Document of

The World Bank

Report No. 16258-BR

STAFF APPRAISAL REPORT

BRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENTAND MANAGEMENT PROJECT

January28, 1997

Public Sector Management andPrivate Sector Development divisionCountry Department ILatin America and the Caribbean Regional Office

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CURRENCY EQUIVALENTS

Currency Unit: Brazilian Reais (R$)

EXCHANGE RATE(as of August 8, 1996)

US$ 1.00 = R$1.0099R$1.00 = US$0.9902

WEIGHTS AND MEASURESMetric System

FISCAL YEARJanuary I to December 31

ABBREVIATIONS AND ACRONYMS

CAR - Companhia de Desenvolvimento e A ao Regional - State Regional DevelopmentCompany

CAS - Country Assistance StrategyCEF - Caixa Economica Federal - Federal Savings BankCODEMA - Conselho Municipal de Desenvolvimento do Meio-Ambiente - Municipal

Environmental Development CouncilCONDER - Companhia de Desevolvimento da Regiao Metropolitana - Metropolitan Region

Development CompanyCRA - Centro de Recursos Ambientais - State Environmental Protection AgencyDESENBANCO - Banco de Desenvolvimento do Estado da Bahia - Development Bank of the State of

BahiaDALY - Disability-adjusted Life YearsDU - Desenvolvimento UrbanoEIA/RIMA - Estudo de Impacto Ambiental,'Relatorio de Impacto Sobre o Meio Ambiente -

Environmental Impact AssessmentFNS - Fundadfao Nacional de Saude - National Health FoundationFPM - Fundo de Participacao dos MunicipiosFUNDURBANO - Fundo de Desenvolvimento Municipal - Municipal Development FundGOB - Government of BrazilICB - International Competitive BiddingICMS - Imposto sobre Circulafdo do Mercado 'erx'i os - Value Added TaxID - Institutional DevelopmentIDB - Inter-American Development BankIERR - Internal Economic Rate of ReturnIPEA - Instituto de Pesquisa Economica Aplicada - Institute of Applied Economic ResearchIPTU - Imposto sobre Propriedade Territorial Urbana - Real Property TaxNCB - National Competitive Bidding

Vice President Gobind T. Nankani, (Acting)Director Constance Bernard, (Acting)Division Chief Paul MeoTask Manager Braz Menezes

- ii -

ABBREVIATIONS AND ACRONYMS (cont.)

OM - Operational ManualPCS - Programa de Comunidade Solidaria - Community Solidarity ProgramPIM - Plano Institucional Municipal - Municipal Institutional PlanPLANASA - Plano Nacional de Saneamento - National Sanitation PlanPRAM - Parana Market Towns Project

PRIM - Plano de Reformas e de Modernizafdio Institucional Municipal - Municipal Reformand Institutional Development Plan.

PRODUR - Programa de Desenvolvimento Urbano do Estado da Bahia - Urban DevelopmentProgram of the State of Bahia

RMS - Regiao Metropolitana de Salvador - Salvador Metropolitan RegionSPU - Secretaria de Politica Urbana - Urban Policy SecretariatUI - Urban Infrastructure ComponentUU - Urban Upgrading Component

FEDERATIVE REPUBLIC OF BRAZILBAHIA MUNICIPAL MANAGEMENT PROJECT

LOAN AND PROJECT SUMMARY

Borrower: State of Bahia.

Guarantor: Federative Republic of Brazil.

ImplementingAgency: Companhia de Desenvolvimento e A do Regional- CAR (State RegionalDevelopment Company).

Beneficiaries: An estimated 77 Municipalities in the State.

Poverty: The project is part of the Program of Targeted Interventions. Basic services would to alarge extent benefit the urban poor in Bahia and a low income urban upgrading programwould be directed to the poorest residents.

Amount: US$100 million equivalent, including up to 5% of the loan amount in retroactivefinancing.

Terms: Repayment in 15 years, at the Bank's standard variable rate, with a grace period of fiveyears and loan amortization based on level repayments of principal.

CommitmentFee: 0.75% on undisbursed loan balances, beginning 60 days after signing, less any waiver.

OnlendingTerms: The Borrower will: (a) on-lend to municipalities through a financial agent to finance at

varying terms Sub-projects under Part C of the project; (b) provide grant funding to themunicipalities to finance municipal reforn, institutional development and basic urbanupgrading sub-projects under Parts A and D of the project; and (c) execute, throughCAR, Part B of the project.

FinancingPlan: See para. 4.14.

Economic Rateof Return: About 20% for infrastructure sub-projects, based on the evaluation of similar sub-

projects and preliminary calculations for a group of first-year municipalities. Sub-project selection criteria ensure a minimum of 12%.

Staff AppraisalReport: No. 14386-BR.

Map: IBRD No. 26941.

ProjectIdentificationNumber: BR-PA-6562

STAFF APPRAISAL REPORTBRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DE'TLOPMENTAND MANAGEMENT PROJECT

Table of Contents

Page NumberLOAN AND SUMMARY PROJECT

1. PROJECT ORIGIN AND DESIGN .................................................. 1

2. THE URBAN SECTOR ................................................... 3A. INTRODUCTION ........................................ 3................................................................. 3B. URBANIZATION: STRUCTURE AND TRENDS ............................................. 3C. THE CENTRALIZED MODEL OF URBAN SERVICE DELIVERY .......................................... 4D. DECENTRALIZATION AND CURRENT URBAN POLICY ............................................. 4E. THE MACROECONOMIC CONTEXT ............................................................................... 6F. SECTOR STRATEGY: A MEDIUM-TERm VISION FOR THE ROLE OF

MUNICIPALITIES .7............. .............. 7G. BANK EXPERIENCE IN THE URBAN SECTOR ................................. 10

3. THE STATE OF BAHIA ....................................... 11A. ECONOMIC ACTIVITY ....................................... 11B. URBANIZATION ............................................................................................ 1............ 11

C. SOCIAL INDICATORS ............................... 12D. TiHE STATE'S DEVELOPMENT PRIORITIES ............................... 12

This report is based on appraisal missions which visited Brazil in April 1995 and May1996. The April 1995 mission consisted of Mary Sheehan, task manager (LAIEU); E.Varon Lenis, sanitary engineer; T. Campbell, urban specialist (LATAD); C. Ramsay,finance specialist (LATSO); and R. Gilbert, economist (Cons.). The May 1996 missioncomprised Messrs. Philip Owusu, task manager (LAIPS); David Vetter, housing andurban specialist (LAIPS); and Roy Gilbert, economist (Cons.). W. Dillinger, economist(LAIPS); J. Redwood, environmental specialist (ENVLW); M. Sugar, disbursementofficer (LOAEL); and J. Michelsen (Cons.) also participated in missions. F. Manibog, A.Manterola and D. Gross (LAIEU) assisted in project preparation. The Peer Reviewers forthe project are T. Campbell (LATAD) and P. Jones (LASHD). B. Menezes, Pr.Operations Officer was appointed task manager in November 1996; Messrs. P. Meo, 0.Grimes and G.T. Nankani are the managing Division Chief, Projects Adviser, andDepartment Director, respectively, for the project.

Page Number

4. THE PROJECT ............................................................ 14A. PROJECT OBJECTIVES AND RATIONALE .14.................................................................... 14

B. PROJECT DESCRIPTION ........................... ................................................. 14Part Al: Municipal Reform (MR) ........... ........................................................... 15Part A2: Institutional Development (ID) ........................................................... 15Part B: Strengthening of CAR and Poverty Study . . 16

Part C: Urban Infrastructure (UI) . .......................................................... 16Part D: Urban Upgrading (U ) ........................................................................ 17

C. PROJECT COSTS AND FINANCING PLAN ....................................................................... 18

D. THE BORROWER AND EXECUTING AGENCY ................................................................ 20

5. PROJECT IMPLEMENTATION .......................................................... 22A. THE URBAN DEVELOPMENT PROGRAM ...................................................................... 22

B. THE PRODUR MUNICIPAL DEVELOPMENT FUND . ..................................................... 23

C. CAR's APPRAISAL PROCESS ............................................................................ 24

Sub-Borrower Eligibility Criteria .............................................. ........................ 25

Sub-Project Eligibility Criteria ...... ................ ............................. 26.............. 26

Review Procedure ............................................................................ 27

D. LEGAL ARRANGEMENTS ............................................................................ 27

E. ENVIRONMENTAL ASPECTS ............................................................................ 28

F. PROCUREMENT ............................................................................ 29

G. DISBURSEMENT 1. . .. . 31

H. ACCOUNTING AND AUDITING ARRANGEMENTS . ................................... ..................... 32

1. MONITORING, MID-TERM REVIEW AND EVALUATION ................................................. 33

J. IMPLEMENTATION SCHEDULE .............................. ....................................... 33

6. FINANCIAL ASPECTS ............................................................ 34A. STATE FINANCES ............................................................................ 34

B. MUNICIPAL FINANCES ............................................................................ 35

C. COST RECOVERY POLICY ............................................................................ 36

D. DIMENSIONING OF PRODUR ........................................................................ .... 3 7

E. SUSTAINABILITY ............................................................................ 37

7. PROJECT BENEFITS AND RISKS ................................................ 38A. FINANCIAL AND INSTITUTIONAL IMPACT AND PILOT MUNICIPAL REFORM .................. 3 8

B. ECONOMIC BENEFITS ................. ........................................................... 39

C. ENVIRONMENTAL AND HEALTH BENEFITS ........................................ . 39

D. POVERTY IMPACT ....................................... 40

E. RISKS .............................. 40

8. AGREEMENTS REACHED AND RECOMMENDATION ............................................. 41A. RAGREEMENTS REACHED .............................................. 41B. RECOMMENDATION ............................................... 42

Page NumberANNEXES

1 . PROJECT ORIGIN AND DESIGN

IA DECENTRALIZATION AND IMPROVED MUNICIPAL MANAGEMENT ............................ 43

IB LESSONS LEARNED FROM PREVIOlJS PROJECTS.. .................. 471 C URBAN POVERTY STRATEGY IN BRAZIL .............................................................. 52ID PROJECT DESIGN MATRIX .............................................................. 57

2. The Urban Sector

2A TAX ASSIGNMENT IN BRAZIL BY JURISDICTION ....................................................... 57

EVOLUTION OF THE SIZESOF THE 3 LEVELS OF GOB ................................................ 59

3. The State of Bahia

3A ECONOMIC PERFORMANCE OF THE STATE .60

3B URBANIZATION IN THE NORTHEAST AND THE STATE .61

3C BAHIA'S MUNICIPAL POPULATION BY SIZE GROUP (AS OF 1991) .623D INDICATORS OF RELATIVE WEALTH IN BAHIA 633E BAHIA: SELECTED SocIo-ECONOMIC INDICATORS BY ECONOMIC REGION 64

3F1 A. Water-Borne Diseases .65

3F2 B. Total Population and Regional Share of Rural and UrbanPopulation, 91 66

3F3 C. Regional Distribution and Growth of Urban and Rural

Population, 80/91 1. 67

3F4 D. Sanitation Indicators .. 68

3F5 E. Urban Household Income, 1991 . .69

3G STATE OF BAHIA CREDITWORTHINESS ASSESSMENT .70

4. The Project

4A DETAILED PROJECT DESCRIPTION .. 734B DETAILED ESTIMATE OF PROJECT COSTS ... 794C MAPPING OF POVERTY .. 804D OUTLINE - DRAFT TERMS OF REFERENCE FOR URBAN DEVELOPMENT

CONSULTANCY 834E CAR: THE EXECUTING AGENCY .. 86

5. Project Implementation

5A PRODUR ORGANIZATION CHART .87

5B PROJECT INSTITUTIONAL AND IMPLEMENTATION ARRANGEMENTS .......................... 88

5C PRODUR PROGRAM DOCUMENTATION . ................................................ 89

5D PRODUR FLOW OF FUNDS CHART ................................................ 90

5E CAR's APPRAISAL PROCESS ................................................ 91

5F ENVIRONMENTAL ARRANGEMENTS ................................................. 96

5G ESTIMATED SAMPLE CONTRACT PROFILES ................................................. 102

5H ESTIMATED DISBURSEMEN-T SCHEDUJLE ................... ............................. 103

5I SELECTED KEY MONITORING INDICATORS ........................... ..................... 104

5J PROJECT IMPLEMENTATION PLAN .... ........................ .................. 1065K SUPERVISION PLAN ................................................. 114

6. Financial Aspects6A MUNICIPAL REVENUES AND EXPENDITURES IN BAHIA .......................................... 1 16

6B DEBT CAPACITY OF THE MUNICIPALITIES ............................................. 117

6C COST RECOVERY INSTRUMENTS ............................................. 117

7 Evaluation of Sub-Projects ........................................... 119

8 Documents in the Project File ............................................ 123

TABLES

I MUNICIPAL REVENUE SOURCES ......................................... 5

1 RELATIVE IMPORTANCE OF MUNICIPALITIES ......................................... 7

3 ELIGIBLE INSTITUTUIONAL DEVELOPMENT INVESTMFNTS ...... 1....................... 15

4 ELIGIBLE INFRASTRUCTURE COMPONENTS ............ 7..............................

5 PROJECT COST AND COMPONENT .19 .......... .................... .................... .........

6 PROJECT FINANCING PLAN ............................. .. ....... ..... ... 2

7 SUB-LOAN TERMS AND CONDITIONS ............. .24

8 PROJECT COST BY ELEMENT AND PROCURFMENII MI 11..-. (

9 MUNICIPAI REVENUES AND EXPENDITURES..

MAP: ECONOMIC REGIONS AND MAJOR CITIES IN THE STATE OF BAI X1 X.

IBRD MAP NO. 26941

STAFF APPRAISAL REPORT

BRAZIL

BAHIA MUNICIPAL INFRASTRUCTUREDEVELOPMENT AND MANAGEMENT PROJECT

1. PROJECT ORIGIN AND DESIGN

1.1 Brazil's 1988 Constitutional reforms enhanced the importance of municipalities,giving them both greater responsibilities and increased revenues to meet their newresponsibilities. These reforms leave municipalities better off now than they were in 1989,largely as a result of Federal and state transfers but also from newly-created own sources.Responsibilities that previously had been delegated to higher levels of government due tolack of local resources and Brazil's centralist system -- in particular in the area of provisionof infrastructure and social services -- are now back in the hands of municipal mayors.The challenge is for municipalities to provide these services efficiently, increasingly relyingon own rather than transferred resources, borrowing prudently, streamlining currentexpenditures, investing in cost-effective projects, and contracting out and privatizingservices where appropriate.

1.2 The proposed project was initiated during elaboration of the urban policy of theState of Bahia in the late 1980s. Bahia had been until then a predominantly rural state.Urbanization rates that exceeded the regional and national averages by the end of the1 980s, however (coinciding with the decentralization reforms), convinced State authoritiesthat well-managed, self-reliant local governments would be essential to the economicgrowth of the State. Because of the commitment of high-ranking State officials, theproject concept gathered force with the explicit support of successive State Governors.The project thus became a key element of development policy for the interior of the State.Government leaders' commitment to the project, and the maturing process that it hasundergone, augur well for strong borrower ownership during implementation.

1.3 This is the seventh State-based municipal development project designed to supportBrazil's decentralization. The gradual transfer of lessons from projects underimplementation in the South of Brazil to the Northeast has been a long-term strategicobjective. It is the first such dedicated Bank-supported project in the Northeast --following a similar component in a multi-sectoral project in Ceara (Loan 3789-BR) and apilot component in a municipal management project in Minas Gerais (Loan 3639-BR).Lessons from these projects, as well as the recent OED report on urban lending,' havebeen incorporated into project design. The major difference in the Bahia project is theexplicit introduction of a reform component to enable the municipalities to increase

Twenty Years of Urban Lending: 1972-1992, An OED Review, June 1994, Report No. 13117.

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revenues generated from own sources, and to encourage municipalities to privatize thedelivery of municipal services. Other key differences are simplification of sub-projectevaluation procedures; a standardized, strategic approach to institutional development;and an explicit poverty-targeted component that builds on the lessons of urban upgradingprograms Bank-wide.

1.4 If municipalities are to be responsible for expenditures on many types of publicgoods and services, then reform of the role, functions and financial management of localgovernments must be designed as a coherent and cohesive package. A set of criteria toassess design of municipal policy-making and reforms2 and their application to the case ofBahia is shown in Annex IA. It is this analysis, along with lessons learned (Annex 1 B),the urban poverty strategy in Brazil (Annex 1 C), and the State's own developmentobjectives that have principally guided both the Bank and State teams in project design.

1.5 The project was identified in April 1993. Three missions assisted the State ofBahia in project preparation. The project was appraised in April 1995 and reappraised inMay 1996, following a review of the state's creditworthiness.

2 Developed in Brazil: The Challenge of Municipal Sector Development in the 1990s, Feb. 1992

(IBRD No. 10616-BR).

3

2. THE URBAN SECTOR

A. INTRODUCTION

2.1 Brazil's 1988 Constitutional reforms enhanced the importance of municipalities inthe country's Federal system, so that they now have both greater responsibilities -- inparticular in the area of provision of infrastructure and social services -- and increasedrevenues from own and transfer sources to fulfill their new responsibilities. This reformcomes at a time when Brazil's municipalities confront increasing challenges in the adequateand efficient provision of services. Against the background of macroeconomic crises(which began in the early 1980s) and high urbanization rates, municipalities face thefollowing set of circumstances: The first is low productivity of infrastructure assets.Brazil's mature infrastructure networks are among the most extensive in the region. Theseaging assets have not been adequately maintained, however, and are insufficient to meetthe growing demand for service. Second, with population pressure and economicvolatility, services increasingly have been provided in an informal and unregulated fashion,which has led to degradation of the urban ecosystem, particularly infavela areas. Third,over the past decade, poverty in Brazil has become increasingly an urban problem. Urbanpoverty's share has increased to roughly half of the total poor. Fourth, with economiccrisis has come the failure of federal infrastructure delivery programs, creating aninstitutional and resource gap. And fifth, despite decentralization, municipalities continueto be dependent financially on Federal and State transfers, particularly in Brazil's Northand Northeast Regions. These factors point to a need to strengthen municipalities'capabilities to efficiently manage both their resources and their responsibilities.

B. URBANIZATION: STRUCTURE AND TRENDS

2.2 Brazil's federal structure of government encompasses 26 states and about 5,000municipalities.3 With about 75% of its 153.2 million inhabitants living in urban areas in1990, Brazil is one of the most populous urban societies in the world.4 In addition to themegacities of Sao Paulo and Rio de Janeiro -- with metropolitan region populations ofabout 16 million and I 1 million, respectively -- Brazil has another nine cities with morethan one million inhabitants, including Salvador, the capital of Bahia (metropolitan regionpopulation of about 2.5 million), and numerous medium-sized cities (with populations of100,000 to one million). The largest urban concentration is found in the more developedSoutheast region of the country, while the North and Northeast Regions until the lastdecade have been predominantly rural.

2.3 In the past, rapid urban population growth required a major effort by public sectorauthorities to keep pace with the increasing demand for urban infrastructure. During the

3 The decision to create new municipalities belongs to the states. During 1992 approximately 300 newmunicipalities were formed.

4 "Urban" is defined as urban concentrations with populations greater than 20,000.

4

1970s, Brazil's urban population grew by 4.4% per year. Migrants leaving depressed ruralareas, the populations of which fell by 60% during the decade, helped fuel this urbandemographic growth. Nationwide urbanization rates slowed in the 1 980s to an average of3.4%. The census also indicates a significant slowdown in Brazil's demographic growth to1.9% per year over the 1980-91 period (against 2.5% per year during 1970-80). Thisreduced pace of population growth may give municipalities some breathing space to makemuch-needed improvements in the quality of urban services provided.

C. THE CENTRALIZED MODEL OF URBAN SERVICE DELIVERY

2.4 Until recently, Brazil's urban policy and infrastructure service delivery mechanismswere strongly centrist through a large network of federal and state institutions. Nationalurban policy was formulated by the National Commission on Metropolitan Regions andUrban Policy (CNPU) during the 1 970s, by an inter ministerial National UrbanDevelopment Council (CNDU) in the mid-i 980s, and finally by a short-lived Ministry ofUrban Development (MDU) from 1985 to 1988. Throughout the entire period urbaninfrastructure financing was dominated by the National Housing Bank (Banco Nacional deHabitacdo - BNH). BNH channeled the proceeds of workers' compulsory savings(FGTS) into housing and sanitation infrastructure. Among the most important BNH-financed programs were the National Sanitation Plan (Plano Nacional de Saneamento -PLANASA) for water and sewerage works, executed through state water and seweragecompanies; and the National Low-Cost Housing Plan (Plano Nacional de Habita(aoPopular - PLANHAP), also executed through state agencies. Urban transport wascentralized as well, under the Brazilian Urban Transport Company (Empresa Brasileira deTransportes Urbanos - EBTU).

2.5 These efforts deliberately excluded municipalities in the name of centrist nationalcoordination objectives and economy-of-scale gains. Since 1982, federal governmentfiscal deficits have precipitated a steady retreat from the use of these central financinginstitutions and their policy-making counterparts. The principal financial intermediary ofthe Government of Brazil (GOB), and one of the country's largest banks, the CaixaEconomica Federal (CEF), has inherited the remainder of these earlier programs withoutthe resources to sustain them. In retrospect, the effective collapse of these centralizedfinancing schemes in the early 1990s could have been foreseen as inevitable since theyrelied on unsustainable subsidies in the absence of meaningful cost recovery.

D. DECENTRALIZATION AND CURRENT URBAN POLICY

2.6 In the wake of the restoration of democracy in the 1980s, and free elections at alllevels of government, the 1988 Constitution represented a watershed. Key provisions ofthe Constitution consolidated the process of decentralizing authority away from thefederal government. Article 30, for example, spells out the responsibilities ofmunicipalities with respect to tax collection and the provision of local services; Articles156 and 158 provide for enhanced fiscal revenues for municipalities to meet theseresponsibilities.

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2.7 Intergovernmental Fiscal Relations. The Constitution increased both municipalshared and own-source revenues, at the expense of federal revenues (Annexes 2A and2B). Between 1988 and end-1993, the municipal share of federal income tax (IR)increased from 17% to 22.5%; federal industrial product tax (IPI) increased from 16% to22.5%; and value-added tax collected by states (ICMS) grew from 20% to 25%. TheConstitution also established a new municipal tax on fuel sales (IVVC) and gave exclusivecollection rights to municipalities for the property transfer tax (ITBI), which was formerlyshared with the states. Additional fiscal revenue has accrued to municipalities mostlythrough increased revenue sharing, primarily the ICMS. New municipal taxes have notreplaced the property tax (IPTU) and service tax (ISS) as municipalities' principal sourceof self-generated revenue. Studies indicate that by end- 1993, these reforms had increasedmunicipal revenues by approximately one-third. The municipal share of all taxes collectedin Brazil in 1993 reached nearly one quarter, against a pre-reform level of 18%. Revenuesources for a sample group of Brazilian state capitals are shown in Table 1.

Table 1: Municipal Revenue Sources; Average for Selected Brazilian State Capitals(percent distribution, 1990)

Total Other Total TotalOwnb ISS IPTU Own Transfer ICMS Other Debt Other Total30.5 15.9 6.5 8.1 53.1 29.8 23.3 4.5 11.9 100.0

a/ Source: Brazil: The Challenge of Municipal Sector Development in the 1990s, IBRDReport 10161-BR, February 1992.bl It should be noted that State capitals' own resources as a percent of the total issignificantly higher than for the total of all municipalities.

2.8 Both the states and the federal government are affected. States have gainedslightly. While their shares of IR rose from 16% in 1988 to nearly 25% in 1993, and IPIfrom 16% to just over one-third, they have lost an extra 5% of ICMS to municipalities.The federal government has seen its 67% share of IR and IPI drop to some 50%.

2.9 Political Change. In addition to its administrative and financial aspects,decentralization is an important dimension of Brazil's governance framework. Itstrengthens the country's return to democracy, begun in 1982, when the first free electionsfor state governors were held as part of the then-military government's move towardspolitical opening, or abertura. In 1984, municipal mayors were elected in somejurisdictions for the first time. Democratic consolidation continued with elections in 1986for part of Congress and for state governors for the second time. The promulgation of thenew Constitution and elections for city mayors for the second time occurred in 1988. In1989, there was direct vote by universal suffrage for President and in 1992 elections formunicipal mayors were again held. The second set of municipal elections are set to takeplace in October 1996. Expanded responsibilities for these elected officials are expectedto lead to increased local accountability.

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2.10 Current Urban Policy. With the Cardoso Administration in 1995 a newSecretariat of Urban Policy (SPU) was established in the Ministry of Planning. The SPUreplaced the former Secretariat of Urban Development, and is intended as a policy-formulating agency, rather than an executive agency. This secretariat will not haveresponsibility for allocation of funds. It will instead be responsible for establishing broadurban development policies. In this work it will coordinate closely with IPEA, the federalgovernment's institute for economic and applied research, and with the government'snewly-established Community Solidarity Program (Programa de Comunidade Soliddria-PCS). The PCS plans to address poverty through decentralized implementation and directinvolvement of beneficiary communities in five areas: (a) nutrition and health; (b)employment generation; (c) social safety nets for vulnerable populations (children andelderly); (d) rural poverty; and (e) urban poverty. The urban poverty focus willconcentrate on the peripheries of medium-size and large cities. The SPU will work closelywith the PCS in coordinating poverty-alleviation efforts in urban areas. The federalgovernment has requested Bank assistance in developing an integrated urban policy,including an urban poverty strategy. A program of technical assistance, training, andseminars is under preparation.

E. THE MACROECONOMIC CONTEXT

2.11 Brazil sustained buoyant economic growth of 8.6% per annum during the 1970sthrough industrial expansion was based initially on inexpensive energy supplies andsubsequently on inexpensive external credit following the oil price shocks of 1973 and1978. Brazil's total external debt rose from US$12.0 billion in 1973 to US$91.3 billion in1982, and the country followed Mexico into default on debt repayments that year.5

Rampant and unstable inflation has hampered Brazil's economic recovery since 1982. Ithas also played havoc with public finances, frustrating attempts of the public sector at allthree levels to generate savings. Economic growth driven by federal government fundingfaltered as additional external resources dried up and interest rates on outstanding loanssoared. Thus, even without the concurrent political pressures in favor of decentralization,economic crisis has made decentralization an appealing financial alternative. In July 1994,the Franco Administration launched a new stabilization plan, the Plano Real, named afterthe new currency created as one of the key fiscal reform measures. In tandem, theGovernment introduced significant structural reforms (beginning in 1990), including tradeliberalization, deregulation, and privatization of state enterprises. These measures arebeing continued under the Cardoso Administration.

2.12 The Share of Brazil's Local Governments in the Economy. As demonstrated inTable 2, municipalities have become significant players in Brazilian public finance. In1990, total municipal resources amounted to 5.2% of GDP (nearly twice the 1985 level),total expenditures 4.3% (1.8% of which represented the wage bill), and capitalinvestments 1% of GDP, or nearly twice the federal government's investment expendituresfiscal base (Annex 2B). With urban growth has also come an important potential, (as yet

Pedro Pablo Kuczynski, Latin American Debt, Johns Hopkins University Press, London, 1988,Appendix 2.

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unexploited). Total municipal revenues now are derived about 20% from own sources,such as property taxes. Better local service provision will increase residents' willingness topay both local taxes and user charges.

Table 2: Relative Importance of Municipalitiesin Brazilian Public Finance

1980 1985 1990

RevenueAs percent of GDP 2.4 2.5 5.2As share of public sector 10.1 11.5 14.6

ExpenditureAs percent of GDP 2.5 2.7 4.3As share of public sector 10.6 11.1 11.3

Source: Brazil: The Challenge of Municipal Sector Development in the 1990s,|BRD Report 10161-BR.

2.13 Municipalities have in the recent past confronted three important linkages with themacroeconomy. First are the negative effects of endemic inflation: (i) parameters ofproperty and other taxes, which are important sources of own revenues, are difficult toadjust for inflation; (ii) financial administration, notoriously weak in smaller municipalities,must be agile and efficient to manage inflation; and (iii) high inflation makes adequateplanning and budgeting virtually impossible. Second is the potential for a municipal debtcrisis if borrowing is not done on a prudent scale. Off-budget items such as suppliers'credits and rollover of existing debt are common, primarily in the larger municipalities,which have a history of borrowing (the smaller ones do not). Caution will need to beexercised in ensuring that discretionary transfers are not relied on to service imprudentborrowing, and that rollovers, transfers and suppliers' credits are adequately accounted forin calculation of credit limits. And third is the paucity of adequate, consistent financialreporting and financial data across municipalities with which to monitor progress onimplementation of policy and impact on the macroeconomy of the country.

F. SECTOR STRATEGY: A MEDIUM-TERM VISION FOR THE ROLE OF MUNICIPALrrIES

2.14 With decentralization, municipalities act as quasi-autonomous managers ofexpenditures for services such as health, education, water supply, waste collection,drainage, paving and public transport. Municipalities, in theory, have a comparativeadvantage in the provision of these services because local governments, particularly after areturn to democratically-elected leaders, are more knowledgeable about local needs andbetter at responding rapidly to changes in these needs. This does not mean thatmunicipalities should provide all services by themselves. For many of these activities,municipalities should rely on the private sector through concessions, contracting orinvestment participation, expanding the scope of service delivery. Since many of these

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services are intermediate goods in the production of private services, municipalperfornance in managing these expenditures will also contribute to Brazil'smacroeconomic performance. Municipalities should also contribute to a return tosustainable macroeconomic growth through their own fiscal efforts, and ensure theirfinancial independence and health by maximizing the revenues they can raise from theirown sources. The local tax burden -- including local tax levels, but also local user feesand the pricing of local services -- should increasingly be determined by the level ofdemand for services.

2.15 In sum, over the medium-term municipalities will need to place greater emphasison efficiency and financial management. The challenge for municipalities today is toestablish their own mechanisms of infrastructure delivery based on increased fiscalautonomy. To this end, improved municipal administration can help to fill the vacuum leftby the demise of national programs. The key goals for municipalities will be to:

(a) mobilize their own resources more effectively, by widening their tax basesand exploring alternative sources of revenue, such as user charges andbetterment taxes;

(b) allocate these resources more efficiently through rigorous appraisal of newinvestments;

(c) increase efficiency in the use of resources for current expenditure throughthe improvement of day-to-day administration;

(d) engage the private sector, through privatization and contracting out, forthose municipal investments and services it can provide more efficiently;

(e) prudently borrow market resources to fund priority operations with higheconomic and financial rates of return; and

(f) begin to plan and budget more effectively while explicitly monitoringfinancial performance.

2.16 Rationale for Bank Involvement. According to the current Country AssistanceStrategy (CAS) discussed by the Board of Executive Directors on June 6, 1995, andupdated in June 1996, support for structural reforms at the federal and state levels is amajor element in the Bank's assistance strategy for Brazil. Moreover, the Bank seeks toshift its assistance strategy increasingly toward states. This re-orientation of emphasis onlending to the states is principally due to the increased importance of the states in theprovision of key services and infrastructure, and the finding that projects are successfulprimarily in states with viable fiscal positions (and hence investment programs); only insuch cases is the needed volume of counterpart funding available. Therefore, the Bankwill focus its lending on: (i) developing policy dialogues differentiated by states or groupsof states; (ii) formulating investment operations that serve as vehicles to improve thepolicy and institutional framework; and (iii) supporting some states' efforts to improvetheir finances.

