Document o f The World Bank

FOR OFFICIAL USE ONLY

Report No. 39371-YF

PROJECT PAPER

ON A

PROPOSED ADDITIONAL FINANCING LOAN

IN THE AMOUNT OF EURO 13.3 MILLION (US$18 MILLION EQUIVALENT)

AND A PROPOSED ADDITIONAL FINANCING CREDIT

IN THE AMOUNT OF SDR 6.6 MILLION (US$ 10 MILLION EQUIVALENT)

TO THE REPUBLIC OF SERBIA

FOR AN

ENERGY EFFICIENCY PROJECT

May 25,2007

Sustainable Development Department South East Europe Country Unit Europe and Central Asia Region

This document has a restricted distribution and may be used by recipients only in the performance o f their official duties. I t s contents may not otherwise be disclosed without World Bank authorization.

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cc ccs EAR ERR EU FSL IDA IBRD M O E M O H MOLSP M O M E PAD P I U PSC SA1 SDR SEEA

CURRENCY EQUIVALENTS (Exchange Rate Effective: April 30,2007)

CurrencyUnit = Euro

CurrencyUnit = SDR Euro 1 = US$1.36135

1 SDR = US$ 1.52493

FISCAL YEAR January 1 - December 31

ABBREVIATIONS AND ACRONYMS Clinical Center Clinical Center o f Serbia European Agency for Reconstruction Economic Rate o f Retum European Union Fixed Spread Loan International Development Association International Bank for Reconstruction and Development Ministry o f Education Ministry o f Health Ministry o f Labor and Social Policy Ministry o f Mining and Engineering Project Appraisal Document Project Implementation Unit Project Steering Committee State Audit Institution Special Drawing Rights Serbian Energy Efficiency Agency

Vice President: Shigeo Katsu

Sector Director Peter D. Thomson Sector Manager: Charles Feinstein

Task Team Leader: Varadarajan Atur

Country Director: Orsalia Kalantzopoulos

FOR OFFICIAL USE ONLY

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REPUBLIC OF SERBIA

Additional Financing for the Energy Efficiency Project

CONTENTS

INTRODUCTORY STATEMENT ........................................................................ 7

BACKGROUND AND RATIONALE FOR ADDITIONAL FINANCING ......... 8

PROPOSED CHANGES ........................................................................................ 9

CONSISTENCY WITH CAS ............................................................................... 12

ECONOMIC ANALYSIS ................................................................................... 12

APPRAISAL OF SCALED-UP PROJECT .......................................................... 13

EXPECTED OUTCOMES ................................................................................... 16

RISKS AND BENEFITS ...................................................................................... 16

FINANCIAL TERMS AND CONDITIONS FOR THE ADDITIONAL FINANCING ......................................................................................................... 17

This document has a restricted distribution and may be used by recipients only in the performance o f their off icial duties . I t s contents may not be otherwise disclosed without Wor ld Bank authorization .

DATA SHEET

Date Country

Project Name

Project ID

Borrower Responsible Agency

0512512007 Team Leader Varadarajan Atur Republic o f Serbia Sustainable Peter Thomson /

Development Sector Charles M. Feinstein Director/ Manager

Additional Financing for Country Director Orsalia Energy Efficiency Project Kalantzopoulos PO90492 Environmental B

Category Republic o f Serbia Government o f Serbia, mainly through the M o M E . Participating ministries and agencies include MOH, MOE, MOLSP, NiS Clinical Center and SEEA

buildings retrofitted would be increased. Does the scaled up project trigger any new safeguard policies? I No

FY Annual Cumulative

For Additional Financing

os 09 10 9.4 12.6 6.0 9.4 22.0 28.0

Current Closing Date Revised Closing Date

5

April 30, 2010 April 30, 2010

Does the scaled up project require any exceptions f rom Bank policies? Have these been approved by Bank Management I s approval f rom any pol icy exception sought f rom the Board

N o N/A N o

Total Bank Financing (US $ million) Proposed terms:

28.0 Standard IDA Terms, IBRD (FSL in Euro)

Source Borrower IBRD/IDA Others Total

6

Local Foreign Total (US$ million) 2.00 0.00 2.00 18.00 10.00 28.00 0.00 0.00 0.00 20.00 10.00 30.00

A. INTRODUCTORY STATEMENT

1. This Project Paper seeks the approval o f the Executive Directors to provide additional financing in an amount of US$28 mi l l ion equivalent to the Republic o f Serbia (Serbia) for the Energy Efficiency Project (Cr. 3870). The additional financing (US$18 mi l l ion equivalent loan and US$10 mi l l ion equivalent credit) would support the costs o f completion o f the current project (about US$8.0 million) and the costs associated with scaling up ongoing work under the current project (about US$20 million), thus completing the original scope o f the current project and increasing i t s impact and development effectiveness. The financing i s made available o n IBRD terms (FSL in Euro) for the loan and on standard IDA terms for the credit portion.

