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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY PROJECT PAPER ON A Report No: ME PROPOSED ADDITIONAL FINANCING AND RESTRUCTURING IN THE AMOUNT OF 4.5 MILLION (US$5.5 MILLION EQUIVALENT) TO MONTENEGRO FOR MONTENEGRO ENVIRONMENTALLY SENSITIVE TOURIST AREAS PROJECT (CREDIT NO ) November 22, 2010 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.

2 CURRENCY EQUIVALENTS (Exchange Rate Effective June 30, 2010) Currency Unit = Euro 1.0 Euro = US$ US$ = 0.814Euro ABBREVIATIONS AND ACRONYMS CAS EIA EIB EMP EU FRR GOM MESTAP MOSPE MJC MJC1 MJC2 PEW Country Assistance Strategy Environmental Impact Assessment European Investment Bank Environmental Management Plan European Union Financial Rate of Return Government of Montenegro Montenegro Environmentally Sensitive Tourist Areas Project Ministry of Spatial Planning and Environment Multi Municipal Joint Solid Waste Company Multi Municipal Joint Solid Waste Company - Lovanja Multi Municipal Joint Solid Waste Company - Mozura Public Enterprise Regional Waterworks Company Crnogorsko Primorje Vice President: Country Director: Sector Manager: Task Team Leader: Philippe H. Le Houerou Jane Armitage Wael Zakout Sanyu Lutalo

3 MONTENEGRO ADDITIONAL FINANCING AND RESTRUCTURING FOR MONTENEGRO ENVIRONMENTALLY SENSITIVE TOURIST AREAS PROJECT CONTENTS Project Paper Data Sheet... i I. Introduction... 1 II. Background and Rationale for Additional Financing... 2 III. Proposed Changes... 5 IV. Economic and Financial Analysis of Cost Overrun or Financing Gap... 6 V. Appraisal of Restructured Project... 7 VI. Expected Outcomes VII. Benefits and Risks VIII. Financial Terms and Conditions for the Additional Financing Annex 1: Revised Results Framework Annex 2 Estimated Costs for Proposed Additional Financing Annex 3 Procurement Plan... 20

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5 Date: November 22, 2010 Country: Montenegro Project Name: Montenegro Environmentally Sensitive Tourist Areas Project Additional Financing Project ID: Original Project ID: P079116; Additional Financing Project ID:P PROJECT PAPER DATA SHEET Team Leader: Sanyu Lutalo Sector Director/Manager: Peter Thomson / Wael Zakout Country Director: Jane Armitage Environmental Category: B Borrower: Montenegro Responsible Agency: Crnogorsko Primorje (Regional Water Company PEW) Revised estimated disbursements (Bank FY/US$m) 1 FY Annual Cumulative Current closing date: December 31, 2010 Revised closing date: June 30, 2012 Does restructured or scaled-up project require exceptions from Bank policies? X Yes No Have these been approved by Bank management? X 2 Yes No Is approval for any policy exception sought from the Board? X Yes No Revised project development objectives/outcomes: Not applicable. Does the scaled-up or restructured project trigger any new safeguard policies? No For Additional Financing [X] Loan [ ] Credit [ ] Grant For Loans/Credits/Grants: Total Bank financing Euro 4.5 million (US$ 5.5 million equivalent) 3 Proposed terms: Fixed Spread Loan repayable in ten years, including a grace period of four years. Financing Plan (Euro m.) (AF) Source Local Foreign Total Borrower 4 IBRD Total Borrower IBRD IDA 5 Total Financing Plan (Euro m.) (Original Project + AF) Source Local Foreign Total Projected 2011/2012 disbursements assuming additional financing approval and extension of closing date. 2 Managing Director endorsed request for policy waiver on May 4, 2010; Board approval is required. 3 Exchange rate has fluctuated due to the volatility of the US dollar, but was originally based on US$6.0 million equivalent. 4 Includes mainly taxes and duties, which will be financed by Government. 5 Undisbursed balance of existing Credit amounting to about US$5.1 million. 6 Government will meet cost of taxes and duties included in this amount. i

