injuries and crashes in Azerbaijan Source: Azerbaijan Statistical Committee (www.azstats.org); Traffic Police from Azerbaijan, April 2010

44 Now there are some 105 vehicles per 1,000 inhabitants (official rate), which is low by European norms. It was 35 in 1995, 39 in 1999, 43 in 2002, 49 in 2004, and 69 in 2007. 45 World Bank, Camos-Daurella, Silcock, Addressing the Road Safety Challenge in South Caucasus, 2009. 29 Fatality rates in the South Caucasus countries and in other European and neighboring countries 20 s 18 le ic 16 h e 14 v 0 12 0 ,0 10 0 1 8 r e 6 p s 4 te a 2 r ty 0 li ta a F

Fatality rates per 10,000 vehicles in Europe Source: World Bank

Technical Assistance under Bank-Funded Highway Projects

84. The Highway project (IDA-35170) was the first Bank transport sector project in Azerbaijan. The project, Board-approved in May 2001, included an institutional development component that initiated road sector modernization.46 Project technical assistance introduced sector officials to general principles and ideas for modern road sector management. The 2009 Implementation Completion and Results Report (ICR) recommended that ARS should continue to implement proposed reforms, and noted that Azerbaijan road sector modernization had much more to do.

85. The Second Highway Project (7356-AZ) implementation started in 2006. The Bank continued support for institutional strengthening through multiple technical assistance activities: (i) updating and modernizing the Road Law; (ii) improving and expanding computer systems in MoT, ARS, and ARS Regional Offices; (iii) completing the Road Data Bank; (iv) superimposing technical road classifications on functional road classifications; (v) developing a model Service Agreement between ARS and its Regional Offices; and (vi) developing capacity in the ARS Ecology and Safety Sector and Land Acquisition Department. The First Additional Financing for the Second Highway Project , approved in 2008, supported development of standard documents for domestic investment projects, a traffic safety strategy, and a road development master plan. Funding was provided for seminars and training for the ARS Investment Division, and for the Transport School curriculum development at the University of Architecture and Construction.

86. Some Second Highway Project technical assistance tasks are being implemented; some are complete. To enhance results and minimize overlap, road sector TA is coordinated with EBRD and ADB. For example, ARS received an EBRD grant to implement the Corporate Plan, which entails institutional strengthening of maintenance works and preparation of service- level agreements for contractual relationships between maintenance units and ARS headquarters. Thus, the Second Highway Project dropped similar TA for preparing Service Agreements.

46The technical assistance was supported by a multi dimensional consultancy undertaken by the Finnroad/Dornier team.

30 Similarly, the ADB Institutional Building has a traffic safety training component, which will be expanded and continued under the Bank projects.47 In general, ensuring that technical assistance yields desired results requires considerable effort. The Second Highway Project technical assistance covers general road sector topics such as law, financing, law on expropriation, and a road development master plan. The Third Highway Project proposed technical assistance will be specific to motorways.

Road Sector Institutional Development Initiatives of other IFIs

87. Cooperation among World Bank, EBRD, and ADB is required in all TA components. Consultation and coordination with transport sector development partners in Azerbaijan will continue under the proposed project. For the past 5-7 years, EBRD, ADB, and the World Bank have supported ARS in several important capital works programs to rehabilitate and upgrade the arterial road network. The Third Highway Project intends to focus on the motorway network and benefit to other IFI-financed sector operations. The EBRD and ADB agreed that policy and institutional development are essential to underpin the considerable level of investments in motorways and both share views detailed in this PAD. The project team will maintain this ongoing informal dialogue with the other IFIs.

88. The EBRD-financed ‘Consultancy to Implement the Corporate Plan’48 has the following objectives:

 Formulate and obtain acceptance for a Service Level Agreement (performance agreement) between the MoT and ARS

 Propose and gain approval for ARS Regional Offices for maintenance management

 Develop three pilot trials for maintenance by contract using direct labor (MUs)

 Begin the consolidation and transformation of the MUs into corporatized entities

 Propose a distribution of decision-making responsibilities between MoT and ARS

89. Improved road sector financing for maintenance, through a service-level arrangement between MoT and ARS is the Corporate Plan objective. Participating IFIs share this objective. Technical assistance under the Second Highway Project aimed to develop a model Service Level Agreement but the project dropped this activity when EBRD found grant financing for the Corporate Plan, which cover the same issues. Since the EBRD consultancy ends in April 2010, it is appropriate for the Bank to help implement maintenance pilot projects in the recommended Corporate Plan.

90. The ADB-supported consultancy for ‘Road Sector Institutional Strengthening’ linked to an ADB sector investment loan has the following broad objectives:

47 Besides road projects, the ongoing Public Investment Capacity Building project can provide traffic safety training. 48 The EBRD consultancy is scheduled for completion in April 2010 31  Improve maintenance practices through organizational development, improve road management systems, equipment, and training in cooperation with World Bank and EBRD

 Study and conduct a legal review of axle load control regulations, help establish weigh stations; advise on monitoring methods for effective axle load control

 Help implement the traffic safety program being developed by the World Bank

 Prepare and train ARS staff in project management and implementation, including environmental and social assessments

91. The ADB Institutional Strengthening technical assistance ended in January 2010. Based on experience and lessons learned, the Bank will continue the institutional strengthening activities for ARS through the Public Investment Capacity Building Project.

32 Annex 2: Major Related Projects Financed by the Bank and/or other Agencies AZERBAIJAN: Third Highway Project

92. Government continues to prioritize investment in main highways and transport corridors to facilitate international trade, economic cooperation, and regional development. Consequently, ARS is implementing a sizeable road investment program of rehabilitation and upgrading. The IFI-financed road investment program in Azerbaijan exceeds US$1.4 billion and covers more than 950km of roads.49 A summary of the IFIs current program, road sections financed, and funding sources are presented below.

Highway Road Section Donor IFI M1 28-45km EBRD M1 6-16km, 89-109km,121-125.5km Chech Export Bank M2 Baku Bypass Abu Dabi Fund M2 Baku Bypass Kuwait Fund M2 Hajigabul-Kurdamir EBRD M2 Kurdamir-Ujar World Bank (IBRD) M2 Ujar-Yevlakh IDB M2 Ujar-Yevlakh OPEC Fund M2 Yevlakh-Ganja Saudi Development Fund M2 Yevlakh-Ganja IDB M2 Yevlakh-Ganja (Ganja Bypass) ADB M2 Ganja-Gazakh (including Tovuz Bypass) World Bank (IDA) M2 Gazakh-Georgian border ADB M3 Alat-Masalli (0-142.9km) World Bank (IBRD) M3 Masalli-Astara ADB M4 Baku-Shamakhi-Mughanli World Bank (IBRD) M6 Hajigabul-Bahramtapa World Bank (IBRD, IDA) R6 Tagiyev-Sahil World Bank (IBRD)

93. World Bank Azerbaijan Highway Project (3517-AZ). The US$40 million project closed in January 2009; main components were rehabilitation of a 94km Ganja-Gazakh segment of the Baku-Georgian border road, including construction of Tovuz bypass, and a TA program to modernize road administration. The September 2009 ICR found the project satisfactory in achieving the development objective. 50

94. World Bank Azerbaijan Second Highway Project (7356-AZ). The US$200 million project was approved on January 2006, and financing was increased to US$675 million following approval of two Additional Financing (in 2008 and 2009). Initially, the project focused on upgrading the Alat-Masalli section (143km) of the Alat-Astara highway (M3) and rehabilitating the road linking Baku to Shamakhi (124km). The Alat-Masalli section was to be widened to four lanes, mostly along a new alignment which would shorten it by 30km, bypass main cities and improve overall traffic safety. The Baku to Shamakhi (124km) is a section of the shortest route from Baku to western Azerbaijan and Georgia. The road needed urgent repairs to

49 Government is funding road investments using commercial bank borrowings of about US$550 million for about 250km of M2 and M4 roads. 50 Implementation Completion and Results Report Highway Project, Report No:ICR00001094, the World Bank, September, 2009. 33 revitalize the regional economy and improve safety. Government requested rehabilitation of the Ujar-Kurdamir section (40km) of the East-West corridor, which was included in the project. Institutional aspects of the project aimed to ensure administration capacity to manage the road sector, develop construction and maintenance design standards, gather road data, and plan and program road investments and maintenance, based on sound economic and technical criteria.

95. The First Additional Financing (7516-AZ) for Azerbaijan Second Highway Project in the amount of US$300 million was approved in April 2008. It aimed to finance upgrading and rehabilitating more sections of M3 Alat-Masalli road: (i) upgrading the remaining 112km of M3 highway between Shorsulu and Masalli; and (ii) rehabilitating R6 Tagiyev-Sahil road (41km), which connects M3 with the M1 highway, the northern part of the North-South corridor leading to the Russian border. The first Additional Financing also supported road sector modernization such as development of standard documents for domestic investment projects, traffic safety strategy, and road development master plan.

96. The Second Additional Financing (7725-AZ/4615-AZ) for Azerbaijan Second Highway Project in the amount of US$175 million was approved June 2009. It focuses on rehabilitating the Hajigabul-Bahramtapa region road network to foster area development. It finances 116km of the M6 highway between Hajigabul and Bahramtapa and rehabilitating about 200km of local roads connecting villages with the M6.

97. World Bank Rail Trade and Transport Facilitation Project (41755–AZ). The US$450 million project was approved March 2008; its main objective was to improve railway services in Azerbaijan, particularly along the transport corridor toward Georgia (East-West corridor), and increase Azerbaijan Railways’ competitiveness, financial sustainability, efficiency, and capacity. The project is expected to support the development of services by enabling the railway to attract growing transit business to Azerbaijan. The restructured project was signed on December 18, 2009.

98. World Bank Public Investment Capacity Building Project (4595-AZ). The US$8.0 million project was approved in June 2009; the development objective is to improve preparation and implementation of investment projects in priority sectors, especially infrastructure. The project will mainly focus on institutional development and capacity building in the roads and water supply and sanitation sectors. It will provide project management training to enhance capacity of ministries and other government agencies. The project design recognizes multi- dimensional capacity building and maximizes linkages with capacity-building components in ongoing Bank projects.

99. Asian Development Bank (ADB). The ADB has provided loans to Azerbaijan to finance the reconstruction of Masalli-Astara section of M3, the Yevlakh-Ganja section, including the Ganja bypass (89km) and Qazakh-Georgian border section (38km) of M2, and improve local roads (about 65km) in project areas. Projects include technical assistance components on road sector institutional strengthening. Consulting services under key TA cover institutional strengthening in the following: (i) road maintenance; (ii) axle load control; (iii) road safety; and (iv) project management and implementation. The ADB is also providing assistance to ARS to establish a secondary roads database and conduct a toll roads study.

100. European Bank for Reconstruction and Development (EBRD). The EBRD is financing sections of M1 and M2 highways and has provided a grant to implement key Corporate

34 Plan recommendations developed under the World Bank-financed Highway project. This technical assistance aims to help ARS conduct institutional strengthening of maintenance activities, through implementing ‘service-level’ agreements to govern the relationship between regional maintenance management divisions and maintenance works units. Consultancy assistance to three selected pilot maintenance works units aims to develop contractor-client performance agreements, including specifications for tasks, quantities, and quality standards. Implementation of this technical assistance is expected to be completed by May 2010.

35 Annex 3: Results Framework and Monitoring AZERBAIJAN: Third Highway Project

Results Framework

PDO Project Outcome Indicators Use of Project Outcome Information To contribute to a more efficient Efficiency: Reduction in road user MoT and ARS will use the and safer Baku-Shamakhi road costs from Baku to Shamakhi.51 information to monitor road and higher quality road services network condition and provide ARS as part of the upgrading to Safety: Reduction of Personal with data to formulate road motorway standards, and to Injury Accident per 100-million management policy. improve the management of the vehicle-km along the Baku- nascent motorway network. Shamakhi road.

