FOR OMCIL USE ONLY. Report No. P-4286-LSO EXECUTIVE DIRECTORS. November 18, 1986

Transcription

1 Public Disclosure Authorized DocLumf of The World Bank FOR OMCIL USE ONLY Report No. P-4286-LSO Public Disclosure Authorized Public Disclosure Authorized REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATION TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT OF SDR 8.0 MILLION TO THE KINGDOM OF LESOTHO FOR THE Public Disclosure Authorized LESOTHO HIGHLANDS WATER ENGINEERING PROJECT November 18, 1986 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 Currency Unit = Maloti (M)l/ US$ H 2.00 Ml = USS 0.50 ACRONTYMS AND ABBREVIATIONS AfDB African Development Bank BLS Botswana, Lesotho, Swaziland CIN Center for Inteenational Migration, Fed. Rep. of Germany cms cubicmeter cms/sec cubicmeter per second DWA Department of Water Affairs, Republic of South Africa EC European Communities EDF European Development Fund EIB European Investment Bank ESCOM Electricity Supply Commission, Republic of South Africa FRG Federal Republic of Germany GOL Government of Lesotho GCh Gigawatt hours JPTC Joint Permanent Technical Commission KW Kilowatt LEC Lesotho Electricity Corporation LHDA Lesotho Highlands Development Authority LHWS Lesotho Highlands Water Scheme Mw Megawatt NORAD Norwegian Agency for Development ODA Overseas Development Administration, UK OVTS Orange-Vaal Transfer System RSA Republic of South Africa SACU Southern Africa Customs Union SIDA Swedish International Development Authority SWAPO South West Africa Peoples Organizatior TCTA Trans-Caledon Tunnel Authority toe -tons of oil equivalent UK United Kingdom UNDP United Nations Development Program UNESCO United Nations Educational, Scientific and Cultural Organization US AID United States Agency for International Deve'lopment WEMMIN Ministry of Water, Energy and Mining, Kingdom of Lesotho KINGDOM OF LESOTHO Fiscal Year April 1 - March 31 / Maloti are at par and circulate alongside South Africa's rand.

3 (i, FOR OMFFCIAL UySE ONLY KINGDOM OF LESOTHO LESOTHO HIGHLANDS WATER ENGINEERING PROJECT CREDIT AND PROJECT SUMMARY Borrower: Kingdom of Lesotho Beneficiary: Lesotho Highlands Development Authority (LHDA) Amount: SDR 8.0 million (US$9.75 million equivalent) Terms: Standard Onlending Terms: The proceeds of the credit would be passed to LHDA as Government's equity contribution. Project Description: The project is the engineering phase of a scheme to transfer the waters of the Senqu (Orange) River for sale to South Africa, and to generate hydroelectricity to meet Lesotho's power needs. It would comprise the following main components: preparation of engineering designs and bidding documents for the water transfer and hydro-power components, and for advance infrastructure; geotechnical investigations; technical assistance for LHDA for project execution and supervision and for securing financing for Phase IA construction project; staff training for LHDA; technical assistance for Lesotho Government's representation on the Joint Permanent Technical Commission (JPTC); environmental and resettlement/compensation studies; and investment planning and electricity tariff studies for Lesotho Electricity Corporation (LEC), and a power generation planning study. Benefits and Risk: With the implementation of the envisaged Lesotho Highlands Water Scheme, for which the proposed engineering project would finance the necessary engineering, Lesotho would obtain considerable benefits through royalties earned from the export of water. These royalties would be channelled to development projects. The risks of the engineering project concentrate first on the timely appointment of consultants and recruitment of LHDA staff. Close monitoring should expedite project implementation. Coordination among the water transfer and the hydropower design consultants should ensure timely completion of their tasks. Design review by panels of experts and additional geological investigations should reduce remaining uncertainties. The current unsettled political conditions in Southern Africa 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.

4 (ii) represent significant political risks for the successful implementation of the project. However, the high degree of cooperatlon during the feasibility study phase and the commitment sbown by the two governments in negotiating a comprehensive water treaty make the risks acceptable at this stage. Extensive studies to date have identified no major environmental or resettlement issues. Proposed project activities should allow timely identification of measures to minimize adverse impact on the local population and the environment. Estimated Project Costs: Local Foreign Total -US$ Million Equivalent Geotechnical Investigations -Water Transfer incl. Dam Hydropower Component Delivery Tunnel Subtotal Engineering Design -Water Transfer incl. Dam Hydropower Component Delivery Tunnel Access Roads inel. Infrastructure Subtotal Technical Assistance Operating Expenses Vehicles/Equipment Training Special Studies Services by Government Agencies Subtotal Physical Contingencies Price Contingencies Subtotal Total Project Costs 1/ / Taxes included in project costs are negligible as most items would not be subject to taxation. Figures may not add due to rounding.

5 (iii) Financing Plan Local Foreign Total -- US$ million Equivalent-- IDA Government of Lesotho European Developuent Fund European Investment Bank UNDP ODA USAID CDM, Fed. Rep. of Germany Republic of South Africa Total Estimated Disbursement of IDA Credit (US$ millions)--- IDA Fiscal Year FY87 FY88 FY89 FY90 FY91 Annual Cumulative Economic Rate of Return: Not applicable Staff Appraisal Report: None Map: IBRD /Out of which US$9.50 million equivalent has been confirmed.

6 INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CrEDIT TO THE KINGDOM OF LESOTHO FOR A LESOTHO HIGHLANDS WATER ENGINEERING PROJECT 1. I submit the following report and recommendation on a proposed development credit for SDR 8.0 million (US$ 9.75 million equivalent), on standard terms, to the Kingdom of Lesotho to help finance a Lesotho Highlands Water Engineering Project. The proceeds of the credit would be passed to the Lesotho Highlands Development Authority as equity contribution. Parallel co-financing totalling US$ million equivalent would be provided by: the European Development Fund (EDF), the European Investment Bank (EIB), the United Kingdom (UK), USAID, the Federal Republic of Germany (FRG), UNDP and the Republic of South Africa (RSA). The Lesotho Government would contribute the equivalent of US$ 3.21 million. PART I - THE ECONOMY 2. The most recent Economic Memorandum on Lesotho (No LSO) was distributed to the Executive Directors in October Country data are presented in Annex I. 3. Lesotho is a small country completely surrounded by the Republic of South Africa with which it must co-exist, notwithstanding ideological differences. It is mountainous and, other than its people and abundant water, it possesses few natural resources. About 12 percent of its 30,400 sq km is suitable for crop farming, but only 0.4 percent has high potential. Crop production is a low-yield, high-risk occupation, due to poor land quality, a harsh climate, and to the existence of alternative sources of income for those who live on the land - employment in South Africa or receipt of remittances from relatives working there. Livestock raising is the country's principal agricultural activity, but overstocking and inadequate herd management have led to overgrazing, widespread soil erosion and limited production. Nonetheless, agriculture is stil1 an important sector of the domestic economy, providing employment and contributing partially to income of up to 70 percent of the popularion. Development of a modern industrial sector has been limited by the small size of the domestic market; the necessity of importing nearly all raw materials and intermediate goods; the proximity of the highly industrialized South African econmy, which supplies Lesotho with most of the goods and services it requires; and a shortage of skilled entrepreneurial, managerial and technical manpower. Presently, manufacturing contributes little more than six percent of value added in the economy.

