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Initial Project Information Document (PID)

Project Name CROATIA-RIJEKA GATEWAY PROJECT

Region Europe and Central Asia RegionSector Roads and highways (45%); Ports; waterways and shippinig (45%); Central

government administration (10%)

Project ID P043195Supplemental ProjectBorrower(s) PRA, HC, HACImplementing Agency PRA, HC, HACAddress Port of Rijeka Authority (PRA)

Address Riva 1 Street, Rijeka 51 000Contact Person. Mr Bojan Hlaca, Director GeneralTel 385-51-212 974 Fax 385-51-213 112 EmailLucka-uprava-ri@ritel hr

Croatian Roads (HC)Address Voncinina 3, Zagreb 10001Contact Person Mr Vladimir Bizjak, President of the Management BoardTel 385-1- 472-2580 Fax 385-1-472-2581 Emailzvonimir.nagy@hc.tel hr

Croatian Motorways (HAC)Address. Voncinina 2, Zagreb 10001Contact Person Mr Stanko Kovac, President of the Management BoardTel 385-1-469-4400 Fax: 385-1-469-4500 Emailstanko kovac@hac hr

Environment Category ADate PID Prepared March 25, 2003Auth Appr/Negs Date May 1 7, 2003Bank Approval Date June 24, 2003

1. Country and Sector BackgroundCroatia has achieved a great deal in the transport sector since independence: war damage has beenrepaired, a body of law generally suitable to govern the transport sector of a sovereign State has beencreated, and a number transport enterprises have been privatized. Sector issues were assessed by theBank in Republic of Croatia - Policy Directions for Transport (Report No. 1 9447-hr, June 15, 1999), andas part a comprehensive diagnosis of strategic development and sector policy issues andrecommendations prepared for the new Govemment (4 Policy Agenda for Reform and Growth February14, 2000). The main sector issues and Government strategy are summarized below:

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Economic Role of Rileka Port Transport plays an important role in international trade which hasbecome more significant since independence and in reestablishing potentially profitable transittraffic. The Government has recognized the key role of Rijeka Port by declaring that Rijeka and Ploceare the two strategic ports (the latter primarily serves Bosnia and Herzegovina, BiH). Rijeka Port'sphysically protected position and natural depth of 25 meters makes it the only port in the North EasternAdriatic Range (NEAR) capable of handling the largest vessels. However, between 1980 and 1997, thePort of Rijeka lost almost 70 percent of its total throughput in general and bulk cargo. While the totalNorthern Adriatic market (Rijeka, Koper, Trieste excluding liquid bulk traffic) increased from about 16million tons in 1990 to 23 million tons in 2001, Rijeka's share of the market declined from 35% to 12%.Annex II provides a detailed SWOT analysis of the three competing ports. The main reasons for thedecline in traffic at Rijeka are the wars in Croatia and BiH which resulted in high insurance rates forusing the port, the loss of traffics to/from the forner Republic of Yugoslavia (FRY), restructuring of theeconomies of the region resulting in a decline of bulk traffic, inefficient operations at Rijeka, and poorland connections.

Several considerations support the reestablishment of the port of Rijeka as the natural gateway forCroatia and Central Europe: (i) peace and political stability within the Balkans, reenforced by the signingin 2001 of a memorandum of understanding on Trade Liberalization and Facilitation by eight heads ofState under the Stability Pact; (ii) Rijeka's competitive advantage as the only deep water port in thenorthern Adriatic which gives it a significant cost advantage for bulk and other volume traffics; (iii)Rijeka's historical role as the primary gateway for Hungary, reenforced by Hungarian policy statementsand investments in Rijeka; (iv) the resumption of traffic to/from FRY; (v) increasing involvement of theprivate sector in port operations, e.g., the container terminal recently concessioned to LR, which has atechnical assistance agreement with an international private operator (Contship Italia); (vi) theimprovement in land connections, i.e. the construction of motorways financed by the EBRD,improvements in railway efficiency supported under the ongoing Railway Modernization andRestructuring Project (RMRP) and customs improvements supported by the Bank under the Trade andTransport Facilitation in Southeast Europe (TTSFE) Project, and (vii) rationalization of the Croatian portsystem by concentrating international traffic at Rijeka and Ploce. Finally, it is worth underlining that theRijeka Gateway project will improve one of the main Trans-European corridor (Corridor Vb), which iscritical for both Serbia-Montenegro and Bosnma-Herzegovina for which Rijeka constitutes the mainnatural access to the Adriatic.

