ASIAN DEVELOPMENT BANK RRP: NEP 36609

REPORT AND RECOMMENDATION

OF THE

PRESIDENT

TO THE

BOARD OF DIRECTORS

ON

PROPOSED LOANS

TO THE

KINGDOM OF NEPAL

FOR THE

KATHMANDU VALLEY WATER SERVICES

SECTOR DEVELOPMENT PROGRAM

November 2003

CURRENCY EQUIVALENTS (as of 30 October 2003)

Currency Unit – Nepalese rupee/s (NRe/NRs)

NRe1.00 = $0.013 $1.00 = NRs75.05

ABBREVIATIONS

ADB – Asian Development Bank DDC – district development committee DWSS – Department of Water Supply and Sewerage EA – executing agency FIRR – financial internal rate of return IA – implementing agency JBIC – Japan Bank for International Cooperation JICA – Japan International Cooperation Agency KVWMSP – Kathmandu Valley Water Management Support Project KVWSMSC – Kathmandu Valley Water Supply Management Support

Committee MC – management contractor MLD – million liters per day MPPW – Ministry of Physical Planning and Works MWSDB – Melamchi Water Supply Development Board MWSP – Melamchi Water Supply Project NGO – nongovernment organization NRB – Nepal Rastra Bank NWSC – Nepal Water Supply Corporation NWSRB – National Water Supply Regulatory Board PPMS – project performance monitoring system PSP – private sector participation SDP – sector development program SDR – special drawing rights TA – technical assistance VRS – voluntary retirement scheme WA – Water Authority (for Kathmandu Valley) WACC – weighted average cost of capital WTP – willingness to pay WUO – Water Utility Operator (for Kathmandu Valley)

NOTES

(i) The fiscal year (FY) of the Government of Nepal ends on 15 July 2003. FY

before a calendar year denotes the year in which the fiscal year ends—e.g., FY 2003 ends on 15 July 2003.

(ii) In this report, "$" refers to US dollars. This report was prepared by a team consisting of K. Tamaki (team leader), J. Kongoasa, A. Qadir, and K. Julian.

CONTENTS Page

LOAN AND PROGRAM SUMMARY iii MAP ix I. THE PROPOSAL 1 II. THE SECTOR: PERFORMANCE, PROBLEMS, AND OPPORTUNITIES 1 A. Sector Description and Performance 1 B. Issues and Opportunities 3 III. THE PROPOSED SECTOR DEVELOPMENT PROGRAM 5 A. Objectives and Scope 5 B. The Program Loan 6 C. The Project Loan 12 IV. PROGRAM BENEFITS, IMPACTS, AND RISKS 18 A. Benefits and Impacts 18 B. Risks 19 V. ASSURANCES 20 VI. RECOMMENDATION 22 APPENDIXES 1. Program Framework 24 2. Development Policy Letter 27 3. Policy Matrix 29 4. Assessment of Alternative Institutional Arrangements 31 5. Organizational Arrangements for Implementation 33 6. Implementation Schedule 34 7. List of Ineligible Items (Negative List) 35 8. Proposed Contract Packaging 36 9. Demonstration Scheme Planning and Basic Design 37 10. Recruitment Procedures and Outline Terms of Reference for Management

Contractor 43

11. Outline Terms of Reference for Implementation Assistance 46 12. Project Performance Management System 47 13. Economic Analysis 50 14. Financial Analysis 57 15. Environmental Assessment of Kathmandu Valley Water Services Sector

Development Program 60

16. Summary Poverty Reduction and Social Strategy 62 17. Terms of Reference for Technical Assistance Consultants (TA 4096-NEP) 64 SUPPLEMENTARY APPENDIX (available on request) Economic Reappraisal of Melamchi Water Supply Project

LOAN AND PROGRAM SUMMARY Borrower The Kingdom of Nepal Classification Poverty Classification: Other

Thematic: Good governance Environment Assessment

Category: C

Program Description The Kathmandu Valley Water Services Sector Development

Program (the Program) will improve the water supply and wastewater services in the metropolitan/urban areas of Kathmandu Valley by supporting institutional reforms and by engaging a management contractor (MC) under a performance-based management contract to operate and manage the urban water supply and wastewater systems. The lending will be a sector development program (SDP) loan in the total amount of Special Drawing Rights (SDR) 10,418,000 ($15 million equivalent), and will consist of: (i) a program loan part (the program loan) of SDR3,473,000 ($5 million equivalent) to finance the initial operating costs for the proposed three key entities, i.e., the Water Authority (WA) and the Water Utility Operator (WUO) for Kathmandu Valley, and the National Water Supply Regulatory Board (NWSRB), and subsequent rightsizing of the newly formed WUO by utilizing the existing voluntary retirement scheme procedures of the Nepal Water Supply Corporation (NWSC); and (ii) a project loan part (the project loan) of SDR6,945,000 ($10 million equivalent) to finance the performance-based management contract, consulting services for the above three key entities to be established under the Program, and the completion of the computerization of the billing and accounting systems currently in progress under NWSC.

Rationale The absence of a clearly defined policy for urban water supply

and wastewater services has handicapped sector progress in Nepal. The existing urban water supply utility, NWSC, which has been supported by a number of development partners for almost 30 years, has not been able to deliver efficient services on a sustainable basis for the residents of the metropolitan/urban areas of Kathmandu Valley. Undue political intervention, weak management, and preoccupation with new investments have contributed to inadequate and inefficient operation and maintenance, and weak revenue collection. Through a number of studies, funded by the United Nations Development Programme (UNDP), the World Bank, and more recently the Asian Development Bank (ADB), it has been recognized that since its establishment, NWSC has been operating primarily as a procurement agency for new works and as such has not been able to develop the skills and corporate culture required for utility management.

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The ongoing implementation of water resource development and

water supply projects, notably the Japan International Cooperation Agency-financed Manohara Project and multiagency-financed Melamchi Water Supply Project (MWSP), have drawn attention to the great need to improve the competency and efficiency of utility management if maximum benefit is to be gained from these substantial investments.

The inability of NWSC to adequately manage the existing water

supply and wastewater systems has led to a clear consensus among the development partners and relevant agencies in the Government of Nepal that institutional reforms and the introduction of the private sector participation (PSP) modality for managing and improving water supply and wastewater services are essential to the sector’s development. As a result, the PSP scheme has been identified as an integral component of the MWSP.

Objectives and Scope The Program aims to establish an appropriate institutional

framework and operational environment that will facilitate the provision of efficient and affordable water supply and wastewater services in the metropolitan/urban areas of Kathmandu Valley. To achieve this objective, the Program will support necessary institutional reforms, including the restructuring of NWSC, and the establishment of three key entities, i.e., the WA and the WUO for Kathmandu Valley, and the NWSRB. The Program will introduce the PSP modality for managing water supply and wastewater service delivery through a performance-based management contract.

The Program Loan Objectives The objective of the program loan is to support the water services

sector institutional reforms by establishing the three key entities to ensure a professional and commercially driven operational environment for the WUO under a performance-based management contract and by rightsizing the staff of the WUO to facilitate efficient operations and management.

Components and Outputs

The two key components of the program loan are the financing of the initial operating costs for the proposed WA and WUO for Kathmandu Valley, and the rightsizing of the newly formed WUO by utilizing existing NWSC voluntary retirement scheme procedures.

Program Loan Amount and Terms

ADB will provide a program loan of SDR3,473,000 ($5 million equivalent) from its Special Funds resources to support the Government’s water services sector institutional reforms, including the NWSC restructuring and the initial operating costs of the WA and WUO together with the subsequent rightsizing of the WUO.

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The program loan will have a 24-year term, including a grace period of 8 years, with an interest of 1% per annum during the grace period and 1.5% per annum thereafter and such other terms and conditions set forth in the draft Loan and Program Agreements.

Program Loan Allocation and Relending Terms

The Government will provide SDR139,000 ($0.2 million equivalent) to the WA in an equal mix of subloan and grant and SDR3,334,000 ($4.8 million equivalent) to the WUO in an equal mix of subloan and grant. The subloans will be rupee denominated and their terms and conditions will be defined in subsidiary loan agreements, acceptable to ADB. The subloans will have an interest of 9% per annum with a repayment period of 30 years, including a grace period of 5 years. Interest during the grace period will be capitalized. The Borrower is the Kingdom of Nepal. The Government will bear the foreign exchange risk.

Program Loan Period and Tranching

The program loan will be implemented over a period of approximately 9 months commencing from program loan effectiveness, with funds being released in two equal tranches $2.5 million equivalent each upon compliance with the policy conditions for the release of the first and second tranches, respectively, as per the policy matrix (Appendix 3). The second tranche is expected to be released approximately 5 months after the first tranche release.

The Project Loan Objectives The objective of the project loan is to support the water services

sector institutional reforms by introducing the PSP modality for the management of water supply and wastewater service delivery in Kathmandu Valley via a performance-based management contract.

Components and Outputs

The key components of the project loan are: (i) the performance-based management contract; (ii) implementation assistance (advisory consulting services for the three new key entities and civil society/nongovernment organization monitoring); and (iii) the completion of ongoing computerization of the billing and accounting systems for current NWSC branches in Kathmandu Valley.

Cost Estimates The total cost of the Project is estimated at $15.0 million

equivalent (including taxes and duties of $1.0 million), of which $7.4 million (49.3%) is the foreign exchange cost including $0.39 million in interest during construction/project implementation. The local currency cost is $7.6 million equivalent (50.7%).

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Financing Plan ($ million)

Source Foreign Exchange

Local Currency

Total Cost

%

ADB 7.4 2.6 10.0 66.7

Government 0.0 5.0 5.0 33.3

Total 7.4 7.6 15.0 100.0

ADB = Asian Development Bank. Project Loan Amount and Terms

ADB will provide a project loan of SDR6,945,000 ($10 million equivalent) from its Special Funds resources, representing 66.7% of the total project cost. The loan will have a 32-year term, including a grace period of 8 years, and an interest of 1% per annum during the grace period and 1.5% per annum thereafter and such other terms and conditions set forth in the draft Loan and Project Agreements.

Project Loan Allocation and Relending Terms

The Government will provide SDR347,000 ($0.5 million equivalent) to NWSC in an equal mix of subloan and grant, SDR174,000 ($0.25 million equivalent) to the WA in an equal mix of subloan and grant, and SDR6,424,000 ($9.25 million equivalent) to the WUO in an equal mix of subloan and grant by using the proceeds of the project loan. The subloans will be rupee denominated and their terms and conditions will be defined in subsidiary loan agreements, acceptable to ADB. The subloans will have an interest of 9% per annum with a repayment period of 30 years, including a grace period of 5 years. Interest during the grace period will be capitalized. The Government will bear the foreign exchange risk.

Period of Utilization Until 30 June 2011

Estimated Project Completion Date

31 December 2010

Implementation Arrangements

The Ministry of Physical Planning and Works (MPPW) will be the Executing Agency (EA) for the Program. Until the establishment of the WA and WUO, the EA will discharge its duties through the Melamchi Water Supply Development Board (MWSDB) as an implementing agency (IA), with the Kathmandu Valley Water Supply Management Support Committee (KVWSMSC) being the project coordination office in charge of overall management and coordination for the Program. KVWSMSC will facilitate the required actions for the institutional reforms with government agencies concerned, and will carry out the recruitment of the MC on behalf of MWSDB/MPPW. NWSC will be an IA for the computerization of billing and accounting systems. A contract compliance unit that will be established within the board of the WUO will assume the responsibilities of an IA once the

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performance-based management contract is signed and will continue as an IA with respect to the supervision of the management contract and other subsequent advisory consulting service contracts for the WUO until the end of project loan implementation. For the advisory consulting services for the WA and the NWSRB, MPPW will take over as an IA through the secretariat of the WA.

Executing Agency Ministry of Physical Planning and Works

Procurement The procurement of all goods and services under the project loan will be undertaken in accordance with ADB’s Guidelines for Procurement. The equipment for the computerized billing and accounting systems required for NWSC and subsequently for the WUO will be procured under international shopping procedures. Minor items estimated to cost $100,000 equivalent or less per contract may be purchased directly, following proper procedures.

Consulting Services For the advisory consulting services for the three key entities,

individual international and domestic consultants will be recruited in accordance with ADB's Guidelines on the Use of Consultants. Other arrangements satisfactory to ADB may be used for the engagement of domestic advisory consultants. Recruitment of the MC will also be carried out in accordance with ADB's Guidelines on the Use of Consultants using the quality-and-cost-based section (QCBS) method with some adjustments. Consultants will be recruited for the computerization of billing and accounting systems in accordance with ADB's Guidelines on the Use of Consultants using normal QCBS method. Other arrangements satisfactory to ADB may be used for the engagement of domestic consultants for this computerization. Civil society groups/nongovernment organizations (NGOs) for the periodic monitoring/performance benchmarking will be recruited in accordance with ADB's Guidelines on the Use of Consultants using the QCBS method based on biodata proposals.

Program Benefits and Beneficiaries

The key program benefits relate to: (i) increased consumer surplus, derived from improved water supply and wastewater services, as well as health benefits from better environmental sanitation and personal hygiene; (ii) strengthened management efficiency; and (iii) improvements in the institutional structure, with the establishment of a clearer framework for setting tariffs.

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Risks and Assumptions The main risks include: (i) general political instability and security issues in the country regarding the insurgency; (ii) temporary absence of Parliament and elected municipal government officials; (iii) uncertainty regarding the new decentralized urban service delivery modality under the Local Self-Governance Act; (iv) insufficient interest in the prospective performance-based management contract among potential operators (consultants); and (v) the capacity of the EA and the IAs to implement the Program. However, the Government has unequivocally given its utmost priority to the overall urban water supply sector reform as an essential component of the MWSP, and has continually shown its commitment to reform. Also, the insurgency is likely to have less impact on an urban-based and institutional development- focused program in the capital region like this. Indeed, this Program can proceed, with some modifications, even if the commissioning of the Manohara Project and the MWSP is delayed. Furthermore, there is broad-based support for the reforms among civil society, and a number of potential operators (consultants) have already indicated serious interest in the management contract. The proposed ADB intervention under this SDP is, therefore, justifiable and timely. The EA and IAs will receive significant assistance from the main TA consultant team recruited under TA 4096-NEP (Kathmandu Valley Water Management Support Project) with respect to the institutional reforms, the recruitment of the MC, and the transition from NWSC to WUO/MC/NWSRB.

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I. THE PROPOSAL

1. I submit for your approval the following report and recommendation on two proposed loans to the Kingdom of Nepal for the Kathmandu Valley Water Services Sector Development Program.

II. THE SECTOR: PERFORMANCE, PROBLEMS, AND OPPORTUNITIES

A. Sector Description and Performance

2. The Ministry of Physical Planning and Works (MPPW) is responsible for all water supply and wastewater services in the country. It reviews and approves sector plans, policies, and development budgets. It also supervises several sector institutions, including the Department of Water Supply and Sewerage (DWSS), the Nepal Water Supply Corporation (NWSC), the Rural Water Supply and Sanitation Fund Board, and the Town Development Fund. The responsibility for water supply and wastewater services in the urban areas of Nepal, including the metropolitan/urban areas of Kathmandu Valley, currently lies with NWSC.

3. The current piped water supply demand in Kathmandu Valley, including unaccounted-for water, is estimated at 150 million liters per day (MLD). However, the combined production capacity of the groundwater and surface water sources in the dry season is between 65 and 85 MLD and even in the wet season, the production capacity only reaches 140 MLD. Under these water shortage conditions, NWSC has applied a rationing system whereby water is allowed to flow to different sections of the metropolitan/urban area in rotation. The control system developed by NWSC is complex to implement as it requires NWSC staff to open and close over 300 valves every day. The result is an inequitable distribution of water, particularly as the areas close to the water sources are very difficult to isolate. While some parts of the city have an abundance of water, the majority of the population only receive water for a few hours every 2–3 days and even then the pressure is low and the quality is poor.

4. As a result, it is common for people to sit up half the night waiting for water to arrive at their houses so that they can pump it to their roof-top storage tanks. Residents are obliged to spend money on ground-level water tanks, booster pumps, and water filters and even then all water must be boiled prior to drinking. While the basic cost of piped water in Kathmandu may be cheap, the indirect costs associated with its use are unreasonably high. In a survey conducted under Loan 1640-NEP (Melamchi Water Supply (Engineering) Project), it was found that 86% of households are compelled to use secondary sources of water such as shallow wells or private tanker supplies (costing in excess of $1.00/1,000 liters) just to meet their basic needs. The service provided by NWSC is generally regarded as poor and the public holds NWSC in low esteem and does not believe that it is working in their best interests.

5. In addition to the poor distribution of water, the lack of adequate long-term water sources is one of the fundamental causes of the chronic drinking-water shortage in Kathmandu Valley. To address this issue, the Government of Nepal initiated the Melamchi Water Supply Project (MWSP) under Loan 1820-NEP(SF), which consists of a river water diversion scheme from the Melamchi Valley to Kathmandu Valley, construction of a water treatment plant and bulk distribution system, together with the rehabilitation and improvement of the secondary and tertiary distribution network. The MWSP also includes a wastewater system improvement component. The first stage of the MWSP will convey 170 MLD, which, in combination with the existing water sources and the Japan International Cooperation Agency (JICA)-financed Manohara Project (20.7 MLD) which will be commissioned in March 2004, will satisfy the water demand of Kathmandu Valley up to 2012.

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6. Over the last two decades, various multilateral and bilateral agencies have attempted to strengthen the performance of NWSC and its predecessors through a sequence of projects that have combined technical assistance (TA), institutional support, and funds for investments. Various studies and reports have examined how far these efforts have improved the performance of NWSC, starting with the Pokharel Commission Report in 1987 and culminating with the implementation completion report for the World Bank Urban Water Supply and Sanitation Rehabilitation Project produced in 2000.1 These studies have identified a variety of factors that explain the poor performance of NWSC, and they have emphasized the problems caused by frequent and inconsistent political interference in the management of the utility. For example, the World Bank report points out that NWSC had seven general managers or executive chairpersons during the period of project implementation from October 1992 to March 1999. There were also seven different chairpersons of the board of NWSC during this period. Such frequent changes in key personnel have undermined the capacity of NWSC to develop and implement programs designed to improve its efficiency and quality of service.

7. Management problems have affected many aspects of NWSC’s services and internal operations. For example:

(i) The water supply system is not only handicapped by poor management of the distribution system and insufficient water resources; the existing treatment facilities are also poorly managed and the distribution system itself has been expanded beyond its ability to supply water. The distribution system comprises a multitude of small diameter pipelines often laid in parallel along the same streets. In some locations, up to 6 pipelines follow the same route;

(ii) Unaccounted-for water, which cannot be accurately measured due to the absence of 24-hour supply and nonfunctioning meters, is estimated at 30–40% of production. Despite substantial investment and support, NWSC has not sustained its programs to detect and fix leaks and prevent other technical losses;

(iii) NWSC computerized its billing records in one of nine branches in Kathmandu Valley in 2002 and expects to computerize two more branches in 2003–2004. However, the majority of billing and all accounting of expenditures still rely on manual ledgers. As a consequence, the company seems to be unable to produce proper management accounts for the whole company or each region; and

(iv) NWSC has been criticized as operating too much as a project execution/procurement agency and clearly has not been able to develop the skills and corporate culture required for utility management. Even then, the eventual disbursement of the World Bank Rehabilitation Project amounted to less than one third of the original project amount and only 60% of the reduced project amount after the midterm review.

8. While many of NWSC’s problems are linked to poor management and incentives, equally important external factors have affected its performance. The critical one has been the reluctance of the Government to adopt and implement a consistent tariff policy. NWSC has stumbled from one financial crisis to another with tariff increases that are too small and too late. As a result, the company has had problems in finding the financial resources to provide counterpart funding for projects or to manage a proper program of network maintenance, replacement, and extension. A large proportion of investments in increasing the coverage of water distribution and sewage collection in Kathmandu Valley over the last 10 years has been 1 See S. Shreshtra. 2001. Water Supply and Sewerage Service Situation in Kathmandu: A Review of Two Reports .

Water Nepal, Vol. 8, No. 12, pp. 105–120.

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funded by customers or municipalities. As a consequence, NWSC has been unable to maintain the technical integrity of its networks.

9. Funding agencies have worsened the tariff problem by failing to pursue consistent policies on the conditions of their assistance. Tariff increases were required as conditions of appraisal and effectiveness for the World Bank Rehabilitation Project, but these conditions were either waived or delayed, and NWSC failed to comply with several loan covenants concerning its financial performance. Since the end of the World Bank project, there has been one significant tariff increase in February 2002 but the financial condition of NWSC is dire and the company is barely able to cover its operating costs. These financial problems are exacerbated by the lack of management accounting information and dubious accounting practices.

10. In summary, NWSC is seen in many quarters as an underperforming utility. It is unable to provide even the most basic services to many of its customers in Kathmandu Valley, who are understandably reluctant to pay more for what they do not receive. Remedying this situation will require an extended period of effort to improve operational performance and the quality of service. At the same time, a significant increase in tariffs is unavoidable simply in order to cover the immediate costs of operating and improving services.

B. Issues and Opportunities

11. The ongoing implementation of water resource development and water supply projects, notably the JICA-financed Manohara Project and the multi agency-financed MWSP, have drawn attention to the great need to improve the level of utility management if maximum benefit is to be gained from these substantial investments.