7 The most significant characteristic of Lesotho's economy is its heavy dependence on South Africa where more than 95 percent of its imports originate, as does most of its foreign investment. Its only outlets to the sea are via South Africa's transport facilities and ports. About 45 percent of the male labor force is employed in South Africa (mainly in mining); remittances of migrant workers constitute over 50 percent of Lesotho's GN; and over 65 percent of government revenues are derived from receipts of duties and taxes collected by the Southern Africa Customs Union (SACU) on behalf of the member countries (Lesotho, Botswana, South Africa, and Swaziland). In addition, Lesotho is a member of the Common (formerly Rand) Monetary Area which, while guaranteeing payment of Lesotho's foreign financial commitments, limits its use of monetary policy instruments. On balance, however, given Lesotho's size, location and resource constraints, the gains from membership in the Customs Union and the Monetary Area outweigh the costs associated with the limitations on policy instruments. 5. Despite constraints to its development, Lesotho's economy grew rapidly in the 1970s. Real GDP rose by about seven percent per annum during the mid-to-late 1970s, and as a result of increasing employment and wages for Basotho in South Africa, real GNP expanded by about nine percent per annum. The gains in domestic output were the result primarily of large increases in public investment and in the provision of government services. Tourism and mining also contributed significantly to economic growth, the former owing to an increasing number of visitors from South Africa and the latter resulting from the opening of a new diamond mine (which has since closed down). The industrial and agricultural sectors, on the other hand, have expanded only modestly since the mid-1970s. 6. Since 1980, however, the factors which made the higher growth rates possible have weakened considerably. Export values have stagnated in nominal terms and by 1985 had fallen in real terms to about half the 1980 total. This slowdown in resource inflows, coupled with the Government's expansionary fiscal policy in the early 1980s, had an adverse effect on Lesotho's balance of payments. The budget deficit widened continuously, reaching over nine percent of GDP in 1981/82. Imports grew sharply, doubling the 1978 level by 1981, and have continued to grow slowly since then. Despite a moderate growth of migrant workers' remittances -- the major source of foreign exchange earnings - the current account deficit rose from US$24 million in 1979 to US$49 million in Much of the deficit was financed by short-term loans which led to a sharp rise in debt service payments. 7. Recognizing the seriousness of the fiscal/balance of payments crisis, the Government instituted an austerity program in It tightened financial controls, froze wages and employment in the civil service and cut back the capital budget. In December 1982, it introduced a sales tax to boost domestic reverlues. Succeeding budgets increased sales and liquor taxes, instituted a withholding tax on interest earnings, and placed some emphasis on cost recovery measures. A tax has also been imposed on imported livestock.

8 -3-8. As a result of these efforts and a significant increase in Customs Union receipts, resulting irom a change in the revenue-sharing formula, both the fiscal situation and the balance of payments improved by The overall budget deficit was reduced to two to three percent of GNP in 1983/84 and 1984/85. The balance of payments current account deficit declined from US$49 million in 1981 to US$6 million in 1983, and recorded a surplus of US$19 million in The improvements in financial management were not, however, without cost, as these actions contributed to slower real GDP growth (1.2 percent per annum) during GNP growth averaged 4.6 percent per annum over the same period but has also slowed in recent years due to slower real increases in mining wages. 9. Lesotho's economic prospects are at best uncertain. Indeed Lesotho has already begun to face the difficult budgetary situation likely to persist throughout the remainder of the decade. The Government's 1985/86 budget deficit reached five percent of GNP, with the deficit in 1986/87 budgetted at 6.7 percent of GNP. While slower than projected implementation will most likely result in a somewhat smaller deficit, this still gives rise to concern. For the future, receipts from the Customs Union are not expected to increase as in the past, as a result of low growth of imports and possible reduction by the RSA in the compensatory payment under SACU. The real level of external development assistance for projects other than the Highlands Water project will most likely not grow given competing demands and the country's limited absorptive capacity. While Lesotho may benefit somewhat from enterprises wishing to locate outside South Africa, no significant direct foreign investment is foreseen, given limited potential in agriculture, industry and mining, and the uncertain political climate. At the same time, the outlook for Basotho employment in South Africa is bleak. Basotho employment in South African mines declined from about 129,000 in 1977 to 118,00) in This downward trend is likely to continue given South Africa's policy of increasing employment of domestic labor, possible reduction in demand for mining products resulting from economic sanctions against the RSA, continued depressed prices for metals and increased mechanization of the mines, thus lowering the demand for unskilled, and hence new recruits, from Lesotho. 10. Although Lesotho's prospects for growth and development are limited by natural constraints, as well as unfavorable external factors, limited opportunities do exist for improving the economy. The high risks and relatively low returns associated with crop agriculture push most young men into the towns or the mines, leaving agriculture in the hands of women and older men who have generally viewed it as a subsistence activity. However, a small but growing number of Basotho are becoming more commercially-oriented farmers. Research results have shown that there is good potential for diversifying output to include production of high-value horticultural crops for import-substitution and export purposes. Further research is needed, as is strengthening of horticultural extension and marketing services. With soil erosion and degradation of the land and vegetative cover remaining problems, Lesotho must begin to address the issue of overstocking. A recent Bank review of the agricultural sector recommends a number of actions which could be taken to improve land management, reduce overgrazing and commercialize livestock production.

9 The industrial sector will increase its contribution to income and employment generation as Lesotho is able to attract enterprises which can compete with South African production and expand their reach beyond the small domestic market to the SACU area and, to a lesser extent, markets outside the region. The prospects which exist in this sector will be explored in a Bank-supported study commencing before the end of The Bank Group is assisting, or planning to assist, the following areas: land use planning and soil conservation efforts; rehabilitation of the highway and rural road network; upgrading services and strengthening institutional development in the urban sector; improvement of basic education and technical and vocational training; and delivery of basic health and family planing services. By far the most promising financial prospect for Lesotho is the exploitation of its abundant water resources through construction of the necessary infrastructure which would allow the sale of water to South Africa. Revenues gained thereby would need to be channelled to investments in other sectors in order to gain maximum development impact. 12. An immediate concern is improving economic management and public sector finances. This will require strengthening mechanisms for expenditure planning and control, and diversifying and increasing revenues. A major problem has been the inadequate link betwesn recurrent and capital budgeting. Particularly in upcoming times of constrained fiscal resources, the Government must begin to prioritize its goals and objectives as a means of Identifying and allocating the scarce resources to priority budgetary programs. The Government must also improve its development planning machinery by strengthening institutional capabilities and providing better training. The absence of an effective planning capability within the Government has in the past led to decisions on major investment projects which are uneconomic and inconsistent with declared economic policy objectives. Notable examples are the original conception of the highly subsidized Food Self-Sufficiency Program (through subsidies have recently been reduced substantially) and the new international airport. 13. As one of the least developed domestic economies in the world, with limited medium-term potential for generating domestic revenues, Lesotho depends almost entirely on external assistance to finance its development program. Grants, mainly from bilateral sources, constitute about 60 percent of total external capital assistance, and the balance consists primarily of loaus on soft terms. IDA is the largest single source of multilateral assistance. As of the beginninig of 1986, of the US$167 million total external public debt, disbursed and outstanding, US$59 million (35 percent) were IDA credits. In 1985, service payments on IDA credits equalled about three percent of Lesotho' s total Pervice payments on medium- and long-term debt. Currently, Lesotho's debt service as a percent of exports of goods and services stands at three percent. PART II -- BANK GROUP OPERATIONS IN LESOTHO 14. The Bank Group's first operation in Lesotho -- a US$4.1 million credit for a highway construction project - was approved in 1966, a few months before the country (then known as Basutoland) became an independent

10 -5- kingdom. To-date, IDA has made 15 credits, totalling US$94.0 million, which have financed four projects in highways, two in agriculture, four in education, two in industrial development and one each in water supply, urban development, and health and population. In addition, the Bank acted as executing agency for UNDP-financed technical assistance for strengthening the Government's development planning organization and for assisting the Government to supervise preparation of the proposed Lesotho Highlands Water Project. Also, IDA is supervising an agricultural marketing and credit project on behalf of the International Fund for Agricultural Development (IFAD). IFC has made one investment of US$330,000 in a quarrying operation. Summary statements on IDA credits and IFC investments are provided in Annex II. 15. Lesotho's performance in implementing IDA-assisted projects has been generally satisfactory. Most projects, particularly those in the education and highways sectors, which constitute the bulk of the Bank Group's portfolio in Lesotho, have been implemented efficiently. Projects in agriculture, however, have encountered serious problems due to ineffective coordination within the Government, delays in appointing project staff, budgetary constraints and inapropriate policies and strategies. The Government has instituted measures to resolve the budget crisis by tightening financial manigement in the public sector (paras. 7 and 8). Also, in IDA-assisted projects, technical assistance is being provided and local staff trained to strengthen project implementing agencies and also, where appropriate, "revolving funds- are being established to obviate the need for prefinancing by the Government of local expenditures financed by IDA. 16. The principal focus of the Bank's assistance strategy is to: strengthen the Government's capacity for effective economic planning and development adminstration to improve policy formulation and effective implementation of development programs and projects; assist in the exploitation of domestic resources with promising development potential; assist in the improvement of policy environment for agricultural development that will lead to increased crop and livestock productivity; improve manpower development and training, including improved and expanded delivery of basic health services and implementation of population control measures; and strengthen public sector institutions, including improving cost-effectiveness of guvernment services. The Bank's assistance for improving economic management and development adminstration is provided mainly through the economic and sector work program, while the lending program is dominated by the Highands Water Project, by far the most promising development prospect for Lesotho. Other lending operations aim to: improve the management and conservation of agricultural resources expand production and employment opportunities in the industrial sector; and improve basic education services and expand technical and vocational training.

