Document of

The World Bank

FOR OFFICIAL USE ONLY

/vv~~ 37 S 7' - -C-

Report No. 12317-BUL

STAFF APPRAISAL REPORT

BULCARIA

WATER COMPANIES RESTRUCTIRING AND l0DERNIIZATION PROJECT

MAY 5, 1994

Infrastructure Operations DivisionCountry Department IEurope and Central Asia Region

I Tis document a a rerited dstrbwn md my be uand by I ony in he perfonnama offtheir offili dutis Its contens may n otheiese be dicosed wiout World Bnk authoitoton.

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

Pub

lic D

iscl

osur

e A

utho

rized

CURRENCY E_UIVALENTS

Currency Unit = Bulgarian Leva (L)

Value of- USSI.00 in L 1/

1991 18.601992 23.00

1993 28.001994 (March) 45.67

PRINCIPAE. ABBREVIATIONS AND ACRONYMS USED

CAS country Assistance StrategyDDSR Bank Debt and Debt Service ReductionEC PHARE European Union Assistance Program for Eastern EuropeGDP Gross Domestic ProductGEF Global Environmental FundGOB Government of BulgariaICB International Competitive BiddingIIP Initial Investment ProgramIS International ShoppingLCB Local Competitive Bidding

LS Local ShoppingNOE Ministry of EnvironmentMRD Ministry of Regional Development and ConstructionNCRDH National Center for Regional Development and HousingPMU Project Management UnitRWCs Regional Water and Sewerage CompaniesUS AID United States Agency for International DevelopmentUS EPA United States Environmental Protection Agency

BULGARIA -- FISCAL YEAR

January 1 - December 31

1/ Values for exchange rates are year averages at the market rate until 1993. T]

value for March 1994 is the monthly average. In February 1991, exchange ratel

were unified and a single market exchange rate was allowed to float in the nei

formed interbank market.

FOR OFFICIAL USE ONLY

WATER COMPANIES RESRUCTURING ADMODERNIZATION OJCTSTAFFAPASAL REPORT

Table of Contents

I. SECTOR BACKGROUND .-. . . . . . . . . . . . .. . .. . . . .1A. Country/Economic Profile . . . .. . . . . . . . . . . . . . 1B. Sector Profile . . . . . .. . . . . . . . . . . . . . . . 2

C. Regional Water and Sewerage Companies--Issues for ProjectDesign . . . . . . . . . . . . . . . . . . . . . . . . . . 4

II. SECTOR RESTRUCTURING STRATEGY .. . . . ....... . ... . 7A. Further Restructuring of the Regional Water and Sewerage

Companies . . . . . . . . . . . . . . . . * . . . . . . . * 7B. Privatizing State Engineering and Construction Enterprises . 8C. Implementing a new Regulatory Framework and Tariff Policies . . 8D. Improving Water Resources Management . . . . . . . . . . . . 9B. Sector E;gagement Criteria .... ..... .. ...... 9

III. RATIONALE FOR BANK INVOLVEMENT . . . . . . . . . . . . . . . . . . . 10

IV. THE PROJECT.. .11A. Objectives.. 11S. Project Components.. . 11C. Project Costs and Financing . . . . . . . . . . . . . . . . . 15D. Cost Recovery/On-lending Policy . . . . . . . . . . . . . . . 17E. Water and Sewerage Companies' Tariffs . . . . . . . . . . . . 18F. Institutional Eligibility Criteria for Sub-loans . . . . . . 19G. Project Implementation. 19B. Procurement .. 21I. Disbursements . . .. . . . . . 25J. Accounts and Audits .. 27K. Supervision . . . . . . . . . . . . . . . . . . . . . . . . . 27L. Environmental Screening .. 28

V. PROJECT JUSTIFICATION . . . . . . . . . . . . . . . . . . . . . . . 30

VI. RISK ASSESSMENT . . . . . . . . . . . . . . . . . . . . . . . . . . 32

VII. AGREEMENTS REACHED AND RECOMMENDATION . . . . . . . . . . . . . . . 33

This report was prepared by R. Van Pulley (Task Manager and Senior Economist),B. Gomez (Senior Financial Analyst), S. Margetis (Senior EnvironmentSpecialist, EC1IN); K. Georgieva (Environment Economist, EMTEN); J. Drozdz(Sanitary Engineer, EMTIN); T. Triche (Institutional/Regulatory Expert,Consultant); A. Damianova (Project Officer, RNB); and S. Kim (Cost/BudgetAnalyst, EC1DR), following a preappraisal mission in March 1993 and anappraisal mission in June 1993, and under the supervision of Mr. R. Halperin(Division Chief, EClIN), and Mr. M. Wiehen, (Director, ECI). Messrs. W.Stottmann (ENTIN) and S. Lintner (EMTEN) were peer-reviewers. The assistanceof the Government of Japan which provided two grants for the preparation ofthe Project is gratefully acknowledged.

This docmet has a -.stricted distibution and may be usod by reents only in hwe pefomaolofficia dutes. t contents may not othewise be lisAosed without Word Bank *thiaon.

LIST OF ANUEXES

1. 1993 Tariffs of Regional Water and Sewerage Companies . . . . . . . 352.- Tariff-Setting Guidelines for Water and Sewerage Companies . . . . 363. Project Investments by Year ..... .. . . . .. . . . . 384. Project Management Unit Budget . . . . ... . . . . . . . . . . . . . 39

5. Terms and Conditions fo. On-leading . ... . . . . . .. . . 406. Institutional Eligibility Criteria for On-Lending . .-. . . . . . 427. Project Nanagement Unit Organization Chart .-. . . . . . . . . . 458.''' project-Manaement 'Unit'Responsibilities-. .'. . . . . . . . . . . 469. Institutional Strengthening Window - Base Cot and Timetable . . . 4710. Initial Investment Program . . . . . . ...... .. 4811. Loan Disbursement Schedule . . . . . . . . . . . . .. .. . . . 5012. Annual and Mid-term Reviews . . . . . . . . . . . . . . 5113. Documents in Project File ........ . . . . . . . . . . . . . 53

&_R: IBRD No. 25226

BULGARIA

STAFF APPRAISAL REPORT

WATER COMANIES RESTRUCTURING AND MODERNIZATION PROJECT

LOAN AND PROM CT IMWP=

Borrower: Republic of Bulgaria.

Executing' Ministry'of Regional Development and Construction (MRD)Agencies: and National Center for Regional Development and

Housing (NCRDH).

Beneficiaries: Regional and Municipal Water and Sewerage Companies (RWCs).

Amount: US$98 million equivalent.

Terms: Repayment in 17 years, including four years of grace, withrepayments calculated on an annuity basis at the Bank'sstandard variable interest rate.

On-lending The Government would on-lend to water companies about USS93Terms: million in leva at a variable interest rate, on a first-come

first-served basis (subject to eligibility criteria). Therate will be the Basic Rate (Central Bank Rediscount Rate)plus a premium initially set at 6%, to compensate for theinterest and the foreign exchange risks which will be assumedby the Government. The interest rate will be adjustedperiodically to reflect changes in the Basic Rate at the timeof the adjustment. About US$5 million would be used by theGovernment to finance project implementation and to provideRWCs and other entitieq with grants for capacity building.

Project The project objectives are to assist the Government to:Objectives: (i) increase the corporate autonomy and commercial

orientation of RWCs and make their management accountable tolocal authorities; (ii) improve health and environmentalconditions in urban areas and conserve water resources;(iii) increase operating efficiency and cost recovery inRWCs; and (iv) demonstrate the feasibility and benefits ofintroducing transparent procurement procedures, efficientcontract management, and competition for supply of goods,works, and services.

Project The project comprises two major components: (i) theDescription: Institutional Strengthening Window (7% of baseline cost)s and

(ii) the Priority Water and Sewerage Investments Window (93%of baseline cost). The Institutional Strengthening Windowincludes: RWCs capacity building through in-country trainingand provision of technical assistance; carrying out a studyof options for improved management of water resources;strengthening and providing technical assistance to the

- Li -

Project Management Unit (PMU) that has been net up by theMRD; and enhancing RWCe investment planning capability andconstruction supervision. The Priority Water and SewerageInvestments Window includes, in-turn, two components: theCompletion and Rehabilitation Window and the Non-revenueWater Reduction Window. $he Project Completion/Rehabilitation Window will fund completion of ongoinginvestments that have high rates of return, andrehabilitation and upgrading of facilities. The Non-revenueWater Reduction Window will respond to the emergingincentives:for water companies to reduce water loss and toimprove their operating efficiency.

Environmental The project, classified in Category B, should have a positiveAspects: environmental impact through: (i) more efficient use and

better quality of drinking water, and (ii) reduction ofpollution from wastewater. To avoid possible detrimentalenvironmental effects, environmental analyses will beprepared for all sub-projects, evaluated by MOE and reviewedand approved by the Bank before sub-project tendering. Somesub-projects will involve internatio-al waterways butnotification to other riparians will not be required underthe Bank's policy because the Project will only financesub-projects that will involve the rehabilitation, upgradingand completion of existing water and sewerage systems andwill be complemented by water demand management and lossreduction program. Thus the sub-projects will have noadverve effect in either the quantity or quality of presentand future water flows. No resettlement issues have beenidentified; if any are identified by the sub-project studies,they should comply with the relevant Bank provisions.

Benefits: All water and sewerage services customers will benefit fromthe efficiency gains generated by the restructuring andstrengthening of water companies, as this should result incost containment and more affordable tariffs. Moreover,restructuring water companies and adding municipalshareholders will introduce the concept of managerialaccountability. Customers will also benefit from upgradedwater services and increased availability of drinking waterto consumers currently experiencing shortages. TheGovernment will benefit from the Project support to theobjective of redefining and making more effective the State'srole in the economy. The Project does this by: {i) shiftinginvestment responsibility from the State budget to the watercompanies; (if) redefining the State's functions away fromoperating the utilities to monitoring and regulating; and(iii) strengthening local authorities, who will become co-owners of the utilities responsible for provision ofservices. Through procurement, the Project will supportincreased competition for the provision of goods and

- iii -

services. The social benefits include improvements in publichealth. Finally, the Project addresses an agreed priority ofthe 1992 Bulgaria Environmental Strategy which, Inter alla,called for completion of priority water and sewerageinvestments with positive health or environmental benefits,and for water conservation measures.

Risks: There are many political and macroeconomic risks that couldnegatively affect Project execution which are not amenable tomitigating measures that can be built into the Project. Thosemitigated through project design itself include thefollowing: (i) political factors which may interfere withRWCs commitment to raise tariffs so as to achieve the agreedfinancial targets. This is minimized by financing relativelysmall affordable investments scattered among a number ofwater companies, incorporating a grace period for repaymentof the sub-loans, and up front approval of agreed upontariff-setting guidelines; (ii) diminishing politicalcommitment to decentralization. This is unlikely given thewidespread political support for the policy, the fact thatall political parties support municipal participation as RWCshareholders, and agreement to restructure at least four RWCsbefore loan effectiveness5 (Lii) the difficulty ofmaintaining a PMU capable of fulfilling the role that it hasbeen assigned. This has been handled by involving the PMUfrom the outset of project preparation, financingImplementation assistance, ensuring competitive staffsalaries and preparing a detailed Manual of Procedures; and(iv) lack of counterpart funds given adjustment-inducedbudgetary restraint. This risk is minimized by AnnualReviews to agree on appropriately sized Annual InvestmentPrograms, and financing with the loan proceeds a relativelylarge percentage of each component, ranging from 70 to 100%.

Poverty Impact: Not Applicable.

Rate of Return: Eligible sub-projects should have an economic rate of -returnnot lower than 12%.

-iv-

ESTIMATED PROJECT MOSS Loal Fogeigg Total

--USS Million--------

Institutional StrongtheningllCapacity Building 0.3 1.2 1.5

-Water Resources Managet!ent 0.1 0.4 0.5PMU and Project Implementatilon

Assistance 0.5 2.0 2.5Investment Planning and -

Construction Supervision _C3

S--ubttsl - -S - - 6.0 7.5

Water and sewerage InvestmentsProject Completion/Rehabilitation

Window 37.4 30.6 68.0

Non-revenue Water Reduction Window 16.5 13. 30.0Subtotal 53.9 44.1 98.0

Total Baseline Costs 55.4 50.1 105.5

Physical Contingencies 4.7 5.6 10.3rr..ce Contingencies 5.1 4.5 9.6

interest During Construction 55.6 S.6

Total 65.2 65.8 131.0

j/ Arnex 9 incLudes a more detailed brealkdom of expenditures under this coqwonent.

FMh_CING (US$ million and percentage)

World Water

Bank ,6OVt. Companies Total

, T. . AMT. %.. .AT. % ..AML. %

Institutional Strengthening 7.5 100 7.5 100

Project Completion/

Rehabilitation 47.5 70 10.2 15 10.3 15 68.0 100Non-revenue Water Reduction 21.0 70 9.0 30 30.0 100

Interest During Construction 5.6 100 5.6 100

Unallocated J16.4 __82 .,2 6 2.3 12_ 19.9 100

Total 98.0 74.8 11.4 8.7 21.6 16.5 131.0 100

ESTIMATED !BRD LOAN DISAB (EUSENTS million)

Bank Fiscal Year j 1996 1997 1I= 1999 2000 2001 2002

Annual 6.1_/ 10.2 18.9 19.1 15.1 15.1 11.5 2.0Cumulative 6.1 16.3 35.2 54.3 69.4 84.5 96.0 98.0

ri In tine with the standard disbursement profite for the water sector loan for all regions.

V Inctudes deposit in the Speciat Account of USS4.0 million.

IU1LQhRL&

VATER COMPANIES RESTRUCTURING AND MODERNIZATION PROJECT

STAFF APPRAISAL REPORT

I. SECTOR BACKGROUND

A. CouMtrylEconomic Profile

1.1 Bulgaria, one of the smaller South-Eastern European countries interms of area (43,000 square miles) and population (8.5 million), belongs tothe group of former socialist countries in transition. A peaceful adjustmentto multiparty democracy has been in progress since 1989. In October 1991 thefirst non-communist Government since 1944 was formed.

1.2 Since February 1991, successive Governments have pursued economicreform and stabilization, including price and trade liberalization. A floatingexchange rate regime has been established. In the initial years of reform,coordinated and austere monetary, fiscal and exchange rate policies wereimplemented to lower inflation and to improve external balance. The burden offiscal adjustment fell hardest on investment, which declined from 9.8% of GDPin 1990 to 1.8% in 1993, resulting in a build-up of unfinished investments.

1.3 Despite impressive adjustments, economy activity has continued tofall and inflation has remained high -- 91% in 1992; and 65% in 1993. GDPfell by about 5% in 1993, implying an aggregate decline of 40% since 1988,though some new private sector activities may not be captured in scatistics.Unemployment has also risen from 1.8% in 1990 to 16.5% in 1993. One factorconstraining economic growth has been the large external debt owed tocommercial banks (US$ 8.5 billion). While an agreement on debt reduction withBulgaria's commercial creditors has recently been concluded, that is expectedto be supported by a Bank Debt and Debt Service Reduction (DDSR) operation,access to capital for trade and investment is likely to remain constrained forseveral more years.

