Document of

The World Bank

.

FOR OFFICIAL USE ONLY

Report No: 87591

INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT

PROJECT PAPER

ON A

PROPOSED ADDITIONAL LOAN

IN THE AMOUNT OF EUROS 19 MILLION

(US$26.2 MILLION EQUIVALENT)

TO THE .

SOCIÉTÉ NATIONALE D’EXPLOITATION ET DE DISTRIBUTION DES EAUX

WITH THE GUARANTEE OF THE REPUBLIC OF TUNISIA

FOR THE URBAN WATER SUPPLY PROJECT

May 13, 2014

Agriculture, Rural and Water Unit Sustainable Development Department

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

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CURRENCY EQUIVALENTS

(Exchange Rate Effective April 30, 2014)

Currency Unit = Tunisian Dinar (TND) 1 US$ = 1.60709999 TND

1 US$ = 0.72311809 EUR

FISCAL YEAR January 1 – December 31

ABBREVIATIONS AND ACRONYMS

AF Additional Financing AFD Agence Française de Développement (French Development Agency) AFSED Arab Fund for Social and Economic Development ANPE Agence nationale de protection de l’environnement (National Environment

Protection Agency -Tunisia) AOT Avis d’Occupation Temporaire (Temporary Occupation Notice – Tunisia) BP Bank Procedure CBT Central Bank of Tunisia CMI Center for Mediterranean Integration CSM Commission Supérieure des Marchés (High Tender Board-Tunisia) DA Designated Account EA Environmental Assessment EBRD European Bank for Reconstruction and Development EIA Environmental Impact Assessment EIB European Investment Bank EMP Environmental Management Plan ERR Economic rate of return EU European Union FM Financial management FMS Financial management system GoT Government of Tunisia IBRD International Bank for Reconstruction and Development ICB International Competitive Bidding IDA International Development Association IFR Interim financial report INT Integrity Vice Presidency of the World Bank IPF Investment Project Financing IsDB Islamic Development Bank ISN Interim Strategy NoteIRR Internal Rate of Return IT Information technology

IUFR

Interim unaudited financial reports

JICA Japan International Cooperation Agency KfW Kreditanstalt für Wiederaufbau (Reconstruction Credit Institute - Germany) LAP Land Acquisition Plan M&E Monitoring and Evaluation MENA Middle East and North Africa NCB National Competitive Bidding NDP National Development Plan NPV Net Present Value NRW Non-Revenue Water NWSIP National Water Security Investment Program OFID OPEC Fund for International Development ONAS Office National d’Assainissement (National Sewerage Board - Morocco) ONEE Office National de l’Eau et de l’Electricité (National Water and Electricity Board -

Morocco) OP Operational Policy ORAF Operational Risk Assessment Framework O&M Operation and maintenance PAD Project Appraisal Document PDO Project Development Objective PIU Project Implementation Unit PPIAF Public Private Infrastructure Advisory Facility P-RAMS Procurement Risk Assessment & Management System SIC Système d’Information Commercial (Customer Billing System) SDF Saudi Development Fund SOE Statement of Expenditures SONEDE Société Nationale d’Exploitation et Distribution des Eaux (National Water

Exploitation and Distribution Company - Tunisia) STEG Société tunisienne de l'électricité et du gaz (Tunisian Electricity and Gas Company)ST Station de traitement (Water treatment unit - Greater Tunis plant - Tunisia) TND Tunisian dinar VAT Value-Added-Tax WPP Water Partnership Program WSC Water Services Corporation (Malta) WSP Water and Sanitation Program WTP Water treatment plant

Regional Vice President: Inger Andersen Country Director:

Sector Director Neil Simon Gray

Junaid Kamal Ahmad Sector Manager Steven N. Schonberger

Task Team Leader: Philippe Marin Co-Task Team Leader: Esther Loening

TUNISIA

URBAN WATER SUPPLY PROJECT ADDITIONAL FINANCING

CONTENTS

PROJECT DATA SHEET……………………………….……………………..…………... i

I. Introduction…………………………………………………………………….… 1

II. Background and Rationale for Additional Financing………………………….… 2

III. Proposed Changes………………………………………………………………... 7

IV. Appraisal Summary………………………………………………………………. 11

Annexes

Annex 1: Detailed Project Costs………………………………………………………… 17

Annex 2: Financial Management, Disbursement and Procurement Arrangements…….. 18

Annex 3: Economic Analysis Methodology and Assumptions…………………………. 27

Annex 4: Implementation Schedule……………………………………………………... 30

Annex 5: Revised Results Framework and Monitoring Indicators……………………… 31

Annex 6: Operational Risk Assessment Framework……………………………………. 37

DATA SHEET

Tunisia

Urban Water Supply Project – Additional Financing (P150033)

Basic Information - Additional Financing (AF)

Project ID: P150033 Expected Effectiveness Date: November 17, 2014 Lending Instrument: Investment Project Finance Additional Financing Type: Financing gap/restructuring

Sectors: Water supply (100%) Themes: Other urban development (100%) Environmental category: B Partial Assessment Expected Closing Date: June 30, 2018 Joint IFC: No Joint Level: No

Basic Information - Original Project Project ID: P064836 Environmental category: B Partial

Assessment Project Name: Urban Water Supply Project New Closing Date: June 30, 2018 Lending Instrument: IPF Joint IFC: No

Joint Level: No AF Project Financing Data

[X] Loan [ ] Credit [ ] Grant [ ] Guarantee [ ] Other: Proposed terms: Commitment-Linked Variable Spread Loan, 18 years maturity and six years grace period.

AF Financing Plan (US$ m) Source Total Amount (US$ m) Total Project Cost:

Co-financing: Borrower: Total Bank Financing: IBRD

26.2 0.0 0.0 26.2 26.2

Client Information Borrower: Société Nationale d'Exploitation et de Distribution des Eaux (SONEDE) Avenue Slimane Ben Slimane Manar II 2092 Tunis Tunisia Tel: (216) 71-887-000 Fax: (216) 71-871-000 sonede@sonede.com.tn www.sonede.com.tn Guarantor: Government of Tunisia Responsible Agency: SONEDE

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1 Figure as of 2014.

AF Estimated Disbursements (Bank FY/US$ m)FY FY15 FY16 FY17 FY18 Annual 1.5 10.5 8.5 5.7 Cumulative 1.5 12.0 20.5 26.2

Project Development Objective and Description Original project development objective: (i) Sustain the reliability and quality of water service in Greater Tunis and selected urban centers, through augmentation, upgrade and renewal of water supply infrastructure. (ii) Enhance the competitiveness and sustainability of SONEDE operations, through modernization of management practices and information systems, for better cost control, enhanced revenue and more responsive customer service. Revised project development objective: To ensure the continuity of water service (twenty four (24) hours per day, seven (7) days a week) to the population in Greater Tunis and other targeted cities; and (ii) improve the financial viability of SONEDE. Project description: The proposed new loan would finance the following activities: (i) the reinforcement of the existing potable water treatment plant of Greater Tunis, with one cubic meter per second (m3/s) expansion of treatment facility #4 (ST4) which was built under the original Project, and rehabilitation and upgrading works, especially for the two older potable water treatment facilities (ST1 and ST2) (under Component 1); (ii) rehabilitation and upgrade of the Belli potable water treatment plant located close to Tunis, serving areas of the Center-East of the country (under Component 2); (iii) replacement of 70,000 customer meters (under Component 3). These activities, for the most part, close a financing gap to urgently expand the production capacity of ST4 in order to sustain continued 24/7 water services for Tunis and other targeted cities. The financing gap is resulting from overly conservative projections of water demand growth in Greater Tunis during the appraisal of the original Project in 2006. The total number of beneficiaries from the Additional Financing (AF) is estimated at about five million (1.6 million connected households), or about 50 percent of the Tunisian population.1

Safeguard and Exception to Policies Safeguard policies triggered: Environmental Assessment (OP/BP 4.01) Natural Habitats (OP/BP 4.04) Forests (OP/BP 4.36) Pest Management (OP 4.09) Physical Cultural Resources (OP/BP 4.11) Indigenous Peoples (OP/BP 4.10) Involuntary Resettlement (OP/BP 4.12) Safety of Dams (OP/BP 4.37) Projects on International Waterways (OP/BP 7.50) Projects in Disputed Areas (OP/BP 7.60)

[X]Yes [ ] No [ ]Yes [X] No [ ]Yes [X] No [ ]Yes [X] No [ ]Yes [X] No [ ]Yes [X] No [ ]Yes [X] No [ ]Yes [X] No [ ]Yes [X] No [ ]Yes [X] No

Does the project require any waivers of Bank policies? Have these been endorsed or approved by Bank management?

[ ]Yes [X] No [ ]Yes [ ] No

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Conditions and Legal Covenants: Financing Agreement Reference Description of Condition/Covenant Date Due

ARTICLE IV - Financial Covenants Section 4.03

Maintaining a minimum ratio of internal cash generation against capital expenditure needs of 30%, towards greater self-financing autonomy Dropped in loan agreement for Loan 7339-TN and not included in Loan 83950-TN based on the financial diagnostic carried out during preparation (see unique financial ratio proposed below).

ARTICLE IV - Financial Covenants Section 4.04 Proposed in Schedule 2, Section V. Other Undertakings: Financial Ratio of “Loan Agreement (Additional Loan for the Urban Water Supply Project) between International Bank for Reconstruction and Development And Société Nationale d'Exploitation et de Distribution des Eaux, Dated [July 15], 2014”

Maintaining an operating ratio of over 100% for strict cost recovery Modified under loan agreement for Loan 7339-TN and included in Loan 83950-TN in order to focus on operating cash flow and cost recovery, namely the working ratio which shall be maintained equal or above 100% by SONEDE for the entire duration of the Project: Maintaining a ratio of total operating revenues to total operating expenses minus depreciation plus interest charges, equal or higher than one hundred percent (100 %). Where working ratio is defined as: Working ratio = Net operating revenues (i.e. revenues from water sales + other operating revenues) / (Operating costs – Depreciation + Interest charge)

Recurrent

ARTICLE IV - Financial Covenants Section 4.05 of “Loan Agreement (Urban Water Supply Project) Between Société Nationale d'Exploitation et de Distribution des Eaux And International Bank for Reconstruction and Development, December 5, 2005” for Loan 7339-TN

Maintaining a debt service coverage ratio of 1.3 or better Dropped in loan agreement for Loan 7339-TN and not included in Loan 83950-TN based on the financial diagnostic carried out during preparation (see unique financial indicator/covenant proposed above).

Schedule 2, Section IV Withdrawal of Loan Proceeds, paragraphs B.1.b and B.1.c of “Loan Agreement (Additional Loan for the Urban Water Supply Project) between International Bank for Reconstruction and Development And Société Nationale d'Exploitation et de Distribution des Eaux, Dated [July 15], 2014”

Condition of disbursement: - under Category (2), unless an EMP, satisfactory to the Bank, covering activities to be carried out by the Borrower under Part A.2 of the Project, shall have been adopted by the Borrower, published by the Borrower on its website and submitted by the Borrower to the Bank for publication at the Infoshop; or - under Category (3), unless an EMP, satisfactory to the Bank, covering activities to be carried out by the Borrower under Part B of the Project, shall have been adopted by the Borrower, published by the Borrower on its website and submitted by the Borrower to the Bank for publication at the Infoshop

SCHEDULE 5 - Implementation Program - Project Coordination and Implementation 1. and 2. of “Loan Agreement (Urban Water Supply Project) Between Société Nationale d'Exploitation et de Distribution des Eaux And International Bank for Reconstruction and Development, December 5, 2005” for Loan 7339-TN

Provisions in loan agreement for Loan 7339-TN were revised and revised wording was included in the loan agreement for the AF (i.e., certain terms and composition of the PIU, and certain Directorates involved in the implementation of the Project)

iv

ARTICLE I - General Conditions ; Definitions of “Loan Agreement (Urban Water Supply Project) Between Société Nationale d'Exploitation et de Distribution des Eaux And International Bank for Reconstruction and Development, December 5, 2005” for Loan 7339-TN

Definition of “Greater Tunis Region” in loan agreement for Loan 7339-TN was revised and a revised definition is included in the loan agreement for the AF (Appendix). The original definition was incorrect. The areas covered by the treatment unit (ST4) of the Greater Tunis water treatment plant (Ghdir-El-Gollah) comprise the four governorates of Greater Tunis

1

I. Introduction

1. This project paper seeks the approval of the Executive Directors to (i) provide an additional loan in an amount of Euros 19 million (US$26.2 million equivalent) to the Société Nationale d'Exploitation et de Distribution des Eaux (SONEDE) for the Urban Water Supply Project (P064836); and (ii) revise the Project Development Objective (PDO), results framework, Closing Date, and some covenants set forth in the legal documents of Loan 7339-TN. The original loan (IBRD 7339-TN) was approved on November 17, 2005 in the amount of EUR 31.0 million (US$38.03 million equivalent), became effective on March 21, 2006, and is currently due to close on June 30, 2015.