11 -6- PART III - THE WATER AND ENERGY SECTORS Introduction 17. The proposed project would cover the detailed design stage of the first construction phase of the Lesotho Highlands Water Scheme (LHWS). This multipurpose scheme would allow, through a system of dams and tunnels, the export of large quantities of water and the generation of hydropower for local use. As the available water resources far exceed all projected local water demands, no major issues arise in the water sector. Bowever, the proposed generation of hydropower to satisfy local power demand raises a number of issues which require an analysis of the energy sector, including the major sector institution, the Lesotho Electricity Corporation (LEC). Water Resources 18. Water is the only natural resource in relative abundance in Lesotho. From the lowlands in the west ( m above sea level), the land rises to the foothills in the central area ( m above sea level) and finally to the Maluti Mountains in the east, which continue into the Drakensberg Mountains in the Republic of South Africa (RSA). This topography strongly influences the distribution of rainfall, which amounts to 800 mm per year in the western part of the country and up to 1200 mm in the eastern part. Interannual variations in rainfall are considerable, resulting in periods of drought and flooding. The rainfall, very heavy at times, occurs mostly in the Southern Hemispbere spring (September to December) and, together with snowfalls, replenishes the water resources estimated at 5,500 million cms per year or 175 cms/sec. Due to topographic and surface conditions, practically all run-off enters the Senqu River (Orange River in RSA) and its tributaries, the Malibamatso, the Senqunyana and the Mohokare (Caledon in RSA) which originate in the Maluti Mountains. Frequent heavy downpours create serious soil erosion on the bare slopes, and this is one of Lesotho's major environmental problems. 19. Water quality is generally good throughout the year. However, surface water sources for urban water supplies require treatment because of high turbidity and the possibility of fecal pollution. Total water consumption accounts for about 0.7 cms/sec, or less than 1 percent of available resources. About 27 percent of the population (about 280,000, or 20 percent of the rural population and 120,000, or 65 percent of the urban population) have access to safe water supply, and the remainder draw water from unprotected sources. The Government plans to increase the coverage of piped water systems to 100 percent in the urban areas and to about 70 percent in the rural areas by year Thus, piped water supplies are estimated to triple by year 2000 but overall water demand is unlikely to exceed 1.5 cms/sec. Irrigated agriculture is limited because the country's topography restricts the irrigable area to about 16,000 ha. Allowing for increased water consumption resulting from normal population growth and additional use for industry and irrigation, available water resources, therefore, far exceed future requirements and water not used in Lesotho is "lost' downstream.

12 20. The growing water deficit in South Africa's industrial hub between Pretoria and Witwatersrand, whose main source of supply is the Vaal River basin, with its main dam and storage reservoir at Vereeniging, provides an opportunity for the profitable exploitation of Lesotho's water resources. Supply in that area is projected to fall short of requirements by RSA could cover the expected water supply shortage from sources within its territory. A proposed scheme, the Orange-Vaal Transfer System (OVTS) would pump water from the same river (dowustream in the Orange Free State Province) over long distances and high lifts, making it expensive to construct and operate and operationally vulnerable. RSA, therefore, approached Lesotho with a proposal to study a water transfer scheme which would divert the same waters from within Lesotho to the Vaal system by gravity. Sector Institutions 22. Water and energy affairs in Lesotho are the responsibility of the Ministry of Water, Energy and Mining (WEMMIN). Its Water and Sewerage Branch is in charge of implementing and operating urban water supply systems in Maseru, the country's capital, as well as in district centers. Water systems in the rural areas are constructed and operated by the Village Water Supply Section of the Ministry of Cooperatives and Rural Development. In an effort to strengthen the institutional set-up, the Government is in the process of changing the Water and Sewerage Branch from a ministerial department to a statutory corporation. 23. The unique size, purpose and multisectoral approach of the Lesotho Highlands Water Scheme (LHWS) effectively takes this project outside the functions of the existing water sector institutions. A separate institution, the Lesotho Highlands Development Authority (LHDA), has been established (para. 62) to handle all aspects of LHWS. However, the hydroelectric generation component requires a much closer link with the existing electric power utilities institutions. Bank/Country Goals and Lending Strategy in the Water Sector 24. The Government of Lesotho's (GOL) objective in developing its water resources has been to provide safe drinking water to urbanized areas and larger rural centers. Irrigated agriculture and hydropower generation are also being explored. While the feasib 4 lity of diverting the surplus Senqu River water to the industrial areas of RSA has been studied for some time, the economic, financial and technical feasibility on such a major scale has been fully assessed only recently. 25. A water supply project supported by an IDA credit of US$6 million, approved in 1979, financed the construction of piped water systems in seven small towns, and will, by 1990, serve about 50,000 inhabitants. This project, which also strengthened the Water and Sewerage Branch, was successfully completed in The Bank was also the executing agency for UNDP-financed consultants who supervised the feasibility studies for LHWS on behalf of GOL.

13 Except for the Lesotho Highlands Water Scheme, the Association has not planned to support other projects is the sector. However, Lesotho continues to obtain funding for the sector from other multilateral and bilateral donors. The Energy Sector Energy Resources 27. Lesotho's energy resources are extremely limited, as are its options for reducing its dependence on RSA for energy supply. Interfuel substitution possibilities are almost nonexistent and, apart from potential hydropower, the energy resource endowment is poor. Lesotho has been virtually treeless for several decades and reforestation, which could provide an indigenous fuel source, is difficult because of the rough terrain and poor soil and climatic conditions. Primary fuel needs are met by local vegetation and agricultural residues and are increasingly supplemented by imported wood, coal, petroleum and electricity. An energy assessment was carried out in 1984 under the UNDP/Bank program, and its principal conclusion was that, notwithstanding limited options, Lesotho could benefit from external assistance for energy sector institution building and improved forestry sector management to achieve self-reliance in fuelwood. 28. With respect to commercial energy resources, some petroleum exploration has been undertaken, but available data do not encourage further exploration. The existing coal and peat deposits cannot be exploited economically. Development of hydropower is the only promising possibility. Generation of hydropower in conjunction with the operation of the proposed LHWS could be an important step towards the utilization of this resource. The overall hydrogeneration potential of the LHWS is about 2,000 GWh, of which about 450 GWh could be developed in the initial phase to be engineered under the proposed project. Future phases could substantially increase the generation of power. 29. A number of mini-hydro sites have been surveyed and two projects are currently being implemented with Norwegian Government assistance, one with an installed capacity of 180 KW, the other with 1.9 MW. As costs of mini-hydros are generally high and seasonal run-offs restrict their continuous operation, the effective contribution to overall energy supply is very small. A feasibility study for a large-scale hydro scheme at Oxbow, with an installed capacity of 54 MW producing yearly 162 GWh, is about to be undertaken with the assistance of tbe African Development Bank (AfDB). Energy Sector Objectives 30. Government objectives in the energy sector are concerned with providing energy supplies by improving the availability of fuel in rural areas through woodlot and improved woodstove projects. There has also been a long-standing interest to find a practical way to develop the country's hydropower. GOL also plans to extend the power transmission networkl to make electricity available in rural areas. However, high costs and low