2. The principal aim o f the proposed additional financing i s to enable the government to complete the original scope o f the project (energy efficiency improvements in 3 social care buildings, 8 schools and 6 hospitals left out due to a cost overrun) and to scale up energy efficiency improvements to include: (a) rehabilitation of the heat supply system o f the NiS Clinical Center along with energy efficiency improvements in al l 17 contiguous buildings o n the campus; complete retrofitted lighting in 10 schools and partial lighting retrofit in 10 schools; and (b) energy efficiency improvements in an additional 7 social care buildings (such as orphanages), 20 schools and 11 hospitals across Serbia. Energy efficiency improvements in four buildings at the University o f Kragujevac wil l also be included.

3. The cost overrun under the ongoing project was encountered in both the Belgrade Clinical Center energy system upgrading and the building retrofitting components, which are attributed to higher supply and works costs and adverse US$ to Euro exchange rates. The cost for the Belgrade Clinical Center component was almost double the appraisal estimates (from US$7.47 million to US$15.35 mi l l ion equivalent), with Bank financing allocation increased from US$6.35 mi l l ion to US$14.05 million. The cost overrun under the building retrofitting component was about 40%, and hence the cost estimates were revised from US$12.36 mi l l ion to US$17.30. The resulting shortfall in the Bank financing i s about US$S.O mi l l ion under the current project after taking into account the allocation for contingencies.

4. There wil l be no cofinancing from other donors for this particular project. However, the project builds o n assistance provided by the EU through i ts European Agency for Reconstruction (EAR) in Serbia, mainly towards institutional development aspects o f SEEA and early demonstration projects. Subject to Serbia’s ratification o f Kyoto Protocol, emission reductions achieved through energy efficiency measures wil l be eligible for trade under the Clean Development Mechanism and will provide an additional income stream to be used to finance activities funded within and beyond the scope o f th is Energy Efficiency Project.

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B. BACKGROUND AND RATIONALE FOR ADDITIONAL FINANCING

5. Background: The original credit for the Serbia Energy Eff iciency Project in the amount o f SDR 14.1 mi l l ion (US$21.0 mi l l ion equivalent) was approved by the Board o f Executive Directors on March 16, 2004, and became effective on June 29, 2004. The project was designed to improve energy efficiency in heating buildings in order to make heating more affordable, as wel l as improve the functional and health environment o f the users. An additional associated objective was to reduce the local and global environmental impact from the use o f dirty fuels for heating buildings in Serbia. These objectives were to be achieved by financing (a) the replacement o f inefficient lignite and heavy oil-fired boilers, which would otherwise continue to be used, with a new gas-fired co-generation plant at the Clinical Center o f Serbia (CCS) in Belgrade. T o this end a gas pipeline to the CCS was extended by the gas supplier NIS-Energogas, f rom the nearest medium pressure gas pipeline about 4 kilometers away; (b) energy efficiency improvements in selected public buildings such as schools and hospitals throughout Serbia, including a maternity hospital in CCS; and (c) technical assistance for capacity building, developing methodologies for energy audits and investment proposals, public outreach, communications and monitoring and evaluation, and training o f municipal and government officials in evaluating capital expenditure decisions o n energy efficient investments. About US$16.4 mi l l ion out o f US$21 mi l l ion (78% o f the credit) have been committed in signed contracts, against which about US$7.1 m i l l i on had been disbursed (about 33% o f the Credit) as o f M a y 8, 2007, and bidding i s underway for remaining lots.