2. The proposed Additional Financing (AF) would close a de facto financing gap in response to faster than anticipated growth in potable water demand in the Greater Tunis area, with urgent production capacity expansion needed to meet the PDO. This financing gap relates to the main investment component in the original Project, i.e. the fourth water treatment unit (ST4) at the Greater Tunis water treatment plant (Ghdir-El-Gollah). SONEDE had initially requested, based on its own demand projections, that this new treatment unit be constructed for a total capacity of 3 m3/s. However the Bank considered, based on more conservative projections, that it was better to build the new treatment facility in two phases, starting first with only 2 m3/s to be financed under the original loan (corresponding to a cost of US$11.4 million in the original Project), but that the technical design would be done for 3 m3/s so as to be able to quickly expand capacity if needed. As of 2014, the original SONEDE projections have proved correct, with an annual increase in water consumption in Greater Tunis of 3.5 percent, as opposed to the 1.5 percent annual increase assumed by the Bank during appraisal of the original project in 2006. As a consequence, the additional capacity expansion of 1 m3/s needs to be built urgently, to avoid water shortages in the Greater Tunis area by 2017-18.2 This higher than expected increase in water consumption is due both to rural migration to the greater Tunis area from impoverished rural areas in the rest of the country (with a rate of population growth much higher than the national average), and an increase in per capita consumption (due to rising living standards). The AF will bridge the resulting financing gap by providing US$10.3 million to add 1 m3/second treatment capacity at ST4.

3. The AF would also fund key infrastructure rehabilitation and upgrading works for water production in other targeted cities, as well as further assist the reinforcement of SONEDE’s financial situation, consistent with the PDO and MNA’s focus on scaling-up results, as well as with the Bank goals. In addition to the ST4 works, the AF will fund three other activities: (i) Rehabilitation and upgrade of the Greater Tunis potable water treatment plant (located in Ghdir-El-Gollah), including of the two other older facilities (ST1 and ST2); (ii) rehabilitation and upgrade of the Belli potable water treatment plant – located near the Greater Tunis area and serving cities in the Center-East; and (iii) purchase and installation of 70,000 customer meters, to help SONEDE replace its backlog of mal functioning meters arising from a reduced rate of meters replacement in recent years. The infrastructure rehabilitation and upgrade of the Greater Tunis (Ghdir-El-Gollah) and Belli water treatment plants will help SONEDE meet the expected continuous growth in water demand, so that it can continue providing continuous water service (24 hours / 7 days) to the population of the targeted project areas. The replacement of mal-functioning meters (which tends to under-estimate actual consumption) will directly

2 Water shortage events are defined as interruptions due to water supply constraints as opposed to interruptions due to regular maintenance and repair works.

2

improve SONEDE’s revenues, and therefore its financial viability. These investments will therefore allow for the scaling up of an already well-performing project in line with MNA regional strategic priority. Importantly, through this AF, SONEDE would incur lower operating costs, and less rapid depreciation of water networks. This will enable it to continue connecting new households, and provide continuous service in the targeted areas, which would have considerable positive impact in terms of quality of service, public health for the entire population of these targeted areas, and stimulate economic development, contributing to the World Bank Group’s twin goals.

4. The Project Development Objective and the results framework have been slightly modified for better focus, clarity and ease of measurement. The revised PDO is: "To ensure the continuity of water service (24 hours per day, 7 days a week) to the population in Greater Tunis and other targeted cities, and improve the financial viability of SONEDE". While the spirit and content of the project remain unchanged, the revised PDO is more focused on outcomes that are directly attributable to the project. The main outcome expected from the Project stems from the infrastructure investments that will ensure that SONEDE can continue providing continuous (24 hours per day – 7 days a week) water supply service to its customers after 2017. Supporting SONEDE’s financial viability is the key outcome expected from institutional activities, and is essential to ensure that SONEDE can remain a sustainable water utility able to provide good service to the Tunisian population. While SONEDE’s overall financial performance is to a large extent dependent inter alia on the Government of Tunisia (GoT)’s water tariff policy, financial viability is as the core of the Bank’s water sector dialogue in Tunisia and the institutional activities included in the project are key priorities for putting the utility on the path towards financial sustainability. The results framework has also been modified to adjust the indicators and make them more specific and measurable, modifying the wording or replacing some indicators with new ones that more accurately capture the implementation, benefits and outcomes of the Project.3

5. The AF safeguard category would remain B.

II. Background and rationale for Additional Financing in the amount of Euros 19 million (equivalent US$26.2 million)

6. The original Project had three components. Component 1 (US$25.9 million) - Greater Tunis: Water systems infrastructure works, including construction of a new water treatment facility (ST4) and a sludge facility at the Tunis water plant in Ghdir-El-Gollah, Component 2 (US$9.1 million) - Other Urban Centers: Infrastructure works to improve water systems in secondary urban centers in the North and center of the country, and Component 3 (US$3.9 million) - Management capacity building: the main activity (US$2.6 million) being the installation of a new customer billing system (Système d’Information Commercial or “SIC”) to be operated jointly with national sewerage utility ONAS (the Tunis West Sewerage Project (P099811) finances in parallel another portion of the installation costs of the SIC).

7. The national water utility SONEDE was established in 1968 as a corporatized public company with financial autonomy. SONEDE provides potable water services to about nine million people across the country (83 percent of the national population). Currently, SONEDE serves a total of 500 cities and towns (100 percent coverage in urban areas), and 2,659 villages and rural communities (about half of the rural population, with another 40 percent being served

3 The revised results framework applies to the activities of both the original loan and of the additional loan.

3

through user association schemes). It is one of the largest water utilities in the Middle East and North Africa (MENA) region, with about 7,000 employees, 2.46 million household connections, and 48,456 kilometers of water network. It is also one of the best performing water utilities in MENA, with all its customers receiving continuous water supply (24 hours/7 days), water losses (Non-Revenue Water) standing at about 28 percent, and a labor productivity ratio of 2.8 staff per thousand connections (with virtually no subcontracting). Most of SONEDE’s revenues come from water sales, and revenues in 2013 stood at about US$180 million. While SONEDE was in good financial standing a decade ago, a four-year tariff freeze (2006-2009) affected the financial situation of the utility from the onset of the Project, resulting in net losses each year since 2008. Thanks to a tariff adjustment program agreed with and implemented by the GoT4 since 2010 (the average water tariff stood at US$0.37 per m3 at the end of 2013), as well as a series of management measures to improve operational efficiency, SONEDE is expected to achieve a positive operating result (operating revenues less operating expenses including depreciation) in 2014, and should reach financial equilibrium (positive net result after taxes) by 2016.

8. The Bank is a strategic partner for SONEDE. The Bank is currently one of the four long-term lenders of SONEDE, together with the French Development Agency (Agence Française de Développement (AFD), with three ongoing loans amounting to US$110 million equivalent), the German Development Agency (Kreditanstalt für Wiederaufbau (KfW), with two loans amounting to US$115 million equivalent), and the Japan International Cooperation Agency (JICA, with two loans amounting to US$112 million equivalent). Despite its modest size, the Project initiated in 2006 has allowed the establishment of a strong partnership between SONEDE, the GoT and the Bank to foster the financial sustainability of the water sector. The Bank is a trusted partner of SONEDE based on the strategic support provided:

(i) In 2010, the Bank was instrumental in convincing GoT to end the four-year tariff freeze, and implement a gradual 7-8 percent annual tariff increase program until 2016 (successive governments have all complied with this commitment, the most recent increase occurring in January 2014).

(ii) In 2013, in partnership with the Center for Mediterranean Integration (CMI), the Bank launched a program of operationally-driven “South-South twinnings” between SONEDE and two other well-performing utilities in MENA, namely the Office National de l’Eau et de l’Electricité (ONEE) in Morocco and Water Services Corporation (WSC) in Malta. Both ONEE and WSC are top performing utilities in terms of reducing water losses. Peer-to-peer exchanges supported by the twinnings will result in a detailed action plan for improving SONEDE’s operational efficiency, which could possibly be implemented thereafter through a new Bank loan envisaged in FY15 for urban water infrastructure rehabilitation.

(iii) The Bank took a leadership role in helping SONEDE and the Government organize a donor conference at CMI in Marseilles on February 4-5, 2014, in order to finance its US$1.4 billion National Water Security Investment Program (NWSIP). The NWSIP was developed to enable SONEDE to cope with growing water demand and the effect of climate change in the next 10-15 years, so as to continue being able to provide continuous (24 hours / 7 days) water services to all its customers. In Marseilles, SONEDE succeeded in mobilizing funding for all its NWSIP investments, securing US$630 million in funding from donors to cover the full NWSIP financing gap, with the

4 The Council of Ministers makes decisions on tariff adjustments based on SONEDE request.

4

largest portion (US$450 million) coming from a group of Gulf country-supported donors, namely Saudi Development Fund (SDF), Islamic Development Bank (IsDB), OPEC Fund for International Development (OFID), and Arab Fund for Social and Economic Development (AFSED). The European Bank for Reconstruction and Development (EBRD) also made its first funding commitment to SONEDE, while KfW, AFD, JICA and the Bank (see below) also confirmed their existing and some incremental support.

9. The Project is a key element of the Bank's broader support to achieve sustainable water security in Tunisia. The proposed AF would continue such strategic support, as part of a series of transformational initiatives:

The infrastructure already completed under the Project is now in full operation, and proved critical in allowing SONEDE to meet increasing water demand amid delicate political changes. As a consequence of the 2006-2009 tariff freeze, many of SONEDE’s water systems are currently operating close to maximum capacity due to a reduction in infrastructure investment –both rehabilitation and expansion. In 2012, and for the first time in modern Tunisian history, water service interruptions on a large scale occurred in a few cities during the peak summer demand. As the Tunisian population is used to receiving continuous 24/7 water services, this event led to serious civil unrest, leading SONEDE to carry out, with the Government’s financial support, several emergency works during 2013 in the concerned cities. In Greater Tunis, it was only thanks to the new ST4 water treatment facility (financed under the Project) becoming fully operational in June 2013 that water service interruptions were avoided during the summer of 2013. The proposed capacity production upgrades are critical to avoid the risk of water shortages and service interruptions in Greater Tunis as well as other targeted cities as early as 2017-18.

Bank’s financial support to SONEDE for infrastructure investment is expected to continue growing over the next years, consolidating the positive outcome of the Marseilles conference by further supporting the NWSIP. The proposed AF is to be followed by a new project for urban water infrastructure in FY15 (US$35 million, in parallel financing with EBRD), and another project for rural potable water access in FY16 (US$40 million, with IsDB).

The Bank is initiating a strategic financial equilibrium study of SONEDE, financed through a grant from the Public Private Infrastructure Advisory Facility (PPIAF) and the Water Partnership Program (WPP). This study, which will be executed by the Bank and is due to be completed by mid-2015, aims at developing a detailed action plan for SONEDE to improve its financial viability over the long term, so as to (i) ensure in the short term that all NWSIP investments will be bankable, and (ii) facilitate in the medium term (after 2016-17) potential access to non-sovereign lending, while ensuring affordability for poor households. The study will analyze in detail SONEDE’s financial situation and operational performance, and determine potential actions for improvement through three main dimensions: (i) increases in revenues through inter alia changes in the current water tariff structure, while guaranteeing affordability for the poor; (ii) reduction in operating costs through inter alia improved water losses reductions and energy efficiency; and (iii) corporate modernization measures. The study will be executed in close partnership with NWSIP donors, who have participated in the finalization of the terms of reference and will be associated in the review of outputs.