1.4 Although the reform process in Bulgaria has been uneven andslower-than-expected in privatization, successive governments since 1991 haveremained committed to the development of a strong market economy, includingkey legislative reforms needed to support privatization, land restitution,demonopolization, and bankruptcy norms. The reform has stimulated thedevelopment of an active private sector, which now accounts for about a thirdof economic activity and over 50% of retail trade. The Government of Bulgaria,while continuing to implement market reforms, is under severe pressure fromtrade unions and political parties to return the economy to growth and preventfurther social tension arising from the adjustment process. The Government's

-2-

program focuses on: (i) accelerating privatization,* (ii) adopting an adequatesocial safety net for low income groups; (iii) successfully concluding theDDSR operation with the commercial creditors; (iv) stimulating the economy andfacilitating private investment by increasing spending on high priority-infrastructure. Accelerating privatization is a key priority. It has beeninitially hindered by legislative uncertainties, and more recently, by-cumbersome asset valuation procedures. To speed the process of privatization,the GOB has proposed and the Parliament is considering several amendments tothe Privatization Law, including the introduction of a mass privatizationscheme. Prospects for a return t* medium- and long- term economic growthremaini positive, if the Government can sustain the reform program, but therisk of setbacks cannot be dismissed.

B. Sector Profile

1.5 Institutional Framework. The National Council on Water (aninterministerial body) established in 1991 is responsible for Waterlegislation and has recently drafted a Water Law which is now pendingParliamentary approval. 11 The Council allocates water resources betweensectors for drinking water, energy, and agriculture. The Ministry of Healthmonitors and enforces drinking water quality standards. The Ministry ofEnvironment (NOE) monitors ambient water quality, enforces standards, andfinances construction of wastewater treatment plants. The Ministry ofRegional Development and Construction (MRD) plays a policy-making andoperational role for the sector; key State-owned sector enterprises are underits authority. These include: (i) Vodokanal Engineering, the major designfirm for large water and sewerage investments; (ii) Vodokanal Invest,responsible for contracting and monitoring construction of State-financedwater and sewerage investments; (iii) Hydrostroy, specialized in construction;and (iv) 29 regional water supply and sewerage companies (RWCs) supplyingservices to about 85% of the population (7.2 million). There are also 14municipal water and sewerage companies serving 15% of the population(1.3 million). Raw water for drinking purposes derives from water companies'own single pur;ose dams, catchments, wells, and large multi-purpose damsoperated by the Dams and Cascades Division of the National Electric Company.irrigation water is supplied by the Ministry of Agriculture.

1.6 Domestic Water Supply and Demand. Water is a relatively scarceresource with a per capita endowment below half the European average (2,400 m3

in Bulgaria versus 5,000 m3 in Europe). About 98% of the population isconnected to the drinking water supply network. About 68% of drinking wateris supplied from surface sources and 32% from groundwater. Households consume61% of water sold while industrial (28%) and agricultural enterprises (11%)account for the balance. Average domestic water consumption is about 116liters per capita per day. Seasonal and year-round regional imbalances inwater supply, compounded by over consumption and physical losses, have led toconsiderable service inequality. Year-round water shortages persist in 103

1I rh dmA kw P*ide fo (I) P0044tio ma rowad dtin g wer a:mg (i) river hai _mang 4 thon &e oa D ew river hclb agendXto be otrgned tunder h Natioal Cocl an Wau;r (00 sol protcio aound wat ame (iv) penitan for vwe alocaiaua ad (VOabdhetka fe, Me dah am aot howcver, go fir eo_ugh in clealy defining redomlkia. au6mWi L h Isd tec at tde tims dhaPi%rta wm Ph dot I in itspruttfoan

-3-

cities and 1,103 settlements. Seasonal shortages prevail in 14 cities and 85settlements. Inadequate access to drinking water has negative social andhealth impacts.

1.7 wastewater. Environmental protection was not a high priorityduring the socialist period. Wastewat2r collection and treatmentinfrastructure lags far behind water supply. -8ased on a survey of water andsewerage companies representing 70% of connections, Qo.ly 18% of customers areconnected to sewers. Moreover, access to sewerage is very uneven throughoutthe territory, ranging from 4% to 75% depending on the company. Only onethird of -uunicipai- sewer systems (i.e., 60-of 187) have :primary or secondarywastewater treatment plants and one quarter of plants do not treat water todesign standards, usually due to lack of equipment or materials. Low coverageof sewerage and sewage treatment has a negative impact on public health andthe environment. About 32% of wastewater discharged into rivers does notcomply with standards. Pre-treatment of industrial discharges is required bylaw, but the Goverament does not have the means to enforce compliance in everycase. Its approach, therefore, is to focus on the most serious cases of non-compliance, about 10% of enterprises.

1.8 The Government has began restructuring the major State enterprisesunder the MRD. First, Vodokanal Engineering, Hydrostroy Construction and allwater companies were transformed from State enterprises into "SoleProprietorship Limited Liability Companies" (i.e., Sole Proprietor Ltd.Company) under the Commercial Trade Act (1991) and all operating subsidieswere eliminated. The shares of Sole Proprietor Ltd. Companies remain State-owned. The objectives of restructuring were to break up monopolies andprovide companies with the corporate structure and commercial incentives toimprove efficiency. After the initial transformation, Vodokanal Engineeringdivested itself of contracting and construction supervision with theestablishment of Vodokanal Invest as a separate Sole Proprietor Lt1. Companyin 1991. Vodokanal Engineering intends to spin off several geotechnicaldivisions. As a result of the contraction in investment, phasing out ofoperating subsidies and divestiture, Vodokanal Engineering staff fell from1,500 to about 700. Vodokanal Invest has a staff of 40.

1.9 Similarly, Hydrostroy was broken up into 13 separate SoleProprietor Ltd. Companies, including 9 regionally-based construction companiesand 4 enterprises specialized in laying pipelines, drilling, heavy industry,and hydrotechnical research. Staff fell from approximately 12,800 to 3,000with the drop in budget-financed construction. The MRD intends to subjectVodokanal Engineering and Hydrostroy enterprises to competition, both amongthemselves (i.e., Hydrostroy regional construction companies) and withemerging private contractors, often comprised of former staff. Eventually, itintends to privatize these enterprises according to the Privatization Act of1992.

1.10 The MRD also began transforming water operating utilities byestablishing 29 regional water and sewerage companies (RWCs). Each RWCdelivers water and sewerage services to 3-17 municipalitiesZ and is organizedas a Sole Proprietor Ltd. Company. For the networks serving a single

Mu or abobe an ceahous; hece. genpkaw ai U.S. 'co_&e.

-4-

municipality, 14 municipal companies were established and transferred to localauthorities, The proposed project would promote further restructuring toimprove RWCs' autonomy, commercial orientation, and local accountability.

C. Regional Water and Sewerag,e -a_&anies-ssues for ProJect Desian

1.11 Commercialization/Coroorate Accountabiljty. For the RWCs, newmanagers were competitively selected by the MRD and now operate under -

individual management contracts incorporating some corporate performanceindicators. Still, widely accepted management efficiency indicators for waterutilities are not routinely collected. Some staff downsizing has alsooccurred, but there is still scope for improving efficiency._ A remainingconcern is that RWCs' management are accountable only to the centralGovernment; hence not necessarily responsive to municipal authorities andconsumers with primary interest in adequate services and affordable prices.Although more corporate autonomy and incentives have been provided by thereforras, company managers still tend to seek guidance from the MRD,particularly on key issues such as pricing. A broader shareholder base isneeded to provide a better corporate environment for efficiency gains.Performance-based incentives and access to training for staff are also needed.

1.12 Accounting. RWCs are required to apply the accounting principlesand standards established in the Accountancy Law and the Chart of Accountswhich entered into force in Bulgaria in 1991. The Law and the Chart areimportant steps toward harmonizing Bulgaria's accounting practices on theinternational standards. The newly introduced principles and standards aresubstantially different from the previous accounting regime. They incorporatethe concepts of profit, prudence, going concern, and consistency. The fullimplementation of the new accounting practices in water and sewerage companieswill require a sustained effort over a long period of time, together withtraining for managers and accounting staff. This process may be facilitatedby water companies contracting accounting and auditing services with privatefirms. Some local firms have been recently established in Bulgaria and themajor international firms have offices in the country.

1.13 Tariff Settina Guidelines. Water and sewerage tariffs are setby water companies in accordance with guidelines issued by the Council ofMinisters. Compliance with the guidelines is monitored by the NationalCommittee on Tariffs. The Council of Ministers guidelines for setting tariffsallow RWCs to cover water and sewerage operating and maintenance costs and adda 12% "mark-up" (rate of "profit"). The "mark-up" is designed to fundcorporate tax payments (amounting to about 50% of the "mark-up"), and anyother financial requirement such as debt service, and contribution toinvestment. RWCs are permitted to set prices for household services at adiscount (typically below 30% of average cost) and cross-subsidize these withhigher charges to industry. Most RWCs in fact set tariffs in this way. Thecurrent tariff-setting guidelines represent a significant improvement over theprevious practice of setting a uniform national tariff. Nevertheless, theyare not fully satisfactory because they do not take into account the specific

1' TIe avoftge n. o ihe Dum wate cooWnum of 7.6 carnpc_IOOO.6 ceme a baft= te tWR is W. BimP (W/0) aiddelopi4 cambua (5-=2sO). Owuag im cwompnie for mo tmido e em to far examd Bu%Ua mm

-s-

investment needs and debt service requirements of water companies. Thisapproach was feasible when investments were financed from the central budget,

but it is not feasible when water companies have to finance investments with

internal cash generation and borrowing. The guidelines and monitoring oftariffs has been the Government's response to pressure from trade unions to

increase the level of intervention in price-setting by monopolLes. This

pressure stems primarily from the public perception that monopolies areraising prices without improving efficiency.

1.14 The thrust of the Project is to ensure that water companies have

both the incentives and wherewithal to improve efficiency and to ensure that

tariffs are sufficient to cover legitimate current and capital costs. to

ensure the latter, the tariff-setting guidelines for water companies will need

to move away from the allowable "mark-up" concept, which does not necessarily

reflect actual costs. Revised tariff-setting guidelines should allow water

companies to: (i) provide for working capital needs (ii) contribute not less

than 30% to planned investments; (iii) cover debt service; (iv) provide

adequate funding for maintenance and renewals; (v) adjust tariffs for

inflation every quarter; and (vi) reduce over time the price differential

between household and industrial consumers (paras.4.21 and 4.22).

1.15 Tariff Levels and Affordabiliy. Before 1990, the unified

househole. tariff was Leva 0.1 mS and 0.4 for industry. Water and sewerage

tariffs rose on average by about 100% in real terms in 1991 and since then,

continuing large nominal increases by most RWCs have kept real prices roughly

stable. There is, however, substantial variation in the tariff levels, partly

explained by cost differentials and partly by water companies' varying

aggressiveness in cost recoverv. For example, among RWCs in April 1993, water

and sewerage tariffs ranged from Leva 0.95 to 7.6 per m3 (US$.04 to .30 per

in3) for households and Leva 1.63 to 10.4 (USS.06 to .40 per m3) for industries

(Annex 1). Despite the increases, the majority *. RWCs maintain low water andsewerage tariffs--generally below 3 leva/ml for domestic water (USS.11W/ in

1993). Tariffs remain affordable with the average annual water and sewerage

bill representing less than 1.4% of the lowast old age pension. Since these

services were substantially underpriced during the socialist period, recent

tariff increases still only barely enable RWCs to cover operating costs and

generally do not allow a contribution to investment or network renewal costs.

Low prices are also partly enabled by the fact that RWCs are relatively debt

free as existing infrastructure was largely financed from the central budget.

Finally, tariffs are kept low by pressure from municipalities and consumers,

who have had to adjust to significant other price adjustments in the economywithout noticeable service improvement. Underpricing results in

overconsumption and strains utility finances, constraining investments in

infrastructure and service., causing their deterioration.

1.16 Billina and Collection. Between 85 and 90% of consumers aremetered, and RWCs have been instructed by the MRD to meter all remaining

unmetered connections. This high ratio, which likely stems from the

prevalence of private housing (i.e., 85%) in Bulgaria during the socialist

period, make the sector rather rare among former socialist economies. The

existence of metering and the personal responsibility for water usage thisengendered should greatly facilitate cost recovery and efficiency gains if

RWCs operate under rules of the game that provide the correct incentives.Billing and collection is also fairly well developed though most systems have

-6-

not been automated. The percentage of water bills eventually collected isrelatively high, particularly from households (i.e., 90% for a samplesurveyed), though there are indications that collections from industrialconsumers have begun to lag recently. RWCs will need to arrest thedeterioration in collection ratios and enforce water cutoffs as industrialrestructuring proceeds and tariffs rise.; -

I.. 17 - Non-revenue Water. It is estimated that non-revenue water4'averages 40% in Bulgaria, but exceeds 50% in some RWCB. Reducing non-revenuewater is critical to improve operating efficiency, cost recovery, andalleviate water shortages. Nevertheless, esatisfactory "diagnosis and curel ishindered by the fact that most production, along with transmission in regionalnetworks, is unmetered. According to the preliminary analysis, 70 to 90% ofwater losses are physical losses attributable to the water network, whichconsists of 50,000 km of pipe--80% of which is asbestos cement. Problems arethreefold. First, the quality of the pipes and rings is poor. Second, civilworks were not carried out according to acceptable standards (e.g., sand bedsaround pipes are sometimes lacking or improperly sized). Third, many pipesare beyond their useful life, which is 25 to 30 years even for good qualityasbestos cement pipes.

1.18 Investment Plannina and Execution. Up until now, water supplyinvestments have been centrally planned, financed, and executed by the MRD.Sewerage investments have been planned by the MOE and financed with budgettransfers to municipalities. Investment costs were not recovered fromconsumers. This centralized decision-making process together with the lack ofmarket-based criteria to guide investment selection or competition amongalternative uses of capital led to significant allocative inefficiencies.Institutionally-fragmented investment planning (e.g., MRD for water, NOE andmunicipalities for sewage treatment) and budget finance also led to a supply-driven approach. Proposed investments were not always viewed from theperspective of an integrated network, nor were tiiey planned from theinstitutional standpoint of the water companies that would operate andmaintain them. This often resulted in overdesign of facilities, designinconsistencies and inefficient processes, including high energy costs.Dependence on annual budget allocations led to long and uncertain constructionperiods and cost escalation. The NRD estimates that there is a backlog ofuncompleted works valued at US$432 million. If cost minimization/efficiencyobjectives are to be achieved in the future through improved accountability,investment planning should increasingly be carried out by the RWCs themselves,since they will also be responsible for operating and maintaining facilitiesand recovering the costs through tariffs. Given their lack of experience withinvestment planning and management, technical assistance and intensive stafftraining is needed.