Privatization of Port Operations The Government has taken a number of steps to reform portoperations, including adopting a new port law, creating a landlord port authority at Rijeka, and initiatingport concessions with consultant assistance financed under a PHRD grant. However, the Governmentgranted Luka Rijeka (LR, port operating company) a global 12 year priority concession to operate theport in 2000. LR, directly through the priority concession or indirectly through joint ventures in theconcession for the Container Terminal and in other potential projects, controls most Rijeka portoperations. However, its financial capacities are quite limited, due to low levels of activity, accumulateddebt and overstaffing. In such a situation, this public monopoly cannot meet the demand forperformance, quality and competitiveness according to standard international benchmarks, and haslimited capacity or incentive to become more efficient. The Bank has agreed to the proposal made bythe Ministry of Maritime Affairs, Transport and Communications (MMATC) to privatize LR during thepriority concession. This would be achieved by putting up for sale a majority of the shares of the variousSuccessor Companies ('daughter' companies) to be created in accordance with the priority concessionPrivate investors would be selected -- through public competitive bidding -- according to their experiencein port operations, technical and financial capacity and commitment to develop port activity in Rijeka. Inorder to implement this, the following questions have been examined further under studies financed

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under a PHRD (Japanese) grant and the Project Preparation Facility (PPF): (i) organization of operations,(ii) creation of profit and cost centers for each terminal operation and other activities, (iii) furthertransformation into daughter companies, (iv) privatization of the mother company and/or independent(sets of) subsidiaries, (v) human resource strategy, (vi) analysis of the status of the accumulated debt, and(vii) transfer of the various terminals and corresponding Successor Companies to private operators Theconditions under which the various terminals will be transferred to private concessionaires have alsobeen examined. This includes the following: (i) review of general objectives and of contractual targets(traffic levels, performances, quality etc.), (ii) respective responsibilities and commitments of the Port ofRijeka Authority (PRA) and of the concessionaires regarding maintenance and development of infra- andsuperstructure, (iii) equipment, (iv) extension of the concessions to allow new investment plans, (v)revision of port tariffs, light dues, and (vi) periodic review of performance. Real owinership rights duringthe concession remain an obstacle to private finanicing, and following the Port Privatization Workshopheld in March, 2002, MMATC is preparing appropriate amendments to the Maritime Domain andSeaports Act. The agreed tine frame for the privatization of the port operations -- expressed in tonsoperated by the private sector/total port tonnage per year -- is as follows: from 0% in 2004 to 30% in2005, 50% in 2006, and 80% in 2008.

Redundant Port Stalt The labor restructuring strategy will be to work out all the details of involuntarydeparture with the union prior to announcing a well publicized voluntary program under a limited timeoffer (two months) with an incenitive of 1,000 Kuna per year of service to a maximum of 25 years foreligible workers. Voluntary departure will be targeted to two groups, the large group of workers who areoften absent due to illness, who are on the protected list and who therefore cannot be made redundantunder labor legislation and to surplus white-collar workers. Workers considered vital to the continuingoperation of LR, workers who are eligible to retire, and workers who are eligible for pre-retirementdeparture will not be eligible for departure with enhanced severance. The IBM business plan calculationsfor staffing levels in Successor Companies, and the RMG estimates of approximately 70 remaining staffin a residual Luka Rijeka suggest a surplus of staff in the range between 687 and 776 workers. LRManagement has accepted a staff surplus in the range between 550 and 650. The LR Social Program willmitigate the negative impact of the severance program which will be implemented in two phases (i)departure of 380 staff on a voluntary basis by the end of 2004; and (ii) departure of 400 staff during theperiod 2005-20067 Based on this level of severance the cost of labor restructuring measures will be in arange between USD 5.9 and USD 7.0 million in a low to medium cost scenario and between USD 6.8 andUSD 8.0 million in a medium to high cost scenario. The Croatian Employment Service (CES) hasdiscussed with Luka Rijeka management arrangements to offer the services of the Mobility Center (MC)in Rijeka, which has to date been assisting HZ workers in on a pilot basis. The Ministry of Labor inCroatia is the beneficiary of a EU program to assist the CES build on the pilot Mobility Center initiative,including funding of Euro 1.5 million for a labor redeployment fund. The LR restructuring project willbuild on the number of lessons learned from the HZ experience in terms of labor redeployment. Theproject will: i) include management training in negotiating skills, conflict resolution, and problemsolving; ii) target workers protected from redundancy with special measures (severance andredeployment); iii) ensure that the Human Resource and Legal Department plays a key role in therestructuring process; iv) promote the Social Plan and related measures with a well publicizedinformation program within LR and in the community to build local support; and v) include terms ofreference for a tracer study in the Social Plan as an integral part of the project.

