Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No: 19643

PERFORMANCE AUDIT REPORT

PEOPLE'S REPUBLIC OF CHINA

SHANGHAI SEWERAGE PROJECT(Loan 2794-CHA/Credit 1779-CHA)

LIAONING URBAN INFRASTRUCTURE PROJECT(Credit 2219-CHA)

September 7, 1999

Operations Evaluation Department

This document has a restricted distribution and may be used by recipients ory i tleperformance of their official duties. Its contents may not otherwise be disclosed withoutWorld Bank authorization.

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Currency Equivalents (annual averages)

Currency Name: RenminbiCurrency Unit: Yuan (Y); Y1.00 - 100 fen

September 1986 (Shanghai appraisal) US$1.00 Y3.70Septemberl989 (Liaoning appraisal) US$1.00 Y5.22December 1995 (Shanghai completion) US$1.00 Y8.40March 1997 (Liaoning completion) US$1.00 Y8.30

Abbreviations and Acronyms

ICB International competitive biddingICR Implementation Completion ReportLPG Liaoning Provincial CouncilLUCRPO Liaoning Provincial Project OfficeLUIP Liaoning Urban Infrastructure ProjectMOF Ministry of FinanceNCB National competitive biddingO&M Operations and maintenanceOD Operational DirectiveOED Operations Evaluation DepartmentOMS Operational Manual StatementSAR Staff Appraisal ReportSMG Shanghai Municipal GovernmentSMSC Shanghai Municipal Sewerage CompanySMWC Shanghai Municipal Waterworks CompanySSC Shanghai Sewerage CompanySSP Shanghai Sewerage ProjectTA Technical AssistanceWSS Water supply and sanitation

Fiscal Year

Government: January 1 - December 31

Director-General, Operations Evaluation : Mr. Robert PicciottoDirector, Operations Evaluation Dept. : Ms. Elizabeth McAllisterManager, Sector and Thematic Evaluations Group : Mr. Gregory IngramTask Manager : Mr. Klas Ringskog and Tauno Skytta

FOR OFFICIAL USE ONLY

The World BankWashington, D.C. 20433

U.S.A.

Office of the Director-GeneralOperations Evaluation

September 7, 1999

MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT

SUBJECT: Performance Audit Report on ChinaShanghai Sewerage Project (Loan 2794-CIA/Credit 1779-CHA) andLiaoning Urban Infrastructure Project (Credit 2219-CHA)

The China Shanghai Sewerage project (Loan 2794-CHA/Credit 1779-CHA) and Liaoning UrbanInfrastructure project (Credit 2219-CHA) were approved on April 14, 1987, and July 24, 1991,respectively. The Shanghai project was financed with a Bank loan in the amount of US$45.0 million andan IDA credit in the amount of SDR78.9 million (US$100.0 million equivalent). The loan and the creditwere closed on December 31, 1995, fully disbursed, two and a half years behind schedule. The Liaoningproject was financed with an IDA credit in the amount of SDR54.2 million (US$77.8 equivalent). Thecredit was closed on March 31, 1997, nine months behind schedule, and a balance of SDRO.26 millionwas cancelled.

The status of urban infrastructure services in China received little attention until the 1980s, whenthe government began to recognize both the need for significantly higher investments and the growingimportance of funding those investments with local resources. Upgrading local government financetherefore became a priority, and the central government began to promote a "users pay" policy. Thegovernment asked the Bank to participate in this process. China looked to the Bank not only for projectfunding support but also for the transfer of experience gained in other countries in preparing andimplementing large-scale urban infrastructure projects.

The Shanghai project was the first urban sewerage improvement project in China and theLiaoning project was the first urban infrastructure project. The latter included water supply improvementsin three major cities of Liaoning province-Shenyang, Fuxin, and Yingkou-as well as urban trafficimprovements in Shenyang. After some initial experience with these projects, the Bank, in cooperationwith Chinese officials, drew up a sector strategy in 1994. That strategy focused on cost recovery, waterconservation, and environmental protection-areas in which the two projects have made some progress.

. The two projects were large and ambitious, but despite their design complexity, both met theirobjectives. Their institution building efforts were delayed, however, and neither project fully achieved itscovenanted financial goals. Still, the projects set in motion a series of institutional and financial reformactivities that have, despite some difficulties, continued since project completion. The experience gainedwith these reforms is a valuable source of lessons for other projects in China and for the ongoing updateof the sector strategy. Bank action to approve follow-on projects in Shanghai and Liaoning is highlycommendable as it helped complete the task.

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

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OED rates the outcome of the Shanghai project as satisfactory, its institutional development impactas modest (upgraded from negligible in the ICR), and sustainability as likely. Bank performance is ratedas satisfactory. The outcome of the Liaoning project is rated as satisfactory, its institutional developmentimpact as modest (upgraded from negligible in the ICR), and sustainability as likely. Bank performance israted as highly satisfactory. In both cases, with the exception noted, these ratings agree with the ICRs.

These projects demonstrate the importance of the good match between project objectives andproject components for achieving realistic and meaningful results. Ambitious objectives often lead tocomplex component designs. A well-timed follow-on project would be appropriate in such situation. Overthe past ten years, the Bank has supported a large number of water supply and sanitation projects inChina. There are indications that this will continue and perhaps expand. Therefore, it would be highlybeneficial to carry out a sector-wide impact evaluation to contribute timely feedback to the ongoing sectorstrategy debate.

Attachment

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Contents

Ratings and Responsibilities ............................... ........ iii

Preface .................... ......................... ...... iv

1. Introduction and Background .......................... ....... IConclusion from China: Urban Environmental Service Management: .. 1

Shanghai ................ .................... ....... 2Liaoning .................................... ......... 2

2. The Projects ................ 2....... ..................... 2Shanghai Sewerage Project .................................. 2

Project Objectives and Components .......................... 2Relevance of Project Design (quality at entry) ................... 3Summary of Project Achievements .......................... 3

Liaoning Urban Infrastructure Project ............................ 3Project Objectives and Components .......................... 3Relevance of Project Design (quality at entry) ................... 4Summary of Project Achievements .............................. 4

Sector Strategy ................. 4..... ................... 4

3. Implementation Experience ............. 4.... ................ 4General Implementation Experience............................. 5

Shanghai ...................................... ...... 5Liaoning ............................................. 6

Institutional Development .............. 7..... ................ 7Shanghai .................................... .......... 7Liaoning ............. ................................ 8

Financial Management ................................ ...... 8Shanghai .................. 8....... .................... 8Liaoning ................... 9...... ................... 9

O&M Activities ..................... ..................... 10Environmental Impact in Shanghai ..... ............. ........... 10Water Resource Development in Liaoning .......................... 11

4. Issues For the Future ................................ ....... 11Sewer Rehabilitation in Shanghai ...................... ........ 11Water Supply in Liaoning ................. ................. 11Institutional Development .................................. 12

Shanghai ............................................ 12Liaoning ........................................... 12

This report was prepared by Tauno Skytta, Consultant. William Hurlbut edited the report. HelenWatkins provided administrative support.