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2.17 The Bank proposes a three-pronged strategy toward state lending: (i) investmentloans, principally in the social sectors and in infrastructure in creditworthy states; (ii)reform loans where strong fiscal and sector policy reforms are being implemented; and (iii)for states with poor creditworthiness, the Bank would lend via federal loans (requiringfederally funded counterpart financing), if suggested by the Federal Government. TheBank would not lend directly to uncreditworthy states. In summary, to improve overallstate creditworthiness, future sector lending operations will take place on a state-by-statebasis, and will primarily be targeted toward those reform-prone states, while otheroperations will be targeted toward less reform-prone states in order to enable them tobecome eligible for future Bank support.

2.18 In this case, Bahia is a creditworthy state (see Annex 3G). The proposed projectwill seek to reduce municipal dependence on state transfers by helping the municipalitiesto increase their own resources and to use them wisely, as well as developing a municipaldevelopment fund.

2.19 Urban Sector Strategy. The Bank's strategy in the urban sector in Brazil, as set outin the report, Brazil: The Challenge of Municipal Sector Development in the 1990s,February 1992 (IBRD No. 10616-BR), is to support the decentralization reforms whichtook effect with the 1988 Constitution, and foster among Brazil's municipalitiesstrengthened financial management and increased fiscal responsibility. This would beachieved through support to financially-sound and reform-oriented states, and throughcontinuing policy dialogue and technical assistance at the federal level. The proposedproject is part of a strategy that has sought to gradually transfer the lessons of urbanexperience in the South of Brazil to the Northeast, where ongoing and planned operationswould reach those states with the largest urban populations.

2.20 Urban Poverty Strategy. The urban share of total poor in Brazil has increasedsignificantly, from about 40% in 1980 to about half of the total in 1993. The reportBrazil: A Poverty Assessment (March 1995) sets out a profile of urban poverty. Itindicates, for example, that a key differentiating feature of the poor and the non-poor isaccess to basic urban infrastructure. Urban sector strategy has also emphasized theimportance of targeting of benefits to the very poor. The project is part of a poverty-alleviation strategy for Brazil that involves economic and sector work, country dialogueand lending in the areas of rural development, health and education as well as urbandevelopment (Annex 1C).

2.21 The primary emphasis is on efficient resource allocation, increased efficiency in thepublic sector, improved environmental management and the appropriate targeting anddelivery of services to the poor. The proposed project is fully consistent both with theBank's Country Assistance Strategy (CAS), and with the Brazilian Government's evolvingurban policy and poverty strategy.

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G. BANK EXPERIENCE IN THE URBAN SECTOR

2.22 Lessons Learned. Since 1978 the Bank has made 18 loans for urban developmentand transport projects in Brazil, totaling about US$1.78 billion. In addition, 19 loanstotaling about US$2.18 billion have been made for water and sewerage projects since1971, also largely in urban areas. The proposed project would build on lessons learnedover several decades in the urban sector. The recent OED review of urban sector lending'cites several features of best practice, among them demonstrated borrower ownership,emphasis on institution-building, secure land tenure for beneficiaries, well-designedenvironmental components, and explicit poverty reduction aims. Constraints to successfulimplementation are excessive focus on physical outcomes (at the expense of institutionaloutcomes), poor design of environmental components, mechanisms that favor high-standard infrastructure, and inadequate assessment of effective demand. The OED reviewargues for a more comprehensive approach to the design of urban projects that securesproject ownership, relies on institutional development and policy reform, taps potentialmacroeconomic linkages, strengthens the congruence of objectives and design, andprovides for well-defined monitoring and evaluation. Consistent with theserecommendations and Brazil's decentralization reforms, the Bank's project objectives haveshifted towards improving the capacity of states and municipalities to effectively assumeincreased responsibilities for efficient management of resources and services under a seriesof projects which began in the southern states of Santa Catarina (Loan 2623-BR --PROURB - closed in 1993); Parana (Loan 3100-BR - PEDU); Rio Grande do Sul (Loan3129-BR - P1MES); Minas Gerais (Loan 3639-BR - SOMMA); and CearA (Loan 3789-BR - PROURB). Lessons from preparation, implementation, mid-term reviews, andcompletion of these projects, among others, have been incorporated into project design.Annex lB presents significant lessons learned and how they are incorporated into thedesign of the proposed project.

6 Twenty Years of Urban Lending: 1972-1992, June 14, 1994 (IBRD No. 13117).

I1

3. THE STATE OF BAHIA

3.1 The State of Bahia covers an area of about 560,000 square kilometers, or aboutthe same size as France, making it the fifth largest of Brazil's states and the largest of theNortheastern states. With I 1.9 million inhabitants (8% of the country's total), Bahia ismore populous that Portugal, and is fourth nationwide in terms of population and first inthe Northeast region. Bahia is composed of three regions: the coastal mata atlantica, ornative Atlantic forest; the cerrado or plains; and the sertdo or semi-arid "outback". Themata atlatitica is by far the most populous of these areas, in which are located the State'smajor urban centers, including Salvador -- the State's capital -- and the nine other citieswhich form the Salvador Metropolitan Region (RMS). Bahia is divided administrativelyinto 15 "economic regions," on the basis of geographical and economic similarities.

A. ECONOMIC ACTIVITY

3.2 The State's economic activity has driven its patterns of urban growth.Traditionally an agricultural region (with 74% of its residents in rural areas in 1950), theState relied on primary export commodities such as cocoa and other agricultural productsuntil the 1 970s when the cocoa market collapsed and the State began to diversify intoother areas. Major efforts to industrialize the economy stem from this era, with theconstruction of refining/petrochemical, pulp and paper and mining and metallurgicalactivities. While economic activity in 1960 was primarily agricultural, by 1993 just 14.5%of the State's GDP of about US$20 billion was produced in the primary agriculturalsectors, with 34.6% in the secondary industrial sectors and 50. 1% of GDP produced in theservice-related sectors (Annex 3A). Industrialization has brought wealth to the State, withGDP of the State the sixth in Brazil, amounting to 5% of the country's total GDP. Thistransformation of the State's economy has brought a dramatic shift in patterns of urbangrowth, with a large part of the population and a large share of GDP generated in urbanareas, particularly in the RMS.

B. URBANIZATION

3.3 As recently as 1980, Bahia was still essentially rural, with less than half itspopulation (49%) living in urban areas. This reflects the traditional rural character of theNortheast, and the fact that it industrialized more recently than Brazil, thus giving itslower urbanization rates than the average for Brazil. By 1991, however, roughly 60% ofBahia's population, or about 7 million people, lived in urban areas (Annex 3B). While thisleaves Bahia significantly less urbanized than Brazil as a whole (where the average ofurban population as a percent of total is 75%), this level matches the average urbanizationof the Northeast Region. Although several Northeastern states have higher rates ofurbanization, Bahia has by far the greatest absolute number of urban dwellers, with nearlyone-third (27%) of the Northeast's total urban residents, and 28% more than the next-ranked urban state (Pernambuco). In fact, the states of Pernambuco, Ceara and Bahiatogether are home to two-thirds of the urban residents of the Northeast. Bahia has 415municipalities, 225 of which have total populations over 15,000 (Annex 3C). Projections

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indicate that by the year 2000, Bahia will have 14.7 million people, or 67% of the total,living in urban areas.

3.4 Bahia has fewer smallholdings of less than two hectares than the rest of theNortheast, with roughly 85% of all smallholders being owners (compared with 56% in theNortheast). Further, drought is not nearly as pervasive as in Ceara, and in the west ofPernambuco and Piaui. These factors make conditions of rural subsistence farming lessdifficult in Bahia than in many other areas of the Northeast, and help explain the stillrelatively large rural population, despite significant industrialization.

C. SOCIAL INDICATORS

3.5 While it is one of the country's richest states, Bahia's large population gives it acomparatively low per capita income of US$1,660, or about 60% of the country's average.Further, wealth is unevenly distributed, with about one-third of the population livingbelow the poverty line (Annex 3D).7 The State has the second-lowest level of literacy inthe Northeast (a region which ranks among the worst in Brazil), after Alagoas. Othersocial indicators confirm the notable contrast between Bahia's comparatively well-offstatus within the Northeast Region and the poor quality of life it affords most of itsresidents. Sanitation services are among the Region's worst: 43.7% of Bahia's residents(73.9% in urban areas) have access to piped water supply (only the State of CearA haslower coverage); 5% of residents (8.4% in urban areas) have collected waste water (onlythe State of Piaui, the poorest state in the country, has lower coverage). There is nomeaningful sewage treatment (Annex 3E). As could be expected from such indicators,60% of children's hospital visits are caused by poor sanitation, with 30% of the deaths ofchildren under the age of one year old due to water-borne diseases. There are wideregional differences among the State's fifteen economic regions (Annex 3F).

D. THE STATE'S DEVELOPMENT PRIORITIES

3.6 Since the early 1990s the State recognized this contrast between its economicwealth and the condition of misery of most of its residents. The State's objective,continued under the current administration which took office in early 1995, is tomodernize and expand its industrial base, with the objective of bringing the State to thirdor fourth place in terms of economic strength, while at the same time improving thequality of life for its residents. In order to meet this objective, the State has established aclear developmental strategy, at the center of which is the need to strengthen theadministration of urban areas, particularly in the State's interior. The objective is togradually shift from providing intermediate goods to the provision of finished products,both for export to other states and countries, and to meet the needs of the State'sincreasingly large urban-based markets. Economic growth will bring increased

7 The poverty line is here defined on the basis of the report Brazil: A Poverty Assessment (March1995) as a per capita income of about one-third the minimum wage (of September 1990, or aboutUS$60) in rural and urban areas of the Northeast, and about half the minimum wage in the case ofSalvador.

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employment opportunities, and will be balanced by a program of investments in the socialsectors, particularly education and health, to prepare a well-qualified work force. In orderto attract investment, however, the State will need to diversify away from its currentgeographic industrial center which is the Salvador Metropolitan Region (RegiaoMetropolitana de Salvador-RMS). This implies strengthening of the cities in the interior,so that they are well-administered and self-sufficient, and attract investment and provideurban services for their local communities. The proposed project is a direct result of theState's multi-year development plan and its development strategy beginning more thantwo years ago in the previous administration.

3.7 Investment priorities for State development have focused on ongoing projects tosupport the health and education sectors, the reformulated rural poverty projects, andsupport to the RMS. Planned investments which are of the highest priority in the Stateadministration are cleanup of the Bahia dos Todos os Santos in the Salvador Metropolitanarea, financed by an IDB loan, a follow-up rural poverty alleviation project supported by aWorld Bank loan (3917-BR), and the proposed municipal infrastructure development andmanagement project.

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4. THE PROJECT

A. PROJECT OBJECTIVES AND RATIONALE

4.1 Objectives. The primary objectives of the proposed Bahia Municipal ManagementProject (PRODUR) are to:

(a) improve the living conditions of the urban poor, through: (i) developmentof detailed, reliable systems for mapping of urban poverty in the state toguide state and local investment strategies; and (ii) a poverty-targetedprogram of urban upgrading in critically poor urban areas, or bolsoes depobreza (pockets of poverty).

(b) increase municipal public sector efficiency and sustainability of financingfor key municipal services;

(c) support privatization and concessioning of service delivery,

(d) increase cost recovery of municipal investments; and

(e) strengthen municipal financial management capacity, especially for effectiveexpenditure control and capital budgeting.

4.2 These project objectives have been explicitly defined in an Urban DevelopmentPolicy. The State is commited to strengthening local governments, through sound fiscaland administrative management, accountability and efficiency in investments and currentexpenditures and equity in service provision. As one of the key means of achieving thesegoals, the State's intention is to reduce discretionary transfers to municipalities and insteadchannel these funds as counterpart to the PRODUIR program, where they will be investedaccording to clearly-defined criteria. Urban areas are expected to play a major part in thefuture economic growth of the State.

B. PROJECT DESCRIPTION

4.3 The project would consist of four primary components: Municipal Reform (MR)(US$10.0 million, 4.5 % of total project costs); Institutional Development (ID) (US$10.0million, 4.5% of total project costs); Urban Infrastructure (UI) (US$186.5 million, 84%of costs); and poverty-targeted Urban Upgrading (UU) (US$15.5 million, 7% of projectcosts). A detailed project description is provided in Annex 4A, and is summarized below.

Part Al: Municipal Reform (MR)

4.4 The Municipal Reform component, which is being tried on a pilot basis, wouldfinance basic reforms that would reduce the role of the municipal government in the

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delivery of urban infrastructure and social services where appropriate. This is to beaccomplished through either privatizing or using private concessions for municipalservices such as water supply and sanitation, solid waste collection and disposal, bus andother transport, operation of markets and slaughterhouses. Funds under the MRcomponent would finance: (i) the technical studies needed to define the reforms; (ii) theactual costs of specialist assistance to implement the reforms (e.g., the cost of auditspecialists and investment firms); and (iii) the incremental recurrent cost of the actualprivatization or concession (for instance, if a municipality decided to privatize its solidwaste collection service, the loan could finance the cost of the transfer to the private entityon a declining basis).

Part A2: Institutional Development (ID)

4.5 The institutional development (ID) component (Part B) consists of technicalassistance, training and equipment purchases for municipalities and for CAR, as well asstudies associated with the modernization and administrative reforms of the municipalities.Needs would be evaluated in three areas: (a) fiscal and administrative; (b) planning; and(c) training. The menu of possible ID interventions are shown in Table 3, and wouldinclude, inter alia:

Table 3: Eligible Institutional Development Investments

Investments Description

Fiscal and Administrative Upgrading property tax cadastres; improving procedures,policies and physical infrastructure for billing andcollection of property and other taxes and tariffs; andimproving procurement procedures.

Planning Preparing and updating master plans; updating realproperty mapping; and works and construction codes andtechnical standards. Also included would be assistancefor preparation of environmental legislation andstrengthening local environmental councils.

Training Training in areas complementary to above, includingother priority areas such as environmental education.

4.6 Of the total of 415 municipalities in the State, it is expected that about 77 willparticipate in the Municipal Reform and the Institutional Development components.These would be the key to entry into the PRODUR program. Individualized technicalassistance and training plans for the MR and ID components would be developed for each

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municipality on the basis of a simple diagnostic questionnaire based on rapid-assessmentmethodologies successfully employed in the South of Brazil and elsewhere.

4.7 Technical assistance interventions would be combined with on-the-job training, toensure effectiveness. On the basis of the diagnosis, a Municipal Reform and InstitutionalDevelopment Plan, or Plano de Reformas e de Modernizaqao InstitucionalMunicipal(PRIM) would be prepared together with the executing agency, CAR. It would then bediscussed and agreed with each municipality in consultation with local groups andrepresentative bodies, setting specific targets for municipal reforms as well as for financialand institutional improvements. To encourage participation in this initial phase of theproject, and ensure wide access to all municipalities, preparation of PRIMs would begrant-financed. Once committed to such a satisfactory PRIM, municipalities would beeligible for grants for technical assistance and training. Following initiation of thisprocess, and providing adequate creditworthiness (see paras. 5.9-5.10), clientmunicipalities would be eligible to apply for sub-loans for infrastructure investments.Grants for technical assistance would be linked to performance standards regardingresource mobilization, cost-recovery and management efficiency which, in turn, would belinked to sub-project eligibility criteria for infrastructure (para. 5.16).

4.8 This approach builds on past sector work and project experience by establishing along-term plan for strengthening of local governments. Both the willingness to reform andto undertake the institutional development components increase the level of commitmentfor capacity strengthening of local governments by working through a state-levelinstitution which will develop a strategy, create procedures, set standards and norms tofacilitate institutional strengthening of municipalities. Implementation of technicalassistance and training would be done through private sector, university and otherproviders, with standard-setting and supervision and monitoring by CAR, which over timewill shift to providing "wholesale" interventions aimed at fostering private sector deliveryof technical assistance and training.

Part B: Strengthening of CAR and poverty study

4.9 A technical assistance package has also been developed under this component thatwould strengthen the CAR in this role. Also included would be a statewide poverty-mapping effort which would enable the State to gauge the extent to which the needs of theurban poor were being addressed by the project -- and make mid-term adjustments ifrequired -- as well as serving as an instrument to guide other State programs.

Part C: Urban Infrastructure (UI)

4.10 Urban infrastructure (UI) investments (Part C) would focus on basic urbaninfrastructure for which municipalities typically do not have sufficient resources withoutexternal financing. It is estimated that the 77 or so municipalities with urban populationsabove 15,000 would be the universe among which clients would be drawn for theinfrastructure component. All these municipalities are expected to participate over the lifeof the Bank-financed project. Sub-project investments would be fully repaid at long-termmarket-approximating interest rates (para. 5.5), with full cost recovery via user charges

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based on economic costs, or indirectly via increased property values and tax collection asa result of infrastructure improvements (para. 7.6 and Annex 7). Investments shown inTable 4 would be eligible:

Table 4: Eligible Infrastructure Components

Investments Description

Urban These would be the large primary investments, which would be carried outInfrastructure in an integrated fashion whenever possible (e.g., sewerage networks

togetlier with street paving and drainage).

Water Water treatment and amplification of production; incremental networkextension and domestic connections; operational and commercialimprovements, such as metering, leak detection and rehabilitation ofequipment.

Sewerage Equipment for treatment systems, extension of networks and domesticconnections. Well-tested, low-cost technologies, in particular in smallcommunities, would be encouraged.

Solid Waste Solid waste collection equipment, construction of landfills, and equipmentfor final disposal. In this component also well-tested, alternative low-costsolutions would be encouraged.

Paving and Street paving, macro- and micro-drainage, flood and erosion control,Drainage channeling of watercourses and vias sanitarias.

Complementary A group of smaller-scale investments, which are usually done inInvestments conjunction with the larger basic infrastructure investments above,

including, inter alia, street lighting, sidewalks and trees/shrubbery.

Regional A small amount of funds would be available for well-justified regionalInvestments cooperative investments, such as multi-municipal landfills. The project also

includes the construction of municipal markets and slaughter houses as wellas the construction or expansion of air, road and water transport passengershelters and tourist bureaus.

Part D: Urban Upgrading (UU)

4.11 The urban upgrading component would be targeted to areas with averagehousehold income below three minimum wages per month. The objective of thecomponent would be to provide a package of integrated urban infrastructure investments

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to low-income residents in the peripheral areas of cities and towns, where the bulk of theurban poor are located. The component would be based on standardized designs and unitcosts and would be maraged by a special unit within CAR. Eligibility criteria wouldinclude that: (a) beneficiary areas must be within a maximum threshold income level (forexample, three minimum salaries per month per household); (b) the investments would belimited by a maximum project cost per capita; (b) investments should be integrated; (c)community participation and organization would need to be demonstrated; (d) residentswould need to have possession of land title, or the area would be able to be converted, orresidents would need to have lived in the area for equal to or more than the amount oftime stipulated by law before titling becomes automatic. Since this is a new approach toinfrastructure service delivery in the State, the overall scope would be limited to US$15.5million, and it would start small in the first year (limited to US$2.0 million). Publicity forthe program would include reference to the limited funds available under this componentfor the first year, in order to stimulate demand. It was agreed that the municipalities wouldcontribute 15% of the cost of the urban upgrading component. The Bank loan will finance45% of the total cost and the remaining 40% will be covered by the state. Both the WorldBank funding and the State contribution would be passed on to the municipalities asgrants.

C. PROJECT COSTS AND FINANCING PLAN

4.12 Project Costs. The project cost table is shown in Table 5 below. As shown, totalproject costs are estimated to be US$222.0 million equivalent, including taxes. Theproposed Bank loan of US$100.0 million equivalent would finance about 45% of totalcosts (50% of costs less taxes). A detailed table of cost estimates is presented in Annex4B.

4.13 Project costs would consist of about US$10.0 million equivalent (or 4.5% ofproject costs) for each of the municipal reform and institutional development components;US$186.5 million (or 84% of costs) for urban infrastructure; and about US$15.5 million(about 7% of costs) for low-income urban upgrading. Costs have been calculated inBrazilian reais (base costs of 1995 updated to May 1996) and converted to equivalent USdollars at prevailing exchange rates. The aggregate scale of investments at the local levelwas determined by the estimated demand for services, borrowing capacity ofmunicipalities, and counterpart payment capacity of the State and municipalities (see para.6.8). A total of 77 municipalities have already been screened for the PRODTR programand 14 sub projects have been appraised for inclusion in the first year program.

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Table 5: Project Costs by Component - (in US$ million equivalent)

% of

Component Local Foreign Total % Foreign Total Costs

Al Municipal Reform 8.0 2.0 10.0 10.0 4.5

A2. Institutional Development 8.0 2.0 10.0 10.0 4.5

B. Strengthening of CAR

C. Urban Infrastructure 141.1 45.4 186.5 24.0 84.0

Basic Sanitation 120.0 39.9 159.9 25.0 72.0

Complementary Investments 12.4 3.3 15.5 20.0 7.0

Regional Investments 8.9 2.2 11.1 20.0 5.0

D. Low-Income Urban 12.4 3.1 15.5 20.0 7.0Upgrading

TOTAL PROJECT COSTSa'/ 169.5 52.5 222.0 24.0 100.0

a/ Including about US$22.0 million in taxes.

4.14 The foreign exchange component is estimated to be about US$52.5 million (24%of base costs). Indirect taxes are about US$22.0 million (10% of base costs) and will befinanced by the State. Due to the project's programmatic approach -- whereby the Bankloan would finance a time-slice of municipal investments -- contingencies have not beenbudgeted. Rough cost estimates for civil works are based on existing engineering designsand unit costs of other similar investments in Brazil, supported by engineering estimatesand recent contract prices. Consultant service costs are based on prevailing local andforeign person-month rates.

4.15 Financing Plan. The project financing plan is shown in Table 6 below. Asindicated, the project would be financed by the proposed loan, totaling US$100.0 million(45% of project costs); by State resources of about US$88.8 million (40% of projectcosts); and by municipal counterpart of about US$33.2 million (15% of project costs).The proposed loan would finance all expected foreign exchange costs (about US$52.5million). The loan would also finance about US$47.5 million of local expenditures, due tothe widespread availability of competitive locally-provided goods and services in Brazil.

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D. THE BORROWER AND EXECUTING AGENCY

During Negotiations, agreement was reached on the project financing plan and theBorrower's guarantee regarding necessary project counterpart funds

Table 6: Project Financing Plan - (in US$ million equivalent)

Bank %State Municipalities Bank Total Total

Municipal Reform 5.5 0.0 4.5 10.0 45.0%

Institutional 5.4 0.0 4.6 10.0 46.0%Development(including CAR andpoverty study)

Urban Infrastructure 74.6 28.0 83.9 186.5 45.0%

Low-Income 6.2 2.3 7.0 15.5 45.0%Upgrading

TOTAL 91.7 30.3 100.0 222.0 45.0%

(| s%oftotal) 41.4% 13.6% 45.0% 100.0%

4.16 The State of Bahia. The Borrower would be the State of Bahia. The State woulduse the proceeds of the Bank loan and its own counterpart funds to capitalize a municipaldevelopment fund (FUNDlURBANO), to be managed by a commercial bank to be selectedunder procedures to be agreed. A financial evaluation of the State is given in paras. 6. 1-6.2.

4.17 The State's Companhia de Desenvolvimento e Avao Regional (CAR) would be theproject's executing agency. During Negotiations, agreement was reached that CAR wouldexecute Parts A-D of the project. CAR would have primary responsibility for all aspectsof project implementation, including evaluation of sub-borrowers' financial andinstitutional capacity, diagnosis of institutional requirements and formulation of technicalassistance and training packages, evaluation of technical, economic and financial feasibilityof sub-projects, and all general aspects of management, operation and monitoring of theproject. These procedures would all be undertaken on the basis of agreed OperationalManuals (para. 5.3). Environmental evaluations would be done through the State's Centrode Recursos Ambientais (CRA; see para. 5.20 and Annex 5H).

4.18 CAR was created by State Law in 1983 as a public "autarky," and latertransformed into a public company in order to provide more flexibility in implementationof its responsibilities. CAR's shares are wholly owned by the State. CAR's ExecutiveDirector is appointed by the Governor. The Secretary of Planning serves as Chairman ofthe Board of Directors. CAR is headquartered in the State's capital, Salvador, and has

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regional offices in seven medium-sized cities around the State. CAR has historically actedprimarily in the rural sector, and in this capacity has significant experience implementingdecentralized programs, including the World Bank-financed Northeast Rural DevelopmentProgram (or PAPP; Loans 2523-BR and 2524-BR). The implementation of the PAPP inBahia was in fact one of the most successful of these state-based programs. As of 1991,CAR has also been given responsibility for the State's programs in urban areas. This is asignificant challenge for CAR, which has an excellent history and experience in the ruralsectors but which has relatively little experience in urban areas. A further challenge stemsfrom CAR's recent assumption of the responsibilities of technical assistance tomunicipalities, a role previously performed by a now-defunct State company, CEMUR.

4.19 Detailed discussions have been held with the State and CAR regarding theinstitutional capacity of the latter, and plans for strengthening capabilities in the urbanarea. Plans include restructuring CAR into three Departments: (a) Regional Development(for rural-oriented programs); (b) Urban Development; and (c) Municipal Action (forsupport to institutional strengthening of local governments). The management andinfrastructure aspects as well as the institutional development and municipal reformcomponents of PRODUR would fall under the Urban Development Department. Theongoing PAPP and its successor, the Northeast Rural Poverty Alleviation Program(NRPA), would be handled by CAR's Regional Development division. CAR also hasplans to establish about 12 additional regional offices, in the context of the PRODUR andNRPA projects.

4.20 Regarding specific project tasks, CAR has established a financial nucleus in theUrban Development Department, which has been trained in public financial analysis, aswell as similar groups for economic and technical evaluation of sub-projects. It wasagreed that CAR would hire specialist consultants, as needed, to assist with projectimplementation.

4.21 Status of Proiect Preparation. Project preparation began during the late 1980s bya group in the office of the Secretary of Planning. Many of those involved in this initialstage of preparation remain involved in the current State government administration;continuity is an important factor in the advanced status of the project. Equally important,CAR has hired consultants to assist in the preparation of the project: one to guide them inthe details of project implementation, and a specialized firm to assist in the preparation ofoperating manuals. This seems a successful approach to project preparation which may bereplicable in other projects. Detailed designs for all first-year sub-projects are underway.These and other documents related to project preparation are available in the Project File(see Annex 8).

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5. PROJECT IMPLEMENTATION

A. THE URBAN DEVELOPMENT PROGRAM

5.1 The Bahia Municipal Infrastructure Development and Management Project(PRODUJR) will support the development of municipal reforms and efficient financialmanagement capacity on the one hand, and priority infrastructure investments on the otherhand. The Institutiohal Development and Municipal Reform Components will be financedby grants to the municipalities and the Infrastructure component will be financed throughan urban development fund. The project's reform component will ensure that themunicipalities in the state reduce their role in the delivery of urban services throughprivatizing and concessioning of most of such services. Through the proposed project, theBank loan and State counterpart funds would capitalize the PRODUR MunicipalDevelopment Fund (FUNDURBANO) which would on-lend resources to municipalitiesfor economically-viable urban infrastructure investments on the basis of well-defined sub-borrower creditworthiness and sub-project eligibility criteria. To ensure that as many ofthe municipalities as possible participate in the municipal reform and institutionaldevelopment components the Bank loan and the state counterpart will fully finance thesetwo project interventions on a grant basis. Poverty-targeted urban upgrading would befinanced by a combination of grants and local contributions (para 4.10).

5.2 While CAR would handle all day-to-day activities of PRODLUR, program policywould be handled by a Board of Directors. The Board would be chaired by the StateSecretariat of Planning, and membership would include representatives from theSecretariat of Finance, other government agencies, and the Association of Municipalities.CAR would serve as the Executive Secretariat of the Board. The organization chart forPRODUR is presented in Annex 5A. Institutional and implementation arrangements forthe proposed project are detailed in Annex 5B.

5.3 Operational arrangements, based on those developed under similar ongoingprograms in the states of Parana, Rio Grande do Sul, Minas Gerais and Ceara, are set outin the Program's Operational Manual (OM). The OM volumes include:

(a) Orientation Manual;

(b) Publicity Flier;

(c) Guidelines for Evaluation of sub-borrowers,

(d) Procurement Guidelines and Standard Bidding Documents,

(e) Sub-Project Evaluation;

(f) Disbursement Manual; and

(g) Monitoring and Evaluation.

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Final versions were presented for review at Negotiations at which it was ageed that thePRODVR program would be carried out in accordance with the Operational Manual(OM). After initial testing the OM would be further simplified and summarized in smallleaflets which would be used in the future marketing of the program. The OM isdescribed further in Annex 5C.

B. THE PRODUR MUNICIPAL DEVELOPMENT F UND

5.4 The PRODUR Municipal Development Fund (FUNDURBANO) would beestablished by State law (para. 5. 18). As noted, CAR, would perform all sub-project andsub-borrower evaluations, and has experience in this type of review (paras. 4.17-4.20).Loan administration and management of the fund would be undertaken by the statedevelopment bank of Bahia, DESENBANCO. About US$84.0 million equivalent of theBank loan would capitalize the FUNDURBANO, together with State resources, in a two-to-one proportion. This is equal to the full amount less about US$16.0 million, which,together with State counterpart would finance the municipal reform and institutionaldevelopment as well as the low-income urban upgrading component, which would befinanced separately from the FUNDURBANO . The FUNDURBANO would on-lend tomunicipalities and up to 85% of the cost of eligible infrastructure sub-projects. Theremaining counterpart (minimum 15%) would be provided by sub-borrowers, throughpayment of invoices (or in-kind labor contributions, in the case of smaller municipalities).

5.5 Terms and Conditions. Sub-loans would be made to sub-borrowers in threecategories, with terms of up to five, 10 and 15 years (including grace periods of one tothree years), depending on the cost-recovery profile of the investments. Sub-loans wouldcarry an interest rate equal to the rates of the World Bank loan to Bahia plus a "spread"of 3% yielding an estimated project average rate on the order of 10%). All sub-loanbalances, disbursements and repayments would be denominated in local currency. It wasagreed that local currency sub-loan amounts and balances would be adjusted for inflationusing the prevailing rate of inflation in Brazil as measured by the IGP-M or any otheradjustment index satisfactory to the Bank and Bahia. Table 6 presents sub-loan terms andconditions for each type of investment.7

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Table 7: Sub-Loan Terms and Conditions

Repayment Grace

Type of Investment Terms Period

Purchase of Computer Equipment, Solid Waste up to up toEquipment, Water and Sewerage System 5 years 1 yearImprovements..Construction of sidewalks,urbanization and planting of trees and shrubbery.

Water Distribution and Sewage Connections, up to up toPaving, Public Lighting, Micro-Drainage. Municipal 10 years 2 yearsmarkets, slaughter houses; air, road and watertransport passenger shelters and tourist bureaus.

Water Production and Treatment, Sewage up to up toTreatment, Solid Waste Disposal, Macro-Drainage. 15 years 3 years

5.6 It was agreed during Negotiations that sub-loans would be guaranteed bymunicipalities' value-added tax (ICMS) revenues (or, in cases where this is insufficient, bythe municipal participation fund (FPM). If a case of non-payment occurs, requiring theinvoking of a guarantee, PRODUR would not re-lend to that sub-borrower until thesituation is satisfactorily resolved. In order to ensure a wide distribution of projectbenefits, it was agreed during Negotiations that no single sub-borrower would be able toborrow annually more than US$15 million, without prior consultation between theBorrower and the Bank.