Urban Redevelopment at Rijeka Port: The Port of Rijeka is an old industrial facility which stretches forseveral kilometers along the waterfront in the middle of the city, creating a barrier to the Adriatic.Rijeka is also constrained on the inland side by mountains. Port traffic passes through city streets,contributing to traffic congestion and increasing the cost of urban transport. Urban planning is also more

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difficult because port property is maritime domain, i.e. administered by the central Government. Muchof this prime potential waterfront area is currently occupied by dilapidated multi-story warehouses whichare not suitable for port operations and have little historical interest, and PRA desires to locate some bulkoperations to other locations, e.g. Bakar Bay. The Municipality and the Port are aware that other cities(e.g. Baltimore, New Orleans, Savannah, Bilbao) have redeveloped old port areas as attractive andprofitable retail, office and public space on a public-private partnership (PPP) basis, and requestedassistance under the project to help with a similar transformation.

The proposed project component consists in redeveloping about 17 hectares of land presently occupiedby warehouses and parking lots, including constructing a ferry terminal building, and constructing a roadconnecting the port to the Rijeka Bypass. The waterfront area to be redeveloped is immediately adjacentto the central business district (CBD) and has a high comimercial and residential potential. Afterredevelopment, the site will provide the only access to the sea from the downtown area and willconstitute a unique recreation facility for city inhabitanits and tourists. As a first step, the City of Rijeka,PRA and LR signed a cooperation agreement on March 15, 2002. A study financed Linder the PPF isdeternining (i) the type of agency that will need to be created to design, manage and implement theschenie, (ii) the best use of the area under current market conditions to achieve a self financinig scheme,(iii) the preliminary costs and revenues of the scheme and (iv) the type of contracts and leases whichwould be the most practical and financially favorable to PRA and the Municipality to develop the siteusing private funds. The project will finance the clearing of the site, the construction of the ferryterminal, and the extension of the primary infrastructure on site and if necessary off site. The projectwill also finance a section of the Rijeka Bypass and port connector road (D404) to improve the flow oftraffic within the city and to/from the port, with a large reduction of the air pollution and noise from largediesel trucks.

Motorway Progranm Croatia has about 593 km of high level tolled roads and inotorways. TheGovernment in power until 2000 initiated a program to construct an additional 1,530 km of motorwaysby the year 2013 at an estimated cost of US$6.5 billion. The Government desired to unify the country,improve international land connections, generate business for domestic contractors and catch up withWestern Europe. However, construction of some of these motorways appeared premature since fewroads carried more than 15,000 vpd at that time. The chosen financing model usually consisted ofagreeing with a foreign consortium to arrange financing in return for the construction contract (andsometimes an operating contract) Decisions were taken in a non-transparent way and there was littlecompetition. Construction prices were typically around 40% higher than in Western Europe. In addition,the Government took out expensive short term loans to cover its equity contributions since funding wasnot provided in the budget. The Government also provided traffic or revenue guarantees to theconcessionaires, increasing their contingent liabilities.

Based in part on the Bank's sector dialogue, the new Government elected in 2000 recognized that themotorway program was not sustainable. The Bank financed an advisor who helped define a reducedprogram, taking into account that some contracts were already signed. Parliament then approved a'Program for Construction and Maintenance of Public Roads for the Years 2001-2004', under which theGovernment plans to expand the network of high level tolled roads from 593 km to 1,330 km over a10-15 year period. The initial 2001-2004 program was funded from a combination of tolls,extra-budgetary revenues from the fuel tax (HRK 0.4/liter) and the budget. At the same time, Parliamentapproved a reorganization of the road sector whereby Croatian Motorways (HAC) was created andplaced under the responsibility of the Ministry of Public Works (MPW) and other main roads were madethe responsibility of Croatian Roads (HC) under the Ministry of Maritime Affairs, Transport andCommunication (MMATC). HC's 2001-2004 program was similarly defined and funded. Bothorganizations were permitted to borrow and required to service their own debts.

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The new motorway program is a significant improvement over the former one, although some issuesremain. The construction of some committed motorways appears premature, the aggregate level ofmotorway expenditure appears too high, motorway construction is partly financed off budget, and theadministrative separation of roads and motorways under two Ministries makes road planning moredifficult. The pace of actual motorway construction will in all likelihood be limited by availablefinancing, although HAC plans to complete the motorway network by 2005. In order to continue theBank's dialogue on motorway construction, the project finances technical assistance to HAC to improveits organizational efficiency and obtain an ISO 9002 certificate. The project finances the rehabilitation ofthe Krk Bridge (under the responsibility of HAC), and the construction of the western section of theRijeka bypass and port connector road (both under the responsibility of HC).