6. Despite some init ial delays, the first batch o f investments has proceeded o n track, with (a) energy efficiency improvements completed in 6 schools and 4 hospitals; and (b) design and preliminary works completed in the Belgrade Clinical Center, including replacement o f 15 o f the 55 substations in heating networks and shutting down o f 3 o f the 6 coal-fired boilers. The delays were mainly due to coordination problems init ial ly experienced by the inter-ministerial Project Steering Committee (PSC) and the finalization o f the tender package for the first lot, both o f which have been overcome at this time. The second batch includes 10 schools and 7 hospitals, plus a maternity hospital and lighting in 2 schools. Seven schools have been almost completed and commissioning is expected imminently, and works are almost completed on 4 hospitals. Lighting improvements at two schools were completed in February 2007. Bidding for the 3 remaining schools and the 3 hospitals i s underway. Due to the cost overrun, only the first two years’ program o f energy efficiency improvements in schools and hospitals could be completed with the original credit funds. Energy efficiency improvements have been monitored before and after the improvements undertaken in the 6 schools and 4 hospitals under the f i rst year program. About a 48% reduction in annual energy consumption was recorded in the f i rs t 3 schools, and about a 44% reduction in annual energy consumption in one hospital. Improvements o f similar range and order in al l the schools and hospitals selected in the scope are anticipated, leading to reduced energy consumption and better environmental & comfort conditions for the population (students, teachers, patients, medical personnel, etc.). Some municipalities have replicated the energy efficiency

8

improvements in other schools, using their own funds, after experiencing the significant energy s.avings.

7. Implementation progress (IP) and Development Objective (DO) ratings for the project have been satisfactory for over two years. The audit report has been found satisfactory and the project has not had any environmental, social or other safeguard problems. A thorough financial management review was conducted in December 2006 during which the Bank found some irregularities resulting in payment o f ineligible expenditures f rom the Special Account. The Ministry o f Mining and Energy refbnded this amount prior to the start o f negotiations. The review analyzed project transactions in depth and identified certain deficiencies in the area o f financial management, mainly related to the system o f internal controls. The corrective actions in the Financial Management Action Plan were implemented by the PIU prior to negotiations, and the financial management arrangements o f the project are now considered satisfactory.

8. Rationale: The team has considered several possible approaches for financing the project, including as a new operation or a repeater project. Processing this as a new operation i s not proposed in the interest o f maximizing cost effectiveness and timeliness in processing, so that the additional financing can complement the on-going activities. A credit/loan provided under an “Additional Financing” arrangement in accordance with OP 13.20 would leverage use o f the Borrower’s existing implementation capacity and utilize existing implementation arrangements for the existing project. The proposed additional financing wil l help Serbia go beyond the technology demonstration pilots and help overcome several barriers to the development o f the energy efficiency market - in particular the lack o f information, lack o f coordinated policies, lack o f practical examples o f bringing together different government agencies that need to come together to realize the untapped potential o f energy efficiency in Serbia. Also, the additional financing will implement energy efficiency (demand side) and energy supply improvements in an integrated manner, maximizing energy savings and cost effectiveness o f the project. The additional financing wil l help set the stage for improving end-use efficiency in the residential sector by providing the necessary practical experience to public officials, which i s needed in order to take the necessary pol icy and tar i f f decisions, develop methodologies for energy audits and contractual arrangements for energy efficiency investments, and trigger development o f a market for energy efficiency services. The Bank would also help mobilize other donor assistance to promote energy efficiency measures. Once Serbia has ratified the Kyoto Protocol, there i s considerable potential for carbon finance investments; the project will take steps to prepare for capturing and monitoring greenhouse gas emission reductions.

C. PROPOSED CHANGES

9. The objective o f the proposed program will remain in l ine with the original development objective o f the Energy Efficiency Project. Continued energy efficiency improvements in schools and hospitals and social buildings are very much in l ine with the government’s priorities. The proposed project scope wil l comprise the fol lowing main components:

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(i) Component A: Energy System Modernization (US$5.94 million): Energy system modernization o f the NiS Clinical Center. The existing two coal-fired and two oil-fired boilers will be replaced by one gas-fired boiler and energy efficiency improvements in 17 buildings in NiS Clinical Center campus wil l be undertaken. The energy system wil l be designed taking into consideration energy efficiency measures in al l the buildings o f the clinical center, which will reduce the energy supply requirements for the same energy demand and will demonstrate the enhanced benefits f rom coordinated implementation o f efficient energy supply and demand components.