1.19 Priority issues facing the RWCs that were factored into projectdesign are:

lack of local ownership of RWCs which reduces accountability tocustomers and dilutes incentives for commercialization andefficiency;

41 Nosi-wvca WatuI(VdUm. pO&W - VO_= SoMVm PWduo"dj1OO

-7-

e operating efficiency and cost recovery remain low with waterlosses estimated at 40% and tariffs barely covering operatingcosts;

staff lack access to training in modern system operation andmaintenance practices, management information systems, accounting,or tariff settinqg-

* companies lack access to capital needed to complete unfinishedwater and sewerage investments, and upgrade. and rehabilitateinefficient networks and facilities. Noreover, the sector lacksfinancial intermediaries capable of brokering resources to fundinvestments; and

* water and sewerage companies lack experience in planning andimplementing their own investments.

II. SECTOR RESTRUCTURING STRATEGY

2*1 The Sector Restructuring Strategy, which the proposed Projectsupports, aims at improving the policy, institutional, and regulatoryframework for water supply and sewerage services over the next decade. Itsmain features are outlined below.

A. Further Restructuring of the Regional Water and Sewerage Companies

2.2 The restructuring strategy seeks to: (i) expand RWCs' autonomy bymodifying their existing corporate structure; (ii) decentralize and promoteaccountability to local authorities by inducting municipal shareholders to theRWCB; (iii) make RWCs financially autonomous with regard to operation andmaintenance, and eventually, investment costs; (iv) make it feasible tointroduce forms of private participation such as concessions, leases ormanagement contracts; and (v) establish transparent and rigorous investmentscreening procedures and effective institutional arrangements to channel fundsfor economically justified sector investments. To achieve these objectives,existing RWCs would first be transformed from Sole Proprietor Ltd. Companiesinto Limited Liability Companies (Ltd. Companies) with a broader shareholderbase. As Ltd. Companies, the RWCs will own and operate water systemspreviously managed by the State and have financial and managerial autonomyunder the 1991 Commercial Trade Act. This includes lnter alla the right tohire or shed staff based on locally competitive wage scales and conditions andthe right to contract-out services to the private sector through concessions,lease contracts or service contracts if shareholders perceive benefits fromsuch arrangements.

2.3 In time, the shares of each RWC would be owned by themunicipalities served in the region. During a transition period of about5 years, not less than 49% of shares would be owned by municipalities on thebasis of population and the rest by the State. During this period, theGovernment will continue to support investments and play a role in monitoringthe performance of company management while the capacity of local authorities

-8-

is strengthened and updated tariff-setting guidelines (para. 1.14) are tested.Once new shareholders' capacity is demonstrated and RWCs are able to coverdebt service and contribute to investment from tariff revenues, the State willgive up its shareholdings. The participation of municipalities asshareholders and the required recovery of investment costs through tariffs arenew institutional and commercial concepts. The MRD will need to exercise firmpolicy guidance to ensure implementation.

2.4 Restructuring RWCs is the main policy objective of the Project.The main stages of development for RWCs are cgrnoratization by transformingwater companies from Sole ProprietorshUps-into Limited Liability Companies;decentralization by inducting municipal shareholders; and commercialization byimproving cost recovery. These measures together will facilitate eventualprivate sector participation in the sector. Draft Articles of Association forthe restructured water companies (with municipalities as shareholders) and thelegal procedures for restructuring are in the Project File. To ensure promptrestructuring of RWCs, agreement was reached at negotiations at negotiationsthat MRD will (i) invite by September 30, 1994 all the relevant municipalitiesto become shareholders of the RWCB, and (ii) complete by March 31, 1995 theregistration of the RWCs servicing municipalities that agree to becomeshareholders as Limited Liability Companies (para. 7.1 (a)). It was alsoagreed that at least four RWCs should be legally registered as LimitedLiability Companies as a condition of effectiveness (para. 7.2.(a)).

B. Privatizing State Engineerint and Construction Enterorises

2.5 The MRD is committed to privatizing the companies resulting fromthe break-up of Vodokanal Engineering and Hydrostroy. To ready them for thiseventuality, both Vodokanal Engineering and Hydrostroy companies will competeas State-owned commercial enterprises without government subsidies againsttheir divested enterprises and against domestic and international privatefirms for the works and services to be financed under the Project. As demardfor their services is stimulated, joint ventures or privatizationopportunities for Vodokanal Engineering and Hydrostroy with local and/orforeign investors are expected to materialize. Without the sector changes anddemand for services promoted by the Project, private investment in thesecompanies is unlikely.

C. Imlementing a new Regulatory Framework and Tariff Policies

2.6 The role of the MRD is to: (i) ensure a smooth transition todecentralized control over water services; Iii) set and enforce policies forstate support to investments in water supply and sewerage; and (iii) collectand publish information-on service levels and water company efficiency thatwill give consumers a "yardstick" against which to compare relativeperformance. Moreover, during the transition period when the State retains51% ownership of RWCU, the MRD will provide guidelines approved by the Councilof Ministers for tariff-setting. MRD as the State's representativeshareholder in the RWCs, will also play a direct role in tariff-setting andmanagement oversight. After the transition Is completed and State ownershipis fully devolved to local authorities, the MRD will have no direct controlover management or tariff-setting, which local governments will assume as

-9-

owners of the companies. The MRD will continue to publish performanceindicators to ensure transparency of RWCs operations and finances as well aspublic awareness.

2.7 Rwes, and municipal water companies participating in the Project,will be required to set tariffs at levels that allow for effective operations,maintenance, renewals, and debt service as provided for in the updated tariff-setting guidelines to be adopted under the project (Annex 2). Raising waterprices over time is expected to result in lower consumption and a general.shift from supply- to demand-oriented management. The collection andpublication of the companies' performance indicators will help to monitor that.tariff levels are justified and that the companies pursue cost minimization.

2.8 Drinking water standards will continue to be set and enforced bythe Ministry of Health while ambient water quality will continue to bemonitored/controlled by the MOE.

D. ImgrovinQ Water Resources Management

2.9 The Government is committed to improve water resources management.major objectives are to clarify institutional responsibilities and integratemanagement of water quality and quantity at the river basin level. Atpresent, functions are divided between the MOE, the National council on Waterand other institutions (para. 1.5). To achieve the objectives, the Governmentwill carry out a study to identify options and recommended actions. The studywhich would be carried out by a team of Bulgarian experts with foreignassistance as needed is part of the Project (para. 4.7). Also, the draftwater law (para. 1.5) and the GEF-financed Danube River Program, which ispreparing pre-investment studies for three Bulgarian tributaries, areattempting a river basin approach to water resources management.

2.10 The Government is also committed to develop new and more effectivemechanisms for water pollution control and abatement. The NOE has alreadycollected baseline data on industrial effluent and pre-treatment for all majordischarge sources. It is upgrading its pollution monitoring capability withassistance from EC PHARE and strengthening the enforcement capabilities of itsRegional Environmental Inspectorates. These measures will complement theProject by ensuring that industrial effluent is properly pre-treated beforedischarge into municipal facilities. More work is needed to ensure that newambient and effluent standards proposed by the MOE are phased in such a way asto meet European Community standards over time with due regard toaffordability. As recommended by the Environment Strategy (Report No. 10142)prepared last year with the World Bank, U.S. EPA and AID, a system of taxesfor wastewater discharges is under preparation. Revenues generated by thetaxes would be used to finance urgent pollution abatement investments.

E. Sector En;asament Criteria

2.11 A long-term strategy has been agreed along with an initial set ofmeasures to be supported by the Project. The emphases of these initialmeasures are in restructuring and strengthening water companies. Further Bank

- 10 -

involvement in the sector will depend on progress in implementing the agreedshort-term measures and adopting solutions which begin to address longer-termstrategic objectives.

2.12 In order to gauge progress in implementing the restructuringstrategy, a series of objective Sector Engagement Criteria have been -

identified. These criteria will form the basis of our evolving sectordialogue and give signals as to whether the Bank should remain activelyengaged in the sector. Sustained and measurable progress together with strongProject implementation performance are expected to justify further Banksupport to the-sector using simplified documentation, to the extent possibleThe Government also plans to seek finance from other donors to increase sectorinvestments along the lines of the Project at an appropriate stage.

2.13 The Sector Engagement Criteria which will be monitored by the Bankduring supervision are as follows:

(i) restructuring RWCs as Ltd. Companies with municipal shareholders;

(ii) establishing effective institutional arrangements and proceduresfor screening potential sector investments based on objectivecriteria, channelling resources to those that qualify, andensuring water companies repay sub-loans;

(iii) maintaining the reduced role of MRD in water company operations,strengthening MRD's role in collecting and publishing sectorperformance indicators, and encouraging municipalities toeffectively oversee water companies' operations;

(iv) establishing cost recovery and on-lending policies that causetariffs to reflect the full cost of services;

(v) privatizing State engineering and construction enterprises servingthe water supply and sanitation sector;

(vi) adopting and implementing institutional arrangements for waterresources management that integrate quantitative and qualitativecontrols at the river basin level; and

(vii) improving environmental protection through a mix of command-and-control and market-based incentive measures.

III. RATIONALE FOR BANK INVOLVEMENT

3.1 The Bank's country assistance strategy (CAS) for Bulgaria,discussed by the Board on March 9, 1993, aims at supporting the Government'sstructural adjustment and macroeconomic stabilization, as well as providinginvestment financing aimed, inter-alla, at assuring adequate infrastructurefor economic growth. Improving the environment is also an important objectiveof the CAS. The proposed Project directly contributes to achieve theobjectives of the CAS by providing a vehicle through which to pursue a broaddialogue and establish the basis for future support to the sector, either

directly to water and sewerage companies or, preferably, via the financialsector once financial reforms are completed. Bank involvement can encouragethe adoption of a coherent strategic framework for the sector based onprinciples of commercial viability, demand orientation, and sustainability.In the absence of Bank involvement, it is unlikely that the country would beable-to mobilize the technical, assistance and financial resources needed tosimultaneously restructure the sector and finance priority infrastructure.The Bankws procurement guidelines will introduce competitive bidding as ameans of stimulating supplier efficiency and t-ansition to-a market economyfor the sector. As the first water sector operation for-an economy intransition, it will provide important-design lessons and implementationexperience for projects elsewhere. Finally, the Projeot meets the 3anke-program objective category of environmentally sustainable development.

IV. THElQO

A. Obiectives

4.1 The project objectives are to assist the Government to:

* increase the corporate autonomy and commercial orientation of RWCsand make their management accountable to local authorities;

* improve health and environmental conditions in urban areas andconserve water resources;

* increase RWCs' operating efficiency and cost recovery; and

* demonstrate the feasibility and benefits of introducingtransparent procurement procedures, efficient contract management,and competition for supply of goods, works, and services.

B. Proiect Components

4.2 The proposed Project, to be implemented from 1994-2001 comprisestwo main components: (i) Institutional Strengthening Window; and (ii)Priority Water and Sewerage Investments Window.

Institutlonal StrenSthening Window

4.3 This component accounts for 7% of Baseline Costs, and will fundconsulting services, acquisition of equipment, and materials for: (I) RWCcapacity building through in-country training and provision of technicalassistance; (ii) carrying a Water Resources Management study; (iii) projectimplementation; and (Lv) enhancing RWCs investment planning capabilities andconstruction supervision.

RWC Capacity Buildina

4.4 In-country training (US$0.5 million) will be provided in highpriority subjects to about 100 representatives of shareholders, managers, and

- 12 -

staff of the water and sewerage companies. Courses will be focussed andshort. The aim is to develop capacity in core areas considered essential forcommercialization. Core training will include 4 modules:

* General Management: Shareholder Responsibilitiesa ManagementStrategy, Planning, and Control; Personnell Public RelationalCommunication, Management Styles and Delegation; and-PrivateSector Participation.

* Financial Managements Financial Accounting and Auditing;- CostAccounting; Tariff Settingt and Financial Planning -and Control.-

* operations and Maintenance: operational Efficiency; Maintenance;Metering; Control of Losses; Billing; and Customer Relations.

* Investment Planning: Sub-project Preparation, Procurement,Disbursement and Supervision Procedures; Investment FeasibilityStudies; Environmental Impact Assessment; and InvestmentAppraisal.

4.5 To complement the core training, a technical assistance program(US$1.0 million) will be established on a matching grant basis to satisfyindividual water companies' demands for more tailored technical assistance.Assistance will be targeted to water companies and other entitiese5 whoseproposals meet the following objectives:

* to increase water companies, operating efficiency and costrecovery;

* to improve environmental and water resources management; and

* to improve the health of the population by improving the qualityof drinking water.

4.6 The maximum allocation from the loan proceeds for any onetechnical assistance on a matching grant basis will initially be US$100,000and would require a minimum 30% matching contribution by the beneficiary.Individual interventions of larger size may be allowed with the approval ofthe MRD and the Bank. Both the maximum grant and the cost-sharing floor maybe adjusted after the first year based on experience. Depending on theaverage size of activity, it is estimated that about 30 technical assistanceactivities can be financed with the proposed allocation. If the technicalassistance program is achieving its objectives as expected, additional projectfunds may be reallocated to it with the agreement of the Bank and the NRD.Activities that potentially benefit =cre than one company or have higher costsharing will have preference.

wfetmrta WA viOk* or rqIsbinUe doi4 above elmu of onern.m Fow afnpk. epMamlhicmlg k sm WuIShe whm adwim heal

Wfec wea suemVed fran eVow. to coomimniniu driking waie omM bcared =nW I, lbyd Nail.. Centw d1 hygIen mi Mefdim E.ohg.

- 13 -

Water Resources Management Studs

4.7 The purpose of this study (US$0.5 million) is to design improvedinstitutional arrangements for managing water resources. Terms of reference,and the arrangements and timetable for implementation were agreed atnegotiations (para. 4.29).

Prolject ImlmnainAssistance

4.8 A Project Management Unit (PMU) has been established-to assist theGovernment in supervising the project and to assist water and seweragecompanies in accessing the loan resources (pakas._ 4.24 and 4.25). The loanitself will finance the local consultants/staff of the PMU along withnecessary equipment and materials (US$1.0 million). The budget for the PMU isincluded in Annex 4.

4.9 In addition, the loan will finance international and localconsultants (Project Implementation Assistance Consultant -- US$1.5 million)that the PMU will need to appraise sub-projects and capacity-building grantrequests submitted by water and sewerage companies. When requested by waterand sewerage companies, the Project Implementation Assistance Consultant willalso prepare bidding documents and/or Terms of Reference. The ProjectImplementation Assistance Consultant will also prepare a diagnostic study andstrategy for the reduction of Non-revenue Water on the basis of fieldinvestigations in pilot areas and assist the PMU in appraising requests bywater and sewerage companies for funds from the Non-revenue Water Window(para. 4.13). The consultant will prepare guidelines to assist water andsewerage companies to design their own action plans for controlling physicaland commercial water losses, define a plan for improved operation andmaintenance and pipe replacement for the pilot areas, and prepare biddingdocuments for procurement of production and distribution meters.

Enhancing Investment Planning and Construction Supervision

4.10 The Project includes funds (US$3.0 million) to be on-lent (para.4.18) to RWCs to enhance investment planning capabilities and constructionsupervision.