12. The inability of NWSC to adequately manage the existing water supply and wastewater systems has led to a clear consensus among the MWSP development partners and relevant government agencies that institutional reforms—in particular the introduction of the private sector participation (PSP) modality for managing and improving water supply and wastewater services—are essential to water services sector development. Clearly defined policy and institutional reforms, improved governance, PSP, establishment of a regulatory mechanism, cost recovery and sustainability, affordable service delivery for the poor, and optimization of the limited water resources must be addressed to ensure success of the ongoing investment projects.

13. Various options for PSP in the provision of water services in the metropolitan/urban areas of Kathmandu Valley were examined first by the World Bank and then by the Asian Development Bank (ADB) over the period 1998–2002.

(i) Full privatization or a concession contract for 20-plus years would be extremely risky for any potential investor/operator. Therefore, it would be necessary to provide very large incentives to induce firms to bid. Further, there is large public resistance to the notion of privatizing basic services such as water supply and wastewater.

(ii) The World Bank attempted to implement a type of affermage or lease arrangement—called a management-lease contract—under which the network assets were to be managed by a private operator. This operator would have been required to make limited investments in improving the network but it would not have borne the full revenue and investment risks associated with a concession. Two separate efforts to implement this arrangement had to be

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cancelled because too few firms with appropriate experience were willing to prequalify. The lesson learned from these unsuccessful efforts was that potential bidders regarded the risks of operating water services in Kathmandu Valley as too high relative to the investment of effort and funds required.

(iii) Since there is a clear reluctance among potential private parties to invest in the Kathmandu Valley system, it seems that some form of performance-based management contract is the only realistic form of PSP that can be adopted in the current circumstances. This conclusion is consistent with experience in other cities around the world where the existing system suffers from serious problems of management and operations. Such a management contract involves the recruitment of an experienced operator, hereafter termed a management contractor (MC), to provide a management team backed up by corporate technical support to improve the utility’s performance. The remuneration of the MC would be based on a combination of a fixed base fee and additional rewards/bonuses for either achieving or exceeding specific performance targets. There is some experience with management contracts in Nepal, but these have been on a fixed-fee basis and they have been designed for relatively short interventions. It is desirable to incorporate stronger performance rewards in a longer contract to ensure that the incentives for the utility and the MC are properly aligned.

14. As a result of past experience and this assessment of the options for PSP, ADB concluded that a performance-based management contract would be the most appropriate form of PSP for the metropolitan/urban areas of Kathmandu Valley. Since one of the goals of introducing an MC is to ensure that the distribution network in Kathmandu Valley is improved so that the water produced by the Manohara Project and the MWSP can be properly used, it is important that the provisions of the management contract should be consistent with the timetable and goals of these projects.

15. Following a period of in-depth consideration and consultation, and with previous experiences very much in mind, the proposal for PSP modality by using a management contract has been developed further. This essentially involves the appointment of an MC for the operation and management of the water supply and wastewater services in the metropolitan/urban areas of Kathmandu Valley for a predefined period of time. An experienced international operator (consultant) will be recruited via international competitive recruitment and will be retained on the basis of a performance-based management contract. The level of risk, both for the Government and the selected MC will be significantly lower than under the previously considered World Bank-financed privatization scheme.

16. Other than the operation and management of the services, a very clear objective of the PSP modality and the appointment of the MC is to achieve extensive technology transfer and to develop the long-term capability of Nepalese managers and engineers to run the water and wastewater services either under public or local private management. The MC will assign a small team of international experts to work closely with local utility staff with the aim of easing the current water crisis. The MC team will initially comprise about 5 staff but will fall to 2 to 3 as the management contract proceeds.

17. A key component of the Program is the reduction of the number of staff working in the Water Utility Operator (WUO) with a view to streamlining operations, increasing organizational efficiency, and improving financial performance. NWSC currently has 2,100 positions, out of which 1,300 are in the Kathmandu Valley operations or in overall corporate management and

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administration. The hierarchical breakdown of employees is senior management (2%), middle management (6%), support staff (47%), and unskilled and semiskilled labor (45%). Studies commissioned by the Private Sector Participation High-Level Committee, in charge of the recruitment of the private operator under the earlier World Bank assistance, estimated surplus staff at around 500 under the previous management-lease contract model. The studies also made recommendations on functional transfer of operational support activities and a new branch structure for the utility.2

18. MC recruitment is now an essential element of the MWSP and, indeed, is an agreed condition for the award of tunneling civil work contracts under both the ADB project and the Norwegian Agency for Development Cooperation/Swedish International Development Cooperation Agency project for the Melamchi diversion scheme. As the award of these contracts is now expected in 2005, MC recruitment is critical for the entire MWSP. Therefore, MC recruitment must be started as a matter of urgency if the current overall implementation schedule of the MWSP is to be maintained.

19. The Kathmandu Valley Water Management Support Project (TA 4096-NEP) was approved in April 2003 by ADB to provide support for the implementation of the Program, in particular the recruitment of the MC and a number of associated institutional reforms. Several individual (bridging) TA consultants have already been engaged under the TA, and the main TA consultant team mobilized in mid-September 2003. This team will assist the Government until the completion of the institutional reforms and successful recruitment of the MC in accordance with its terms of reference that is presented in Appendix 17. The Program has been formulated based on, among other things, the reports prepared by these individual consultants as well as by the special assistance for project implementation-2 consultant team of the Japan Bank for International Cooperation (JBIC), under the overall framework of the MWSP, which already included this Program conceptually as one of its integral components.

20. The proposed Program is highly relevant to ADB’s country strategy and program for Nepal to achieve sustainable poverty reduction through building effective institutions for basic service delivery. In the water and wastewater sector, ADB policy advocates the adoption of an integrated river basin management approach, improvement in access to quality water services, and the introduction of regulatory control and partnerships with the private sector for development, all of which are present in the Program. Similarly, the Program is relevant to Nepal’s development objectives as defined in the Government’s 10th 5-Year Plan and sets out as a prime objective the long-term goal of supplying a minimum level of drinking water services to the entire population of Nepal with increases in the level of service over the years. Further relevant objectives of the plan include the provision of appropriate wastewater services, reduction of water-borne diseases, and the removal of the burden of water fetching primarily assumed by women and children.

III. THE PROPOSED SECTOR DEVELOPMENT PROGRAM

A. Objectives and Scope

21. The Program aims to establish an appropriate institutional framework and operational environment that will facilitate the provision of efficient and affordable water supply and wastewater services in the metropolitan/urban areas of Kathmandu Valley. To achieve this objective, the Program will support necessary institutional reforms, including the restructuring of

2 The financing offered by the World Bank for this restructuring plan was subsequently withdrawn and the plan did

not materialize.

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NWSC, and the establishment of three key entities, i.e., the Water Authority (WA) and the WUO for Kathmandu Valley, and the National Water Supply Regulatory Board (NWSRB). The Program will introduce the PSP modality for managing water supply and wastewater service delivery through a performance-based management contract. The program framework is presented in Appendix 1 and the development policy letter is in Appendix 2.

22. The lending will be a sector development program (SDP) loan in the total amount of $15 million, and will consist of: (i) a program loan part (the program loan) of $5 million to finance the initial operating costs for the proposed WA and WUO for Kathmandu Valley, and the NWSRB, and subsequent rightsizing of the newly formed WUO by utilizing NWSC’s existing voluntary retirement scheme (VRS) procedures; and (ii) a project loan part (the project loan) of $10 million to finance the management contract, consulting services for the three key entities to be established under the Program—the WA, WUO, and NWSRB—and the completion of computerizing the billing and accounting systems currently in progress under NWSC.

B. The Program Loan

1. Objectives

23. The objective of the program loan is to support the water services sector institutional reforms by establishing the three key entities to ensure a professional and commercially driven operational environment for the WUO under a performance-based management contract and by rightsizing the staff of the WUO to facilitate efficient management and operations. The policy matrix for the program loan is presented in Appendix 3. These reforms are essential for the provision of efficient and affordable water supply and wastewater services in Kathmandu Valley. The scope of the Program includes: (i) restructuring of NWSC and establishment of the WA to hold assets for water supply and wastewater services; determine policies and license/contract awards; and monitor licenses/contracts for the operation of water supply and wastewater services in Kathmandu Valley; and (ii) establishment of the WUO to operate the water supply and wastewater services in Kathmandu Valley, under a license granted by the WA; and the rightsizing of the WUO.

2. Components and Outputs

24. Implementation milestones for the program loan are identified in the policy matrix (Appendix 3). The two key components of the program loan are the financing of the initial operating costs for the proposed WA and WUO for Kathmandu Valley, and the rightsizing of the newly formed WUO by utilizing existing NWSC VRS procedures supplemented, as appropriate, by additional VRS procedures for all categories of NWSC contract/temporary staff who are not covered under the current NWSC VRS procedures.

3. Important Features—Water Sector Institutional Reforms

25. The water sector institutional reforms included under the program loan will involve the restructuring of NWSC and the establishment of the WA and WUO, together with the establishment of the NWSRB as originally envisaged under the MWSP. The background to the selection of the proposed new institutional arrangement is presented in Appendix 4. The background was extensively discussed and subsequently agreed among ADB and other MWSP external funding agencies, in particular JBIC and its special assistance for project implementation-2 consultant team.

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a. Water Authority

26. The main functions of the WA will be to:

(i) act as the asset owner of the water supply and wastewater systems in the metropolitan/urban areas of Kathmandu Valley. In due course, the infrastructure developed under MWSP will be transferred to the WA as well. As the asset owner, the WA will be responsible for ensuring the development of the additional infrastructure required for the expansion of the water supply and wastewater systems in the future. Major projects to develop infrastructure for additional interbasin raw water transfer schemes will also be the responsibilities of the WA, and may be delegated to a body established specifically for that purpose;

(ii) award and monitor a license for the operation and management of the water supply and wastewater systems serving the metropolitan/urban areas of Kathmandu Valley; and to award and monitor contract(s) for the operation and maintenance of the interbasin raw water transfer scheme infrastructure constructed under MWSP and any subsequent projects;

(iii) develop and oversee the implementation of policies for water supply and wastewater services in Kathmandu Valley; and

(iv) identify the need and obtain funding for future development of the water supply and wastewater systems.

27. The WA will be governed by a board, with a chairperson appointed by the Government, and will include representatives of: the Government, five municipalities in Kathmandu Valley, three district development committees (DDCs) in Kathmandu Valley, professional associations and the business community, and civil society.

28. The WA will have a small secretariat that will primarily focus on policy issues, financial management of the authority’s assets and liabilities, and monitoring the performance of the WUO. It will appoint independent technical auditors to audit the technical and service performance of the WUO. It will be required to publish and make available to the public an annual report covering the performance of the water supply and wastewater systems, future investment plans, and major policy issues.

29. The assets and liabilities of NWSC relating to the water supply and wastewater systems in the metropolitan/urban areas in Kathmandu Valley will be transferred to the WA. The Government will allocate a proper portion of existing debts owed by NWSC to the WA. The provisions of the operation and management license awarded by the WA to the WUO will include regular license fees to be made by the WUO to the WA that will cover the costs of (i) interest on outstanding debts linked to the assets of the water supply and wastewater systems transferred to the WA, (ii) depreciation of these assets, and (iii) a part of the administrative costs of the WA. The WA will be required to maintain separate accounts for its administrative activities as an asset owner. After meeting the costs of debt service, the WA will use any surplus funds to finance investments in the water supply and wastewater systems in Kathmandu Valley.

30. The establishment of the WA as the asset owner of the water supply and wastewater systems in Kathmandu Valley will be carried out by enactment of a new act. This will also require the existing Nepal Water Supply Corporation Act (NWSC Act) to be amended for NWSC

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to look after the out-of-valley towns only. This will mean that NWSC will remain as the out-of-valley water authority-cum-water utility operator.

b. Water Utility Operator

31. The responsibilities of the WUO will be to operate and manage the water supply and wastewater systems in Kathmandu Valley transferred from NWSC and from the municipalities in the case of combined storm-water drains-cum-sewers, plus any further extensions to these systems. It will be responsible for all financial and technical aspects of the operation and management of water supply and wastewater services in Kathmandu Valley, including the collection of tariffs, employment of staff, and dealing with customer complaints.

32. The powers and obligations of the WUO will be defined by the terms and provisions of the operating license awarded by the WA. This license will include a provision to submit trimesterly (once every four months) reports to the WA on specific indicators of the performance of the water supply and wastewater systems. The WUO will also execute a program of investment for the improvement and/or extension of the existing water supply and wastewater systems that is authorized by the WA, subject to the provisions concerning procurement procedures as stipulated in its legal framework. Each year, the WUO will prepare a rolling 5-year plan for the future investment requirements of the water supply and wastewater systems. This will be submitted to the WA for its approval and for the allocation of the necessary financial resources. As required by the WA, it will also help prepare technical plans and other project documents necessary for the future investment requirements.

33. The WUO will not own the assets of the water supply and wastewater systems, but it will be responsible for maintaining these assets and for executing investment programs to improve and/or extend the systems as agreed with the WA. The WUO will be established with initial assets in the form of office equipment, inventories, and receivables from Kathmandu Valley customers transferred from NWSC, plus a subsidiary loan provided by the Government by drawing upon the proceeds of the program loan to finance required working capital.

34. The WUO will be established as a limited liability company under the provisions of the Companies Act 2053. The shareholders in the company will include the Government, municipalities within Kathmandu Valley, representatives of civil society, and a trust representing the interests of employees. The Government will have an initial shareholding of less than 30% of the voting shares but will, in addition, hold nonvoting shares reflecting the remaining value of the assets transferred from NWSC to the WUO. Provision will be made for converting these nonvoting shares into voting shares after the expiry of the management contract. This will allow the Government to choose from various options for the delivery of water supply and wastewater services in Kathmandu Valley by making appropriate use of its voting shares.

35. The objective of the company will be to undertake the delivery of water and wastewater services in Kathmandu Valley in accordance with a high level of commercial and professional discipline. There will be no political/ex officio representation on the board of the WUO and the articles of association and shareholders' agreement will specify that directors of the board are to be selected on the basis of specified professional and technical qualifications and experience.

36. The board will include four to six nonexecutive directors appointed for fixed terms of 4 years, which can be renewed once or twice only, selected in accordance with a procedure and criteria defined in the articles of association and shareholders' agreement. Each nonexecutive director will be paid an honorarium plus fee for attending board meetings. The directors will select one of themselves to act as chairperson of the board.

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37. The WUO will appoint an MC to manage all of its operations for an initial period of 4 years, which will be extended, upon satisfactory performance, by an additional period of about 2 years. The end of the extension period will approximate to 1 year after the commissioning of the MWSP. The relationship between the board of the WUO and the MC has not been finalized because it depends upon legal provisions concerning the role of directors under the Companies Act 2053 which are under review. The primary responsibility of the nonexecutive directors will be to supervise, via a small contract compliance unit, the performance of the MC and its compliance with the provisions of the management contract. The contract compliance unit will be supported, as necessary, by advisory consulting services funded under the project loan, in particular for supervising the MC. The WUO board will have the power to approve or disapprove certain types of strategic decisions that will have to be made by the WUO. These will include the rolling 5-year investment plans that must be submitted by the WUO to the WA.

38. The WUO will prepare an annual budget in accordance with the provisions of its operating license as the basis for the submission of a proposal to the NWSRB for the adjustment of tariffs. The terms of the license may specify the permitted tariff adjustments in the early years of the license, in which case the role of the NWSRB will be to check that the tariffs proposed by the WUO comply with the provisions of the license.

39. The WUO will make a regular payment to the WA as defined in its operating license. In addition, it will pay a regulatory charge to cover the costs of the NWSRB. The MC will be rewarded by a combination of a fixed fee—established at the beginning of the contract in accordance with its proposal—plus a performance-based bonus calculated according to a preidentified formula using a limited number of key performance indicators, which will be as simple as possible, such as water production, revenues of the WUO, and the quality of service enjoyed by customers as measured by the proportion of households receiving water on a regular schedule.

40. The assessment of the performance of the WUO will be carried out by an independent technical auditor whose findings will be binding on both parties to the management contract. The findings will also be shared with the NWSRB.

41. The articles of association and shareholders’ agreement of the WUO will place restrictions on the power to pay out dividends. The level of profits will be closely monitored by the NWSRB.

c. National Water Supply Regulatory Board

42. The NWSRB will carry out proper regulatory functions to protect the public/consumer interests. The function of the NWSRB may be limited to economic regulation—similar to the function of the Electricity Tariff Fixation Commission—focusing on review of tariff adjustment proposals. The TA consultant team, which will assist the Government until the completion of the institutional reforms and successful recruitment of the MC, will establish the detailed functions and structure of the NWSRB. After the demobilization of the TA consultant team, advisory consulting services will be available for implementation assistance funded under the project loan during the implementation period. The NWSRB may be a small entity—only a few board members and small secretariat—with mostly seasonal activities, usually once a year. The NWSRB will also handle customer complaints that cannot be resolved between customers and the WUO. The findings of the performance assessment of the WUO to be carried out by an independent technical auditor will be shared with the NWSRB. Also, the NWSRB will use the findings of periodic monitoring/performance benchmarking of the water supply and wastewater service delivery under the new institutional framework to be carried out by qualified civil society

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groups/nongovernment organizations (NGOs) as a part of the implementation assistance funded under the project loan.

d. Rightsizing of the Water Utility Operator

43. One of the primary components of the program loan is assistance in the rightsizing of the WUO. All NWSC staff, including all categories of contract/temporary staff, currently working on Kathmandu Valley water supply and wastewater services will initially be seconded to the WUO for a probation period of 1 year prior to becoming its full-time employees. Those staff who do not become full-time employees of the WUO will return to NWSC either during or at the end of the probation period and will, subject to NWSC’s decision, be eligible for the VRS or reassigned within NWSC. Alternatively, those staff who already qualify for the VRS at the time of secondment to the WUO may elect for early retirement at that time.

44. Rightsizing will be carried out under the existing NWSC Act, in particular NWSC Employees’ By-Laws, which cover procedures for retrenchment and collective dispute resolution relating to rightsizing, and the operational procedures of ADB with respect to monetary VRS packages and nonmonetary assistance. Appropriate grievance procedures will be developed. The program loan will also finance nonmonetary assistance, such as skills training, business advisory services, and identification of new jobs. The TA consultant team will help the Government evaluate the past/existing VRSs adopted in Nepal, and design an appropriate package for the program loan.

45. The TA consultant team will draw on the work of the Private Sector Participation High-Level Committee on NWSC rightsizing and will recommend an operational structure, estimate updated staff redundancies, and prepare a rightsizing plan. The design of the rightsizing plan for the WUO will be in line with the past/existing VRSs of similar government entities and will be carried out in a participatory and consultative manner with representatives of all relevant stakeholders, including employees of NWSC.

4. Financing Plan

46. ADB will provide a program loan of Special Drawing Rights (SDR) 3,473,000 ($5 million equivalent) from its Special Funds resources to support the Government’s water sector institutional reforms, including NWSC restructuring and the initial operating costs (e.g., staff salaries) of the WA and the WUO during the first year of their operations, together with the subsequent rightsizing of the WUO. The program loan will have a 24-year term, including a grace period of 8 years, with an interest of 1% per annum during the grace period and 1.5% per annum thereafter and such other terms and conditions set forth in the draft Loan and Program Agreements. The Government will provide $0.2 million to the WA in an equal mix of subloan and grant, and $4.8 million to the WUO in an equal mix of subloan and grant. The subloans will be rupee denominated and their terms and conditions will be defined in subsidiary loan agreements, in form and substance, acceptable to ADB. The subloans will have an interest of 9% per annum with a repayment period of 30 years, including a grace period of 5 years. Interest during the grace period will be capitalized. The Borrower is the Kingdom of Nepal. The Government will bear the foreign exchange risk.

5. Implementation Arrangements

a. Program Management

47. MPPW will be the Executing Agency (EA) for the program loan. Until the establishment of the WA and the WUO, the EA will discharge its duties through MWSDB as an implementing

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agency (IA) with the Kathmandu Valley Water Supply Management Support Committee (KVWSMSC) the project coordination office in charge of overall management and coordination for the program loan. KVWSMSC will facilitate the required actions for the institutional reforms with government agencies concerned, and will carry out the recruitment of the MC on behalf of MWSDB/MPPW. During this initial period, the executive secretary of the KVWSMSC will report all program-related issues and activities to the secretary of MPPW through MWSDB. Upon their establishment, the WA and the WUO will assume the responsibilities of IAs and will continue as IAs until the end of program loan implementation. NWSC will closely collaborate with the WUO for the implementation of NWSC's VRS.