(ii) Component B: Energy Efficiency Improvements in Social Service buildings (schools, hospitals and orphanages) across Serbia (US$20.42 million). This component wil l finance the installation o f energy efficiency equipment and retrofitting in schools, hospitals, orphanages and other social care buildings. The investment program consists o f 26 primary schools and 4 buildings o f University o f Kragujevac, 33 hospitals (out o f which 17 in NiS CC) and 10 orphanages as wel l as complete lighting retrofits in 10 schools and partial lighting retrofits in 10 schools. El igible energy efficiency measures are: roo f insulation, including roofing; wa l l insulation; window replacement; basement ceiling insulation; piping insulation; balancing valves; thermostatic valves; automatic temperature control at the boiler or substation level; replacement o f boiler and/or burner; lighting. The lighting in the surveyed schools was found to be inadequate and poorly designed, often a source o f eye strain for the children. Based on experience gained during implementation o f the original project, working conditions (quality o f air, temperature and lighting) and social and demographic impact would be additional considerations in selection o f sites and buildings for retrofitting.

(iii) Technical Assistance (US$1.13 million): The TA under the proposed additional financing would help (a) the SEEA to provide technical support such as energy audits and monitoring and undertake external communications, including training o f officials; and (b) project financial management, auditing and incremental costs covering office space and facilities for the PIU, operating and maintenance costs o f equipment, vehicle, office supplies, utilities, communications costs, translation costs, and office equipment.

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Estimated Project Costs (US$ million)

1

2

rovements in social

Description Institutional arrangements - Project Management

Project Costs

Disbursement arrangements i Procurement

6 /

7 Implementation Schedule

Ither Complementary Changes Remarks The project would uti l ize the existing project management arrangements; some additional staff would be needed in the PIU and SEEA in order to implement the additional financing scope by the closing date o f the original project. Costs comprise additional loan o f US$18 m i l l i on equivalent and additional credit o f U S $ l O mi l l ion equivalent. The financing plan will be adjusted to reflect the changes in financing sources discussed in th is paper. Slight change to improve FM arrangements as reflected in Financial Management Act ion Plan, which was implemented pr ior t o negotiations. No change in the main disbursement arrangements except for a change in the percentage o f expenditures to be financed for al l activities to 100 percent. The procurement under the additional financing wil l be carried out in accordance with the Procurement and Consultants’ Guidelines, M a y 2004 and revised in October 2006. The additional procurement would require hiring o f some additional staff in PIU. No extension o f closing date envisaged The proposed program will be implemented over a 33

~~

month period. To be provided on a blend o f IBRD/IDA terms Borrower will provide the proceeds o f credit and loan to participating ministries and will bear a l l responsibility for debt service under the proposed credit and loan; no specific on-lending arrangements are anticipated.

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D. CONSISTENCY WITH CAS

10. The proposed project remains consistent with the Bank’s Country Assistance Strategy FY05-07 for Serbia, which aims to (i) create a smaller, more sustainable, more efficient public sector; (ii) create a larger, more dynamic private sector; and (iii) reduce poverty levels and improve social protection and access to public services. By improving the energy efficiency o f social service buildings (schools, hospitals, and orphanages), the additional financing wil l reduce heating costs and heating emissions, and thus reduce the drain on public resources. Discussions with the newly formed Government o f priorities for a new Country Assistance Strategy for FY08-10 are expected to begin in June 2007. I t is likely that energy efficiency wil l continue to be a priori ty o f the Government, particularly efforts to reduce pol lut ion and improve energy efficiency to make heating more affordable. Many o f the schools and hospitals selected for energy efficiency improvements are in remote areas where the incidence o f poverty i s significantly higher than in urbanized areas.

E. ECONOMIC ANALYSIS

11. An updated economic analysis was carried out on the modernization o f heating system (Clinical Center o f Serbia) under Component A, reflecting the actual investments and current (February 2007) operating costs, compared to the original analysis included in the PAD. Fuel prices have increased significantly since the original PAD was finalized, actual investments in the CHP are largely similar to appraisal estimates, but the investment in the heating system increased significantly. Accordingly the updated economic rate o f return (ERR) o f Component A would be 29.6% compared with 32.4% in original PAD. Further, after incorporating the costs o f the natural gas pipeline connection incurred by the Belgrade municipality and the supervision costs, the updated ERR would be 15.4% compared to 15.9% before changes to prices.

12. The above analysis does not include the value o f avoiding environmental damages due to the reduction o f pollutants from the plant. The environmental damage costs are significant, especially in the case o f the Belgrade Clinical Center, a facility within a densely populated (urban) area with a very short stack (chimney). A survey o f environmental damage costs was carried out based on which damage costs were developed for the Belgrade Clinical Center. The resulting ERR for Belgrade CCS (including conservative environmental damage costs) would be 21.2%, or about 5% higher than in the base case. The corresponding ERR for the proposed NiS CCS i s estimated to be about 24%, which would be higher when environmental benefits are incorporated.