14 -9- projccted revenues hinder the prospects of this objective. The feasibility and priorities of undertaking network extensions, as well as of increasing the power generation capacity in Lesotho, would be determined on the basis of studies included in the proposed engineering project. Strengthening the financial operations and planning capability of LEC is of high priority. Agreement was reached with the Government during negotiations that (i) an investment planning and tariff study for LEC, under terms of reference acceptable to the Association, would be initiated within six months of the effectiveness of the EDF Loan Agreement and completed 18 months thereafter; and (ii) not later than three months after the completion of this study, a power generation study would be started and completed within six months under terms of reference acceptable to the Association. The findings of these studies, which would be financed by EDF, and the implementation and timing of proposed actions would be submitted to the Association for its review and comments. It was also agreed that investments in the power sector would be carried out in accordance with an investment program based on the recommendations of the aforementioned studies. Commercial Energy Demand and Supply 31. Reliable supply and demand data are limited to commercial forms of energy, including imported fuelwood, and indicate that, at about 0.1 toe p.a. per capita, commercial energy consumption in Lesotho is among the lowest in the world. Domestic energy consumption (including private cars) represented 55 percent of total commercial energy of 146,200 toe, in Industry used only seven percent of all energy, because of the limited size of the sector, the commercial and government sectors used 29 percent (including fuel consumption by cars) and agriculture about six percent (including diesel use in tractors). Aviation accounts for about one percent of total commercial energy, while losses make up the remaining two percent. 32. Demand for commercial energy (petroleum, electricity and coal) is expected to grow at about five percent p.a. through 1995, with the following composition by fuel type: Recorded Projected Growth Growth (toe) Z of p.a. (toe) % of p.a. (toe) % of 1981 Total in Z 1984 Total in X 1995 Total Petroleum Electricity Coal Total Renewable Energy 33. Because of the acute need for improved access to energy in the rural areas, emphasis has been placed on increasing the supply of renewable

15 -LO - energy. Several bilateral and international organizations are assisting with projects which include: (i) the Woodlot Project (ODA) and reforestation projects (SIDA), (ii) the Renewable Energy Technology Project (USAID), with emphasis on woodatove improvements and dissemination, (iii) two mini-hydro plants (NORAD), and (iv) a biogas and solar demonstration project (UNESCO/UNDP). A request has also been made to the Government of Finland for assistance in the woodfuel sector. Energy Pricing 34. Although prices of petroleum products and electricity are set by GOL, they are very much dependent on prices in RSA, the source of Lesotho's energy imports. An inter-state oil committee of Botswana, Lesotho and Swaziland (the BLS countries) further monitors procurement, allocation, pricing and conservation of petroleum in the three countries. 35. As some 85 percent of Lesotho's electricity is supplied by the Electricity Supply Commission (ESCOM) of RSA, electricity prices in Lesotho depend on the cost of supply from ESCOM. Lesotho, therefore, benefits from the ESCOM tariffs, which are among the lowest in the world because most of RSA's electricity generation is from low-cost coal. Despite rising labor costs, ESCOM's real price of electricity has remained relatively constant in the past and should continue to do so as greater use is made of reject coal (middlings) resulting from the export of high grade coal and as mining productivity continues to increase. Operational improvements at ESCOM's generating stations, expected as an outcome of a recent extensive assessment of ESCOM's operations, should, together with future energy conservation in industry, reduce the rate of generation expansion and, hence, financial costs arising from load growth. Furthermore, restructuring of the tariff by increasing peak rates should delay additions to the generation capacity. Electricity prices should therefore rise in real terms only when productivity improvements cease and conservation measures are exhausted. As ESCOM supply tariffs are based on average financial costs, in accordance with South African Government's policy, tariffs should increase at a lower rate than if marginal cost pricing principles were applied. 36. ESCOM sells electricity to LEC on the same basis as to other bulk consumers in the Orange Free State Province of RSA. The tariff combines a demand or capacity-related charge with an energy charge, a normal feature for this type of supply. Starting in 1975, ESCOM increased its tariff with inflation (presently at about 16 percent). GOL has been reluctant, however, to raise LEC tariffs simultaneously, with the result that LEC's financial performance has deteriorated to its present unsatisfactory level (para. 42). GOL recognizes, nevertheless, the need for overhauling LEC'stariff by introducing peak load pricing. The tariff study to be done as part of the investment planning study (para. 30) will develop a strategy for improving LEC's financial position.

16 Energy Sector Organization Energy Planning 37. WEMNIN is responsible for the production and distribution of all forms of energy, including electricity. The Department of Energy, which was receutly established, is in charge of energy planning, policy formulation and data collection and analysis. Priorities of the department' s work program include an urban energy use survey, the evaluation of interfuel substitution and conservation technologies, particularly in the field of renewable energy, and the execution of an electricity tariff study. Key issues that the department will address include access to and affordability of different types of fuels. Electric Power 38. LEC, a parastatal corporation under the jurisdiction of WENKIN, is responsible for the public supply of electricity throughout the country. About 85 percent of all electricity consumed in Lesotho is supplied by ESCOM, and the rest is generated by small diesel stations in three centers operated by LEC. LEC will also operate the two mini-hydro stations under construction at Semonkong and Mantsonyane in Maseru and Thaba-Tseka Districts,respectively. Most of LEC's management team are new to their positions and, with the exception of the Managing Director and the Planning Engineer, are expatriates. Despite extensive technical assistance in the past, LEC's overall performance has deteriorated significantly in the past few years because of management changes, costs of system expansion, and the reluctance of GOL to raise tariffs in line with ESCOM price increases (para. 36). Lesotho Electricit, Corporation (LEC) 39. LEC's operations are concentrated in Maseru where 8,800 customers, representirg 80 percent of its total clientele, take about 70 percent of the total load. With the exception of Maseru, load densities are low; hence costs are high. Substandard transmission lines, built in the past with the aim of reducing investment costs, are gradually being replaced to reduce high transmission losses. These losses increased from seven percent in the early 1970s to 13 percent in Demand growth has been flat for the past three years, in contrast to previous growth rates of 8-10 percent p.a. In 1984/85 (year ending March 31), the total maximum demand from ESCOM was 30.9 MW, compared with 30.0 MW in 1982/83 and 29.9 NW in 1983/84. Total sales declined, however, from 110 Glih in 1983/84 to 103 GWh in 1984/85 due to the recession in the economy. 41. New customers have to pay most of the extension cost before being connected to the system and this has been a deterrent to load growth. As a result, access to electricity is limited to about two percent of the total population, despite the fact that many households could connect to existing distribution facilities if arrangements were made for payment of the connection charges in installments. The LEC investment planning study

