Document of The World Bank

FOR OFFICIAL USE ONLY

Report No. 52221-BR

PROJECT PAPER

ON A

PROPOSED ADDITIONAL FINANCING LOAN

IN THE AMOUNT OF US$326.775 MILLION

TO THE

STATE OF Sa0 PAULO (BRAZIL)

WITH THE GUARANTEE OF THE FEDERATIVE REPUBLIC OF BRAZIL

FOR A

SA0 PAULO STATE FEEDER ROADS PROJECT

June 23,2010

Sustainable Development Department Brazil Country Management Unit Latin America and Caribbean Regional Office

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

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CURRENCY EQUIVALENTS

(Exchange Rate Effective 0 1/15/20 10)

AADT CETESB CPS DER-SP

DR GPN HDM IADB IBRD ICB IRI IRR NPV QCBS ROW TORS UN UCPPR US$

Currency Unit = Real (R$) R$1.78= US$l

FISCAL YEAR

January'l -December 3 1

ABBREVIATIONS AND ACRONYMS

Annual average daily traffic State's Company for Technology in Environmental Sanitation Country Partnership Strategy State of Sao Paulo road administration (Departamento de Estrada de Rodugem do Estado de Suo Paulo) Regional Directorates General Procurement Notice Highway Development and Management Model Inter American Development Bank International Bank for Reconstruction and Development International Competitive Bidding International Roughness Index Internal rate of return Net present value Quality and Cost-Based Selection Right of Way Terms of Reference United Nations DER'S Coordination Unit for Externally-financed Projects US dollar

Vice President: Pamela Cox Country ManagedDirector: Makhtar Diop

Task Team Leader: Eric Lancelot Sector ManagerDirector: Aurelio Menendefiaura Tuck

1

I . I1 . I11 . IV . V . VI .

FOR OFFICIAL USE ONLY BRAZIL

S A 0 PAUL0 STATE FEEDER ROADS ADDITIONAL FINANCING

CONTENTS

Introduction ........................................................................................................................ 1

Background and Rational for Additional Financing in the amount US326 Million .. 1

Proposed Changes ............................................................................................................... 3

Appraisal Summary ........................................................................................................... 6

Benefits and Risks ............................................................................................................... 9

Financial Terms and Conditions for the Additional Financing ................................... 10

ANNEX 1: Revised Result Framework and Monitoring Indicators ....................................... 11

ANNEX 2: Risk Framework ....................................................................................................... 15

ANNEX 3: Detailed Description of New Project Activities ..................................................... 16

ANNEX 4: Economic Analysis ................................................................................................... 20

ANNEX 5: Safeguard Policies .................................................................................................... 26

ANNEX 6: Procurement Plan .................................................................................................... 32

ANNEX 7: Financial Management and Disbursement Arrangements .................................. 35

ANNEX 8: Documents in the Project File ................................................................................. 37

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

.. 11

BRAZIL

bate: June 23,2010 Country: Federative Republic of Brazil Project Name: Silo Paulo State Feeder Roads Additional Financing ,

Original Project ID: P106663 AF Project ID: P118077

S A 0 PAUL0 STATE FEEDER ROADS ADDITIONAL FINANCING PROJECT PAPER DATA SHEET

Team Leader: Eric Lancelot Sector DirectodManager: Laura TucWAurelic Menendez Country Director: Makhtar Diop Environmental Category: B ORAF rating: n.a.

Borrower: State of Si0 Paulo, Brazil Responsible agency: Departamento de Estrada de Rodagem do Estado de Sao Paulo (DER- SP) Revised estimated disbursements (Bank FY/US$M) (Original project + AF) FY 2010 201 1 2012 2013 2014 Annual 140.0 260.0 66.0 15.65 11.77 Cumulative 140.0 400.0 466.0 48 1.65 493.42 Current closing date: June 30, 2014 Revised closing date [if applicable]: n.a. Does the restructured or scaled-up project require any exceptions from Bank policies? XYes o N o Have these been approved by Bank management? XYes o N o Is approval for any policy exception sought from the Board? oYes X N o Revised project development objectives/outcomes [If applicable/ n.a. Does the project trigger any new safeguard policies? No.

[XI Loan [ ] Credit [ 3 Grant For LoandCreditdGrants: Total Bank financing (US$): 326,775,000.00 Proposed terms: Commitment-linked, US$ denominated IBRD Flexible Loan with variable spread with all conversion options, repayable in 30 years, including 5 years o grace and level principal repayments.

Financing Plan (US$M.) (AF)

For Additional Financing

Source Local I Foreinn 1 Total Borrower 82.00 82.00 IBRD 240.00 86.78 326.78 Total 322.00 86.78 408.78

Source Local Foreign Total Borrower 418.05 93.72 51 1.77 IBRD 369.99 123.44 493.43 Total 788.04 217.16 1005.20

Financing Plan (US$m.) (Original project + AF)

... 111

BRAZIL

S A 0 PAUL0 STATE FEEDER ROADS ADDITIONAL FINANCING

I. Introduction 1. This Project Paper seeks the approval of the Executive Directors to provide an additional financing (AF) loan to the State of Silo Paulo in Brazil in an amount of US$326.775 million, for the Bank-financed Silo Paulo State Feeder Roads Project (the Parent Project). The proposed additional loan will help finance (a) anticipated cost overruns of works under the Parent Project in about 700 km of the 1,500 km of road sections to be rehabilitated under the Parent Project, and (b) costs associated with the scale up of the Project’s physical component, by providing financing for the rehabilitation of about 1,200 km additional paved feeder roads. Overall, the Parent Project and Additional Financing loans are expected to help finance the rehabilitation of 2,700 km of municipal roads.

11. Million 2. In 2007, the State administration launched the Prb-Vicinais Program (the Program) aiming at rehabilitating all deteriorated paved municipal feeder roads in the State, a network of roads covering an overall extension of 12,800 km (details on Program current status are given in annex 3). These paved feeder roads constitute the backbone of the road networks of the 645 municipalities in the State and a key access between the State’s major agricultural and industrial production areas and its main transport corridors. Given the limited financial and technical capacity of most municipalities, the State has been financing the progressive paving of these roads and managing their maintenance for the past 30 years. In spite of these efforts, by the mid 2000’s, the condition of the roads had deteriorated to the point where over 60% of the roads were in poor condition. This situation prompted the Silo Paulo Government to launch the Program, expected to contribute to substantially improve the condition of the municipal paved roads. 3. As of today, close to 6,350 km of roads have already been rehabilitated, works are underway on an extension of 1,400 km, and bidding processes are being carried out on an additional 3,260 km. Over 80% of the works under the Program are expected to be completed by December 2010. As further detailed in annex 3, the program is phased with an overall cost estimate of US$1.875 billion. The first three phases amounting US$1.3 billion, are partially funded by the Silo Paulo Government’s general revenues, for US$980 million, the IADB, for US$180 million, and the Bank, for US$145 million under the Parent Project. The state Government has asked additional Bank support to cover anticipated cost overruns of the eligible expenses and finance a scale up of the Parent Project which will contribute to closing the financing gap under the Program in an amount of US$550 million. Of this amount, US$230 million would be financed from general revenues and US$320 million from the proposed additional financing. 4. The Board approved the Parent Project (Sa0 Paulo Feeder Roads Project- P106663 - loan number 7688-BR) on July 9, 2009 for a loan amount of US$166.65 million, including US$145 million to finance works under the Program. The Project became effective on October 28, 2009. The Parent Project’s original and unchanged development objective is to improve the efficiency

Background and Rational for Additional Financing in the amount US326.775

1

of the Borrower’s paved municipal road network. Efficiency will be improved as a result of improvements in the conditions of the paved municipal road network combined with enhancements to the institutional framework of the Borrower in four key areas to deliver adequate transport conditions to users: planning, environmental licensing, participation of private sector, and execution). 5, The Parent Project includes two components:

> a Feeder Roads Rehabilitation component (US$154.65 million), covering the eligible expenditures generated by the rehabilitation of approximately 1,500 km of municipal roads under the Program, the cost of consolidating the State Road Agency’s (DER-SP) capacity to manage its road investment programs, including the Pr6- Vicinais Program and, as needed, the rehabilitation of sections of State paved roads enhancing the connection between the rehabilitated municipal paved roads and the State and Federal paved road networks for an amount of up to US$lO million; and

> an Institutional Strengthening component (US$12 million) to support the structuring and management of the State investment program, the modernization of the State’s environmental management system, the consolidation of planning and logistics capacity in the transport sector, the improvement of public sector execution capacity in the road sector, and the strengthening of the capacity of municipalities to define and implement mechanism for sustainable maintenance of municipal networks.

