Document of The World Bank

Report No: ICR0000490

IMPLEMENTATION COMPLETION AND RESULTS REPORT

(IBRD-44840)

ON A

LOAN

IN THE AMOUNT OF US$ 30.0 MILLION

TO THE

ARGENTINE REPUBLIC

FOR A

WATER SECTOR REFORM PROJECT

October 3, 2007

Sustainable Development Department Argentina, Chile, Paraguay and Uruguay Country Management Unit Latin America and the Caribbean Region

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CURRENCY EQUIVALENTS (Exchange Rate Effective 08/31/07)

Currency Unit = Argentine Peso ($)

AR$1.00 = US$ 0.316 US$ 1.00 = 3.16 AR$

FISCAL YEAR

ABBREVIATIONS AND ACRONYMS

AFERAS Federal Association of Regulatory Agencies for Water and Sanitation APL Adaptable Program Loan CAS Country Assistance Strategy DO Development Objective EIRR Economic Internal Rate of Return ENOHSA National Agency for Water and Sanitation Works EPH Argentina Permanent Household Survey ICB International Competitive Bidding ICR Implementation Completion and Results Report INDEC Argentine Statistics and Census Institute M&E Monitoring and Evaluation NCB National Competitive Bidding NPV Net Present Value PAD Project Appraisal Document PDO Project Development Objective PMU Project Management Unit PSR Project Supervision Report PSP Private Sector Participation OP Operational Policy QAG Quality Assurance Group QAE Quality at Entry QSA Quality of Supervision Assessment SNRSD Secretary of Natural Resources and Sustainable Development SPIDES Water and Sanitation Sector Information System TA Technical Assistance WS&S Water Supply and Sanitation WTP Willingness to pay

Vice President: Pamela Cox Country Director: Pedro Alba Sector Manager: David Sislen (Acting at time of ICR review) Project Team Leader: Manuel Mariño ICR Team Leader: Manuel Mariño

ARGENTINA Water Sector Reform Project

CONTENTS

Data Sheet A. Basic Information B. Key Dates C. Ratings Summary D. Sector and Theme Codes E. Bank Staff F. Results Framework Analysis G. Ratings of Project Performance in ISRs H. Restructuring I. Disbursement Graph

1. Project Context, Development Objectives and Design........................................................... 12. Key Factors Affecting Implementation and Outcomes ........................................................ 103. Assessment of Outcomes ...................................................................................................... 194. Assessment of Risk to Development Outcome..................................................................... 265. Assessment of Bank and Borrower Performance ................................................................. 276. Lessons Learned ................................................................................................................... 307. Comments on Issues Raised by Borrower/Implementing Agencies/Partners....................... 32 Annex 1: Project Costs and Financing .......................................................................................... 33 Annex 2. Outputs by Component .................................................................................................. 34 Annex 3: Economic Analysis ........................................................................................................ 42 Annex 4: Bank Lending and Implementation Support/Supervision Processes ............................. 52 Annex 5: Beneficiary Survey Results............................................................................................ 54 Annex 6: Stakeholder Workshop Report and Results ................................................................... 55 Annex 7: Summary of Borrower's ICR and/or Comments on Draft ICR...................................... 56 Annex 8: Comments of Cofinanciers and Other Partners/Stakeholders........................................ 57 Annex 9: List of Supporting Documents....................................................................................... 58

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A. Basic Information Country: Argentina Project Name:

AR WATER SCTR RFRM

Project ID: P006046 L/C/TF Number(s): IBRD-44840 ICR Date: 10/05/2007 ICR Type: Core ICR

Lending Instrument: APL Borrower: GOVT OF ARGENTINA

Original Total Commitment:

USD 30.0M Disbursed Amount: USD 24.5M

Environmental Category: B Implementing Agencies: ENOHSA Cofinanciers and Other External Partners: B. Key Dates

Process Date Process Original Date Revised / Actual Date(s) Concept Review: 04/04/1997 Effectiveness: 12/26/2000 12/26/2000

Appraisal: 06/09/1997 Restructuring(s): 08/22/2002 06/17/2004

Approval: 06/01/1999 Mid-term Review: 12/16/2003 Closing: 07/31/2002 03/31/2007 C. Ratings Summary C.1 Performance Rating by ICR Outcomes: Unsatisfactory Risk to Development Outcome: Substantial Bank Performance: Moderately Unsatisfactory Borrower Performance: Moderately Unsatisfactory

C.2 Detailed Ratings of Bank and Borrower Performance (by ICR) Bank Ratings Borrower Ratings

Quality at Entry: Moderately Satisfactory Government: Moderately Unsatisfactory

Quality of Supervision: Moderately Unsatisfactory Implementing Agency/Agencies:

Moderately Unsatisfactory

Overall Bank Performance:

Moderately Unsatisfactory

Overall Borrower Performance:

Moderately Unsatisfactory

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C.3 Quality at Entry and Implementation Performance Indicators Implementation

Performance Indicators QAG Assessments

(if any) Rating

Potential Problem Project at any time (Yes/No):

No Quality at Entry (QEA):

Highly Satisfactory

Problem Project at any time (Yes/No):

Yes Quality of Supervision (QSA):

Satisfactory

DO rating before Closing/Inactive status:

Unsatisfactory

D. Sector and Theme Codes

Original Actual Sector Code (as % of total Bank financing) Central government administration 22 1 Sewerage 39 77 Water supply 39 22

Theme Code (Primary/Secondary) Access to urban services and housing Primary Primary Environmental policies and institutions Primary Not Applicable Other urban development Primary Secondary Pollution management and environmental health Primary Primary Regulation and competition policy Primary Secondary E. Bank Staff

Positions At ICR At Approval Vice President: Pamela Cox Shahid Javed Burki Country Director: Pedro Alba Myrna L. Alexander Sector Manager: David N. Sislen Danny M. Leipziger Project Team Leader: Manuel G. Marino Yoko Katakura ICR Team Leader: Manuel G. Marino ICR Primary Author: Isabelle Fauconnier F. Results Framework Analysis Project Development Objectives (from Project Appraisal Document) The project's original objective was to support the reform process in about five medium-size municipal and provincial utilities through the introduction of private sector participation in the operation and management of water utilities, adoption of appropriate

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regulatory frameworks, and institutionalization of tariff policies and tested investment alternatives to reach poor consumers better. At the same time, the project also aimed at creating a Federal backstopping capacity to adress the emerging post-privatization issues such as weak regulatory regulatory capacity, slow extension of services to the poor, and conflict resolutions. Revised Project Development Objectives (as approved by original approving authority) Project restructuring was submitted to the Board in June 2004 and approved. The revised project objectives include: (a) to support the reform of the water and sanitation sector in Argentina through the promotion of efficiency in the operation and financing of water utilities; (b) to support the establishment of sound regulatory frameworks for the water sector; and (c) to address universal service and environmental issues pertaining to said sector. The project remains focused on improvements of existing water supply and sanitation infrastructure in medium-sized cities of between 50,000 and 500,000 inhabitants. (a) PDO Indicator(s)

Indicator Baseline Value

Original Target Values (from

approval documents)

Formally Revised Target Values

Actual Value Achieved at

Completion or Target Years

Indicator 1 : To support the reform process in medium-size municipal and provincial utilities Value quantitative or Qualitative)

0 Utilities 5 Utilities 3 Utilities 0

Date achieved 07/19/2004 03/30/2007 06/25/2004 03/30/2007 Comments (incl. % achievement)

Note that "Actual Value Achieved at Completion" indicator is not applicable at project closing as the T.A. component to support the reform process under the project was not implemented.

(b) Intermediate Outcome Indicator(s)

Indicator Baseline Value

Original Target Values (from

approval documents)

Formally Revised

Target Values

Actual Value Achieved at

Completion or Target Years

Indicator 1 : Weighted average labor productivity (water connections per employee) Value (quantitative or Qualitative)

167 500 200 300

Date achieved 05/10/1999 03/30/2007 06/25/2004 03/30/2007 Comments (incl. % achievement)

Note that "Actual Value Achieved at Completion" indicator is not applicable at project closing as the T.A. component to support the reform process under the project was not implemented.