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10. Project disbursements stand at 81 percent; implementation has been consistently rated MS or above. Implementation Status Reports (ISRs) over the period January 2013 to January 2014 have consistently rated progress towards PDO and overall Implementation Progress (IP) either “satisfactory” (S) or “moderately satisfactory” (MS). Despite a challenging political transition, SONEDE has been able to entirely complete the two infrastructure components (90 percent of the loan amount) as of December 2013 (rated Highly Satisfactory, HS). These infrastructure investments proved essential for SONEDE to continue providing continuous (24 hours / 7 days) water services to the population in Greater Tunis area and other targeted areas. The ST4 water treatment plant became fully operational in June 2013, just in time to avoid water shortages in Tunis during the summer peak demand, and has operated at maximum capacity (2m3/s) since then.

11. SONEDE estimates that without the proposed urgent infrastructure investments, the Greater Tunis area and other large cities of the Center-East region will face water shortages as early as 2017. Under the original Project, it was expected that building the water treatment facility ST4 at Ghdir-El-Gollah complex with a capacity of 2m3/s would be sufficient to meet demand growth in the Greater Tunis until the mid-2020s. However, in recent years, SONEDE faced faster than expected water demand in the Greater Tunis area, due both to rural migration from impoverished rural areas nationwide and an increase in per capita consumption. Water sales increased from 103.7 million m3 in 2006 and to 126.4 million m3 in 2012, corresponding to an overall increase of 22 percent - or 3.5 percent per year - while the forecast growth rate used in 2005 was of 1.5 percent per year. In response to faster demand, the AF would fund not only the capacity expansion of ST4 up to 3 m3/s, but also urgent rehabilitation and upgrade works for the two older treatment facilities (ST1 and ST2), and other assets (i.e. intake pumping station, treated water reservoirs, internal networks) of the Greater Tunis water treatment plant (Ghdir-El-Gollah complex), as well as rehabilitation and upgrade works of the Belli water treatment plant serving large cities on the Center-East region (e.g. Nabeul, Sousse and Sfax). These two water treatment complexes are among the five largest water treatment plants managed by SONEDE nationwide and are key for ensuring that SONEDE can continue to provide continuous (24 hours / 7 days) water services after 2017 and meet the needs of the population and industries in the country’s major urban areas.

12. Alternative donor financing for this AF operation was considered. The Government indicated its preference to complete the new activities needed to meet the Project objectives through the framework of the already well performing Urban Water Supply Project, with funding from the same partner, especially since the largest investment proposed is the expansion of ST4 financed by the Project. Hence, an AF from the Bank was deemed the most appropriate instrument to respond to SONEDE’s need for urgent implementation.

13. Readiness of the AF operation is high. The proposed new investments are of a straightforward nature. The corresponding implementation and supervision arrangements, through already existing structures in SONEDE and a well-functioning Project Implementation Unit (PIU), are adequate. SONEDE has already demonstrated its capacity to carry out infrastructure investments in a highly satisfactory manner despite a challenging environment. All tender documents are due to be completed by end of June 2014.

14. Financial equilibrium is expected to be reached by 2016. SONEDE was in good financial standing a decade ago, but its financial situation has deteriorated in the past eight years. This is due directly to the tariff freeze from 2006 to 2009, which resulted in net losses since 2008, with net results hitting a low of -14.6 percent of revenues in 2011. While SONEDE is

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expected to recover a positive operating result (operating revenues less operating costs and depreciation) by 2014 and achieve financial equilibrium (with positive net result) by 2016, its financial outlook remains uncertain. According to the financial diagnostic carried out during the preparation of the AF, the level of SONEDE’s indebtedness remains manageable until 2020, and SONEDE is able to fully support the proposed AF loan based on current performance. However, the expected steep increase in electricity tariff - as the national power utility STEG phases out, at the Government’s initiative, its subsidy policy to industrial users - will have a negative impact on SONEDE’s financial situation, at a time when the operation of new desalination plants will increase its electricity consumption significantly. In this context, the strategic financial equilibrium study, to be carried out in parallel with the AF and funded through a joint PPIAF-WPP grant, will be essential for identifying how to ensure SONEDE’s financial viability beyond 2016 (the last year of the current tariff adjustment plan) and the bankability of the NWISP infrastructure investments. Several NWSIP donors, including EBRD, KfW, AFD and European Investment Bank (EIB) have already expressed interest in funding parts of the action plan to be developed under the strategic finance equilibrium study, once it is finalized in 2015.

15. Financial ratios under the original Loan Agreement could not be met by SONEDE, due to the tariff freeze from 2006 to 2009. The overall financial performance of SONEDE was monitored through three financial ratios, included as covenants in the original Loan Agreement: (a) maintaining a minimum ratio of internal cash generation against capital expenditure needs of 30 percent; (b) maintaining an operating ratio of over 100 percent for strict cost recovery; and (c) maintaining a debt service coverage ratio of 1.3 or better. The tariff freeze imposed by the Government from 2006 to 2009 prevented SONEDE from being able to comply with these financial covenants, from the onset of the original Project. Based on the financial diagnostic carried out during appraisal, and given current uncertainties surrounding the future financial situation of SONEDE until the strategic tariff and financial equilibrium is completed, the financial covenants framework has been simplified to include only one financial indicator focused on operating cash flow and cost recovery, namely the working ratio5 which shall be maintained equal or above 100 percent by SONEDE for the entire extended duration of the Project.

16. The fourth financial covenant is to satisfy standard auditing and reporting requirements. Over several years, external auditors issued qualified opinion (or “reserves”) on the general financial statements of SONEDE (as opposed to financial statements related to the Loan Account, which were all certified without reserves). These reserves were related inter alia to issues regarding commercial accounts management, as well as fixed assets valuation. SONEDE's Board has already taken a number of corrective measures, including hiring in November 2013 an accounting firm to solve the issue with fixed assets. The difficulties with commercial accounts management are largely related to the current state of SONEDE’ customer billing system, which dates from the 1980s and is fundamentally obsolete, and will be replaced by the SIC financed under the Project.6 In the meantime, SONEDE has submitted during

5 Defined as (net operating revenues) divided by (operating costs minus depreciation plus interest charges). SONEDE is currently in compliance with the proposed covenant and, based on current financial projections, is expected to remain in full compliance for the extended duration of the Project (until 2018). 6 The installation of the joint ONAS-SONEDE "SIC" started in March 2013, following a long and complex process. It has been progressing steadily over the last 12 months. The schedule for completion is tight and implementation remains complex as it involves significant coordination efforts between SONEDE and ONAS. The longer timeframe provided by the AF will ensure potential delays during the installation and start-up phases can be managed.

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appraisal an action plan addressing the above-mentioned concerns (Annex 2.a), which was reviewed and deemed satisfactory by Bank.

17. The AF is fully consistent with the Tunisia Interim Strategy Note (ISN) 2013-2014 and the regional strategy. The improvement in potable water production capacity to be funded by the AF will directly contribute to the regional strategic engagement to supporting client countries meet their specific development goals, while strengthening inclusion and sustainable growth, in line with the Bank’s poverty reduction and shared prosperity goals. It contributes to the three strategic areas that the ISN supports, namely: (i) sustainable growth and job creation; (ii) social and economic inclusion; and (iii) better governance. At the same time, the AF demonstrates the ability of the Bank to be flexible and to respond quickly to new arising challenges and demands – as is the case with the situation created by higher than projected water demand in Greater Tunis. This flexibility principle reflects the need to continue strengthening the partnership with Tunisia. The strong partnership will continue through a series of high profile lending and technical assistance projects.

III. Proposed Changes

18. The proposed AF will finance the activities that are now needed to meet the revised PDO in the context of more rapid than anticipated water demand growth. Further details are indicated in the Technical Appraisal Summary.

Under Component 1 - Improvements to the Greater Tunis water supply system:

Sub-component 1.a: Expansion of capacity of the new ST4 treatment facility of the Ghdir-El-Gollah plant in Greater Tunis by an additional 1 m3/s (US$10.3 million). This activity will finance the urgent capacity expansion of the recently completed ST4 water treatment facility, from the current 2 m3/s to 3 m3/s. This higher capacity had been considered in 2006 as one technical alternative for the Project, but it was decided at appraisal to phase investments, reducing the initial ST4 capacity to 2 m3/s. With demand growing faster than the scenario used at design, SONEDE needs to carry out this 1 m3/s expansion as soon as possible to avoid water service interruptions in Greater Tunis as early as 2017.

Sub-component 1.b: Rehabilitation and upgrade of the Greater Tunis water treatment plant, including the other water treatment facilities (US$6.9 million). The Ghdir-El-Gollah plant has been producing all potable water to supply the Greater Tunis area since the 1970s. It requires urgent rehabilitation and upgrading works, especially for its two older potable water treatment facilities (ST1 and ST2) to avoid future service interruptions and improve water treatment processes (for better control of energy and treatment costs).

Under Component 2 - Improvements to water supply systems in other urban centers:

Rehabilitation and upgrade of the Belli water complex (US$4.1 million). The Belli water treatment complex, located in the South-East of Greater Tunis, produces potable water from raw water coming from the Medjerda-Cap Bon canal. It supplies several large cities on the Center-East region, including Nabeul, Monastir, Sousse and Sfax. This water production infrastructure started operations in 1984 and also requires some urgent rehabilitation and upgrade to reduce risks of service interruptions in upcoming years.

Under Component 3 - Management capacity building:

Purchase and installation of 70,000 customer meters (US$2.8 million). Due to its recent difficult financial situation, SONEDE had to reduce its rate of meters replacement, and many customer

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meters are now currently broken or malfunctioning (under-metering). A large program to replace malfunctioning meters was launched in 2013 with support from donors. The replacement of 350,000 meters is currently under way with financing from KfW and AFD. The proposed replacement of an additional 70,000 meters will complement this ongoing effort. It will directly improve SONEDE’s revenues and overall financial sustainability, and is also expected to have a positive impact on water conservation.

Table 1: Summary of Project and AF Activities

Component Original activities Activities under AFComponent 1: Improvements to the Greater Tunis water supply system

Expansion of treatment and storage capacity at Tunis’s Ghdir-el-Gollah water treatment plant (construction of ST4 treatment facility)

1. a) Expansion of capacity of the new ST4 treatment facility of the Ghdir-El-Gollah water treatment plant by 1 m3/s

Rehabilitation of transmission line from Ghdir-El-Gollah water treatment plant to Ras Tabia storage tank

1. b) Rehabilitation and upgrade of the other water treatment facilities of Ghdir-El-Gollah water treatment plant

Augmentation of storage, pumping and distribution capacities in several peripheral subsystems (Mornag, Bir-el-Kassa, La Gazelle, Borj Touil)

Reinforcement of power supply at Greater Tunis water treatment plant As per revised procurement plan (2013) - see footnote 7

Replacement of raw water intake pumps at the Greater Tunis treatment plant As per revised procurement plan (2013)- see footnote 7

Component 2: Improvements to water supply systems in other urban centers

Upgrades in SONEDE’s northern and central operating regions (storage, transmission, distribution)

Rehabilitation of the Belli potable water treatment complex (serving cities on the Center-East region such as Nabeul, Sousse and Sfax)

Component 3: Management capacity building

a. Corporate plan and organizational audit Removed from the Project during mid-term review, for SONEDE to implement under alternative funding sources (EU grant has been identified by SONEDE)

b. Financial planning model

c. Installation of modern Customer Service information system (SIC) to improve, inter alia, billing efficiency

Acquisition and replacement of 70,000 malfunctioning meters

d. Human Resources management system

Acquisition of rolling equipment for network repairs As per revised procurement plan (2013) - see footnote 7

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19. As noted in paragraph 14 above, the financial equilibrium study (Bank-executed) is financed in parallel by a grant from PPIAF and WPP.

20. Project costs. The costs by component for the original loan and the proposed AF are shown in Table 2 below, all Value-Added-Tax (VAT)-inclusive. The June 2012 restructuring allowed the financing of 100 percent of Project costs through loan proceeds.

Table 2: Costs by Components

Component Original project

(US$ million) AF

(US$ million)

Component 1: Greater Tunis 25.9 17.2

Component 2: Other urban centers 9.1 4.1

Component 3: Management capacity building 3.9 2.8

Physical contingencies 3.7 0.8

Financial contingencies (incl. front-end fees) 4.6 1.3

Total 47.2 26.2

21. Implementation arrangements and other arrangements will slightly change, as follows:

(a) Two financial covenants are dropped, namely maintaining a minimum ratio of internal cash generation against capital expenditure needs of 30%; and maintaining a debt service coverage ratio of 1.3 or better. The original strict cost recovery covenant (“maintaining an operating ratio of over 100%”) is modified according to the new definition of “working ratio calculated as (net operational revenues) divided by (net operational costs minus depreciation plus interest charges) to be equal or superior to 100%.