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7 I. INTRODUCTION 1. This Project Paper seeks approval from the Executive Directors to provide additional financing of 4.5 million to Montenegro for the Environmentally Sensitive Tourist Areas Project (MESTAP), Credit Number The proposed additional financing would support completion of the regional sanitary landfill for the Bar and Ulcinj Municipalities (Mozura Landfill) under Project Component 1 (Environmental Infrastructure) and the provision of equipment for the operation of the regional sanitary landfill. Originally, the Project was to be co-financed by the Government of Montenegro and the Bank, but after the 2009 global financial crisis, the Government became unable to cofinance from its budget, leading to an unanticipated financing gap. The financing gap further increased due to price escalations caused by the devaluation of the Euro against the dollar and changes in landfill design due to a change from the original landfill site envisaged at appraisal. Therefore, the Government and the Municipalities of Bar and Ulcinj have jointly requested the proposed additional financing to cover their budget gap. 2. The Government additionally requested that the project be restructured to drop outstanding activities under Project Component II (Environmental Rehabilitation) in order to fully leverage available Bank resources for the sanitary landfill. The dropped activities would comprise the closing of two remaining uncontrolled and unsanitary waste disposal sites in Bar and Ulcinj, which will now be financed through a recently approved European Investment Bank (EIB) funded solid waste management program being implemented in parallel. World Bank funding for the dropped activities would be reallocated to Component I to complete the landfill. This change entails a restructuring of the original credit. 3. In addition to the scaling down of Component II by dropping the activities relating to closing of the two uncontrolled and unsanitary waste disposal sites, the restructuring of the original Credit would also involve: (a) revision of the Results Framework and monitoring indicators to reflect the dropped activities in Component II, in particular a change in the relevant outcome/impact indicator target from: Four current municipal disposal sites properly closed to Two current municipal disposal sites properly closed ; (b) re-allocation of the funds saved from Component II to Component I for construction of the Mozura landfill; (c) a change in the description of Component I in the Development Credit Agreement (DCA) to reflect the fact that the regional landfill in Bar would be constructed at a new location and not on a rehabilitated existing site as originally envisaged; (d) a change in the percentage of expenditures eligible for financing to allow for 100 percent financing for all categories in line with updated country financing parameters; (e) amendment of Schedule 5 of the DCA, Terms and Conditions for the Sub-credit and Project Implementation Agreement, to reflect that repayment provisions for the sub-credit only apply to the Multi-Municipal Joint Solid Waste Company Lovanja (MJC1) and the sub-credit and project implementation agreement related to MJC1; (f) extension of the Credit closing date from December 31, 2010 to June 30, 2012; (g) alignment of procurement procedures with the procurement procedures of the additional loan; and (h) removal of MJC2 current audit provisions to align the 1

8 Development Credit Agreement with the additional loan. The Development Credit Agreement will be amended to reflect the above, including related changes. II. BACKGROUND AND RATIONALE FOR ADDITIONAL FINANCING 4. Context and Background: Montenegro s beautiful coastal area is a major tourist destination in the region. During appraisal for the original Project, pollution from poor solid waste management posed a major threat to the tourism industry in coastal municipalities, and this threat remains. The Project responded to Government priorities to improve solid waste collection and disposal services in several coastal municipalities including Kotor, Budva, Tivat, Bar and Ulcinj. Project design was aligned with the main elements of Government strategy for the sector, which included, inter alia, support for a regional approach to solid waste disposal. The World Bank Board of Directors approved MESTAP on September 11, The US$9.5 million Project became effective on April 8, 2004: US$7.0 million was to be financed through an IDA Credit and US$2.5 million was to be financed by Government. 5. Consistency with CAS: Activities to be financed through the proposed additional financing are consistent with Montenegro s FY07-10 Country Assistance Strategy (CAS), which identifies European Union (EU) accession as a national priority. Progress towards accession depends in part on Montenegro s ability to harmonize with EU standards for environmental management, including solid waste disposal. 6. Progress to date: During the first few years of implementation, Project performance was satisfactory with respect to both likelihood of achieving the development objective (DO) and implementation progress (IP). MESTAP progressed with implementing the Environmental Infrastructure Component in the northern coastal Municipalities of Kotor, Budva, and Tivat. An existing uncontrolled unsanitary waste dumpsite located at Lovanja in Kotor Municipality was rehabilitated, and the first phase of a new regional sanitary landfill was constructed to serve the three municipalities. The Lovanja regional landfill, which was designed to be implemented in three phases, was successfully operated by MJC1 7 established through the Project, resulting in establishment of an effective model for management of solid waste on a regional level in Montenegro. The Project also financed the closing of two uncontrolled waste disposal sites in Tivat and Budva, reducing environmental degradation, as well as trucks, containers, and equipment for solid waste collection and disposal for the Kotor, Budva, and Tivat Municipalities, which has improved waste collection and disposal and overall environmental quality in the area. 7. The Lovanja landfill was however granted a temporary license by the Municipality of Kotor to operate for an initial three year period on the understanding it would be renewed after the Municipality s spatial and detailed urban plans were updated to allow for construction of a long-term landfill, which would authorize construction of 7 The Multi Municipal Joint Landfill Company Lovanja, jointly owned by the Municipalities of Budva and Kotor and Crnogorsko Primorje (PEW) was registered as a limited liability company on July 7,