6. Both the progress toward achieving the Parent Project development objective and the implementation performance are rated satisfactory. In particular, close to 60% of eligible civil works under the Parent Project are already completed in a satisfactory fashion, from a technical and safeguards perspective, with expectation of full completion by September 20 10. Under the institutional strengthening component, the main activities are currently being tendered. These activities are expected to start in the second semester of 2010 and should be completed by the Project closing date. Disbursements under the loan have reached US$154 million (or 92% of the loan amount) in about 8 months since loan effectiveness. Rationale for additional financing 7. The Borrower sees investments in infrastructure as a key measure to deal with the negative effects of the global crisis. However, following a reduction in fiscal revenue growth of 15% from 2008 to 2009, the Borrower anticipates an additional 10% reduction from 2009 to 2010, which will limit its ability to finance priority investments, including the Program. 8. The need for additional Bank financing for scaled-up activities to cover the Program financing gap was identified early by the State. During the preparation of the Project, the State indicated to the Bank that it had sought Federal Government authorization to borrow additional resources from the Bank in support of the Program (see paragraph 23 of the Project Appraisal Document, Report N. 43255-BR). The two main reasons for which Bank support was not initially structured as a single loan, were: > the Parent Project was an opportunity for the Bank to re-engage with the State of Sao Paulo

in the road sector (the last related Bank project closed at the end of the 1980s). As the partnership between the SBo Paulo Government and the Bank consolidated during Project preparation, the Government decided to expand such partnership through this proposed additional financing; and

2

>

9.

Federal Government authorization for new State borrowing is conditional upon a satisfactory State’s government’s fiscal situation. A review is undertaken annually which includes the setting of new borrowing ceilings. In turn, the State government allocates annually its new borrowing space across its various priority expenditure programs. In the case of S9o Paulo State which has a large number of priority expenditure programs, this process results in a fragmented approach to new borrowing. In 2008, the feeder roads program to be funded by the Bank was thus limited to US$166.65 million, and the Parent Project was prepared and approved by the Board with this borrowing limit. It was only in 2009 after the finalization of the Parent Project preparation that a new authorization to initiate the preparation of the operation aiming at borrowing an additional US$326.77 million was granted by the Federal Government,

The proposed AF is fully in line with the Bank’s Country Partnership Strategy 2008-201 1 (CPS - Report #42677-BR) discussed by the Board on May 1, 2008, including a macro foundation (macro fundamentals, good governance and public sector management) and three pillars (equity, sustainability and competitiveness). The CPS also recommends that the Bank be engaged at the sub-national level with states led by highly-motivated Governors, on programs which are of high priority and have political support. The proposed AF will support Bank assistance on the competitiveness pillar to a State with good macro fundamentals on a high priority program which has political support both at the state and municipal levels. It would also support the Government closing the financing of the Program in the context of the global crisis.

111. Proposed Changes 10. The development objective of the Additional Financing is the same as for the Parent Project: to improve the efficiency of the Borrower’s paved municipal road network. The proposed AF is a combination of financing for the anticipated cost overrun and the scale up of the Parent Project’s civil works component. The AF will finance: Part 1 (a) Feeder Roads Rehabilitation Works

(i) Financing of anticipated cost overrun of works to be financed under the Parent Project covering approximately 700 km of eligible road sections; and (ii) Carrying out of rehabilitation works on approximately 1,200 km of additional specific sections of the Borrower’s municipal paved road network not included in the Parent Project, that have been identified as eligible road sections’ under the 4 first phases of the Pro-Vicinais Program, including, inter alia: (A) rehabilitation of existing road bases and surfaces, as well as of bridges; (B) rehabilitation of shoulders to protect the shoulders’ surfaces from erosion and improve the driving conditions; (C) road safety improvements, including horizontal traffic signaling; and (D) rehabilitation and upgrading of drainage systems;

(b) Project Management Consolidating DER-SP’s capacity to manage its road investment programs, including the Prd- Vicinais Program. The allocation of proceeds for the Parent Project and AF is presented in the table

As per eligibility criteria defined for the Project (see PAD section 1I.C. 1. and annex 3 of present AF) I

under the Revised Project Cost section below. 11, Anticipated cost overruns are mainly due to (a) an unfavorable evolution of the US$/R$ parity in the past months, when a substantial part of the Parent Project expenses has occurred, combined with an important adjustment of construction prices in Brazil late 2009; and (b) an underestimation of the costs of solutions of works at Parent Project preparation stage, based on prices observed in previous phases while technical solutions under the Program third phase, the major source of Parent Project spending, eventually needed to be stronger than under the previous phases to respond to more deteriorated conditions of the concerned roads. In this context, the Parent Project will finance the rehabilitation of about 800 km of eligible municipal roads, against 1,500 km initially planned. With the AF, total Bank’s support will reach 27% of the Program, against the adjusted 8% under the Parent Project and the Bank will finance the rehabilitation of about 2,700 km of roads. Institutional and implementation arrangements 12. The AF is expected to be implemented over a four-year period. The AF will not require a change of the Parent Project closing date of June 30, 2014. Institutional and implementation arrangements, which proved to be robust under the Parent Project, will remain identical. Specifically, (a) the Borrower is the State of Sao Paulo, represented by its Finance Secretariat; (b) the executing agency is the State Road Administration (DER-SP), in charge of executing the Program under a subsidiary agreement; and (c) within DER-SP, Program management is under the responsibility of the Coordination Unit for the Program (DER-SP PCU), with consulting firms’ support for preparation of engineering designs and technical and environmental supervision of civil works. These arrangements will continue for the AF. Likewise, the specialized consultancy services that have provided support under the Parent Project in procurement, financial management and project management will continue under the AF. Project outcome indicators 13. The Parent Project outcome indicators and targets remain unchanged for the AF since they were established at the overall Program level during Parent Project preparation. One new Intermediate Outcome Indicator, a Bank Core Indicator, is proposed in replacement of one of the Parent Project indicators to better measure the achievement of the intermediate outcomes of the project (see details in annex 2). The arrangements for result monitoring will remain the same as the ones used under the Parent Project. Revised Project cost 14. The revised project costs per component and loans disbursement schedule are presented in the tables below. Under category (l), the Borrower requested the possibility to include goods in the category of expenses eligible for Bank financing, so as to cover the purchase of equipments that would support activities for improved management of the road investment program. The request was reflected in the table specifying categories of Eligible Expenditures in the Loan Agreement and detailed in the table below.

4

Category Parent Project Additional Bank Financing Financing

( 1) Works, Non-Consultant services, and 145,000,000 100% Consultant Services under the Part 1 of the Parent Project

(1 ) Works, Goods, Non-Consultant 325,958,062.50 100% services, and Consultant Services under the Part 1 of the AF

(2) Goods, Non-consultant services, 12,000,000 100% Training, and Consultant services for the Part 2 of the Parent Project

(3) Unallocated 9,233,375

(4) / (2)Front-end Fee 4 16,625 Amount 816,937.50 pursuant to Section

2.03 of this Agreement in accordance with Section 2.07 (b) of the General Conditions

0 Amount payable pursuant to Section 2.07 (c) of the this Agreement

( 5 ) / (3) Premia for Interest Rate Caps and Interest Rate Collars

Total loan proceeds 166,650,000 326,775,000.00

Revised loans disbursement schedule (US$ million) t I I I I I I

Total

145,000,000

325,958,062.50

12,000,000

9,233,375

1,233,562.50

493,425,000

Parent Project

Additional Financing

Total

FY2010 FY2011 FY2012 FY2013 FY2014 Total

140.00 10.00 6.00 5.65 5.00 166.65

250.00 60.00 10.00 6.77 326.77 140.00 260.00 66.00 15.65 11.77 493.42

Parent Project Initial extension Revised extension 1,500 km 800 km

5

Additional Financing Cost Overrun 700 km Scale-up 1,200 km

Total Parent Project and AF 2,700 km

prior review and will need to be in compliance with the technical and safeguard provisions. Retroactive financing is expected to reimburse eligible works of the third and fourth phases of the Program executed up to one year before signature of the loan agreement. 16. All requests for withdrawal of loan proceeds will include a statement to the effect that the expenditures have not been financed by other external sources. The Operational Manual includes the procedures for the prior review of expenditures to determine their eligibility. Advance contracting in line with Bank guidelines is being carried out for the works expected to be procured as part of this AF.

IV. Appraisal Summary 17. The AF is structured following the same appraisal framework already developed for the Parent Project, at the technical, safeguard, and fiduciary levels. 18. The Parent Project Operating Manual was updated with complementary documentation on: (i) economic assessment, (ii) environment, with updated version of the environmental assessment, (iii) procurement, including bidding plan of the Prd- Vicinais Program fourth phase, and (iv) legal agreements. 19. In particular: (i) fiduciary and safeguard arrangements will remain the same as under the Parent Project and the AF will be implemented following exactly the same rules and procedures as adopted for the Parent Project; and (ii) civil works to be financed under the AF will be selected following the same selection criteria used under the Parent Project. Policy Exceptions

