Document of The World Bank FOR OFFICIAL USE ONLY PROJECT APPRAISAL DOCUMENT ON A PROPOSED LOAN IN THE AMOUNT OF US$190 MILLION TO THE

Transcription

1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY PROJECT APPRAISAL DOCUMENT ON A PROPOSED LOAN IN THE AMOUNT OF US$190 MILLION TO THE STATE OF PERNAMBUCO Report No: BR WITH THE GUARANTEE FROM THE FEDERATIVE REPUBLIC OF BRAZIL FOR A PERNAMBUCO SUSTAINABLE WATER PROJECT (PROJETO DE SUSTENTABILIDADE HÍDRICA DO ESTADO DE PERNAMBUCO) Sustainable Development Department Brazil Country Management Unit Latin America and the Caribbean Region November 30, 2009 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 APAC ARPE BOD Capibaribe Melhor CEL CURRENCY EQUIVALENTS (Exchange Rate Effective March 18, 2009) Currency Unit = Reais (R$) R$ 2.30 = US$ 1.00 US$ 0.43 = R$ 1.00 FISCAL YEAR January 1 December 31 ABBREVIATIONS AND ACRONYMS O&M Operation and Maintenance State Water and Climate Agency State Multi-Sector Regulatory OBA Output-based Aid Agency OBD Output-based Disbursements Biochemical Oxygen Demand PAC Federal Growth Acceleration Recife Municipal Urban Program Development and Social Inclusion PMSS Brazil Federal Water Supply and Project Sanitation Sector Modernization Special Procurement Commission - Project Comissão Especial de Licitação Proagua Brazil Federal Water Resources CFC Federal Accounting Council COMPESA Pernambuco State Water Supply and Sanitation Company CPL Permanent Procurement Commission - Comissão Permanente de Licitação CPRH State Environmental Agency CPS Country Partnership Strategy (Report # BR) discussed by the Executive Directors on May 1, 2008 CSL Sectoral Procurement Commission - Comissão Setorial de Licitação EA Environmental Assessment EMP Environmental Management Plan ESF Environmental Social Framework FMA Financial Management Assessment GDP Gross Domestic Product GoPE Government of Pernambuco HDI Human Development Index IFR Interim, Un-audited Financial Management Report ITEP Pernambuco Institute of Technology MMA Ministry of Environment Ministério do Meio Ambiente MRR Metropolitan Region of Recife Prometropole RPF SDEC SFC SIAFEM SIL SOE SRH SWAp TCE UEGP UIP WRM WSS Vice President: Pamela Cox Country Director: Makhtar Diop Sector Director: Laura Tuck Sector Manager: Guang Zhe Chen Task Team Leader: Thadeu Abicalil Management Project State of Pernambuco - Recife Urban Upgrading Project Resettlement Policy Framework State Secretariat for Economic Development Federal Internal Control Agency States and Municipalities Financial Administrative System Sector Investment Loan Statement of Expenditure State Secretariat for Water Resources Sector-Wide Approach State Accounting Court State Program Management Unit Project Implementation Unit Water Resources Management Water Supply and Sanitation

3 BRAZIL Pernambuco Sustainable Water Project (Projeto de Sustentabilidade Hídrica do Estado de Pernambuco) CONTENTS FOR OFFICIAL USE ONLY Page I. STRATEGIC CONTEXT AND RATIONALE... 1 A. Country and sector issues... 1 B. Rationale for Bank involvement... 5 C. Higher level objectives to which the project contributes... 6 II. PROJECT DESCRIPTION... 7 A. Lending instrument... 7 B. Project development objective and key indicators... 7 C. Project components... 7 D. Lessons learned and reflected in the project design E. Alternatives considered and reasons for rejection III. IMPLEMENTATION A. Institutional and implementation arrangements B. Monitoring and evaluation of outcomes/results C. Sustainability D. Critical risks and possible controversial aspects E. Loan conditions and covenants IV. APPRAISAL SUMMARY A. Economic and financial analyses B. Technical C. Fiduciary D. Social E. Environment F. Safeguard policies G. Policy Exceptions and Readiness Annex 1: Country and Sector or Program Background Annex 2: Major Related Projects Financed by the Bank and/or other Agencies This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not be otherwise disclosed without World Bank authorization.

4 Annex 3: Results Framework and Monitoring Annex 4: Detailed Project Description Annex 5: Project Costs Annex 6: Implementation Arrangements Annex 7: Financial Management and Disbursement Arrangements Annex 8: Procurement Arrangements Annex 9: Economic and Financial Analysis Annex 10: Safeguard Policy Issues Annex 11: Project Preparation and Supervision Annex 12: Documents in the Project File Annex 13: Statement of Loans and Credits Annex 14: Country at a Glance Annex 15: Map IBRD

5 BRAZIL PERNAMBUCO SUSTAINABLE WATER (PROJETO DE SUSTENTABILIDADE HÍDRICA DO ESTADO DE PERNAMBUCO) Date: November 30, 2009 Country Director: Makhtar Diop Sector Manager/Director: Guang Zhe Chen Project ID: P Lending Instrument: Specific Investment Loan PROJECT APPRAISAL DOCUMENT LATIN AMERICA AND CARIBBEAN LCSUW Project Financing Data [X] Loan [ ] Credit [ ] Grant [ ] Guarantee [ ] Other: Team Leader: Marcos T. Abicalil Sectors: Water supply (40%); Sewerage (40%); General water, sanitation and flood protection sector (20%) Themes: Access to urban services and housing (50%); Water resource management (50%) Environmental Category: A Full Assessment For Loans/Credits/Others: Total Bank financing (US$m.): Proposed terms: variable spread loan in U.S. Dollars, with a commitment-based amortization consisting of annuity repayments of principal, payment dates on May 15 and November 15, six and a half years of grace period, and twenty seven and a half years of total loan term. Financing Plan (US$m) Source Local Foreign Total Borrower International Bank for Reconstruction and Development Total: Borrower: State of Pernambuco Palácio do Campo das Princesas Praça da República s/n Recife Pernambuco Brazil Tel: 55(81) Fax: 55(81) governo@governadoria.pe.gov.br Responsible Agency: Water Resources Secretariat Rua Cruz de Cabuga, 1111 Santo Amaro Recife PE - Brazil

6 Tel: (55-61) Fax: (55-61) COMPESA Avenida Cruz Cabuga Santo Amaro Recife Pernambuco Brazil Tel: 55(81) Fax: 55(81) presidencia@compesa.com.br Estimated disbursements (Bank FY/US$m) FY Annual Cumulative Project implementation period: Start May 2, 2010 End: Apr 30, 2015 Expected effectiveness date: June 30, 2010 Expected closing date: November 30, 2015 Does the project depart from the CAS in content or other significant respects? Ref. PAD I.C. Does the project require any exceptions from Bank policies? Ref. PAD IV.G. Have these been approved by Bank management? Is approval for any policy exception sought from the Board? Does the project include any critical risks rated substantial or high? Ref. PAD III.D. Does the project meet the Regional criteria for readiness for implementation? Ref. PAD IV.G. [ ]Yes [X] No [ ]Yes [X] No [ ]Yes [X] No [ ]Yes [X] No [ ]Yes [X] No [X]Yes [ ] No Project development objective Ref. PAD II.B., Technical Annex 3 The Project development objective is to improve sustainable water supply and sanitation services for the population residing in the Capibaribe river basin and in the Metropolitan Region of Recife (MRR) Project description [one-sentence summary of each component] Ref. PAD II.C., Technical Annex 4 The proposed project will complement and contribute to the implementation GoPE's water sector program through the following components: 1) Water Sector Management and Institutional Development, including strengthening the State of Pernambuco s: (A) water sector institutional and regulatory frameworks as well as the State of Pernambuco's capacity for integrated water sector planning, policy and management; (B) policies, regulatory framework and institutional models for the provision of water supply and sewerage services and for sustainable irrigated agriculture; and (C) capacity for overall project implementation and monitoring.

7 (2) Improving Efficiency in the Provision of Water Supply and Sanitation Services, including: (A) carrying out of activities designed to reduce technical and commercial water losses and improve COMPESA s services, sales and operational efficiency (Non-revenue Water Activities); and (B) provision of technical assistance to support the implementation of selected activities of COMPESA s strategic plan implemented during the Project period. (3) Water Supply and Sanitation Service Expansion, including the following sub-components: (A) expansion and integration of the Pirapama Water Supply System; and (B) carrying out of activities designed to protect and optimize the Tapacurá, Carpina and Jucazinho water reservoirs in the Capibaribe River Basin, reduce up stream pollution and support the State of Pernambuco and COMPESA in leveraging future investments for priority projects. Which safeguard policies are triggered, if any? Ref. PAD IV.F., Technical Annex 10 Safeguard Policies Triggered by the Project: a. Environmental Assessment (OP/BP 4.01); b. Natural Habitats (OP/BP 4.04); c. Physical Cultural Resources (OP/BP 4.11); d. Involuntary Resettlement (OP/BP 4.12); e. Forests (OP/BP 4.36) f. Safety of Dams (OP/BP 4.37) Significant, non-standard conditions, if any, for: Ref. PAD III.E. Board presentation: None Loan effectiveness: a. The COMPESA Implementation Agreement has been executed on behalf of the Borrower and COMPESA. b. In addition to the usual legal opinion, the Bank requires legal opinions confirming that: (i) the COMPESA Implementation Agreement has been duly authorized or ratified by the State of Pernambuco and COMPESA and is legally binding upon the State of Pernambuco and COMPESA in accordance with its terms; and (ii) the Loan has been registered by the Guarantor s Central Bank. Covenants applicable to project implementation: In addition to the standard contractual clauses and conditions required by the Bank, the following covenants are included in the Legal Agreement: The State of Pernambuco shall: a. Throughout project implementation, maintain a unit within SRH (UEGP) and cause COMPESA to maintain a unit (UIP), both with the powers and responsibilities set forth in the Operational Manual; and no later than two months from the Effective Date, have said units fully staffed with personnel with experience and qualifications satisfactory to