Road Maintenance Finance. Road maintenianlce was under funded from the war until 2001

Type of works/budget in 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004US$ million actual actual actual actual actual actual actual actual planned plannedMaintenance 30 59 75 80 57 39 65 127 158 140Reconstruction 17 59 38 1 50 19 1 47 62 82New Construction* 82 148 133 306 157 192 224 664 789 621TOTAL 129 266 246 387 264 250 291 848 1008 843

* includes motorways, also includes upgrade/modernization of the expressways to motorway standard

Funds were initially diverted to the war itself and then to the repair of war damage. The Highway SectorProject (Loan 3869-HR) contributed to a more than two-fold increase in maintenance expenditures from1995 to 1998, but expenditures fell again in 1999 and 2000 due to the diversion of funds to the motorwayprogram. The more disciplined Program approved by the new governmenit, discussed above, provides onaverage US$140 million per annum for road mainteniance (or about 25% of the total road expenditures)financed from extra-budgetary revenues from fuel tax (HRKO.6/liter), extra-budgetary vehicleregistration fees and the budget The maintenance budget is almost in line with the Bank's previouslyrecommended US$170 million p.a. needed to catch up with the backlog over six years. Actual 2001expenditures are in line with the Program. The Government would be asked to confirm at thenegotiations its commitments to allocate a minimum of 25% of the total road expenditures to roadmaintenance.

PMS/BMS: Implementation of the pavement and bridge management systems (PMS/BMS) was initiallysupported under the Bank's Highwvay Sector Project. An inventory of the condition of the HC roadnetwork has been completed in December 2002. Traffic levels, pavement roughness, rutting, pavementsurface deterioration, skid resistance and status of the pavement structure were surveyed The surveyresults are being used for prioritizing of the road maintenance works on the national roads network.Croatian Telecom has been contracted to install an integrated PMS/BMS system for all HC Districts,which would then be expanded to the counties. To complement the systoemall equipment (trafficcounters, weigh-in-motion scales, weather monitorinig system), PMS/BMS softvare upgrade, andtechnical assistance/training would be financed under the project. Software to improve HC's ability toadminister the road network would also be included.

Road Safetv Improvements Road accident rates are high in Croatia (about 7 fatalities/I 0,000 vehiclescompared to 2 fatalities/10,000 vehicles in Western Europe). This has an adverse impact on the Croatianeconomy and society, including international road transport. The Road Safety Study prepared under theHighway Sector Project recommended number of actions that are currently being implemented under theGovernment's National Road Traffic Safety Program. The Ministry of Interior (Mol) leads working group

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consisting of representatives of the Mol, MMATC, Ministry of Health, Ministry of Education, HC, HAC,Automotive Club, Institute of Traffic Medicine and Psychology, and Croatian Insurance Bureau Thetraffic police together with MMATC identified 147 so called 'black spots', or locations witlh highincidence of traffic accidents. These black spots can be eliminated through (i) traffic managementimprovements; (ii) design improvement, or through (iii) combined civil enginieering-traffic measures. Thegovernment has already eliminated 28 of the black spots and other 20 will be included in the betternentprogram under the ongoing EIB project. The proposed loan would finance improvement of 30 out of theremaining 107 black spots.

Railway Restructuring The Government is currently restructuring HZ withi Bank assistance under theRailway Modernizationi and Restructuring Project (RMRP, Project P039361, 1999). The objective of theproject is to modernize and restructure HZ in order to reduce its deficit and financial burden on theeconomy, and create a company adapted to a competitive transport market. The US$ 1 83 million project,cofinanced by the EBRD and Government, finances severance payments for redundant staff, trackrenewal and maintenance, rehabilitation of traction and rolling stock, environmental protection, techinicalassistance and training. Agreed finanicial and staffing targets are spelled Olut in the Governmeit's Letterof Development Policy (LDP). After a slow start in initiating actions to meet the LDP targets, projectimplementation improved following a change of Government in 2000 and the appointment of areform-oriented Supervisory Board and key personnel at HZ. A Social Program approved by Parliamenlt,provided the legal basis for the retrenchmenit of surplus staff. Both Government policies andimplementationi of the project are nlow satisfactory.