5.7 Flow of Funds. The Borrower has provided a diagram showing the projected flowof funds from the various financing sources to CAR, the financial agent and sub-borrowers(Annex SD); and a model which simulates funds flows on basis of the terms, estimatedlending, and returns to the FUNDURBANO over a 20-year period (available in the ProjectFile.) If the project is implemented according to schedule, the revolving nature of theFund would enable it to continue lending funds of roughly the same order of magnitude inthe five-year period following project completion as was lent during the peak of projectexecution.

C. CAR's APPRAISAL PROCESS

5.8 CAR's Urban Department (DU) would handle all aspects of management andoperation of the PRODUR Program, including preparation of all sub-borrower and sub-project appraisals according to selection criteria set out in the Operational Manual.During appraisal, CAR presented the Bank with evidence of satisfactory increased staffing

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and computerization of the DU. Annex 5E sets out in detail CAR's appraisal process,which is summarized below.

Sub-Borrower Eligibility Criteria

5.9 Given PRODUR's essentially reform and urban infrastructure objectives, it willfocus its activities principally in those municipalities with significant urban characteristics.In addition to meeting the creditworthiness criteria (see Chapter 6) municipalities wishingto participate in PRODUR would have to meet one of the following criteria: (i) have anurban population of at least 15,000 in 1991 according to the census of the InstitutoBrasileiro de Geografia e Estatistica (Brazilian Institute of Geography and Statistics-IBGE); or (ii) be one of the 33 strategic urban centers as defined in Bahia's UrbanDevelopment Strategy.8 In addition, municipalitites with a debt capacity of US$1 millionare eligible independently of their population. It is expected that about 77 municipalitieswill be eligible to participate in PRODUR. Full sub-borrower eligibility criteria aredetailed in the Program's Operational Manual. Key steps for entry are as follows:

(a) signature of a Participation Agreement (Convenio de Adesao) whichformalizes municipal interest in PRODUR and commitment to itsprinciples;

(b) completion of an assessment of the potential for municipal reform as wellas an institutional and financial diagnosis, according to the rapidassessment methodology developed and tested under similar programs inother states;

(c) establishment of an agreed set of institution-building actions, with clearly-defined performance targets;

5.10 To undertake infrastructure sub-loans, municipalities and water agencies wouldhave to meet the following additional creditworthiness criteria:

(a) demonstrated compliance with Federal legislation on payment of taxes andother obligations;

(b) a clear demonstration that either:

(i) the municipality's primary surplus during the preceding year is atleast 15% of its total revenues (excluding credit); or

s These cities are highlighted in the State's current Urban Development Strategy because of theirpotential for economic development related to major industrial or infrastructure projects or tourism.Thirty strategic cities (with urban population of less than 15,000) are included: Conde, Jandaira,Cachoeira, Sao Felix, Camamu, Ubaitaba, Alcobaca, Caravelas, Mucuri, Nova Vicosa, Prado, SantaCruz de Cabralia, Araci, Jeremoaba, Monte Santo, Tucano, Riachao do Jacuipe, Curaca, Andarai,Boquira, Lencois, Macaubas, Mucuge, Rio de Contas, Riacho de Santana, Correntina, Formoso doRio Preto, Riachao das Neves, Santana, Livramento do Brumado, Santo Se, Capim Grosso and SaoDesiderio.

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(ii) total outstanding and proposed debt and guarantees do not exceedtotal municipal revenues (excluding credit) of the previous year,adjusted for inflation;

(c) demonstrate that it has adequate counterpart funds (minimum 15 % of thecost of the sub-project);

(d) show adequate mechanisms for cost recovery; and

(e) provide a state or national transfer as subloan guarantee.

Sub-Project Eligibility Criteria

5.11 Sub-project eligibility criteria are set out in the OM. During Negotiations it wasagreed that all sub-projects would undergo technical, economic, financial andenvironmental evaluation by a team of CAR staff.

5.12 Technical evaluation involves analysis of demand for the service, anddemonstration that the chosen alternative is the least-cost means of meeting demand. Thisevaluation would be performed by CAR's technical unit, which would be comprised ofurban engineers, with the assistance of specialized consultants as necessary (for examplefor solid waste disposal, or alternative sewage treatment). Proposals will be returned tomunicipalities for revision if necessary. In the case of sewage treatment and solid wastedisposal sub-projects, low-cost, well-tested9 alternative technologies such as anaerobicsewage treatment should be encouraged, where appropriate.

5.13 Economic cost-benefit analysis would be carried out to determine project viability.The minimum criteria for sub-projects would be that they provide an internal economicrate of return (IERR) which meets or exceeds the opportunity cost of capital, estimated at12%. In the case of revenue-earning services, such as water, sewerage and public lighting,economic benefits would be calculated on the basis of tariff revenues as a proxy forwillingness to pay. In the case of non-revenue earning services, such as drainage andpaving, economic benefits would be based on increased land values as a result of theinfrastructure improvements. For those sub-projects estimated to cost less thanUS$500,000, estimation of per capita benefits would be sufficient, providing the technicalsolution is least-cost and benefits are shown to be largely within the municipality. Healthbenefits would also be quantified using disability-adjusted life years (DALYs) as a measurefor sewerage treatment and macro drainage sub-projects (para. 7.6).

5.14 Financial cost-benefit analysis would provide the basis for determining cost-recovery. All infrastructure sub-projects (with the exception of some sewage treatmentand solid waste disposal), are expected to achieve full cost recovery. Sub-projectinvestments would be linked to specific targets to increase user fees and taxes, to be

Several Brazilian States and localities (i.e. the State of Parana) have developed simple low-costprimary sewage treatment, for example, which have been well-tested, with favorable results.

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agreed with municipalities in the PRIM and reflected in the terms and conditions of sub-loans for infrastructure investments.

5.15 Environmental Screening. All necessary environmental evaluation and assessmentwould be part of required documentation (para. 5.20 and Annex 5F). Environmentalassessments, where required, would be completed by private consultants, evaluated byCRA and submitted to CAR prior to signature of sub-loan contracts.

5.16 Infrastructure investments would be linked to specific institutional developmentand/or municipal reform interventions. For example, investments in solid waste collectionand disposal, if determined to be a municipal priority and economically viable, could beaccompanied by appropriate increases in the relevant user charges and/or taxes, technicalassistance in zoning and land-use, in the improved enforcement of local environmentalregulations and training for involved staff at the local level. In this way, the institutionaldevelopment and infrastructure components would be fully complementary. For each sub-borrower, a team of one engineer, one economist/financial analyst and one institutionalspecialist will be assigned to work together with local authorities, from diagnosis andPRIM to evaluation and supervision of the infrastructure investments.

Review Procedure

5.17 Given the large number of small and medium-sized sub-projects expected duringthis project, CAR would undertake the evaluation of municipal sub-components beyondthose evaluated during appraisal according to agreed criteria set out in the program'sOperational Manual10 Below these amounts ex-post reviews, on the basis of spot-checking, would be undertaken during supervision. Sub-projects would be considered forreview until three months before the project's Closing Date.

D. LEGAL ARRANGEMENTS

5.18 Implementation arrangements for the project would be formalized in the followinglegal documents and other minutes of understanding:

(a) State law authorizing the State to borrow from the Bank'

(b) State law establishing the FUNDURBANO;

(c) State decree regulating the FUNDURBANO;

(d) Contract(s) between the State of Bahia, CAR and the financial agent(s);

(e) Model participation agreement (conWvnio de adesdo) between the State,CAR and municipality;

0 It should be noted that this review is separate from the prior review thresholds for procurement(para. 5.25) and disbursement (para. 5.27).

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(f) Model negotiation agreement (minute of understanding) between CAR andmunicipality (for the municipal reform and/or institutional developmentcomponent);

(g) Model Sub-Loan Contract between the financial agent, CAR andmunicipality for on-lending fund in support of a sub-project;

(h) Model Grant Agreement between the State and the municipality forretransmitting funds to support a municipal reform and/or institutionaldevelopment, or to partially support an urban upgrading component; and

(i) Model municipal law authorizing a municipality to participate in PRODUR.

5.19 Drafts of all of these documents have been prepared. Agreement on the finalversion of the model Sub-Loan Contracts and Grant Agreements was reached atNegotiations. It was further agreed that all conditions present in the legal agreementsbetween the Bank and CAR, the State and the Federal Government, would be reflected inthe sub-agreements, as necessary.

E. ENVIRONMENTAL ASPECTS

5.20 Specific guidelines for evaluation of municipal projects with environmental impacthave been established by the State environmental agency, Centro de Recursos Ambientais(CRA) for the purposes of the project. The new rules establish guidelines forenvironmental screening by project size and expected impact (on the basis of physicalmeasures, such as pipe size for water and sewerage). These guidelines are roughlycomparable to similar ones in other states, and are compatible with both federalgovernment law and Bank guidelines. There are three categories: the first, for projects ofsignificant size and impact, would be a full environmental impact assessment and report(EIA/RIMA); the second category, for projects of smaller size and impact, would be asimplified environmental assessment, or environmental control report (RCA). The thirdcategory of investments would require only licensing. Environmental assessments underthe project will be prepared by private consultants and reviewed by CRA. TheOperational Manual would stipulate that environmental assessment would be conducted asneeded, consistent with Brazilian law and Bank guidelines, prior to signature of sub-loancontracts. It was agreed that EIA/RIMAs and RCAs would have been completed for sub-projects with environmental impact," consistent with Brazilian and State laws and Bankguidelines, prior to any disbursement on the relevant component. It was also agreed thatthe Bank would have prior review of any resettlement plans. Furthermore, the stategovernment would prepare and adopt an acceptable framework for resettlement plans byAugust 31, 1997. None of the 14 sub-projects to be implemented during the first yearinvolves resettlement. CAR would provide technical assistance to municipalities andoversee the environmental screening process, from selection of consultants (for which itwill maintain an open data base of firms) to subsequent evaluation by CRA. CAR will also

l Although not foreseen under the project, this would include any impact and plans for resettlement, ifnecessary.

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maintain an agreed model terms of reference for environmental assessments, prepared inconjunction with CRA and the Bank (Annex 5F). CRA is being strengthened to performits role under the recently-approved Pollution Control Project for the Bahia de Todos osSantos, financed by the Inter-American Development Bank (IDB). Significant involuntaryresettlement (more than 100-200 individuals) is not foreseen under this project. In theeven that any such resettlement is proposed in the course of project implementation,however, the state and CAR agreed that any sub-project involving such resettlementwould be subject to the prior review and appraisal of the Bank prior to disbursement, andthat resettlement plans satisfactory to the Bank would be prepared.

F. PROCUREMENT

5.21 All procurement of goods and works would be carried out following the WorldBank's Guidelinesfor Procurement under IBRD Loans and IDA Credits (published inJanuary 1995 and revised in January 1996). Civil works under the proposed projectwould represent about US$ 124.0 million, or 56% of total project costs; equipment andmaterials about US$77.7 million, or 35%; and consultant services, including technicalassistance, training, studies, engineering design and works supervision, about US$20.4million, or 9% of costs. Proposed procurement arrangements for the project aresummarized in Table 8. Annex 5G provides estimated profiles for sub-project contracts

5.22 Civil Works. The estimated value for civil works contracts is US$124.0 million.Due to the nature of the project, there will be a number of small contracts as well as largerones. Most contracts will be scattered throughout municipalities in the State and averageUS$100,000 - US$3.0 million in value, with a few exceptions of works for larger projects,expected to cost over US$5.0 million. It is expected that the smaller, dispersed contractswill not be attractive to foreign bidders. It was agreed that all contracts for civil worksestimated to cost less than the equivalent of US$5.0 million, and up to an aggregate valueof US$15 rnillion per beneficiary, will be procured on the basis of national competitivebidding (NCB) procedures satisfactory to the Bank. Procurement under NCB will use thestandard bidding documents for Brazil agreed with the Bank. Foreign firms will beallowed to participate in the bidding. Above these limits, procurement would be carriedout on the basis of international competitive bidding (ICB), using standard biddingdocuments issued by the Bank. For small works costing US$350,000 or less, all contractswould be procured under lump-sum, fixed-price contracts awarded on the basis ofquotations obtained from three qualified domestic contractors in response to a writteninvitation. The invitation shall include a detailed description of the works, including basicspecifications, the required completion date, a basic form of agreement acceptable to theBank, and relevant drawings, where applicable. The award shall be made to thecontractor who offers the lowest price quotation for the required work, and who has theexperience and resources to successfully complete the contract

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Table 8: Project Costs by Element and Procurement Method(in US$ million equivalent)a

Project Element ICB NCB Otherb N.B.F. TOTAL

Civil Works 22.0 89.7 12.2 124.0(15.1) (28.5) (3.7) (47.2)

Equipment and Materials 27.6 42.1 8.0 77.7(27.6) (12.6) (2.4) (42.6)

Consultant Services -- -- 20.4 -- 20.4(10.2) (10.2)

TOTAL 49.6 131.8 40.6 0.0 222.0

of which Bank financed (42.7) (41.1) (16.3) (0.0) (100.0)

a Numbers in parentheses are the respective amounts financed by the Bank.

b Other methods include local quotations (goods and works) and hiring ofconsultants.

5.23 Goods. Purchase of equipment and materials is expected to total about US$77.7million under the project. The majority of these purchases will be small machinery,equipment and materials necessary for the installation of infrastructure services, and pipes,connections, water meters and other equipment associated with domestic water andsewerage connections. While a large number of contracts are estimated to range betweenUS$50,000 and US$250,000, there will be some scope for economy-of-scale purchasingof equipment, and a special effort will be made to identify ICB packages above theselimits. It was agreed that all contracts for equipment and materials estimated to cost lessthan the equivalent of US$250,000, and not exceeding an aggregate value per beneficiaryof US$3 million, would be procured on the basis of NCB procedures satisfactory to theBank, with foreign firms allowed to participate in the bidding. Above these limits,procurement will be carried out on the basis of ICB using standard bidding documentsissued by the Bank. ICB documents would indicate that domestic preference would applyin bid evaluation. National shopping procedures acceptable to the Bank would beallowable for small equipment purchases estimated to cost the equivalent of less thanUS$50,000, up to an aggregate of US$250.000 per beneficiary.

5.24 Consultant Services. All technical assistance, studies, training, detailedengineering design and construction supervision contracts, amounting in total to aboutUS$20.4 million, will be procured in accordance with the Bank's Guidelines for the UJse ofConsultants (August 198]), including proposals from foreign and local firms.

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5.25 The GOB's procurement regulations and procedures have been revised through anew procurement law (No. 8,666 of June 21, 1993). The new law improves a number ofprocedures, and it specifically authorizes executing agencies to procure goods and servicesfinanced by multilateral institutions in accordance with the norms and procedures of theinstitutions. But it also includes some provisions which are or can be interpreted asdiverging from Bank procurement policy. However, standard bidding documents for NCBfor goods and works have been recently agreed with GOB (April 1995), and most of thesedifferences have been resolved. Special provisions applicable to NCB procedures wereagreed during Negotiations and incorporated into the Loan Agreement. Procurementunder the project would be overseen by CAR's urban department, and managed byindividual municipalities.

5.26 Standard bidding documents and contracts for civil works and services under NCBand local quotation methods have been prepared and are set out in the OperationalManual. A model letter of invitation and standard contract for consultant services is alsobe included in the Operational Manual. All procurement under ICB (about 22% of totalproject costs) will be subject to prior Bank review of advertising, bidding documents, bidevaluation and contract awards. In the interest of expediting project execution, allprocurement under NCB would be reviewed by CAR. However, NCB procurement forworks expected to cost US$2.0 million and above, and totaling US$63.8 million, would besubject to the Bank's prior review. The proposed arrangements would provide prior-review coverage of about 56% of the total cost of Bank-financed goods and works(Annex 5G). This coverage is considered appropriate. A general announcement of thetypes and sizes of contracts to be awarded during the subsequent one-to-two year periodwould be published at the start of each year in the journal Development Business and innewspapers of wide national circulation in Brazil. Agreement was reached on theseprocurement arrangements at Negotiations.

G. DISBURSEMENT

5.27 The proceeds of the proposed loan would be disbursed according to the followingcategories and percentages:

(i) for sub-loans or grants for infrastructure investments, 53% of theapplicable disbursement under the sub-loan or grant, and 100% ofthe sub-loan or grant amounts in the case of foreign expenditures,excluding taxes;

(ii) for grants for institutional development or municipal reform sub-projects, 45% of amounts disbursed from the grant of 100% of theamount of the grant in case of foreign expenditures;

(iii) for goods purchased in connection with the institutionalstrengthening of CAR, 50%; and

(iv) for consultant services to strengthen CAR and for the studies to beundertaken by CAR, 100% of total expenditures.

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5.28 Disbursements are expected to be completed over a six-year period, as reflected inAnnex 5H. A disbursement schedule somewhat shorter than the regional profile of sevenyears is justified by the experience and competence of the executing agency and theproject's timing within the local electoral cycle. The Project's expected Completion Dateis September 30, 2001, and Closing Date is March 31, 2002.

5.29 In order to ensure efficient and timely implementation of the project, it was agreedduring Negotiations that a Special Account with an authorized allocation of US$7.0million equivalent would be established in a commercial bank acceptable to the Bank andthe Borrower. The initial allocation for the Special Account will be US$5 million untildisbursements reach US$30 million. Because the project would involve a substantialnumber of small contracts, disbursement for civil works contracts amounting to less thanUS$2.0 million, for purchase of goods amounting to less than $350,000 and for consultantservices from firms amounting to less than US$100,000 and for consultant services fromindividuals for less than US$50,000, would not require the Bank's prior review and wouldbe made under the Statement of Expenditures (SOE), as well as subloans and grants,procedure, prepared and certified by CAR, which has adequate accounting controls forthis purpose. Expenditures for contracts above these limits would be documented. Alldocumentation would be retained by the DU for inspection during Bank supervision andbe subject to review of external auditors. Because several sub-projects are well-advanced,retroactive financing of up to 5% of the loan amount for eligible expenditures incurred notmore than twelve months prior to Loan Signature, would be made. During Negotiations,agreement was reached on these disbursement arrangements.

H. ACCOUNTING AND AUDITING ARRANGEMENTS

5.30 The accounts of CAR, the project's executing agency, are examined annually byprivate external auditors, as well as State-level government auditing bodies. Accountingpractices and procedures, including the chart of accounts, have been reviewed and foundsatisfactory. During Negotiations agreement was reached on the following accounting andaudit arrangements: (a) that the financial agent would maintain a separate, consolidatedproject account of sub-project expenditures for monitoring and audit purposes, to beaudited along with CAR corporate accounts by private external auditors acceptable to theBank; and (b) that the project accounts of participating municipalities be maintainedseparately, and be subject to annual audits by the State's Tribunal de Clonias, orAccounting Tribunal, provided it continues to meet adequate standards of independence,capacity, and timeliness. The Tribunal de Contas of Bahia has been evaluated by the Bankas having the necessary independence. The reports under (a) would be furnished to theBank within six months of the end of each fiscal year. Agreement would also be soughtthat a summary of key issues noted in individual municipal audits would be preparedannually by qualified consultants and furnished to the Bank no later than eight monthsafter the end of the fiscal year. This annual report would be financed under theInstitutional Development component.

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I. MONITORING, MID-TERM REVIEW AND EVALUATION

5.31 In addition to CAR's site visits, sub-borrowers would be expected to present periodicprogress reports on project implementation (with periodicity established in sub-loan contracts),on the basis of which CAR would furnish concise quarterly progress reports to the Bank. Thesereports would compare actual and forecast progress. The detailed range of project monitoringindicators is provided in the OM. These include standard agreed performance indicatorsmonitoring physical, financial and operational progress of individual sub-projects, andaggregated project performance for all sub-projects. A set of "key impact indicators" andtargets, selected from among the group of indicators to be monitored during the project, wouldbe agreed, including inter alia: (a) number of Participation Agreements signed; (b) number ofPRIMs completed; (c) overall project completion, measured in expenditures; (d) discretionarytransfers as a percent of total State transfers to municipalities; and (e) average property tax percapita in the State (see Annex 5I). These indicators, among others, would be monitored inquarterly reports. Agreement was reached during Negotiations that quarterly reports befurnished no later than 30 days after the end of each of the following quarters: March 31, June30 and September 30, and an annual report would be prepared for the December 31 period, tobe furnished within two months of year-end. These reports would include, inter alia, themonitoring indicators set out in the OM, as well as a forecast investment plan. Reportingrequirements would begin with the first full quarter following Loan Effectiveness.

5.32 In order to review project progress, and if necessary reorient implementation, agreementwould be sought during Negotiations that a Mid-Term Review would be scheduledapproximately three years after Loan Effectiveness. Agreement was reached that the Borrower,through CAR, would prepare and furnish to the Bank an Implementation Completion Reportwithin six months after the Closing Date. The supervision plan for the project (Annex 5K)includes key specific objectives of the mid-term review.

J. IMPLEMENTATION SCHEDULE

5.33 Annex 5J presents the proposed project's agreed implementation schedule, whichoutlines key actions in project execution for smooth implementation. This will be furtherdetailed through the use of project management software, to be established and programmedduring the project's inception mission. Of primary importance are targets for ParticipationAgreements with municipalities, procurement of major works, and progress on technicalassistance interventions. This schedule is to be prepared on a rolling quarterly basis.Arrangements for project supervision are outlined in the supervision plan in Annex 5K Physicalproject supervision will be carried out by the regional offices of CAR, the DU and itsconsultants on the basis of site checks.

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6. FINANCIAL ASPECTS

A. STATE FINANCES

6.1 A detailed review of the financial situation and creditworthiness of the State ofBahia was carried out using the methodology developed in sector work on Brazilian StateDebt12 This review showed that the previous State administration embarked on a policy ofsound financial management which placed the State of Bahia in a relatively stable financialcondition, despite macroeconomic difficulties at the national level. Beginning in 1991,State officials designed a plan to put the State's financial house in order. A Federal law ofNovember 1993 (No. 8,727) gave the States a window of opportunity to reschedulecertain debts, an opportunity fully exploited by Bahia. Approximately US$1.5 billion ofState debt was rescheduled. In addition, virtually all of the debt owed by the Statetreasury to BANEB, and thence by BANEB to federal financial institutions, wastransformed into a loan owed directly by the State treasury to the Federal treasury, thusending the conflict inherent in the State's borrowing from its own bank. Previous to this,the State's financial management could be characterized as poor, with persistent currentaccount deficits until 1987. Beginning in 1990, however, the current account surpluseshave been significant. Since 1989, revenues have increased in real terms by 45% followingthe fiscal reforms of the 1988 Constitution,

6.2 The finances of the state have improved remarkably as a result of the abovemeasures. Further efforts to streamline administrative management, monitor costs moreclosely and strengthen personnel management could result in even more improvements.For instance, while there is a freeze on hiring, personnel expenses continue to be high withno mechanism for dismissing staff or for re-allocating staff with specific skills to areas oftheir comparative advantage. Likewise the budgetary process, specifically with respect tointernally financed capital investments, could benefit from a more rational allocationsystem.

6.3 The State's financial situation is set out in the tables in Annex 6A. In 1995, thecreditworthiness study showed the following results:

(a) total current revenues = US$2.8 billion.

(b) current account surplus = S$427 million.

(c) primary surplus = US$185 million

(d) primary surplus/ revenue = 6.6%.

12 World Bank, Brazil: State Debt: Crisis and Reform, Report No. 14842-BR, Washington, November14, 1995.

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6.4 The State is promoting greater municipal financial independence and autonomy,and considers the proposed project a key instrument for achieving greater municipal fiscalresponsibility.

B. MUNICIPAL FINANCES

6.5 Following the decentralization in 1988, resources and expenditures of Brazilianmunicipalities both increased substantially. Municipal revenues rose from about 11% ofthe country's total disposition of final revenue (average over the last two decades) toabout 17% in 1990. Expenditures increased from about 11% of final disposition to about14% of the total. While these data indicate the relative importance municipalities haveassumed in the overall economy, the specific effects are not yet fully clear. Largermunicipalities seem to have benefited disproportionately more than smaller municipalities,as did those with a larger industrial base over those with weaker economies. Mostmunicipalities, however, are much better off financially following the reforms. This canhave a perverse impact on own resources, however, with those cities receiving the highestvalued-added tax transfers from the State, for example, allowing own revenue collectionto decrease during the period.

6.6 Data for selected municipalities in Bahia reveal their considerable dependence onfederal and State government transfers, as is the case in most of the rest of Brazil. Themost significant municipal transfer components are: (a) the municipal participation fund(FPM); and (b) the State value-added tax (ICMS). On average, Federal transfers of FPMand State transfers of ICMS made up 85% of total municipal revenues in Bahia in 1992.While FPM was significant in poorer municipalities, ICMS was more important in theSalvador metropolitan region, which accounts for about 70% of Bahia industrial output.Both the FPM and the ICMS are dependent on the level of economic activity. Wheneconomic activity is slow, transfers are adversely affected; the narrower the municipal taxcollection base, the more serious the impact. This situation highlights the importance ofown collection capacity, which in turn depends on both the incentive structure and onmunicipalities' restructuring of their administrative and financial framework so as to beable to better exploit their tax potential.

6.7 Table 9 below indicates municipal revenue sources on the basis of a sample of 66municipalities. As shown, own-source revenues, primarily represented by IPTU and ISS,represented on average about 10% of total revenues in 1992. The project would generateincreased own revenue through criteria that would ensure cost-recovery through usercharges, betterment fees, and property and other taxes.

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Table 9: Municipal Revenues and ExpendituresSample Group of 44 Municipalities in Bahia for 1993)

Revenues % of Total Expenditures % of Total

Transfers (FPM & 85 Current 70.0ICMS)

Own Source 10 Capital & other 30.0Revenues

Other 5

TOTAL 100 TOTAL 100.0

Surplus/(Deficit) 5%

6.8 Debt Capacity. Most of the smaller municipalities borrowed relatively little beforethe advent of the Plano Real. In fact, most of the 44 municipalities had no contracted debtin 1993. Most "financing" was done by arrears in the hyperinflationary period. There washowever, some borrowing through infrastructure lines of credit operated by the GOBthrough CEF, especially by the larger municipalities. PRODUR will be the first chance forlarge-scale municipal borrowing in the State. Municipalities in general are creditworthy,since they have not previously borrowed and are now better off than previously.However, there are several large municipalities which are significantly leveraged, and mustborrow with extreme caution.

6.9 Estimates of total existing debt capacity for 202 municipalities eligible toparticipate in PRODUR were prepared with 1993 data from a representative sample of 44municipalities These estimates show a total existing debt capacity of nearly US$214million for the municipalities (Annex 6B). The data show that about 70 municipalitieswould have a limit greater than US$1 million per year, while the remainder would haveannual capacity between about US$500,000 and US$1 million.

C. COST RECOVERY POLICY

6.10 Subprojects would have to demonstrate significant direct cost or indirect costrecovery. Services which are revenue-earning (water supply, sewerage, solid wastecollection) would recover costs directly from final beneficiaries through tariffs and usercharges, while services which are non-revenue earning (paving and drainage, for example)would be recovered through increases in property valuation and subsequent property and

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betterment taxes. Revenue-earning services constitute 47 % of the total infrastructureprogram, while non-revenue-earning account for the rest. Annex 6C contains a breakdown ofthe direct and indirect cost-recovery instruments for all components.

D. DIMENSIONING OF PRODUR

6.11 In order to dimension investments for the PRODUR program, the State and CARevaluated several key areas: demand for resources; municipal and State capacity to borrowand repay loan funds; and State and municipal technical, institutional and financial absorptivecapacity. First, as part of project preparation, in 1994, CAR undertook a survey of 66 of theState's larger cities, representing about six million inhabitants, or about 50% of the population.The study confirmed that the most widely demanded investments were water supply, sewagecollection and treatment, solid waste collection and disposal, street paving and drainage, andidentified potential investments on the order of US$250.0 million. Second, CAR prepared anevaluation of the credit limits of a sample of 44 of the State's municipalities, which indicates aState-wide limit on the order of US$500 million. Finally, the State Government demonstratedin its historic financial statements that for the past several years it has been spending on theorder of US$600.0 million on annual capital investments, largely in urban infrastructure. It isthe equivalent of these funds which would go into the FUNDURBANO as State counterpart.The proposed project size of US$222.0 million for infrastructure and institutionaldevelopment investments over a six-year period (or about US$37.0 million per year) wasbased on these findings. With State counterpart of about US$72.0 million (about US$12.0million per year) and about US$50.0 million from municipalities (about US$8.0 million peryear) to be provided each year, the project is conservatively dimensioned. Simulationsindicate that about 77 of the State's municipalities (those with population greater than15,000) will participate in the project.

E. SUSTAINABILITY

6.12 Cost recovery at the sub-project level, and the fact that the Bank loan would be repaidby the State (making Bank funds a permanent capitalization of the FUNDURBANO) increasethe project's chances of putting the financing of municipal investments on a more sustainablebasis through this fund. Furthermore, the project's reform components are expected to leadto strengthened municipal management thus allowing the municipalities to cover their currentexpenditures, service their debt and generate surpluses for future infrastructure investments.The commitment of the government of the State of Bahia to project objectives is a primaryfactor contributing to the likely sustainability of the project's impact on municipal finance.The effective mobilization of community involvement in the definition of local investmentpriorities by an experienced executing agency is an important factor in assuring that theproject's impact will be obtained initially and sustained after project completion. In addition,the proposed project is designed to benefit from the lessons of experience of seven successfulmunicipal management projects in other states in Brazil.

38

7. PROJECT BENEFITS AND RISKS

7.1 The expected benefit of the project will be to endow the State of Bahia with modelmunicipalities in terms of efficient urban service delivery and sound finances whoseinstitutional arrangements can be emulated elsewhere. These model municipalities wouldpursue a combined policy of privatization of these services where possible and ofincreased public sector efficiency at the local level through pilot programs of municipalreform. Strengthened municipal finances should result from applying the project's rigorouseligibility criteria for sub-project financing itself, in addition to specific municipal reformand institutional actions directly supported by the project.

7.2 Through the experience of these model municipalities, it is also expected that theproject will demonstrate that the improvement of the living conditions of the urban poor inthe State of Bahia--through the efficient provision of infrastructure and services--can becompatible with municipal reform. As a priority, project funding will finance cost-effectivesub-projects with high rates of return in municipalities whose administrations arecommitted to reform. The urban poor will benefit most from the low-cost solutions tourban infrastructure and service delivery favored by the project. For being sanitation-related, the positive impacts of these investments upon the urban environment throughoutthe State of Bahia should lead to significant public health improvements for the urbanpoor.

7.3 PRODLJR's sub-project screening and evaluation procedures--involving technical,economic, financial and environmental assessments--would help ensure that the expectedbenefits are achieved.

A. FINANCIAL AND INSTITUTIONAL IMPACT AND MUNICIPAL REFORM

7.4 The proposed project would strengthen the financial management of localgovernments, enabling them to better provide the services for which they are responsibleunder Brazil's Constitution, thus putting into effect the federal and state governments'decentralization objectives. To become eligible for sub-project financing under PRODUR,municipalities will have to meet rigorous creditworthiness criteria, itself an importantincentive to increasing revenues and savings at the local level. Specific projectcomponents, such as the cadastre, will help broaden the fiscal base of municipalities. Theproject will also encourage user charges to be levied at the local level for urban servicesfinanced through PRODUR. Through focusing more upon economically and financiallyviable investment projects, municipalities will have more opportunities to increase own-source revenues through appropriate taxes and user charges based on economic costs, andimproved collection practices.