Quality: Percentage of M Roads in Good and Fair Condition as a share of total M Roads of the network.52 Intermediate Outcomes Intermediate Outcome Use of Intermediate Outcome Indicators Monitoring Component One Component One Component One Upgrade a 100 km section of Number of km upgraded / MoT and ARS will use the the M4 road between Baku and rehabilitated for Baku-Shamakhi information to monitor Shamakhi, from two lanes to Percentage of safety audits implementation progress and four lanes motorway standards. conducted on road accidents prepare an action plan to address recorded during construction stage potential delays. of Baku-Shamakhi Safety audit of detailed designs and at construction completion. Component Two Component Two Component Two Study, design and pilot- Design of a Motorway Operations MoT and ARS will use the implement a sustainable and Maintenance Manual information to monitor financing and management Assessment of operations and implementation progress and scheme for motorway maintenance pilot on sections of prepare an action plan to address operations and maintenance. the existing motorways potential delays or difficulties. Presenting assessment and MoF, MoT and ARS will use the motorway financing and information to identify new management recommendations to opportunities for infrastructure MoF, MoT and ARS financing, focusing on Motorway Development of a pilot Motorway Assets Management. Management Unit.

51 Road user costs include transit time and vehicle operating costs. 52 One of IDA’s core indicators for transport, others are not applicable for this Project. 36 Arrangements for Results Monitoring

101. ARS, under the supervision of Ministries of Transport and Finance, will monitor project implementation. This includes supervising works and TA, auditing financial statements, and monitoring project indicators during the project lifetime. The ARS will submit bi-annual reports to the Bank covering implementation progress and key issues, in a format satisfactory to the Bank, one month after the end of each calendar semester. Progress reports will focus on results, not process-related information. The monitoring by ARS will be supplemented by regular Bank implementation support missions and project implementation monitoring by Bank Baku- based specialists. In view of the selected indicators, no data collection difficulties or capacity issues are anticipated.

37 Target Values Data Collection and Reporting

Project Outcome Indicators Baseline 2011 2012 2013 2014 Frequency and Data Collection Responsibility Reports Instruments for Data Collection

Efficiency: Reduction in road user costs from Baku 100%55 80% Every year Technical reports PIU, ARS to Shamakhi;53 and Road Data Statistical Unit Bank Safety: Reduction of Personal Injury per 100- million vehicle-km along the Baku-Shamkhi road; 100%56 90% 80% 70% Every year

Quality: Percentage of M Roads in Good and Fair Condition as a share of total M Roads of the network.54 55%57 60% 65% 70% Every year

Intermediate Outcome Indicators

Component One

Number of km upgraded / rehabilitated for Baku – 0 30 70 100 100 Every 6 months Project PIU and ARS Shamakhi Monitoring Statistical Unit reports Percentage of safety audits conducted on road accidents recorded during construction stage of 0 25% 60% 80% 80% 80% Each year Baku – Shamakhi done Safety audits on detailed design done Safety audits on construction completion

53 Road user costs include transit time and vehicle operating costs. 54 M1, M2, M3, M4, M5 and M6 (currently within the control of ARS). 55 For a 2009 vehicle, car US$0.32/km and for MGV US$0.69/km between km15 – km 116 on the Baku-Shamakhi road 56 Personal Injury rate per 100 million vehicles kms between 2001 2005 is 17.3 57 Based on projections from 2005 data (To be confirmed by December 2010). 38 Component Two

Design of a Motorway Guidelines done Project ARS and PIU Monitoring

Assessment of operations and maintenance pilot on reports sections of the existing motorways done Every 6 months

Presenting assessment and motorway financing and management recommendations to MoF, MoT done Every 6 months and ARS

Development of a pilot Motorway Management done Unit

39 Annex 4: Detailed Project Description AZERBAIJAN: Third Highway Project

102. Component 1: Upgrading M4 road section Baku-Shamakhi into four-lane motorway and related road safety activities (US$296 million without VAT). This component comprises civil works for the above-mentioned road and consultancy services for works supervision and technical audits. The component finances road safety activities to be implemented throughout the project (i.e., during design, construction, and opening of the new four-lane road). Any land acquisition and resettlement costs would be financed by Government. In addition, there is a funding for the design of a future motorway investment to be specified by the Government.

103. Upgrading of Baku-Shamakhi to a four-lane motorway (US$286 million without VAT): The component will finance Baku-Shamakhi road upgrading to four lanes for about 100km from km 15 to km116 (Shamakhi bypass will be a 8km two-lane road, to be upgraded to four-lane when transit traffic justifies). The first 13.3km of the Baku-Shamakhi road is being four-laned and the rest of the existing two-lane road is being rehabilitated under the World Bank- financed Second Highway Project.. The proposed project mainly serves Mountainous Shirvan economic zone region and also facilitates road services towards west and north-west part of Azerbaijan and Georgian border. Detailed design to widen the first 30km (km 15 to km 45) to four-lane is complete. No land acquisition is needed for this first tranche of civil works; therefore it is expected that works will commence on the first 30km soon after project is declared effective. Most of the road widening will be carried out within the existing right-of-way, with few exceptions, such as the Shamakhi bypass.

104. No significant technical issues are expected during construction. Estimated total construction cost is US$286 million (average US$2.8 million per km ), including supervision and technical audits. The design for road upgrade to four lanes is financed under the Second Highway Project. Most sections of the proposed road follow existing alignment of the two-lane highway with Category I-b geometric standards under Former Soviet Union Standards (SNIP). If necessary or to achieve savings, designers can use other standards, such as those recommended by the European Committee for Standardization on design and construction of roads and highways, or the American Association of State Highway and Transportation Officials. Realignment and bypass options will be considered. Consultants in charge of detailed design will minimize impacts on the rehabilitation works; designers will also minimize the need for land acquisition.

105. Road Safety Improvement (US$7.0 million without VAT): Azerbaijan lacks capacity to deal with road safety issues, and poor driver behavior is widespread. An institutional framework for road safety is lacking and skilled road safety professionals are in short supply. There have been efforts to identify gaps and develop proposals, but no actions have been taken.

106. Highways II has a substantial road safety component: (i) preparation of a road safety strategy and a five-year Action Plan; (ii) design and first-stage implementation of a road crash data-base; (iii) capacity building, professional development and equipment for traffic police; and (iv) preparation of road safety audit guidelines and black-spot identification and treatment guidelines. Recruitment is underway for consultants to carry out this work, which is expected to start in early 2010. The main counterpart for the traffic safety component of the Second Highway

40 Project is the traffic police, who are designated ‘lead agency’ for road safety in Azerbaijan. A State Road Safety Commission also exists in Azerbaijan, but meets rarely.58

107. The Third Highway Project road safety activities are modest, measurable, and focused on construction and motorway operation. The component will finance road safety activities along the Baku - Shamakhi road, and help establish mechanisms to use and apply to operation of the entire motorway network. The component will finance US$0.5 million for safety audits of designs and traffic safety supervision reviews so contractors implement good practices for road safety and traffic management during civil works, which has not been the case so far during road repair or reconstruction under the Highway and Second Highway Projects. The component will finance US$6 million additional civil works earmarked as a provisional sum in civil works contracts for road safety improvements during construction of the additional two lanes. This is expected to include better facilities for pedestrians, improved junction designs and roadside crash barriers. By the end of construction, the component will finance US$0.5 million to prepare a mechanism to complete safety audits prior to motorway opening and to develop a traffic safety management strategy for daily road operation. It is anticipated that this will provide a template for all future motorway construction projects in Azerbaijan.

108. Consultancy for Design of a Motorway Investment (US$3.0 million without VAT) This subcomponent will follow the practice developed under Highway and Second Highway Projects of funding for consultants to design a future motorway investment; this segment to be specified by the Government at a later date. The Bank involvement would ensure cost efficient designs that take into account environmental and social safeguards issues.

109. Component 2: Institutional Development for ARS and MoT in motorway operations and maintenance (US$5.0 million without VAT). Government plans to have the 1,000+km motorway network operational by 2015,59 up from 180km in 2005, most of which was entering Baku. This ambitious undertaking has focused only on capital investment, not arrangements to manage operations and maintenance, nor financing mechanism reforms. Therefore, Azerbaijan is aiming to complete its motorway infrastructure through capital investment, but without a road management strategy. Consequently, this project is timely to support development of a sustainable motorway management and financing policy, an efficient mechanism to allocate resources and ensure delivery of quality motorway services. Project assistance will be two-fold: (i) a study, led by MoT, to explore options for a management and financing policy and efficient allocation of resources for Azerbaijan motorways (US$0.5 million, procured and disbursed by the PIU); and (ii) activities implemented directly by ARS to test operations and maintenance mechanisms to ensure delivery of quality motorway services (US$4.5 million), including an operations and maintenance pilot on sections of the existing motorways (US$3.5 million).

(i) Preparation of a study for a management and financing policy and efficient allocation of resources for Azerbaijan motorways (US$.0.5 million without VAT)

110. MoT will lead the technical discussions for a study on how to prepare a sustainable motorway infrastructure scheme. The study would lead MoT and MoF to discuss and agree on funding and spending arrangements, a mechanism for motorway capital investment, and

58 The current composition of the Road Safety Commission includes Deputy Prime Minister (Chairman), Deputy Minister of Transport, Chief of State Road Police, Deputy Mayor of Baku, Chairman of ARS, Head of Transport and Communication Department of the Cabinet of Ministers, and Head of Administrative Agencies Department of the Cabinet of Ministers. 59 Motorway: four or more than four lanes highway with full or partial access control and used for motor vehicle only. 41 operations and maintenance. The abundant literature available needs to be adapted to Azerbaijan’s motorway network, which was almost nonexistent five years ago and could be completed within a decade, according to Government. The component will help develop the concept of user-pay principles for the motorway network. By project-end, the MoT and MoF will have reviewed options and agreed upon a mechanism for motorway funding and spending and implement it. This agreement could happen as early as at the mid-term review and reform could be in full swing by 2015 when the project ends and the 1,000+km of new motorways are operational.

(ii) Institutional development of the ARS in motorway operation and maintenance (US$4.5 million without VAT)

111. Current status: Despite the rapid expansion of the Azerbaijan’s motorway network, network operations and maintenance have not yet been fully considered. Ten years from now activities will be very different. Now 63 units across the country are in charge of maintenance for the entire road network, by territory. The units operate on the main network and local roads, but the notion of “operation” of a road network appears to mean standard routine maintenance and winter maintenance, which is acceptable for local roads. However, motorways operations require specific instructions and arrangements, which do not exist yet. The only agreement is the contractual arrangement between ARS, supervision, and construction contractors. Operations are fragmented for motorway sections open to traffic today. The ARS handles maintenance, the Ministry of Interior enforcement and emergency interventions, and regional authorities manage the access roads.

112. Possible scenarios: Many options60 exist for operations and maintenance arrangements of the motorway network in Azerbaijan, but a set of parameters common to all options is that the road must be serviced 24x7, interventions must be rapid and well coordinated, and users should understand services available during their travel.

113. Activities financed under the component and implemented by ARS: Based on experience and as recommended by ARS, it is likely premature to impose one option among many to organize operations and maintenance. Instead, the project will finance testing of mechanisms under local conditions to extract lessons learned and select the best option. Therefore ARS activities during component implementation will be:

 Establishing “Motorway Guidelines” (US$0.5 million). This document will define all parameters and rules for motorway construction, operations, and maintenance; it will specify construction standards, and services provided to users based on typology and minimum operator requirements; it will define principles governing arrangements between the MMU and operators.

60 For instance, a new division, the Motorway Management Unit (MMU), could be responsible for (i) coordination with MoT on programming and financing of capital investment and recurrent costs; and (ii) implementing all operations and maintenance delegated to operators. Alternatively, three operators could be established for operations and maintenance of the 1,000km motorway network by motorway section: (i) operator for M1 and M4, (ii) operator for M2 and M3 and (iii) operator for the network around Baku. The Motorway Management Unit would have performance-based contract with each unit. Performance would be measured by level of service; operators could be public, (restructured existing maintenance units), or private.