(b) The Closing Date is extended from to June 30, 2015 to June 30, 2018.

(c) The results framework is modified (Annex 5).

(d) The composition of the PIU is slightly modified (including specialists in environmental and social management in the PIU’s key personnel).

(e) The definition of the Greater Tunis region is modified. The areas covered by the treatment unit (ST4) of the Greater Tunis water treatment plant (Ghdir-El-Gollah) comprise the four governorates of Greater Tunis.

22. Results Framework: The proposed AF includes modifications to the PDO and previous project design, thereby resulting in revisions to the Results Framework of the Project. Modification of the PDO aims to increase the focus on outcome and better reflect the current priority of the Government, namely ensuring continuity of 24 hours / 7 days water service to all SONEDE customers in the face of fast growing demand. The related indicators were modified or dropped due to difficulties in attribution and measurability. Three PDO

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indicators are proposed (instead of six): one for continuity (24 hours / 7 days) of water service (existing), one for the number of beneficiaries from infrastructure works (modified), and one for financial viability of SONEDE (new). Adjustments to the intermediate results indicators have also been made in consultation with SONEDE (Table 3), in order to better align the indicators with the investments supported by the AF. The full updated Results Framework of the Project, including reasons for each of these changes, and arrangements for monitoring are provided in Annex 5. Table 3 below highlights key changes made to the intermediate results indicators.

Table 3: Intermediate Results Indicators

Indicator Original target Changes Revised targetComponent 1 - Improvements to the Greater Tunis water supply systemNumber of new connections

8,360 to 9,120 yearly

Revised Piped household water connections that are benefiting from rehabilitation and upgrading works undertaken under the project (number)

Core sector indicator Estimated at 850,000 million (cumulative) by project end

Volume of water sold in Greater Tunis area

100-110 million m3 yearly

Same Corresponding to additional plant capacity in Greater Tunis treatment plant (GEG)

146 million m3 yearly by 2018

New (AF 1.a)Completion rate of expansion works of ST4 potable water plant in Greater Tunis (percentage)

100 percent Completion rate for ST4 will separate targets for original Project (2 m3/s) and for expansion under the AF (1 m3/s)

New (AF 1.b)Completion rate of rehabilitation and upgrading works at Greater Tunis potable water treatment plant

End of project target is 100 percent

Completion rate of reinforcement of power supply at Greater Tunis water treatment plant As per of revised procurement plan of original Project

End of project target is 100 percent

Completion rate of replacement of raw water intake pumps at Greater Tunis water treatment plant As per of revised procurement plan of original Project

End of project target is 100 percent

Component 2 - Improvements to water supply systems in urban centersOther cities Number of new connections

900 to 990 yearly Revised Piped household water connections in areas that are benefiting from rehabilitation and upgrading works undertaken under the project (number)

Core sector indicator. Measurement of connections benefiting from Bank funding will distinguish the cities covered by the works financed under the original Project (located in the

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North West, and estimated at 480,000 by 2018) and those financed under the AF (Center-East region estimated at 490,000 by 2018)

Volume of water sold in targeted cities

6,770,000 to 8,230,000 m3 yearly

Same Revised targets for expanded volumes

Will be separated between the cities covered in the works financed under the original project (located in the North West) and those financed under the AF (Center-East region)

Belli

New (AF)Completion rate of rehabilitation and upgrading works of the Belli water treatment facility (percent)

End of project target is 100 percent

Component 3: Management capacity buildingImplementation of studies, tools, and systems

Installation completed of (i) joint customer management system (joint SONEDE-ONAS), (ii) financial model, (iii) HR system

Corporate plan and organizational audits dropped

Completion rate, end target is 100 percent Completion rate will separate institutional activities (i), (ii), (iii)

Setting of management performance objectives

Dropped

Acquisition of rolling equipment for network repairs As per of revised procurement plan of original Project

Completion rate, end target is 100 percent

New (AF) Purchase and installation of 70,000 customer meters

70,000 new meters installed

IV. Appraisal Summary

Technical Appraisal

23. Water treatment capacity expansion works. The proposed 1 m3/s expansion of the treatment station ST4 at Ghdir-El-Gollah through the addition of a third unit similar to the previous two units built within the original Project, was already foreseen in the original design of the ST4 in 2006. As the design of the ST4 facility was made for a total capacity of 3 m3/s, the detailed technical design of the proposed 1 m3/s to be added under the AF is already fully

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available. It is still up-to-date and does not require any adjustment. SONEDE is thus using the technical design prepared in 2006 to finalize the corresponding bidding documents.

24. Rehabilitation and upgrade works. The detailed list of activities proposed by SONEDE for the rehabilitation and upgrade works of the Greater Tunis and Belli water treatment plants was reviewed and validated by the project team. The rehabilitation works will focus on assets that have reached their useful life and for which rehabilitation is urgent, so as to minimize the risks of water production capacity shortages in the Greater Tunis area and the cities served by the Belli water complex in the Center-East region. Limited upgrading works of these two water production plants are also proposed to further improve operational efficiency and help reduce energy consumption and chemicals usage. These proposed works consist in equipment replacement and in civil works of a straightforward nature that do not raise technical challenges.

25. Meter replacement. The acquisition of 70,000 meters is part of a larger meter replacement program, already funded partly by KfW and AFD. The meters replacement program entails standard operational work and no particular challenges are expected.

Economic Appraisal

26. Using the same cost-benefit approach adopted in the original Project in 2006, the economic benefits of the infrastructure components are calculated based on the opportunity costs of alternative water supply, with projections from 2015 to 2040 for the infrastructure investments, and 10-year projections for the meters replacement (Annex 3 provides details on the economic analysis methodology and assumptions). For lack of any water vending services in Tunisia, the analysis used as a proxy the cost of water supply in rural areas, updated at 22.6 TND/m3 (based on inflation since 2005). The quantity of water that would have to be purchased from alternative vendors without the AF is estimated based on SONEDE’s projections of the number of households that would be denied the benefits of piped water through new connections due to production capacity shortage, and related average consumption of only 30 liters per habitant per day. Financial costs are converted into economic costs by deducting taxes and using a conversion factor of 0.8 to adjust for the costs of unskilled labor and custom duties (data from the National Statistics Institute). The economic benefits of replacing the meters have been estimated assuming an average under-metering rate of 30 percent for the meters to be replaced, and a useful life of five years followed by growing under-metering by ten percentage points in year 6-10 (70% under-metering on average by year ten).

27. Estimates of economic Net Present Value (NPV) and economic rate or return (ERR) are based on an opportunity cost of 12 percent (Table 4). In addition to the base case, two alternative (less favorable) scenarios have been tested: (i) five percent annual increase in project costs, (ii) five percent annual increase in project costs, and five percent annual decrease in project benefits. Under the base case, the AF is well justified, with a combined ERR of 39 percent for the infrastructure investments (Components 1 and 2), and an ERR of 238 percent for the meters replacement (Component 3). Taking into account benefits such as increased reliability of water quality, reduction in production costs, and better equity between customers, the AF would yield even higher returns.

28. Sensitivity analysis shows that the ERR drops to 25 percent for the infrastructure investments, and 138 percent for the meters replacement, in the less favorable scenario (when benefits are reduced by as much as five percent annually and costs rise by five percent a year compared to the base scenario) confirming the overall strong economic viability of the AF investments.

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Table 4: NPV and ERR

Economic analysis: Opportunity Cost of Capital = 12%

Scenarios Base case 5% annual increase in project costs

5% annual increase in project costs and 5% annual decrease in project benefits

ERR NPV ERR NPV ERR NPV Greater Tunis water plant 38% 197 million TDN 34% 192 million TDN 25% 96 million TDN Belli water plant 43% 68 million TDN 39% 64 million TDN 27% 27 million TDN Meter replacement 238% 9 million TDN 190% 9 million TDN 143% 7 million TDN

Fiduciary Appraisal

29. No new fiduciary arrangements are sought. A summary of the fiduciary arrangements is outlined below and detailed in Annex 2.

Financial Management. In accordance with OP/BP 10.00 and “Financial Management Practices in World Bank Financed Investment Operations” Manual, the Bank performed, as a part of the preparation process of the AF, a financial management capacity assessment to determine the continued adequacy of SONEDE’s financial management arrangements to support project implementation. It was determined that existing financial management arrangements are capable of recording all project’s transactions and balances, supporting the preparation of regular and reliable financial statements, safeguarding the entity’s assets, and are subject to external auditing reviews, and thus, are acceptable to the Bank. The proposed AF will be implemented using the same financial management arrangements agreed for the original Project, i.e.: budgeting, accounting, internal controls, funds flow, financial reporting and auditing. Therefore, oversight for the implementation of financial management arrangements under the AF will remain SONEDE’s responsibility through the dedicated PIU already established. The project’s overall FM risk rating remains low. SONEDE has wide experience managing not only Bank-financed projects but projects funded by other recognized international donors (i.e. JICA, AFD, KfW), and has broad knowledge of Bank’s fiduciary requirements. Furthermore, current available information indicates that SONEDE’s financial management performance for the original loan has been systematically rated satisfactory, except for the last financial management performance review where a MS rating was given due, among other things, to the qualified entity’s audit report for 2012. An action plan to address audit findings is already in place and will be closely followed-up by the Bank. In order to ensure smooth AF implementation, the Bank will continue monitoring the effective implementation of project’s financial management arrangements, review project financial management performance and compliance with financial covenants, identify corrective actions if necessary and monitor fiduciary risk. The financial management supervision strategy will include desk review of unaudited interim financial reports (UIFRs) and annual audited entity and project’s financial statements, and on-site visits on a semi-annual basis. Disbursement. The AF will be implemented using the same disbursement arrangements currently employed for the original loan, except that it will be using a Designated Account (DA). The proceeds of the loan would be disbursed in accordance with the disbursement procedures of the Bank and will be used to finance project activities through the following

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disbursement methods: direct payment, advance, special commitments and/or reimbursement, accompanied by appropriate supporting documentation in accordance with the procedures described in the Disbursement Letter and the Bank's "Disbursement Guidelines". Requests for Reimbursement will be accompanied by “Statement Of Expenditure” and required supporting documents will be sent to the Bank in connection with payments against contracts for (a) works and goods valued at US$1,500,000 or more, (b) consulting firms valued at US$100,000 or more, and (c) individual consultants valued at US$50,000 or more. The documentation supporting expenditures will be retained at SONEDE and will be readily accessible for review by the external auditors and Bank supervision missions. The use of advance to the DA method was confirmed during Appraisal upon SONEDE’s request to open a DA at the Central Bank. Matters related to withdrawal and reporting on the use of AF proceeds, minimum value of withdrawal applications, supporting documentation, frequency of reporting eligible expenditures under the DA, and other important disbursement information are described in the AF’s Disbursement Letter. The revised disbursement schedule has also been finalized during Appraisal as is attached in Annex 2.b. Procurement. SONEDE, through the PIU, would continue to be responsible for overall coordination of procurement of all AF-funded activities. SONEDE has implemented close to ten Bank-financed projects through its history, and a number of other projects funded by KfW, JICA and AFD in recent years. Its staff has good experience with the different steps of procurement (from preparation of bidding documents to notification of consultants/suppliers/contractors, and record keeping), and is familiar with Bank’s requirements. An assessment of SONEDE’s capacity to implement procurement was carried out by the Bank during the preparation of the original Project and confirmed during Appraisal of the AF. SONEDE’s overall capacity to adequately carry out procurement associated with the AF was deemed adequate and hence the overall procurement risk rating remains moderate. This includes the upcoming higher volume of procurement linked to NWSIP and the remaining procurement activities related to the remaining funds from the original loan.7 During Appraisal, the Procurement Specialist also verified that the preparation of bidding documents using Bank-approved Standard Bidding Documents was on track to meet the end of June 2014 deadline for submission to the Bank for review, and close monitoring will continue to be provided during implementation. SONEDE will also assign appropriate staff capacity commensurate to the Project. The Bank will provide refresher training to SONEDE staff on Bank Procurement and Consultants guidelines (including Standard Bidding Documents) when the AF operation starts.