7.5 The project's pilot municipal reform program would also strengthen localgovernments institutionally through a pilot program of municipal reform. ThroughPRODUR, municipalities will be encouraged to privatize revenue-generating servicesthrough the sale of assets or the granting of concessions to private operators. Participatingmunicipalities would enjoy more efficient public administration through implementing

39

reform measures agreed under PRODUR. In this way the proposed project would alsosupport the federal government's overall macro economics objectives of achieving leaner,more efficient public sector management at all levels.

B. ECONOMIC BENEFITS

7.6 The weighted-average internal economic rate of return (IERR) for theinfrastructure component is expected to be on the order of 20%. Calculation of theproject IERR is be based on the individual IERRs for a range of sub-projects for onemunicipality with the most advanced first year program of investments. Estimates of theERRs of sub-projects of the remaining cities' first year programs would be prepared byLoan Effectiveness. During project implementation, such cost-benefit analysis would beprepared for all infrastructure sub-projects, accounting for about 84% of the total value ofPRODUR investments. On the basis of the experience other similar programs in Brazil, therange of returns for individual sub-projects is expected to be on the order of 12% to 50%.Sub-project selection criteria ensure a minimum 12% economic rate of return for all sub-projects, with the exception of sewage treatment and macro drainage, for which healthbenefits would also be calculated with the use of disability-adjusted life years (DALYs:details Annex 7). Detailed economic cost-benefit and sensitivity analyses are presented inAnnex 7. Through guiding local governments to make efficient investments in urbaninfrastructure and services, the project can contribute to improvements that will makecities more attractive for investment by the private sector.

C. ENVIRONMENTAL AND HEALTH BENEFITS

7.7 Because its infrastructure component is focused on the basic sanitation sectors, theproject is expected to have positive environmental impacts primarily derived fromimprovements to solid waste collection and disposal, storm drainage, sewage collectionand treatment, water supply systems through reduced leakage and increased coverage, andfrom a more integrated approach to management of sanitation services at the municipallevel. The technical assistance component may finance, among other things, the drafting ofmunicipal environmental legislation and strengthening of municipal environmentalcouncils. The project has been rated environmental category "B." Environmental aspectsof the project are treated in greater detail in Annex 5F.

7.8 Basic sanitation improvements financed by the project are expected to lead tobetter public health conditions among the communities directly affected. According toBahia State health officials, introducing sewage collection into a low income area for thefirst time can more than halve the incidence of waterborne diseases such as diarrhea andworm infections that affect communities without basic sanitation. Children are particularlyvulnerable to these diseases which are responsible for 17. 1% of all cases of infantmortality in Bahia. To assess public health impacts, sub-project evaluation includes anassessment of the number of DALYs (disability-adjusted life-years) in the communityaffected by the investment. Focusing upon the reduction of diarrhea and worm infections,the project assessment uses parameters of DALY loss by diarrhea and worm infection in

40

Latin America reported by the 1993 World Development Report, and estimates the costeffectiveness of the expected impact (details: Annex 7).

D. POVERTY INEPACT

7.9 The project is expected to have an important impact on the overall situation of thepoor in the State. The preliminary indications from the draft Brazil Poverty Assessmentdemonstrate that a key distinguishing feature of the poor from the non-poor is lack ofaccess to basic urban infrastructure. By their nature and design standards, infrastructureinvestments under the project would benefit the urban poor. Furthermore, the institutionalstrengthening and changes in service provision which should come about as a result of theproject is likely to have a proportional impact on the poor (below the poverty line),estimated to be about one-third of total population in the State. The low-incomeupgrading component will be a poverty-targeted program benefiting households withincomes of less than three minimum salaries. Poverty mapping at the State level will alsobe an important instrument in ensuring that investments are appropriately targeted andhave the desired impact.

E. RisKs

7.10 Since municipal reform envisioned by PRODUR has not previously been attemptedin the State of Bahia, there are risks that the zeal of municipalities to pursue tough reformmeasures may wane, especially in the face of eventual political opposition. Stimulatingcompetition among municipalities for PRODUIR funding, rewarding those making mostprogress with reforms, is a key feature of the project design aimed at mitigating this risk.The voluntary participation in the project of new mayors that have taken office in January1997 should ensure continuity of political commitment to the agreed reforms.Furthermore, increasing fiscal tightness in the public sector allied to macro economicfactors, should provide incentives for municipalities to continue to pursue these reforms.

7.11 There is an additional risk that PRODUR's ID component may not be fullyimplemented owing to the challenges posed by a complex intervention in manymunicipalities spread across a territory as large as France's. For this reason, agreedtechnical assistance and training programs and targets for municipalities to enter theproject's first-year program have already been prepared, and a team of experiencedconsultants will assist CAR with implementation and train CAR staff in these functions.Furthermore, progress on the institutional development component, where necessary, willbe linked explicitly to the infrastructure component. The risk to the ID program is alsosomewhat mitigated through CAR's ready access to the experience of other states withsimilar projects. There are few technical risks associated with the project, since mostinfrastructure investments are of a routine nature applying well-tried solutions adoptedelsewhere.

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8. AGREEMENTS REACHED ANDRECOMMENDATION

A. AGREEMENTS REACHED

8.01 During negotiations, agreement was reached on the following:

(a) the implementation arrangements (including mix grant and counterpartfunds) for the urban upgrading component (para. 4.11);

(b) the project financing plan and the Borrower's guarantee regardingnecessary project counterpart funds (para. 4.16);

(c) that CAR would execute Parts A-D of the project, (para. 4.17);

(d) the final version of the Operational Manual, and that the PRODURprogram will be implemented in accord with the Manual (para. 5.3);

(e) sub-loan interest rate to be calculated on the basis of the interest rate of theBank loan plus a spread of 3%; and an appropriate adjustment index (IGP-M) for local-currency sub-loan balances (para. 5.5);

(f) appropriate guarantees to be provided bv sub-borrowers; and that no sub-borrower would be able to borrow annually more than US$15 million,without prior consultation with the Bank (para. 5.6); ,

(g) sub-borrowers would demonstrate that either: (i) the current surplus in theprevious fiscal year was at least 15% or (ii) the total outstanding andproposed debt and guarantees do not exceed municipal revenues during thepreceding fiscal year (para 5.10);

(h) sub-projects expected to cost the equivalent of US$5 million or more, thefirst three sewage treatment and solid waste disposal sub-projects costingmore than US$5 million and any sub-project, regardless of cost, requiringenvironmental assessment or a resettlement plan would be subject to priorreview by the Bank of all technical, economic, financial and environmentalaspects (para. 5. 11);

(i) model Sub-Loan Contracts and Grant Agreements; and that all conditionspresent in the Loan Agreement between the Borrower and the Bank bereflected in the sub-agreements as necessary, the Bank will have priorreview of any resettlement plans and the state would prepare and adopt anacceptable framework for resettlement plans by August 31, 1997. (para.5.20);

42

(j) procurement arrangements satisfactory to the Bank (para. 5.26); and theBank will have prior review of any resettlement plans and the state wouldprepare and adopt an acceptable framework for resettlement plans byAugust 31, 1997 (para. 5.20);

(k) disbursement arrangements satisfactory to the Bank, includingestablishment of a Special Account (para. 5.29);

(1) audit arrangements satisfactory to the Bank (para. 5.30);

(m) quarterly monitoring reports, including one detailed annual report, befurnished to the Bank on the dates agreed (para. 5.31); and

(n) a Mid-Term Review would be scheduled three years after loaneffectiveness; and that the Borrower would prepare and furnish to the Bankan Implementation Completion Report within six months after the ClosingDate (para. 5.32).

8.02 As Conditions of Disbursement, the Bank would have prior review for thoseprojects above a total cost exceeding US$5.0 million, and the first three sub-projectscosting more than US$2.0 million for sewage treatment and solid waste disposal sub-projects (para. 5.17) and any sub-project involving resettlement (para. 5.19); andenvironmental assessments would be undertaken consistent with Brazilian law and Bankguidelines, including resettlement plans if necessary (para. 5.20).

B. RECOMMENDATION

8.03 Subject to the above conditions, the project would be suitable for a Bank loan ofUS$100 million equivalent, to be repaid over a period of 15 years, including five years ofgrace, at the Bank's standard variable interest rate. Retroactive financing for up to 5% ofthe proposed loan amount for eligible expenditures incurred up to 12 months prior toLoan signing, is also recommended (para. 5.29).

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ANNEX IA

BAHIAMUNICIPAL INFRASTRUCTURE DEVELOPMENT

AND MANAGEMENT PROJECT- PRODUR

DECENTRALIZATION AND IMPROVED MUNICIPAL MANAGEMENT

1. The Case for Decentralization. There are several arguments in favor of federalismor decentralization. Economists argue that because some public services have nationwidebenefits (e.g., defense and research) while others are geographically limited (eg., publiclighting), allocative efficiency calls for public services to be provided (and their costs shared)in line with the preferences of the residents of the relevant benefit region. That is, serviceswith nationwide benefits should be provided for nationally, services with local benefitsshould be provided for locally. Decentralization is also justified for political reasons. It isbelieved that decentralization is needed in order to limit the power of one individual overanother and that it provides a training ground for democratic government. On theinstitutional front, decentralization appears to facilitate the local coordination necessary inthe case of multiple local services (i.e., street paving, water and sewerage services).

2. The Brazilian Context. Brazil's 1988 Constitution is the most recent attempt of thecountry to promote decentralization and federalism. Commitment to enhance the role ofstates and municipalities in the conduct of public policy is a clear characteristic of theConstitutional text. The Constitution has increased municipal responsibilities, so that theynow cover, inter alia, urban public transport, pre-school and elementary education,preventive health care and land-use. At the revenue level the number of municipal taxes hasdoubled from two -- a tax on property and a tax on services -- to four: the urban propertytax (IPTU); the excise tax on services in a number of tertiary activities (IS S), a tax onproperty sales (ITBI) and a fuel tax (IVVCLG). As a result of these changes, the share ofmunicipalities in total government revenues has more than doubled. However, in absoluteterms the effect has not been as large as expected, due primarily to the recessive economicenvironment.

3. Recession and fiscal adjustment have also motivated both the federal and stategovernments to accelerate the implementation of the responsibilities assigned by theConstitution to the municipalities. However, it is uncertain whether municipalities will havethe capacity to assume these new responsibilities and to manage their new resourcesefficiently and equitably. In several sectors, for instance health and environment,municipalities' experience is very limited.

4. Findings of Economic and Sector Work. Recent Bank economic and sector work-- in particular, the study Brazil: The Challenge of Municipal Sector Development ini the1990s' -- has identified several issues in municipal management, one of the key areas of

_/ IBRD Report No. 10616-BR, February 1992.

44

reform recommended in the report. On the expenditure side, municipalities demonstrateinsufficient investment levels and an oversized administration which has tended to consumemost of the increase in revenues through current expenditures. On the revenue side, there isa clear lack of incentive to maximize own-revenues and to be accountable for financialmanagement. User fees and property taxes are not used efficiently, so negotiated transferscontinue to be major items in municipal budgets in selected cases. The need fortransparency and sustainability require that negotiated transfers be replaced by formula-driven transfers and that extra-budgetary accounts (another non-transparent way ofreceiving and spending resources) be included in the ordinary budget.

5. The PRODUR Project and Decentralization. The proposed Bahia MunicipalInfrastructure Development and Management (PRODUR) Project fits into the abovecontext by explicitly addressing the major issues in municipal management identified in thesector work. Its main objective is to assist the municipalities of the State of Bahia incarrying out their new responsibilities as efficiently as possible. It does that in several ways:

(a) The project provides financial incentives to local governments to enlargetheir investment capacity and to provide public services in a sustainablefashion -- the use of full cost-recovery through tariffs and taxes is the onlyway to ensure that those public services will be provided even after the lifeof the project.

(b) It strengthens local institutional capacity, with particular emphasis onfinancial management and the basic sanitation and environmentalinfrastructure sectors, traditionally municipal responsibilities. Theinstitutional content will emphasize the following activities:

(i) providing training and technical assistance for financialmanagement;

(ii) presenting simple, realistic guidelines, performance indicators andinformation structures to assist proper management;

(iii) identifying activities than can be fully privatized;

(iv) designing appropriate incentives to keep expenditures under tightcontrol;

(v) strengthening local environmental management councils andlegislation;

(vi) ensuring the strengthening of municipal tax administration capacityprimarily through upgrading and renovating property tax cadastresand appropriate training; and

(vii) improving targeting in poverty alleviation.

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(c) In addition, through computerization of its financial and institutionaldatabases, the proposed project will begin to move the State andmunicipalities towards a Municipal Management Information System(FMIS) that could help monitor macroeconomic policy, provide consistentreporting at all levels and form an analytical base to improveintergovernmental fiscal transfers.

(d) Local Government Performance: Normative Criteria. Decentralizationneeds to be assessed in terms of how local governments are delivering theservices for which they are responsible. The above-referenced sectorwork, using basic precepts from economic literature, provides guidance inthis respect. It argues that performance of the public sector in general andof the municipalities in particular can be assessed in terms of: (i)accountability; (ii) production efficiency; (iii) demand efficiency; (iv)equity; and (v) sustainability, explained in greater detail as follows:

(i) Accountability is a direct requirement of increased responsibility.Accountability to the electorate is required as a guarantee that theconduct of the elected officials is in line with the voters' wishes.Accountability to the higher levels of the government is requiredwhen municipalities act as agents (or as spenders) of federal or stategrant funds. Reliable financial data are probably the single mostimportant requirement for accountability.

(ii) Production efficiency stipulates that services provided by themunicipality should correspond to the minimum cost provision.This can be measured directly, observing whether a municipality haschosen the least-cost solution to provide a given service, orindirectly by looking at how employment has evolved or howsignificant is the participation of the private sector.

(iii) Demand efficiency relates to the level at which consumer demand ismatched by provision of public services at an economic cost.Demand efficiency is measured by the degree to which publicservices are financed by cost recovery applied along the lines of thebenefit principle -- those who benefit from the good or serviceshould be those who pay.

(iv) Equity goals include assessing the degree to which actions increaseor diminish interpersonal or inter-regional income disparities. It isgenerally accepted that equity concerns should be pursued byhigher levels of government. Local governments trying to promoteincome distribution with their own resources run into financialproblems as higher-income taxpayers tend to leave the community.The realm of the local government should be limited to theprovision of services for which cross-subsidies are feasible -- for

46

example water supply financed by high-income groups and madeavailable to low-income households through life-line rates.

(v) Sustainability provides that imbalances between expenditures andrevenues be minimized, and implies that revenue authority be asclose as possible to expenditure authority.

Table I A-I indicates the areas of analysis and indicators which can be used to assess theadequacy of municipal policymaking according to these five criteria.

Table IA-1: Criteria to Assess Local Government Policy-Making

Policy Objectives Criteria/Indicators Project Features

Accountability suggests that Audits Through the ID component the projectjurisdictions should be would: improve budgetary procedures (endaccountable to their electorates for Transparent budget of off budget transfers; reduce discretionary,how tax money is spent and to grants, improve investment planning andupper levels of government for Transparent transfers budgeting); publicize decisions throughhow grant money is allocated and consultation with local groups; establishfor how well they are performing No off-budget transfers clear and strict auditing requirements.delegated roles.

Production efficiency stipulates Evolution of employment by servicethat public services should be provided; reliance on private sectorprovided at minimum costs. for provision of social goods - in Least cost technical solutions will be a

principle the private sector is better criterion of sub-project selection.equipped to find least-cost solutions.

Demand efficiency measures how The price of goods and services The cost of recovery criteria ensure thatsupply of services matches should reflect their economic costs, tariffs for revenue-earning services wouldconsumer preferences. including negative extemalities such over time reflect economic costs (tariff

as those arising from polluting studies at the local level could be financedactivities. under thc ID component). In addition to

improved tax-setting policies and collectionCost recovery should follow benefit procedures, ID will emphasize training ofprinciple; that is, those who benefit municipal staff in the basic principles offrom the service should pay. cost-recovery.

Equity Goals include interpersonal National transfers should be Responsibility lies with the State. Poverty(between persons) and inter- responsive to effective demand, both mapping Statewide, the targeting urbanregional (between geographic in tenns of location (particular upgrading component, and monitoringareas) and inter-generational areas) and in terms of services indicators.(between generations over time). demanded.

Sustainability provides that Revenue authority should be as close The project's objective is to ensure thatimbalances between expenditure as possible to expenditure authority. municipalities have sustainable conditionsand revenues should be to maintain provision of services andminimized. Transfers should be limited investment capacity even after project

(sustainable and transparent) and closes. The PRODUR Fund is designed tobased on revenues that are continue relending, through repayments, andreasonably buoyant (predictable) will seek additional capitalization from

private sources through the municipalfinance study.

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ANNEX lB

BAHIAMUNICIPAL INFRASTRUCTURE DEVELOPMENT

AND MANAGEMENT PROJECT- PRODUR

LESSONS LEARNED FROM PREVIOUS PROJECTS

1. In the first part of this annex, the focus is on the historical experience of nearly twodecades of Bank lending to Brazil in the urban and water supply sectors. Many of theselessons, combined with the incentives created by the political and fiscal decentralization of1988, contributed to the emergence of a new generation of municipal development projectsfocusing on strengthening the capacity of local governments to manage and provide basicservices. Lessons learned from these more recent experiences are discussed in the second partof this annex.

A. HISTORICAL PERSPECTIVE

2. Since 1978 the Bank has made 20 loans for urban development and transport projectsin Brazil, totalling about US$2 billion. In addition, 18 loans totalling about US$2 billion havebeen made for basic sanitation projects since 1971, also largely in urban areas. With this longhistory of Bank involvement in the sector, many important lessons have been drawn. Theproposed project would build on lessons learned over these decades in the urban sector. Therecent OED review of urban sector lending, Twenty Years of Urban Lending. 1972-1992,June 14, 1994 (IBRD No. 13117), cites several features of best practice, among themdemonstrated borrower ownership, emphasis on institution building, secure tenure forbeneficiaries, well-designed environmental components, and explicit poverty reduction aims.Constraints to successful implementation are excessive focus on physical outcomes (at theexpense of institutional outcomes), poor design of environmental components, mechanismswhich favor high-standard infrastructure, and inadequate assessment of effective demand. Thereport argues for a more comprehensive approach to design of urban projects which securesproject ownership, relies on institutional development and policy reform, taps potentialmacroeconomic linkages, strengthens the congruence of objectives and design, and providesfor well-defined monitoring and evaluation.

3. Consistent with these recommendations and Brazil's decentralization reforms, theBank's project objectives have shifted towards improving the capacity of states andmunicipalities to effectively assume increased responsibilities for efficient management ofresources and services under a series of projects which focus on the strengthening of localgovernmental capacity for service provision on the basis of permanent municipal developmentfunds at the State level. These funds are designed to provide a reliable source of financing forurban infrastructure investment, under appropriate technical, economic and financial selectioncriteria which aim at the greatest efficiency in use of funds. Investments are complemented bytechnical assistance and training towards improved financial management. The first of theseprojects was the Parand Market Towns Project - PRAM (2343-BR), followed by the Santa

48

Catarina Small Towns Development Project - PROURB (2623-BR -- closed December 3 1,1993) and more recently Municipal Development Projects in the States of Parana - PEDU(3100-BR); and in the State of Rio Grande do Sul - PIMES (3129-BR); the Minas GeraisMunicipal Management and Environmental Infrastructure Project - SOMMA (3639-BR); andthe Ceara Water Resource Management and Urban Development Project - PROURB (3789-BR). These projects set the framework for further policy formulation for the sector, based onthe experience of the past two decades. The projects and their current status are shown inTable IB-1 below:

Table IB-I: Status of Recent Urban Projects in Brazil.Project Board Amount Mid-Term PCRlICR DisbursedNo. Date (US$ M) Review Date Date (US$ M)a/2343-BR 08/23/83 52.70 N.A 11/30/90 51.932623-BR 09/19/85 24.50 N.A. 12/14/94 24.33100-BR 06/22/89 100.00 6/93 03/31197 70.03129-BR 10/24/89 100.00 11/92 03/31/97 35.03639-BR 7/20/93 150.0 tbd tbd 25.13789-BR 9/6/94 140.0 tbd tbd 14.0

a/ As of October 29, 1996.

B. RECENT EXPERIENCE

4. Some clear lessons have emerged from the PCR of the Parana Market Towns Project -PRAM (completed in 1990), the PCR of the Santa Catarina Small Towns Project (PROURB,completed in 1993), and from mid-term reviews conducted more recently for other projects.The lessons learned from such projects can be divided into three broad categories: (a) factorsof comparative success, or those which contributed to smooth and rapid achievement ofobjectives and which support the sustainability of the basic project design; (b) factors ofcomparative difficulty which affected projects in the past and which, however, have now beenlargely resolved; and (c) factors which continue to contribute to delays, complications orproblems, and which are not yet fully resolved. The latter should be explicitly considered inthe design of subsequent operations. The first two are explained in summary form, and thethird in a matrix format which demonstrates how the specific issues have been addressed in thedesign of the proposed project.

Success Factors

(a) Demand for Resources. The forecast demand for resources has in factmaterialized, as reflected in the complete commitment of loan funds underPRAM and PROURB (SC).

(b) Community Response. Community/constituent response has been extremelypositive to reforming local administrations, as expressed in: willingness to paythrough tariffs and taxes for services efficiently provided; reelection of manymayors who participated in these projects; and wide coverage in all states:PRAM achieved coverage of about 90% of all municipalities in the State;PEDU has reached 99%; PIMES about 50%; PROURB 99%; and SOMMA

49

has active projects underway or under preparation in about 100 of the State'snearly 800 municipalities.

(c) Institutional Consistency. Projects are most successful when implementedunder the institutional structure of a pre-existing program. For example, alarge part of the success of the PEDU program has to do with the earlier workdone under the PRAM project. PROURB (CE) also built on existing Stateprograms. Many of the same systems (for disbursements, monitoring, channelsfor discussions with mayors, etc.) are still in place and have simply beenupgraded. Conversely, PIMES and SOMMA have had start-up difficultiespartially due to lack of this prior experience.

(d) Repayment of Funds. The PRAM and PROURB projects, and initial resultsfrom the PIMES and PEDU projects have demonstrated municipal ability andwillingness to repay loan funds. The guarantees are firm and credible, andhave not been called in any of the programs.

(e) -Increase in Municipal Own Resources. There is evidence from all fourprojects that municipal financial management has improved. This is mostevident in Parana, where the second project has benefited from the existence ofthe first PEDU municipal finance study.

(f) Timing of Start-up. Both PEDU and PIMFS began near the beginning of themayoral term. This undoubtedly has helped in the projects' implementation.Conversely SOMMA suffered the consequences of the shift in municipaladministrations. During the reelection cycle a lag can be expected.

5. These factors demonstrate sustainability of the overall project concept, and justifyconsideration of follow-up operations.

Past Implementation Issues

6. Three important external factors have in the past hindered project implementation.However (due to in part to collaboration between the GOB and the Bank), measures havebeen taken to reduce or change the impact of these factors. These areas are related to:procurement; sub-loan approvals, and disbursement.

(a) First, procurement arrangements under all projects in Brazil have suffered theconsequences of Brazilian procurement legislation's inconsistency with theBank's procurement guidelines. In June 1993 a new federal procurement lawwas passed, effectively eliminating most of the serious inconsistencies. Thisnew law, together with use of the Bank's standard bidding documents, shouldeffectively eliminate many procurement problems which led to significantdelays in other programs. Standard bidding documents for NationalCompetitive Bidding (NCB) for goods and works were agreed upon in 1995between the Bank and the government, and are now in widespread use.

50

(b) Second, the Senate Resolution (Resolution No. 69 of 1995) setting outguidelines for public sector indebtedness in the past stipulated that allmunicipalities should be reviewed individually. Conditioned on the fact thatmunicipal projects adopt federal creditworthiness criteria, each State willapprove its municipal borrowing program at the same time as the State'sborrowing and the Federal Government's guarantee is approved. While notperfect, this will reduce the executing agency's sub-project processing time,and save staff time previously spent lobbying the Senate committee.

(c) Third, regarding disbursements, there is no longer a Brazil-wide requirement tohold all Special Accounts in the Central Bank in Brasilia. In the past this hascreated some confusion and lag time in disbursement processes. SpecialAccounts are now held in a commnercial bank mutually agreeable to the parties.This will also minimize processing delays.

Current Complicating or Delaying Factors

7. The matrix shown as Table 1B-2 below indicates the key, unresolved factors of projectcomplication or delay, and outlines how the design of the proposed project incorporatesmeasures which will mitigate the risk of such factors.

Table 1B-2: Matrix of Lessons Learned in :Recent Urban Projects in Brazil and Their Incorporation intoProject Design

Lesson Incorporation into Project Design

One of the key sources of implementational delay has been a broad sector Investments have been limitedfocus: infrastructure, institutional and social sectors have all been represented. primarily to the sanitation-relatedExperience demonstrates that infrastructure investments are more quickly sectors, determined by the State andimplemented; social sector investments under both PEDU and PIMES are by a sampling of municipalities to bebehind schedule. At mid-term, funds have been reallocated to infrastructure, among the highest priorityprimarily water sector operational improvements. Part of reason is difficulty investments in the State. Linkage toin administering projects with varied sectoral focus, particularly expertise for the social sectors will be doneevaluation, supervision and monitoring of sub-projects. SOMMA limited through improved coordination withthese investments to the sanitation-related sectors. ongoing (education, health) projects.

A second key source of delays has been lack of focus and clarity in the The project would have explicitinstitutional development (ID) component. Capacity-building technical linkage between TA andassistance was begun with PRAM; however, it was not given priority. infrastructure, with realistic, limnitedPRODURB applied stricter conditionality for sub-loans, but this was not conditionality on sub-loans. Termsenforced. Under PEDU, PIMES and SOMMA explicit ties between the and conditions for the institutionalinstitutional development and infrastructure components were established, development component have beenfocusing on efficient management (financiaUinstitutional). The conditionality discussed in detail with the State andwas in fact enforced somewhat too strictly in the first years of PEDU (with municipal mayors. These will bethe quest for perfection causing delays). As a result, ID investments in clearly defined in the OperationalPEDU's first year were low. Terms for onlending for the ID component were Manual.also somewhat unclear.

51

Lesson Incorporation in Project Design

In several of the projects, institutional arrangements were not clearly defined, Acceptable bylaws and statutes forparticularly responsibilities among institutions. Lack of clear statutes and the Program which legally bindbylaws made such programs vulnerable to changing political fortunes; lack of institutional arrangements would haveseparation between Executive Councils/Boards of Directors and implementing been approved by the State prior tobodies, between management and supervision of program also created Negotiations. The project unit is aconfusion at times. Key team members were sub-contracted to the executing fully-functioning department of theagency, rather than having permanent staff positions. CAR with career staff.

Computerized project management and monitoring is essential. However, CAR has begun a comprehensivemuch of the evaluation and monitoring has to be put in place during scheme for computerization ofimplementation, rather than having a well- organized system available early evaluation and monitoring of theon in the program. program, based on an existing in-

house monitoring system in operationfor the Bank-financed NortheastRural Poverty Alleviation (NRPA)program.

Early and thorough marketing of the program is essential to its success. Lack The State embarked on a publicityof this compromises coverage. (Neither PIMES, SOMMA, nor PROURB campaign for the program, and planshad the benefit that PEDU did of well- established channels from a previous for marketing have been agreed.program).

Information gathering (for the purpose of the institutional and financial Information gathering will be thediagnosis) from municipalities is often complicated and time-consuming, due responsibility of CAR, who alreadvto unfamiliarity with forms, poor data, and weak institutional capacity. has significant experience in

gathering municipal and regionaldata, and will standardize andsimplify the procedure as much aspossible

A well-defined group of first-year investments is fundamental to effective Investments in 14 municipalities haveproject launch. Lack of this was an early problem in PEDU and PIMES, been appraised.while SOMMA's 22 municipalities may have been too ambitious, spreadingthe executing agency too thin; the seven prepared for PROURB (CE) mayhave been important in its early success.

Pilot components, if not begun right away, often do not begin at all. Housing The pilot Municipal Reform Programpilots were not begun early in project implementation in PIMES and PEDU of privatization and/or concessionsand government officials lost interest. While pilots have been useful means of would be identified early through aexploring alternatives in SOMMA and PROURB (CE) for example, they have diagnosis of each interestedbeen delayed in start-up due to a focus on main project objectives. municipality.

52

ANNEX IC

BRAZILBAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENT

AND MANAGEMENT PROJECT

URBAN POVERTY STRATEGY IN BRAZIL

1. Brazil's poverty indices and other social indicators suggest that on average Brazilianshave a lower quality of life than citizens of other countries with similar levels of per capitaGDP. However, Brazil has such extreme regional disparities, and income is distributed sounequally among the population, that national averages reveal little. The standard of livingexperienced by most Northeasterners versus most Southeasterners, and within themacroregions by low income versus high income households, is very different. Poverty tendsto be more prevalent and severe in rural areas. Nonetheless, metropolitan and other urbanareas account for a large, and growing, share of the poor.

2. Brazil's level of public spending in the social sectors has been comparable to that ofother middle income countries. While Brazil has made clear progress since the 1970s on anumber of fronts, dramatically increasing access to electricity, water and sewage systems,health services and schooling, and lowering the incidence of child malnutrition, improvementsin social indicators have not been commensurate with the magnitude of public social spending.Macroeconomic instability, low economic growth and increasing income inequality haveplayed a role in keeping social conditions from progressing more rapidly over the past decadeand a half In addition, inefficient use of public funds has been widely recognized as part ofthe problem.

3. Poverty in the Northeast. The Northeast has the highest incidence of poverty of anyregion in Brazil.' Whether one lives in a metropolitan area, a non-metropolitan urban area, ora rural location, poverty is most prevalent in the Northeast.2 Although poverty is mostcommon in Brazil's rural areas and least common in its metropolitan regions, the Northeast isso disadvantaged relative to the rest of the country that poverty is more prevalent in theNortheast's metropolitan areas (Recife, Salvador and Fortaleza) than it is in the rural areas ofother macroregions. Over one-third of all metropolitan poor, half of the poor living in non-metropolitan urban areas, and 70% of the rural poor live in the Northeast..

The incidence of poverty is the share of the population having per capita household incomes below thepoverty line. The analysis presented here is drawn from Brazil: A Poverty Assessment. The datasource used to conduct the poverty analysis in that report was the 1990 PNAD household survey. Thepoverty line used was based on the cost of a food basket meeting recommended nutritionalrequirements, adjusted for cost of living differences.

2 Metropolitan areas include the nine officially designated metropolitan regions and Brasilia. Otherurban areas encompass all areas considered urban in the PNAD, but not included in the metropolitanregions. All county seats are categorized as urban, regardless of their population.

53

4. Not only is poverty more prevalent in the Northeast, but the conditions under whichthe poor live are worse there than in the rest of Brazil. Life expectancy at birth for a person inthe lowest income group (family income up to 1 minimum wage) is 15 years shorter in theurban Northeast than in the urban Southeast. Poor Northeasterners are more likely than otherpoor Brazilians to live in dwellings without internal plumbing, electricity, adequate sewerageservices, and garbage collection. This is so even when the degree of urbanization is similar.Even non-poor residents of the Northeast have worse indicators than other Brazilians,including at times, those with much lower incomes. Average life expectancy at birth isactually higher for urban Southeasterners with family incomes up to I minimum wage than itis for urban Northeasterners with family incomes between 3 and 5 minimum salaries. Liketheir poor neighbors, the non-poor living in the Northeast tend to have lower access toservices and poorer housing conditions than the non-poor, and even the poor, from otherregions.

