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					                            PROJECT INFORMATION DOCUMENT (PID)
                                      APPRAISAL STAGE
                                                                                 Report No.: AB3664
    Project Name                       Manila Water Supply Financial Strengthening and Service
    Region                             EAST ASIA AND PACIFIC
    Sector                             Water supply (100%)
    Project ID                         P071119
    Borrower(s)                        METRO. WATERWORKS & SEWERAGE SYS.(MWSSS)
    Implementing Agency
    Environment Category               [ ] A [X] B [ ] C [ ] FI [ ] TBD (to be determined)
    Date PID Prepared                  February 15, 2008
    Date of Appraisal                  February 6, 2008
    Date of Board Approval             June 24, 2008

1. Country and Sector Background

The Philippines had a population of 85 million in 2005. The urban area of Metro Manila (MM)
has a population of about 10.8 million, and comprises 16 cities and 1 municipality (tbc)
subdivided into 1,700 barangays1. It is a middle income country, with per capita income of
US$1,160. MM is an important economic zone, producing 37% of GDP of US$37 billion in
2005. Industries in MM include tanneries, textile mills, food processing, distilleries, chemical
and metal plants. Poverty is high, with 40 percent of the population living on less than US$2 per
day. About 36% of the MM population lives in informal settlements (about 2.5% of MM land
area) without adequate basic services, including water supply and sanitation.

In MM, the Metropolitan Waterworks and Sewerage System (MWSS) is the body mandated to
provide water supply, sewerage and sanitation services. By the mid 90s, water supply service
levels were deteriorating: non revenue water (NRW) was over 60%, pressures were low, and the
supply was intermittent, and there was widespread dissatisfaction with the level of service.
MWSS privatized these services in 1997 through two 25-year concessions to: Manila Water
Company Inc (MWCI) for the East Manila Service Area having a population of about 2.3
million; and Maynilad Water Services Inc. (MWSI) for the West Manila Service Area with a
population of about 8.2 million. The MWSI concession area covers 17 municipalities.

MWCI, the concessionaire for the East Service Area successfully met or exceeded its broad
performance targets, reduced NRW from 63% to about 30% in 2007, and improved service
levels and coverage of water supply, sewerage and sanitation services. Over the same period,
MWSI was unable to make progress: (a) about 36% of customers received less than 12 hours a day;
(b) about 56% of households had low water pressures; (c) about a quarter of the residents did not
have direct access to the network; and (d) commercial and physical losses were increasing, with non
revenue water (NRW) reaching about 67% by 2007.

    Barangay is the lowest level of local government
In March 2001, after struggling with technical challenges and the effects of the Asian Crisis on Peso
exchange rates, MWSI suspended payment of concession fees and repayment of its debt payments.
It subsequently issued a notice of termination of the concession agreement in February 2003, and
sought court protection in November 2003. As part of these bankruptcy proceedings, a Debt and
Capital Restructuring Agreement (DCRA) and a rehabilitation plan were prepared (including
reference to possible Bank financing) and MWSI surrendered 84% of its equity to MWSS2.
These shares were sold under a public bidding in December 2006 to the new concessionaire3 for
the bid amount of US$ 504 million. Further details related to the restructuring of MWSI are
provided in the Financial Annex.

The suspension of the concession fee payments by the former concessionaire had an adverse
financial impact on MWSS – which remains responsible for servicing the outstanding debts at
the time of privatization. After a period of uncertainty MWSS has been able to recover
financially by accessing the previous concessionaire’s performance bond and using the proceeds
from the 2006 sale of the equity shares. The financial health of MWSS however remains heavily
reliant on satisfactory performance of the concessionaires, which, to a large degree, depends on
reductions of NRW and increased water sales.

MWSI recognizes that addressing NRW reduction to increase water sales is the key to the
success of the concession. MWSI has formulated an NRW Recovery Program (the Program), to
be implemented during 2007-2012, that comprises: (i) isolation of 31 hydraulic areas (HA); (ii)
zoning and establishment of approximately 1,400 district metered areas (DMA) in the existing
distribution network and in the future expansion area, within the HAs; (iii) partial and full
rehabilitation of priority networks in the DMAs, including rehabilitation or re-installation of
consumer connections; (iv) on going NRW reduction and management program, including
equipment, staff and operating budget; and (v) expansion of access to water supply through
providing 175,000 connections to new consumers including those living in un-serviced areas.
The estimated capital cost of the Program is PhP29.959 billion (US$698 million).

Key success factors for delivery of the Program are: (a) adequate funds to finance the capital
expenditure (Capex) program; (b) a sound NRW reduction and management action plan,
including the necessary trained staff, equipment and annual Opex budget; and (c) satisfactory
incentives for staff implementing the NRW reduction and management program.