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5. Assessment of Performance .................................. 12Project Ratings .................................... ...... 12

Shanghai ..................................... ....... 12Liaoning ........................................... 13

Borrower Performance ..................................... 13Shanghai ............................................ 13Liaoning ............................................ 13

Covenants and ODs .................... .................. 14Shanghai ........................................... 14Liaoning ........................ .................... 14

Bank Performance ........................................ 15Shanghai ........................ .................... 15Liaoning ........................ ................... 15

6. Conclusions and Lessons .............................. ....... 15Generic Lessons ................... ................... 15Shanghai ..................................... ....... 16Liaoning ........................ ................... 16

Annexes

A. Basic Data Sheet ....................................... ....... 18B. Urban Environmental Service Management ........................... 23C. Project Components; Shanghai ................. .................. 25D. Project Components; Liaoning .............................. ...... 26E. Comments from the Borrower ..................................... 28

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Shanghai Project

Principal Ratings

ICR ICR review Audit

Outcome Satisfactory Satisfactory Satisfactory

Sustainability Likely Likely Likely

Institutional Negligible Moderate ModestDevelopment

Borrower Performance Satisfactory Satisfactory Satisfactory

Bank Performance Satisfactory Satisfactory Satisfactory

Key Staff Responsible

Task Manager Division Chief Country Director

Appraisal John W. Huang Zafer Ecevit Shahid Javed Burki

Midterm (no mid term review)

Completion Geoffrey Read Sangsu Choi Yukon Huang

Liaoning Project

Principal Ratings

ICR ICR review Audit

Outcome Satisfactory Satisfactory Satisfactory

Sustainability Likely Uncertain Likely

Institutional Negligible Negligible ModestDevelopment

Borrower Performance Satisfactory Unsatisfactory Satisfactory

Bank Performance Satisfactory Highly satisfactory Highly Satisfactory

Key Staff Responsible

Task Manager Division Chief Country Director

Appraisal John Huang Zafer Ecevit Shahid Javed Burki

Midterm (no mid-term review)

Completion Edward Motte Keshav Varma Yukon Huang

s

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Preface

This is a Performance Audit Report (PAR) on two projects in China: the ShanghaiSewerage Project (Ln. 2794 CHA/Cr. 1779-CHA) and the Liaoning Urban InfrastructureProject (Cr. 2219-CHA). For the Shanghai Project, a bank loan in the amount of US$45million and an IDA credit in the amount of SDR78.9 million (US$100 million equivalent)were approved on April 14, 1987. The loan and the credit were closed on December 31,1995, fully disbursed, two and a half years behind schedule. For the Liaoning Project, anIDA credit in the amount of SDR54.2 million (US$77.8 million equivalent) was approvedon July 24, 1991. The credit was closed on March 31, 1997, nine months behindschedule; a balance of SDRO.26 million was cancelled. The Basic Data Sheets for the twoprojects are presented in Annex A.

The PAR was prepared by the Operations Evaluation Department (OED). TheImplementation Completion Reports (ICR) were prepared by the East Asia and PacificRegional Office on June 28, 1996 (Report No. 15846) and March 31, 1998 (Report No.17550), respectively. The PAR is based on the ICRs, the President's Reports, theprojects' legal documents, and the Staff Appraisal Reports (SARs). In addition, theanalysis draws upon the discussions with the borrower, a review of relevant project filesand other background material collected during the audit mission in March 1999.

The ICRs provide accurate accounts of the achievements of both projects. The PARbuilds on this information and elaborates on the projects' institution building, efficiencyof operation, and lessons.

Copies of the draft PAR were sent to the relevant Government officials, for theirviews and comments. Comments from the Shanghai Municipal Sewerage Company havebeen reproduced as Annex E.

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1. Introduction and Background

1.1 Until the 1980s, the Chinese government concentrated on industrialization andpaid little attention to urban infrastructure services. The main urban issues are shortage ofhousing, traffic congestion, inadequate water supply and sanitation services, as well as airand water pollution. During the 1980s, the government decided that significantly higherinvestments in urban services were required to remedy past inadequacies and to providefor future growth. Increasingly, urban investments would need to be funded from localresources. Therefore, upgrading local government finance was another priority area ofconcern.

1.2 Past pricing policies have contributed to inefficient use and inadequatemaintenance of most urban services. The government recognizes this deficiency and ispromoting a "users pay" policy. The full enforcement of this policy is, however, part ofwage reforms that may take some time to complete. The initial sector review revealedthat in water supply and sanitation (WSS) management was weak and responsibilitiesdivided. Institutional strengthening through better financial planning and management,tighter regulations to support operations, and more intensive staff training are urgentlyneeded. Sector studies have been conducted by the Bank in cooperation with Chineseofficials to address these issues. The most recent study (1994) concludes:

Conclusion from China: Urban Environmental Service Management:

1.3 "China now has an urgent need to reorient the provision of urban environmentalservices toward the market economy. The failure to do so would condemn urban residentsto a deteriorating environment and poor quality, but increasingly expensive, services thatdo not protect them from the growing stream of urban domestic and industrial pollutants.While the imposition of user fees may be politically difficult, city leaders must recognizethat the costs will be paid directly or indirectly, and that the current choice to rely onindirect payment leads to excess demand, on the one hand, and an inability to meet needs,on the other. The result in the end is greater pollution and higher total costs for theservice provided. The avoidance of adequate user fees also denies city leaders full use ofa powerful and efficient tool, collective treatment of pollutants, as they seek the mostcost-effective means of sustaining an environment supportive of economic growth."'

1.4 The Bank's role in the urban WSS sector in China has focused on (i) assisting thegovernment in preparing high-priority and cost-effective projects for urban services; (ii)providing project funding, as well as attracting other sources of external financing; (iii)helping to strengthen institutions responsible for preparing, constructing, and operatingurban services through technical assistance; (iv) promoting sound financial and cost

1. Source: World Bank Report No. 13073-CHA, December 31, 1994. A brief summary of this report is presented inAnnex B.

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recovery policies for the sector; (v) helping develop sector policies, legislation, andregulations conducive to efficient urban development and operation of urban services;and (vi) promoting environmental protection. China has looked to the Bank for transfer ofexperience gained in other countries and has maintained a steady dialogue with the Bankon a number of urban environmental projects.2 The Shanghai Sewerage Project (SSP)was the first of these projects in China, followed by the Liaoning Urban InfrastructureProject (LUIP). Thereafter, there have been two more projects in both Shanghai andLiaoning, as well as several others elsewhere in China that are currently underimplementation.

Shanghai

1.5 Shanghai is one of the largest cities in Asia, with a population of some 12 million(December 1995) and a rapidly growing economy. The SSP was the first phase of aprogram of works to improve the environment in Shanghai through the interception,treatment, and disposal of about 1.4 million m3/day of wastewater that discharged into theHuangpu River and Suzhou Creek. The project was designed to benefit about 2.6 millionpeople. The background of the project is given in Annex C together with projectcomponents.

Liaoning

1.6 The Liaoning province has a population of about 36 million (1991) of which some70 percent are urban. It is China's major industrial base. The LUIP covered three cities:Shenyang (the capital of the province), Yingkou, and Fuxin. The project was important tothe Bank's overall strategy of assisting China in the transition from centralizeddevelopment planning to a market-responsive and efficient system of developmentthrough enterprise reforms. The background of the project is presented in Annex Dtogether with project components.

2. The Projects

Shanghai Sewerage Project

Project Objectives and Components

2.1 The project objectives were to (i) establish appropriate institutional andorganizational arrangements for the management of liquid wastes and environmentalprotection in Shanghai; (ii) establish a self-financing company to deliver and manageurban wastewater services; (iii) strengthen mechanisms to control discharge and improve

2. Such projects most often include major components on water supply and sanitation.

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water quality in the Huangpu River and its tributaries; and (iv) support the first part of aphased program of works to provide primary wastewater infrastructure services to enableeconomic growth. The details of the project components are shown in Annex C.

Relevance of Project Design (quality at entry)

2.2 The Shanghai project focused on major institutional reforms, and was at the sametime scheduled to implement fundamental technical improvements to the seweragesystem of the city. This proved to be a monumental job and the project design becamerather complex. As a result, project implementation had to overcome significantobstacles, chiefly delays that could have been avoided with more careful project designand using a more gradual approach to project implementation.

Summary ofProject Achievements

2.3 The audit agrees with the ICR assessment that the project objectives were largelymet: (i) institutional arrangements for wastewater management were in place by projectcompletion; (ii) though delayed, arrangements for charging for wastewater services, forthe first time in Shanghai, was a significant step toward achieving a sound financialstanding; (iii) the creation of a managed Upper Huangpu Protection Zone, supported bytraining in discharge monitoring and analysis, began to show a quantifiable improvementon the environmental quality of the waterways; and (iv) the physical program providedessential wastewater services to meet the needs of some 2.5 million urban residents, andthe necessary infrastructure3 for enabling urban redevelopment and related economicgrowth. The issues that need to be addressed in the near future are mostly institutional,such as implementation of cost recovery policy and further strengthening of O&Mactivities. On the technical side, completion of the existing sewer network rehabilitationis an urgent task.