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G. Ratings of Project Performance in ISRs

No. Date ISR Archived DO IP Actual

Disbursements (USD millions)

1 06/25/1999 Satisfactory Satisfactory 0.00 2 08/30/1999 Satisfactory Satisfactory 0.00 3 06/14/2000 Satisfactory Satisfactory 0.00 4 11/27/2000 Satisfactory Satisfactory 0.00 5 12/14/2000 Satisfactory Satisfactory 0.00 6 06/28/2001 Satisfactory Unsatisfactory 1.80 7 10/30/2001 Satisfactory Unsatisfactory 3.02 8 11/24/2001 Satisfactory Satisfactory 3.02 9 05/30/2002 Satisfactory Satisfactory 3.02

10 06/24/2002 Unsatisfactory Unsatisfactory 3.02 11 08/29/2002 Unsatisfactory Unsatisfactory 3.02 12 09/05/2002 Unsatisfactory Unsatisfactory 3.02 13 11/27/2002 Unsatisfactory Unsatisfactory 3.55 14 05/30/2003 Unsatisfactory Unsatisfactory 3.55 15 12/05/2003 Unsatisfactory Unsatisfactory 4.55 16 06/03/2004 Unsatisfactory Unsatisfactory 8.18 17 06/29/2004 Unsatisfactory Unsatisfactory 8.18 18 11/30/2004 Satisfactory Unsatisfactory 10.93 19 05/09/2005 Moderately Satisfactory Unsatisfactory 11.66 20 06/28/2005 Unsatisfactory Unsatisfactory 11.66 21 05/26/2006 Unsatisfactory Unsatisfactory 15.54 22 12/14/2006 Unsatisfactory Unsatisfactory 20.35

H. Restructuring (if any)

ISR Ratings at RestructuringRestructuring

Date(s)

Board Approved

PDO Change DO IP

Amount Disbursed at

Restructuring in USD millions

Reason for Restructuring & Key Changes Made

08/22/2002 N U U 3.02 Never ratified by Government.

06/17/2004 N U U 8.18

Allow borrowing by non-PSP utilities (same performance conditions); allow grants for urgent actions in poor urban areas (softened performance conditions).

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I. Disbursement Profile

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1. Project Context, Development Objectives and Design 1.1 Context at Appraisal At the time of appraisal, Argentina’s Secretary of Natural Resources confirmed to the Bank that private sector participation (PSP) continued to underpin the government’s strategy to improve the quality and efficiency of water and sanitation services in urban and rural areas. While demand for privatization remained strong, recent experiences also demonstrated how complex and difficult a process this was. The Buenos Aires concession was already under considerable stress, the privatized utility in Corrientes was experiencing low levels of investments and the Tucumán concession had been terminated. Most provinces and a large number of municipalities and cooperatives were increasingly requesting from the Federal Government technical assistance and financial support to open their utilities up to competition, create regulatory agencies and avoid some of the mistakes of the past. The Bank’s country assistance strategy (CAS) agenda at the time included the privatization of water utilities and reduction of fiscal transfers to inefficient public utilities (Document No. 14278-AR, with a discussion update on May 15, 1997 and progress reports in March and November 1998). The 1995 financial crisis in Argentina provoked by the Mexican peso devaluation opened a window of opportunity for accelerating reforms, supported by the Bank. This included the provision of water supply and sanitation (WS&S) services in the provinces and municipalities. The project built on the technical assistance already being offered to subnational governments under a water sector loan (Ln. 3281-AR, Water Supply II), which was still ongoing, and by the World Bank Institute to carry out the privatization process and regulate utilities, and provide financial support for initial and urgent rehabilitation/emergency investments in the privatized utilities and other forms of PSP. At the same time, the program supported the CAS goal of strengthening basic services and improving welfare by promoting the delivery of affordable water and sanitation services for the urban poor. The main sector issues at the time were low service coverage and poor quality WS&S services; low investments; inadequate revenues, internal cash generation and efficiency; and a weak institutional framework. The reform issues identified in the project appraisal document (PAD) included a lack of transparency in the privatization process; weak and expensive regulatory institutions and inefficient tariff regimes; poor choice of award criteria; lack of clear strategy and feasible models to expand services to the urban poor in the context of PSP; limited participation of risk capital by private investors in water and sanitation utilities; and lack of well-defined contracts and regulatory frameworks for existing cooperatives. In addition, cross-sector issues included a fragmented water resources management system, a complex framework of environmental institutions and regulations affecting the sector, and the lack of a policy framework to address poverty issues. As the first project to directly support the Government’s reform agenda, the project was to support the second generation of PSP arrangements targeting the improvement of efficiency and expansion of WS&S services in medium-size cities of the country (population between 50,000 and 500,000), and to address the sector and reform issues outlined above. It reflected the strategic choice already made by the government and supported by the Bank to move from public ownership and management of water and sanitation to a privately-led model of operation. While the past privatizations had demonstrated some flaws, the choice of lending to well-performing public utilities was not considered. The choice instead was to improve on the private model. The project was to be executed by the National Agency for Water and Sanitation Works (Ente Nacional de Obras Hídricas y Sanitarias - ENOHSA), under the supervision of the Secretariat of Natural Resources and Sustainable Development (SNRSD). Under the terms of the loan, ENOHSA would on-lend project funds to eligible sub-borrowers such as utilities and municipal and provincial governments meeting

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certain PSP and regulatory criteria. Operators selected under acceptable procedures would be free to procure works and goods under their own terms. The Bank would finance up to 60% of eligible investments of the first five years of the investment plan. The terms of eligibility are detailed in section 1.5 below. At project identification, alternative options were considered for Bank support to the WS&S sector such as:

a. complete withdrawal in order to allow the market to function and the private sector to assume all financing. This approach was discarded because it wrongly assumed that the sector was as attractive to the private sector as telecom and power, that price signals were right, that the regulatory framework was adequate, and that markets already had the capacity to address all sector issues and externalities and generate the incentives for a continuous and efficient expansion of services;

b. a conventional investment lending project. This was discarded because an APL was deemed more suitable to support the PSP-oriented reform process;

c. a technical assistance project. This was discarded because non-recourse financing was not yet feasible in the sector;

d. a guarantee project to provide partial risk guarantees to protect investors against sovereign risk and uncertainties associated with the functioning of economic regulation. This was discarded because of its stringent requirements and high transaction costs.

A sector reform project was selected to accelerate PSP in the sector, while addressing pending issues of the reform. The project was to provide limited financing for rehabilitation/emergency investments during the initial years of PSP, and technical assistance to consolidate the privatization strategy. The Government of Argentina considered this alternative, combined with the APL mechanism, the most adequate for the condition of the sector in Argentina at the time. The program would accelerate the transfer of a large number of utilities to private management while the participation of the Bank was perceived by the private sector as a key stabilizing factor. The participation of the Bank was considered justified during a transitional phase estimated to last five to ten years, to expand and consolidate the reform of water utilities in urban centers with a population greater than 50,000. During this timeframe, most of the investment responsibilities in this market segment were expected to shift to the private sector. The PAD listed the following as the value that Bank support would add in this project:

• Introduce transparency to the privatization process; • Bring privatization experience and intellectual leadership from elsewhere around the world; • Bring techniques and experiences in extending water and sanitation services to the urban poor on

a large scale; • Bring management discipline to the project; • Bank financing would act as a catalyst for private sector financing; • Establish credibility for the sector information system to be developed through the project.

1.2 Original Project Development Objective (PDO) and Key Indicators (as approved) The project's original objective as stated in the PAD was to support the reform process in about five medium-size municipal and provincial utilities while addressing the pending issues of existing private utilities, regulatory frameworks, and regulatory agencies.

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The project aimed to achieve four specific outcomes: (i) efficiently run utilities under private management; (ii) private utilities with a clear strategy to expand services to the poor; (iii) cost-effective regulatory practices; and (iv) reliable financial and operational information of utilities. This project was conceived as phase 1 of a two-phase adjustable program lending (APL) program. The overall program sought to support water sector reform in a total of at least 22 medium–size cities with population of about 50,000 to 500,000. While extending the reforms to these new medium-sized cities, the program also supported resolving the emerging issues of the earlier reform process in larger cities: weak economic regulation of utilities, slow expansion of services to the urban poor, and the lack of a well-defined framework to enforce environmental standards. It was expected that the project benefits to the first five utilities to be supported under this project would demonstrate the operational and financial viability of the program and set the stage for replication to other utilities in the later stages.