8 the Bank. b. Enter into an agreement with COMPESA under terms and conditions satisfactory to the Bank, to set forth the arrangements for the implementation of Components 2 and 3 of the Project. c. Prior to initiating activities for the benefit of a Cooperation Entity (SDEC, ARPE, CPRH and ITEP), enter into an agreement with each of the Cooperating Entities, under terms and conditions satisfactory to the Bank, to set forth the arrangements for the implementation of Component 1 of the Project. d. (i) Upon issuance of the legal instrument establishing APAC enter into an agreement (the APAC Implementation Agreement) with APAC under terms and conditions satisfactory to the Bank, to set forth the arrangements for the implementation of Component 1 of the Project by APAC (in substitution for the implementation that would otherwise have continued to be carried out by the State of Pernambuco through SRH); and (ii) thereafter, prior to transferring responsibilities for implementation of Component 1 of the Project to APAC, furnish to the Bank for its approval, the evidence of the fiduciary and safeguards capability of APAC to carry out said Component of the Project. e. Carry out the Project in accordance with the Operational Manual, satisfactory to the Bank. f. (i) Carry out the Pirapama Water Supply Conveyance System Resettlement Plan in accordance with its terms; and (ii) furnish to the Bank, for its approval, in accordance with the Resettlement Policy Framework, any needed Resettlement Plan, and thereafter carry out such Resettlement Plans in accordance with their terms. g. Carry out the Project in accordance with the Environmental Management Plan. h. Prior to initiating any activities under Component 2 (a) of the Project (Non-Revenue Water Activities) for which the Pirapama dam supplies water: (i) establish an Independent Panel to review, with powers and responsibilities acceptable to the Bank, the safety of the Pirapama dam, (ii) cause the Independent Dam Safety Panel to evaluate the safety of the Pirapama dam under terms of reference satisfactory to the Bank and identify any remedial action to improve its safety; and (iii) furnish to the Bank: (a) an action plan to address deficiencies, if any, in the Pirapama Dam safety; and (b) evidence, in form and substance satisfactory to the Bank, of the actions taken to address any such deficiencies. i. Prior to the implementation of any Non-revenue Water Activity under Component 2 (a) of the Project, furnish to the Bank, for its approval, the respective Non-revenue Water Activity. Condition of Disbursement: No withdrawal shall be made for payments made in respect of Non-Revenue Water Activities under Component 2 (A) of the Project unless the Bank shall be satisfied that the actions of the Dam Safety Action Plan then due have been taken.

9 I. STRATEGIC CONTEXT AND RATIONALE A. Country and sector issues 1. Brazil has undergone a rapid urbanization process, in which the urban share of the population has grown from 56% to over 80% in the past 30 years, making Brazil one of the most urbanized countries in the world. Today cities account for 90% of the country s gross domestic product (GDP) and include half its poor. Once at the forefront of the country s economic transformation, Brazilian cities are now grappling with the problems of widespread informality, slums, raising crime and violence, inadequate service provision, and environmental degradation. 2. Water resources and associated services and infrastructure are key elements for Brazil s social and economic sustainable and equitable development. Brazil s primary water resources issues are related to scarcity (especially in Northeast region but also in large metropolitan areas), pollution (in most urban areas), and recurrent droughts and floods (which could be exacerbated by climate change and increased hydrological variability). Brazil faces daunting challenges to expand and improve water and sanitation services, as 7% of urban households lack access to a potable water supply and 43% lack access to sewerage networks 1, aggravated by the challenging need to improve service efficiency, reliability and quality The relative lack of access is at much higher levels in rural areas, as only 28% of the households have access to a potable water pipeline and 24% have access to either sewerage systems or septic tanks. 3. The State of Pernambuco has a territory of 98,311 km 2, comprising 185 municipalities and with a population of 8.4 million, 76% of which live in urban areas. Recife is the state s capital, and its metropolitan region, with a population of about 3.7 million, is the biggest urban agglomeration of the Northeast Region and the fifth in Brazil. In terms of economic development, the State produces about 2.7% of Brazil s GDP. Although Pernambuco has experienced growth rates slightly superior to the national average, it has lost ground over time to neighboring states, which have grown at higher rates. Nevertheless, the Government of Pernambuco (GoPE) expects a turnaround in development and a sharp economic growth as a result of a large investment program of about US$8.5 billion in infrastructure and industrial projects it plans to implement over the next five years, in spite of the financial crisis. 4. To deal with the effects of the global financial crisis, the Government of Brazil, and GoPE 2, in particular, are implementing a simultaneous consistent countercyclical fiscal policy to protect both the macroeconomic stability and key social indicators. The main direct impact of the financial crisis on GoPE has been a reduction of revenues of 4.7% in the first quarter of 2009, mostly due to the reduction of federal transfers. On the other hand, state revenues from sales tax increased in the same period given that most of the planned public and private infrastructure and 1 With sanitation there is a very wide variation of access across states, with lower rates of access in the North and Northeast states. Source: World Bank Group s Country Partnership Strategy Brazil , Report # BR, discussed by the Executive Directors on May 1, Pernambuco is one of the four Brazilian states that embarked in the Choque de Gestão (management shock) reform movement, which involves securing a healthy macroeconomic and fiscal situation, improving efficiency and service quality in key sectors that account for a significant part of State expenditures, and committing the State government to measurable results, among other managerial innovations. The Bank is supporting this state policy through the Pernambuco Education and Public Management Project. 1

10 industrial investments remain on track. The state is being able to keep social expenses and infrastructure investments, while maintaining crucial fiscal targets such as primary surplus. 5. Pernambuco is one of the driest states in Brazil with a per capita water availability of 1,320 m 3 /year on average, equivalent to 3.5% of the national average per capita availability. The state s semi-arid Sertão and Agreste sub-regions represent 89% of the state s territory and have only about 20% of the water available in the state, with per capita water availability ranging from 400 m 3 /year to 800 m 3 /year, respectively. The coastal wetter sub-regions of Mata Pernambucana and the MRR concentrate 57% of the population, mainly in the MRR (43% of the state population and 65% of the state GDP) and about 80% of the available water. 6. The low water availability in the semi-arid regions of the State, coupled with the high rate of urbanization and economic activity in the coastal regions place the state s available water resources under a great deal of stress. In spite of high levels of coverage with about 91% of urban households connected to the public water supply network, the service is unreliable and intermittent. Of the 170 municipalities that are served by the Pernambuco State Water Supply and Sanitation Company (COMPESA), only 30 receive water 24 hours per day. Rationing is commonplace, even in the MRR, where residents on average alternate between 24 hours with water supply and 28 hours without service. Water losses are estimated to be around 60%, which is significantly above the 40% national average. 7. Strategic confined aquifers are being overexploited at alarming rates in the MRR. The unreliability of the water services supplied by COMPESA in the MRR has had serious impact on groundwater resources as large users seek alternatives by self-provisioning from aquifers. This situation was particularly acute after a severe drought in 1998/99, when residents received 1 day of water supply service over a 10-day period. The State Secretariat for Water Resources (SRH) has introduced zoning criteria to guide the licensing of new wells and the issuance of groundwater rights; however, the unsustainable use of groundwater has persisted due to the limited institutional capacity for enforcement. 8. Although the legal framework for water resources management in Pernambuco 3 includes all basic principles of modern water management, implementation of the state water resources management (WRM) policy has been hindered by the lack of adequate information and institutional capacity. Frequent administrative changes at the state level with regards to the management of water resources have contributed to the vulnerability of sector institutions and prevented the formation of an entity at the state level with adequate resources and staff to carry out the needed integrated planning and management of water resources. 9. With regards to sanitation, of the 170 municipalities served by COMPESA, only 20 have sewerage networks with an average coverage of about 20%, well below national and regional averages. This situation impacts not only the un-served population presenting risks to public health, but also indirectly the population served as the raw wastewater contributes to the pollution of water resources. Some of the most important state water sources, located in the 3 The states legal framework for the management of water resources is set by Federal Law 9.433/1997 and State Law /2005 2