5. The Urbanization of Poverty in Brazil. Brazil's population has becomeconcentrated in urban areas over the last three decades. In the 1960s and 1970s, the promiseof employment opportunities fueled the large-scale migration of rural Northeasterners tourban areas, particularly to economically vibrant metropolises of the Southeast such as Rio deJaneiro and Sao Paulo. In the 1 980s, economic stagnation rendered these cities less capableof absorbing the influx of rural Northeasterners seeking to improve their welfare. However,the lack of opportunities and extreme poverty of the rural Northeast continued to stimulateout-migration. The populations of medium-sized cities and Northeastern metropolitan areashas expanded as intra-state migration from rural to urban areas has accelerated.

6. By the early 1990s, three-quarters of all Brazilians were living in urban areas. Withmore of the population residing in cities and towns, the share of urban poor relative to ruralpoor has grown. Over 50% of Brazil's poor are now urban. In more urbanized regions suchas the Southeast, the vast majority of the poor live in cities and towns. Even in the Northeast,urban areas already contain around 45% of the region's poor. Assuming that the process ofurbanization continues, poverty will become an increasingly urban phenomenon in Brazil.Strategies designed to address the specific characteristics and problems of urban poverty willbe more urgently needed.

7. The Nature of Urban Poverty. In the Northeast, poverty rates and social indicatorstend to be worse in medium-sized and smaller urban areas while the metropolitan areas arecomparatively better-off. In the Southeast, the relative position of the large metropolitanareas and smaller urban centers is reversed, and poverty indices tend to be higher in themetropolitan areas.

8. Cities have been unable to keep up with the demand for low-income housing andutility services created by rapid urbanization. Squatter settlements, orfavelas, and otherinformal communities have sprung up in nearly every city and many towns. The urban poorare concentrated in these settlements, which are often located on the peripheries of urbancenters in flood-prone areas. Although manyfavela houses are made of brick (particularly inmore established favelas), homes are also constructed of less durable materials. Lack ofaccess to basic services--especially piped water from the public system, sewage and garbage

54

collection--is a problem for many poor households, especially in the cities of the Northeast.Higher-income households generally have better access to basic services.

9. In the crowded conditions of the poorer urban communities, the lack of servicescreates an unhealthy living environment. Waterborne diseases and respiratory infections tendto be more common and more severe among the poor, and are more frequently a cause ofdeath among poor urban infants and toddlers than among better-off children. Similarly,malnutrition is more prevalent among poor children. It is a particularly serious problemamong urban children in the Northeast, where over one-fifth of all children under the age offive are physically stunted. Children in the urban Southeast are much less likely to bemalnourished. Income differences only partly explain the much higher rates of childmalnutrition in the urban Northeast. Access to basic utilities also seems to be a factor.

10. Another characteristic of urban poverty is more limited access to quality educationalopportunities. Low-income children have much less access to pre-school and day carefacilities than the better-off. Similarly, poor urban children aged 10 to 14 are less likely thanthe non-poor to attend school. On average the education that poor children receive is oflower quality than that received by the non-poor, both because better-off children are morelikely to attend private school and because poorer states and municipalities tend to spendmuch less per public school student.

11. The relationship between poverty and child labor is complex. While children in allincome classes work, child labor is more common in the urban and metropolitan Northeastthan in the Southeast. Poor children who work (particularly those in female-headedhouseholds) tend to work longer hours. Children working in urban areas face multiple threatsto their physical and moral well-being. The problem of"street children" is a unique feature ofurban poverty, and appears to be intimately linked with the need for poor children tocontribute to household income.

12. Characteristics of the Urban Poor3. Roughly one-third of the urban poor live infemale-headed households. Poor households are more likely than non-poor households to beheaded by a woman, by an adult below the age of thirty, and by an illiterate. In theNortheast, one-third to one-half of all poor household heads in urban areas are illiterate. Poorhousehold heads also tend to have fewer years of schooling than the non-poor Poor

3 The comparisons of the urban poor and nonpoor made in this annex hold region and residence in ametropolitan area versus "another" urban area constant. That is, the poor in Northeasternmetropolitan areas are compared and contrasted with the nonpoor in Northeastern metropolitan areas,the poor in non-metropolitan urban areas of the Southeast are compared to the non-poor living in theurban Southeast, and so on. All comparisons are based on calculations made by Sonia Rocha usingthe 1990 PNAD household survey data, as reported in Brazil: A Poverty Profile, a background paperprepared for the World Bank (June 27, 1995).

55

households are somewhat larger than non-poor households, and have more young children onaverage.

13. Employment patterns differ among the urban poor and non-poor. Compared to better-off workers, the poor are more likely to be employees or self-employed, and less likely to beemployers. Poor householders are more likely than the nonpoor to work in the service sector,agriculture, and construction, and less likely to work in manufacturinrg, trade or the civilservice. In addition, informal employment is more common among the poor. Workingwithout a labor card is especially prevalent among poor workers in non-metropolitan urbanareas of the Northeast. Labor force participation rates--both overall and for womenseparately -- are higher in nonpoor households. The combination of more children and lowerlabor force participation rates among adults of working age results in much higher dependencyratios in poor households.4

14. The Government's Poverty Strategy. President Cardoso has identified social justiceand poverty reduction as priorities for his administration. The Government views the battleagainst poverty as a long-term task that will require continued economic development,redistribution of income, reform of government and efficient implementation of significantpublic sector programs in the areas of health and education. The Government also recognizesthe importance of implementing and managing effective social programs of immediate benefitto low-income Brazilians.

15. The Community Solidarity Program (PCS), a Government of Brazil initiative, aims tomobilize all levels of Brazilian government and society to address the basic needs of the poor.Like the earlier Fight Against Hunger program, the Programa de Comunidade Solidaria isgrounded in the principles of decentralization and community participation, and promotespartnership between the federal government and the states, municipalities and Braziliansociety as a whole. Its main objectives include:

(a) improving the management of selected, high priority social programs throughthe promotion of community participation;

(b) supporting the implementation of Government projects and initiatives in areaswith high concentrations of poverty; and

(c) identifying new priorities and developing action plans for Government and civilsociety.

16. Poverty in the State of Bahia. Roughly 30% of Bahia's population have per capitaincomes below the poverty line. Infant mortality rates are high: around 96 out of every 1,000children born in Bahia do not live to their first birthday. Sixty-three percent of the state'schildren under the age of seven live in households with inadequate access to water; 58% ofthe zero to six year-olds live in households where the head earns one minimum salary or less.Service coverage is particularly low in medium and small cities and towns and rural areas.However, even in the capital, Salvador, one-fifth of the zero to six year-olds live in

4 The dependency ratio is the number of non-working household members per working adult.

56

households not connected to the general water system. Only 5% of Bahia's population havesewage collection. Water and sanitation system coverage in Bahia is thus low even relative tothe rest of the Northeast.

17. Policy Implications of the Causes, Characteristics and Profile of Urban Poverty. Urbanpoverty has multiple causes and dimensions. Macroeconomic instability and economicstagnation are the environment in which urban poverty thrives best. Inadequate access toproductive employment and other income generating opportunities, lower quality and quantityof schooling, and limited availability of basic sanitation and other urban infrastructure are bothcauses and consequences of urban poverty. The linkages among these factors areconsiderable.

18. Poor households are more likely than better-off households to lack access to cleanwater, sewage systems and garbage collection. Lack of basic sanitation exacerbatesmalnutrition, by subjecting young children to diarrheal diseases that hinder their body's abilityto convert food into energy and good health. This can lead to stunting and other chronicconditions which have negative implications for future productivity. In the short run, bymaking childhood illnesses more likely, lack of access to basic sanitation can hamper afiamily's ability to generate income by diverting parents from work in order to care for sickchildren.

19. Poor children are much less likely than better-off children to graduate from primaryschool (let alone secondary school). This perpetuates the cycle of poverty through the linkbetween wages in adulthood and educational attainment, and contributes to the inter-generational transfer of poverty. The importance of enhancing the quality of public schoolsattended by poor children for urban poverty reduction can hardly be over-emphasized.

20. When a household's adults lack access to employment that generates sufficient incometo support the family, children are often required to prematurely take on income-earningresponsibilities. This exposes children to many risks, hinders schooling and rarely leads to jobopportunities that will allow them to break the cycle of poverty in adulthood.

21. These are just a few examples of the linkages among urban poverty, education, basicurban infrastructure, and employment. The policy implications of these linkages are thatsynergies exist and policy interventions on several fronts can multiply their impact.

22. Another clear implication of the profile of urban poverty is that urban areas in theNortheast ghould receive priority in the allocation of resources and implementation ofprograms to address urban poverty. However, effective policy interventions require effectivepublic institutions. The share of public resources controlled by municipalities has grownrapidly since 1988, increasing the importance of skilled public management at the local level.The Northeast lacks a strong cadre of local public administrators. With some exceptions, theprovision of social services in the Northeast has traditionally been characterized by unevenadministration, inefficient use of resources and paternalism. To overcome these tendencies,investments must be made in the training of middle- and senior-level urban administrators inrelevant skills, in the adoption of rational planning methodologies, and in the regularreinforcement and upgrading of these skills.

57

ANNEX IDBRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENTAND MANAGEMENT PROJECT- PRODUR

Project Design Matrix

| Objcclives Tools.C:nmponenis Policy Indicators Risks

Consolidate Institutional Explicit link between Increase capita (see Cost-recoverypreviously rural development institutional development and Annex 2), own mechanisms noturban structures, component: TA & infrastructure; full cost- revenues/transfers; enforced: tariffs andby strengthening training for recovery policy on tariffs and current expenses/total taxes notmunicipal increasing own property taxes revenues; ex-post IERRs; appropriatelyfinancial resources, current no. municipalities with increased or collectedmanagement, and expense control, MIS systems; no. training due to lack ofas a corollary, investment courses political will; weakinstitutional prioritization link betweencapacity institutional

development &infrastructure

Target benefits to Infrastructure Selection criteria; use of Income per capita of Weaker, poorerurban poor investment criteria, poverty mapping in the State beneficiaries (baseline municipalities will

urban upgrading and over time), infant not be able/havecomponent in low- mortality and other interest inincome area, sanitation indicators participation, despitepoverty mapping targeting

Increase efficient Infrastructure Selection criteria: tariffs cover Service coverage ratios; Technical risks,infrastructure investment economnic costs; least-cost investment unit costs; tariffs not increased,coverage in components technical alternative; market- increased joint water and municipalities'priority sanitation based on-lending terms; sewerage provision implementationsectors potential private participation capacity

in fund

Create sustainable Revolving fund Fund bylaws: rnarket-based Rate of re-capitalization Lack of private sectorfinancing channels State on-lending rates; municipal of fund; success in interest (effortsmechanism for resources, fund creditworthiness "ranking" attracting private sector premature in light ofurban managed by private through financial indicators capital; success of distortions ininfrastructure bank (transition to ranking exercise financial markets)investments, private capitalincluding markets)mobilizing privatecapital

Improve Sanitation Selection criteria, limited Water quality indicators, Cost-recoveryenvironmental infrastructure; TA targeted grants for regional infant mortality and other mechanisms notmanagement & training for investments, linkage of health indicators enforced: tariffs and

improved institutional development and taxes notlegislation, zoning, infrastructure components appropriatelycommunity increased or collectedparticipation due to lack of

political will

58

ANNEX 2BRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENTAND MANAGEMENT PROJECT - PRODUR

TAX ASSIGNMENT IN BRAZIL BY JURISDICTION

Federal ~~~~~State muncipal

Income Tax (IR) Value-Added Tax (ICMS) Services Tax (ISS)

Industrial Products Tax (IPI) Inheritance, Donations Taxes Urban Property Tax (IPTU)(CMD)

Import Tax (II) Vehicle Registration Tax Fuel Retail Sales Tax(IPVA) (IVVCLG)

Export Tax (IE) Supplementary Capital Gains Property Transfer Tax (ITBI)Tax

Rural Property Tax (ITR) Frontage Tax

Financial Operations Tax (IOF)

Wealth Tax (IGF)

Social Contribution on Profits

Mineral, Hydroelectric Tax

Source: A Nova ConstituiVdo Brasileira, Article VI, "Da Tributaqdo e do Or'amento," pp. 67-78.

BRAZILBAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENT

AND MANAGEMENT PROJECT

ECONOMIC PERFORMANCE OF THE STATE

Evolution of the Size of the Three Levels of Government(Item as % of GDP)

Own-Revenue Collection Available Own Revenues

Federal State Municipal Total Federal State Municipal TotalYear A B C D=A+B+C E F G H=E+F+G

1970 17.33 7.95 0.70 25.98 15.77 7.56 2.64 25.98

1975 18.59 5.99 0.71 25.28 17.20 5.91 2.17 25.28

1980 18.60 5.44 0.73 24.77 17.14 5.49 2.14 24.77

1985 16.39 5.74 0.56 22.69 14.46 5.81 2.43 22.69-'-~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~

1986 17.54 6.85 0.64 25.02 15.28 6.77 2.97 25.02

1987 16.87 5.99 0.59 23.45 14.90 6.08 2.48 23.45

1988 15.69 5.71 0.61 22.01 13.84 5.80 2.38 22.01

1989 14.80 6.69 0.61 22.10 13.12 6.30 2.68 22.10

1990 17.32 7.40 0.85 25.57 14.72 7.14 3.72 25.57

60

ANNEX3A

BRAZILBAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENT

AND MANAGEMENT PROJECT

ECONOMIC PERFORMANCE OF THE STATE

Contribution of Selected States to National GDP (%)

State 1970 1975 1980 1985 1990Sao Paulo 39.4 39.2 37.5 37.6 35.8

Minas Gerais 8.3 8.6 9.3 11.8 12.5Rio de Janeiro 16.7 15.4 14.2 12.3 10.9

R.G.do Sul 8.6 8.6 8.0 7.5 7.0Parana 5.4 6.7 5.8 6.1 6.3

Bahia 3.8 3.8 4.3 4.5 4.8

Source: FIBGE and Programa de Estudos dos Estados da EBAP/FGV

Table 1: Sectoral Composition of Bahia's GDP, 1960-1990 (%)

Year/Sectors Primary Secondary Tertiary1960 40.0 12.0 48.01970 21.2 13.4 65.41980 16.4 31.6 52.01990* - 15.0 30.0 55.0

Source: CEI/CPE/SEPLANTEC*estimates

61

ANNEX 3B

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENTAND MANAGEMENT PROJECT

URBANIZATION IN THE NORTHEAST AND THE STATE

States PopulationStates l__ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _

Total Urban Percent Urban

Alagoas 2,512,991 1,481,125 58.9

Bahia 11,855,157 7,007,729 59.1

Ceara 6,362,620 4,158,059 65.4

Maranhao 4,929,029 1,972,008 40.0

Paraiba 3,200,677 2,051,576 64.1

Pernambuco 7,122,548 5,046,535 70.9

Piaui 2,581,215 1,366,218 52.9

R.G. do Norte 2,414,121 1,668,165 69.1

Sergipe 1,491,867 1,001,940 67.2

Total NE 42,470,225 25,753,355 60.6

Source: Census, 1991.

62

ANNEX 3CBRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENTAND MANAGEMENT PROJECT

BAHIA'S MIJNICIPAL POPULATION BY SIZE GROUP (AS OF 1991)

Population Group Total Populationby Number of Total

Inhabitants Municipalities l

Inhabitants % of total Cumulative Percent

8,000 or less 40 260,870 2.2 2.2

8,001 to 15,000 151 1,763,209 14.9 17.1

15,001 to 30,000 153 3,197,558 27.0 44.1

30,001 to 60,000 46 1,852,622 15.6 59.7

60,001 to 100,000 16 1,165,831 9.8 69.5

100,001 - 150,000 4 503,618 4.3 73.8

150,001 - 250,000 3633,543 5.3 79.1

250,001 - 500,000 1405,848 3.4 82.5

above 500,000 12,072,058 17.5 100.0

TOTALSTATE 415 11,855,157 100.0

Memo Items:

Total above 15,000 224 9,831,078 83.0% l

Total Brazil 4,800 153,164,000 --

Sources: Data on the State of Bahia: CAR; Data on Brazil, IBRD.

63

ANNEX 3DBRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENTAND MANAGEMENT PROJECT

INDICATORS OF RELATIVE WEALTH IN BAHIA

Monthly Income of Urban Households Brazil vs. the State of Bahial_______ (as of 1987)I Total Household Income Groups (number of minimum salaries per month)2

House-holds'

<1I >1<2 >2<5 >5<10 >10<20 >20 other3

BRAZIL____

number(°°°) 34,291 4,081 5,967 11,145 6,755 3,532 1,955 857

% of total 100.0 11.9 17.4 32.5 19.7 10.3 5.7 2.5

cumulative j --- 11.9 29.3 61 8 81.5 91.8 97.5 100.0

B3AIA

number(000) 1,555 657 344 270 110 52 26 96

%oftotal 100.0 42.1 22.3 17.3 7.1 3.3 1.7 6.2

cumulative -- 42.1 64.4 81.7 88.8 92.1 93.8 100.0

Sources: Brazil: Pesquisa Nacional porAmostra de Domicilios, Rio de Janeiro, IBGE, 1988.Bahia: CAR, State of Bahia.

Does not include pensioners or household employees. Average persons per householdapproximately 4.

2 One minimum salary in Brazil currently average about US$ 110.

3 Other signifies either no response obtained, or famnilies with no income at all.

64

ANNEX 3EBIkAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENTAND MANAGEMENT PROJECT

WATER SUPPLY AND SEWERAGE COVERAGE LEVELS IN THE NORTHEAST ANDBAHIA

Percent of Populationwith Service

States

Water Supply Sewerage

Total Urban Total Urban

Alagoas 44.6 74.6 6.8 11.4

Bahia 43.7 73.9 5.0 8.4

Ceara 37.7 57.6 6.9 10.5

Maranhao 35.0 73.2 7.0 14.5

Paraiba 57.8 90.2 12.8 20.0

Pemrnambuco 65.6 90.7 13.5 18.7

Piaui 48.3 90.2 2.1 3.9

R.G. do Norte 57.6 83.1 7.2 10.5

Sergipe 60.4 90.0 7.4 11.0

Source: Catalogo Brasileiro de Engenharia Sanitaria e Ambiental No. XVII, 1992/1993.

65

ANNEX 3F-1

BRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENTAND MANAGEMENT PROJECT

BAIA: SELECTED Soclo-ECoNoMIc INDICATORS BY ECONOMIC REGION

A.Water-Borne Diseases

Economic regions Occurrences

Hepatitis- 1 992 Cholera- 1993 Diarrhea - 1993Metropolitan Salvador 931 313 33,482Litoral Norte 73 44 1,489Reconcavo Sul 101 116 2,975Litoral Sul 339 3,024 12,091Extremo Sul 119 9 2,754Nordeste 244 337 14,542Paraguacu 259 712 27,984Sudoeste 231 236 12,168Baixo Medio Sao Francisco 125 30 2,892Piemonte Diamantina 127 331 6,260Irece 31 207 8,428Chapada Dimantina 281 3 6,406Serra Geral 301 5 8,077Medio Sao Francisco 111 23 809Oeste 86 2 658BAHIA 3,360 5,392 141,015

Source: CIS/SESAB.

66

ANNEX 3F-2BRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENTAND MANAGEMENT PROJECT

BAHIA: SELECTED Soclo-EcoNoMIC INDICATORS BY ECONOMIC REGION

B. Total Population and Regional Share of Rural and Urban Population, 1991

Economic regions Total Population Urban Population Rural Population

No. % No. % No. %

Metropolitan Salvador 2,496,521 21.04 2,421,340 34.51 75,181 1.55Litoral Norte 463,726 3.91 _ 299,941 4.27 163,785 3.38Reconcavo SUl 628,952 5.30 326,633 4.66 302,319 6.23Litoral Sul 1,381,994 11.64 782,382 11.15 599,612 12.36Extremo Sul 533,219 4.49 328,127 4.68 205,092 4.23Nordeste 1,098,935 9.26 369,288 5.26 729,647 15.04ParaguaCu 1,193,161 10.05 655,727 9.35 537,434 11.08Sudoeste 1,009,757 8.51 607,743 8.66 402,014 8.29Baixo Medio Sao 342,550 2.89 186,672 2.66 155,878 3.21Francisco _1 L L

Piemonte Diamantina 603,098 5.08 240,748 3.43 362,350 7.47Irece 361,131 3.04 169,381 2.41 191,750 3.95Chapada Dimantina 479,479 4.04 130,874 1.87 348,605 7.19Serra Geral 524,793 4.42 194,899 2.78 329,894 6.80MedioSaoFrancisco 311,722 2.63 112,722 1.61 199,000 4.10Oeste 438,953 3.70 190,243 2.71 248,710 5.13BAHIA 11,867,991 100.00 7,016,720 100.00 4,851,271 100.00

Source: EBGE.

ANNEX 3F-3BRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENT AND MANAGEMENT PROJECT

BAHIA: SELECTED SocIo-ECONOMIC INDICATORS BY ECONOMIC REGION

C. Regional Distribution and Growth of Urban and Rural Population, 1980 and 1991

Inhabitants, 1980 Inhabitants, 1991 Degree of Population Growth RateUrbanization (%) 1980-1991 (%)

Economic regions Total Urban Rural Total Urban Rural 1980 1991 Total Urban RuralMetropolitan Salvador 1,766,582 1,696,318 70,264 2,496,521 2,421,340 75,181 96.0 97.0 3.2 3.3 0.6

Litoral Norte 393,607 220,348 173,259 463.726 299,941 163,785 55.6 64.7 1.5 2.8 0.2Reconcavo Sul 588,419 259,315 329,104 628,952 326,633 302,319 44.7 52.0 0.6 3.3 -1.2

Litoral Sul 1,122.190 554,739 567,451 1,381,994 782,382 599,612 49.4 56.6 1.9 3.2 -0.5

Extremo Sul 456,463 124.299 332,164 533,219 328,127 205,092 27.2 61.5 1.4 9.2 -1.0

Nordeste 880,288 232,525 647.763 1.098,935 369,288 729,647 26.4 33.6 2.0 4.3 -1.5

Paraguacu 963.373 433,074 530,299 1,193,161 655,727 537,434 44.9 54.9 2.2 3.8 -1.3

Sudoeste 862.940 421,085 441,855 1,009.757 607,743 402,014 48.8 60.2 1.3 3.4 1.8

Baixo Medio Sao 288,224 106,683 181,541 342,550 186,672 155,878 37.0 54.5 1.6 5.2 0.3Francisco

Piemonte Diamantina 450,844 138,346 312,498 603,098 240,748 362.350 30.7 40.0 2.7 5.2 0.5

Irece 274,721 102,664 172,057 361,131 169,381 191,750 37.4 46.9 2.5 4.7 -4.1

Chapada Dimantina 381,708 76,355 305,353 479,479 130,874 348,605 20.0 27.3 2.1 5.1 2.6

Serra Geral 438,506 119,581 318,925 524,793 194,899 329,894 27.3 37.1 1.6 4.5 -1.4

Medio Sao Francisco 249,665 72,051 177,614 311,722 112,722 199,000 28.9 36.2 2.0 4.1 -4.0

Oeste 336,816 102,921 233,895 438,953 190,243 248,710 30.5 43.3 2.4 5.7 1.6

BAHIA 9,454,346 4,660,304 4,794,042 11,867,991 7,016,720 4,851,271 49.3 59.1 2.1 3.8 1.6

Source: IBGE, Demographic Census 1980 and 1991.Urbanization level = Ratio between urban population/Total regional population (CEI).

ANNEX 3F-4

BRAZILBAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENT AND MANAGEMENT PROJECT

Bahia: Selected Socio-Economic Indicators by Economic Re2ion

D. Sanitation IndicatorsHouseholds

Economic regions Water Supplied by Public Water Supplied by own Adequate Water SupplySource (own tap) Source (Well) Septic Tak Inadequate Sewerage

No. % No. % No. % No. %Metropolitan Salvador 30,755 32.43 1,174 1.58 1,102 1.55 3,036 1.49

Litoral Norte 4,213 4.44 2,538 3,42 2,362 3.32 7,323 3.59

Reconcavo Sul 4,453 4.70 4,624 6.23 4,417 6.21 13,050 6.40

Litoral Sul 11,084 11.69 9,720 13.10 9,012 12.68 26,037 12.77

Extremo Sul 4,651 4.90 3,176 4.28 3,095 4.35 8,651 4.24 aNordeste 4,979 5.25 10,543 14.20 10,265 14.44 30,227 14.82

Paraguacu 8,933 9.42 8,349 11,25 7,945 11.18 23,502 11.52

Sudoeste 8,344 8.80 5,988 8.07 5,738 8.07 16,995 8.33

Baixo Medio Sao 2,454 2.59 2,246 3.03 2,212 3.11 6,454 3.16Francisco

Piemonte Diamantina 3,289 3.47 5,503 7.41 5,279 7.43 15,648 7.67Irece 2,599 2.74 2,982 4.02 2,839 3.99 8,082 3.96

Chapada Dimantina 1,835 1.93 5,157 6.95 4,988 7.02 13,631 6.68

Serra Geral 2,620 2.76 4,773 6.43 4,763 6.70 12,840 6.30Medio Sao Francisco 1,717 1.81 3,224 4.34 3,101 4.36 8,270 4.05

Oeste 2,918 3.08 4,225 5.69 3,952 5.56 10,216 5.01BAHIA 94,844 100.00 74,222 100.00 71,070 100.00 203,962 100.00

Source: IBGE.

ANNEX 3F-5BRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENT AND MANAGEMENT PROJECT

BAHIA: SELECTED SOCiO-ECONOMIC INDICATORS BY ECONOMIC REGION

E. Urban Household Income, 1991

Income Groups (Number of Minimum SalarieLess than 1/4 Groups 1/4 to 2 Group 2 - 5 G & morc Undeclared Total

Economic regions No. % No. % No. % No. % No. % No. %Metropolitan Salvador 41,076 7,39 269,247 48.44 129,565 23.31 113.891 20.49 2,014 0.36 555,836 100%Litoral Norte 4,133 6.42 42,881 66.61 11,189 17.38 5,987 9.30 193 0.30 64,376 100%Reconcavo Sul 4,672 6.39 54,824 74.98 9,023 12.34 4,475 6.12 118 0.16 73,118 100%Litoral Sul 16,913 10.02 116,486 69.01 21,935 13.00 13,149 7.79 343 0.20 168,796 100%Extremo Sul 6,234 8.75 48,320 67.82 10,333 14.50 6,184 8.68 178 0.25 71,248 100%Nordeste 3,647 4.47 59,568 72.97 12,799 15.68 5,534 6.78 73 0.09 81,629 100%Paraguacu 10,256 7.18 94,866 66.41 24,141 16.90 13.242 9.27 343 0.24 142,847 100%Sudoeste 9,148 6.99 94,908 72.53 17,014 13.00 9,565 7.31 236 0.18 130,854 100%Baixo Medio Sao 1,965 5.65 27,708 79.59 2,567 7.37 2,531 7.27 42 0.12 34,814 100%Francisco

Piemonte Diamantina 3,091 5.91 39,269 75.01 6,813 13.01 3,105 5.93 68 0.13 52,352 100%Irece 2,299 6.39 27,541 76.48 4,153 11.53 1,963 5.45 54 0.15 36,011 100%Chapada Dimantina 2,008 7.13 20,997 74.51 3,528 12.52 1,570 557 76 0.27 28,180 100%Serra Geral 3,270 8.01 28,520 69.86 5,978 14.64 2,978 7.30 83 0.20 40,825 100%Medio Sao Francisco 1,617 4.66 24,720 71.26 5,783 16.67 2,529 7.29 42 0.12 34,690 100%Oeste 2.341 5.97 27,434 69.90 6,146 15.66 3,242 8.26 82 0.21 39,247 100%BAHIA 112,672 977,291 270,969 189,945 3,945 - 1,554,823

Source: IBGE

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ANNEX3GBRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENT ANDMANAGEMENT PROJECT

STATE OF BAHIA CREDITWORTHINESS ASSESSMENT

1. A creditworthiness assessment of the state of Bahia is carried out here using theguidelines developed in Assessing State Creditworthiness in Brazil. No.8. EconomicNotes. Country Department 1. LAC, 1996.

Backsround

2. Over the 1993-95 period, the Government of Bahia's budgetary accountsregistered primary surpluses every year with an average primary surplus of R$130 million(constant prices of January 1996). The state suffered a large overall deficit in only oneyear 1994, but the average overall deficit for the period was only R$40 mnillion, or only 1.5percent of average net revenues over the period (net of municipal transfers).

Financial Projections

3. Table 3G-1 below presents financial projections for the state for the period 1995-2000. The data for 1995 are actuals, with some minor estimated items.

Table 3G-1 Bahia - Public Accounts

(In constant R$ millions of January 1 1996)

1995 1996 1997 1998 1999 2000I. Current Revenues 2,790 2.888 3,018 3168 3.327 3.493

(Net of transfers tomunicipios & borrowings)

II. Current Expenditures 2 363 2.396 2 506 2.619 2,735 2866(a) Personnel 1,728 1,728 1,806 1,887 1,972 2,070(b) Debt Service (interest) l' 197 212 224 232 238 245- internal 178 189 203 212 220 228- external 19 23 21 20 18 17(c) Other 438 456 476 500 525 551

III. Residuo Divida -- 229 236 243 240 234IV. Amortization 496 278 291 302 177 190V. Capital Receipts 471 0 0 0 0 0VI. Capital Expenditures 439 439 439 439 439 439

1/ Includes debt service on an accrual basis up to the 11 % limit on the relevant categories of debt.

Source: Capacidade Financeira do Estado da Bahia (IBRD Consultant Report).

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4. The item " Residuo Divida" refers to the excess of accrued debt service andamortization on certain categories of debt. There is a limit of 11% of net revenues on thisdebt service. This limit has been negotiated between the states and the Federal Senateaccording to Senate Resolution No. 69 in order to avoid undue pressure on essentialcategories of expenditure. The excess is capitalized into the existing debt stock and repaidbeyond the horizon presented here, when debt service and amortization would fall belowthis limit.

5. Assumptions. The assumptions underlying the projections are conservative. Theyare: (1) Revenue growth. It is assumed that revenue grows at a rate of 3.5 % in 1995,4.5% in 1996 and 5 % per annum thereafter. These rates are close to the projected growthof the state economy and also represent a modest degree of additional tax effort. (2)Personnel expenditures. It is assumed that personnel expenditure growth is 0 % in 1996because of an adjustment effort on the part of the state with no increase in nominal wagesgranted this year. There is positive growth at a rate of 4.5 % thereafter. (3) Debt service.Debt service is projected according to actual contracts, except for debt in the form ofbonds. It is assumed that bonds are amortized over 50 years. The state, however, servicesthe interest and there is no debt forgiveness. (4) New Borrowing: No new borrowing isallowed. (5) Capital Expenditures. Capital expenditures are held constant at the 1995level. However, because budgetary surpluses are generated, there is a margin forincreasing capital expenditure.

6. Results. A number of accounting concepts are monitored and presented in Table3G-2 below. The CurrentAccountBalance. This indicator is monitored to see if the stategovernment is generating public savings to finance part or all of its annual investmentprogram. Primary Balance (overall deficit excluding interest payments). This indicatoris monitored to see if the primary surplus will be adequate for meeting future interestpayments, and perhaps some portion of amortization's. Overall Balance. This ismonitored to see if it is at least shrinking as a share of revenues. The Ratio of the Stock ofDebt to Net Revenue. This indicator should be declining over time. We see in the tablebelow that the current and primary balances are in surplus and growing over the projectionperiod. The overall balance is positive and large enough to result in a rapidly decliningdebt-to-revenue ratio over the projected period.