Table 1. Key performance indicators at appraisal Utility-based Program based Sector based

Operational Unaccounted-for-water % Metering % Water coverage % Sewerage coverage % No. of connections/employee Collection ratio %

Fiscal impact Taxes paid (US$/year)

Fiscal impact Taxes paid (US$/year)

Financial Debt/equity ratio Liquidity ratio Debt service coverage

Efficiency impact Water meters installed (#)

Financial impact Revenue generated (US$/year) Investment (US$/year)

Reform impact # Utilities with PSP # Approved regulatory frameworks Revenue generated (US$/year)

Poverty impact # Connections in Villa Miseria

Technical Assistance impact TA for PSP/regulatory model (man-month) Regulatory training (hours)

Service quality impact Client satisfaction with service quality

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1.3 Revised PDO (as approved by original approving authority) and Key Indicators, and reasons/justification

Following the macroeconomic crisis that shook Argentina starting in December 2001, the project underwent a first, unsuccessful attempt at adaptive restructuring in 2002 (see section 2.2 below). A second project restructuring was proposed at the mid-term review (December 2003) and approved by the Board in June 2004. This restructuring was both adaptive and corrective in nature, seeking to adjust the criteria for and destination of sub-loans and grants in response to i) low demand from eligible sub-borrowers for funds under the project; and ii) urgent needs in areas that had become especially vulnerable to sanitary risk due to increasing population density combined with deepening poverty. The restructuring thus allowed efficiently operating utilities other than PSP-led concessions or cooperatives to apply for project financing, and it allowed for grant funds to be directed to areas with emergency needs due to poverty and/or environmental conditions. Finally, the restructuring extended the closing date of the project to permit the adequate use and disbursement of funds. The loan amendment was countersigned by the Government of Argentina in July 2005. The revised project objectives were to support: (a) the reform of the water and sanitation sector in Argentina through the promotion of efficiency in the operation and financing of water utilities; (b) to support the establishment of sound regulatory frameworks for the water sector; and (c) to address universal service and environmental issues pertaining to said sector. The project remained focused on improvements of existing water supply and sanitation infrastructure in medium-sized cities of between 50,000 and 500,000 inhabitants.

Table 2. Key performance indicators after restructuring (shading indicates changes) Utility-based Program based Sector based Operational

Unaccounted-for-water % Metering % Water coverage % Sewerage coverage % No. of Connections/employee Collection ratio %

Fiscal impact Taxes paid

Fiscal impact Taxes paid(US$/year)

Financial Debt/equity ratio Liquidity ratio Debt service coverage

Efficiency impact Water meters installed (#)

Financial impact Revenue generated (US$/year) Investments (US$/year)

Reform impact # Eligible Utilities # Strengthened regulatory entities Revenue generated (US$/year)

Poverty impact Poor population benefited

Technical Assistance impact TA for regulatory entities (Benchmarking and SPIDES) (man-month) Regulatory training (trainee-hours)

Service quality impact Client satisfaction with service quality

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1.4 Main Beneficiaries, (original and revised, briefly describe the "primary target group" identified in the PAD and as captured in the PDO, as well as any other individuals and organizations expected to benefit from the project) Expected benefits were described as program (APL1+APL2), rather than project (APL1 only) benefits and included the following:

a. efficiency gains from private sector management of sector operations and a sound and stable regulatory framework;

b. increased and more efficient investments to rehabilitate and expand infrastructure; c. fiscal gains through increased tax revenues and reduced public transfers to water utilities. d. In the long term, improve the sector’s access to private capital markets by providing much needed

credibility in the regulatory environment and by providing stability and a track record of well-designed concession/PSP contracts.

e. Provide credible and acceptable PSP models to be tested under the project and adapted by other utilities in the country.

As described in the PAD, improved operational and investment efficiency would translate into more reliable water and sanitation services, the elimination of water rationing, reduction of waste due to increased metering, improved water quality and reduction of water pollution, and better services to the poor by the establishment of service and coverage targets in poor areas within PSP arrangements and better sizing, timing and technology choice of sector investments through the incentives guiding private sector decision-making. The PAD stated the target population for the entire program rather than just this project. The target population was 1.7 million, including 200,000 urban poor, as defined by the Headcount Index of Poverty and the NBI indicator (unsatisfied basic needs) developed by the census and statistics institute (INDEC). Annex 4 of the PAD included a distributive analysis of costs and benefits of the reform program using a sub-sample of three sub-projects1 to identify winners and losers. It determined that “the big winner is the government while also the other stakeholders, such as society and shareholders realize a sizeable share of the benefits of sector reform.” However, the net impact on consumers was less clear: “Consumers stand to lose from PSP due to the increased efficiency in the operation of the utilities resulting in higher water and sewerage bills. In return, however, they will benefit from improved services which were not fully quantified in the analysis.2” 1.5 Original Components (as approved) The project components as described in Annex 2 of the PAD, are presented in the matrix below (Table 3). The matrix also shows the revised components after project restructuring in June 2004.

1 The Misiones sub-project, which was in fact implemented, was among these.

2 The analysis assumed that economic benefits were equal to willingness to pay for water and sewerage disposal services, itself estimated at 5% of household income. Improved hygienic and environmental conditions resulting from improved WS&S coverage and quality and of temporary job generation during the project were not quantified.

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Table 3. Original vs. Revised Components of the Project Original Components (May 1999) Revised Components (June 2004)

A. Investment component (US$40.6 million). Investments to be financed under the project were those which restored the capacity of existing systems, and generated the highest impact on revenue. Investments eligible for financing under this component included: rehabilitation and replacement of pipes, revamping and improvement of water treatment plants and intake facilities, upgrading substandard connections, supply and installation of water meters, repair and replacement of pumping and control equipment, supply of emergency and maintenance equipment, improvement and extension of water and sewerage services to the poor. The component had three parts, as follows:

Part 1. Utilities with PSP arrangements procured through the Bank guidelines ($30 million) The project would support investments in utilities with: (i) a PSP contract procured under bidding procedures acceptable to the Bank; and (ii) a regulatory framework acceptable to the Secretary of Natural Resources and Sustainable Development and consistent with guidelines discussed with the Bank. Operators selected under acceptable procedures would be free to procure works and goods under their own terms. The Bank would finance up to 60% of eligible investments of the first five years of the investment plan. Guidelines for subproject evaluation and eligibility criteria are in the Project Operational Manual.

Part 2. Other utilities and cooperatives ($6.7 million) The project would also support investments in other utilities and cooperatives. It included PSP-contracts procured prior to the project and/or under procedures that were not cleared by the Bank and cooperatives (such as Olavarria). Investments of works and goods under this part were to be procured following Bank Guidelines. Utilities and cooperatives would be eligible for financing of selected investment subprojects subject to: (a) attainment of minimum operational indicators; (b) agreement on a multiyear investment plan; (c) provision of adequate guarantees; (d) acceptance of financial covenants established in the Project Operational Manual; and, (e) adoption of the provincial regulatory framework, acceptable to the Secretary of Natural Resources and Sustainable Development. Guidelines for subproject evaluation and eligibility criteria are in the Project Operational Manual.

Part 3. Service improvements for the urban poor (US$3.8 million) The project would support investments in utilities with long-term concessions which are willing to implement innovative approaches to improve/expand services to the urban poor. The concessionaires of Cordoba, Rosario, and Formosa had agreed to participate in the first phase. Detailed design of the component is available in project files. The implementation procedures are in the Project Operational Manual.

Part A: Subprojects (US$19.9 million)

1. (US$14 million) Improvement by Sub-borrowers of their existing water supply and sanitation infrastructure in Argentine medium size cities of between approximately 50,000 and 500,000 inhabitants through the rehabilitation and replacement of pipes; rehabilitation of water treatment plants and intake facilities; upgrading of substandard water connections; installation of water meters; repair and replacement of pumping control equipment; supply of emergency and maintenance equipment; and carrying out of other activities which improve existing water supply and sanitation sector physical assets or involve the installation or creation of new physical assets for said sector (all except as covered by Part A.3 of the Project). 2. Part A.2 was deliberately left blank in the loan amendment; (Part A.1 became applicable to all sub-borrowers, themselves expanded to include Provincial, Municipal, concessioned, and cooperative utilities).