13. Economic analysis was also carried out for the stand alone building retrofitting investments under Component By which yields an ERR o f about 10.5% excluding environmental benefits. Apart from the contiguous buildings in Belgrade and N i s clinical centers, most have a remote energy supply (e.g., district heating or electricity) and energy efficiency options entail significant variation with regard to economics, very often impacted by site-specific conditions and requirements. Finally, i t should be emphasized

12

that often, social considerations and clearly unacceptable conditions (e.g., very l o w temperature and/or inadequate lighting in the school classroom) warrant building retrofits.

F. APPRAISAL OF SCALED-UP PROJECT

14. Technical: The NiS Clinical Center, consisting o f 27 buildings, gets its heating and hot water f rom an o ld coal-fired plant and two oil-fired boilers. The coal-fired boiler i s at the end o f its operating l i fe and constitutes a safety and environmental hazard. The very low stack (less than 20 meters height) results in release o f pollutants at the ground level within a densely populated residential area. Inspections in the last few years have determined this plant to be unreliable, unsafe and failing to meet the relevant emission standards, and have determined that it should shut down. Also, most buildings o f the NiS Clinical Center are in need o f rehabilitation and energy efficiency improvements, which have the potential to reduce the energy supply needed. Coordination o f energy demand (efficiency) measures with the design o f a new, efficient energy supply system would also demonstrate increased benefits.

15. While Phase I o f this project has retrofitted many hospitals and schools, the number o f remaining buildings requiring energy efficiency measures i s vast and remains a priority for the Government. The project scale up will implement energy efficiency improvements at schools and hospitals across Serbia, consistent with the respective Sector Master Plans developed in consultation with the Bank. Thus, the scale up scope includes the Kragujevac University, Vranje Clinical Center, 32 schools, 3 5 hospitals and 10 social buildings as we l l as improved lighting in 20 schools. Based on technical and economic criteria agreed with the Bank, the Government prioritized candidate sites for energy efficiency improvements which include 124 schools, 40 hospitals and 15 social buildings. Subsequently, the Government has proposed to also consider social and demographic aspects with a view to include public buildings from poor regions. The SEEA wil l identify the specific sites for energy efficiency improvements under the project in consultation with the PIU, which wil l be reviewed by the Bank.

16. Financial: Counterpart fund requirements for the Project are modest and cover mostly subproject preparation costs. Based on submission o f annual budget proposals from the Ministries o f Mining and Energy, Education, Health, and Labor and Social Policy, the Ministry o f Finance wil l make the necessary provision o f funds in the budget for the counterpart funds as wel l as for withdrawal o f proceeds o f the Credit. Recurrent costs o f operating and maintaining investments are borne by the municipalities and the Health Insurance Fund, which wil l benefit from cost reductions due to efficiency improvements.

17. Social: There are no issues related to land acquisition, resettlement or social safeguards in the project. The building efficiency improvements undertaken have already demonstrated positive social impacts (see also Section G) and the project i s expected to widen such impacts through the additional financing and scale up o f the scope. Regarding the ongoing energy system modernization at the Belgrade CCS, there are already visible

13

and perceptible impacts due to the shut down o f three o f the six coal fired boilers and reduced pollution, with benefits expected to be even greater after the completion o f the new gas fired system by end-2007. The new systems are expected to require less staff (25 instead o f the current 50 at Belgrade CCS, as one gas fired boiler wil l replace 19 coal and fuel o i l fired boilers) and the PSC is taking steps to minimize impacts o n affected staff through retraining o f qualified staff, early retirement and natural attrition, etc.

18. Institutional: The existing arrangements include a PIU with staff and facilities financed under the ongoing credit for day-to-day management o f the project, and an inter- ministerial project steering committee (PSC) led by the Ministry o f Mining and Energy, for coordinating and overseeing overall implementation o f the project. All the participating ministries - health, education, social pol icy - are represented on the PSC. The SEEA provides support for energy audits, technical review, monitoring, etc. These arrangements have been functioning wel l and will be continued for the additional financing project also. The PIU wil l be strengthened through additional staffing in technical and financial management areas to handle the expanded scope o f the project.