Priority Water and Sewerage Investments Window

4.11 The investment window would have two components: ProjectCompletion/Rehabilitation Window (para. 4.12) and Non-revenue Water ReductionWindow (para. 4.13). Approved sub-projects should contribute to one or moreof the following sector priorities:

* reduce water losses,

* increase water and sewerage companies operational efficiency andcost recovery potential;

* provide water supply in areas of acute shortage;

* improve drinking water quality where health is threatened;

- 14 -

* ensure sewage collection where an existing wastewater treatmentplant is underutilised; and

* reduce pollution in sensitive water courses, where upstreampollution prevents downstream use of natural resources such as

- --- drinking water; or results in irreversible environmental damage(i.e., biodiversity, beaches).

PFoiect ComDletionuRehabilitatjon window

4?12 The Project gives priority to completion of ongoing investmentes,elimination of system bottlenecks, and rehabilitation and upgrading offacilities. US$68 million of project funds have thus been allocated to aProject Completion/Rehabilitation Window for water and sewerage sub-projectsthat are deemed eligible based on agreed criteria (para. 4.23). Many neededinvestments were initiated by the Government in earlier years, butconstruction was halted due to lack of funds. There are also cases of systemswhere bottlenecks have arisen due to design and construction imbalances. Forexample, there are instances where sufficient water supply has been developed,but treatment plant capacity lags; hence the efficiency of the system is poor.Deferred maintenance and rehabilitation of existing facilities have resultedin systems operating below design standards. Eligible sub-projects shouldhave an estimated economic rate of return not lower than 12% (PMU Manual ofProcedures (para. 4.25)).

Non-revenue Water Reduction 1indow

4.13 - The Non-revenue Water Reduction Window (US$30 million) willrespond to the emerging incentives for water and sewerage companies-to reducewater losses and to improve their operating efficiency. The objective duringthe project implementation period is to reduce water losses from about 40% to25%. This is an ambitious target. Success requires a commercial orientationand new managerial approaches by water and sewerage companies that encourageadequate operation and maintenance, including network upgrading andreplacement and using high quality materials and civil works. Studies andtraining included under the Institutional Strengthening Component will supportthis objective. Investment resources provided through this Window willfinance:

* installation of accurate production meters6/ satisfying about 50%of the country's total requirements; and

* purchase and installation of equipment needed to improvecommercialization, system operations and maintenance, andreplacement of pipes and accessories.

6 It b mitat twi t 1of0 waiaeu at.S rN_ tge pmi 1,rbkm down u folhw. _wa _uin (10.0t. OmOv, (S.0C9,'OterN pla (4. PgpI SW- 260. mdpd eou (1,000.

- 15 -

C. Prolect Costs and Financlnf

4.14 The total cost of the Project is'estimated at US$131.0 millionincluding physical and price contingencies and 80% of interest and othercharges on the Loan (para. 4.15), net of taxes. This figure excludes the sunkcosts-of investments initiated and funded by the Government (aboutUS$75 million) which would be completed under the project. Table 1 providesProject Cost Estimates, including the estimated breakdown of local (US$65.2million) and foreign costs (US$65.8 million). The'relative size of thedifferent investment windows is notional and reflects the overall investmentpriorities, The Base Coate of the Pro$ect are-US$105.5 million,expressed in April 1994 prices. Physical contingencies-are about 10% ofbaseline cost. Price contingencies were estimated on the basis of expectedannual inflation rates (ODP deflators) from 1994 to 2001.7/

Table 1: Prolect Cost Estimates(US$ million)

Local Foreion Total… -------US$ Million--------

Institutional StrengtheningyCapacity Building 0.3 1.2 1.5Water Resources Management 0.1 0.4 0.5PMU and Project Implementation

Assistance 0.5 2.0 2.5Investment Planning and

Construction Supervision 0.6 2.4 3.0Subtotal 1.5 6.0 7.5

Water and Sewerage InvestmentsProject Completion/RehabilitationWindow 37.4 30.6 68.0

Non-revenue Water Reduction Window 16.5 13.5 3Q.0Subtotal 53.9 44.1 98.0

Total Baseline Costs 55.4 50.1 105.5

Physical Contingencies 4.7 5.6 10.3Price Contingencies 5.1 4.5 9.6Interest During Construction 55.6

Total 65.2 65.8 131.0

I/ Ariex 9 includes a more detalLed breakdom of expenditures wider this caianent.

71 1. amumed Maioe ste. .rm *do.e 40% fwr 194. 30% for 199, 20% fwr 1990 10% for 199 .. I 6% forto UMflg faw yulm ftdforIn 1.2X for 1994.2.41 for 199, S.2X for 19963.4X fo 199.3.2% fo 1998.3.3% fo 199. S.4% io 200 ui 3.3% for 201. JIbebor mumnd tbat tlhe a_cing will be puiodio 4ilal Xa t oas d;ffom.bleno r frign inflaian

- 16 -

4.15 The financing plan (Table 2) includes the proceeds of the Bankloan, the Government's contribution and internal cash generated by water andsewerage companies. The Bank loan of US$98 million will finance-about 75% ofproject costs including 80% interest and other charges on the Bank loan. Thelatter up to US$5.6 million. The interest and other charges to be financed bythe loan correspond to part of the loan to be on-lent by the Government towater and sewerage companies. The financing of interest and other charges onpart of-the Loan to be on-lent is justified because the RWCs are only nowbeing established and their cash flow is still limited in relation to theirinvestment needs. The Bank loan will be repaid by the Government over 17years including 4 years of-grace with repayments calculated on an annuitybasis at the BankCs- standard variable rate of interest. The local cou-nterpartfinancing of US$33.0 million will be provided by the Government (US$11.4million) and by water and sewerage companies (US$21.6 million). Proposed costsharing principles have been designed: (i) to minimise the impact on the Statebudget during the adjustment process; (ii) recognize the value of theGovernment's prior contribution to uncompleted investments8 and the positiveexternalities for some types of investments that have beneficial health orenvironmental effects; and (iii) to ensure that each contract is financed byno more than two sources of funds, the Bank loan and local funds -- eitherfrom water and sewerage companies or the Government budget depending onwhether they are water supply-related (i.e., Bank/water and seweragecompanies) or sewerage (i.e., Bank/Government). Minimizing the number offinancing sources will facilitate implementation.

Table 2: Proiect Fiancini Plan(US$ million)

World WaterBank Govt. Companies Total

AMT. % AMT. .AMT AMT

Institutional Strengthening 7.5 100 7.5 100Project Completion/Rehabilitation 47.5 70 10.2 15 10.3 15 68.0 100

Non-revenue Water Reduction 21.0 70 9.0 30 30.0 100Interest During Construction 5.6 100 5.6 100Unallocated 16.4 _ _ 1.2 _6 2.3 12 19.9 100

Total 98.0 74.8 11.4 8.7 21.6 16.5 131.0 100

4.16 In line with these principles, water supply investments from theProject Completion/Rehabilitation Window and the Non-revenue Water Window willbe financed by the Bank loan (70%) and water and sewerage companies (30%).Sewerage investments will be financed by the Bank loan (70%) and theGovernment budget (30%). For the Institutional Strengthening component, theBank loan will finance 100% of foreign expenditures and 90% of items procured

f Aw at 9f&cwoktobeflauadwr UM CrWdw an mm am X0% coiple*d. a cmesadve estima of &*v fA p odWworsioUS$75iHUs srh p

- 17 -

locally; however, water and sewerage companies will share expenses by coveringthe cost of staff travel and subsistence for training and making at least a30% contribution to each technical assistance activity. These contributionsare not included in the cost tables.

4.17 -The-Project Financing Plan broken down by -local and foreign costsis presente-d in Table 3 below.

Table 3: Proiect Logal and Foreign Cost and SouKcS of Financing. - ... . - . (US$ uillon) - -............ ..

Local Foreian Total

World Bank 32.2 65.8 98.0Government 11.4 0.0 11.4Water and Sewerage Companies 21.6 .0.0 21.6

Total 65.2 6

D. Cost RecovenrvOn-lend1ng Policy

4.18 The proceeds of the loan allocated to the ProjectCompletion/Rehabilitation and Non-revenue Water Reduction Windows (US$47.5million and US$21.0 million respectively) will be on-lent by the Government towater and sewerage companies which meet the eligibility criteria under theProject (para. 4.23). The proceeds allocated to investment planning andconstruction supervision (US$3 million) will also be on-lent. The proceeds ofthe loan allocated to Capacity Building Program, the Water ResourcesManagement study and project implementation assistance (US$4.5 million) willbe provided by the Government to the sector on a grant basis to encourage andfacilitate the water and sewerage companies restructuring and the efficiencyimprovements. US$5.6 million of the loan will finance interest duringconstruction (para. 4.1S). The remaining US$16.4 million remain unallocated.

4.19 In designing the on-lending terms and conditions for sub-loans towater and sewerage companies, the GOB has adhered to the following criteria:

(i) the interest rate on sub-loans should take into accountfinancial market conditions so as to provide incentives forefficient resource allocation;

(ii) the repayment period of sub-loans should result in a cashflow which allows the Government to service the Bank loanwith the payments received from the water and seweragecompanies, so as not to create new budgetary demands; and

- 18 -

(iii) the tariffs required for water and sewerage companies toservice their debts should be affordable by the consumers toensure sustainability of the restructuring process.

4.20 In line with these criteria, sub-loans will be denominated in levaat a variable interest rate.; The rate will be the Basic Rate (Central B^nkRediscount Rate) plus a premium to compensate for the credit and the foreignexchange risks which will be assumed by the Government. The interest ratewill be adjusted periodically to reflect changes in the Basic Rate at the timeof the adjustment. It in proposed that the sub-loans will be long-term,

-initially 13 years, including a 3-year grace period for the repayment of bothprincipal and interest. With the agreement of the Bank, the terms may beadjusted for new sub-loans during the project execution period in response tochanging conditions in the financial markets, and to ensure that the recoveryof sub-loans provides the Government with sufficient funds to repay the Bankloan. The terms and conditions of sub-loans (Annex 5) were agreed atnegotiations (para. 7.'(b)).

E. Water and Sewerage Companies' Tariffs

4.21 As part of the sector restructuring program, the GOB is updatingthe guidelines for tariff setting by RWCs. The revised tariff guidelines(Annex 2) will apply to all RWCs, regardless of whether or not they arereceiving sub-loans under the Project. The updated guidelines are easy forthe water and sewerage companies to apply and the NRD to administer andmonitor. The main improvements vis-a-vis the old guidelines (para. 1.14) arethat RWCs will:

* make adequate provision for financing infrastructuremaintenance and renewals, system expansion, and debt service;

* make specific provisions for working capital needs;

* implement quarterly tariff adjustments to compensate forinflation; and

* be encouraged to introduce rising block tariffs as a substitutefor the existing preferential tariff for households versusindustry.

4.22 In order to provide for adequate operation and maintenanceexpenditures, the level of tariffs is expected to rise in all water andsewerage companies, not only those with sub-loans approved under the project.The anticipated level of tariffs has been estimated for companies included inthe Initial Investment Program (IIP -- para. 4.30). For the six companies inthe IIP, the tariff increases in real terms that would be required toadequately cover operation and maintenance range from 30 to 50%, over a fouryear period. An additional 5 to 10% increase would be required at the end ofthe grace period to cover debt service on the sub-loans. Forecasted cash flowstatements are in the Project File. The tariff-setting guidelines enablewater and sewerage companies to phase-in these expected adjustments based onactual costs, and improvements in systems operation and maintenance during thesub-project execution period. This gradual approach to tariff increases

_ 19 _

protects consumers from large price increases and thus improve its politicalviability and sustainability. Also, the operational improvement programs(para. 4.23) for each water company will include specific targets for improvedoperational and financial performance. At negotiations, agreement was reachedthat issuance of revised tariff guidelines taking into account the criteria inparas. 4.21 and 4.22 in a manner satisfactory to the Bank will be a conditionof effectiveness (para. 7.2 (b)). Additional details on the guidelines areprovided in Annex 2

P. Institutiogal Eligibi_itv Criteria for Sub-loans

4.23 RWCs that wish to qualify for sub-project finance must first berestructured as Limited Liability Companies with not less than 49% ownershipby the municipalities in their service area and the rest by the State.Municipal companies without State participation will also be eligible uponsatisfying all other institutional eligibility criteria. These criteria(Annex 6) are that companies must be in compliance with the NRD's updatedguidelines for setting tariffs; submit quarterly performance indicators to theMERD and the PMU; prepare operational improvement programs and submit them tothe MRD and the PMU; and participate in the training program. Theseeligibility criteria were agreed upon at negotiations (para. 7.1(c)). At thattime it was also agreed that the Bank will make a prior review of the firstsix sub-projects to be financed by the Bank loan and any subsequent sub-project whose total cost is US$5.0 million or more (para. 7.1(d)). These sub-projects, as well as the first four loans and grants under the InstitutionalStrengthening Window (para. 4.28) are viewed as "demonstration sub-projects"which will provide design lessons and implementation experience for other sub-projects. The PMU will take specific actions to use the experience of thesesub-projects for transfer of experience to the beneficiaries of future sub-loans.

G. Project ImRlementation

4.24 Responsibilities. The Government as Borrower would be representedby the Ministry of Finance. The Project Executing Agency would be the MRD,which has established the PMU to assist in Project execution. The PMU hasbeen established within the National Center for Regional Development andHousing (NCRDH), a specialized institute under the MED. In addition tooverseeing the PMU, the MRD will issue the updated tariff guidelines approvedby the Council of Ministers; complete the restructuring of RWCs; and collectand publish the performance indicators to be submitted by the water andsewerage companies. The MRD will award and sign consultant contracts underthe Institutional Strengthening component and certify that the sub-projects inthe Annual Investment Program compiled by the PMU meet the eligibilitycriteria agreed by the Bank and Government. The MRD will engage anImplementation Assistance Consultant (para. 4.9), acceptable to the Bank underTerms of Reference also acceptable to the Bank, to assist in Project execution(para. 7.1 (e)). Draft Terms of Reference were agreed upon at negotiationsand are in the Project File. The consultant should be selected prior to loaneffectiveness (para. 7.2 (c)).

- 20 -

4.25 The PMU was established by the MR3 at the outset of projectpreparation and it has gained a great deal of experience that will serve itwell during implementation. The Organization Chart for the PNU is included inAnnex 7. The PNU will operate according to an agreed Manual of Procedures(Project File) that was agreed at negotiations (para. 7.1 (f)). At thattime, agreement was also reached on the staffing needs of the PNU0 and how theywill be met. The main responsibilities of the PM1U are to organize theselection process for consultants to be hired under the institutionalstrengthening component and supervise the consultants; assist water andsewerage companies in preparing sub-projectal appraise sub-projects andcompile an Annual Investment Program for submission to the MRD and World Bank;monitor sub-project implementationj and report to the MRD. and the World Bankon the status of implementation (Annex 8). Assurances were obtained atnegotiations that the organizational structure, staffing and functions ofNCRDH will at all times be such as to facilitate satisfactory Projectimplementation (para. 7.1 (g)).