3. Improvement by Sub-borrowers and/or Grantees (as the case may be) of their existing water supply and sanitation infrastructure serving poor urban areas in Argentina through the rehabilitation and replacement of pipes; rehabilitation of water treatment plants and intake facilities; upgrading of substandard water connections; installation of water meters; repair and replacement of pumping control equipment; supply of emergency and maintenance equipment; and carrying out of other activities which improve existing water supply and sanitation sector physical assets serving such poor urban areas or involve the installation or creation of new water supply and sanitation sector physical assets serving said areas.

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B. Institutional Component (US$5.2 million) This component was to finance the costs of the management of the project, training of regulators, technical assistance to continue advancing the reform of the sector, establishment of a sectoral information system, and development and implementation of environmental regulations. The component had four parts, as follows: Part 1. Project Management (US$1.5 million) A Project Management Unit (PMU) would be established at ENOHSA and it would be responsible for the supervision of subprojects. The Secretary of Natural Resources and Sustainable Development would provide the overall guidance to the project. ENOHSA would also be responsible for financial management of the project, including sub-loan administration, disbursement, and reporting and audits. The PMU would be led by a Coordinator financed under the project. The General Manager would be assisted by three functional teams, comprising 7 professionals, all financed under the project. The functional teams were: a privatization/regulation team, a project administration team, and a poverty team. To avoid creating a large PMU, a team of external consultants would be recruited to work under the supervision of the PMU to assist in monitoring the performance of utilities and supervising execution of investment subprojects. The PMU would be responsible for the day-to-day management of project implementation. A detailed description of PMU is on the Project Operational Manual. Procurement training for ENOHSA and sub-borrowers under Part B and C of the investment component was also be financed under this component. Part 2. Regulatory and Sector Training (US$0.5 million) The project would support training at two different levels. The first would be to assist utilities in improving professional proficiency and certifying of key operational functions. The second would be to assist regulatory agencies (including local government environmental agencies, as necessary) in building human capacity to regulate utilities. A detailed description of the training program is in the Project Operational Manual. Part 3. Technical Assistance to Support Sector Reform (US$3.1 million) The project would support financing of about 1,400 man-months of technical assistance to: (i) assist provincial/municipal governments in preparing privatization and regulatory framework documents; (ii)assist provincial/municipal governments in carrying out PSP transactions; (iii) maintain a backstop capacity at the Federal level to assist sector entities during the transition from public to private management, including crisis assistance to utilities and governments; and, (iv) assist concessionaires in effectively implementing low cost--community oriented--subprojects in Villas Miseria. Part 4. Sectoral Information System (SIS) (US$0.1 million) The project would support further development and update of a sector information system. It would also develop a utility information system containing operational and financial performance indicators. It was to be used to facilitate mobilization of private sector funds and to establish comparators among utilities for a "yardstick" competition system. The project would finance the detailed design of the SIS, once the evaluation of current sector information system (Sistema SPIDES) was completed. This component was expected to benefit from a similar initiative proposed for Brazil's utility sector, and from the benchmarking study commissioned by the Bank with the Water Research Council.

Part B: Institutional Strengthening (US$2.6 million) 1. Provision of technical assistance in support of the operation of the PMU. 2. Provision of training to: (a) Sub-borrower staff to improve their professional skills and allow certification of their ability to carry out key operational functions; and (b) provincial and municipal water and sanitation sector regulatory agency personnel to improve their regulatory capacity. 3. Provision of technical assistance to: (a) Sub-borrowers to support the carrying out of Subprojects under Part A.3 of the Project; and (b) Secretaría de Obras Públicas (SOP) and ENOHSA to provide federal backstop and crisis assistance to Sub-borrowers and provincial and municipal governments in the transition from public to private management of water and sanitation sector utilities. Sub-components 3(i) and 3(ii) were dropped.

4. Provision of technical assistance to ENOHSA to develop and update the information systems (known as SPIDES) for the water and sanitation sector and the utilities operating therein, including the acquisition and utilization of goods required to update and develop said systems. 5. (New) Acquisition and utilization of goods for purposes of strengthening: (a) the regulatory capacity of water sector regulatory agencies (at the federal, provincial and/or municipal level) to be selected by the Borrower in accordance with criteria acceptable to the Bank; and (b) the operational capacity of AFERAS.

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C. Environmental Component (US$1.0 million)

Part 1. Environmental Regulation (US$0.5 million) The project would finance updating of key environmental standards including for sewage and sludge disposal, preparation of guidelines for environmental impact assessment (construction of water and sanitation projects, environmental monitoring and contingency plans), environmental auditing of selected subprojects, and a prototype water quality management diagnostic study for the Salidulce river basin. Detailed design of the component is in project files and implementation arrangements are in the Project Operational Manual.

Part 2. Environmental services (US$0.5 million). The project was to finance emergency actions to mitigate negative environmental impacts related to water infrastructure. It included, inter-alia: environmental clean-up services, removal of hazardous wastes, and equipment to address environmental damage.

Part C: Environmental Actions (US$0.2 million) (No change) 1. Provision of technical assistance to SOP to update environmental standards (such as for sewage and sludge disposal), prepare guidelines for the preparation of environmental impact assessments in the water and sanitation sector, perform environmental audits of selected investment projects in said sector and prepare a water quality management diagnosis for the Salidulce river basin. 2. Carrying out of emergency actions (such as environmental clean-ups and removal of hazardous wastes) and provision of goods to mitigate negative environmental impacts that may arise in relation to water and sanitation sector infrastructure.

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1.6 Revised Components As mentioned above, after a failed attempt at restructuring in 2002, a second project restructuring was approved by the Board in July 2004 and ratified by the Government of Argentina in July 2005. The main changes to the project consisted of (i) modifying the eligibility criteria for the sub-borrowers so that not only privately held concessions and cooperatives, but any provincial, municipal, concessioned or cooperative utility operating under determined efficiency criteria would be eligible; and (ii) eliminating the pilot investment projects for poor areas (which were never executed) and instead making grants available to eligible utilities for investment activities in poor urban areas. In addition, technical assistance for PSP strengthening at the provincial/municipal level was eliminated, and a new subcomponent allowed for the acquisition of goods in support of regulatory capacity at the federal, provincial and/or municipal level and of operational capacity of the Federal Association of Regulatory Agencies for Water and Sanitation (AFERAS). Finally, the environmental component was not modified in substance but it was reduced in size, from US$ 1 million to 0.2 million. As detailed in the loan amendment, the revised components are presented in Table 3 above. 1.7 Other significant changes Funds were re-allocated among components as shown in Table 4 below.

Table 4. Allocation of Loan Proceeds Before and After Project Restructuring Original Loan Agreement (2000) Revised Loan Agreement (2004)

Category Amount of loan

% of Expenditures to be financed

Amount of loan % of Expenditures to be financed

Goods under Part A.1

7,200,000 60% 1,000,000 75%

Goods under Parts A.2 and A.3

2,200,000 52% 1,000,000 (for old Part A.2, and Part A.3)

75%

Goods under part C.2

200,000 100% of foreign 82% of local

0

Works under Part A.1

10,800,000 60% 13,000,000 75%

Works under Parts A.2 and A.3

3,300,000 52% 2,000,000 (for old Part A.2, and Part A.3)

52% under Subprojects which were approved b/w effective date and March 31, 2002

Consultant services under Part B

5,200,000 100% 2,600,000 (for consultants’ services and training)

100%

Consultant services under Part C

800,000 100% 200,000 100%

Works under Part A.3

N/a 4,700,000 75% under Sub-projects which were approved after March 31, 2002

Goods under Parts B.4 and B.5

N/a 200,000 75%

Unallocated 5,000,000 Fee 300,000 due 300,000 due Total 30,000,000 30,000,000

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Finally, the restructuring extended the closing date of the project to permit the adequate use and disbursement of funds. The closing date of the project was initially set to July 31, 2002. It was extended several times, due to the deep macroeconomic crisis that shook Argentina in 2001-2002, ensuing delays in the re-negotiations and price adjustments of works contracts, the restructuring itself and various procurement and execution delays, as detailed in section 2.2 and in Annex 2. The project ultimately closed on March 31, 2007. 2. Key Factors Affecting Implementation and Outcomes 2.1 Project Preparation, Design and Quality at Entry The Water Sector Reform Project followed the Water Supply and Sewerage Sector Project (Ln. 3181-AR), which was approved in December 1990 and closed in April 2000, and which received a satisfactory ICR rating in January 2001. The initial emphasis of that project was on strengthening decentralized utilities to make them more efficient and financially viable. The 1980 decentralization of water and sewerage services had been hastily carried out, resulting in weak provincial utilities and declining service quality and coverage. During the implementation of Ln. 3281 there was an important shift in government strategy, to make PSP the main tool for achieving efficiency and coverage goals in the delivery of these services, accompanied by strengthened regulatory functions in the public sector. To reflect this, Ln. 3281 modified its support to provide direct technical and financial assistance to the privatization of public utilities, while building public sector capacity to formulate policy and regulate privatized utilities. The Water Sector Reform Project was conceived while the implementation of this strategy was in full swing and the government sought to spread this approach to the provinces. The PAD listed numerous lessons learned, along with the ways in which the project would address these. In particular, measures included:

• detailed preparatory work to ensure that the project would be front-loaded with a significant pipeline of sub-projects at loan effectiveness;

• requiring that the private operators identify and implement the projects, as the public sector was found to have limited capacity to do so;

• allocating investments in a demand-driven, competitive manner along with an APL design to ensure investment efficiency, flexibility and satisfactory development impact;

• targeting private operators for institutional strengthening rather than public utilities, to improve its effectiveness;

• making private operators rather than provincial governments responsible for counterpart funds, as provincial governments had limited capacity to do so;

• allowing private operators rather than local governments to carry out procurement, in order to avoid paralyzing government processes;

• funding the Project Management Unit (PMU) to ensure effective staffing and capacity. In addition, the PAD presented lessons learned from recent difficulties experienced by PSP-oriented reforms in Argentina and elsewhere. These included:

• the need for strong political commitment to PSP from the top levels of government; • the pitfalls of hasty PSP-oriented reform and lack of proper competition in the award of PSP

contracts; • the potential dangers of implementing PSP without a sound regulatory framework and capable

regulators in place; • the advantage of multi-sector regulatory agencies at the provincial level;

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• the need for credible dispute resolution mechanisms in PSP contracts; • the need for a gradual approach to privatization combined with targeted subsidies for service

connections for the poor, when afforded by the existence of a clear government strategy and a strong institutional base.

2.1.1 Preparation Activities and Government Commitment. Preparatory studies were extensive, funded under the previous loan 3281-AR and covering 23 utilities willing to subscribe to the reform agenda of the Secretary of Natural Resources and Sustainable Development. Consulting firms prepared the reform programs for each utility, including a PSP strategy, a regulatory framework of WS&S services, and bidding documents for PSP. The analysis prepared by the consultants also included a technical evaluation of the service provided by each utility and a diagnosis of its infrastructure, detailed proposals and estimates for investment and service targets, the economic and financial evaluation of the viability of the proposed reform program and an inventory of existing environmental regulations and issues pertaining to WS&S services in the corresponding locality. Based on these studies, the provincial and municipal governments engaged in debate to obtain consensus on the detailed reform model to be adopted. The project preparation team composed of Bank staff and ENOHSA staff supervised the work of the consultants and further evaluated nine utilities already in an advanced stage of the reform process, through an economic and financial model and preparation of simplified line diagrams for all major system components, cost estimates for key investments and a consistency analysis of investment costs and service targets. According to interviews conducted for this ICR, government commitment appeared very high during project preparation, with the Sub-secretary of Water Resources a strong advocate, backed by a solid team of consultants (themselves funded under the previous loan 3281-AR). The Secretary of Natural Resources and Sustainable Development (SNRSD) sent a letter from the Ministry of Economy, Public Works and Services in July 1997 confirming to the Bank that PSP continued to underpin the government’s strategy to improve the quality and efficiency of water and sanitation services in urban and rural areas. This was confirmed again by the SNRSD in March 1998. 2.1.2 Evaluation of design and preparation activities Quality at entry (QAE) for this project was assessed at the pre-approval stage (December 1997) and rated “fully satisfactory.” The final QAE report was issued in January 2000, with a “Highly Satisfactory” rating. The project was considered an example of Best Practice, with top ratings for the areas of (i) project objectives, concept and approach; (ii) technical and economic aspects; (iii) institutional capactiy analysis; and (iv) risk assessment and sustainability. The QAE stated that “Overall, this is a carefully prepared project with a number of best practice features related to: developing and strengthening the privatization and regulatory agencies; sovereign lending to segments of the sector that are not suitable for financing by private companies (poor in peri-urban areas of mid- and smaller-sized cities); sequencing of the reform program and of the investments; good preparation of sub-projects; solid economic assessment and outstanding features in the financial analysis; adopting an APL with two phases thereby permitting (if found necessary) adjustments to the program that is designed to turn around this seriously neglected sector. Indeed, the project offers a good illustration for the approach advocated in the Sector Board's recent PIP. Several less advanced areas that would require close attention during the early stages of project implementation are as follows: a) adoption of adequate provisions for public consultation and disclosure (on environmental aspects); and b) additional measures to permit the measuring of social outcomes.”

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However, with the benefit of hindsight, a number of design features merit discussion and provide useful lessons for future projects. Although the macroeconomic crisis that erupted in December 2001 played an important role in shaping the ultimate outcome of the project, it also exacerbated pre-existing structural issues in the project design. Key lessons from the preparatory and design process of this operation include the following, and are detailed in the following sections:

• Clearly distinguish between the means (such as increasing PSP) to achieve reform vs. the ends (such as greater efficiency and improved services) that are sought;

• Avoid overly detailed designs for certain sub-components (such as sub-borrowing criteria and processes) and insufficiently detailed designs for others (such as poverty and environmental sub-components);

• Assess actual consumer demand for new services - both willingness to pay for new and/or improved services, and willingness to connect to those services - using stakeholder consultations and other social science tools (surveys, focus groups). This step is key to adequately evaluate project benefits, and to adapt project design if it is necessary to incentivize demand;

• Reflect such estimated consumer demand - both willingness to pay for new and/or improved services, and willingness to connect - for services in the economic analysis;

• Ensure that the economic analysis is tailored to ask the right questions of the project design; • Simplify institutional arrangements for project and sub-project execution so that responsibilities

and accountability are clearly assigned. Ensure that executing agency retains the commitment and the mandate to adequately execute the project’s components, between the time of appraisal and the time of project effectiveness. Monitor these aspects closely during project implementation.

• Carefully assess key risks relating to the macroeconomic environment, the government’s commitment to the chosen strategy or its ability to adhere to scheduled tariff increases.

2.1.2.1 Means versus ends. The project documents listed PSP-oriented reform as the project and program objective, rather than as the tool to achieve efficiency and improved service quality and sustainability. Throughout the 1990s, after disappointing results with various forms of decentralization of public services among many client countries, the Bank increasingly recommended PSP as the preferred tool to address operational and financial inefficiencies in the water and sewerage sector. Ten years later and after many hard-learned lessons, there is something of a consensus that PSP is only one among several tools to address efficiency issues in this sector, and that it is not a panacea. However, at the time of appraisal, PSP had become a quasi-shorthand for the achievement of efficiency and better services quality, within international policy circles and for the Argentine government. This may explain why the PDOs for this project cited PSP as an objective rather than as a means to reach the desired objective. 2.1.2.2 Detailed design. To avoid errors made in the past with regard to PSP reform, the project design was very detailed. Thorough guidelines were prepared in the operational manual. One objective of producing such detailed guidelines and contract templates was to allow the implementation of the reform program to become more “systematic” at a high level of quality, and to narrow or eliminate the possibility for errors during implementation. The unintended effect was that the IBRD sub-loan process and conditions were considered by the executing and sub-executing agencies to be too narrow, rigid and difficult to follow. They were also difficult to modify and adapt to the changing circumstances. As a corollary to the point above regarding means vs. ends, the definition of the PDOs led to the narrowing of eligibility criteria for sub-loans: only utilities with PSP (including cooperatives) could benefit from investment funds. This had a direct impact on project implementation, as the demand for sub-loans was ultimately lower than expected. Only two sub-projects, one in the province of Misiones and one in Buenos Aires Province (Olavarría) were executed under the initial project design, and a third