9 subsequent phases. It had to close in 2009 after four years of operation because the Municipality of Kotor at the time declined to renew the license to allow for construction of a second cell due to a change in its position regarding use of the site, apparently linked to the so-called not in my backyard (NIMBY) concerns. Since 2009, environmental legislation in Montenegro took effect, requiring all municipalities to dispose of their waste in sanitary landfills and several coastal municipalities including Kotor, Budva, Tivat and Bar have had to incur very high economic costs to dispose their wastes in the sanitary landfill in Podgorica under temporary arrangements until they are able to construct their own. Plans are now underway to update Kotor s Spatial Plans by December 2010 in order to allow for construction of a long-term regional landfill for the northern coastal municipalities with EIB financing, based on the same model to be managed by the Lovanja Landfill Company. Construction of this landfill is envisaged to start around mid-2011 and it is likely to be operated by the Lovanja landfill company established through MESTAP. 8. Lessons drawn from the Kotor experience have been considered in designing the Mozura landfill: (a) the importance of ensuring adequate political buy-in for long-term engagement by all stakeholders in the Mozura case extensive dialogue and consultations were held with key stakeholders and their commitment will be confirmed through signing of a legally-binding Service Agreement between the beneficiary municipalities and the landfill company which would be valid for the design life of the Mozura landfill the signing of such Service Agreement will be an implementation covenant in the DCA and Loan Agreement to be met prior to commencement of construction of the Mozura landfill; (b) investment in a landfill with reasonably large capacity that would be operated over a longer term the Lovanja landfill was designed for a capacity of four years (Phase 1), but the Mozura landfill has been designed for a capacity of 25 years without recycling, in four phases, with Phase 1 designed for ten years. In spite of the above challenges, the waste collection and disposal system established through the project in Kotor, Budva and Tivat continues to function effectively using the trucks and equipment purchased through the Project to transport the wastes to Podgorica after recycling 8 using equipment purchased through the project. 9. Construction of the second regional landfill for the southern coastal Municipalities of Bar and Ulcinj the Mozura Landfill- on the other hand, was significantly delayed because, until late 2008, the stakeholders failed to reach agreement on an acceptable location. Before the proposed Mozura site was identified, three other sites were considered and eventually rejected due to public and political resistance. The project IP rating was subsequently downgraded to unsatisfactory and between June 2007 and March 2008 disbursements were suspended by the Bank pending agreement on a suitable site and implementation of an action plan to complete preparatory activities for the landfill. The Municipality of Bar finally provided the Mozura site 9, which was endorsed by all key stakeholders and gazetted for this purpose in the Municipality s 8 The recycling plant at Lovanja currently handles only wastes from Kotor and Tivat municipalities. 9 The land is officially owned by the State of Montenegro, but Bar Municipality was provided with the right to use it under existing Spatial Planning laws. 3

10 approved Detailed Urban Plan. Preparatory work, including the Environmental Impact Assessment (EIA) was completed, and the tender for landfill design and construction is ready for award and signature once the financing is approved. A multi-municipal landfill management company jointly owned by the Municipalities of Bar and Ulcinj (Mozura D.o.o or MJC2) was established and registered in Montenegro s commercial court to operate the landfill once it is constructed. A Service Agreement between the municipalities and the Mozura D.o.o has been drafted and is to be executed by construction as an implementation covenant prior to commencement of construction. In spite of this progress, the Project s IP rating is maintained as Moderately Unsatisfactory due to the existing financing gap since the contract cannot be awarded until adequate financing is available to complete the landfill. 10. The rating for likelihood of achieving the Project Development Objective (PDO) is Moderately Satisfactory; this rating considers achievements in establishing an effective solid waste collection and disposal model, reduction on environmental degradation and improvement in environmental quality in the Kotor, Budva, and Tivat areas of the coast, as well as the potential for creating ecologically and commercially sustainable solid waste disposal services in Bar and Ulcinj if additional financing is approved and the new landfill is completed as planned. The likelihood of achieving the PDO is enhanced by the strict enforcement of the 2009 environmental legislation, under threat of penalties, requiring that all municipal waste be disposed of in sanitary landfills which has compelled several coastal municipalities, including Kotor, Budva, Tivat and Bar, to dispose of their wastes in the Podgorica Sanitary landfill in the short-term. Finally, in light of EIB commitment through its programme to finance another regional landfill for the Kotor, Budva and Tivat area based on the established model, it is likely that municipal waste generated on the coast will be disposed of in sanitary landfills in an ecologically and commercially sustainable manner. 11. Rationale for requesting additional financing: Government and the Municipalities of Bar and Ulcinj jointly requested the additional loan to cover the financing gap due to the failure to meet counterpart funding requirements as a result of the severe fiscal squeeze brought about by the global financial crisis, as well as price escalations caused by the devaluation of the Euro against the dollar and changes in landfill design due to a change from the original landfill site envisaged at appraisal. There is a balance of about US$5.1 million under the existing IDA Credit, which Montenegro does not want to lose even though it became creditworthy for IBRD in Government initially approached EIB in 2009 to co-finance the Mozura landfill with the Bank. EIB however raised some concerns with the micro-location of the site, specifically relating to its seismic stability and visibility from the road, and proposed a new microlocation on a land parcel not owned by the Municipality and for which no preparatory work had been undertaken. Government was unwilling to consider the new site given the preparatory work concluded and the time that had already been lost on the project, and requested the Bank s support for additional financing. The Bank team carried out further technical and environmental due diligence by sending experts to review the concerns that had been raised, and was able to confirm that the site was technically and 4