42  Testing a small experimental Motorway Management Unit at ARS (US$0.5 million). The component will finance an international consultant to be based in Baku during the assignment to pilot a small MMU at ARS (2 to 3 people). The component will finance goods and services for the Motorway Management Unit, which will be staffed with ARS personnel, or national short-term consultants. The MMU will be responsible for dealing with units in charge of operations and maintenance of the M4 Baku Shamakhi (an “open” network with at-grade intersections) and M3 Alat Masalli (a “closed” network with fences and separated grade interchanges). The objective is for the MMU to prepare all requirements and contractual arrangements in time for infrastructure opening to traffic. Then, the operators, most likely the existing maintenance units, will have budgets that allow them to provide the required level of service. The internal consultant and the MMU will explore out-sourcing operations and maintenance to the private sector, using performance-based management. By end-project, the MoT should have sufficient information to organize motorway operations and maintenance based on recommendations from ARS.

 Carrying out an operations and maintenance pilot on sections of the existing motorways (US$3.5 million). Several roads have been recently upgraded to 4 lanes. The operations and maintenance of these 4 lane-roads, which are now part of the nascent motorway network, need to be modernized. The Project will fund the training, some limited equipment mostly for traffic safety purposes such as guardrail, signaling, trailers for mobile signalization during works to prevent accidents during intervention, provide consultancy support for the maintenance units that are responsible for the related sections of the motorways. The pilot will help the ARS and the related maintenance units to design a service agreement between the units with ARS maintenance department at the headquarters outlining the resources available to this unit and corresponding service obligations. Senior ARS management is supportive of one unit responsible for one entire corridor but this has to be further investigated. At Mid Term Review, there will be an assessment of the progress of these maintenance units in improving their performance.

114. Component 3: Project Implementation (US$1.0 million without VAT) The project will fund consultant services to staff the PIU; provide equipment and TA to support project management capacity of the PIU, ARS, and MoT, including office equipment, software, training and seminars, financial management TA, and project financial audits.

43 Annex 5: Project Costs AZERBAIJAN: Third Highway Project

Project Cost By Component Project Total World Bank Borrower and/or Activity US$ million US$ million US$ million Component 1: Upgrade section of the M4 348.64 236.37 112.27 road Baku-Shamakhi into four-lane motorway and implement related road safety activities

Component 2: Provide technical 5.9 4.00 1.9 assistance, training, and institutional development for ARS and MoT in motorway operations and maintenance

Component 3: Project Management 1.18 0.80 0.38

Total Baseline Cost 355.72 241.17 114.55

Physical Contingencies 10% included in above amounts Price Contingencies 10% included in above amounts 355.72 241.17 114.55 Total Project Costs1 Front-end Fee61 0.43 0.43 0.00 Total Financing Required 356.15 241.60 114.55

1Identifiable taxes and duties are about US$54 million, and the total project cost, net of taxes, is US$302 million.

61 The Front-end Fee represents 25 basis points of the Loan amount, or US$429,000. 44 Annex 6: Implementation Arrangements AZERBAIJAN: Third Highway Project

115. MoT and ARS have extensive experience with World Bank-financed operations. The Project will be implemented by ARS under supervision of MoT, the policymaking and regulatory agency in charge of the transport sector. The existing PIU responsible for the Second Highway Project will support the proposed project. The PIU is staffed with seasoned local consultants, including engineering, procurement, and financial management staff62, and has significant capacity developed through implementing Bank-financed projects. The PIU is also assisting ARS to implement ADB- and EBRD- financed highway projects. Before project effectiveness, two international consultants will be hired; one to help the PIU with daily operations and implementation of technical assistance, and one to help ARS with policy implementation of the Road Asset Management System, and sharing international best practice tailored to Azerbaijan.

116. Under the Third Highway Project, the PIU will be responsible for procurement and disbursement, and gathering information on project monitoring and reporting. The PIU will continue with existing systems used under the Second Highway Project , and will be in charge of daily activities for project implementation and coordination, including planning, budgeting, procurement, disbursement, auditing arrangements, monitoring and evaluation, and implementation progress reports. MoT will lead the technical discussions on the renewed funding policy and efficient allocation of resources for Azerbaijan motorways (Component 2), since it better corresponds to MoT’s mandate and scope of responsibilities. Under this arrangement, ARS and the PIU will be in charge of implementation of the Project. The ARS, the agency in charge of managing the road network, will test a pilot program that will set up a dedicated MMU and an operations and maintenance pilot on the sections of the existing motorways. Some TA financed under Component 2 will specify detailed MMU structure, responsibilities, and relationships with ARS and MoT.

117. Simultaneous implementation of several operations under a tight schedule requires enhanced ARS and PIU implementation capacity. To provide additional capacity, ARS agreed to hire an international consultant for ARS and another for the PIU, which is expected to improve PIU pro-activity on challenging tasks, and boost capacity for the comprehensive technical assistance program implemented within Bank-financed highway projects. The international consultants will support ARS and PIU in efficient, cost-effective, and sustainable management and implementation of the Road Network Development Program and provide high- level technical support and advice to ARS senior managers on policy and project matters. The Third Highway Project focuses on motorways development so the Project will also finance an international consultant to help with reforms for motorway network operations and maintenance, in close coordination with ARS and MoT.

118. The PIU will adapt the existing operational manual to The Third Highway Project operations. The manual will clarify (i) project management organization; (ii) PIU, ARS, and international consultants mandates; (iii) procurement procedures; (iv) financial management and disbursement procedures; and (v) guidelines for project implementation, in particular for phasing, environmental, and social issues.

62 The PIU organizational chart includes PIU Director, six engineers, three procurement specialists, three financial specialists, three secretaries/translators, and two drivers.

45 Annex 7: Financial Management and Disbursement Arrangements AZERBAIJAN: Third Highway Project

A. Financial Management

Executive Summary

119. The PIU within ARS will have the responsibility for financial management (FM), loan disbursement and auditing arrangements. The adequacy of PIU’s FM arrangements was assessed during preparation of the Second Additional Financing for Second Highway Project and reviewed again during the preparation of the proposed Third Highway project. Weaknesses identified and reported in May 2009 during the preparation of the Second Additional Financing for Second Highway Project have been addressed. The current arrangements, systems and controls are found to be adequate and meet Bank FM requirements. The existing 1C accounting and financial reporting system is being customized to accommodate the proposed project needs. The FM staff capacity has been improved by recruiting a Financial Specialist Assistant in 2009. She has been offered a number of on-the-job trainings to improve her skills. In addition, PIU staff will participate in FM and Disbursement Trainings to be organized under the Public Investment Capacity Building Project. The current FM staff capacity is adequate. The internal policies and procedures are documented in the Project Operational Manual. Additional Third Highway Project specific controls and procedures will be included in the POM to improve internal control framework of the project. The proposed Project will also provide technical assistance to upgrade the FM capacity of the PIU staff. The overall FM residual risk level for the proposed project is assessed as moderate.

Country and Sector Issues

120. A number of studies including A&A ROSC dated September 2006 and draft PEFA report dated February 2008 carried out for Azerbaijan in Public Financial Management area identified weaknesses and made recommendations to strengthen public and corporate sector accounting, auditing, governance, and financial accountability frameworks. Government has made efforts to strengthen public financial management by enacting a Budget System Law, modernizing the Treasury operations, and strengthening capacity of the Chamber of Accounts. Government continues to receive support from IFIs to reinforce public financial management, particularly to improve budget preparation and allocation, introduce internal audit function, and increase overall accountability and transparency in financial reporting. The Corporate and Public Sector Accountability Project will support corporate sector development and investment, improve public financial management and accountability, and establish sustainable training capacity in accounting and auditing, thus integrating Bank support into overall Government accounting and auditing reform program. The current Road sector financing and budgeting challenges are highlighted in paragraphs 75-80 of this document.

46 121. A summary of project risk assessment follows:

FM Risk FM Risk (at (after Comments appraisal) Risk Mitigating Measures mitigation) INHERENT RISK 1. Country Level Weak public financial H Weaknesses are partially H Financial management and addressed under the CAPSAP Management institutions based on project. draft PEFA report. 2. Entity Level ARS Financial S The PIU within the ARS has set M Financial Management systems up FM arrangements satisfactory Management are weak. to the Bank. 3. Project Level Large and complex S The PIU is being strengthened by M Financial operation. recruiting International Management Consultants. Overall Inherent S M Risk

CONTROL RISK

4. Budget Inadequate and/or S The annual budget preparation M delayed allocation of and allocation will be closely annual budget to monitored by the Bank team. finance proposed Comprehensive budgeting investment. procedures were introduced for Second Additional Financing for Second Highway Project. 5. Accounting The existing system is M M being upgraded for the entire PIU portfolio. 6. Internal Controls There were few cases S Specific Internal control M of delayed payment of procedures will be included in invoices. the POM of the project 7. Funds Flow Minimum delays M Monitoring timing of release of M anticipated. counterpart funds. 8. Financial IFRs are submitted on M Interim Financial Reports (IFRs) L Reporting a regular basis. for project reporting will be generated using the 1C accounting software. 9. Auditing The audit reports S Auditors acceptable to the Bank M under HII were to be appointed by the end of slightly delayed. each fiscal year to minimize Therefore, audit delays in starting field audit and reports for HIII may subsequent issue of audit reports. be delayed as the project is large and complex. Overall Control S M Risk Overall FM Risk S M H = High S = Substantial M = Moderate L = Low

47 122. Strengths. The PIU within the ARS has extensive experience in implementing Bank funded projects. It is currently responsible for implementation of Bank funded Second Highway Project It has the necessary human and technical resources to implement the project.

123. Weaknesses and Action Plan. At the end of 2009 there were few occasions when invoices submitted by contractors were not paid punctually due to delayed approval of Variation Orders. The PIU will need to revise the existing Project Operational Manual to include project specific internal controls and procedures, including revision of the current practice of Variation Orders preparation and approval.

Action Responsibility Deadline Existing POM will be revised for the PIU Within 2 months of new project. effectiveness, the POM is revised.

124. Implementation Arrangements and Staffing. The existing PIU, responsible for on- going Second Highway Project will implement FM activities. The PIU has extensive experience in implementing Bank-funded projects and PIU FM staff capacity is adequate.

125. Budgeting. ARS is a state-owned organization. Its activities are fully financed out of the state budget. As a state-owned organization, ARS is subject to regulation by the Budget Systems Law in preparation of its investment and administration budgets. The annual budget process starts in January and ends with the approval of final government budget for next year by Parliament at the end of each year. The draft budget of ARS is prepared by relevant departments and then submitted to the Ministry of Finance. The ARS budget includes funds allocated for investment operations, including IFIs funded projects.

126. The PIU and the Bank during the preparation of the Second Additional Financing for Second Highway Project agreed to comprehensive budgeting arrangements. The currently agreed budgeting process includes not only preparation of the required budget allocations in monetary terms but also development of planned physical volume of main civil works by categories such as amount of road to be asphalted etc. This will help the PIU and Bank to better monitor budget execution. The draft project budget is prepared by PIU with the assistance of technical experts and then submitted to ARS relevant departments and management for approval and subsequent consolidation into overall ARS annual budget. Final approved budgets are then submitted to the Bank. The PIU will have overall responsibility to coordinate the budget preparation with all ARS relevant departments. Budget figures will be entered into the accounting software and their execution will be monitored through the quarterly interim un- audited financial reports (IFRs). The project budget will be split by quarterly expenditures, components, and sources of finance. The residual budgeting risk is Moderate.

127. Project Accounting and Information Systems. The PIU will be responsible for project accounting using the existing 1C Bookkeeping software. The software is being customized to automatically generate the required quarterly financial monitoring reports of the project. The residual Accounting and Information systems risk is Moderate.

48 128. Internal Control and Internal Audit. Two financial specialists and one assistant will handle FM aspects of all projects implemented by PIU. They will be responsible for project accounting, financial reporting, disbursements and auditing arrangements for Second and Third Highway Projects, and would report to PIU Director on project operational matters. A proper segregation of duties arrangements are in place and they are documented in the POM. At the end of 2009 there were a few occasions when invoices submitted by contractors were not paid in a timely manner due to delay in approval of Variation Orders. The PIU will need to revise the existing Project Operational Manual to include project specific internal controls and procedures, including revision of the current practice of Variation Orders preparation and approval. The residual Internal Control risk is Moderate.