11 Capibaribe river basin and providing water to about 2.6 million people, are receiving increasing pollution loads due to untreated domestic sewage. 10. Given the negative impact water scarcity and unreliable water supply and sanitation services have on the economic performance and social development in the State, GoPE has selected the water sector as a priority and an important element of its state development plan. To this effect GoPE developed a strategy for the sector with the following ambitious objectives: (a) improve state water resources development and management policies and practices in order to allow for the expansion of access to safe and reliable water for human consumption and productive uses, and (b) reach universal access to water supply and sanitation in urban areas by the years 2014 and 2018, respectively. Based on this strategy, GoPE is starting to implement a comprehensive water sector program which focuses on four lines of action, as follows: 11. Consolidation and strengthening of the state s institutional framework to adequately manage water resources, including adequate organization, planning and management tools. The GoPE plans to implement this line of action through: (i) establishing and strengthening a State Water and Climate Agency (APAC) to be in charge of water resources planning and management; (ii) reviewing the current water and sanitation regulatory regime in and preparing a long-term regulatory business plan; (iii) fostering participatory management activities, such as the establishment of new river basin committees and strengthening of existing ones as well as the establishment of water supply infrastructure users associations and councils; (iv) revising, preparing, publishing and disseminating plans on water resources and selected river basins; (v) preparing technical studies for the efficient and sustainable use of groundwater, with a special focus on the MRR and its complex groundwater dynamics; (vi) improving water use regulation; (vii) modernizing and expanding the hydro-meteorological and water quality monitoring network, with a focus on most critical river basins and aquifers; (viii) implementing river basin rehabilitation activities, and (ix) promoting sustainable irrigated agriculture by exploring options for improved water use efficiency and effectiveness in agriculture, among others. 12. Optimization of existing water infrastructure and increasing operational and financial efficiency of water supply and sanitation services. This line of action mainly focuses on the performance of COMPESA and on investments and activities targeted to improve the company s operational efficiency, corporate governance and management. GoPE is closely coordinating the implementation of this line of action with efforts related to increasing water availability in the MRR, in order to ensure that investments in augmenting the region s water supply are optimized. Activities planned include the implementation of comprehensive programs to reduce nonrevenue water, the preparation of water supply and wastewater master plans for the MRR and several river basins in the state, undertaking a valuation exercise for COMPESA, which will be an important in establishing the company s capital base for regulatory purposes, among others. 13. Investment in expanding water supply and sanitation service coverage in urban areas. In order to alleviate the chronic water shortages in the MRR, the GoPE plans to augment the supply of water to the MRR by expanding and integrating the Pirapama water supply system to the MRR water supply structure, and by implementing investments in sewerage and treatment that in the short- to medium-term aim at reducing the pollution loads from untreated sewage within the Capibaribe river basin, the main source of water for the MRR and Agreste sub-regions. The expansion and integration of the Pirapama water supply system is on-going with financing 3

12 secured from the Federal Growth Acceleration Program (PAC). It is estimated to cost about R$510 million (US$220 million). The dual strategy to end rationing in the MRR and the Pirapama Water Supply System Ending rationing and improving supply reliability is a top priority for the GoPE and COMPESA. In the case of the MRR, the state is implementing a dual strategy, to improve efficiency and increase supply. Water supply efficiency is focused on reduction and control of water losses; however, results are not sufficient to end rationing and have a reliable supply in the short term. In order to face that challenge and provide reliable supply for the MRR even under droughts periods, GoPE is concluding the Pirapama water supply system, with a peak production capacity of 5.13 m 3 /s. The Pirapama water supply system was conceived in 1968 as the main source of supply to the MRR, and its design and construction was included in Metropolitan Water Supply Master Plan of The system s construction started shortly thereafter, and since then it has run into financing constraints that have prevented its completion to date. Works for the Pirapama dam were concluded in late 2000, and the reservoir was filled up in In 2008, the Pirapama water supply system became a top priority for the GoPE and also of the federal government. As such, adequate financing in the amount of about US$220 million has been secured through the PAC that will ensure the system s construction is concluded by October Works are being carried out in the remaining parts of the system, namely the bulk water mains, water treatment plant, treated water mains, potable water storage centers, and water supply interconnections with the existing distribution network. Since 2008, the Pirapama reservoir is providing an average of 1.0 m 3 /s of bulk water to increase de production of the Gurjaú water system. 14. Designing and implementing adequate water and sanitation programs in rural communities and small towns using adequate technologies, financing and management frameworks. COMPESA currently serves urban agglomerations in the State, which leaves rural communities and dispersed settlements virtually without service. Some projects have been implemented with the support of development agencies in an attempt to address this precarious situation, and the overall outcome has been mixed. This line of action focuses on reviewing past experiences as well as developing and implementing demonstration projects to show improved management of water supply and sanitation services. This will be subsequently followed by scaling up and replicating contributing to the universal access goals set by the GoPE. 15. Reliable and efficient management of water resources in order to reach adequate irrigation, water supply and sanitation service provision are critical to achieving sustainable economic growth and social development goals. Given the increasing imbalance between the demand and availability of water in the state, the GoPE, in formulating its strategy for the sector, has estimated that investments in the order of about R$3.9 billion (US$1.7 billion) are needed in the next 3 to 5 years to achieve its established short- to medium-term goals of improvement in service provision. As such, the proposed Project forms a key contribution to the R$1 billion package that the government has secured for the sector, and helps the state of Pernambuco in better leveraging additional resources from the PAC. 16. In addition, the Project will support the state policies to deal with the impact of the financial crisis in both infrastructure investments and fiscal stability. Investments in water supply 4

13 and sanitation expansion and efficiency will support the expected economic growth and social indicators improvements. To reduce short-term pressure on the state budget, the project was designed in such a way that it will not require additional resources to finance counterpart funds, but rather use existing federal and state-funded programs. B. Rationale for Bank involvement 17. The project fits within the World Bank Group s Country Partnership Strategy (Report # BR) discussed by the Executive Directors on May 1, 2008, which highlights the need for infrastructure development for sustainable growth, shifts the World Bank support to states and moves to a more comprehensive approach to the water sector. 18. As part of its engagement strategy with the Bank, the State has requested Bank support in three priority areas - public sector management, education and water through two investment operations: i) a SWAp comprising public sector management and education, and ii) a sector investment loan for the water sector, which would help the state develop a comprehensive approach to the broader water sector, while at the same time finance priority investments. It is expected that the Bank operation would help the state lay a foundation for moving towards a performance-based sector-wide approach. 19. The Bank brings a large amount of expertise to the State, building on a long-standing program of support. Over the past ten years, the Bank has supported the implementation of the Federal Water Resources Management Project (Proagua), which finances WRM in all states in the northeast region and was executed in Pernambuco by SRH. Proagua s support to the state of Pernambuco is noteworthy as it has supported the GoPE s effort to improve its WRM systems and is the first big step toward more sustainable and integrated WRM in the State markedly in relation to institutional development. However, its impact has been limited because of insufficient resources in the face of the level of investments required in the sector. In addition, the proposed Project nicely complements a program of support the Bank has in three neighboring States: Ceará, Bahia and Rio Grande do Norte. The presence of the Bank in these semi-arid Northeast States can help build synergies and address the regional challenges of WRM. 20. The Bank has also financed the Federal Water Supply and Sanitation Sector Modernization Projects (PMSS I & II) to support the modernization of the Brazil s sanitation sector, which has also supported the state of Pernambuco, and COMPESA in particular, namely in the development of strategic planning and organizational restructuring. PMSS also contributed to: (i) the establishment of the National Water Supply and Sanitation Information System (SNIS), internationally recognized as best practice in sector information, (ii) the dissemination of modern approaches to services operation, and (iii) the development of state regulatory frameworks and agencies, including to the establishment of the 2007 Federal Guidelines Law for Basic Sanitation. The PMSS experiences on utility reform and improved regulation are very relevant to the proposed Project. 21. Given the negative impact that water scarcity, unreliable water supply and lack of sanitation services have on the economic performance and social development in the State, GoPE has selected the water sector as a priority in its partnership with the Bank and an important element of its state development plan. The Bank is ideally positioned to support a broad 5

14 engagement across the water sector in Pernambuco, as it is able to build upon a range of ongoing engagements at the federal level in WRM, water supply and sanitation, as well as state - and municipal-level engagements in urban development. In addition, the Bank is currently engaged in Pernambuco in the areas of urban development through the Recife Urban Upgrading (Prometropole) and the Recife Municipal Urban Development and Social Inclusion (Capibaribe Melhor) Projects, and rural poverty through the state s Rural Poverty Reduction (ProRural) Project (additional financing). It should be noted that the Capibaribe Melhor project targets the lowest part of the Capibaribe watershed, in one of the poorest areas of the municipality of Recife. This project comprises improvements of urban spaces along the banks of the Capibaribe river; development and rehabilitation of infrastructure, social and economic development and institutional development of the local government. 22. Another key rationale fort Bank support is the Bank s convening power and ability to foster collaboration across agencies. The GoPE is committed to addressing water issues in the state in a comprehensive manner, while financing priority investments, which require a great deal of coordination, strategic planning and innovation. The GoPE sees the Bank as a strategic partner for its ability to be an honest broker to coherently address complex challenges of the urban, water and development agendas, while assisting with coordination across agencies. The state also seeks the Bank s international experience and ability to explore synergies and catalyze reform efforts, integrating technical expertise and public policies to address multi-sector challenges, as it implements its state development plan for the sector. C. Higher level objectives to which the project contributes 23. The GoPE recognizes that there is increasing demand for scarce water, and that preventive and corrective measures to either preserve or increase water availability, quantity and quality are crucial to development. The state also recognizes that investments in expansion, although necessary, are not sufficient. Adequate incentives are also needed to optimize the use of infrastructure and water resources, and to ensure adequate operation and management. From this perspective, it is important to improve and consolidate an efficient and comprehensive water sector management model and strengthen the institutional capacity of relevant state agencies within a sector-wide and long-term perspective. In addition, the state also needs to protect and reduce pollution loads of key water supply sources, increase wastewater collection and treatment, increase access and reliability of water supply in a more efficient manner, reduce water losses and optimize existing infrastructure. To deal with rural water supply and sanitation the state needs to develop and implement an adequate model of service provision. Finally, regarding WRM more broadly, the state plans to improve its management capacity and make use of economic instruments for better allocating water rights and for recovering costs. 24. The proposed project brings an important innovation in the way the water supply reliability issue is addressed through a broad set of coordinated measures to jointly improve water resources management and water supply and sanitation service delivery. In the interface of WRM and WSS interventions, issues of expansion, performance and quality of service provision are approached in the perspective of their impacts on the water resources base, at the same time as selected water resources management actions are supported to allow sustainable improvements in the delivery of water services. Such improved coordination between WRM and WSS is a common aspect to all components of the Project. In addition to support the GoPE in 6