17 (para. 30) would also investigate methods to reduce the cost of house connections. Lower connection charges, linked with payment over time, should stimulate load growth. Increased economic activity as a result of the construction of LHWS is also expected to stimulate electricity sales and an average growth rate of seven percent p.a. may be reached. 42. LEC's financial performance has deteriorated steadily from FY1980. LEC realized a net profit of Maloti 1.0 million (US $0.5 million) on sales of Maloti 4.6 million (US $2.3 million) in 1980 but had a net loss of nearly Maloti 0.5 million (US $0.25 million) on sales of Maloti 7.6 million (US $3.8 million) in FY1984. Although provisional results for FY1985 show some improvement, LEC continues to operate at a slight loss. This deteriorating performance was caused by inadequate tariff increases in the face of ESCOM tariff increases, greater debt service payments for loans denominated in foreign currencies due to the devaluation of the Maloti, and low-margin extensions to rural areas. 43. Customer capital contributions for system expansion amount to about 70 percent of total cost, an increase from 44 percent in Long-term debt accounted for 27 percent of capital in 1980, 14 percent in 1985, and will'rise as more loans are obtained to finance the expansioin program. However, future debt financing will be considered only if LEC's revenues meet operating and maintenance expenses, as well as debt service, and finance a portion of its annual investment program. 44. LEC's future investment requirements for transmission and distribution expansion will, according to preliminary indicative estimates, amount to about Maloti 40 million (US $20 million) over the years 1986 to About half of this would be for rural electrification. In the period, another Haloti 52 million (US $26 million) would be required, with 80 percent for rural electrification. These levels of investment should increase the total number of connections to about 25,000 by 1996, serving about 7 percent of the total population. However, no financing for these investments has been identified. The power sector investment planning study to be carried out under the proposed project would assist LEC in determining the viability and priority of components of its investment program, as well as outline a financing strategy (para. 30). The Lesotho Highlands Water Scheme (LHWS) Background 45. The idea to divert large quantities of the waters of the Senqu River, from the natural south-westwardly flow north to the Johannesburg area in the RSA, has long been an engineer's dream. The feasibility of exporting these waters was first studied in the 1950s. It was again studied in the 1960s (under a UNDP-financed project executed by the Bank), before the current studies started early in the 1980s. The scheme became progressively larger as the water requirements in South Africa grew. The earlier studies did not result in a project because agreement could not be reached between the two governments on payment for water exports.

18 The present project studies began in 1978, when the Lesotho and South African governments appointed a joint technical committee to further study a possible water conveyance scheme. The resulting feasibility report (1979) recommended construction of a 35 cubic meters per second (cms/sec) water transfer scheme, later increased to 70 cms/sec, requiring the phased construction of four dams and about 100 km of water transfer tunnels. The project included a hydropower generation component. 47. Following the review of the preliminary feasibility study, the two governments agreed on the preparation of a more detailed project layout and on the scope of another, more detailed, feasibility study. The cost of this feasibility study was shared by the two governments, and the study itself was carried out by two consulting groups engaged by the respective governments but working as a joint operation. Stage 1 of this study started in August 1983 and was completed in December of the same year. Lesotho's funding was made available through a grant from EDF. UNDP financing, with the Bank as executing agency, provided a technical assistance team to supervise execution of the studies on behalf of the Government of Lesotho. 48. The main objectives of the Stage 1 study were to: (i) identify the layout for more detailed study in Stage 2; (ii) confirm that environmental and socio-economic aspects were solvable; (iii) confirm that there were no legal obstacles to project implementation; and (iv) confirm that the advantages of the cost differential of a water transfer scheme built in Lesotho, compared to an alternative built in RSA, could be determined and would be sufficiently attractive to both governments. The studies further measured the quantities of water available for transfer, located and dimensioned the dams, tunnels and hydropower facilities, and prepared cost estimates. 49. The Stage 1 studies identified an optimum project layout and concluded that there were no unsolvable environmental, socio-economic or legal difficulties. The two governments then agreed in 1984 to go ahead with Stage 2 of the feasibility studies and to increase the eventual quantity of water to be exported to 70 cms/sec. The proposed project layout foresees the construction of four dams for water storage (initially at Katse, and later on at Mohale, Mashai and Tsoelike), water transfer works with an ultimate delivery capacity of 70 cms/sec, including about 100 km of tunnels, and a hydropower plant (see map and Annex IV for detailed project description). The Stage 2 feasibility studies were completed in April Water Treaty, Domestic Legislation 50. The basic agreement between the two countries to proceed with the implementation of the project is the Treaty 'r the Lesotho Highlands Water Project between the Government of the Kingdom of Lesotho and the Government of the Republic of South Africa. The Treaty, which was signed on October 24, 1986, covers the rights and obligations of each party and lays down the quantities of water to be delivered, the cost sharing provisions, and the scope and calculation of benefit (royalty) payments. It further sets out the principles for financing, constructing, operating and maintaining the

19 system. The Treaty provides that South Africa will be responsible for all the costs of that part of LHWS related to the delivery of water to South Africa, covering the cost of implementing, operating and maintaining the scheme. In addition, South Africa will provide loan guarantees if required by lenders. Thus, Lesotho will assume virtually no financial obligation for the water transfer component. However, Lesotho will be solely reponsible for financing the hydropower component. As a net benefit to Lesotho, the Treaty provides for payment by RSA of a "royalty" (paras. 68 and 69). The Treaty also provides for the establishment of a number of institututions -- described in paras which will be responsible for implementing the project. Detailed Features of LHWS 51. LHWS would be executed in several phases, of which Phase 1A is scheduled to begin in Phase 1A would provide a continuous supply to RSA of some 17cms/sec of water from the Katse reservoir. It would include a transfer tunnel to a hydropower complex (whose generating capacity will be determined under the engineering project), a tailpond, and a delivery tunnel for discharge into the Ash River in RSA. The water would then flow into the Vaal Dam, the main reservoir on the system supplying the Johannesburg-Pretoria area. Phase 1. would provide a further 10 cms/sec by coanstructing a dam at Mohale and a 32-km tunnel transferring water from the Mohale reservior into the Katse reservoir. 52. Phase 2 would add a further 36 cms/sec by construction of a dam at Mashai whence, according to present design concepts, the water would be pumped to the Katse reservoir, requiring the construction of a 20-km transfer tunnel and a pumping station. A second transfer tunnel and a second delivery tunnel, parallel to the ones constructed under Phase 1A, would also be constructed. The hydropower installation could also be enlarged. Phase 3 would add 6 cms/s.c by the addition of the Tsoelike reservoir, pumping arrangements and a 10-km tunnel to the Mashai reservoir. 53. With the implementat4on of the whole LHWS, a total of 70 cms/sec water would eventually be diverted to RSA. This corresponds to the long-term regulated average yield of the catchment area, and represents about 40 percent of the total estimated yield of the Senqu/Orange River basin of 175 cms/sec. Present use of these waters by Lesotho and all other riparians amounts to about 1,500 million cms per year, which corresponds to 47 ems/sec, thus leaving a generous margin -- about 60 cms/sec -- for future use in Lesotho or downstream. 54. Additional hydrological studies to be completed by mid-1988 are presently being carried out to confirm the yield of the catchment areas. In the worst case, a 10 percent to 15 percent smaller yield could be expected. This would be compensated for by initially advancing future construction phases and later by tapping additional catchment areas. The impact on Phase 1 may not exceed three percent (2-3 cms/sec) and would require advancing Phase 2 by six months.

20 International Water Rights 55. The Senqu/Orange River, which originates in Lesotho, is an international waterway. It flows through the Republic of South Africa and forms the bo'indary between South Africa and Namibia (South-West Africa) before reaching the Atlantic Ocean. Riparian states are, therefore, RSA and Namibia. As RSA would be a beneficiary of LIWS, Lesotho notified only Namibia of the proposed scheme. The United Nations Council for Namibia, the governing body mandated under General Assembly Resolution No (S-V) of May 19, 1967, informed the Government of Lesotho in 1985 that it had no objection to the scheme. Before notifying the Council, the Government had informed the Association that Lesotho had consulted the South-West Africa People's Organization (SWAPO) which had not objected to the scheme. The unallocated margin of 60 cms/sec (see para. 53) of the Senqu/Orange River should be sufficient to meet future water requirements of Lesotho and Namibia which are estimated not to exceed 8 cms/sec and 6 cms/sec respectively. Moreover, Treaty provisions foresee maintaining a minimum required flow in the Senqu/Orange River downstream of LHWS. The implementation of LHWS should not, therefore, jeopardize future water-based developments in Lesotho or Namibia. Implementation of Phase 1A 56. The major water storage and transfer components of Phase 1A of LEWS would be: (i) Katse dam: 155m high of either rockfill or concrete arch type with an active storage capacity of 1,245 million cms; (ii) Transfer tunnel: 48-km long and 4-m diameter, with an average flow capacity of 28 cms/sec (to allow addition of the Stage 1B flows); and (iii) Delivery tunnel: 34-km long and 4-m diameter with an average flow capacity of 28 cms/sec to accomodate Phases LA and 1B. 57. The hydropwer component of this phase of the project would consist of a power generating plant whose final installed capacity and layout will be determined on the basis of studies to be conducted under the engineering project. 58. The construction contracts for the major elements will be let on the basis of international competitive bidding, limited by such eligibility requirements as the eventual financing institutions may impose. Construction of the 48-km transfer tunnel may be bid in three slices and the delivery tunnel in two packages interfacing at the Lesotho/South Africa border. Upgrading of 60 km of existing roads and construction of 140 km of access roads must precede the major construction of the Katse dam and the transfer tunnel. These roads will take at least two years to construct in difficult terrain and separate financing for this crucial pre-construction infrastructure will be required.