48. The organizational arrangements for the implementation of the Program are presented in Appendix 5 and the implementation schedule is included as Appendix 6.

b. Period of Implementation

49. The implementation period of the program loan is 15 months, to be completed by June 2005.

c. Procurement and Disbursement

50. The proceeds of the loan will be utilized to finance the full foreign exchange costs (excluding local taxes and duties) of items produced in and procured from ADB member countries. In accordance with the simplified disbursement procedures and related requirements for program loans (ADB Policy Document R50-98), goods and services produced and originating in ADB member countries will be procured, with due consideration to economy and efficiency, in accordance with standard public sector procedures in Nepal that have been found to be acceptable to ADB, and normal private sector commercial practices acceptable to ADB. Goods commonly traded on the international commodity markets will be procured in accordance with procedures appropriate to the trade, and acceptable to ADB. In accordance with provisions of ADB's Simplification of Disbursement Procedure and Related Requirements for Program Loans, the proceeds of the program loan will be disbursed to the Government as the Borrower. The Government will (i) certify that the value of eligible imports, as defined in the Loan Agreement for the period, is equal to, or greater than, the amount of requested withdrawal under the Loan Agreement; and (ii) certify that the requested withdrawal will be used to finance eligible items procured in accordance with the Loan Agreement. A list of ineligible items is presented in Appendix 7.

d. Counterpart Funds

51. The Government will ensure that the counterpart funds in local currency generated from the program loan proceeds are made available to meet the costs associated with implementation of the program loan, in particular: (i) the payment of all dues to staff of NWSC relating to or following from retrenchment, whether as a result of statutory provisions or otherwise, including, but not limited to, wages in arrears and other benefits such as pension contributions as well as severance benefits; and (ii) payments of other liabilities of NWSC.

e. Monitoring and Tranching

52. The program loan will be released over a 9-month period in two tranches of an equal amount to meet the expected occurrence of associated costs. The first tranche of SDR1,736,000 ($2.5 million equivalent) will be released approximately 4 months after program loan effectiveness, and the second tranche of SDR1,737,000 ($2.5 million equivalent) will be

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released approximately 5 months after the release of the first tranche, subject to compliance with the conditions for their release.

53. Monitorable and time-bound actions are reflected in the policy matrix. Both the Government and ADB will regularly and closely monitor program loan implementation.

f. Accounting, Auditing, and Reporting

54. An audit of the use of the loan proceeds will be undertaken if requested by ADB, and ADB retains the right to (i) examine any documents relating to the Program, and (ii) verify the validity of the certification issued by the Government for each withdrawal application.

g. Program Performance Monitoring and Evaluation

55. The Government and ADB will jointly monitor and review the progress of the fund release conditions as specified in the policy matrix (Appendix 3) to ensure that they are met in substance and on schedule.

C. The Project Loan

1. Objectives

56. The aim of the Project is to improve, on a sustainable basis, the operation of the water supply and wastewater services within the metropolitan/urban areas of Kathmandu Valley. The objective of the project loan is to support the water sector institutional reforms by introducing the PSP modality for the management of water supply and wastewater service delivery in Kathmandu Valley via a performance-based management contract. There is a broad-based consensus among the MWSP development partners and relevant government agencies that the introduction of this approach can substantially improve the operation of water supply and wastewater services in Kathmandu Valley on a sustainable basis.

2. Components and Outputs

57. The key components of the project loan are: (i) the performance-based management contract; (ii) implementation assistance (advisory consulting services for the WA, WUO, and NWSRB and civil society/NGO monitoring); and (iii) the completion of the process of computerizing the billing and accounting systems for branches in Kathmandu Valley, which NWSC has already started. The bulk of the project loan will finance the base fee payments under the management contract for the 4-year initial contract term plus the extension period, while the Government will primarily cover the performance-based bonus payments through the WUO by means of improved tariff revenues through, e.g., better collections, higher volumes of water sold, and higher tariff rates. Indicative contract packaging is proposed in Appendix 8.

a. Management Contract

58. The introduction of the PSP modality in the operation of water supply and wastewater services through a performance-based management contract is fundamental to the Program. In line with this approach, the operation of the water and wastewater services in the metropolitan/urban areas currently served by NWSC will be reassigned to a new company established as the WUO under an operating license awarded by the WA. An MC will be recruited via international competitive recruitment to manage the WUO. The MC will be responsible for managing the operation and management of the water supply and wastewater services, and the execution of investment programs to improve the distribution networks in Kathmandu Valley. More specifically, the tasks of the MC will include:

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(i) improving the long-term performance and efficiency, and expanding the coverage, of water supply and wastewater services;

(ii) improving services to the poor through a targeted program of connections and service improvements in low-income communities;

(iii) improving the operation and management of the water and wastewater systems through mechanisms such as more efficient revenue collection, implementation of computerized billing and accounting, management information systems, improved customer service, occupational safety and maintenance practices, and reduced leakage;

(iv) assisting and advising the WUO’s board of directors in relation to strategic planning, budget preparation, and tariff setting;

(v) improving the effectiveness of the WUO’s human resources through a coordinated capacity-building program;

(vi) managing, in collaboration with the WA and others, the implementation of an investment program to improve the water distribution network, including bulk water metering, properly sequenced network rehabilitation, and renewal of connections; and

(vii) coordinating the distribution network improvement investment programs associated with the construction of the Melamchi diversion scheme and water treatment plant undertaken by others.

59. In addition to improving the performance and quality of water and wastewater services, an important objective of the management contract is to change the culture and operating practices of the utility in a manner that will permit local managers and engineers to continue to operate these services in an effective manner after the end of the contract. The MC will assign a small team of experienced international and domestic staff to work with the staff of WUO with the goal of improving the quality of services provided for customers in Kathmandu Valley. It is expected that the management team of the MC will initially consist of at least 3 full-time international experts with additional experts and other specialist support being provided by the MC as required. The number of full-time international staff will be gradually reduced during the course of the management contract.

60. The management contract will be signed no later than early December 2004 and the MC will commence its duties after a 1-month mobilization period. The contract will be for an initial period of 4 years, which will be extended, upon satisfactory performance, by an additional period of about 2 years. The end of the extension period will approximate to 1 year after the commissioning of the MWSP in order to provide operational stability during this critical period. MWSDB currently projects commissioning in mid-2009.

61. While the MC will be primarily concerned with the overall operation and management of the water supply and wastewater systems, its duties will also include the implementation of a demonstration scheme, the basic concept of which is to show how well a water supply system can be run when a capable and experienced management unit is put in place. This relates not only to the quantity and quality of water supplied but also to the improved efficiency in meter reading, system maintenance, and response to customer requests/complaints. With regard to the actual supply of water, the targets for the demonstration scheme can be summarized as follows:

(i) satisfy the scheme area population’s water demands so that they no longer need to utilize secondary sources;

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(ii) water should be of a potable standard and be esthetically pleasing;

(iii) water should be supplied at an adequate pressure; and

(iv) ideally water should be available on a 24-hour basis, although it should be recognized that even 12 hours supply per day would be a significant improvement over the current situation. A key related aim is to keep the supply system full of water and under pressure so as to avoid both contamination and excessive air entrainment.

62. Such a supply system would make filtering and boiling of water unnecessary and would improve the health of the public. Through previous studies, it has already been proven that the willingness to pay (WTP) for improved piped water supply services is very high. However, the sudden introduction of a demonstration scheme that has a significantly higher level of service may not be socially acceptable because it may create the impression that an improvement in service in one neighborhood is at the expense of the level of service in other neighborhoods, and may undermine the acceptability of the MC. In order to address this issue, the demonstration scheme will be initiated only after a base-level service (e.g., 2–4 hours supply every day on a regular schedule) has been achieved for the majority of the service area. Also, a differentiated tariff schedule will be proposed under which customers who receive a reliable and improved level of service will be charged a higher tariff. The demonstration scheme should be introduced gradually starting from a relatively small area and then expanded on a regular basis as the benefits of better management and operational performance are realized. The required design work for the demonstration scheme is to be carried out under the MWSP in parallel with the recruitment of the MC. The actual physical works will be tendered and implemented by the MC following the commencement of its services in January 2005. Further details of the demonstration scheme are presented in Appendix 9. Outline terms of reference for the MC is presented in Appendix 10.

b. Implementation Assistance (Advisory Consulting Services and Civil Society/NGO Monitoring)

63. The WA and NWSRB will be established by 15 July 2004 and the WUO by 1 October 2004. The TA consultant team and temporary staff will work with the new institutions in order to facilitate a smooth transition from the NWSC management to the WA and WUO management. Also, advisory consultants, including representation on legal issues related to the management contract, will be recruited under the project loan as needed throughout the project loan implementation period. In addition, periodic monitoring/performance benchmarking of the water supply and wastewater service delivery under the new institutional framework as well as evaluation of the effectiveness of the new institutional framework itself will be carried out by qualified civil society groups/NGOs. The findings of the periodic monitoring/performance benchmarking and the institutional effectiveness evaluation will feed into the project performance monitoring and evaluation exercise. Outline terms of reference for the implementation assistance is presented in Appendix 11.

c. Computerization of Billing and Accounting Systems

64. NWSC has begun a program to computerize its billing and accounting systems in its branch offices serving Kathmandu Valley. It will be important for NWSC to continue with this task and complete it for the remaining branch offices before the end of 2004, when its transition to the WA and the WUO is expected. An appropriate allowance for this task has been made under the project loan. In addition, provision has been made for the computerization of the central accounting system. If NWSC cannot complete the task by its transition to the WA and the WUO, the WUO will take over the output of and responsibility for the task, including

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remaining contractual responsibilities, together with other initial assets (in the form of office equipment, inventories, and receivables) and obligations transferred from NWSC.

3. Cost Estimates

65. The total cost of the Project is estimated at $15.0 million equivalent (including taxes and duties of $1.0 million), of which $7.4 million (49.3%) is the foreign exchange cost including $0.39 million in interest during construction/project implementation (Table 1). The local currency cost is $7.6 million equivalent (50.7%). The bulk of the total cost consists of the base fee payments (foreign exchange cost and local currency cost) and the performance-based bonus payments (local currency cost) under the performance-based management contract.

Table 1: Summary of Cost Estimates for the Project Loan ($ million)

Item Foreign

Exchange Local

Currency Total Costs

A. Cost a 1. Management Contract 5.4 5.4 10.8 2. Implementation Assistance 0.3 0.3 0.6 3. Computerization of Billing and Accounting Systems 0.4 0.1 0.5 Subtotal (A) 6.1 5.8 11.9 B. Contingencies 1. Physical b 0.5 0.4 0.9 2. Price c 0.4 0.4 0.8 Subtotal (B) 0.9 0.8 1.7 C. Taxes and Duties 0.0 1.0 1.0 D. Interest During Construction/Project Implementation

0.4 0.0 0.4

Total 7.4 7.6 15.0 % 49.3 50.7 100.0 a In July 2003 prices. b 7.5% for the services. c 2.4% per annum for foreign exchange costs and 5% per annum for local currency costs throughout the implementation period.

Note: Figures may not add up due to rounding. Source: Asian Development Bank estimates.

4. Financing Plan

66. The Government has requested that ADB provide a project loan in the amount of SDR6,945,000 ($10 million equivalent) from its Special Funds resources, representing 66.7% of the total project cost. It is proposed that ADB provide such a loan in the amount of SDR6,945,000 ($10 million equivalent). The loan will have a 32-year term, including a grace period of 8 years, with an interest of 1% per annum during the grace period and 1.5% per annum thereafter and such other terms and conditions set forth in the draft Loan and Project Agreements. It will cover the entire foreign exchange cost of the project loan in the amount of $7.4 million (including interest during construction/project implementation amounting to

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$0.4 million) and 34.2% or $2.6 million equivalent of the local currency cost. Local currency financing of $5.0 million equivalent, or approximately 33.3% of the total project cost, will be provided by the Government and will primarily cover the performance-based bonus part of the cost of the management contract. The proposed financing plan is summarized in Table 2. The Borrower is the Kingdom of Nepal. The foreign exchange risk will be borne by the Government. The Government will provide SDR347,000 ($0.5 million equivalent) to NWSC in an equal mix of subloan and grant, SDR174,000 ($0.25 million equivalent) to the WA in an equal mix of subloan and grant and SDR6,424,000 ($9.25 million equivalent) to the WUO in an equal mix of subloan and grant by using the proceeds of the project loan. The subloans will be rupee denominated and their terms and conditions will be defined in subsidiary loan agreements, in form and substance acceptable to ADB. The subloans will have an interest of 9% per annum with a repayment period of 30 years, including a grace period of 5 years. Interest during the grace period will be capitalized. The Government contribution in local currency will primarily cover the performance-based bonus payments due to the MC, which will be generated by the WUO by means of improved tariff revenues, through, e.g., better collections, higher volumes of water sold, and higher tariff rates.

Table 2: Financing Plan of Project Loan ($ million)

Source Foreign Exchange Local Currency Total % Asian Development Bank 7.4 2.6 10.0 66.7 Government 5.0 5.0 33.3 Total 7.4 7.6 15.0 100.0 Source: Asian Development Bank estimates.

5. Implementation Arrangements

a. Project Management

67. MPPW will be the EA for the project loan. Until the establishment of the WUO, the EA will discharge its duties through MWSDB as an IA, with the KVWSMSC being the project coordination office in charge of overall management and coordination for the project loan. KVWSMSC will facilitate the required actions for the institutional reforms with government agencies concerned, and will carry out the recruitment of the MC on behalf of MWSDB/MPPW. During this initial period, the executive secretary of the KVWSMSC will report all project-related issues and activities to the secretary of MPPW through MWSDB. Also during this initial period, NWSC will be an IA for the computerization of billing and accounting systems. A contract compliance unit that will be established within the board of the WUO will assume the responsibilities of an IA upon the performance-based management contract signing and will continue as an IA with respect to the supervision of the management contract and other subsequent advisory consulting services contracts for the WUO until the end of project loan implementation. For the advisory consulting services for the WA and the NWSRB, MPPW will take over as an IA through the secretariat of the WA.

68. The organizational arrangements for the implementation of the Program are presented in Appendix 5 and the implementation schedule is included as Appendix 6.

b. Period of Implementation

69. The project loan will be implemented over a period of approximately 6 years and 8 months from about April 2004 to 31 December 2010.

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c. Procurement

70. The procurement of all goods and services under the project loan will be undertaken in accordance with ADB’s Guidelines for Procurement. The equipment for the computerized billing and accounting systems required for the WUO will be procured under international shopping procedures. Minor items estimated to cost the equivalent of $100,000 or less per contract may be purchased directly, following proper procedures to ensure economy, efficiency, and quality.

d. Consulting Services

71. For the advisory consulting services for the three key entities, individual international and domestic consultants will be recruited in accordance with ADB's Guidelines on the Use of Consultants. Other arrangements satisfactory to ADB may be used for the engagement of domestic consultants.

72. The proposed performance-based management contract is different from normal consulting service contracts. The MC will be recruited in accordance with ADB's Guidelines on the Use of Consultants using the quality-and-cost-based selection (QCBS) method with some adjustments, which are elaborated in Appendix 10. Consultants will be recruited for the computerization of billing and accounting systems in accordance with ADB's Guidelines on the Use of Consultants using normal QCBS method. Other arrangements satisfactory to ADB may be used for the engagement of domestic consultants for the computerization of billing and accounting systems.

73. Civil society groups/NGOs for the periodic monitoring/performance benchmarking will be recruited by the WA and the WUO in accordance with ADB's Guidelines on the Use of Consultants using the QCBS method based on biodata proposals.

e. Disbursement Arrangements

74. A small contract compliance unit, reporting to the nonexecutive directors of the WUO, will be responsible for preparing disbursement projections for the ADB loan and requesting budgetary allocations for counterpart funds. An imprest account will be established by the Government at Nepal Rastra Bank for the project loan. The imprest account ceiling shall be equivalent to 6 months estimated expenditures or 10% of the total project loan amount, whichever is less. The imprest account will be established, managed, and liquidated in accordance with ADB's Loan Disbursement Handbook and with detailed arrangements agreed by the Government and ADB. The contract compliance unit will coordinate timely release of funds to the MC. The ADB statement of expenditure procedures will be used to liquidate and replenish the imprest account for individual payments not exceeding $50,000.

f. Accounting, Auditing, and Reporting

75. Annual project audits will be conducted in compliance with international audit standards and Nepal’s specific regulations. Project accounts and the corporate accounts of the WA and the WUO will be audited annually or sooner if so required under the relevant acts under which they are to be established. The accounts of the former NWSC will be separated accordingly into those for the WA, WUO, and out-of-valley assets and operations. Also, auditors acceptable to ADB will audit the use of the imprest account and statement of expenditure procedures. A separate audit opinion of these should be included in the annual audit report. Audit reports will be submitted to ADB within 9 months of the end of each fiscal year.

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g. Project Performance Monitoring and Evaluation

76. In accordance with ADB's project performance management system (PPMS) guidelines, a shortlist of verifiable performance indicators for monitoring and evaluation is to be prepared. PPMS activities will be conducted periodically to gather information through multiple sources, including those civil society groups/NGOs which will carry out periodic monitoring/performance benchmarking of the water supply and wastewater service delivery and evaluation of the effectiveness of the new institutional framework, so as to determine whether the inputs for implementing the project loan have rendered expected benefits to the intended beneficiaries. PPMS also seeks to detect any deficiency and discrepancy between the plan and the execution of the project loan in using the resources efficiently so that timely corrections can be made to adjust the design of the project loan. Further details of the PPMS are presented in Appendix 12.

h. Project Review

77. The project loan will be reviewed jointly by MPPW, WA, WUO, and ADB to assess the progress semiannually and at midterm. The midterm review of the Project will concentrate on assessing the performance of the MC and will decide whether the option should be given to the MC to continue. Independent technical and financial auditors will assist MPPW, WA, WUO, and ADB in this assessment exercise. The midterm review will also pay particular attention to the level of skills transfer that has taken place by this time and will assess the likelihood that the WUO will be in a position to operate and manage the water supply and wastewater services in a sustainable manner and without external support by the end of the extended management contract period.

IV. PROGRAM BENEFITS, IMPACTS, AND RISKS

A. Benefits and Impacts

78. The Program is expected to have the following benefits:

(i) Increased consumer surplus, derived from improved water supply and wastewater services, as well as health benefits from improved environmental sanitation and personal hygiene. Earlier studies have provided indications of a high WTP for improved water supply services. Almost 70% of the households presently connected are willing to pay a monthly bill of NRs600 for improved water supply services while almost 50% of the households presently not connected are willing to pay NRs500 per month for similar services, according to a WTP survey carried out in 2001. These figures may be compared with a typical monthly charge for an unmetered NWSC connection of NRs70 at the time the survey was carried out. For the households who are connected to the NWSC system, the median WTP is NRs900 per month for improved water supply services, i.e., at least 50% of the sample is willing to pay more than NRs900 from their monthly income to obtain the improved services. The mean WTP is NRs1,030 per month among connected households. For poor households currently connected to NWSC system, the mean WTP is NRs800.3 The MC will have obligations to improve the availability and efficiency of water supply services, provide the services in a more equitable manner, and improve other relevant aspects of the services. Benefits of providing improved services could

3 The 95% confidence interval is NRs970–1,110 for all (poor and nonpoor) households with a connection. For the

poor households with a connection, the 95% confidence interval is NRs680–910.

19

be valued by using the median WTP multiplied by the total number of households, in order to represent the amount that households are willing to pay for the improvement to the services;

(ii) Improved management efficiency. Existing staff morale is low. The MC could transform the culture of the utility by offering commensurate rewards reflecting performance and quality of service. The long-term impact of a better managed and more financially sustainable utility would be substantial, as opposed to the current situation where the utility is a drain on public sector resources, since current tariffs are insufficient to cover even its operating costs, let alone investment costs; and

(iii) Improvements in the institutional structure, with the establishment of a clearer framework for setting tariffs (based on principles established in the legal framework) and an independent regulatory body in charge of tariff setting. In turn, those institutional improvements could have a ripple effect on institutional management (and a positive impact on sustainable urban development) in Kathmandu Valley and in the country as a whole. (There are few shining examples of successful private sector participation in Nepal and a success story in the water services sector could pave the way for other reforms aiming at introducing private sector participation for efficiency improvements.)

79. The financial principles include the need for cost recovery, primarily from Kathmandu Valley water consumers, demand management by proper pricing, ensuring access to water and its affordability for the urban poor, and facilitating payment of water bills. Financial projection reflects revenue generation improvements from the water tariff, reduction of nonrevenue water, greater collection efficiency, and rightsizing of staff. With enhancement in overall operational efficiency, net income after depreciation and interest starts to emerge from year 2005, and cash surplus is expected by year 2010 onward, which is sufficient to serve the debt service repayments from year 2011. Further details of the economic analysis are presented in Appendix 13 and of the financial analysis in Appendix 14.

80. In environmental terms, the Program is classified as category C. An initial environmental and social assessment of the Program has been carried out to identify any adverse impacts that could arise as a result of its implementation. Measures to prevent or mitigate such detrimental impacts have then been identified. The initial assessment reviewed and examined the scope of the potential environmental, health, safety, and social impacts of program activities and deliverables. The environmental assessment of the Program is included as Appendix 15. Particular consideration will be given to incorporating pro-poor policies and incentives to ensure more equitable distribution of resources and the provision of service levels that meet the needs of the poor and that are affordable. The design of such pro-poor policies will be based on existing information about the poor’s WTP for the services, the identification of the unconnected poor, and consultation exercises.

81. The Project does not involve any construction work directly but is focused on institutional restructuring and improved asset management through a performance-based management contract and start-up consulting services. Initial financing for related physical infrastructure will be provided under the MWSP and other potential funding sources. The Program is an integral component of the overall MWSP. The environmental impact assessment, including the resettlement policy framework and entitlement matrix for the overall MWSP, has been approved by the Government and was reviewed by ADB at the time of the MWSP project appraisal. The Program will not cause any significant environmental impacts if it is carried out in accordance with the applicable rules and regulations of Nepal, and with the findings of the environmental

20

impact assessment. Also, there is no physical investment component under the Program that requires involuntary resettlement. The summary poverty reduction and social strategy for the umbrella MWSP has been included as Appendix 16.

