Report and Recommendation of the President to the Board of Directors Project Number: 40610 September 2007 Proposed Loan and Technical Assistance Grant Republic of Armenia: Rural Road Sector Project CURRENCY EQUIVALENTS (as of 24 August 2007) Currency Unit – dram (AMD) AMD1.00 = $0.0030 $1.00 = AMD337.75 ABBREVIATIONS ADB – Asian Development Bank ARD – Armenian Roads Directorate Non-Commercial State Organization ASIF – Armenia Social Investment Fund EA – executing agency EARF – environmental assessment and review framework EIRR – economic internal rate of return EMP – environmental management plan GDP – gross domestic product HDM4 – Highway Development and Management Model 4 IA – implementing agency ICB – international competitive bidding IDPR – internally displaced persons and refugees IDPRDF – internally displaced persons and refugees development framework IDPRDP – internally displaced persons and refugees development plan IEE – initial environmental examination iRAP – international Road Assessment Programme IRI – international roughness index JBIC – Japan Bank for International Cooperation JICA – Japan International Cooperation Agency LRNP – Lifeline Road Network Program MCC – Millennium Challenge Corporation MOTC – Ministry of Transport and Communications NCB – national competitive bidding NPV – net present value PAM – project administration memorandum PBC – performance-based contract PGC – project governing council PMU – project management unit PPMS – project performance monitoring system PRSP – Poverty Reduction Strategy Paper RF – resettlement framework RP – resettlement plan SIEE – summary initial environmental examination TA – technical assistance UNESCAP – United Nations Economic and Social Commission for Asia and the Pacific UNAIDS – Joint United Nations Programme on HIV/AIDS UNDP – United Nations Development Programme USAID – United States Agency for International Development NOTES (i) The fiscal year (FY) of the Government of Armenia and its agencies ends on 31 December. (ii) In this report, "$" refers to US dollars. Vice President L. Jin, Operations Group 1 Director General J. Miranda, Central and West Asia Department (CWRD) Director S. O’Sullivan, Infrastructure Division, CWRD Team leader H. Koide, Principal Infrastructure Finance Specialist, CWRD Team members B. Konysbayev, Counsel, Office of the General Counsel L. B. Lahm, Senior Advisor, Office of the Vice President (Operations 2) P. Lizot, Head, Project Administration Unit, CWRD O. Nazmieva, Financial Control Specialist, Controllers Department S. Tu, Environmental Specialist, CWRD L. P. Alejandro, Assistant Project Analyst, CWRD A. L. Silverio, Administrative Assistant, CWRD CONTENTS Page LOAN AND PROJECT SUMMARY i MAP I. THE PROPOSAL 1 II. RATIONALE: SECTOR PERFORMANCE, PROBLEMS, AND OPPORTUNITIES 1 A. Performance Indicators and Analysis 1 B. Analysis of Key Problems and Opportunities 2 III. THE PROPOSED PROJECT 6 A. Impact and Outcome 6 B. Outputs 6 C. Special Features 7 D. Project Investment Plan 7 E. Financing Plan 8 F. Implementation Arrangements 8 IV. TECHNICAL ASSISTANCE 12 V. PROJECT BENEFITS, IMPACTS, ASSUMPTIONS, AND RISKS 13 A. Economic Benefits 13 B. Project Sustainability 14 C. Environmental Impacts 14 D. Social and Poverty Impacts 14 E. Indigenous People 14 F. Internally Displaced Persons and Refugees 15 G. Land Acquisition and Resettlement 15 H. Risks 16 VI. ASSURANCES AND CONDITIONS 16 A. Implementation Arrangements 16 B. Conditions for Disbursement 19 VII. RECOMMENDATION 20 APPENDIXES 1. Design and Monitoring Framework 21 2. Road Subsector Analysis 23 3. External Assistance to the Road Subsector 29 4. Selection Criteria and Approval Process for Subprojects 30 5. List of Subprojects Identified for the Project 32 6. Detailed Cost Estimates and Financing Plan 34 7. Project Organization and Implementation Arrangements 36 8. Indicative Implementation Schedule 37 9. Procurement Plan 38 10. Economic Analysis 42 11. Summary Poverty Reduction and Social Strategy 47 SUPPLEMENTARY APPENDIXES (available on request) A. Outline Terms of Reference for Subproject Preparation and Project Supervision B. Financial Management Assessment C. Outline Terms of Reference for Transport Sector Development Strategy D. Summary Initial Environmental Examination E. Internally Displaced Persons and Refugees Development Framework F. Resettlement Framework LOAN AND PROJECT SUMMARY Borrower Republic of Armenia Classification Targeting classification: Targeted intervention (geographic poverty) Sector: Transport and communications Subsector: Roads and highways Themes: Sustainable economic growth, capacity development Subthemes: Fostering physical infrastructure development, institutional development Environment Category B. An initial environmental examination (IEE) has