11 environmentally feasible 10 and solutions to address the said issues could be incorporated in the design. 12. Considering Project age, its relatively small size, and its implementation history, Bank Management considered the option of closing the Project and cancelling the remaining balance. It did, however, ultimately decide to consider Government s request, in light of Montenegro s dire fiscal situation and constrained Bank lending framework; the importance of curbing environmental degradation through, inter alia, establishing sustainable sanitary landfills for Montenegro s vital tourism sector; and the overall readiness for implementation demonstrated through the completed preparatory activities, advanced procurement, and strong ownership of the Project at both the central and local levels. III. PROPOSED CHANGES 13. Proposed Additional Financing: The Additional Financing will finance the design and construction of a regional sanitary landfill to serve the municipalities of Bar and Ulcinj and the provision of equipment for the operation of the regional sanitary landfill. Changes directly relating to the additional financing would entail a revised cost and financing plan to reflect the additional 4.5 million (US$5.5 million equivalent) IBRD loan and Government contribution of 1.6 million including taxes and duties. The financing instrument would be an IBRD Fixed Spread Loan repayable in ten years, including a grace period of four years. The investments will be financed by Government as a capital investment since they are new, and ownership will be transferred to the Mozura D.o.o which is jointly owned by the municipalities of Bar and Ulcinj after completion of construction. Total estimated Project cost for remaining activities, including the available balance under the IDA Credit, is about 9.9 million with taxes and duties. A summary of estimated Project costs and financing arrangements is given in the datasheet and Annex 2. Terms and conditions of the new IBRD loan will be reflected in a new Loan Agreement. In addition, two new Subsidiary Agreements, one between the Government and PEW and one between the Government and Mozura D.o.o (MJC2) will be prepared to reflect the parties implementation obligations the PEW Subsidiary Agreement and related legal opinion will be an effectiveness condition, whilst the MJC2 Subsidiary Agreement and related legal opinion will be an implementation covenant to be met prior to commencement of construction. Also, a service agreement between Mozura D.o.o MJC2 and the two municipalities under terms satisfactory to the Bank will be a covenant to be met prior to commencement of construction. 14. Restructuring existing Project: Restructuring of the existing Project would comprise: (i) scale down of Component II by dropping remaining activities relating to closing of two remaining uncontrolled and unsanitary waste disposal sites; (ii) revision of the Results Framework and monitoring indicators to reflect the dropped activities in Component II, and in particular a change in the relevant outcome/impact indicator target from: Four current municipal disposal sites properly closed to Two current municipal 10 This issue is discussed in more detail in Section V: Environment, of this Project Paper. 5

12 disposal sites properly closed ; (iii) re-allocation of the funds saved from Component II to Component I for construction of the Mozura landfill (please see Table 1 below for details on the re-allocations); (iv) a change in the description of Component I to reflect the fact that the regional landfill in Bar would be constructed at a new location and not on a rehabilitated existing site; (v) a change in the percentage of expenditures eligible for financing to allow for 100 percent financing for all categories in line with Montenegro s current country financing parameters; (vi) amendment of Schedule 5 of the Development Credit Agreement (DCA)-Terms and Conditions for the Sub-credit and Project Implementation Agreement to reflect the fact that repayment provisions for the sub-credit only apply to the Multi-municipal joint solid waste company Lovanja (MJC1) and the sub-credit and project implementation agreement related to MJC1; (vii) extension of the Credit closing date from September 30, 2010 to June 30, 2012; (viii) alignment of procurement procedures with the procurement procedures of the additional loan; and (ix) removal of MJC2 of current audit provisions to align the Development Credit Agreement with the additional loan. Table 1. Summary of Proposed Re-allocation of Credit Proceeds Category of Expenditure Allocation % of Financing Current Revised Current Revised Current Revise Goods NA 2,560,000 1,300, Works NA 1,420,000 2,680, Consultant Services NA 360, , Incremental Operating Costs NA 160, , Unallocated NA 500, , IV. ECONOMIC AND FINANCIAL ANALYSIS OF COST OVERRUN OR FINANCING GAP 15. The Economic Rate of Return (ERR) was not estimated during original Project appraisal because most Project economic benefits would accrue from externalities such as improved environmental conditions, reduced barriers to tourism development in Project areas, and intangible aesthetic benefits due to reduced uncontrolled waste dumping. Benefits of reduced environmental damage are only partially captured through consumer fees for solid waste management. Nonetheless, it was confirmed that the Project had a positive return, based on annual flows derived from financial revenues and costs in the financial cash flow analysis, even without accounting for intangible benefits. A Financial Rate of Return (FRR) and risk analysis was performed for the additional financing to assess future financial viability of the MJC2. The FRR was estimated on the basis of the stream of costs (investments and O&M costs) and benefits for a 20-year period. The financial viability forecast was based on two key assumptions: (i) a full cost-recovery tariff rate; and (ii) collection rates no lower than 90 percent. The financial benefits for the Mozura sanitary landfill company are the collected revenues; Net Present Value (NPV) was -3.1 million, and FRR equals 2.9 percent. The discount rate used is 10 percent. The negative NPV was due to efforts to maintain affordable tariffs for consumers (less than 2% of average household income for Bar and 2% for Ulcinj). The financial projection over the economic life of the investments however shows stable positive cash flow, therefore investments are financially justified. 6