B. Risks

82. The main risks include (i) general political instability and security issues in the country regarding the insurgency; (ii) temporary absence of Parliament and elected municipal government officials; (iii) uncertainty regarding the new decentralized urban service delivery modality under the Local Self-Governance Act; (iv) insufficient interest in the prospective performance-based management contract among potential operators (consultants); and (v) the capacity of the EA and the IAs to implement the Program, in particular with respect to the complexity of the proposed institutional arrangements. However, the Government has unequivocally given its utmost priority to the overall urban water supply sector reform as an essential component of the MWSP, and has continually shown its commitment to reform. Also, the insurgency is likely to have less impact on an urban-based and institutional development-focused project in the capital region like this. Indeed, this Program can proceed, with some modifications, even if the commissioning of the Manohara Project and the MWSP is delayed. Furthermore, there is broad-based support for the reforms among civil society, and a number of potential operators (consultants) have already indicated serious interest in the contract. The proposed ADB intervention under this SDP is therefore justifiable and timely. The EA and the IAs will receive significant assistance from the TA consultant team in respect of the institutional reforms, the recruitment of the MC, and during the transition period between NWSC and the WUO/MC. In addition, the International Monetary Fund's Poverty Reduction and Growth Facility arrangement for Nepal became effective as of 18 November 2003 to support the country's economic reform.

V. ASSURANCES

A. Specific Assurances

83. The Government has given the following specific assurances, in addition to the standard assurances, which have been incorporated in the legal documents:

(i) The Government will ensure that the Program is maintained as a priority of the Government, and allocate and make available, in a timely manner, sufficient counterpart funds from its budget for each fiscal year for the efficient and timely implementation of the Project;

(ii) The Government will ensure that should the management contract be terminated by either WUO or the MC in accordance with the standard termination clauses included in the WUO/MC contract, a replacement MC, acceptable to ADB, is appointed without delay and in accordance with transparent international competitive bidding procedures. The Government will further ensure that appropriate management arrangements are in place until the appointment of the replacement MC to bridge the gap that may arise due to the termination of the management contract;

(iii) The Government will ensure that, at all times, the board of the WUO will act independently and impartially in accordance with the articles of association of the WUO and the shareholders’ agreement entered into among the stakeholders of the WUO. In addition, the Government will ensure that the nonexecutive directors of the WUO will be selected in accordance with the agreed criteria. The articles

21

of association, shareholders’ agreement, and criteria for the selection of nonexecutive directors will be subject to ADB’s prior approval;

(iv) MPPW will, by 1 December 2004, establish a system of financial reporting by the WA and WUO to MPPW, acceptable to ADB;

(v) The Government will continue its overall policy of freezing new recruitments for vacant NWSC positions within Kathmandu Valley. The Government will ensure that the deputation of NWSC staff working in Kathmandu Valley to the WUO will be completed by 1 January 2005. The Government will further ensure that the rightsizing exercise of those WUO staff deputed from NWSC will be completed by 31 December 2006;

(vi) The Government will ensure compliance with the relevant provisions of Water for All: The Water Policy of the Asian Development Bank;

(vii) The Government will take all necessary measures to mitigate the impacts of water tariff increases, including the introduction of a new water tariff schedule, on vulnerable groups;

(viii) The Government will take adequate measures to mitigate the impact of the rightsizing program for the WUO by, among other things, (a) the development of an appropriate assistance package, including a monetary VRS package and nonmonetary assistance such as skills training, business advisory services, and identification of new jobs; and (b) the development of appropriate grievance procedures addressing, among other things, gender-based discrimination;

(ix) The Government will ensure: (a) that the objectives achieved, policies adopted and actions taken, as set forth in the development policy letter, will continue to be in full force and effect for the duration of the Program period and subsequently; (b) proper and timely achievement, adoption, compliance and implementation of the objectives, policies and actions to be achieved, adopted, complied with and implemented as set forth in the development policy letter; and (c) that once achieved, adopted, complied with and implemented, such objectives, policies and actions will continue to be in full force and effect during and subsequent to the Program period;

(x) The Government will acquire and install sound accounting capability to ensure tracking and minimizing corruption in the implementation of the Program;

(xi) The Government will ensure that the objectives, policies and actions set out in the Loan Agreement dated 24 January 2001 entered into between the Government and ADB for the MWSP will: (a) be achieved, adopted, undertaken and implemented in the manner stipulated therein; and (b) continue to be in full force and effect during the implementation of the Program;

(xii) The Government will ensure that no persons will be adversely affected in terms of ADB's Policy on Involuntary Resettlement and ADB's Policy on Indigenous People;

(xiii) The Government will ensure that irrespective of the institutional restructuring to be undertaken under the Program/Project, the resettlement plan for MWSP will remain in full force and effect and binding upon the Government and will be implemented by the Government as originally contemplated and agreed with

22

ADB under the Loan Agreement dated 24 January 2001 between the Government and ADB;

(xiv) The Government will ensure that the Program/Project will be carried out in accordance with ADB's Policy on Gender and Development; and

(xv) The Government will ensure that the Program/Project will be carried out in accordance with the Government's environmental rules and regulations, ADB's Environment Policy, ADB's environmental guidelines as set forth in the Environmental Assessment Guidelines (2003), and the results of the environmental impact assessment for the MWSP.

B. Condition for Program Loan Effectiveness

84. The following condition will apply for program loan effectiveness: NWSC implements a revision of its tariffs for water supply and wastewater services in Kathmandu Valley, which:

(i) increases the average revenue per cubic meter of water billed by at least 15% in nominal terms; and

(ii) has a structure of tariffs with cross-subsidies between classes of consumer limited only to the poorest households.

C. Conditions for Project Loan Effectiveness

85. The following conditions will apply for project loan effectiveness:

(i) The RFP documents for the recruitment of the MC are issued to short-listed companies/consortia acceptable to ADB; and

(ii) The subsidiary loan agreement is signed, in form and substance satisfactory to ADB, between the Government and NWSC. The subloan will have an interest of 9% per annum with a repayment period of 30 years, including a grace period of 5 years. Interest during the grace period will be capitalized.

D. Conditions for Disbursement of Project Loan

86. No withdrawals will be made from the Project loan account until:

(i) (a) the WUO subsidiary loan agreement, in form and substance satisfactory to ADB, has been entered into between the Government and the WUO; and (b) the assumption agreement, pursuant whereto the WUO will assume the rights and obligations of MWSDB and NWSC under the Project Agreement, has been entered into between the WUO and ADB;

(ii) (a) the WA subsidiary loan agreement, in form and substance satisfactory to ADB, has been entered into between the Government and the WA; and (b) the novation agreement, pursuant whereto the WA will be added as a party to the Project Agreement, has been entered into between the WA and ADB; and

(iii) tariffs for water supply and wastewater services in Kathmandu Valley are adjusted in accordance with the provisions of the act establishing the NWSRB that will articulate, among other things, principles and a schedule, acceptable to

23

ADB, for further adjustments of tariffs for water supply and wastewater services in real terms to ensure that the revenues of the WA and the WUO are sufficient to cover debt service, depreciation of fixed assets, and all operation and maintenance costs, including the performance-based bonuses paid to the MC.

VI. RECOMMENDATION

87. I am satisfied that the proposed loans would comply with the Articles of Agreement of ADB and recommend that the Board approve:

(i) the loan in various currencies equivalent to Special Drawing Rights 3,473,000 to the Kingdom of Nepal for the Kathmandu Valley Water Services Sector Development Program from ADB’s Special Funds resources with an interest charge at the rate of 1% per annum during the grace period and 1.5% per annum thereafter; a term of 24 years, including a grace period of 8 years; and such other terms and conditions as are substantially in accordance with those set forth in the draft Loan and Program Agreements presented to the Board; and

(ii) the loan in various currencies equivalent to Special Drawing Rights 6,945,000 to the Kingdom of Nepal for the Kathmandu Valley Water Services Sector Development Project from ADB’s Special Funds resources with an interest charge at the rate of 1% per annum during the grace period and 1.5% per annum thereafter; a term of 32 years, including a grace period of 8 years; and such other terms and conditions as are substantially in accordance with those set forth in the draft Loan and Project Agreements presented to the Board.

Tadao Chino President

25 November 2003

Appendix 1 24

PROGRAM FRAMEWORK

Design Summary Performance Indicators/Targets

Monitoring Mechanisms Assumptions and Risks

Goal Improve health and well-being of Kathmandu Valley urban residents, in particular the poor

Reduced incidence of water-borne diseases of the population by the commissioning date of the MWSP—currently expected in 2009

Government health statistics to be reviewed on an annual basis

Purpose Equitable distribution of program benefits, in particular targeting the poor customers Implement water sector institutional reforms to ensure a professional and commercially driven operational environment on a sustainable basis

Adequate quantity of water supplied (total and for the poor) to make secondary sources no longer needed Number of additional water supply connections (total and for the poor) for expanded service coverage Potable water quality (WHO standards) Adequate supply pressure Adequate and convenient service hours

NWSRB benchmarking key performance indicators to be monitored throughout the program period

Outputs Establishing appropriate institutional framework Establishing NWSRB Establishing WA for Kathmandu Valley Forming and incorporating WUO company WA awards operating license to WUO Government allocates appropriate proportion of existing debts of NWSC to WA WUO and MC sign a performance-based management contract

Act/Ordinance approved by 15 July 2004 (TC1) Act/Ordinance approved by 15 July 2004 (TC1) Registration completed by 1 October 2004 (TC2) License awarded by 1 November 2004 (TC2) Transaction completed by 1 November 2004 (TC2) Contract signed by 1 December 2004 (TC2)

Program Loan TC monitoring MOF MPPW MWSDB KVWSMSC WA WUO NWSRB MC NWSC ADB TA consultant team

Institutional reforms under the Local Self-Governance Act work and the introduction of PSP is not delayed General political instability Temporary absence of Parliament and elected municipal government officials A performance-based management contract will establish incentives for efficient operations Recruitment of MC is successfully completed with sufficient interest among potential operators (consultants)

Appendix 1

25

Design Summary Performance Indicators/Targets

Monitoring Mechanisms Assumptions and Risks

Computerizing billing and accounting systems

Work completed by 31 December 2004

Activities Designing of modalities to be used for pro-poor water supply service delivery and incorporating them as conditions in the prospective RFP and in the subsequent contract with MC Water levy arrangements Engineering design consultant for the proposed demonstration scheme to be engaged. His TOR to be incorporated in the prospective RFP for information purposes Restructuring of NWSC NWSRB starts regulation WA for Kathmandu Valley starts operation WUO for Kathmandu Valley starts operation Handover from NWSC to WA and WUO Initiation of PSP scheme by performance-based management contract Distribution network improvement/expansion and service improvement WUO rightsizing by using voluntary retirement scheme and nonmonetary assistance Management efficiency and staff capacity strengthening by MC

Ongoing till February 2004 Ongoing till December 2004—MC signing From June 2004 for about 6 months November 2004 From November 2004 and ongoing From November 2004 and ongoing From November 2004 and ongoing From November to end-December 2004 From January 2005 and ongoing From April 2005 and continuing throughout the Program From January 2005 for about 2 years From January 2005 and continuing throughout the Program

Trimesterly progress reports of KVWSMSC and, subsequently, WUO/MC Monthly progress reports of TA consultant team MOF MPPW MWSDB KVWSMSC WA WUO NWSRB MC NWSC ADB TA consultant team

Strong political will for institutional reforms for Kathmandu Valley All necessary legislative arrangements are in place Full cooperation of all parties Good working relationship between nongovernment organizations, community-based organizations, and overall civil society, and KVWSMSC and MWSDB Participatory approach is successful Capital investment funding by ADB and other cofinancier(s) are available

Appendix 1 26

Design Summary Performance Indicators/Targets

Monitoring Mechanisms Assumptions and Risks

Inputs Program loan total Project loan total Performance-based management contract Consulting services

$5 million $10 million $9 million (base fees) 10 person-months, international; 43 person-months, domestic

Trimesterly progress reports of KVWSMSC and, subsequently, WUO/MC Monthly progress reports of TA consultant team MPPW MWSDB KVWSMSC WA WUO MC NWSC TA consultant team

Political support with counterpart fund and counterpart staff engagement

ADB = Asian Developm ent Bank, KVWSMSC = Kathmandu Valley Water Supply Management Support Committee, MC = management contractor, MOF = Ministry of Finance, MPPW = Ministry of Physical Planning and Works, MWSDB = Melamchi Water Supply Development Board, MWSP = Melamchi Water Supply Project, NWSC = Nepal Water Supply Corporation, NWSRB = National Water Supply Regulatory Board, PSP = private sector participation, RFP = request for proposals, TC = tranche condition, TOR = terms of reference, WA = Water Authority, WUO = Water Utility Operator.

Appendix 2 27

DEVELOPMENT POLICY LETTER

28 Appendix 2

Appendix 3

29

POLICY MATRIX

Policy Measure Actions and Implementation Arrangements Tranche Condition Number

Implementation Milestone

Institutional Reforms Objective: To support the water services sector institutional reforms by establishing three key entities 1.1 Relevant act for the establishment of the WA and

the NWSRB enacted. The act also to articulate principles and a schedule for further tariff adjustments to ensure financial sustainability of the water supply and wastewater services in urban areas of Nepal, in particular, the metropolitan/urban areas of Kathmandu Valley.

TC1 15 July 2004

1.2 Establishment of the WA and the NWSRB. TC1 15 August 2004 1.3 The WA enters into the WA assumption agreement

with ADB and assumes all relevant rights and obligations of MWSDB.

TC1 15 August 2004

1.4 The WA enters into the WA subsidiary loan agreement with the Government upon terms and conditions acceptable to ADB.

TC1 15 August 2004

1.5 The Government determines and allocates a proper portion, satisfactory to ADB, of existing debts of NWSC to the WA.

TC2 1 November 2004

1.6 The allocation of a proper portion of existing debts of NWSC to the WA to become effective.

TC2 1 January 2005

1.7 The WUO to be formed and incorporated as a limited liability company under the Companies Act 2053, as amended or superseded.

TC2 1 October 2004

1.8 The WUO enters into the WUO assumption agreement with ADB and assumes all relevant rights and obligations of MWSDB.

TC2 1 October 2004

1.9 The WUO enters into the WUO subsidiary loan agreement with the Government upon terms and conditions acceptable to ADB.

TC2 1 October 2004

30

Appendix 3

Policy Measure Actions and Implementation Arrangements Tranche Condition

Number Implementation Milestone

Water Utility Operator Governance Objective: To ensure professional and commercially driven operational environment for the WUO under a performance-based management contract 2.1 The WA approves the leasing of the assets of the

water supply and wastewater systems in Kathmandu Valley to the WUO under an operating license.

TC2 1 November 2004

2.2 The leasing of the WA's assets of the water supply and wastewater systems in Kathmandu Valley to the WUO to become effective.

TC2 1 January 2005

2.3 The WUO signs a performance-based management contract with the MC recruited through transparent international competitive recruitment.

TC2 1 December 2004

2.4 The MC commences implementation of the management contract and becomes fully functional.

TC2 1 January 2005

ADB = Asian Development Bank, MC = management contractor, NWSRB = National Water Supply Regulatory Board, TC = tranche condition, WA = Water Authority, WUO = Water Utility Operator.

Appendix 4

31

ASSESSMENT OF ALTERNATIVE INSTITUTIONAL ARRANGEMENTS

1. For the selection of the proposed new institutional arrangement, the following four primary options have been considered. Inside KV Outside KV Transition Requirements Advantages Disadvantages

Option AO Operator AO Operator 1 WA WUO NWSC NWSC • Create WA by an Act

• WA grants a license to WUO • Amend NWSC Act to limit

responsibilities on out-of-KV towns

• Cleanest and quickest break from previous situation for services in KV

• Reorganization limited to inside KV only • In line with decentralization policies if the

same approach is later adopted for the rest of Nepal

• Limited disruption to NWSC staff • Ties in with UEIP and allows the out-of-

valley urban municipalities to be involved • Allows WA to focus on solving immediate

inside-valley water service problems, while allowing NWSC to concentrate on resolving water issues of out-of-KV towns

• Immediate senior management disruption for inside-KV operations

• Contractual insecurity if ordinance repealed

2 NWSC (WA at later

stage)

WUO NWSC NWSC • License agreement between NWSC and WUO

• Create WA by an Act • Amend NWSC Act to modify its

board representation in the interim

• Initial disruption limited, but the possibility of implementing the change later is uncertain, i.e., it may not happen

• Against the sector reform spirit of the MWSP as it risks maintaining the status quo

• Very difficult to induce the necessary changes in NWSC to introduce an operational and commercial discipline

• High risk of interference by NWSC in WUO affairs, which may hamper the initiative

• Contractual insecurity if ordinance repealed 3 NUWA WUO NUWA Other

local/ regional WUOs

• Create NUWA by an Act • NUWA grants a license to WUO • NUWA licenses assets to other

urban out-of-KV local/ regional WUOs

• None • Contradicts decentralization policies as it creates a national urban water authority with limited involvement of municipalities

• NUWA would be too similar to NWSC • Extensive consultations with the out-of-KV

municipalities required to seek consensus • Contractual insecurity if ordinance repealed

4 NWSC WUO NWSC Other local/

regional WUOs

• NWSC would be stripped of its operational responsibilities (by an ordinance for the inside-KV and under the existing NWSC Act for the out-of-KV towns), and become de facto asset owning entity, delegating the operational functions to WUOs

• None • May not achieve the objective of reforms, i.e., sound sector policy formulation and increased transparency

• Contradicts decentralization policies as it creates a de facto NUWA with limited involvement of municipalities

• Requires reassignment of all NWSC staff immediately

• NWSC does not have the institutional capacity to function as NUWA for KV and out-of-KV towns, while also managing the transition

AO = asset owner, KV = Kathmandu Valley, MWSP = Melamchi Water Supply Project, NUWA = National Urban Water Authority, UEIP = Urban and Environmental Improvement Project, WA = Water Authority for the Kathmandu Valley, WUO = Water Utility Operator for the Kathmandu Valley.

Appendix 4

32

A. Rationale for Option 1

2. The biggest factor in favor of Option 1 is that it will allow the clearest break from the previous situation and will enable the Government to create much improved governance structures for the authority in Kathmandu Valley. Other options would require a much more protracted transition process (either if the Water Authority (WA) is created at a later stage, as in Option 2, or if a National Urban Water Authority (or a de facto National Urban Water Authority) is created, as in Options 3 and 4, which would require consulting with municipalities outside Kathmandu Valley to reach a consensus on the provision of water and sanitation services in their jurisdiction). In addition, it is in line with proposed decentralization policies for the sector, because it leaves open the question of the future arrangements for municipalities outside Kathmandu Valley without prejudging them (as would be done with Options 3 and 4). At a later stage, municipalities may choose to break up from the Nepal Water Supply Corporation (NWSC) to create their own dual water authority/water utility operator institutional framework or merely a water authority. Such process could potentially be supported by the Urban and Environmental Improvement Project (UEIP) loan, in the same way as it would be possible for Options 3 and 4.

B. What Would Option 1 Entail?

3. Option 1 would entail the breakup of NWSC into three main entities:

(i) A WA would be established, to hold the assets for water supply and wastewater services, determine policies, and award and monitor licenses/contracts for the operation of water supply and wastewater services in Kathmandu Valley;

(ii) A Water Utility Operator (WUO) would be in charge of operating water supply and wastewater services in Kathmandu Valley, under the terms of a license granted by the WA;

(iii) NWSC would remain in activity in towns currently under its jurisdiction, at least during an interim period. At a later stage, and according to a timeline to be determined by the municipalities themselves in accordance with the Government, water supply and wastewater services in towns outside the valley could be organized on the basis of a model similar to what is recommended for the valley, i.e., the municipality would act as water authority and owner of the assets, while a utility would be created to manage the services under the delegated authority of the municipality, or municipality runs its own public water authority-cum-water utility operator.

4. In addition, a National Water Supply Regulatory Board will be created to supervise the sector throughout the country. Its main function will be to set tariffs for the provision of water supply and wastewater services on the basis of economic principles. It will also obtain and publish comparable information on the quality of water supply and wastewater services across the country and will act as a secondary recourse mechanism for customer complaints that have not been adequately addressed by the provider of water supply and wastewater services.

Appendix 3

33 A

ppendix 5 33

ORGANIZATIONAL ARRANGEMENTS FOR IMPLEMENTATION

Water Authority (WA)

WA Board of Directors

(Ex officio, political, advocacy)

Representation: - Ministry of Finance (MoF) - Ministry of Physical Planning and Works (MPPW)

- Ministry of Water Resources (MWR)

- Municipalities - District development committees (DDCs)

- professional associations - Business community

- Civil society

Water Utility Operator (WUO)

Operating License

WUO Board of Directors Management Contractor

(MC)

Performance-based

Management Contract

Ownership: - Ministry of Finance (MoF) - Ministry of Physical Planning and Works (MPPW)

- Ministry of Water Resources (MWR)

- Municipalities - District Development Committees (DDCs)

- trust representing interests of employees

- civil society

WUO Board Member Selection Committee

(c/o KVWSMSC)

General Public/Civil Society

Application/Nomination

Nomination

WUO Staff

National Water Supply Regulatory Board

(NWSRB)

Independent Financial and Technical Auditors

Melamchi Water Supply Development Board

(MWSDB)

Nepal Water Supply Corporation (NWSC)

Staff Transfer

Ass

et T

rans

fer

Management Contract Evaluation Committee

(c/o KVWSMSC)

Engineering consultants Civil work contractors Equipment suppliers Service contractors

WA Secretariat

Economic Regulation

Kathmandu Valley Water Supply Management Support

Committee (KVWSMSC)

Small-Scale Service Provider

Operating License

Bulk Water Supply Contract

Licensing/Economic Regulation

Executive Committee

34 A

ppendix 6

IMPLEMENTATION SCHEDULE

Project Component 2003 2004 2005 2006 2007 2008 2009 2010

1 Institutional Reforms Establishing KVWSMSC KVWMSP TA Bridging TA Consultants Main TA Consultant Team 2 Management Contractor Short-listing Proposal/Evaluation/Award Management Contractor 3 Melamchi Diversion Scheme Access Roads & Power Tunnel Construction 4 Water Treatment Plant 5 Dist’n Network Improvement 6 WW System Improvement

KVWMSP = Kathmandu Valley Water Management Support Project, KVWSMSC = Kathmandu Valley Water Supply Management Support Committee, TA = technical assistance, WW = wastewater.