Environmental Appraisal (including safeguards)

30. There are no further environmental impacts associated with this additional loan, since it does not involve significant changes from the original Project and no new safeguard issues arise as a result of the proposed AF activities. All the new investments to be financed will be subject to Operational Policy Environmental Impact Assessment (OP 4.01). The

7 These remaining funds of US$2.7 million (arising mostly from exchange rate fluctuations due to the appreciation of the Euro since 2006) are expected to be disbursed by June 2015, well within the AF timeframe through the revised procurement plan which was approved by the Bank. The activities to be financed were included in this revised procurement plan in 2013 and include: (i) reinforcement of the power supply of the Greater Tunis water treatment plant (under Component 1); (ii) rehabilitation of two pumps at the raw water intake of the Greater Tunis water treatment plant (under Component 1); and (iii) purchase of operating equipment and vehicles for network repairs (under Component 3).

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Environmental Assessment (EA) that was done by SONEDE in 2005 has been updated - consultations were held in Tunis and feedback was reflected in the updated EA which was disclosed in the country and through Infoshop on April 4, 2014. The revised EA incorporates (i) the provisions of the new national legislation on Environment Impact Assessment (EIA); (ii) recommendations for limiting the impacts during execution of the works, and during the operation of the potable water treatment (mainly for Belli water complex) sludge management and disposal in compliance with the Bank policies and the Tunisian legislation (this will include an assessment of current sludge management at the Belli complex, and identification as applicable of technical alternatives and action plan); and (iii) monitoring plans indicating the mitigating and monitoring measures, responsible parties and timing. The updated EA also includes the Environment Management Plan (EMP) for the expansion works of ST4 of the Ghdir-El-Gollah water treatment plant (Component 1.a of the AF). As mentioned in the updated EA, SONEDE will elaborate and execute the EMPs related to Component 1.b and Component 2 sub-projects as separate documents. These EMPs were not completed at the time of Appraisal because the detailed nature of the rehabilitation works and technologies to be used were not yet finalized. The finalized EMPs will be submitted to the National Environment Protection Agency (Agence nationale de protection de l’environnement – ANPE) and the Bank for approval and disclosed in country before the works start. The finalization of these two EMPs is therefore a disbursement condition for the corresponding sub-components. In addition, SONEDE and the Bank will jointly perform an environmental assessment to better evaluate the approach and documentation processes used to monitor the implementation of EMPs for the investments of the original Project. The objective of this assessment is to provide key recommendation to reinforce SONEDE capacity's in performing such activities. SONEDE’s institutional and organizational capacities for supervision and implementation of the environmental safeguards related to this AF will also be reinforced to ensure compliance with the provisions of the revised EA with, at the outset a training session for SONEDE staff on OP 4.01 and Bank safeguards in general that will be supported by the Bank.

Social Appraisal (including safeguards)

31. The AF is expected to lead to favorable social outcomes, including continuity of potable water supply. SONEDE provides universal access in all its service areas (100 percent coverage through individual connections). The targeted areas supported by the AF include poor families living in urban, peri-urban and some rural areas, and these will benefit from the new investments which ensure that SONEDE can continue providing them continuous 24/7 water service. In terms of affordability, a poverty diagnostic to be conducted through a global Water and Sanitation Partnership (WSP) initiative, which will assist SONEDE in the context of the implementation of the financial equilibrium study, in case the development of a progressive tariff structure better targeted to the poor is needed. As regards social safeguards, the AF project does not trigger OP 4.12 since the AF-financed investments will not require land acquisition or new rights of way. During Appraisal, it was confirmed that both the Greater Tunis water treatment site and the Belli water treatment site are well secured, with a well-maintained fence, security guards, and adequate signage providing evidence that encroachment is not to be expected. It was also certified that the location of all new proposed investments is on land already in SONEDE's possession since the 1970s. Also, although the AF does not have citizen engagement dimension per se, SONEDE’s procedures to ensure grievance have been reviewed during Appraisal from a social safeguard perspective. It was found that (i) historically, SONEDE has provided 24/7 service and should continue to do so through this AF without service deterioration, and (ii) SONEDE’s existing responsiveness to its connected client is deemed adequate -- currently,

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customers are aware of how to communicate service concerns through phone and physical visits to commercial agencies of SONEDE. However, it was agreed that SONEDE will establish an enhanced complaint mechanism available for citizens, by making these mechanisms more explicit on its website, offices, and at work sites. This will consist, among others, in indicating a contact point for addressing complaints, and sensitizing workers on how to handle eventual complaints. As regards past investments, a due diligence review and a note to the files provide evidence of compliance of the original Project with agreed-upon land acquisition procedures. The note also indicates in detail the transparent system established in consultation with SONEDE to regularize pending land contracts.

Risk Appraisal

32. As this is an AF operation, all project implementation systems are functioning appropriately, however, the overall risk of project implementation is considered substantial. Two main areas of risks to implementation have been identified, that could potentially affect the achievement of the PDO. These relate to the country context and procurement, as summarized below. Mitigation measures have been identified and incorporated in the design of the AF and ongoing preparation. An updated Operational Risk Assessment Framework (ORAF) is included in Annex 6.

Country risk. This risk is the only one considered substantial, and is outside of the control of the Borrower. The country situation remains challenging, as it has embarked on a political transition process, and there has been significant degradation of economic conditions over the last three years. The current transitional government was appointed in January 2014, until new national elections are held. So far, due to its status as an autonomous corporatized public utility, SONEDE was only minimally affected by the disruptions following the revolution. SONEDE is a highly respected company in Tunisia, and the fact that all successive governments since 2010 have complied with the tariff adjustment program, allowing until now four tariff increases, suggests that there is a broad consensus across the political spectrum and within civil society about the importance of ensuring SONEDE’s sustainability. The increasing presence of donors, through the NWSIP, also creates further incentives for the Government to continue implementing the tariff increase program until 2016, and ensure SONEDE’s full financial viability. The Bank will continue to closely monitor the evolution of the national situation to ensure continued smooth implementation of the project.

Procurement risk. The overall procurement risk is considered moderate. As cumbersome national procedures and duplication between Bank and national procurement procedures have affected the implementation of the initial Project, several measures were taken during the preparation of the AF operation to reduce the risk of delays. The team’s Procurement Specialist verified that the preparation of bidding documents by SONEDE, using Bank-approved Standard Bidding Document, was on track to meet the agreed date of end of June 2014 for submission to the Bank for review. SONEDE also committed to assign appropriate staff to support procurement as necessary. Finally, SONEDE committed to work closely with the Bank and Commission Supérieure des Marchés (CSM, Tunisia’s High Tender Board) to avoid unnecessary duplication of procurement procedures.

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Annex 1: Detailed Costs of the Additional Financing

Tunisia: Additional Financing Urban Water Supply Project

Component Total cost TDN million

1: Water infrastructure in Greater Tunis 27.7

1.1 Expansion of ST4 treatment facility (1 m3/s) 16.6 1.2 Rehabilitation and upgrade of Greater Tunis treatment plant (GEG) 11.1

1.2.a. Intake pumping station (pumping station 1) 3.0 1.2.b. ST1 treatment facility 1.7 1.2.c. ST2 treatment facility 3.3 1.2.d. Treated water reservoirs 1.6 1.2.e. Internal networks 1.1 1.2.f. Others 0.4

2: Water infrastructure in other urban centers 6.7

2.1 Intake pipe (DN1600, ductile iron) of Belli treatment plant 2.5 2.2 Rehabilitation and upgrade of Belli treatment plant 4.2

2.2.a. Raw water basin 0.5 2.2.b. STB1 treatment facility 3.1 2.2.c. Others 0.6

Sub-total infrastructure 34.4

3: Management capacity reinforcement

Acquisition and installation of 70.000 customer meters 4.4 Sub-total capacity reinforcement 4.4

Total investment costs 38.8 Physical contingencies 0.9 Financial contingencies 1.6

Total AF costs 41.3

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Annex 2: Financial Management and Disbursement Arrangements

Tunisia: Additional Financing Urban Water Supply Project

2 a. Financial Management (FM) and Disbursement

Summary. As a part of the preparation process of this AF, the Bank performed a financial management capacity assessment to determine the continued adequacy of SONEDE’s financial management arrangements to support project implementation, in accordance with OP/BP 10.00 and the Manual “Financial Management Practices in World Bank Financed Investment Operations”. The review determined that existing financial management arrangements are acceptable to the Bank since they are capable of recording all project transactions and balances, supporting the preparation of regular and reliable financial statements, safeguarding the entity’s assets and are subject to external auditing reviews acceptable to the Bank. As for the original loan, oversight for the implementation of financial management arrangements under the AF operation will be SONEDE’s full responsibility through the dedicated PIU established for the original Project, for which overall FM performance has been found acceptable. SONEDE has wide experience handling Bank-financed operations and broad knowledge of Bank’s financial management and disbursement procedures and requirements. However, a few weaknesses were identified during the assessment: (i) SONEDE has little prior experience handling the advance disbursement method, and (ii) follow-up on audit findings has not always been done efficiently. To mitigate those risks the following measures have been agreed with SONEDE:

Project’s DA will be opened at the Central Bank of Tunisia (CBT) and will be managed by them. The CBT currently handles most project designated accounts of the World Bank portfolio in Tunisia.

An action plan to overcome audit findings for 2012 is already in place and close follow-up will be done by the Bank’s FM team.

An FM and disbursement training focusing on financial reporting and disbursement methods will be delivered soon after effectiveness.

Financial management risk assessment. On the basis of the Bank’s FM assessment, the overall FM residual risk is considered low, as per the following table:

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Table 5: Financial Management Risks

Risk type8 Risk

Rating

Comments/risk mitigating measures

incorporated into Project design

Residual Risk

Rating

Inherent risk L L

Country level M Country level for this operation is moderate due mostly to the transition context in which political uncertainty remains.

M

Entity L SONEDE has wide experience managing WB financed projects. L

Project L AF operation design is not complex and will finance additional activities under existing three components of the original loan. Overall FM performance for the original loan has been found acceptable.

L

Control risk L L

Budgeting L Project’s expenditures will be embedded in SONEDE’s budget. L

Accounting L SONEDE will use its own accounting system and auxiliary supplemental records (excel spreadsheet). These systems are already in place have proved to be reliable and accurate during the implementation of original loan.

L

Internal Control L SONEDE has an acceptable internal control system which includes among others, adequate segregation of duties, reconciliation activities and physical verification of assets.

L

Funds Flow M Funds will flow through the project’s DA. While this disbursement method is relatively new to SONEDE, the risk related to funds flow is low since DA management will be done by the CTB which has broad experience handling project DAs.

L

Financial Reporting

L SONEDE will continue to prepare and submit Interim financial reports (IFRs) to the Bank, on a semi-annual basis. IFRs for the original loan have systematically been submitted in a satisfactory and timely manner.

L

Auditing M Annual audits on project and SONEDE’s financial statements for the parent loan have been submitted to the Bank on time. Statutory audit report for FY2012 had a qualified opinion; however, an action plan to address audit findings is agreed upon and being implemented. Bank close follow-up of the implementation of the action plan will continue.

M

Overall FM risk L L

Description and assessment of AF financial management arrangements The purpose of this section is to (1) spell out the main features of financial management arrangements of the AF operation and (2) identify necessary actions to enhance efficiency of existing procedures, and/or adequately address any additional challenge emerging, in particular this case, the use of the new disbursement method “advances” to the project’s DA. Budgeting arrangements. The Management Control Unit (Unité de Controle de Gestion) of SONEDE is responsible for all budget activities including project’s budget preparation, analysis and presentation. Additionally, the project’s financial management system (FMS) maintains

8 The inherent FM risk is that which arises from the environment in which the project is situated. The FM control risk is the risk that the project’s FM system is inadequate to ensure that project funds are used economically and efficiently and for the intended purpose. The overall FM risk is the combination of the inherent and control risks as mitigated by the client control frameworks. The residual FM risk is the overall FM risk as mitigated by the Bank supervision effort.

