Document of The World Bank Public Disclosure Authorized Report No. 13206-PE Public Disclosure Authorized STAFF APPRAISAL REPORT PERU LIMA WATER REHABILITATION AND MANAGEMENT PROJECT Public Disclosure Authorized NOVEMBER 1, 1994 Public Disclosure Authorized LA3 Department Environment and Urban Development Division Latin America and the Caribbean Regional Office Currency Equivalents Currency unit = sol US$1 = 2.16 soles (March 31, 1994) 1 figures in U.S. dollars unless otherwise noted Weights and Measures Metric Fiscal Year January 1 - December 31 Abbreviations and Acronyms CEPRI-SEDAPAL SEDAPAL's privatization committee COPRI Interministerialcommittee for privatization CORTAPA Former tariff-settingboard FONAVI National Housing Fund SEDAPAL Servicio de Agua Potable y Alcantarilladode Lima (Lima Water and Sewerage Service Company) SENAPA SuperintendenciaNacional de Agua Potable y Alcantarillado(former urban water agency) SLA Subsidiaryloan agreement Peru Lima Water Rehabilitation and Management Project Staff Appraisal Report Contents Loan and Project Summary ........................................ .v I. Water and Sanitation Sector Overview ................................... 1 A. Economic background ....................................... 1 B. Institutional and legal framework .1............................... I C. Current sector issues ................................... 2 D. SEDAPAL ................................... 3 E. Lessons from Bank experience ................................. .4 II. The Project .5 A. Objectives and rationale .5 B. Water demand .5 C. Description .6 D. Cost .. 7 E. Economic evaluation ........................................ 8 F. Poverty alleviation and affordability .9 G. Financial analysis .10 H. Environmental impact .14 1. Risks . .. .. .. .. .. .. ... 14 III. Project Implementation .14 A. Arrangements .14 B. Subproject selection criteria .16 C. Project supervision .17 D. Procurement . 17 E. Disbursement .18 F. Advance contracting and retroactive financing .18 G. Auditing arrangements .18 H. Reporting and monitoring .19 IV. Agreements Reached and Recommendation ........................... 19 This report is based on the findingsof an appraisal missionthat visited Peru from April 26 to May 13, 1994. The mission was comprised of Messrs./Mmes. Abel Mejia, Yoko Katakura, Caroline Van Den Berg, Eid Nouhra (LA1IN), Alex Bakalian, Thelma Triche (TWUWS),Robert Taylor (LAIIE), Rudy Van Puymbroeck(LEGLA), Orville Grimes (LA1DR), Luz Maria Gonzales (consultant),and Makoto Nakao (OECF). Rita Cestti, Manuel Mariffo(TWUWS), Carlos Velez (LA1IN), Jerson Kelman, DominiqueBerthon, Jean Louis Olivier, Roberto Chama, Eduardo Baso, and Eduardo Buroz (consultants)also participated in project missions. Carlos Olle from SEDAPALcoordinated project preparation.Juan Barandiaran,Ana Mendoza, Carlos Oyafuso,Alfredo Garcia, R. Rojas, E. Rojas, M. Sheen, and Carlos Paredes comprisedthe ProjectPreparation Team in Peru. Thelma Triche (TWUWS)and Walter Stottmann(EMTIN) are peer reviewers. Mr. Asif Faiz was the responsibleDivision Chief during projectpreparation and appraisal.The sector DivisionChief, ProjectsAdvisor, and DepartmentDirector are Messrs. Eugene D. McCarthy, Robert Crown, and YoshiakiAbe. - 1i - Tables 1. Project costs ............................................... .8 2. Financing plan, 1994-2000 ..................................... 11 3. Financial data, SEDAPAL, 1987-93 .............. .. ... ... .. ... .. .. 12 4. Sensitivity analysis for two tariff rate structures ......... .. .. .. 13 5. Project costs by procurement method .............. .. ... ... .. ... .. .. 18 Annexes .21 1. Bank Loans to Peru for Water and Sanitation Sector and Related Loans ..... 23 2. Experience and Lessons Learned from Previous Projects ...... 24 3. Peru's Privatization Program ............ ... .. .. .. .. .. .. .. .. ... .. 26 4. SEDAPAL Management Plan ........... .. .. .. .. .. .. .. .. .. .. .. 28 5. SEDAPAL Investment Plan ............ ... .. .. .. .. .. .. .. .. ... .. 30 6. Detailed Project Cost ........................................ 38 7. Technical Assistance ................. .... ... .... ... ... .... ... 43 8. Water Demand in Metropolitan Lima ......... .. .. .. .. .. 47 9. Cost Benefit Analysis: Methodology and Results ....................... 55 10. Marginal Cost Pricing Analysis: Methodology and Results ...... 66 11 Financial Projections ................ ... ... .... ... ... ... ... .. 74 12. Notes and Assumptions for Financial Forecasts ....... 77 13. Procurement Plan and Implementation Schedule ....... 84 14. Implementation Plan ................ ... ... ... ... ... ... ... .. 90 15. Project Flows: Legal, Financial and Technical ......................... 95 16. Project Review . 