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Table 3G-2: Bahia -Creditworthiness Indictors(In constant R$Million of January, 1996)

1995 1996 1997 1998 1999 2000Current Surplus excluding 427 492 512 549 592 627Residuo DividaCurrent Surplus. including 427 263 276 306 352 393Residuo DividaPrimary Surplus ' 185 265 297 342 391 433Overall Balance -12 53 73 110 153 188Primary Surplus/Revenue 6.6 9.2 9.8 10.8 11.8 12.4(as percentage)Debt Stock/Revenue 1.57 1.52 1.44 1.33 1.25 1.17

1/ The primary surplus in 1995 does not include capital receipts since these are borrowings. Forthe years 1996 to 2000, we assume that capital receipts are zero.

Source: Capacidade Financeira do Estado da Bahia (IBRD Consultant Report). Feb. 1996.

Oualitative Management Issues

7. The state has been consistently fiscally conservative in recent years. Bahia is oneof the few in Brazil to already be in near compliance with the Lei Camata target of limitingpersonnel expenditures to 60% of net current revenues. In addition, the state passed a lawearlier this year which authorizes a special "voluntary dismissal" program to furthercontrol expenditures in this area. A sign of the administration's forward-looking approachis a plan, currently being designed, to use privatization revenues and property sales tocreate a fund for financing an anticipated future increase in the pension payroll.

Conclusion

8. Based on the above criteria, Bahia can be considered creditworthy. The state has acurrent account surplus. The margin of the surplus is above 10%, even with "ResiduoDivida" being considered part of expenditure. The primary surplus is growing. There isan overall deficit in the base year of the projections, but a surplus in the remaining yearsthat is growing. The stock of debt to revenue ratio remains very high; however, the debtservice to expenditure ratio is below 10 percent because the bulk of Bahia' s debt is longterm contractual debt with Federal financial institutions on favorable terms or, withmultilateral external creditors. The projections assume that all short term arrears are paidoff by the end of 1998--the end of the term of the present government. The projectionsare not unusually sensitive to parameters such as the wage level or interest rates, and thewage to revenue ratio is close to the " Lei Camata" guideline of 60% of net currentrevenues.

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ANNEX 4ABRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENTAND MANAGEMENT PROJECT

DETAILED PROJECT DESCRIPTION

1. Outlined below is a detailed description of the project components: MunicipalReform (Part A); Institutional Development, including a Poverty Mapping Study (Part B),Urban Infrastructure (Part C); and Poverty-Targeted Urban Upgrading (Part D).Operational arrangements which set out selection criteria and link the technical assistanceand infrastructure sub-projects are described in Annex 5E.

A. Municipal Reform (MR) Component(US$ 10.0 million, 4.5% of project costs)

2. The primary objective of the Municipal Reform component of the project is toincrease the efficiency and sustainability of the delivery of infrastructure and socialservices in Bahia's municipalities..

3. This is to be accomplished through encouraging the municipalities to enter intopartnership with the private sector to provide municipal services wherever this can bemore efficiently done. In this manner the role of the municipal public sector would bereduced to those critical administrative, social, and other operational functions that cannotbe provided efficiently by others.

4. Together with CAR, the municipalities seeking to participate in PORDUR wouldundertake an analysis of the range of services provided by the municipality. Servicescurrently being provided which could be privatized and/or farmed out to privateconcessions would be identified. Consultants would be engaged to assist CAR and themunicipalities in this exercise as necessary. An implementation plan would be drawn up.

5. Funds from the loan would be made available, on a grant basis, to finance the costsof consultants in the diagnosis as well as the implementation of the privatization orconcession program. In addition the funds could finance the incremental cost of thetransfer on a declining basis.

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B. Institutional Development (I1D) Component(US$10.0 million, 4.5% of project costs)

(a) Objective

6. Should the initial diagnosis judge them to be necessary the MR component the IDcomponent will provide entry into the program. The specific objectives of the ID for themunicipalities are to:

(i) improve local government financial management, particularlyincreasing own as a portion of total revenues and efficiency incurrent expenditures;

(ii) reinforce municipal capacity to plan. prioritize, select andimplement efficient infrastructure investments on the basis ofappropriate selection criteria; and

(iii) strengthen municipal government professional staff in the aboveareas through training

(b) Implementation

7. Eligibility criteria will ensure that all municipalities entering the program developan acceptable institutional and financial development plan. The institutional developmentplan will be consolidated with the municipal reform program to the negotiating agreement(accordo de negocia,ao)

8. Once a program of institutional development actions is agreed, including bothtraining and technical assistance, the municipality will determine sources of assistance onthe basis of a short list. For training, municipalities will choose among independentconsultants. It is planned that most technical assistance interventions will be executed byindependent consultants according to standards and guidelines prepared by CAR andagreed with the CAR and the Bank. For technical assistance, municipalities will choose onthe basis of terms of reference and short lists as stipulated under the Program's guidelinesand consistent with Bank procurement guidelines (see Chapter 5).

9. Sample terms of reference for standard technical assistance irvestments, such asupgrading of property cadastres, will be agreed with the Bank for tllis purpose. CAR willalso maintain a database of consulting firms interested in providing technical assistance tomunicipalities in these areas, to be advertised annually. This list will in no way berestrictive, and will be available to municipalities simply as a resource.

10. Because of its fundamental goal of increasing local government own-resourcemobilization and improved efficiency in both current and capital expenditures, theinstitutional development component is directly linked to progress on infrastructureinvestments. This linkage will be established in each municipality through the PRIM andsub-loan contracts, and closely monitored through agreed indicators.

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(c) Technical Assistance Investments (US$4. 1 million)

(i) The technical assistance sub-component would focus oninterventions in two main areas:

(ii) fiscal and administrative: upgrading property tax cadastres(including reevaluating existing property, inclusion of un-registeredproperty); improving procedures, policies and physicalinfrastructure for billing and collection of property and other taxesand tariffs; improving procurement procedures; and

(iii) planning: preparing and updating of master plans; updating realproperty mapping; works and construction codes and technicalstandards.

11. Technical assistance costs have been estimated on the basis of current market costs ofsimilar technical assistance interventions in Bahia and other states, estimated by CAR.Technical assistance investments averaging about US$50,000 per municipality for about 220municipalities have been budgeted.

(d) Training Investments (US$3.6 million)

12. The training program is designed to complement the technical assistance componentand would be largely oriented towards on-the-job training, rather than classroom lectures. Itwould include, inter alia, the following areas: municipal accounting and budgeting,procurement methods, land-use planning and usage of master plans, environmental protectionand enforcement instruments, financial and administrative management; project evaluation.

13. Local training unit costs (costs per participant per day) would be estimated on thebasis of on-going programs implemented by other Brazilian agencies, averaged fromaggregate costs per event per day. Costs include rental of training facilities, trainers' fees andhonoraria, and travel and subsistence costs for both trainers and participants. It is estimatedthat about 1200-1500 municipal staff will be trained under the project.

(e) Equipment (US$1.2 million)

14. PRODLJR will also finance limited and well-justified office equipment purchases,largely computers, printers, and other office technology upgrades which will improve theefficiency of processes and information flow in municipalities.

(f) State Technical Assistance and Studies (US$ 1. 1 million)

15 Technical assistance for the CAR would also be provided under this component. Theproject would finance training and technical assistance to prepare CAR to discharge the roleof executing agency. This would include hiring of an internationally-recognized urbanadvisor. Under this component would also be included the Statewide poverty mapping study,

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details of which would be discussed during appraisal and agreed during Negotiations (terms ofreference would also be included as Annex 4C).

C. Infrastructure Component(US$186.5 million, 84% of project costs)

(a) Focus and Dimensioning of PRODUR

16. Upon taking office in 1995, the new State government identified the basicsanitation sectors, including water, sewerage, drainage and solid waste as among its keypriorities. As is set out in its Policy Statement on Urban Development, the State'sintention is that the PRODUJR program will be one of its primary vehicle for suchinvestments in the State.

17. In order to dimension investments for the PRODUR program, the State and CARevaluated several key areas: demand for resources; municipal and State capacity to borrowand repay loan funds; and State and municipal technical, institutional and financialabsorptive capacity. First, as part of project preparation, in 1994, CAR undertook asurvey of 66 of the State's larger cities, representing about 924,000 inhabitants, or about8% of the population. The study confirmed that the most widely demanded investmentswere water supply, sewerage collection and treatment, solid waste collection and disposal,street paving and drainage. Second, CAR prepared an evaluation of the credit limits of asample of 36 of the State's municipalities, which indicate an annual State-wide debt limitof on the order of US$200 million. Finally, the State Government demonstrated in itshistoric financial statements that for the past several years it has been spending on theorder of US$630 million on annual capital investments, largely in urban infrastructure. Itis the equivalent of these funds which would go into the FUNDURBANO as Statecounterpart. The proposed project scope of about US$220 million for infrastructure andinstitutional development investments over a six-year period (or about US$37 million peryear) was based on these findings. With State counterpart of about US$72 million (aboutUS$15 million per year) and about US$33 million from municipalities (about US$5.5million per year) to be provided each year, the project is conservatively dimensioned.Simulations indicate that about 77 of the State's municipalities will participate in theproject. While municipalities which have access to loan funds under the Bank-supportedNRPA program would not be eligible, municipal eligibility for sub-loans would depend onfulfillment of the criteria for selection, eg., acceptable debt capacity and adequate financialand institutional capacity.

(b) First-Year Program

18. The proposed Bank loan will finance, together with State and municipalcounterpart resources, a time slice of municipal investments. The investment programs ofsubsequent years are likely to mirror that of the first year, although the exact mix of sub-projects cannot be determined in advance and will be subject to change depending on thepriorities of the sub-borrowers. Thus the physical targets, established on the basis of thefirst year program, should be seen as indicative only and will be reviewed throughoutproject implementation.

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(c) Terms and Conditions

19. The infrastructure component would be subject to the following guidelines: Nomunicipality will receive more than 10% of total funds lent in any given year, without priorBank agreement. This arrangement would be reviewed at the project's mid-term. Allinfrastructure sub-projects will be bid and executed by the sub-borrowers. All investmentsexpected to cost more than US$5 million would require the prior review of the Bank.

20. As explained elsewhere, infrastructure investments would be financed through sub-loans for up to 85% of the sub-project costs from the PRODUR Fund and the remaining 15%(minimum) provided by the municipality as counterpart, in the form of payment of receipts forexpenditures. The form of counterpart contribution would be agreed prior to contracting theloan, and stipulated in the sub-loan contract between the financial agent, CAR and themunicipality. Each sub-loan would have a grace period and maturity corresponding with thesub-project's implementation and pay-back periods, respectively.

21. Municipal governments and local water companies would bid and implementinvestments in various water and sewerage investments. Low-cost and alternativetechnologies for sewerage treatment would be prioritized. Sewerage treatment investmentswould be eligible when, in addition to other selection criteria, technical analysis demonstratestheir benefits to be primarily "on-site," or within the municipality. Those "off-site"investments, for which benefits may be more broadly spread to other surroundingmunicipalities in a water-basin area require formation of a water basin consortium and adetailed feasibility study, for which grant financing would be available.

(d) Water and Sewerage Investments (US$75.5 million)

22. Eligible investments under this component would be: (i) water distribution connectionsand limited production and treatment; (ii) sewage collection and limited, primarily low-costtechnology, treatment; and (iii) operational improvements such as metering. Water andsewerage components will be executed by municipalities in cases where they operate thesystems, or by municipal companies, in cases where they operate municipal systems.Sewerage treatment investments over US$2 million would be subject to Bank prior review.

(e) Drainage, Paving and Erosion Control Investments (US$75.6 million)

23. Micro- and macro-drainage and erosion/flood control investments would includeconstruction and in some cases rehabilitation of drainage networks. Because lands subject toflooding are generally less valuable, these at-risk areas are often the sites of informal low-income settlements. Diagnosis of at-risk areas is part of the technical assistance component inaffected municipalities and would be identified in the institutional evaluation process. Pavinginvestments would include local roads, minor rehabilitation repairs and related retaining wallsand drainage. Most municipalities expected to participate in the program have public worksdepartments which are capable of designing and supervising these relatively simple works. Ifduring project implementation the Bank and CAR determine that this is not the case, the StateRoads Department (Departamento de Estradas e Rodagem -DER), or other qualified

78

consultants, could be contracted to operate as a technical agent for works administration andsupervision.

(f) Solid Waste Investments (US$8.9 million)

24. This component would consist of construction of sanitary landfills, limited alternativedisposal technologies such as recycling and composting plants, and purchase of solid wastecollection and disposal equipment. The component would also include construction ofdesignated hazardous waste disposal sites. Technical assistance for evaluation and supervisionof sub-projects would be provided by university and local specialized consultants. Solid wastedisposal investments over US$2 million would be subject to Bank prior review.

(g) Complementary Investments (US$15.5 million)

25. It is expected that other, smaller investments related to the above larger investmentswould also be undertaken, such as street-lighting, sidewalks, traffic management, and plantingof trees.

(h) Regional Investments (US$11.1 million)

26. Regional cooperative investments in large shared infrastructure among severalmunicipalities, such as landfills. These sub-projects, along with the participating sub-borrowers, must meet all of the eligibility criteria established in the project. Other projectcomponent include the construction of municipal markets and slaughterhouses and theconstruction and/or expansion of air, road and water transport passenger shelters and touristbureaus.

D. Urban Uparadini(US$15.5 million, 7% of costs)

27. The urban upgrading component would be targeted to areas with averagehousehold income below two minimum wages per month. The objective of thecomponent would be to provide a package of integrated urban infrastructure investmentsto low-income residents in the peripheral areas of cities and towns, where the bulk of theurban poor are located. The component would be based on standardized designs and unitcosts and would be managed by a special unit within CAR. Eligibility criteria wouldinclude that: (a) beneficiary areas must be within a maximum threshold income level (forexample, three minimum salaries per month per household); (b) the investments would belimited by a maximum project cost per capita; (b) investments should be integrated; (c)community participation and organization would need to be demonstrated; (d) residentswould need to have possession of land title, or the area would be able to be converted, orresidents would need to have lived in the area for equal to or more than the amount oftime stipulated by law before titling becomes automatic. Since this was a new approach toinfrastructure service delivery in the State, the overall scope should be limited to US$15.5million, and it should start small in the first year (limited to US$2 million). Publicity forthe program should include reference to the limited funds available under this componentfor the first year, in order to stimulate demand.

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ANNEX 4BBRAZIL

BARUI MUNICICPAL INFRASTRUCTURE DEVELOPMENT ANDMANAGEMENT PROJECT

DETAILED ESTIMATE OF PROJECT COSTS4(IN USS MILLIONS)

COMPONENTS %Proect Total YearI2 Year 3 Year 4 Year5 Year-6

_Cost

A. MunicipalReform 4.5 10.0 0.5 1.0 2.0 2.0 2.5 1.0

B. Institutional Development 4.5 10.0 0.5 2.0 2.0 3.0 1.5 1.0

A. I Technical Assistance 5,0 4.1 0.3 0.5 1.0 1.0 1.0 0.3

A.2 Tramiing 2.5 3.6 0.3 0.5 0.7 0.7 0.8 0.6

A.3 Equipment 1.0 1.2 0.1 0.1 0.3 0.3 0.2 0.2

A.4 State T.A & Studies 0.5 1.1 0.1 0.2 0.3 0.3 0.2 0.1

C. Urban Infrastructure 84.0 186.5 9.3 28.0 46.6 46.0 37.3 18.6

C.l BasicSanitation 72.0 159.8 8.0 24.0 40.0 40.0 32.0 16.0

Water Supply 14.0 31.1 1.6 4.7 7.8 7.8 6.2 3.1

-Sewerage 20.0 44.4 2.2 6.7 11.1 11.1 8.9 4.4

- SolidWaste 4.0 8.9 0.4 1.3 2.2 2.2 1.8 0.9

- Drainage 5.0 11.1 0.6 1.7 2.8 2.8 2.2 1.1

- Paving 23.0 51.1 2.6 7.7 12.8 12.8 10.2 5.1

- Erosion Control 3.0 6.7 0.3 1.0 1.7 1.7 1.3 0.7

- Slope Stabilization 3.0 6.7 0.3 1.0 1.7 1.7 1.3 0.7

C2 Complementay Investments 7.0 15.5 0.6 2.3 3.9 3.9 3.1 1.6

- Street Lighting 3.5 7.8 0.4 1.2 1.9 1.9 1.6 0.8

- Urbanization 3.5 7.8 0.4 1.2 1.9 1.9 1.6 0.8

C3 Regional Investments 5.0 11.1 0.6 1.7 2.8 2.8 2.2 1.1D. Urban Upgrading in Low Income 7.0 15.5 0.8 2.3 3.9 3.9 3.1 1.6

Percent of Total Project Cost/Yr. 5.0 15.0 25.0 25.0 20.0 10.0

Total Proiect Cost 222.0 11.1 33.3 55.5 55.5 44.4 22.2

T.A.= Technical Assistance.

4 Costs include indirect local taxes, estimated to total about US$22.0 million, or about 10% ofthe project costs Due to the programmatic approach proposed

under the project, price and physical contingencies have not been budgeted.

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ANNEX 4C

BAHIA M UNICIPAL NIFRASTRUCTURE DEVELOPMENTAND MANAGEMENT PROJECT

Outline - Terms of Reference

MAPPING OF POVERTY

(Translation of the Terms of Reference (TORs) agreed at Negotiations)

Justification:

1. Brazil's efforts to modernize and develop its economy has been comprehensive.While Brazil is building one of the largest economies in the modern world, its statistics onthe quality of life are alarming. Brazil's complex society requires the implementation ofmore efficient policies to overcome its basic problems.

2. The concern with analyzing poverty conditions, particularly urban poverty, isworldwide. Efforts in the area have accelerated since the 1970s with emphasis being puton the dynamics between urban development and economic development. The researchdone, so far, shows that the traditional indicators of economic development, such asGNP, do not capture the full extent of relative or absolute poverty and the miserableconditions under which those social groups living below the poverty line are subjected.

3. Poverty indicators used worldwide began to be based more heavily on vitalstatistics, such as the Physical Quality of Life Index (PQLI), which essentially considersindicators such as birthrates, infant mortality rates, longevity and education. Nationallevel poverty indicators also use variables such as the percentage of the population withaccess to health services, housing, education, income level, access to formal employment,access to appliances such as stoves, radios and televisions, and access to water, sewageand electricity services.

4. The results of such analyses offer a "quality" input for regional urban planning;moreover, the existence of such studies at the State level can lead to the development ofvarious policies, especially compensatory policies, which represent an important new roleof the State.

5. With the support of international institutions, the Federal Government hasundertaken several studies that use variables recognized worldwide to measure the qualityof life of the population. The result has been some conclusions about topics such assurvival rates for children ages 0-6 years, a hunger map, and human developmentindicators.

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6. These results facilitated interstate and inter-municipal comparisons on the basis ofwhich a system evolved that explicitly ranks the different States. This, in turn, led to theestablishment of a corresponding national data base on poverty and quality of life. Whilethe above studies used distinct points of reference, invariably the primary data gatheredwere the same; that is, infant mortality rate, mortality rate, life expectancy, percentage ofthe population served by sewage services, level of education, etc. By comparing theresults of the different studies, there was little difference found in the ranking of themunicipalities. Hence, the classification of municipalities is consolidated in terms ofpoverty level and quality of life.

7. The global results found for municipalities are easily transposed to the urban area,as there is little difference in the averages for socio-economic status, with the exception ofmedium and large cities. The latter show an imbalance between supply and demand forurban services due to large migration flows, and normally involve a socially destructiveprocess characterized by deterioration of the urban environment in the form of slums,problems with criminality, a reduction in the provision of health services, education,sewage, etc.--all of which make the quality of life very difficult, especially for the poor.

8. The number of medium and large cities is relatively small in the State of Bahia. Theclassification of municipalities by their urban poverty level is available through the above-mentioned studies. If adjustments need to be made due to special circumstances, a reviewof such studies would be made to gather the needed supplementary information.

9. While extensive studies make it possible to elaborate on interurban ranking, astudy locating and researching inter-urban poverty in each city is needed to prioritizeGovernment actions affecting the poor.

Objective:

10. The objective is to provide to the State the urban planning tools capable ofmeasuring the level of poverty in each municipality; to create the possibility of makingcomparisons between inter- and intra-urban areas; and to make it viable to develop socialpolicies based on social equity.

11. To achieve this goal the participation of the municipalities from the planning stagethrough the final phase is a priority to obtain results to address the State's actualcircumstances.

Scope and Methodology - The Inter-Urban Poverty Map:

12. This study would select variables and parameters that facilitate the measurement ofpoverty levels and consequently the quality of life in each municipal center, and whichmake it possible to identify the intra-urban areas and to classify them by level of need.

13. To design this "zoning," a very simple methodology is planned that requires theparticipation of the municipalities for the input and design of the map.

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14. Utilizing maps of the designated city, three or four representatives from eachmunicipality-- municipal government, board of representatives, and social personalitieschosen according to the local situation--would map the urban location using theirknowledge and experience, and, taking into consideration the quality of life of theirrespective populations, would demarcate the different zoning borders.

15. To verify this initial mapping, the study would consider the following aspects ineach zone: total number of houses; resident population; percentage of households servedby water, electricity, and sewage; urban maintenance; population served by health servicesand public education; total number of registered illnesses; family income levels;predominant types of jobs; household patterns; and other information that would berelevant for classifying the areas according to their poverty level.

16. The above-mentioned data are generally available to the municipalities in aggregateterms. Moreover, the municipal governments have tools that allow the requiredinformation to be provided more precisely. In some cases, it will be necessary to estimatethe data or to gather it in the field.

17. CAR will participate in the work of compiling the data, with the result being thedesign of a map showing the final zoning from the indicators and parameters used in thestudy.

Final Product:

18. The study will present as its final product:

a) Mapping of regional areas of the urban space to facilitate planning policiesand subsequent actions;

b) Technology to implement a data base of municipal information.

Consultants Profile:

19. As the study is multi sectoral it will require a team of professionals with variedspecialties. Ideally, the firm to be chosen would have the following competencies:

experience in developing similar studies; and the individuals to participatein the study must themselves have experience in similar studies.

successful implementation of similar studies.

Deadline:

20. 90 to 120 days from the date of the signed contract.

83

ANNEX 4D

BRAZILBAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENT

AND MANAGEMENT PROJECT

OUTLINE-DRAFT TERMS OF REFERENCE FOR URBAN DEVELOPMENT CONSULTANCY

Justification:

1. The State Development and Regional Action Company (CAR) plans to embark onan ambitious program of urban development that is designed to assist in strengtheningurban infrastructure and services in the State's cities so as to provide better livingconditions for their inhabitants, especially low-income people and the poorest segment ofthe urban populations.

2. In order to carry out this role, CAR needs to develop a strategy and prepare forthe implementation of the Bahia Municipal Infrastructure Development and ManagementProject. This strategy would involve a clear vision of the kinds of projects to be financedand how best to implement them. To work successfully in poor urban areas, CAR willneed to develop techniques or community outreach to tap existing community resourcesand to create new leadership structures where these are inadequate. The strategy willinvolve three main activities: (1) development of a comprehensive strategy; (2)development of an appropriate structure and operational procedures; (3) recruitment andtraining of staff.

Objectives:

(a) Conduct a strategic planning exercise that identifies the primary mission ofCAR in urban development and sets priorities for actions, and a timetablefor implementation;

(b) Identify CAR's information needs, the best sources of such information andthe best ways to collect, store and retrieve data necessary for themanagement of the project. This would include data and analyses ofpopulation, migration, morbidity and mortality, income, living levels, urbanservices available.

(c) Modify the structure of CAR so as to carry out the major functionsforeseen. These include planning and budgeting, project evaluation,community outreach, institutional relations (including contracts), staff andbeneficiary training, financial operations, procurement advising, projectmonitoring, evaluation.

84

(d) Develop appropriate training procedures for CAR staff, prepare specifictraining activities, including in-service training, and training of municipalstaff in community mobilization.

(e) To achieve these objectives, CAR will hire an experienced consultant orgroup of consultants that will assist CAR in achieving these goals.

Methodoloty:

3. The consultant will first prepare a detailed timetable of activities in consultationwith CAR's management. Once agreed, the first strategic planning activity will be plannedand held. Following this activity, the consultant will assist CAR management inimplementing the necessary changes in CAR's structure and procedures. At this time.CAR will begin receiving and evaluating subproject proposals for year 2 of the project.The consultant will provide necessary technical assistance for carrying out each of thefunctions listed in para. B-3. In conjunction with CAR management, the consultant willorganize and coordinate appropriate training events in each of the activities specified.Finally, the consultant will participate in the monitoring and evaluation of CAR activities.

Deliverables:

(a) Agenda for strategic planning exercise.

(b) A comprehensive list of data sources and a strategy for collecting and using suchdata as is necessary for the management of the project.

(c) A comprehensive database of institutions and individuals in the State and beyondcapable of assisting with each necessary activity including academic and other researchers,public officials, information sources, a consultant roster, community organizationspecialist, relevant NGO's throughout the State, domestic and international sources oftechnical assistance, libraries and other documentary resources.

(d) Detailed terms of reference for each function in para. B-3 including job descriptionfor each professional position.

(e) Detailed plans for training activities including terms of reference for individuals orinstitutions to conduct the training, course descriptions including agendas, trainingmaterials (documents, video materials, etc.), and a schedule for training events. Tentativesuggested list of events:

(i) The development of the urban network in Bahia (2 days);

(ii) Economic conditions and the causes of poverty in Bahian cities (3days);

(iii) Identification of Poverty Pockets in Bahian Cities (2 days);

85

(iv) Strategic interventions in Urban Areas (basic sanitation, healthproject, education, community mobilization, food and nutritionprograms, employment generation, economic development (5 days);

Urban Management Skills:

(a) Public Administration;

(b) Planning and Budgeting;

(c) Scheduling and Monitoring;

(d) Sanitation in poor neighborhoods.

(v) solid waste disposal and recycling

(vi) sewerage and septic systems;

(vii) water supply

(e) Community mobilization and public participation in project;

(f) Environmental education.

(viii) Project Review (2 days);

(ix) Community Outreach and Mobilization Workshop (3 days);

(x) Project Monitoring and Evaluation (2 days).

9. Appropriate instruments for project monitoring and evaluation and directparticipation in the first quarterly monitoring activities and the first annual projectevaluation.

Qualifications:

10. The successful consultant will present a detailed proposal for the implementationof the above terms of reference. The consultant will have letters of intent from specialistwith the necessary qualifications to carry out each of the activities outlined above. Theconsultant will present specialist with university training and specialized training to at leastthe Master's level or the equivalent and at least five full years of professional experience inthe relative areas which shall include: urban planning, strategic planning, communityoutreach, training, and project evaluation and monitoring.

86ANNEX 4E

BRAZILBAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENT

AND MANAGEMENT PROJECT

CAR: THE EXECUTING AGENCY

1. The State's Companhia de Desenvolvimento e Aqao Regional (CAR) would be the project'sexecuting agency. CAR would have primary responsibility for all aspects of project implementation,including evaluation of sub-borrowers' financial and institutional capacity, diagnosis of institutionalrequirements and formulation of technical assistance and training packages, evaluation of technical,economic and financial feasibility of sub-projects, and all general aspects of management, operationand monitoring of the project. These procedures would all be undertaken on the basis of an agreedOperational Manuals.

2. CAR was created by State Law in 1983 as a public "autarky," and later transformed into a publiccompany in order to provide more flexibility in implementation of its responsibilities. CAR's sharesare wholly owned by the State. CAR's Executive Director is appointed by the Governor. TheSecretary of Planning serves as Chairman of the its Board of Directors. CAR is headquartered in theState's capital, Salvador, and has regional offices in seven medium-sized cities around the State. CARhas historically acted primarily in the rural sector, and in this capacity has significant experienceimplementing decentralized programs, including the World Bank-financed Northeast RuralDevelopment Program The implementation of the NRDP in Bahia was in fact one of the mostsuccessful of these state-based programs. As of 1991, CAR has also been given responsibility forexecution of the State's programs in urban areas. This is a significant challenge for CAR, which hasan excellent history and experience in the rural sectors but which has relatively little experience inurban areas. A further challenge stems from CAR's recent (1995) assumption of the responsibilitiesof technical assistance to municipalities, a role previously performed by a now-defunct Statecompany, CEMUR.

3. Detailed discussions have been held with the State and CAR regarding the institutional capacity ofthe latter, and plans for strengthening capabilities in the urban area. Plans include restructuring CARinto three Departments: (a) Regional Development (for rural-oriented programs); (b) UrbanDevelopment; and (c) Municipal Action (for support to institutional strengthening of localgovernments). While the management and infrastructure aspects of PRODUR would fall under theUrban Development Department, the Municipal Action Department would handle the institutionaldevelopment component. The ongoing NRDP and its successor, the Northeast Rural PovertyAlleviation Program (NRPA) now under preparation, would be handled by CAR's RegionalDevelopment division. CAR also has plans to establish about twelve additional regional offices, in thecontext of the PRODUR and NRPA projects.

4. Regarding specific project tasks, CAR has established a financial nucleus in the UrbanDevelopment division, which has been trained in public financial analysis. It was also agreed that inlight of CAR's previous rural focus, that both the Urban Development Department, and the projectitself, would benefit from an urban planning and development specialist adviser who could be hired ona part-time contractual basis as part of the program in order to advise CAR on its role in thedevelopment and implementation of State urban development policy, establishment of an urbandevelopment department within CAR, and help to establish priorities and guide the department inproject execution questions.

87

ANNEX 5ABRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENTAND MANAGEMENT PROJECT

PRODUR ORGANIZATION CHART

Regional Meetings

Start Deliver PIM tO

D istribution of M unicipaliLieS

Operational Manua) Signing DfParnicipation Agreements

MUzsiCjpa1JEie Participate inCAR/CEMUR's

Training Plan

S Authori2ation fromA Municipalire Define - Municipajites Deliver P?slT MUnpicPaliry'S House of Invetment to Regional OfficesA I Representatives (LAV) Progams- CARIDescnbanco Analysis PMI

T - EvaluatIon FindingsF - NgudnE r Letter of Intentdon

Seplantec/MunicipaliPyM CAR

N

T

R Urban Planninsg| Urbar. Infrastructure,,,I and Admnistrative Works

N Mrsciirumfion Subproiecl B)dding by Suboroiets

G Municipalir

Bidding by Bidding Analysts by CAR Municipaliq PrTen flsCARCEMUR LIssue Findings | PTechnical Pri

.ii" ! Contract

| Implementation of | | Municipalitv-Desenbanco |

Municipality Approves Biddinrg Approval ANon-Approvali

FContract and Issue of Services

| Implementateon byMunicipal Htdll

.~ ~ ~~~~F Implemcrtuion

88

ANNEX 5BBRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENTAND MANAGEMENT PROJECT

PROJECT INSTITUTIONAL AND IMPLEMENTATION ARRANGEMENTS

JS;tuton. Functio Description of Role

CAR Project Executing Agency Select sub-borrowers on the basis of creditworthiness andinstitutional capacity; and sub-projects on the basis ofagreed technical, economic and financial selectioncriteria (all set out in the Operational Manual).

Independent Technical Agents (for CAR and Hired as necessary from universities, private sector, etc.,Consultants municipalities) in all sub-projects, as for technical assistance with sub-project evaluation and

needed supervision; also would implement T.A. sub-projects,according to norms set by CAR.