19. Environmental: The proposed program extension does not change the environmental category o f the project (Category B), as al l impacts are expected to be positive. An Environmental Assessment report will be prepared for the NiS Clinical Center Component as part o f the feasibility study, which i s expected to be completed by December 2007. Completion and disclosure o f an Environmental Assessment (EA) and Environmental Management Plan (EMP), including public consultations as per OPBP 4.01, i s set as a condition o f disbursement towards Component A o f the Project. An EMP for the energy efficiency retrofitting was prepared during the original project and will continue to be used in the additional financing. Installation o f a modem energy supply system at NiS Clinical Center, and energy efficiency measures in schools, hospitals and social buildings are expected to have a positive impact on the environment. The installation o f the energy supply system at NiS would be a major improvement o f the local environment, as i t replaces an old and highly pol lut ing system consisting o f a coal- fired boiler and two small oil-fired boilers. None o f these boilers has environmental control equipment, with emissions (particulates, SO2 and NOx) being released at ground level within densely populated residential areas; also there is no dust control and ash is being disposed o f in an open area without any dust control measures. The new energy supply system will eliminate the particulates, SO2 and ash, and reduce significantly NOx and C02. Also, they will eliminate dust as there i s no need for transport o f coal, open storage and handling facilities and disposal o f ash.

20. The project, including the energy supply system at N i s and the energy efficiency measures in al l the buildings, will lead to a significant reduction o f greenhouse gas emissions (C02), which could also generate Certified Emission Reductions (CER) for trading after Serbia ratifies the Kyoto Protocol.

21. Procurement: Procurement arrangements wil l be similar to the ongoing project, but wil l be in accordance with the Bank’s latest procurement guidelines. The relevant

14

thresholds for prior review and for procurement methods wil l be as under the ongoing project. The procurement plan contemplated i s shown below.

Description of Component A- Investment at CC NIS Gas boiler, steam generator, gas pipe Connection Pipe network and heat Substation Indoor installation Design and supervision Total Component A

No. of bid Cate- Cost Proc. Bid Contr. Contr. packages gory Est. 11 method Bid Inv. Opening Signing Compln.

1 G 1,125 ICB May08 July08 Aug08 Sept.09

1 W 0,793 NCB May08 July08 Aug 08 Aug.09

1 W 3,028 ICB May08 July08 Aug08 Sept.09 1 CS 0,495 QCBS Oct.07 Dec.07 Feb.08 Mar.10

I 5,441 I B- Investment in Public Buil Retrofit of schools, hospitals and social buildings Civil works First year Second year Heating systems First year Second year Lighting First year Second year Design and supervision Total component B C- Technical assistance Incremental operational costs Annual financial audit SEEA - Eqpt for measuring SEEA - Social survev Total component C

ings

4 W 6,474 ICB Jan.08 April 08 May08 Oct.08 4 W 6,979 ICB Sep.08 Dec.09 Jan.09 Sept.09

2 W 1,262 NCB Jan.08 April08 May08 Oct.08 2 W 1,389 NCB Oct.08 Jan.09 Feb.09 Sept.09

1 W 0,550 NCB Feb.08 May08 June08 Oct.08 1 W 0,550 NCB Nov.08 Feb.09 Mar.09 Sept.09 2 CS 1,720 QCBS May07 July07 July08 Mar.10

I 18,924 I nla other 0,930

1 CS 0,040 LCS annually 1 G 0,050 Shopping

Several CS 0,110 CQllndiv Sep.07 Oct.07 Nov.07 Dec.07 -1

I/: Excluding contingencies and subproject preparation costs

22. Financial Management: Perceived corruption in the country i s high. State Audit Institution (SAI) has not been established yet, although the Law o n S A I was passed in November 2005. Internal audit s t i l l has relatively l o w capacity and needs to gain experience. Sound financial management arrangements have now been instituted for the project in order to address the aforementioned risks.

23. During the financial management supervision in December 2006, the Bank identified several control weaknesses and financial management issues. The system o f internal controls for the project has recently been considerably strengthened by implementation o f an agreed action plan which addressed weaknesses identified during supervision. Following the implementation o f the agreed action plan, the current financial management arrangements are satisfactory to the Bank to ensure use o f hnds for

15

intended purposes. There are no overdue audits under the ongoing project. Financial Monitoring Reports (FMRs) are submitted timely to the Bank and reliability o f the reports i s satisfactory.