15 moving towards addressing sector issues in a more coherent and comprehensive manner with a long-term view, the proposed project will help the state in laying a foundation for moving towards a performance-based sector wide approach. II. PROJECT DESCRIPTION A. Lending instrument 25. The Project will be supported by a specific investment loan (SIL) in the amount of US$190 million. B. Project development objective and key indicators 26. The Project development objective is to improve sustainable water supply and sanitation services for the population residing in the Capibaribe river basin and the MRR. 27. The key indicators of achievement of Project objectives are: (a) Reduction in the percentage of served population subject to water rationing in the MRR from 88% in 2008 to 10% in 2015; and (b) Reduction in the pollution load of tons of BOD/year discharged the municipalities targeted by the project s wastewater investments by C. Project components 28. The Project will complement and contribute to the implementation GoPE s water sector program through the following components 4 : (1) Water Sector Management and Institutional Development, (2) Improving Efficiency in the Provision of Water Supply and Sanitation Services, and (3) Water Supply and Sanitation Service Expansion. Component 1: Water Sector Management and Institutional Development (US$29 million) 29. This component will contribute to the GoPE s goal of long-term water security, through strengthening the sector s institutional and regulatory frameworks as well as the state s capacity for integrated sector planning, policy and management. This component will be implemented by the SRH and will finance technical assistance activities, goods and works to consolidate, improve and implement integrated WRM, such as the following set of activities: 30. (A) Integrated Water Resource Management. Carrying out of activities designed to strengthen the sector s institutional and regulatory frameworks as well as the borrower s capacity for integrated sector planning, policy and management, such as: (a) establishment of APAC, including development of its organizational structure, business strategy, and administrative processes, construction and equipping of its headquarters offices, development of staff training and performance enhancing programs, and provision of information technology and training to its staff; (b) establishment of new river basin committees and strengthening of existing ones, as well 4 There is a Contingent amount and a FEF that have not been allocated to any Component. 7

16 as establishment of water supply infrastructure users associations and councils; (c) revision, preparation, publishing and dissemination of water resource plans, including a State s water resources plan and selected river basins plans in the Borrower s territory; (d) carrying out of studies designed to improve the efficiency and sustainability of the use of groundwater, with a special focus on the MRR and its complex groundwater dynamics; (e) carrying out of studies to improve water use regulation, including those needed to address gaps on knowledge base, improve decision-making tools, revise rules and procedures, introduce bulk water charging, and enable more effective enforcement for both surface and groundwater use; (f) modernization and expansion of the hydro-meteorological and water quality monitoring network, with a focus on the Borrower s most critical river basins and aquifers, including the modernization of the Borrower s existing meteorological laboratory, modernization and expansion of the state hydrometeorological and water quality monitoring network, and design and installation of flood alert systems; (g) carrying out of environmental rehabilitation activities such as riparian re-forestation, control of sediments in rivers, headwaters recovery and protection, rehabilitation and protection of threatened water supply sources, with focus on the MRR and the Capibaribe river basin; and (h) carrying out of other activities as may be proposed by GoPE and approved by the Bank. 31. (B) Water Services and Infrastructure. Strengthening the Borrower s policies, regulatory framework and institutional models for the provision of water supply and sewerage services and for sustainable irrigated agriculture through, inter alia: (a) development of a water supply and sewerage services strategy for rural and small towns in the State s Agreste and Sertão regions, operational models, and specific plans; (b) implementation of pilot projects to test the models developed, all such pilot projects selected by the Borrower and approved by the Bank; (c) improvement of the Borrower s water supply and sewerage regulation, by inter alia, assessing the current regulatory regime in the State, elaborating new regulatory governance models and instruments, and developing terms of reference for the preparation of a long-term regulatory business plan for ARPE; and (d) carrying out of engineering, technical, social, environmental, finance, economic and legal studies and development of related instruments as needed for the preparation of a public-private partnership model or other model for involvement of the private sector for the construction, operation and maintenance of the Sertão Pernambucano canal and its irrigated perimeter. 32. (C) Project Management. Strengthening the Borrower s capacity for overall project implementation and monitoring, including support to the implementation of the Project s EMP and the Project s information and communication activities, support for strengthening of SRH s capacity for the internal control of projects implemented by SRH and COMPESA, staff training and dissemination activities and carrying out of selected studies including one for the development of an urban environmental plan for the Municipality of Toritama, studies for agricultural reuse of treated wastewater and on water quality and eutrophication control alternatives for the Carpina, Tapacurá and Jucazinho water supply reservoirs. Component 2: Improving Efficiency in the Provision of Water Supply and Sanitation Services (US$52 million) 33. This component will be implemented by COMPESA to increase the company s operational and economic performance and improve its corporate governance and management. This support will be carried out through the financing of technical assistance activities, 8

17 acquisition of goods and works necessary for the implementation of the following set of activities: 34. (A) Non-revenue Water Activities. Carrying out of activities designed to reduce technical and commercial water losses and improving COMPESA s services, sales and operational efficiency in selected areas of the MRR, and covering activities such as: the establishment and isolation of hydraulic areas and the establishment of metering districts in southern areas of the MRR, improvement of metering, updating the technical databases within each hydraulic area, improvements to telemetry, electrical installations and equipment, engineering services for design and supervision of non-revenue water recovery and network rehabilitation, and monitoring progress of non-revenue water implementation and reduction and quality of construction and staff training. 35. (B) Corporate Development. Provision of technical assistance to support the implementation of COMPESA s strategic plan implemented during the Project period, with a focus on activities that can improve the utility s financial equilibrium, overall customer satisfaction, staff productivity, as well as corporate organization and management, including among others: the preparation of a corporate non-revenue water program and plan, water supply and wastewater master plans for the MRR, water supply and wastewater master plans for several river basins in the State, inventory and valuation of COMPESA assets and studies for the physical and operational integration of water supply systems in the MRR, for sludge management and for wastewater reuse. Component 3: Water Supply and Sanitation Service Expansion (US$320 million) 36. This component will support the GoPE and COMPESA in the implementation of activities aimed at: (i) increasing the volume of water supplied in the MRR and in the Capibaribe river basin, which will result in reduced population affected by intermittent supply, (ii) expanding sewerage services in the main cities located upstream of the main water supply reservoirs in the Capibaribe river basin, reducing pollution loads and protecting water quality, and (iii) improving the state s capacity to leverage future investments, by reviewing and preparing plans and engineering designs for future priority water supply and sewerage systems to be implemented in the state. This component will be implemented by COMPESA and is divided into the following sub-components: (a) Pirapama Water Supply System Sub-component (US$220 million). This sub-component is fully financed by counterpart funds for the expansion and integration of the Pirapama Water Supply System. This sub-component comprises the construction of the Pirapama water supply conveyance system, inter alia, a raw water pumping station near the Pirapama dam, a bulk water pipeline linking the pumping station to the water treatment plant, a conventional water treatment plant with sludge treatment facility, a potable water pipeline to the Jordão reservoir, a potable water pipeline to supply water to existing Cabo and Ponte dos Carvalhos reservoirs, the construction of the Jordão reservoir, and the integration of the distribution main from the Jordão reservoir to the existing distribution network. (b) Expansion of Services Sub-component (US$100 million). This sub-component will be carried out through technical assistance, works and goods to support the GoPE in implementing 9

18 activities designed to protect and optimize the Tapacurá, Carpina, and Jucazinho water reservoirs in the Capibaribe River Basin, to reduce upstream pollution, and to support GoPE and COMPESA in leveraging future investments for priority projects. Activities to be supported under this sub-component comprise, inter alia: (i) construction and supervision of works of sewerage systems for the cities of Toritama, Limoeiro, Paudalho, Salgadinho, and expansion of system for the Vitória de Santo Antão, and other works as may be proposed by the Borrower and/or COMPESA and agreed by the Bank; and (ii) preparation of regional and municipal water and/or wastewater master plans and detailed engineering designs for priority projects that will be identified once the master plans are completed. D. Lessons learned and reflected in the project design 37. The Bank s water sector experience worldwide and long-term involvement in Brazil have provided valuable lessons reflected in the Project s design, such as the following: (a) (b) (c) (d) WRM and WSS programs have not always been demonstrably pro-poor. The inability of low income households to afford the cost and the payment of fees related to connecting to the sewerage network can undermine the benefits of sanitation and water quality control investments. The Project applies specific mechanisms to ensure adequate inclusion and benefits to the poor, such as participatory approaches, subsidies and social tariffs targeting poorest population, financing poor households connections into wastewater systems, and introduction of bulk water charges with specific provisions to protect the poor. These mechanisms will allow the Project to simultaneously target the needs of the poor and to reach watershed management objectives. Watershed management programs have focused on upstream micro-level activities and institutions and have produced little or no evidence of impacts on downstream areas. The project will support a more comprehensive and participatory process of watershed planning, a new institutional arrangement and a broader range of planning tools, incorporating land use and water resources together with other aspects of spatial planning. The project is also supporting the GoPE in implementing a much improved M&E system to provide the scientific and economic knowledge for adequate watershed management. WRM and WSS projects in Brazil need to develop adequate tools and mechanisms to reconcile cross-sectoral water demands, and focus on longer term objectives. The Project is supporting GoPE in implementing an integrated approach at the basin and urban levels. However, persistence, patience and flexibility are needed to implement such innovative integrated WRM and WSS interventions, which should be customized to the unique characteristics of the region and basin. Institutional stability is key for long-term policy development and implementation. Advances in the use of economic instruments in WRM have been limited in Brazil. The few successful initiatives in implementing bulk water charges followed a gradual and pragmatic approach where charges were set at values negotiated with key water users (particularly WSS). Efforts to develop water rights systems need to be selective and consistent with the institutional capacity to enforce such rights. Once demonstrable results become available in more critical basins, water authorities may build support for scaling up and for institutional strengthening. 10