Appendix 7 35

LIST OF INELIGIBLE ITEMS (NEGATIVE LIST)

1. Proceeds of the program loan will finance the foreign currency expenditures for the reasonable cost of imported goods required during the program loan.

2. No withdrawals from the loan account shall be made in respect of the following items:

(i) expenditures for goods included in the following groups or subgroups of the United Nations Standards International Trade Classification, Revision 3, or any successor groups or subgroups under future revisions as shall be designated by the Asian Development Bank (ADB) by notice to the Government:

Group Subgroup Description of Items

112 Alcoholic beverages;

121 Tobacco, unmanufactured; tobacco refuse;

122 Tobacco, manufactured (whether or not containing tobacco substitutes);

525 Radioactive and associated materials;

667 Pearls, precious and semiprecious stones, unworked or worked;

718 718.7 Nuclear reactors, and parts thereof; fuel elements (cartridges), nonirradiated for nuclear reactors;

897 897.3 Jewelry of gold, silver, or platinum-group metals (except watches and watch cases) and goldsmiths’ or silversmiths’ wares (including set gems); or

971 Gold, nonmonetary (excluding gold ore and concentrates).

(ii) expenditures for goods intended for a military or paramilitary purpose or for luxury consumption;

(iii) expenditures for pesticides categorized as extremely hazardous or highly hazardous in Class 1a and 1b, respectively, of the World Health Organization’s Classification of Pesticides by Hazard and Guidelines to Classification;

(iv) expenditures for goods supplied or to be supplied under any contract that a national or international financing institution or any other financial agency has financed or agreed to finance, including any contract financed or to be financed under any loan from ADB; or

(v) payment made for expenditures incurred more than 180 days prior to the loan effective date.

36 Appendix 8

PROPOSED CONTRACT PACKAGING

No.

Description of Works

Package

Recruited by Method Amount ($’000)

1 Management Contract Single contract KVWSMSC/ WUO

ADB guidelines (international)

9,000 (base fee) + bonus

2 Implementation Assistance/ Advisory Consulting Services

Multiple small contracts KVWSMSC/ WA/WUO/ NWSRB

ADB guidelines (international and domestic)

500

3 Computerization (equipment and software)

Single contract NWSC IS 400

4 Computerization (consultancy)

Single Multiple contracts NWSC ADB guidelines (international and domestic)

100

Total 10,000 + bonus

ADB = Asian Development Bank, IS = international shopping, KVWSMSC = Kathmandu Valley Water Supply Management Support Committee, NWSC = Nepal Water Supply Corporation, NWSRB = National Water Supply Regulatory Board, WA = Water Authority, WUO = Water Utility Operator.

Appendix 9 37

DEMONSTRATION SCHEME PLANNING AND BASIC DESIGN

A. Background

1. Over recent years, the level of water supply service provided to the urban population of Kathmandu Valley has been very poor. As a result of the current rationing system operated by the Nepal Water Supply Corporation (NWSC), water is only available on an intermittent basis and even then the pressure is low, the quantity of water small, and the quality poor. The general public hold the NWSC in very low esteem and do not believe that it is working in the best interests of the public.

2. It is common for people to sit up half the night waiting for water to arrive at their house so that they can pump it to their roof-top storage tanks. Residents are obliged to spend money on ground-level water reservoirs, booster pumps, and water filters, and even then all water must be boiled prior to drinking. While the basic cost of piped water in Kathmandu may be cheap, the indirect costs assoc iated with its use are unreasonably high. The majority of people are obliged to look to secondary sources of water such as shallow wells or private tanker supplies just to meet their basic needs. When tanker water costs in the order of NRs100 to NRs150 per 1,000 liters (approximately 10 times that of piped water) it is an expensive option, especially considering that many tanker operators simply collect polluted water from the local streams and rivers. Where tanker supplies are unaffordable, people have no option but to go to the river to bathe or wash their clothes. The expense of not having an adequate supply of potable water is compounded by the inevitable medical bills resulting from the treatment of water-borne diseases (typhoid, cholera, and hepatitis are common) and the loss of income due to sick time.

3. In contrast, some parts of the urban area, noticeably in the northeast, have a better level of service, primarily due to the their proximity to the sources and the difficulty of isolating subzones during the rationing process.

4. There is a desperate need to achieve a more equitable distribution of water throughout the urban area and to restore the public’s faith in the ability of the Government to serve them well. One of the principal aims of the proposed demonstration scheme is to show that a high quality of service can be achieved through the introduction of private sector management and that if people do receive good service, then they are willing to pay a higher charge for it. At the same time more realistic data can be obtained on water demand under “normalized” piped water supply service conditions.

B. Concept and Aims

5. The basic concept of the demonstration scheme is to show how well a water supply system can be run when a capable and experienced management unit is put in place. This relates not only to the quantity and quality of water supplied but also to the improved efficiency in meter reading, system maintenance, and response to customer problems/complaints. With regard to the actual supply of water, the clear targets for the demonstration scheme can be summarized as follows:

(i) satisfy the scheme area population’s water demands so that they no longer need to utilize secondary sources;

(ii) water should be of a potable standard and be aesthetically pleasing;

(iii) water should be supplied at an adequate pressure; and

38 Appendix 9

(iv) ideally water should be available on a 24-hour basis, although it should be recognized that even 12 hours supply per day would be a significant improvement over the current situation. A key related aim is to keep the supply system full of water and under pressure to avoid both contamination and excessive air entrainment.

6. Such a supply system would make filtering and boiling of water unnecessary and would improve the health of the public. Through previous studies, it has already been proven that the willingness to pay for improved piped water supply services is very high. The demonstration scheme should have efficient systems with regard to:

(i) meter reading;

(ii) meter replacement/repair/calibration;

(iii) billing;

(iv) bill collection;

(v) where appropriate, the administration of water supply via public standpipes;

(vi) receiving customer complaints and feedback and responding accordingly;

(vii) installation of new connections;

(viii) water loss monitoring, leak identification and repair;

(ix) the management contractor (MC) being seen as an integral part of the community;

(x) hygiene education programs;

(xi) improved record keeping and data collection, especially water demand figures for the purposes of further scheme design in the rest of Kathmandu Valley;

(xii) improved liaison with other utility service authorities; and

(xiii) financial management including operation and maintenance costs, depreciation of assets, debt financing, and reinvestment of profits in further system improvement.

7. The MC should develop a computer model of each aspect of the water supply system, but especially the demonstration scheme, and train counterpart staff in its use in order that it can become one of the key planning tools for the future. The model should be linked with a geographic information system and include details such as land topography, soil type, pipeline material, customer identification, billing information, and payment records.

C. Timing and Social Issues

8. It is currently anticipated that the Manohara Project will be in operation by March/April 2004, although it is possible that this will be delayed with ongoing land and power supply problems. This date is approximately 9 months before the MC is due to be appointed (December 2004) and as time will be required to prepare for the implementation of the demonstration scheme, the situation may therefore arise whereby it will not be put into practice until at least 1 year after the Manohara Project has been commissioned.

9. There is a distinct negative aspect to this timing in that the water being supplied by the Manohara Water Treatment Plant would already have been absorbed into the management

Appendix 9 39

system for the water distribution network and a new water supply versus water demand equilibrium established. From the social point of view, it may then be difficult to reallocate water to the demonstration scheme, as it will be seen to be having a negative impact on the parts of the urban area not included.

10. The sudden introduction of a demonstration scheme that has a significantly higher level of service may not be socially acceptable and may undermine the authority and acceptability of the MC. In order to address this issue, the demonstration scheme will be initiated only after a base-level service (e.g., 2–4 hours supply every day on a regular schedule) has been achieved for the majority of the service area. Also, a differentiated tariff schedule will be proposed under which customers who receive a reliable and improved level of service will be charged a higher tariff. In order to avoid creating the impression that an improvement in service in one neighborhood is at the expense of the level of service in other neighborhoods, the demonstration scheme should initially be introduced in only half of the area and be extended to include the second half once the benefits of better management and operational performance are realized. The required design work for the demonstration scheme is to be carried out under the Melamchi Water Supply Project in parallel with the recruitment of the MC. The actual physical works will be tendered and implemented by the MC following the commencement of its services in January 2005.

11. It is important that the general level of water supply is improved across Kathmandu Valley in parallel with the implementation of the demonstration scheme and that a threshold level of water supply is reached before the scheme is fully implemented. This objective could be achieved by bringing forward the next phase of the bulk distribution system (BDS)/distribution network improvement (DNI) design/construction program and to prepare the design of an integrated BDS/DNI during the period of MC tender preparation and appointment. The aim would be to develop a distribution system, which would have a more equitable delivery of water than is currently experienced, but which would also be a first phase of the Melamchi Water Supply Project. As suggested in the Japan Bank for International Cooperation special assistance for project implementation report, it would be reasonable to expect overall cost savings to be made in the BDS/DNI compared to the present design. Similarly, consideration should also be given to conducting the detailed design of the new pipelines required within the demonstration scheme in parallel with MC tender preparation and appointment. This approach would have two other benefits: (i) if the operators preparing proposals for the MC contract can see what construction work is about to be undertaken then they will have far greater confidence that they will be able to achieve the required performance targets, and (ii) there would be a saving of at least 1 year as construction work on the system upgrading could commence as soon as the MC has been appointed. The need to introduce the demonstration scheme on a phased basis has been incorporated into the scheme planning and basic design.

D. Planning and Basic Design

1. Water Availability

12. Once the Manohara Water Treatment Plant has been commissioned, it is intended that between 12.2 million liters per day (MLD, in the dry season) and 14.8 MLD (wet season) of the treated water produced will be conveyed to the Min Bhawan reservoir and between 4.8 MLD (dry season) and 5.9 MLD (wet season) will be conveyed to the Bode reservoir. It would not be appropriate to amend this proposed allocation of water produced by the Manohara water treatment plant as:

40 Appendix 9

(i) the timing is such that the water treatment plant might be commissioned at least 1 year ahead of the demonstration scheme by which time the residents of Madhyapur Thimi/Bhaktapur would have already benefited, albeit in a small way, from the increase in water supply. It would not be appropriate, or indeed socially acceptable, to subsequently reduce the volume supplied to this area and return to the current situation;

(ii) land in the Madhyapur Thimi/Bhaktapur area is already being developed in anticipation that water will soon be available. Reallocation of the water at this stage is likely to cause considerable difficulties; and

(iii) the 350 mm diameter transmission main from Manohara water treatment plant to the Min Bhawan reservoir, which will soon be constructed, will not have the capacity to convey the full 20.7 MLD flow.

It is therefore recommended that the demonstration scheme is established on the basis of using a proportion of the currently allocated flow to the Min Bhawan reservoir (12.2 MLD in the dry season and 14.8 MLD in the wet season).

2. Demonstration Scheme Location

13. In examining possible locations for a demonstration scheme, four key factors have been taken into consideration:

(i) continuity of water supply to the service reservoir;

(ii) the ease with which the supply zone can be isolated from the rest of the Kathmandu water distribution system;

(iii) the need for a variety of customer types as this will ensure that a comprehensive tariff system can be tested based on broad experience of the supply categories; and

(iv) the ease with which the demonstration scheme can be phased in over time.

14. Two possible demonstration schemes have been explored:

(i) a distribution zone served by the proposed Min Bhawan tank; and

(ii) a distribution zone served by the proposed Singha Durbar tank.

15. The supply of water to the Min Bhawan tank would be from the Manohara Project and will be as secure as any in the city, as it will have a dedicated transmission main with no connecting pipelines along its length. The existing distribution system in the vicinity of the tank is relatively straightforward and can be isolated without excessive changes to the pipe network. The demonstration scheme would have a balanced mix of medium standard housing, small commercial businesses, schools and colleges, although there is no significant industry in the area. There are a number of poor areas, noticeably adjacent to the rivers, where squatter-type housing exists. It would be relatively easy to subdivide the area into two zones, which could be included in the demonstration scheme in a phased manner.

16. The Singha Durbar tank would be supplied by the existing 600 mm diameter pipeline, which distributes water from the Mahankal Chaur water treatment plant, rather than by the Manohara Project. Due to the high number of connections to this main and the ongoing rationing of water, the pressure in the main is low and there is considerable doubt as to whether

Appendix 9 41

water will actually be able to flow into the tank. The distribution system itself also receives water from a number of the other treatment plants serving Kathmandu. As a result of the multiple supply sources, the distribution system in this part of the city is complex and it would be difficult to isolate the demonstration scheme. The area has a high ratio of government, army, and other institutional demands and as such would probably not be a good example for the rest of the city. In addition, it would be very difficult to implement a demonstration scheme in a gradual manner.

17. Considering the above issues, a demonstration scheme based on the Min Bhawan tank would have a good chance of success whereas one based on the Singha Durbar tank would not. It is therefore proposed that efforts are concentrated on the establishment of the Min Bhawan demonstration scheme.

18. It should be noted that there are other potential demonstration areas within Kathmandu, including the Chabahil area in the northeast of the city close to the Mahankal Chaur water treatment plant and where there is also a good mix of customer types and isolation of the area would be reasonably straightforward. However, the benefits of private sector participation will not be quite so apparent here as the level of water supply is already better than average. This area could however be considered as a potential follow-up project once the success of the Min Bhawan demonstration scheme has been established or indeed, consideration could be given to the early imposition of a higher water tariff.

3. Basic Design

19. The Min Bhawan distribution zone, as defined in the Japan International Cooperation Agency basic design study report on the project for improvement of Kathmandu water supply facilities (October 2001), will not be appropriate for the demonstration scheme due to low-pressure problems in the northern and eastern sections. The proposed limit of the zone, and hence the demonstration scheme, has therefore been modified and will comprise two distinct areas as follows:

(i) Area 1a—located in the immediate vicinity of the Min Bhawan service reservoir and comprising the section of Ward 34 to the south of the New Baneswor Road; and

(ii) Area 1b—located immediately to the west of Area 1a and comprising the section of Ward 10 to the south of the New Baneswor Road.

20. The housing in the demonstration scheme area is relatively new as a result of the rapid development over the last 5 to 10 years. The land adjacent to the New Baneswor Road is used for institutional and commercial purposes. The area is served by a number of pipelines, particularly along the main road, but these are grossly undersized in comparison to the water demand and the inhabitants generally rely on water tankers or shallow wells, as they receive virtually no water during the dry season. New distribution pipes will be required for much of the demonstration scheme area.

21. From an examination of available distribution network drawings, it would be relatively easy to isolate the two proposed areas from the rest of the Kathmandu Valley distribution system. Pipelines should not however be cut, but gate valves installed and closed as this will ensure maximum flexibility in the future management of the distribution system.

42 Appendix 9

22. An approximate estimate of the population has been made for each area based on the figures presented for the wards in the 2001 population census: Area 1a has 13,500, Area 1b has 8,500, giving a total of 22,000 people.

23. At this preliminary stage, it has been assumed that 100% of the population will be served, 30% by full plumbing, 55% by yard tap, and 15% by public standpipe and that the per capita demands for water are 150 liters per capita per day (lpcd) for full plumbing, 90 lcd for yard taps, and 25 lcd for public standpipes. On this basis, the average per capita demand across the demonstration scheme would be in the order of 98 lcd. The total domestic demand can then be calculated to be 2.2 MLD. If it is further assumed that 20% of the water will be used for nondomestic purposes, then the total average water demand is 2.6 MLD. Adopting an initial figure of 35.0% for physical water losses (not unaccounted-for water), the average total water required for the demonstration scheme to be successful is 4.0 MLD.

24. Applying the same variation in demand adopted in the Japan International Cooperation Agency study, but equating the peak month demand with the dry season and the low demand with the wet season, the demonstration scheme water demand would be 4.4 MLD in the dry season and 3.6 MLD in the wet season. Comparison with the water availability figures given above of 12.2 MLD in the dry season and 14.8 MLD in the wet season indicates that there is more than sufficient Manohara Project water to satisfy the needs of the demonstration scheme.

25. While this is clearly a satisfactory situation, the demand for water may change rapidly once people see the benefits good service can bring and it would be reasonable to expect more households to upgrade their supply system to full plumbing or yard taps as appropriate. In parallel, people will also begin to invest in water-dependent devices such as washing machines, which, up to the present time, has been pointless.

26. In line with the social issues discussed, it may be preferable to introduce the demonstration scheme in three stages, commencing with Area 1a and following on with Area 1b later, rather than in one sudden step. The separate water requirements are: Area 1a—2.7 MLD in the dry season and 2.2 MLD in the wet season; and Area 1b—1.7 MLD in the dry season and 1.4 MLD in the wet season.

27. The aim would be to introduce each area to the demonstration scheme as improvements are made to the overall water distribution system serving Kathmandu Valley. Using this approach the development of the demonstration scheme would not unduly detract from water allocated to other parts of the urban area and hence the demonstration scheme will not be seen as a cause of increased hardship for those households not initially involved. The timing for the expansion of the demonstration scheme to include Area 1b is highly dependent on both the success of the initial demonstration scheme in Area 1a together with the rate at which improvements can be made throughout the rest of Kathmandu Valley.

Appendix 10 43

RECRUITMENT PROCEDURES AND OUTLINE TERMS OF REFERENCE FOR MANAGEMENT CONTRACTOR

A. Recruitment Procedures

1. In view of the earlier unsuccessful attempts to recruit a private operator under a management-lease contract, the Government and the Asian Development Bank (ADB) have agreed to pursue a shorter performance-based management contract. Under this arrangement, the management contractor (MC) will be reimbursed through a base fee (i.e., experts’ inputs and out-of-pocket expenditures) for management services and additional performance-based incentive bonus payments linked to its performance measured by a set of key performance indicators. A management contract, which does not require the MC to invest in the physical infrastructure of the water supply and wastewater systems, is more straightforward than the earlier management-lease contract and will be more suitable given the current conditions in Nepal. It should facilitate private sector participation by reducing risks for the Government as well as for the MC and thus ensure a more competitive recruitment environment and better price for the services. Recruitment of the MC will be carried out under ADB's Guidelines on the Use of Consultants with some adjustments.

2. The MC will be a company or consortium (called the operator or consultant), which will have direct responsibility for managing all of the operations of the Water Utility Operator (WUO). The length of the contract is relatively long and greater flexibility will be allowed for the operator (consultant) in terms of its staffing arrangements. The MC will have to bear much greater risk than a typical consultant. This is because a substantial amount of its total remuneration will be dependent upon its success in improving the performance of the WUO. Also, in preparing their proposals, operators (consultants) will have to investigate the state of the existing systems in greater depth and, therefore, the costs of preparing a proposal will be higher than those normally incurred by typical consultants. Because of the limited number of operators (consultants) with required expertise, and possible limited interest in this assignment due to the high cost involved in preparing a competitive proposal, the shortlist may not meet the Guidelines' requirement of "normally 5–7 firms."

3. In order to come up with a shortlist of well-qualified potential operators (consultants), short-listing criteria must include the following two elements:

(i) criteria to identify potential operators (consultants) that define the basic requirements of practical operating experience and financial capacity for participation in the preparation of proposals; and

(ii) a summary of the experience and skills of the operator (consultant) together with their brief responses to a specific list of questions that will focus on the way in which they have addressed or would propose to address problems similar to those which will be faced by the WUO in improving the performance of water supply and wastewater services in Kathmandu Valley.

4. Operators (consultants) meeting the criteria will be considered by the evaluation committee for possible short-listing based on expression of interest received.1 Primary weight in this evaluation will be given to each operator's (consultant's) corporate experience and approach to managing water supply and wastewater systems facing grave operational problems

1 An interested company/consortium (consultant) will be given a preformatted expression of interest template to

complete.

44 Appendix 10

such as those prevalent in Kathmandu Valley. It may be difficult to ensure "reasonable" geographic and country balance in the resulting shortlist of operators (consultants), as the expertise required for such services is not widely available. Therefore, it is proposed to waive the Guidelines' "reasonable" geographic and country balance requirement for this particular recruitment. However, operators (consultants) are free to associate with any regional and domestic firms and individuals from ADB member countries to strengthen their proposals. Also, potential operators (consultants) must demonstrate not only their in-depth technical strengths but also high-quality back-up support to fulfill their commitment over the period of the contract. The short-listed operators (consultants) will then be invited to submit technical proposals containing detailed technical plans for the operation of and improvement to the water supply and wastewater systems together with their financial proposals according to the request for proposals documents, using the quality and cost-based selection method in accordance with the Guidelines.