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manual records of loan allocations by category of expenditures and by project’s component, actuals and variances. Accounting system. Project’s withdrawal applications, financial statements and accounting records will be prepared by the project’s accountant. Project transactions will be recognized following the cash basis of accounting and SONEDE will use their own Chart of Accounts. For the project’s accounting SONEDE will use the “J.D.E. One World 9.0” accounting information system, which has the capacity of maintaining records and accounts to reflect, in accordance with accounting practices compatible with International Accounting Standards and national requirements, the utility’s operational and financial position, including records and separate accounts for the proposed project. Additionally, during Appraisal, the project’s FM Specialist confirmed that the PIU has developed various manual reports that keep track, among others, on Bank project-related disbursements, expenditures, payments to suppliers, commitments, and financial ratios calculation. Automated and manual information support the preparation of the IFRs that are submitted to the Bank twice a year. Finally, administrative procedures are in place to ensure that all transactions and balances are recorded correctly, regular and reliable financial statements are prepared, and entity’s assets are safeguarded. Internal control. The internal control system of SONEDE has been deemed satisfactory by the Bank. It encompasses a series of activities, policies and procedures, automated tools, approvals, authorizations, verifications, reconciliations, security over assets and segregation of duties. These control activities are applied to the entire institution including projects.

Flow of funds. Withdrawal of loan proceeds for the AF operation will be mainly through the “Advance disbursement method” which allows for the Bank to provide funds to the Borrower so that it may finance expected project expenditures as they are incurred. The description of the flow of funds is represented in Figure 1 where the solid lines represent the flow of money and the dotted lines represent the flow of information:

Figure 1: Funds flow

1. Advances from the World Bank will be deposited in the project’s DA opened at the CBT, upon SONEDE’s instruction.

World Bank

1

Consultants/ providers/

sub-contractors

DA open and managed by

TCB

2

3

SONEDE

3

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2. Following national practice, whenever there is a need to pay to suppliers of goods and services under any component of the AF operation, SONEDE will instruct the CBT to transfer funds from the DA to the goods/service provider’s bank’s accounts directly.

3. Further advances to the project’s DA account will be made upon reporting on the use of a prior advance. SONEDE (through the CBT) will monthly report on the use of loan proceeds advanced to the project’s DA in accordance with the Disbursement Letter. Total project’s eligible expenditure will be summarized in the Statement of Expenditures (SOE) prepared by CBT and will be submitted to the Bank for processing.

Financial reporting. The FM specialist of the PIU will use SONEDE’s accounting system and manual auxiliary reports, as described earlier, to prepare consolidated semi-annual IUFRs and the annual audited project financial statements. These reports will be prepared on a cash basis, in both Tunisian Dinar and US dollars, using the standard formats already in place for the original loan. After loan effectiveness, semi-annual IUFRs will be submitted to the Bank within 45 days after the end of each six-month calendar period. External audit. Annual audits on project financial statements and on statutory financial statements will be submitted to the Bank within six months after the end of each calendar year of loan disbursements (or other period agreed with the Bank). The audit scope, the terms of reference, the auditor and the audit standards have to be acceptable to the Bank. Audit requirements include the following:

Table 6: Audit Requirements

Report Due date Annual audit report on SONEDE’s financial statements will include: Income Statement, Balance Sheet, Cash Flow Statement and attached notes.

Within six months after the end of each calendar year.

Annual audit report on Project financial statements and eligibility of expenditures will include: statement of sources and uses of funds; appropriate schedules classifying project expenditures by component and activity showing yearly and cumulative balances.

Within six months after the end of each calendar year of loan disbursements (or other period agreed with the Bank).

Disbursement arrangements. The proceeds of the AF loan would be disbursed in accordance with Bank’s disbursement procedures and will be used to finance AF activities through the following disbursement methods: advances to the DA, direct payment, special commitments and/or reimbursement accompanied by appropriate supporting documentation in accordance with the procedures described in the Disbursement Letter and the Bank's "Disbursement Guidelines". Loan disbursement arrangements9 are summarized below:

9 For details, see the Disbursement Handbook for World Bank Clients.

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Table 7: Disbursement Arrangements

Disbursement method

The primary disbursement method for the project will be advances to the DA.

Designated Account

A segregated DA will be opened at the CBT. The DA ceiling amount discussed with SONEDE during Appraisal is 2,000,000 Euros

Supporting documentation

Withdrawal from the loan proceeds will be accompanied by SOEs10” and required supporting documents will be sent to the Bank in connection with payments against contracts for (a) works and goods valued at US$1,500,000 or more, (b) consulting firm contracts valued at US$100,000 or more, and (c) individual consultant contracts valued at US$50,000 or more. The documentation supporting expenditures will be retained at SONEDE and will be readily accessible for review by the external auditors and World Bank supervision missions.

Limits Minimum value of applications for direct payments, disbursements and special commitment is 20 percent of the DA Advance.

Disbursement schedule. The disbursement plan was confirmed with SONEDE during Appraisal (table 8).

Table 8: Disbursement Projections up to September 30, 2018

(End disbursement date)

Com-ponent

Activity

Disbursement projections (TDN million)

Y1 Y2 Y3 01/01/2018 to 30/06/2018

01/7/2018 to 30/09/2018

TOTAL 2015 2016 2017

1. a 1) Expan. ST4 0 8 7 1.6 0 16.6

1. b 2) Reha/up. GEG 0 4 5 2.1 0 11.1

2 3) Reha/up. Belli 0 2 2.6 2.1 0 6.7

3 4) Meters 3 1.4 0 0 0 4.4

TOTAL 3 15.4 14.6 5.8 0 38.8

Notes: Projections 1) includes VAT: 18%, 2) do not include opening commissions, 3) do not include contingencies.

Table 9 specifies the eligible expenditures that may be financed out of the proceeds of the Loan, the allocation of the amounts of the Loan to each category, and the percentage of expenditures to be financed for eligible expenditures in each category.

10 All SOE supporting documentation would be available for review by external auditors and Bank staff at all times during AF implementation, until at least the later of: (i) one year after the Bank has received the audited Financial Statements covering the period during which the last withdrawal from the Loan Account was made; and (ii) two years after the AF Closing Date. The Borrower shall allow the Bank’s representatives to examine these records.

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Table 9: Eligible Expenditures

Category Amount of the LoanAllocated

(expressed in Euro)

Percentage of expenditures to be

financed (inclusive of Taxes)

(1) Goods, works and non-consulting services for Component 1.1 and 3 (equivalent to “Parts A.1 and C” in Loan Agreement)

10,000,000 100%

(2) Goods, works and non-consulting services for Component 1.b (equivalent to “Part A.2” in Loan Agreement)

5,300,000 100%

(3) Goods, works and non-consulting services for Component 2 (equivalent to “Part B” in Loan Agreement)

3,200,000 100%

(4) Front-end-fee 47,500 Amount payable pursuant to Section 2.03 of Loan 83950-TN in accordance with Section 2.07 (b) of the General Conditions

(4) Unallocated 452,500 TOTAL AMOUNT 19,000,000 Disbursement conditions. The preparation and publication of EMPs related to the rehabilitation and upgrade works at the Greater Tunis (Component 1.b) and Belli (Component 2) potable water plants (indicated as expenditure categories (2) and (3) in Table 9 above) approved by the Bank are disbursement conditions. FM supervision. The scope of project supervision will include reviewing the implementation of FM arrangements and FM performance, identifying corrective actions if necessary, and monitoring fiduciary risk. It will take place twice a year and include (a) reviewing of IFRs; (b) reviewing of the auditors’ reports and follow-up of any issues raised by auditors in the management letter, as appropriate; (c) participation in project supervision missions and (d) updating the FM rating in ISRs. Action plan. Although SONEDE has complied systematically with Bank’s audit requirements, last audit report on SONEDE’s financial statements for 2012 had a qualified opinion. Reasons for the reservation are: i) fixed assets valuation and inventory were not accurate; ii) suspense accounts have not been cleared in a timely manner and show old balances not yet reconciled; iii) receivables and related accounts, customer advances and branch offices accounts are not duly reconciled; and iv) bank account reconciliations show old suspense amounts pending clearance since 2002. An action plan to address audit findings was prepared by SONEDE and submitted to the Bank on March 25, 2014. During appraisal, the action plan was discussed in depth with the project’s Financial Management Specialist and SONEDE’s Financial and Accounting Director and was found acceptable to the Bank. Below is a summary of the approved action plan:

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Table 10: Action Plan to Address Audit Findings

Reservation Action Responsible Deadline

Fixed assets valuation and inventory

AMC Ernst & Young Young (member firm of Ernst & Young EMEIA Limited, based in Tunisia) has been hired by SONEDE for fixed asset inventory, reconciliation and valuation. The consultancy work entails 4 phases that have to be performed in sequence.

-1st: Assessment of current situation (4 months). Completed as of March 2014.

-2nd: Inventory activities preparation (6 months)

-3rd: Inventory and tagging (12 months)

-4th: Accounting reconciliation & valuation (10 months)

SONEDE through AMC Ernest and Young

August 2016

Suspense accounts, receivables and related accounts, customer advances and branch office’s accounts.

A procurement process has been initiated by SONEDE in order to hire a consultant firm that will make a diagnostic of those accounts and propose accounting adjusting entries. SONEDE envisages that the consultant work would start in May 2014.

SONEDE through the hired consultant firm.

October 2014

Bank account reconciliation

Bank account reconciliation is ongoing. As of March 2014, outstanding balances pertaining to 1996, 1997, 1998, 1999, 2000, 2001, 2007 and 2009 have been cleared.

SONEDE December 2014

2 b. Procurement

Applicable guidelines: Procurement for the proposed AF will be carried out in accordance with the World Bank "Guidelines: Procurement of goods, works and non-consulting services under IBRD loans and IDA credits & grants by World Bank Borrowers” dated January 2011 (“Procurement Guidelines”), and the provisions stipulated in the Loan Agreement. National Competitive Bidding (NCB) will be carried out with procedures acceptable to IBRD. The Guidelines on Preventing and Combating Fraud and Corruption in Projects Financed by IBRD Loans and IDA Credits and Grants”, dated October 15, 2006 and revised in January 2011will apply.

Results of the procurement risk assessment: An assessment of SONEDE has been undertaken. This assessment is based on Bank’s knowledge of SONEDE’s procurement experience under the original project. The objective of this capacity assessment was to determine whether the implementing agency has the capacity to adequately carry out the procurement function of the Project. This evaluation took into account the entire contracting process which encompasses: (i) planning; (ii) preparing bidding documents; (iii) receiving and evaluating bids or proposals; (iv) finalizing and signing the contract or agreement; and (v) monitoring the implementation; and (vi) filing and archiving documents for audit and post review. SONEDE has few staff with good experience in procurement management under multilateral and bilateral projects – including the original project and several other projects funded by KfW, JICA, and AFD. This staff is responsible for all the procurement processing from the preparation of the bidding documents stage up to the notification of the consultant/supplier/contractor and for record keeping. The assessment reveals that, while the SONEDE has gained extensive experience in the Bank procurement procedures under the parent project, the following risks are plausible: (a)

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difficulties at SONEDE in handling a high volume of procurement, and (b) duplication of national and Bank’s procurement procedures associated with a too slow, cumbersome and bureaucratic procurement prior review by the national procurement committees (High Tender Board and SONEDE’s Procurement Committee). These two risks may result in bottlenecks and slow implementation of the project; and in poor quality of contract management. Overall, if the proposed mitigation measures as indicated in the action plan (see Table 11) are applied, SONEDE will be able to implement procurement procedures within the framework of the project. The overall procurement risk has been rated as moderate. The detailed final assessment report will be uploaded to Procurement Risk Assessment & Management System (P-RAMS).The summary assessment and recommendations are shown in Table 11 below:

Table 11: Procurement Analysis and Mitigation Measures

Analysis of procurement Capacity

Issues/Risks Mitigation measures

1. Accountability for procurement decision in the implementing agencies

While the procurement decisions, within SONEDE, are clearly defined in the Tunisian public procurement decree as to the national public procurement, there may be duplication of Bank and Tunisian procedures.

SONEDE to be trained/updated on Bank procurement rules

2. Internal manuals and clarity of the procurement process 3. Record keeping and document management system Procurement records will be kept under the custody of the responsible units within SONEDE

Project’s fiduciary documents might be scattered across different units in SONEDE

Ensure that training is given to SONEDE to ensure that project specific files are kept for all procurement and related transactions and recorded contract by contract.

4. Staffing The PIU comprises SONEDE staff

There might be turnover in PIU Ensure SONEDE has adequate capacity to manage the AF and NWISP-related procurement.

5. Procurement planning SONEDE is required to regularly update AF procurement plan

The procurement plan might not be accurately and timely updated

Ensure that the procurement plan is timely updated and advertised on ImageBank.