19 (e) Past experience shows that co-financing of specific activities between Bank and counterpart funds commonly leads to project delays, since the state budget is subject to revenue and other fiscal constrains that can limit disbursement of counterpart funds. This becomes particularly relevant in economic crisis, which affects state revenues. Project design and finance structure are defined in a way that a set of activities would be 100% financed by Bank funds, while a complementing set of activities, for which funding has already been secured, would be 100% financed by the GoPE counterpart funds. E. Alternatives considered and reasons for rejection 38. Several options have been considered as alternatives to the proposed Project design. These include: providing support through a multi-sector investment operation with a sector-wide approach (SWAp) and using output-based financing. 39. Multi-sector investment operation with a SWAp approach. An alternative initially considered for the design of the proposed Project was a multi-sector SWAp comprising the water and the education sectors. Not only were there no obvious expected synergies that could be achieved through a multi-sectoral approach, but also, the expected Government expenditure program and requested Bank support in each sector were considered sufficiently large to warrant separate programs. Therefore, the GoPE and the Bank decided on having two separate loans: a SWAp for education and public sector management (US$150 million), and a traditional SIL for the water sector (US$190 million). A single-sector SWAp was also considered but deemed inappropriate as the State is still strengthening its water sector policy, adjusting its institutional responsibilities and plans on implementing bulky investments in major infrastructure works. 40. Use of output-based financing. A second alternative considered in the Project design refers to the use of an output-based financing structure for the proposed Project s efficiency component, namely the non-revenue water activities. This alternative would entail the financing of outputs (e.g., actual delivery of services) and, if possible, outcomes (e.g., increase in the availability of water), rather than specific works. Upon an assessment of: (i) the reliability of the baseline information available and the existing risks arising from uncertainty of the existing situation, (ii) uncertainties of the expected outputs and respective unit and total cost from the implementation of the Project, and (iii) the fiduciary capacity of COMPESA, a traditional standalone input-based project was deemed more adequate, whereby the loan would finance specific inputs/capital investments based on completion of physical milestones. 41. Nevertheless, depending on improvements in information collection, results of the initial phase of the non-revenue water activities and fiduciary improvements of COMPESA achieved in the first two years of Project implementation, and also on the experience of implementing the OBA scheme for the proposed Bank-financed Water Recovery (REAGUA) Project in the State of São Paulo, the use of output-based financing mechanisms either OBA or OBD for the implementation of the efficiency and expansion components could still be considered at the midterm review. This gradual approach of moving from traditional stand-alone inputs for the earlier stage of implementation towards the use of output-based mechanisms, based on the Project s implementation track record, was considered appropriate. 11

20 III. IMPLEMENTATION A. Institutional and implementation arrangements 42. The Project will be implemented between 2010 and 2015, and its overall implementation will be under the general coordination of SRH. SRH will be specifically responsible for the implementation of Component For the purposes of implementation of Component 1 and the coordination of implementation of Components 2 and 3, the SRH has revised and strengthened the roles, structures and procedures of the existing State Program Management Unit (UEGP), which is currently assisting in the implementation of the Bank-financed Proagua project. The UEGP was created in 1997 to support the implementation of the Proagua project and is directly linked to the SRH. The UEGP s staffing and structure has been revised to meet the project s implementation needs. 44. The GoPE plans to establish and strengthen a State Water and Climate Agency (APAC) to be in charge of water resources planning and management, as part of its strategy to consolidate and strengthen of the state s institutional framework to adequately manage water resources, including adequate organization, planning and management tools. Once established, APAC would take over some roles and responsibilities which are currently under SRH mandate. Upon the creation of APAC, (i) a specific agreement will be signed between SRH and APAC, through which SRH would remain responsible for the acquisition of works, goods and services required to implement the Project, on behalf of APAC; or (ii) to implement such activities by specific transitional rules set forth in the APAC law. Once APAC is fully operational, some responsibilities for the implementation of Component 1, could be transferred from SRH to APAC, through a revised agreement satisfactory to the Bank, and through Bank fiduciary and technical capacity assessments to implement those activities. 45. SRH will delegate to COMPESA the responsibility for the implementation of Components 2 and 3, respectively: improving efficiency in the provision of water supply and sanitation services, and water supply and sanitation service expansion. In order to formalize this arrangement, by project effectiveness a specific implementation agreement will be signed between SRH, on behalf of the GoPE, and COMPESA which specifies the parties specific roles and responsibilities for Project implementation, monitoring, evaluation and reporting. COMPESA established a Project Implementation Unit (UIP) to coordinate implementation of the project activities under COMPESA s responsibility and hold regular supervision meetings involving SRH/UEGP to track and monitor results and ensure that any necessary corrective measures are taken in order to comply with loan fiduciary requirements and to ensure that everything necessary is done to achieve the project s objectives. 46. Aside from COMPESA, the State Secretariat for Economic Development (SDEC), the State Multi-Sector Regulatory Agency (ARPE), the State Environmental Agency (CPRH) and the Pernambuco Institute of Technology (ITEP) will benefit from technical support under Component 1. As such, these state institutions will sign technical cooperation agreements with the SRH setting their respective roles and responsibilities for Project implementation prior to initiating bidding processes for the implementation of their respective activities. For the 12

21 implementation of rural and small towns water supply and sanitation pilot projects, which may be defined upon the completion of specific studies, the beneficiary entities will sign technical cooperation agreements with the SRH, satisfactory to the Bank, setting their respective roles and responsibilities for Project implementation Project Implementation Matrix Component 1. Water Sector Management and Institutional Development 2. Improving Efficiency in the Provision of Water Supply and Sanitation Services 3. Water Supply and Sanitation Service Expansion. Implementing Partner Key Activities Cooperation Instrument Agency Agencies Integrated water resources SRH, ARPE, SRH Technical Cooperation management CPRH, ITEP Agreement Water services and SRH/ARPE-CPRH- SRH SRH, SDEC infrastructure SDEC-ITEP Project Management SRH SRH Not applicable Non-revenue water program Corporate development technical assistance (a) Service Expansion (b) Engineering Design COMPESA COMPESA COMPESA COMPESA Implementation Agreement SRH/COMPESA Implementation Agreement SRH/COMPESA B. Monitoring and evaluation of outcomes/results 47. The results framework and monitoring strategy is included in Annex 3. This framework has been developed in close coordination with the SRH, who will consolidate the data at the project level and produce semi-annual reports to monitor progress. An impact evaluation study that will analyze the effect of the planned investments on improving water sustainability in the Capibaribe river basin and in the MRR is to be agreed with the GoPE in the first year of project implementation. A brief description of the impact evaluation study proposed methodology that could be used in undertaking this study is presented in the last section of Annex Overall responsibility for monitoring and evaluation of the Project will lie with SRH, which will provide timely information about the progress and execution of the project, including qualitative and quantitative information on the execution of selected activities, procurement and contractual decisions, accounting and financial recording, and other operational and administrative matters. Responsibilities for other entities with regards to data collection for monitoring and evaluation purposes are described in the Project s results framework. SRH will be assisted in the overall monitoring and evaluation process by COMPESA and specialized consultants as appropriate. The Project Operations Manual will provide specific details regarding monitoring and evaluation responsibilities, including data collection requirements, timing and use of the information. C. Sustainability 49. The Project is in line and contributes to the GoPE s policy and long-term objectives for the water sector, ensuring a high level of commitment by the GoPE to the implementation and sustainability of the proposed activities. In addition, the Project s financing structure reduces the 13

22 risks associated with the global economic crisis and the resulting reduction on state revenues as a result of the economic slowdown, since counterpart funds come from investments currently under implementation and with secure financing sources. As a result the GoPE views the Project as bringing new sources of investments to support economic growth and is highly committed to its implementation and sustainability. 50. Sustainability of the Project depends on the existence of a clear, capable structure for WRM, on the appropriate management and operation of the state s water resources infrastructure and on efficient provision of water supply and wastewater services. This will be ensured through: (i) institutional strengthening and adequate regulation; (ii) improved management and efficient operation of water infrastructure and services; (iii) adequate long-term sector planning and investments, (iv) adequate and stable financing sources, structures and rules to sustain efficient WRM activities and water supply and sanitation service provision; and (v) dissemination of lessons, basin plans, and water resources information to increase the engagement of water users in decision making. D. Critical risks and possible controversial aspects Risks Risk Mitigation Measures Risk Rating with Mitigation I. Sector Governance, Policies and Institutions State level Tariff setting is based on discretional parameters and on annual revision processes, leading to high regulatory cost and risk. The project will support improvements in the sector regulatory governance, through (i) technical assistance activities to the State Multi-sector Regulatory Agency (ARPE); (ii) supporting the establishment of a State Water and Climate Regulatory Agency (APAC), and (iii) financing the development and implementation of regulatory tools for water use, improved management procedures, bulk water charges, as well as integrated environmental licensing and enforcement. Moderate Sector planning and regulation at the state level not yet fully compatible with requirements of new water federal law. The Project will help improve sector planning, regulation and governance at the state level, and facilitate coordination, with a view to bringing them in line with the federal law. Moderate II. Operation-specific Risks Proposed project results, particularly reduction in pollution loads, are not achieved. This risk could be increased by COMPESA s limited experience in operating wastewater treatment plants. Implementation of bulk water charges may have adverse social impacts on the poor The project will provide TA to support decisions on the most appropriate technology for wastewater treatment and reuse, when possible, and for engineering design. Water quality monitoring systems in the watershed will also be supported, allowing early identification of non-compliance and the responsible authorities to set specific recommendations for the adoption of correction measures. In addition, ARPE already regulates and monitor COMPESA s technical performance. The project will also support training for COMPESA staff Bulk water charges are expected to be very low, as in Brazil they normally represent less than 1% of the potable water supply tariff. In addition, COMPESA already has in place a social tariff scheme for potable water supply which provides about 60% subsidy to the tariff to about 20% of residential consumers. Moderate Low 14