Liaoning Urban Infrastructure Project

Project Objectives and Components

2.4 The project objectives were to (i) improve water supply conditions in the threeproject cities through physical works and strengthening of institutions, regulations,management, and financial and pricing policies; (ii) improve traffic and public transportconditions in Shenyang through a pilot program of selected low-cost physical works andinstitutional strengthening; and (iii) improve measures for water pollution abatementthrough technical assistance in wastewater treatment, and strengthening of institutionsand enforcement measures for water pollution control. The details of the components arelisted in Annex D.

3. The physical components as originally designed (Annex C) were completed.

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Relevance of Project Design (quality at entry)

2.5 The borrower's high state of project preparation, assisted by bilaterally fundedlocal design institutes and foreign consultants, allowed the construction to proceed withfew difficulties upon credit effectiveness.4 The project, however, experienced delaysduring implementation mainly in carrying out studies and in utilization of technicalassistance (TA) activities.

Summary ofProject Achievements

2.6 The audit's review and observations confirm that achievement of the project'sphysical objectives was substantial. The project even exceeded its objectives for theamount of water transmission and distribution mains constructed by nearly 40 percent,and was thus able to increase service beyond the original targets. For the transportcomponents, major improvements in Shenyang's traffic flows were achieved, as trafficspeed improved up to 13 km/h. Implementation of traffic corridor improvements alsoreduced the number of accidents by about 65 percent. However, achievements of theproject's institutional and financial objectives were much less than expected, as theborrower did not realize the full benefits of the TA and training. In addition, furtherdevelopment of water conservation measures and completion of operations monitoringare issues that need to be dealt with in the near future.

Sector Strategy

2.7 Both projects were designed before the first sector strategy was drawn up in 1994and therefore chiefly addressed local issues as identified during project preparation. Theaudit, however, notes that their designs cover the key aspects of the 1994 strategy quitewell and that they contributed to advancing the new cost recovery policy and seekingcost-effective means of sustaining a supporting environment for economic growth. Bothprojects were quite ambitious as well, and their designs therefore became complex. As aresult, especially their strategy related aspects were difficult to implement. Better focusedassistance to these two first-time borrowers on specific aspects of (i) Bank procurementprocedures; (ii) the importance of cost recovery; and (iii) implementation of TA-activities, could have helped in overcoming some of these implementation obstacles.

3. Implementation Experience

3.1 The key entities involved in the implementation of SSP were the ShanghaiMunicipal Government (SMG); the Shanghai Sewerage Company (SSC); and theShanghai Municipal Sewerage Company (SMSC). The implementation of LUIP was

4. One additional year of preparation (owing to internal political issues in 1989) was required between projectappraisal and board presentation.5. The transport component was about 16 percent of the total project costs.

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carried out by the Liaoning Provincial Government (LPG) and the special LiaoningUrban Construction and Renewal Project Office (LUCRPO) established for the purpose.LUCRPO also established sub-offices in the three project cities of Shenyang, Fuxin, andYingkou, to coordinate the project activities with the respective water companies. Thissection describes the sequence of implementation events in some detail, and highlightsthe key achievements and shortcomings, as the case may be, as observed and analyzedduring the audit mission.

General Implementation Experience

Shanghai

3.2 hnplementation of the project was originally planned to take five years, withcompletion in June 1992. Construction generally proceeded satisfactorily. However,delays arose due to the slow startup by this first-time borrower (unfamiliarity with Bankprocurement procedures), unexpectedly difficult ground conditions along sections of theinterceptor sewer, lengthy investment project approval procedures by the centralgovernment, and technical difficulties on a major outfall tunnel contract (collapsed tunnellining). In addition, sewer rehabilitation of 6 catchments was added during theconstruction period. As a result, the project completion date had to be extended by 2.5years.

3.3 Construction: The quality of construction workmanship was reported to be of ahigh standard, and the audit mission's field visits confirm this. However, supervisionreports highlight the adoption of lower construction standards than recommended ininternational practice at the time (for instance, with less cover to reinforcement bars inculvert construction). This concern is now being addressed under the follow-on project soas to consistently comply with the current international practice. In this respect, it isworthwhile to highlight the benefit from the bilateral assistance (Australian government),which supported planning, engineering, and institutional analysis inputs that significantlycontributed to enabling a new organization to successfully implement a demanding,large-scale infrastructure program.

3.4 Land Acquisition and Resettlement: As major works had to be constructed incongested central areas of the city, land acquisition, resettlement of residents, andrelocation of industries became important parts of the project. SSPCC was able tosubstantially reduce the actual number of resettled persons (down from 15,000, estimatedat appraisal, to the actual of 9,200 people), and implemented the resettlement programsatisfactorily. In addition, 394 factories were successfully relocated. This reduced impactof resettlement was achieved by careful design and routing of major sewer lines.

3.5 Procurement: International contractors showed some interest to bid for worksunder the project, but after bid evaluation, most of the civil works were won by localfirms. It may be mentioned that in the follow-up environment project in Shanghai (Loan3711 -CHA) and the second sewerage project, even increasing the ceiling for ICB civilworks contracts to $10.0 million does not seem to have encouraged international

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contractors to participate to any great extent. Of 12 contracts for equipment andmaterials, only two were awarded to foreign suppliers.

3.6 Sewer Rehabilitation: A comprehensive study was conducted to identify theextent of rehabilitation needs in Shanghai; the study was completed in 1991. Some of themain problems highlighted in the study were damaged pipe joints, pipe corrosion orcollapsed pipes, and silting of pipes. Out of about 50 areas investigated in the study, onlysome six have been implemented so far, thus leaving a large number of areas still to be

6connected to the new trunk-infrastructure. As a result, the full achievement of theproject's environmental benefits is seriously delayed. The findings of the study are,however, now being dealt with through rehabilitation of the secondary and tertiary sewerlines. The results of the study should be fully utilized under the ongoing second project.The audit mission discussed the situation with SMSC and the ways to speed up theprogress in sewer rehabilitation, perhaps engaging private firms in these activities.

Liaoning

3.7 Overall, the implementation of the project proceeded smoothly. The physicalaspects of the project as appraised were completed in 1994, one year ahead of schedule.However, the closing date was extended by nine months to allow for the completion andpilot implementation of a water resource pricing study and a tariff study, and to completeadditional works (distribution network) financed from credit savings. In general, thisdelay, and the poor quality of the studies, affected the institutional capacity building.LUCRPO did not firmly focus on the institutional objectives.

3.8 Water Supply: Overall, achievements of physical objectives in water supply weresubstantial, in fact the coverage objective was exceeded. This included construction ofwater transmission and distribution mains, intake works, pumping stations, and watertreatment plants in the three cities. Equipment was procured for water supply andpollution control monitoring. Through cost savings, some 108 km of additional waterdistribution lines were constructed.

3.9 Transport: Achievement of the physical objectives in urban transport was alsosubstantial, including major improvements in Shenyang's traffic flows through the roadupgrading component, which included seven corridor separation schemes,7 mostlyseparating bicycles from motorized traffic with barriers. The audit mission receivedupdated calculations on benefits of this component that confirm the ICR estimates ontraffic speed, i.e. an increase of about 17 percent, and the substantial reduction of trafficaccidents. The audit mission observed that the traffic control center constructed under theproject could be used more effectively for managing rush hour traffic flows through theroughly 70 intersections it covers.

6. Three districts still remain to be inspected.7. Originally, ten such schemes were to be constructed, but during implementation it was agreed to include three ofthem in a future program (proposed Liaoning Urban Transport Project, FY99). Funds earmarked for three schemeswere utilized to construct five flyovers.

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3.10 Land Acquisition and Resettlement: LUCRPO and the three city project officeshad prepared suitable plans for both the acquisition of land and the resettlement ofinhabitants as part of their project preparation activities. Acquisition of land (some 27hectares in permanent use for pumping stations, etc. and about 600 hectares in temporaryuse for laying of major transmission mains) was successfully completed early in projectimplementation. The number of homes to be resettled was small; all were resettled nearbytheir previous residents and compensated for assessed damages.