129. Financial Reporting and Monitoring. Although the PIU was not able to send Q4 2008 IFRs of the Second Highway Project in a timely manner, IFRs for recent several quarters were submitted within agreed deadlines and they have been found to be acceptable to the Bank. The PIU will maintain project records and accounts and prepare unaudited Interim Financial Reports (IFRs). The IFRs will be submitted to the Bank no later than 45 days after the end of each quarter for monitoring project financial performance. Currently PIU submits, in a timely manner, satisfactory to the Bank IFRs of the existing project. The IFRs of the Third Highway Project will include the following reports: Sources and Uses of Funds, Uses of Funds by project activities, designated account statement and project Balance sheet. The IFR templates have been prepared and agreed with the Bank. The POM will have sample IFRs of the project. The residual Financial Reporting risk is Low.

130. External Audit. Audit reports of the Second Highway Project for FY 2007 and FY2008 were delayed 5.5 and 1.5 months, respectively. Auditors issued unqualified audit opinions. However, the Management Letter mentioned several insignificant internal control weaknesses, which are being addressed by the PIU. To avoid possible delays in the submission of audit reports, the PIU will be required to appoint auditors before the end of each fiscal year. The audit requirement under the proposed Third Highway Project will be the audit of project financial statements. The audit would be conducted by independent auditors acceptable to the Bank, and under terms of reference and auditing standards acceptable to the Bank. Acceptable auditing standards are International Standards on Auditing (ISA) issued by the International Auditing and Assurance Standards Board (IAASB) of the International Federation of Accountants. The audited financial statements will be submitted to the Bank no later than six months after end of each calendar year audited. The cost of financing the audit is eligible for Bank financing. The following chart identifies the audit reports that will be required to be submitted under the project:

Audit Report Due Date Entity financial statements N/A Project financial statements (PFS), including SOEs and Within six months of the end Special/designated account. The PFSs include sources and of each fiscal year and also at uses of funds by category, by components and by financing the closing of the project. source; SOE statements, Statement of designated account, notes to financial statements, and reconciliation statement.

The residual External Audit risk is Moderate.

49 B. Funds Flow and Disbursement Arrangements

131. Terms of the Loan and Credit, and Disbursement Methods. The US dollar denominated IBRD flexible loan is commitment linked with a variable spread and a final maturity of 17 years including a 4 year grace period. The IDA credit terms are 20 years to maturity including a grace period of 10 years. The co-financing percentage will be IBRD/IDA 80 percent; Government 20 percent of project costs exclusive of taxes. Government will be responsible for VAT and other taxes. The loan and credit will be disbursed through transaction- based disbursement methods that include: reimbursements with full documentation, reimbursements on basis of Statements of Expenditures for small expenditures with defined thresholds, payments against Special Commitments, direct payments to third parties, and payments through the Designated Account.

132. Designated Accounts. To facilitate project implementation, Designated Accounts will be opened in a commercial bank on terms and conditions acceptable to the Bank, for the IBRD loan and the IDA credit, respectively. The Designated Accounts, which will be managed by the PIU, will be replenished on a monthly basis, as needed. The total ceiling will be limited to US$15 million for IBRD and US$5 million for IDA. The Designated Accounts will be audited annually in conjunction with the audit of the project financial statements.

133. Disbursements will be made on the basis of full documentation for (i) contracts for goods costing more than the equivalent of US$200,000 each; (ii) contracts for works costing more than the equivalent of US$1 million each; and (iii) services under contracts of more than the equivalent of US$100,000 for each consulting firms and more than the equivalent of US$50,000 each for individual consultants. Disbursements below these thresholds and for expenditures against incremental operating costs and training would be made according to certified Statement of Expenditure (SOEs). For all expenditures financed under Statement of Expenditures (SOEs) full documentation in support of the SOEs will be retained in the PMU for at least two years after the project closing date. This information will be available for review by Bank missions during project supervision and by the projects auditors. SOEs will be audited in conjunction with the annual audit of the project. Further instructions on the size of the Minimum Application and on how funds will be withdrawn from this Loan will be provided in the Disbursement letter.

134. The withdrawal of proceeds from the IBRD loan and the IDA credit will be made in accordance with the following schedule:

50 Amount of the Amount of the IBRD Loan IDA Credit Percentage of Category of Allocated Allocated Expenditures to be Expenditure (Expressed in USD) (Expressed in USD) Financed (Net of VAT) (1) Goods, Works, Consultant Services 171,171,000 70, 000, 000 80% including Audit, Training and Incremental Operating Costs for the Project

(2) Front-end-Fee 429, 000 Amount payable pursuant N/A to Section 2.03 of the IBRD agreement in accordance with Section 2.07 (b) of the General Conditions (3) Premia for Interest Amount due under Section Rate Caps and Interest N/A 2.07(c) of the IBRD Rate Collars agreement TOTAL AMOUNTS 171,600,000 70,000,000

135. Government/ARS Contribution. The Government’s contribution (the total Government co-financing share is US$114,76 million, including VAT) to finance project expenditures will be disbursed from budget allocations through a Project Account maintained in a commercial bank, and managed by PIU. Funds would be released to the project to finance project expenditures as expenditures are incurred, and Project Account replenished regularly to minimize delays in project implementation.

136. Supervision Plan. The Bank will conduct financial management supervision every six months to monitor progress of project implementation. The frequency of the FM supervision can be reduced subject to satisfactory FM arrangements. The first full financial management supervision will take place during the first year of project implementation. The financial management supervision will pay particular attention to: (i) Loan disbursements and financial management arrangements; (ii) review of the project’s Interim Financial Reports and audited financial statements; and (iii) review of implementation of auditor’s recommendations on strengthening systems and controls as outlined in the Management Letters issued by the auditors with the annual Audit Reports. The FM supervision will focus on civil works contracts.

51 Annex 8: Procurement Arrangements AZERBAIJAN: Third Highway Project

A. General

137. Procurement for the Azerbaijan Third Highway Project will be carried out in accordance with the World Bank’s "Guidelines: Procurement under IBRD Loans and IDA Credits" published May 2004 and revised in October 2006 (Procurement Guidelines); and "Guidelines: Selection and Employment of Consultants by World Bank Borrowers" published May 2004 and revised in October 2006 (Consultant Guidelines) and the provisions stipulated in the Loan Agreement and Financing Agreement. The various procurement actions under different expenditure categories are described in general below. For each contract to be financed under the LA and the FA, the various procurement or consultant selection methods, the need for pre- qualification, estimated costs, prior review requirements, and time frame have been agreed between the Borrower and the Bank in the Procurement Plan (PP). The PP will be updated at least annually or as required to reflect the actual project implementation needs and improvements in institutional capacity. A General Procurement Notice (GPN) has been published in January 2010 in UNDB on-line and in its printed version as well as in DgMarket online. Specific Procurement Notices (SPN) will be published for all ICB procurement and Consulting contracts as per Guidelines as the corresponding bidding documents and RFPs become ready and available.

B. Assessment of the Agency’s Capacity to Implement Procurement

138. A Country Procurement Assessment Report (CPAR) was prepared in November 2009. The CPAR was conducted on the basis of four OECD-DAC/World Bank pillars for public procurement. Conclusion is that all four Pillars need improvements for the system to meet the standards and international practices. Azerbaijan has an advanced Public Procurement Law, but institutional aspects require improvement as well as enforcement of the legislation, which is the weakest aspect of the country procurement system.

139. The implementing agency of the Project will be ARS. As this project is part of the road program financed by the Bank in Azerbaijan the ARS PIU will continue implementing procurement, and accordingly the update of the assessment of the implementing PIU of ARS to implement Project procurement conducted by the Bank for the Second Additional Financing for Second Highway Project, in July 2009 remains valid for the current project. Summary of the main findings are: (i) the procurement unit of the ARS with the support of the PIU has the necessary experience to carry out procurement under the Project; (ii) the procurement unit could be overloaded with work as it is responsible for several other Projects and procurement under own budget, all carried out under very tight schedule; and (iii) dealing with numerous contractors and consultants demands reinforced attention to contract administration.

140. The ARS, assisted by the PIU, has previous experience in procurement according to Bank procurement guidelines and or consultants’ selection guidelines. While usually the PIU delivers procurement actions timely evaluation processes and final approval of contracts may take longer than needed. The PIU needs to improve its own monitoring of the supervision consultants, particularly in all aspects related to contract administration.

52

C. Procurement Risk Assessment 141. The overall procurement risk is rated “moderate”. The risks associated with procurement and the mitigation measures were identified in the assessment of ARS procurement capacity and are summarized in the table below:

Table 1: Summary Risk Assessment Ratinga of Ratinga of Description of Risk Risk Mitigation Measures ResidualRrisk Monitoring of contract M Demanding strict observance of L implementation and contract duties by the Supervision administration may be affected Consultant, and resolving any by the increasing workload contract implementation issues based on contract provisions as soon as these arise. Ongoing selection of a high level TA consultant to the PIU with knowledge of procurement should be of help. Contractors financial capacity M Capabilities of winning contractors L may be affected by the to be carefully reviewed at the stage financial crisis of evaluation. Payments to contractors on the basis of contract provisions to be expedited. Procurement and financial S Public Investment Capacity Building M management capability Project will strength the capability currently of the ARS could through training. cause some delay Delayed procurement could M Advance procurement of works (PQ) L slow Project implementation for the first section road has started. Design for the first section is completed, and design for the two remaining contracts is ongoing in accordance with Bank requirements. Average M M H: High; S: Substantial; M: Moderate; and, L: Low.

D. Procurement Implementation and Arrangements

142. Procurement activities will be carried out by the PIU of the ARS, staffed with an experienced Senior Procurement Specialist. The country NCB standard bidding documents for goods and works are reviewed and found acceptable to the Bank. The acceptable NCB bidding document can be found in the Project Implementation Manual (PIM) and project file. Domestic preference in accordance with clause 2.55 and Appendix 2 of the guidelines will apply to goods contracts only.

143. Procurement of Works. Works procured under this project would include: (i) three contracts subject to prequalification : Contract No. 1, Third Highway Project/CW/ICB-01, road

53 section, km 15 – km 45: Construction of a 2 lane highway with structures; Contract No. 2, Third Highway Project/CW/ICB-02, km 45 – km 85): Construction of an approximately 40km 2-lane highway with structures; and Contract No.3, Third Highway Project/CW/ICB-03, road section from km 85 to km 116: Construction of a 2 lane highway with a length of approximately 31 km; and (ii) relevant road safety improvements.

144. Procurement of Goods. Goods procured under this project would include: equipment for improving the management and maintenance of roads, road safety, and environmental monitoring.

145. Selection of Consultants. Consultants’ services contracts to be procured under this Project will include Selection of Consultants for: (i) Supervision of works; (ii) Design for Future Investments; (iii) Technical Audits; (iv) Study on Framework for Motorway Management Unit; (v) Road Safety implementation; (vi) Project Audit, (vi) TA for Motorway Planning and Finance, (vii) Design of Motorway Guidelines, and (viii) TA for Operations and Maintenance pilot on sections of the existing motorways. Short lists of consultants for services estimated to cost less than US$200,000 equivalent per contract may be composed entirely of national consultants in accordance with the provisions of paragraph 2.7 of the Consultant Guidelines. The Procurement Plan also allows for a QCBS for design for future operations in the Azerbaijan road program.

146. Operating Costs. These expenditures would cover the operating costs of PIU as well as Project financial audits, which would be financed by the Project as per annual budget approved by the Bank. Operating cost will not include salaries of civil servants.

147. Advanced Procurement. PQ for the works Contract No. 1, Third Highway Project/CW/ICB-01, road section, km 15 – km 45 started early in 2010.

148. Retroactive Financing. The Recipient/Borrower has not selected retroactive financing.

149. Technical Issues as Part of Procurement Decisions. The detailed design and bidding documents for the first 15km road section were completed late 2009, under the Second Additional Financing for Second Highway Project. PQ documents and bidding documents were prepared by the PIU. The Prequalification started in early 2010.

150. Filing and Records Keeping: The ARS PIU will be in charge of filling and record keeping. The PIU has experience in this activity from other WB-financed projects. Agreed reporting format are included in the project operation manual.