23 Risks Risk Mitigation Measures Risk Rating with Mitigation Implementation capacity and sustainability SRH has been recently re-established, water resources management has faced institutional discontinuity that may persist. The project will support the establishment of the new State Water and Climate Agency APAC, which is designed as a more stable and independent body. Project sustainability will be reinforced by technical assistance activities Moderate SRH and PMU are not yet adequately staffed. Limited COMPESA capacity to manage several works at the same time, since it is already managing several works at about R$1.0 billion and plan to invest additional R$2.9 billion in the following years, including the Bank loan. Financial Management Lack of prior experience with World Bank procedures, weakness of internal control mechanisms Procurement Lack of adequate Procurement Planning, monitoring, and weakness in knowledge of World Bank Procurement Guidelines. III. Overall Risk Strengthening and adequate staffing of the PMU at SRH is a dated covenant. During supervision the Bank team will further assess the institutional and technical capacity to determine whether specific measures are needed to strengthen SRH and the PMU. COMPESA implemented a new strategic planning and electronic management system, which includes contract procurement and management modules. The project will support COMPESA in improving and implementing its strategic planning and corporate governance. The project also foresees the use of consulting services to supervise larger works. SRH and COMPESA will design and update their respective financial management systems with a project chart of accounts following the project design. SRH and COMPESA will designate financial staff that will be trained and be part of the project implementing teams. The project s operational manual will include a chapter detailing the financial management arrangements. Fiduciary training will be provided Besides the implementation of procurement planning as mandatory, both SRH and COMPESA will develop and implement a procurement planning/monitoring module, integrated with the accounting/finance system. Training will be provided and SRH is going to hire a procurement consultant. Moderate Moderate Moderate Moderate Moderate E. Loan conditions and covenants 51. Before effectiveness: (a) (b) The COMPESA Implementation Agreement has been executed on behalf of the Borrower and COMPESA. In addition to the usual legal opinion, the Bank requires legal opinions confirming that: (i) the COMPESA Implementation Agreement has been duly authorized or ratified by the State of Pernambuco and COMPESA and is legally binding upon the State of Pernambuco and COMPESA in accordance with its terms; and (ii) the Loan has been registered by the Guarantor s Central Bank. 52. In addition to the standard contractual clauses and conditions required by the Bank, the following covenants are included in the Legal Agreement: 15

24 The State of Pernambuco shall: (a) (b) (c) (d) (e) (f) (g) (h) (i) Throughout project implementation, maintain a unit within SRH (UEGP) and cause COMPESA to maintain a unit (UIP), both with the powers and responsibilities set forth in the Operational Manual; and no later than two months from the Effective Date, have said units fully staffed with personnel with experience and qualifications satisfactory to the Bank. Enter into an agreement with COMPESA under terms and conditions satisfactory to the Bank, to set forth the arrangements for the implementation of Components 2 and 3 of the Project. Prior to initiating activities for the benefit of a Cooperation Entity (SDEC, ARPE, CPRH and ITEP), enter into an agreement with each of the Cooperating Entities, under terms and conditions satisfactory to the Bank, to set forth the arrangements for the implementation of Component 1 of the Project. (i) Upon issuance of the legal instrument establishing APAC enter into an agreement (the APAC Implementation Agreement) with APAC under terms and conditions satisfactory to the Bank, to set forth the arrangements for the implementation of Component 1 of the Project by APAC (in substitution for the implementation that would otherwise have continued to be carried out by the State of Pernambuco through SRH). (ii) Thereafter, prior to transferring responsibilities for implementation of Component 1 of the Project to APAC, furnish to the Bank for its approval, the evidence of the fiduciary and safeguards capability of APAC to carry out said Component of the Project. Carry out the Project in accordance with the Operational Manual, satisfactory to the Bank. (i) Carry out the Pirapama Water Supply Conveyance System Resettlement Plan in accordance with its terms; and (ii) furnish to the Bank, for its approval, in accordance with the Resettlement Policy Framework, any needed Resettlement Plan, and thereafter carry out such Resettlement Plans in accordance with their terms. Carry out the Project in accordance with the Environmental Management Plan. Prior to initiating any activities under Component 2 (a) of the Project (Non-Revenue Water Activities) for which the Pirapama dam supplies water: (i) establish an Independent Panel to review, with powers and responsibilities acceptable to the Bank, the safety of the Pirapama dam, (ii) cause the Independent Dam Safety Panel to evaluate the safety of the Pirapama dam under terms of reference satisfactory to the Bank and identify any remedial action to improve its safety; and (iii) furnish to the Bank: (a) an action plan to address deficiencies, if any, in the Pirapama Dam safety; and (b) evidence, in form and substance satisfactory to the Bank, of the actions taken to address any such deficiencies. Prior to the implementation of any Non-revenue Water Activity under Component 2 (a) of the Project, furnish to the Bank, for its approval, the respective Non-revenue Water Activity. 16

25 Condition of Disbursement: No withdrawal shall be made for payments made in respect of Non-Revenue Water Activities under Component 2 (a) of the Project unless the Bank shall be satisfied that the actions of the Dam Safety Action Plan then due have been taken. IV. APPRAISAL SUMMARY A. Economic and financial analyses 53. The Pernambuco Sustainable Water Project is economically and financially feasible with net economic benefits of US$766 million and economic internal rate of return of 37%. The financial net benefit is of US$446 million and internal rate of return of 23%. Detailed financial, economic, and distributive analyses were carried out for the proposed Project, complemented by risk and sensitivity analyses. An overview of these analyses and results is presented below, while details can be found in Annex On the basis of the Project objectives the cost-benefit analysis was carried out to determine the economic and financial feasibility of two components: (i) Improving Efficiency in the Provision of Water Supply and Sanitation Services, together with the expansion of the Pirapama water supply system; and (ii) Service Expansion, particularly expansion of the sewerage and wastewater treatment in selected municipalities in the Capibaribe river basin. The net benefit of each component equals the difference between the incremental benefits and the incremental costs of two scenarios: with and without project. 55. The cost benefit analysis was built from three perspectives: financial, economic, and distributive analysis. From a financial perspective, each activity is appraised measuring its costs and benefits at market prices. Financial benefits are measured as: (i) revenue increase when service expansion is attained, and illegal connections are incorporated into the billing system; and (ii) savings on financial operating costs. Economic Results 56. The economic results show positive returns for both components. The non-revenue water program to be supported by the Project is highly profitable with economic benefits over US$700 million and internal rate of return of 39%. The proposed sanitation works shows profits of US$23 million and a rate of return of 19%. The whole project shows a net return of USS$766 million and a profit of 37%. Results of the economic analysis Net Present Value (million US$) Internal Rate Investment activity of Return Benefits Costs Net benefit (%) Water Supply Efficiency Non-Revenue Water 1, % Sanitation Sewerage and WWTP % Total 1, % 17

26 Financial Results 57. The non-revenue water program to be supported by the Project, together with the implementation of the Pirapama water supply system, is financially viable with returns of US$ 449 million and internal rate of return of 24%. The proposed sanitation works are close to its break-even point with benefits almost covering total costs. The whole project gets a net profit of US$446 million and an internal rate of return of 23%. Results of the financial analysis Net Present Value (million US$) Internal Rate Investment activity of Return Benefits Costs Net benefit (%) Water Supply Efficiency Non-Revenue Water % Sanitation Sewerage and WWTP (2) 9% Total % Distributive Analysis 58. The difference between economic and financial flows represents rents or monetary flows that accrue to someone other than COMPESA. Taxes represent monetary flows accruing to the government. Winners and losers with the project are identified by decomposing economic and financial costs for each input of the project and comparing the differences. The big winners are the customers with a return of US$238 million. These earnings come from savings when water rationing is reduced or eliminated and when sewerage service is available, the savings offset the payment they have to make to COMPESA when connected, and the investment cost they incur to adjust in-house connections. The net gain for the economy as a whole is US$319 million. Financial Analysis of COMPESA 59. A financial analysis of COMPESA was undertaken based on its performance during the period and its projected financial situation for the next ten years. Historical information corresponded to four years of audited financial statements ( ) and preliminary information for For the ten years projection, the main assumptions consisted of water consumption, served population, investment programs and their related targets. 60. This analysis has shown that COMPESA is financially viable and able to operate and maintain the proposed investment program if expected improvements in performance are achieved and GoPE assumes the repayment of the World Bank loan. COMPESA s financial projections show sound financial results, with its operating margin increasing from 19% in 2009 to 38% in In addition, the company s relation between operating expenses (with depreciation) to operating revenues decreases from 0.96 to 0.75, and its net income to revenue ratio increases to 19% in 2014, compared to 0.6% in B. Technical 61. The Project relies on water supply and sanitation technologies appropriate to the Brazilian context and no significant technical obstacles are expected during Project execution. The proposed integrated WRM and WSS systems will deal with surface and ground water 18