13 16. Tariff calculations were also carried out for two Scenarios: Scenario A: without project (disposal of waste from coast in the Podgorica landfill) and Scenario B: with project (Mozura Landfill constructed). The calculations considered two main criteria; first, to ensure financial viability of the Company based on the utility cost recovery approach and second, the impact of the MJC2 tariffs should be affordable for the concerned families (less than 2 percent of household income). In 2010 the PSLC is charging the coastal municipalities Euro 67.7/per ton of waste (without VAT), resulting when the cost of transportation is added, in a cost of about Euro 80/ton. This cost (without the transport cost) is anticipated to go up to 84 Euro/ton in 2021 if adjusted for inflation of 3% annually, which is three times the estimated tariff of MJC2. Details on the analysis are available in the project files. Table 2: Estimated Tariffs for Mozura d.o.o Scenarios Scenario A (Current disposal in Podgorica) Scenario B (Projection for Mozura landfill) N/A V. APPRAISAL OF RESTRUCTURED PROJECT 17. Technical: Additional financing would support design and construction of Phase One of the regional sanitary Mozura Landfill and the provision of equipment for the operation of the regional sanitary landfill. The selected landfill site is located at Možura in the Municipality of Bar, 17 km southeast of the city of Bar and 11 km northwest of the city of Ulcinj. A conceptual design was prepared on the basis of a 2008 feasibility study and it formed the basis for preparation of technical specifications for the design and build contract through which a qualified contractor will be selected in accordance with World Bank procurement guidelines to prepare detailed landfill designs and associated infrastructure, including administrative buildings and access roads; and to construct and install them. The landfill will be designed for a period of about 23 years without recycling and 28 years with recycling. It will be constructed and operated in four phases. Phase One will be designed to operate for a period of 10 years, without recycling. The landfill structure for this phase will consist of six sub-cells with 6 m high embankments, each with an impermeable base layer, stable containment walls, and a cover system of intermediate temporary covers during operation, and an impermeable stable final cover when a cell reaches capacity and is closed. Landfill design and construction specifications will be governed by the Law on Waste Management and the EU Directive 99/31/EC, 06/12EC, 08/98EC to incorporate all pollution control measures to comply with EU requirements for leachate collection and treatment, gas collection, drainage, and other supporting infrastructure to ensure that the landfill is technically sound, costeffective, and environmentally sustainable. The Project will also finance equipment such as compactors to operate the landfill. All goods, equipment, and works must meet international standards, and Montenegrin authorities certification prior to commissioning. 7

14 18. Institutional: PEW will continue as Project implementing agency with responsibility for project management as defined in the legal agreements, including managing safeguard and fiduciary aspects, such as procurement and financial management. While PEW 11 no longer holds its original mandate for managing solid wastes at the coast, the company has agreed with Government to continue its role as implementing agency for the MESTAP until it closes. 19. Management of Landfill Operations: The Municipalities of Bar and Ulcinj have established the Mozura Joint Solid Waste Company (MJC2) D.o.o as a multi-municipal joint company to assume ownership of assets and manage operations of the proposed regional sanitary landfill. The municipalities own 100 percent of company shares (Bar 65 percent; Ulcinj, 35 percent) and its Board of Directors comprises solely representatives of both municipalities. Mozura D.o.o/ MJC2 will not receive actual project funds; instead ownership of the Mozura landfill assets constructed under the Project and related assets will be transferred to the company by the Government as a grant upon completion of construction (which is expected towards the end of the project implementation period), under contractual terms to be agreed between the Bank and the Government, and will then operate it. MJC2 will not have sub-loan repayment obligations. Mozura D.o.o. will represent the municipalities during the design and construction phases. A Service Agreement between Mozura D.o.o MJC2 and the two municipalities has been drafted and the execution of the final agreement will be a loan covenant to be met prior to commencement of construction. The Bank will provide a no objection to contract signing for landfill construction only after these arrangements are in place. The municipal waste management companies in each municipality will continue to carry out waste collection and transport waste to the landfill. 20. Procurement: The PEW procurement capacity was reassessed as part of preappraisal and found adequate. Procurement activities under the parent Project were reviewed periodically during Project supervision and found satisfactory. Overall procurement risk for additional financing is rated Moderate in light of PEW procurement experience. Procurement arrangements and procedures for additional financing will remain the same as under the parent Project. Procurement under additional financing would be carried out according to World Bank Guidelines: Procurement under IBRD Loans and IDA Credits dated May 2004, and revised October 2006 and May 2010; and Guidelines: Selection and Employment of Consultants by World Bank Borrowers dated May 2004, and revised October 2006 and May 2010, and provisions stipulated in the Loan Agreement. The original Development Credit Agreement will also be amended to align procurement procedures for the Credit going forward with the procurement procedures of the additional loan. Procurement responsibilities for additional financing will remain with the PEW. 21. Procurement Plan: The Procurement Plan was updated to include activities to be financed through additional financing. Additional activities will include four main 11 PEW s jurisdiction has been scaled down to cover only water supply. However the company will be maintained as the project implementing agency. 8