20. The Project requires a policy exception with respect to the limit for retroactive financing. Following consultations within the Bank and with the Borrower, Bank management agreed to increase the limit for retroactive financing to US$! 14 million, or 35% of the loan amount, above the 20% limit established in Bank policies, as: (i) delays at the federal level in authorizing the negotiations (due in part to an institutional restructuring in the National Secretariat of Treasury), combined with the relative exceptional implementing capacity shown by the Borrower under the Program are expected to result in about US$120 million of eligible expenditures paid by the Borrower by the time the Project legal agreement is expected to be signed; (ii) budget constraints and revenues shortfall for the Government in the context of the global crisis could put at risk the Government's capacity to achieve its 4-year targets under its Rural Roads Rehabilitation Program if not fully supported by Bank loan; and (iii) the Government showed strong desire to associate more deeply the Bank to its flagship Prd-Vicinais Program. The same exception was granted under the Parent Project. Economic analysis 21. During the preparation of the Parent Project, the economic analysis was based on an evaluation of the phase 2 of the Program, for which detailed data were available at the time of appraisal. This analysis was then expanded to the phase 3 considering the homogeneity of interventions expected under the Program. A new evaluation of the phase 3 was undertaken during AF preparation based on a lot per lot economic evaluation and confirmed that the execution of this phases would brin high economic returns to the State even when considering updated unit costs: the Program's 4' phase would reach a NPV of R$885 million at 12 percent discount rate, a ratio NPV/Capital cost of 0.77 and an economic rate of return of 40.7%.

fl

6

22. The methodology used to complete the economic evaluation of the AF including the Program’s 4th phase, was similar to the one adopted under the Parent Project (see details in annex 4). It consisted in undertaking the economic analysis of the phase 4 of the Program, including detailed costs and expected benefits per lot of works as defined at AF appraisal stage. The economic evaluation of the phase 4 of Program investments yields an overall net present value, at 12 percent discount rate over a 20 year period, of R$544 million, a ratio NPV/Capital cost of 1.2 and an economic rate of return of 20.5%. 23. Sensitivity analysis showed that under a worst-case scenario, including a substantial rise in costs by 20% and a cost benefit decrease by 20%’ the Program’s 4‘h phase would still yield significant benefits, with an economic rate of return of 15.8% and an NPV of R$478 million. Technical 24. The civil works to be financed under the AF will follow the same technical specifications (engineering design preparation and works execution) as the ones defined under the Parent Project including marginal improvements to take stock of the experience gained from the implementation of the Program’s previous phases. Such adaptations mainly include: (i) improved customization of the design, with smaller homogeneous segments, improved diagnostic of road conditions, and the execution of geological tests as necessary; and (ii) better understanding of local constraints for the execution of works, which notably led to the replacement of technical solutions not commonly used by equivalent and more often used solutions of works. Fiduciary 25. Procurement arrangements for the AF will be identical to those under the Parent Project. Procurement under the Parent Project has already taken place in accordance with the Bank guidelines, and will continue to be undertaken employing the ‘Guidelines: Procurement under IBRD Loans and IDA Credits’ and ‘Guidelines: Selection and Employment of Consultants by World Bank Borrowers’, versions dated May 2004, and revised in October 2006 and May 2010. Eight ICB processes for works covering the whole extension of the Program’s phase 3 have successfully been undertaken following Bank’s guidelines and procedures. Four additional ICB processes covering part of the Program’s phase 4 are being procured in the same manner and the same level of satisfactory progress is expected. Likewise, several processes of selection of consultants and procurement of goods, all with prior evaluation, are being undertaken in a satisfactory fashion. From a fiduciary perspective, the AF implementation will not entail additional risks than those identified during the preparation of the Parent Project. As such, the risk that DER-SP will not assume its fiduciary responsibilities in a satisfactory manner continues to be evaluated as low with respect to procurement. (See annex 6 for an updated Procurement Plan and further details.) 26. The Project’s financial management arrangements under the proposed Additional Financing are the same as the ones used under the Original Project and comply with OP/BP 10.02. The Financial Management arrangements of the Borrower in terms of the obligation of the AF were reviewed and found acceptable. Financial management and audit arrangements were considered satisfactory for the Parent Project and should remain satisfactory under the Additional Financing. In the Financial Management Assessment conducted in February 2008, the residual overall FM risk associated with the Parent Project was rated as moderate, and project accounting, financial reporting, information systems and internal controls were adequate and reliable to provide the necessary information to manage and monitor Project implementation. As

7

in the original loan, Interim Financial Reports (IFRs) will be sent to the Bank not later than 60 days after the end of each calendar semester, and the annual audit reports will be furnished to the Bank not later than six months after the end of each year. (See annex 7 for updated Financial Management details.) Social aspects 27. The AF will finance civil works of the same nature on road sections with the same characteristics as those civil works financed under the Parent Project (see details in annex 3). No new safeguards are triggered by this AF. The social risks associated with the AF are limited due to the nature of the proposed interventions. The road rehabilitation activities to be supported by the Project will take place within the existing rights-of-way (ROW) . These interventions usually do not entail the need for land acquisition or displacement of people (involuntary resettlement). However, should a few localized land acquisitions become necessary to improve road safety and traffic conditions (through treatment of accident-prone spots), DER-SP will use the Involuntary Resettlement Framework prepared under the Parent Project. The Framework is in accordance with Bank safeguard policy requirements. Moreover a comprehensive set of norms, laws and procedures are in place to identify and mitigate the potential social and environmental impacts of the interventions under the Project. These are consistently applied to all DER-SP works. Capacity to implement these norms is considered adequate. 28. Based on the assessment prepared by DER-SP, the Program will not impact indigenous populations or strictly protected areas. The Project will not harm any vulnerable groups (quilornbolas3 or c a i ~ a r a s ~ ) or other indigenous peoples. This is confirmed by the screening prepared by the State using a geographical information system: all road sections were plotted against protected areas and indigenous peoples’ lands to confirm that the proposed works would not affect these areas directly or indirectly. 29. A detailed evaluation of the management by the Borrower of the safeguard has been undertaken under the Parent Project during the preparation of the AF. The evaluation concluded that none of the works executed so far under the Program involved any resettlement or interference with indigenous population or indigenous areas. This was also confirmed, on a sample basis, through field supervision missions. Environmental aspects 30. The AF, just like the Parent Project, is classified as Category B, under OP4.01. No new safeguards are triggered by this AF. An updated Environmental Assessment was prepared for the AF and published in September 2009. Such assessment was included in the Operation Manual. The rehabilitation and maintenance works are limited to the existing platform of the feeder roads, mostly to the pavement, with limited ancillary interventions on the ROW. The potential adverse environmental impacts on human populations or environmentally sensitive areas impacts are site-specific and mostly associated with the construction phase of the works to be financed. Few impacts, if any, are irreversible and mitigation measures can be readily

2

* The ROW consists of the paved strip and the entire public-owned area reserved for the construction, operation, and maintenance of the roadside. ’ Quilombola communities are Afro-Brazilian descendents of escaped slaves which are today are among the poorest and most disadvantaged of all rural communities in Brazil on all socio-economic indicators. Found throughout Brazil, the highest concentrations of quilombola communities are located in the Northeast Region. ‘ The term Cui~arn is commonly used to describe artisanal fishermen or agriculturists of mixed African, European and Native South American descent living within the Atlantic Rain Forest.

8

designed and implemented, Due to the Program’s location and type of intervention it is not expected that the AF implementation will generate any significant indirect or cumulative impact. 31. The State of SBo Paulo and the DER-SP have a comprehensive legal framework and good implementation capacity to identify, mitigate and monitor social and environmental impacts related to road works. Institutions in charge of environmental and social agenda are overall adequately staffed and have widespread presence in the state’s territory. In addition, specialized consultants have been hired to support DER in undertaking environmental supervision of the works on a continuous basis: monthly reports and final environmental impact assessments at the end of each road works are being prepared. Such environmental supervision will be continued and strengthened under the new phase of the program. It should be noted that social impacts on road side dwellers and road users are also monitored by the environmental supervision which shall inform DER which will cause contractors and municipalities to adopt adequate mitigation measures. 32. An evaluation of the environmental management of works under the Program so far has been undertaken during AF preparation. Based on the results of this evaluation completed by Bank’s missions field visits during Parent Project supervision, it was found that the environmental management of works under the Program is being carried out in accordance with appropriate standards, as agreed upon with the Bank, and that therefore the risk linked to inappropriate management of works on an environmental and social point of view remains low.

Triggered safeguard policies

Safeguard Policies Triggered by the Project Yes No Environmental Assessment (OP/BP 4.01) [XI [ I Natural Habitats (OP/BP 4.04) [ I Ex1 Pest Management (OP 4.09) [ I [XI Physical Cultural Resources (OP/BP 4.1 1) Ex1 [ I Involuntary Resettlement (OP/BP 4.12) [XI [ I Indigenous Peoples (OP/BP 4.10) [I [XI Forests (OP/BP 4.36) [ I [XI Safety of Dams (OP/BP 4.37) [ I [XI Projects in Disputed Areas (OP/BP 7.60)* [ I [XI Projects on International Waterways (OP/BP 7.50) [ I 1x1

V. Benefits and Risks 33. Similar to the Parent Project, the AF will support a high priority State investment program which was structured by the present Governor and has strong support from the benefiting municipalities. Over the last 3 years, the State has proven that it has an adequate capacity to implement the Program, with more than 60% of the overall Program already completed (more than 6,000 km of municipal roads already rehabilitated). In addition, at Parent Project preparation and initial implementation, as well as during the AF preparation, the State has shown its strong commitment to the partnership with the Bank, undertaking preparation and implementation activities in a satisfactory and timely fashion. The overall level of residual risk

* By supporting the proposedproject. the Bank does not intend to prejudice the final determination ofthe parties’ claims on the disputed areas

9

associated with the implementation of the AF is assessed as low (see table of risk in annex 2). No controversial aspects are expected to result from the implementation of the proposed AF and mitigation measures under the Parent Project will continue to be applied in order to ensure the overall residual risk remains low. VI. Financial Terms and Conditions for the Additional Financing 34. The proposed lending instrument is a Specific Investment Loan (SIL), structured as a US$ denominated IBRD Flexible Loan with a variable spread option, commitment-linked with all conversion options, repayable in 30 years including a 5 years of grace and level repayment schedule.