The proposed Bank-supported project will finance selected portions of the Program investments
planned for 2008 through 2012. It would include: establishment of HAs and DMAs, provision of
connections to new consumers, project implementation support and capacity building for NRW
reduction and management. Thus the Bank financing will set up the enabling environment that
will allow MWSI to carry out subsequently implement the full and partial rehabilitation of the
tertiary networks within the DMAs, and actively manage the NRW program, leading to the
requisite reductions in NRW

    The remaining 16% is owned by Lyonnaise Asia Water (Holdings) Pte Ltd.
    DMCI/Metro Pacific Consortium
2. Objectives

The project development objective (PDO) is to create an enabling environment for the reduction
of non–revenue water (NRW), and to expand access to piped water supply in the Manila West
Service Area in a financially sustainable manner.

Key outcome indicators are: (i) percentage of NRW in the Manila West Service Area; and (ii)
number of new consumers with access to water supply in the Manila West Service Area. Output
indicators are: (i) number of hydraulic areas (HA) established; (ii) number of district metered
areas (DMA) established; (iii) quantity of NRW recovered; (iv) increase in quantity of water
billed; and (v) number of new service connections.

3. Rationale for Bank Involvement

The rationale for Bank involvement is based on the following factors: (a) a loan to MWSI,
provided through the Development Bank of the Philippines, will help MWSI realize its NRW
reduction goal quicker, and provide the necessary stability during the early implementation
period without having to rely solely on its self-generated revenues; (b) improved financial
performance of MWSI through reductions in NRW will lead to improved financial health of
MWSS; (c) the ability to rapidly improve quality of services and reduce NRW economically and
efficiently has been demonstrated by MWCI in the East concession area; (d) a successful
outcome will restore confidence in privatization of water services in MM and the country; and
(e) the ability of the Bank to bring regional and international experience in NRW reduction
strategies to the proposed project, such as the key role played by the Bank in the reduction of the
Phnom Penh Water Company’s NRW from 57% in 1998 to 17% in 2003, and the use of
performance based contracting to reduce NRW in Ho Chi Minh City.

4. Description

The project comprises traditional reimbursable investments and output-based disbursements, as
indicated below:

Component 1: Establishment of Hydraulic Areas (HA)
Restructuring and optimization of the primary distribution network to form 23 of the Program’s
31 HA each with a single feed equipped with a flow meter to enable computation of individual
water balances of each HA. Works comprise construction of about 120 km primary distribution
mains and the installation of flow and pressure monitoring equipment. Total cost: PhP 6,858.3
billion (US$ 144.80 million). (Traditional disbursement)

Component 2: Establishment of District Metered Areas (DMA)
Division of HAs to form approximately 1,300 DMA in the existing distribution network with
single inflow feed and pressure reducing valves (PRV). Works comprise construction of about
118 km of distribution mains, inflow chambers and PRV chambers. Total cost: PhP 4,211.7
billion (US$57.90 million). (Output Based Disbursement)
Component 3: New service connections
Installation of about 175,000 service connections to new consumers in the existing and future
service areas. Total cost: PhP 1,208.3 billion (US$ 25.2 million). (Output Based Disbursement)

Component 4: Technical Assistance
Project technical assistance comprises of two parts. Total Cost PhP495.8 million (US$10.3
million). (Traditional Disbursement)

       (a) Project implementation support comprising: (i) consultant services for complex
       detailed designs; (ii) international consultant services for construction supervision; (iii)
       services of NRW specialists to formulate a structured results-oriented NRW reduction
       strategy and action plan, including necessary staff, training in NRW management,
       equipment and annual operating budgets;

       (b) Capacity building support comprising: (i) development of a comprehensive GIS-based
       database of the water supply distribution networks, including hardware, software and
       application development; (ii) telemetry system to monitor flows and pressures in
       DMA/HA; and (iii) equipment requirements for the NRW management.

5. Financing

Project Cost Estimate. The total project cost estimate including physical and price contingencies
is PhP12,782.0 million (US$268.5 million).

Source:                                                                              ($m.)
Borrower                                                                            143.50
International Bank for Reconstruction and Development                               125.00
                                                                        Total       268.50

6. Implementation

Borrower. The Development Bank of the Philippines (DBP), a government financial institution,
would be the Borrower, and would on-lend directly to MWSI, which would implement the
project. DBP is a government bank functioning as an intermediary financing institution for
various multilateral and bilateral agencies, including the Bank. DBP has experience with the
Bank procedures in the Local Government Urban Water and Sanitation Project (Ln 70800-PH).
The loan will be in USD and will be passed on to MWSI in the same currency, with a spread to
cover the cost of DBP’s administration and assessed project risks, and with a term consistent
with the remaining years of the Concession Agreement. The Government of the Philippines will
provide the sovereign guarantee for the loan.