15 contracts: (i) Contract for design and construction of the Mozura landfill; (ii) Contract for supervision of the construction of the Mozura landfill; (iii) Contract for landfill equipment; and (iv) Contract for financial audit 12 services for 2008, 2009, 2010, and The updated procurement plan is provided in Annex Financial Management: Project financial management (FM) arrangements are acceptable and arrangements instituted for implementing the original credit are assessed as satisfactory. The unit in charge of implementation within the PEW is adequately staffed and implementation capacity assessed as adequate. The FM responsibilities for additional financing will therefore remain with PEW. Funds will be made available to PEW by the Borrower under the PEW Subsidiary Agreement by giving PEW access to the proceeds of the Loan for purposes of implementing the project, but the proceeds will not be taken onto the books of PEW as a grant. Overall Project FM risk before mitigation measures is assessed as Substantial, and with mitigation measures, as Moderate. Assessed risk is based on country diagnostic work in FM, pertaining to country-and project-level risks, including budgeting, accounting, reporting, internal controls, internal audit, external audit, and flow of funds. Project FM arrangements described below represent measures to mitigate identified risks. 23. Audit: The 2007, 2008 and 2009 audit of financial statements for the ongoing Project were submitted and the audit opinions were clean. Auditors identified no issues Audit opinion on PEW entity financial statements was qualified for one item, an uncertain long-term investment in Water Utility Herceg Novi (value: 205K). This audit qualification was assessed as not imposing significant risk on the use of Project funds for intended purposes. Auditors raised no issues in the management letter accompanying the Project audit report, but raised several minor issues in the entity management letter, which were discussed with the implementing entity. 24. Financial reporting: Quarterly financial reports for the original credit were submitted to the World Bank by due dates; they provide reliable financial information and will continue to be provided. Compliance with the Credit covenants has been substantial, relating mainly to ensuring sound financial management for the Project, entity (PEW) 13 and the Lovanja landfill company (MJC1) accounts. The Borrower will be required to ensure that Project and Entity (PEW) Financial Statements are audited by an independent auditor acceptable to the Bank in accordance with auditing standards acceptable to the Bank on an annual basis to cover one fiscal year of the Borrower, and that the said audited Financial Statements for each such period shall be furnished to the Bank not later than five (5) months after the end of such period. 25. Environment: Activities to be supported under proposed additional financing raise no issues to alter Project environmental Category B, nor trigger any new safeguard policies. An Environmental Impact Assessment (EIA) and Environmental Management 12 Audits for 2007, 2008, and 2009 were completed. 13 PEW s jurisdiction has been scaled down to cover only water supply. However, PEW will be maintained as the Project implementing agency. 9

16 Plan (EMP) were prepared for the proposed Mozura landfill in accordance with the Law on Environmental Impact Assessment (Official Gazette of the Republic of Montenegro 80/05) and World Bank guidelines for Environmental Assessment. The final EIA report and EMP were publicly disclosed in Montenegro on May 4, 2010 and at the Bank s InfoShop on May 5, Government confirmed that Environmental Assessment and implementation of activities to be dropped from the project through restructuring, specifically closing of two uncontrolled waste dumpsites that will now be financed by EIB will also be conducted in accordance with EU and Montenegrin environmental directives and legislation. Montenegrin environmental procedures are aligned with relevant EU directives. The Bank team reviewed the EIB Financing Agreement and confirmed with the Ministry of Spatial Planning and Environment (MOSPE) and Procon, the implementing agency in charge of managing the EIB Project on behalf of Government, the arrangements for implementing these activities. 26. Issues/Impacts and Mitigation measures: Landfill operation is expected to result in significant overall positive impacts: improved environmental quality for human habitation with associated benefits of improved prospects for public health, tourism, and employment generation. However, some potentially negative impacts would need to be addressed during construction and operation to maintain the area s environmental integrity. In response to the concerns raised by EIB as a potential co-financier, on site stability in relation to coastal area seismic risk, and site visibility, the Bank team carried out a detailed assessment of these issues, including reviewing seismological risk and associated potential intensities (up to grade IX on the Mercali scale), the specific geological site conditions, and geotechnical assumptions and calculations of the landfill design. It was concluded that regional seismic risk is significant but the proposed Mozura site appears geologically homogeneous and stable, without tectonic or structural elements or weaknesses that would aggravate a seismic event, and that the landfill design allows a sufficient factor of safety (FS) to accommodate additional dynamic loads during a seismic event. The assessment also concluded that landfill site visibility could be easily resolved through site landscaping with shrubs and trees. Other potential negative impacts of the landfill were identified as: noxious odors, water contamination, dust, noise, and vibration, and risk of landfill gas explosion. Construction-related environmental impacts are likely to be localized, temporary, and efficiently mitigated by applying good practices for international landfill construction. Appropriate mitigation measures were identified and included in the EMP. No cultural or historical monuments or any protected natural resources are in the wider Mozura site vicinity. 27. EMP Implementation: Arrangements for managing Project environmental aspects will remain unchanged. Once the detailed landfill design is developed as part of the design contract under the Project, the EMP will be updated with agreement of IBRD and re-disclosed, prior to commencement of works. Whilst the Borrower bears overall responsibility for ensuring EMP compliance and update, overall, ensuring implementation and compliance with the EMP during construction, mitigating any Project environmental impacts and updating the EMP during the detailed design phase - after seeking the no objection to the suggested changes from the Bank- will be the contractor s responsibility under contractual obligations during construction, and the 10