10

ANNEX 1: Revised Result Framework and Monitoring Indicators Sao Paulo State Feeder Roads - Additional Financing

1, The Parent Project development objective, outcome indicators and targets globally remain unchanged for the AF as they were established at the overall Program level at preparation stage. However, it is proposed to change the indicator on the average percentage delay in the execution of civil works contracts concluded during a year, by one of the Bank Core Indicators, the number of km of municipal roads rehabilitated. Indeed, the indicator on the average percentage delay in the execution of civil works contracts was eventually considered not the best appropriate to measure the intermediate outcome as: (i) work contracts duration is short under the Program (8 to 10 months in average). As a result, any particular event beyond the handling of the DER-SP could potentially substantially alter the value of the indicator (such as an exceptionally long wet season), irrespective of any particular change in the performance of DER-SP in contracts management; and (ii) with a value of 8.1% for 2008 and 6.2% for 2009, the DER already exceeded by far the indicator objective by Project end as envisioned at Parent Project preparation. Arrangements for results monitoring 2. The responsibility for result monitoring for the Project will remain the same as for the Parent Project. It is shared between the different beneficiaries of the Parent Project and AF, in their respective areas of responsibility. The various Project coordinators will be responsible for reporting to DER-SP on a quarterly basis, information on, among others, procurement planning, certification of bills, progress in the activities underway, and achievement of intermediate outcome indicators. 3. The responsibility for the monitoring of Project outcome indicators (Parent Project and additional financing) will be split as follows: (i) DER-SP will monitor the values of the indicators on the reduction of economic costs to users on improved road sections, evolution of road condition, and satisfaction level of road users (with survey methodology to be developed by the State Statistics Foundation (SEADE)), as well as the number of engineering designs for rehabilitation investments defined by the PMS; (ii) the Secretariat of Environment will monitor the values of the indicator on the average time for issuing environmental licenses; (iii) the Secretariat of Transport will monitor the value of the change in employment levels in the feeder roads’ areas of influence, and will undertake the study to define the agenda to reduce logistics bottlenecks; and (iv) the Economic and Planning Secretariat will monitor the value of the indicator on level of private/external financing under road investment programs. 4. The two tables in the following pages present the Objectives, Indicators and Targets for the Project, with the adjustment indicated in the first paragraph of this Annex.

11

PDO

. evolution of condition of municipal paved road network , average percentage delay in civil works contracts concluded during a given year

Improve efficiency of the paved municipal road network

. evolution of condition of municipal paved road network . number of km of municipal roads rehabilitated

Intermediate Outcomes

Improved efficiency of the Prd- Vicinais program

Improved timeliness and quality of environmental licensing

Increased capacity to attract private/external financing for state investments

Improved state transport interventions’ efficiency

Improved efficiency in management of road rehabilitation investments

Project Outcome Indicators

, reduction of economic costs to users on paved municipal road network , satisfaction of road users on paved municipal road network

Intermediate Outcome Indicators

Original I Proposed

. agenda of public and private sector actions to reduce logistics bottlenecks agreed with key stakeholders , in a given year, % of engineering designs bid for road rehabilitation investments identified as priority by PMS for that year

Use of Project Outcome Information

. Monitoring of Government efficiency in undertaking the Prd- Vicinais program

Use of Intermediate Outcome Monitoring

. Evaluation (and as necessary adaptation) of the efficiency of the state’s Prd- Vicinais program

. Adoption of corrective measures during activities’ implementation for quality assurance and timeliness of products to be delivered. , Reallocation of funds

from non-performing to performing activitiedbeneficiaries as part of Project supervision.

12

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s 0 m 2 vi

N 0 0 9 -

- I 4 0 0

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0 0

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- I ,g m

0 0

2. s vi - 1 m

3 4

g m

0 8 8 e + .?

a m"

I ? s v, N

U

U

K <

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$ 8 3" < % E E

W

g W

Risk

State Government commitment to efficient AF implementation

State Government commitment to decrease following upcoming elections

Ability to handle procurement

Ability to handle financial management

Ability to handle safeguard policies

Overall Project risk

ANNEX 2: Risk Framework Sao Paulo State Feeder Roads -Additional Financing

Risk Rating

Low

Moderate

Low

Moderate

Low

Low

Risk Rating Justification/Mitigation Measure

0

0

0

0

efficient handling of Program’s first 3 phases good level of responsiveness during Project and AF preparation and Parent Project supervision AF supports program with strong champion Works under Program’s fourth phase already under bidding, part of which following ICB Bank’s procedures at least 2 supervision missions a year 0

0 Program has high political visibility and is likely to remain priority with the future State Government

0 All civil works expected to be undertaken under the Program will be contracted prior to the elections

0 Bank team to liaise with Silo Paul0 Government transition team and new Government team as soon as those are in place

0 executing agency has good track record in procuring externally-financed activities, and has a solid procurement unit. Procurement of the third phase has been handled efficiently. Procurement in support of the Parent Project has been handled efficiently.

0 training on IBRD procedures and regular missions by the team’s procurement specialist

0 executing agency capacity meets O P B P 10.02 minimum requirements

0 training on IBRD procedures (financial management and disbursements) and regular missions by the team’s financial management specialist

0 Borrower has sound safeguard framework and good experience in handling safeguard requirements of multilateral development banks

0 No safeguards issues with the Silo Paulo Government Program or the Parent Project.

Residual Risk

Rating Low

Low

Low

Moderate

Low

Low

15

ANNEX 3: Detailed Description of New Project Activities Sao Paulo State Feeder Roads -Additional Financing

1. Anticipated cost overruns and scale-up and of the Project’s Feeder Roads civil works component (US$326.775 million) 1. The proposed AF is a combination of anticipated cost overrun and scale up of the Parent Project’s civil works component. The AF will finance:

Detailed Description of New Project Activities

Part 1 (a) Feeder Roads Rehabilitation Works (i) Financing anticipated cost overrun of works to be financed under the Parent Project covering approximately 700 km of eligible road sections; and (ii) Carrying out of rehabilitation works on approximately 1,200 km of additional specific sections of the Borrower’s municipal paved road network not included in the Parent Project, that have been identified as eligible road sections7 under the 4 first phases of the Pro-Vicinais Program, including, inter alia: (A) rehabilitation of existing road bases and surfaces, as well as of bridges; (B) rehabilitation of shoulders to protect the shoulders’ surfaces from erosion and improve the driving conditions; (C) road safety improvements, including horizontal traffic signaling, and (D) rehabilitation and upgrading of drainage systems; (b) Project Management Consolidating DER-SP’s capacity to manage its road investment programs, including the Prd- Vicinais Program.

2. The allocation of proceeds for the Parent Project and AF is presented in the table under the Revised Project Cost section below. 3. Anticipated cost overrun is mainly due to (a) an unfavorable evolution of the US$/R$ parity in the past months, when a substantial part of the Parent Project expenses has occurred, combined with an important adjustment of construction prices in Brazil late 2009; and (b) an underestimation of the costs of solutions of works at Parent Project preparation stage, based on prices observed in previous phases while technical solutions under the Program third phase, the major source of Parent Project spending, eventually needed to be stronger than under the previous phases to respond to more deteriorated conditions of the concerned roads. In this context, the Parent Project will finance the rehabilitation of about 800 km of eligible municipal roads, against 1,500 km initially planned. With the AF, total Bank’s support will reach 27% of the Program, against 8% under the Parent Project. 4. Eligibility criteria for the selection of civil works to be financed under the AF are the same as those under the Parent Project, namely: (i) the technical solutions to be implemented need to follow the typology agreed upon under the Parent Project; (ii) an internal rate of return (IRR)

As per eligibility criteria defined for the Project (see PAD section I1 C I and annex 3 of present AF) 7

16

greater than 12%', (iii) civil works contracts tendered in accordance with procedures agreed upon under the Parent Project; (iv) environmental and social impacts identified and mitigated in accordance with procedures agreed upon under the Parent Project; and (v) engineering designs carried out following the Manual of procedures for engineering design and supervision of works. 5. The AF will finance eligible civil works under phases 3 and 4 of the Prd-Vicinais program. Both the 3rd and 4th phases (totaling 6,400 km) are expected to be executed between 2009 and 201 3 (see detailed status of the Program in the following paragraphs). Municipal paved roads are often the only paved link to the rest of the network for local populations and industries and as such, they play an essential role in the local setting both from an economic and social standpoint. They are characterized by relatively short extensions (typically between 5 and 40 km) and relatively high annual average daily traffic (AADT): in average, AADT is close to 700 vehicles per day, only 5% of roads are characterized by AADT below 300, while about 10% of roads support traffic above l,000/day (highs at 3,000-4,000). 2. Current status of the Program 5. As detailed in the Parent Project PAD, the Prd-Vicinais program is a State Government program launched in 2007, aiming at recovering the condition of the municipal road networks. These networks, which in total reach close to 12,800 km, have been paved about twenty years ago and most of the road infrastructure had reached the end of its life span in the mid 2000s. The program was gradually structured in 4 phases, two of which have already been substantially completed (totaling 4,650 km). Additional components of the Program include a set of 900 km of paved municipal roads, the maintenance and rehabilitation of which is included under state road concessions.