6. Bidding document, short-listing and evaluation criteria

SONEDE might be not familiar with the use of the latest Supply and Install standard bidding document

Explain/present the document to SONEDE.

7. Advertisement, pre-bid/proposal conference and bid/proposal submission

There might be a risk of lack of transparency in the advertisement process

Ensure that ICB opportunities are advertised in UNDB online and NCBs on public procurement portal and newspaper(s) of national circulation

8. Evaluation and contract award

The evaluation process might take long time and delay the project implementation

Ensure that timeframe as per procurement plan is respected by SONEDE

9. Review of procurement decision

The potential risk is the duplication of Tunisian and Bank’s procurement rules resulting in delays and bottlenecks

Sensitize SONEDE on procurement rules that apply to the AF and make sure that there is no duplication

10. Contract management and administration

While SONEDE is quite experienced in this field, there might be some issues of contract management given the complex nature of some of them

Ensure that SONEDE understands clearly the arbitration mechanism.

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11.Procurement oversight

The potential risk is the duplication of Tunisian and Bank’s procurement prior review procedures resulting in delays and bottlenecks

Sensitize SONEDE on procurement rules that apply to the project and make sure that there is no duplication of national and Bank’s procedures

Prior review and procurement methods thresholds. The thresholds as presented in Table 12 will apply.

Table 12: Prior Review Thresholds (US$) Procurement type Amounts

Works, turnkey and supply & install (S&I) of plant/equipment 15 million Goods 3 million IT systems and non-consulting services 3 million

Procurement method thresholds (US$) Goods Works ICB NCB Shopping ICB NCB Shopping

Tunisia >3 million ≤ 3 million ≤ 200,000 > 10 million ≤ 10 million ≤ 300,000

Procurement plan. The AF procurement plan was disclosed on ImageBank on May 13, 2014.

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Annex 3: Economic Analysis

Tunisia: Additional Financing Urban Water Supply Project

Economic viability

The AF activities have been assessed for economic viability. Expected benefits from the AF operation for the Tunisia population are highly positive.

Using the same cost-benefit approach adopted in the original Project in 2006, the economic benefits of the infrastructure components are calculated based on the opportunity costs of alternative water supply, with projections from 2015 to 2040 for the infrastructure investments, and 10-year projections for the meters replacement. For lack of any water vending services in Tunisia, the analysis used as a proxy the cost of water supply in rural areas, updated at 22.6 TND/m3 (based on inflation since 2005). The quantity of water that would have to be purchased from alternative vendors without the AF is estimated based on SONEDE’s projections of the number of households that would be denied the benefits of piped water through new connections due to production capacity shortage, and related average consumption of only 30 liters per habitant per day. Financial costs are converted into economic costs by deducting taxes and using a conversion factor of 0.8 to adjust for the costs of unskilled labor and custom duties (data from the National Statistics Institute). The economic benefits of replacing the meters were estimated assuming an average under-metering rate of 30 percent for the meters to be replaced, and a useful life of five years followed by growing under-metering by ten percentage points in year 6-10 (70% under-metering on average by year ten).

Estimates of economic Net Present Value (NPV) and economic rate or return (ERR) are based on an opportunity cost of twelve percent. The two infrastructure components of the AF operation are necessary for SONEDE to meet future increase in water demand from the growing population of targeted areas, to avoid switching from continuous supply 24 hours / 7 days to intermittent water supply. The total beneficiary population is estimated at about five million people (figure as of 2014 not taking account population growth). The proposed expansion of the ST4 treatment facility (adding 1 m3/s) in the Greater Tunis water plant needs to be launched without delay since the first phase of ST4 is already operating at full capacity. The rehabilitation of the other treatment facilities of the Greater Tunis water plant and the Belli water complex is equally important to avoid future shortages in water production capacity. Without these urgent infrastructure investments, SONEDE would be faced with constrained production capacity starting in 2017. Receiving intermittent service in many urban systems across the country would have considerable negative impact in terms of quality of service and public health for the entire population of those areas; higher operating costs; accelerated depreciation of water networks; bottlenecks for economic development, and most likely, civil unrests and riots. In order to avoid these effects, SONEDE would be forced to stop connecting new households in targeted areas.

The replacement of 70,000 customer meters will also bring benefits in terms of revenue enhancements and increased financial viability for SONEDE, as well as more equity between customers with regards to being billed for actual consumption. In the evaluation of the original Project, the economic analysis of Component 3 presented a special challenge due to the indirect relationship between the installation of new management

28

systems under the Project and the stream of benefits that these were expected to trigger. With the AF operation, a conservative estimate of the expected benefits from replacing 70,000 meters can be easily calculated by estimating the resulting additional cash flow for SONEDE – the meters to be replaced being currently either blocked or under-metering actual water consumption.

Methodology

The analysis used during the evaluation of the original Project in 2005 was updated to estimate the economic benefits from the infrastructure investments (90 percent of total project cost), using updated figures.

The same methodology used in 2006 for the economic evaluation of the investments under the original Project was applied to the AF’s new investments. The expected costs and benefits have been estimated and the Net Present Value (NPV) and the Economic Rate of Return (ERR) were calculated. Overall AF NPV is estimated at US$171 million at a 12 percent discount rate with a 39 percent ERR for the infrastructure investments (Components 1 and 2).

The basis for estimating the economic benefits is that without the proposed investments, SONEDE would not be able to meet demand for new connections in targeted areas. Hence, the benefits of the infrastructure components would be at least equal to the cost of the alternative means that would be used to meet water needs without the AF operation. In this hypothetical situation, households and other users would have to rely essentially on the purchase of water from water vendors at high prices and/or on investment in private wells and storage capacity. Applied to the investments of the original project, this analysis had led in 2006 to ERR estimates between 43.3 percent and 37.9 percent (depending on hypothesis), confirming the high economic viability of these investments. For quantitative purposes, the avoidance of such costs had been assumed to be the main benefit from the infrastructure investments of the project. It was however a conservative estimate, as it did not account for additional benefits expected from the rehabilitation works in terms of more reliable water quality and reduced water production costs.

Sensitivity analysis

Sensitivity analysis shows that the ERR drops to 25 percent for the infrastructure investments, and 138 percent for the meters replacement, in less favorable scenario, confirming the overall economic viability of the AF investments. In addition to the base case, two alternative (less favorable) scenarios have been tested: (i) five percent annual increase in project costs, (ii) five percent annual increase in project costs, and five percent annual decrease in project benefits. Under the base case, the AF is well justified, with a combined ERR of 39 percent for the infrastructure investments (Components 1 and 2), and an ERR of 238 percent for the meters replacement (Component 3). Taking into account benefits such as increased reliability of water quality, reduction in production costs, and better equity between customers, the AF would yield even higher returns.

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Table 13: NPV and ERR

Economic analysis: Opportunity Cost of Capital = 12%

Scenarios Base case 5% annual increase in project costs

5% annual increase in project costs and 5% annual decrease in project benefits

ERR NPV ERR NPV ERR NPV Greater Tunis water plant 38% 197 million TDN 34% 192 million TDN 25% 96 million TDN Belli water plant 43% 68 million TDN 39% 64 million TDN 27% 27 million TDN Meter replacement 238% 9 million TDN 190% 9 million TDN 143% 7 million TDN

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Annex 4: Implementation schedule

Tunisia: Additional Financing Urban Water Supply Project

2014  2015  2016  2017  2018 

Component  T2  T3  T4  T1  T2  T3  T4  T1  T2  T3  T4  T1  T2  T3  T4  T1  T2  T3  T4 

                                                        

1: Infrastruct. Greater Tunis                                                          

Station ST4 (Phase  2)                                                          

Procurement                                                          

Execution                    1  1  1  1  1  1  1  1  1  1          

                                                          

Rehabilitation GEG plant                                                          

Procurement                                                          

Execution                       1  1  1  1  1  1  1  1  1  1        2: Infrastructures other urban centers                                                          

                                                          

Rehabilitation Belli plant                                            

Procurement                                            

Execution                                            

                                                          

Purchase intake pipes Belli*                                                          

Procurement                                                          

Execution                 1  1                                     

                                                          

Layout intake pipes at Belli                                                           

Procurement                                                          

Execution                       1  1                               

                                                          

Other purchases (fittings)                                                          

Procurement                                                          

Execution                    1  1                                  

                                                          

3: Management capacity                                                          

Customer meters                                                          

Procurement                                                          

Execution                 1  1                                     

                                                           

* DN1600 – ductile iron. 

 

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Annex 5: Revised Results Framework and Monitoring Indicators

Tunisia: Additional Financing Urban Water Supply Project

Revisions to the Results Framework Comments/ Rationale for Change

PDO Current (PAD) Proposed (i) Sustain the reliability and quality of water service in Greater Tunis and selected urban centers, through augmentation, upgrade and renewal of water supply infrastructure. (ii) Enhance the competitiveness and sustainability of SONEDE operations, through modernization of management practices and information systems, for better cost control, enhanced revenue and more responsive customer service.

To ensure the continuity of water service (24 hours / 7 days) for the population of Greater Tunis and other cities, and improve the financial viability of SONEDE.

The PDO has been simplified and revised to better reflect intended outcomes.

PDO indicators Current (PAD) Proposed change Volume of water sold in target

areas Dropped Transferred to intermediate

results indicator None New PDO indicator for

financial sustainability: Working ratio (target ≥ 100%) Calculated as (net operational revenues) divided by (net operational costs minus depreciation plus interest charges)

This financial ratio was chosen based on the financial diagnostic of SONEDE completed during preparation.

New connections in the areas targeted by the project

Revised Direct project beneficiaries of which female (50%)

The indicator on beneficiaries refers to beneficiaries in areas targeted by rehabilitation and expansion works

Water shortage events (unmet demands, after 2009)

Continued This indicator is relevant. Update of end of project target value

Client satisfaction rates, as measured through periodic surveys

Dropped

SONEDE provides reliable service quality with continuous supply (24/7).

Duration of bill collection cycle Dropped This indicator is not relevant since the project has no direct impact on bill collection (The latter is mostly a matter for

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Revisions to the Results Framework Comments/ Rationale for Change

SONEDE of applying strict connection cuts policies in case of non-payment, and negotiating with the Government for late bill payments from public agencies).

Ratio of “labor costs/ sales” Dropped This indicator is not relevant since the project has no impact on labor productivity

Intermediate Results indicators Current (PAD) Proposed change Component 1: Improvements to the Greater Tunis water supply systemGreater Tunis Number of new connections Volume of water sold

Revised Component 1. Core sector

indicator: Piped household water connections that are benefiting from rehabilitation works undertaken under the project (number)

Volume of water sold in Greater Tunis

(AF 1.a) Completion rate of expansion works of ST4 potable water plant in Greater Tunis (percentage)

(AF 1.b) Completion rate of rehabilitation and upgrade works at Greater Tunis potable water plant

Completion rate of reinforcement of power supply at Greater Tunis water treatment plant (as per revised procurement plan for original Project)

Completion rate of replacement of raw water intake pumps at Greater Tunis water treatment plant (as per revised procurement plan for original Project)

The intermediate indicator on connections is slightly modified to clarify that the investments under AF will ensure that continuous water supply for all connections is maintained in the project targeted areas

Completion rate for ST4 will separate targets for original Project (2 m3/s) and for expansion under the AF (1 m3/s)

Component 2: Improvements to water supply systems in urban centers

Other cities in the North West and Center of the country

Number of new

Partly revised Core sector indicator

Piped household water connections that are

The intermediate indicator on connections is slightly modified to clarify that the investments under AF will ensure that

33

Revisions to the Results Framework Comments/ Rationale for Change

connections Volume of water sold

benefiting from rehabilitation works undertaken under the project (number)

Volume of water sold targeted cities

Completion rate of reinforcement works in the targeted cities (average)

continuous water supply for all connections is maintained in the project targeted areas

Belli water complex (Center-East region cities) Core sector indicator:

Piped household water connections that are benefiting from rehabilitation works undertaken under the project (number)

Volume of water sold in targeted cities

Completion rate of rehabilitation works of the Belli water treatment facility (percent)

Target 100 percent

Component 3: Management capacity buildingImplementation of studies, tools, and systems

Rate of installation/completion of the (i) joint customer management system (joint SONEDE-ONAS), (ii) financial planning model, (iii) HR system, (iv) acquisition of rolling equipment

Target 100 percent

Purchase and installation of 70,000 customers meters

Number of meters replaced Target 100 percent

REVISED PROJECT RESULTS FRAMEWORK

Project Development Objective (PDO): To ensure the continuity of water service (24 hours per day, 7 days a week) to the population in Greater Tunis and other targeted cities, and improve the financial viability of SONEDE

PDO Level Results Indicators

Cor

e UOM

Baseline Original Project Start

(2006)

Progress To Date (2013)

Cumulative Target Values

Frequency Data Source/ Methodology

Responsibility for Data

Collection Comments 2014 2015 2016 2017 2018

1. Working ratio

Percent 121 % 116 %

≥ 100% ≥ 100% ≥ 100% ≥ 100% ≥ 100% Annual

Net operational revenues divided by (net operational costs minus depreciation plus interest charge)

SONEDE

SONEDE is currently in compliance with this proposed financial indicator/ covenant and, based on current financial projections, expects to remain in compliance for the extended duration of the Project (until 2018).