CRA State environmental protection agency Statutory responsibility for review of EAs and PCAs.

Commercial bank Financial agent Responsible for management of the PRODUR fund.

Municipalities Sub-Borrowers Undertake all investments, with assistance of sectoraltechnical agencies and specialized consultants as needed(standards for infrastructure investments to be consistentwith State and/or federal guidelines.

P__je_t__om_onent ___________D_ 1:_Implementation Agency

Part A - Training and T.A. (Grants) CAR with private sector consultants

Part B - Studies & T.A. CAR with private sector consultants

Part C - Infrastructure Sub-loans CAR with collaboration of municipalities

Part D - Urban Upgrading in Low-Income Areas CAR with collaboration of municipal micro-regions

89

ANNEX5CBRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENTAND MANAGEMENT PROJECT

PRODUR PROGRAM DOCUMENTATION

1. Drafts of the following legal documents have been prepared and were discussedand finalized, where appropriate, during Appraisal.

(a) State law authorizing the State to borrow from the Bank;

(b) State law establishing the FUNDURBANO;

(c) State decree regulating the FUNDURBANO;

(d) Contract(s) between the State of Bahia, CAR and the financial agent(s);

(e) Model participation agreement (convenio de adesdo) between the State,CAR and municipality;

(f) Model negotiation agreement (minute of understanding) between CAR andmunicipality (for the institutional development component);

(g) Model Sub-Loan Contract between the financial agent, CAR andmunicipality for onlending fund in support of a sub-project;

(h) Model Grant Agreement between the State and the muncipality forrepassing funds to support an institutional development, or to partiallysupport an urban upgrading component; and

(i) Model municipal law authorizing a municipality to participate in PRODUR.

2. Operational arrangements will be set out in the Program's Operational Manual (OM),drafts of which have been finalized and agreed during Negotiations and will be published formallyas a condition of Effectiveness. The OM volumes include:

(a) Orientation Manual;

(b) Publicity Flier;

(c) Guidelines for Evaluation of Clients;

(d) Procurement Guidelines and Standard Bidding Documents;

(e) Sub-Project Evaluation;

(f) Disbursement Manual; and Monitoring and Evaluation

90

ANNEX 5D

BRAZILBAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENT

AND MANAGEMENT PROJECT

PRODUR FLOW OF FUNDS CHART

-WodidBark stt E3 E EphTrnsfer innoacs as pr

ad Annrul Omafin Plan

-anni Pk~a

[Urect tsaeofrsour afierarmlysisandfindis

_Special, Avlout forPtoject I mplentaion

91

ANNEX 5E

BRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENT

AND MANAGEMENT PROJECT

CAR's APPRAISAL PROCESS

1. PRODUR is open to all municipalities in the State of Bahia, providing themunicipality adheres to its objectives and meets the basic eligibility criteria for theprogram. Steps on the critical path to entry in the Program are presented in detail in theProgram's Operational Manual (OM), and explained below.

(a) The first step for entry into the program is the signature of a ParticipationAgreement between the municipality and the State, indicating municipalinterest in and adherence to Program objectives.

(b) The second step is completion of a diagnostic form the objective of whichis to gather data related to municipal financial, fiscal, planning,environmental management and infrastructure service provision.Depending on municipal capability and preference, this form is completedprepared by the municipality alone or in conjunction with technicalassistance from private consultants. This diagnostic tool was refinedduring appraisal. It is available in the Project File.

(c) The third step, on the basis of this diagnosis, the municipality agrees withCAR on a program of priority institutional investments (comprised oftechnical assistance and training) for a medium-term period.

(d) Fourth, the municipality must demonstrate compliance with Federallegislation regarding payment of intergovernmental taxes and otherobligations.

2. On the basis of this analysis, a set of standard performance targets are agreed withthe municipality for improved financial and institutional management and formalized theaccordo de negocia,ao. Completion of these steps enables municipalities to begin traininginvestments.

3. CAR will play the role of Executive Secretariat (Secretario Executivo, or SE) ofthe Program's Board of Directors (Conselho Diretor). In this role, CAR will assist infilling out the Institutional and Financial Diagnosis Forms, and advice and technicalassistance to ensure that all applications are complete and data is presented correctly andin a timely way. The assistance of the CAR will be critical in this phase of analysis, asmany other programs have suffered significant set-backs in implementation as a result ofpoorly completed applications.

92

4. To be eligible for infrastructure investments, municipalities will have todemonstrate creditworthiness, provide a feasibility study (as a minimum) of the proposedinvestment, and demonstrate that the investment is: (a) the least cost technical solution(details of the analysis are shown below); (b) a high-priority investment (compared withother infrastructure investments) by evaluation of its economic benefits; and (c) that it isdemonstrates cost recovery. Furthermore, in addition to the standard performance targetsto be agreed in the accordo de negociagao, specific cost-recovery targets will be agreedfor infrastructure investments with financing under the Program. As mentioned, theinstitutional diagnosis, project feasibility studies (for successfully evaluated projects) anddetailed designs will be eligible as municipal counterpart.

5. The Urban Department (DU) within CAR will prepare all sub-project appraisals,with the assistance of technical agents as needed, and according to agreed criteria set outin operational manuals. DU staff will undertake three main areas of analysis: (a)creditworthiness/financial evaluation of sub-borrowers; (b) institutional evaluation of sub-borrowers; and (c) technical, economic and financial evaluation of sub-projects. Alleva.luations will be done by a team of analysts (one engineer, one economist/financialanalyst and one institutional specialist) assigned to each sub-borrower for the full sub-project cycle, from evaluation through implementation, supervision and monitoring.

A. Creditworthiness and Financial Evaluation of Sub-Borrowers

6. Upon completion of the initial Participation Agreement, CAR prepares acreditworthiness evaluation and financial analysis of the municipality or water authority.Financial evaluation will be done by CAR financial analysts, who are experienced in thistype of analysis.

7. Creditworthiness is determined on the basis of the criteria set out in BrazilianFederal Senate Resolution #69 of 1995 on debt limits for the public sector, which arestringent. The legal limit is determined to be the higher of the following:

(a) the global amount of performed operations in a financial exercise shouldnot exceed the value of the loan repayment due or overdue during the year,or 20% of real net revenues, whichever is higher;

(b) the maximum annual expenditures, including repayment of principal of alloperations, will not exceed the real savings margin.

8. Evaluation of financial performance and management is based on review of theprevious three years' financial data, including breakdowns of revenue and expenditures,trend and ratio analysis, and review of financial management and accounting practices.

9. Because one of the project's primary objectives will be to improve local financialmanagement, the aim will be to: (a) improve the relationship between own and transferresources in the State; (b) provide adequate cost recovery for all services; (c) improvecurrent expenditure policies and management practices; and (d) stimulate efficient, cost-effective investments on the basis of appropriate technical, economic and financial

93

evaluation. Thus, evaluation emphasizes the indicators to be monitored in the program:proportion of own to transfer revenues, and per capita current and capital expenditures.

10. The financial evaluation under the project will provide the initial base-line datarequired to begin to achieve these objectives. It will also provide complementaryrecommendations for improvements in financial management, accounting and auditingwhich will tie into the institutional evaluation in the PRIM (see below). Furthermore, thisdata will provide the basis for a municipal financial information system (FMIS) in theState, an important deficit in the sector country-wide as identified in sector work.

11. The summary creditworthiness evaluation for the approximately 45-50municipalities were evaluated during appraisal, of which seven to ten would be included inthe Program's first year.

B. Institutional Evaluation of Sub-Borrowers

12. Following completion of the institutional diagnostic forin, evaluation of municipalinstitutional strengths and weaknesses is done by CAR. CAR is in the process ofestablishing a group of 4-6 specialists in the area of municipal management and trainingwho will be dedicated full-time to PRODUR. Guidelines for this analysis are set out in theProgram's OM. The evaluation identifies areas for improvement within two primarycategories:

(a) administrative and fiscal, to be done in conjunction with the financialevaluation done by CAR (cadastre, taxes, tax collection performance); and

(b) municipal planning (zoning legislation, master plans).

13. The recommended actions would be prioritized (high, medium and low priority)according to the following criteria:

High: Those actions which have overall highest impact on improved municipalfinancial management, particularly on own resource mobilization; contributedirectly to the economic and financial feasibility of the proposed sub-projects;and/or strengthen municipal environmental management capacity.

Medium: Those actions which increase municipal resource management in areas otherthat the focus of the project.

Low: Those actions which are desirable but not essential to the project's objectives.

14. Estimates for implementation time and costing are then determined. Communityparticipation will be an important factor in determining priorities, and both communitymeetings and approval of local representative assemblies will be required prior to themunicipal government's approval of any accordo de negocia,ao. Targets of theseminimum agreed goals would be: (a) own resources as a percent of total; (b) IPTU percapita; (c) current expenses as a percent of total.

94

15. Once a municipality has agreed to the accordo de negociaCao, and thendemonstrates sufficient creditworthiness, a feasibility study for investments, this may besubmitted for technical, economic and financial evaluation.

C. Technical, Economic, Financial and Environmental Evaluation of Sub-Projects

16. The technical, economic and financial evaluation of sub-projects will be performedaccording to guidelines set out in the Program's Operational Manual (Volume 2). Allevaluation procedures will employ sensitivity analysis, particularly in cases where risks areperceived to be high, or when alternatives present similar costs and benefits.

17. The initial technical evaluation will generally be done on the basis of feasibilitystudies. The evaluation will be made by CAR engineers, with the assistance of specializedconsultants as necessary, depending on the required expertise. Engineers will ensure,through comparative analysis, that the least-cost technical solution has been chosen andwill verify demand for services, dimensioning of proposed investments, design standardsand cost estimates, recommending changes and revisions as necessary. Under theprogram, priority will be given to rehabilitation over new systems, and to low-costalternative technologies -- where sufficiently well-tested and risk-free, such as anaerobicstabilization ponds for sewage treatment.

18. For those infrastructure sub-projects with quantifiable economic benefits,economic evaluation will be done by CAR economists, on the basis of a model preparedwith the assistance of a consultant experienced in cost-benefit analysis and familiar withevaluation of similar types of sub-projects. A simple methodology has been selected, inorder to be widely accessible to a wide range of municipalities expected to participate inPRODUR, since training in cost-benefit analysis for municipal authorities is among one ofthe project benefits. For revenue-earning services, user charges will be considered a proxyfor willingness-to-pay (although this does not capture full benefits). For non-revenueearning services, benefits will be determined on the basis of a Hedonic model, whichemploys increased property values as a result of investments as a primary benefitdeterminant. Economic costs are net of taxes, debt service payments, depreciation, etcand represent incremental costs associated with the project. Using a discount rate whichapproximates the social opportunity cost of capital, estimated to 12%, individualinvestments are evaluated and ranked. A discount period of 15 years is used. If sub-projects do not achieve the minimum hurdle of 12% economic rate of return, the project isnot accepted and is sent back to the municipal authorities with a recommendation formeasures which would improve the sub-project's viability, such as reviewing project costs(including reviewing the technical solution proposed, if not shown to be least cost),increasing user charges and taxes (concurrent tariff study to be recommended as part oftechnical assistance). For water and sewerage investments for municipalities or municipalcompanies, a marginal cost study will be recommended as part of the technical assistancepackage, and results should be explicitly incorporated into the analysis. Details are set outin Annex 7.

19. The financial evaluation of sub-projects is designed to ensure that rates of returnmeet the cost of borrowing (about 12%), to determine the payback period of the

95

investment, and determine cost recovery instruments, once the investment has been shownto be technically viable and economically justifiable. This evaluation will be done by CARfinancial analysts, and will be linked to the financial evaluation of the municipality (whichprovides the base data for the analysis of cost-recovery potential) and the financialrecommendations in the PRIM with which it must be consistent.

20. To participate in PRODUR, sub-projects must not have environmentally-negativeimpact (most in fact are estimated to have positive impacts). Thus, all proposed sub-projects must undergo a rigorous environmental evaluation, on the basis of guidelinesestablished for municipal sub-projects of this nature by the State environment protectionagency (CRA). The CRA guidelines present a clear indication for municipalities of thetype of environmental screening required for municipal and project size, scope andexpected impact, whether full environmental assessment (EIA/RIMA), limited assessment(RCA) or simple licensing. When EIA/RIMA or RCA are required, private consultantswill be contracted by the sub-borrower, and CRA will review and grant eventual licensingfor acceptable projects. Details are set out in Annex 5H.

21. Sub-Loan Agreement. The culmination of these evaluations would be arecommendation which leads to refinement exact priorities and agree on terms of sub-loanagreements. The summary form makes specific recommendation on the actions to betaken, loan amounts and conditions of lending, including targets for the three-fourstandard indicators, and targets. Specifically, it would include actions and agreements toachieve the cost-recovery targets for proposed investments and targets for the institutionalinterventions. The recommendation is discussed with municipal authorities, and on thebasis of the discussion a financing contract would be signed. This recommendation formis also used to monitor progress. The sub-loan agreement would be executed through thefinancial agent.

22. Bidding and Implementation of Investments. Municipalities would bid allinfrastructure works, with technical assistance and oversight from CAR, according to theProgram's OM, which is based on Brazilian law and the Bank's guidelines forprocurement. To the extent feasible, the cost of technical agents for sub-projectevaluation and supervision would be included in the interest rate "spread," andmunicipalities would be able to choose among qualified agencies.

23. Monitoring and Evaluation. CAR would monitor and evaluate progress accordingto indicators to be agreed at negations and set out in the Program's OM. In addition tothe detailed physical, financial and operational indicators set out in Annex 51, there wouldbe a group of "key impact indicators" for the purpose of overall evaluation and steering ofthe program, both during implementation and at mid-course. The evaluation,recommendation and monitoring of the project will be computerized, and automated in anintegrated management information system. CAR computer technicians developed a draftproposal for doing this work was reviewed during appraisal.

96

ANNEX 5FBRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENTAND MANAGEMENT PROJECT

ENVIRONMENTAL ARRANGEMENTS

I. Environmental Screening and Review Procedures Under PRODUR

1. PRODUR will finance infrastructure and urban services at the municipal level, forwhich the details of the majority of sub-projects were not known at the time of projectappraisal, PRODUR is characterized as a sectoral investment program. Because of thisprogranmmatic sectoral nature, and the fact that local governments are the executors ofproposed works, it is necessary to set out specific guidelines for environmental reviewsrequired for each type of sub-project, in order to be consistent with Brazilian legislationand World Bank norms. During pre-appraisal an initial version of this typology wasprepared and discussed, and is outlined in Section II below. This was refined duringappraisal (however is not expected to change significantly), and all arrangements wereagreed during Negotiations. These guidelines will become part of the Operational Manualwhich orients the program.

2. The first step in environmental review of sub-projects would be preparation of apreliminary evaluation or "screening" of each sub-project to determine the extension,nature and seriousness of its potential environmental impacts, and the type of analysiswhich would be required. On the basis of this preliminary evaluation, each sub-projectwould be classified in one of three review categories:

(a) sub-projects whose potential environmental impacts are sufficiently large orserious and should be subjected to a broad environmental evaluation(Study/Report on Environmental Impact - EIA/RIMA);

(b) sub-projects whose potential environmental impacts are less significant andshould be subject to an environmental analysis that is less broad, buthowever includes at least an identification of mitigatory measures andenvironmental monitoring (Environmental Control Report/Plan -RCA/PCA); and

(c) sub-projects which will not have negative environmental impacts and whichwill not require a specific environmental evaluation.

3. Establishment of these guidelines and their enforcement is the function of theState's environmental protection agency, the Centro de Recursos Ambientais (CRA), withthe approval of the State environmental council Conselho Estadual do Meio Ambiente(CEPRAM; see Section III). Environmental licensing is the responsibility of CEPRAM.This licensing is done in three stages: licensing of location (before preparation ofengineering designs, considering principally alternatives of location); (ii) license forinstallation (before construction of the project, when alternatives designs are considered);and (iii) licensing of operation (after construction and before operation).

97

4. Once the category of each sub-project is determined, the environmental evaluationwould be done on the basis of detailed engineering designs and/or feasibility studies, asrequired. Considering the scale and probable location of sub-projects to be financed byPRODUR, it is anticipated that the great majority of cases where some type ofenvironmental evaluation or analysis will be necessary will consist of preparation ofEnvironmental Control Reports and Plans (RCA/PCA; see para. 10).

5. If it is necessary to undertake a full environmental assessment (EIA/RIMA) for anygiven sub-project, the preparation of the EIA/RIMA would be the responsibility of thesub-project proponent (municipality) through contracting of specialized consultantservices, and on the basis of terms of reference prepared by CRA, previously approved byCEPRAM and consistent the Bank's guidelines, as set out in OD 4.01. A standardizeddraft version of such terms of reference has been prepared by the Borrower. The analysisof the EIA/RIMA would be done by CRA, which would issue a specific technical opinionfor consideration and approval of CEPRAM, including the conditionalities (mitigatory andcontrol measures and environmental monitoring) for the concession of licenses to installand operate the sub-project

6. Per the Bank's guidelines, the following would be essential elements of anyEIA/RIMA:

(a) that consultation with the population affected by the sub-project and withlocal NGOs is held during the process of preparing the terms of referencefor the EIA/RIMA and once draft versions of the preliminary EIA/RIMAare available;

(b) that; the RIMA is accessible to the public in a form which can be easilyunderstood; and

(c) that an executive summary of the EAJIMJMA be prepared, describingsuccinctly: (i) the legal, administrative and policy framework under whichthe EIAJRIMA was prepared; (ii) the sub-project; (iii) the environmentaland socio-economic baseline data; (iv) the environmental impacts expected;(v) the analysis of alternatives from an environmental standpoint; (vi) theplan of mitigatory measures; (vii) environmental management and trainingactions; and (viii) the environmental monitoring plan.

7. Both for sub-projects classified in the first (EIA/RIMA) and in the second(RCA/PCA) categories, mitigatory, compensatory and control and monitoring measureswould be recommended. The technical opinion from CRA would also includerecommendations (with costs, schedule for execution and respective institutionalresponsibilities) which would become an integral part of the detailed designs for the sub-projects. The implementation of these measures during construction and operation wouldalso be accompanied by the municipality and by CAR, as part of supervision.

8. Significant involuntary resettlement (more than 100-200 individuals) is notforeseen under this project. In cases where it may necessary to involuntarily relocate a

98

population larger than 100-200 persons in connection with any sub-project to beconsidered for financing under PRODUR, a detailed resettlement plan, acceptable to theBank and consistent with OD 4.30, would also be required prior to approval. It wasagreed during Negotiations that any sub-project involving such resettlement would besubject to the prior-review and appraisal of the Bank prior to disbursement. If a smallernumber of person were to be involuntarily relocated, the following would be the minimumrequirements: (i) adequate compensation; (ii) logistical support in their move; and (iii)financial assistance in grant form for relocation. The first year program reviewed duringappraisal was found, on the basis of engineering designs and site visits, not to involve anyresettlement.

H. PRODUR Sub-Project Categories and Probable First-Year Investments

9. CRA has prepared a draft version of a State-wide classification system forenvironmental screening and review, based on practice within the State and on theexperience of other states, such as Parana, Minas Gerais, and Ceara which already havesuch regulations established. The draft guidelines proposed by CRA break sup-projectsinto groups by type and by size (determined by design standards, such as diameter of pipe,or measures of impact, such as number of hectares affected).

10. As noted earlier, given the types of proposed sub-projects to be financed underPRODUR, many investments will not require review and where review will be required, itwill usually be in the form of a PCA/RCA. It is expected that the requirement forEIA/RIMAs will be rare, and likely to be only for large sewage treatment and solid wastedisposition sub-projects, or larger integrated urbanization sub-projects. The types of sub-projects actually proposed by CAR that would be subject to analysis or evaluation andlicensing are:

Table 5F-1: PRODUR Sub-Projects and Environmental Reviews

Type of Sub-Project Type of Environmental Review Proposed*

Urban upgrading in low-income areas Licensing or PCA

Water supply systems Licensing or PCA

Sewerage networks Licensing or PCA

Treatment of sewerage PCA or EIA/RIMA

Collection and disposition of solid waste PCA or EIA/RIMA

Macrodrainage Licensing or PCA

Microdrainage, paving, streetlighting, Licensingarborization

* Where "or" is indicated, type of review would depend on size and impact of theproposed sub-project. Detailed criteria are set out in the Project File.

99

11. It should be noted that integrated sub-projects, for example sewerage trunkinfrastructure, macrodrainage, and paving together, would likely require either a PCA or afull EIA/RIMA (depending on size and impact), and if involving resettlement would alsorequire a resettlement plan. Thus in addition to the guidelines above, in order toadequately screen for such integrated multi-sectoral sub-projects it would be agreed thatany sub-project expected to cost more than US$5 million, and any sewage treatment orsolid waste disposal sub-project expected to cost more than US$2 million, would beappraised by the Bank prior to approval of the sub-project. This would be monitored inthe project's quarterly reports. Further, it would be a condition of disbursement that allEIA/RIMAs required under the agreed guidelines, and including mitigatory plans andresettlement plans, be satisfactory to the Bank.

12. Sub-projects in the project's first year will be located in seven municipalities. Allof the municipalities have populations in the 65,000 to 200,000 range, and so are on thelarge side of the potential universe of borrowing municipalities. It should be noted thatthe seven municipalities of the first year are all larger, regional poles. It is more likely thatenvironmental review would be required for investments in these cities, while the patternof investments in subsequent years is likely to involve smaller municipalities and smallersub-projects, and thus likely less requirement for full environmental reviews. Theinvestments proposed, and the likely environmental screening category, are shown below:

Table 5F-2: Sample First-Year Sub-Projects

EnvironmentMunicipality Population Type of Sub-Project US$ million Review*

Itabuna 185,000 water supply, 5.0+ PCApavement, drainage l

Juazeiro 130,000 solid waste collection 2.0 licensing orand erosion control PCA

Alagoinhas 120,000 pavement, d rainage 1.2 licensing

Eunapolis 70,000 sewage collection 1.5 PCA

Ilheus 220,000 erosion control, 1.5 licensing orpavement PCA

Santo Antonio 65,000 pavement, sewage 2.2 PCA orde Jesus collection licensing

Teixeira de 85,000 pavement, sewage n.a. PCA orFreitas treatment licensing

100

]I. Environmental Institutions and Policies in Bahia

13. Environmental policy in the State of Bahia is guided by State law No. 3,858(1980), and by regulation t1Orough State decree no. 28,687 (1982), which provide for therequirement of environmental licensing for certain urban infrastructure and relatedinvestments, particularly sewerage or solid waste treatment or final disposition, waterresource investments and housing development. The federal government's environmentalcouncil (CONAMA) also stipulates licensing for sanitation-related investments, throughresolutions no. 001 (1986) and no. 05 (1988) which note that the detailing of specificcriteria and standards would be left to the States.

14. The State environmental agency, Centro de Recursos Ambientais, or CRA, wasestablished in 1980, with the same state law which established State environmental policy.At the same time, the State's environmental council, Conselho Estadual do MeioAmbiente, or CEPRAM, which authorizes environment-related decisions and policies, wasestablished.

15. CRA is responsible for elaborating the State's Environmental Plan and for thefollowing activities: coordinating and executing State environmental recuperation policy,identifying activities of the public power and private initiative which could potentiallycause environmental impact, establishing norms for environmental control according todirectives established by CEPRAM, environmental education, maintaining informationsystems related to environment and pollution, evaluating environmental quality andimpacts, preparing inventories of environmental resources, proposing to CEPRAMstandards for quality and criteria for sustainable management, and issuing technicalopinions related to concession of licensing for location, construction and operation whichmay cause environmental impact, based on the previous analysis specified.

16. An organization chart for CRA is shown below. Although once based largely inthe metropolitan region of Salvador, as a result of much of the State's industry beingcentralized there, CRA has established regional offices in Ilheus, Jequie, Barreiras, Feirade Santana and Juazeiro, as well as a dedicated office in the petrochemical pole ofCamacari in the RMS. This regionalization has accompanied the industrial, mining andagricultural growth in the State.

101

Centro de Recursos Ambientais (CRA)

Organizational Structure.

| Administrative |_ Technical lI Counci Assstnc

Administrativeand FinancialDepartment

Evaluationand Environmental

Impact ControlBoard of Office of DepartmentDirectors the Director

Department |

EnvironmentalDevelopmentDepartment

I Offices l

17. CAR's ability to review environmental assessments is currently being strengthenedunder a recently-approved IDB-financed project for Pollution Control of the Bahia dosTodos os Santos. If funds are not provided in a timely way under this project for suchstrengthening, it would be possible to reallocate funding under the proposed project forthis purpose.

102

ANNEX 5GBRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENTAND MANAGEMENT PROJECT

ESTIMATED SAMPLE CONTRACT PROFILES

EstimatedValue of Estimated Percentage of

Range of Contracts Within Number of Total AboveContract Values' Each Range Contracts Within Prior-Review

(US$ '000) (US$ million) Each Range Threshold

Civil Works

5,000 and above 22.0 4

2,000 to 4,999 63.8 25

250 to 1,999 12.5 25

50 to 249 17.7 154

0 to49 8.0 123

Subtotal Civil Works 124 331 69.2

Equipment and Materials

250 and above 27.6 23

50 - 250 42.1 290

0 - 50 8.0 200

Subtotal Equipment &Materials 77.7 513 35.5

TOTAL 201.6 844 56.2

Including contingencies.

103

ANNEX 5HBRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENTAND MANAGYEMENT PROJECT

ESTIMATED DISBURSEMENT SCHEDULE

DisbursementIBRD Fiscal Year in Quarter Cumulative Disbursement

and Quarter Ending (US$ million) (US$ millions) (Percent of total)

FY1997September 30, 1996December 31, 1996 6. 02 6.0 6%March31, 1997 2.0 8.0 8%June 30, 1997 2.0 10.0 10%

FY1998September 30, 1997 2.0 12.0 12%December31, 1997 3.0 15.0 15%March31, 1998 3.0 18.0 18%June 30, 1998 5.0 23.0 23%

FY1999September 30, 1998 5.0 28.0 28%December31, 1998 5.0 33.0 33%March 31, 1999 5.0 38.0 38%June 30, 1999 6.0 44.0 44%

FY2000September 30, 1999 6.0 50.0 50%December31, 1999 7.0 57.0 570/oMarch 31, 2000 7.0 64.0 64%June 30, 2000 7.0 71.0 71%

FY2001September 30, 2000 7.0 78.0 78%December 31, 2000 5.0 83.0 83%March 31, 2001 5.0 88.0 88%June 30, 2001 5.0 93.0 93%

FY2002September 30, 2001 3.0 96.0 96%December 31, 2001 2.0 98.0 98%

March 31, 2002 2.0 100.0 100%

2/ Includes an initial deposit into the Special Account of US$6.0 million.

104

ANNEX 5I

BRAZILBAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENT

AND MANAGEMENT PROJECT

SELECTED KEY MONITORING INDICATORS

1. A detailed set of monitoring indicators, and methodology for calculation, source ofdata, standards for measurement and levels (where applicable) would be set out in theproject's Operational Manual. These indicators would include standard physicalmeasurements of works completed, unit costs per sub-project, number of training andtechnical assistance interventions, etc., as well as financial/economic measures such asdisbursement rates and unit costs per sub-project.

2. In order to measure the impact of the project, as well as physical and financialprogress, a group of key monitoring indicators would also be selected from the largergroup of monitoring indicators. A sample of likely indicators are set out below, anddivided into five categories: (a) a group of selected "key impact indicator" (which haveestablished targets that attempt to demonstrate the expected impact of the project): (b)infrastructure investments; (c) institutional development; (d) financial/fiscal; and (e)project implementation. Because of the difficulty in establishing reliable base data for thewhole State, preliminary estimates of status for the indicators below would be part of thefirst year's quarterly reports, and would be monitored (and adjusted) thereafter as anormal part of project reporting, along with the physical and financial measurements ofproject progress.

Indicators unit 1996 11997 1998 1999 2000lKey ProjetaPe nrforance&Targets ______

Participation Agreements No. T__I I_

PIMs Completed No . __1__1 _

Project Costs (Paid) US$ 1

IPTU/capita* US$Savings Margin* % _ _ __ _

Ad Hoc Transfers/Total*

.Iniastructure Indiators (State-wide and by municipality)New connections (water) By municipality, company and State; number

and percent of total.New connections (sewerage) By municipality, company and State; number

and percent of total.Potable water quality Free chlorine index; coliform index, turbidity,

* To be measured on the basis of State-wide aggregated data.

105

| PH (WHO standards)Receptor water quality DBO, dissolved oxygenOccurrence of flooding Number of floods per yearInstitutional Development Indicators (State-wide and by municipality)Municipalities with computerized Number, degree of computerizationaccountingCadastre coverage (resid.) By municipality and aggregated for StateCadastre coverage (comm.) By municipality and aggregated for StateFinancial/Fiscal IndicatorsOwn Revenues/Total Measure of own resource mobilization and

independence from transfersCurrent/Total Expenses Measure of ability to investAverage Water Tariff By municipality, by company and aggregate for

StateAverage Sewerage Tariff By municipality, by company and aggregate for

StateEx-Post Project EIRR Measured following project completion

according to methodology Operational Manuals.Minimum of 12%, with expected range 12-90%

Ex-Post Project FIRR Measured following project completionaccording to methodology in OperationalManuals. Minimum of 12%, with expected

I range 12-60%Project Implementation Indicators ___Average appraisal time Number of days; measure of efficiency of

Project Unit

Subloans approved US$Average subloan approved US$Disbursement request Number per monthDisbursement processing time - Number of days; measure of efficiency ofCAR Project UnitDisbursement processing time - Number of days, measure of efficiency ofSpecial Account Project UnitOverdue payments Number of municipalities, values and amount of

____ ___ ____ ___ ____ ___ ___ tim e overdue

106

ANNEX 5JBRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENTAND MANAGEMENT PROJECT

PROJECT IMPLEMENTATION PLAN

The Project

1. Project Description and Objectives - The Bahia Municipal InfrastructureDevelopment and Management Project (PRODUR) is designed to be the first phase in along-term State program to support development of local financial management capacityand priority infrastructure investments, the former through direct financing, and the latterthrough an urban development fund. Through the proposed project, the Bank loan andState counterpart funds would capitalize the PRODUR Municipal Development Fund(FUNDUTRBANO) which would on-lend resources to municipalities for economically-viable urban infrastructure investments on the basis of well-defined sub-borrowercreditworthiness and sub-project eligibility criteria. Poverty-targeted urban upgradingwould be financed by a combination of loan, grant and local contributions.

2. The objectives of the proposed project would be to: (a) strengthen theinstitutional and financial management of urban municipalities so as to enable them tobetter manage their resources in support of the State's decentralization and economicgrowth strategies; and (b) improve the living conditions of the State's urban residents,primarily the urban poor, through: (i) establishing a mechanism for sustainable long-termfinancing of priority urban infrastructure for local governments; (ii) development ofdetailed, reliable systems for mapping of urban poverty in the State to guide State andlocal investment strategies; and (iii) a poverty-targeted program of urban upgrading incritically poor urban areas.

3. The proposed project would consist of (i) an institutional development componentto upgrade municipal financial administration, in particular property tax records andcollection; (ii) a basic urban infrastructure component to improve water, sewerage,drainage, solid waste, street paving and lighting in the municipalities of Bahia; and (iii) anurban upgrading component, consisting of about 20% of the funds for infrastructure whichwould be targeted to very poor urban areas. Poverty mapping at the State level wouldalso be undertaken.