Prd-Vicinais Program status and financing

I Program I 81% I 10% I 8% I 63% I 10% I 27% I * rehabilitation and maintenance planned under ongo ing state road concessions.

Section II.C.1 ofthe PAD indicated erroneously 15%, when the Detailed Project Description of the PAD (Annex 4) gives 12%, IRR threshold 8

usually used for Road Projects.

17

First phase 6. Bidding for civil works was launched in August 2007 and works started in February 2008. Works under the first phase are now completed, with 2,115 km of municipal paved roads rehabilitated, covering 150 road sections in 199 of the 645 municipalities of the State (spread in 13 out of the 14 regions of the state), for a total value of R$457 million (US$233 million). 7. Basic engineering designs were prepared by DER-SP Direction for Engineering, with the support of a specialized consultant, on the basis of DER-SP regional units’ assessment of road condition and field experience. The same consultant also provided support to the DER-SP in the overall management of the phase and fostered the DER-SP in preparing the engineering projects under the 2nd phase. Meanwhile, consultants, generally one per DER-SP regional division, were hired to support the DER-SP in works supervision. Second phase 8. Bidding for civil works was launched in February 2008 and works started in October 2008. Civil works under the second phase are basically completedg, with partial financing from the IADB. The second phase includes the rehabilitation of 2,525 km of municipal paved roads, covering about 150 road segments in 200 municipalities, for a total cost of R$690 million (US$385 million). Building on the experience of the first phase, works were bid on the basis of executive engineering designs based on objective detailed (though visual) assessment of the road conditions to improve the works solutions. Works encompassed improved rehabilitation activities (e.g. including edge break repairs). Additionally, technical specifications were inspired by the methodology discussed with the Bank during the preparation of the Project, including normalized technical solutions and process of executions which were later included in the Project’s Manual of Procedures for preparation of engineering design and supervision of works (see Parent Project Operational Manual). 9. Similar to the first phase, the 2nd phase overall management by the road administration was supported by a consultant, also in charge of helping the DER-SP in preparing the projects under the 3‘d phase. Likewise, consultants were hired to support works’ technical and environmental supervision. Third phase 10. Most works financed under the Parent Project are being executed under this phase. Bidding for civil works was launched in April 2009 following Bank’s procurement procedures, and works started in September 2009. Works are underway, and are expected to be completed by December 2010. The third phase includes the rehabilitation of 3,115 km of municipal paved roads on about 257 road segments in 98 municipalities, for a total estimated cost of R$1.085 billion (US$600 million). Engineering designs have been prepared following the procedures of the Manual of Procedures for preparation of engineering design and supervision of works under the Program. This Manual was structured with the Bank during Parent Project preparation, and is included in the Project Operational Manual. The Operational Manual was updated for the AF. 1 1. Similar to the other phases, the DER-SP is supported by consultants for the management of the third phase. Road consulting companies and Environmental consulting companies support the DER-SP in the supervision of the works under the third phase. While these services are fully

One road section remained to be concluded at AF preparation 9

18

financed by the State, both the nature and the organization of this supporting structure was discussed and agreed upon with the Bank during Project preparation. Fourth phase 12. Bidding for civil works has been launched in April 2010, including 4 ICB processes following Bank's procurement procedures. Works are expected to start by September 201 0 and completion is expected by 2013. The fourth phase is expected to cover 3,260 km of municipal paved roads, on about 499 road segments, for an estimated cost of US$407 million. Engineering designs for this phase have been carried out following the procedures agreed upon with the Bank, mainly based on the procedures defined for the 3'd phase with the introduction of a set of small improvements resulting from lessons learnt from the previous phases. Main improvements included:

- Sectioning of solutions per homogeneous conditions - Characterization of the road structure through visual observation of edge breaks and, when

not conclusive, borrow pits - Elimination of surface treatment solutions from the catalogue of technical solutions as

these are not employed in the State and result in scarcity of adequate material and lack of capacity for more appropriate execution

- Use of particular solutions requiring pre-determined staff and equipment, notably recycling and micro asphalt, only above minimum thresholds trigged by economic worthiness; use of more classical palliative solutions otherwise.

13. Similar to the other phases, the DER-SP will be supported by consultants for the management of the fourth phase, namely, road engineering consulting companies and environmental consulting companies will support the DER-SP in the supervision of the works. Again, while these services will be fully financed by the State, both the nature and the organization of this supporting structure was discussed and agreed upon with the Bank during Project preparation.

19

ANNEX 4: Economic Analysis Sao Paulo State Feeder Roads -Additional Financing

1. General context 1. The Prd- Vicinais Program intends to rehabilitate the State’s paved municipal networks. The objective of the Silo Paulo Government’s Program is to treat a major part of the network (or about 12,000 km) of which about 2,700 km are to be financed under the Parent Project and its Additional Financing. 2. Summary of methodology and results of the economic analysis 2.1 Scope of the appraisal 2. Paved road rehabilitation works are among road investments with the highest economic return, In addition, road sections under the Prd- Vicinais program share similar characteristics and defaults, to be remedied by a set of similar technical solutions. During Parent Project preparation, an economic evaluation of the Prd-Vicinais program’s phases 2 and 3 was undertaken (no evaluation of phase 1 was undertaken as the necessary data was not available). This economic evaluation confirmed that the execution of phases 2 and 3 would bring high economic returns. It also confirmed the Program’s overall viability, given the relative homogeneity of the road sections conditions and needed works. Taking into account the above, the scope of the economic appraisal for the Additional Financing (which would finance parts of Phase 3 and 4) complements the evaluation undertaken at Parent Project appraisal, including : (i) an updated economic analysis for phase 3, with the latest data available; and (ii) the economic analysis of the Program’s phase 4. 2.2 Methodology 3. The economic analysis of the Parent Project included a network evaluation completed by a project by project evaluation of the rehabilitation works to be executed under the Prd- Vicinais program. This evaluation was realized by the DER of Silo Paulo using the Highway Development and Management Model (HDM-4) that performs a Cost Benefit analysis of roads investment and maintenance projects using the Consumer’s Surplus approach. A similar approach was used in the new evaluation, including an economic evaluation of each individual lot of road investment of the Program’s phases 3 and 4. 4. The Project benefits mainly consist of the reduction of vehicle operating costs and passenger time costs, together with maintenance costs reduction to the road agency when compared to the reference scenario (a “do minimum” scenario including only routine maintenance and reconstruction when the infrastructure triggers a deteriorated situation). Additional benefits to road users which have not been quantified include reduced accidents, improved driving and riding comfort. Following the same methodology as for the Parent Project economic appraisal, the Project externalities on environment (including global warming), expected to be negligible or even positive, were not taken into account in the analysis. 5 . The Program was analyzed by assessing the actualized streams of benefits to road users over the study period and savings on maintenance costs (as compared to the without Program case) net of the costs of the proposed road works. The yearly discount rate used was 12%.

20

2.3 Summary of benefits and costs

provided in the table below. For the Pr6-Vicinais 4th phase, a summary of the revised economic evaluation's results are 6.

Project capital costs (R$ million) I Net "esent Value (R$ million) Internal Rate of Return (YO)

Phase 3 Phase 4 1,153 453

885 544.3 40.70% 2OSOYo

7. The soundness of the Program's 3rd and 4th phase economic viability is confirmed, with respective NPV of R$885 million and R$544 million at a 12% discount rate and respective IRR of 40.7 and 20.5%. The respective ratio of NPV/Capital cost is 0.77 amd 1.2. 8. The economic analysis showed that for this class of roads, the direct costs for the DER-SP of implementing today rehabilitation followed by a well-calibrated maintenance (including routine and periodic maintenance) were less than the costs of a future emergency rehabilitation program (id est total reconstruction when road deterioration reaches a critical stage). 3. Transport characteristics on the paved municipal road networks 3.1 Current network condition and traffic 9. The current network condition and traffic data of the target roads included in the third and fourth phase of the Program were obtained through visual qualitative estimates on-site by DER- SP local representatives and road specialized local consultants. The following table presents the paved network length statistics in terms of traffic and road condition expressed in qualitative terms (subjective evaluation of the pavement condition). The evaluated paved network of the Program's 3rd phase has an aggregated length of about 3,130 km, the 4'h phase of about 1,730 km. The network is quite homogenous in terms of traffic and road conditions with overall more deteriorated conditions of road structure for road sections under the 3rd phase and higher traffic than under the 4'h phase. Details of road conditions are given in the table below for the Program's 3rd phase while under the 4'h phase. Annual Average Daily Traffics (AADT) range from 100 to 200, with an average of 130, and average IRIs, per lot, range from 4.7 to 5.4. Worst sections have IRIs around 7.5.