4.26 In line with the restructuring objective of the Project, water andsewerage companies will have significantly enhanced responsibilities for sub-project implementation. Water and sewerage companies will prepare their owninvestment proposals including technical, economic, financial, legal andenvironmental studies required to demonstrate feasibility and submit them tothe PMU for review. They will also sign an on-lending agreement with the MRD;prepare and launch tenders for goods, works, and services; and negotiate andsign contracts with suppliers of goods, works and services after obtaining thenecessary no objections from the PMU and/or the Bank. Procurement will besimplified by the use of standard bidding document (para. 4.34). In addition,the Bank has already started to provide and will continue to provide trainingon procurement matters (para. 4.45).

4.27 In order to ensure high quality construction supervision and makeit possible to group sub-projects under a single supervision contract, thisservice will be available to the subject to the companies under centrallyarranged contracts managed by the PMU and paid for by the companies with sub-loans under the Project. To promote competition and the development of thelocal consulting engineering capacity, it is envisioned that about sixcontracts will be awarded as sub-projects are approved. The participatingwater and sewerage companies will be represented in the selection committeefor the supervision consultants and will sign the contract jointly with thePMU. Water and sewerage companies that do not wish to avail themselves ofthis service may procure construction supervision services at their ownexpense, subject to the review and approval of the P14U. Selection ofconsultants for the technical assistance program and the improvement ofinvestment planning and feasibility studies will be made jointly by watercompanies and PMU.

4.28 Institutional Strenothenino Window. The MRD through its PMU willbe responsible for implementing this component, which aims at strengtheningsector institutions. The RWCs training will be carried out by the P1W withthe help of consultants. The consultant will prepare the core trainingmodules and organize the training courses for water and sewerage companies.Selection of consultants for the technical assistance program and theimprovement of investment planning and feasibility studies will be madejointly by water companies and PMU. Contracts with consultants will be signed

- 21 -

by water companies, subject to PMU approval. Bank approval will be requiredfor the first two activities to be carried out under each the capacitybuilding program and the improvement of investment planning capabilities andconstruction supervision (para.7.1 (d)). Other activities will be reviewedex-post during supervision. -

4.29 For the Water Resources Management Stuiy (para. 4.7) to be carriedout under the institutional strengthening component, the PMV will beresponsible for managing the consultants under the overall guidance of theMRD. Other governmental entities may be involved to ensure adequate..stakeholders participatiot.-- These -inlude inter-alia -the National -Council onWater, the Ministries of Agriculture and Environment, and the Committee onEnergy. Terms of Reference for the study are included in the Project File.At negotiations, agreement was reached that the study will be carried out by ateam of Bulgarian experts with foreign assistance as needed. The consultantsshould be satisfactory to the Bank (para. i.1 (h)). The timetable forcontracting the study is included in Annex 9. Agreement was also reached thatwithin 30 days of completion of the study, the Government will furnish to theBank a copy of its findings and recommendations, and within six months of thecompletion of the study, the Government will furnish to the Bank its proposalto implement the study's recommendations or alternatives satisfactory to theBank (para. 7.1 (h)).

4.30 Initial Investment Program. In order to ensure that projectimplementation is accelerated, a large number (38) of potential sub-projectssubmitted by the MRD, MOE, and by water and sewerage companies were screenedby the PMU and consultants during project preparation on the basis oftechnical, economic, financial and institutional criteria.9 / Sub-projects forsix RWCs (Dobrich/Makedonka, Sliven, Pleven, Bourgas/Pomorie, Zlatna Panega,Stara Zagora/Kazanlak -- Annex 10), have been cleared to proceed to thedetailed feasibility stage. Sub-projects for these six RWCs will constitutethe Initial Investment Program, with a current estimated value of US$32million. The feasibility studies for three of them are being carried outunder a Japan Grant executed by the Government through the PMU.

R. Procurement

4.31 The project elements, their estimated costs, and the procurementarrangements are summarized in Table 4.

4.32 All goods and works to be financed from the Bank loan proceedswould be procured in accordance with the Bank's Guidelines for Procurement(May 1992), including amendments as of the loan signing date and using thecountry standard bidding documents for Bulgaria. Bulgarian manufacturerscompeting for the contracts for the supply of goods procured underinternational competitive bidding (ICB) procedures would receive a preferencein bid evaluation of 15% of the CIF price or the prevailing custom dutyapplicable to non-exempt importers, whichever is less, provided they can prove

2I- Sub-pojcts we r u _edu aMording Lo %ebhncl oe rlaichlui: () the beeft ofibe sub-paoject ine e imtin of RBOD mluedam forsweag or adddo volume of wa for ww suply; (ij ie consscyq of the sub-p wit othet eomon f thea to_ nd actuddand of the popuaton; (ii) tress for Impuko ncluding ahabfil of ddleddei dgus m uwcqibb or aeed a* nmoddico. Subrje metg telidc egIiOt wm Om subjted to finanl. cow=. sued cwlhmmlenblae Ioascctalec (a) Lh cap y of th wat copy to cowr sravice oa the Dank kb trug w XF, (b) do aom effeaiveneof thb wsi_nsmawue in tem of BOD5 reduct for sago at rddtl vaoum of wte for wae sqpgr. (a) _1ft by low icme b_m:ds (d)

- 22 -

to the satisfaction of GOD and the Bank that the manufacturing cost of suchgoods includes a value addeu in Bulgaria equal to at least 20% of ex-factorybid price of such gooda.

4.33 Goods and equipment to be financed from the Bank loan proceedswill consist of equipment for treatment plants, pumping-stations, sewero,pipes, water meters, vehicles, computer systems and office equipment. As faras practicable these will be sliced and packaged in such a manner that allpackages will be large enough to attract international competition and at thesame time will contain suitable "slices" to attract small manufacturers.Local suppliers especially water and sewer pipe manufacturers are expected tobid on most of this equipment and joint ventures arrangements between localand foreign manufactures are also expected. Goods and equipment packagesestimated to cost more than US$250,000 equivalent each will be procuredthrough ICS. Two drinking water treatment plants (Sliven and Zlatna Panega)would be procured through ICB on a turnkey-barsis with the "industrial model"of domestic preference applicable to domestic manufacturers and contractors,following a two-stage procedure. The sludge digester at Pleven would beprocured through LCB on a turn-key basis following a single-step biddingprocedure. International Shopping (IS) based on comparison of pricequotations obtained from at least three suppliers from three eligiblecountries will be used for contracts estimated to cost less than US$250,000with an aggregate limit of US$3.0 million. Local Shopping (LS) based oncomparison of price quotations obtained from at least three suppliers will beused for contracts estimated to cost leas than US$50,000 with an aggregatelimit of US$1.0 million.

- 23

TaAe 4: gr/ n wmt

P olect stement I& C oth,er ^ Cs

1. Works

1.1 Water Puwping 1.0 1.0(0.7) (0.7)

1.2 Water rsnks - 2.5 0.7 3.2(1.8) (O.S) (2.3)

1.3 Laying of Pipelines 1.0 1.0(0.7) (C.7)

t.4 Sewer yolks 3.0 1.2 4.2(2.1) (0.8) (2.9)

1.5 Instatlation of Meters 5.3 5.3(3.8) (3.8)

1.6 Remaining ProJects 10.M 6.4 17.1(?.6) (4.S) (12.1)

2. Turnkey Contracts

2.1 Drinking Vater 16.2 16.2Treatment Plants (11.6) (11.6)

2.2 Studge digester O.S 0.5(0.3) (0.3)

3. Goods3.1 Equipment 14.1 3.0!( 17.1

(10.1) (2.3) (12.4)3.2 PIpes & Pipeline 29.3 29.3

(21.0) (21.0)3.3 Meters 5.3 5.3

(3.8) (3.8)3.4 Remaining Projects 14.7 1.0!* MY.?

(10.5) (0.8) (11.3)4. TA Contracts & Training

4.1 Training & Capacity- 1.9 1.9BuildIng (1.9) (1.9)

4.2 water Resources Management 0.6 0.6(0.6) (0.6)

4.3 PHIU Operating Costs 1.3 1.3(1.3) (1.3)

4.4 PNU Inplep entation Assistance 1.9 1.9(1.9) (1.9)

4.5 Investment Ptanning &Construction Supervision 3.8 3.8

(3.8) (3.8)

5. Misceltaneous

5.1 Interest During Construction 5.6 5.6(5.6) (S.6)

Total 96.3 15.6 13.5 5.6 131.0

The Bank (68.8) (11.0) (12,6) £L;6 (2L9.

t/ International Shopping (USS3.0 million) and Local Shopping (US#1.0 million).N.A. Not Applicable

- 24 -

4.34 Procurement of civil works estimated to cost more thanUS$1,000,000 equivalent will be through ICa. For civil works of estimatedvalue between US$250,000 and US$1,000,000 that are not be of interest toforeign bidders, procuirement will be through local competitive bidding (LCB)procedures. For both ICU contract and-LCB contracts of value exceedingUS$250,000 the bidding documents drafted following the Bank's Sample BiddingDocuments for Small Works (SBDSW) with unit price option and price adjustmentprovision will be used. For woxks in remote areas or for some rehabilitationtype works estimated to cost less than US$250,000 equivalent, which would notbe of interest to foreign bidders, procurement will be through LCB proceduresusing the bidding documents drafted following SBDSW on fixed and lump-sumprice option, with payment only in local currency. However, to compensate forlocal inflation the bidders will be permitted to denominate their bid pricesin US dollar with provision for payments only in local currency at theexchange rates applicable on the dates of progress payments. For procuremertunder LCB for the Bank-financed portion of the civil works foreign bidderswould be allowed to participate. Al'. civil works contracts with constructionperiods exceeding eighteen months will be subject to price escalation.Typically, the construction period for small contracts valued below US$250,000would be less than eighteen months. Local contractors experienced in waterand sanitation works are numerous and they are expected to bid for smallcontracts under the Project.

4.3S All contracts awarded through ICB, contracts awarded through LCBvalued in excess of US$250,000 and contracts for technical assistance andconsultants services valued in excess of USS100,000 equivalent will be subjectto prior Bank review. This limit would result in prior review of over 95%percent of total procurement. All other contracts will be subject toselective ex-post review by the Bank. During negotiations, standard biddingdocuments for Bulgaria for ICB, LCB, Two-Stage Bid and Consultant Serviceswere agreed (para. 7.1 (i)).

4.36 Bulgaria is in the process of drafting procurement laws that willsupersede existing laws, regulations and procurement practices. Since theBulgarian law regulations and procedures are yet to be reviewed by the Bankto verify that they are acceptable for the procurement proposed under theProject, assurances have been obtained *rom the GoB that the procurement ofProject components to be financed from Bank loan proceeds will be strictly inaccordance with the requirements under the Bank's Procurement Guidelines andthe standard bidding documents for Bulgaria will be used for all LCB as wellas ICB procurement.

4.37 Consultant contracts will be awarded following the Guidelines forthe Use of Consultants by World Bank Borrowers and by the World Dank asExecuting Agency. Consulting contracts, with the exception of theImplementation Assistance Consultant, will be selected with price as one ofthe considerations (technical merits 80% and price 20%). The ImplementationAssistance consulting contract, was included as a third phase of the ongoingcontract for project preparation. At the Government's option, and with theBank's agreement, direct negotiations may be held with this consultant tocarry out phase three of the contract. If agreement cannot be reached, or ifthe Government prefers, the Implementation Assistance consultant would beselected based on competitive basis and in accordance with Bank's ConsultantGuidelines.

- 25 -

4.38 The consultant contracts listed in Annex 9 range from 30 to 90staff-months, with baseline costs of individual assignments ranging fromUS$0.5 million to US$1.5 million. Terms of Reference are in the Project File.It is expected to award about six construction supervision contracts averagingUS$350,000 each as sub-projects are approved.

4.39 In addition to the above consultancies, there will be someconsultants (individual and firms) hired by water and sewerage companiesreceiving matching grants under the Capacity-Building Program. Theseconsultants will also be hired in accordance with Bank procedures.

I. Disbursements

4.40 Loan proceeds will be disbursed over eight years with the closingdate of June 30, 2002. Table S provides the summary disbursement schedulewith quarterly estimates included in Annex 11. It was agreed that the finaldate for approval of sub-loan proposals will be December 31, 1999(para. 7.1 (j)).

Table 5. Estimated Loan Disbursements V

(US$ million)

Bank Fiscal Year 199 1996 1997 1998 1999 20_0 2001 20Annual 6.1_ 10.2 18.9 19.1 15.1 15.1 11.5 2.0Cumulative 6.1 16.3 35.2 54.3 69.4 84.5 96.0 98.0

I/ In line with the stawdard disbursement profile for the water sector loan for all regions.

y Includes deposit in the Special Account of USS4.0 million.

4.41 The Bank loan will finance 90 to 100% of eligible expenditures forconsultants, auditors, goods, equipment, and materials procured under theInstitutional Strengthening Window; 70* of investments under the ProjectCompletion/Rehabilitation Window with the balance provided by the State budget(i.e., sewerage) or water and sewerage companies (i.e., water supply); and 80%of interest and other charges accrued on the Bank loan until January 31, 2002up to US$5.6 million, which would be withdrawn by the Bank from the loanaccount. The remaining 20% of interest and other charges would be paid by theGovernment. Table 6 presents the allocation of loan proceeds by projectcomponent.

- 26 -

Tdb4- 6: Allocation of .Lan P_roac_es

Cateoorv An t of toan Expenditures(USS) to be Financed

1. Institutional Strengthening Window 7,500,000(a) Investment Ptanning' and

Construction Supervision 3,000,000- Consultant Services * . . .100.* Equipment ------------------------------------------------------ 100% of foreign expenditures;

t00X of locat expendituresSex-factory cost);

-- - - - -- 9n0 of. loca expenditure for otherItems procured locally.

(b) Capacity Building, Water ResourcesManagement and PHU and ProjectImlopemntation Assistance 4,500,000* Consultant and Auditing Services ---- 1----------------------------- t00X* Equipment -------------------------- 1------------------------------- 100X of foreign expenditures;

100t of local expenditures(ex-factory cost);

9O0 of tocal expenditures for otheritem procured locally.

11. Water and Sewerage Investments Window 47,500,000(a) Project Completfon/Rehabilftation Window

Civil works,installation, sadTurnkey contracts.70X

Goods, equipment and aterials 70 of foreign expenditures;70% of local expenditures

(ax-factory cost);70% of local expenditures for other

items procured locally.

(b) mon-Revenue Reduction Window 21,000.000Civil works,instaltation ....................................... 70XGoods, equipment, and nterisas --------------------------------------- 70% of foreign expenditures;

701 of local expenditures(ex-factory cost);

70% of local expenditures for otheritem procured locally.

Ill. Interest and Other Charges on the Loan 5,600,000accrued on or before January 31. 2002

IV. Unallocated 16.400.000

Total0

4.42 The Borrower will establish a Special Account in US dollars in abank acceptable to the World Bank and on terms and conditions alsosatisfactory to the World Bank. The authorized allocation to this accountwould be US$4 million equivalent, representing about 4 months of averageexpenditures under the loan. At the request of the Borrower and, based onproject needs, the World Bank would make an initial deposit or deposits into

- 27 -

the Special Account, up to the amount of the authorized allocation.Applications for replenishment of the Special Account would be submittedmonthly, or when one-third of the amount deposited has been withdrawn,whichever occurs earlier. DocumetltLtion requirements for replenishmentallocations would follow the same procedure as described in the above sectionon "Disbursements". In addition, monthly bank statements of the SpecialAccount which have been reconciled by the Borrower should accompany allreplenishment requests.