Category

(1) Goods, including supply and

24. Disbursement Arrangements: The existing disbursement arrangements wi l l continue for the additional financing project. During negotiations, the Borrower indicated that it preferred to disburse simultaneously from the Loan and Credit, in the proportion o f 70% and 30% respectively. The Bank agreed to the split provided that the Borrower ensures that the PIU wil l handle the split and submit two applications, one for the IBRD portion and one for the IDA portion. The allocation o f financing proceeds i s as follows.

Amount o f Amount o f Financing IBRD Loan IDA Credit Percentage

(US$ mi l l ion (US$ m i l l i on es.1 es.1

10.2 1 5.50 100% installation (2) Works 5.00 2.85 100% \ I

(3) Consultants’ services

(4) Incremental operating costs including auditing services

1.63 0.88 100%

0.60 0.33 100%

G. EXPECTED OUTCOMES:

(5) Unallocated TOTAL

26. The project wil l enhance achievements and outcomes o f the Energy Efficiency project, increasing the number o f clinical centers and the number o f schools, hospitals and orphanages to be retrofitted. The expected outcomes are: (i) improvements in quality o f heating, air and lighting in social buildings and surroundings o f project boundaries; (ii) health improvements o f targeted population measured through surveys; (iii) energy savings and corresponding reduction in expenditures for energy in the municipalities; and (iv) lower expenditures for the health insurance fund through energy savings. Social surveys conducted by SEEA have confirmed the satisfaction and enhancement o f comfort levels reported by the target population. Another beneficial outcome would be potential carbon credits accruing f i om the project through reduced carbon intensity and avoided carbon dioxide emissions, which could be traded when Serbia ratifies the Kyoto Protocol.

0.56 0.44 18.00 10.00

H. R I S K S AND BENEFITS:

27. Risks: The main risk associated with the project i s potential delays due to the complexity o f the project (number o f components and 70 to 80 sites spread throughout the country), the ability o f SEEA to provide adequate technical and administrative

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support, and inefficient review process. Phase I o f the project highlighted these as the most critical issues. Below i s a summary o f the project risks with the mitigation measures.

Risk Delays due to high volume o f activities and 80 sites, and inability o f the consultant to mobilize adequate qualified staff

Delays due to inefficient review process

Inadequate capacity at P IU and SEEA to support the project

Rating Risk Mitigation Measures Separate energy survey/audit from design and supervision work. H i re multiple contractors, each focusing on one region o f Serbia

High

Streamline performance o f the Steering Committee and strengthen P I U capacity

Project will provide adequate resources for PIU Moderate and SEEA to hire more staff

Moderate

28. Benefits: The project wil l continue to monitor the measurable benefits using the same indicators as for the original project. Expected benefits are measured through the following: (a) improvement in air quality through reduction in emissions o f local air pollutants (sulfur dioxide, nitrogen oxide, and particulates) and greenhouse gases (carbon dioxide) produced by the boilers used by the Clinical Center for meeting i t s heat demand; and (b) energy savings o f the retrofitted public and social buildings, and cost o f heat per square meter. The results achieved and monitored at the four completed and monitored buildings retrofitted show (a) about 47% savings in energy consumption, from 3417 MWh to 1812 MWh or 1142 k W m 2 to 568 kWWm2; and (b) about 52% reduction in C 0 2 emissions equivalent, f iom 915 tons to 477 tons. The project wi l l also aim to monitor through surveys the increased end-user satisfaction measured through improvement in indoor air quality, indoor temperature, and perception surveys o f improvement in comfort o f students, improvement in learning conditions and health with lighting (level o f Lux and eye diseases), patients and residents, etc.

I. FINANCIAL TERMS AND CONDITIONS FOR THE ADDITIONAL FINANCING

29. The original financing was provided on IDA credit terms. The additional financing will be a blend o f IBRD Loan and IDA Credit, totaling US$28 mi l l ion equivalent (US$18 mi l l ion equivalent, IBRD; and US$10 mi l l ion equivalent, IDA). Serbia has selected a FSL on standard terms (in Euro, with repayment over seventeen years with a five year grace period). The IDA Credit will be with a twenty year maturity and a ten year grace period. The Borrower wil l provide the proceeds o f the credit and loan to participating ministries to undertake the specific energy efficiency improvements under the project. Accordingly, as under the existing project, the Borrower will bear al l responsibility for debt service under the proposed credit and loan and n o specific on- lending arrangements are anticipated.

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