Fair Poor Critical TOTAL

1450 4501 1650 6501 <950

>950

Traffic

TOTAL

3.2 Road Costs 10. evaluation are provided in the following table:

For routine maintenance, the average unit costs used for the purpose of the economic

IRI < 4.0 4.0 5 IRI 1 5.0 5.0 5 IRI 7.3 km 151.3 km 10.0 km 5 yo

45.9 km 546.24 km 102.2 km 22% 170.7 km 1 199.9 km 100.5 km 47% 131.5 km 652.1 km 15.5 km 26%

1 1 % 81% 7% 100%

21

Code

Routine MR

General MG

Routine Drainage MD

11. For road rehabilitation, the costs factored in the economic appraisal were the engineering projects’ costs estimates. The following table presents the most recent average unit costs for road works.

Phase 3 Phase 4 R$/km R$/km

5,071 .OO 9,360.00

35,100.00 50,700.00

2,099.00 2,340.00

Work Class Work type Routine

Routine General

3.3 Vehicle Operating Costs 12. The following table presents the average vehicle fleet characteristics used for appraisal,

Predominant Work activity Economic cost Routine maintenance 9,360 R$km General maintenance 50.700 R $ k m

I IESA loading factor I 2.961 2.961 7.51 10.831 14 171 10.831

4. Paved municipal roads rehabilitation and maintenance evaluation 4.2 Network Rehabilitation and Maintenance Strategies 13. For HDM evaluation purposes, the following typology of works was used to evaluate the Prd- Vicinais Program, based on the planned works resulting from the detailed design. Detailed matrixes were prepared for each lot and the matrix below summarizes the broad assumptions.

22

Fair (IRI<3)

Reconstruction AC3 + PP 5% to 15% PP 5% R + AC3 + PP 5 to 15%

Poor Critical 7 5 IRI 3 5 IRI < 7

AC3: 3 cm Asphalt Concrete Layer PP: Pothole Patching

14. hypotheses:

HDM was run on each lot of works, taking into consideration the following maintenance

without project alternative: routine maintenance including vegetation clearing, drainage cleaning, pothole patching (1 OO%), and rehabilitatiodreconstruction when IRI >7 topped with asphalt concrete (except for the two first years of the project).

with project alternative: the above projected rehabilitation works, the routine maintenance of the without Project alternative completed by a periodic maintenance consisting in the resurfacing with asphalt concrete when IRI reaches 4.5.

4.3 Net Benefits of the Rehabilitation and Maintenance Activities 15. The following table details the net present value (NPV) and internal rate of return (IRR) respectively of the 98 lots and 16 lots of the Prb-Vicinais program phase 3 and 4. Overall, this phase presents NPV respectively of R$885 million and 544 million at a 12% discount rate. The average IRR on phase 3 and 4 is respectively estimated at 40.7% and 20.5%. 5. Sensitivity analysis 16. A sensitivity analysis was realized to assess the results' robustness when costs and benefit hypotheses are altered. Assuming that project costs are 20% higher than estimated and project benefits 20% lower than expected, the IRR of the rehabilitation and maintenance activities would still be respectively 33.15 and 15.8% and the NPV R$ 790million and 478 million for the 3rd and 4th phases of the Program.

17. confirmed to be particularly robust.

Overall, the economic viability of the 3rd and 4th phase of the Prd-Vicinais program

23

Detailed results of the economic evaluation per Lot - Pro-Vicinais program phase 3

24

Detailed results of the economic evaluation per Lot - Pro-Vicinais program phase 4

AVERAGE

IRI -.I

Bid DR REGION LOT m AADT v " . I .

RESULTS

NPV(MR$), I IRR ~

I

25

ANNEX 5: Safeguard Policies Sao Paulo State Feeder Roads -Additional Financing

1. The Parent Project is a Category B with the Environmental Assessment, Physical-Cultural Resources, and Involuntary Resettlement policies triggered. No new safeguards are triggered by this Additional Financing and the Project remains Category B. The Environmental Assessment has been updated to consider the roads under the AF. The observations made on the Parent Project apply to the AF, unless otherwise noted.

2. The AF activities are expected to have negligible impacts on the environment and society. The implementation of the previous phases of the Prd- Vicinais Program has demonstrated the limited impact of these activities on the environment and society. Impacts are limited due to the fact that: (i) the roads are already paved and have been in operation for years, (ii) roads are located in already vastly human altered landscaped, (iii) all the works are expected to be located in the existing ROW, (iv) there will be no need for realignments of existing roads, (v) identified environmental impacts, expected to occur mostly during works phase, are of limited magnitude, site-specific and reversible, and well-known mitigating measures exist and are currently employed; and (vi) the implementing agency has a good capacity to identify and mitigate impacts.

3, Potential negative direct impacts include: (i) limited need for land acquisition; (ii) interference with natural areas; (iii) degradation of areas that source materials for works; (iv) construction accidents; and (v) noise and vibration caused by the works. Indirect and cumulative impacts, such as land cover land use changes at the roads environs are expected to be negligible, as the municipal roads benefiting from the Project are located in one of the most intensively used productive landscapes and densely populated areas in Brazil. Additionally, the roads have been paved for long time.

4. Mitigation measures for environmental and social impacts are well known and do not pose institutional or legal challenge to be implemented. DER-SP has a sound set of policies, procedures and standards to handle social and environmental impacts. These are consistently applied to all DER-SP works. Finally, mitigation measures for social and environmental impacts can be readily designed and implemented, within the aforementioned institutional context.

5. The Borrower and the Project’s implementing agency have a comprehensive legal framework and good implementation capacity to identijj, mitigate and monitor environmental impacts related to road works. DER-SP’s environmental advisory group (Assessoria Ambientat) has developed, with support from the Inter-American Development Bank an environmental management system (EMS) structured in line with the IS0 14001/2004 standard. The current EMS comprises policies, procedures, manuals and technical solutions catalogue for handling appropriately environmental questions related to road works. The different types of civil works are categorized according to the level of necessary scrutiny and care. Environmental licensing and monitoring procedures are streamlined and well established. Mitigation measures are well known and do not represent an implementation challenge, especially with respect to simple

26

works, such as rehabilitation works. The Bank has reviewed these documents and found them consistent with the Bank’s safeguard requirements.

6 . The Project will also generate positive social and environmental impacts. In addition to expected positive outcomes and impacts related to reduced transportation costs and increased accessibility to markets and public services, the Parent Project and AF will contribute to: (i) improve road safety conditions; (ii) correct road drainage, avoiding erosive processes; and (iii) correct older remaining environmental liabilities, such as erosions.

7. Based on the assessment prepared by DER-SP, the Additional Financing will not have impacts on indigenous populations or strictly protected areas. It should be noted that none of the works under the Program (phases 1, 2 and beginning of phase 3) involved any involuntary resettlement or interference with indigenous population and indigenous areas.

8. Additionally, the project will not result in any signijkant impact or conversion of natural habitats. The project works which eventually take place on water crossings and may affect minor stretches of riparian vegetation require specific authorizations by DEPRN and DAEE. These authorizations set forth the mitigation or compensation mechanisms to be complied with by contractors. Compliance with these requirements is monitored regularly by the Environmental Supervision contracted by DER.

9. The institutional jiamework and capaciv, in place at the state and implementing agency levels for preventing and mitigating social and environmental impacts, is deemed to be satisfactory. A comprehensive set of norms, laws and procedures are in place to identify, prevent and mitigate social and environmental impacts of investment projects. Capacity to implement these norms is considered adequate. Institutions in charge of environmental and social agenda are overall adequately staffed and have widespread presence in the state’s territory. The state has also a very active Ministe‘rio Pziblico (Brazilian institution representing the people and civil society) to oversee public sector compliance with its own norms and procedures.

10. The process of environmental impact management and licensing has been simplified for road rehabilitation and maintenance since 2002 according to the state law. The system is based on two levels of environmental impacts management for road works:

P Significant impacts on environment, comprising activities in sensitive milieu, such as protected areas or areas with native vegetation, which require prior Specific authorizations granted by the State Environmental Agency (CETESB);

> Minor reversible impacts on non-sensitive milieu in the areas contingent to the works within the ROW, such as borrow pits, material disposal, construction site and service way. Any such minor non-compliance to DER’S technical environmental specifications under this category of impacts detected by the environmental supervision triggers a Notification of environmental non-con formity treated either at the local or at the central level, depending on the magnitude of the impact. Upon notification, contractors must remedy the problem according to the technical standards defined by the DER (e.g. on erosion control, re-vegetation of areas subject to earthworks). The non treatment of notified minor non-conformities by the contractors within the deadlines fixed by the

27

norms triggers a range of sanctions, from non-payment of executed works until resolution of the non-conformity to fines.

11. Additionally, the corpus of laws and norms on environment imposes the environmental licensing of any unit of production of intrans in the road works, such as that asphalt plants, quarries, concrete plants etc.

12. Overall, the respect of environmental norms and standards has been satisfactory so far under the Prd- Vicinais program. In particular, as identified under the safeguard compliance assessment carried out by the team for the AF, the average number of minor reversible impacts which triggered non-conformities has been low (a total of 0.0077 non-conformities/km x year under first stage of the program and 0.0064 non-confonnitiedkm x year under the second stage of the program) and all triggered non-conformities have been remedied in a timely manner (less than 30 days in average).