21 While the Dronosed engineering project will finwice detailed enqineering, includinz preparation of bidding documents and bid evaluation, preparation of detailed working drawings and construction supervision will be financed under the constructinn project. Although it is likelv, and preferable, that the consultants who work under the engine!ering project would continue throughout the construction phase, this will have to be resolved at the time of appraisal of Phase IA. 60. Once the access roads are built (scheduled for 1990), construction of Phase IA will follow and is programmed for completion five years later. This is based on conservative assumptions on tunnel work in a predictable geology which would permit completion and water delivery by However, general experience with projects of this type and size and possible delavs in access road construction indicate that completion of the construction of the dams and tunnels could be delayed by a year or more. Therefore, price contingencies were calculated on the basis that project construction would start a year later and take a year longer than currently programmed. 61. The cost of Phase IA Is currently estimated at US S1.2 billion, including physical and price contingencies. This amount is only preliminary as the hydropower component has still to he costed on the basis of the selected layout (paras. 70/72). Interest during construction, as well as other financing charges, is not included. Lesotho Highlands Development Authority (LEDA) 62. The Treatv provides for the establishment -- under Lesotho law -- of the Lesotho Highlands Development Authority (LHDA) which wlll be in charge of the execution of the engineering project, construction of subsequent phases and operation and maintenance of LHWS, including the power generation component. LHDA was established by an Order of His Majesty King Moshoeshoe II, which was published as Order No. 23 in the Government Gazette on November 14, The Board of Directors of LHDA comprises seven members, with the Principal Secretary of the Ministry of Water, Energy and Mining as its chairman, and the Chief Executive of LHDA as an ex-officio member. The remaining five members will be appointed by the Minister of Water, Energy and Mining for their expertise in managerial, technical and financial matters. The Chief Executive, appointed by the Minister, will be responsible for executing the Authority's policies and its day-to-day operations. The Board's powers and functions include approval of contracts, tender documents and maior design parameters, as well as financing arrangements, budgets, implementation plans, operation and maintenance schedules, and appointment of auditors. Joint Permanent Technical Commission (JPTC) 64. The Treaty also provides for the establishment of the Joint Permanent Technical Commission (JPTC) with equal representation of three delegates each from Lesotho and RSA. Its main responsibility is to monitor

22 the implementation and operation of the project in all matters related to the delivery of water to RSA. JPTC is the instrument by which RSA's interests are safeguarded by ensuring that the project is efficiently implemented and operated; that the funds for which RSA is responsible under the Treaty are properly expended by LHDA; and that the agreed quantities of water are delivered to RSA according to the established time schedule, Establishment of JPTC became effective on the signing of the Treaty. Trans-Caledon Tunnel Authority (TCTA) 65. The Department of Water Affairs (DWA) of RSA will be responsible for implementing the water delivery works within RSA, including construction of the water delivery tunnel. These functions will be exercised by the Trans-Caledon Tunnel Authority (TCTA) whose establishment is also provided for under the Treaty. TCTA will be set up under the RSA Water Act which has been amended for this purpose. SACU Payments 66. Lesotho is a member, together with Botswana, Swaziland (the BLS countries) and RSA of the Southern Africa Customs Union (SACU). All imports into the SACU area are subject to import duties which go into a common revenue pool administered by RSA. Payments to each of the BLS countries are determined by a formula which determines each country's share in proportion to its share of total imports and the production of excisable goods, enhanced by a factor of All payments are received two years after they are generated. 67. A modification to the customs union agreement introduced in 1978 provides that each BLS country receive at least 17 percent of the value of its imports and its production of excisable goods. As Lesotho's share in the common pool has been between five percent and seven percent, the 17 percent margin now applies, with a two-year delay. SACU rebates accruing to Lesotho from the water transfer component of LHWS are expected to be significant (US$ 84 million or M 168 million in 1983 prices). These rebates are accounted for in calculating the royalty (para. 69). Royalties 68. The major benefit that Lesotho would receive from LHWS is the royalty to be paid by RSA. These payments will be determined by sharing the cost savings accruing to RSA by constructing the LHWS instead of the more costly OVTS (para. 21). 69. The basis for sharing the savings, which are estimated at about US$0.9 billion (M 1.8 billion) in 1983 prices, is established under the Treaty. It allocates to Lesotho 56 percent of the cost savings. Lesotho would receive a continuous flow of royaltlies proportional to the volume of water delivered, starting in 1995, with an initial amount of US$10 million (M 20 million) in 1983 prices, increasing to US$60 million (M 120 million) by The royalty consists of the savings in investment costs on the

23 18 - basis of a 50-year annuity discounted at six percent, and savings in operation, pumping and maintenance colts, calculated per cubic meter of water delivered by discounting the savings and scheduled water deliveries at six percent. All royalty payments would be adjusted for inflation and the portion relating to pumping costs, for increases in electricity tariffs. The royalty would be a net benefit to Lesotho as the cost of exporting the water would be paid in full by 'outh Africa (para. 50). The Hydropower Component 70. The Lesotho Government attaches high priority to utilizing the energy of the reservoired water of LHWS for the generation of hydroelectric power. This has resulted in making the LHWS a multipurpose scheme with the combined objective of selling water to RSA and generating electric energy to meet Lesotho's electricity needs, thereby providing a measure of independence from RSA. The Association has consistently worked toward the identification of an economically viable hydro-power component. The feasibility study developed the optimum layout of a peak power generating plant (initially with an installed capacity of 75 KW) designed to meet projected peak power requirements of Lesotho while base power requirements would continue to be imported from RSA. 71. Following appraisal of the engineering project, another hydropower layout was identified which would generate base energy for the Lesotho grid and might provide a higher rate of return. The peak power configuration would require construction of two balancing reservoirs with a power plant. This would permit peak power generation while at the same time maintaining a constant water flow out of tle tailpond reservoir to RSA. The base power configuration would require construction of only a tailpond reservoir as the 48-km water transfer tunnel would form the headrace. This alternative, while confirmed to be technically possible, needs to be investigated in more detail. At the current state of preparation, parameters identifying the economic viability of an optimum hydro-power component are insufficiently defined to arrive at a final conclusion. 72. Agreement has, therefore, been reached with GOL that the two hydropower alternatives referred to above be studied further to determine the optimal solution that would be selected for final design under the engineering project. The appraisal, including economic evaluation, of this solution would form part of the appraisal of Phase 1A, which would then allow the Bank to define its position regarding support for the hydropower component. Furthermore, in order to reduce the risk of delaying construction of the water transfer component - because of uncertainty about raising funding for the hydropower component -- the designs of Phase 1A would include a contingency plan that would permit construction of the hydro-power component at a later stage without interfering with the continuous delivery of water in accordance with Treaty provisions.