2. Direct project of which female beneficiaries

Number 0

5.5 million

(original Project and AF)

5.65 million

5.83 million

6.01 million

6.19 million

6.38 million

Annual

Total population in Project and AF areas

SONEDE Institut National de la Statistique

Cumulative. Refers to beneficiaries in areas targeted by rehabilitation and expansion works 50% women

3. Water shortage events Number 0 0

0

0 0 0 0 Monthly Ongoing operational monitoring

SONEDE

Water shortage events would be unscheduled interruptions due to water supply constraints (not scheduled interruptions in the network e.g. for repair purpose).

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35

Intermediate Results and Indicators

Intermediate Results Indicators

Cor

e

Unit of Measu-rement

Baseline Original Project Start

(2006)

Progress To Date (2013)

Target Values

Frequency Data Source/ Methodology

Responsibility for Data

Collection Comments 2014 2015 2016 2017 2018

Intermediate Result 1: Component 1: Improvements to the Greater Tunis water supply system

Greater Tunis

Original Project: Piped household water connections that are benefiting from rehabilitation and upgrading works undertaken under the project

X Number (million)

0 0.72

0.74

0.77 0.8 0.82 0.85 Annual Monitoring reports

SONEDE In Greater Tunis

Original Project: Volume of water sold

million m3/year

103.7 129

133 138 143 148 153 Annual Monitoring reports

SONEDE In Greater Tunis

Original Project: Completion rate of expansion works of ST4 potable water plant in Greater Tunis (2 m3/s)

% 0% 100% 100%

100%

100%

100% 100% n.a. Completed SONEDE

AF 1.a Completion rate of expansion works of ST4 potable water plant in Greater Tunis (1 m3/s expansion)

% 0%

0% 0% 40% 80% 100% 6 months Contract supervision

SONEDE

AF 1.b Completion rate of rehabilitation and upgrading works at Greater Tunis water plant

% 0%

0% 0% 45% 75% 100% 6 months Contract supervision

SONEDE

Original Project – as per revised procurement plan: Completion rate of reinforcement of power supply

% 0%

40% 100%

100%

100% 100% 6 months Contract supervision

SONEDE

Original Project - as per revised procurement plan: Completion rate of replacement of raw water intake pumps

% 0%

40%

100%

100%

100%

100% 6 months Contract supervision

SONEDE

Intermediate Result 2: Component 2: Improvements to water supply systems in urban centers

Original Project: Other cities in other urban centers

Piped household water connections that are benefiting from rehabilitation and upgrading works

X number 0 0.40

0.42 0.43 0.45 0.46 0.48 Annual Monitoring reports

SONEDE In North and Center urban centers

Volume of water sold targeted cities (North and Center)

m3/year 44.9 57.1

59.0 61.0 63.0 65.1 67.3 Annual Monitoring reports

SONEDE

36

Intermediate Results and Indicators

Intermediate Results Indicators

Cor

e

Unit of Measu-rement

Baseline Original Project Start

(2006)

Progress To Date (2013)

Target Values

Frequency Data Source/ Methodology

Responsibility for Data

Collection Comments 2014 2015 2016 2017 2018

Original Project: Completion rate of works in other cities of the North and Center

% 0% 100% 100%

100%

100%

100% 100% n.a. Completed SONEDE

AF: Belli water complex (Center-East cities)

Piped household water connections that are benefiting from rehabilitation and upgrading works undertaken under the project

X Number (million

) 0 0

0.45 0.47 0.48 0.49 0.49 Annual

Monitoring reports

SONEDE In Center-East cities

Completion rate of rehabilitation works of the Belli water treatment facility

% n.a 0%

0% 00% 30% 70% 100% 6 months Monitoring reports

SONEDE

Volume of water sold targeted cities (Center-East)

million m3/year

0 0 74.9

76.1

77.3

78.1

79.0

Annual Monitoring reports

SONEDE

Intermediate Result 3: Management capacity building

Rate of completion of the (i) joint customer management system (joint SONEDE-ONAS)

% 0 0

30% 100% 100% 100% 100% Annual Contract supervision

SONEDE and World Bank

Rate of completion of (ii) financial planning model

% 0 0

0% 30% 90% 100% 100% Annual Contract supervision

SONEDE

Rate of completion of (iii) HR system % 0 100%

100% 100% 100% 100% 100% Completed in 2011

SONEDE

Number of meters purchased and installed (cumulative)

Number n.a. 0 0 40,000 70,000

70,000

70,000 Annual

Contract supervision

SONEDE

Rate of completion of rolling equipment purchase (as per revised procurement plan)

% n.a. 0

30% 100% 100% 100% 100% Annual Contract supervision

37

Annex 6: Operational Risk Assessment Framework (ORAF)

Tunisia: Additional Financing Urban Water Supply Project

1. Project Stakeholder Risks Stakeholder Risks Rating Low Description: SONEDE may not perform well or feel ownership of the project

Risk Management: The proposed AF will allow SONEDE to carry out investments of urgent and strategic

nature in the Greater Tunis area, and has been requested by SONEDE. SONEDE is one of the best performing executing agencies in Tunisia, and a reliable long-

term Bank partner. It has already demonstrated its capacity through the Project to implement infrastructure investments in a highly satisfactory manner. SONEDE’s ownership and capacity for the implementation of the AF proposed were assessed at appraisal and deemed satisfactory.

Resp: SONEDE

Stage: Implementation

Recurrent: X Due Date: 06/30/2018

Frequency: Status: Ongoing

2. Implementation Agency (IA) Risk (including Fiduciary Risks) 2.1 Capacity Rating Moderate Description:

Like others implementing agencies in Tunisia, SONEDE is affected by slow procurement processes. This could generate delays in implementing the new investments.

Risk Management: Slow procurement is caused by the multiplication of cumbersome and bureaucratic procurement prior review. Measures to mitigate potential procurement delays include: 1) The Bank shall work with the High Tender Board and SONEDE’s Procurement Committee

to avoid any duplication between national and Bank procurement procedures. 2) SONEDE will finalize all AF-related tender documents, so as to start procurement soon after

Board approval. During implementation, the Bank team will closely monitor procurement processes to make sure there are no delays in contract management.

3) Ensure SONEDE has adequate capacity to manage the NWISP-related procurement. Provide refresher training on Bank procurement procedures.

Resp: CMU, SONEDE

Stage: Preparation, implementation

Recurrent: X Due Date: 06/30/2018

Frequency: Status: Ongoing

2.2 Governance Rating: Moderate Description:

Lack of capacity of SONEDE to implement the investments under the proposed AF, due for instance to lack of staff or organizational issues.

Risk Management: Within SONEDE, the Directorate for Engineering Studies, the Directorate of Construction, and the Directorate of Operations are responsible for implementation. The PIU remains responsible for coordination of the AF operation, fiduciary oversight and reporting, and technical reporting. It comprises a Director, a technical division and a financial division both fully staffed and has

38

been performing well since 2006. Both fiduciary and project reporting by PIU have been of consistent quality. The main infrastructure investments proposed under the AF are straightforward, and fall well within SONEDE's capacity which is among the best performing executing agencies in Tunisia. Resp: PIU, Directorate for Engineering Studies, Directorate of Construction, Directorate of Operations

Stage: Implementation

Recurrent: X Due Date: 06/30/2018

Frequency: Status: Ongoing

3. Project Risks 3.1 Design Rating Low Description:

Weak contract supervision and management by SONEDE

Risk Management: The investments contemplated for the AF are of a simple technical nature. SONEDE recently completed the construction of the first phase of ST4 treatment facility in a very satisfactory manner. The proposed works are considered standard tasks for SONEDE. Resp: SONEDE

Stage: Implementation

Recurrent: X

Due Date: 06/30/2018

Frequency: Status: Ongoing

3.2 Social and Environmental Rating Low Description: Safeguards OP 4.01 for treatment water facilities is not properly enforced.

Risk Management: The original EA (2005) and EIA for ST4 water treatment plant (2006) took into account the

anticipated total capacity of 3 m3/s. The EA has been updated and disclosed in country and through Infoshop on April 4, 2014. The works for the Ghdir-El-Gollah and Belli complexes are standard in nature and concern facilities already in operation. An EMP will be prepared for each sub-project to ensure that all potential impacts or nuisance during works and any impact linked to operations are properly managed. SONEDE’s capacity to correctly supervise OP 4.01 requirements will be supported by the Bank through training and technical assistance as needed during implementation.

The only expansion works will take place on the premises of the Greater Tunis water treatment plant as confirmed during appraisal (OP 4.12 will not be triggered).

A Social Specialist will be assigned to the Project. Resp: Bank

Stage: Implementation

Recurrent: Due Date: 08/31/2014

Frequency: Status: Ongoing

39

3.3 Program and Donor Rating Low Description: There is no co-financing involved.

Risk Management: The Bank has maintained close coordination with SONEDE’s main lenders on sector dialogue and strategic issues, especially AFD, KfW and JICA. Information related to the upcoming financial sustainability study have been shared with all donors active in the Tunisian water sector, following the commitment made by the Bank during the donor conference of Marseilles in February 2014. Resp: N/A

Stage: Recurrent: Due Date: Frequency: Status:

3.4 Delivery Monitoring and Sustainability Rating Moderate Description:

Poor quality of construction and O&M arrangements could negatively impact project outcomes. SONEDE’s 2012 financial statements have been qualified by external auditors. SONEDE’s customer and billing system is obsolete and does not allow SONEDE to exercise sufficient controls and generates billing and collection errors, and system bugs.

Risk Management: SONEDE has competent staff which is fully able to carry out infrastructure design and supervision of civil works. The PIU has been reporting on Project’s advancement with consistent quality since 2006. The same procedures for conducting monitoring and reporting will apply during the AF. A detailed action plan to resolve audit findings was submitted to the Bank for approval. The action plan is deemed acceptable and is SONEDE has already started to put in place. Additionally it is expected that SONEDE’s new commercial management system (SIC) will also help to solve auditors’ reserves when it is in place as of June 2015. The Bank team is closely following-up on the implementation of the SIC contract to ensure that both SONEDE and the contractor duly stick to the contract timetable. Additionally, an action plan to address audit findings was submitted by SONEDE on March 25, 2014 and approved by the Bank on April 3, 2014. SONEDE’s capacity to continue providing continuous (24/7) water services beyond 2018 will depend on the timely implementation of the NWSIP. This is largely linked to the improvement of its borrowing capacity over the next four years. The strategic financial equilibrium study to be carried jointly by SONEDE and the Bank, and subsequent implementation of the action plan to reinforce SONEDE’s financial capacity, will ensure that SONEDE will have sufficient borrowing capacity to implement the NWSIP. Resp: SONEDE

Stage: Implementation

Recurrent: Due Date: 06/30/2018

Frequency: Status: Ongoing

4. Overall Risk 4.1 Overall Implementation Risk (04/29/2014) Rating Substantial Comments: The substantial rating is based on the evaluation of the country context.

The project seeks to finance additional activities under Component 1, 2, and 3 of the original Project. SONEDE’s FM and procurement systems have proved satisfactory during the original Project and capacity is present in the PIU. The financial sustainability risk will be mitigated through the planned financial equilibrium technical assistance package which is conducted in parallel. Overall, fiduciary, safeguards, and institutional risks that may affect the implementation of the forthcoming investments are deemed to be manageable. Further risk assessments will be undertaken with the close involvement the concerned specialists and the country team and additional support will be provided as required.