96 17. Guidelines for Evaluation of Subprojects ............................. 98 18. Supervision Plan. ........................... 103 19. Monitoring Indicators. ......................... 104 20. Loan Disbursement Schedule . 108 21. Selected Documents Available in Project File ........................ 109 Maps .112 IBRD 26211 IBRD 26212 IBRD 26213 - iii - Peru Lima Water Rehabilitation and Management Project Staff Appraisal Report Loan and Project Summary Borrower: Republic of Peru. Beneficiary: Lima Water and Sewerage Service Company (SEDAPAL). Amount: US$150 million equivalent. Terms: Repayment in 17 years, includinga grace period of five years, at the Bank's standard variable rate, with level repayment of principal. The Government will extend the loan to SEDAPAL under the same terms and conditions. SEDAPAL will bear the foreign exchange risk. Project objectives: The project's goal is to improve the efficiency of water and sanitation delivery in the Lima-Callao metropolitanarea. The project will promote water conservation, support SEDAPAL's privatization, rehabilitate damagedwater supply and sewerage systems, expand services to the urban poor in the pueblosjovenes, and support reforms in the legal and institutionalframework of the water and sanitation sector. Project description: The project has four components. The water conservationcomponent includes preparing a customer cadastre, reconstructingwater meter boxes, and installing 406,000 water meters. This componentwill also initiate conjunctiveuse of surface and groundwater in three districts where groundwater is depleted and the risk of saline contaminationis serious. The rehabilitationcomponent will improve water supply and sewerage in the twelve districts that comprise 40 percent of SEDAPAL's water sales and 75 percent of total revenue. Wells will also be rehabilitated under this component.The pueblosjovenes componentwill expand and improve water and sanitation services for 600,000 of Lima's poor. The institutionalstrengthening component involves studies and technical assistance programs for SEDAPAL and the Superintendencyof Sanitary Services. Poverty aspects: The pueblosjovenes componentis targeted toward the poor. At project's end, 600,000 beneficiaries-about 26 percent of the total number of beneficiaries-will be the urban poor living in the outskirts of Lima. In addition, the water conservation componentwill install water meters in high-incomehouseholds. Water savings obtained from this component will be directed to the pueblosjovenes. Environmental aspects: A detailed environmentalassessment was prepared for the project. The project is classified as Category B under the Bank's rating system. Although construction impacts are expected from the rehabilitation,their effects on land use and ecological systems are expected to be minimal. - iv - Project benefits: The project will provide 834,000 people with improvedwater supply and 788,000 people with improved sewerage. The pueblos jovenes componentwill provide an additional600,000 low-incomeresidents with both new and improved services. Other project benefits include savings from reducing unaccounted-forwater and water consumptionin high-incomeareas, health benefits from the pueblos jovenes component, increased reliability of water supply services, reduced water costs in low-incomeareas, and preservationof water resources. Project risks: The project's main risks include political opposition to the sectoral reform- including privatization-that may slow the reform process, ineffectiveexecution of the project during the transition from public to private sector operation, insufficient counterpart funding, and non-acceptanceof Bank funds by the concessionaire. The risk of political opposition is minimizedby three factors. First, the new regulatory and institutionalframework is the result of two years of consensus-buildingby the Government of Peru to advance reform. Second, the timing and social environment for privatization is favorable-the current administrationwants to advance SEDAPAL's privatization before the April 1995elections. Finally, successful privatization in other sectors and public utilities has created social support for privatization. The risk of ineffectiveexecution of the project during the transition period is minimizedby a managementagreement to be signed between SEDAPAL and the government. This agreement defines key operational and investment performance objectivesand will be evaluatedevery three months until the private operator assumes responsibility. If privatizationis unsuccessful, terms for a second managementagreement will be discussedwith SEDAPALand the government during the Project Review. Annual managementagreements should be signed thereafter. If privatization is successful, a performance plan-as part of the concession