J. Accounts and Audits

4.43 On-lending agreements for sub-loans will require water andsewerage companies to submit to the PNU audited financial statements for eachfiscal year not later than June 30 of the following year. The P3W will reviewthe audit reports of water and sewerage companies and will take appropriateaction to ensure that the auditor's recommendations to improve water andsewerage companies' accounting and internal control systems are implemented.If water and sewerage companies are not in a position to supply adequatefinancial statements in the short-term, a compliance schedule will be workedout as a sub-loan condition. These audits may be financed from theInstitutional Strengthening Window as they will increase the transparency ofwater and sewerage companies operations and finances. The Bank will reviewthe audits on a sample basis to ensure that the PMU is satisfactorilyenforcing water and sewerage companies' compliance with audit requirements.

4.44 During negotiations assurances were provided that the SpecialAccount, Project Accounts, Statements of Expenditure and the pro-formaaccounts of the PNU will be audited at the end of each fiscal year byindependent auditors acceptable to the World Bank (para. 7.1 (k)). Auditswill be made available to the World Bank by June 30 each year.

K. Supervision

4.45 Intensive Bank supervision is needed because the Projectincludes significant policy and institutional content and investments arescattered. Much of the day-to-day supervision will be carried out by the PMU,but Bank-intensive supervision of the PMU will be required, particularly inthe early years. Field supervision will take place about three time each yearincluding an Annual Project Review mission. Supervision requirements are 30staffweeks in FY95, 30 in FY96 and 20 each FY97-FYOI making for a total of 180staffweeks. During the first year a Project Launch Workshop will also beorganized along with a training seminar in procurement, disbursement, andaccounts/audits. The estimated ratio of supervision costs (180 staffweeks) topreparation costs (about 170 staffweeks) is about 1 to 1. Supervisioneconomies will be sought by relying on the Bank Resident Mission for routineconsultations. Costs for follow-on projects should decline as the PMU andwater and sewerage companies gain experience in investment planning andimplementation and Bank procedures.

4.46 For each Annual Project Review, the PMU will furnish fordiscussion an Annual Investment Program based on agreed eligibility criteria.It will also prepare an Assessment of the previous year's implementation

- 28 -

experience for discussion with the Bank, MRD and participating water andsewerage companies during the first quarter of each calendar year. The AnnualProject Review will coincide with the Government's annual budget cycle toensure consistency between the proposed next year investment program andcounterpart fund availability. Each year, the P3U will also update projectcosts based on the unit prices derived from previous tenders. A Mid-termReview will also be held. This review is scheduled for June 1997, and inaddition to the matters to be covered in the annual review would provide foran in depth assessment of the progress achieved in meeting.the projectobjectives and of the issues faced during implementation, and should result inan agreement on further actions that may be required. The scope of-the Mid-term-and Annual Reviews wan agreed at negotiations, and is shown in Annex 12(para. 7.1 (1)).

4.47 During negotiations, it was agreed that the PNU will furnish tothe Bank quarterly progress reports within 20 days of the end of each quarter(para. 7.1 (m)). These reports should include a summary of implementationstatus, a proforma financial statement for the PMU and Special Account,progress report on restructuring water and sewerage companies, performanceindicators for water and sewerage companies, training courses provided duringthe period, new capacity-building grants approved, and update of progress onthe Water Resources Management Study. Included in these reports will also beprocurement information to be collected and recorded as follows: (a) contractaward information; (b) revised cost estimates for individual contracts and thetotal project, including best estimates of allowances for physical and pricecontingency, (c) revised timing of procurement actions, including advertising,bidding, contract award, and completion time for individual contracts, and(d) compliance with aggregate limits on specified methods of procurement.

L. Environmental Screening

4.48 The Project is classified in Environmental Screening Category OS",requiring sub-project environmental analyses, consistent with O.D. 4.01. Theproject is expected to generate significant environmental benefits in threemain areas: (i) reduced pressure on the environment resulting from reducedwater losses; (ii) direct positive impact on water quality for affectedrivers, groundwater and seawater resulting from improved sewage treatmentfacilities; and (iii) improved consistency between water supply, sewerage, andwastewater treatment in current and future project design.

4.49 Preliminary environmental analysis of sub-projects in the proposedZIP (in Project File) has been carried out to identify benefits, examinepotential negative impacts and propose mitigation measures where needed. Thereview of the preliminary environmental analysis points to the need fort(i) environmentally acceptable disposal of sludge from the wastewatertreatment plants (especially in view of the additional sludge to begenerated), and (ii) assessment and control of any detrimental effects of themarine outfall for the treated effluent from the wastewater treatment plant inPomorie. Satisfactory sludge disposal plans will be developed andincorporated into final wastewater treatment plant designs which will besuamitted to the Bank for approval before-tendering. An environmental impact

- 29 -

study for the Pomorie outfall will be carried out and reviewed and approved bythe MOE and the Bank before completion of the final design for the outfall.The results of the study will be submitted to the Bank for approval.

4.50 All environmental analyses for sub-projects will be evaluated bythe MOB in line with the Republic of Bulgaria's Environmental ImpactAssessment Regulation (No. 1 of December 28, 1992). The regulation along withMOE's evaluation process, mechanism and capacity were reviewed and foundsatisfactory by the sank. The enviro.Auental analyses and their evaluation bythe MOE will be submitted to the Bank for review and approval before sub-loanapproval by the Borrower (para. 7.1 (d)). The environmental analyses shouldbe consistent-with the requirements for Category "8B" Project..

4.51 Some sub-projects that could be eligible for funding under theProject would involve water of either rivers that flow through Bulgaria andone of its neighbors (i.e., Greece, Romania, Turkey or former Yugoslavia) ortributaries of such rivers. However, notification to other riparians will notbe required under the Bank's policy because the Project will only finance sub-projects that will involve the rehabilitation, upgrading and completion ofexisting water and sewerage systems, and will be complemented by water demandmanagement and loss reduction programs. Thus, the sub-projects will have noadverse effect on either the quantity or quality of present and future waterflows. To ensure that the proposed sub-projects satisfy these two conditions,assurances were provided at negotiations that all proposed sub-projects thatinvolve surface water from international waters will be submitted to the Bankfor prior review and approval (para. 7.1 (d)). After such review, the Bankwill only approve the financing of sub-projects which wills (i) have noadverse effect on the quantity of water flows to any other riparian countries,since they will have to involve no or only marginal increase in waterextraction and will incorporate measures to improve demand management and lossreduction; (ii) have no adverse effect on water quality as they will involve,where appropriate, completion and/or upgrading uf axisting wastewatertreatment plants which will help to improve the quality of downstream riverwater; and (iii) be of such nature as to not be subject to adverse effectsfrom the uses of water made by other riparians (para 7.1 (n)). In addition,since the Water Resources Management Study undertaken under the InstitutionalStrengthening Window of the Project involves international waterways,assurances were also obtained at negotiations that the terms of reference forthe study will include examination of any potential riparian issues (para. 7.1(d)).

4.52 No resettlement issues have been identified at present.Feasibility studies for sub-projects will include a review and identificationof potential population displacements. At negotiations agreement was reachedthat sub-borrowers will be required to comply with the resettlement guidelinesof the Bank and a satisfactory resettlement plan will be required for sub-project approval (para. 7.1(d)). Dam safety procedures were reviewed andfound satisfactory during preparation of the Bank's Energy Project (SAR ReportNo. 11240-BUL). No dam construction is envisaged in the Project.

- 30 -

V. PROJECT JUSTIFLCATION

5.1 The Project is justified by the Government's strong commitment torestructure and modernize the water sector-a process that began in 1991 priorto the World Bank's involvement. It will provide direct benefits forconsumers, macroeconomic benefits, and social and environmental benefits.

5.2 Direct Benefits for Consumers. All consumers can potentiallybenefit-from the efficiency gains generated by the restructuring process andthe Institutional Strengthening Component of the Project, which is open to all-water and sewerage companies. It is expected that the restructuring,technical asistLance, and investment will strengthen companies' managerialefficiency, financial viability, service quality, and capacity to pian andimplement investments. This should result in cost containment and affordabletariffs. Moreover, restructuring of water and sewerage companies and addingmunicipal shareholders will introduce the concept of managerial accountabilityto local consumers. The performance monitoring indicators (para. 4.23) to bereported by water and sewerage companies to the MMD will serve to provide tothe public compaxative information on efficiency. The benefits expected toaccrue to consumers in terms of improved efficiency can also be measuredthrough such indicators.

5.3 The infrastructure investments under the Project will result infurther direct benefits to consumers. The major benefits include upgradingwater services and improving the availability of water to consumers currentlyexperiencing drinking water shortages. This would be the result of both thecompletion of unfinished water supply investment (e.g., water treatmentplants, tanks) and the expected reductions in non-revenue water from 40% to25% during the Project period. For the three water supply investments thathave already been identified for the ZIP (i.e., Sliven, Zlatna Panega, andMakedonka) it is anticipated that they will together eliminate drinking waterdeficits for a population of 386,000. Rteductions in non-revenue water shouldreduce the need and cost associated with developing new water sources. rnaddition, improving sewage collection and treatment should help to reversedeteriorating water quality and prevent higher water treatment costsdownstream. Direct benefits to consumers and the rate of return oninvestments will be estimated for sub-projects as they are identified andfeasibility studies completed. The Manual of Procedures to be followed bythe PMU establishes that unless the Bank shall otherwise agree, eligiblesub-projects should have a rate of return not lower than 12%.

5.4 Macroeconomic Benefits. The Project supports the Government'smacroeconomic objective of redefining and making more effective the State'srole in the economy. It does this by: (i) shifting investment responsibilityfrom the State budget to water and sewerage companies, which will recovercosts through user charges; (ii) redefining State functions away fromoperating utilities to monitoring and regulating; and (iii) strengtheninglocal authorities, who will become responsible for provision of services.

5.5 The Project complements the Bank SAL-supported adjustment processby restoring finance for critically needed investments and stimulatingemployment and growth. The Government's 1994-96 investment program envisageswater and sanitation sector investments amounting to approximately US$55

- 31 -

million a year. The program, however is not realistic because of budgetaryconstraints and the lack of credit for sector operations. rn practice, theinvestments in the sector are likely to be determined by the availability of=external financing. Under these conditions, the project is expected toaccount for the bulk of sector investments at least for the initial years ofProject execution. Beyond that, water and sewerage companies and otherexternal-sources are expected to-increase their share. -

5.6 The Project will help to -improve public tavestment programminq byintroducing economic, financial, and technical criteria to guide investmentselection--an approach that might be adopted later by other sectors. Mostinvestments in the program have large aunk costs and high economic returns.which without the Project may not be realized given fiscal constraints and thefact that they are relatively small and scattered, hence not amenable toexternal financing.

5.7 Through procurement, the Project will support the Government'sobjectives of increasing competition. Stimulating the sector should facilitateprivatization of local suppliers of goods and services to the sector and/orestablishment of foreign joint ventures.

5.8 Social and _nviroSnmental Benefits. The social benefits includeimprovements in public health and employment gains. Improvements in publichealth would occur through reduction of drinking water contamination, althoughlack of reliable epidemiological studies makes it difficult to quantify suchbenefits. Based on the expected impact of the Project on GDP and averageimport intensity at present, the Project expenditures will generateapproximately 45,000 jobs during the disbursement period (1994-2001), or anaverage of 5,600 jobs per year. Employment generation will be higher if localsuppliers improve their competitiveness vis-a-vis foreign suppliers. moreover,investments proposed for the IIP are located in areas of the territorycharacterized by steep drops in industrial output exceeding 30%, unemploymentabove 14%, and below average per capita income.

5.9 The Project addresses an agreed priority of the 1992 BulgariaEnvironment Strategy which inter alla called for completion of priority waterand sewerage investments with positive health or environmental benefits, andfor water conservation measures. The three sewerage investment identified forthe ZIP (i.e., Kazanluk, Pomorie, Pleven) will facilitate secondary treatmentfor a population of 242,000 (Population Equivalent 800,000). The AnnualInvestment Program will include assessments of population to be benefitted bysewerage sub-projects in the investment program. Through the Core TrainingProgram, the Project will upgrade environmental management and awareness ofwater and sewerage companies' staff.

5.10 Affordability. All sub-investments analyzed for the IIPdemonstrate that they tn be financed with affordable tariffs. The share ofwater expenditures in average household income is estimated at les than 1I,while the maximum affordable level is estimated at 2.5%. Ensuring that lowincome households can afford enough water is also facilitated by encouragingwater and sewerage companies to adopt a rising block tariff structure if theywish. The first block of water consumed (e.g., up to 5 m3/household/month)would be sold at a lower price, while consumption above this level would becharged at a higher price. The two block tariffs ahould provide a balance

- 32 -

between the goal of affordability and the competing objectives of costrecovery and efficiency and reduce and/or eliminate the current differentialbetween industrial and household consumers.

VI. RISK ASSESSMENT

6.1 There are many political and macroeconomic risks that couldnegatively-affect Project execution which are not amenable to mitigatingmeasure. that can be built into the Project. Those mitigated through projectdesign itself include the following:

* political or macro-economic factors which may interfere with RWCs'commitment to raise tariffs sufficiently to improve systeuoperations and maintenance and repay the Bank loan. This isminimized by financing relatively small affordable investmentsscattered among a number of water and sewerage companies,incorporating a grace period for repayment of the sub-loans, andthe issuance of updated tariff-setting guidelines as a conditionof loan effectiveness;

* RWC restructuring could slow if the political commitment todecentralization diminishes. This is unlikely as all politicalparties are committed to this policy and will benefit frommunicipalities participation as RWC shareholders. In addition,restructuring of at least four RWCs will be accomplished beforeeffectiveness. The policy is reinforced by complementary Banktechnical assistance in Local Government Reform financed by theinstitutional Development Facility;

* project investment costs may be underestimated given the dynamicnature of price changes, previous lack of competition, anddifficulty of estimating completion costs. This is handled byproviding finance for contingencies, a flexible investmentprogram, and update of unit costs based on initial tenders;

* implementation may be negatively impacted by the inherentdifficulty of establishing a capable PM1. This has been handledby involving the PNU from the outset of project preparation,financing implementation assistance, providing for competitivestaff salaries and recruitment, and preparing a detailed Manual ofProcedures. This Manual codifies experience already gained inBulgaria and builds on the Bank's experience with successful urbanprojects in other Regions; and

* counterpart funds may constrain the project given adjustment-induced budgetary restraint. This risk is addressed by financing arelatively large percentage of each component, rangirig from 70 to100% and agreeing on an appropriately sized Annual InvestmentProgram.

- 33 -

* Furtheruor, the proposed nnual and Mld-term Review (paras. 4.46)t-t1l provide the Bank the opportunity to periodically reassess the

paogress achieved in meeting the project objectives, and todiscuss further measures that may become necessary.