DBP will ensure that MWSI implements the project in accordance with the legal agreements.
DBP will engage an independent consultant to: (a) verify technical details, confirm and certify
achievement of outputs, required for output-based disbursements; and (b) monitor overall project
implementation including progress in NRW reduction.
Implementing Agency. MWSI, the loan recipient and implementing agency, is one of two
private concessionaires of the MWSS, responsible for the Manila West Service Area. MWSI has
extensive experience in the preparation and implementation of water supply and sewerage

Project Implementation Period. The project will be implemented over a four year period
starting July 1, 2008 through June 30, 2012.

Project Management. MWSI has set up an in-house Project Management Group (PMG) to
carry out designs, procurement, construction supervision and contract management, technical
audits and overall project management. The key activity of NRW Reduction will be done by
decentralized independent Business Centers (BC), organized along HA boundaries, which are
responsible for technical and administrative management of the distribution network.

The PMG will engage consultants for detailed designs, construction supervision, development of
telemetry and GIS systems, and expert support for NRW reduction activities database.

NRW Strategy and Action Plan Development. MWSI will formulate an NRW reduction
strategy and action plan, including manpower requirements, training, equipment and annual
operating budget requirements to achieve the targeted reduction of NRW of 35% by 2012. This
plan will be implemented by the NRW teams in the BCs. A draft plan has been prepared and its
finalization with content acceptable to the Bank is a condition of effectiveness.

Safeguards Implementation. MWSI will implement the safeguard matters relating to the
environmental impacts, land acquisition and resettlement. An independent safeguard monitor
will be hired under the project to report on compliance with Bank procedures. Dam safety issues
relating to the Angat and Ipo Dams will be implemented by the National Power Corporation and
the Common Purpose Facilities, respectively, under the leadership of MWSS. Funds for the dam
safety activities will be provided by MWSI and MWCI (the concessionaires) under separate
arrangements. The Government of the Philippines will ensure that the relevant parties carry out
the activities in accordance with the agreements. [A legal opinion to that effect has been secured
by the Bank]

Oversight by MWSS. As long term owner of the assets MWSS will have the opportunity to
observe implementation activities and bring any concerns to the attention of the construction
supervision consultant, in writing, with a copy to MWSI. The construction supervision
consultant will review and take any action deemed necessary, and provide copies of any reports
to MWSS, and MWSI. MWSI will provide MWSS a copy of the semi-annual progress
reports.(tbc during appraisal).

Monitoring and evaluation of outcomes/results

The principal tool for monitoring and evaluation will be data input to the Results Framework in
Annex 3. The Project Management Group (PMG) will compile data and information on a
continuing basis for monitoring and evaluation of outputs and outcomes, and to update the
Results Framework. This information will be incorporated in the semi-annual progress reports.
Additional monitoring will be done to provide information for output-based disbursements: (a)
for certification of the number of DMAs formed and new connections installed; (b) for
verification of inputs and costs to produce the outputs; and (c) for monitoring of progress in
NRW reduction in the MWSI Service Area, through data on water billings.

Mid-term Review. A mid-term review will be carried out in January 2010 to review the need for
review of output-based disbursements and project restructuring, if any.

7. Sustainability

As the new owner of the concession, MWSI is strongly committed to improve its finances and
service levels. In order to attain financial viability, it has launched the NRW Recovery Program
to increase revenues through reduction of NRW from the current 67% to 35% in 2012.
Successful implementation of this Program depend on adequate capital funding from self-
generated revenues, adequate annual operating budget, knowledgeable and experienced staff,
incentives for the company and staff, and equipment for the day-to-day NRW management.
MWSI has plans to achieve all of these requirements and will finance the Program using self-
generated revenues, and external borrowing including proceeds from the Bank loan. Rate re-
basing discussions have commenced with the Regulatory Office and tariff amendments, if any,
will take effect January 1, 2009. For the financial analysis, it was conservatively assumed to hold
tariffs unchanged.

8. Lessons Learned from Past Operations in the Country/Sector

Foreign Exchange Risk Management. Significant exposure to foreign exchange risks and its
inability to effectively manage these risks was one of the key factors in the failure of the original
MWSI concession. The mechanism allowed by the original concession contract proved
inadequate to cover the devaluation of the peso following the Asian financial crisis during 1997-
2001. Two revisions to the original concession agreement (the “accelerated EPA” (AEPA) and a
“foreign currency differential adjustment” (FCDA) will allow the effects of Peso depreciation to
be recovered through the tariffs, and appear sufficiently robust to avoid the recurrence of
significant foreign exchange losses at MWSI.