5. The evaluation of the technical proposals submitted will give approximately equal weight to: (i) the qualifications of the proposed management team (i.e., a group of individuals); (ii) the experience, expertise, and support facilities of the operators (consultants); and (iii) the proposals for the operation of and improvement to the water supply and wastewater systems of the operators (consultants). The proposed management team for each operator (consultant) will be required to make a presentation of their proposal in Kathmandu and to answer questions about their experience and approach to addressing the problems faced by the WUO. The financial proposals will indicate their costs for performing the services (remuneration and out-of-pocket expenditures). Under the contract, the operators (consultants) will also receive a performance-based bonus payment and details of this will be indicated in the request for proposals documents. Considering the unique and complex nature of this particular recruitment, an ADB observer will attend key evaluation committee meetings, in particular the presentation and interview sessions.

B. Outline Terms of Reference

6. The management contract will have the following key features:

(i) performance-based contract, with remuneration comprising a fixed fee and performance-based incentive payments;

(ii) performance-based payments will be linked to achievement of a limited number of easily measurable key performance indicators (key performance indicator baseline levels will be determined during the first year of operations);

(iii) delivery of a number of service obligations as defined in the WUO license issued by the Water Authority (WA), which may include activities such as the computerization of billing, preparation of asset management plans, and specific pro-poor activities; and

(iv) responsibility for implementing investments on behalf of WA/WUO and supervising a major distribution network improvement program.

It is anticipated that the MC will bring in a limited number of expatriate staff and its management team is likely to include several Nepalese nationals.

1. Brief Description of Scope of Work 7. The MC will be responsible for managing the operation and management of the water supply and wastewater services, and the execution of investment programs to improve the

Appendix 10 45

distribution networks, in the metropolitan/urban areas in Kathmandu Valley, including the five municipalities of Kathmandu, Lalitpur, Bhaktapur, Kirtipur, and Madhyapur-Thimi in accordance with agreed levels of service targets. In particular, among others, the tasks of the MC will be to:

(i) improve the long-term performance and efficiency, and expand the coverage of water supply and wastewater services, in the defined service area;

(ii) improve services to the poor through a targeted program of connections and service improvements in low-income communities;

(iii) improve the operation and management of the water and wastewater systems through mechanisms such as more efficient revenue collection, implementation of computerized billing and accounting, management information systems, improved customer service, occupational safety and maintenance practices, reduced leakage, etc.;

(iv) assist and advise the WUO board of directors in relation to strategic planning, budget preparation, and tariff setting;

(v) improve the effectiveness of WUO human resources through a coordinated capacity building program;

(vi) manage, in collaboration with the WA and others, the implementation of an investment program to improve the water distribution network, including bulk water metering, properly sequenced network rehabilitation and renewal of connections;

(vii) coordinate the distribution network improvement investment program associated with the construction of the Melamchi diversion scheme and water treatment plant undertaken by others;

(viii) implement a “demonstration scheme” in a specified area including significant service improvements early in the contract to demonstrate the benefits of improved levels of service to customers; and

(ix) resolve customer complaints and measure customer satisfaction.

2. Contract Implementation Period 8. The management contract will be for an initial period of 4 years, which will be extended, upon satisfactory performance, by an additional period of about 2 years. The end of the extension period will approximate to 1 year after the commissioning of the Melamchi Water Supply Project. 9. It is anticipated that the WA, WUO, and National Water Supply Regulatory Board will become effective and commence operations on 1 November 2004, that the management contract will be signed in early December 2004, and that the MC will mobilize during the first week of January 2005. Implementation advisors (see Appendix 11) will be appointed to oversee the transition period between the effective date for WA/WUO/NWSRB and mobilization of the MC to ensure a smooth transition period for the new entities, the secondment of staff and resources from the Nepal Water Supply Corporation, and the satisfactory transfer of responsibilities to the MC.

46 Appendix 11

OUTLINE TERMS OF REFERENCE FOR IMPLEMENTATION ASSISTANCE: ADVISORY CONSULTING SERVICES AND CIVIL SOCIETY/NGO MONITORING

A. Context

1. The Water Authority (WA), Water Utility Operator (WUO), and the National Water Sector Regulatory Board (NWSRB) are anticipated to become effective and commence operations on 1 November 2004, with the management contract signed in early December 2004 and the management contractor (MC) mobilized during the first week in January 2005. Implementation Advisors will be appointed to oversee the transition period between the effective date for WA/WUO/NWSRB and mobilization of the MC to ensure a smooth transition for the new entities, the transfer of staff and resources from the Nepal Water Supply Corporation (NWSC), and the satisfactory transfer of responsibilities to the MC.

2. The implementation advisors will have extensive expertise and experience in legal, financial, and technical aspects of the management of major corporate institutional restructuring and change implementation.

B. Brief Description of Scope of Work

3. Key activities are detailed below:

(i) Provide expert support and advice to the new entities to ensure the smooth transfer of responsibilities from NWSC to them;

(ii) Provide expert support and advice to the new NWSC board to enable it to adapt to its new role and revised functions for outside Kathmandu Valley towns;

(iii) Assist senior staff in each of the entities to familiarize themselves with key functions, identify any problem areas and provide hands-on assistance to instill understanding and confidence in staff;

(iv) Ensure satisfactory coordination and liaison between the various entities; (v) Provide advice and support to ensure the smooth transfer of staff and material

resources from NWSC to the new entities; (vi) Provide expert counseling and advice to resolve any uncertainties and confusion,

and identify/implement appropriate solutions as mutually agreed to resolve potential conflict;

(vii) Liaise with all organizations and existing stakeholders to ensure a smooth transition period;

(viii) Liaise with the MC to assume the MC’s responsibilities, providing mediation wherever necessary between the MC and the WUO;

(ix) Provide ongoing support for public relations activities during the transition period to ensure continuity and successful implementation; and

(x) Carry out periodic monitoring/performance benchmarking of the water supply and wastewater service delivery under the new institutional framework as well as evaluation of the effectiveness of the new institutional framework itself (qualified civil society groups/nongovernment organizations)

C. Indicative Staffing Requirements and Timing

4. It is envisaged that 10 person-months of international experts and 43 person-months of domestic specialists will be required to deliver the required services. The implementation advisors will mobilize on 1 October 2004, 1 month prior to the effective date for the new entities, and will first complete the transition on 1 February 2005, 1 month after mobilization of the MC.

Appendix 12 47

PROJECT PERFORMANCE MANAGEMENT SYSTEM

A. Introduction and Approach

1. A project performance management system (PPMS) is a set of activities used to identify, record, and analyze (monitor and evaluate) information to ensure that a planned intervention will have the desired result and a beneficial impact. It seeks to establish a cause-and-effect relationship between a project and the impact.

2. In accordance with the PPMS guidelines of the Asian Development Bank (ADB) and with the program objectives, the PPMS will assist the Program to bring about improvements in water supply and wastewater services, which are expected to benefit people's well-being, health, and their environmental hygiene. Indicators pertaining to physical and socioeconomic development are identified in PPMS formats to facilitate monitoring and evaluation of benefits that will accrue from the program components to the beneficiaries. Periodic monitoring/performance benchmarking of the water supply and wastewater service delivery under the new institutional framework as well as evaluation of the effectiveness of the new institutional framework itself will be carried out by qualified civil society groups/nongovernment organizations (NGOs). The findings of the periodic monitoring/performance benchmarking and the institutional effectiveness evaluation will feed into the PPMS.

3. Under this Program, the PPMS is further expanded as the technical audit to identify the achievements on the key performance indicators for the performance-based management contract.

B. Project Performance Management System Framework

4. It is proposed that the PPMS will cover three aspects of program implementation, namely:

(i) institutional strengthening of each of the three key entities, namely the Water Authority (WA), the Water Utility Operator (WUO), and the National Water Supply Regulatory Board (NWSRB), as measured by the increased capacity and efficiency to carry out its respective mandate;

(ii) implementation of the performance-based management contract/performance of the management contractor (MC) including (a) plan, design, tender, and construction, (b) service delivery in terms of quantity and quality, and (c) number of beneficiaries; and

(iii) impact evaluation identifying changes in the areas of economic growth, public health, poverty reduction, gender discrimination reduction, and community participation.

5. It is proposed that a baseline survey be carried out during the first year of the performance-based management contract in close cooperation with the MC to collect initial data on physical, financial, and institutional strengthening, and impact indicators as outlined in the next section. It is suggested that a midterm PPMS survey be performed to enable data to be available at the time of the ADB midterm review, and a final PPMS survey be conducted at the end of the Program to determine the overall impact. The terms of reference for the PPMS/technical audit would be developed by the advisor (consultant) for the WA in collaboration with the WA and the WUO. The next section elaborates potential preliminary

48 Appendix 12

performance indicators, which could be included and refined in the terms of reference for the PPMS/technical audit.

C. Performance Indicators

1. Institutional Strengthening Indicators

a. Revenue Generation and Financial Management

6. Performance indicators for institutional strengthening with respect to revenue generation and financial management of the WUO (and the NWSRB for item (vii)) will include the following:

(i) Ratio of total annual revenue to total annual expenditure;

(ii) Percentage change in generated revenue;

(iii) Percentage change in the volume of water billed;

(iv) Percentage change in the number of customers;

(v) Percentage change in nondomestic customers i.e., identify those who revert to using the supply system rather than their private sources;

(vi) Change in tariff collection efficiency (total collected over total billed); and

(vii) Timely and appropriate-level tariff adjustments (the NWSRB)

b. Operation and Maintenance

7. Performance indicators for institutional strengthening with respect to operation and maintenance of the WUO will include the following:

(i) Budgeted and realized expenditure for improvements of the distribution network and all associated mechanical and electrical equipment;

(ii) Budgeted and realized expenditure on water treatment and disinfection;

(iii) Hours spent on staff training;

(iv) Nonrevenue water as a percentage of water produced; and

(v) Hours before responding to customer repair request/customer complaint.

2. Subproject Implementation Indicators

a. Water Supply

8. Performance indicators for subproject implementation with respect to water supply operations of the WUO will include the following:

(i) Increase in volume of water delivered in new systems or additional water delivered in rehabilitated systems;

(ii) Planned vs. actual duration for detailed design, tender and construction;

(iii) Planned vs. actual subproject cost;

(iv) Delivery and use of water broken down by type of connection (house connection, standpipe, commercial, industrial, institutional, other), estimated number of beneficiaries, volume of consumption, and hours of service;

Appendix 12 49

(v) Percentage reduction in customer complaints; and

(vi) Rates, collectibles, and accounts receivable.

b. Sewerage and Sewage Treatment

9. Performance indicators for subproject implementation with respect to sewerage and sewage treatment operations of the WUO will include the following:

(i) Type and size of facilities constructed;

(ii) Planned vs. actual duration for detailed design, tender and construction, and procurement of equipment;

(iii) Planned vs. actual subproject cost;

(iv) Volume of sewage treated as percentage of volume generated; and

(v) Beneficiary satisfaction surveys.

3. Impact Evaluation Indicators

a. Economic Growth

10. Impact evaluation indicators for the overall institutional framework on the economic growth will include the following percentage increase in land values.

b. Public Health

11. Impact evaluation indicators for the overall institutional framework on the public health will include the following:

(i) Percentage change in incidence of diarrhea and other water-borne diseases;

(ii) Percentage change in biochemical oxygen demand (BOD 5) and e-coli count in a representative sample of well water and/or pipe-borne water;

(iii) Percentage change in incidence of vector borne diseases from insects; and

(iv) Improved river quality at sampling points to be established early in the project by means of percentage changes in biochemical oxygen demand (BOD 5) and e-coli count and dissolved air concentration. The Bagmati River will be given particular attention.

50 Appendix 13

ECONOMIC ANALYSIS

A. Objectives of the Program

1. The Program aims to establish an appropriate institutional framework and operational environment that will facilitate the provision of efficient and affordable water supply and wastewater services in Kathmandu Valley. This appendix outlines the economic rationale for the Program, the main expected costs and benefits, and the distribution of such benefits. However, it should be noted that the Program is primarily one of institutional reforms with some intangible or difficult-to-quantify benefits (and costs), and that additional information is still to be collected for finalizing the design of such reforms by the consultants for Technical Assistance (TA) 4096-NEP.

B. Identification of Problems

2. At present, water supply and wastewater services in the urban areas of Kathmandu Valley are deficient, which creates a high degree of water stress in the valley, with the following characteristics:

(i) Approximately 30% of the urban population in the valley do not currently have an in-house connection, and it is estimated that around 60% of the unconnected are poor. According to recent estimates, approximately 10% of the total number of households were made up of unconnected poor although this is likely to be an underestimate as this evaluation only included formal housing and did not enumerate slums, squatters, or informal renters. These groups constitute the bulk of poor people in the valley and are not currently receiving appropriate services. The unconnected poor have to rely on traditional stone-spouts, standpipes, shallow wells, tanker supplies, or informal connections. Such supplies are grossly inadequate: total amounts provided are insufficient for appropriate levels of hygiene, and a considerable time is spent on collecting water (especially by women), either for extracting water through hand-pumps or queuing at stand post delivery points;

(ii) For those with connections, water services are provided for approximately 2 hours every alternate day. The pressure is very low and, although illegal, pumping is typically required for extracting water out of the piped network. This situation is worse during the dry season, when the gap between available supply and demand widens. The utility operates a strict rationing program, with approximately 60 dedicated staff (for operating valves and distributing scarce water) employed in the valley. Although hours of supply are fairly regular, water is often distributed at odd hours (especially in the middle of the night), which causes great inconvenience for customers. Households have had to invest in storage (both ground-level water reservoirs and roof-top storage tanks) and pumping facilities, in order to cope with intermittent supply at low pressures. Poor households cannot afford such expense and their storage capacities are often very limited;

(iii) Due to the intermittency of water supply and network leakage, water quality is poor. There are no systems in place for monitoring water quality on a regular basis. No drinking water standards have been adopted and no government agency has been made responsible for monitoring drinking water standards. Therefore, the Nepal Water Supply Corporation (NWSC) is practically self-regulating in that respect. Health problems linked to such poor quality are

Appendix 13 51

frequent, taking a heavy toll on labor productivity. Households cope with such poor quality through filtering and boiling water, but most poorer households find it difficult to adopt such coping strategies; and

(iv) Many households have dug their own shallow wells or rely on community-managed shallow wells. In addition, privately operated water tanker companies have dug wells and sell water to the more affluent households in the city. There are no controls over such groundwater abstractions and no detailed analysis of the impact of such abstractions on the aquifer. As the urban areas expand, such abstraction levels are likely to be unsustainable. Several wells (particularly shallow wells used for household supplies) have already dried up.

3. Over the last two decades, various multilateral and bilateral agencies have attempted to strengthen the performance of NWSC and its predecessors through a sequence of projects that have combined technical assistance, institutional support, and funds for investments. Various studies have examined and reported how far these efforts have improved the performance of NWSC, starting with the Pokharel Commission Report in 1987 and culminating with the implementation completion report for the World Bank’s Urban Water Supply and Sanitation Rehabilitation Project produced in 2000.2 These studies have identified a variety of factors that explain the difficulty in improving the performance of NWSC, and they have emphasized the problems caused by frequent and inconsistent political interference in the management of the utility. For example, the World Bank report points out that NWSC had seven general managers or executive chairpersons during the period of the Rehabilitation Project’s implementation from October 1992 to March 1999. There were also seven different chairpersons of the board of NWSC during this period. Such frequent changes in key personnel have undermined the capacity of NWSC to develop and implement programs designed to improve its efficiency and quality of service.

4. NWSC computerized its billing records in one of nine branches in Kathmandu Valley in 2002 and expects to computerize two more branches in 2003–2004. However, the majority of billing and all accounting of expenditures still rely on manual ledgers. As a consequence, the company seems to be unable to produce proper management accounts for the whole company or each region.

5. NWSC has been criticized as operating too much as a project execution/procurement agency and clearly has not been able to develop the skills and corporate culture required for utility management. Even then, the eventual disbursement of the World Bank Rehabilitation Project amounted to less than one third of the original project amount and only 60% of the revised (reduced) project amount after the midterm review.

6. While many of NWSC’s problems are linked to poor management and incentives, there have been equally important external factors that have affected its performance. The critical one has been the reluctance of the Government to adopt and implement a consistent tariff policy. NWSC has stumbled from one financial crisis to another with tariff increases that are too small and too late. As a result, NWSC has had problems in finding the financial resources to provide counterpart funding for projects or to manage a proper program of network maintenance, replacement, and extension. A large proportion of investments in increasing the coverage of water distribution and sewage collection in Kathmandu Valley over the last 10 years was funded

2 See S. Shreshtra. 2001. Water Supply and Sewerage Service Situation in Kathmandu: A Review of Two Reports .

Water Nepal, Vol. 8, No. 12, pp. 105–120.

52 Appendix 13

by customers or municipalities. As a consequence, NWSC has been unable to maintain the technical integrity of its networks.

7. Funding agencies have worsened the tariff problem by failing to pursue consistent policies on the conditions of their assistance. Tariff increases were required as conditions of appraisal and effectiveness for the World Bank Rehabilitation Project, but these conditions were either waived or delayed, and NWSC failed to comply with several loan covenants concerning its financial performance. Since the end of the World Bank project, there was one significant tariff increase in February 2002 but the financial condition of NWSC is dire and the company is barely able to cover its operating costs. These financial problems are exacerbated by the lack of management accounting information and dubious accounting practices.

8. In summary, NWSC is seen in many quarters as an underperforming utility. It is unable to provide even the most basic of services to many of its customers in Kathmandu Valley, who are understandably reluctant to pay more for what they do not receive. Remedying this situation will require an extended period of effort to improve operational performance and the quality of service. At the same time, a significant increase in tariffs is unavoidable simply in order to cover the immediate costs of operating and improving services.

9. Finally, with high levels of leakage in the network, it would be extremely inefficient (and costly) to introduce the Melamchi Water Supply Project (MWSP) without appropriate improvements to the system as the additional water would simply be lost physically or financially. Reforms are therefore needed to improve the quality of the network prior to the introduction of the MWSP and to alleviate the problems related to water scarcity during the interim period, i.e., up to the commissioning of the MWSP.

C. Identification of Best Option

10. The recent history of development assistance to the water services sector in Nepal has shown that it was inefficient to invest funds in the systems, and particularly in distribution network improvement or the improvement of commercial activities, without accompanying institutional reforms that would increase the company’s autonomy, establish a proper incentive framework, and reduce undue political interference. Attempts at reforming the NWSC Act in order to improve the autonomy of NWSC’s board have repeatedly failed. Despite existing provisions allowing NWSC to increase tariffs, they have not been increased even to keep up with inflation due to the lack of a willingness to charge. As a result, NWSC went into a vicious spiral. The Government, therefore, decided to introduce the private sector participation (PSP) modality and associated sector reforms in order to make a clear departure from this spiral by establishing a proper incentive framework, limiting political interference, and introducing required professional skills for improved management.

11. Various options for PSP in the provision of water services in the metropolitan/urban areas of Kathmandu Valley were examined first by the World Bank and then by ADB over the period from 1998 to 2002:

(i) Full privatization or a concession contract for 20-plus years would be extremely risky for any potential investor/operator. Therefore, it would be necessary to provide very large incentives to induce firms to bid. Further, there is large public resistance to the notion of privatizing basic social services such as water supply and wastewater management;

Appendix 13 53

(ii) The World Bank attempted to implement a type of affermage or lease arrangement—called a management-lease contract—under which the network assets were to be managed by a private operator. The operator would have been required to make limited investments in improving the network but it would not have borne the full revenue and investment risks associated with a concession contract. Two separate efforts to implement this arrangement had to be cancelled because too few firms with appropriate experience were willing to prequalify. The lesson learned from these unsuccessful efforts was that potential bidders regarded the risks of operating water supply and wastewater services in Kathmandu Valley as too high with respect to the investment funds required; and

(iii) Since it has been proven that there is a clear reluctance among potential private parties to invest in the Kathmandu Valley system, it seems that some form of performance-based management contract is the only realistic form of PSP that can be adopted in the current circumstances. This conclusion is consistent with experience in other cities around the world where the existing system suffers from serious problems of management and operation. Such a management contract involves the recruitment of an experienced operator, hereafter termed a management contractor (MC), to provide a management team backed up by corporate technical support to improve the utility’s performance. The remuneration of the MC would be based on a combination of a fixed base fee and additional rewards/bonuses linked to specific key performance indicators. There is some experience with management contracts in Nepal, but these have been on a fixed-fee basis and they have been designed for relatively short interventions. It is desirable to incorporate stronger performance rewards in a longer contract to ensure that the incentives for the utility and the MC are properly aligned.

12. As a result of the discouraging past experiences in shoring up the existing public utility (i.e., NWSC), and this assessment of the potential options for PSP, ADB concluded that a performance-based management contract would be the most appropriate option for the metropolitan/urban areas of Kathmandu Valley. Since one of the goals of introducing an MC is to ensure that the distribution network in Kathmandu Valley is improved so that the additional water produced by the Manohara Project and the MWSP can be properly used, it is important that the provisions of the management contract should be consistent with the timetable and goals of these projects.