2. ObjectivesThe overall objective of the project is to increase Croatia's trade competitiveness by improving theinternational transport chaini through the Rijeka Gateway for both freight and passengers traffics throughmodernizinig the port and road network connections, and privatizing port operations. Specific objectivesinclude: (i) increasing efficiency and improving financial, social and environmental conditions at RijekaPort, rehabilitating infrastructure and replacing equipment; (ii) preparing to redevelop part of Rijeka Portfor urban purposes, and (iii) improving international road connections linked to the Rijeka gateway, andthe administration of the road sector.

3. Rationale for Bank's InvolvementThe lessons that the Bank has learned working with Croatian Railways will be applied to similar reformsrequired in the port sector. The project offers an opportunity to continue the important sector dialogueon the motorway program. The Bank will also take advantage of its long established relationshipworking in the transport sector

4. DescriptionThe project includes three components: (a) port restructuring and moderization; (b) port/city interfaceredevelopment; and (c) international road improvements.

A - Port Restructuring and Modernization (US$75.1 million including contingencies)

To allow smooth transfer of the operations related to the handling of woods and timber this componentwill include (i)nfrastructure rehabilitation worksat the Western port area: demolition of outdatedmulti-storied warehouses that restrict open storage space and port performance, with the exception of twowhich will be rehabilitated for their historical value; Wiherstructure works would be designed tofacilitate terminal leases/concessions; (iii) rehabilitation of Vienna berth and repaving and rehabilitationof utility networks; and (iv)restoration and protection along the Zagreb berth (includes construction of aberthing capacity of a minimum 250 m length to allow vessels of 15 m draft and more to service the port

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of Rijeka), and backlog rehabilitation works needs to be undertaken in various part of the port tocomplement the above works.

As a contribution to thtknowledge economy and to help develop traffic and improve safety, a VesselTraffic Management System (VTMS) or a radar-based system coupled with a database and identifyingand monitoring ship movements has been identified as an immediate need under the project. Environmentprotection equipment has also been identified and included under the project. LR operates old andoutdated yardequipment purchased by the former State Owned Enterprise (SOE) and that need to bereplaced. Also, most quay cranes they rent from PRA are old, slow and have a low capacity (5 tons orless). New heavy mobile cranes and equipment would be procured by PRA under the project.

A privatization advisor would help prepare a business plan for LR covering: (i) organization ofoperations, (ii) creation of profit and cost centers for each terminal operations and other activities, (iii)further transformation into daughter companies, (iv) privatization of the mother company and / orindependent (sets of) subsidiaries, (v) human resource strategy, (vi) analysis of the status of theaccumulated debt, and (vii) concession of terminals to private operators. He would also consult issuesconnected with the priority concession: (i) review of general objectives and of contractual targets (trafficlevels, performances, quality etc. as detailed in Annex 1l), (ii) respective responsibilities andcommitments of the port authority and of the concessionaires regarding mainitenanlce and development ofinfra- and superstructure, (iii) equipment, (iv) extension of the concessions to allow new investmentplans, (v) port tariffs, light dues, and (vi) periodic review of performance. The project would alsofinance management modernization consultantsand consultants to prepare designs diil workscontracts, to assist in preparing a BOT contract for further expansion of Zagrebacko berth and forconstruction of D 403 connector road; and to supervise civil works under the projeclSince PRA PIU isnot very experienced in implementation of Bank-financed projects, training in accounting, financialmanagement and procurement will be required

An Electronic Data Interchange (EDI) systen onnecting the port administration and port users willfacilitate trade through improved efficiency and safety of the port operations. Based on LR 's Social Planproposal, a severance program would be also financed under the project.

The project would also finance provision of a suitablefinancial management system and training for it'suse. In addition, the borrower requested that a-Ruditing firm is hired to audit the project as well as theentity financial statements.

B - Port/City Interface Redevelopment (US$43.2 million)

The modernization of the passenger terminal represents a promising activity for the port of Rijeka. Thiscomponent aims at the development of a waterfront area open to business and commercial activities. Theproject will finance preparation works at the Delta and Porto Barros areas as well as the construction ofa passenger terminal along the breakwater.

The 4 km lon,raga-Braidica (D404) connector roadwould link the Bypass to the port of Rijekareducing heavy truck traffic through the congested center of the city.