27 resources and also with improved management and conservation of other natural resources in rural areas as part of water resources planning. 62. The Project design provides a broad, strong framework for stakeholder participation to increase ownership by promoting the participation of water users in integrated WRM and in the investment process, and through activities to strengthen river basin committees and water users associations. At the same time, the Project will work to ensure that several other key crosssectoral issues are included, such as provision of good quality and guaranteed fresh water for human consumption, reduced untreated wastewater, conservation of aquifers, etc. In line with the above-mentioned approach, the Project will develop adequate management and financing models for irrigation and for the provision of rural and small town water supply and wastewater services. 63. The control and reduction of water losses included in the efficiency component is based on international norms and best practices, notably the methodology of the International Water Association. The rehabilitation of existing and building of new wastewater collection networks and wastewater treatment plants will follow the Brazilian standards for system dimensions and the standards of quality of CPRH and CONAMA for effluent discharged and sludge disposal, including continuous monitoring of treated wastewater and sludge reuse, which are in line with IFC/World Bank Group Environmental, Health and Safety Guidelines for wastewater and Environmental Water Quality. In addition, only small- and medium-sized wastewater treatment facilities will be built, which reduces the technical complexity of these interventions. 64. Finally, the Project will provide technical assistance and support to the implementation of improved irrigation infrastructure and management of irrigated areas, with larger participation and co-financing by the private sector to ensure sustainability and the efficiency of the water used. C. Fiduciary 65. Financial Management. A financial management assessment was carried out in accordance with Bank guidelines. By negotiations SRH, the UEGP and COMPESA demonstrated the minimum satisfactory financial management arrangements in place, since staff is adequately trained and the SIGMA II system is installed and working in coordination with the state s public financial management system (e-fisco). The financial management risk associated with the Project has been assessed as moderate. 66. Flow of Funds. All procurement and financial management will be centralized in the UEGP, for component 1, and in COMPESA, for Components 2 and 3. Funds will be advanced, in local currency, from the Designated Account into a second operating account in Recife specially set up for loan funds. Upon instructions from the UEGP and the COMPESA, payments will be made to suppliers for all Project components. Retroactive financing up to 20% of the loan amount is proposed. Annex 7 provides additional details of the project s financial management arrangements. 67. Procurement. Procurement of all contracts financed by the Loan will follow the Bank Procurement Guidelines. The procurement will be done using the Bank s Standard Bidding Documents (SBD) for all ICB packages. A detailed procurement plan for the first 18 months of 19

28 project implementation was prepared by GoPE and approved by the Bank on November 18, An assessment of the capacity of the implementing Agencies (SRH and COMPESA) to implement procurement actions for the project was carried out by the Bank on November 7, The assessment has reviewed the organizational structure for implementing the project and the interaction between the project s staff responsible for procurement and the relevant units for administration and finance. 69. Related concerns identified include: (i) lack of Procurement Planning in both agencies; (ii) lack of procurement monitoring (SRH); (iii) need for continuing training in procurement in both agencies; and (iv) identified weakness in knowledge of World Bank procurement rules and procedures. The corrective measures agreed upon are: (i) implement procurement planning as mandatory; (ii) develop and implement a procurement planning/monitoring module; (iii) integrate the procurement planning/monitoring module with the accounting/finance system; (iv) implement training in association with the state school and/or the State university; and (v) hire a procurement consultant. The overall Project risk for procurement is moderate. Annex 8 provides additional details on the Project s procurement arrangements. D. Social 70. A Social Analysis was undertaken in conjunction with the Environmental Assessment. The Social Analysis revealed that the various municipalities targeted by the Project within the Capibaribe river basin present conditions of high poverty and social vulnerability and significant deficits in water supply and sanitation services, particularly for wastewater where the level of collection and treatment is extremely low or inexistent, with important consequences for the health of the population and the quality of the water bodies and supply sources. This deficit is most acute among the poorest parts of the population given the general social inequalities. 71. The Project is expected to have a positive impact on the quality of life and the socioeconomic indicators of the population residing in the municipalities targeted by the Project and in the Capibaribe river basin in general. As the objective of the Project is to improve water quality, safety and sustainability, it is anticipated that the population currently under-served or without access to water supply and sanitation services will greatly benefit from the Project in terms of both quantity and quality at a reasonable cost. The Project also plans to cover the connections cost to connect low income dwellings to the sewerage, which combined with the social tariff scheme developed by COMPESA 5 will provide direct benefit to these families by facilitating the effective service provision. In addition, Project interventions increase the possibility of attracting further investment and private capital, thus improving the competitiveness of these municipalities. 72. The ongoing construction of the Pirapama water supply system, which is financed with government funds and constitutes the Project counterpart financing, has entailed the resettlement of 202 families and 92 processes of acquisition of sections of land as right of way. The 5 COMPESA has developed a social tariff scheme aimed at improving affordability of water services to low income families. Households benefit by having their minimum tariff reduced to R$7.98 from the regular charge of R$19.29 (a 59% subsidy). Enrollment in the program is subject to adherence to specific eligibility criteria. 20

29 resettlement of families was required to construct the elevated water service reservoir named Jordão (139 families), the treated water main to reach the Jordão service reservoirs (48 families), the bulk water main from the Pirapama reservoir to the water treatment plant (11 families), treated water main alongside of the federal road named BR 101 (4 families) and one family in the expansion of the existing water storage center of Ponte dos Carvalhos. The acquisition of 92 sections of land was required to create the linear right of way along the water supply mains, for which the owners kept the right to use the land with restrictions regarding the type of crops. 73. Out of the 202 families, 187 resettled families were removed from an area formally owned by COMPESA, and 4 from an area formally owned by the federal transportation infrastructure agency. The informal occupation of these areas by low-income families took place during the several years of interruption that affected the construction of the Pirapama Water Supply System. When the construction reinitiated in 2008, COMPESA opted for implementing a comprehensive social program to undertake the resettlement of these families, in order to ensure that the resettlement would contribute to improving the living conditions of these families. 74. The social program included: (i) support by qualified social professionals in its implementation; (ii) asset valuation parameters that ensured families of the appropriate replacement of these assets; (iii) use of adequate consultation methodologies; and (iv) appropriate methods for handing in the compensation of affected families. The resettlement already carried out (including the social program) described in Annex 10 of the PAD has been reviewed by the Bank and found to be appropriate and consistent with Bank safeguard policies, and is deemed to be part of the Pirapama Resettlement Plan of July 11, Additional resettlements are planned as the construction of the Pirapama water supply conveyance system progresses, affecting about 130 families and eight small business that will be resettled and 82 properties that will be temporarily affected as right of way. A resettlement plan has been prepared (The Pirapama Resettlement Plan of July 11, 2009) and deemed satisfactory by the Bank on July 17, Additional details on the resettlement already carried out and of the RAP are available in Annex Although there are no foreseen involuntary resettlement needs for the implementation of the other works to be financed by the Project, there still exists the possibility that a case of involuntary resettlement could arise during Project execution, for example an eventual relocation of a family because of the construction of a wastewater pumping station or a wastewater treatment plant. To prepare for these contingencies, and in accordance with the resettlement policy of the Bank, a Resettlement Policy Framework (RPF) was prepared to guide the resettlement process if this becomes necessary, which will be very similar to the resettlement undertaken thus far with a few minor adjustments. Social documents were also submitted to public consultations carried out on September 2, 2008 and on April 16, E. Environment 77. As part of its objectives and design, the Project has a strong environmental emphasis, whose main positive contributions to the natural environment are summarized below, as well as the potential negative impacts identified. 21

30 Positive Environmental Impacts 78. Water Quality. The Project would result in significant water quality improvements to the Capibaribe river basin and several other river basins through the reduction and treatment of pollution sources, and restoration of environmental services provided by riparian zones of urban streams. The Project will directly address the current lack of wastewater collection and treatment which is responsible for a number of critical negative urban environmental and quality-of-life impacts within the Capibaribe river basin. 79. Specifically, the Project will address the current critical water quality situation within the river basin through repairs to the existing sewerage network, the expansion of sewerage services to cover all critical urban areas within this river basin, the identification of irregular household sewerage connections, and construction of sewage systems. In addition to the reduction and treatment of domestic pollution sources, the Project will target industrial and other non-domestic pollution sources for reduction through identification of existing and potential pollution sources, implementation of a water quality monitoring program to identify the presence and composition of industrial pollutants, and institutional enhancements for addressing environmental issues. 80. Additionally, by emphasizing the incorporation of environmental criteria in the design, planning and implementation of the Project activities, as well as promoting environmental education amongst residents, the Project will indirectly lead to long-term improvements in water quality. Lastly, Project activities to restore riparian vegetation and protect environmental units will result in the restoration of important environmental services provided by buffered, unpolluted, free-flowing creeks. 81. Efficient water supply services. The Project will directly improve COMPESA s and municipal water and sanitation providers capacity in efficiently using water resources by reducing water losses and reducing the contamination of water sources. 82. Water Resources and Environmental Management. The Project will directly improve the environmental management of the Capibaribe river basin natural resources through support to the state and COMPESA s environmental management units, as well as to the river basin management bodies. This support will emphasize technical capacity improvements related to the state and COMPESA s execution of the environment requirements associated with plans and works. The Project will also finance the creation and operation of the state water agency (APAC) of Pernambuco. The Project will contribute to additional urban environmental management improvements through support to the strengthening of water resources management and water quality monitoring. 83. Specifically, the Project s support to the water resources management committees, both financially and institutionally, through the development of river basin plans, environmental education programs and water quality monitoring, will result in improved water quality. The Project will strengthen the Committee s technical capacity by developing planning tools, through developing decision models for water usage and discharge, and through mapping land use and capability. This system will serve as a basis for the Project s monitoring of Capibaribe river water quality. The Project will also promote greening of the urban environment through integration of environmental considerations in urban planning, as described above. 22