13. Following a period of in-depth consideration and consultation, and with previous experiences very much in mind, the proposal for PSP modality by using a management contract has been developed further. This essentially involves the appointment of an MC for the operation and management of the water supply and wastewater services in the metropolitan/urban areas of Kathmandu Valley for a predefined period of time (an initial period of 4 years, which will be extended, upon satisfactory performance of the MC, by an additional period of about 2 years). An experienced international operator (consultant) will be recruited via international competitive recruitment and will be retained on the basis of a performance-based management contract. Under this scheme, the level of risk, both for the Government and the selected MC, will be significantly lower than under the previously considered World Bank-financed PSP scheme.

54 Appendix 13

D. Program’s Likely Benefits

14. The Program is likely to have the following benefits:

(i) Increased consumer surplus, derived from improved water supply and wastewater services, and health benefits from improved environmental sanitation and personal hygiene. It is rather difficult to separate the benefits of the MWSP from those of this Program. Basically, the MWSP is dependent on this Program while this Program can be freestanding. In other words, this Program is necessary for the MWSP while the MWSP will boost the benefits of this Program. Earlier studies have provided indications of a high willingness to pay (WTP) for improved water supply services. Almost 70% of the households presently connected are willing to pay a monthly bill of NRs600 for improved water supply services while almost 50% of the households presently not connected are willing to pay NRs500 per month for similar services according to a WTP survey carried out in 2001. These figures may be compared to a typical monthly charge for an unmetered NWSC connection of NRs70 at the time the survey was carried out. For the households connected to the NWSC system, the median WTP is NRs900 per month for improved water supply services, i.e., at least 50% of the sample are willing to pay more than NRs900 from their monthly income to obtain the improved services. The mean WTP is NRs1,030 per month among connected households. For poor households currently connected to the NWSC system, the mean WTP is NRs800.3 The MC will have obligations to improve availability and efficiency of water supply services, provide the services in a more equitable manner, and improve other relevant aspects of the services. All the above benefits are under the assumption that both the MWSP and the Program have been successfully completed. Without the MWSP, however, some of the above benefits are still expected to materialize in conjunction with the proposed demonstration scheme by using JICA's Manohara bulk water. Benefits of providing improved services could be valued by using the median WTP multiplied by the total number of households, in order to represent the amount that households are willing to pay for the improvement to the services;

(ii) Improved management efficiency. Existing staff morale is low. The MC could transform the culture of the utility by offering commensurate rewards reflecting performance and quality of services. The long-term impact of a better managed and more financially sustainable utility would be substantial, as opposed to the current situation where the utility is a drain on public sector resources, since current tariffs are insufficient to cover even its operating costs, let alone investment costs; and

(iii) Improvements in the institutional structure, with the establishment of a clearer framework for setting tariffs (based on principles established in the legal framework) and an independent regulatory body in charge of tariff setting. In turn, those institutional improvements could have a ripple effect on institutional management (and a positive impact on sustainable urban development) in Kathmandu Valley and in the country as a whole. (There are few shining examples of successful private sector participation in Nepal and a success story in the water services sector could pave the way for other reforms aiming at introducing private sector participation for efficiency improvements.)

3 The 95% confidence interval is NRs970–1,110 for households with a connection. For poor households with a

connection, the 95% confidence interval is NRs680–910.

Appendix 13 55

E. Program’s Likely Costs

15. The Program will require the following costs:

(i) Costs of the MC: the fixed base fee is to be paid for out of the project loan while the performance-based bonus is to be paid for out of the WUO's own (improved) revenues, primarily through water tariffs. While the first component is a net cost, comparable to the costs of a TA project, the second component is to be financed through the efficiency improvements and corresponding revenue increments that the management contractor would bring about;

(ii) Costs of the voluntary retirement scheme (VRS): a more realistic number of staff to be made redundant is to be estimated by the TA consultant team, but it is currently estimated that approximately 800 staff would be permanently transferred to the WUO ultimately, out of a total of approximately 1,200 NWSC staff currently working for its Kathmandu Valley operations. A total of 38 people have so far taken part in the existing VRS scheme, at an average cost of approximately NRs1 million per person (approximately $13,000). In addition, approximately 100 people are currently on a waiting list and many more have applied. The VRS scheme, therefore, appears to be attractive for certain workers, although such preference is not currently voiced by trade unions at a collective level. Accompanying activities would focus on assistance, for example, in the identification of alternative employment for employees that have been made redundant and the retraining of employees, in particular the most vulnerable ones. Therefore, there could be some benefits to be extracted from encouraging former NWSC staff to take up other potentially productive activities. Expected growth in the total number of customers and the total value of services provided may mean that the total number of staff will not be much smaller in 5 or 10 years than at present, but the composition and skills of the work force will be quite different;

(iii) Costs of the distribution network improvement program: in order to be able to bring about expected benefits, the MC would need to have access to public financing for carrying out a physical distribution network improvement program. The exact costs of such a program are yet to be estimated, and would be financed separately; and

(iv) Other transition costs: the proposed institutional reforms are likely to require other transition costs linked to the restructuring of NWSC into three entities—the WA, the WUO, and the NWSRB. The remaining NWSC, which will be responsible for areas outside Kathmandu Valley, could be further broken up into municipal or regional utilities (depending on an evaluation of the appropriate scale of service provision) in order to be more responsive to local needs outside Kathmandu Valley, which have so far tended to be neglected due to a high level of focus on Kathmandu Valley requirements.

F. Distribution of Benefits

16. The increase in the average per capita volume of water supplied, resulting from the more efficient operation and management of the water supply and wastewater services, the optimization of the water production facilities, the reduction in unaccounted-for water, and the more equitable distribution of water throughout the metropolitan/urban area of Kathmandu Valley will benefit the majority of the inhabitants of the area. However, it should be noted that

56 Appendix 13

those people living adjacent to the existing water production facilities and transmission pipelines in the northern part of Kathmandu Valley are likely to undergo a reduction in water supply volumes in the early part of the program implementation period as better measures for the distribution of water are implemented. This reduction will, however, be temporary and measures will be taken to ensure that any reduction in supply volumes is not unreasonable.

17. Considerable attention will be paid in the design of the performance-based management contract in order to ensure that the poor benefit from improved water supply services. Tariff increases are not expected to affect the poor negatively, since they are the ones who are usually paying the highest (real or opportunity) volumetric costs for water at present, by obtaining water from alternative sources because they are unconnected or by coping with the intermittency or unreliability of water supplies (i.e., high coping costs).

18. Other than the operation and management of the services, a very clear objective of the PSP modality, and the appointment of the MC, is to achieve extensive technology transfer and to develop the long-term capability of Nepalese managers and engineers to run the water supply and wastewater services, either under public or local private management. It is anticipated that the entire workforce of the WUO and the overall Nepalese water supply industry will benefit from such technology transfer.

19. The actual restructuring of NWSC will have a negative impact on some of the existing senior managers whose responsibilities, and therefore importance, within the government structure will be adversely affected. Discussions will be held prior to the handover period in order to identify ways in which the impact of imbalanced senior managers' posts and responsibilities can be mitigated.

20. Rightsizing the WUO via the NWSC's VRS scheme will have both beneficial and negative impacts on the current working-level NWSC staff. Many staff will see it as a benefit, as it gives them an opportunity to obtain a sum of money that will allow them to retire or start up their own business. A number of NWSC staff have already applied for voluntary redundancy—see para. 15 (ii). Where negative impacts are expected, the TA consultant team will develop a nonmonetary benefit program, such as identification of alternative employment and retraining in order to limit the impact on the most vulnerable employees.

21. Other adversely affected people may include water tanker owners/operators and drivers, together with street water vendors, whose business may be reduced with time.

Appendix 14 57

FINANCIAL ANALYSIS

A. General

1. Financial analysis and calculation of the financial internal rate of return (FIRR) conducted under the project preparatory technical assistance were reviewed and revised in accordance with the Asian Development Bank (ADB) Framework for the Economic and Financial Appraisal of Urban Development Sector Projects. For revenue-generating components, the FIRR was calculated for the Water Utility Operator (WUO) following ADB’s Guidelines for the Financial Analysis of Projects . The financial sustainability of the WUO was assessed based on the Guidelines for the Financial Governance and Management of Investment Projects Financed by the Asian Development Bank.

B. Assumptions Used in Financial Projections

1. General Assumptions

2. The financial projection for the WUO consists of projected receipts and expenditures in Nepalese rupees (NRs) and expressed in current prices incorporating projected general inflation over the forecast period FY2004–2020. WUO is assumed to take over Kathmandu Valley operations of the Nepal Water Supply Corporation (NWSC), whose operations will be managed and improved by the management contractor (MC). The financial projection assumes 60% of operations of NWSC, as considered within the Kathmandu Valley coverage, for allocation of fixed assets leased and the debt servicing. While all of the loans are not transferred from the NWSC, the WUO is assumed to remit funds to cover only the current debts (i.e., principal and interest) servicing on all the wastewater loans and three fifths of the water supply loans.

2. Past Performance of Nepal Water Supply Corporation Operations

3. NWSC operations within Kathmandu Valley during the period FY2000–2002 showed a decline in collection efficiency with average collection period ranging from 385 days in 2000, to 466 days in 2001, and to 501 days in 2002. Nonrevenue water remained approximately at 37% in 2000 and 2001 respectively, and at 38% in 2002. The utility was overstaffed with a ratio of 11.4 staff per 1,000 connections in 2002. NWSC was behind in debt servicing the loans of NRs1.2 billion, with accumulated arrears in principal amortization of NRs381 million and interest payments of NRs151 million.

3. Revenues

4. The average water tariff for all the categories of consumers is calculated and applied to the demand forecast. It is assumed that the existing standpipes will be metered and charged at the lifeline rate. For the sewerage revenues, it is assumed that 50% of the water bill of consumers connected to the sewerage network is collected as sewerage revenues. Since not all in-valley water customers have sewerage connections, the sewerage revenues are assumed to remain at the current level of 26% of the total water revenues before the Melamchi Water Supply Project (MWSP) is completed. The existing sewerage connections are assumed to remain the same after the completion of the MWSP. Other operating revenues are assumed to be at the same level as in the past, currently estimated at 12% of the water revenue. Nonoperating revenues, such as the interest earned on time-deposit investments in excess of the WUO’s monthly cash requirements, is assumed at 5% a year.

58 Appendix 14

4. Expenditures

5. The total number of local personnel of the WUO is assumed to decline from 9.5 staff per 1,000 connections in 2002 to 6.0 at the end of the first 4 years of the management contract. Power expenditure is assumed to remain the same until MWSP completion, as electricity is assumed to be the same unit cost per cubic meter of water produced in 2002, increasing over the years due to inflation. This expenditure, however, is assumed to decline by 50% annually upon completion of the MWSP as the additional water will be gravity fed, and it will involve closing down inefficient pumping-dependent groundwater sources. Fuel for vehicles and generators, and chemicals are assumed to have the same unit cost per cubic meter of water produced as in 2002, but increasing with inflation. Repairs and maintenance of the assets is assumed to be 2% a year up to 2005 and lower thereafter as the distribution network improvement proceeds. Provision for bad debts is assumed to decline from 4.5% in 2002 to 2.5% for the period 2003 to 2007, and further decline to 2% thereafter. General and administrative expenses are assumed to be the same as in the past at 21.6% of the WUO’s personnel expenses. Management fees are assumed to cover the fixed fee and performance incentives payable to the MC. Regulatory expenses are assumed to be NRs170 million per annum. And sewerage expenses are estimated to remain the same as the current level, i.e., at 21% of sewerage revenues.

5. Cost Recovery Policy and Tariff

6. The basis for setting the tariff includes the need for cost recovery, primarily from Kathmandu Valley water consumers; addressing demands by proper pricing; increasing access to water and affordability for the urban poor; and facilitating payment of water bills. The financial projection includes revenue generation improvement from, in particular, the water tariff, nonrevenue water rate, collection period, and staff rightsizing. It is assumed that the water tariff is substantially increased by 2005, with subsequent increases of 15% annually from 2006 to 2009, followed by 30% and 25% in 2010 and 2011, respectively. This would result in a simplification of the tariff structure and increases reaching NRs30/m3 in 2011, and NRs31/m3 from 2012 with an annual increase at the same rate as inflation. It is assumed that the nonrevenue water rate will decline from 38% in 2003 to 26% in 2009. It is assumed that the collection period will improve from 120 days in 2003 to 45 days by 2009, and that the debt service coverage ratio is improved by 0.9 and 1.0 times in 2011 and 2012, respectively, and at least by 1.2 times from 2013. With institutional reforms and the ability of the private operator to deliver 24-hour-a-day potable water to its customers leading to an increase in overall operational efficiency and improved revenue generation, the financial projection shows that the WUO is capable of paying the lease payments and will be significantly self-sustained.

C. Financial Internal Rate of Return

7. Basic assumptions used in computing the FIRRs include the following: (i) all revenues and costs are expressed in constant July 2003 prices on an incremental basis; (ii) project investment costs were derived from estimated costs, less price contingencies and interest during construction; and (iii) capital expenditures are recorded at the time they are incurred, while interest and depreciation are excluded. The purpose of the financial cost-benefit analysis is to assess the financial viability of the Program. It focuses on the additional financial benefits (usually in terms of additional revenues, and capital and operating cost savings or reductions) attributable to the Program for the WUO, rather than the economy as a whole. The resulting FIRR indicates the profitability of the Program, and should exceed the weighted average cost of capital (WACC) to be financially viable. The WACC of the water supply component is estimated to be 4.0%. The resulting FIRR of 0.28% is due to comparatively less revenue generated

Appendix 14 59

through deferment of construction of one half of the water treatment plant in favor of the distribution network improvement.

D. Beneficiary Affordability

1. Willingness to Pay

8. A study on the willingness to pay (WTP) for improved water supply in Kathmandu Valley4 was undertaken in 2001 to measure how much households are willing to pay for a reliable supply of water amounting to 500 liters per day per household. A contingent valuation5 study was conducted covering a total of 1,500 randomly sampled households in five urban municipalities of Kathmandu Valley (i.e., Kathmandu, Lalitpur, Bhaktapur, Madhyapur Thimi, and Kirtipur) to collect information on demand for improved water services. The study found considerable demand for improved water services.

9. Almost 70% of the households that are connected to the NWSC system are willing to pay a monthly bill of NRs600, and almost 50% of the households that are not connected to the NWSC system are willing to pay a monthly bill of NRs500. These figures may be compared with a standard monthly charge for an unmetered NWSC connection of NRs70 at the time the survey was carried out. For the households that are connected to the NWSC system, the median WTP is NRs900 per month for improved services, i.e., at least 50% of the sample is willing to pay more than NRs900 from their monthly income to obtain the improved services. The average WTP is NRs1,030 per month among connected households. For poor households currently connected to NWSC system, the mean WTP is NRs800.6

10. Among unconnected households, the mean WTP for improved service from a private connection, is NRs840 per month. The mean WTP for an improved water supply from a shared connection, which is similar in all respects except that it will provide about 250 liters of water a day, is NRs230 per month. 7 The mean monthly WTP of poor households currently not connected to the NWSC system is NRs630 for a private connection and NRs240 for a shared connection.

2. Affordability Analysis

11. Applying the proposed water charges and wastewater surcharges with the expected water consumption, the percentage of average monthly expenditure on water and sewerage was assessed with reference to household incomes. Based on the 2001 census, median household income in Kathmandu Valley is estimated at NRs14,000 per month, and the lowest quartile median is estimated at NRs6,070 per month. Upon completion of the MWSP, an average monthly water bill of NRs540 can be expected for a household of six persons based on an assumed consumption level of 100 liters per capita per day (lpcd). This would equate to 3.9% of the household’s income, i.e., within the generally accepted expenditure level of 3–4% of the median monthly household income.

4 Willingness to Pay for Improved Water Supply in Kathmandu Valley. August 2001. Water and Sanitation Program

for South Asia, India. 5 This is a method that has been specifically developed to elicit maximum WTP for a service by presenting

consumers with a contingent scenario in which they have the opportunity to obtain 24-hour-a-day clean and safe water provided by a private sector operator.

6 The 95% confidence interval is NRs970–1,110 for households with a connection. For poor households with a connection, the 95% confidence interval is NRs680–910.

7 For the group of unconnected households, the 95% confidence interval is NRs700–1,010 for a private connection and NRs30–380 for a shared connection.

60 Appendix 15

ENVIRONMENTAL ASSESSMENT OF KATHMANDU VALLEY WATER SERVICES SECTOR DEVELOPMENT PROGRAM

1. The proposed interventions, anticipated outcomes, risks, and mitigation measures are summarized in the matrix of potential environmental impacts below:

Policy Intervention Economic and Social Outcomes

Environmental Risk Mitigation Measures

Financing and Governance Creation of WA, WUO, and NWSRB

Separation of political direction (WA) from utility operation (WUO), which is to be based on sound commercial practices, and increased transparency and accountability Improved customer care Sustainable water services through improved operational efficiency and revenue collection Management and financial capacity strengthening of the sector; introduction of best practice

Unacceptable differential service levels between consumer categories to maximize financial return in preference to social equitability Inaction over customer complaints Poor performance of WUO Poor retention of suitable high-caliber Nepalese to fill key posts

Guidelines and procedures to be defined in the policies of each entity, with overall monitoring and control responsibility vested in WA or NWSRB Customer complaint resolution as function of NWSRB Tariff adjustments based on achievement of performance targets Recognition of competence and good performance through payment structure

Implementation of VRS Improved efficiency in water sector operation leading to efficiencies in tariff and reduced water bills

Unimproved efficiency in water sector operation due to inadequate VRS and/or its implementation

Provision of generous compensation package, skill training, advice, and support for setting up local commercial ventures

Health More equitable water distribution and enhanced levels of service

Improved public hygiene, health, improved labor availability, reduced personal expenditure on water/healthcare Reduced water collection workload for women and children

Increased pollution resulting from increased water availability without appropriate sanitation facilities Failure by WUO to deliver service improvements

Integrated responsibility in the WUO for water supply and wastewater disposal services Reflection of achievement of performance indicators in tariff increments

Community Participation and Gender Consultation with civil society over service delivery policies

Development of social responsibility, “ownership” of services, reduced alienation

Disenfranchisement of poor communities within society

Continuing dialogue with civil society representatives and their inclusion on WA and WUO boards

Appendix 15 61

Policy Intervention Economic and Social Outcomes

Environmental Risk Mitigation Measures

Development of local water user committees Development of local commercial ventures (small-scale independent water service providers), sector support initiatives such as meter reading, facility caretakers, etc.)

Lack of suitable candidates Insufficient start-up capital, lack of experience

Dialogue and support from WUO/MC Support from WUO, access to funds from municipal and loan budgets

Environment Improved system efficiencies (reduced leakage, pollution control, etc.)

Better resource utilization and reduced unit costs Reduced damage to urban infrastructure, roads and services due to leaks, etc. Reduced pollution and environmental degradation through effective wastewater treatment

Over-abstraction of aquifers Failure to reduce leakage Lack of clarity in wastewater asset ownership

Efficient conjunctive use of water resources Performance incentive payments paid for achievement of targets Adoption of wastewater assets by Government on behalf of municipalities

MC = management contractor, NWSRB = National Water Supply Regulatory Board, VRS = voluntary retirement scheme, WA = Water Authority, WUO = Water Utility Operator.

62 Appendix 16

SUMMARY POVERTY REDUCTION AND SOCIAL STRATEGY: KATHMANDU VALLEY WATER SERVICES SECTOR DEVELOPMENT PROGRAM

A. Linkages to the Country Poverty Analysis Sector identified as a national Yes priority in country poverty analysis?

Sector identified as a national Yes priority in country poverty partnership agreement?

Contribution of the sector/subsector to reduce poverty in Nepal: The Kathmandu Valley Water Services Sector Development Program (KVWSSDP or the Program) will provide a solution to mitigate the socioeconomic stress caused by the inadequate supply of safe drinking water for Kathmandu Valley residents. The Program will improve the water supply and wastewater services in the metropolitan/urban areas of Kathmandu Valley by supporting institutional reforms and by engaging a management contractor (MC) under a performance-based management contract to operate and manage the urban water supply and wastewater systems in conjunction with the ongoing Melamchi Water Supply Project (MWSP). This will benefit 180,000 households in the valley in terms of quantity, quality, and timeliness as well as more equitable distribution of water supply. The impact ratio for the poor has been estimated to be four times that for the not-so-poor. The Project will also provide socioeconomic benefits of reduced workload for women and children. These benefits have not been quantified and, to that extent, the economic benefits are understated.