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was added after restructuring in 2004, in the province of Tucumán. In hindsight, it appears that non-PSP-reformed utilities might have used the investment funds and technical assistance beneficially, had they had access to those funds earlier on in the project. In 2001, many utilities remained under public management and the prospects for PSP-oriented reform had substantially dimmed. Two factors compounded the effect of overly narrow eligibility criteria on the demand for sub-loans: first, the move away from PSP as a government strategy as the country was entering recession and controversy around PSP was intensifying; second, the macroeconomic crisis which made utilities (like most other entities, public or private) reluctant to contract dollar-denominated debt. A more detailed discussion of the ramifications of the crisis for project implementation is included in section 2.2 below. On the other hand, certain components may have been under-designed, such as the poverty pilot sub-component and the environmental component. Three years had elapsed after project effectiveness before terms of reference and a call for proposals were ready for the studies to design the poverty pilot investments. However, none of the proposals submitted by prospective consultants were satisfactory, and this sub-component was later re-shaped under the restructuring to eliminate the poverty focused pilot projects and replace them with standard type investments targeting poor urban areas. Possible (combined) reasons for the failure of the original poverty-focused sub-component were (i) the government had found other means to address poverty through nationwide programs on public services and employment (PROSAC, and later Agua Más Trabajo and Cloacas Más Trabajo); and (ii) in the midst of the crisis, the priority of the project team was to save the existing active components of the project. 2.1.2.3 Social Aspects and Participatory Approach. The results on reform programs that emanated from the preparation studies were intensively discussed at the governmental level. The PAD also states that consultative meetings were held with stakeholders, including provincial and municipal governments, provincial and municipal utilities, cooperatives, regulators, private operators, financial institutions and investors, service-users, NGOs and community-based organizations. UNICEF helped to prepare the project component relating to extension of WS&S services to low income areas, detailed in the operational manual. Section E7 presents a table on the participatory approach, listing stakeholders and the type of input they had: information sharing, consultation, or collaboration. However, there is little detail provided regarding the substance of those consultations, and in particular whether prospective service users expressed demand for new sewerage services. We now know that collaboration with various stakeholders can yield specific outputs and feedback that may help in assessing overall demand for project benefits. 2.1.2.4 Economic Analysis. The benefits of the project were equated to households’ willingness to pay for improved services, which itself was not evaluated through a survey, but estimated as a percentage (on average 5%) of household income, based on similar data gathered in other countries. In hindsight, it appears that it would have been useful to evaluate actual demand for improved services and connections to new sewerage networks – i.e. willingness to connect - in order to better assess project benefits. Comparing the affordability for households of maintaining existing sanitation systems (mostly septic tanks) vs. connecting to new sewerage systems, given the projected connection costs and internal plumbing costs, would have provided a key input to project and policy design. While the PAD made a mention of these issues in connection with the Misiones sub-project (p.23), the analysis apparently disregarded internal plumbing costs and assumed that all households newly habilitated to connect to the sewerage service would in fact connect – which did not happen, as will be seen in section 2.2. Demand for new connections was therefore overestimated, and the full economic benefits of the project may remain at least partially unrealized due to the non-connection of a significant number of households to newly available sewerage networks.

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A more accurate assessment of households’ willingness to connect would have allowed for better follow-up on the project’s stated intent to support the design of a social tariff and subsidy mechanism, along with targeting mechanisms and price caps on connection charges, which were stipulated in the summary guidelines for regulatory models and concession contracts. Indeed, in at least two of the sub-projects, connection charges appear to be prohibitively high. For the future, technical assistance components might include the design of a coherent social and subsidy strategy for tariffs and connections, as an explicit and separate activity. 2.1.2.5 Institutional Design. Institutional arrangements were somewhat complex, with a national-level implementing agency (ENOHSA) overseen by the SNRSD and required to work with the COFESA (Federal Council for Sanitation) to coordinate with the provinces on matters relating to sector policy and resources allocation. For each sub-project, a sub-executing agency and sometimes a third agency was involved (in the case of Posadas, the province was the sub-borrower but the concessionaire was the executing agency). Added to these strata were the regulatory entities (one per sub-project) and contractors. As a result, responsibilities may have been too vaguely defined, especially with regard to the origin of counterpart funds, the oversight of works and importantly, the setting of sector policy. In spite of the recognition that hasty reforms and the lack of adequate regulatory structures were risk factors, the timetable for this project was very ambitious (2 years for 5 utilities). Expectations regarding the speed of reform programs and the establishment of new regulatory frameworks were probably overly optimistic. The project was to be managed under the guidance of the SNRSD, which would also carry out policy formulation and coordination with provincial governments, assisted by ENOHSA, the financial and implementing agency. The Project Management Unit established in ENOHSA initially was to be staffed with a coordinator backed up by a team of eight consultants, whose terms of reference were defined in the POM. Later, however, the PMU was staffed from within the organization rather than with exterior consultants, a choice that was meant to prolong the benefits of the project’s training and technical assistance within the organization. ENOHSA’s mandate is to implement public works and it has a limited role in setting sector policies and guidelines, which made it an unnatural partner/manager for reform-oriented technical assistance activities. Moreover, ENOHSA has become an executing agency for a large portfolio of investments: as a result there are bottlenecks and the technical departments within ENOHSA are reportedly saturated. Ideally, such a reform-oriented investment project would be executed by an entity that holds a mandate for both policy-setting and investment planning. Investments would then be allocated according to a coherent strategy that would simultaneously consider issues of access to services (including economic access and affordability), quality of services and efficiency in the delivery of services. 2.1.2.6 Assessment of Risks. The project documents listed a number of risks, many of them rated substantial, such as limited interest from local and international investors in the WS&S sector in Argentina, opposition to privatization from the population, politicians and unions, and the failure to address the culture of non-payment of water. These risks were to be mitigated through the preparation of well-designed PSP bidding documents and contracts, availability of Bank financing in the first five years for each utility, marketing and moderate expectations and “adequate mechanisms to address the issue of the urban poor”. However, it appears that three key risks were either underestimated or not considered: 1) the risk of a changing macroeconomic environment – though the country was entering a recession at the time of approval; ii) the risk of a change in the government’s PSP-focused strategy or commitment to the project strategy, despite clear signals of mounting public opposition to PSP; and iii) the risk that tariffs would not

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be adequately adjusted to changing costs during project execution, despite the lack of experience in Argentina with tariffs closely following operational costs and the admitted infancy of the regulatory systems to be established. Although it acknowledged the possibility that local and international investors might not be interested in project-supported PSP reform, the project design did not detail the reasons for such risk (such as, for example “country risk”), and by extension it did not explicitly consider larger macroeconomic risks. While the PAD recognized that the failure of past privatization efforts had eroded credibility, public support and investment interest, it regarded this project as the antidote to those criticisms, if well executed. 2.1.3 Revised Design at Project Restructuring When the project was restructured in 2004, some of the design issues highlighted above were addressed. The main change consisted in making the eligibility criteria for the sub-loans more flexible to allow any provincial, municipal, concessioned or cooperative utility operating under determined efficiency criteria to be eligible, not just privately held concessions and cooperatives. The objective of this modification was to make the project funds available to a larger group of utilities in need of investment funds. Secondly, the pilot investment projects for poor areas had never been designed or executed, and were therefore replaced by grants available to eligible utilities for investment activities in poor urban areas. The aim was to achieve a greater impact on poor communities using the loan proceeds. These changes ultimately enabled one additional investment sub-project to benefit from the loan proceeds. In other slight modifications, the technical assistance for PSP strengthening at the provincial/municipal level was eliminated, and the environmental component was not modified in substance but it was reduced in size, from US$ 1 million to 0.2 million. However, these design changes did not significantly affect the outcome of these sub-components, as will be seen in section 2.2 below. 2.2 Implementation The implementation of the project was affected by the following main factors:

• The shift of government strategy away from PSP-oriented reform of WS&S utilities, leading to low level of government interest in the project;

• The macroeconomic crisis that shook Argentina in late 2001/early 2002 • Late effective restructuring of the project; • Disputes regarding counterpart funds (Misiones) and contract re-determination; • Households’ lower-than-expected willingness to connect to newly available sewerage services; • Procurement delays and overly ambitious timetables for the execution of works, translating into

untimely execution; As noted in the previous section, the level of government commitment to the project was judged to be very high during the project preparation. However, after the loan was approved in May 1999, the transition to loan effectiveness was slow. The loan was signed and declared effective over one year after Board approval (i.e., three years after appraisal), after a change of government and a move of the government’s sector policy away from PSP, amid growing public controversy over the Buenos Aires WS&S concession and others. Although the new government was clearly opposed to the previous administration’s reforms and the new head of ENOHSA was explicitly in disagreement with the PDO, the Bank’s project team, with management support, remained resolute in the advocacy for the proposed reforms and of the PDOs. The team dedicated much time to convincing the government of the validity of