Readiness for Implementation. Implementation Completion Reports of previous operations
with MWSS, and the experience with the ongoing Third Manila Sewerage Project show that
substantial delays occur in the start of project implementation, even though all physical
objectives were achieved in the end. There is no evidence to suggest that similar delays will
occur with the MWSI Program which has already started in 2007 and is disbursing at an annual
rate of approximately $100m (tbc). With regard to the traditional reimbursable investments the
detailed designs, specifications and cost estimates for at least the first year of implementation
will be ready at negotiations. In addition some $15 million (tbc) is planned for retroactive
NRW Reduction Strategy. One key lesson emerging from a comparison between MWCI and
MWSI, and from international experience, is that making significant reductions in NRW requires
consistent management focus, structured leak detection and repair programs, sizeable
investments, disconnection of illegal connections, and a changed management within the
organization. A key contributor to a successful NRW reduction program is the provision of
adequate incentives at the company and individual staff level to motivate them to diligently
pursue the NRW reduction. MWCI (the East Manila concessionaire), widely seen as a success,
was not been able to reach the originally projected NRW reduction targets, but reached the
current levels after several years of delays. The design of the project incorporates lessons learned
from MWCI experience, and draws on international best practice in NRW reduction including;
establishing isolated hydraulic areas within the distribution network, use of decentralized
network management to accompany and guide network rehabilitation; capacity building to
manage NRW on a day-to-day basis; conservative sensitivity analysis on achievable loss
reduction; and financing to mobilize external advisors to assist in the NRW reduction effort.

Monitoring NRW Reduction Performance. It is recognized that the establishment of DMAs
does not guarantee NRW reduction; but it will enable MWSI to pursue its network
modernization and NRW reduction program, and will contribute significantly to its success.
Through careful monitoring of the flows and pressures in the DMAs (for which the project will
finance the required telemetry system), MWSI NRW reduction teams will be able to take timely
action to find and fix physical and commercial losses.

9. Safeguard Policies (including public consultation)

    Safeguard Policies Triggered by the Project                                              Yes                     No
    Environmental Assessment (OP/BP 4.01)                                                    [X ]                    []
    Natural Habitats (OP/BP 4.04)                                                             []                    [X ]
    Pest Management (OP 4.09)                                                                 []                    [X ]
    Physical Cultural Resources (OP/BP 4.11)                                                  []                    [X ]
    Involuntary Resettlement (OP/BP 4.12)                                                    [X ]                    []
    Indigenous Peoples (OP/BP 4.10)                                                           []                    [X ]
    Forests (OP/BP 4.36)                                                                      []                    [X ]
    Safety of Dams (OP/BP 4.37)                                                              [X ]                    []
    Projects in Disputed Areas (OP/BP 7.60)*                                                  []                    [X ]
    Projects on International Waterways (OP/BP 7.50)                                          []                    [X ]

10. List of Factual Technical Documents

A. General
     No                   Name of Document                         Date of the                   Prepared by
      01   Debt and Capital Restructuring Agreement                April 2005       MWSI and Lenders,
           (DCRA)                                                                   Quezon City Regional Trial Court
                                                                                    (Rehabilitation Court)

 By supporting the proposed project, the Bank does not intend to prejudice the final determination of the parties' claims on the
disputed areas
B. Studies and Designs

                                                      Date of the
    No               Name of document                                          Prepared by
   01     Water Supply Services Recovery Project      May 2006      Radian Consulting Inc. Philippines
          (Development Support for MWSS Financial                   jointly with Halcrow, UK
          Feasibility Study
   02     Planning Guidelines for Water Supply           2005       MWSI Project Management Group
          (MWSI code of Practices)
   03     Project Procurement Plan                    Nov 2006      MWSI Project Management Group
   04     Project Implementation Plan                 Nov 2006      MWSI Project Management Group
   05     Draft Environmental Framework                 ????        MWSI Project Management Group
   06     Draft Land Acquisition and Resettlement       ????        MWSI Project Management Group
          Policy Framework
   07     First draft EA Baseline Report and EIS        ????        MWSI Project Management Group
   08     Maynilad NRW Recovery Program               Dec 2007      MWSI Project Management Group
   09     Maynilad Project Proposal                   Jan 2008      MWSI Project Management Group

C. Bank Staff Assessments

                                                      Date of the
     No                Name of document                                         Prepared by
   01        Procurement Capacity Assessment Report      ????                   World Bank

   03        Financial Management Assessment of           ????                  World Bank

   04        Economic Calculations                        ????                  World Bank

   05        Review and Recommendation of              Dec 2007                 World Bank
             Maynilad NRW Recovery Program

11. Contact point
Contact: William D. Kingdom
Title: Lead Water and Sanitation Specialist
Tel: (202) 473-9093
Fax: (202) 477 1205

12. For more information contact:
       The InfoShop
       The World Bank
       1818 H Street, NW
       Washington, D.C. 20433
       Telephone: (202) 458-4500
       Fax: (202) 522-1500

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