3.11 Procurement: Some procurement difficulties resulted from the Bank's English-language tender documents, but close supervision helped in this regard. Also in Liaoning,the ICB threshold seems to have been set too low because no foreign firms ever bid onthese contracts. NCB, instead of being truly national, seems to have been carried out atthe provincial level only. To improve competition, ways of reducing bidding restrictionsshould be considered for future projects.

Institutional Development

Shanghai

3.12 Prior to the project, the responsibility for sewerage services in Shanghai wasdivided between various units and all O&M activities were funded through governmentalbudgetary allocations; no direct user charges were levied. During project formulation, theSMG recognized this unsatisfactory situation and established Shanghai SewerageCompany (SSC) in March 1987 as a condition for Board Presentation. SSC's objectivewas to become a financially autonomous sewerage company to manage waste water fromwithin Shanghai City. However, in 1995 (eight years after being established and when theproject was nearing completion), SSC still operated along the lines of a governmentdepartment, i.e., depending on governmental budgetary allocations for day-to-day O&M.

3.13 The organizational study prepared under the project, although slightly delayed,was available for the preparation of the second project in 1995. As per therecommendations of the study, SMG established the Shanghai Municipal SewerageCompany, Ltd. (SMSC) as a self-accounting, and self-funding state-owned enterprise.SMSC has a rational, pyramidal organization to facilitate operational effectiveness. Theaudit mission was reported9 that institutional development and training support beingprovided under the second project are starting to result in SMSC's functioning as anindependent and legally autonomous public enterprise having all rights and powers of acompany, including being held responsible for its operations, with the exception thatSMG still sets tariffs and charges for the service.

3.14 In the future, the financial objective of SMSC would be to (i) preserve the valueof its assets and (ii) earn sufficient funds from its operations to meet O&M costs and debt

8. SMSC was formed following the merger of SSC and the Shanghai Sewerage Project Construction Company(SSPCC).9. Bank supervision reports confirm this information.

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service, and generate funds for new investments. The audit finds that these objectives arebeing met and further progress has been made since project completion, especially in thefinancial management of SMSC (para. 3.18).

Liaoning

3.15 As the two major studies were considerably delayed, LPG and the watercompanies of the project towns were not able to benefit from their results andrecommendations by the time of project completion. The audit finds, however, thatpositive progress has since been made in the following areas of relatively successfulimprovements: (i) computerized billing systems and leak detection programs wereimplemented, although only on a pilot basis, especially in Fuxin and Yingkou; (ii) theinstitutional measures for traffic planning and management systems developed under theproject have been integrated into Shenyang's traffic management system; and (iii) thefunds listed for water pollution monitoring provided information for the preparation ofthe follow-on Liaoning Environment Project (Ln 3781-CHA).

3.16 Training, which was to include overseas visits and in-house training for the watersupply components, was eventually curtailed as it was realized that suitable internationalcandidates for the specified advisor posts were not available for long-term assignments.Only one short-term advisor was employed by the three water companies, amounting totwo weeks each to advise them on the water system leak-detection program. In thetransport sector, training was more comprehensive and was carried out in the areas oftraffic engineering, planning, enforcement (safety), bus operations and workshopmanagement, as well as bus maintenance, but was also curtailed before projectcompletion. Bank supervision reports noted that the unwillingness of the project officesto implement the TA-components, as designed at appraisal, severely diluted theeffectiveness of this component.

Financial Management

Shanghai

3.17 In parallel with SSC's establishment, direct-user service fees were introduced inDecember 1986 for industrial and commercial customers, first set at only fen 12/m'. Thislow and partial tariff was inadequate and therefore, to comply with the financialcovenants (para. 3.14), SMG had to contribute through utility tax allocation andgovernmental budgetary provision. To rectify the situation, a tariff study was carried out(in 1992) to recommend new tariff policies. On this basis, SMG proposed (in 1993) anew tariff structure, including tariffs for domestic customers, together with an action planfor regular tariff increases to ensure better covenant compliance in the future. Even so, itwas only in July 1995 that SSC was authorized by SMG to charge domestic customers atfen 14/m 3 and to adjust its non-domestic tariffs to fen 34/M3 .1 However, implementation

10. Bank agreed to postpone the compliance date for this covenant to after FY94.

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of this authorized adjustment was not confirmed until April 1996. Tariffs were furtherincreased in October 1998 to fen 24/m3 for domestic service and to fen 37/M3 for non-domestic service.12

3.18 These tariffs still have not generated revenues that are adequate to fullymeet the financial covenant. SMSC provided the audit mission with annual financialreports for FY93 through FY97 that confirm the project's improvements in financialmanagement. The operating revenues increased nearly four times between FY93 andFY97, and the cash balance (a liquidity indicator) increased by about ten times. On thisbasis, SMSC fully complied with the financial covenant in FY96, but just missed it inFY97. The average incremental cost of wastewater service was estimated at fen 39/M3 atappraisal and is likely somewhat higher now, thus giving a clear indication of the need tocontinue indirect charges and governmental subsidies to ensure SMSC's financialviability and the sustainability of the physical assets provided under the project, untildirect tariff levels are brought into line with the actual costs of the service.

3.19 Technically, SMG/SSC complied with the financial covenants under theproject, but not without significant delays and prompting by Bank missions. In practice,however, tariffs were set at levels that required substantial operating subsidies to SSCduring the whole implementation period to be in compliance with the financial covenants.SMG's reluctance to set wastewater tariffs at levels that would allow SSC to be self-financing was perhaps mainly triggered by concerns for affordability and communityreaction. Nevertheless, the introduction of tariffs for the waste water service, and later,the improved tariff structure were major steps forward on the financial side, and furtheractions aimed at enhancing SMSC's financial condition required under the second projectcan be expected to establish it as a financially stronger utility.

Liaoning

3.20 The project did not include detailed cost recovery objectives for the three watercompanies involved. However, as part of the institutional strengthening efforts, financialand water pricing policies were expected to be established. Unfortunately, the studies thatwere carried out to set the basis for these reforms (the water resource pricing study andthe water tariff study), were of poor quality and benefits arising from them were ratherminimal. The water companies were also expected to prepare annual financial forecasts(for a rolling eight-year period). The forecasts were produced, but in a mechanistic way.Their application into a real-life situation began, however, only some time after projectcompletion

3.21 The audit mission finds now that some effort is being taken to base the financialmanagement on real financial data in all three project cities. All water companiesprovided the mission with their financial figures for FYs1996-98. The data show thatwater tariffs were increased several times during project implementation, and as a result,

11. This is reportedly the first time in China that domestic customers have been charged for wastewater services.12. It is noted that the domestic customers are being billed through joint-billing with the Shanghai MunicipalWaterworks Company (SMWC), with the wastewater charge shown separately.

10

their financial situation has improved. The tariff increase may have also led toconservation measures as annual water consumption has declined, especially in Yingkouand Fuxin, but less so in Shenyang.

O&M Activities

3.22 All project entities have maintained sound progress in strengthening their O&Moperations after project completion. These are some of the most significantimprovements:

3.23 Shanghai: SMSC has taken important steps to make its operations more effective.All major sewer repair works are being contracted out. The workshop that handlesmechanical and electrical works is being expanded under the second project, and itoperates as a revenue earning unit thus making its operation self-funded. Outsourcing ofO&M activities has not yet been considered, but is perhaps one of the ways to furtherenhance effectiveness.

3.24 Liaoning: O&M data from the three water companies indicate that improvementsare being made in both operational effectiveness and water conservation. O&M units ofthe water companies all carry out revenue earning activities in addition to their regularfunctions within the day-to-day operations of the water system. Thus, they operatepractically as self-funding units. Metering of water connections is being expanded andleak-detection programs are under way and are being followed by necessaryrehabilitation of water mains.

Environmental Impact in Shanghai

3.25 The project completes the first stage of a major long-term environmental programto clean up the aquatic environment of Suzhou Creek and of Huangpu River, long knownto be the most polluted waterways in the Shanghai area, if not in China. Already after afew years since project completion, water quality results show signs of recovery. Theaudit mission was provided with some indicative water quality data as follows:

Dissolved oxygen Chemical oxygen Biological oxygendemand demand

Sample points 1992 1994 1997 1992 1994 1997 1992 1994 1997Beixinjin Bridge 2.23 0.32 1.30 101.4 75.4 68.7 45.4 25.5 19.3Wuningher Bridge 1.31 0.44 1.44 158.4 84.7 61.7 62.4 31.7 17.2Zehjianghn Bridge 1.93 0.76 1.59 104.0 78.5 56.9 34.2 21.8 22.0Outfall Area 8.38 15.0 1.0

Note: Sample points starting from upstream of the Suzhou Creek.