Procurement Plan

151. The ARS at appraisal developed an initial Procurement Plan (PP) for the entire project scope consistent with the implementation plan, which provides information on procurement packages, methods and Bank review method. Since this would cover the entire project completion period it will be tentative. However, a firm procurement plan for first 18 months of the project should be prepared and this plan will be agreed upon between the Borrower and the Bank project team at negotiations, and will be available at the implementing agency’s project database and on the Bank’s external website. The PP will be updated in agreement with the Bank project team annually or as required to reflect the actual project implementation needs and improvements in the implementing agency institutional capacity.

54 Frequency of Procurement Supervision

152. In addition to the prior review supervision to be carried out by the Bank team, the capacity assessment of the Implementing Agency recommends post reviews to be carried on at least 10 percent of the contracts subject to post review. It is expected that a supervision mission in the field will be conducted every six months during which post reviews will be conducted. As a minimum one post review report which will include physical inspection of sample contracts including those subject to prior review will be prepared each year. Not less than 10 percent of the contracts will be physically inspected.

Acceptability of National Competitive Bidding:

National Competitive Bidding, subject to the following additional provisions: (i) there shall be no eligibility restrictions based on nationality of bidder; (ii) pre-qualification shall not be used for simple works procurement and shall be conducted only for large works contracts; (iii) entities in which the State or a State official owns a shareholding of whatever size shall not be invited to participate in tenders for the Government unless they are and can be shown to be legally and financially autonomous and they operate under commercial law; (iv) no national preferences may be applied on the basis of the origin of products or labor; (v) joint venture partners shall be jointly and severally liable for their obligations; (vi) no “participation fee” shall be required of bidders for the purchase of bidding documents. The only charge shall be equivalent to the cost of producing (copying) the bidding documents; (vii) in the evaluation of bids, bids may not be rejected where they differ substantially from the estimated prices calculated by the procuring entity, except where the bid prices exceed the available budget; (viii) rebidding shall not be carried out without prior approval of the Bank; (ix) works contracts of more than eighteen (18) months’ duration shall include appropriate price adjustment provisions; (x) prior approval of the Bank shall be required for any modification in the contract scope and conditions during implementation; and (xi) standard bidding documents approved by the Bank shall be used.

Anti Corruption Measures:

 The borrower shall ensure that the project, including procurement, is carried out in compliance with the current version of the Bank’s Anti-Corruption Guidelines.

 All bidding documents, including contracts, used under the Project shall include the latest version of the provisions on fraud and corruption.

 All members of the evaluation committees shall sign a disclaimer on absence of conflict of interest and confidentiality for each evaluation process.

55 Procurement Plan Azerbaijan: Third Highway Project Works, Goods and Services

I. GENERAL

1. Project information: Azerbaijan, The Third Highway Project. Project ID: P118023, Implemented by the ARS through PIU.

2. Bank’s approval Date of the Procurement Plan [Original : April 5, 2010

3. Date of General Procurement Notice: 01/27/2010

4. Period covered by this procurement plan: first 18 months from date of approval of the Original Procurement Plan.

II. Goods and Works and Non-consulting Services

1. Prior Review Threshold: Procurement Decisions subject to Prior Review by the Bank as stated in Appendix 1 to the Guidelines for Procurement:

Procurement Method Prior Review Threshold Comments 1. ICB (Goods) All 2. NCB (Goods) First Contract & >$300K 3. ICB (Works) All 4. NCB (Works) First Contract & >$500K 5. ICB (Non-Consultant Services) All 6 SH First Contract

2. Prequalification. Bidders for ICB works contracts estimated to cost more than US$10M shall be prequalified in accordance with the provisions of paragraphs 2.9 and 2.10 of the Guidelines.

3. Proposed Procedures for CDD Components (as per paragraph. 3.17 of the Guidelines: Not Applicable

4. Reference to (if any) Project Operational/Procurement Manual: Procurement activities will be carried out by the ARS assisted by the PIU. The country NCB SBDs for goods and works are reviewed and found acceptable to the Bank.

5. Any Other Special Procurement Arrangements: Advanced Procurement has been carried out in compliance with World Bank Guidelines (the Bank has given no objection to PQ for the works contract CW2010-1, Contract: Four Laning of Baku-Shamakhi- Muganli Road, km 15,0-45,0).

56 Procurement Packages with Selection Methods and Time Schedules

Expected Contract Package Description/ Location Bid- Start Award Cost No. Opening Date Date

Method Date (US$) /m

Estimated Date Completion PQ Started BD Released Procurement (PRIOR / Post) / Post) (PRIOR Review By Bank PQ, Yes/Not No. of Packages

A B C D E F G H I J K L

1. WORKS Baku-Shamakhi Contract No. 1 Y 1 ICB Prior 02/20/10 07/15/10 08/26/10 09/26/10 10/15/10 10/15/12

Baku-Shamakhi Contract No. 2 Y 1 ICB Prior 09/15/10 12/21/10 02/04/11 03/21/11 04/15/11 04/15/13

Baku-Shamakhi Contract No. 3 Y 1 ICB Prior 09/15/10 12/21/10 02/04/11 03/21/11 04/15/11 04/15/13

Road Safety works (several packages) N TBD TBD TBD TBD TBD TBD TBD TBD TBD

Total 1. for works

Office Equipment and goods for motorway unit (several 2. GOODS N TBD SH Prior N/A 07/01/10 08/01/10 08/15/10 08/15/10 09/30/10 packages) Maintenance and Traffic Safety Equipment for ARS N TBD TBD Prior N/A 11/01/10 12/16/10 01/15/11 01/15/11 02/30/11 (several packages) Total 2. for goods

III. Selection of Consultants

1. Prior Review Threshold: Selection decisions subject to Prior Review by the Bank as stated in Appendix 1 to the Guidelines Selection and Employment of Consultants:

Selection Method Prior Review Threshold Comments 1. Competitive Methods All (Firms) 2. Single Source (Firms) All 3. IC above US$50K All First Contract regardless of value 4. IC SSS All

2. Short list comprising entirely of national consultants: Short list of consultants for services, estimated to cost less than US$200,000 equivalent per contract, may comprise entirely of national consultants in accordance with the provisions of paragraph 2.7 of the Consultant Guidelines.

3. Any Other Special Selection Arrangements: N/A

57

Consultants Packages with Selection Methods and Time Schedules

Review Expected Advertisement Contract Package Estimated Selection by Bank Proposal Start Completion for EOI Award No. Description of Assignment/ Location Cost Method Prior / Submission Date Date Date Date (US$) / m Post Date

A B C D E F G H I J

3. CONSULTANTS' SERVICES Supervision of works for the 3 Contracts QCBS Prior 04/01/10 06/02/10 08/15/10 09/15/10 09/15/13 Road Safety Audit (for design and supervision) QCBS Prior 03/01/10 05/14/10 06/15/10 07/15/10 07/15/13 Road Safety Audit for Motorway Opening and QCBS Prior 09/01/10 11/15/10 12/15/10 01/15/10 08/15/11 Operating Procedures TA for Motorway Planning and Financing IC Prior 06/01/10 N/A 08/01/10 08/15/10 08/15/11 Establishment of Motorway Guidelines QCBS Prior 05/01/10 07/15/10 08/15/10 09/15/10 09/15/11 Technical Audit IC Prior 06/01/11 N/A 08/01/11 08/15/11 03/01/13 Advisor to Motorway Unit IC Prior 04/01/10 04/15/10 04/20/10 04/30/10 08/30/10 Training of Motorway Unit Staff (several Prior 11/01/10 12/01/10 12/15/10 01/10/11 03/10/11 CQ packages) Design for a Future Motorway Project QCBS Prior TBD TBD TBD TBD TBD Project Audit LCS Prior 09/01/10 10/01/10 12/01/10 12/15/10 08/15/11 Total Consultants Services

Procurement Thresholds Legend: International Competitive Bidding (in accordance with section 2 of the Guidelines) ICB For works contracts valued at or more than USD 2M For goods contracts valued at or more than USD 300,000 National Competitive Bidding (in accordance with section 3.3 of the Guidelines) NCB For works contracts valued less than USD 2M For goods contracts valued less than USD 300,000 DC Direct Contracting (in accordance with section 3.6 of the Guidelines) Shopping (in accordance with section 3.5 of the Guidelines) For works contracts valued at or less than USD 100,000 SH For goods contracts valued at or less than USD 100,000 Aggregate Shopping amount for the project: USD 500,000 to be monitored during the project period

Selection of Consultants

QCBS Quality and Cost-based Selection (in accordance with sections 2.1 - 2.28 of the Consultant’s Guidelines)

QBS Quality Based Selection (in accordance with section 3.2 the Consultant’s Guidelines)

CQ Consultants Qualifications (in accordance with section 3.7-8 of the Consultant’s Guidelines)

LCS Least-Cost Selection (in accordance with section 3.6 of the Consultant’s Guidelines)

SSS Single source Selection (in accordance with section 3.9-13 of the Consultant’s Guidelines)

IC Individual Consultant (in accordance with section V of the Consultant’s Guidelines)

58 Annex 9: Economic and Financial Analysis AZERBAIJAN: Third Highway Project

A. Economic Analysis

153. The economic analysis of the Baku-Shamakhi road upgrading is based on estimated traffic volumes and forecasts, vehicle operating costs (VOC), time savings for users, and economic project costs. The main evaluation inputs are:  Capital investment and maintenance costs, reflecting June 2009 prices  The benefit stream, reflecting June 2009 prices, comprising savings in VOC, travel time, and maintenance  Implementation of investments during 2010-13 , and benefits evaluation over 20 years  Benefits accruing for each completed section, starting in 2011

154. The project is expected to enhance Shamakhi area regional development and contribute to Government economic diversification strategy. The project will serve the mountainous Shirvan economic region in central Azerbaijan, an area covering 7.0 percent of the country that includes Shamaxi, Aghsu, Ismayilli and Gobustan rayons with 280,500 people, or about 3.2 percent of national population. The region is strategically located on the shortest route from Baku to the Georgian border; it provides a transit route to and from metropolitan Baku that is important for neighboring economic regions, particularly the Sheki-Zagatala region, a major food producer and a major national tourism destination. Agriculture accounts for 72 percent of economic production in the region, or 4.2 percent of national agricultural output.

155. A recent Turkish Development Bank study carried out for the Ministry of Economic Development examined investment potential in the Mountainous Shirvan region and identified areas for productive investments.63 The paper confirms the region’s strategic location, due to its proximity to Baku, easy road access to Georgia and Turkey, and access to an educated and affordable labor force with literacy levels over 97 percent. The study singles out agriculture, tourism, and industry as highest potential productive activities. Recent substantial investments confirm the potential of light industry - televisions, air conditioning systems, refrigerators, and other household appliances; and automotive assembly. The television assembly plant employs 250 people, sells in domestic markets, and exports to neighboring countries, and a new household appliances plant has a 1250-person employment capacity. High-end tourism development welcomes some 65,000 tourists per year to more than 20 hotel facilities in the region. A five-star hotel has opened recently and another is under construction. In 2009, productivity in the region was up 8.8 percent compared to the previous year.

B. Upgrading of the Baku-Shamakhi Road

156. According to the economic evaluation for widening the road between Baku and Shamakhi to four-lane road, the financial costs for widening and costs of realignment in proposed sections were estimated at US$292,953,600 including physical contingencies.64 The quantity calculation is based on a typical design solution and therefore 20 percent for physical contingencies was added to estimated costs of works. Physical contingencies represent the

63 A Study on Potential Investment Areas in the Mountainous Shirvan Region, Kalkinma, September 2009. 64 Costs without VAT. 59 monetary value of additional resources and work that may be required beyond the base cost to complete the project. The main unit prices have been cross checked with tender prices for similar projects under construction and were adjusted to actual market prices.

157. Table below gives construction costs, including realignment, as used in the economic analysis for the additional carriageway, based upon tendered prices. These costs were applied throughout for widening to four lanes.