17 implementing agency PEW will supervise mitigation measures with support from the construction supervision consultant. Then, the landfill operating company (Mozura MJC d.o.o) will assume responsibility for ensuring compliance with the EMP during the operation phase. 28. Social: Social impacts from activities to be carried out under additional financing are expected to be positive and after the new landfill commences operations the Project is expected to benefit residents of the municipalities served. A detailed social assessment was carried out prior to appraisal of the original Project and most issues remain the same. The principal concerns identified relate to quality-of-life issues for residents and tourists due to poor solid waste management; these are being addressed by establishing the modern landfills and closing existing unsanitary dumpsites. OP 4.12 is not triggered as the Project anticipates no relocation of households or land acquisition due to landfill construction; the Municipality of Bar provided 14 the parcels of land for the proposed landfill and access road, which were designated for this purpose in the Municipal urban plan. Moreover, no loss of assets or access to assets, loss of income, or loss of access to legally designated parks and areas is anticipated. During appraisal the Bank team s Social Scientist visited the sites for the uncontrolled landfills at Kruce (Ulcinj) and Café (Bar) to be dropped from the project and financed by EIB, as well as the Mozura site and confirmed that there are no people living on the sites, no on-going economic activities such as farming, and no people whose livelihood depends on the sites. None of the sites is located close to legally designated parks nor hinders access to any such park. It was thus confirmed that no social safeguards related issues are triggered. VI. EXPECTED OUTCOMES 29. Project outcomes are unaffected by the changes proposed under additional financing. However, the outcome indicator target on the number of unsanitary waste disposal sites closed will drop from four to two. Since the two remaining sites will be closed under the EIB loan executed in parallel, the outcomes are still expected to be achieved outside of the Project. VII. BENEFITS AND RISKS 30. At appraisal, overall Project risk was assessed as Moderate. Some risks identified during appraisal remain and their mitigation measures are updated in this Project Paper. Additional risks and adequate mitigation measures for them have been identified, but overall risk remains Moderate. Table 3 summarizes activities and risks. Exceptions to Bank policies 31. OP requires satisfactory implementation of a project as one of the prerequisites for additional financing (paragraph 2(a) of OP 13.20). According to the staff 14 The land in question is owned by the State of Montenegro, but the State has made it available for Bar Municipality s use. 11

18 guidelines entitled Processing of Additional Financing: Guidance to Staff, dated November 18, 2009 (Guidance), satisfactory project performance for the purposes of OP requires, inter alia, that ISR ratings over the most recent 12 months, including those for implementation progress (IP) and development objective (DO) have been consistently rated Moderately Satisfactory (MS) or better. The Project meets all the criteria for eligibility for additional financing under OP/BP as outlined in the Guidance; except for the requirement that IP is satisfactory; IP is rated Moderately Unsatisfactory (MU) because of the overall implementation delays with respect to construction of the Bar-Ulcinj landfill. While Government fulfilled an agreed Action Plan to ensure that the activities to be financed are ready for implementation and the key contracts are now ready for award, the IP rating has been maintained as MU because award of the landfill design and build contract is partly dependent on adequate funding being available. Processing additional financing would thus require the Executive Directors to agree to issue a waiver to approve this policy exception. Before such waiver the Managing Director needs to endorse the waiver prior to Board presentation. The Managing Director endorsed the policy waiver on May 4, 2010, and the Executive Director s approval is sought for this waiver. VIII. FINANCIAL TERMS AND CONDITIONS FOR THE ADDITIONAL FINANCING 32. The proposed additional financing of 4.5 million would be provided on IBRD terms as a Fixed Spread Loan repayable in ten years, including a four-year grace period. Financing for the parent Project was provided by IDA on modified IDA terms, as a Credit for SDR5.00 million (US$7.0 million equivalent) with a 20-year maturity and a 10-year grace period. 12

19 Table 3 Summary of Project Risks Risk factors 15 Description of risk Rating a of risk I. Operation-specific Risks Technical The Design and Build contractor for the Moderate Design sanitary landfill does not prepare a good quality design or is unable to complete construction in time. Implementation Capacity and Sustainability Counterpart funding The Implementing Agency (PEW) has a good record and well-qualified staff, but too few competent technical staff; those available are supervising several other activities and projects, which increases the risk inadequate Borrower capacity to supervise the contractor during landfill design and construction. Government has difficulty raising required counterpart funds, especially in the event of cost overruns. Moderate Mitigation measures The following measures have been taken to mitigate this risk: Contractors were prequalified using sound technical and commercial criteria to aid selection of competent contractors. Technical support was provided to strengthen conceptual design and technical specifications in bidding documents to minimize the possibility of sub-optimal designs. A qualified consultancy firm will be hired to supervise contract design and construction quality and minimize construction delays. As mentioned above, a qualified consultancy firm will be hired to support the Implementing Agency in contract management and supervision to ensure highquality design and timely completion of activities. Moderate Overall Government contribution to additional financing is relatively low and mainly covers taxes and duties; in light of the additional implementation period, spreading this amount over the 2011 and 2012 budgets reduces risk of failure to pay. Moreover, while Rating a of residual risk Moderate Low Low 15 These represent an updated risk assessment of those identified at appraisal of the original project and at the concept stage for the additional financing. 13