3.26 Except for the dissolved oxygen, the above data shows significant improvementsin the water quality of the Suzhou creek between 1992 and 1997; 30 to 50 percentreduction for the chemical oxygen demand and 40 to 50 percent for the biological oxygendemand. The water quality at the outfall area shows no indication of negative impactfrom the sewage discharge.

11

Water Resource Development in Liaoning

3.27 All three project cities augmented the capacity of their surface water-based supplysystems and thus improved the reliability of their distribution systems significantly. InShenyang the works included a major dam, large diameter twin-transmission main, and anew water treatment plant. Also in Fuxin and Yingkou intake and transmission capacitywas increased. This gives the water companies more time now to develop new watersources for a long-term planning horizon. In Shenyang for instance, this includes thedevelopment of new groundwater well fields, for which investigations are already underway. In addition, city water companies are carrying out water conservation measuresthrough leak-detection and rehabilitation programs. It is important that these efforts becontinued effectively and expanded.

4. Issues for the Future

Sewer Rehabilitation in Shanghai

4.1 A new project was approved in 1995 to further expand the sewerage system ofShanghai, namely the Second Shanghai Sewerage Project (Ln. 3987-CHA). This projectis addressing the sewer rehabilitation problems identified in a 1991 study (para. 3.6). It isimportant that the results of ongoing sewer investigations be used in planning theserehabilitation activities. Furthermore, the capacity of the Shanghai Municipal DrainageMonitoring Center should be used to the maximum extent to enhance the operationalmonitoring of the system. The center can be expected to produce valuable data formanaging the system more effectively and programming its rehabilitation needs andpriorities.

Water Supply in Liaoning

4.2 During the operation of the Liaoning project, standard performance targets wereestablished for the three water companies. However, due to the variations in conditions ofthe three companies, each company was encouraged to adopt its own set of measurespertaining to their operational performance. In addition to actual water productioncapacity indicators, the main performance indicators were suggested to cover (i) meteringof water service connections (percentage of total number of connections); (ii)unaccounted-for water (percentage of water produced); and (iii) staff index (number ofstaff per 1,000 service connection). The most recent information, reviewed during theaudit mission, indicates that the data collection systems are now in place. The data thatare being collected are most valuable for planning future system expansions andoperational improvements.

12

Institutional Development

Shanghai

4.3 The institutional strengthening of SSC proceeded slowly, and its expectedfinancial sustainability was not fully achieved. Therefore, its successor, SMSC, still todayneeds to resolve important institutional issues to make its operations financially andtechnically fully sustainable (paras. 3.17 through 3.19). It is important that Banksupervision of the second project pay careful attention to this area.

4.4 In retrospect, slow progress on institutional reform should have been anticipateddue to (i) major emphasis on construction of works; (ii) unfamiliarity of SSC with Bankprocedures; (iii) requirement of tough actions by SSC (and later by SMSC) throughfinancial covenants (designed to coincide with the planned completion of the physicalcomponents); and (iv) the lack of optimal organizational structure at the outset of theproject. Some useful lessons could be learned from a comparison with the ShanghaiMunicipal Waterworks Company (SMWC), which has been in operation for more than ahundred years. After 1995, SMG has shown firm intention to press on toward making thesystem financially self-sustaining by approving substantially increased wastewater tariffs.Further tariff adjustments are necessary under the second project to ensure continueddevelopment of SMSC's financial capacity.

Liaoning

4.5 Even though the project helped to achieve various operational and institutionalimprovements, the water companies will need to continue these improvement efforts ontheir financial and operational efficiency in order to generate the funds needed to sustainthe quality of service and to meet the growing demand. This makes it imperative that theresults of the tariff study be implemented so that the water companies do not have todepend on the municipal and provincial governments for financial subsidy for theseneeds. The improvements that have continued since project completion in the financearea suggests that the sustainability of project benefits is becoming more certain.

5. Assessment of Performance

Projects Ratings

Shanghai

5.1 Overall, the ICR rated project outcome as satisfactory and sustainability ofbenefits as likely; the OED review agreed with these ratings. The ICR rated theachievement of institutional development impact as negligible, which the OED reviewupgraded to modest because the borrower exhibited good progress by undertaking

13

institutional restructuring and by adopting respective study recommendations. Findings ofthe audit now confirm that the upgrading was justified

Liaoning

5.2 In the ICR, project outcome was rated as satisfactory and the institutionaldevelopment impact as negligible; the OED review agreed with both ratings. The ICRrated the sustainability as likely which the OED review downgraded to uncertain. Theaudit's findings now justify that the institutional development impact be upgraded tomodest and the sustainability back to likely as the original rating in the ICR

Borrower Performance

Shanghai

5.3 Borrower performance was generally satisfactory, though with deficiencies in thearea of financial management. Management and staff continuity within SSC/SSPCC (andlater within SMSC) has certainly contributed to the successful implementation of thephysical components of this project. While SSC demonstrated a capacity to operate andmaintain the physical assets that were constructed, for reasons discussed above, itpartially failed to grow into the self-financing institution envisaged at appraisal. Theborrower successfully implemented all the studies identified in the SAR (although withsome delay), as well as carried out various in-country and overseas training programs thatwere identified at appraisal.

5.4 The Huangpu River Basin Study provided the design for the ShanghaiEnvironment Project (Ln. 3711-CHA) and for the formation of the upper Huangpu waterprotection zone, thus strengthening Shanghai's ability to reduce pollution. The tariffpolicy and organization and management study provided a basis for the revised tariffs,and contributed to SMG's decision to create SMSC. The training undertaken yieldedresults as shown by the ability of an initially weak municipal department to managemajor construction works and embark on complex institutional upgrading. SMSC'sfinancial sustainability also began to show improvements.

Liaoning

5.5 Along with Bank missions, the borrower (represented by LUCRPO) and the threecities spent considerable effort in preparing this project, and they had a close workingrelationship throughout the entire project cycle. In addition, the LPG establishedLUCRPO along with four municipal project offices. The offices were adequately staffed,but mostly with engineers who initially possessed insufficient construction and contractmanagement experience and limited skills in institution building aspects of the project.On the basis of feasibility studies, detailed designs and tender documents were readiedfor tendering during the additional year of preparation between appraisal and board(footnote 4). The borrower's high state of project preparation allowed construction toproceed with few difficulties upon credit effectiveness.

14

5.6 Borrower performance during implementation continued to be satisfactory.Despite the inflationary environment, the project was well executed. All majorconstruction activities planned at appraisal were completed by the end of 1994, about oneyear ahead of schedule. Resettlement was carried out efficiently as noted above. Theestablishment of the city project offices outside the water companies was perhapssomewhat of an overkill, as they contributed little to project development and actuallyaffected implementation efficiency and the chance for water companies to gain thenecessary project management experience.

5.7 As far as studies and the technical assistance go, the borrower's performance wasdeficient. None of the three water companies showed the necessary commitment to thecompletion of these activities. This includes the full implementation of the computerizedbilling systems, the leak-detection program (both of which were only at a pilot phase atproject completion), and the financial forecasting for management, which was not wellcomprehended by the water companies. LUCRPO did not show adequate leadership inthese technical assistance areas. These activities have continued quite favorably,however, after the project and overall, the borrower performance in Liaoning is rated assatisfactory.

Covenants and ODs

Shanghai

5.8 Compliance with the covenants was maintained by SMG/SSC throughout theproject period, although at times reluctantly and with delays, especially with regard tofinancial covenants. In retrospect, institutional development and financial managementcould have received greater emphasis during formulation of the project covenants;actions required to take place five years down the line do not always merit seriousattention by the executing agencies. No ODs (or OMSs) were violated in the preparationand implementation of the project.