13, To ensure that contractors are in compliance with environmental and social requirements under the current Parent Project, DER-SP has contracted external environmental supervision of works. The environmental supervision activities will be expanded to cover works to be financed under the AF. In particular, environmental management of the works under the Prd-Vicinais III are currently supervised by 3 specialized consulting companies, reporting directly to DER’S Environmental Advisory unit, hired following terms of reference agreed upon with the Bank, which follow the principles detailed below for the next phase.

14. The Environmental Supervision of works is being carried out following the technical specijkations within the SGA (Environmental Supervision of Road Works ET-DE-S00/002 Supervisgo Ambiental de Empreendimentos Rodoviarios). This technical specification defines the scope of activities, periodicity, routines and reporting duties for the environmental and social supervision of all DER-SP road works. The Bank has reviewed the Terms of Reference of the environmental supervision and found them satisfactory. The environmental supervision, as stipulated in its Terms of Reference, should oversee works execution and report the occurrence of any negative social and environmental impacts to contractors, local DER staff and to DER environmental advisory in order to ensure the timely mitigation of any negative impact, should this occur.

15. As per the Terms of Reference (and in line with the actual environmental supervision), the environmental supervision of the Program’s fourth phase will consist of regular field visits and monthly environmental monitoring report of the works, that includes: (i) registration and analysis of the proposed environmental programs situation; (ii) assessment of the compliance with environmental requirements in the environmental licenses and authorizations issued by CETESB (e.g. installation of industrial plants), DEPRN (vegetation suppression and natural habitats), DAEE (water crossings) etc; (iii) timely notifications of any issues that could compromise the environmental quality and safety of works;(iv) regular monitoring of any social impacts on road side dwellers and users; and (iiv) analysis of environmental compliance, providing eventual recommendations for the Regional Unit (DR) responsible for coordination of the SGA within the DER-SP to take action in case any issues arise. Under the aforementioned assessment of compliance with environmental requirements, licenses and authorizations, the environmental

28

supervision ensures the screening of eventual impacts on natural habitats and proper implementation of mitigation measures.

16. The environmental supervision of works will therefore, as it currently does, verify the fulJillment of DER-SP technical specifications related to the environment, resettlement and physical cultural property also for the new works to be executed under the Program's fourth phase. The environmental supervision will assess if preventive, mitigating, corrective and compensatory measures of forecasted environmental impacts in the Plan for Environmental Control of Construction (PCA) of the Project are being satisfactorily implemented. Finally the Environmental supervision will verify if the established requirements in the environmental licenses and authorizations and the social impacts related to construction services are being fulfilled. As per the Terms of Reference of the Environmental Supervision, any social impacts are to be monitored constantly and any issues social are to be reported to DER-SP Environmental Advisory for action. All mitigation measures, environmental and social, are to in accordance with the frameworks agreed with the Bank".

17. Upon completion of the works a j n a l report will also be prepared by the Environmental Advisory team and sent to Sdo Paulo 's Environmental Impact Assessment Department (DAIA), containing: (i) evaluation of the environmental quality of services, (ii) demonstration of the DER-SP and contractor's implementation of the requirements of the licenses and authorizations, (iii) indication of expected procedures to be managed until the completion of works. Under the work contracts, sanctions are foreseen if contractors fail to comply with works environmental requisites.

As per the Loan Agreement prior to carrying out any civil works under the Project, the Borrower shall cause DER-SP to submit to the Bank evidence that environmental and social impacts have been identified and planned mitigation measures defined, in accordance with the provisions of the Updated Environmental Assessment and the involuntary Resettlement Framework, as applicable.

10

29

Triggered Bank’s Safeguards Policies

18. The Bank safeguards that have been triggered include Environmental Assessment / OP 4.01, Physical Cultural Resources / OP 4.11, and Involuntary Resettlement / OP 4.12. Environmental Assessment and Involuntary Resettlement Frameworks have already been prepared under the Parent Project. The Parent Project’s Environmental Assessment was updated for the AF and the Parent Project’s Involuntary Resettlement Framework remains applicable for the AF.

Triggered safeguard policies Safeguard Policies Triggered by the Project Yes No Environmental Assessment (OPBP 4.01) [XI [ I Natural Habitats (OP/BP 4.04) E1 Ex1 Pest Management (OP 4.09) [ I [XI Physical Cultural Resources (OP/BP 4.1 1) [XI [ I Involuntary Resettlement (OP/BP 4.12) [XI [ I Indigenous Peoples (OP/BP 4.10) [ I [XI Forests (OP/BP 4.36) [ I [XI Safety of Dams (OP/BP 4.37) [ I [XI Projects in Disputed Areas (OP/BP 7.60)* [ I [XI Projects on International Waterways (OP/BP 7.50) El [XI

19. Environmental Assessment /OP 4.01: the Borrower updated the Parent Project’s Environmental Assessment to analyze the potential adverse impacts of the new roads to be financed under the AF and proposed a set of institutional strengthening activities (additional to those already being implemented under the Parent Project).

20. The environmental assessment provides a description of DER-SP environmental management system. The report include inter alia: (i) a description of the project; (ii) social and environmental description of the project area; (iii) legal and institutional framework for the project’s social and environmental management; (iv) procedures for consultation in the municipalities benefiting from the project; and (v) details of the environmental monitoring procedures to be used by DER-SP in the project. It should be highlighted that all of these items mentioned above are part of DER-SP environmental management system which comprises norms, procedures and standards. Finally, the report outlined the activities targeted on the institutional strengthening component which would include improvements in the aforementioned procedures and standards, their review, streamlining and capacity building for their widespread use in DER-SP’s decentralized units (DR).

21. Field visit during Bank supervision missions confirmed the appropriate handling of environmental issues in undertaking works under the Program in compliance with the EA requirements. The EA was updated for the AF including the new set of roads envisioned in the

* By supporting the proposedproject, the Bank does not intend to prejudice the final determination of the parties’ claims on the disputed areas

30

Program’s fourth phase. Such roads were again screened to evaluate any possible impact on protected areas, or indigenous or other fragile peoples. No such impacts are expected.

22. Involuntary Resettlement/OP 4.12: Though no land acquisition has been required under the Prci-Vicinais so far (phases 1, 2 and 3), OP 4.12 has been triggered and the Parent Project’s Resettlement Policy Framework will apply to this AF in the case that any land acquisition or involuntary resettlement is needed.

23. The Involuntary Resettlement Framework establishes that compensation values should be based on the replacement value of the land and assets. It should be noted that the roads benefiting from the Project are under the municipal jurisdiction. Therefore, to carry out civil works, DER-SP has to sign a partnership agreement (conv2nio) with each municipality, establishing mutual obligations between DER-SP and the municipality. Typically, the municipality would be responsible, with DER-SP’s technical assistance, for any involuntary resettlement issue. Full compliance with DER-SP social and environmental requirements will be a sine-qua-non condition for the civil works to take place and DER-SP is bound to ensure compliance with Bank policy on involuntary reselttlement. Non-compliance with agreed-upon mitigation measures on behalf of the municipality is subject to legal remedies, including the suspension of works. The Involuntary Resettlement Framework prepared for the Parent Project will be followed for the AF. No resettlement or land acquisition was necessary under the Program so far.

24. Physical Cultural Property - OP/BP 4.1 1 : Under Brazilian legislation, provisions for the protection of cultural property are part of the environmental licensing procedures. The National Institute for Historical and Cultural Heritage (IPHAN) is the Brazilian institution responsible for handling archeological and cultural property issues. Whenever “change findings” occur it is mandatory for DER-SP to seek IPHAN’s support to address “chance findings” issues. Chance finding procedures are included in the DER-SP Environmental Management System’s (SGA IP- DE-S00/003) and will be included in the works contracts.

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ANNEX 6: Procurement Sao Paulo State Feeder Roads -Additional Financing

1. Procurement under the Additional Financing will be carried out following the same arrangements as under the Parent Project, in accordance with the World Bank’s “Guidelines: Procurement under IBRD Loans and IDA Credits” dated May 2004, revised in October 2006 and May 2010; and “Guidelines: Selection and Employment of Consultants by World Bank Borrowers” dated May 2004, revised in October 2006 and May 2010, and the provisions stipulated in the Additional Financing Legal Agreement. The procurement methods to be used under the additional financing are detailed below. International Competitive Bidding for works and Quality and Cost Based Selection for consultant services methods are part of the procurement methods used under the Parent Project and have already been successfully used under advanced procurement in line with Bank guidelines and procedures. An initial procurement plan (detailing procurement methods, need for prequalification, estimated costs and prior review requirements) has been prepared during project preparation, and will be updated at least annually or as required to reflect the actual Parent Project and AF implementation needs. 2. The Parent Project is being carried out through the Stio Paulo State Roads Department (DER-SP). The result of the procurement assessment conducted during the Parent Project preparation was that, overall, the legal framework, the procurement capacity and arrangements and organization in place were satisfactory. The implementation by the DER-SP of the bidding processes under the Parent Project in an efficient manner confirmed this evaluation. The risk for procurement thus continues to be evaluated as low for the AF and no additional actions need to be undertaken to ensure the readiness of the DER-SP for the planned procurement processes. 3. In particular, the tendering of the civil works of the 3rd phase of the Program, reviewed by the Bank, has been successfully undertaken in 2009 following Bank’s procedures. The results showed an adequate level of competition with 96 different bidders for the 97 lots, an average of 6 proposals per bidder, an average of 5.7 proposals per lot and the lowest evaluated price at an average 4.5% below the DER-SP budget estimate. So as to further improve the quality of the bidding results, the following actions have been agreed upon: (i) an increased integration of the bidding packages for eligible works of the 4‘h phase, if possible combined in the same package; and (ii) an improved combination of road sections under lots of larger size, whenever operationally worthwhile. Both measureshave been taken into consideration for the packaging of the new ICB for the Program’s 4‘h phase launched early 2010.