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the project’s approach, in order to salvage the reform effort with a view to providing better services to the 70% of the Argentine population then served by private operators. However, equity in access to services was becoming a major concern of government policy, and judged by the government to be at odds with PSP-reform as it had played out so far. The loss of government interest in the project strategy may have translated into the early and sustained understaffing of the PMU and in the chronic delays to obtain signatures for key project milestone documents, including loan amendments. In turn, the insufficient staffing of the PMU may have played an important role in the lack of attention to certain components of the project, such as the poverty pilot investments and the environmental component. In December 2001, Argentina’s economy collapsed after several years of recession, leading to a default on external debt service. The crisis led to the end of 1:1 convertibility law between the Argentine peso and the dollar, and to a rapid devaluation reaching AR$4 per US$1 during the height of the crisis (the peso has since stabilized at AR$3 per US$1). The devaluation eventually helped to increase exports (and fiscal revenues from taxes) but it also raised the prices of imports, contributing to a resurgence of inflation. In turn, this led purchasing power to decline considerably, which affected all levels of the economy, aggravating existing poverty and plunging many middle-class Argentine households into poverty. Poverty levels soared from 35% under the poverty line before the crisis to 55% during the crisis. The crisis had a severe impact on the project in several ways: (i) tariffs for water and sewerage services were frozen to help consumers cope with declining purchasing power; (ii) utility operators holding dollar-denominated debt to finance investment programs encountered grave difficulties as the peso was devalued while revenues declined, due to the tariff freeze and declining bill recovery; and (iii) the uncertainty around the peso’s value and rapid inflation caused works that were in progress in Olavarría to be stopped, and contracts for works that had been awarded before the crisis (Misiones) to be held at a standstill. Like for all other projects in Argentina, contracts were subject to a price re-determination process factoring inflation and other risks. The formula for price redetermination was negotiated between the government and the Bank and issued only in December 2002, and it took until June 2003 to make the formula fully operational (a total of 18 months after the height of the crisis). After the macroeconomic crisis, a first attempt at restructuring the project was made in 2002, in response to the crisis and in an attempt to assist the government through increased technical assistance to address urgent regulatory weaknesses and the utilities’ debt restructuring needs. This initial restructuring was approved by the Bank’s Board on August 22, 2002 to expand the development objectives as follows: (a) to support the reform of the water and sanitation sector in Argentina through increased private sector participation in the operation and financing of water utilities; (b) to support the establishment of sound regulatory frameworks for the water sector and to address universal service and environmental issues pertaining to said sector; (c) to support the Borrower’s efforts to strengthen the public services regulatory frameworks weakened as a result of the economic crisis that hit Argentina in early 2002; and (d) to support the Borrower’s efforts to promote voluntary corporate restructuring. However, the corresponding amendment to the loan was never countersigned by the Government of Argentina. In hindsight, it appears that maintaining the PSP reform objective may have been unrealistic given (i) the critical macroeconomic situation and associated low attractiveness of the Argentine WS&S sector to foreign investors; (ii) the weak position of existing private operators holding debt in foreign currency; and (iii) the deepening poverty in the country, which diminished prospects for cost-recovery while a coherent framework of targeted subsidies remained absent and the tariff freeze was still in force. On the one hand, the project team faced a central government that was clearly lukewarm about both the initial and revised PDOs. On the other hand, provincial authorities and private operators reportedly expressed that this project was important as the sole source of technical assistance and investment

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financing for sector reform, especially in light of a recent IDB loan cancellation. This rationale probably underpinned the Bank’s decision not to move toward loan cancellation at various stages during the crisis and the initial period of recovery. The Quality of Supervision Assessment report issued in September of 2002 noted that the project restructuring was conducted without an in-depth review of needs, and pointed out that the Bank should have focused more on addressing the emerging issues of PSP-oriented reform, such as social and poverty issues and regulatory issues, in addition to convincing the government of the PDOs. It also stated that the allocation of budget resources for supervision was insufficient to conduct an in-depth review of the project objectives and design. The second restructuring was proposed during the mid-term review in December 2003. As seen in section 1 above, this restructuring sought to re-define and simplify the project objectives while increasing its chances for successful implementation. Sub-loans were now available to all WS&S utilities demonstrating good practice toward meeting efficiency indicators in operational and financial management, not only PSP-reformed utilities. Grants were also made available to less well-performing utilities that demonstrated urgent needs related to poverty and environmental conditions. Establishing appropriate regulatory frameworks remained a key PDO, and addressing universal service and environmental issues in the sector was the third objective. The emphasis on PSP-oriented reform was dropped. Despite these substantial modifications, the government took 12 months to ratify the amendment, signaling its enduring low level of interest in the project. It appears that once funding for the Tucumán sub-project came into focus, signing the amendment became more of a government priority. A key difficulty in the case of the Misiones sub-project was in ensuring the availability of counterpart funds, which were to be paid by the private operator. After the macroeconomic crisis and its ramifications described above, the concessionaire found it difficult to assemble those funds and the Province was not in a position to take over that responsibility due to its own fiscal hardships. This situation contributed to a long-lasting dispute between the operator and the province, later involving the contractor who faced great uncertainty about payments for the works executed. Eventually, the concessionaire opted to finance the counterpart commitments rather than to exit the contract, but in the meantime substantial delays occurred in the execution of the works. As seen in section 2.1.2.4 above, although the project design assumed that households would connect to newly available sewerage services as soon as these would become available, in fact this has not happened. In Misiones, only about 400 households have chosen to connect out of 10,000 to whom the service is now available. In Olavarria, only 1,030 households have connected out of 15,477 potential beneficiaries. The main reasons for this appear to be (i) the existence of alternatives for sewerage disposal (septic tanks) that do not require (ii) a large upfront cash outlay (up to AR$2,000) to pay for internal plumbing modifications and connection fees. Although the lower-than-expected connection rate has only a modest financial impact on two of the three the utilities, who charge users for the service once they can access it, regardless of actual connection3, it has an important economic impact in that it diminishes the actual economic, health and environmental benefits realized through this project. Finally, procurement and execution delays occurred in the case of the Tucumán sub-project, which was included after the project restructuring. The procurement delays were explained as a combination of an unsatisfactory first round of bids leading to a re-bidding of the contract, and to somewhat slow and 3 This was considered best practice at the time of appraisal and remains so today.

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complex Bank procurement review processes. The execution delays were attributed to poor weather conditions, unforeseen construction impediments, and a built-in delay due to an unrealistic timetable for the execution of the works (6 months rather than 12). A detailed timeline of the project milestones and institutional context is provided in Annex 2B.

2.3 Monitoring and Evaluation (M&E) Design, Implementation and Utilization The project was prepared over ten years ago, when no major emphasis was placed on the monitoring and evaluation design. ENOHSA through the PMU was charged with supervising and controlling the compliance of sub-project executors with the operational and financial performance indicators detailed for the project (see section 1) and to verify their progress towards improved efficiency. The PMU was also to monitor the progress of the poverty pilot sub-component as measured by the number of new connections made to poor urban households, and the progress of the regulatory strengthening component as measured by the number of participants, and the hours of training per participant. The PMU was authorized to take the necessary preventive and corrective measures to improve the allocation of resources. The Project Management Unit established in ENOHSA initially was to be staffed with a coordinator backed up by team of eight consultants, whose terms of reference were defined in the POM. Later, however, the PMU was staffed from within the organization rather than with exterior consultants, a choice that was meant to prolong the benefits of the project’s training and technical assistance within the organization. From the outset, however, the PMU consisted of only one staffer with support from ENOHSA’s other divisions, and this structure was probably too light to successfully shepherd the project. This insufficient staffing further reflected the government’s lack of interest in the project, rather than the unavailability of funds to hire the consultants, as these funds were provided for under the loan but never used. The PMU prepared a semi-annual report to the World Bank on the status of the project, on or near the 31 of March and the 30 of September each year. These reports were generally submitted on time and well-prepared, although they did not systematically track progress on performance indicators for the project. The Quality of Supervision Assessment (September 2002) gave a satisfactory rating while highlighting a number of issues of concern. In particular, it judged the project reporting to be weak and observed that there was no evidence that the M&E system described in the project’s operational manual was being used by the project team, on either the Bank’s or the borrower’s side. Moreover, it pointed out that the M&E system as designed was not geared to effectively consult the poor and monitor impacts on the poor, nor did the project’s supervision budget allow sufficient resources to focus on this. The ICR review did not detect any significant change in these aspects of M&E practices in the 2003-2007 period of implementation, noting that the project restructuring might have been an opportunity to strengthen M&E design and practice. 2.4 Safeguard and Fiduciary Compliance The project was classified as Environmental Category B. The PAD stated that as most investment subprojects financed by the project would be rehabilitation of existing water systems, the project would not have any significant negative environmental impact. In practice, a substantial portion of the works actually financed consisted in the construction of new sewerage collection infrastructure (Olavarría, Misiones, and Tucumán) and in the expansion of existing sewerage treatment capacity (Olavarría and Tucumán). Net environmental benefits are observed in Olavarría and expected in Tucumán.