Liaoning

5.9 Compliance with covenants was limited. The water companies only partiallycomplied with the covenant to carry out action plans for improved water metering, leak-detection and staffing. The studies of tariffs and water pricing were poorly done, and thefinancial forecasts were submitted late and were of low quality. Although not specificallycovenanted in the credit agreement, the training programs for both water supply andtransport came late in the project and fell short of project plans. Resettlement was carriedout in accordance with the agreed resettlement action plan. The preparation andimplementation of the project were carried out in accordance with relevant ODs (orOMSs).

15

Bank Performance

Shanghai

5.10 The Bank enjoyed a close and frank working relationship with the participatinggovernment agencies responsible for project execution (SMG, SSC, and SMSC) and staffcontinuity helped in this regard. Initially, the "skills" of Bank missions werepredominantly in "engineering" reflecting the major emphasis during the initial years ofthe project on designs, tendering, and construction of works. These findings were alsoconfirmed by SMSC's views that the Bank missions and the task managers were alwaysvery helpful and provided excellent guidance in the implementation of the project.Overall, the Bank performance is rated as satisfactory.

Liaoning

5.11 The approach by the Bank to project preparation and appraisal was satisfactory.The scope was rightly limited to water supply construction and road improvements (inone city) and yet emphasized necessary institution and policy reforms. In the one-year lagbetween appraisal and board presentation, the Bank reviewed procurement documentssuch that construction could get underway immediately after effectiveness.

5.12 Throughout the project cycle, there was excellent staff continuity in the Bankmissions. Supervision missions emphasized the water supply component since itconstituted over 70 percent of the total cost of the project. The lack of covenantsregarding studies and TA activities made it difficult for task managers to enforceimplementation of these activities. Future projects should link institutional developmentswith time-bound covenants to ensure the full implementation of the institutionaldevelopment program in a timely manner. LUCRPO expressed its high regard to theprofessionalism and dedication of the Bank task managers. The overall Bankperformance is rated as highly satisfactory.

6. Conclusions and Lessons

6.1 Both projects largely met their objectives, but with some delayed achievement ofinstitutional goals, particularly in achieving the cost recovery targets. As the auditfindings show, project entities have, however, made substantial progress in these areasafter project completion. The audit findings also confirm that both projects made asignificant contribution toward achieving the key aspects of the 1994 sector strategy. Thisexperience is now valuable when the up-dating of the strategy is under consideration.

Generic Lessons

6.2 Both projects demonstrate the importance of a good match between projectobjectives and respective components for achieving realistic and meaningful results.

16

When the objectives are ambitious, the design of components often becomes complex, aswas the case in these two projects. A well-timed follow-on project would be appropriatein such situation.

6.3 Project management offices were established for coordinating and guiding variousaspects of project implementation. While this arrangement may be justified, it can also bea limiting factor if the skills and inclinations of the unit's staff is not balanced. Forinstance, too much engineering can affect the achievement of institutional capacitybuilding objectives of the project.

6.4 Over the past ten years, the Bank has supported a large number of water supplyand sanitation projects in China. Updating of the sector strategy indicates that the lendingportfolio is likely to increase. The experience from the completed projects should bethoroughly analyzed with a sector-wide impact evaluation to provide timely andcomprehensive feedback to the ongoing strategy debate.

Shanghai

6.5 The ICR and its review by OED present important lessons:

* Institutional development is a slow process that requires careful designsuitable to the particular enabling environment.

* The programs involving physical works and institutional and financialdevelopment require a balanced implementation plan of the whole utility.

* Such a plan should be supported through appropriately designed and timedcovenants.

* The Bank can play a meaningful role in supporting large-scale urbaninfrastructure, especially through encouraging the borrower to payadequate attention to institutional and financial reforms.

* In order to attract international contractors in similar lending operations inthe future, there may be a strong case for large management contractsmoving toward program lending.

Liaoning

6.6 Similarly, the ICR of this project presents several project-specific lessonsconfirmed by the OED review:

* To ensure the full implementation of the program, project designs mustlink institutional development to appropriate incentives and action plansearly in the project.

* Contracts of longer than one year must contain price escalation clauses.* The ICB contract ceiling of US$3.0 million for civil works contracts in

China was (in the early 1990s) too low to attract foreign bidders.* Provincial governments require fully experienced staff in both technical

and managerial areas and in project supervision to provide the leadership

17

necessary to carry out large-scale investment projects and to effectivelyassist city project staff.

18

Annex A

Basic Data Sheet

1. CINA SHANGHAI SEWERAGE PROJECT

(LOAN 27946/CREDIT 1779-CHA)

Key Project Data (Amounts in US$ million)Appraisal Actual or Actual as % ofestimate current estimate Appraisal estimate

Total project costs 356 441 123.9Loan amount 153

Cumulative Estimated and Actual Disbursements

FY88 FY89 FY90 FY91 FY92 FY93 FY94 FY95 FY96

Appraisal estimate 12.0 33.0 71.0 104.0 131.0 145.0

Actual (US$M) 10.26 14.70 29.56 53.63 72.40 98.89 131.26 151.09 153 .3b

Actual as % of appraisal 75.0 44.5 41.6 51.6 55.3 68.2 90.5 104.2 105.8

Date of final disbursement:

Project DatesOriginal Actual

Identification 3/85 6/85Preparation 1985-86 1985-86Appraisal 9/86 9/86Negotiations 2/87 2/87Board Presentation 4/14/87 4/14/87Signing 7/14/87 11/23/87Effectiveness 10/14/87 3/7/88Project Completion 6/30/92 12/31/95Closing date 6/30/93 12/31/95

a. Includes the initial disbursement of $9.0 million for the Special Account.

b. Due to appreciation of SR, the actual amount in dollars increased substantially.

19

Staff Inputs (staff weeks)Actual Weeks Actual US$000

Through appraisal 161.6 415.6

Supervision 97.9 280.3

Completione 5.0 15.0

Total 264.5 710.9

Annex A

Mission DataPerformance rating'

Date No. of Staff days Specialization(month/year) persons infield represented e Implementation Development

Status objectives

Through appraisal 9/86

Appraisal through Board 4/87Approval

Board approval through 3/88effectiveness

Supervision 1 4/88 1 2 E 1 1

Supervision 2 11/88 1 5 E

Supervision 3 5/90 1 5 E 1 1

Supervision 4 1/91 2 9 EC,F 1 1

Supervision 5 11/91 2 11 E,F 1 1

Supervision 6 5/92 3 20 ME,E,EE 1

Supervision 7 10/92 4 ME,F,EE, 1 1EC,IN

Supervision 8 12/93 5 ME,E,EE,EC, 1 1RE

Supervision 9 7/94 4 ME,E,F,RE,TS 5 45

Supervision 10 2/95 3 10 ME,F,E 5 5

Supervision 11 4-6/96 4 1 EC 1 1

Completion 2/96 3 1 E,F,EE 1 1

c. Estimate.

d. E = Sanitary Engineer; EC= Economist; EE= Environmental Specialists; F= FinancialAnalyst, IN=Institutional

Specialist; ME = Municipal Engineer; RE = Resettlement; TS = Tunnel Specialist

e. Borrower involved in two Bank-supported follow-on investments (Loans 3711 and 3987) both of which supportedexpanded wastewater infrastructure. Considerable indirect supervision through cost-effective Borrower dialogue as partof project preparation benefited both direct supervision of SP and formulation of follow-on investments.

f. I = No significant problems, 2= Moderate problems

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Other Project Data

FoLLoW-ON OPERATIONS

Operation Loan no. Amount Board date

(US$ million)

Shanghai Environment Project 3711 1994

Second Shanghai Sewerage Project 3987 1995

21

Annex A

Basic Data Sheet

2. CHINA LIAONING URBAN INFRASTRUCTURE PROJECT

(CREDIT 2219-CIIA)

Key Project Data (Amounts in US$ million)Appraisal Actual or Actual as % ofestimate current estimate Appraisal estimate

Total project costs 128.6 108 84.0Loan amount 77.8

Cumulative Estimated and Actual Disbursements

FY92a FY93 FY94 FY95 FY96 FY97 FY98

Appraisal estimate 14.8 37.3 55.2 68.5 77.8

Actual (US$M) 26.6 49.6 65.8 67.5 71.6 73.4 75.9

Actual as % of appraisal 180 133 119 99 92 94 98

Date of final disbursement: July 25, 1997

Project DatesOriginal Actual

Identification 2/88 7/18/88Preparation 1988-1989 1988-1989Appraisal 2/25/89 9/89Post-Appraisal 1/91Negotiations 10/89 4/6/90Board Presentation 8/24/89 3/21/91Signing 12/89 4/25/91Effectiveness 3/90 7/24/91Project Completion 12/31/95Closing date 6/30/96 3/31/97

Staff Inputs (staff weeks)

Actual Weeks Actual US$000

Through appraisal 83.0 232.5

Supervision 61. 186.5

Completionb 65.1 197.9

Total 216.7 644.4

a. Includes initial disbursement of $5.2 for Special Account.

b. Estimate.