31 84. Biodiversity/Natural Habitats. The Project is expected to result in improvements to the aquatic and riparian biodiversity within the Capibaribe river basin. The Project s emphasis on improving the quality of rivers and restoration of protecting environmentally sensitive areas along streams will promote the restoration of habitat for wetland and non-wetland species alike, and will promote the maintenance of existing aquatic and riparian habitats. Through the improvement of water quality the Project will result in direct improvements to aquatic and riparian habitats in the Capibaribe river basin. Potential negative environmental impact 85. During construction: Given the proposed Project objectives and activities focused on improving key environmental aspects within the Capibaribe river basin, no negative impacts are foreseen at the regional level. Potential negative impacts might happen at the local level, associated with the construction works. To avoid these potential negative impacts, appropriate measures were incorporated in the Project. These measures are addressed in the Environmental Assessment and Environmental Management Plan, especially concerning to the technical criteria to be adopted by the engineering designs, the environmental assessment to be undertaken following the recommendations in the environmental framework, as well as in the Environmental Construction Manual, which is going to be part of the bidding documents and contracts for the execution of works to be financed by the project. F. Safeguard policies Safeguard Policies Triggered by the Project Yes No Environmental Assessment (OP/BP 4.01) [ ] [ ] Natural Habitats (OP/BP 4.04) [ ] [ ] Pest Management (OP 4.09) [ ] [ ] Physical Cultural Resources (OP/BP 4.11) [ ] [ ] Involuntary Resettlement (OP/BP 4.12) [ ] [ ] Indigenous Peoples (OP/BP 4.10) [ ] [ ] Forests (OP/BP 4.36) [ ] [ ] Safety of Dams (OP/BP 4.37) [ ] [ ] Projects in Disputed Areas (OP/BP 7.60)* [ ] [ ] Projects on International Waterways (OP/BP 7.50) [ ] [ ] 86. Environmental Assessment (OP 4.01). Through its focus on environmental recovery and improvement in the quality of life for local residents, the Project will primarily have positive environmental impacts and will improve and protect critical natural assets with focus on water resources. The proposed Project has received an Environmental Category A rating. A comprehensive Environmental Assessment (EA) was made according to the Bank Safeguard Policies (see Annex 10). The EA evaluates existing conditions, identifies potential direct and indirect environmental impacts, and proposes measures to mitigate negative impacts and to enhance positive impacts. * By supporting the proposed project, the Bank does not intend to prejudice the final determination of the parties' claims on the disputed areas 23

32 87. The Environmental Management Plan (EMP) summarizes these measures along with their associated costs, responsibilities, and schedule. Public consultations were carried out in September 2, 2008 and in April 16, 2009 and documented following the disclosure procedures recommended by the Bank s environmental policy. The EA results and recommended measures are incorporated in the EMP and into Project components. Consultations were carried out in preparing the Project. In addition, as part of the environmental licensing process, SRH and COMPESA consulted several times with civil society organizations. These consultations were covered by newspapers and radio, Project documentation was made available at the office of the State Secretariat for Water Resources SRH, and safeguard studies were made available at the InfoShop on May 29, The Natural Habitats Policy (OP 4.04) is triggered because the Project will rehabilitate and protect water resources, including degraded riparian vegetation under the category of natural habitats and urban parks that will also protect vulnerable environmental sites. In addition, wastewater systems interventions (treatment plants, interceptors and pumping stations) are likely to moderately impact environmental protected areas. Considered by the legislation as public use interventions, such interferences may be authorized by the environmental agency and negative impacts minimized through the use of appropriate construction techniques and the later recuperation of the area where the intervention took place, for which specific procedures will be included in the EMP 89. The Forest Policy (OP 4.36) is triggered because the Project will rehabilitate degraded riparian vegetation and extend the area with appropriate vegetation, and promote reforestation as part of the environmental compensatory measures for the implementation of the Pirapama Water Supply Conveyance System. Main compensatory measures include the demarcation of the 100- meter environmental protection area (APP) surrounding the reservoir s banks, and reforestation of about 360 hectares in that area, which is already owned by COMPESA. The company will be responsible for such reforestation and maintenance and has created a nursery tree farm of about 3 hectares, in cooperation with the non-governmental organization ECO-Pirapama. Only native species from the Atlantic Forest jointly selected by the company and by CPRH will be used. 90. Physical Cultural Resources (OP 4.11). Brazil has a well-developed legislative and normative framework for management of physical cultural property, which is under the oversight of the National Institute for Protection of Historical and Archeological Sites (Instituto do Patrimônio Histórico, Artístico e Cultural Nacional - IPHAN). In accordance with IPHAN and Bank requirements, the State of Pernambuco will include procedures for screening any known cultural property in the Project area and incorporate chance find procedures in the event that culturally significant resources are discovered during implementation. Procedures for the identification and protection of physical cultural resources will be included in the EMP. 91. The Involuntary Resettlement Policy (OP 4.12) is triggered because: (i) ongoing, counterpart financed infrastructure works (the Pirapama water supply conveyance system) have affected 294 families, including the resettlement of 202 families and 92 processes of acquisition of sections of land as right of way, which has been evaluated and the findings indicated that the resettlement procedures undertaken were appropriate and consistent with the Bank safeguard policies; (ii) additionally about 130 families and eight small business will be resettled and 82 24

33 properties will be temporarily affected 6 as right of way to allow the Pirapama water supply conveyance system construction works, for which a resettlement plan has been prepared and considered satisfactory to the Bank (The Pirapama Resettlement Plan dated July 11, 2009, approved by the Bank on July 17, 2009); (iii) for the remaining infrastructure works, although the technical information available do not anticipate the need for any resettlement, the Pernambuco Sustainable Water Project Resettlement Framework was prepared stating principles and procedures for the Project, which will be used in the preparation of resettlement plans or any other resettlement document needed in the unlikely case it becomes necessary. 92. Safety of Dams Policy (OP 4.37) is triggered because an existing and operational reservoir to supply water to the metropolitan region of Recife is part of the Pirapama water supply system, and some of the infrastructure that constitute the Pirapama system is included in the Project. Works for the Pirapama dam were concluded in late 2000, and the reservoir was filled up in The construction of the dam and the reservoir were subject to detailed environmental impact assessment and report (EIA), commissioned by COMPESA and prepared by a local consulting firm in All required environmental licenses were issued by the State Environment Agency (CPRH) and the water rights were granted by SRH. Since 2008, the Pirapama reservoir is providing an average of 1.0 m 3 /s of bulk water to increase de production of the Gurjaú water system. The dam has been in operation since 2001 with no reported safety incidents. However, considering that the Pirapama dam is about 20 meters high and a significant withdrawal is expected to start on October 2010, the dam would be evaluated by an Independent Dam Safety Panel, to be commissioned by SRH prior to the beginning of any activities under Component II, for which the Pirapama dam supplies water. No disbursement will be made for non-revenue water works unless any remedial actions proposed by the panel have been taken. G. Policy Exceptions and Readiness 93. No policy exceptions are required and the project is considered ready for implementation based on the following: (a) (b) (c) (d) (e) Project counterpart financing has been secured and is already financing on-going works. Project implementation and fiduciary arrangements have been defined and are ready to become operational upon project effectiveness, and qualified staff is available. A procurement plan for the first 18 months of project implementation is ready and the Borrower has started the preparation of bidding documents. The environmental and social assessments, which include the Resettlement Policy Framework, were finalized and disclosed locally and at the InfoShop on May 29, Arrangements for the monitoring and evaluation of results have been agreed upon and are in place. 6 Properties temporarily affected do no involve resettlement of families or permanent loss of business. Compensation will be provided according to the Resettlement Plan. 25

34 Annex 1: Country and Sector or Program Background BRAZIL: Pernambuco Sustainable Water Project 1. Brazil has undergone a rapid urbanization process, in which the urban share of the population has grown from 56% to over 82% in the past 30 years, making Brazil one of the most urbanized countries in the world. Today cities account for 90% of the country s GDP and include half of its poor. Once at the forefront of the country s economic transformation, Brazilian cities are now grappling with the problems of rampant informality, rising crime and violence, inadequate service provision, and environmental degradation. Slums have become part of the urban landscape, and serious water supply and sanitation coverage deficits sharpen the inequalities between the rich and the poor. 2. Water resources and associated services and infrastructure are key elements for Brazil s social and economic sustainable and equitable development. Brazil s primary water resources issues are related to scarcity (especially in Northeast region but also in large metropolitan areas), pollution (in most urban areas), and recurrent droughts and floods (which could be exacerbated by climate change and increased hydrological variability). Brazil faces daunting challenges to expand and improve water services, as 7% of urban households lack access to a potable water pipeline and 43% lack access to sewerage connection. 7 The relative lack of access is at much higher levels in rural areas, as only 28% of the households have access to a potable water pipeline and 24% have either access to sewerage or septic tank. The access gap is exacerbated by the challenging need to improve service efficiency, reliability and quality. 3. The State of Pernambuco has a territory of 98,311 km 2, comprising 185 municipalities and with a population of 8.4 million, 76% of which live in urban areas. Recife is the state s capital, and its metropolitan region, with a population of about 3.7 million, is the biggest urban agglomeration of the Northeast Region and the fifth in Brazil. The state is divided into 5 subregions: Metropolitan Region of Recife (14 municipalities), Mata Pernambucana (43 municipalities in the coast), Agreste Pernambucano (71 municipalities), Sertão Pernambucano (41 municipalities) and São Francisco Pernambucano (15 municipalities). Pernambuco Sub-Regions 7 With sanitation there is a very wide variation of access across states, with lower rates of access in the North and Northeast states. Source: Country Partnership Strategy Brazil