been Assessment undertaken, and a summary initial environmental examination (SIEE) is in Supplementary Appendix D. Project Description The proposed Rural Road Sector Project (the Project) will (i) enhance the economic integration of selected rural communities, which make up about 10% of the total rural population, through improvement of high priority rural feeder roads totaling about 220 kilometers (km) connected to the national road network; and (ii) strengthen the transport sector management capability. To maximize the benefits and reach out to the majority of the rural population in the country, the Project has been designed by actively maintaining operational partnerships with the Japan Bank for International Cooperation (JBIC), Japan International Cooperation Agency (JICA), US Millennium Challenge Corporation (MCC), Armenian Social Investment Fund (ASIF), international Road Assessment Programme (iRAP), Joint United Nations Programme on HIV/AIDS (UNAIDS), United Nations Economic and Social Commission for Asia and the Pacific (UNESCAP), United Nations Development Programme (UNDP), and United States Agency for International Development (USAID). Rationale Facing ongoing globalization, Armenia has progressively made efforts to strengthen the interlinkage between its economy and other economies. The transport sector, particularly the road subsector, has played an increasingly important role in this process. As the predominant transport mode, road transport is important for the national economy and population and serves 98% of passenger traffic and 66% of freight traffic. The majority of the road network traverses mountainous terrain, and altitudes frequently exceed 1,500 meters (m) above sea level. Steep gradients, deep cuttings, and high embankments are common in mountainous areas, and landslides occur frequently. Severe winter weather requires extensive efforts to maintain access. In many areas of the road network, high intensity rainfall and poor road drainage cause traffic problems and road infrastructure damage. The extreme climate also causes a negative impact on the behavior of road pavements, particularly because of freezing and thawing in the spring. In Armenia, 1.2 million people (about 38% of the total population) live ii in rural areas, of which more than 45% is poor. Poverty has been reduced from 50.0% in 2000 to 29.8% in 2005 but poverty reduction has been slower in rural areas. This is mainly because of constrained economic activities—primarily attributable to mountainous topography and poor transport infrastructure—imposing high direct and indirect transport costs on the rural population, and limiting income opportunities and expansion of rural industries. High transport costs and constrained road access have also negatively affected non- income aspects of poverty in rural areas because of limited access to social service delivery institutions. To respond to challenges created by road infrastructure deficiency, the Government’s main road subsector policy until 2015 focuses on the rehabilitation and maintenance of existing roads in line with the Poverty Reduction Strategy Paper (PRSP). The Government adopted three strategic goals for its road infrastructure development for the period 2006–2015: (i) maintenance and improvement of the main road network to enhance the country’s business competitiveness and support the economy, (ii) improvement of the socioeconomic condition of the rural population through rehabilitation of rural roads in support of the PRSP, and (iii) improvement of traffic safety. The Government plans to (i) complete the rehabilitation of old bridges and other ancillary facilities along the main highways by 2010, (ii) complete the rehabilitation of secondary roads and bridges by 2015, (iii) meet rural road transport demands in a cost-effective manner, and (iv) ensure road safety throughout all road categories. To address inefficient infrastructure as one of the main causes of poverty, the Government has set rural infrastructure development as the cornerstone of the PRSP and has prepared rural infrastructure investment programs to reduce rural poverty. In the road sector, the Government developed a Lifeline Road Network Program (LRNP) in 2004, with assistance from the World Bank. The LRNP will improve the access of rural communities to the national highway system in an optimal manner throughout the country. It targets 784 high priority rural feeder roads (secondary and local roads) totaling about 2,700 km. Under the small-scale technical assistance for preparing the Project, the overall cost of the LRNP has been preliminarily updated to an estimated $300 million. MCC has committed to provide $67 million for the rehabilitation of rural roads (totaling about 940 km), while the Government