24 PART IV - THE PROJECT Introduction 73. The proposed project was identified in 1982 when the feasibility study was commissioned. Subsequently, the Government of Lesotho formally requested Bank assistance in carrying out the project. The Project was appraised in October 1985 and the Credit negotiated in Washington, D.C., in May The delegation of Lesotho was led by Mr. A.M. Monyake, Principal Secretary, Ministry of Planning and Economic Affairs. Further processing of the project was held up by delayed completion of negotiation and signing of the Treaty. Project Objectives and Description 74. The proposed project would be the preliminary phase of the most significant operation in the Government's effort to broaden the country's base for development by exporting water. The project's objective is to develop Phase IA of LHWS from the feasibility stage to construction. It would (i) refine optimization of the hydropower component and develop detailed designs; (ii) undertake further geological investigations; (iii) prepare bid documents and evaluate bids; (iv) provide technical assistance and training for establishing and developing LHDA; and (v) assist LHDA in securing financing for the construction of Phase 1A. Rationale for Participation by the Association 75. The main reason for the Association's participation in the engineering project is the conviction that the implementation of LHWS is in the best economic interests of Lesotho, and that the Association's advice in the preparation and design of the project would help Lesotho derive maximum benefits from the scheme. The lead role played by the Association - at the request of GOL - and its financial commitment have facilitated securing the necessary financing for the project. Also, the Association would assist in ensuring that environmental, as well as resettlement aspects, are adequately covered during the construction phases. Finally, because of the trust and confidence it enjoys from both parties to the project, the Association is better placed than other donors to facilitate successful project development and implementation, while safeguarding Lesotho's interests and promoting the widest possible international cooperation in the scheme. Project Details 76. The project would include the following major elements (see also Annex IV). (a) Optimization Studies. Assessment of hydropower options for selecting the optimum layout, to be followed by the detailed design of the selected configuration of the hydropower scheme. This will include the technical and economic optimimization of all elements of the proposed hydropower component to ensure that the layout of the water transfer scheme will permit the addition of hydropower generation at a later stage if necessary (para. 72).

25 (h) Geotechnical Investigations, Preparation of Designs and Bidding Documents. Carrying out of geotechnical investigations and preparation of detailed designs and bid documents for (1) all elements of the water transfer component (Katse dam, transfer tunnel, and delivery tunnel), (ii) the hydropower complex, and (iii) infrastructure works in Lesotho. Design of infrastructure improvements in RSA and improvements of the Ash River in RSA would be the responsibility of various South African authorities, coordinated through the Department of Water Affairs. (c) Technical Assistance and Training for LHDA. LHDA would receive direct technical assistance arranged under agreements with consulting firms, individuals and bilateral agencies, enabling it to direct and supervise project execution. This technical assistance would encompass engineering, finance, accounting and administration, including personnel matters, and would also cover environmental and resettlement aspects. While most of the technical assistance personnel would be employed directly by LHDA, there would be a self-contained provision for the review of designs by a panel of internatinnal experts, and also for insurance review and for mobilizing financing. As initially, most of the expert personnel would be recruited externally, there would be a long-term training program initiated under the proiect to increase employment opportunities for Basotho. (d) Technical Assistance for JPTC. Additional technical assistance would be provided to enable GOL to be adequately represented on the JPTC (para. 64). The assistance would consist of a specialist fully experienced in matters relating to the operation of large-scale water resource schemes. (e) Studies - Special studies relating to environmental and resettlement aspects would be included under the project. These studies relate to inventoring cultural assets, wildlife and plants, and proposing protective measures. Particular importance would be given to the elaboration of a resettlement plan as part of a regional development plan. Current estimates indicate that the implementation of Phase IA could result in the resettlement of about 700 families. (f) LEC Development Planning and Tariff Study and Power Generation Planning Study. Given LEC's precarious financial position and the need for extending its distribution system, a development planning and tariff study would be carried out to provide the necessary information for determining the scope and cost of a system expanslon program; outline further technical assistance and training requirements; and provide the basis for agreeing on an action Plan for improving LEC's operations and tariffs. A power generation planning study would outline the strategy for future investments in power generating capacity. (g) LHDA Operations Expenses. As LHDA will not have its own revenuies to cover its operating expenses during the design phase, the proposed proiect would include provision for these expenses. (h) Equipment/Vehicles. The project would include the purchase of office equipment, including data processing equipment, and vehicles.

26 Arrangements for Consultant Services 77. Consultants to be financed by the Association for the technical assistance components and the design of a component of the water transfer facilities, corresponding to about half of the design services, would be selected in accordance with the Bank's guidelines. The shortlist prepared by GOL for the technical assistance consultants and the consultants for the water transfer design component are satisfactory to the Association. Consultants financed from other.aurces will be recruited in accordance with the respective financing agencies' requirements. The RSA-financed consultants for the water transfer component, who will be contracted by LHDA, are familiar with the project (they participated in the feasibility study) and will provide valuable continuity. The consortium will be beaded by Niham Shand, a firm long associated with the Lesotho Highlands Water Scheme, supported by specialized assistance from outside sources. The Association-financed water transfer consultants would be selected on the basis of their initial responses to the terms of reference covering the water transfer design. The selected consultants would then, together with Niham Shand, submit a joint proposal and come to a formalized cooperative arrangement in the form of a joint venture or a consortium. The Association would be satisfied with such an arrangement. Project Cost and Financing 78. The total cost of the project is estimated at US$51.3 million, comprising US$37.8 million (or 74 percent) in foreign costs and US$13.5 million (or 26 percent) in local costs, including taxes and duties. Cost estimates are based on estimates prepared by the feasibility study consultants and the GOL study supervisor. They were reviewed by the RSA study supervisor and the appraisal mission and appear reasonable. Physical contingencies, which total about US$4.8 million, are about 11 percent of the base costs and include 10 percent of the base cost of studies and technical assistance, and 15 percent for geotechnical investigations. Price contingencies, amounting to US$4.4 million, which are 10 percent of base costs (end 1986) were calculated assuming a five percent annual escalation rate for foreign costs and eight percent thereafter for Maloti costs. 79. Funding for the engineering project would come from the sources listed below. The proposed IDA Credit of US$9.75 million would finance about 19 percent of total cost, including about 19 percent of local cost. Allocation of IDA Credit (including all contingencies) (US $million equivalent) Component Local Foreign Total (i) Part of design of Water Transfer Component (ii) Technical Assistance Engineering (iii) Technical Assistance Finance Water Transfer (iv) Review Panel (v) Training Total

27 Further funding of US$3.21 million equivalent would come from the Government of Lesotho, US$10.1 million equivalent from EDF, of which US$9.5 million has heen confirmed, US$3.04 million equivalent from EIB, US$0.94 million equivalent from UNDP, US$1.46 million equivalent from ODA, US$0.41 million from USAID, US$0.58 million equivalent from CDM and US$21.76 million equivalent from RSA. External financing would cover about 94 percent of total cost. Annex V provides information on the components to be financed by each of the funding agencies. The execution of the EDF Loan Agreement and the EIB Loan Agreement would he conditions of credit effectiveness. 80. Confirmation has been received from RSA that financing is avallable for (i) starting the design of the water transfer components, (ii) design of the access roads in Lesotho and related geotechnical investigations and that subsequent funding will be made available in time, and (iii) that funds are available within RSA for designing infrastructure Improvements within RSA, as well as for the design of the Ash River improvements. 81. The proceeds of the proposed IDA Credit would be passed on hy GOL to LHDA as an equity contribution. Proiect Execution 82. In order to begin optimlzation and design work by May 1987, as currently planned, consultant selection should take place during the first quarter of Shortlists of the engineering consultants to be financed by the Association have been established by the Government of Lesotho and are acceptable to the Association. Contract negotiations would take place during the first quarter of RSA has already proposed to GOL the consultants to be funded by RSA (para. 77). Consultant selection for the components to be financed by EIWF iz currently underway. 83. The consultants to provide technical assistance to LHDA should be available no later than the start of work by the design consultants. Individual recruitment of experts, either directly by LHDA, or by aid agencies, would coincide with the arrival of the technical assistance team and the start of work of the design consultants. Consultants for the special studies would be recruited by LHDA so that most of the studies could begin as scheduled. A detailed Proiect execution schedule, which establishes target dates for tasks and dates for recruitment of consultants by position, was agreed upon at negotiations. The project is scheduled fnr completion by February 28, Audit 84. LRDA's forerunner, the Lesotho Highlands Water Project Unit in the Ministry of Water, Energy and Mining, was Dot subiect to external audit because it was a government department. During negotiations, agreement was reached that: (i) LHDA's accounts would be audited annually by independent auditors acceptable to the Association; and (ii) the audit reports would he sumitted to the Association within four months of the end of the fiscal year.