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The project’s operational manual included limited guidelines on environmental assessment of sub-projects to be included in the applications for sub-loans. Staff reviews in 2005 and 2006 by financial and procurement specialists of the project’s financial management and procurement reported that these activities were conducted satisfactorily. In the case of Tucumán, an unsatisfactory first round of bids was appropriately thrown out and the process began anew, although this obviously caused unwanted delays. As stated above, there was some concern about the slowness of procurement review processes within the Bank. 2.5 Post-completion Operation/Next Phase There is currently no next phase: the APL 2 has been cancelled in light of the change in government strategy. The works contracted for the Olavarría sub-project were completed under the project. In the cases of Misiones and Tucumán, which had reached 77% and 79% completion respectively at project closing, it is understood that ENOHSA will provide the necessary funding to the provinces to complete the works. The works executed in the three sub-components are being operated and maintained by the operators who oversaw their construction. All three operators show continually improving operational and financial efficiency. However, as mentioned previously, the main concern is with the rate of connection to new sewerage networks, given the observed reluctance of potential consumers to incur internal plumbing and connection costs without substantial subsidies, and in the absence of such subsidies in two out of the three cases (Olavarría and Misiones) for the time being. In Olavarría (Buenos Aires Province) since the completion of works in 2005 only 1,030 connections have been made out of 15,477 potential new connections to the sewerage network. In Posadas (Misiones Province), only approximately 400 (200 legal and an estimated 200 illegal) out of 10,600 connections have occurred. In both of these sub-projects, unless an adequate connection subsidy program is established, the investments may be underutilized, with continuing ramifications for environmental degradation to both surface and subterranean water resources caused by the inadequate disposal of wastewaters, and associated health impacts. In Tucumán, the rate of new connections to sewerage service is expected to be higher for 25,000 projected possible connections once the works are finished. This is at least partly due to the provincial government’s proactive subsidy policy of encouraging new connections to the service, which relies heavily on federal funding through the Cloacas más Trabajo program. The ultimate outcome and sustainability of the Tucumán sub-project thus depends on the government’s ability to sustain and expand this policy. Regarding the investment made in updating and expanding the SPIDES database, there is some concern about the sustainability of the SPIDES system now that project funding has ended. Indeed, ENOHSA has not appointed any staff to ensure the continued updating and maintenance of the database or the associated website. 3. Assessment of Outcomes 3.1 Relevance of Objectives, Design and Implementation The overall objective of the 2006-2008 CAS is to seek opportunities to build a medium-term investment partnership to support the transition from crisis recovery to sustained growth with continued poverty reduction and improved equity. In this context, the Bank’s interventions are designed to advance the three pillars previously established under the 2004 CAS: (1) sustained growth with equity, (2) social inclusion, and (3) improved governance. Both the initial and revised project objectives were relevant to the current CAS as they focused on improving the quality and efficiency of water and sanitation services, which are key in support of economic growth, on expanding access to the services for the poor, and on

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strengthening regulatory capacity at the provincial level. The initial project design also required the beneficiary utilities to contribute substantial counterpart funds and to repay the loan proceeds to the Borrower (the Argentine Republic), assuming foreign exchange risk. These design features were meant to increase accountability and governance at the utility and provincial level. As discussed in section 2.1 above, the formulation of the initial objectives, with PSP as a principal goal, became increasingly dissonant with the changing policy environment and is now at odds with the more neutral approach reflected in the current CAS. The revised project objectives placed more explicit emphasis on the utilities’ achievement of efficiency and on addressing urgent needs relating to poverty and the environment, which also reflects the approach of the new CAS. The project’s emphasis on working closely with the Provinces and local utilities to improve local regulatory capacity and financial self-sufficiency at the utility level remains in line with the approach recommended in the current CAS. The eventual decision to have the PMU staffed by permanent ENOHSA personnel is also in line with current thinking at the Bank, in order to mainstream the improved technical capacity and to protect the institutional memory of a project rather than have it rest with independent consultants. However, as seen above, the strategy proved susceptible to insufficient allocation of personnel to the PMU, due to the government’s change in strategic direction since the preparation of the project. 3.2 Achievement of Project Development Objectives The achievement of objectives should be assessed relative to both the initial PAD objectives and the revised objectives after project restructuring in 2004. The project's original objectives were to support the reform process in about five medium-size municipal and provincial utilities through the introduction of private sector participation (PSP) in the operation and management of water utilities, adoption of appropriate regulatory frameworks, and institutionalization of tariff policies and tested investment alternatives to reach poor consumers better. Although three utilities were ultimately supported through project-financed investments, only two of these had undergone a reform process, which had already occurred under the previous project, Ln. 3281-AR. None received technical assistance relating to tariff policies or to investment alternatives to better reach the poor. None of the corresponding provinces received technical assistance to strengthen their regulatory frameworks. As a result, none of the initial project development objectives can be considered to have been met. The revised project objectives included: (a) to support the reform of the water and sanitation sector in Argentina through the promotion of efficiency in the operation and financing of water utilities; (b) to support the establishment of sound regulatory frameworks for the water sector; and (c) to address universal service and environmental issues pertaining to said sector. Of these, only objective (c) was partially met. Through the investments made, the project did improve the means for three utilities to provide better services to more people, including a substantial portion of low-income households. As such, the relevant outcome indicators are: water service coverage, sewerage service coverage, and poor population benefited. However, the extent to which these achievements were made is a function of the outcome of each sub-loan within Component A, as described in Annex 2. Objective (b) was only obliquely addressed through the technical assistance to the SPIDES database, also described in Annex 2. Both before and after restructuring, the project did contribute to better environmental conditions through the sub-projects it financed for sewage disposal and treatment. Indeed, the only investments completed before project restructuring (they were in fact retroactively financed at loan effectiveness) consisted of the rehabilitation and expansion of the Olavarría sewage treatment plant, resulting in 100% of treatment of that city’s wastewaters (vs. 25% before). However, the percentage of wastewater treated was not an outcome indicator for the project, either before or after the revision of PDOs.

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3.3 Efficiency The detailed economic analysis is presented in Annex 3. 3.3.1 Summary

• The initial economic analysis presented in the PAD was sophisticated and informative but potentially mis-applied to the justification of this project by focusing on the overall reform program rather than on the specific investments and technical assistance proposed under APL1.

• The questions that are relevant for ICR purposes are different from those that motivated the initial economic analysis given that the project did not accomplish reform objectives and did not fund T.A. for reform. The main relevant question is now: “Were these investments worthwhile?”

• The ex-post analysis uses similar parameters but focuses on the economic viability of the investments actually implemented. A new model was constructed reflecting incremental costs and benefits incurred or to be incurred under the project. Ex-ante and ex-post NPVs are therefore not strictly comparable.

• The ICR identifies key lessons from the project regarding willingness to connect assumptions that have ramifications for the estimation of benefits from the project, and in turn for tariff and subsidy strategies at the time of project design to permit the full realization of benefits.

• The estimation of benefits remains tricky and the ex-post analysis modifies initial willingness to pay (WTP) assumptions by counting WTP only for those households who actually chose to connect, and discounting total WTP to reflect a less-than-100% bill collection rate.

The results of the analysis show th