C - International Road Improvements (US$144.8 million)

The project would finance Hfianagement capacity improvements such as TA and training andsupervision services for civil works and equipment installation for both HC and HAC road/bridge works

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components. Implementation of the pavement and bridge management systems (PMS/BMS) was initiallysupported under the Bank's Highway Sector ProjectSmall equipment, PMS/BMS software upgrade.and technical assistance/trainin would be financed under the project, including software to improveHC's ability to administer the road network. Preparation of aaxle load studyto develop a strategy forenforcement and eventual adoption of the EU standard; and prevention of excessive damage to thenational roads network through pilot fixed scale installation will be also included under the project. Theproject would also provide technical assistance in obtaining an ISO 9002 certificate for HAC.

The proposed Western section of tWieka Bypass (Orehovica - Sv. Kuzam; 6.5 km; 4 lanes) isexpected to relieve traffic in a highly congested city which is squeezed between the mountains and seaIt would also provide a through link for tourist traffic traveling from Italy/Slovenia/Central Europe toDalmatian coast. Road accident rates are high in Croatia (about 7 fatalities/10,000 vehicles compared to2 fatalities/10,000 vehicles in Western Europe). As a follow-up on the recommendations of the RoadSafety Study prepared under the Highway Sector Project, the proposed loan would finance theimprovement of 30 'black spots'in the road network wvhere there is a higih incidence of traffic accidentsKrk bridge provides the only road, electricity, water and oil (pipeline) connection from the mainland tothe island of Krk where the Rijeka Airport and Omisalj Oil Terminal are located. The project wouldfinance rehabilitation of the first section of this bridge.

Project preparation facility reimbursement (US$1.5 million)

Five preparatory studies for the port component have been financed under the PPF: (i) preparation ofdetailed engineering and project design; (ii) study on port/urban redevelopment; (iii) environmentalassessment summary (for the entire project); (iv) business plan for LR; and (v) preparation of social planfor LR. Training of the PRA PIU staff has been financed under the PPF.

An indicative project cost estimate (incl. physical and price contingencies) based on a tentative US$155million Bank loan is shown below.

A - Port Restructuring and ModernizationB - Port/city Interface RedevelopmentC - International Road ImprovementsD - Project Preparation Facility

5. FinancingTotal (USSm)

BORROWER $109.60IBRD $155.00IDATotal Project Cost $264 60

6. Implementation

Legal Structure of the Loan Agreements

The World Bank and the Government agreed on principle on the legal structure of the loan agreements,with PRA, HC, and HC responsible for the implementation of their respective parts of the project. Asubsidiary loan agreement will be concluded between PRA and LR for the financing of the redundancycomponent, as well as the acquisition of heavy cargo handling equipment, procurement of a financialmanagement system and technical assistance during the privatization process. The subsidiary loanagreement will be complemented with a Project Agreement between the Bank and LR. As agreed earlier

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during the preparation of the project, the three loans will be guaranteed by the Government

Financial Management

Each executing agency - PRA, HC, and HAC will implement its respective component. HC, and to alesser extent HAC, are staffed by trained professionals with adequate capacity to implement the project.PRA staff responsible for implementation of the port component has performed very well whileimplementing the PPF studies. The Port/urban interface redevelopment component will be implementedon the basis of a memorandum of understanding between PRA, LR and the Municipality of Rijeka.Tiheproject management capacity of PRA, HC, and HAC is satisfactory. The three organizationis will receivesome training (in the use of the financial management system and in procuremenit) and consultanitassistance (for preparation of designs, supervision of works, and drafting of technical specifications)under the PPF and during project implementation. Both HC and HAC have finalicial managementsystems acceptable to the Bank. Funding has been provided under the project to up-grade the finanicialmanagement and management information systems of PRA, which will then be in a position to use thenew system to produce reports acceptable to the Bank All three entities will open Special Accounts incommercial banks acceptable to the Bank, to maintain Bank funds. Counterpart funds will be paid fromthe entities own bank accounts

Financial Reporting. The three entities will ensure the preparation and distribution of consolidatedperiodic progress reports to the Bank, for their relevant project components to reflect: (i) sources anduses of funds, by component and activity; (ii) project progress; and (iii) procurement activities In thiscontext, the three entities will prepare quarterly Financial Monitoring Reports (FMRs), which would besubmitted to the Bank within 45 days of the end of each quarter. The FMR formats will be discussed andagreed with the entities during appraisal. The first FMRs will be submitted at the end of the first quarterafter project effectiveness.

Audit Arrangements. The three entities will be responsible for ensuring that the Project financialstatements, Special Accounts, and Statement of Expenditures (SOEs) are audited by independentauditors, acceptable to the Bank, in accordance with International Standards on Auditing (ISA). Theaudits will cover all funds related to the project, including counterpart funds, for all project components.The audited financial statements, the special accounts, and SOEs of the preceding fiscal year will be sentto the Bank within six months of the end of the calendar year. In addition to the audit of the projectaccounts, the financial statements of the three entities will be audited by independent auditor acceptableto the Bank. These audit reports will be submitted to the Bank within six months of the closing of thecalendar year. The TORs for the audits will be discussed and agreed with the entities during appraisal.