22

Annex A

Mission DataPerformance rating

Date No. of Staff days Specialization Types of(month/year) persons infield representede Implementation Development Problems

Status objectives

Appraisal through 9/89Board Approval 3/91 4 21 E,F,EC,IN

Board approval 3/91through 7/91effectiveness

Supervision 1 7/91

Supervision 2 3/97

Supervision 3 11/91 4 10 E,F,IN 1 1

Supervision 4 6/92 2 12 E, 1

Supervision 5 11/92 2 8 E,JN 1

Supervision 6 5/93 3 11 E,IN,F 1 1

Supervision 7 12/93 3 7 E,IN,F 1

Supervision 8 6/94 4 7 E,F,IN,F HS HS

Supervision 9 3/96 33 4 E,F,F HS S TA & Studies

Completion 3/97

11/97

5/97 1 2 EC

Other Project Data

FOLLOW-ON OPERATIONS

Operation Loan no. Amount Board date

(US$ million)

Liaoning Environment Project 3781-CHA 77.8 3/21/91

Helen Watkins\\StreetTallcDept Disk2@OED@WORLDBANK\INFRA\SKYTTA\China Audit\Basic Data Sheet Liaoning.doc8130199 12:03 PM

C. E = Sanitary Engineer; EC= Economist; EE = Environmental Specialists; F = FinancialAnalyst, IN=InstitutionalSpecialist; ME= Municipal Engineer; RE = Resettlement; TS = Tunnel Specialist

d. Borrower involved in two Bank-supported follow-on investments (Loans 3711 and 3987) both of which supportedexpanded wastewater infrastructure. Considerable indirect supervision through cost-effective Borrower dialogue as partof project preparation benefited both direct supervision of SP and formulation of follow-on investments.

c. I = No significant problems, 2= Moderate problems

23

Annex B: Urban Environmental Service Management-Summary of SectorStrategy, 1994

Nearly 90 percent of the urban population in China is served by water systems. Thequality of the water provided generally meets the guidelines for safe water, and 24-hour supply iscommon. The major problem with these systems is low quality of construction and materialswhich combined with inadequate maintenance, substantially reduces system life and increases thelong-run cost of supply.

Although China's raw water resources are below international averages, the totalindustrial and domestic consumption rivals that of water-abundant countries like Canada, withenterprises consuming two to three times more than international best practices. Furthermore, thereal price of water has dropped sharply since 1980; by 1989, inflation had driven the real price tohalf the 1980 level. By the late 1980s, many cities had overexploited and polluted raw watersources, and the need to tap distant sources drove up the cost of new supplies by over 7 percentper year. Some cities began tariff increases in the late 1980s and recaptured some of the realrevenue losses, but on the whole, current water prices remain about half the level needed for self-sustaining water company operations.

The estimated 10 million m3/day shortfall in urban water supply can be reduced, andfuture investment needs constrained, if Chinese cities aggressively use price as a water demandmanagement tool. One study conducted in Shanghai found a price elasticity of -0.38 and anincome elasticity of 0.22 on households, both consistent with international findings. Industrialelasticities have not been estimated as quotas rather than price have determined consumption formost firms. However, price increases alone will not end the need for new investment in watersupply. The severe water shortages in North China, where 1992 domestic supplies fell below 40I/day in 18 cities, can be effectively addressed only by a combination of improved pricing andinvestment in supply.

Nearly 40 percent of urban China is unserved by sewers, with wastewater going directlyinto lakes and rivers and 30 percent will remain unserved in the year 2000 according to estimates.The low sewerage coverage and inadequate sewage treatment destroy ambient water quality.Based on international experience, this problem disproportionately affects the poor, who are lesslikely to have access to safe water supplies.

Chinese cities have little incentive to invest in sewerage and wastewater treatmentbecause they receive little or no income for handling wastewater. Furthermore, perhaps due tountreated wastewater affecting downstream cities more than the producing city, municipalwastewater handling has lagged behind national needs.

Given the low quality of urban surface waters, downstream effects, and widespreadaquifer pollution, the national government should require the 203 largest cities to provide primarytreatment within 10 years to reduce the receiving water quality to below irrigation standards; thiswould reduce pollution loads by some 30 percent from these cities, which account for 80 percentof total loads.

The estimated cost of this wastewater investment program is $490 million per year overthe next 10 years, or about three times current levels. The implied 15 percent increase in urbaninfrastructure programs would be offset by the drop in water supply investments resulting fromthe new water demand management program. Under the wastewater program, user fees wouldcover all costs. Sewerage tariffs for households and small enterprises would continue to be leviedagainst 80 percent of water use, with larger enterprises being charged on metered loads. The

24

combined impact of the water and sewerage tariff increases would triple average effective waterprices, and would reflect the true price of delivering safe water. It would encourage water saving,postpone investments in new supplies, and promote sewerage systems that are of economical size.Any delay in implementation will force the construction of larger and more costly systems in thefuture.

25

Annex C: Project Components

Shanghai

Before the project, the operation and maintenance (O&M) of services in Shanghai wasfunded through budgetary allocations of Shanghai Municipal Government (SMG). In March1987, at the start of the project, the Shanghai Sewerage Company (SSC), a financiallyindependent company was established to manage the liquid waste of the city. Direct-user servicecharges (Y 0. 12/m) for commercial and industrial consumers were introduced for the first timein Shanghai in late 1986. The project's covenants required the implementation of wastewatertariffs so that, after 1992, SSC's revenues would cover its O&M expenses and the larger of eitherdepreciation or total debt service.

Project infrastructure was designed to serve about 2.6 million people (estimated to beabout half of the population of the urban area in the year 2000). The components were:

(a) Construction of a sewerage system comprising 35 kilometers (kin) of intercepting sewers,about 21 km of link sewers, 2 main and 8 smaller pumping stations, a treatment plant and otherancillary works(b) Conducting of four project-related studies(c) Staff training(d) Setting up a self-financing sewerage company, the Shanghai Sewerage Company (SSC)(e) Creating a mechanism to control and improve water quality in the Huangpu River and itstributaries. The Huangpu River is the main source of water supply for Shanghai.

The total project cost was estimated at $441 million (Y3,704 million) compared to anappraisal estimate of $356 million (Y1,530 million). The 24 percent increase in project cost sinceappraisal in dollar terms was mainly due to increases in the costs of materials and labor. The 242percent project cost increase in yuan terms reflects: (a) the devaluation of local currency; (b) thefact that most expenditures were in local currency, and were increased by the labor and materialscost increases; and (c) the price contingencies allowed at 4.1 percent were underestimated. Theseincreases are considered reasonable under the circumstances.

Bank Group financing of a credit of SDR 78.9 million and a loan of $45.0 millionamounted to $153.34 million (35 percent of project costs), which was fully disbursed. SMGprovided the balance of the counterpart funds in a satisfactory manner.

26

Annex D

Liaoning

The project resulted from the Hun River Basin Management Study, which was financedby bilateral donors, assisted by UNDP and supervised by Bank staff. This study, carried outbetween 1987 and 1989, defined the environmental situation of water resources in the centralriver basin of Liaoning Province and identified schemes to improve water resource managementin the area. The study also assessed the feasibility of several schemes to improve water resourcemanagement and water utilization. The highest priority schemes were incorporated into theLiaoning project.