4. Economic and Financial Analysis - Economic cost-benefit analysis would bedone to determine project viability. The minimum criteria for sub-projects would be thatthey provide an economic internal rate of return (EIRR) which meets or exceeds theopportunity cost of capital, for which the rate of 12% serves as a proxy. In the case ofrevenue-earning services, such as water, sewerage and public lighting, economic benefitswould be calculated on the basis of tariff revenues as a proxy for willingness to pay. Inthe case of non-revenue earning services, such as drainage and paving, economic benefitswould be based on increased land values as a result of the infrastructure improvements.

107

For those sub-projects estimated to cost less than US$500,000 per capita benefits wouldbe sufficient, providing the technical solution is least-cost and benefits are shown to belargely within the municipality. Financial cost-benefit analysis would provide the basis fordetermining cost-recovery. All infrastructure sub-projects (with the exception of somesewage treatment and solid waste disposal), are expected to achieve full cost recovery.Sub-project investments would be linked to specific targets to increase user fees and taxes,to be agreed with municipalities in the PRIM and reflected in the terms and conditions ofsub-loans for infrastructure investments.

5. Project Risks - The major project risk is implementation of the institutionaldevelopment program, which is a challenging component requiring significant advanceplanning, in particular in a state with varied municipal institutional capacities. For thisreason, agreed technical assistance and training programs and targets for municipalities toenter the project's first-year program have been prepared and progress on the institutionaldevelopment component will be linked explicitly to the infrastructure component for allsub-borrowers. This risk is also somewhat mitigated through the executing agency'saccess to the experience of other states with similar projects. There are few technical risksassociated with the project, since most infrastructure investments are of a routine nature,with the exception of certain sewerage treatment sub-projects which may employ low-costalternative technologies still somewhat innovative and less-well tested. Amounts allocatedto this type of sub-project are limited, and Bank prior-review of sub-project proposalsminimizes this risk. There is a risk that municipal elections in 1996 may be disruptive tothe project, however the fact that the State government recently took office (January1995) for a four-year term which coincides with the project implementation period,diminishes this risk somewhat by ensuring continuity at the State level. The executingagency is an experienced State agency with a good record in implementing projectsfinanced by multilateral agencies.

Financin2 Plan:

Components Bank State of Munic. Total CostsBahia

Loan Counterpart Counterpart Total(To be used as (State Grant to (Grant toGrant to Munic.) Munic.) Munic.)

Institutional Development 12.2 7.8 0.0 20.0(12.2) (7.8) (20.0)

Infrastructure 83.9 56.5 46.1 186.5(0.0) (0.0) (0.0)

Low Income Urban 3.9 7.7 3.9 15.5Upgrading (3.9) (7.7) (11.6)

Total 100.0 72.0 50.0 222.0(16.1) (15.5) (31.6)

108

6. Municipal Development Fund (FUNDURBANO) - The PRODURFUNDUJRBANO would be established by the State and loan administration andmanagement of the fund would be undertaken by DESENBANCO. About US$84.0million equivalent of the Bank loan would capitalize the FUNDURBANO, together withabout US$75 million of State resources. This is equal to the full amount less aboutUS$16.0 million, which, together with State counterpart would finance the institutionaldevelopment, municipal reform and the low-income urban upgrading component, whichwould be financed separately from the FUNDURBANO. The FUNDURBANO wouldon-lend to municipalities for up to 85% of the cost of eligible infrastructure sub-projects.The remaining counterpart (minimum 15%) would be provided by sub-borrowers, throughpayment of invoices (or in-kind labor contributions, in the case of smaller municipalities).Sub-loans would be made to sub-borrowers in three categories, with terms of up to five,ten and fifteen years (including grace periods of one to three years), depending on thecost-recovery profile of the investments

2. Implementation Arrangements

7. Institutional Arrangements - The Borrower would be the State of Bahia. TheState would use the proceeds of the Bank loan and its own counterpart funds to capitalizea municipal development fund (FUNDURBANO), to be managed by a commercial bankto be selected under procedures to be agreed. The State's Companhia deDesenvolvimento e Afiao Regional (CAR) would be the project's executing agency. CARwould execute Parts A-D of the project. CAR would have primary responsibility for allaspects of project implementation, including evaluation of sub-borrowers' financial andinstitutional capacity, diagnosis of institutional requirements and formulation of technicalassistance and training packages, evaluation of technical, economic and financial feasibilityof sub-projects, and all general aspects of management, operation and monitoring of theproject. These procedures would all be undertaken on the basis of an agreed OperationalManuals (para. 2.4 below). Environmental evaluations would be done through the State'sCentro de Recursos Ambientais (CRA; see Annex 5H). While CAR would handle all day-to-day activities of PRODUR, program management would be handled by a Board ofDirectors. The Board would be chaired by the State Secretariat of Planning, andmembership would include representatives from the Secretariat of Finance, othergovernment agencies, and the Association of Municipalities. CAR would serve as theExecutive Secretariat of the Board. The organization chart for PRODUR is presented inAnnex 5A. Institutional arrangements for the proposed project are detailed in Annex SB.

8. The State will strengthen the capabilities of CAR in the area of providing technicalassistance to municipalities. Plans include restructuring CAR into three Departments: (a)Regional Development (for rural-oriented programs); (b) Urban Development; and (c)Municipal Action (for support to institutional strengthening of local governments). Whilethe management and infrastructure aspects of PRODUR would fall under the UrbanDevelopment Department, the Municipal Action Department would handle theinstitutional development component. CAR also has plans to establish about twelveadditional regional offices.

109

9. Regarding specific project tasks, CAR has established a financial nucleus in theUrban Development division, which has been trained in public financial analysis, as well assimilar groups for economic and technical evaluation of sub-projects. CAR would hireconsultants when and as necessary to assist with project implementation.

10. Operational Arrangements - Operational arrangements are set out in theProgram's Operational Manual (OM). Final versions of each of the volumes would beagreed during Negotiations and the PRODllR program would be operated in accordancewith the OM. The OM would be simplified and summarized in small leaflets which wouldbe used in the marketing of the program. The OM is described further in Annex SC.

11. Eligible Sub-borrowers - The PRODUR program would be open to almost allmunicipalities in the State which meet the Program's eligibility criteria, with the exceptionof those localities eligible for the NRPA program and its planned successor. While thereare approximately 400 municipalities in the target group of eligible municipalities, it wasagreed that the probable beneficiary group would be those municipalities with populationsover 15,000 (approximately 220 in the State, representing about 80% of the totalpopulation). Full sub-borrower eligibility criteria are detailed in the Program's OrientationOperational Manual referenced above. Key steps for entry are as follows:

(a) signature of a Participation Agreement (Convenio de Adhesdo) whichformalizes municipal interest in PRODUR and commitment to itsprinciples;

(b) completion of an institutional and financial diagnosis, according to rapidassessment methodology developed and tested under similar programs inother states;

(c) establishment of an agreed set of institution-building actions, with clearly-defined performance targets, outlined in a Municipal Reform andInstitutional Development Plan (PRIM);

12. To undertake infrastructure sub-loans, municipalities and water agencies woulddemonstrate:

(a) demonstrated compliance with Federal legislation on payment of taxes andother obligations;

(b) demonstrated debt capacity according to federal guidelines for publicsector borrowing (set out in Senate Resolution #69, 1995);

(c) availability of required counterpart funds (minimum 25% of proposedproject costs); and

(d) ability to provide a guarantee (typically ICMS contribution).

13. Legal Arrangements - Implementation arrangements for the project would beformalized in the following legal documents:

a) State law authorizing the State to borrow from the Bank and establishingthe FUNTDURBANO;State decree regulating the FUNDURBANO;

110

b) Regulations of FUNDURBANO;c) Contract between the State of Bahia, CAR and the financial agent to

implement the program;d) Model participation agreement between the State, CAR and municipality;e) Model negotiation agreement between CAR and municipality (for the

institutional development component);f) Model contract between CAR and municipality for implementation of a

sub-project; andg) Model municipal law authorizing a municipality to participate in PRODUR.

14. Draft versions of all of these documents have been prepared and were reviewedduring Appraisal. Agreement on the final version of the model Participation Agreementsand Sub-Loan Contracts were reached during negotiations. Agreement was reached thatall conditions present in the legal agreements between the Bank and CAR, the State andthe Federal Government, would be reflected in the sub-agreements, as necessary.

15. Bank's Role During Implementation - The Bank would ensure that: (i) projectobjectives are being achieved; (ii) legal covenants are being fulfilled; (iii) the Bank'sprocurement guidelines are being applied; (iv) cost recovery measures were beingachieved; (v) sub-borrower and sub-project selection processes are transparent and thatcriteria agreed in the Operational Manuals are being applied; and (vi) provide technicalassistance in selected areas where the Bank has a comparative advantage (i.e. regional andsectoral best practices, environmental assessment, resettlement, economic and financialevaluation). This would be done through periodic supervision missions (about two peryear), frequent communication with the Borrower, principally through electronic mail, andreview of periodic reports and studies. The Bank would review procurement processes ona ex-ante basis, all procurement of goods, works, and consultant services over the limitsestablished as follows: (i) all contracts for civil works estimated to cost the equivalent ofUS$5.0 million or more; (ii) all contracts for goods estimated to cost US$300,000 ormore; (iii) all consultant contracts estimated to cost US$50,000 or more for individualsand US$100,000 or more for firms; and (iv) terms of reference for all consultant services,regardless of value. In addition, the Bank would review all sub-projects expected to costthe equivalent of US$5 rmillion or more (US$2 million in the case of the first three sewagetreatment and solid waste disposition sub-projects) would be subject to specific reviewand appraisal of all technical, economic, financial and environmental aspects by the Bank.Given the large number of small and medium-sized sub-projects expected during thisproject, ex-post reviews on the basis of spot-checking would be undertaken below theseamounts during supervision. Sub-projects would be considered for review until threemonths before the project's Closing Date. A Mid-Term Review will be carried-out by theBank and the Borrower approximately three years after Effectiveness to assess theproject's progress and its achievement of objectives, and to reorient implementation ifdeemed necessary

11i

3. Implementation Schedule

16. The project's implementation schedule, which outlines key actions in projectexecution for smooth implementation is attached and will be finalized during negotiations.This will be further detailed through the use of project management software, to beestablished and programmed during the project's inception mission. Of primaryimportance are targets for Participation Agreements with municipalities, procurement ofmajor works, and progress on technical assistance interventions. This schedule is to beprepared on a rolling quarterly basis. Arrangements for project supervision are outlined inthe supervision plan in Annex 5K. Physical project supervision will be carried out by the,regional offices of CAR, the DU and its consultants on the basis of site checks.

4. Monitoring and Evaluation

17. In addition to CAR's site visits, sub-borrowers would be expected to presentperiodic progress reports on project implementation (with periodicity established in sub-loan contracts), on the basis of which CAR would furnish concise quarterly progressreports to the Bank. These reports would compare actual and forecast progress. Thedetailed range of project monitoring indicators is provided in the OM (Volume 5). Theseinclude standard agreed performance indicators monitoring physical, financial andoperational progress of individual sub-projects, and aggregated project performance for allsub-projects. A set of "key impact indicators" and targets, selected from among the groupof indicators to be monitored during the project, would be agreed, including inter alia: (a)number of Participation Agreements signed; (b) number of PIMs completed; (c) overallproject completion, measured in expenditures; (d) discretionary as a percent of total Statetransfers to municipalities; and (e) average property tax per capita in the State (see Annex5K). These indicators, among others, would be monitored in quarterly reports.Agreement was reached during Negotiations that quarterly reports be furnished no laterthan 30 days after the end of each of the following quarters: March 31, June 30 andSeptember 30, and an annual report would be prepared for the December 31 period, to befurnished within two months of year-end. These reports would include, inter alia, themonitoring indicators set out in the OM, as well as a forecast investment plan. Reportingrequirements would begin with the first full quarter following Effectiveness.

112

ANNEX 5J

PROJECT IMLEMENTATION SCHEDULE

Bahia Municipal Management Project

021S Q03'S 04S51 0196 029 036 0416 VS 0'97 02'9? tD Name M|J J|AIS T IEDJIf|M AMJ J |AIS l J IF I IJ JI White Cover

2 White Cover lssued

3 Appraisal

4 Green Cover

S Green Cover Issued

6 Negotiations

7 Tentatiw Board Presertation

8 Loan Signing

9 Conditions of Effectiveness

10 Project Agreement authorized by State

11 LA regstered In BACEN

12 HireUrbanPtn. &Oev. Specialst I13 Operational Manuals Issued |

14 Five Sub-Loan Agreemnts Ssgned I

15 State legally esab. FUNDURBANO

16 Financial Agenrcy Agreem signed

17 Loam Effectiveness I *

18

t9 Estabilsh Special Account i 1

20 _

21 Ist Year Program t 0Munic.

22 Es:ab 7 10 Municipalibes to Part,

23 Finalize Sut-projects (S munic)

24 Submit 1st yr. Implementabon Plan

25 Upgrading (Part C) Implenlation Plan

26 Prepare Standardize TORs for ID

27 Prepare Inst Diagnostics (5 Municj

28 Prepare PIM (S Munic.)

29 Revise Implement. Plan lo reflect PIM i

30 Preare ID interventions (5 munkc)

31 Send TORs to Bank Sank No Obj. l

32 Select Consuttants

33 Begin ID Intervenbons | |

34 Prepare Bid Packages Intra. Sub-proj. |

35 Send r5st 3 NCSs to Bank

36 Bid sub-projects. Bank revew. Award

37 Begin Sub-projects

3839 Marketing Program

113ANNEX 5J

PROJECT IMPLEMENTATION SCHEDULE

Bohla Municipal Management Project

02 95 | 03 95 04 VK O 02 96 031i96 | 0496 1 01 97 | 0210 Name A M IJ i J A | S 0 N I D AJ I F I MTA I MIJ I i 1 A rS I o rN I M DA | M J I J9 Martkehng Program

40 Prep. of Manreting Plan Malterials

41 Prep. of simpliried Op Manuels i

42 1 st Launch Seminar w/ 10 Munc.

43 1st Regional Marketng Seminar

44 2nd Reglonal Marketing Seminar i

45;

46 Procurement Advertisement

47 Prepare Gen. Proc. Notice 948 Putlish Gen Proc Notice in DS

49 Publish NCB mifrt. sub-proicts knlo t

Si Reporling

|52 995 AnnusI Progrtss Report

| 53 | tns 4th quarter progress report

9 o IVAiSt qMtMer Progress Report

SS 1 t99 2nd Quarter Progrtas Report

1996 3rd Quamter Progrega Report 7

57 I 996 4th Quarter Progress Report

59 I995 FinancialuAirdit& 1 !T

60 I Select Auditor(s) 7I

61j Prepare Audit(s)

62 1 995 Audit of Project Accounts

163 A995 udit O Special Account. SOE|

| 1O | t995 Audit o CAR Fin. Statements | [

| 66 | MiC -Te-rr R-ew | i - - - - -

Pro1act: Critcal Progress 'SummeNr umryWDate 4/26/95 Noncrincat -)P%!5v'. M,iestone

114

ANNEX 5KBRAZIL

BAHIA MUNICIPAL INFRASTRUCTURF, DEVELOPMENTAND MANAGEMENT PROJECT

SUPFRVISION PLAN

1. A supervision strategy has been tentatively formulated, emphasizing: (i) a thoroughand detailed project inception or launch mission, the aim of which will be to test thesoundness of the basic project planning, implementation and monitoring tools; (ii) periodicshorter missions of local consultants, in addition to at least two full supervision missionsper year; and (iii) establishment of electronic mail communication between the Bankheadquarters in Washington and ihe project office in Salvador.

2. To launch the project, an inception mission is planned for the third quarter ofFY97 (February 1997). The mission would be scheduled for about one and a half weeks,and would comprise a sanitary engineer, an environmental specialist, institutionaldevelopment specialist, economist and operations assistant in addition to the task manager(and brief visits from procurement and disbursement staff, as needed). Following projectinception two additional supervision missions would be held during the fiscal year, in orderto build on the momentum of project inception and to iron-out any implementationdifficulties. Local consultants would make periodic visits to bolster implementationbetween missions during this critical first year. For FY97 and FY98, a minimum of twofull-scale supervision mission would be scheduled per year consisting of a four-personcore team (engineer, institutional development specialist, environmental specialist and taskmanager), complete with site visits, along with one to two shorter, skeleton-staffedsupervision visits during the year, also utilizing local consultants for between-missionconsultative visits.

3. During project preparation, standardized reporting arrangements were discussedand would be agreed during project launch, in order to streamline supervision. A mid-term review would be scheduled for approximately the fourth quarter of FY2000, forabout one and a half weeks, and including an engineer, and environmental specialist, aneconomist, institutional development specialist and operations assistant in addition to thetask manager. The objectives of the mnid-term review would include, inter alia:

(a) review of progress and achievements on the institutional developmentcomponent;

(b) review the beneficiary population in the context of poverty mapping andmake any mid-term adjustments required;

(c) review of key performance indicators (i.e., ex-post rate of returnevaluation; increase in own-source revenue collections);

115

(d) review of the allocation of resources among sub-components and proposedre-allocation, as necessary, depending on project progress and consistencywith project objectives;

(e) effectiveness of institutional and implementation arrangements, and degreeto which these could be simplified and/or adjusted to improve projectimplementation efficiency and effectiveness;

(f) review the success of the poverty targeted urban upgrading component andmake mnid-course adjustments as required;

(g) determine the appropriateness of use of simplified economic evaluation ofsmaller sub-projects (US$500,000 or less) using indicators monitoredduring the first years of project implementation; and

(h) assess CRA's effectiveness in environmental review of sub-projects.

ANNEX 6ABRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENT AND MANAGEMENT PROJECT

MUNICIPAL REVENUES AND EXPENDITURES IN BAHIA

Performance Indicators 1992

Ration/Population Size Groups 8,000 15,000 30,000 60,000 100,000 150,000 250,000 9,999,999

Tax Revenue/Total Revenue 1.51 1.50 3.84 3.13 8.80 18.51 9.14 36.35

State & Federal Transfers/Total 90.92 91.57 90.08 87.13 70.81 65.62 85.03 52.69Revenues _

Other Revenues/Total Revenues 7.57 6.57 6.02 9.73 20.39 15.87 5.82 10.95

Current Expenditures/Total 75.56 76.19 74.91 70.78 63.52 42.44 61.87 32.36Expenditures _

Capital Investment/Total 21.06 19.48 20.56 21.02 31.39 42.18 27.75 6.08Expenditures

Personnel Expenditures/Current 36.04 35.19 39.68 44.61 54.88 62.35 59.43 65.60Expenditures

Deficit -2.43 -2.46 -2.99 -2.85 -11.77 -34.39 -11.36 -11.39

Financial Expenses from Federal 71.50 70.16 58.94 60.16 36.09 16.82 35.86 19.83Transfers

Relative Cost of Administration 78.80 80.41 78.95 78.30 67.64 55.44 70.84 74.95

Current Savings Rate (1) -1,816.89 -2,044.09 -1,148.70 -970.75 -364.18 -115.15 -520.53 -82.91

Self Financing Ratio (Administrative) 5.22 4.66 8.01 9.34 21.54 46.48 16.12 54.67

Self Financing Ratio 5.13 4.67 7.30 7.45 11.93 16.40 11.84 38.83

Current Savings Ratio (2) 15.03 13.17 15.61 14.30 14.45 25.89 15.54 15.62

Effective Savings Rate 19.24 17.56 18.61 19.40 23.33 15.50 20.08 15.41

Property Tax/Net Revenues 3.87 3.05 4.31 4.99 5.43 0.77 10.62 26.15

Per Capita Revenues 425,295.53 336,385.95 331,659.99 251,527.64 355,880.71 725,653.54 349,195.31 376,540.21

Per Capita Expenditures 435,882.71 344,855.72 341,846.78 257,744.43 390,235.75 967,564.61 390,100.83 414,702.65

Source: DTN-ME/CAR-SEPLANTEC

117

ANNEX 6B

BRAZILLBAHI1A MUNICIPAL INFRASTRUCTURE DEVELOPMENT

AND MANAGEMENT PROJECT

DEBT CAPACITY OF THE MUNICIPALITIES

Number of Avg. Muicip. EstimatedPopulation Municipalities Debt Capacity Number of Total Debt

Category (Inhabitants) Surveyed* ('000 R) Municipalities Capacity_ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _(' 0 0 0 R )

I 15,001 to 30,000 15 797.5 153 122,015

II 30,001 to 60,000 17 976.9 46 44,939III 60,001 to 100,00 7 1,321.9 16 21,150

IV 100,001 to 150,00 3 2,418.8 4 9,675V 150,001 to 250,000 2 5.324.8 3 15,974

Sub Total 44 213,753

*Those participating in the First-year Program

118

ANNEX 6CBRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENTAND MANAGEMENT PROJECT

COST RECOVERY INSTRUMENTS

Subproj ect Recovery

Instrument

Water catchment, production water tariff

Water transmission, distribution water tariff, IPTU, ITBI

Sewerage collection sewage tariff, IPTU, ITBI

Sewage treatment sewage tariff

Solid waste collection garbage tax, IPTU

Solid waste disposal garbage tax, IPTU

Drainage IPTU, ITBI

Street paving IPTU, ITBI

Public lighting tariff, IPTU, ITBI

Property tax assessment upgrading IPTU/ITBI

Technical assistance general revenues

Training general revenues

IPTU: Imposto Sobre a Propriedade Territorial IJrbana - Real Property Tax.ITBI: Imposto Sobre a Transferencia de Bens Immobilizados.

119

ANNEX 7BRAZIL

BAHIA MUNICIPAL INFRASTRUCTURE DEVELOPMENTAND MANAGEMENT PROJECT

EVALUATION OF SUB-PROJECTS

1. Methodology. Most Sub-projects proposed by municipalities for financing underPRODUR will be subject to five stages of evaluation: (i) technical; (ii) economic; (iii)financial; (iv) environmental; and (v) public health. Subprojects such as water andsewerage network eytensions, water system improvements, drainage, paving and streetlighting investments, have readily quantifiable benefits. These sub-projects will undergoeconomic and financial evaluation according to agreed selection criteria andmethodologies which are set out in the project's OM. A simple methodology has beenfollowed, in order to be widely accessible to a wide range of municipalities expected toparticipate in PRODUR.

2. Technical Evaluation. Through in-house engineering expertise and externalconsultations where necessary, CAR will examine the appropriateness of the specificationsof each proposed subproject, ensuring that least cost solutions are applied, as well asverifying that a demand exists for the proposed services.

3. Economic Evaluation. This will use cost: benefit analysis to estimate economicrates of return (ERRs) of proposed investments which must exceed the long termopportunity cost of capital in Brazil, currently estimated at 12%. For non-revenuegenerating services--notably paving and drainage--increased land values resulting from theimprovements would be used to measure benefits. For revenue generating services--suchas water, sewerage and solid waste collection--financial flows from payments made byusers, less taxes, would be used as a proxy for economic benefits.

4. Since the proposed project takes a programmatic approach to financing municipalinvestments, an exact forecast of investments for the project implementation period is notpossible. Based on estimated project costs and performance of similar projects, some 75%of investments should have readily quantifiable benefits under the selected methodologies.Project components without quantifiable benefits, such as institutional development,would not be subject to economic evaluation. The financial benefits from technicalassistance investments in the area of fiscal and financial modernization would be evaluatedand closely monitored, however.

5. Economic benefits measured for PRODUR's economic evaluation would be asfollows. For revenue-earning services, such as water supply and sewerage, user chargeswould be used as a proxy for willingness-to-pay benefits (although this does not capturefull benefits such as consumer surplus). For non-revenue earning services, such as pavingand drainage, benefits would be determined through increased property values--expressedas a fifteen year benefit stream--resulting from the improved living conditions provided by

120

the investments. Estimates of property value changes would be made empirically for eachproposed subproject by the municipalities and verified by CAR, by comparing with-projectand without-project scenarios. This would involve observing the difference between thevalue of the unimproved area slated for investment, and the value of a similar area alreadyserved by urban infrastructure of the kind proposed. Local real estate agents and residentswould be the primary source of this market information, which would be cross-checkedwith data from similar projects elsewhere in Brazil and consolidated into a PRODURproject cost and benefit data base. As more and more sub-projects are evaluated, this database would serve as a basic reference for verifying the accuracy of subproject informationcontained in applications for PRODUR financing. Experience from Bank financed projectsin other states of Brazil has shown that, through the stronger demand for environmentallyimproved areas, land values can increase significantly after infrastructure and urban serviceimprovements in low income neighborhoods.

6. Economic evaluation will take the economic costs of sub-projects to be all capitalexpenditures and all necessary re-investment, plus recurrent expenditures for operationand maintenance. All economic costs and benefits are assumed to be net of taxes andduties. Subproject selection criteria would ensure that least cost technical solutions areselected. As a priority, the proposed project would first optimize the use of existingfacilities. A fifteen year discount period would be used as a standardized economic life ofthe investments. A model for each type of sub-project has been developed by theBorrower for use in sub-project screening and evaluation.

7. Economic evaluation for selected sub-projects in a number of cities and sectorswere reviewed during appraisal. Based on the sample of sub-projects reviewed--pavingand water supply sub-projects--it is expected that economic rates of return for this type ofinvestment will be of the order of 12%-35%. Ex-post economic evaluation conducted forsuch investments undertaken in other states (with similar programs) indicate rates ofreturn in the range of 12-90%. For Loan Negotiations, the Borrower provided finalizedcost-benefit analyses of the first year program of the municipality whose investments are inthe most advanced stage of preparation. Subproject evaluation of the remainder of the firstyear program for other cities would be a condition of Loan Effectiveness.

8. During the first half of project implementation, responsibility for undertaking thesubproject cost-benefit analyses will rest primarily with the PRODUR evaluation team inCAR, who will build up a data base of subproject cost and benefit information. At thesame time, it is expected that CAR will be able to fully build-up an in-house capability inthese evaluation tasks. Thereafter, during the second half of project implementation, CARwill provide technical assistance to participating municipalities in subproject evaluation sothat each participating city may be able to train its own staff and develop its own capacityto assess the performance of investments and determine priorities for their own municipalinvestment program based upon efficiency criteria implied by the cost-benefit analysis.

9. Financial Evaluation and Cost Recovery. Where financial costs are benefits areclearly discernible in the case of revenue generating services, PRODUR would estimatethe internal financial rates of return (FRR) of proposed sub-projects. This estimate wouldhelp determine cost-recovery requirements and establish guidelines for sub-loan terms and

121

conditions. Benefits would be the same as for the economic evaluation. Costs wouldinclude all taxes, debt service and other charges. The financial evaluation would usefinancial rates of return (FRRs) as the basis for determining cost recovery. All revenuegenerating investments are expected to achieve a FRR for the municipality of at least 6%.

10. Environmental screening. This would be ensured through the compliance, whereappropriate, of all sub-projects with the State's own rigorous environmental requirements(details: Annex 5F).

11. Evaluation of Public Health Impacts. Because of their high up-front capital costand relatively small financial returns, sewerage sub-projects rarely generate sufficientmeasurable benefits to justify the investment in purely financial or economic terms. Forexample, recent experience in the state of Minas Gerais has shown that using tariffs paidby beneficiaries as a proxy for such benefits, estimated internal rates of return seldomexceeded 6%. In spite of this, sewerage systems are believed to generate large healthbenefits over long periods, especially to a low income communities which formerly mayhave had no basic sanitation service. These benefits are not captured by the tariffs thatbeneficiaries typically pay, or even those they may be willing to pay.

12. For this reason, the health benefits likely to accrue from sewerage investmentsproposed by the project would be examined separately by PRODUR. Introducing this kindof basic sanitation into an area of a city which previously had none can significantly reducethe incidence of diarrhea and waterborne intestinal diseases among the beneficiarypopulation. According to Bahia State health officials, at least 50% of cases of thesediseases can be eliminated through basic sanitation improvements of the kind envisionedunder the project. In Bahia, waterborne intestinal diseases are responsible for 4.0% ofdeaths among the population as a whole, three times as much as mortality resulting fromtraffic accidents. Children are particularly vulnerable to these diseases, which account for17.1% of infant mortality in the State of Bahia.3

13. This method involves estimating DALYs (disability adjusted life years) lostthrough specific diseases. The DALY measures healthy life years (DALYs) lost per groupof 1,000 persons affected by a combination of mortality and disability caused by each of aseries of specific diseases. DALYs are expressed as the present value of the weightedaverages of the estimated years equivalent lost among different age groups. The 1993WDR tabulates observed DALY values for 1990 by disease and by region of the world.4

14. For the purposes of the project, the estimate of DALYs saved in Bahia was basedupon three important premises:

* The number of DALYs per disease and 1,000 people in the urban areas of Bahiahave the same value as the 1993 WDR estimates for Latin America as a whole.

3Bahia, Centro de Informacoes da Secretaria de Saude Anuario Estatistico: Informac6es de Saude, Salvador 1994.

4As proposed in the World Development Report 1993: Investing in Health (WDR-93).

122

* Only DALYs resulting from two disease groups are susceptible to reductionthrough sewerage systems: (i) diarrhea, and (ii) worm infections. According to the1993 WDR, these two groups together account for 8.2% of all DALYs in LAC, or19.1 DALYs per annum per 1,000 people in the region.

* Sewerage projects will reduce the incidence of these diseases among the peopledirectly served by 50%, thereby eliminating half the respective DALYs lost perannum.

* To establish a methodology to be used under the proposed project, first the totalnumber of DALYs saved through the project we examined, and then the costeffectiveness of the project investment with respect to each DALY saved, wasestimated. The latter was measured by the investment cost per DALY.

15. Preliminary results indicate that a sewerage scheme benefiting 3,600 people in thecity of Amargosa could save 34 DALYs annually among the community over the life ofthe investment at an initial cost of R$5,355 per DALY saved. Additional results for othercities will be forthcoming by Loan Effectiveness.

123

ANNEX 8BRAZIL

BAHIA MUNICIPAL MANAGEMENT PROJECT

DOCUMENTS IN THE PROJECT FILE

I. MARCO REFERENCIAL

2. ASPECTOS INSTITUTIONAIS

3. DOCUMENTOS LEGAIS

4. FUNDO

5. MEIO AMBIENTE

6. DEMANDAS MUNICIPAIS

7 ESTUDO DA CAPACIDADE DE ENDIVIDAMENTO

8. PROJETO PILOTO PARA 0 ANO 1 (6 municipios)

9, MANUAIS OPERACIONAIS

a) Manual de Orientac6esb) Livreto PublicitArioc) Roteiro para Avaliacao de Clientesd) Manual de Licitac6ese) Detalhamento dos Componentesf) Manual de Programacao Financeirag) Guia de Projetosh) Manual de Monitoria e Avaliacao

10. ESTUDO DOS 10 MIJNICIPIOS NaO ATENDIDOS PELA EMBASA

11. CARTA DO GOVERNADOR AO BIRD

12. INDICADORES DO DESEMPENHO FINANCEIRO DOS MUNICIPIOS

13. ESTRUTURA ORGANIZACIONAL DO ESTADO

14. PROJECOES DE FUNDURBANO, CARIDESEMBANCO

15. RELATORIO DA PESQUISA INSTITUCIONAL FINANCIERA DO MUNICIPIO -PIM: AMOSTRA DE 66 MUNICIPIOS

16. PROCEDIMENTOS E CRITERIOS PARA 0 LICENCIAMIENTO AMBIENTAL

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i

IMAGING

Report No: 16258 BRType: SAP