Disbursements. Disbursements arrangements for the three entities will be made based on traditionaldisbursement methods (i.e., from the Special Account with reimbursements made based on Statements ofExpenditures (SOEs) and full documentation, and direct. To facilitate timely project implementation, thethree entities will establish, maintain and operate special accounts under terms and conditions acceptableto the Bank. The option to move to a FMR based disbursements will be considered at a later date, whenthe individual entities and the Bank have agreed that such a move is justifiable.

7. SustainabilityThe project will seek sustainability through:

* increased efficiency in port operation by greater involvement of the private sector;* improved port financial performance leading to reduced Government contribution in the longer term* improved management of motorways and national roads; and

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* secured funding mechanisms for road maintenance

8. Lessons learned from past operations in the country/sectorThere are several lessons learned from the Bank's past experience in implemeniting this type of projects.Those have been incorporated into the design and preparation of the Rijeka Gateway project:

(i) There are lessons which can be learned from reforming HZ under the RMRP (Section 2) which ilmany ways parallels the effort to reform Rijeka Port. First, the RMRP emphasized the importance ofobtaining an early reform commitment from the Governmenit. This was, in fact, not fully realized untiltwo years after the project was approved when a new Government took office. A second related point isthat reform-oriented managers, in particular middle managers, are necessary for success. Third, the newGovernment required that an adequate social program be put in place before involuntary staff separationsbegan (the initial phase of voluntary staff separations was implemenited without difficulty). Fourth, Earlyinvolvement of labor unions and development of healthy partnership with labor unions in the process oflabor restructuring. Fifth, HZ's financial results are to a significant degree determined by Governmentdecisions which are not under the control of the implementinig agency (levels of investmenit, publicservice obligation payments, tariff policy)

(ii) The previous Government initiated a premature motorway construction program and reduced theroad maintenance budget below the required level. Decisions were made at a high level in anon-transparent way, and implemented by Ministry of Public Works (MPW) which was not directlyinvolved in the ongoing Highway Sector Project. It is unlikely that the Bank could have influenced thesedecisions directly. The Bank instead intensified its dialogue by preparing a sector report and discussing apossible Bank guarantee for the construction of the Zagreb-Gorican Motorway This more patientapproach bore fruit when the newvly elected Parliament approved a more disciplined "Program forConstruction and Maintenance of Public Roads for the years 2001-2004". Major sector issues of thistype require continuous dialogue with the authorities over a long period of time, and in this case a changeof Government. This dialogue will be continued under the present project.

(iii) Additional lessons from the recently completedHighway Sector Project and Emergency Transportand Mine Clearing Projitllude (i) the importance of simple project design, (ii)commercialization/privatization reduces costs, and (iii) significant institutional improvements can occurwhen working in a new field (mine clearing).

(iv) We have also learned from working in other countries in the region that the possibility of EUaccession is a powerful motivator for institutional reforms deemed necessary to compete in the EU, andfor international transport improvements.

These lessons have been taken into account in the design of the project.

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9. Environment Aspects (including any public consultation)Issues : The modernization of the Rijeka Port including preparation for urban redevelopment

would not lead to any dredging or major works in the water. The only activities which raiseenvironmental concern are: (a) the demolition of old ware houses, which has used asbestos in the roofingand side wall material, and possibly also asbestos as an insulation material around pipes and insideventilation ducts; (b) the use of PCB in a transformer within the Zagrebacko berth area; and (c)reclamation of land along the Zagrebacko berth for creation of larger area for handling of cargo andbulky goods. PCB as well as PCB contaminated soil around the transformer will be separated andhandled as hazardous waste and transported to a certain facility collecting and storing the PCBcontaminated material for further management in accordance withi the Croatian legislation The debrisfrom the demolition activity, after separation of the asbestos material, asphalt, and oil contaminiiated soil,will be dumped in the harbor, within the area along the Zagrebacko berth to be reclaimed under theProject, if the analysis of the debris (see below) would show an acceptable level of potentialcontaminianits. Analysis of soil was carried out around all the warehouses to be demolished, and theresults show that only a limited amount of soil would be regarded as contaminiated with oil and heavymetals, particularly chroine (Cr) and lead (Pb). The concentrationi of hydro carbons (oil) and heavymetals in the material to be used for land reclamation is one the same level as material and soil used foragricultural purposes or below or on the same level as background values for soil and rocks. Thisamount regarded as contaminated will be separated from the soil and debris to be disposed in the sea, andit will be handled as hazardous waste and be disposed in accordance with Croatian regulations. Theasbestos material will likewise be disposed at a safe place in accordance with Croatian regulations. Inorder to make sure that no contaminated material by accident would be included in the material used forland reclamation, additional analysis will be carried out by the contractor, which activity is regulated inthe Environmental Management Plan (EMP).