Construction Costs Capital Costs (US$ million) per km by section Section Economic Costs Financial Costs KM 15.0 – 47.5 2.273 2.682 KM 47.5 – 110.0 2.866 3.381 KM 110.0 – 116.0 3.380 3.988 Source: Consultants estimates and tendered prices

Current Traffic and Growth Projections

158. Base traffic (2009) was estimated by updating actual 2005 traffic counts, since the ongoing rehabilitation of the existing two-lane road prevents counting of actual traffic on the project road. The update was carried out by applying the rate of GDP growth to traffic during 2005-09, assuming an income elasticity of demand equal to 1.3. The resulting Baku-Shamakhi traffic growth rate for the period is consistent with growth rates observed on the rest of the highway network. Included in the traffic projections are generated traffic calculated at 10 percent of the normal traffic level. This is to capture the increased economic and other activities as a result of the implementation of the project. The base year traffic for road sections ranges from about 11,000 to 22,000 vpd.

159. Estimated rates of traffic growth were based on Bank non-oil real GDP forecasts (i.e., 3.5 percent for 2010; 5.3 percent for 2011; 5.7 percent for 2012; and 6.1 percent for 2013). The income elasticity of demand was considered to be 1.0 for goods transport and 1.3 for people transport (buses, minivans and cars), as car ownership and demand for transport services is expected to grow substantially with rising per capita incomes. Income elasticity for transport demand gradually decreases to reach 1.1 for goods and 0.9 for people by 2016.

60

Observed Traffic

Time Count Count Assume 5% Forecast* Correlating Sections From Time To Car Truck Hourly Hour Average 2009

km 10.0 - km 15.0 12:55 13:00 120 12 1440 28,800 13:00 13:05 87 3 1044 20,880 23,120 22,110 13:05 13:10 82 9 984 19,680 km 15.0 - km 47.5 13:25 13:30 40 3 480 9,600 13:30 13:35 40 1 480 9,600 9,440 11,646 13:50 13:55 38 2 456 9,120 km 47.5 - km 110.0 14:00 14:05 45 3 540 10,800 14:05 14:10 61 1 732 14,640 14:10 14:15 45 2 540 10,800 14:25 14:30 61 2 732 14,640 14:30 14:35 45 540 10,800 13,067 13,163 14:40 14:45 69 9 828 16,560 14:45 14:50 62 4 744 14,880 14:50 14:55 44 528 10,560 14:55 15:00 58 696 13,920 km 110.0 - km 116.0 insufficient observations 13,014 *based on 2005 counts and applied 2005-2008 observed GDP growth

160. Costs and Benefits. The cost benefit analysis was performed with the help of the Highway Development and Management Model (HDM 4) comparing the “without project” case with the proposed upgrading to a four-lane road.65 A discount rate of 12 percent was adopted for this project in line with World Bank guidance for infrastructure investment in Azerbaijan. The discount base year was 2009; the 25-year evaluation period begins with base year 2009. Project opening is expected to be in 2013 for the widened four-lane Baku-Shamakhi Road. Final evaluation year is 2033.

161. Project costs and the costs for routine and periodic maintenance are based on ongoing pre-feasibility studies, and border prices. Work and business travel time was valued at the full economic rate; non-work travel time was valued at 30 percent of the full rate. Work/business trips values assume an employee’s value is equal to the wage rate plus other costs of employment—valued at about 33 percent of the wage rate, which was valued at an estimated average of US$2.28 per working hour.

162. Vehicle operating cost (VOC) data for the main vehicle categories using Azerbaijan national roads was based on previous studies, most notably the recent work by RRI on the M3 Alat-Astara. This data was reviewed and updated during the ADB-funded “Institutional Strengthening of Road Sector, East-West Highway Improvement project (ADB Loan 2206 AZE)” by Finnroad. A draft discussion paper was submitted to ARS in April 2009. The vehicle economic costs for base year 2009 used in the analysis are in the table below.

65 The term, ‘without project’ means without Third Highway Project; this section of the road is newly rehabilitated two lanes under the Second Highway Project. 61 Vehicle Economic Unit Costs (In US$) 3-axle 4+axle

2-axle rigid articulated Vehicle Costs (in US$) Car Minibus LGV Bus GV HGV GV

New Vehicle Cost 21,603 24,916 18,264 155,820 32,474 54,500 283,073

Cost of New Tire 86 99 348 175 200 300 375 Cost per hour of 24.74 24.74 24.74 24.74 24.74 24.74 24.74 Repair/Maintenance Cost per hour of Vehicle 0 25.11 20.92 25.11 20.92 25.11 25.11 Crew Passenger in work-time 7.50 7.50 7.50 7.50 7.50 7.50 7.50 delay cost per hour Passenger in non work- 2.25 2.25 2.25 2.25 2.25 2.25 2.25 time delay cost per hour Annual interest (%) 12 12 12 12 12 12 12 Source: The Consultant/RRI

163. The analysis yielded an overall EIRR of 14.5 percent. Exogenous variables introduced to the model were limited to the quantification of benefits derived from a 20 percent reduction in traffic accidents. During 2002-05, prior to rehabilitation, this stretch of road averaged 10 fatalities per year and 25 accidents resulting in personal injuries. The economic cost of these events was US$204,780 per fatality, US$27,657 per serious injury, and US$ 817 per damaged car, according to calculations in recent Finnroad studies.

Summary Economic Analysis for Baku-Shamakhi Widening to Four Lanes Net Present Value Section ($m) NPV/Cost Ratio EIRR (%) KM 15.0 – 47.5 14.467 0.338 15.5 KM 47.5 – 110.0 16.502 0.161 14.0 KM 110.0 – 116.0 2.609 0.227 14.3 Total: 33.578 0.214 14.5

E. Economic Analysis and Sensitivity Test

164. A sensitivity analysis was conducted on the economic modelling results with regard to construction costs and projected traffic growth rates. The results are summarised in the table below.

Summary of Results of Sensitivity Analysis

EIRR Cost Cost Traffic Traffic All Sections (%) +20% –20% +20% –20% Km 15.0 – 116.0 14.5 12.3 17.3 20.4 9.7

62 Annex 10: Safeguard Policy Issues AZERBAIJAN: Third Highway Project

Environmental Safeguards

165. The Regional Environmental Review (RER) has been initially prepared in 2005 and subsequently updated in 2009 to describe the existing environment, discusses and compares project alternatives and identifies potential environmental risks and issues to be addressed during preparation of site-specific EIAs and during project implementation. Similarly, the Environmental Management Framework (EMF) has also been developed in 2005 and updated in 2009 that outlines the procedures for the environmental screening, management consultation and disclosure of sub-projects. The Project area is characterized by saltwort and ephemeral deserts and wormwood-saltwort semi-deserts. The topography is represented mainly by undulating arid hills and mountains. The road crosses a series of wide river terraces and ancient river canyons which all represent erosion types of landscape. Overall along the study corridor flora biodiversity is high featuring between 600-729 plant species. The area also harbors a number of species, including threatened species of national and international importance.

166. A right-of-way (ROW) of the existing two-lane Baku-Shamakhi road is 60 m, 30m on each side from the existing road center-line. Generally, it provides enough room for road widening for the four main design alternatives. However, at certain sections of the road, the ROW is significantly reduced. Therefore, the implementation of these alternatives will involve land acquisition as well as additional land acquisition to allow for embankments, the construction of interchanges, local connector roads, and possible bypasses and realignments.

167. The RER identifies that the Project implementation is associated with potential environmental impacts such as destabilization of slopes in sensitive areas, loss of tree plantations in various sections alongside the existing road, disturbance of drainage systems, extraction of road construction materials, increased dust production and air and noise pollution, etc. The RER provides strategic recommendations to be considered at the stage of developing site-specific EIAs and should enhance environmental performance of each individual sub-project:

Slope destabilization: The preparation of the detailed design should verify geo-technical conditions of the road sections. The landslide hazard risk assessments for the road need to be undertaken and appropriate mitigation measures (temporary and permanent) need to be recommended by site-specific EIAs. The results of the risk assessments will contribute to the multicriteria assessment of road widening options.

Roadside plantations: Significant portions of the land immediately adjacent to the road are under the ownership of the State Forest Fund (Jangi Forestry), therefore, any potential vegetation losses resulting from the individual sub-projects will require approval from that department of the MENR. Where the loss of such plantations cannot be avoided, their replacement should be considered at detailed design and budget. In accordance with international best practice it is recommended that native species be used, such as tamarisk, juniper, oleaster, fig and pomegranate, which will be suitable for plantation along the road within semi-desert and arid landscapes. This will be dealt with within the EIA stage and within the EMP (which should include a Restoration Plan). The use of wood cut from live trees whether from roadside plantations or other sources by the workforce for fuelwood or construction purposes should be prohibited. 63

Drainage: To eliminate the flooding that is reported to regularly affect Gobustan town and Sabir Village it is recommended to envisage the improvement of drainage in the sections in question (between km 90 and 93, and km 103-105). When preparing the TORs for the detailed design, this issue should be recommended for detailed analysis.

Disturbance to mud volcanoes’ areas: These are strictly protected areas and no construction or agricultural activity is allowed within these areas. The detailed design should ensure that the protected areas are intact by the proposed road widening. Furthermore, it should be ensured that borrows pit sites and access roads to borrow pit sites are not in vicinity to these protected areas. No stockpiling of material will be allowed in reserve area either.

Protected species: The impairment of the local breeding colony of the globally threatened Lesser Kestrel (Falco naumanni) on the bridges over the Jeyrankechmez may be avoided through the definition of seasonal restrictions for the execution of any construction works in this area. The restrictions for the execution of any construction works will be required throughout the nesting season, i.e. April to July. Hunting and/or trading in any protected species by the workforce should be prohibited. The specific mitigation measures, if necessary, will be detailed in the site specific EIAs. The impairment of the of the Greek Tortoise (Testudo graeca,) and the European Pond Turtle (Emys Orbicularis) may be minimized if in winter the wildlife specialists will check all earth moving activities, and all found tortoises and turtles will be moved to a safe location.

Acquisition of construction materials: Impacts associated with the construction and use of borrow pits are varied and should be given consideration within any EIAs, EMPs and Construction Management Plans undertaken in subsequent phases of the project. In particular, (i) impacts associated with the borrow pit construction and material extraction activities: air emissions, noise and vibration from equipment, impacts to any archaeology present on site, visual impacts, impacts to the water table and groundwater (from interceptions to the water table through excavation as well as from leakages and spillages of fuel and oils), changes to surface water flows and drainage and issues associated with the disposal of waste material; and (ii) impacts associated with the construction of temporary access roads and transport of materials to the construction site: these can include waste arising and disposal, increased traffic, and consequent increase in air and noise emissions

Surface water quality of rivers crossing the study area: impacts to water quality would be likely to arise mainly from discharge of runoff containing suspended sediments (soil) or contaminated materials into the water course, or from accidental spillages of oils/chemicals and fuels into the water course. In order to prevent such events, appropriate procedures should be implemented for the handling, storing and using of hazardous chemicals on site (during construction), in particular in the vicinity of watercourses and groundwater zones. Emergency response plans should be put in place and appropriate equipment (e.g. spill containment kits) provided, as well as relevant staff training. In addition, any runoff from the road into the water course during the operational phase should be prevented through the use of mechanisms such as oil and silt interceptors.

64 Disposal of materials/waste: This issue will be dealt with at project level with the development of project-specific EMPs. Only approved disposal sites should be used.

Contaminated land: the issue will be dealt with in the site-specific EIAs and EMPs, if contaminated land is found to be an issue in any area likely to be directly affected by a project. The areas that are more likely to show a certain level of contamination are garages, car repair shops, scrap yards, gas works, chemical works and landfills/dump sites, etc along the road. Furthermore, the road is used to transport oil-derived products, therefore, spillages are likely to have occurred and some ground contamination may also be present alongside the road. However, no data is available to make conclusions about the levels of contamination or how widespread it is or how likely it is to have reached any sensitive receptors at this stage.

Worker health and safety: This issue will have to be addressed in the EIAs and EMP.

168. The updated RER and EMF were disclosed in country in 2009, at the meetings held in various locations along the road. The RPF was disclosed in February 2010. The Minutes of these meetings have been properly recorded and included in the RER and RPF as annexes, and are available for information and references at the ARS PIU. Site specific Environmental Impact Assessment and Management Plan has been prepared for the first 30 km section of the road (km 15-45) to address the issues and concerns raised in the RER, with the first draft disclosed prior to the project Appraisal on January 29, 2010. The EIAs for the remaining sections of the road will be prepared during Project implementation. In-house capacity of ARS to ensure implementation of the EIAs is assessed to be weak and will be strengthened by targeted trainings to be delivered to the ARS Ecology and Safety Sector under the Public Investment Capacity Building Project and as part of individual EA assignments of independent consultants.