28 Agreement was further reached that, in carrying out their assignment, the auditors would: (i) ensure that actual costs and disbursements with regard to the project have been properly recorded in the project's progress reports; and (ii) certify the correctness of the amounts associated with the operation of the Special Account (para. 88). Procurement 86. Consultants' services to be financed out of the Credit would be procured in accordance with Bank guidelines (para. 77). Disbursement 87. The proposed credit would be disbursed to cover: (1) Consultants Services, Technical Assistance 100 percent of costs of consulting services for studies and technical assistance (SDR7.13 million); (2) Training 100 percent of total costs for overseas training (SDR 0.08 million); (3) Refunding of Project Preparation Advance (SDR 0.09 million) (4) Unallocated (SDR 0.70 million) 88. In order to expedite disbursements, a Special Account in US dollars, with an initial deposit of US$0.9 million, representing an average of three months expenditures, would be established in the Central Bank of Lesotho on terms and conditions satisfactory to the Association. All IDA eligible expenditures would be prefinanced from the Special Account, unless otherwise previously agreed to by the Association. Withdrawal applications for replenishment of the Special Account would have a minimum value of US$225,000 equivalent. All reimbursements of expenditures against contracts for consultants' services valued at less than US$20,000 equivalent would be made on the basis of statements of expenditure. Relevant documentation would be retained by LHDA and be open to review by the Association. Reimbursement of expenditures related to training would be made against a training program approved by the Association. All other payments relating to contracts over US$20,000 equivalent would be made against full documentation. The annual audit (para. 84) would also cover tne operation of the Special Account and statements of expenditure. Since the project covers the engineering and design phase of a subsequent construction project, the estimate disbursements (Annex VI) were not derived from existing disbursement profiles but from other similar projects. To allow sufficient time for submission of final invoices, a closing date of December 31, 1990 is proposed.

29 24 - Monitoring 89. Dates for critical actions of the project implementation schedule were agreed upon during negotiations, and these will be compiled and updated in quarterly reports to monitor progress. Agreement was further reached that within six months of project completion, LHDA would prepare and submit to the Association a project completion report on the basis of an outline to be mutually agreed upon. Environmental and Resettlement Issues Environmental Impact 90. The relevant studies carried out during the feasibility studies did not identify any major environmental issues as the landscape and river systems are already severely degraded. Climatic conditions and the nature of the reservoirs should prevent the introduction and spread of vector diseases such as schistosomiasis and malaria. Serious erosion and overgrazing now exists and may be exacerbated by the project. Watershed and range management restoration measures will, as part of the regional development plan, help to ameliorate these problems. 91. Additional environmental studies will be carried out under the engineering project. These include: (i) an epidemiological survey and an outline of precautionary measures to confirm that the project will not create conditions which would allow the spread of vector or water-borne diseases; (ii) a wildlife and botanical survey to determine whether rare or unusual vegetation or wildlife could be adversely affected by the project and what protective measures should be taken; and (iii) a heritage conservation survey to identify any significant archeological resources which may be affected by the project and outline feasible preservation measures. Other studies concerning environmental issues, such as range management, irrigation, soil conservation and fishery development would form part of the regional development plan. Specia'ists would review, under the proposed project, all environmental aspects, including recommended actions. Impact of LEWS on the Local Population 92. Prior to the beginning of the initial phase of construction of LHWS (Phase IA), fewer than 100 households would be affected by loss of arable and grazing land required for the construction of access roads and work camps. Thereafter, the reservoir to be constructed at Katse would flood, over the years 1994 to 1996, an estimated 600 ha of arable and 2,915 ha of grazing land. Preliminary estimates show that a maximum of 700 households, representing one third of the area's population, would lose arable land; all of the 2,100 households would be affected by the loss of communal grazing land; and about 15 households would lose their dwellings.

30 The second phase of the project (Phase 1B) would, by year 2000, inundate about 1,000 ha of arable land, about 1,500 ha of grazing land, effecting an estimated 870 households. About 85 of those households would also lose their dwellings. Detailed surveys to be carried out under the proposed project would determine the exact number of households affected. I 93. Compensating those who would lose their arable land is a pressing issue as only 13 percent (400,000 ha) of Lesotho's land is suitable for farming and much of this consists of soils of depleted fertility and agronomic properties. No arable land is available for compensation in the vicinity of the project area. However, the possibility of land being made available for resettlement further away from the project area will be investigateduring the proposed project. Resettlement is further complicated by the increasing investment in livestock, with stocking rates already far beyond the carrying capacity of the land. The Social and Environmental Unit to be established within LHDA will carry out the necessary surveys and investigations. 94. The tasks of the Social and Environmental Unit will be to: (1) outline a viable resettlement program; (ii) design a compensation program for property losses and inundation of arable land; (iii) draw up a regional development plan for the population adversely affected by loss of winter grazing land; and (iv) develop a program for mitigating adverse environmental impacts. The objective of the compensation policy and regional development plan would be to ensure that the affected population is given the opportunity to be economically self-sustaining within the shortest time possible or, at the very least, ensure that living standards match those enjoyed before resettlement. In preparing the regional development plan, programs would be developed for improving range management, soil conservation, and crop and livestock production. Also, the potential for developing a fishing industry, agro-forestry and small-scale enterprises would be studied. The scope for enhancing overall living conditions would be assisted by constructing water supply systems, health clinics, schools and feeder roads. Justification and Benefits 95. The implementation of the project has potentially far-reaching implications for Lesotho's economy. It would be by far the largest development project in Lesotho (estimated to cost about three times the country's GNP). The project would convert a resource, which at present has no comparable alternative use, into an export commodity which would earn the country much-needed income for investment in other sectors.

31 The exact level of revenues payable to Lesotho in the form of royalties will be determined by the quantities of water delivered. Preliminary calculations indicate that these royalties could exceed the value of all Lesotho's trading exports at present. As RSA would pay for all costs associated with constructing, operating and maiutaining the water transfer component and guarantee and amortize associated loans (para. 50), and the royalty payments would be additional to those cost-related payments, a rate of return cannot be calculated and would be infinite. The construction phases, which would last into the next century, would provide significant domestic employment opportunities. Construction of access roads should open up areas difficult to access at present. The activities associated with the construction phases should bring about additional economic development in the project area. Risks 97. The implementation of the engineering project will concentrate first on the recruitment of consultants and LHDA staff. Close monitoring of the early steps in recruitment and adherence to the Implementation schedule rhould expedite project initiation. However, given the number of institutions involved in project financing, it is possible that some elements of the project will slip. Close coordination early in the design of the hydropower and water transfer components should ensure timely completion of the two major design tasks. Risks associated with the development of designs will be minimized through reviews by a panel of international experts. Addieional geological investigations should reduce the remaining uncertainities. 98. Transition into the construction phase contains considerable uncertainties, since bidding can proceed only when (i) access road construction is sufficiently advanced; and (ii) financing for Phase 1A is secured so that tendering can proceed. This risk, therefore, is associated with raising financing for the access roads and thereafter, for Phase IA. The provision of financial advisory services to LHDA would minimize this risk. 99. Financing for the hydropower component may be more difficult to raise as Lesotho would be solely responsible for financing this component. The water project, therefore, would be designed to allow the addition of hydropower at a later date without interfering with water deliveries (para. 72) The technical risks appear to be manageable and somewhat below normal for works of this type and magnitude. The engineering is being carefully executed and the geological and hydrological factors are reasonably predictable and favorable. Base costs and physical contingencies, therefore, do not present unusual uncertainties The location, topography and design of the project, as developed so far, give reason to believe that no major environmental and resettlement issues will evolve. The planned census and regional development plan should facilitate the identification of satisfactory solutions and measures to be taken in time to avoid adverse impacts on the local population.