- VII. AOIEMKDt1! REACHED AND RECONNKNIATION

7.1 At negotiations, agreement was reached on the following matters:

(a) the invitation by September 30, 1'994 to the municipalities tobecome s,barebolders of the RWCs and the registering of RWCS asLimited Liability Companies not later than March 31, 1995 (para.2.4);

(b) the term and conditions of sub-loans (para. 4.20);

(c) the institutional eligibility criteria for sub-loans (para. 4.23);

(d) the prior review and approval of sub-projects, InstitutionalStrengthening activities, environmental analyses, sub-projects andstudies involving surface waters, and resettlement plans (paras.4.23, 4.28, 4.50, 4.51, ard 4.52);

(e) the need to maintain Implementation Assistance Consultants and theTerms of Reference for the Consultants (para. 4.24);

(f) the Manual of Procedures to be followed by the PMU and itsstaffing needs (para. 4.25);

(g) the NCRDH organizational structure, staffing and functions(para. 4.25);

(h) the hiring of consultants, the Terms of Reference, for the WaterResource Management study and commitment to implement therecommendations of the study (para. 4.29);

(i) the standard bidding documents (para. 4.35);

(j) the final date for approval of sub-loans (para. 4.40);

(k) the audit procedures (para. 4.44);

(1) the scope of the Mid-term and Annual Reviews (para. 4.46);

(m) the reporting requirements (para. 4.47); and

(n) the criteria for Bank approval of sub-projects involvinginternational waterways (para. 4.51);

- 34 -

7.2 Agreement was also reached on the following conditions ofeffectiveness:

(a) qgintering at least four RWCS as Limited Liability companies,(para. 2.4);

(b) issuance of the revised tariff-setting guidelines (para. 4.22)1and

(C) selecting the Implea_ntation Assistance Consultant (para. 4.24).

7.3 *lon. The proposed Project constitutes a suitablo basisfor a Bank Loan to the Government of Bulgaria in the amount of WS$98 millionat the standard variable interest rate for a period of 17 years, including afour-year grace period, with repayments calculated on an annuity basis.

May 5, 1994

-35 -

. ~ ~ ~ ~ ~ ~ ~ ~ ~ ~ Pp.

13 Tffs of Rcuoall We ad SWevrw e Ceun

TartsemSofWaes

Wate Seer5 Tota Wutrnde_t

1. ......ard . .- ,:ti4P .n 3.10 0.12 6.10 0.26 0.40 0.93 0.8 00 3.50 0.13 7.40 0a

lovlch 4.00 0.15 6m 0.3 0.10 0.04 25 0.01 4.10 0.16 6.45 04*Dich 7.60 0.2 10.40 0.39 0.0 0.02 0O.5 0.3 1 0.1 10.90 0.41Slam Zas 1.10 0.07 4O 0.15 0.20 0.01 0.20 0.01 2.00 0.0 4M 0.16Dow$a 1.80 0.07 5.00 0.19 1.10 0.07 5.00 0.19liii.. 2.00 0.08 5.00 019 0.09 0.003 0.09 0.003 2.09 0.08 5.09 0.19

jB _goe~pad 1.80 0.07 SAO 0.19 0.40 0.02 0.40 0.02 2.20 0.01 5.40 0.20Trgvihi 4.00 0.15 6.70 0.25 4.00 0.15 6.7 OmVaum 4.00 0.15 6.20 0.23 0.40 0.02 1.50 0.06 4.40 0.17 7.70 0.29V. Tanve 3.40 0.13 4.50 0.17 o0o 0.02 0.65 0.02 3.90 0.15 5.15 0.19Vidin 3.50 0. 4.20 0.16 0.50 0.02 1.00 0.04 4.00 0.15 s5D 0.20Vau. 3.09 0.11 4.50 0.17 0.40 0.02 0.0 0.02 5.40 0M 5.00 0.19lebtaft 1.60 0.06 3s 0.13 0.30 001 0.50 0.02 1.90 0.07 4.D 0.15Kadim 2.50 0.09 4.00 0.S 0.35 0.0 0.35 0.01 QS8 0.11 435 0.16EWjAdUf 2.50 0.0a 5.70 0.14 0.30 0.01 0.50 0.93 Z2o 0l. 4.20 0.16u5man= 2.1 0.11 7.50 0.28 1.00 0.04 1.40 U.S 3.10 0.14 .90 0.54paFUr 2.40 0.09 4.90 0.1 0.12 0.005 0.0 0.01 2.52 Q1 51to 0.19Peals 1.30 0.05 3.57 0.14 0.25 0.01 1.14 0.04 1S 0.06 4.71 0.18PIN 2.00 0.0 330 0.12 0.20 0.01 0.20 0.01 2.20 0.0 5.50 0.13Rapid 4.0 0.15 7.50 O 05 0.02 0.50 00M 4.50 0.17 80 0.30Rous 1.75 O00 4.00 0.15 0.20 0.01 0.30 0.01 1.95 0.07 4Jo 0.16S1dm 4.50 0.17 9.00 034 0.2S 0.01 0.2S 0.01 4.75 0.18 9.25 OmSmell 3.00 0.11 6.40 0.24 0.20 0.01 0.20 0.01 3.20 0.12 6.0 0.2SSofia-Rg. 0.9S 0.04 1.63 0.06 0.25 0.01 0.37 0.01 1.20 0.05 2.00 0.Hake 2.90 0.11 5.78 0.22 0.10 0.004 0.20 0.01 3.00 0.1 5.9" 0.29b_ 35.25 0.12 3.15 0.19 0 0002 0.15 0.01 3.0 0.12 5.30 0.Ymbo1 2.50 0.09 5.60 0.14 0.20 0.01 0.20 0.01 2.70 0.10 3.10 0.14

1PWb 6.00 0.23 7.00 0.26 6.00 0.25 7.00 0.26Duzrgd 2.45 0.09 5.1o 0.22 0.05 0.002 .10 0.00 2.50 0.09 5.90 0.22

- 36 -Page 1 of 2

ngWMIA

Water Comuanies Reytructurina and Modernizatlon Protect

Tari££ Settina Guidelines for V^ter and Seweraae Oomnanies

o' clietives-

Tariff and other operating revenues should:

(a) recover the water and sewerage companies capital and current costs

(b) encourage customers to conserve water; and

(c) be affordable to customers.

Costs to be Financed from Tariffs and Other et R _nes

To meet the objectives of the Tariff Guidelines, tariffs and otheroperating revenues in any fiscal year should be sufficient to cover

(a) all expenses related to operations, including administration, andadequate maintenance (but excluding depreciation). Specificexpenses in this category include:

.MaterialsSalariesExternal servicesSocial InsuranceManagement CostOther current expenditures for good operation andmaintenance, including commercial costs

(b) debt service (repayment of principal + interest)

(c) taxes other than profit taxes

(d) dividends and taxes on profits, if any

(e) at least 30% of capital expenditures

(f) working capital needs (the difference between current assets andcurrent liabilities at the end of any fiscal year).

Tariffs and Other Oerating Revenues

Tariffs and other operating revenues includes the sum of revenues fromtariffs for water and sewerage services and customers deposits and customrscontributions for capital expenditures.

- 37 -Annex 2Page 2 of 2

Adjusting Tariffs and Other Charges

Water-companies should adjust their tariffs every quarter on January.March,-June and September to reflect the inflation, based on Bulgaria'sconsumer price index of the preceding calendar quarter.

Structure of Tariffs

Companies should consider a rising block tariff. This would mean thatcustomers could buy enough for their basic needs at a low price. Any morewater would be at a higher price. All customers, including industry, wouldhave the inexpensive first block and the more expensive second block. Forlarge industrial and commercial users, almost all of their consumption wouldbe at the higher rate.

A raising block tariff:

(a) ensures people can afford the water they need (through theinexpensive first block);

(b) allows companies to recover their costs (through the more expensiv@second block); and

(c) encourages customers to conserve water; people who uses a lot ofwater have to pay the higher price.

(d) Companies need to decide on the size of the first block, and theprice of each block. As a starting point should consider a firstblock of 5 m3 per household per month (or other connection).

(e) Companies should also implement separate tariffs for water andsewerage taking into account the costs of providing each service.

Responsibility for Setting Tariffs

The General Meeting of the water company is responsible for setting thelevel and structure of tariffs.

The company's manager is responsible for recommending the tariff leveland structure to the General Meeting with appropriate justification.

Reporting Tariffs

The tariffs should be notified to the MRD in the quarterly PerformanceIndicators Report.

BULGARI

Water Companles Restuctina and Moderiaton Prolt

Proiet Investnents by Yea(US$ millon)

t995M 1996 1997 1 199I 9 aQ!. m ToW

A. Institutional StrenatheninaTraining & Capacity Building 0.1 0.4 0.5 0.4 0.1 0.0 0.0 0.0 1.5Water Reswources Management 0.0 0.1 0.2 0.1 0.1 0.0 0.0 0.0 0.5PMU and ProJect ImplementationAssistance 0.1 0.4 0.5 0.4 0.3 0.3 03 0.2 2.5

Investment Planning and ConsructionSupeislon 0.1 0.4 0.6 0.5 0.5 0.4 0.2 0.3 3.0

Sub-total 0.3 1.3 1.8 1.4 1.0 0.7 0.5 0.5 7.5. 0

B. Water and Sewerace InvestmentsProct Comnpletion/Rehabilitation Window 0.6 4.6 11.0 13.6 12.2 11.0 9.5 5.5 68.0Non-Renue Reduction Window 0.3 2.1 4.8 6.0 5.4 4.8 4.2 2.4 30.0

Sub-total 0.9 6.7 15.8 19.6 17.6 15.8 13.7 7.9 98.0

Total Baseline Costs 1.2 8.0 17.6 21.0 18.6 16.5 t4.2 8.4 105.5

Physical Contingencies o.O 1.0 1.7 2.1 1.8 1.5 1.3 0.9 10.3Price Contingencies Q.O 0.2 0.7 1.4 1.8 2.0 2.2 1.3 9.6Interest During Construction 0.0 0.7 1.S 2.2 1.2 0.0 0.0 0.0 5.6

Total Prolect Cost 1.2 9.9 21.5 26.7 23.4 20.0 17.7 10.6 131.0

0 m04

BULGAI

WatrCm,ne Re _tmun & Mdrnzton oect

Opeatg Budge (1994-2001)MuS Thousands)

1stYear 2ndYe 3WdYa 4thYer SthYea 6th Yer 7th Year Sib Year Total1994 1995 1996 1997 1995 1999 2000 2001 1994-20O0

10/95-9194 10t94-9/95 lJ96 10196j9/97 10197-/8 19/99 1019/Q10 10100-9/01

Positon:Igheb" vel 3 11 11 11 10 7 4 4

S&wpot Leel 2 5 5 S S 4 3 2TOTAL 5 16 16 16 15 11 7 6

Salaries 30.0 114.5 115.6 116.1 111.5 14.5 57.0 38.9. 668.8Tning 13.7 3.0 3.0 3.0 0.0 0.0 0.0 0.0 22.7Operanl Trvd 5.4 5.S 5.6 5.7 5. 5.5 5.2 5.0 43.6commirnlcasIol 6.6 6.7 6.9 7.0 7.0 6.5 6.0 S.0 51.7TrSaSon SeaMi 2.2 2.2 2.3 2.3 2.2 2.0 1.5 1.0 15.6

Ntatle 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 1.7HospItalIty 0.2 0.2 0.2 0.2 0.2 0.2 0.2 0.2 1.7Oveoea (utd*boderNCRDH evIce) 30.0 30.0 30.0 30.0 15.0 15.0 1S.0 15.0 130.0Vddele Optg Ct 8.6 1.S 8.9 9.1 9.0 8.7 8.5 6.0 67.6Msa3mo nd Repalrs 0.3 0.3 0.3 0.3 0.3 0.3 0.3 0.3 2.5Cgtra euvilce 3.3 3.4 3.4 3.5 3.4 3.0 2.4 0.5. 22.9

1.8 1.$ 1.9 1.9 1.8 1.7 1.5 1.0 13A8ubta 102.3 176.7 178.4 190.2 156.3 127.7 97.9 73.0. 1092.3

Eu W and PFt rnu 10.0 00 0.0 0.0 0.0 0.0 0. 2

TOTAL II.4 166.7 178.4 IS0.2 156.3 127.7 97.9 73.0 IIISA

Not: (i) h fitar qopeg uet of $118,400 is beng fiad _tbd flt d apn nt 0 cminnt and th rmainin budet of SI mMino, uder loa(U Th adffg r th fint fo ye(1994-1997) will be compsd of t followig 11 BlgarIape Director, Head ofFn, of P m A,

accefu_5 two finanIal blst tO prourem exess two ntbast prjct meit tabif ng istce coonator; ad five rd t staff.Th folowing posto wm be bdised satg in the fift ye batinig asance coordiao (1998); fbL anablyt, proceme experstmv. ptro. expert and om < aerta (1999); fin anlyt. procamur e xt pewt mv. pro. expet ande sa ety C000); and onm ecrtaty (2001). X

0

- 40 -Annex 5Page 1 of 2

BULGARIA

Water Companies Restructurina and Modernization Proiect

Terms and Conditions for On-lendinc

1. The Government will on-lend the proceeds of the Bank loan to water andsewerage companies which meet the eligibility criteria under the Project. Theterms and conditions of the sub-loans should meet the following criteria:

(i) the real interest rate on the sub-loans should be positive in themedium- to long-term to take into account the financial marketconditions and to provide incentives for efficient resourceallocation;

(ii) the repayment period of the sub-loans should result in a cashflow which allows the Government to service the Bank loan withthe payments received from the water companies, so as not tocreate new budgetary demands; and

(iii) the tariffs requured for the water companies to service theirdebts should be affordable by the consumers.

Terms and Conditions

2. Unless the Bank shall otherwise agree the terms and conditions for thesub-loans are:

CurrencX: The sub-loans will be denominated in leva.

Interest Rate: The interest rate established at the time ofapproval of the sub-loan will be the Basic Rate(Central Bank Rediscount Rate) plus 6 percentagepoints.1 / The interest rate will be adjustedevery three months to reflect the Basic Rate atthat time.

Repayment Period: The repayment period for the sub-loans will be 13-years, including a 3-years grace period for therepayment of both principal and interest. Duringthe grace period, interest will be capitalizedevery six months.

This spread will be revised from time to time to ensure that the interestrates charged are in line with market conditions.

-41- Annex 5Page 2 of 2

Method of ReSa=ment: The sub-loans will be repaid to the Government onan annuity basis.

Adiustina the Terms and Conditions

3. These terms may be adjusted in the future for new sub-loans in responseto. changing conditions in the financial markets 4 and to ensure that therecovery of the sub-loans provides the Government with suffic-ent funds torepay to the World Bank the part of the loan which should be serviced by thewater companies. The terms will be discussed and agreed with the World Bank.