1. Procurement Arrangements 1.1 Procurement Methods

a. International Competitive Bidding (ICB). All works, respectively goods and non-consulting services contracts estimated to cost US$25,000,000, respectively US$5,000,000 equivalent per contract or more, will be procured under contracts awarded on the basis of ICB procedures. All ICB contracts shall be prior reviewed by the Bank. b. National Competitive Bidding (NCB). Procurement of works estimated to cost less than US$25 million and procurement of goods and non-consultant services estimated to cost less than US$5 million per contract, may be procured through the national competitive procurement method under Law 8,666/93 (concorrencia). Additionally, for non-consulting services and goods estimated to cost less than US$5 million per contract, the method known as pregao eletronico

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under Law 10,520/02 can also be used. The Procurement Plan shall specify the circumstances under which such methods may be used. c. Shopping, Procurement of works estimated to cost less than US$500,000 equivalent per contract and goods and non-consultant services estimated to cost less than US$lOO,OOO per contract can be procured through the Bank shopping procedure. The use of pregao eletronico will be allowed as an alternative in the case of goods and non-consultant services. d. Direct contracting, when justified and in accordance to Clause 3.6 of the Procurement Guidelines. e. Quality and Cost-Based Selection (QCBS). These procedures could be used for consulting services and training contracts. f. Selection based on Consultants’ Qualifications (CQS). These procedures could be used for small assignments for which the need for preparing and evaluating competitive proposals is not justified according to 3.7 of the Guidelines. g. Least-Cost Selection (LCS). These procedures could be used for consulting services, contracts, costing less than US$200,000. h. Individual Consultants Based on Qualifications (IC). These procedures could be used for assignments which meet the criteria specified in Section V of the Guidelines. i. Single-Source Selection (SSS). These procedures could be used for assignments which meet the criteria specified in Section I11 of the Guidelines.

1.2 Advertising 4. A General Procurement Notice (GPN) was published in UN Development Business online (UNDP online) and in the Development Gateway’s dgMarket on November, 24 2009, in the UNDB-online on November 25,2009, and in the UNDB paper issue 764 of December 16, 2009. The AF Procurement Plan was sent to the Bank and agreed upon on December 5 , 2009 and is found in paragraph 2 below. In addition, invitations to bid for works under ICB procedures and requests for expression of interests for consultant contracts expected to cost US$200,000 or more will be advertised in UNDB online, DgMarket, the Official Gazette of the State of Sao Paulo as well as in appropriate newspapers of national circulation or electronic portal of free access. At preparation time, all works given in the Procurement Plan below have been duly advertized and bid, and the bids are under evaluation.

1.3 Bank Reviews 5. The proposed prior review thresholds for the AF are the same as for the Parent Project, US$15,000,000 for works, US$5,000,000 for goods non-consulting services and US$200,000 for consulting services.. All ICBs shall be prior reviewed by the Bank regardless of the amount involved as well as all eligible contracts subject to retroactive financing.. In addition to the prior review supervision to be carried out from Bank offices, at least one annual procurement post-review mission will be carried out during Project implementation. The ratio of Bank reviews shall be not less than one in 20 contracts

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1.4 Reporting Requirements 6. The reporting on procurement will include procurement monitoring tables for both the Parent Project and the AF activities. The schedule of submission to the Bank by DER-SP will remain on a semester basis. Such tables will include the foreseen and actual timelines of the various steps related to the procurement of each contract included under the Project.

2. Details of the Procurement Arrangements Involving International Competition a. Works and Non Consulting Services (i) List of contract packages to be procured within the first 18 months of the Additional Financing execution:

KM Bidding District Procu Pre Dom Rev by rernent qual pref Bank

1

2

3

3 - Bauru 250 33 ICB No No Prior Apr-10

4 - Araraquara 136 20 ICB No No Prior Apr-10

8 - Riberao Preto 352 57 ICB No No Prior Apr-IO

14 - Barretos 150 25 ICB No No Prior Apr-10

9 - S . J . Rio Preto 469 67 ICB No No Prior Apr-10

1 1 -Aracatuba

12 - Presidente Prudente 4

27 1 34 ICB No No Prior Apr-10

93 15 ICB No No Prior Apr-10

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TOTAL 1721 252

Ref. No. Description of Assignment Estimated

cost (US$ million)

1 Works Supervision for phase 4 of Pr6- 6 Vicinais program of eligible expenditures

exDenditures 2 Environmental supervision of eligible 2

Selection Review Method by Bank Proposals

(Prior / Post) Submission Date

QCBS Prior 1212009

QCBS Prior 1012009

ANNEX 7: Financial Management and Disbursement Arrangements Sao Paulo State Feeder Roads -Additional Financing

1, The additional financing will amount US$326,775,000.00. The Bank would finance 100% of the categories of Eligible Expenditures, as detailed in Section IV of the Loan Agreement. Financial Management (FM) under the Additional Financing will be carried out following the same arrangements as under the Parent Project. Details of these arrangements can be found in Annex 7 of the PAD of the Parent Project. Updated information relevant to the AF is outlined below. 2. The Project’s financial management arrangements under the proposed Additional Financing are the same as the ones used under the Original Loan and comply with OP/BP 10.02. Financial management and audit arrangements were considered satisfactory for the Parent Project and remain satisfactory under the Additional Financing. In the Financial Management Assessment conducted in February 2008, the residual overall FM risk associated with the Parent Project was rated as moderate, and project accounting, financial reporting, information systems and internal controls were adequate and reliable to provide the necessary information to manage and monitor Project implementation. As in the original loan, Interim Financial Reports (IFRs) will be sent to the Bank not later than 60 days after the end of each calendar semester, and the annual audit reports would be furnished to the Bank not later than six months after the end of each year. 3. The Project Coordination Unit - PCU within DER-SP will keep the same administrative and FM structure as for the original financing, with functions and staff, as defined in the Project Operational Manual - POM, acceptable to the Bank. In the POM will be described the flow of funds and disbursement arrangements, as follow. Flow of Funds & bisbursement Arrangements 4. During project implementation, the disbursement methods that would be used are the following: (i) advances; (ii) direct payments, and (iii) reimbursement (for retroactive financing). The documentation for the uses of Loan proceeds will be realized by SOE’dRecords & Summary Sheets. The Borrower will withdraw the proceeds of the Loan in accordance with Section IV of Schedule 2 to the Loan Agreement, while the supporting documentation will be detailed in the disbursements letter - DL. 5 . The Project will have access to funds advanced by the Bank to the segregated Designated Account (DA) in BRL (separatehegregated from the DA under the Original Loan), opened at the Banco do Brad-SEFAZ- SPY for further transfer in Reais to the State Single Account - SEFAZ and then to the DER segregated from the original loan operating account (opened at the Banco do B r a d in Sao Paulo), for the final payments. The Minimum Value of Applications for Direct Payments and Reimbursements would be of US$l,OOO,OOO equivalent. 6. The maximum outstanding amount - the Ceiling of the DA - will be of R$90,000,000. The reporting frequency for the DA would not be longer than six months.

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Supporting Documentation 7. expenditures paid from the DA:

The following supporting documentation is required for Reimbursements and to document

Summary Sheet with Records evidencing eligible expenditures (e.g., copies of receipts, supplier invoices) for payments made under contracts for Works costing US$50,000,000 equivalent per contract or more; payments made under contracts for goods and Non- consultant services costing US$l 0,000,000 equivalent per contract or more and payments made under contracts for Consultant services costing US$ 100,000 equivalent per contract or more;

Statement of Expenditure for payments that do not exceed the thresholds established above;

List of payments against contracts that are subject to the World Bank's prior review.

0

0

Retroactive financing

8. The Bank may reimburse the Borrower for payments that the Borrower has made from its own resources before 'the legal agreement date (Signing Date) for reasonable eligible expenses incurred for the purposes of the Project, for an amount up to US$114,371,250.00 million equivalent (35% of the loan) provided such expenditures were paid in the period not exceeding 12 before the Signing Date. The Bank will disburse the funds from the loan account to the SEFAZ single treasury account in Reais.

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ANNEX 8: Documents in the Project File

Sao Paulo State Feeder Roads -Additional Financing

0 Updated Project Operational Manual 0 Expanded Project environmental assessment Project Involuntary Resettlement Framework

Project Cultural Property Framework 0 Project procurement and financial management assessments 0 Updated Project economic analysis

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