Some of the warehouses within the area of Zagrebacko berth were originally given a temporaryprotection by the local branch of Ministry of Culture (MOC) on May 5, 2002. On November 25, 2002,MOC decided to lift the protection for four out of six old warehouses due to their poor condition. Theremaining two warehouses will be protected for the future, and will be rehabilitated under the Project.

Environmental Assessments (EAs) for the Rijeka Bypass road (part of road D-8) and the port connectorroad (road D-404) were prepared in 1996 and are in conformity with the Croatian legislation. TheseElAs were reviewed once more, as part of the overall EA for the Project, and the consultants confirn thatproposed mitigation measures are adequate to secure that the planned road constructions would not leadto any adverse impacts on water resources, and people's standard of living, and that no additionalmitigation measures are required. Along the roads separate and closed systems for collection of run-offwater and eventual spillages due to accidents will be constructed. Collected water will be diverted to atreatment plant before its discharge to the sea. Reduction of increased noise levels, where foundnecessary, will be mitigated by construction of barriers and plantinig of green screens.

It should be mentioned that both the Rijeka Bypass and the port connector road will result inconsiderable environmental benefits for Rijeka inhabitants. A large part of the current traffic throughRijeka will be diverted to the bypass/connector road, while heavy trucks to/from the container terminal tothe Bypass road will to a large extent go underground in a tunnel, instead of through already congestedstreets in the Rijeka City center, which is currently is the only way for the heavy traffic from the port.

These changes will result in a large reduction of the air pollution from exhaust gases from specific alldiesel driven vehicles, and a reduced noise level. In addition it is also expected that the number ofaccidents and injures will be reduced.Land needed for the construction of the roads is acquired for thewestern part of the road D-8 (between Orehovica and Draga), while the land acquisition for the western

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part of road D-8 (between Draga and Sv. Kuzam) is ongoing in accordance with the stringent proceduresdescribed in the Croatian legislation, and expected to be finished before end of June 2003 TheExecutive Summary of the project Environmental Assessment is attached as Annex 12 to the PAD.

In addition, the implementation of the Project requires the resettlement of 10 families withinl the portarea, where the road D-404 starts, and of two families at the Sv. Kuzam junction. The negotiationis withthe 10 families living in two buildings withinl the port area is ongoing, and the families will be providedsimilar or better apartments in Rijeka, and agreements to resettle the two families at the Sv. Kuzamjunction is already reached.

Annex 13 to the PAD (Land Acquisition and Resettlement Plan) outlines in more detail all issues relatedto land acquisition and resettlement.

The project will also include the elimination of 30 "black spots", in order to improve road safety. Thisresult will be achieved through managerial measures, such as improving visibility, imposing speedreductions, and setting up traffic light for regulation of traffic in some intersections. These activitieswould not lead to any environmental issues or need for land acquisition.

Finally, the project xvill include the rehabilitation of the Krk bridge In this case there are nodisturbances for the waterway, as all bridge foundations are located on land, and there are no bridgesupport in the water.

It should be mentioned that the current handling of grains and cereals in the Port, leads to emission ofparticulate matters when the products are transported to and unloaded from the existing silos. The RijekaPort Authority has already procured air control equipment in order to eliminate the emission ofparticulate matters from the silos, and the Project will finance covered conveyer belts for transport thegrains between the ships and the silos. In addition, the Project will finance equipment for facilitatingseparation of different waste generated in the Port and from ships arriving to Rijeka, as well asequipment for abating eventual oil spillage in the harbor.

10. Contact Point:

Task ManagerMichel AudigeThe World Bank1818 H Street, NW

Washington D.C. 20433Telephone (202) 473 29 56/473 48 06Fax: (202) 614 09 00

11 For information on other project related documents contactThe InfoShopThe World Bank1818 H Street, NWWashington, D C 20433Telephone (202) 458-5454Fax (202) 522-1500Web. http 11 www worldbank org/infoshop

Note: This is information on an evolving project. Certain components may not be necessarilyincluded in the final project.

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