- 42 Ann-s*6

Page 1 of 3

,BUL$GAR

Water Companie Restructurina and Modernization Proiect

Institutional Eliaibility Criteria for On-Lending

1. Companies that wish to apply for sub-project loans under theproject must demonstrate their commitment to improving the efficiency-of-company management and operations. Satisfactory fulfillment of the followingcriteria would be required.-

Company Restructuring

2. A state water company must be restructured as a Limited LiabilityCompany with 51 percent of the shares owned by the State and not less than 49percent of shares owned by the municipalities served by the company.municipal companies, which have already been transformed into municipalcompanies without State participation, would also be eligible upon satisfyingall other criteria.

Performance Re22rtinc and Im_rovement Proaram

3. To qualify for a sub-loan, a company must be in compliance withthe MRD requirements for reporting performance indicators and with theprovisions of the Bulgarian Trade Act regarding capitalization, management andaccounting procedures. (MRD reporting requirements are outlined inAttachment 1.)

4. The company is required to prepare an improvement program withrealistic targets for each of the indicators along with a detailed descriptionof steps to be taken to improve operation and maintenance practices,commercial and financial performance. The company could make use of theproject's Capacity Building Program to carry out its improvement program. Thecompany's performance would be monitored by the implementation agency onbehalf of the MRD, and it would be expected to show satisfactory progress inachieving and maintaining the targets. Failure to perform could result insuspension of sub-loan disbursements.

Core Trainina

5. All water companies will be eligible to take advantage of the CoreTraining Program (Attachment 2) that will be offered under the project.Completion of the six courses that have been designated high-priority, by thecompany managers indicated, would be expected prior to approval of sub-loans.This requirement will be enforced flexibly, particularly if the relevantmanager has already demonstrated competence in the course matter or hasrecently completed equivalent training. Justifiable course substitutionswithin the Core Training Program will be permitted on a case-by-case basis.The companies participating in the first year investment program would beexpected to fulfill this requirement within a reasonable time after the CoreTraining Program begins to operate.

43- Annex6

Page 2 of 3

Rleoular Re irtina of Performance Indicators

1. In the context of the aector restructuring program, the role ofthe MRD will evolve. Its direct involvement in sector operations willdiminish, while its policy-making, monitoring, and regulatory roles will beenhanced. The iRD will publish comparative data on the companies' performanceas a way- of keeping the public informed about the -quality and cost- ofservices. As long as the State provides investment grants or guarantees loansfor water supply companies, the MRD will monitor the financial and operationalperformance of the companies in order to ensure the viability of the companiesand their ability to use resources effectively and repay the sub-loans.

2 To enable the Ministry to fulfill these roles, all water companieswill be required to report the following operational and financial indicatorsto the MRD. All indicators would be submitted on a quarterly basis, withintwo weeks after the end of the quarter. This is an initial indicative list.Additional and more complex indicators should be added, and the frequency ofreporting may be increased as the capacity of the companies to measure theirperformance increases.

Commercial indicatores

- total population in service area, percentage connected to watersupply, percentage connected to sewerage

- number of water subscribers, broken down by metered and non-metered

- number of sewerage connections

- total volume (mz3) of water billed per month, broken down bymetered and non-metered

- average volume of water billed per subscription per month

- collection ratio (total collections divided by total billings)

Overatina indicators:

- total volume (nm) of water produced each month, metered andestimated

non-revenue water percentage for each month (volume of waterproduced minus volume of water sold divided by volume of waterproduced)

44- Annex 6

Page 3 of 3

-- -water loses per km per day for each month (total produced mlnustotal sold divide by number of km of pipe divid by-number ofdays in each month)

- stff/connection ratio (number of Staff per 1000 water supplysubscribers-

Financal& indicgtors:

- unit prices for water and seworage supplied for each consumercategory (the tariff schedule)

- profit margin (total revenues minus total operating costs, beforedepreciation, divided by total revenues)

- costs per m3 (total operating costs divided by total volume ofwater sold)

- energy costs per m3 (total energy costs divided by total volum ofwater sold)

- labor costs per m= (total labor costs, including social securitytaxes, divided by total volume of water sold)

- cash flow (the forecast for the next quarter of total revenues andtotal expenses, including profit taxs if applicable)

- current ratio (current assets divided by creditors due within thenext year)

- debtor turnover (sales divided by debtors)

PROJECT MANAGEMENT UNITORGANIZATION CHART

| Director se +3

iged of Pr__aeat lRSad of FQwc |l Departent ------------- - - Depart…-et .d-watrator

(Dsputf blsector) (DepuAty Dir co"r)

Procurement znwst.eat TraiLing/Technical PinaneLal Accountant SecretaryIxpert Projects Expert Assistance Analyst

(2 Positions) [ 2)stions) Coordinator (2 PosLtions) (3 Positions)

lb tz

0D X

S.

-46 -AD

Page I of 1

Water Companies RestructurnrS and Modernization Prolect

-Project Nanaoeeent Unit .1PHUtflRennonsibilitien

The P1U will:

- organize tenders for the institutional strengthening contracts andsupervise the consultants selected;

- assist water companies in preparing sub-loan applications;

- appraise sub-projects submitted by water companies;

- submit environmental reviews to the Ministry of Environment for clearance,and where required, to the World Bank;

- assist water companies, at their request, to prepare tender documents forsub-project investments;

- review, clear and, where required, submit tender documents and biddocuments to the World Bank for no objection;

- prepare on-lending agreements for signature by the MED and WaterCompanies; monitor construction or implementation of sub-projectinvestments;

- approve payment to the contractor or supplier;

- prepare withdrawal applicatlons for submission to the Ministry of Finance;and prepare all required reports to the World Bank; and

- prepare the Annual Investment Program; and

- monitor sub-project implementation.

§ e [ [ lW # | L0 0

S E| |g: t t[g

.~~~~~~~~1

p X iW't

- 48 -

Page 1 of 2

at,er Coemanies Restructurina and Modenization Project

Initial Investment Prooram

The Initial Investment Program (IIP) includes completion of 3 watersupply-systems (Slatna Panega,-liLven and Makedonka) to eliminate drinkingwater deficits for a population of 386,000 and 3 sanitation system (Pomorle 'Kazanluk and Pleven) to allow efficient wastewater treatment for a populationof 245,000. These projects will not adversely change the quality and quantityof water flows to other riparians.

() Za,tpa Panaga sub-project is a regional scheme aiming atproviding sufficient drinking water to the towns of Lukovit,Cherven Briag, Zlatna Panega and Radomirtsi from SlatnaPanega Lake and abandoning the polluted Iskar and ZlatnaPanega River's sources. The project is under thejurisdiction of Lovech and Pleven Water Companies andincludes the construction of a water treatment plant, awater storage tank (1,000 n3) and the completion of about 101km of water pipelines.

(ii) Sliven sub-project will supply drinking water to the town ofSliven from the existing Assenovets reservoir, a tributaryof Tundia River. The sub-project includes the constructionof a water treatment plant, a water storage tank (10,000 m3)and completing about 3.0 km of water pipelines. The systemwill be operated by Sliven Water Company.

(iii) Makedonka sub-project (Dobrich Water Company) aims to reducecurrent peak water shortage in Dobrich by increasing thedrinking water supply from existing groundwater sources.The UIP component includes the supply and installation ofpumps at existing boreholes, the construction of a waterstorage tank, pumping stations and about 8 km of pipelines.

(iv) Pomorie sub-project will reduce the pollution discharge intothe Black Sea from this coastal resort town. The project isunder the jurisdiction of Burgas Water Company and includesthe completion of a wastewater treatment plant which is at avery advanced stage of construction (population equivalent50,000), the rehabilitation of seven wastewater pumpingstations, the construction of sewers and a sea outfall.

(v) Kazanluk sub-project will reduce the pollution dischargedinto the Tundja River, which is a source of drinking waterfor the town of Stara Zagora. It includes the completion ofKazanluk wastewater treatment plant (population equivalent268,000), and the construction of main sewers. The utilityresponsible for the system is Stara Zagora Water Company.

- 49 -

Page 2 of 2

(vi) ~jgPleven sub-project will increase the existing wastewatertreatment plant efficiency (population equivalent SOO,OOQ)and reduce the pollution of Tuchnitta River, a tributary ofDanube River, by constructing sewage collectors, and sewerswhich will collect sewage currently flowing untreated toTuchnitae. The Project also includes the installation of amethane gas recovery system which will significantly reduceenergy consumption of the wastewater treatment plant.

- 50 -

,nd - W W.e Dl*6s 3

3. ." .. . 1.9 . . , S

Q_4rade (1J84J (U8 (%efT

Decebr31 1994 4l0 4l0 4lsMU& SI. 1995 3.9 5.0 4.1%Jam 30. 1995 2I. 63 t6.3%

PYIM

September30, 1995 1.8 7.9 2.1%December 31. 1995 2.0 9.9 I.2%Mar31. 1996 3.9 138 t4.1%Jk 30, 1996 2.5 163 16.f%

Se _tember 30.1996 6.4 22.7 23.2%December31. 1996 4.9 274. 2.2%Mact5. t997 4.9 52.5 33.2%Jm30. 1997 2.7 5.2 33.9%

Setmb9 3 197 4.1 3. 40,1XDecmbcr3l. 197 2.0 41.9 42XYMrc31. 1998 3.8 49.1 5.1%

Jamo 301998 5.2 54.3 55.4X

September 30.1998 2. 59 581%

Jam 30, 1999 4.7 69.4 70.8%

September30. 1999 3.1 72.5 74WDecember31. 1999 3.9 764 78.0%March31. 2O0 3.9 30.3 81.9%Jaw 30. 200 4.2 84.5 862%

SCptber30. 2000 3.6 88I 89.9%Decmbetr31. 2000 3.9 92.0 93.9%March31. 2001 2.0 94.0 95.9%Jm 30. 2001 2.0 960 9.0%

PY2002

Seplemb_r30. 2001 IA 97A0 99.0%Decemr31. 2401 IA 980 100.0X

-51 - Annex 12Page 1 of 2

BULGARIA

Water Comnanies Restructurinc and Modernization Prolget

Annual and Mid-term Reviews

The-Annual Reviews will emphasize compliance with the Sector EngagementCriteria and progress in project. execution. The PMU will.have available forthe Reviews the following information:

(a) assessment of progress made in each one of the SectorEngagement Criteria (see next page);

(b) Annual Implementation Assessment;

(c) Annual Investment Program;

(d) assessment of progress made under each component of thetechnical assistance and training components under theproject against agreed schedules and targets; theidentification of issues and recommendations for remedialactions; and updated timetables for completion of thecomponents;

(e) summary of consultants progress reports and contractinformation including expenditures and disbursements;

(f) details of sub-loans approved by MMD to be financed underthe Project, which should include: (i) name of the sub-borrower; (ii) amount of the loan; (iii) summary of sub-project objectives and components; (iv) expected sub-projectcost; (v) amount of the sub-loan disbursed; (vi) expectedsub-project completion date; and (vi) major issues, if any;

(g) summary table indicating, item by item, the appraisalestimates of costs versus expenditures and loandisbursements at the end of the reporting period inaccordance with Project Accounts and the balance availableunder the loan by categories of investment; and

(h) summary of loan covenants and their status of compliance.

The Mid-term Review, in addition to the above will include:

(a) an assessment of all past years of project execution;

(b) the investment program until project completion end;

(c) seeking agreement on actions to be taken to ensuresatisfactory project implementation.

- 52 -

Annex 12AttachmentPage 2 of 2

sector Rnaaement Criteria

(i) restructuring RWCe as Ltd. Companies with munic$ipal shareholders;

(iL) outablishing effective-institutional arrangements and procedures forscreening potential sector investments based on objective critsria,-channelling resources to those that qualify, and ensuring watercompanies repay sub-loans;

(iLL) maintaining the reduced role of MRD in water company operations,strengthening MRD's role in collecting and publishing sectorperformance indicators, and encouraging municipalities to effectivelyoversee water companies' operations;

(iv) establishing cost recovery and onlending policies that cause tariffsto reflect the full cost of services;

(v) privatizing State engineering and construction enterprises servingthe water supply and sanitation sector;

(vi) adopting and implementing institutional arrangements for waterresources management that integrate quantitative and qualitativecontrols at the river basin level; and

(vii) improving environmental protection through a mix of command-and-control and market-based incentive measures.

- 53 -Annex 13Page 1 of 1

Water ComDanies Resttutugring and modernization Proj ec

Documents in Project File

1. Environment Strategy for 8ulgaria Prepared by the World Bank, U.S EPAand AID dated March 17, 1992.

2.. PMU Manual of Procedures..-

3. PMU October 1993 - September 1994 Operating Budget Assumptions.

4. Maps:

(a) Income Revenue per Capita of the Population(b) Drop of Industrial Output 1989-1991(c) Unemployed - 1991(d) Ecological Status(e) Evaluation of the Natural Potential for Tourism

5. SAFEGE Project Planning and Feasibility Study -- Phase 1s

(a) Baseline Report (Vol.. I-II), April 1993(b) Interim Report (VolQ. I-III), April 1993(C) Final Report (Vols. I-III), October 1993

6. Draft Subsidiary Loan Agreement.

7. Environmental Protection Act (Promulgated State Gazette No. 86/18October 1991 and amended State Gazette No. 100/10.12 1992).

8. Regulation No. 1 of 28 December 1992 on Environmental Assessment Impact.

9. Process for Restructuring Regional Water and Sewerage Companies.

10. Draft Articles of Association for Regional Water and Sewerage Companies.

11. Ministry of Environment - Organization Chart.

12. Sample Review of Environmental Assessments by the Mini$try ofEnvironment.

13. Draft Terms of Reference for:

(a) The Water Resources Management Study(b) Implementation Assistance Consultants(c) Core Training

14. Forecasted cash flow for water companies in the Initial InvestmentProgram.

IBRD 2522623' 24° 25 26' 2r

Danube River

. { <r O ~~~Tcraov , =CrO orert 44ILom Buchqt Severniok OC s

~~~9 ; 4 sho3e AQ T*Obrc

OF~~~~~~~~~~~~~~~~~~~~~~~~~~~~~T

Y UG O S LAA FBerkovica rastaY ~ sbdvQ UsaR G. 0og S L; V.T V I A 0 To

43' 4''

g~~~ fvDo~~tevgr Ele\ )Garov-/

OFt \ . a ~~~~~~~~ ~~ ~ ~~~~~~~Sliven A <Pernicg 3tf < << fo \ t == -X BLACK

I b r g : DxJpn; ll ~~~~~~~~~~~~~~~~~~~~~~~ X~~ombol BugaM tendAl C O A Dupnica

42'~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~2

Sandonski Solin T U R K E Y

dk /pd ,,t s ,, ~~->$*~~domF«sc> IPehichV 7 ~~~~~~~ > Podkova o

23'~~~~~~2

RO6~~w.JIA ~BULGARIAWATER COMPANIES RESTRUCTURING AND

OF Seo ~~MODERNIZATION PROJECTSofia ,. ~~~~Re-gionaI Woter Highways ~)National Capital SEA OF

~~~ OF ~~~~~~C-ompanies Main Roads * Distridt Centers MARMARAJM N 2 h7lMunicipal Water Railroads E Selected Cities

TURKEY Companies -- nternational Boundaries Divers

OCTOBER 1993