B. Poverty Analysis Proposed Classification: Other/Good governance What type of poverty analysis is needed? Poverty in Nepal The recent estimate indicates that 42% of Nepal’s total population are living below the official poverty line, and poverty reduction is the primary objective of the Government’s development policy, as indicated in the Government's 10th Development Plan (2002–2007). Poverty in the Kathmandu Valley (i) Although no official estimates of the extent of poverty in Kathmandu Valley are available, data derived from the Nepal Living Standards Survey of 1995/96 indicate that, based on a poverty threshold of NRs9,000 per capita per annum, equivalent to about $122, the extent of the urban poor ranges from 10% to 13%. However, given that rents and other costs are higher in Kathmandu than in other urban areas of the country, 12–15% would be a conservative estimate of urban poverty in Kathmandu Valley. Nevertheless, income poverty alone is insufficient to understand the extent of poverty in the valley. (ii) Most of Kathmandu’s poor live in very low-quality houses, squatter settlements, or rental accommodation. Rental accommodation is occupied by a range of low-income groups, such as daily wage earners, hawkers, and semiskilled laborers. Squatters live mainly on marginal government-owned land. Their population has grown considerably and is now estimated at 18,000. Overall, most poor live in small settlements in the midst of higher-income housing and, consequently, are not very visible. (iii) Access to reliable water supplies is a problem for most low-income communities. Reliance on public supplies from the Nepal Water Supply Corporation (NWSC) is minimal; most urban poor depend on private or traditional sources of supply. Shallow wells are a popular source, but these are usually contaminated and responsible for a variety of water-borne diseases. About 67% of the population believes that the quality of water supplied by NWSC is poor; almost 72% of households in Kathmandu Valley treat their water before consumption. Boiling and filtering, the most common means of treatment, involve considerable expense and impact mainly on the poor. Based on a 1999 survey undertaken during MWSP project preparation, 36% of the hous eholds suffer from water-related diseases. Diarrhea, stomach ailments, and dysentery are the dominant health problems and impact significantly on productivity and income because of working days lost and treatment expenses. Diarrhea is a leading cause for child mortality throughout Nepal. (iv) The hardships in accessing water in Kathmandu Valley are severe. With piped water supplies limited to 2 hours every alternate day, most consumers, and particularly the poor, rely on secondary sources. Although the time spent by the poor in accessing water for domestic use varies, approximately 1 hour is required. A number of domestic functions are undertaken at the water point to minimize the volume of water to be carried home. Women are the predominant carriers of water. Residents of low-income areas carry home only about 10 liters per person of water every day. This is insufficient to maintain basic hygiene and sanitation standards, and is a prime cause of the high levels of morbidity and mortality.

Appendix 16 63

C. Participation Process Stakeholder analysis: Yes The umbrella project of KVWSSDP, MWSP, has been prepared with extensive participation of stakeholders, including beneficiaries, adversely affected people, village development committees and ward representatives, district development committees and municipality officials and representatives, ministries concerned and the Melamchi Water Supply Development Board (MWSDB), the private sector, external funding agencies, nongovernment organizations, and consultants. MWSP will also undertake consensus building at all levels on issues such as water services, environmental and social impact mitigation and compensation, and employment. Extensive consultations with stakeholders will continue under KVWSSDP, in particular focusing on pro-poor service delivery strategy development. Participation strategy required: Yes To support the introduction of private sector participation (PSP) scheme for the water supply and wastewater services in Kathmandu Valley, the Kathmandu Valley Water Supply Management Support Committee (KVWSMSC) has been established under MWSDB. KVWSMSC will ensure that stakeholders are kept informed about KVWSSDP and are given an opportunity to express their views. It will carry out a proactive public relations campaign to identify any potential conflict area at an early stage, assist in consensus building between the Program and the local communities.

D. Gender and Development Strategy to Maximize Impacts on Women Hardship in water management is more severe among the poorer households, and mostly among women, who bear the predominant responsibility for water collection, storage, and treatment. Therefore, quite naturally, the Program will benefit women significantly and disproportionally. Gender Plan Prepared: Yes To ensure that women's participation and gender concerns are fully addressed, a gender strategy has been developed and is being implemented. Apart from this, it has been agreed that at least one of the members of the regulatory body will be female.

E. Social Safeguards and Other Social Risks

Subject

Significant/ Nonsignificant/

None

Strategy to Address Issues

Plan Required Resettlement None There is no physical investment component

under the Program that requires involuntary resettlement.

None

Indigenous Peoples

None The Program will not adversely impact a specific indigenous people or ethnic minority/disadvantaged caste group.

None

Labor None Since the proposed retrenchment under the Program uses NWSC's voluntary retirement scheme, there is little risk of increased poverty incidence under the Program.

None

Affordability None A recent survey indicates that there is significant willingness to pay among Kathmandu Valley residents, ranging from $0.43/m 3 (poor/upgraded from unconnected to shared connection) to $0.86/m3 (nonpoor/already connected). Therefore, the increased water tariff will still be well within the affordable level.

None

Other Risks/ Vulnerabilities

None None

64 A

ppendix 17

TERMS OF REFERENCE FOR TECHNICAL ASSISTANCE CONSULTANTS (TA 4096-NEP)

I. SCOPE OF WORK

1. A consulting team will be recruited for a period of about 12 months. Approximately 40 person-months of international and 60 person-months of domestic consulting services inputs are required. A water supply expert experienced in private sector participation (PSP) will be the team leader, bearing the overall responsibility for the whole scope of the assignment (see paras. 9 to 21 of the TA Paper for TA 4096-NEP for Background Information). The team will comprise international and domestic consultants with various expertise including institutional, legal, regulatory, financial, economic, engineering, procurement, public relations, environmental, social, and labor relations. Responsibilities are categorized under the following five subtasks: A- Management Contractor (MC) Recruitment; B- National Water Supply Regulatory Board (NWSRB); C- Nepal Water Supply Corporation (NWSC) and Kathmandu Valley Water Authority (KVWA); D- Project Preparation; and E- Other Related Tasks. A check (ü) indicates the subtask(s) each expert is expected to carry out. (I) indicates international consultant and (D) indicates domestic consultant. The tasks of the consulting team will include, but will not be limited to, the following:

International and Domestic Consultants for the Main Team

MC

Recruit

NW

SR

B

KV

WA

PP

TA

Others

Position

A B C D E

Assignments

1. Team leader (I) 2. Deputy team leader/

municipal engineer (D) These two professionals will assume overall responsibility for the effective performance of the team as a whole. The deputy team leader will also assume the responsibilities of the domestic municipal engineer, which are described under Position #11.

√ √ √ √ √ (i) Coordinate closely with the Ministry of Physical Planning and Works (MPPW); the Melamchi Water Supply Development Board (MWSDB), in particular its Kathmandu Valley Water Management Support Committee (KVWMSC); and other relevant government agencies, and relevant multilateral and bilateral development partners.

(ii) Hold monthly coordination/progress-review meetings with all relevant government agencies and their consultants. Prepare the minutes of meetings and issue them to all parties concerned within 1 week.

(iii) Provide advice to MPPW, MWSDB, and KVWMSC as required. (iv) On behalf of KVWMSC, prepare reports for submission to higher authorities and relevant

development partners including ADB. (v) Turn over all study outputs, reports, and other documentation to KVWMSC in electronic and paper

forms upon completion of the assignment. (vi) If necessary, suggest alternative measures for the MC contract and operations in case KVWA

and/or NWSRB are/is not ready in the initial phases of the MC contract. 3. Transaction advisor (I) 4. Contract/procurement

specialist (D)

√ (i) Review lessons learned from past efforts and prior studies. (ii) Assess risks and bidding climate, and sound out potential bidders.

Appendix 17

65

MC

Recruit

NW

SR

B

KV

WA

PP

TA

Others

Position

A B C D E

Assignments

These two professionals will work as a subteam for the assigned tasks. The transaction advisor will assume primary responsibility, while the contract/ procurement specialist will support him/her.

(iii) Develop an overall contracting strategy, both immediate and long-term (i.e., including succeeding contracts after the renewed (i.e., second) 5-year management contract), for the urban water supply and sanitation private sector participation (PSP) scheme in Kathmandu Valley for KVWMSC and MPPW’s approval.

(iv) After approval, finalize the implementation plan for the approved contracting strategy. (v) Evaluate the prequalification (PQ) applications and prepare a list of prequalified applicants. (vi) Develop request for proposals (RFP) documents including draft MC contract in consultation with

relevant government agencies and prequalified applicants, and issue the RFP to the prequalified applicants.

(vii) Evaluate proposals and prepare award recommendation. (viii) Help KVWA (or MPPW if KVWA is not ready by then) negotiate and reach agreement with the

recommended bidder. (ix) Develop arrangement for procurement of works and goods under the MC management in

consultation with ADB and the Government. 5. Regulatory specialist (I) 6. Public administration

specialist (D) These two professionals will work as a subteam for the assigned tasks. The regulatory specialist will assume primary responsibility, while the public administration specialist will support him/her.

√ (i) Review prior preparatory studies on the regulatory body. (ii) Define the roles and responsibilities of NWSRB by clearly differentiating its responsibilities as

regulator and those of KVWA as administrator of the urban water supply. (iii) Draft supporting policies for NWSRB, and help gain approval for such supporting policies. (iv) Help KVWMSC identify candidates and appoint NWSRB board commissioners. (v) Develop a draft organization chart for NWSRB, identify working-level staffing needs, develop job

descriptions, and assist in hiring staff members for NWSRB. (vi) Design and implement training programs for NWSRB board commissioners, assist in establishing

its operations, and provide training for its working-level staff as needed. (vii) Develop and document necessary regulations and procedures and present them for NWSRB board

approval. (viii) Establish reporting procedures to maintain utility information, customer information and

socioeconomic information; and set up adequate software and hardware to systematically maintain and update such an information database.

(ix) Work with the public relations specialists to build relationships with relevant stakeholders. (x) If necessary, suggest alternative measures for the MC contract and operations in case KVWA

and/or NWSRB are/is not ready in the initial phases of the MC contract. 7. Water sector management/

policy specialist (I) 8. Water supply management

specialist (D)

√ (i) Work with the transaction advisor and contract/procurement specialist on the overall contracting strategy.

(ii) Establish baseline conditions, develop a set of key performance indicators (KPIs), their targets, and methods to measure actual performance against the targets.

66 A

ppendix 17

MC

Recruit

NW

SR

B

KV

WA

PP

TA

Others

Position

A B C D E

Assignments

(iii) Prepare MPPW (subsequently KVWA) to administer their responsibilities under the management contract.

(iv) Define service area of MC and recommend modality for management of isolated rural water supply schemes currently being operated by NWSC in consultation with stakeholders.

(v) Identify measures for encouraging local participation in MC and suggest measure for local capacity building for incorporation in the MC contract.

(vi) If necessary, suggest alternative measures for the MC contract and operations in case KVWA and/or NWSRB are/is not ready in the initial phases of the MC contract.

√ Provide policy development support for the regulatory specialist/public administration specialist.

These two professionals will work as a subteam for the assigned tasks. The water sector management/policy specialist will assume primary responsibility, while the water supply management specialist will support him/her. In particular, they will plan and implement the institutional transition from NWSC to KVWA.

√ (i) Review prior preparatory studies on the establishment of KVWA. (ii) Define the roles and responsibilities of MPPW (subsequently KVWA) by clearly differentiating its

responsibilities as administrator of the management contract from those of NWSRB as regulator of urban water supply.

(iii) Draft supporting policies for KVWA and help gain approval for them. (iv) Facilitate agreement on the powers and duties of KVWA. (v) Facilitate agreement on appropriate representation on the board of directors (number of members,

qualifications, etc.) and voting rules of KVWA. (vi) Help KVWMSC identify candidates and appoint KVWA board members. (vii) Develop a draft organization chart for KVWA, identify working-level staffing needs , develop job

descriptions and a staffing plan for KVWA, and assist in reassigning/transferring staff in the unbundled Kathmandu Valley operations units of NWSC.

(viii) Design and implement training programs for KVWA board members and working-level staff. (ix) Help KVWA staff develop necessary regulations and procedures for KVWA board approval. (x) Identify management information resources related to utility operations at NWSC that must be

transferred to the new KVWA. Establish reporting procedures to maintain such management information and additional information on water resources management, in particular what has been prepared under the Optimizing Water Use in Kathmandu Valley study (ADB TA 3700 NEP).

(xi) Develop mechanisms for licensing and charging for use of groundwater in the Kathmandu Valley.

Appendix 17

67

MC

Recruit

NW

SR

B

KV

WA

PP

TA

Others

Position

A B C D E

Assignments

9. Labor relations specialist (I+D)

√ √ (i) Review prior reports on restructuring and staff retrenchment of NWSC. (ii) Meet with NWSC management and representatives of its unions to understand their concerns and

perspectives. (iii) Work with KVWMSC, MPPW, other relevant government agencies, and local International Labour

Organisation (ILO) officials to understand policies with respect to retrenchment and retraining of excess NWSC employees and potential options for them, and propose a strategy for the transition of NWSC to KVWA.

(iv) Prepare a plan for facilitating reassignment/transfer of NWSC employees to KVWA and other potential workplaces. Also, prepare an additional severance payment package (so-called “golden handshake”) for NWSC employees. Consolidate these as a set of policy conditionalities for a program -type loan.

(v) Draft clauses regarding conditions related to (former) NWSC employees, if any, and include them in draft MC contract documents.

10. Groundwater management specialist (I+D)

√ √ Work with the Groundwater Resources Development Board (GWRDB) for outside the Kathmandu Valley and with KVWA for the Kathmandu Valley to establish mechanisms for licensing and charging for use of groundwater.

√ (i) Evaluate the technical part of the proposals submitted for MC selection. (ii) Prepare a preliminary design for the demonstration scheme using additional bulk water from the

Manohara River (JICA project). √ Work with relevant government counterparts to make the best use of the accomplishments of the

Optimizing Water Use in Kathmandu Valley study.

11. Municipal engineer (I+D) The domestic municipal engineer will also assume the responsibilities of the deputy team leader, which are described under Position #2 above.

√ (i) Prepare preliminary engineering design in conjunction with the new loan project. (Note that the new loan project is not expected to finance any substantive capital investments. These investments are expected to be financed initially by reallocating funds under MWSP.)

(ii) Prepare cost estimates for the capital investments in conjunction with the new loan project. (iii) Prepare contract packaging for the new loan project. (iv) Prepare initial environmental examination report for the physical works involved with the associated

distribution network rehabilitation and improvement in conjunction with the loan project, together with matrices of potential environmental impacts of the policy actions to be included in the loan project.

12. Economist (I) √ √ (i) Carry out an economic survey of various currently available alternative water supply options. (ii) Carry out economic analysis of overall regulation for the designing of NWSRB. (iii) Help MPPW/NWSRB review the economic impact of the regular tariff schedule and alternative tariff

schedule for the demonstration scheme area, in particular on the poor. (iv) Define principles for basing decisions for tariff setting. (v) Help develop tariff level for different service levels to be adopted within the service area.

68 A

ppendix 17

MC

Recruit

NW

SR

B

KV

WA

PP

TA

Others

Position

A B C D E

Assignments

√ (i) Carry out economic feasibility analysis and alternatives consideration. (ii) Prepare a logical framework together with proposed tranche conditions and key performance

indicators/targets for the program loan part (i.e., NWSC restructuring) of the prospective SDP project. In collaboration with the labor relations specialists, carry out consultation sessions among relevant stakeholders to build consensus on the development of the logical framework.

(iii) Carry out a benefit distribution analysis and a poverty impact analysis. (iv) Carry out an affordability analysis on the proposed cost recovery arrangements.

√ (i) Update fixed asset registers. (ii) Prepare a mock budget for the prospective MC for the first year of its operation of the water supply

systems to assess the financial requirements for the MC. (iii) Prepare a 5-year financial projection and mock cost recovery plan to simulate financial viability of

the MC operations from its viewpoint. (iv) Carry out necessary financial analysis and measure for unbundling of NWSC between in-valley

and outside the valley services. √ (i) Estimate the costs of establishing NWSRB.

(ii) Identify all the potential sources of funding and subsidies, if any, for NWSRB. (iii) Help KVWMSC and MPPW (subsequently NWSRB) prepare a 5-year financing plan for NWSRB

(primarily by a surcharge on the water tariff) to ensure its sustainable operations. (iv) Define principles for basing decisions for tariff setting. (v) Help develop tariff level for different service levels to be adopted within the service area.

√ (i) Help KVWMSC and MPPW/KVWA develop a regular tariff schedule and an alternative tariff schedule for the demonstration scheme area for NWSRB's approval.

(ii) Estimate the costs of NWSC retrenchment. (iii) Estimate the costs of establishing KVWA. (iv) Identify all the existing and potential sources of funding/subsidies for KVWA, including portions of

MPPW budget, if any, that will be transferred to KVWA. (v) Determine the timing and amount of capital investment subsidies that will be provided under the

loan-grant blend financing of the Melamchi Water Supply Project (MWSP). (vi) Design financial mechanisms to charge for groundwater usage. (vii) Help KVWMSC and MPPW (subsequently KVWA) prepare 5-year financial projection and cost

recovery plan (including water tariffs, connection charges and other charges) to ensure financial viability of the KVWA operations.

13. Financial specialist (I+D)

√ (i) Prepare cost estim ates and overall financing plan for the loan project. (ii) Carry out financial feasibility analysis for the loan project.

14. Legal specialist (I+D) √ (i) Provide assistance for the transaction advisor and contract/procurement specialist in developing RFP documents, including a draft MC contract.

(ii) Help MPPW negotiate and reach agreement with the recommended bidder.

Appendix 17

69

MC

Recruit

NW

SR

B

KV

WA

PP

TA

Others

Position

A B C D E

Assignments

√ (i) Draft/refine legislation required for establishing NWSRB. (ii) Incorporate NWSRB in the draft Municipal Water Services Act. (iii) Help MPPW present legislation for NWSRB for approval and enactment. (iv) Take any additional legislative steps necessary to establish NWSRB. (v) Draft relevant clauses related to NWSRB and include them in the draft MC contract documents.

√ (i) Draft amendments to the existing NWSC Act, if necessary, for its transition to KVWA. (ii) Draft/refine legislation required for establishing KVWA. (iii) Help MPPW present legislation for KVWA for approval and enactment. (iv) Take any additional legislative steps necessary to establish KVWA.

√ (i) Review draft legislation for the proposed Municipal Water Services Act and prior studies on institutional/policy reform with relevant government officials.

(ii) Finalize draft legislation of the proposed Municipal Water Services Act. (iii) Help MPPW present legislation on the proposed Municipal Water Services Act for approval and

enactment. (iv) Help MWR prepare and enact legislation for licensing and charging for use of groundwater.

√ √ √ (i) Define the meaning of being poor as a matter of government policy; identify the people who fall under this definition; understand their needs, in particular the women, through consultation regarding service levels and affordability; develop a strategy to require the MC to facilitate pro-poor and gender-sensitive urban water supply service delivery in the Kathmandu Valley; and ensure its incorporation in draft MC contract documents and government investment programs.

(ii) Ensure that a regular tariff schedule and an alternative tariff schedule for the demonstration scheme area proposed by MPPW (subsequently KVWA) for NWSRB's approval are pro-poor.

√ (i) Prepare a resettlement plan for the new loan project, if necessary. (ii) Ensure that project components incorporate features to meet the needs of the poor.

15. Social development specialist (I+D)

√ (i) Facilitate levying decision-making regarding the interbasin water transfer from the relatively poorer Melamchi Valley to the relatively richer Kathmandu Valley in conjunction with MWSP.

(ii) Propose a new unit to support water supply service delivery to potential low-income customers with its institutional arrangements and implementation modality.

√ Keep the public updated on the status of MC recruitment in coordination with MWSDB and its public relations (PR) consultant.

16. Public relations specialist (I+D)

√ (i) Identify relevant stakeholders, establish contact with them, understand their interests and propose the ways in which these interests can best be served, and help establish a customers’ advisory committee to be incorporated in NWSRB.

(ii) Establish contact with other similar regulatory bodies in neighboring/other countries and/or international professional regulatory associations to obtain and update relevant information on utility regulation outside Nepal.

70 A

ppendix 17

MC

Recruit

NW

SR

B

KV

WA

PP

TA

Others

Position

A B C D E

Assignments

√ Establish contact with other similar agencies in neighboring/other countries and/or international professional water utility associations.

√ (i) Identify issues and topics of interest among relevant stakeholders, develop and implement means to gather feedback from the public on urban water supply sector reforms in the Kathmandu Valley to be conducted under the Project, compile information, and propose effective means for making the information available for the public.

(ii) Coordinate with the public relations efforts of MWSDB with regard to MWSP in general in cooperation with MWSDB's public relations consultant.

(iii) Hold stakeholders consultative meetings on a regular basis and prepare the minutes of meetings.

II. INDIVIDUAL INTERNATIONAL AND DOMESTIC CONSULTANTS

2. In addition to the main consultant team, ADB will recruit about three individual international consultants with the following expertise: (i) transaction advisory on MC recruitment; (ii) overall water supply utility management, focusing particularly on its finance; and (iii) physical planning of the water supply distribution network. A total input of 6 person-months is expected from these individual international consultants. Also, ADB will recruit about two individual domestic consultants with the following expertise: (i) overall water supply utility management, focusing particularly on its finance; and (ii) physical planning of the water supply distribution network. A total input of 4 person-months is expected from these individual domestic consultants. These individual consultants will assist the Government's counterpart staff, in particular during the initial few months of the TA before the main consultant team is recruited.

III. COUNTERPART FACILITIES

3. The Government shall provide and make available to the consultants, free of charge, the following facilities, services, equipment and materials:

(i) adequate number of counterpart staff, with appropriate qualification;

(ii) adequate office space, including furniture and utilities;

(iii) data gathering services to the extent required for the project and as far as available; and

(iv) one open domestic telephone line.

Appendix 17

71

IV. REPORT PREPARATION, PRODUCTION, AND TRANSMISSION

4. The following reports will be prepared in English and will be made available in hard copy (5 copies) and in electronic form (5 CD-ROMs) in a format satisfactory and suitable for use by the recipients:

(i) an inception report within one months of TA commencement;

(ii) an interim report within 4 months of TA commencement;

(iii) a draft final report within 11 months of TA commencement;

(iv) a final report one week after receiving comments from the Government and ADB; and

(v) brief (i.e. no more than three pages) monthly progress report at the end of each month when none of the above reports (i.e. (i) through (iii)) is due.