The study found the most severe water shortages in the cities of Shenyang, Yingkou, andFuxin. Water demand in all three cities exceeded production capacity, and supply restrictions hadbeen imposed on both industrial and domestic consumption. Within the built-up areas of thecities, which were serviced by the City Water Companies, all residential and commercial userswere served. Some industrial users, to meet their total demand for water, were extractinguntreated water either from groundwater sources or from nearby water courses to supplement theavailable commercial water supply. When the Liaoning project was prepared, it was estimatedthat the water company would produce only about one-half of the demand in 1995, and by theyear 2000 only about one-third of the demand would be met.

In addition to water capacity problems, the city of Shenyang also had severe transportproblems. The number of motor vehicles and non-motorized vehicles (mostly bicycles) wasgrowing rapidly and increasing congestion. Poor traffic management further exacerbated thesituation with varying speeds among the different vehicle types, resulting in serious congestion,travel delays and accidents. Bus ridership meanwhile, had leveled off and in some cases evendeclined because of traffic, which increased bus travel times, congestion caused by bicycle trafficand deteriorating bus service. Traffic separation by motorized and non-motorized vehicles wasbadly needed, as were improvements in the bus companies' equipment and operations.

The components of the project were:(a) Shenyang Water Supply (US$52.7 million): Construction of about 51 km of watertransmission pipeline, and 32 km of distribution pipelines;(b) Fuxin Water Supply (US$27.0 million): Construction of intake works, sedimentation basinand pumping station at Naodehai Reservoir, about 74 km of water transmission mains, 2 boosterpump station a water treatment plant, and about 14 km of supply pipeline to the city network(c) Yingkou Water Supply (US$18.4 million): Construction of about 57 km of water transmissionpipeline, water intake at Daliao River (120,000 m3 per day), pumping station, about 49 km ofdistribution pipelines and improvements to existing water treatment plants(d) Water Pollution Control (US$1.8 million): Procurement of equipment and instruments forenvironmental pollution monitoring, and a mobile laboratory and equipment for water qualitymonitoring work(e) Shenyang Urban Transport (US$20.8 million): Improvement of about 44 km of arterial roadcorridors, procurement of maintenance and repair equipment for bus and trolley-bus depots andgarages, improvement of operation management for bus routing and scheduling, maintenance andfinancial control, procurement of road maintenance and road safety (line marking and signing)equipment, and implementation of a computerized road maintenance system(f) Project Support Technical Assistance (engineering-related) (US$3.1 million): Advising onproject management and construction supervision, and consultants for the preparation of asecond-phase project(g) Capacity Building Technical Assistance (institution-related) (US$1.6 million): Experts to

27

provide technical and financial advice to the management of the water supply companies,technical experts to advise the management of public transport companies in Shenyang, technicalexperts to advise on urban transport management and road safety enforcement, and training forstaff of the project offices, staff of the water supply companies, and other staff engaged in watersupply, urban transport, traffic control, and environmental protection(h) Policy Development Technical Assistance (institution-related) (US$0.8 million): Studies onwater resource and water supply pricing, and effective methods for industrial wastewatertreatment including the strengthening of environmental protection laws and regulations.

The total project cost was US$108.0 million, versus the appraisal estimate of US$128.6million.

28

Annex E

Comments from the Borrower

SHANGHAI MUNICIPAL SEWERAGE COMPANYAdd: 152 Tan Jia Qiao Rd, Shanghai, 200070, China

Telephone: 0086-21-5652 3132 * Fax: 0086-21-5652 9502

FACSIMILE COVER SHEET AND MESSAGE

DATE: August 19,1999 NO. OF PAGES: 3(including cover sheet)

TO: Mr. Gregory Ingram FAX NO: 001-202-477-6391Title: Manager Telephone: 001-202-477-1234Dept/Div: Sector and Thematic Evaluations Group

Operations Evaluation DepartmentOrganization; the World BankCity/Country: 1818 H Street N.W, Washington, D.C. 20433 USA

COPIED TO: FAX NO:

FROM: Lu Hong DE FAX NO: 0086-21-5652 9502Title: General Manager Telephone: 0086-21-5652 8732Organizion:. Shanghai Municipal Sewerage CompanyCity/Country: Shanghai, China

SUBJECT: Comments on PAR of the Shanghai Sewerage Project andthe Liaoning Urban Infrastructure Project

MESSAGE:

Thank you for your draft Performance Audit Report of the Shanghai Sewerage Project

(Loan 2794-CHAICredit 1779-CHA) and the Liaoning Urban Infrastructure Project

(Credit 2219-CHA). We have studied the component of the Shanghai Project in the

report and in general we agree with the evaluations made in the report except for a few

points. Our comments are attached. They are shown in bold and italic in the original

paragraph.

Best regards,

Lu Hong DE

General Manager

SMSC

29

Annex E

The order of paragraphs is as the original order in the PAR

3. Implementation Experience

3.1 The key entities involved in the implementation of SSP were the Shanghai

Municipal Government (SMG); the Shanghai Sewerage Company (SSC); and.the

Shanghai Municipal Sewerae Company (SMSC5.. We suggest using the Shanghai

Sewerage Project Construction Company (SSPCC) instead of the Shanghai

Municipal Sewerage Company (SMSC) because SSC and SSPCC were two separate

companies at the time when the first Shanghai Sewerage Project was under

implementation. It was at the end of 1995 that SSC and SSPCC were merged into

the present SMSC

Geaeral Implementation Experience

Shanghai

3.2 Implementation of the project was originally planned to take. fve years, with

completion in March 1992. Construction generally proceeded satisfctorily. However,

delays arose due to the slow startup by this firs-time borrower (unfamiliarity with Bank

procurement procedures), unexpectedly difficult ground conditions along sections of

the interceptor sewer, lengthy investment project approval procedures by the central

government. and technical difficulties on a major outfall tunnel contract (collapsed

tunnel lining). Here we suggest adding "In addition, sewer rehabilitation of 6

catchments was added during the consrucion period" As a result, the project

completion date had to be extended by 2.5 years.

3.4 Land Acquisition and Resettlement: As major works had to be constructed in

congested central areas of the city, land acquisition, resettlement of residents, and

relocation of industries became important parts of the project. SMS (Here we

suggest changing SMSC with SSPCC.) was able to substantially reduce the actual

number of resettled persons (down from 15,000, estimated at appraisal, to the actual of

9,200 people)...

30

Annex E

3.5 Procurement: There was little or no interest shown by international or

national/reional contractors to bid for works under the orpject practically all civil

works contracts (ICB and NCB) were won by local firms. We suggest re-phrasing the

under lined sentence as follows: The international contractors showed interest in

bidding for the works under the proje4 incluing civil works, however, they were

lack of advantages. especially in civil works. for example their labor cost was muck

high, therefore most of the civil works contracts were won by local firms. Then

followed by the original sentences.

3.6 Sewer Rehabilitation: A comprehensive study was conducted to identify the

extent of rehabilitation needs in Shanghai; the study was completed in 1991. Some of

the main problems highlighted in the study were damaged pipe joints, pipe corrosion

or collapsed pipes, and silting of pipes. The audit observed that little was done despite

the comprehensive findings of the study. Out of about 50 areas investiated in the

study. only some six have imlemented so far. thus leaving a large number of areas still

to be connected to the new trunk-infrastructure. As a result the full achievement of the

proiect's environmental benefits is seriously delayed. We suggest changed the

underlined sentences into "The comprehensive findings of the study by Shanghai

are being dealt with through rehabilitation of the sewer system with upgraded

standard&" Then followed by "The resualt of the study should be fully utilized

under the ongoing second project The audit mission discussed the situation with

SMSC and the ways to speed up the progress in sewer rehabiltadon perhaps

engaging private firm in these acdvities

Borrower Performance

Shanghai

5.3 Borrower performance was generally satisfactory, though with deficiencies in the

area of financial management. Management and staff continuity within SSC (and later

within SMSC... We suggest replacing SSC with SSCISSPCC (and later within

SMSC)...

The above are all our comments on PAR.