Social Safeguards

169. The project road passes through sparsely populated areas. For most of the project road section, sufficient Right Of Way (ROW) has been obtained on either side of the project road so the existing two lane road can be expanded to four lanes without acquisition of private land or other impact that will trigger OP 4.12, except for about 9.75km section where the existing ROW is significantly narrowed or private businesses operate near the road. Also, the construction of a bypass is expected to require the acquisition of about 17ha of private land.

170. A Resettlement Policy Framework (RPF) was prepared that describes potential project impacts and sets out policies and procedures that will apply to the project. It provides compensation principles and eligibility criteria, which is in line with the Bank social safeguard policy. Public consultation was conducted in the project areas, where local population were consulted of the project scope, expected impact and likely mitigation measures, construction schedule, and so on. Participants of consultation meetings expressed support to the Project as it will ease the access of Baku to the east and Ganja and Sheki to the west, and also because a considerable amount of short term jobs can be created in road construction66. The draft final RPF was disclosed on February 5, 2010, through the Infoshop and in Azerbaijan for comments from

66 Anecdotal evidence suggests that local population have access to cars when they need to travel, and that improvement of road conditions will benefit a wide range of local population. 65 interested parties. Should any comments be received, the RPF may be revised to incorporate them.

171. The 30km section of the road that will be financed under the first year program will not result in land acquisition or other impact that will trigger OP 4.12. The Resettlement Action Plan (RAP) will thus not be prepared for the first year program. RAP will be prepared for the remaining sections of the project road when detailed designs are ready. RAP will provide a detailed inventory of project impact, compensation and rehabilitation packages eligible for categories of project affected people (PAP) and grievance redress mechanisms in line with provisions of RPF and the OP 4.12.

172. The capacity of ARS in land acquisition, even after two highway projects that precede the Project, is still limited, and the ARS will likely face challenges in successfully acquiring needed private land on time under the Project. Also, there are risks that the rationale to determine compensation and rehabilitation measures are not clearly communicated to affected people who may consider they are mistreated. Experience from preceding highway projects were reviewed and taken into consideration in the design of the Third Highway project in order to minimize such risks.

173. Under the first Highway Project, the ARS successfully acquired 58ha of private land for the construction of the Tovuz Bypass. The land acquisition process was delayed by about 2 years partly because the impact survey conducted by the ARS's consultant was not endorsed by the State Land and Cartography Committee (SLCC) as their specialists did not participate in the survey and because, when the survey was redone which confirmed the findings of the consultant, land prices significantly increased from what were originally agreed by land owners and applicable unit prices needed to be adjusted.

174. Under the Second Highway Project, which will require the acquisition of about 270ha of private land, specialists of the SLCC participated in the survey in order to harmonize approval procedure. Census was taken and the inventory of project impact was developed, to determine who is eligible for what compensation. However, unit prices to be used as the basis to determine compensation amounts have yet to be determined, as the original prices set by the District Land Commission were rejected by the Ministry of Finance on the ground that they do not adequately reflect the current market prices. As soon as the unit prices are determined, the Resettlement Action Plan (RAP) would be submitted to the Bank for approval.

175. Land acquisition under the Third Highway Project will take into account the lessons learnt from the preceding highway projects in Azerbaijan, namely: (i) field survey will be conducted in close collaboration with the relevant government agencies; (ii) prevailing land prices have been assessed prior to project appraisal, at the time when RPF was prepared; (iii) land prices will be reexamined when a site-specific RAP is developed in close collaboration with specialists of the Ministry of Finance; (iv) a monitoring consultant will be hired who will work closely with and advise the ARS during the implementation of the RAP, actively engage with PAP and receive grievances from them, and help the ARS address them; and (v) an independent consultant will be hired to conduct an external monitoring of land acquisition processes, especially during the early stage.

66 Annex 11: Project Preparation and Supervision AZERBAIJAN: Third Highway Project

Planned Actual PCN review 11/18/2009 Initial PID to PIC 12/15/2009 Initial ISDS to PIC 12/15/2009 Appraisal 02/08/2010 02/08/2010 Negotiations 03/10/2010 04/05/2010 Board/RVP approval 05/25/2010 Planned date of effectiveness 09/01/2010 Planned date of mid-term review 10/01/2012 Planned closing date 03/31/2015

Key institutions responsible for preparation of the project:  Ministry of Transport  Azer Road Service JSC

Bank staff and consultants who worked on the project included: Name Title Unit Jacques Buré Task Team Leader ECSSD Elizabeth Wang Co-Task Team Leader ECSSD Elena Chesheva Operations Officer ECSSD Ghada Youness Senior Counsel LEGEM Gulana Enar Hajiyeva Environmental Specialist ECSSD Jesus Renzoli Senior Procurement Specialist ECSSD Jiangbo Ning Highway Engineer ECSSD Marie Laygo Program Assistant ECSSD Mirtha Pokorny Transport Economist-Consultant ECSSD Nijat Valiyev Infrastructure Specialist ECSSD Norpulat Daniyarov Financial Management Specialist ECSSD Olivier Le Ber Acting Program Team Leader MNSTR Renee Desclaux Senior Finance Officer CTRFC Romain Pison Junior Professional Associate ECSSD Sadiq Aliyev Operations Analyst ECSSD Satoshi Ishihara Social Development Specialist ECSSD Vusala Asadova Program Assistant ECCAZ Ben Gericke Peer Reviewer EASIN Eric Lancelot Peer Reviewer LCSTR Michel Bellier Peer Reviewer MNSTR

Bank funds expended to date on project preparation: 1. Bank resources: US$187,650.00 (April 16, 2010) 2. Trust funds: 0 3. Total: US$187,650.00

Estimated Approval and Supervision costs: 1. Remaining costs to approval: US$ 20,000.00 2. Estimated annual supervision cost: US$120,000.00

67 Annex 12: Documents in the Project File AZERBAIJAN: Third Highway Project

Bank Assessment

1. Project Concept Note

2. Project Information Document, Concept Stage

3. Aide Memoires of the previous mission

4. Quality Enhancement Review for Azerbaijan

Other Studies and Reviews

1. Study for Widening Options for a four lane road between Baku and Shamakhi: 2 February 2009 - KOCKS Consult Gmbh.

2. Azerbaijan Motorway Improvement and Development Baki-Shamakhi Road Widening: km 15 to 45 Regional Environmental Review: May 2009 - Scott Wilson.

3. Azerbaijan Motorway Improvement and Development Baki-Shamakhi Road Widening: km 15 to 45 Outline Environmental Management Plan: May 2009 – Scott Wilson.

4. Azerbaijan Motorway Improvement and Development Baki-Shamakhi Road Widening: km 15 to 45 Environmental Assessment Report km 15 to 45: November 2009.

5. Azerbaijan Motorway Improvement and Development Resettlement Policy Framework: November 2009 – Scott Wilson.

6. Economical Evaluation: August 2009 (revised Jan 2010).

7. Preparation of bidding documents and Detailed Design of km 15-45.

8. Highway 3 Risk Assessment Review – version 001 printed on Jan 11 2010.

9. The Survey on Market Price of Land along Baki-Shamakhi Highway, Draft Final Report, February 2010.

68 Annex 13: Statement of Loans and Credits AZERBAIJAN: Third Highway Project

Difference between Expected and Actual Original Amount in US$ Millions Disbursements Project FY Purpose IBRD IDA SF GEF Cancel. Undisb. Orig. Frm. ID Rev’d P115396 2009 Public Investment Capacity Building 0.00 8.00 0.00 0.00 0.00 7.77 0.45 0.00 P099924 2008 CORP & PUB SEC ACCT - CAPSAP 0.00 11.00 0.00 0.00 0.00 10.82 3.90 0.00 P083108 2008 RAIL TRADE AND TRANSPORT 450.00 0.00 0.00 0.00 0.00 450.00 32.00 0.00 FACILITATION P102117 2008 Second Education Sector Development 0.00 25.00 0.00 0.00 0.00 22.65 3.11 0.00 Proj P105116 2008 SOCIAL PROTECTION 0.00 26.70 0.00 0.00 0.00 24.69 13.70 5.00 DEVELOPMENT P109961 2008 Second National Water Supply & San. 230.00 30.00 0.00 0.00 0.00 258.83 42.50 0.00 P110679 2008 ARP/ II-INTEGRAT. SOLID WASTE 29.50 0.00 0.00 0.00 0.00 28.93 2.60 0.00 MANAGEMENT P100582 2007 REAL ESTATE REG. 30.00 0.00 0.00 0.00 0.00 26.28 1.98 0.00 P096213 2007 NATIONAL WATER SUPPLY & 230.00 0.00 0.00 0.00 0.00 225.17 105.17 0.00 SANITATION P099201 2006 JUDICIAL MOD 0.00 21.60 0.00 0.00 0.00 19.11 13.80 0.00 P094488 2006 Highway 2 613.00 62.00 0.00 0.00 0.00 518.96 30.70 65.70 P094220 2006 Health Sector Reform Project 0.00 50.00 0.00 0.00 0.00 44.47 11.26 13.05 P090887 2006 ADCP-II 0.00 29.20 0.00 0.00 0.00 6.59 -0.02 0.00 P089751 2005 IDP ECON DEVT SUPPORT 0.00 26.50 0.00 0.00 0.01 12.85 -2.05 5.95 P083341 2005 POWER TRANSMISSION 48.00 0.00 0.00 0.00 0.00 18.30 18.30 1.14 P081616 2005 FIN SERVS DEVT 0.00 12.25 0.00 0.00 0.00 4.85 4.11 0.00 P049892 2004 PENSION & SOC ASST 0.00 10.00 0.00 0.00 0.00 3.19 2.75 0.00 P076234 2004 RURAL INVSMT (AZRIP) 0.00 30.00 0.00 0.00 0.00 11.41 -4.55 -2.44 P008286 2003 IRRIG DIST SYS & MGMT 0.00 35.00 0.00 0.00 0.00 2.52 -3.02 0.00 IMPROVMT P066100 2002 AVIAN FLU (formerly IBTA 2) 0.00 9.45 0.00 0.00 0.00 0.09 -1.78 -1.78 Total: 1,630.50 386.70 0.00 0.00 0.01 1,697.48 274.91 86.62

69 AZERBAIJAN STATEMENT OF IFC’s Held and Disbursed Portfolio In Millions of US Dollars

Committed Disbursed IFC IFC FY Approval Company Loan Equity Quasi Partic. Loan Equity Quasi Partic. Azerigazbank 3.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 2003 Azerigazbank 0.90 0.00 0.00 0.00 0.90 0.00 0.00 0.00 2006 Azerigazbank 0.00 2.30 0.00 0.00 0.00 0.00 0.00 0.00 1999 Baku Hotel 1.46 0.00 0.00 0.00 1.46 0.00 0.00 0.00 2002 MFB Azerbaijan 0.00 1.60 0.00 0.00 0.00 1.60 0.00 0.00 2006 MFB Azerbaijan 3.00 0.00 0.00 0.00 3.00 0.00 0.00 0.00 2003 Rabitabank 0.90 0.00 0.00 0.00 0.90 0.00 0.00 0.00 UniBank 5.00 0.00 0.00 0.00 2.39 0.00 0.00 0.00 Total portfolio: 14.26 3.90 0.00 0.00 8.65 1.60 0.00 0.00

Approvals Pending Commitment FY Approval Company Loan Equity Quasi Partic. 2001 Azer JV Increase 0.00 0.00 0.00 0.00 Total pending commitment: 0.00 0.00 0.00 0.00

70 Annex 14: Country at a Glance AZERBAIJAN: Third Highway Project

Azerbaijan at a glance 12/9/09

Europe & Lower- POVERTY and SOCIAL Central middle- Development diamond* Azerbaijan Asia income 2008 Population, mid-year (millions) 8.7 441 3,702 Life expectancy GNI per capita (Atlas method, US$) 3,830 7,418 2,078 GNI (Atlas method, US$ billions) 33.2 3,274 7,692