20 Procurement Financial viability Risk of further delays related to completing procurement for the main investment contract, i.e., the Design and Construction contract for the landfill. Financial sustainability of the landfill operations is not attained due to either of the following: a) municipal waste collectors do not dispose projected volume of municipal solid waste in landfill; b) municipal solid waste collection companies pay less than 100% of invoices to Mozura D.o.o; c) consumers unwilling or unable to pay for solid waste services and increased costs due to landfill operations; or d) Tariffs insufficient to cover O&M landfill costs. Moderate Moderate economic growth has remained slow in 2010, Government projections indicate the economy is expected to gradually recover in To mitigate this risk, the Bank has provided technical support to ensure that the bidding documents are sound and completed in time to allow bidding to commence as early as possible, thereby increasing the potential for high-quality bids. Bids were evaluated in September and October 2010 and the contracts are ready for award. These risks have been mitigated through the following measures: Prior to signing design and build contract, municipalities will sign a Service-level Agreement with the Mozura D.o.o, obliging them to meet specified conditions based on put or pay principle. During the analysis, a more conservative forecast was used for the volume of municipal solid waste to be disposed in the Mozura sanitary landfill, i.e. 10% less; and lower-than-projected payment rates from municipal companies, i.e. 90% was used. Financial analysis was based on a tariff considered affordable, i.e. less than 1-2% of household income. Municipalities will carry out public information initiatives to educate people about the benefits of improved solid waste management and the need to increase tariffs. The Service Level Agreement will include provisions requiring municipalities to adjust tariffs as needed. Low Moderate 14

21 Environmental Other All landfill projects carry inherent political risk linked to resistance by individuals or groups to the siting of waste facilities. In this case, key stakeholders finally agreed on the site and the public was invited to comment; no public comments were received resisting landfill construction. Bank may encounter reputational risk because of EIB withdraw from co-financing the landfill, citing questions about seismic stability, and site visibility. The Municipality of Bar does not renew the license for operation of the landfill. Moderate Moderate Moderate Hold community engagement/public information and consultations. The Bank carried out technical due diligence during pre-appraisal for a comprehensive investigation of these issues. Two technical experts confirmed that the site was seismically stable, and that adequate mitigation measures would remedy landfill visibility. EIA and technical specifications were strengthened accordingly. The Bank and EIB have had subsequent discussions on findings and EIB expressed interest in continued collaboration with the Bank in the sector. The landfill location (Mozura) has been included in the Municipality s detailed urban plan, and a provision will be included in the subsidiary agreement between Government and MJC2to ensure that the license is in place for the landfill to be operated on a sustainable basis. The Service level agreement between the Municipality and the landfill operator will also include a provision to ensure that the landfill is operated for a period of up to its design life, with the license being valid for an initial period of ten years. Overall Risk Moderate Moderate Low Low Low 15

22 ANNEX 1: REVISED RESULTS FRAMEWORK 16 Hierarchy of Objectives Key Performance Indicators Data Collection Strategy Critical Assumptions Sector Related CAS Goal The Transition Support Strategy for Montenegro (in lieu of a CAS) identifies the following priorities: (i)stimulating near-term growth and creating the basis for sustainability; (ii)improve social well-being and (iii)improve governance and build effective institutions Project Development Objective: Improve solid waste collection and disposal in the coastal area Correct environmental degradation caused by current unsanitary municipal disposal sites Develop institutional framework for solid waste management sector Sector Indicators: Environmental quality Adequate collection and disposal of solid wastes Effective institutional setup for the solid waste sector Outcome / Impact Indicators: 90% of solid waste produced in the coastal area is collected on a set schedule and disposed in proper facilities Two current municipal disposal sites properly closed Creation of two multi-municipal joint companies that are operational and financially sustainable according to the service quality and financial sustainability indicators Continued public acceptance of the proposed solid waste management solution, indicated by more than 70% approval rating of the Project as measured by the follow-up social Sector/ country reports: Environmental reports and Environmental Impact Assessment which provides baseline data to measure impact Project reports Project reports: Regular progress reports Supervision Mission reports Implementation Completion Report Follow-up social assessment From Goal to Bank Mission) Environmental degradation if coastal area adversely affects prospects for tourism growth. Support to Government to develop the sector's institutional framework will provide a basis for further sector development from Objective to Goal) Political and economic stability. Project implementation does not reduce incentives to Government and municipalities to continue sector reform once immediate needs are satisfied. 16 This Results Framework presents the combined indicators for both the IDA Credit and the proposed loan, updated from Annex 1 of the original PAD. 16