Average annual growth, 2002-08 Population (%) 1. 0 0 . 1 1. 2 Labor force (%) 2.2 1.0 1.6 GNI Gross per primary M ost recent estimate (latest year available, 2002-08) capita enrollment Poverty (% of population below national poverty line) ...... Urban population (% of total population) 52 64 41 Life expectancy at birth (years) 70 70 68 Infant mo rtality (per 1,000 live births) 32 21 46 Child malnutrition (% of children under 5) 8..26 Access to improved water source Access to an improved water source (% of population) 78 95 86 Literacy (% of population age 15+) 10 0 9 8 8 3 Gross primary enrollment (% of school-age population) 116 9 8 10 9 Azerbaijan M ale 117 99 112 Lower-middle-income group Female 115 97 106

KEY ECONOM IC RATIOS and LONG-TERM TRENDS 1988 1998 2007 2008 Economic ratios* GDP (US$ billions) .. 4.4 33.0 46.1 Gross capital formation/GDP .. 33.4 21.5 20.2 Exports of goods and services/GDP .. 22.7 68.1 69.5 Trade Gro ss do mestic savings/GDP .. 1.5 61.1 64.9 Gross national savings/GDP .. 2.7 48.8 32.2

Current account balance/GDP .. -30.7 27.3 35.7 Interest payments/GDP .. 0.5 0.3 0.2 Domestic Capital savings formation To tal debt/GDP .. 15.9 10.9 9.3 Total debt service/exports .. 2.1 0.8 0.8 Present value of debt/GDP .. .. 7.8 7.5 Present value of debt/exports .. .. 10.9 8.8 Indebtedness 1988-98 1998-08 2007 2008 2008-12 (average annual growth) G D P - 10 . 6 15 . 9 2 5 . 0 10 . 8 3 . 6 Azerbaijan GDP per capita -11.7 14.9 23.6 9.6 2.5 Lower-middle-income group Expo rts o f go o ds and services .. 19.9 44.1 10.4 5.7

STRUCTURE of the ECONOM Y 1988 1998 2007 2008 Growth of capital and GDP (%) (% of GDP) Agriculture .. 18.9 7.0 6.3 100 80 Industry .. 36.5 68.5 69.9 60 M anufacturing .. 8.7 5.2 4.5 40 Services .. 44.6 24.5 23.8 20 0 -20 Household final consumption expenditure .. 83.3 28.5 24.5 03 04 05 06 07 08 General gov't final consumption expenditure .. 15.2 10.4 10.6 GCF GDP Imports of goods and services .. 54.5 28.5 24.8

1988-98 1998-08 2007 2008 Growth of exports and imports (%) (average annual growth) Agriculture -5.7 7.0 4.0 6.1 60 Industry -5.5 17.8 32.8 10.0 40 M anufacturing -15.4 3.7 10.2 7.1 Services -7.7 9.8 12.5 13.7 20

Household final consumption expenditure -3.8 11.4 15.6 15.4 0

General gov't final consumption expenditure -2.7 14.7 24.1 13.6 03 04 05 06 07 08 Gross capital formation 57.0 23.4 -2.5 7.7 Exports Imports Impo rts o f go o ds and services .. 18.1 14.0 13.2

Note: 2008 data are preliminary estimates. This table was produced from the Development Economics LDB database. * The diamonds show four key indicators in the country (in bold) compared with its income-group average. If data are missing, the diamond will be inco mplete.

71 Azerbaijan

PRICES and GOVERNMENT FINANCE 1988 1998 2007 2008 Inflation (%) Domestic prices (% change) 25 Consumer prices .. -0.8 16.7 20.8 20 Implicit GDP deflator .. -1.0 21.0 20.9 15 10 Government finance 5 (% of GDP, includes current grants) 0

Current revenue .. 19.8 28.2 50.2 03 04 05 06 07 08 Current budget balance .. -2.1 12.0 31.6 GDP deflator CPI Overall surplus/deficit .. -3.9 2.3 16.7

TRADE 1988 1998 2007 2008 Export and import levels (US$ mill.) (US$ millions)

Total exports (fob) .. 678 21,269 30,586 40,000 Crude oil .. 207 18,421 26,974 Petroleum products .. 243 1,769 2,169 30,000 M anufactures .. 125 959 1,320 Total imports (cif) .. 1,724 6,045 7,575 20,000 Food .. 175 731 922 10,000 Fuel and energy .. 356 1,292 1,064 Capital goods .. 435 2,217 2,106 0 Export price index (2000=100) .. 57 237 311 02 03 04 05 06 07 08 Import price index (2000=100) . . 10 2 114 12 2 Exports Imports Terms of trade (2000=100) .. 55 209 254

BALANCE of PAYMENTS 1988 1998 2007 2008 Current account balance to GDP (%) (US$ millions) Exports of goods and services .. 1,009 22,517 32,133 40 Imports of goods and services .. 2,425 9,424 11,464 Resource balance .. -1,415 13,093 20,669 20 Net income .. -13 -5,079 -5,266 0 Net current transfers .. 64 1,005 1,050 02 03 04 05 06 07 08 Current account balance .. -1,364 9,019 16,454 -20

Financing items (net) .. 1,303 -6,121 -4,404 -40 Changes in net reserves .. 61 -2,898 -12,050

Memo: Reserves including gold (US$ millions) .. 449 4,273 14,838 Conversion rate (DEC, local/US$) .. 0.8 0.9 0.8

EXTERNAL DEBT and RESOURCE FLOWS 1988 1998 2007 2008 Composition of 2008 debt (US$ mill.) (US$ millions) Total debt outstanding and disbursed .. 709 3,593 4,309 IB RD .. 0 21 78 A: 78 IDA .. 141 660 698 B: 698 Total debt service .. 24 202 298 G: 1,169 IB RD .. 0 1 3 C: 79 IDA .. 1 11 13 D: 364 Composition of net resource flows Official grants 0 36 111 108 Official creditors .. 73 183 213 Private creditors .. 67 230 350 E: 752 Foreign direct investment (net inflows) .. 1,023 -4,749 15 F: 1,169 Portfolio equity (net inflows) 0 0 2 0 World Bank program Commitments .. 40 260 638 Disbursements .. 21 74 106 A - IBRD E - Bilateral Principal repayments .. 0 6 8 B - IDA D - Other multilateral F - Private C - IMF G - Short-term Net flows .. 21 68 98 Interest payments .. 1 6 8 Net transfers .. 20 62 90

Note: This table was produced from the Development Economics LDB database. 12/9/09

72 Annex 15: Map No. IBRD 37356 AZERBAIJAN: Third Highway Project

73 IBRD 37356 To Kayakent 45°ETo Tbilisi 46°E 47°E 48°E 49°E 50°E 51°E

RUSSIANR U S S I A N AZERBAIJAN HIGHWAY PROJECTS GEORGIAG E O R G I A BalakenBalaken FEDERATIONF E D E R A T I O N BALAKENBALAKEN HIGHWAY I PROJECT ZagatalaZagatala er iv To Tbilisi R KHACHMAZKHACHMAZ ur HIGHWAY II PROJECT & HIGHWAY II Sam ZAGATALAZAGATALA GUSARGUSAR KhachmazKhachmaz PROJECT - ADDITIONAL FINANCING I GusarGusar HIGHWAY II PROJECT - ADDITIONAL FINANCING II* GAKHGAKH GakhGakh GubaGuba HIGHWAY III PROJECT AGSTAFAAGSTAFA DevechiDevechi HIGHWAYS GAZAKHGAZAKH ShekiSheki MAIN ROADS M2M2 GUBAGUBA DEVECHIDEVECHI AgstafaAgstafa M5M5 OGHUZOGHUZ M1M1 41°N GazakhGazakh SiyazanSiyazan RAILROADS Shamkur OghuzOghuz Baku – Shamakhy Reservoir SHEKISHEKI SIYAZANSIYAZAN NATIONAL CAPITAL 41°N 4 Lanes, 124 km M TovuzTovuz i GabalaGabala Kura ng AUTONOMOUS REPUBLIC CAPITAL ec KhiziKhizi he TOVUZTOVUZ vir SHEMKIRSHEMKIR Re RAYON CAPITALS SHEMKIR ser GABALAGABALA SAMUKHSAMUKH voi ShemkirShemkir r SHAMAKHYSHAMAKHY NabiagalyNabiagaly IsmailliIsmailli INTERNATIONAL BOUNDARIES To Dilizhan MingechevirMingechevir KHIZIKHIZI MINGECHEVIRMINGECHEVIR GanjaGanja ISMAILLIISMAILLI RAYON BOUNDARIES AgdashAgdash GoychayGoychay ShamakhyShamakhy SUMGAYITSUMGAYIT GANJAGANJA YevlachYevlach M4M4 SumgayitSumgayit GeranboyGeranboy *First objective was regional development. GedabayGedabay AGDASHAGDASH GOYCHAYGOYCHAY KhanlarKhanlar YEVLACHYEVLACH AkhsuAkhsu MarazaMaraza KhyrdalanKhyrdalan DashkesanDashkesan KHANLARKHANLAR GERANBOYGERANBOY AKHSUAKHSU UdjarUdjar M4M4 GEDABAYGEDABAY GOBUSTANGOBUSTAN BAKUBAKU BardaBarda ABSHERONABSHERON DASHKESANDASHKESAN TartarTartar UDJARUDJAR KyurdamirKyurdamir BARDABARDA BAKUBAKU TARTARARTAR ZARDABZARDAB ZardabZardab KYURDAMIRKYURDAMIR M2M2 Kura HAGIKHAGIKABULABUL Gazi-Gazi- KelbadzharKelbadzhar 40°N AGDAMAGDAM AGDZHEBEDIAGDZHEBEDI MammadMammad SabirabadSabirabad AgdzhebediAgdzhebedi 40°N ARMENIAA R M E N I A KELBADZHARKELBADZHAR SABIRABADSABIRABAD IMISHLIIMISHLI AliAli BayramliBayramli AlatAlat To Yerevan AgdamAgdam KHODZHALYKHODZHALY SaatlySaatly KhodzhalyKhodzhaly ImishliImishli ALIALI BBAYRAMLIAYRAMLI BEILAGANBEILAGAN SAATLYSAATLY Caspian KhodzhavenoKhodzhaveno LACHINLACHIN O BeilaganBeilagan ShushaShusha N E V SadarakSadarak A Sea SHUSHASHUSHA H Araz SALYANSALYANSALYAN Z SADARAKSADARAK D M6M6 LachinLachin O H FizuliFizuli SharurSharur KHODZHAVENOK BILASUVARBILASUVAR SalyanSalyan Araz FIZULI SHARURSHARUR FIZULIFIZULI M7M7 SHAKHBUZSHAKHBUZ BilasuvarBilasuvar Kura KANGARLIKANGARLI ShakhbuzShakhbuz NeftchalaNeftchala GivrakhGivrakh GubadlyGubadly DzebrailDzebrail NEFTCHALANEFTCHALA BABEKBABEK GUBADLYGUBADLY DZEBRAILDZEBRAIL JalilabadJalilabad M3M3 NAKHCHIVANNAKHCHIVAN JALILABADJALILABAD Araz DZHULFADZHULFA Reservoir BabekBabek ZangilanZangilan MasallyMasally 39°N N 39°N ORDUBADORDUBAD A DzhulfaDzhulfa IL MASALLYMASALLY M8M8 G N A OrdubadOrdubad ZANGILANZ YardymlyYardymly YARDYMLYYARDYMLY AZERBAIJAN This map was produced by the Map LENKORANLENKORAN Design Unit of The World Bank. The LerikLerik LenkoranLenkoran boundaries, colors, denominations and any other information shown on this 01020 30 40 50 map do not imply, on the part of The To Jolfa LERIKLERIK World Bank Group, any judgment on KILOMETERS the legal status of any territory, or any endorsement or acceptance of such boundaries. ISLAMICI S L A M I C REPUBLICR E P U B L I C OOFF IIRANR A N ASTARAASTARA AstaraAstara 45°E 46°E 47°E 48°E To Rasht 50°E

JANUARY 2010